Finance

Finance may be defined as the provision of money at the time when it is required. It refers to the
management of flows of money through an organisation .

Financial Management

Financial management refers to the application of planning and controling function of

management to the finances of the organisation.

Importance of Financial Management

● Finance is considered as the life blood of an organisation.

● Helps in obtaining sufficient funds at minimum cost.

● Ensures effective utilisation of funds and

Tries to generate maximum profits to finance the expansion and modernisation of the
enterprise.

● Ensures safety of funds through creation of reserves and re investment of profits.

Relationship Of Finance With other Business Functions:

● Purchase function- Raw materials needs to be procured in order to undertake

production which will require the availability of enough funds to make purchases.A
finance manager plays a key role in procurement of the raw materials at the best
possible price.

● Production Function- For undertaking production, the firm will need machinery and
staff. For all of this, money will be required which will be arranged by finance manager.
● Sales and Marketing function- Advertisement is an expense for the company which
requires some funds to be spent on it.

Similarly, all the functions are dependent on the finance function thats why it is considered to be
a life blood for an organisation.

Functions in Financial Management

1.Executive/ Major functions-

● Financial forecasting
● Investment decision
 ● Managing corporate asset structure
● Management of income
● Management of cash
● Deciding new sources of finance
● To carry negotiations
● Analysis and appraisal of financial performance.

2. Routie Functions-
● Record keeping
● Preparation of financial statements
● Cash planning and its supervision
● Credit management
● Custody and safeguarding financial securities
● Assisting top management with current and future expected business conditions.

Scope/ Approaches to Finance Function-

1. Traditional Approach- This approach evolved during 1920s and remained till 1950.
● At that time Financial Management was known as Corporate Finance.
● The role of a finance manager was very limited only to arrange funds from financial
markets or by banks and other financial institutions.

Limitations of Traditional Approach

● Outward looking approach as ot ignores proper utilisation of funds.

● Ignores working capital financing
● Limited Empowerment of finance manager.

Modern Approach- The modern approach views finance in a broader sense. It includes both
raising of funds as well as thier effective utilisation as a pat of finance. In this approach the role
of a finance manager was broadened and now he or she is supposed to execute a variety of
tasks such as estimating financial requirements, raising funds from at the best possible cost,
thier effective utilisation and so on.

Major Financial Decisions-

1.Investment Decision- The investment decision can be classified into two categories namely:
● Short term investment decision/ working capital finance- The money is arranged to meet
day to day financial requirements of a business such as rent, wages, salaries etc. The
money is genrally required for less than a year.
● Long term Investment- The money is arranged to purchase assets such as land,
building, machienery, etc and fulfill the expansion plans of the organisation. The money
 is needed for genrally more than a year and the decision is taken on the basis of capital
budgeting.

2 . Financing Decision-

It is concerned with arrangement of funds to finance the desired investment project. A finance
manager explores and compares various souces of funds and selects the one which is most
suitable to the needs of the organisation.
Some important points to be kept in mind while arranging funds:
● Source of finance
● Cost of capital
● Capital structure
● Terms and Conditions of the financier

3. Dividend Decision- Dividend is the part of profit which an organisation distributes among its
shareholders. It is a type of cost to the organisation which it pays to the partners of the company
or shareholders.

Effect of Dividend Decision on the welath of shareholders and Valuation of a Firm-

It is a five step process, lets understand it in a simplified way:

1. Company decides to pay dividend
2. The demand for company’s share increases due to the good news.
3. Increase in the price of company’s share price
4. Increase in the Wealth of the shareholders
5. Increase in the market capitalizion of the firm.

Time Value Of Money

Annuity- A series of equal payments or cashflows over a specific period of time is known as
annuity.

There are 2 types of annuity:

1. Regular or Deferred Annuity- When the cashflows occur at the end of the period, it is
known as regular annuity.
2. Annuity Due- When the cash flows occur in the beginning of the period, it is known as
annuity due.

Techniques Of Time Value Of Money

1. Compounding Technique- This technique helps to find the future value of money with
the help of a given present value.
 2. Discounting Technique- This technique is helpful in calculating the present value of
money with the help of given future values.

The future value at the end of the period can be calculated by a simple formula given below.

● Vn= Vo(1+i)whole power n

● Where, Vn is Future value of period

● Vo is present value
● i is interest rate

Doubling Period

1. Rule of 72- Doubling Period= 72/ Rate of Interest.

2. Rule of 69- Doubling period=.35+69/ROI

Multiple Compounding Periods

● Vn= Vo(1+i/m) whole power n×m

● Where, Vn is future value
● Vo is present value
● i is interest rate
● m is frequency of compounding in a year

EIR( Effective Interest Rate)

EIR is used to find the actual rate of interest when ther is more than one compounding period
because the money is compounded more than once in a year so the interest rate should be
higher than what we are given in question.

● EIR= (1+i/ m) whole power m - 1

● Where EIR is effective rate of interest
● i is nominal interest rate
● m is frequency of compounding in a year

Compound Value Of Regular Annuity

● Vn = R(ACF i,n)
● Where R is annuity value
● ACF is an annuity compound factor which is given in the compound factor table.
● i is interest rate
● n is the number of years
Compound Value Of Annuity Due

● Vn = R (ACF i,n) (1+i)

● Where R is annuity value
● ACF is an annuity compound factor which is given in the compound factor table.
● i is interest rate
● n is the number of years

Present Value

● Future Value/(1+r) whole power n

Present Value of Regular Annuity

● Vo= R(ADF i, n)
● Where, R is the value of annuity
● ADF is the annuity discount factor which is given in the table.
● i is the discount rate
● n is number of years.

Present Value of Annuity Due

● Vo= R(ADF i, n) (1+i)

● Where, R is the value of annuity
● ADF is the annuity discount factor which is given in the table.
● i is the discount rate
● n is the number of years.