FINANCIAL

MANAGEMENT
INTRODUCTION
Financial management is that managerial
activity which is concerned with the planning
and controlling of the firms financial
resources
SCOPE OF FINANCIAL
MANAGEMENT
Traditional Approach
Modern Approach
Traditional Approach
The scope of finance function was treated by
the traditional approach in the narrow sense
of procurement of funds by corporate to meet
their financing needs.
The traditional approach, which was popular
in the early stage, limited the role of
financial management to raising and
administering of funds needed by the
corporate enterprises to meet their financial
needs.
It deals with the following aspects.
Arrangement of funds from financial
institutions.
Arrangement of funds through financial
instruments like share, bonds etc.
Looking after the legal and accounting
relationship between a corporation and its
sources of funds.
Main limitations of Traditional
Approach
Ignored working capital financing .
No Emphasis on allocation of funds.
Time value of money is not considered.
MODERN APPROACH
According to this approach, the finance
function covers both acquisition of funds as
well as their allocation . The main contents
of this approach are
What is the total volume of funds an
enterprise should arrange ?
How should the funds required be
financed?
How the funds can be properly allocated ?
FINANCE FUNCTION
Investment or long-term asset- mix decision.
Financing or capital mix decision.
Dividend or profit allocation decision.
Liquidity or short-term asset-mix decision.
INVESTMENT DECISION
Investment decision or capital budgeting
involves the decision allocation of capital
or commitment of funds to long-term
assets that would yield benefits in the
future . Two important aspects of the
investment decisions are :
The evaluation of the prospective
profitability of new investment .
The measurement of a cut-off rate .
As the future is uncertain, investment
decisions involve risk .
Investment proposals should therefore, be
evaluated in terms of both expected return
and risk .
Correct cut-off rate is the required rate of
return or the opportunity cost of capital .

FINANCING DECISION
Here the point is to decide where and how to
acquire funds to meet the firms investment
needs .
The central issue is to determine the
proportion of equity and debt .
The mix of debt and equity is known as the
firms capital structure .
The financial manager must strive to obtain
the best financing mix or the optimum capital
structure .
The use of debt affects the return and risk of
shareholders .
A proper balance will have to be struck
between return and risk .
In practice , a firm considers many other
factors such as control, flexibility, loan
covenants, legal aspects etc. in deciding its
capital structure .

DIVIDEND DECISION
The finance manager must decide whether
the firm should distribute all profits , or retain
them, or distribute a portion and retain the
balance .
The optimum dividend policy is one that
maximizes the market value of the firms
share .
The finance manager should also consider
the question of dividend stability , bonus
shares and cash dividends .
LIQUIDITY DECISION
Investment in current assets affects the firms
profitability, liquidity and risk .
A conflict exists between profitability and liquidity
while managing current assets.
If the firm does not invest sufficient funds in current
assets, it may become illiquid .
But it would lose profitability as idle current assets
would not earn anything .
Thus a proper trade-off must be achieved between
profitability and liquidity .
Finance functions affect the size, growth,
profitability and risk of the firm, and
ultimately, the value of the firm .
The function of financial management is to
review and control decisions to commit or
recommit funds to new or ongoing uses .
Financial Objectives
Profit Maximization.
Shareholders wealth maximization (SWM).
PROFIT MAXIMIZATION
Profit earning is the main aim of every
economic activity .
A business being an economic institution
must earn profit to cover its costs and provide
funds for growth .
No business can survive without earning
profit .
Profit is a measure of efficiency of a business
enterprise.
Arguments in favour of profit maximization as
the objective of business
When profit earning is the aim of business
then profit maximization should be the
obvious objective .
Profitability is a barometer for measuring
efficiency and economic prosperity of a
business enterprise, thus, profit
maximization is justified.
Economic and business conditions do not
remain same at all the times .
There may be adverse business conditions
like depression, severe competition, strikes,
lock outs etc.
A business will able to survive under
unfavourable situation, only if it has some past
earnings .
Therefore, a business should try to earn more
and more when the situation is favourable.

Profits are the main sources of finance for
the growth of a business, so a business
should aim at maximization of profits for
enabling its growth and development .
Profitability is essential for fulfilling social
goals also .
A firm by pursuing the objectives of profit
maximization also maximizes socio
economic welfare .
Criticism of Profit Maximisation
A firm pursuing the objective of profit
maximization starts exploiting workers and the
consumers. Hence, it is immoral and leads to a
number of corrupt practices .
The term Profit is vague and it cannot be
precisely defined . It means different things for
different people .
Should we consider short-term profits or long
term profits ? Does it mean total profits or earning
per share ? Should we take profits before tax or
after tax ?
Profit maximization objective ignores the
time value of money.
It ignores the fact that cash received today
is more important than the same amount
of cash received after some years .
It does not take into consideration the risk
of the prospective earnings stream .
SHAREHOLDERS WEALTH MAXIMISATION
(SWM)
SWM means maximizing the net present
value (or wealth) of a course of action to
shareholders.
The net present value (NPV) of a course of
action is the difference between the present
value of future cash inflows and present
value of cash outflows .


3 1 2
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2 3
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NPV
(1 ) (1 ) (1 ) (1 )
NPV
(1 )
n
n
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t
t
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Where c1, c2 . Cn Cash inflows in

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k Discount rate
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A financial action that has a positive NPV
creates wealth for shareholders and therefore
is desirable .
Between a number of projects the one with
the highest NPV should be adopted.
From the Shareholders point of view the
wealth created by a company through its
action is reflected in the market value of the
companys shares.

Therefore, the wealth maximization principle
implies that the fundamental objective of a
firm is to maximize the market value of its
shares.
The value of the companys shares is
represented by their market price which, in
turn, is a reflection of the firms financial
decisions .

Arguments in favour of wealth maximization as
the objective of business
The objective of wealth maximization has a clear
focus on shareholders interest .
Market price of a stock is the most visible
parameter which can be used to assess the
performance of publicly traded firm .
The market price of a stock is updated
continuously reflecting the impact of new
information coming out about the firm .
Stock price is the most relevant measure of
shareholders wealth since they can sale their
stock and receive the market price at any time .

CRITICISM OF SWM
The objective is not descriptive of what the
firms actually do .
The objective of wealth maximization is
not necessarily socially desirable .
Finance managers role
The exact organisation structure for financial
management will differ across firms.
The finance officer may be known as the finance
manager in some organisations, while in others
as the vice-president of finance or the director of
finance or the financial controller.


1.Funds raising.
2.Funds allocation.
3.Profit planning.
4.Understanding capital market.