PR Academy

FINANCIAL MANAGEMENT (FM)

Chapter 1: Scope and Objectives of Financial Management
What is financial Management?
It focusses on acquisition and allocation of funds with an aim to make profits for the
owners of the company. In other words, it deals with planning and controlling of a
firm’s financial resources.
FM – Definition:
“Financial Management comprises of forecasting, planning, organizing, directing, co-
ordinating and controlling of all activities relating to acquisition and application of the
financial resources of an undertaking in keeping with its financial objective.”
There are two functions of FM, which we can derive from the above definition:
1. Acquisition of Funds
2. Efficient use of funds
Procurement of Funds:
Sources of funds include Owner’s fund, Leasing, Venture Capitalist, Commercial loans,
Debentures and bonds.
Different sources of Funds will have different characteristics with respect to cost, risk
and control.
1. Equity – Less risk, High cost, and diluted control,
2. Debenture – High risk, Low cost and no control dilution
3. Funding from banks – Varied types of Funding are available
4. International Funding - FDI, FII, ADR, and GDR
Effective Utilisation of Funds:
Funds procured should earn a return more than the cost incurred on acquiring them.
1. Utilisation for Fixed assets: A finance manager shall use capital budgeting
techniques to analyse the profitability of the investment
2. Utilisation for Working Capital: Optimum level of WC must be maintained.
Evolution of Financial Management:
Traditional Phase: Considered during infrequent events such as Mergers, takeovers,
expansion and Liquidation.
Transitional Phase: Everyday problems were given importance.
Modern Phase: It aims at aiding in decision making. Many theories such as capital
budgeting, efficient market, valuation models were developed.
Finance Function/ Decisions:
Value of the Firm, 𝑽 = 𝒇(𝑰, 𝑭, 𝑫)
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Madesh Kuppuswamy MSc (Edin)
 PR Academy

Finance functions are divided into long term and short-term functions.
Long Term Finance Decision:
Investment Decisions:
• Investment must be made after careful assessments.
• Allocation must be made between short- and long-term assets.
• Asset and inventory management done based on production requirements.
Financing Decisions:
▪ Ideal balance between Equity and Debt
▪ Cash flow analysis
▪ Assessment of risk with respect to type of financing
▪ Using Hedging techniques to shield against Foreign exchange risk.
Dividend Decisions:
➢ Amount to be paid out and amount to be retained for organisational growth
must be decided.
➢ Dividend decisions have an impact on the company’s market value.
Short term Finance Decision/ functions: Nothing but Working Capital
Management.
Importance of Financial Management:
1. It is key success of any business
2. Proper management of finance enables a firm to be successful
3. Finance is the elixir for an organisation.
Scope of Financial Management:
It deals mainly with procurement, investment, financing, and dividend.

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Madesh Kuppuswamy MSc (Edin)
 PR Academy

Objectives of Financial Management:

Profit Maximisation: Decisions are made to increase the profit of the company.
Nevertheless, it can never be sole aim of a firm. Moreover, unwarranted importance
of profit may lead to problems:
1. Term itself is vague
2. Must understand the risk involved
3. Time pattern of return must be analysed.
4. It is a narrow objective and may lead to ethical.
Wealth/Value Maximisation:
Wealth = PV of Benefits – PV of Cost
In order to maximise the wealth of the firm, the financial manager shall:
1. Analyse the cash flows of the firm
2. Cost benefit analysis
3. Application of Time Value of Money
Value of Firm = Number of Shares X Market price of Share
V = Value of Equity + Value of Debt
Wealth or Value maximisation will help in overall development of the society on the
other hand, restriction of growth may lead to restriction of investment.
Conflicts in Profit Versus Value Maximisation Principle:
When there are more participants i.e. stakeholders, in a business, the objective of profit
maximisation can not be pursued by the owners because the profit maximisation of
objective of the owners may conflict with the interest of other stakeholders. For
example, owners may pay less wages in order to maximise profits, however, Labourers
would want a fair wage.
Therefore, it is healthier for the organisation to follow Wealth maximisation, which
may concur with the interest of major stakeholders.
Illustration 1:
Profit is the basic requirement of any entity. Else, it will lose its capital and cannot be
able to survive in the long run. However, the risk is always associated with profit, the
higher will be the risk involved with it.
In the short term, the risk factor can be neglected, but in the long-term, the entity
cannot ignore the uncertainty. Shareholders are investing their money in the company
with the expectation of getting good returns and if there is no effort is made to increase
their wealth. They will invest in the company.
If the finance manager takes irresponsible decisions regarding risky investments,
shareholders will lose their trust in that company and sell out the shares which will

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Madesh Kuppuswamy MSc (Edin)
 PR Academy

adversely effect on the reputation of the company and ultimately the market value of
the shares will fall.
Finally, it can be said that for day to day decision making, Profit Maximization can be
taken into consideration as a sole parameter but when it comes to decisions which will
directly affect the interest of the shareholders, then Wealth Maximization should be
wholly considered.
Difference between Profit and Wealth Maximisation:

PROFIT MAXIMIZATION WEALTH MAXIMIZATION

Profit Maximization is based on the increase Wealth Maximization is based on the cash
of sales and profits of the organization. flows into the organization.
Focused On
Profit Maximization emphasizes on short Wealth Maximization emphasizes on long
term goals. term goals.
Time Value of Money
Profit Maximization ignores the time value of Wealth Maximization considers the time
money. Time value of money refers the value of money. In wealth maximization, the
money receivable today is more valuable than future cash flows are discounted at an
the money which is going to be received in suitable discounted rate to represent their
future. present value.
Risk
Profit Maximization ignore the risk and Wealth Maximization considers the risk and
uncertainty. uncertainty.
Reliability
Wealth maximisation objectives ensures fair
In the new business environment Profit
return to the shareholders, reserve funds for
maximisation is regarded as unrealistic,
growth and expansion, promoting financial
difficult, inappropriate and immoral.
discipline in the management.
Objective
Profit Maximization objective leads to Wealth Maximization provides efficient
exploiting employees and consumers. it also allocation of resources, it ensures the
leads to inequalities and lowers human economic interest of the society.
values.

Role of Finance Executive:

❖ Financial Planning and Analysis
❖ Investment Decisions
❖ Financing and capital structure decisions
❖ Management of Financial Resources
❖ Risk Management
In the current world, the role of CFO has spread past accounting and financial
reporting to Strategic planning, Risk management, and Regulatory compliance.

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Madesh Kuppuswamy MSc (Edin)
 PR Academy

Financial Distress and Insolvency:

The management of the company must analyse the product and its price and demand
regularly. Furthermore, the finance manager requires careful management of debt of
the firm, because, higher the debt higher will be the risk for the organisation as it will
put stress on the cash requirement to pay the interest rates. Though short-term cash
distress can be accepted, nevertheless, if it continues for long period of time, it may
result in liquidation of the company.
Relationship between FM and Related Disciplines:
FM and Accounting:
The information generated by the Financial Reporting such as P&L, Balance Sheet,
and Cash Flow statement aide in assessing the past performance of the firm and
provide insights for the future direction. However, both are closely related, the differ
in the treatment of funds.
Treatment of Funds
Accounting – Measurement of funds are based on Accrual basis, which do not
completely reflect the financial state of the organisation.
FM – Measurement of Funds are based on Cash flow basis, which truly reflect the
financial state of the organisation, which in turn helps the Finance Manager to avoid
insolvency.
Decision Making
Accountants collect the data through various financial statements as said above, and
Finance Managers use this data to making decisions regarding future of the company.
FM relationship with Related Disciplines:
Finance Managers also use the information provided of other departments in the
organisations such as Marketing and Sales, Production and Quantitative Methods. For
example, information relating to demand for a product shall be provided by the
Marketing and Sales Department. Production department can aide in Cost analysis.
We can use quantitative models to assess a new project.
Finally, economics plays an import role in analysing the demand and supply behaviour
of a product with respect to price.
Agency Problem and Cost:
The agency problem is a conflict of interest inherent in any relationship where one
party is expected to act in another's best interests. In financial management, the
agency problem usually refers to a conflict of interest between a company's
management and the company's stockholders. Thus, it leads to Agency Cost.

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Madesh Kuppuswamy MSc (Edin)
 PR Academy

The Agency Costs include the costs of any inefficiencies that may arise from
employing an agent to take on a task, along with the costs associated with managing
the principal-agent relationship and resolving differing priorities. There are different
types of Agency cost, namely Monitoring, Bonding, Opportunity and Structuring costs.
The manager, acting as the agent for the shareholders, or principals, is supposed to
make decisions that will maximize shareholder wealth even though it is in the
manager’s best interest to maximize his own wealth.
Minimising the Agency Problem:
The agency problem may also be minimised by incentivising an agent to act in better
accordance with the principal's best interests. For example, a manager can be
motivated to act in the shareholders' best interests through incentives such as
performance-based compensation, direct influence by shareholders, the threat of firing
or the threat of takeovers.
Principals can also alter the structure of an agent's compensation. If, for example, an
agent is paid not on an hourly basis but by completion of a project, there is more
incentive to act in the principal’s best interest. In addition, performance feedback and
independent evaluations hold the agent accountable for their decisions.
Question for Discussion:
In recent years, there have been a number of environmental, pollution and other
regulations imposed on businesses. In view of these changes, is maximisation of
shareholder wealth still a realistic objective?

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Madesh Kuppuswamy MSc (Edin)