FINANCIAL MANAGMENT

MODULE-1

MODULE-1
1. 2.

Introduction to finance Objectives of financial managemt Changing role of finance managers Organization of finance function profit max wealth max.

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DEFINITION OF FINANCIAL MANAGEMENT

The subject of financial management deals with the managerial activity which is concerned with the planning and controlling of firm¶s financial resources. According to Van Horne & Wachowicz, ³Financial Mgt is concerned with the acquisition, financing & mgt of assets with some overall goal in mind.´ To quote, Joseph & Massie, ³Financial mgt is the operational activity of a business that is responsible for obtaining & effectively utilizing the funds necessary for efficient operations´. To conclude, ³finance is the backbone of every business´

INTRODUCTION TO FINANCE

FINANCE is the art & science of managing money FINANCIAL SERVICES is concerned with the design & delivery of advice & financial products to individuals, businesses & governments. APPROACHES/EVOLUTION OF FM

Traditional Approach

Transitional Approach

Modern Approach

TRADITIONAL PHASE (1920¶S)

Lasted for 4 decades It focused on 4 selected as aspects: It treats the entire subject of finance from the outsiders point of view (invt. Bank, lenders, others) rather than the financial decision maker in the firm. Focus on corporate finance (procurement of funds) Sequence of treatment was on certain episodic events like: Formation-issuance of capital-major expansion -merger-reorganization liquidation during the Life Cycle of an enterprises. Heavy emphasis on long-term financing & lacks emphasis on the problems of working capital management

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2.

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TRANSITION PHASE

It began in the early 1940¶s -1950¶s Similar to earlier phase Emphasis is given to the day-to-day (working capital) problems faced by the financial managers. Capital budgeting techniques were developed.

MORDERN PHASE

Began in the mid 1950¶s Commendable devpt. With combination of ideas from economic & statistics has led the F.M to be more analytical & quantitative. Focused more on efficient & wise allocation of funds to various uses & defined in a broad sense In addition to the above aspects ««« Supply of funds to all divisions of organization Supervision of cash inflows and outflows Evaluation of performance of various divisions Keeping touch with the stock exchange, market price of shares. Record keeping Maintaining liquidity.

     

SCOPE OF FINANCIAL MANAGEMENT
1 Investment decision (acquiring of asset) (asset mix decision)
a)

Long Term Assets Short Term/Assets

Capital budgeting (selection of invt proposal-profitable) Working capital management (trade-off b/w profitability and risk) Financing decision (financing-mix / capital structure) Dividend policy decision (dividend-pay out ratio)

b)

2 3

Three broad activities of Finance Management: 1. Capital Budgeting 2. Capital structure 3. Working capital management.

FUNCTIONAL AREAS OF FINANCIAL MANAGMENT
1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13.

Determining financial need Determining Sources of funds. Financial Analysis Optimal capital structure Cost volume profit analysis. Profit planning and control Fixed assets management. Project planning and evaluation. Capital budgeting Working capital management Dividend policies Acquisitions and mergers. Corporate taxation

OBJECTIVES OF FM

Profit maximization Wealth maximization-Share holder orientation Sales maximization To maximize economic Value Added (EVA)

 Maximization of profits.
Simply means maximizing the rupee income of the firm. This objective is justified by the following points. a. Business is an economic activity carried on for making profits. b. It also maximizes social economic welfare c. Only profit maximize will survive in the long run. d. Profit is the proof of success. e. Profit is the best source of funds for expansion, growth and innovation. f. Profit is essential for earning goodwill, recognition and prestige in the market. g. Reward for risk taking.

There are several reasons as to why some firms don¶t want to have profit maximization as the objective:
1. To attain industry leadership

2. To prevent competition

3. To avoid government intervention

4. To ensure customer satisfaction

5. To avoid labor unrest

6. To maintain sufficient liquidity.

PROFIT MAXIMIZATION

ARGUMENTS INFAVOUR OF PROFIT MAXIMIZATION

1. 2. 3. 4. 5.
1. 2. 3. 4. 5. 6. 7. 8.

It is a measure of economic efficiency Ensures maximum welfare toall stakeholders Increases confidence of the management Attract investors Indicates efficient use of funds
ARGUMENTS AGAINST PROFIT MAXIMIZATION It is a vague term Does not consider time value of money Does not take into account risk Encourages corrupt practices More profit attract government intervention Cutthroat competition Problems from employees True picture of organization-not reflected.

Limitations:
1. It is vague 2. It ignores the time value of money 3. It ignores risk 4. It overlooks quality aspect of future activities 5. No dividend

W EALTH MAXIMIZATION

Prof. Ezar Solomon adopted wealth- maximization/ value maximization objective which removes all the drawbacks of the profit maximization objectives. The wealth or µNet Present Worth¶ of a course of actions is the diff. b/w gross present worth& the amount of capital investment required to achieve the benefit. Gross Present-worth represents the present value of expected cash benefits. In simple, it means maximizing the present value of a course of action.

Steps for wealth maximization:
1. Avoid high level of risks 2. Pay dividend 3. Maintain growth in sales 4. Maintain the price of firm¶s equity shares

Implications of Wealth Maximization

1. Supplier of loan capital/lenders/creditors 2. Employees/workers 3. Society/public 4. Management/employer

WEALTH MAXIMIZATION-MAXIMIZES MARKET CAPITAL
1. 2. 3. 4.

Features Increase in Profit Reduction in cost Judicious mix of funds Minimum risk ARGUMENTS IN FAVOUR It is a broad term Considers time value of money & risk factors Focus on stakeholders interest Helps in framing a strong dividend policy

1. 2. 3. 4.

MANAGERS VERSUS SHAREHOLDERS¶ GOALS

A company has stakeholders such as employees, consumers, suppliers, government and society.

debt-holders,

Managers may perceive their role as reconciling conflicting objectives of stakeholders. This stakeholders¶ view of managers¶ role may compromise with the objective of SWM. Managers may pursue their own personal goals at the cost of shareholders, or may play safe and create satisfactory wealth for shareholders than the maximum. Managers may avoid taking high investment and financing risks that may otherwise be needed to maximize shareholders¶ wealth. Such ³satisfying´ behaviour of managers will frustrate the objective of SWM as a normative guide.

FINANCIAL GOALS AND FIRM¶S MISSION AND OBJECTIVES

Firms¶ primary objective is maximizing the welfare of owners, but, in operational terms, they focus on the satisfaction of its customers through the production of goods and services needed by them Firms state their vision, mission and values in broad terms Wealth maximization is more appropriately a decision criterion, rather than an objective or a goal. Goals or objectives are missions or basic purposes of a firm¶s existence

FINANCIAL GOALS AND FIRM¶S MISSION AND OBJECTIVES
The

shareholders¶ wealth maximization is the secondlevel criterion ensuring that the decision meets the minimum standard of the economic performance.

In

the final decision-making, the judgement of management plays the crucial role. The wealth maximization criterion would simply indicate whether an action is economically viable or not.

AGENCY PROBLEM

Conflicts of interest among stockholders, bondholders and mangers. Agency theory: the analysis of principal-agent relationships, in which one person, an agent, acts on behalf of another person, a principal. Agency problem arises due to the separation of ownership & control of business firms. In theory, the S.H¶s being the owners of the firm, control its activities. In practice, however, the large modern corporation has a diffuse & fragmented set of S.H¶s & control often lies in the hands of directors. The separation of ownership & control raises worries that the mgt team may pursue objectives attractive to them, but which are not necessarily beneficial to the S.H¶s- this is termed µmanagerialism¶. This conflict is what is known as the principal-agent problem (agency problem) Agency costs: the incremental costs of having an agent make decisions for a principal Monitor managers¶ behaviour & Create incentive schemes & control for managers to pursue S.H¶s Wealth maximization.

  

 

GOAL CONGRUENCE

Linking rewards to shareholders wealth improvements- share option or allot share Sackings: threat of being sacked with the accompanying humiliation & financial loss may encourage mgrs not to diverge-S.H.W.M Selling shares and the take-over threat- fear of being taken over- establish some sort of backstop position to prevent S.H W considerations being totally ignored. Corporate governance regulations: legislation-designed to encourage directors to act in S.H¶s interests. Information flow: to acctg profession, stock exchange, the regulating agencies & the investing public force firms to release more accurate, timely & detailed information. This helps to monitor wealth-destroying actions by wayward mangers early.

Qualities of Financial manager
1. He should be a man of honest and high degree of integrity. 2. He should be well educated. 3. Should be aware of policies and plans of top management. 4. Should have an up to date knowledge of capital market, SE, taxes, laws. 5. Should have knowledge of various financial instruments and markets. 6. Should maintain close contact with banks and FI. 7. Should maintain close contacts with other departments of organisation. 8. Should have leadership, communication, organising and motivating skills.

ORGANIZATION OF THE FINANCE FUNCTIONS BOARD OF DIRECTORS

MANAGING DIRECTOR

FINANCE COMMITTEE

VICE PRESIDENT PRODUCTION

VICE PRESIDENT FINANCE

VICE PRESIDENT SALES

TREASURES

FINANCIAL CONTROLLER

Financial planning & fund-raising mgr

Cash manager

Credit manager

Foreign Capital exchange manager Expenditure manager

Tax manager

Cost accounting manager

Corporate accounting mgr

Financial accounting mgr

Internal auditor

Performance evaluation

FINANCIAL MANAGER¶S ROLE

FUNDS RAISING FUNDS ALLOCATION PROFIT PLANNING UNDERSTANDING CAPITAL MARKETS

EMERGING / CHANGING ROLE OF THE FINANCIAL MANAGER IN INDIA: Investment planning

Financial structure Mergers, acquisitions, and restructuring Working capital management Performance management Risk management Corporate governance Investor communication

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