INTRODUCTION

Finance is the life blood of an organization – Warren Buffet

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What is Finance?
Suppose you want to start up a business. No matter what the
nature of the proposed business is, its size or how it will be
registered, you will have to address some fundamental
questions:

How much investment is required to set up the business? It

includes preliminary expenditure, land and building, plant and
machinery, and furniture and fixture.
How will you raise the money? It includes long term sources
like equity and debt.
How will you finance your day-to-day activities? It includes
your inventory, giving credit to customers, and some cash to take
care of daily operations.
All this involves finance.
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What is Financial Management?
While these are not the only areas of financial decision
making, they are certainly the important ones.
Financial Management refers to the efficient and
effective utilization of finance (referred to as funds) in
such a manner so as to accomplish the objectives of the
organization.
It broadly involves two aspects - managing inflow and
outflow of funds.
As a financial manager you broadly try to pre-pone your
inflows and post-pone your outflows.
As a finance manager you also need to make a risk – return
trade off in every financial decision because of agency
problems.
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What is Financial Accounting?
Financial accounting is basically the backbone of any financial
management system.
Without proper financial accounting records, finance managers
will not be in a position to take financial management decisions.
Financial accounting is basically a process in which financial
transactions are condensed and classified and recorded and
summarized in the books of accounts based on certain
established principles to prepare the Income statement and
Balance sheet.
Management accounting uses this output to prepare certain
advanced MIS reports (e.g. fund flow statement, ratio analyses) to
aid in financial decision making.
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Financial Accounting Vs Financial
Management
 Users of Information : External – Internal
 Type of Analysis : Whole – Part
 Data Used : Raw Data – Semi finished Data
 Nature of Analysis : Historical – Futuristic
 Unit of Measurement : Quantitative – Qualitative
 Frequency : Medium to Long Term – Short Term
 Nature : Objective – Subjective
 Precision : Very High – Low to Medium
 Legal Compulsion : Very High – Low
 Nature of Content : Low to Medium – Very High
 Level of Management : Low – Medium to High
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Economics Vs Financial Management
The macro economic environment defines the setting within
which a firm operates, and undermines the conceptual
underpinnings for financial decision making.
The key macro economic variables that influences a firms
objectives are – inflation and interest rates.
A firms top-lines, bottom-lines, including share prices are
largely influenced by these two factors.
Other key macro economic factors that influences a firm are –
economic growth rate, tax environment, currency stability,
money supply, supply of skilled man power, govt policy on
land acquisition, etc.
Without understanding of economics, financial decisions
become irrelevant redundant.
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Important areas of financial decisions
Capital Budgeting – The process of analyzing, appraising and
taking decisions with regards to investments in new projects or
businesses or scaling up existing businesses in the form of
increasing existing capacities.
Working Capital Management – It involves the assessment of
requirement of funds for carrying on the day to day activities of
the businesses, followed by effective monitoring and control.
Capital Structure – It involves decisions regarding the composition
or mix of raising of long term funds from equity shares –
preference shares – debentures.
Dividend Policy – It refers to establishing patterns in dividend
payment decisions of a firm to its equity shareholders based on its
goals and objectives.
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Objectives of financial management
Profit Maximization – The most traditional school of
thought in finance argues that a business entity exists for the sole
purpose of making profits and not charity. Therefore profit
maximization is the main objective of finance.
Critique: Profit generally implies the surplus of revenue over cash.
However, profits can also be earned by selling of fixed assets like
land, investments held by a firm or through other sources like
interests and dividends on investments or commissions.
Such non-orthodox sources of generating profit does not in any
way enhance the health of the organization as they are not
regular sources nor primary to its business.
Profit is also not well defined and vague.

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Objectives of financial management (contd)
Shareholder Wealth Maximization – According to
this school of thought since the equity shareholders provide seed
capital and are the ultimate risk bearers of the firm, therefore
financial decisions should be taken in a manner that enhances
equity share prices as the profits ultimately belongs to the
shareholders.
Critique: The capital market skeptics argue that the stock market
displays myopic tendencies and are often incorrectly priced.
Some argue that other important stakeholders are ignored like
employees, suppliers, customers, etc.
Most importantly, it ignores the society at large, as a firm cannot
exist in vacuum.

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Objectives of financial management (end)
Stakeholder Wealth Maximization – According to
this modern school of thought financial decisions should be
taken in a way to ensure not only the equity shareholders, but all
relevant stakeholders are benefitted from it. The logic is while
shareholders provide only the risk capital, other stakeholders
also contribute largely to the success of any firm.
Critique: Balancing the interests of all the relevant stakeholders
is not practical. There is no way to determine the right balance
and will be left to individual discretion.
Further, if a firms social objectives supersedes its business
objectives, it will fail to rival its competitors and ultimately
become sick.

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How to choose organization form?
An organization is an artificial person. Therefore, choosing the
type of organizational form is important as it has serious financial
implications, especially from the point of view of finance, taxation
and control.
Sole Proprietorship – It is a business entity owned by a single
person and is subject to minimal government regulations. It is
simple, very easy to set up and set up costs are nominal. The
owner bears all the profits and losses of the firm. Owners
liabilities are unlimited.
Such firms have limited ability to raise capital and attract talent.
It is relatively easy to transfer the assets and or sell of the firm.

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Partnership firm
Partnership – A partnership firm requires a minimum of 2
(two) members to be set up and can have at the most 20
members (except in the case of NBFCs 10 members).
It is governed by the Indian Partnership Act, 1932.
Government regulations are slightly more complex and set up
costs are on the incremental side.
The partners share all the profits and losses of the firm.
Partners liabilities are unlimited individually and collectively.
Partnership firms have somewhat greater ability to raise
capital, however attracting talent remains status quo.
It is the firm which owns the assets therefore, It is relatively
difficult to transfer the assets or sell of the firm.
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A Company
Company – It is registered under the Indian Companies Act, 1956
(as revised 2013). A private company can at the most have 50
shareholders, while for public company there is no limit to the no.
of shareholders.
Government regulations are very complex and set up costs are also
very high.
Public ltd Cos are regulated by SEBI.
The shareholders share all the profits and losses of the firm
however, their liabilities are limited.
A company has unlimited potential to raise capital, and can also
attract the brightest talent in the industry.
It is the firm which owns the assets therefore, It is very difficult to
transfer the assets and or sell of the firm.
Stakeholders can also sue for winding up.

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Other issues in selecting organizational
form
Decision Making – In proprietorship firms decision making is
the fastest. In a partnership firm the consent of all the partners
is essential (except for sleeping partners). Therefore, decision
making process slows down. In a company, since superiors need
to ratify decisions, often at multiple levels; decision making is
the slowest.
Confidentiality – In a proprietorship firm information is shared
with no one, therefore confidentiality is very high. In case of a
partnership firm, confidentiality comes down. Since company’s
need to file their financial details with RoC and stock exchanges,
a lot of information is there in the public domain.
Succession Planning – It is the smoothest in case of a company.

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Agency problem
In proprietorship or partnership it is the owners or partners who
also manages the activities of the business entity.
However, in case of a company there is complete divorce between
ownership (or principal) and management.
Professional managers are usually appointed to manage the day to
day affairs of the business. There is an implicit relationship of trust.
It is expected that the decisions taken by the managers (or agents)
should be well aligned with the dictum of the owners. However,
often there is a conflict between the two. This is known as agency
problem.
Agency problem needs to minimized through a holistic and 360
degree appraisal of their performance and rewards.

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The finance vertical
Entry Level (0 – 5 yrs) : In industry, entry level finance
functions typically involves around managing working
capital, which includes inventory, debtors and cash. In a
bank it could include: credit appraisal, credit monitoring and
control. In an IT or consulting positions it could include
financial or investment analysis.
Mid Level (5 – 15 yrs): In industry, mid level finance
functions typically involves investment or treasury
management or may be heading a particular division or even
SBU. In such cases projects appraisal or capital budgeting,
including raising long term finance (advisory capacity)
becomes an important function. In a bank it could include
an operations or branch head. In IT industry it could be a Sr
Consultant.

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The finance vertical (cont)
Senior Level (15 – above yrs) : In industry, senior level
finance functions (CFO) typically involves designing of
capital structure and dividend policy. As the CFO is
primarily responsible for RoI he also is final approving
authority for new projects or scaling up existing businesses.
In a bank it could include senior positions at regional – zonal
– head office levels, where decisions are taken with regards
to exposures in different industries, base rate across different
lending products and opening of new branches or ATMs.
In IT / Consulting industry it could be of Country or
Functional heads, directly reporting to the BoD.

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End

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