•Financial Management

•An Introduction
 Contents
 Introduction to FM
 Scope
 Objectives
 Functions
 Role of Financial Manager
 Assignment - Interface of Financial
Management with other Functional Areas
 Key challenges faced by Modern FM
 Financial Environment
 FINANCE
Finance is the life-blood of business.
Without finance neither any business can be
started nor successfully run . Finance is
needed to promote or establish business,
acquire fixed assets, make necessary
investigations, develop product keep man
and machines at work, encourage
management to make progress and create
values.
FINANCIAL MANAGEMENT
Financial management is one the functional
areas of management. It refer to that part of
the management activity which is
concerned with the planning and controlling
of firms financial resources.
 DEFINITION
“Financial management is the application of
planning and control function of the finance
function”

Howard and Upton

 NATURE AND SCOPE OF
FINANCIAL MANAGEMENT
The nature of financial decisions would be
clear when we try to understand the
operation of a firm. At the very outset, the
promoters makes an appraisal of various
investment proposals and selects one or
more of them , depending upon the net
benefits derived from each as well as on the
availability of funds.
 PROCESS INVOLVED IN
FINANCIAL DECISION
1. Selection of investment proposals ,known as the
investment decision.
2.Determination of working capital
requirements, known as the working capital
decision.
3. Raising of funds to finance the assets, known
as the financing decision.
4. Allocation of profit for dividend payment,
known as the dividend decision.
•Three decision areas in finance:
Investment decisions - What assets should the
company hold? This determines the left-hand side
of the balance sheet. these decision are concerned
with the effective utilization of funds in one
activity or the other. The investment decision can
be classified under two groups :
(i) Long term investment decision
(ii) Short term investment decision
The former are referred to as the capital
budgeting and the latter as working capital
management.
 Financing decision
Financing decisions - How should the company
pay for the investments it makes? This determines
the right-hand side of the balance sheet. it is also
known as capital structure decision. It involves the
choosing the best source of raising funds and
deciding optimal mix of various source of finance.

A company can not depend upon only one source

of finance, hence a varied financial structure is
developed. but before using any particular source
of capital ,its relative cost of capital ,degree of risk
and control etc should be thoroughly examined by
the financial manager.
The major source of long-term capital are shares
and debentures.
 DIVIDEND DECISION
Dividend decisions - What should be done
with the profits of the business? The
dividend decision is concerned with
determining how much part of the earning
should be distributed among the share
holders by way of dividend and how much
should be retained in the business for
meeting the future needs of funds internally.
 Factors influencing financial
decision
These factors are divided into two parts -
1.Micro economic factor
2.Macro economic factor
Micro economic factor - micro economic factor is
related to the internal condition of the firm-
(a) Nature and size of the firm
(b) Level of risk and stability in earnings
(c) Liquidity position
(d) Asset structure and pattern of ownership
(e) Attitude of the management
 Macro economic factor
These are the Environmental factors-

1. The state of the economy

2. Governmental policy
 •All management decisions
should help to accomplish the
goal of the firm!

•What should be the goal of the firm?

Objectives of financial management

The objective of financial management

are considered usually at two levels –the
Objective of financial management-

1. Maximization of profits
2. Maximization of wealth
 Maximization of profits
Profit earning is the main aim of every
economic activity. Profit maximization
simply means maximizing the income of
the firm . Economist are of the view that
profits can be maximized when the
difference of total revenue over total cost is
maximum, or in other words total revenue
is greater than the total cost.
 PROFIT PLUS POINTS  PROFIT MINUS
POINTS
 Measures business  Profit is not a clear term
performance (Long / Short)
 Ensures timely payments  Leads to employee and
to Shareholder, consumer exploitation
employees, Government,  Does not consider Risk
Creditors factor and Time value of
 Ensures expansion and Money
diversification  Leads to cut throat
 Indicates efficient use of competition
Funds  A/c Manipulation
 Estimating exact profits is
impractical
 Maximization of wealth
According to prof solomon ezra of stand ford
university , the ultimate goal of financial
management should be the maximization of the
owners wealth. The value of corporate wealth may
be interpreted in terms of the value of the
company’s total assets. The finance should
attempt to maximize the value of the enterprise to
its shareholders. Value is represented by the
market price of the company’s common stock.
WEALTH PLUS WEALTH MINUS
POINTS POINTS
 Clear term as it  It is not descriptive
considers present  It differs from one
value of cash flows entity to another
 Considers time value
of money
 Considers interest of
External Parties
 Aims at Dividend and
returns
 Considers impact of
Risk
 Other Objectives
 Balanced Asset Structure – Fixed and
Current Asset balance
 Liquidity – Co’s capacity to meet short term
and long term obligations
 Planning Funds – Cost of Funds to be
minimized
 Financial Discipline – Scandals, misuse of
Funds
 •What about risk? Isn’t risk
important as well as profits?
• How would the stockholders of a small
business react if they were told that their
manager cancelled all casualty and liability
insurance policies so that the money spent
on premiums could go to profit instead.
• Even though the expected profits increased
by this action, it is likely that stockholders
would be dissatisfied because of the
increased risk they would bear.
 •The common stockholders are
the owners of the corporation!
• Stockholders elect a board of directors who
in turn hire managers to maximize the
stockholders’ well being.
• When stockholders perceive that
management is not doing this, they might
attempt to remove and replace the
management, but this can be very difficult
in a large corporation with many
stockholders.
•More likely, when stockholders
are dissatisfied they will simply
sell their stock shares.
•This action by stockholders will
cause the market price of the
company’s stock to fall.
•When stock price falls relative
to the rest of the market (or
relative to the rest of the
industry) ...
•Management is failing in their job to
increase the welfare (or wealth) of the
stockholders (the owners).
•Conversely, when stock price is
rising relative to the rest of the
market (or industry), ...

•Management is accomplishing their goal

of increasing the welfare (or wealth) of
the stockholders (the owners).
 •The goal of the firm should be to
maximize the stock price!
• This is equivalent to saying the goal is to
maximize owners’ wealth.
• Note that the stock price is affected by
management’s decisions affecting both risk
and profit.
• Stock price can be maintained or increased
only when stockholders perceive that they
are receiving profits that fully compensate
them for bearing the risk they perceive.
 •Important focal points in the
study of finance:
• Accounting and Finance often focus on
different things
• Finance is more focused on market values
rather than book values.
• Finance is more focused on cash flows
rather than accounting income.
 Functions
 Anticipating Financial needs
 Acquiring Financial Resources
 Allocating Funds in Business
 Administering Allocation of Funds
 Analyzing Financial Performance
 Accounting and reporting to management
 Maintaining Liquidity
 Ensuring Profit and Wealth maximization
 Functions
 Day to Day  Specific Functions
 Cash Custody  Functional planning
 Bank Accounts and Budgeting
 Loan Collection  Investment Decisions
 Payment of Cash for  Cost Accounting
transactions  Profit Analysis
 Financial Accounting
 Internal Audit
 •Why is market value more
important than book value?
• Book values are often based on dated
values. They consist of the original cost of
the asset from some past time, minus
accumulated depreciation (which may not
represent the actual decline in the assets’
value).
• Maximization of market value of the
stockholders’ shares is the goal of the firm.
 Why is cash flow more important
than accounting income?
• Cash flow to stockholders (in the form of
dividends) is the only basis for valuation
of the common stock shares. Since the
goal is to maximize stock price, cash flow
is more directly related than accounting
income.
• Accounting methods recognize income at
times other than when cash is actually
received or spent.
 •One more reason that cash flow
is important:

• When cash is actually received is important,

because it determines when cash can be
invested to earn a return.
[Also: When cash must be paid determines
when we need to start paying interest on
money borrowed.]
 •Examples of when accounting
income is different from cash
flow:
• Credit sales are recognized as accounting
income, yet cash has not been received.
• Depreciation expense is a legitimate
accounting expense when calculating
income, yet depreciation expense is not a
cash outlay.
• A loan brings cash into a business, but is
not income.
 •More examples:
• When new capital equipment is purchased,
the entire cost is a cash outflow, but only
the depreciation expense (a portion of the
total cost) is an expense when computing
accounting income.
• When dividends are paid, cash is paid out,
though dividends are not included in the
calculation of accounting income.
•Definitions: Operating income vs.
operating cash flow

• Operating income = earnings before interest

and taxes (EBIT). This is the total income
that the company earned by operating
during the period. It is income available to
pay interest to creditors, taxes to the
government and dividends to stockholders.
 •Operating cash flow:
• Operating cash flow
= EBIT + Depreciation - Taxes.
This definition recognizes that
depreciation expense is added in computing
EBIT, since it is not a cash outlay.

• It also recognizes that taxes paid is a cash

outlay.
Importance of Proper Financial Management

Maximum use
of resources
Make sound FINANCIAL Evaluate new
business business
decisions MANAGEMENT opportunities

performance
Measure
business
Emerging Role / Key Challenges
of Financial Manager
 Investment planning
 Financial structure
 Mergers, acquisitions and restructuring
 Working capital management
 Performance management
 Risk management
 Investor relations
BEAS Co Ltd, plans for an IPO at Rs.10 per share with an
objective to raise capital to establish itself and has plans to
raise Rs. 500,000 but managed to distribute only Rs. 300000 to
the public through banks, finance companies and brokers, out
of the capital limit of Rs. 10,00,000 as per the MOA. The
response was moderate and the total number of share
applications received was Rs. 1,00,000. In response to the first
call of Rs 5 per share the total funds received was Rs.40,000.
Questions: (1 mark each)
1. What is the price of one share?
2. What is the objective behind the IPO? What does IPO stand
For?
3. What is the Value of the First call?
4. Whom did the company approach for the distribution of
shares to the public?
5. Calculate Authorized capital .
6. Calculate Issued capital .
7. Calculate subscribed capital .
8. Calculate called up capital .
9. Calculate paid up capital .
10. Calculate the number of shares issued by the company .
1. What is the price of one share? Rs.10 per share
2. What is the objective behind the IPO? What does IPO
stand For? Initial Public offering - with an objective to
raise capital to establish itself
3. What is the Value of the First call? Rs 5 per share
4. Whom did the company approach for the distribution of
shares to the public? banks, finance companies& brokers
5. Calculate Authorized capital . 10,00,000
6. Calculate Issued capital . Rs. 300000
7. Calculate subscribed capital . Rs. 1,00,000
8. Calculate called up capital . Rs 50,000
9. Calculate paid up capital. Rs.40,000
10. Calculate the number of shares issued by the company.
Rs. 300000 / 10 per share = 30,000