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Finance may be defined as the art and science of managing money. The major areas of finance are financial services and managerial finance/corporate finance/financial management. Financial services is concerned with the design and delivery of advice and financial products to individuals, businesses and governments.
Finance - Introduction
In modern competitive business world finance is the key store of each and every operational activities of the business. No business can be started without adequate financial resources . All business concern needs money to make more money.
Finance - Introduction
Finance is defined as the provision of money at the time when it is required. Without adequate finance, no enterprise can possibly accomplish its objectives. Finance has been traditionally classified into two classes: 1. Public finance; and 2. Private finance.
Finance - Introduction
Public finance deals with the requirements, receipts and disbursements of funds in the government institutions like states, local self-governments and central government. Private finance is concerned with requirements, receipts and disbursements of funds in case of an individual, a profit seeking business organization and a nonprofit organization.
Finance - Introduction
Private finance can be classified into: 1. Personal finance, 2. Business finance; and 3. Finance of non-profit organizations. Personal finance deals with the analysis of principles and practices involved in managing one’s own daily need of funds. The study of principles, practices, procedures, and problems concerning financial management of profit making organizations engaged in the field of industry, and commerce is under taken under the discipline of business finance.
religious. .Introduction The finance of non-profit organization is concerned with the practices. procedures and problems involved in financial management of charitable. social and the other similar organizations.Finance . educational.
.Finance .Introduction Financing of sole trader and partnership is easy and the financial requirements are limited. In case of company type of organization financial requirements are huge volume of finance which cannot be contributed by a few investors.
. creating value to the assets of the business enterprises by efficient allocation of funds. Financial management is the overall management effort which is closely associated with planning and controlling of company’s financial resources.Financial Management Financial management is concerned with raising of funds. It means manage the finance is called financial management.
In any finance manager must understand the real problems associated with procurement of funds to identify the way for optimum utilization of funds. .Financial Management It is a specialized function of general management. It gives the special attention for the effective management of funds.
. “Financial Management is the area of business management devoted to a judicious use of capital and a careful selection of sources of capital in order to enable a business firm to move in the direction of reaching its goals”.Financial Management Definition “Financial Management is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations”.
harmonizing individual motives and enterprise goals”. .Financial Management Definition “Financial Management is an area of financial decision making.
Basic Principles of financial Management Risk and Return Time value of Money Cash flow concept Incremental cash flow analysis Wealth Maximization .
.Basic Principles of financial Management Risk and Return: Every financial decision has two aspects these are risk and return. Every decision involves a risk. Time Value of money: It refers to the mathematics of finance for calculating future values and present values of cash. Financial Management decisions are taken to optimize returns through the calculations of risk and return.
Basic Principles of financial Management Cash Flow Concept: Financial management is based on the inflows and outflows of cash. It uses cash revenues and cash-expenses to find out the return on its investments. This concept helps in judging whether the new project is good for the firm. Incremental cash flow analysis: Cash flows are measured of those proposals which are an addition to the already existing projects. .
Basic Principles of financial Management Wealth Maximization: maximization of shareholders wealth considers all cash flows pertaining to futures decisions. It is the concept based on cash flows to measure the economic value of a firm. .
Traditional approach and 2.Evolution of Financial Management The evolution of financial management can be discussed under two distinct approaches these are 1. . Modern approach. The traditional phase was called the outsider looking approach and the modern phase is called the insider looking approach. The traditional phase was from 1920 to 1950 and the modern phase began in 1950.
.Traditional Approach Procurement of funds: This approach was concerned with the procurement of funds through an analysis of financial instruments. institutions and sources of funds. Outsider looking approach: It only considered the interest of the outsiders and there was no emphasis on the investment of funds.
preference shares and debt securities.Traditional Approach Capital Budgeting: The attention given by financial management was towards the procurement of funds for long-term use. Working capital was not considered at all. Financial instruments: Its function for procuring funds was through the issue of financial instruments like equity share. .
Modern Approach The modern approach to financial management gave the subject increased responsibilities and brought about an integrated and analytical scope of finance. Integrated finance function: Finance as a subject is a study of capital markets and institutions. It also covers security markets and studies security analysis and portfolio management .
It covers the allocation of funds not only in long-term usage but also in day-to-day routine matters. Leverage 4. Cost of capital 3. Capital budgeting 2. Working Capital .Modern Approach Management Function: Finance is no longer an outsider looking approach. 1. Techniques: Modern financial management covers tool and techniques of evaluation in the following areas.
Anticipating of financial needs: Financial management of the organization has to estimate financial needs with the help of the cash flow statements. cash budgets and other related tools.Importance of Financial Management Acquiring financial resources: It involves the organization has to decide where to obtain fund for their business needs. . It requires tapping the potential sources of funds and raising the funds at low cost for both short term as well as long term financial needs of the company.
Importance of Financial Management Guide to Decision making: Financial management contributes valuable guidance to concern with regard to important financial aspects. Analyzing financial performance: All entrepreneurs must expect a continuous and consistent return on investment. The cost of each financial decision and return of each must be analyzed . Allocating the funds in business: It indicates allocation and deployment of funds to various assets enable to achieve the maximum return.
Importance of Financial Management Finance for Business promotion: Adequate finance is very much essential for the successful operation of the any business. Accounting and reporting: It indicates financial management of the concern should advise and supply information about the financial performance to the top management. .
The funds will have to be raised from various sources. It is not possible to substitute or eliminate this function because the business will close down in the absence of finance. The development and expansion of business rather needs more commitment for funds.Finance Function Finance function is the most important of all business functions. The sources will be selected in relation to the implications attached with them. .
The funds should be used in such a way that maximum benefit is derived from them. . Proper Utilization of funds: Though raising of funds is important but their effective utilization is more important.Aims of finance function Acquiring sufficient funds: The main aim of finance function is to assess the financial needs of an enterprise and then finding out suitable sources for raising them.
sufficient funds will have to be invested.Aims of finance function Increasing Profitability: The planning and control of finance function aims at increasing profitability of the concern. Maximizing Firm’s Value: . To increase profitability.
Financial Decisions Investment Decisions Financing Decisions Dividend Decisions .
The assets may be 1. Long term assets and 2. Long-term assets which will yield a return over a period of time in futures. .Investment Decision The investment decision relates to the selection of assets in which funds will be invested by the firm. Short-term or current assets defined as those assets which in the normal course of business are convertible into cash shortly. Short-term or current assets.
Capital Budgeting: It is the long term investment decision. It is probably the most crucial financial decision of a firm. It relates to the selection of an assets or investment proposal or course of action whose benefits are likely to be available in future over the life-time of the project. .Investment Decision The first category of assets is popularly known as capital budgeting in the financial literature and the second category is known as working capital management.
. Decision relates to risk and uncertainty Decision relates to evaluation of worth of the long term project.Investment Decision The long-term assets can be either new or old/existing ones. It involves decision relates to the choice of the new assets.
Working capital = CA . Current assets means the assets that can be converted into cash shortly. When there is no sufficient working capital organization become illiquid and may not have ability to meet its current obligation.CL The optimum expected current ratio is 2:1 .Investment Decision Working Capital Management: It is concerned with the management of the current assets.
.Financing Decision It is broadly concerned with financing mix or capital structure or leverage. The term capital structure relates to the optimum combination of Debt and Equity. The best combination indicates that combination which give more return to the shareholders. It is the duty of the financial manager to identify the proper proportion of the sources of funds that maximize return to the shareholders.
Financing decision involves 1. .Financing Decision The source of funds that maximize return to the shareholders. Capital structure theory 2. Capital structure decision.
Here it is very important to decide 1. whether to retain the dividend by the organization for future development and expansion. dividend payout ratio (D/P) is 100%. .Dividend policy decision Dividend is that part of profit paid to the shareholders. Whether to pay dividend to the shareholders 2. When the entire profit is given to the shareholders as dividend.
If cost of equity is greater that the return on investment. D/p ratio should be 100%. If cost of equity is less than return on investment dividend may be retained by the organization.Dividend policy decision If the entire profit is retain by the organization. D/P ratio is 0% and Dividend retention ratio is 100%. .
Profit Maximization Wealth Maximization .Goal or Objectives of Financial Management Objective of financial management is the decision making or goal of financial management.
In specific operational terms. financing and dividend policy decision of a firm should be oriented to the maximization of profits. actions that increase profit should be undertaken and that those that decrease profits are to be avoided. the profit maximization criterion implies that investment.Profit Maximization as a decision Criterion According to this approach. as applicable to financial management. .
projects and decisions which are profitable and reject those which are not. They are Owner-oriented concept Operational concept According to owner-oriented concept profit is amount of share paid to owners.Profit Maximization as a decision Criterion 1. . profit is referred as profitability. According to operational concept we select assets. 2. According to operational concept. The term profit can be used in two senses.
Profit is a test of economic efficiency.Profit Maximization as a decision Criterion In the literature of financial management. It provides the yard stick by which economic performance can be judged. . profit maximization is concerned as on the basis of operational concept and we avoid profit on the basis of owners concept.
Ambiguity (confusion) 2. being questioned and criticized several grounds. Timing of benefit 3. 1.Profit Maximization as a decision Criterion Profit maximization criteria has however. Quality of benefit .
and so on. It leads to confusion. .Ambiguity Profit maximization criteria for financial decision making is based on the term profit which is vague and ambiguous. It conveys different meaning to different people. profit may be short-term or long-term. If profit maximization is an objective. it may be beforetax profit or after tax. which one of the above profit should be maximized. it may be total profit or rate of profit. To illustrate.
000 Profit before tax Tax Rate Profit after tax Rs.Ambiguity Project I Investment Rs. 60.00.000 50% Rs. 54. 3. 1.00.00. 3.000 Project II Rs.000 Rs.000 10% Rs.000 . 50.
5000 ---Period II 10000 10000 Period III 5000 10000 ------------------20000 20000 .Timing of Benefit If profit maximization is the objective. we choose the project which gives more return that is we apply bigger the better principle. Let us consider the following example. Time – pattern of benefits (Profits) Project A Project B Period I Rs.
.Timing of Benefit Both the project A and project B are identical. It profit maximization is the objective. So it is concluded that profit maximization does not considered timing of benefit. Project A gives more return to the earlier stage. both the project are ranked equally and we cannot choose the better principle. when we apply the bigger the better principle. Actually here we apply earlier the better principle.
risk is more. . when uncertainty is more. the higher the quality of benefit. The term quality here refers to the degree of certainty with which benefit can be expected. That is more certainty.Quality of benefit Profit maximization technique does not consider quality of benefits.
Uncertainty about expected benefits (profits) Project A Recession 900 Project B ---- Normal Boom 1000 1100 ______ 3000 1000 2000 ______ 3000 .
Project B has wide fluctuation and has more uncertainty. So we choose project A. Project A has less fluctuation and has more certainty.Uncertainty about expected benefits (profits) When we apply profit maximization technique. . we cannot conclude the better projects. But applying quality of benefits.
Therefore profit maximization objective is ignore. Has Ambiguity 2. Profit maximization technique 1.Finally we arrive the following results. Does not consider quality of benefits. . Does not consider the time value of money 3.
The shareholders economic value is the dividend that he receives presently and the future dividend benefits and capital appreciation of the share. The market price of a share is the present value of all the future cash flows in terms of benefits and dividend expected from the firm. .Wealth Maximization The shareholders wealth is reflected in the market value of the share.
.Wealth Maximization The three important financing decisions are taken through the cash flow concept of finding out the present value of the share. Wealth maximization has the advantage of considering the time value of money. which is the basic principle of financial management.
This removes any doubt about the concept of risk.Wealth Maximization This concept measures risk and uncertainty. The value of the firm’s share is measured through the net present value. which is useful to understand the market value of the share. Thus wealth maximization can be considered to be consistent with the objective of maximizing owner’s wealth. .
Concept Time value of money means that the value of a unit of money is different in different time periods. .Time Value of Money . Time value of money is analyzed because the value of money keeps on changing. Under this concept the value of money received today is more than the value of same amount of money received after a certain period.
Time Value of Money . If the money received at a later date is compensated by receiving a higher amount at the end of the period than it is today. The time preference of money is usually because of a rate of interest. .Concept Most people think that money has a much greater value today than the amount of money that is received at a later date.
Concept The individual will try to receive a compensation for the postponement of his receipt of money. His required rate of return is called the opportunity cost of capital.Time Value of Money . . He will also have some risk attached to postponement.
2. At a future they may not be able to purchase goods because of risk in the market due to inflation.Time Value of Money . . Time value of money is based on three important aspects: Compensation for uncertainty: An individual is keen to possess money in the present date because he is certain that the money with him is liquid. The future is full of uncertainties. Preference for present consumption: Many people feel that money received today can provide the acquisition of goods and services that they require for their needs. For these reasons money is preferred at a current date.Concept 1.
If an individual has an availability of cash he can determine alternative opportunities to re-invest his funds in those available outlets.Concept 3. .Time Value of Money . The re-investment opportunity: The relevance of possessing money currently is a justification for investing funds whenever he can earn a higher amount.
Techniques of Time value of Money Compounding Technique Discounting or Present Value Technique .
Under this method the interest received is actually reinvested.Compounding Technique According to the compounding technique the interest earned on the principal amount becomes a part of principal at the end of the compounding period. Compounding technique is used to determine the future value of money. .
This is calculated for single cash flow or for a series of cash flows. the rate of interest and the number of years for which it is invested. . The future value(FV) consists of the present value(PV).Compounding Technique Compound Value: The compound value is the future value(FV) of money.
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