SHAH SIR’S

ARIHANT COMMERCE CAREER ACADEMY

-a step towards excellence
Campus 1: C/o Mahatma Fule School, Mudholkar Peth, Amravati.
Campus 2: Raghunandan Terminal, Opp. Govt. Polytechnic,Amravati.

Class: - MBA 1ST Year 2Rd Sem Subject:- CORPORATE FINANCE

FINANCE MANAGEMENT AND PLANNING

FINANCIAL MANAGEMENT -

MEANING

For any business, it is important that the finance it procures is invested in a manner that the returns
from the investment are higher than the cost of finance. In a nutshell, financial management –

 Endeavors to reduce the cost of finance

 Ensures sufficient availability of funds

 Deals with the planning, organizing, and controlling of financial activities like the
procurement and utilization of funds.

DEFINITION
“Financial management is the activity concerned with planning, raising, controlling and
administering of funds used in the business.” – Guthman and Dougal

“Financial management is that area of business management devoted to a judicious use of capital
and a careful selection of the source of capital in order to enable a spending unit to move in the
direction of reaching the goals.” – J.F. Brandley

“Financial management is the operational activity of a business that is responsible for obtaining and
effectively utilizing the funds necessary for efficient operations.”- Massie
The scope of Financial Mangement

The introduction to financial management also requires you to understand the scope of financial
management. It is important that financial decisions take care of the shareholders‘ interests.

Further, they are upheld by the maximization of the wealth of the shareholders, which depends on
the increase in net worth, capital invested in the business, and plowed-back profits for the growth
and prosperity of the organization.

The scope of financial management is explained in the diagram below:

Core Financial Management Decisions

In organizations, managers in an effort to minimize the costs of procuring finance and using it in the
most profitable manner, take the following decisions:

1. Investment Decisions: Managers need to decide on the amount of investment available out
of the existing finance, on a long-term and short-term basis. They are of two types:

 Long-term investment decisions or Capital Budgeting mean committing funds for a long
period of time like fixed assets. These decisions are irreversible and usually include the ones
pertaining to investing in a building and/or land, acquiring new plants/machinery or replacing
the old ones, etc. These decisions determine the financial pursuits and performance of a
business.

 Short-term investment decisions or Working Capital Management means committing funds

for a short period of time like current assets. These involve decisions pertaining to the
 investment of funds in the inventory, cash, bank deposits, and other short-term investments.
They directly affect the liquidity and performance of the business.
2. Financing Decisions: Managers also make decisions pertaining to raising finance from
long-term sources (called Capital Structure) and short-term sources (called Working
Capital). They are of two types:

 Financial Planning decisions which relate to estimating the sources and application of
funds. It means pre-estimating financial needs of an organization to ensure the availability of
adequate finance. The primary objective of financial planning is to plan and ensure that the
funds are available as and when required.

 Capital Structure decisions which involve identifying sources of funds. They also involve
decisions with respect to choosing external sources like issuing shares, bonds, borrowing
from banks or internal sources like retained earnings for raising funds.
3. Dividend Decisions: These involve decisions related to the portion of profits that will be
distributed as dividend. Shareholders always demand a higher dividend, while the
management would want to retain profits for business needs. Hence, this is a complex
managerial decision.

Principles of Financial decision

Principles act as a guideline for investment and financing decisions. Financial managers take
operating, investment, and financing decisions. Some of this is related to the short term and some
long term. The 6 Principles of Finance everyone should Know whether it is for individuals or
organizations.
1. Risk and Return

The principle of Risk and Return indicates that investors have to be conscious of both risk and
return, because the higher the risk higher the rates of return, and the lower the risk, the lower the
rates of return. For business financing, we have to compare the return with risk. To ensure
optimum rates of return investors need to measure risk and return by both direct measurement
and relative measurement.

2. Time Value of Money

This principle is concerned with the value of money, that value of money is decreased when time
passes. The value of $1 of the present time is more than the value of $1 after some time or years.
So before investing or taking funds, we have to think about the inflation rate of the economy and
the required rate of return must be more than the inflation rate so that the return can compensate
for the loss incurred by the inflation.

3. Cash Flow

The cash flow principle mainly discusses the cash inflow and outflow, more cash inflow in the
earlier period is preferable to later cash flow by the investors. This principle also follows the
time value principle that’s why it prefers earlier benefits rather than later years benefits.

4. Profitability and Liquidity

The principle of profitability and liquidity is very important from the investor’s perspective
because the investor has to ensure both profitability and liquidity. Liquidity indicates the
marketability of the investment i.e. how easy to get cash by selling the investment. On the other
hand, investors have to invest in a way that can ensure the maximization of profit with a
moderate or lower level of risk. This is best overlooked by a qualified accountant to ensure all
tax obligations are met.

5. Diversity

This principle helps to minimize the risk by building an optimum portfolio. The idea of a
portfolio is, never to put all your eggs in the same basket because if it falls then all of your eggs
will break, so put eggs separated in different baskets so that your risk can be minimized. To
ensure this principle investors have to invest in risk-free investments and some risky investments
so that ultimately risk can be lower. Diversification of investment ensures minimization of risk.

6. Hedging

The hedging principle indicates that we have to take a loan from appropriate sources, for short-
term fund requirements we have to finance from short-term sources, and for long-term fund
requirements we have to manage funds from long-term sources. For fixed asset financing is to be
done from long-term sources.

Finally, if you have a basic understanding of finance and its principles then you will be able to
take financial decisions effectively. And there is a higher possibility to become financially
gainer.

AGENCY PROBLEM –
An agency problem is a conflict of interest inherent in any relationship where one party is
expected to act in another's best interests. In corporate finance, an agency problem usually
refers to a conflict of interest between a company's management and the company's
stockholders. 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 their own wealth.

 An agency problem is a conflict of interest inherent in any relationship where one party
is expected to act in the best interest of another.
 Agency problems arise when incentives or motivations present themselves to an agent to
not act in the full best interest of a principal.
 Through regulations or by incentivizing an agent to act in accordance with the
principal's best interests, agency problems can be reduced.

ORGANIZATION OF FINANCE FUNCTION-

Today, finance function has obtained the status of a science and an art. As finance function has
far reaching significance in overall management process, structural organization for further
function becomes an outcome of an important organization problem. The ultimate responsibility
of carrying out the finance function lies with the top management. However, organization of
finance function differs from company to company depending on their respective requirements.
In many organizations one can note different layers among the finance executives such as
Assistant Manager (Finance), Deputy Manager (Finance) and General Manager (Finance). The
designations given to the executives are different. They are
Chief Finance Officer (CFO)

Vice-President (Finance)

Financial Controller

General Manager (Finance)

Finance Officers

Finance, being an important portfolio, the finance functions is entrusted to top management. The
Board of Directors, who are at the helm of affairs, normally constitutes a ‘Finance Committee’ to
review and formulate financial policies. Two more officers, namely ‘treasurer’ and
‘controller’ – may be appointed under the direct supervision of CFO to assist him/her. In larger
companies with modern management, there may be Vice-President or Director of finance,
usually with both controller and treasurer.
It is evident from the above that Board of Directors is the supreme body under whose supervision
and control Managing Director, Production Director, Personnel Director, Financial Director,
Marketing Director perform their respective duties and functions. Further while auditing credit
management, retirement benefits and cost control banking, insurance, investment function under
treasurer, planning and budgeting, inventory management, tax administration, performance
evaluation and accounting functions are under the supervision of controller.

Meaning of Controller and Treasurer

The terms ‘controller’ and ‘treasurer’ are in fact used in USA. This pattern is not popular in
Indian corporate sector. Practically, the controller / financial controller in India carried out the
functions of a Chief Accountant or Finance Officer of an organization. Financial controller who
has been a person of executive rank does not control the finance, but monitors whether funds so
augmented are properly utilized. The function of the treasurer of an organization is to raise funds
and manage funds. The treasures functions include forecasting the financial requirements,
administering the flow of cash, managing credit, flotation of securities, maintaining relations
with financial institutions and protecting funds and securities. The controller’s functions include
providing information to formulate accounting and costing policies, preparation of financial
reports, direction of internal auditing, budgeting, inventory control payment of taxes, etc.
According to Prof. I.M. Pandey, while the controller’s functions concentrate the asset side of the
balance sheet, the treasurer’s functions relate to the liability side.

Emerging Role of a Financial Manager in India

Financial activities of a firm is one of the most important and complex activities of a firm.
Therefore in order to take care of these activities a financial manager performs all the requisite
financial activities.

A financial manger is a person who takes care of all the important financial functions of an
organization. The person in charge should maintain a far sightedness in order to ensure that the
funds are utilized in the most efficient manner.

His/Her actions directly affect the Profitability, growth and goodwill of the firm.

Following are the main functions of a Financial Manager:

1. Raising of Funds

In order to meet the obligation of the business it is important to have enough cash and
liquidity. A firm can raise funds by the way of equity and debt.

It is the responsibility of a financial manager to decide the ratio between debt and equity. It
is important to maintain a good balance between equity and debt.

2. Allocation of Funds

Once the funds are raised through different channels the next important function is to
allocate the funds.

The funds should be allocated in such a manner that they are optimally used. In order to
allocate funds in the best possible manner the following point must be considered

1. The size of the firm and its growth capability

2. Status of assets whether they are long-term or short-term
3. Mode by which the funds are raised

These financial decisions directly and indirectly influence other managerial activities. Hence
formation of a good asset mix and proper allocation of funds is one of the most important
activity

3. Profit Planning
 Profit earning is one of the prime functions of any business organization.

Profit earning is important for survival and sustenance of any organization. Profit planning
refers to proper usage of the profit generated by the firm.

Profit arises due to many factors such as pricing, industry competition, state of the economy,
mechanism of demand and supply, cost and output.

A healthy mix of variable and fixed factors of production can lead to an increase in the
profitability of the firm.

Fixed costs are incurred by the use of fixed factors of production such as land and
machinery. In order to maintain a tandem it is important to continuously value the
depreciation cost of fixed cost of production.

An opportunity cost must be calculated in order to replace those factors of production which
has gone thrown wear and tear. If this is not noted then these fixed cost can cause huge
fluctuations in profit.

4. Understanding Capital Markets

Shares of a company are traded on stock exchange and there is a continuous sale and
purchase of securities. Hence a clear understanding of capital market is an important
function of a financial manager.

When securities are traded on stock market there involves a huge amount of risk involved.
Therefore a financial manger understands and calculates the risk involved in this trading of
shares and debentures.

Its on the discretion of a financial manager as to how to distribute the profits. Many
investors do not like the firm to distribute the profits amongst share holders as dividend
instead invest in the business itself to enhance growth.

The practices of a financial manager directly impact the operation in capital market.

Financial Planning
A financial plan is an overall evaluation of an individual's current pay and future financial state
by using the current known variables to predict the future income, asset values, and withdrawal
plans. Financial Planning includes the budget which organizes the business and the individual
finances and at times includes a series of steps or specific goals for spending and saving for the
future. This plan distributes the future income to various types of expenses such as rent or
utilities and also reserves some income for the short-term and long-term savings as well. A
 financial plan is sometimes referred to as an investment plan, while personal financing focuses
on specific areas like risk management, estates, colleges, or retirement.

Objectives of Financial Planning

 Preparing a budget: Financial planning helps you prepare the budget that fits your financial
plan. It enables you to track your income and expenditure and minimizes your expenses.

 Determine current financial position: Financial planning helps determine your current
financial position by analyzing your current income, expenses, and liabilities. It considers your
future goals and helps you create an investment plan to achieve them.

 Setting up financial goals: It helps you identify your financial goals. These goals may include
retirement savings, buying or constructing of home, children’s education or marriage, etc.

 Setting up financial plans: Financial planning allows you to take action to achieve your short-
or long-term goals. It lays down the various investing strategies you can use to achieve your
financial goals.

 Review financial plans: It is mandatory to monitor your financial plans regularly so that it is
aligned to achieve your goals. Financial planning helps you in reviewing your portfolio
performance.

Advantages / Benefits of Financial Planning

Financial planning is important due to following reasons:

1) Increasing Business: Financial planning helps in increasing the scale of the business, as it
provides for proper funding as well as operating plans.

2) Easy Operations: A good financial plan also helps for easy operations. A business is able to
work smoothly as all the plans and procedures are discussed in proper details. Proper control
system also allows for early detection of deviations.

3) Proper Utilisation of Capital: A good financial plan allows for proper use of capital including
tangible and intangible assets. It also ensures that the business is able to access latest technology
and machinery as required.
4) Optimum Scaling of Operations: Financial planning helps in proper development of the
business. It helps in achieving financial as well as operational efficiency. It is also important for
recognising various current and potential issues.

5) Better Fund Management: Financial planning helps in proper management of business funds.
It also ensures that the firm is able to meet its financial obligations as and when required. It
builds the goodwill of the firm and prevent from over trading situations.

6) Increasing Return: Financial planning is also important to ensure that the firm is able to make
full use of its capital. It avoids instances of over or under-capitalisation and helps to achieve
better rate of return.

Steps to financial planning

Step 1 - Defining and agreeing your financial objectives and goals
The goals and objectives will be the guide to the financial plan and should provide a roadmap for
your financial future. They should contain the following features:

 Quantifiable and achievable

 Clear and have a defined timeframe

 Separate your needs from your wants

They should be agreed and documented with your financial adviser to assist you measure
progress. They should also be reviewed periodically to capture changing circumstances and to
ensure they remain relevant.

Step 2 – Gathering your financial and personal information

The financial planning process and its success will depend on the quality and clarity of the
information communicated to your adviser. Your adviser will complete a detailed financial fact-
find to capture all relevant information in relation to your finances. This will include:

 Income and expenditure

 Assets and liabilities

 Risk attitude, tolerance and capacity

Step 3 – Analysing your financial and personal information

Your financial adviser reviews the information provided in step 2 and uses it to produce a report
that reflects your current financial profile. The following ratios are produced to improve your
understanding of your financial circumstances and to pinpoint areas of strength or weakness:
 Solvency Ratio

 Savings Ratio

 Liquidity Ratio

 Debt Service Ratio

Your attitude, tolerance and capacity for risk are assessed using a psychometrically designed risk
tolerance questionnaire in relation to investment assets. This is also analysed to assess your asset
allocation for investment or pension goals.

Step 4 – Development and presentation of the financial plan

The financial plan is developed based on the information received in step 2 and analysis
completed in step 3. Each of the goals and objectives in step 1 should be addressed and a
recommendation for each identified. It will include:

 Net worth statement (a balance sheet)

 Annual consolidated tax calculation

 Annual cash flow report (displaying surplus or deficit)

The report is presented, explained, discussed and then signed by both client and adviser.

Step 5 – Implementation and review of the financial plan

Once the analysis and development of the plan is complete, the adviser will outline the
recommended courses of action. This can involve implementing:

 A new pension or investment strategy

 Changing debt provider

 Additional life or serious illness insurance

 Income and expenditure adjustments

The Adviser may carry out the recommendations or serve as your coach, coordinating the
process with you and other professionals such as, accountants or investment managers. They
may also handle the interaction with financial product providers.

Financial planning is a dynamic on-going process that requires continuous monitoring. Review
of the actions recommended in the plan should take place regularly, and the goals should be
reviewed annually to take account of a change in income, asset values, business or family
circumstances.
Factors affecting financial planning

1. Understand Spending Routine

First, you must check out your spending behavior because it defines your financial planning.
More expenses will cause fewer savings and affect your retirement goals and insurance needs.
So, if you spend unnecessarily, it’s time to think again and create a budget to save a significant
share of your earnings as savings. However, you can remember that when you fail to control
your financial behavior, you also fail to execute the best standards for financial planning.

2. Investment vs Savings

How do you manage your money to use as investment and savings? Savings are essential to keep
in hand to avail good opportunities. At the same time, good investment options help you generate
wealth with limited earning sources. You can invest your money in NPS, FD, Mutual Funds,
Shares, Debentures, and other investment options. So, you can keep getting an ideal return on
investment and achieve several financial planning milestones. However, if you haven’t focused
on investment and savings yet, it can be a big mistake you are making right now. Because
keeping money in the bank is not only the way to walk with time and do financial planning.

3. Backup for Emergencies

None of the financial planning runs without thinking about backup for emergencies. If you only
invest money and save funds in the bank, it is insufficient. Because an emergency can come at
any time and cause the loss of all money and assets you have built. Hence, it’s also essential to
get a good health cover and life insurance for you and your family members. So, you can easily
face a hard time without affecting your financial planning. There are many ways you can get
good health and life coverage at low premiums. Hence, you should research and find the ideal
insurance to avail.

4. Financial Goals

Do you know what your financial goals are and their numbers? Knowing several financial goals
is essential. It is also essential to make financial goals that are time-bound and measurable. It
helps you decide which goal you can easily accomplish and which can take time. For example,
you need to buy a home and invest money in a retirement plan and other activities. So, when you
have these achievable goals, you can decide how you will allocate your money and put these.

5. Age and Dependents

Most people work on financial planning after their 30s, which can be a matter of thinking.
Because the more age you will have, the more burden you will have to face. Hence, you can start
working on your financial plan early. It can be the 20s or 22s. Because when you avail insurance
cover or invest in any asset, you will find less premium or amount compared for aged people.
However, if you do not think in the early stage, it can be one of the factors affecting financial
planning.

6. Trend in Culture

The current culture is changing and evolving, and now you have to come up with different ideas
to fulfill your goals. For example, if you want to do graduation or want to buy a home, in that
case, you can not rely on your savings. You may have to take a loan from organized or
unorganized sectors. And for this, you need to have a stable income source to pay the premium
and loan amount. Hence, while confirming your financial plan, you must also add a clause for
this section to stay prepared to face any situation.

7. Inflation Rate

You might have a stable source of income, and you are putting efforts into maintaining your
financial planning and keeping running. But suddenly, the inflation rate started rising, and
everything became costly. You have the same income and sources in that scenario, but things
have become costly. You may have to pay more interest on the loan, receive less interest on your
savings account, and share prices start decreasing. Your financial planning can be at risk and
cause you a loss in such a situation. However, it’s an external factor, and individuals do not have
control. But still, it’s good to think about it at once and prefer your plan based on it.

8. Financially Independence

Do you know when you will become financially independent? Some people want to buy a home,
some want to pay an unlimited premium of NPS to get pension and retirement benefits, and some
want to maximize their wealth by 10x. So, what is your financial goal, and what do you want to
achieve? You must know the answer to the same question to make the most of the financial plan
you just created.

9. Financial Advisor

A financial advisor helps you understand how to diversify your money and maximize wealth.
They also help you understand various earning and tax-saving opportunities. You can consult
with your family or professional CAs, CFOs, and other financial advisors. Because they know
how to make a proper chart of financial planning that has a proper element of investment,
savings, emergency funds, tax-saving funds, and other options. It’s a holistic approach but works
well in most situations. So, you should also consult with a certified financial advisor to achieve
your goals on time.

Capitalisation
Capitalization means the amount of capital invested in a business. The capital of the
company may comprise various types of securities such as common and preferred stock,
debentures, bonds and long term loans which are summed up in the capital account on a
balance sheet.

This invested capital and debt, generally of the long-term variety, comprises a company’s
capitalization, i.e., a permanent type of funding to support a company’s growth and related
assets.

According to Guthman and Dougall, “capitalization is the sum of the par value of stocks
and bonds outstanding”.

“Capitalization is the balance sheet value of stocks and bonds out stands”. -Bonneville and
Dewey.

According to Arhur. S. Dewing, “capitalization is the sum total of the par value of all
shares”.

Stages of Capitalisation

The amount of Capitalisation is computed by both cost theory and capitalized value of
earning theory. However capitalized value of earning theory is considered to be more
scientific and modern. One can highlight upon the justification of the amount of
capitalization by considering the earning of the concern.

If the amount of capitalization is more as compared to earnings, it will be called the stage of
‘over-capitalisation’; when the amount of capitalization is less as compared to earnings; it is
a case of ‘under-capitalisation’. However, when the amount of capitalization is the same as
warranted by the amount of earnings, it is a case of ‘Fair Capitalisation’.

(A) Over-Capitalisation:

It is quite clear that when any business concern continuously fails to earn as much income
on the capital employed as not sufficient to give dividend at a reasonable rate to its
shareholders, this is constantly a case of over capitalisation. According to Bonneville,
Dewey and Kelly, “When a business is unable to earn a fair rate of return on its outstanding
securities, it is over capitalised.”

In this connection, Gerstenberg opines that a “corporation is over-capitalised when its

earnings are not large enough to yield a fair return on the amount of stocks and bonds that
have been issued.” Hogland has to say on this point “Whenever the aggregate of par values
of stocks or bonds outstanding exceeded the true value of fixed assets, the corporation was
said to be over-capitalised.”

It must be clear that a company is said to be over-capitalised only when it has not been able
to earn fair income over a long period of time. In such a situation, the real values of a
company’s total assets would be less than their book values. As a result, market value of
equity shares declines.

(B) Under-Capitalisation:

Under-capitalisation is just the reverse of over-capitalisation but it should never be taken to

indicate deficiency or inadequacy of capital. The stage of under-capitalisation arises when
the concern starts earning at a rate higher than current rate. In fact, it is an index of proper
and effective utilisation of capital employed in the concern.

In the words of Gestenberg, “A Corporation is under capitalised when the rate of profits, it
is making on the total capital is exceptionally high in relation to the return enjoyed by
similar companies in the same industry or when it has too little capital with which to
conduct its business.”

On the other hand, Hogland is of the opinion that under-capitalisation means excess of
assets when compared with total share capital invested in the business. In fact, under-
capitalisation is indicative of sound financial position and good management of the
company.

(C) Fair Capitalisation:

In essence, there should neither be over-capitalisation nor under-capitalisation. It is very

essential for a business entity to have fair capitalisation. Fair capitalisation is that stage of
capitalisation where the amount of capitalisation is the same as warranted by the amount of
earnings.

In other words, at fair capitalisation:

Actual Rate of Earning = Current Rate of Earning

Real Value of the Business = Book Value of the Business

Real Value per Share = Book Value per Share

This stage of fair capitalisation is a very ideal situation. This can be achieved by debt and
equity components in the capitalisation.