FINANCIAL

MANAGEMENT
SEMESTER II
Meaning and Definition of Financial Management
• According to Solomon : Financial management is the area of business
management devoted to the judicious use of capital and careful selection of
sources of capital in order to enable a spending unit to move in the direction of
reaching its goals

• Hoagland : Financial management deals with how the corporation obtains the
funds and how it uses them”-- Hoagland

• Financial management is an applied branch of management that looks after the

finance function of a business.

• Financial management is the operational activity of the business that is

responsible for obtaining and effectively utilizing the funds necessary for
efficient operations”.
Evolution of Financial Management
Traditional Phase
• Traditional phase lasted for about four decades. Following were its
important features:
1) The focus of financial management was mainly on certain episodic
events like formation, issuance of capital, major expansion, merger,
reorganization and liquidation in the lifecycle of the firm.

2) The approach placed great emphasis on long term problems.

3) Financial management was not considered to be a managerial

function.
Transitional Phase
 The Transitional Phase began around the early 1940s and
continued through the early 1950s.

 Nature of financial management during was similar to that of

the traditional phase.

 Greater emphasis was placed on the day-to-day problems faced by

financial managers in the areas of funds analysis, planning and control.
Modern Phase
Modern period of evolution of FM makes use of economic theories for
increasing effectiveness.
The distinctive features of the modern phase are:
1) Changed macroeconomic scenario contributed heavily to the evolution
process of financial management concerns itself with the optimal allocation
of financial resources.
2) The discipline of FM became multidisciplinary in nature with the
application of statistical and mathematical theories for solving financial
problems. These methods are used for forecasting, financial modeling and
risk assessment.
3) The central concern is considered to be a rational matching of funds to
their uses so as to maximize the wealth of the shareholders.
4) The approach is more logical.
Role of Finance Manager
Scope/Approaches of Financial Management

Traditional School of Thought

Acquiring
Managing
Assessment funds
accounting
of fund Procurement through
and legal
requirement financial
framework
products
Modern School of Thought
Investment Decisions
• Long Term Assets
• Short term Assets
Investment decisions may be classified into two main categories

1. Capital Budgeting Decisions

2. Working Capital Decisions

Financing Decisions

• Decide from where, when and how to acquire funds to meet needs.

• Determine appropriate proportion of debt and equity.

Dividend Ratio

• Decide whether the firm should distribute all profits or retain them or
distribute a portion and retain a balance.
Liquidity Decision

• Investment in current assets affects the firm’s liquidity and

profitability
• Current assets to be managed effectively
Significance of Financial Management
• Controlling function
• Aid to Managerial Decision Areas
• Wealth Maximization
• Financial Management is an Analytical Tool
• Administrative in nature
• Finance function is centralized
• Role for managerial function
• Performance measure
Objectives of FM
Profit Maximization
• Profit maximization implies that a firm either produces maximum
output for a given amount of input.

• Uses minimum input for producing a given output.

• Profit earning is the main aim of every business activity

• Related to maximization of earnings per share of the ifrm
PROFIT MAXIMIZATION

• Cover its costs and provide funds for growth.

• Profit is the measure of efficiency
• Help an organization to face market fluctuation.
• Considered as the most appropriate measure of a firm’s performance.
• Profits provide protection against risks.
Arguments in favour of Profit
Maximization
 Profit is a barometer through which the performance of a business
unit can be determined.
 Profit ensures maximum welfare of all the stakeholders.
 Profit maximization increases the confidence of management for
modernization, expansion and diversification.
 Profit maximization attracts the investors to invest.
 Profits indicate efficient utilization of funds.
 Profits ensure survival during adverse business conditions
Points Against Profit Maximization
 It may encourage corrupt and unethical practices.
 It ignores time value of money.
 It does not take into account the element of risk.
 It attracts cut throat competition.
 Huge amount of profit may attract Government intervention.
 Huge profits may invite problems from workers who may demand
increased wages and salaries.
 Customers may feel exploited.
 The term profit is vague and it cannot be defined precisely.
Wealth Maximization

 The goal of the management should be such all the stakeholders are
benefited.
 A financial action that has a positive NPV creates wealth for
shareholders and, therefore, is desirable.
 The wealth will be maximized if NPV criteria is followed in making
financial decisions.
 NPV is the difference between the present value of its benefits and
present value of its costs. If
 Pv(benefits)>Pv(costs)=Positive
 Pv(benefits)<Pv(costs)=Negative
Points in Favor of Wealth Maximization
• Advanced and can be better compared to the objective of profit
maximization since firms are trying to increase value of the stakeholders
• Involves the comparison of the value to cost associated with the
company
• Wealth maximization takes into concern both time value and risk factors
of the firm
• Wealth maximization promotes and improves optimum and efficient
utilization of resources
• It aims to achieve and fulfil economic obligations of the society.
 Indian Financial System
• Christy – The objective of the financial system is to “Supply funds to
various sectors and activities of the economy in ways to promote the
fullest possible utilization of resources without the destabilizing
consequence of price level changes or unnecessary interference with
individual desires.
• Robinson– the primary function of financial system is “ To provide a
link between savings and investment for the creation of new
wealth and to permit portfolio adjustment in the composition of
the existing wealth”.
 Functions of Indian Financial System
• To connect the investors with the savers
• Assistance in selection of a project
• Risk allocation
• Availability of information
• Reducing the cases of asymmetric information
• Reduction in the borrowing and the transaction cost
• Liquidity promotion
• Financial broadening and deepening
 Importance of IFS
• Increment in the output and production of the economy
• Accelerating Quantum and Pace of savings
• Facilitates Innovations
• Evaluation of Assets, Increasing the Liquidity, Production and
Spreading of Information
• Provide Risk Management Services
• To Ensure stability and resilience
• Introduction of discipline in Management companies and guiding
them
• Accelerating the rate of economic growth
 Structure of IFS

Financial Financial
Financial Financial Institutions Services
Assets/Instruments Markets

1. Regulatory
Seco 2. Intermedia Asset and
Prim Fee based
ndar ries Fund based
ary Organized Services
y Unorganized 3. Non- Services
Intermedia
ries
Capital Money
 Primary and Secondary Financial
Instruments
PRIMARY • SECONDARY
• Equity • Equity Shares
• Forwards • Right issue or Rights shares
• Futures • Preference shares
• Options • Government Securities
• Swaps • Debentures
• Commercial paper • Bond
• Treasury bills
 Financial Markets
• Unorganized and organized
• Under organized market
• Capital Market
A. Equity Market – Primary, Secondary
B. Debt Market
• Money Market
 Financial Intermediaries
• Commercial Banks

• Non banking financial institutions

• Investment companies

• Insurance companies
 Regulatory System

• RBI
• SEBI
• IRDA
• AMC
 Non-intermediaries
• IDFC-Infrastructure Development Finance Company
• NABARD- National Bank for Agriculture and Rural Development
• IFCI - Industrial Finance Corporation of India
 Financial Services
• Asset and Fund Based
i) Lease Financing
ii) Hire Purchase
iii) Factoring
iv) Forfaiting
v) Mutual fund
vi) Exchange Traded Fund
vii) Consumer Credit or consumer Finance
viii)Bill Discounting
ix) Housing Finance
 contd………..
• Fee Based Financial Services
i) Merchant Banking
ii) Credit Rating
iii) Stock Broking
iv) Debt Securitization
v) Letters of Credit
vi) Bank Guarantees
 Major Issues in Indian Financial systems
• Missing coordination among the financial institutions
• Monopolistic market structure
• Major hold of Development Banks in the Industrial Financing
• Inactive and Erratic Capital market
• Imprudent Financial Practice