Chapt

er-
1 I
ntr
oduct
iont
oFi
nanci
alManagement

I
NTRODUCTI
ON

Businessconcer nneedsf inancetomeett heirrequir

ement si ntheeconomi cwor l
d.Any
ki
ndofbusi nessact ivi
tydependsont hef inance.Hence,i tiscal ledasor ganizati
on.
Whet herthebusi nessconcer nsar ebig orsmal l
,t heyneed f i
nancet ofulf
il
ltheir
businessact i
v i
ti
es.I nthemoder n worl
d,al ltheact ivit
iesar econcer ned witht he
economi cactivi
tiesandv erypar t
icul
artot hroughanyv entureoract iv
iti
es.Theent i
re
businessactivit
iesar edir
ectl
yr el
atedwi t
hmaki ngpr ofit.(Accor dingtotheeconomi cs
conceptoff actor sofproduct i
on,rentgivent ol andlord,wagegi v entolabor,i
nterest
giv
ent ocapitalandpr ofitgivent oshareholdersorpr oprietors),abusi nessconcer n
needsf i
nancet o meetal lther equir
ement s.Henceeach t erm i shav i
ng diff
erent
meani ngsanduni quechar act
ers.

MEANI
NGOFFI
NANCE

Fi
nancemaybedef inedastheIti
ncludesFi
nancealsoisref
erredastheprov
isionof
moneyatt hetimewheni ti
sneeded.Financefuncti
onist heconceptoffinance
i
ncludescapital
,funds,money,andamount.Buteachwor dishavinguni
quemeani ng.
Studyingandunder standi
ngtheconceptoffi
nancebecomeani mport
antpar
toft he
businessconcer
n.

Companiesdonotwor kinav acuum,i solatedfrom ever

ythi
ngel se.Itint
eract
sand
tr
ansactswiththeot herenti
ti
espresenti ntheeconomi cenvir
onment .Theseent i
ti
es
i
ncludeGovernment ,Suppl
ier
s,Lenders,
Banks, Cust
omers,Shareholders,
etc.whodeal
wit
ht heorgani
zationi nsever
alway s.Mostoft hesedeali
ngsr esultineit
hermoney
fl
owinginorf l
owingoutf rom thecompany .Thisfl
ow ofmoney( orfunds)hastobe
managedsoast or esulti
nmaximum gainst ot hecompany.

DEFI
NITI
ONOFFI
NANCE

Accor
dingt
oKhanandJai
n,“
Financei
sthear
tandsci
enceofmanagi
ngmoney
”.

Accor
dingt
oOxf
orddi
cti
onar
y,t
hewor
d‘f
inance’
connot
es‘
managementofmoney
’.

Webster’
sNi nt
hNewColl
egiat
eDi cti
onar
ydefinesf i
nance as“t
he Sci
ence on study
ofthemanagementoffunds’andt hemanagementoff undasthesy
stem thati
ncludes
thecir
culat
ionofmoney,thegr antingofcredit
,themakingofinv
estments,andt he
provi
si
on ofbankingf
aci
li
ti
es.

DEFI
NITI
ONOFBUSI
NESSFI
NANCE

Accordingt
otheEncy
clopedi
aofSocialSciences,“
Cor
porati
onf
inancedealswiththe
fi
nancialpr
obl
ems ofcorporat
e ent
erpr
ises.These pr
oblems i
nclude t
he f
inancial
aspect
soft hepr omotionofnew ent er
pri
sesandt heiradmi ni
strat
ionduringearly
devel
opment,theaccount ingprobl
emsconnect edwiththedi st
inct
ionbetweencapital
andincome,theadministr
at i
vequesti
onscreatedbygr owthandexpansi on,andfi
nal
ly,
thefi
nanci
aladj
ustmentsr equir
edforthebolst
eringuporr ehabi
li
tat
ionofacor por
ati
on
whichhascomeintofinancialdi
ffi
cul
ti
es”.

Managingthisflow offundseffi
cient
lyi
st hepurvi
ew off inance.Sowecandefi
ne
fi
nanceast hest udyofthemet hodswhichhelpuspl an,raiseandusefundsinan
eff
ici
entmannert oachi
evecorporateobj
ectiv
es.Fi
nancegr ewoutofeconomicsasa
speci
aldi
scipl
inetodealwithaspecial
setofcommonpr oblems.

Thecor
por
atef
inanceobj
ect
ivescoul
dbet
o:

1.Prov
idet
hel
i
nkbet
weent
hebusi
nessandt
heot
herent
it
iesi
ntheenv
ironment
and

2.I
nvest
mentandf
inanci
aldeci
sionmaki
ng

Letusf
ir
stl
ookatwhatwemeanbyi
nvest
mentandf
inanci
aldeci
sionmaki
ng.

1.I
nvestmentDeci si
on:Thei nvestmentdecisionalsoref
err
edt oast hecapi
tal
budgetingdeci
sion,si
mplymeanst hedecisionstoacqui
reasset
sort oinv
esti
n
a project
.Assetsar e def
ined aseconomi cr esour
cesthatare expect
ed t
o
generatefut
urebenefi
ts.

2.Fi
nanci
ng Deci
sion:Thesecond f
inanci
aldeci
sion i
sthef
inanci
ng deci
sion,
whi
chbasi
call
yaddressest
woquestions:

 Howmuchcapit
alshoul
dber
aisedt
ofundt
hef
ir
m'soper
ati
ons(
bot
h
exi
sti
ng&pr
oposed?)

 Whati
sthebestmi
xoff
inanci
ngt
heseasset
s?

Financingcouldbet hroughtwoway s:debt( l

oansf r
om varioussourcesli
kebanks,
fi
nancialinst
it
uti
ons,publi
c,et
c.)andequi
ty(capi
talputinbytheinv
estorswhoareal
so
known as owner s/ sharehol
ders).Sharehol
ders are owners because t
he shar
es
representtheownershi
pinthecompany .

Fundsar er ai
sedf rom fi
nanci
almarkets.Financialmar ketsareagener icterm usedt o
denot emar ketswher ef i
nanci
alsecur i
tiesar et eat
.Thesemar ketsincludemoney
mar kets,debtmarketandcapitalmarkets.Financingandi nvesti
ngdecisionsar eclosely
relat
edbecauset hecompanyi sgoingt or aisemoneyt oinvestinapr ojectorasset s.
Thosewhoar egoi ngtogivemoneytot hecompany( whetherlendersorinvestors)need
tounder standwher et hecompanyisinv estingtheirmoneyandwhati thopest oearn
from theinvestment ssothatt
heycanassur ethemselvesoft hesafetyoftheirmoney .

DEFI
NITI
ONOFFI
NANCI
ALMANAGEMENT
Financi
almanagementisanintegr
alpartofover
allmanagement
.Iti
sconcer nedwit
h
t
he duties ofthe f
inanci
almanager sint he busi
ness f
ir
m.The t erm f i
nanci
al
managementhasbeendef i
nedbySolomon,“I
tisconcer
nedwitht
heeffi
cientuseofan
i
mpor t
anteconomi
cresourcenamely,
capit
alf
unds”.

Themostpopularandacceptabledef
ini
ti
onoff
inancialmanagementasgivenbyS.C.
Kuchalisthat“Financi
alManagementdealswith procur
ementoff undsand t
heir
eff
ecti
veut
il
izat
ioninthebusi
ness”
.

HowardandUpton:Fi
nanci
almanagement“ asanappl
i
cat
ionofgener
almanager
ial
pr
inci
plest
othear
eaoffi
nanci
aldeci
sion-
making.

WestonandBr
igham:Financi
almanagement“i
sanar eaoff
inanci
aldeci
sion-
maki
ng,
har
monizi
ngi
ndiv
idual
mot i
vesandenter
pri
segoal
s”.

JoshepandMassi e:Fi
nanci
almanagement“ i
st heoperat
ionalacti
vi
tyofabusi ness
thati sresponsi
bleforobtai
ning and ef
fect
ivel
yutil
i
zing the f
unds necessar
yf or
effi
cientoper
ati
ons.

Thus,
Financi
alManagementismai nlyconcer
nedwit
ht heef
fect
ivef
undsmanagement
i
nthebusiness.I
nsi
mpl ewords,Financi
alManagementaspracti
cedbybusi
nessf
ir
ms
canbecall
edasCorporati
onFinanceorBusinessFi
nance.

TYPESOFFI
NANCE
Financeisoneoftheimport
antandintegralpar
tofbusinessconcer
ns,hence,i
t
playsamajorr
oleinev
erypartoft
hebusinessacti
vi
ti
es.I
tisusedinallt
heareaof
theacti
vi
ti
esundert
hedif
fer
entnames.
Fi
nancecanbecl
assi
fi
edi
ntot
womaj
orpar
ts:
 Fi
nance

Pr
ivat
e Publ
i
c

Fi
nance Fi
nance

I
ndi
vi
dual Par
tner
shi
p Bus
ines
s Cent
ral Stat
e Semi
Gov
ernment
Fi
nance Fi
nance Fi
nanc
e Gov
ernme
nt Gov
ernme
nt

Fi
g.Ty
pesofFi
nance

Ty pesofFi nancialDecisions–3Ty pes:InvestmentDecisi

on,Financi
ngDecisionand
Div i
dendDeci sion
Financialmanagementi sconcernedwi t
ht heacquisi
ti
on,f
inancingandmanagementof
asset swithsomeov erallgoalsinmi nd.Thecont entsofmoder napproachoff i
nancial
managementcanbebr okendowni ntot hreemajordecisions,vi
z.,(1)Investment
decision( 2)Financingdeci si
onand( 3)Di v
idenddecisi
on.
Af irmt akesthesedeci si
onssi multaneousl yandconti
nuouslyinthenormalcour seof
business.Fi rm maynott akethesedeci si
onsi nasequence,butdeci si
onshav et obe
takenwi ththeobj ecti
veofmaxi mizi
ngshar ehol
der
s’wealt
h.
1.InvestmentDeci sion:
Itismor ei mportantthant heot hertwodeci sions.Itbeginswi t
hadet er minationoft he
totalamountofasset sneededt obehel dbyt hefir
m.I notherwor ds,inv est
ment
decisionrelatestothesel ectionofasset s,onwhi chafirm wil
l i
nvestfunds.
Ther equiredassetsf al
lintot wogroups:
(i
)Long- term Assets( fi
xedasset s–pl ant&machi neryland&bui ldings,et c.,)which
i
nv ol
v ehugei nvestmentandy i
eldar et
ur nov eraper i
odoft i
mei nfutur e.Invest mentin
l
ong- t
er m assetsispopul arl
yknownas“ capitalbudgeting”.Itmaybedef i
nedast he
fir
m’sdeci si
ont oi nvesti tscur r
entf undsmostef fi
cientl
yi nfixedasset swi than
expect edflowofbenef it
sov eraseriesofy ear s.
(i
i)Shor t
-term Assets(cur rentassets–r awmat erial
s,wor k-
in-
process,f inishedgoods,
debt
ors,cash,et
c.,
)thatcanbeconv
ert
edi
ntocashwi
thi
naf
inanci
aly
earwi
thout
diminut i
oni nv alue.I nv estmenti ncur r
entasset si spopul ar
lyter medas“ wor kingcapi tal
management ” .Itr elatest ot hemanagementofcur rentasset s.
Itisani mpor tantdeci sionofaf irm,asshor t-surv ivali sthepr erequisitef orl ong-
ter m
success.Fi rm shoul dnotmai ntainmor eorl essasset s.Mor easset sreducesr eturnand
therewi llbenor i
sk, buthav ingl essasset si smor er i
skyandmor epr ofit
able.Hence, the
mai naspect sofwor kingcapi t
al managementar et het rade-offbet weenr iskandr et
ur n.
Managementofwor ki
ngcapi t
alinv ol vest woaspect s.Onedet ermi nationoft heamount
requiredf orrunni ngofbusi nessandsecondf i
nanci ngt heseasset s.
2.Financi ngDeci sion:
Afterest imat ionoft heamountr equi r
edandt hesel ect i
onofasset sr equi redtobe
purchased,t henextf inanci ngdeci sioncomesi nt ot hepi cture.Fi nanci almanageri s
concer nedwi thmakeupoft her ighthandsi deoft hebal ancesheet .Itisr el
at edtot he
fi
nanci ngmi xorcapi talst ruct ureorl ev erage.Fi nanci almanagerhast odet erminet he
propor ti
onofdebtandequi tyincapi tal structur e.
Itshoul dbeonopt imum f i
nancemi x,whi chmaxi mi sesshar ehol ders’weal t
h.Apr oper
balance wi llhav et o be st ruckbet ween r iskand r eturn.Debti nvolvesf i
xed cost
(i
nterest )
,whi chmayhel pi ni ncr easi ngt her eturnonequi tybutal soi ncreasesr isk.
Raising off unds by i ssue ofequi ty shar es i s one per manentsour ce,butt he
sharehol derswi llexpecthi gherr atesofear nings.
Thet woaspect sofcapi talst ructur ear e- Onecapi tal structuret heor i
esandt wo
determi nati
onofopt imum capi tal struct ure.
3.Div i
dendDeci si on:
Thisist het hirdf i
nanci aldeci sion, whi chr elatest odi videndpol icy .Dividendi sapar tof
profit
s, whichar eav ailabl ef ordi stribut i
ont oequi t
yshar eholder s.Pay mentofdi vi
dends
shouldbeanal yzedi nr elationt ot hef i
nanci aldeci sionofaf irm.Ther ear etwoopt ions
avai
lableindeal ingwi thnetpr ofi
tsofaf ir
m,v i
z.,di
str
ibutionofprofi
tsasdividendsto
theordinaryshar eholderswher ether eisnoneedofr et
ent i
onofearningsortheycanbe
ret
ainedi nthefirmi t
selfiftheyarer equiredforfi
nancingofanybusi nessact
ivity.
Butdistri
butionofdi videndsorr etainingshouldbedet erminedintermsofitsimpacton
theshar eholders’weal th.Financialmanagershoul ddet erminetheoptimum di vi
dend
poli
cy,whi chmaxi mizesmar ketv alueoft heshar etherebymar ketval
ueoft hefi
rm.
Consideringthef actorst obeconsi der edwhiledetermini
ngdi vi
dendsisanotheraspect
ofdivi
dendpol i
cy .
SCOPEOFFI
NANCI
ALMANAGEMENT
Fi
nancialmanagementi
soneoft
heimportantpar
tsofover
allmanagement,
whichi
s
di
rect
lyr el
atedwi
thvar
iousf
unct
ionaldepart
mentsli
keper sonnel
,mar
keti
ngand
producti
on. Financi
al management cover
s wide area with mult
idi
mensi
onal
approaches.Thefoll
owi
ngarethei
mpor t
antscopeoff
inanci
almanagement.
1.Fi
nanci
alManagementandEconomi
cs
Economi cconceptsl ikemi cr
oandmacr oeconomi csaredirectl
yappliedwith
thefinancialmanagementappr oaches.Inv est
mentdeci sions,mi croand
macroenv ir
onment alf actor
sarecl oselyassociatedwi t
ht hef uncti
onsof
fi
nancialmanager.Fi nancialmanagemental sousest heeconomi cequations
l
ike moneyv alue discountf act
or,economi cor derquant it
yet c.Financial
economi cs is one of t he emer ging area,whi ch prov i
des immense
opportunit
iestofi
nance, andeconomi calar
eas.
2.Fi
nanci
alManagementandAccount
ing
Account
ing recor
ds i
ncl
udes t
he f i
nancialinfor
mation oft he business
concer
n.Hence,we can easi
lyunder stand t
he rel
ati
onship between the
fi
nanci
almanagementandaccount i
ng.Int heoldenper i
ods,bothf i
nancial
managementandaccounti
ngaretreat
edasasamedi scipli
neandt henithas
beenmer gedasManagementAccount i
ngbecauset hispartisv erymuch
hel
pfultof i
nancemanagertotakedeci si
ons.Butnow aday ’sf i
nancial
managementandaccounti
ngdi
scipli
neareseparateandinterr
elat
ed.
3.Fi
nanci
alManagementorMat
hemat
ics
Moder nappr oachesoft hef i
nanci
almanagementappl iedlar
genumberof
mat hemat i
calandstati
sticaltool
sandt echniques.Theyar ealsocall
edas
economet ri
cs.Economicor derquant
it
y,discountfactor
,timeval
ueofmoney ,
presentv al
ueofmoney ,costofcapital
,capi t
alstruct
uretheori
es,di
vidend
theori
es,rati
oanalysi
sandwor ki
ngcapit
al anal
ysi
sar eusedasmat hematical
andst at
isti
caltool
sandt echni
quesinthef i
eldoffi
nancialmanagement.
4.Fi
nanci
alManagementandPr
oduct
ionManagement
Product
ionmanagementi st heoper at
ionalpar toft hebusinessconcer n,
whichhelpstomul t
iplyt hemoneyi nvestedintopr of i
t.Prof
itoftheconcer n
dependsupont hepr oduct ionper for
mance.Pr oduct ionperformanceneeds
fi
nance,becausepr oductiondepar tmentr equiresr aw mat er
ial
,machi nery,
wages,oper ati
ng ex penses et c.These expendi t ures are decided and
esti
matedbyt hefinanci aldepar t
mentandt hefinancemanageral locat
est he
appropr
iatef
inancet opr oduct iondepart
ment .Thef inancialmanagermustbe
awareoft heoper at
ionalpr ocessandf i
nancer equi redforeachpr ocessof
product
ionactiv
iti
es.
5.Fi
nanci
alManagementandMar
ket
ing
Produced goods are soldint he marketwi t
hi nnov
ati
ve and moder n
approaches.Forthi
s,t
hemar ketingdepartmentneedsfi
nancetomeett heir
requi
rements.Thefi
nancialmanagerorf i
nancedepart
mentisresponsi
bleto
all
ocatetheadequat
efinancetothemar keti
ngdepart
ment.Hence,marketi
ng
andfinanci
almanagementareinterr
elat
edanddependsoneachot her.
 6.Fi
nanci
alManagementandHumanResour
ce
Fi
nancialmanagementi s also rel
ated wi t
h human r esour
ce depar t
ment ,
whichprovi
desmanpowert oal lthefunct i
onalareasoft hemanagement .
Fi
nancialmanagershouldcar ef
ullyevaluatetherequirementofmanpower
to each depart
mentand al l
ocatet he finance tot he human r esource
depart
mentaswages,sal ary,remuneration,commission,bonus,pensionand
othermonetar
ybenefit
st othehumanr esourcedepartment.Hence,financial
managementisdirect
lyrel
atedwi thhumanr esour
cemanagement .

OBJECTI
VESOFFI
NANCI
ALMANAGEMENT
Eff
ecti
veprocurementandef fi
cientuseoffi
nanceleadtopr
operuti
li
zationoft he
fi
nance bythebusi nessconcern.Iti
stheessent
ialpar
toft
hef i
nancialmanager .
Hence,thefi
nancialmanagermustdet ermi
nethebasicobj
ecti
vesoft hefinancial
management.ObjectivesofFi
nancialManagementmaybebroadlydi
videdintotwo
part
ssuchas:
1. Pr
ofi
tmaxi
mizat
ion
2. Weal
thmaxi
mizat
ion.

Weal
th
Pr
ofi
t

Obj
ect
ives

Fi
g.Obj
ect
ivesofFi
nanci
alManagement

Pr
ofi
tMaxi
mizat
ion
Mainaim ofanyki ndofeconomicact ivi
tyisearni
ngpr ofi
t.Abusinessconcer nis
alsofunct
ioningmai nlyforthepurposeofear ningpr ofi
t.Pr
ofiti
st hemeasuring
techni
questounder standthebusi
nessef f
ici
encyoftheconcern.Profitmaximizat
ion
i
sal sothetradit
ionalandnarrow approach,whichaimsat ,maximizest heprofi
tof
theconcern.Profi
tmaxi mi
zati
onconsistsofthefoll
owingimportantfeatures.
1. Pr
ofi
tmaxi
mizat
ioni
sal
socal
l
edascashi
ngpershar
emaxi
mizat
ion.I
tleads
tomaxi
mi zethebusi
nessoperati
onforprofi
tmaximizat
ion.
2. Ult
imat
eai m oft
hebusinessconcer
nisearningprof
it
;hence,i
tconsi
der
sal
l
t
hepossiblewaystoi
ncr easet
heprofi
tabi
li
tyoftheconcern.

3. Pr
ofi
tist
hepar
amet
erofmeasur
ingt
heef
fi
ciencyoft
hebusi
nessconcer
n.
Soi
tshowst
heent
ir
eposi
ti
onoft
hebusi
nessconcer
n.
 4. Pr
ofi
tmaxi
mizat
ionobj
ect
iveshel
ptor
educet
her
iskoft
hebusi
ness.

Fav
orabl
eAr
gument
sforPr
ofi
tMaxi
mizat
ion
Thefoll
owingi
mportantpoi
ntsar
einsuppor
toft
hepr
ofi
tmaxi
mizat
ionobj
ect
ivesof
thebusi
nessconcer
n:
(
i) Mai
nai
misear
ningpr
ofi
t.
(
i) Pr
i ofi
tist
hepar
amet
eroft
hebusi
nessoper
ati
on.
(
ii
i) Pr
ofi
treducesr
iskoft
hebusi
nessconcer
n.
(
iv) Pr
ofi
tist
hemai
nsour
ceoff
inance.
(
v) Pr
ofi
tabi
l
itymeet
sthesoci
alneedsal
so.

Unf
avor
abl
eAr
gument
sforPr
ofi
tMaxi
mizat
ion
Thef
oll
owi
ngi
mpor
tantpoi
ntsar
eagai
nstt
heobj
ect
ivesofpr
ofi
tmaxi
mizat
ion:
(
i) Pr
ofi
tmaxi
mizat
ionl
eadst
oexpl
oit
ingwor
ker
sandconsumer
s.
(
i) Pr
i ofi
tmaxi
mizat
ioncr
eat
esi
mmor
alpr
act
icessuchascor
ruptpr
act
ice,
unf
airt
radepr
act
ice,
etc.
(
ii
i) Pr
ofi
tmaxi
mizat
ionobj
ect
ivesl
eadst
oinequal
i
tiesamongt
hesakehol
der
s
such ascust
omer
s,suppl
i
ers,
publ
i
cshar
ehol
der
s,et
c.
Dr
awbacksofPr
ofi
tMaxi
mizat
ion
Pr
ofi
tmaxi
mizat
ionobj
ect
iveconsi
stsofcer
tai
ndr
awbackal
so:
(
i)I
tisv
ague:I
nthi
sobj
ect
ive,pr
ofi
tisnotdef
inedpr
eci
sel
yorcor
rect
ly.I
t
creat
essomeunnecessar
yopi
nionr
egar
dingear
ninghabi
tsoft
hebusi
ness
concern.
(
i)I
i ti
gnor
est
het
imev
alueofmoney
:Pr
ofi
tmaxi
mizat
iondoesnotconsi
dert
he
ti
mev al
ueofmoneyort henetpresentval
ueofthecashinfl
ow.Itleads
cert
aindiff
erencesbetweentheact
ualcashinf
lowandnetpr
esentcashflow
duri
ngapar ti
cularper
iod.
(
ii
i)I
tignor
esr
isk:Pr
ofi
tmaxi
mizat
iondoesnotconsi
derr
iskoft
hebusi
ness
concer
n.Ri sks maybe int
ernalorext
ernalwhi
ch wi
l
laf
fectt
he ov
eral
l
operat
ion ofthebusi
nessconcern.
Weal
thMaxi
mizat
ion
Wealt
h maximizati
on is one ofthe moder
n approaches,which i
nvolv
es latest
i
nnovati
onsandi mprov
ementsi nt
hefi
eldofthebusinessconcer
n.Theterm wealth
meanssharehol
derwealthortheweal
thofthepersonsthosewhoareinvol
vedint he
busi
nessconcern.
Wealt
hmaxi mizati
onisalsoknownasv al
uemaximizat
ionornetpr
esentworth
maximizat
ion.This object
iveis a uni
ver
sall
yaccept
ed conceptinthe fi
eld of
busi
ness.
Fav
orabl
eAr
gument
sforWeal
thMaxi
mizat
ion
(
i) Weal
thmaxi
mizat
ioni
ssuper
iort
othepr
ofi
tmaxi
mizat
ionbecauset
hemai
n
ai
m ofthebusi
nessconcer
nundert
hisconcepti
stoi
mpr
ovet
hev
alueor
weal
thof thesharehol
der
s.
(
i) We
i al
th maxi
mizat
ion consi
der
sthe compar
ison of t
he v
alue t
o cost
associatedwit
ht hebusi
nessconcern.Totalvaluedet
ect
edf r
om thet
otal
costi ncur
redforthebusinessoper
ation.Itprovi
desext
ractval
ueofthe
businessconcern.
(
ii
i) Weal
thmaxi
mizat
ionconsi
der
sbot
hti
meandr
iskoft
hebusi
ness
concer
n.
(
iv) Weal
thmaxi
miz
ati
onpr
ovi
desef
fi
ciental
l
ocat
ionofr
esour
ces.
(
v)I
tensur
est
heeconomi
cint
erestoft
hesoci
ety
.

Unf
avor
abl
eAr
gument
sforWeal
thMaxi
mizat
ion
(
i) Weal
thmaxi
mizat
ionl
eadst
opr
escr
ipt
ivei
deaoft
hebusi
nessconcer
nbuti
t
maynotbesui
tabl
etopr
esentdaybusi
nessact
ivi
ti
es.
(
i) We
i al
thmaxi
miz
ati
oni
snot
hing,
iti
sal
sopr
ofi
tmaxi
mizat
ion,
andi
tist
he
i
ndi
rectnameoft
hepr
ofi
tmaxi
mizat
ion.
(
ii
i) Weal
thmaxi
mizat
ioncr
eat
esowner
shi
p-managementcont
rov
ersy
.
(
iv) Managemental
oneenj
oyscer
tai
nbenef
it
s.
(
v) Theul
ti
mat
eai
m oft
heweal
thmaxi
mizat
ionobj
ect
ivesi
stomaxi
mizet
he
pr
ofi
t.
(
vi) Weal
thmaxi
miz
ati
oncanbeact
ivat
edonl
ywi
tht
hehel
poft
hepr
ofi
tabl
e
posi
ti
onoft
hebusi
nessconcer
n.

APPROACHESTOFI
NANCI
ALMANAGEMENT
Financi
almanagementappr oachmeasur est hescopeofthef i
nancialmanagement
i
nv ari
ous fiel
ds,which i
nclude the essent i
alpartoft he finance.Financial
managementi s notar evolut
ionaryconceptbutanevoluti
onary.Thedefini
ti
onand
scopeoff i
nanci
almanagementhasbeenchangedf r
om oneper i
odt oanot
herperiod
andappl i
edv ar
iousi
nnovati
ons.Theor et
icalpoint
sofv i
ew,f i
nancialmanagement
approachmaybebr oadl
ydivi
dedi nt
otwomaj orpar
ts.

Appr
oach

Tr
adi
ti
onal
Appr
oach Moder
nAppr
oach
 Fi
g.Appr
oachest
oFi
nanceManagement

Tr
adi
ti
onal
appr
oach:

Thet raditionalappr oacht ot hescopeoff inanci almanagementr ef er

st oi t
s
subj ect-mat ter,inacademi cl i
teratur eint hei nit
ialst agesofi tsevol uti
on,asa
separ atebr anchofacademi cst udy .Thet erm‘ corpor ati
onf i
nance’wasusedt o
descr ibewhati snowknowni nt heacademi cwor ldas‘ f
inanci almanagement ’
.As
thenamesuggest s,t heconcer nofcor porat i
onf i
nancewaswi ththef inanci ngof
cor porateent erpri
ses.I n otherwor ds,thescopeoft hef inancef unctionwas
treatedbyt het radi
tional approachi nthenar rowsenseofpr ocur ementoff undsby
cor porateent er pri
set omeett hei rf i
nancingneeds.Thet erm‘ pr
ocur ement ’was
usedi nabr oadsensesoast oi ncludet hewhol egamutofr ai
si ngfundsex ternal
ly.
Thusdef i
ned, thefieldofst udydeal ingwi thf inancewast r
eat edasencompassi ng
threei nterrelat edaspect sofr aisingandadmi ni st
er i
ngr esour cesf rom out side:(i
)
thei nstituti
onalar rangementi nt hef orm off inanci alinsti
tutionswhi chcompr i
se
theor gani zat i
onoft hecapi t
almar ket;(ii
)t hef inanci ali
nstrument sthroughwhi ch
fundsar er aisedf r
om t hecapi talmar ketsandt her elatedaspect sofpr acticesand
the pr ocedur al,aspect s ofcapi talmar kets;and ( ii
i)the legaland ac c ounti
ng
relati
ons hipsbet weenaf i
rm andi tss ourcesoff unds .

Moder
nAppr
oach

Themoder napproachviewst hetermfinanci

almanagementi nabr oadsenseand
providesaconceptualandanal yti
calf
ramewor kforfi
nanci
al maki
ng.Accor di
ngt o
i
t,t he fi
nance functi
on cov ers bot
h acquisit
ions offunds as wel las t hei
r
all
ocations.Thus,apartfrom theissuesinvol
vedi nacquir
ing-
ext
er nalfunds,the
mainconcer noff i
nancialmanagementi stheef f
ici
entandwi seal locati
onof
fundst ovari
oususes.Def inedinabroadsense, iti
sviewedasani ntegralpartof
overallmanagement .

Thenewapproachi sananalyt
icalwayofv i
ewingthef i
nanci
alpr oblemsofaf irm.
Themai ncontentsofthisappr oacharewhati st hetotalv ol
umeoff undsan
enter
pri
seshoul dcommit?Whatspeci f
icassetsshouldanent er
priseacquire?
Howshouldthef undsr
equir
edbef i
nanced?Alt
ernati
vely,
thepr i
ncipalcontentsof
themodernappr oachtofi
nancialmanagementcanbesai dt obe:( i
)How l arge
shoul
danent erpri
sebe,andhow f astshoul
di tgrow?(ii
)Inwhatf orm shouldit
holdasset
s?(i
ii
)Whatshouldbet hecomposit
ionofitsli
abil
i
ties?

The three questi

ons posed above coverbet ween them the majorf i
nancial
probl
emsofaf ir
m.I notherwords,fi
nanci
almanagement ,accordi
ngt othenew
approach,isconcernedwiththesoluti
onoft hr
eemaj orprobl
emsr el
ati
ngt othe
fi
nancialoper
ati
onsofaf ir
m, cor
respondi
ngt othethr
eequestionsofinvest
ment ,
fi
nancinganddi videnddecisi
ons.Thus,financialmanagement ,i
nt hemodem
senseoftheter
m, canbebrokendownintot
hreemajordeci
sionsasfunct
ionsof
fi
nance:(i
)Thei nvestmentdeci
sion,(
ii
)Thef i
nanci
ngdecision,and(i
ii)The
div
idendpol
icydeci
sion.

FUNCTI
ONSOFFI
NANCEMANAGER

Financef unctionisoneoft hemaj orpartsofbusinessorganization,whichi nvol

vesthe
per manentandcont i
nuousprocessoft hebusi nessconcern.Fi nancei soneoft he
i
nt err
elatedfunctionswhichdealwi thpersonalfuncti
on,marketingf uncti
on,producti
on
functionandr esear chanddevelopmentact iv
iti
esoft hebusinessconcer n.Atpresent,
ever ybusinessconcer nconcentratesmor eont hef i
el
doffinancebecause,i tisav er
y
emer gingpar twhi chrefl
ectstheent i
reoperati
onalandpr ofitabilit
yposi ti
onoft he
concer n.Decidingtheproperfi
nanci alf
uncti
onist heessent
ialandul ti
mat egoalofthe
businessor ganizati
on.
Fi
nancemanageri soneoft heimport
antr
olepl ayersi nthefi
eldoff inance
funct
ion. Hemusthav eentir
eknowledgeint heareaofaccount i
ng,finance,
economicsandmanagement .Hisposi
ti
onishighlycri
ticalandanalyt
icalt
osol ve
vari
ousprobl
emsr el
atedtofi
nance.Apersonwhodeal sf inancer
elat
edact ivi
ti
es
maybecalledfi
nancemanager
.
Fi
nancemanagerper
for
mst
hef
oll
owi
ngmaj
orf
unct
ions:
1.For
ecast
ingFi
nanci
alRequi
rement
s
Itistheprimaryfuncti
onoft heFinanceManager. Heisresponsiblet o
esti
mate t hef i
nanci
alrequir
ementoft hebusi
nessconcern.Heshoul d
esti
mate,how muchf i
nancesrequi
redtoacqui
refi
xedassetsandf orecast
theamountneededtomeett heworki
ngcapit
alr
equi
rement
sinfutur
e.
2.Acqui
ri
ngNecessar
yCapi
tal
Aft
er decidi
ng the f
inanci
alrequi
rement
,the f
inance manager shoul
d
concent
ratehow thef
inanceismobi
liz
edandwhereitwil
lbeavai
labl
e.Iti
s
al
sohighlycr
iti
cali
nnatur
e.
3.I
nvest
mentDeci
sion
Thefinancemanagermustcar eful
lysel
ectbestinvestmentalter
nativesand
consi
dert hereasonabl
eandst ableret
urnfr
om thei nvest
ment.Hemustbe
wellversedint hef i
eldofcapi talbudgeti
ngtechni questodet erminethe
eff
ecti
veut i
li
zati
on ofi nvest
ment .Thefi
nancemanagermustconcent r
ate
topri
ncipl
esofsaf et
y,l
iquidi
tyandpr of
it
abi
li
tywhileinvest
ingcapital
.

4.CashManagement
Presentday’
scashmanagementpl ay
samaj orrol
eint heareaoffinance
because propercash managementi s notonly essent
ialforeffecti
ve
uti
li
zati
onofcashbut i tal
sohel
pstomeett heshort
-t
erml i
qui
dit
yposit
ion
oftheconcern.
5.Int
errel
ati
onwi t
hOtherDepart
ments
 Finance manager deal
s withv ar
ious funct
ionaldepart
ment s such as
mar keti
ng,product
ion,per
sonnel,system,r esear
ch,dev el
opment ,et c.
Financemanagershouldhavesoundknowl edgenotonlyinf i
nancer el
ated
area butalso wellver
sed i
n ot herareas.He mustmai ntai
n a good
relat
ionshi
pwithal
lthef
unct
ional
departmentsofthebusi
nessorganizati
on.
Depar
tment
-I
For
ecast
ingFunds

ngFunds
V

Accqur
I

Depar
t -
ment

t
i
Managi

ngFunds

ment
Depar
Fi
nance
Manager

-I
II
Depar
tment
-I
I

Fi
gFunct
ionsofFi
nanci
alManager

I
MPORTANCEOFFI
NANCI
ALMANAGEMENT
Financeisthel i
febloodofbusi nessorgani
zation.Itneedstomeett herequirementof
thebusinessconcer n.Eachandev erybusinessconcer nmustmai ntai
nadequat e
amountoff inancef ortheirsmoothrunningoft hebusinessconcernandalsomai nt
ain
thebusinesscar efull
ytoachi evethegoalofthebusi nessconcern.Thebusinessgoal
canbeachi evedonl ywi ththehel pofef f
ectivemanagementoff i
nance.Wecan’ t
neglecttheimpor tanceoff i
nanceatanyt imeatandatanysi tuati
on.Someoft he
i
mpor tanceoft hef i
nancialmanagementi sasf oll
ows:

Fi
nanci
alPl
anni
ng
Fi
nancialmanagementhel
pst odeter
mi nethefi
nanci
alrequi
rementofthebusi ness
concer
nandl eadst
otakefinanci
alplanni
ngoftheconcern.Financi
alpl
anningisan
i
mpor t
antpar
tofthebusi
nessconcern,whichhel
pstopromoti
onofanent er
prise.

Acqui
sit
ionofFunds
Fi
nancialmanagementinvolvestheacqui
sit
ionofrequi
redfinancetot hebusiness
concern.Acqui
ri
ngneededfundsplayamajorpar
tofthef
inancialmanagement,which
i
nvolvepossibl
esour
ceoffinanceatmini
mum cost.

Pr
operUseofFunds
Properuseandal l
ocat
ionoffundsleadst
oi mprov
et heoperati
onaleff
ici
encyofthe
businessconcer
n.Whenthef i
nancemanagerusesthefundsproper
ly,t
heycanreduce
thecostofcapit
alandi
ncreasetheval
ueofthefi
rm.

Fi
nanci
alDeci
sion
Financi
almanagementhel pstot
akesoundf
inanci
aldeci
sioni
nthebusi
nessconcern.
Financi
aldeci
sionwi l
laff
ecttheent
ir
ebusinessoperat
ionoftheconcer
n.Because
thereis adir
ectr el
ati
onshipwi
thvari
ousdepart
mentfuncti
onssuchasmar ket
ing,
producti
onpersonnel
,etc.
I
mpr
ovePr
ofi
tabi
l
ity
Prof
it
abi
li
tyoftheconcernpurel
ydependsontheeffect
ivenessandpr operutil
i
zat
ion
offunds bythe busi
ness concer
n.Financi
almanagementhel ps t
oi mpr ovethe
prof
it
abi
l
ityposit
ionoftheconcernwiththehel
pofst r
ongf inanci
alcontroldevi
ces
suchasbudgetar
ycontr
ol,r
ati
oanalysi
sandcostvol
umepr ofitanal
ysi
s.

I
ncr
easet
heVal
ueoft
heFi
rm
Financi
almanagementisveryimport
antinthefi
eldofincr
easingtheweal
thofthe
i
nv est
orsandt
hebusinessconcer
n.Ul
timateai
m ofanybusi
nessconcer
nwil
lachi
eve
themaxi mum prof
itandhigherprofi
tabi
l
ityl
eadsto maximizethewealt
hoft he
i
nv est
orsaswel
lasthenati
on.

Pr
omot
ingSav
ings
Savi
ngsar epossibl
eonlywhent hebusinessconcer near nshigherprofi
tabi
li
tyand
maximizi
ngwealth.Eff
ecti
vefinanci
almanagementhel pst opromot i
ngandmobi li
zing
i
ndivi
dualandcorporatesavi
ngs.Nowaday sfi
nancialmanagementi salsopopular l
y
knownasbusinessf i
nanceorcor porat
efinances.Thebusi nessconcer
norcor porate
sect
orscannotfuncti
onwithouttheimportanceofthefinancialmanagement .

Ti
meVal
ueofMoney
:

The ti
mev al
ue ofmoney( TVM)i stheconceptt hatmoneyav ail
ableatt hepr esentt
ime
i
swor thmor ethanthei denticalsum i nthef utureduet oit
spot ential
 earningcapacity
.
Thiscor eprinci
pleoffinancehol dst hatpr ovidedmoneycanear ninterest,anyamount
ofmoneyi swor t
hmor et hesooneri tisr eceived.TVM isalsosomet imesr efer
redtoas
presentdiscountedv alue.Thet i
mev alueofmoneydr awsf rom thei deat hatrati
onal
i
nv estorsprefertoreceivemoneyt odayr atherthant hesameamountofmoneyi nt he
futurebecauseofmoney 'spot ent
ialt ogr ow inv al
ueov eragiv enper iodoft i
me.For
exampl e,moneydeposi t
edi ntoasav ingsaccountear nsacer taininterestrateandi s
thereforesaidtobecompoundi nginv alue.

Reasonsf
ort
imev
alueofmoney
:

1.Thef utur
eisalwaysuncertai
nandi nv
olv
esri
sk.Ani
ndi
vidualcanneverbe
cert
ainofgett
ingcashinfl
ow i
nfutur
eandhencehewi
lll
i
ket orecei
vemoney
todayinst
eadofwai
tingfort
hefut
ure.

2.Peoplegenerall
yprefertouset heirmoneyforsati
sfy
ingt hei
rpresentneedsin
buyingmoref ood,orclot
hesoranot hercar
,thandef
erri
ngt hem f
orfutur
e.The
presentneedsar econsider
edur gentascompar edtofuture needs,moreover
,
theremayalsobeaf earinone’
smi ndthathemaynotbeabl etousethemoney
i
nf utur
eforfearofil
lnessordeath.

3.Moneyhastimevaluebecauseoftheoppor
tunit
iesavai
l
abl
et oinvestmoney
r
ecei
vedatearl
i
erdatesatsomei
nter
estorot
herwiset
oenhancefutur
eearni
ngs.
 Forexampl e,i
fyouhav eRs.100today,y
oucanputi ti
ny ourbankaccountand
earninterest.Aft
eroney earint
erestwoul
dbeRs.8andy ouwouldhaveRs.108
attheendoft heyear
.So,ifyouhaveachoicebet
weenRs. 100todayoraft
erone
year,iti
st hesameasachoi cebetweenRs.108nextyearandRs.100nextyear
.
Anyr ati
onal woul
dprefert
hel ar
geramount.

Techni
quesoft
imev
alueofmoney
:

Therear etwomethodsusedforascert
aini
ngt heworthofmoneyatdif
fer
entpoint
sof
ti
me, namel y
,compoundi
nganddiscount
ing.Compoundingmethodisusedtoknowt he
fut
urev alueofpr
esentmoney.Conver
sely,
discount
ingisawaytocomputethepresent
val
ueoff uturemoney.

COMPOUNDI
NGTECHNI
QUE:

Iti
st hemethodofcal cul
atingt hefuturev al
uesofcashf l
owsandi nvol v
escal cul
ati
ng
compoundi nterest
. Undert hisprocess,i nterestiscompoundedwhent heamount
earnedonani ni
tial
deposit(theinit
ialprinci
pal)becomespar toftheprincipalattheend
oft hef i
rstcompoundi ngper iod.Principalreferst otheamountofmoneyonwhi ch
i
nter esti
sr eceivedthatis,incompoundi ng,fut ureval
uesofcashf lowsatagi ven
i
nter estr
ateattheendoft hespecifiedper i
odoft imearefound.Thefuturev al
ue(F)of
alumpsum t oday(P)fornper iodsati rateofinteresti
sgivenbytheformul a

Fn=P(
1+i
)n=P(
CVFn,
i
).

Andthecompoundv al
uefact
orcanbefoundoutbyr
efer
ri
ngt
ot hetabl
eofcompound
val
ues.Forexample:ifRs1000isi
nvest
ed@ 10%compoundinter
estfor3year
s,t
he
ret
urnf
orfi
rstyearwi
ll
be

Amountatt
heendoft
he1sty
ear=(
1000)+(
1000x0.
10)=Rs,
1,100
Amountatt
heendoft
he2ndy
ear=(
1000)+(
1100x0.
10)=Rs,
1,210
Amountatt
heendoft
he3r
dyear=(
1000)+(
1210x0.
10)=Rs,
1,331
Thecompoundi nter
estphenomenoni smostgener al
lyassociat
edwi t
hseveralsavi
ngs
deposit
edwi t
hthem.Ast heint
erestr
ateincreasesforsomegi venyear,
thecompound
i
nterestfact
oral
soincreases.Theref
ore,thehighertheint
erestrat
e,thegreateri
sthe
fut
uresum.

DI
SCOUNTI
NGTECHNI
QUE:

Discounting 
is t he pr ocess of det ermining pr
esent value 
of a ser ies of
future 
cash fl
ows. Present val
ue of a future 
cash  f
low (i
nfl
ow or out
flow) isthe
current 
wor t
h ofaf utur
esum of money  
orstream of  
cash 
fl
owgivenaspecif
iedrat
eof
return.
 Pr
esentv al
ue isalsocall
ed di
scountedv alue.
Presentval
ueist
hereci
procalofcompoundval
ue.Today
’sval
ueofar
upeer
ecei
vabl
e
atanyf ut
uredat
eisknownaspr esentv
alueofmoney.Ifwewantt
ogetthesame
purchasi
ngpowerorexchangev alueofasum ofanyf uturedat
eont hepr
esentday,t
he
nominalsum wi llbesmal l
er.Inotherwor
ds,t hevalueofRs.100atanyf utur
edat e
mustbeequi val
entt oasum ofRs.100mi nussomet hingoftoday.Thereducti
onof
nominalsum f rom t henomi nalsum ofaf uturedatei sduetochangei ntime.The
deducti
onofnomi nalsum dependsont her ateofinterestorrequi
redrat
eofr et
urn.
Hencepr esentvaluei sascer¬t
ainedbysubt
r acti
ngdiscountsfr
om thenominalmoney
offutur
edat e.

Thetechniqueusedt ocalculat
epr esentv alueofmoneyi sknownasdi scounting.Just
as inthe compoundi ng technique there mayar ise t
wo ki nds ofproblems whi l
e
cal
culati
ngt hepresentvalueofmoney .Firstly,t
heremaybeasi nglesum receivabl
eat
aparti
cularfutur
ey earwhosepr esentvaluei stobecalculated.Secondl
y,theremaybe
aser i
esofsumsr ecei
vablei nsev eralf utureyearswhosepr esentvaluei st o be
cal
culated.Theser i
esofsumsmaybeev enorunev en.Ifitisevenwegett heannui t
y
ser
ies.

ConceptofDi scounti
ng:
Discounti
ngisapr ocessoft ranslat
ingfuturecashf l
oworaser i
esoffut
urecashflows
i
ntot oday’
sv al
ue.Today ’svalueisknownast hepr esentval
ueoffut
urecashinf
lows.
Presentvalueisascertainedbysub¬t ract
ingdiscountsfrom t
henominalmoney.Under
thediscounti
ngt echnique,discountiscalculat
edont hereducedval
ueoftheoriginal
sum ev er
yy ear.Inotherwor ds,di
scount i
ngpr ocessisrepeatedonthedimini
shing
balanceoftheor i
ginalsum.

TechniquesofDiscount
ing:
Justasundercompoundi ng,t
herearedi
ffer
entt
echni
quesdev el
opedf
orascertaini
ng
thepresentval
uedependingonthefr
equencyoft
hediscount
ingamountrecei
vableina
l
umpsum oraser i
esofcashfl
ows.

TwoCent
ral
Ter
ms:
PresentVal
ueandFut
ureVal
ue:

Indiscountedcashflowanal ysisDCF, two" timev alueofmoney "termsarecentr

al:
Presentvalue(PV)iswhatt hef uturecashf lowiswor thtoday.
Futurevalue(FV)isthevaluet hatflowsi noroutatt hedesignat
edt i
meinthefutur
e.
A $100cashi nfl
ow thatwi llar r
ivetwoy earsf rom now coul d,forexample,havea
presentvaluetodayofabout$95, whilei t
sfuturev alueisbydefini
ti
on$100.
Foreachcashf l
owev ent,
t hepr esentv alueislesst hant hecor
respondi
ngfutureval
ue,
exceptforcashf l
owev ent
soccur ri
ngt oday ,i
nwhi chcasePV=FV) .

Thef urtheri
ntothefuturebeforeacashfloweventoccurs,
themor ediscounti
nglowers
thepr esentvaluebel
owi tsfutur
evalue.Thet
otalofallofthecashf l
owpr esentval
ues
forthecashf lowseries,acr
ossat i
mespanext endi
ngintothefuture,i
sthenetpresent
value( NPV)ofacashf lowstream.
DCFi scenterstagewhendeci si
onmaker sandinvestorseval
uatepotenti
ali
nvestments,
acti
onpr oposals,orpur chases.Lookingf orwar
di nt ime,theanalystproject
scash
i
nflowsandout fl
ows( cashflowst r
eams)t heinv
est orcanexpectfrom eachoft hese.
Otherthingsbei ngequal,analystswil
lrecommendt heacti
onori nvest
mentwi ththe
mor esubstanti
al cashfl
owNPV, asthe"bett
erbusinessdecisi
on."