 Financial management def.

- Financial management is that managerial activity which is

concerned with planning and controlling of the firm’s financial resources. It is concerned
with acquiring, financing and managing assets to accomplish the overall goal of a business
enterprise.
 Aspects of Financial Management- 1. Procurement of Funds 2. Utilization Of Fund
 1. Procurement Of Funds
a) Equity- The funds raised by the issue of equity shares are the best the risk point of
view for the firm, since there is no question of repayment of equity capital except
when the firm is under liquidation. From the cost point of view, however, equity
capital is usually the most expensive source of funds. This is because the dividend
expectations of shareholders are normally higher.
b) Preference share- These are a special kind of shares; the holders of such shares
enjoy priority, both as regards to the payment of a fixed amount of dividend and
repayment of capital on winding up of the company.
c) Debenture- Debentures as a source of funds are comparatively cheaper than the
shares because of their tax advantage. The interest the company pays on a
debenture is free of tax, unlike a dividend payment which is made from the taxed
profits. The interest payment has to be made whether or not the company makes
profits.
d) Funding from banks- Commercial Banks play an important role in funding of the
business enterprises. Apart from supporting businesses in their routine activities
(deposits, payments etc.) they play an important role in meeting the long term and
short term needs of a business enterprise.
e) International funding- Funding today is not limited to domestic market. With
liberalization and globalization a business enterprise has options to raise capital
from International markets also. Foreign Direct Investment (FDI) and Foreign
Institutional Investors (FII) are two major routes for raising funds from foreign
sources.
 2. Effective Utilisation of Funds
a) Utilization for Fixed Assets- Capital budgeting (or investment appraisal) is the
planning process used to determine whether a firm's long term investments
such as new machinery, replacement machinery, new plants, new products, and
research development projects would provide the desired return (profit). It is
done to know if assets are optimally utilized.
b) Utilization for Working Capital- The finance manger must also keep in view the
need for adequate working capital and ensure that while the firms enjoy an
optimum level of working capital they do not keep too much funds blocked in
inventories, book debts, cash etc.
 Importance of Financial Management:
a) Determination of size of the enterprise and determination of rate of growth.
b) Determining the composition of assets of the enterprise.
c) Determining the mix of enterprise’s financing i.e. consideration of level of debt to
equity, etc.
d) Analysis, planning and control of financial affairs of the enterprise.
 Objectives of Financial Management
a) Profit Maximisation
b) Wealth / Value Maximisation
  Sources of Finance-
a) Share capital or Equity share
b) Preference shares
c) Retained earnings
d) Debentures
e) Loans from financial institutions
A) Equity Capital:
I. Features:
1. It is a source of permanent capital.
2. Ownership per share is equal.
3. Equity shareholders are entitled to dividends after the income claims of
other stakeholders are satisfied.
4. In the event of winding up, ordinary shareholders can exercise their
claim on assets after the claims of the other suppliers of capital have
been met.
5. The cost of ordinary shares is usually the highest. This is due to the fact
that such shareholders expect a higher rate of return (as their risk is the
highest) on their investment as compared to other suppliers of long-
term funds.
II. Advantage:
1. It is a permanent source of finance. Since such shares are not redeemable
2. The company is not obliged legally to pay dividends. Hence in times of
uncertainties or when the company is not performing well, dividend
payments can be reduced or even suspended.
3. The company can make further issue of share capital by making a right
issue.
III. Disadvantage:
1. The cost of ordinary shares is higher because dividends are not tax
deductible.
2. Investors find ordinary shares riskier because of uncertain dividend
payments
3. The issue of new equity shares can also reduce the ownership and control
of the existing shareholders.
B) Preference Share Capital:
I. Features:
1. Such shares are normally cumulative, i.e., the dividend payable in a year
of loss gets carried over to the next year till there are adequate profits to
pay the cumulative dividends.
2. The rate of dividend on preference shares is normally higher than the
rate of interest on debentures, loans etc.
II. Advantage:
1. Non-payment of preference dividends does not force company into
liquidity.
2. There is no risk of takeover as the preference shareholders do not have
voting rights except in case where dividend arrears exist.
3. The preference dividends are fixed and pre decided. Hence Preference
shareholders do not participate in surplus profits as the ordinary
shareholders.
4. Preference capital can be redeemed after a specified period
 III. Disadvantage:
1. One of the major disadvantages of preference shares is that preference
dividend is not tax deductible and so does not provide a tax shield to the
company. Hence a preference share is costlier to the company than debt e.g.
debenture.
2. Preference dividends are cumulative in nature. This means that although
these dividends may be omitted, they shall need to be paid later.

C) Retained Earnings- Long-term funds may also be provided by accumulating the profits of the
company and by ploughing them back into business. Such funds belong to the ordinary
shareholders and increase the net worth of the company.
D) Debentures:
I. Feature:
1. Debentures are either secured or unsecured
2. Debentures are normally issued in different denominations
3. The cost of capital raised through debentures is quite low since the interest
payable on debentures can be charged as an expense before tax.
4. From the investors' point of view, debentures offer a more attractive prospect
than the preference shares since interest on debentures is payable whether or
not the company makes profits.
II. Advantage:
1. The cost of debentures is much lower than the cost of preference or equity
capital as the interest is tax-deductible.
2. Debenture financing does not result in dilution of control.

III. Disadvantage:
1. Debenture interest and capital repayment are obligatory payments.
2. Since debentures need to be paid during maturity, a large amount of cash
outflow is needed at that time.

 Cost of Capital: It is the cost of raising funds required in order to finance the proposed
projects.
a) Cost of Debt: It is the rate of return which is expected by lenders. This is the interest
rate which is expected at the time of issue. It may be at discount, premium and at
par.
b) Cost of preference shares - Preference share are also fixed cost bearing security and
if dividend on preference shares is not paid, it is going to affect the right of equity
shareholders. Preference shares can also be issued at par, premium and discount
and can be both redeemable and irredeemable.
c) Cost of Equity Shares- It indicates the minimum rate which must be obtained on the
project before their acceptance and raising of equity capital to finance them. They
are also issued at par, premium and discount.
d) Cost of Retained Earning- The profits which is not distributed to the shareholders
and is retained by the company is called RE. The opportunity cost of retained
earnings is the dividend foregone by the shareholders.
 Weighted Average Cost of Capital (WAAC): It is the weighted average cost of different
various sources of finance. All these cost are weighted in respect to their share in the total
investment to get the overall cost of capital which is termed as WAAC.
 Importance of WAAC:
1. It sets the benchmark of rate of return for the company.
2. It benchmarks the company with its competitors.