•Financial Management

•An Introduction

Contents
Introduction to FM  Scope  Objectives  Functions  Role of Financial Manager  Assignment - Interface of Financial Management with other Functional Areas  Key challenges faced by Modern FM  Financial Environment

FINANCE
Finance is the life-blood of business. Without finance neither any business can be started nor successfully run . Finance is needed to promote or establish business, acquire fixed assets, make necessary investigations, develop product keep man and machines at work, encourage management to make progress and create values.

.FINANCIAL MANAGEMENT Financial management is one the functional areas of management. It refer to that part of the management activity which is concerned with the planning and controlling of firms financial resources.

DEFINITION “Financial management is the application of planning and control function of the finance function” Howard and Upton .

the promoters makes an appraisal of various investment proposals and selects one or more of them .NATURE AND SCOPE OF FINANCIAL MANAGEMENT The nature of financial decisions would be clear when we try to understand the operation of a firm. At the very outset. . depending upon the net benefits derived from each as well as on the availability of funds.

Allocation of profit for dividend payment. known as the dividend decision. known as the working capital decision. 2. . Raising of funds to finance the assets.PROCESS INVOLVED IN FINANCIAL DECISION 1. 4. 3.known as the investment decision. Selection of investment proposals .Determination of working capital requirements. known as the financing decision.

What assets should the company hold? This determines the left-hand side of the balance sheet. these decision are concerned with the effective utilization of funds in one activity or the other. The investment decision can be classified under two groups : (i) Long term investment decision (ii) Short term investment decision The former are referred to as the capital budgeting and the latter as working capital management. .•Three decision areas in finance: Investment decisions .

but before using any particular source of capital .its relative cost of capital . It involves the choosing the best source of raising funds and deciding optimal mix of various source of finance.degree of risk and control etc should be thoroughly examined by the financial manager. hence a varied financial structure is developed. The major source of long-term capital are shares and debentures.How should the company pay for the investments it makes? This determines the right-hand side of the balance sheet. .Financing decision Financing decisions . A company can not depend upon only one source of finance. it is also known as capital structure decision.

What should be done with the profits of the business? The dividend decision is concerned with determining how much part of the earning should be distributed among the share holders by way of dividend and how much should be retained in the business for meeting the future needs of funds internally.DIVIDEND DECISION Dividend decisions . .

Macro economic factor Micro economic factor .micro economic factor is related to the internal condition of the firm(a) Nature and size of the firm (b) Level of risk and stability in earnings (c) Liquidity position (d) Asset structure and pattern of ownership (e) Attitude of the management .Micro economic factor 2.Factors influencing financial decision These factors are divided into two parts 1.

Macro economic factor These are the Environmental factors- 1. Governmental policy . The state of the economy 2.

•All management decisions should help to accomplish the goal of the firm! •What should be the goal of the firm? .

2. Maximization of profits Maximization of wealth .Objectives of financial management The objective of financial management are considered usually at two levels –the Objective of financial management1.

. Economist are of the view that profits can be maximized when the difference of total revenue over total cost is maximum. Profit maximization simply means maximizing the income of the firm . or in other words total revenue is greater than the total cost.Maximization of profits Profit earning is the main aim of every economic activity.

Creditors Ensures expansion and diversification Indicates efficient use of Funds            PROFIT MINUS POINTS Profit is not a clear term (Long / Short) Leads to employee and consumer exploitation Does not consider Risk factor and Time value of Money Leads to cut throat competition A/c Manipulation Estimating exact profits is impractical . PROFIT PLUS POINTS Measures business performance Ensures timely payments to Shareholder. employees. Government.

the ultimate goal of financial management should be the maximization of the owners wealth. The value of corporate wealth may be interpreted in terms of the value of the company’s total assets. Value is represented by the market price of the company’s common stock.Maximization of wealth According to prof solomon ezra of stand ford university . . The finance should attempt to maximize the value of the enterprise to its shareholders.

WEALTH PLUS POINTS  Clear term as it considers present value of cash flows  Considers time value of money  Considers interest of External Parties  Aims at Dividend and returns  Considers impact of Risk WEALTH MINUS POINTS  It is not descriptive  It differs from one entity to another .

Other Objectives Balanced Asset Structure – Fixed and Current Asset balance  Liquidity – Co’s capacity to meet short term and long term obligations  Planning Funds – Cost of Funds to be minimized  Financial Discipline – Scandals. misuse of Funds  .

•What about risk? Isn’t risk important as well as profits? • How would the stockholders of a small business react if they were told that their manager cancelled all casualty and liability insurance policies so that the money spent on premiums could go to profit instead. . • Even though the expected profits increased by this action. it is likely that stockholders would be dissatisfied because of the increased risk they would bear.

.•The common stockholders are the owners of the corporation! • Stockholders elect a board of directors who in turn hire managers to maximize the stockholders’ well being. but this can be very difficult in a large corporation with many stockholders. • When stockholders perceive that management is not doing this. they might attempt to remove and replace the management.

when stockholders are dissatisfied they will simply sell their stock shares.•More likely. . •This action by stockholders will cause the market price of the company’s stock to fall.

•When stock price falls relative to the rest of the market (or relative to the rest of the industry) . .. •Management is failing in their job to increase the welfare (or wealth) of the stockholders (the owners)..

. when stock price is rising relative to the rest of the market (or industry). . •Management is accomplishing their goal of increasing the welfare (or wealth) of the stockholders (the owners).•Conversely.. .

. • Note that the stock price is affected by management’s decisions affecting both risk and profit.•The goal of the firm should be to maximize the stock price! • This is equivalent to saying the goal is to maximize owners’ wealth. • Stock price can be maintained or increased only when stockholders perceive that they are receiving profits that fully compensate them for bearing the risk they perceive.

•Important focal points in the study of finance: • Accounting and Finance often focus on different things • Finance is more focused on market values rather than book values. • Finance is more focused on cash flows rather than accounting income. .

Functions Anticipating Financial needs  Acquiring Financial Resources  Allocating Funds in Business  Administering Allocation of Funds  Analyzing Financial Performance  Accounting and reporting to management  Maintaining Liquidity  Ensuring Profit and Wealth maximization  .

Functions      Day to Day Cash Custody Bank Accounts Loan Collection Payment of Cash for transactions        Specific Functions Functional planning and Budgeting Investment Decisions Cost Accounting Profit Analysis Financial Accounting Internal Audit .

• Maximization of market value of the stockholders’ shares is the goal of the firm. minus accumulated depreciation (which may not represent the actual decline in the assets’ value). . They consist of the original cost of the asset from some past time.•Why is market value more important than book value? • Book values are often based on dated values.

. cash flow is more directly related than accounting income. • Accounting methods recognize income at times other than when cash is actually received or spent.Why is cash flow more important than accounting income? • Cash flow to stockholders (in the form of dividends) is the only basis for valuation of the common stock shares. Since the goal is to maximize stock price.

] .•One more reason that cash flow is important: • When cash is actually received is important. [Also: When cash must be paid determines when we need to start paying interest on money borrowed. because it determines when cash can be invested to earn a return.

.•Examples of when accounting income is different from cash flow: • Credit sales are recognized as accounting income. • Depreciation expense is a legitimate accounting expense when calculating income. but is not income. yet depreciation expense is not a cash outlay. • A loan brings cash into a business. yet cash has not been received.

•More examples: • When new capital equipment is purchased. but only the depreciation expense (a portion of the total cost) is an expense when computing accounting income. . • When dividends are paid. cash is paid out. though dividends are not included in the calculation of accounting income. the entire cost is a cash outflow.

•Definitions: Operating income vs. This is the total income that the company earned by operating during the period. It is income available to pay interest to creditors. taxes to the government and dividends to stockholders. . operating cash flow • Operating income = earnings before interest and taxes (EBIT).

. since it is not a cash outlay. This definition recognizes that depreciation expense is added in computing EBIT.•Operating cash flow: • Operating cash flow = EBIT + Depreciation .Taxes. • It also recognizes that taxes paid is a cash outlay.

Importance of Proper Financial Management Maximum use of resources Make sound business decisions FINANCIAL MANAGEMENT Evaluate new business opportunities Measure business performance .

acquisitions and restructuring  Working capital management  Performance management  Risk management  Investor relations  .Emerging Role / Key Challenges of Financial Manager Investment planning  Financial structure  Mergers.

10. . 8.000.10 per share with an objective to raise capital to establish itself and has plans to raise Rs.40. What is the Value of the First call? 4. What is the objective behind the IPO? What does IPO stand For? 3. 9.BEAS Co Ltd.00. 500. Calculate paid up capital . 1. Calculate Issued capital .00.000.000 but managed to distribute only Rs. 10. 6. out of the capital limit of Rs.000 as per the MOA. Calculate subscribed capital . Calculate Authorized capital . In response to the first call of Rs 5 per share the total funds received was Rs. Calculate called up capital . What is the price of one share? 2. 7. 300000 to the public through banks. Questions: (1 mark each) 1. Whom did the company approach for the distribution of shares to the public? 5. Calculate the number of shares issued by the company . The response was moderate and the total number of share applications received was Rs. finance companies and brokers. plans for an IPO at Rs.

10.10 per share What is the objective behind the IPO? What does IPO stand For? Initial Public offering . 10. 1. Rs. 4.000 Calculate called up capital . Rs 50.000 Calculate the number of shares issued by the company.40. 6. 8.with an objective to raise capital to establish itself What is the Value of the First call? Rs 5 per share Whom did the company approach for the distribution of shares to the public? banks. 7. Rs.000 Calculate paid up capital. 300000 Calculate subscribed capital . 300000 / 10 per share = 30. 9. Rs.00. 5. 3.000 Calculate Issued capital .1.000 . What is the price of one share? Rs. finance companies& brokers Calculate Authorized capital . 2.00. Rs.

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