Financial Management

Unit 1
 Definition of Finance

“Finance may be defined as the position of

money at the time it is wanted”
 Classification / Type of Finance
Finance

Public Finance Private Finance

1. Central Government 1. Personal Finance

2. State Government 2. Business Finance
3. Local Administration 3. Finance of Non-Profit Organistions
 Approaches to Finance

1. Providing of funds
2. Raising of funds and their effective utilisation
 Approaches of Finance Function

1. The Traditional Approach

2. The Modern Approach
 The Finance function has been classified into three

1. Long-Term Finance – This includes finance of investment 5

years or more. Sources of long-term finance include owner
capital, share capital, long-term loans, debentures, internal
funds and so on.
2. Medium Term Finance – This is financing done between 1 to
5 years, this can be sourced from bank loans and financial
institutions.
3. Short Term Finance – This is finance needed below one year.
Funds may be acquired from bank overdrafts, commercial
paper, advances from customers, trade credit etc
 Meaning Financial Management

The term ‘Financial Management’ consists of

two words – ‘Financial’ and ‘Management’.
“Financial” denotes the process of identifying,
obtaining and allocating sources of money.
“Management” is the process of planning,
organising, coordinating and controlling
various resources for the accomplishment of
organisational goal.
 Definition Financial Management

“Financial management is the application of the

planning and control functions of the finance
functions.”
 EVOLUTION OF FINANCIAL MANAGEMENT

The evolution of financial management may

be divided into three broad phases:

i) The traditional phase

ii) The transitional phase
iii) The modern phase.
 Functions of Financial Management

Financial Management

Concerned with

Financing Decision Investment Decision Dividend Decision

Analyses

Risk and Return Relationship of

Trade

To Achieve the goal of

Wealth Maximization
 Functions of Financial Management

1. Investment decision
2. Financing decision
3. Dividend policy decision
Objective of Financial Management
Functions of Financial Management
 Factors influencing Financial Decisions
I. External Factor
State of Economy
Structure of capital and money markets
Government policy
Taxation policy
Lending policy of financial institutions

II. Internal Factor

Nature and size of business
Expected return, cost and risk
Structure of ownership
Trend of earnings
Age of the firm
Liquidity position
Working capital requirements
Conditions of debt agreements
 RISK-RETURN TRADE OFF

Financial decisions of a firm often involve

alternative courses of action. A finance
manager has to select amongst the various
alternatives available to him.

Investment Decisions
- Capital Budgeting
- Working Capital Management
Risk

Financing Decisions Market

- Capital Structure Value of
the Firm

Dividend Decisions Return

- Dividend Policy
 Financial Management Process

The financial management process begins with

the financial planning and decisions.
While implementing these decisions, the firm
has to acquire certain risk and return
characteristics.
The characteristics determine the market price
of shares and shareholder wealth.
The process must include the feedback system.
Financial Planning and
Control

Feedback

Financial Decisions Market Price Shareholders

1. Investment decision Risk and of share wealth
2. Financing decision Return Po Wo=NPo
3. Dividend decision
Functional Areas of Financial Management

1. Determining Financial Needs

2. Selecting the Sources of Funds
3. Financial Analysis and Interpretation
4. Cost-Volume-Profit Analysis
5. Capital Budgeting
6. Working Capital Management
7. Profit Planning and Control
8. Dividend Policy
 Functions of a Finance Manager

1. Financial Forecasting and Planning

2. Acquisition of Funds
3. Investment of Funds
4. Helping in Valuation Decisions
5. Maintain Proper Liquidity
 Sources of Finance
1. Short – Term Finance
The finance acquired for a period of 1 year or slightly more falls under this category. This is also called as working capital finance.
1. Trade Credit
2. Commercial Paper (CP)
3. Letter of Credit (LC)
4. Bank Overdraft
5. Accrued Expenses and Income
6. Certificate of Deposit (CD) – Short term deposit
7. Bill Discounting

2. Medium-Term Finance
Medium term finance is raised for a period between 1 year to 5 year.
1. Borrowing from Commercial Bank or Financial Institutions,
2. Debenture issue
3. Acceptance of public deposit

3. Long – Term Finance

Long – term finance is the backbone for the financial strength of a business.
1. Shares
2. Debentures
3. Term Loans (also called as Working capital Finance – More than 10 Years)
4. Lease Financing
 Shares

It is a primary source of a joint stock company for procuring

Long- term finance.

Capital of a company is split into smaller units termed as

“Shares” .

The investors subscribing to such shares are termed as

“Shareholders” of the company.
 Types of Shares

1. Equity Shares
2. Preference Shares
 Equity Shares

 Equity shares are also termed as ordinary shares or common

shares.

 Equity share holders are the Owners of the company.

 They have the voting rights and part of decision- making process.

 The shareholders’ return on the funds invested bythem in the

company is in the form of “Dividend”.

 At the time of liquidation, equity shareholders are the last one to

get their money bank.
 Features of Equity Shares
1. Owned capital
2. Attached Right
3. Return on shares
4. Transfer of shares
5. Benefit of Right issue
6. Benefit of Bonus shares
7. Capital appreciation
 Advantages of Equity Shares

I. Advantages to Investors
1. Capital profit
2. Interest in the company’s Activities
3. Best for Investment
4. Right to interfere in Management
II. Advantages to Company
1. No Fixed Burden of Dividend
2.Bear the Risk
3. Availability of Fixed capital
 Disadvantage of Equity Shares
I. Disadvantages to Investors
1. Uncertainty of Income
2. Irregular Income
3. Capital Loss
4. Not the Best Alternative
II. Disadvantages to Company
1. Difficult to Remove Over-Capitalisation
2. Centralisation of Control
3. Change in Management Policy
 PREFERENCE SHARES

As the name suggests, theses shares have certain

preferences as compared to other types of shares. These
shares are given two preferences.

– Whenever the company has distributable profits, the

dividends are first paid on preference share capital.

– The second preference is the repayment of capital at the time

liquidation A fixed rate of dividends is paid on preference
share capital. Preference
 Features of Preference Shares

1. Maturity
2. Claims on Income
3. Claims on Assets
4. Control
5. Hybrid form of security