FINANCIAL

MANAGEMENT
M O D U L E :- 1
Introduction to F.M.
&

Working Capital Decision1

 Syllabus – M O D U L E - 1
INTRODUCTION TO FINANCIAL MANAGEMENT (F.M.)
• Understanding & the meaning of F.M.
• Financial System
• Time Value of Money
• Basics of Risks and Returns
• Concepts of Time Value
• Compounding and Discounting
• Annuities
• Valuation of Bonds and Shares
C O N T 2. .
CONT.
Syllabus – M O D U L E - 1
WORKING CAPITAL MANAGEMENT
• Understanding Working Capital Management as a
Decision to Create Value for Business
• Principles of Working Capital Management
• Various Approaches
• Estimation of Working Capital
• Management of Components of Working Capital
– Cash,
– Receivables,
– Inventory and
– Sources of Working Capital Finance 3
 M O D U L E : Content
• FINANCIAL MANAGEMENT
• FINANCIAL SYSTEM
• TIME VALUE OF MONEY (TVM)
• BASICS OF RISK AND RETURN
• VALUATION OF BONDS AND SHARES
• WORKING CAPITAL MANAGEMENT
• MANAGEMENT OF COMPONENT WORKING CAPITAL
• CASH MANAGEMENT
• RECEIVABLES MANAGEMENT
• INVENTORY MANAGEMENT
• SOURCES OF WORKING CAPITAL FINANCING
• REGULATION OF BANK FINANCE 4
FINANCIAL
MANAGEMENT
5
 CONTENT
• Meaning and Definition of Finance
• Meaning and Definition of Financial Management
• Scope of Financial Management
• Functions of Financial Management
• Importance of Financial Management
• Objectives of Financial Management
• Profit Maximization
• Wealth Maximization
• Profit Maximization versus Wealth Maximization
• Relationship of Financial Management with Related Disciplines
• Organization of Finance Function
• Financial Managers
6
 Meaning and Definition of Finance
• According to F.W. Paish, “Finance may be defined as
the position of money at the time it is wanted.”
• Finance may be defined as the provision of money at
the time when it is required.
• Finance refers to the management of flows of money
through an organization.
• It concerns with the application of skills in the
manipulation, use and control of money.
• Finance is the pivot around which the whole business
operations cluster, Right from birth of business till
the liquidation. 7
 Meaning and Definition of Financial
Management
• According to J,F. Bradley, “Financial Management is
the area of business management devoted to the
judicious use of Capital & Careful selection of
sources of capital in order to enable a spending unit
to move in the direction of reaching its goals.”
• F.M. is the effecting & efficient utilization of
financial resources. It means creating a balance
among financial planning, procurement of funds,
profit administration & sources of funds.
C O N T 8. .
 Meaning and Definition of Financial
CONT.. Management
• The term FINANCE means procuring sources of
money supply and allocation of these sources on
the basis of forecasting monetary requirements of
the business.
• The term MANAGEMENT means planning,
organization, co – ordinization and control of
human activities and physical resources for
achieving the objectives of an enterprise.

9
 Scope of Financial Management
• Financial Management has undergone
significant changes, over the years in its
scope and coverage.
– Traditional Approach
(Procurement of Funds)
– Modern Approach
(Effective Utilization of Funds)

10
 Traditional Approach
(Procurement of Funds)
• The Scope of Finance was treated, in the
narrow sense of procurement or arrangement
of funds.
• The utilization of administering resources was
considered outside the preview of the finance
function.
• It was felt that the Finance Manager had no
role to play in decision – making for its
utilization. CONT..
11
CONT.. Traditional Approach
(Procurement of Funds)
As per this approach, the following aspects only
were included in the scope of financial
management
• Estimation of requirements of finance
• Arrangement of funds from financial institutions
• Arrangement of funds through financial
instruments such as shares, debentures, bonds
and loans, and
• Looking after the accounting and legal work
connected with the raising of funds. CONT..
12
CONT.. Traditional Approach
(Procurement of Funds)
Limitations of Traditional Approach
• Outsider – looking in Approach
• Ignored Routine Problems
• Ignored Non – Corporate Enterprises
• Ignored Working Capital Financing
• No Emphasis on Allocation of Funds

13
 Modern Approach
(Effective Utilization of Funds)
 The modern approach views the term financial
management in a broad sense and provides a
conceptual and analytical framework for
financial decision making.
 According to it, the financial function covers
both acquisitions of funds as well as their
allocation.
 Defined in a broad sense, it is viewed as an
integral part of over all management.
14
CONT.. Modern Approach
(Effective Utilization of Funds)
 Thus, apart from the issues involved in
acquiring external funds, the main concern of
financial management is the efficient and wise
allocation of funds to various uses.
 F.M. is concerned with the solution of
 Investment Decision
 Financing Decision
 Liquidity Decision
 Dividend Decision C O N T15. .
 Functions
of
Financial Management
• Investment Decision
• Financing Decision
• Dividend Policy Decision
• Liquidity Decision

16
 Investment Decision
• The investment decision relates to the selection of
assets in which funds will be invested by a firm.
• The assets acquired for business can be divided into
two parts
– Long – term or fixed assets which are used for
earning over a longer period.
– Short term or current assets which can be
converted into cash within an accounting period.

C O N T17. .
CONT.. Investment Decision
• Accordingly, the asset selection decision of a firm is
of two types
– The first of these involving the first category of
assets is popularly known in the financial
literature as capital budgeting.
– The aspect of financial decision – making with
reference to current assets or short – term assets
is popularly designated as working capital
management.

C O N T18. .
CONT..
• Capital Budgeting Decisions:
– Under these decisions, financial manager has to decide
as to which of the different available alternatives the
best to invest in.
– For this purpose, expected profit accruing from that
asset is evaluated by using different techniques.
• Working Capital Decisions:
– For the efficient management of Working Capital,
financial manager must maintain adequate balance in
liquidity and profitability. If W.C. more, it reduces Profit
and Increase Liquidity and If W.C. less, it risk for liquidity.
– Profitability and Liquidity have inverse relationship.
19
 Financing Decision
• The concern of the financing decision is with the
financing – mix or capital structure or leverage.
• The term capital structure refers to the proportion
of debt (fixed – interest sources of financing) and
equity capital (variable – dividend securities /
sources of funds)
• The financing decision of a firm relates to the choice
of the proportion of these sources to finance the
investment requirements.

20
 Dividend Policy Decision
• The dividend decision relating to the dividend
policy.
• The dividend decision should be analyzed in relation
to the financing decision of a firm.
• Two alternatives are available in dealing with the
profits of a firm: they can be distributed to the
shareholders in the firm of dividends or they can be
retained in the business which course should be
followed – dividend or retention.
21
 Liquidity Decision
• Liquidity Decision is concerned with the
management of current assets.
• Working Capital Management is concerned with the
management of current assets.
• It is concerned with short – term survival.
• Short term – survival is a prerequisite for long term
survival.
• Investment in Current Assets affect the profitability,
liquidity and risk.
• When more funds are tied up in current assets, the
firm would enjoy greater liquidity . CONT..
22
CONT..
Liquidity Decision
• With excess liquidity, there would be no default in
payments, so there would be no threat of
insolvency for failure in payments.
• Higher liquidity is at the cost of profitability.
• A proper balance must be maintained between
liquidity and profitability of the firm.
• The strategy is in ensuring a trade – off between
liquidity and profitability.
• Working Capital Management is day to day problem
to the finance manager. His skills of financial
management are put to test daily. 23
Importance of Financial Management
• Financial Planning and Control
• Essence of Managerial Decision
• Improve Profitability
• Financial Management is a Scientific & Analystical
Analysis
• Continuous Administration Function
• Centralized Nature
• Basis of a Managerial Process
• Measure of Performance
24
 Objectives of Financial Management
• Financial Management’s main aim is to use business
funds in such a way that the earnings are maximized.
• Financial Management provides a framework for
selecting a proper course of action and deciding a
viable commercial strategy.
• The main objective of a business is to maximize the
owner’s economic welfare.
• There are two main objectives of Financial
Management:
– Profit Maximization
– Wealth Maximization
25
 Profit
Maximization
• Introduction
• Arguments in favour of Profit Maximization
• Limitations of Profit Maximization

26
 Introduction
• Profit earning is the main aim of every economy
activity.
• Profit also serve as a protection against risks which
cannot be ensured,
• The accumulated profits enable a business to face
risks like fall in prices, competition from other units,
advertise government policies etc.
• Profit Maximization is the traditional and narrow
approach, which aims at maximizing the profit of
the concern. It is also called as cashing per share
maximization. 27
Arguments in favour of Profit Maximization
• Profit is the Test of Economic Efficiency
• Efficient Allocation of Fund
• Social Welfare
• Internal Resources for Expansion
• Reduction in Risk and Uncertainty
• More Competitive
• Desire for Controls
• Basis of Decision – making

28
 Limitations of Profit Maximization
• Quality of Benefits
• Ambiguity – Vague
• Timing and Value of Money – Ignored
• Change in Organization Structure
• Social Welfare may be Ignored
• Ignores Financing and Dividend Aspects

29
 Wealth
Maximization
• Introduction
• Arguments in favour of Wealth Maximization
• Limitations of Wealth Maximization

30
 Introduction
• The wealth maximization principle implies that the
fundamental objective of a firm should be to
maximize the market value of its shares.
• The wealth maximization objective is consistent
with the objective of maximizing the owner’s
economic welfare.
• This is also known as net present worth
maximization approach, it takes into consideration
the time value of money.

31
Arguments in favour of Wealth Maximization
• The main aim of the business concern under this
concept is to improve the value or wealth of the
shareholders.
• Wealth Maximization considers the comparison of the
value to cost associated with the business concern.
• It provides extract value of the business concern.
• Wealth Maximization considers both time and risk of
the business concern.
• Wealth Maximization provides efficient allocation of
resources.
• It ensures the economic interest of the society 32
 Limitations of Wealth Maximization
• The objective of Wealth Maximization is not,
necessarily, socially desirable.
• There is some controversy whether the objective of
maximization
• However, there is always a possibility of conflict of
interest between the shareholders’ interests and
managerial interest.
• Many a time, individuals place their personal
preferences and selfish interests, ahead of the
institutional interest.
33
Profit Maximization versus Wealth Maximization
Profit Maximization Wealth Maximization
Definition or Nature Definition or Nature
• It relates to optimizing the input • Maximizing the wealth in the
– output relationship of hands of shareholders
resources to minimize the Purpose of Concept
wasteful costs. • To enhance the value of the firm
Purpose of Concept and the market value of the
• Maximize the profitability shares.
Formulae Formulae
• Profit = Total Revenue Receipt – • Wealth = No. of Shares * Price
Total Costs Rational
Rational • Maximize value of firm and
• Growth in future and shelter enhancing shareholder value 34
against contingencies
Profit Maximization versus Wealth Maximization
Profit Maximization
Time Span
• Shorter time Period
Time Value of Money
• Does not give due
consideration
Immediate Beneficiaries
• First benefits to management
and later shareholder
Limitation or Constraints
• Exploitative tendency and
gives lower priority to
shareholders
Wealth Maximization
Time Span
• Long - term value
Time Value of Money
• Gives due consideration to the
time value of money
Immediate Beneficiaries
• First benefit to shareholder and
then to the organization
Limitation or Constraints
• Very Long Span of time, so
increased efforts on value
building.
35
 Relationship of Financial Management with
Related Disciplines
• Financial Management and Economics
• Financial Management and Accounting
• Financial Management and Mathematics
• Financial Management and Production
Management
• Financial Management and Marketing
• Financial Management and Human Resource

36
 Organization of Finance Function
• The ultimate responsibility of discharging the
finance function is that of the Board of Director,
who discharges this function through the Chief
Financial Officer (CFO)
C.F.O (Director of Finance)
Finance Manager / Accounts Manager /
Treasurer Controller

Budget Cash Credit Financial

Tax Audit
Division Mangt. Mangt. Acct.
Capital Expenditure
C O N T37. .
Management
CONT..
Organization of Finance Function
• The CFO is a member of the top management team
and is a party to formulation of strategic policies
relating to acquisitions, mergers, capital structure,
diversification, etc.
• Nevertheless, he is also responsible for all routine
aspects of finance.
• By whatever name called, his functions can be
classified
– Functions of CFO as a Controller, and
– Functions of CFO as a Treasurer
C O N T38. .
CONT..
Functions of CFO as a Controller
• Formulation of accounting and costing policies,
standards and procedures
• Preparation of financial statements and
maintenance of books of account, direction of
internal auditing and cost control.
• Preparation and Interpretation of regular financial
reports and statement, inventory control and
general accounts.
• Budgeting and control of corporation and results.
• Interpretation of control data
• Internal audit CONT..
39
CONT..
Functions of CFO as a Treasurer

• Cash Management Functions

– Opening accounts and depositing funds in banks.
– Payment of company obligations through proper
disbursement procedures
– Maintaining records of cash transactions
– Management of petty cash and bank balance
• Credit Management Functions
– Orderly Handling of collections
– Handling cash discounts and terms of sale for prompt
payment
– Collections
– Determination of Customers credit risks C O N T40. .
CONT..
Functions of CFO as a Treasurer

• Financial Planning Functions

– Reporting Financial results to the officers of the company
– Planning borrowing requirements
– Forecast of cash receipts and disbursement
– Planning the company investment program
– Advice on dividend payment
• Security Floatation Functions
– Recommendation of type of security most desirable for
company borrowing requirements and correlation of
these with company’s long term ability to pay.
– Provision for trustee ; Registration of transfer agent
41
 Financial Managers
• Determining Financial Needs
• Choosing the sources of funds
• Financial Analysis and Interpretations
• Cost – Volume Profit Analysis
• Capital Budgeting
• Working Capital Management
• Profit Planning and Control
• Dividend Policy

42
FINANCIAL
SYSTEM
43
 CONTENT
• Meaning & Definition of Financial System
• Feature of Financial System
• Functions of Financial System
• Structure of Financial System
• Importance of Financial System
• Weakness of Financial System

44
Meaning & Definition of Financial System
• According to Robinson, the primary function of the
system is , “To provide a link between saving and
investment for the creation of new wealth and to permit
portfolio adjustment in the composition of the existing
wealth.”
• A financial system or financial sector functions as an
intermediary and facilitates the flow of funds from the
area of deficit.
• The word “System” in the term “Financial System”
implies a set of complex and closely connected or
interlined institutions, agents, practices, market,
transactions, claims and liability in the economy.
• It is concerned about money, credit and finance. 45
 Flow of Financial System

Flow of Funds (Saving)

Seekers of Suppliers of
Funds Funds
(Mainly business
firms and (Mainly
government ) Households)
Income and Financial Claims

46
 Feature of Financial System
• Financial System provides and ideal linkage
between depositors and investors, thus encouraging
both savings and investments.
• Financial System facilitates expansion of financial
markets over space and time.
• Financial System promotes efficient allocation of
financial resources for socially desirable and
economically productive purpose.
• Financial system influences both the quality and the
pace of economic development
47
 Functions of Financial System
• Link between savers and investors
• Helps in Projects Selection
• Allocation of Risk
• Information Available
• Minimizes Situations of Asymmetric Information
• Reduce Cost of Transaction and Borrowing
• Promotion of liquidity
• Financial Deeping and Broadening

48
 Structure of Financial System
• Financial Institutions / Intermediaries
– Regulatory
• SEBI, IRDA,RBI, AMFI, etc
– Intermediaries
• Banks – SBI, PNB, etc
• NBFCs – LIC, UTI, GIC, etc
– Non – Intermediaries
• NABARD, IDBI, IFCI, etc
• Financial Services
– Merchant Banking, Credit Rating
– Leasing , Hire Purchase C O N T49. .
CONT..
Structure of Financial System
• Financial Markets
– Unorganized Market
• Not controlled by RBI or Regulatory Body
• Money lenders, trader, indigenous bankers,
private finance company, chit funds, etc
– Organized Market
• Capital Market (Financial Assets) (Long Term)
– Primary Market
– Secondary Market
• Money Market (Short Term) C O N T50. .
CONT..
Structure of Financial System
• Financial Assets / Instruments
– Primary Securities
• Equity, Shares and Debentures
– Secondary Securities
• Mutual Funds, Insurance and Bank Deposits,
etc

51
 Importance of Financial System
• Increase the output of the Economy
• Accelerate the volume and Rate of Savings
• Makes Innovation
• Evaluating Assets, Increasing Liquidity, and
Producing and Spreading Information
• Risk Management Services
• Stability and Resilience
• Disciplining and Guiding the Management
Companies
• Accelerates the Rate of Economic growth
52
 Weakness of Financial System
• Lack of Coordination between different Financial
Institutions
• Monopolistic Market Structures
• Dominance of Development Banks in Industrial
Financing
• Inactive and Erratic Capital Market
• Imprudent Financial Practices

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