Introduction to Financial

Management

Financial Management I
Prof. Deepa Iyer

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 What is Financial Management?

• Financial Management means planning,

organizing, directing and controlling the
financial activities such as procurement and
utilization of funds of the enterprise. It means
applying general management principles to
financial resources of the enterprise.

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 Main Forms of Organization

• Sole proprietorship

• Partnership Firm

• Not for profit Organizations

• Joint stock company

While each form of organisation has certain advantages and limitations,

the public limited company form of organisation generally appears to be
the most appropriate form from the point of view of shareholder wealth
maximisation.

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 Financial Statements

A complete set of financial statements comprises:

a) Balance Sheet;
b) Profit & Loss account;
c) Statement of changes in equity;
d) Statement of cash flows;
e) Notes to Accounts, comprising a summary of
significant accounting policies and other explanatory
information

However, for a sole proprietor generally only first two are

prepared.

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 Financial Decisions
Capital
Budgeting
Investment
Decisions
Working Capital
Management

Cost of Capital

Financial Financing Capital Structure

Decisions Decisions Decisions

Leverages

Dividend Policy
Dividend
Decisions
Retained
Earnings

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 Financial Decisions

• Investment decisions includes investment in fixed

assets (called as capital budgeting). Investment in
current assets are also a part of investment decisions
called as working capital decisions.
• Financial decisions relate to the raising of finance
from various resources which will depend upon
decision on type of source, period of financing, cost
of financing and the returns thereby.

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 Financial Decisions

• Dividend decision - The finance manager has to take

decision with regards to the net profit distribution. Net
profits are generally divided into two:

Dividend for shareholders - Dividend and the rate of it

has to be decided.

Retained profits/earnings - Amount of retained profits

has to be finalized which will depend upon expansion
and diversification plans of the enterprise.

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Relationship of Finance to Economics and Accounting

• Financial management has a close relationship to

economics on one hand and accounting on the other.
• Relationship to Economics:
Macroeconomic environment defines the setting within
which the firm operates. GDP growth rate, savings rate,
fiscal deficit, interest rates, inflation rate, exchange rates,
tax rates, and so on have an impact on the firm.
Microeconomic theory provides the conceptual
underpinnings for the tools of financial decision making.
Finance, in essence, is applied microeconomics.

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Relationship of Finance to Economics and Accounting

• Relationships to Accounting:
Accounting is concerned with score keeping, whereas
finance is aimed at value maximising.
The accountant prepares the accounting reports based on
the accrual method. The focus of the financial manager is
on cash flows.
Accounting deals primarily with the past. Finance is
concerned mainly with the future.

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 Goal of Financial Management- Maximising
Shareholder Wealth

• Financial management is in many ways an integral part of the

jobs of managers who are involved in planning, allocation of
resources and control.
• Finance Theory rests on the premise that managers should
manage their firm’s resources with the objective of enhancing
the firm’s market value and maximise the wealth of the
shareholders.

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 Goal of Financial Management- Maximising
Shareholder Wealth

• A business proposal-regardless of whether it is a new

investment or acquisition of another company or a
restructuring initiative –raises the value of the firm only if the
present value of the future stream of net cash benefits
expected from the proposal is greater than the initial cash
outlay required to implement the proposal.
• A confluence of forces appears now to be prodding Indian
companies to accord greater importance to the goal of
shareholder wealth maximisation.

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 Goal of Financial Management- Maximising
Shareholder Wealth

• In general, when you take a financial decision, you have to

answer the following questions :
What is the expected return ? What is the risk exposure ?
Given the risk-return characteristics of the decision, how
would it influence value ?

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Goal of Financial Management- Maximising
Shareholder Wealth

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 Organisation of Finance Function

The treasurer is responsible mainly for financing and investment activities and the
controller is concerned primarily with accounting and control.
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 Agency Problem

• The agency problem usually refers to a conflict of interest

between a company's management (the agent)and the
company's Shareholders (the principal). While there are
compelling reasons for separation of ownership and
management, a separated structure leads to a possible
conflict of interest between managers and shareholders.
• The lack of perfect alignment between the interests of
managers and shareholders results in the agency
problem.

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 Agency Problem

• To mitigate the agency problem, effective monitoring has

to be done and appropriate incentives have to be
offered.

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 Emerging Role of Financial Manager in India

• The job of the financial manager in India has become more

important, complex and demanding due to the following factors:
• Liberalisation
• Globalisation
• Technological developments
• Volatile financial prices
• Economic uncertainty
• Tax law changes
• Ethical concerns over financial dealings
• Shareholder activism

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 Emerging Role of Financial Manager in India

• The key challenges for the financial manager appear to be in

the following areas:
– Investment planning and resource allocation
– Financial structure
– Mergers, acquisitions, and restructuring
– Working capital management
– Performance management
– Risk management
– Corporate governance
– Investor relations

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