Financial Management

Why learn Financial management ?

• Manage your financial resources both on the personal level and within your
business plan.

• It's more than just balance sheets.

• It's comprised of short-term and long-term goals, with cash management

plans and investment decisions in place.

• Without an in-depth understanding of how these things affect your bottom

line, your decision making will always be one step behind
Course Objectives
• Recognize financial management concepts and theories and their role
in managerial decision-making.

• Evaluate the financial management decisions based on the value

created for shareholders.

• Apply various tools and techniques of financial management in

various decision-making scenarios.
Finance
• The money you need to start or support a business, etc.
• To provide the money to pay for something.

Eg: An example of finance is a bank giving a loan to someone to

purchase a house.

• Financing: is the process of raising funds or capital for any kind of

expenditure
Meaning
• Financial Management means planning, organizing, directing, and
controlling the financial activities such as procurement and utilization
of funds of the enterprise.

• It means applying general management principles to the financial

resources of the enterprise.
Procurement of Funds
Utilisation of Funds
• Utilization for Fixed Assets
• Funds are to be invested in a manner so that the company can produce at its
optimum level without endangering its financial solvency.
• The finance manager would be required to possess sound knowledge of
techniques of capital budgeting

• Utilization for Working Capital:

• To ensure that while the firms enjoy an optimum level of working capital
• Too many funds not blocked in inventories, book debts, cash etc.
Scope/Elements
1.Investment decisions
• Investment in fixed assets (called capital budgeting)
• Investment in current assets (working capital decisions)
2.Financial decisions
• The raising of finance from various resources
• Will depend upon decision on the type of source, period of financing, cost of financing, and
the returns thereby.
3.Dividend decision
• Decision with regards to the net profit distribution.
• Net profits are generally divided into two:
1. Dividend for shareholders- Dividend and the rate of it has to be decided.
2. Retained profits- will depend upon the expansion and diversification plans of the enterprise.
Functions of Financial Management
• Estimation of capital requirements
• Determination of capital composition
• Choice of sources of funds
• Investment of funds
• Disposal of surplus
• Management of cash
• Financial controls
Key roles of Financial management
• Bookkeeping and Accounting
• Reporting
• Receivables and Payables
• Investment Opportunities
• Risk
Risks
• In finance, the risk is the probability that actual results will differ from
expected results
• Risk relates to any material loss attached to the project that may
affect the productivity, tenure, legal issues, etc. of the project
 Systematic Risk

• Systematic risk is due to the influence of external factors on an organization.

• Such factors are normally uncontrollable from an organization's point of view.

• It is a macro in nature as it affects a large number of organizations operating

under a similar stream or same domain
 Unsystematic Risk

• Unsystematic risk is due to the influence of internal factors prevailing within an

organization.

• Such factors are normally controllable from an organization's point of view.

• It is micro in nature as it affects only a particular organization.

• It can be planned so that necessary actions can be taken by the organization to

mitigate (reduce the effect of) the risk.
Evolution of Financial Management
• Traditional Phase (Finance up to 1940)
• The focus of financial management was on certain events which required
funds e.g., major expansion, merger, reorganization etc.

• Heavy emphasis on legal and procedural aspects as at that point in time the
functioning of companies was regulated by a plethora of legislation

• Designed and practiced from the outsiders’ point of view mainly those of
investment bankers, lenders, regulatory agencies, and other outside interests.
Evolution of Financial Management
• Transitional Phase (After 1940)
• More emphasis was laid on problems faced by finance managers in the areas
of fund analysis planning and control.
• In this stage, the essence of financial management was transferred to working
capital management
Evolution of Financial Management
• Modern Stage (After 1950)
• The main focus of financial management was on the proper utilization of
funds so that the wealth of current shareholders can be maximized

• The techniques and methods used in the modern stage of financial

management were analytical and quantitative

• Techniques like capital budgeting, valuation models, dividend policy, option

pricing theory, behavioral finance developed in this era
Why is Financial Management important in an
organization?
• Helps in Financial Planning
• Assists in acquiring and managing funds
• Helps in funds allocation
• Provides insights to make critical financial decisions
• Cuts down financial costs
• Improves profitability and value of the organization
• Makes employees aware of financial savings and investments
• Helps in planning the future growth of the organization
• Helps in achieving economic stability
Goals of Financial Management
Profit Maximisation
• What is profit?

• Profit=Total Revenue – Total cost

• Financial Gain

• Amount that is left after deducting all the costs of the inputs from the
total sales revenue.
What is Profit maximisation?
• Profit Maximization is the capability of the firm in producing
maximum output with the limited input, or it uses minimum input for
producing stated output.

• It is a process through which the firm ascertains the level of Input,

Output, and the price, that results in higher profit

• As per classical economists profit maximisation is an appropriate

measure to evaluate the operational efficiency of the firm
Wealth Maximisation
• What is wealth?

• Wealth of the firm=Total number of Equity Shares X Market Price per

share
OR
• Wealth of a firm= Total market value of all the tangible and intangible
assets -Total debts and Liabilities

• The value of all the assets which a person, company, or a country owns.
Wealth maximisation
• Process through which firm takes efforts to increase the value of its
business, so as to increase the market value of shares

• It is reflected in the company’s shares which ultimately increases its

market capitalization
Wealth Maximisation
• Wealth maximization is the ability of a company to increase the
market value of its common stock over time.

• The market value of the firm is based on many factors like its
goodwill, sales, services, quality of products, etc.

• This will help the firm to increase its share price in the market, attain
leadership, maintain consumer satisfaction and many other benefits
are also there
Profit Maximisation
Arguments in favour
• Profit maximization is the obvious
objective when profit is the main aim.
• Profitability is a barometer for
measuring the efficiency & prosperity
of a business
• To survive In an unfavorable situation
• For the expansion and diversification
• For fulfilling social goals
Arguments against
• Ambiguity
• Ignores time value of money
• Direct relationship between risk
and return
• Exploitation of workers and
employees
• Ignores social considerations
Wealth Maximisation
Arguments in favour
• It serves the interest of all shareholders
• Owners economic welfare
• Long run survival and growth
• Consider risk factors and the time value
of money
• Increase the market value of the shares
• Value maximization of equity
shareholders by increasing price per
share
Arguments against
• Offers no clear relationship
between financial decisions and
share price
• Can lead to management anxiety
and frustration.
• Wealth maximization is difficult
when ownership and
management are separated
 BASIS FOR COMPARISON PROFIT MAXIMIZATION WEALTH MAXIMIZATION

Concept The main objective of a concern is to The ultimate goal of the concern is to
earn a larger amount of profit. improve the market value of its
shares.

Emphasizes on Achieving short term objectives. Achieving long term objectives.

Consideration of Risks and No Yes

Uncertainty

Advantage Acts as a yardstick for computing the Gaining a large market share.
operational efficiency of the entity.

Recognition of Time Pattern of No Yes

Returns
Conclusion???
• Day to day decision making, Profit Maximization can be taken into
consideration as a sole parameter but when it comes to decisions
which will directly affect the interest of the shareholders, then Wealth
Maximization should be exclusively considered.
Time Value of Money
Time Value of Money
• An important principle in finance is that the value of money is time
dependent.
• The value of a unit of money is different in different time periods.
• The value of a sum of money received today is more than its value
received after some time.
• Conversely, a sum of money received in future is less valuable than it
is today.
• The time value of money is also referred to as time preference for
money
Reasons for Time Value of Money
• Investment Opportunities:
• Money has the potential to grow over a period of time because it can be
invested somewhere.
• For example, if Rs. 1000 can be invested in a fixed deposit for one year at 7%
p.a., the money will grow to Rs, Rs. 1070 at the end of one year.
• Therefore, given the choice of Rs. 1000 now or the same amount in one year’s
time, it is always preferable to take Rs. 1000 now.
Reasons for Time Value of Money
• Inflation:
• Inflation is the fall in the purchasing power of money.
• It makes money cheaper and the goods and services costlier. Suppose you can
buy 1 kg of rice with Rs. 50 today.
• If the inflation rate is 10%, You need Rs. 55 to buy 1 kg of rice a year from
now.
• Risk:
• Money received now is certain, whereas money tomorrow is less certain.
• This ’bird in the hand’ principle is extremely important in investment
appraisals.
Reasons for Time Value of Money
• Personal consumption preference:
• Many people have a strong preference for immediate rather than delayed
consumption.
• For a hungry man, promise of a meals next month means nothing.
Techniques
• Two methods to calculate the time value of money
• Compounding Technique
• Discounting Technique
Compounding Technique
• In compounding technique, interest is added (compounded) to the
initial deposit (principal) and becomes part of the principal at the end
of each compounding period.

• Annual compounding, semi-annual compounding, quarterly

compounding, monthly compounding etc.
Compounding Technique Formula
• FV = P (1+i)n
• In which
• FV = Amount at the end of the period
• P= Principal at the beginning of the period
• i = Rate of interest
• N= number of years
Compounding Technique Formula
• For semi-annual compounding, the formula is:
• A = P (1+i/2)n x2
• For quarterly compounding, the formula is:
• A = P (1+i/4)n x4
• Alternatively, for compounding more than once a year, the formula
can be expressed as:
• A = P (1+i/m)n x m
• Where m = number of times per year compounding is made.
Discounting Technique
• Discounting is the process of determining the present value of a
payment or a stream of payments that is to be received in the future.
• Given the time value of money, a dollar is worth more today than it
would be worth tomorrow
• A discount rate (also referred to as the discount yield) is the rate used
to discount future cash flows back to their present value.
 Discounting Formula

• FV is used to denote the future value of cash flow

• r is used to denote the discount rate
• t is used to denote the time period that an
investment will be held for
The present value can also be the sum of all future cash flows discounted back. It is known
as the Net Present Value (NPV).