CHAPTER - 1

we all
must
OBJECTIVES OF FIN
know that
NANCIAL MANAGEMENT

be resources are
do not utilized in the Walways
y s scarce whereas
scarce the demand for those is very high.
So the resources

deposit wn learn in financial management.

organisations Some
the v e manner. This
borrowed
funds, cheques
yet
they rece on
receive
we
pay heavy
the same day. Such organizations
charges interest
arises because; these
on

organisations
Tupee idle
they
have no reali Overy fa1 in realising their own debtors. All this
realisa On of the time value of money. It has to be realised by everybody that, keeping
even for aa do the finance
day tcosts. and their solutions
are to be understood by
manager. S All these problems and
s . All
problems
Financial management
deals with procurement of funds and its utilisation.
Discuss the functions of financial management.
ne
activities / functions of a
financial manager can be divided into tour eads.
a) Acquisition of i.e capital mix decision or financing
decision
capital
b) Employment of capital i.e long term asset mix decision
or investment
decision.

c) Distribution of profits lividend or profit allocation

decision.
d) a n c e of
i. decision.
working capital 1.c short term asset mix decision liquidity
or

1.
Financing decision
where
structure i.e when,
manager has to determine about the best financing mix or capital investment. 1ne COrc
una how to acquire the fund to meet the monetary requirement of the firm's structure.
proportion of debt/ equity mix and this is called the firm's capital
determine
theto obtain the best financing nix i.e the optimum capital structure. Optimum
O manger strives
Here the
price of shares is
aptal structure is that combination of debt and cquity where the market
maximum
A finance manager while procuring funds must consider the following three factors:

(1B) Controi (C) Risk

(A) Cost

is lowest in debentures is they areissued at low rate. Also the interest is tax
(A) Cost: The cost
deductible Equity Shareholder has higher diividencd expectation and even dividends are not tax
deductible. So the cost of equity is high.

When company issues further eyuity shares, it automatically dilules the controlling
(B) Control: a
have voting
Cuulative prelerence shareholders can
interest of the present owners. Similarly.
ol the Board of Directors, in case dividends on such
rights and thereby affect the composition
F'inancial institutions normally stipulate that they
shares are not paid for two consecutive years.
FHence. when the management agrees to raise
shall have one or more directors on the 15rds.
lo forego a part of its control over the
loans from financial institutions. by inplication lgrees
isions coneening capit:al structure are taken after
company. It is obvious, theretore, Th:it
keeping the control factor in nin

v : ilerest is paid in case of losses

even
Risk The debentures entail a lug. ue,
. is
(C) and are to be repaid on redemption anl lirsily on liquidation. This is not the case with equity

shares.
to be at the minimum but with proper balancing of risk and control
The cost of the fund has
factors. In the age of only the procurement of funds is not enough. The
globalization,
resources must be mobilised through innovative ways or such financial products, which caters
 to the needs of investor's viz. multiple option convertible bond. Further funds can even be
raised from abroad. So the pros and cons of resources from abroad must also be considered.
2. Investment decision:
Funds procuredfrom different sources have to be invested in various kinds of assets. Long term
funds are used in a project for various fixed assets and also for current assets. A part of long term
funds is also to be kept for financing the working capital requirements. The inventory policy would
be determined by the production manager and the finance manager. The financial implications of
each investment decision are to be thoroughly analysed. This is done through techniques of capital
budgeting decision.
(i) Evaluation of profitability of new investment.

ii) Measurement of cut-off rate against which the return on new investment can be compared.
Investment decision is very important as the project is to be evaluated on expected profits and
prediction about future is never easy. Further a large amount of money is involved. The recovery
of investment in undesirable sectors is very low.

3. Dividend decision:
The finance manager is concermed as to how much to retain and how much to pay. This also is to be
based on maximization of the MPS of the firm. So that dividend policy is considered the best, which
optimises the MPS. At the time of taking this decision availability of cash profits, liquidity, legal
requirements, tax, Ke etc. are considered.
4. Liguidity decision:
This involves the management of cash, debtors, stock and total working capital that affects the

solvency. Here the manager has to decide how much f

earning prospects of a firm, liquidity and
efficiently. This
is to be invested in each and every item of current assets and to manage those
ensures that too much funds are not blocked in stock, debtors and cash etc.

5. Other Functions:
review the financial
Evaluating financial performance : A finance manager has to constantly
Such a review helps the
performance of the various units of organisation generally in terms of ROI.
in various divisions and what can be done to
management in seeing how the funds have been utilised
improve it.

Financial negotiation: The finance manager plays a very important role in carrying out negotiations
with the financial institutions, banks and public depositors for raising of funds on favourable terins.
Cash management : The finance manager lays down the cash management and cash disbursement
with view to supply adequate funds to all units of organisation and to ensure that there is
policies a
no excessive cash.

Keeping touch with stock exchange : Finance manager is required to analyse major trends in stock
market and their impact on the price of the company share.

What arethe Objectivesof financialmanagement:

Objectives offinancial management
It has traditionally been argued that the objective of the business is to maximize the profits. Hence the
objective of financial management is also considered to be profit maximised. This implies that finance
manager makes his decision in such a manner that the profits are maximized. However it cannot be the sole
objective of the business. There is another objective of finance manager and that is wealth maximization. Let
us consider these two in the light of their pluses and minuses.
 1ent
Profit Maximisation: -6

produce
This eans the firm
has to
or
maximisation of the
maximum output rupee Ome of the fim. So
under this theory
market price of its product
really
the above is
Services or to from
rom a a
give
given amount of input, or the firm to
increase
the market

reduce nd omoetitive and following a

competitive
are s

aifficult and almost the amount of expenditure rfectly theory

and following

impossible to achieve. It is dered asas a sho short -term

a
criticisms e v e .
considered
consi
a) Iheterm profit is vague. It conveys a different meaning to differentpeople Or
is the possibility
b) is a direct the risk higher
Ihere relationship
ship between risk and
profit. Higher
profit. Hg be ignored
totally.
PIOfits. If profit mav the risk factor has to important
A I s a t i o n is the only goal, most
which is the
c) does not take into account the time pattern of
returns, starts to
accrue

ne theory than another

project but its profits
Onsideration. If a project gives more total profits money.
value of
Say arter l0 or 15 years, the former project may be rejected
because of time Profit
practices.
well as ethical trade
d) fails to consider the interest of workers,
workers, consumers,
consumers, sociey as
society h t e d policy
policy of the product.
of the produe
Amisation at the coa or is a shortsighted
t Or social and moral obligation
e) c quality of the product is deteriorated. Goodwill in long term is hampeiu

Wealth Maximisation: of the company

is to create value
The objective
It means the maximisation ofthe wealth of the shareholders.

for its shareholders. According to VanHome "value is represented by the dividenddecisions. The value
and
investment, financing dividend b risk of these
y Snares) which in turn is a function of firm's future earnings per share, the timing and
O e irm takes into account present and prospective factors
earnings, the dividend
camings, dividend policy of the firm and many other and
condition company imdus
of c0. general economic
Vdrket price per share depends on performance & supply factors of market,
mass psychology, goodwill
Srucure, dividends, timing & risks, demand
A
etc.

The value is a function oftwo factors

a. The likely rate of EPS and
b. Capitalisation rate.
MPS = EPS/Ke
is going to operate in
depends
rate of EPS upon the assessment as to how profitably a company
The likely If a company
the expectations of the company's shareholders.
the future. The capitalisation rate reflects not look upon
or risky financing pattern, the investors will
earns a high rate of EPS through risky operations
the MPS will be low.
its share with favour. To that extent

that his decisions are such that the MPS of a company in long run is
The finance manager has to ensure
financial policy has to be such that it optimises the EPS, keeping in view
maximised. This implies that the
mind. Wealth maximisation is therefore a better objective for a commercial
the risk and other factors in
undertaking since it represents both return and risk.

Conflicts in Profitversus Value Maximisation Principlee

In any company, the management is the decision taking authority. As a normal tendency the management
may pursueits own personal goals (profit maximization). But in an organization where there is a significant
outside participation (shareholding, lenders ete.), the management may not be able to exclusively pursue its
personal goals due to the constant supervision or tne various stakeholders of the company-employees,
creditors, customers, government, ec. EverY ennty associated with the company will evaluate the
performance of the management from the fulfillment of its own objective. The survival of the management
vill be threatened if the objective of any of the entities remains unfulfilled.
ealth maximization objective is generally in accord with the interests of the various groups such as
pioyees, creditors and society, and thus, it may be consistent with the management objective or
Owing to limitation (timing, social consideration etc.) in profit maximization, in today's real world
SIuations which is uncertain and
multi-period in nature, wealth maximization is a better objecave
time period is short and degrec of profit
where the
maximization amount to ess:lially the s a .
uncertainty is not great, wealth maximization and

The table below highlights of

some the ada s d lisadvantages of both profit maximization anna
wealth maximization goals:-
Goal Objective Advantages Disadvantages
Profit Large amount ) Easy to calculate profits Emphasizes the short term

Maximization of profits (ii) Easy to determine the link gains

between financial decisions (ii) Ignores risk or uncertainty
and profits. (iii) Ignores the timing of returns
(iv) Requires immediate resources.
Shareholders Highest market (i) Emphasizes the long term (i) Offers no clear relationship
between financial decisions
Wealth value of shares gains
Maximisation (ii) Recognises risk or uncertainty and share price.
(ii) Can lead to management
(ii) Recognises the timing of anxiety and frustration.
returns
(iv) Considers shareholders.
return.