FINANCIAL MANAGEMET- INTRODUCTION

Financial management has two components

 Finance
Fund required for operating an activity.
 Management
It is concerned with planning, organising, directing and controlling.

Therefore Financial Management refers to planning, organising, directing and controlling of fund
required for operating an activity.

Activities of Financial Management

 Planning of fund concerned with budgeting and forecasting.

 Organising is concerned with arrangement of fund.
 Directing means effective utilisation of fund.
 Controlling is concerned with comparison of actual with budgeted.

Areas covered under Financial Management

 Procurement of Funds (Effective Acquisition of fund)

 Effective Utilisation of Funds
 Parity between Distribution and Retention Fund

Procurement of fund

Fund can be obtained from different sources like

o Equity share capital
o Preference share capital
o Debentures
o Loan from financial institutions or banks

To build a good capital structures the acquisition should be from effective source. The
following points to be considered to decide the effective sources. It is a combination of 3 factors.

Company’s Point of View

Acquisition of Fund Cost Control Risk

o Equity share capital (ES) Higher Dilution Happens Low Risk

Lower than ES
o Preference share capital (PS) No Dilution Low Risk
Higher than BF

o Borrowed Funds (BF) Lower No Dilution High Risk

Which source is to be selected is the basic issue. Whether any one of the sources or combination
of sources.

For example:

You require ` 5,00,000 for investment

o If equity share capital is considered low risk (from company’s point of view), but investors
exception will be high since their risk is higher. Say investors exception is 20% then the
cost of equity is ` 1,00,000 [5,00,000 x 20%].

o If debentures is available for 16% then the cost will be lower compared to equity share
capital i.e. ` 80,000 [5,00,000 x 16%] but risk from the company’s point of view is higher

o Therefore combination of source is preferable

Combination of equity share capital and borrowed fund

Situation 1 Situation 2 Situation 3

Sources of Fund
Amount Cost Amount Cost Amount Cost

Equity Share Capital -@20% 3,00,000 60,000 2,50,000 50,000 2,00,000 40,000

Debentures - @16% 2,00,000 32,000 2,50,000 40,000 3,00,000 48,000

Total 5,00,000 92,000 5,00,000 90,000 5,00,000 88,000

Above illustration clearly indicate that when the combinations of sources are used the cost can be
reduced and risk & cost parity maintained.

Therefore Effective Source = Combination of Various Source of Fund.

Effective Utilisation of fund

 It must be ensure that the funds are not kept idle or there is no improper use of funds.
 The funds are to be invested in a manner such that they generate returns higher than
the cost of capital to the firm.
 Similarly, adequate working capital should be maintained so as to avoid the risk of
insolvency.
 The fund is said to be effectively utilised when it is deployed considering the following
factors.
o Liquidity
o Return
o Risk
 o Cost of Investment

Therefore to conclude financial management is the inter play between cost, control, risk,
return and liquidity.

Objectives of Financial Management

 Profit Maximisation: Profit Maximisation means that the primary objective of a company
is to earn profit. Profit maximisation focus on short-term objective.

 Wealth / Value maximisation: Wealth / Value maximisation means that the primary
goal of a firm should be to maximize its market value and implies that business decisions
should seek to increase the net present value of the economic profits of the firm. It focus
on medium / long term objective.

 The value maximisation objective of a firm is superior to its profit maximisation

objective due to following reasons.

Wealth / Value Maximisation Profit Maximisation:

The value maximisation objective of a Profit maximisation objective does not

firm considers all future cash flows, consider the effect of EPS, dividend
dividends, earning per share, risk of paid or the wealth of the
a decision etc. shareholder.

A firm that wishes to maximise the A firm with the objective of profit
shareholders wealth may pay regular maximisation may refrain from
dividends dividend payment to its shareholders.

Recognise the risk- return relationship Does not consider the effect of risk

The maximisation of a firm’s value as The profit maximisation can be

reflected in the market price of a share considered as a part of the wealth
is viewed as a proper goal of a firm. maximisation strategy.