Unit 1-fm-intrduction-1 ppt

FINANCIAL MANAGEMENT
UNIT 1
Dr. THULASI KRISHNA. K, Ph.D.
Dept. of Management Studies,
MITS, Madanapalle, A.P.

DEFINITION OF FINANCIAL MANAGEMENT
– Managerial activities which deal with planning and
controlling of firms and financial sources.
– Financial management is an area of financial decision making,
harmonsing individual motives and enterprise goals.
- Weston Brigham

Meaning of Finance
 Finance is a branch of economics concerned with resource allocation as
well as resource management, acquisition and investment. Simply,
finance deals with matters related to money and the markets.
 Finance is often defined simply as the management of money or
funds’ management.

Meaning of Business Finance
According to the Wheeler, “Business finance is that business
activity which concerns with the acquisition and conservation of
capital funds in meeting financial needs and overall objectives of a
business enterprise”.
According to the Guthumann and Dougall, “Business finance can
broadly be defined as the activity concerned with planning, raising,
controlling, administering of the funds used in the business”.

OTHER DEFINITIONS OF FINANCIAL MANAGEMENT
Financial management is an integral part of overall management. It is
concerned with the duties of the financial managers in the business firm.
Solomon defines as, “It is concerned with the efficient use of an
important economic resource namely, capital funds”.
S.C. Kuchal defines it as “Financial Management deals with procurement
of funds and their effective utilization in the business”.

NATURE OF FINANCIAL MANAGEMENT
Financial management refers to that part of management activity, which
is concerned with the planning and controlling of firm’s financial
resources.
Activities of Financial Management
a. Anticipating financial needs
b. Acquiring financial resources
c. Allocating funds in business

EVOLUTION OF FINANCIAL MANAGEMENT
 The Evolution of financial management is classified in to two
categories.
- Traditional approach
- Transitional approach
- Modern approach

TRADITIONAL APPROACH (1920-40)
 According to this approach, the scope of the finance
function is restricted to “procurement of funds by corporate
enterprise to meet their financial needs.
 The term ‘procurement’ refers to raising of funds externally
as well as the inter related aspects of raising funds.

 Emphasis was on long-term finance
 In traditional approach, the resources could be raised from
the combination of the available sources like internal and
external sources.

LIMITATIONS OF TRADITIONAL APPROACH
 This approach is confined to ‘procurement of funds’ only.
 It fails to consider an important aspect i.e., allocation of
funds.
 Focused only on corporate finance.
 It deals with only outsiders i.e., investors, investment
bankers.

 The internal decision making was completely ignored in this
approach.
 The traditional approach failed to consider the problems
involved in working capital management.
 It neglected the issues relating to the allocation and
management of funds and failed to make financial
decisions.

TRANSITIONAL PHASE (1940-50)
 Emphasis on working capital management
 Capital Budgeting Techniques were developed.

MODERN APPROACH (from 1950)
 The modern approach is an analytical way of looking into
financial problems of the firm.
 According to this approach, the finance function covers both
acquisition of funds as well as the allocation of funds to
various uses.
 Financial management is concerned with the issues
involved in raising of funds and efficient and wise allocation
of funds.

MAIN CONTENTS OF MODERN APPROACH
 How large should an enterprise be and how far it
should grow?
 In what form should it hold its assets?
 How should the funds required be raised?
- Financial management is concerned with finding
answer to the above problems. (Rational matching of
funds to their uses for maximizing shareholders’ wealth)

 This phase has seen advancements in capital structure
decisions, cash management models and dividend
policies.

FUNCTIONS OF FINANCE
 There are three finance functions
 Investment decision
 Financing decision
 Dividend decision

INVESTMENT DECISION
 Investment decision relates to selections of asset in
which funds will be invested by a firm.
 The asset that can be acquired by a firm may be long-
term asset and short-term asset.

 Decision with regard to long-term assets is called
capital budgeting.
 Decision with regard to short-term or current assets is
called working capital management.

Capital Budgeting
 Capital budgeting relates to selection of an asset or
investment proposal which would yield benefit in future.
 It is concerned with long-term investment decision
making.

 It evaluates the investment proposal in terms of risk
associated with it and such evaluation is made against
certain norms or standard. This standard is broadly known
as cost of capital.

Working Capital Management
 Working capital management or current asset
management is an important part of investment
decision.
 Proper management of working capital ensures firm’s
liquidity and solvency.
 A conflict exists between profitability and liquidity while
managing current asset.

Working Capital Management
 If a firm does not invest sufficient funds in current
assets it may become illiquid and may not meet its
current obligations.
 The financial manager should develop proper techniques
of managing current assets so that neither insufficient nor
unnecessary funds are invested in current assets.
 If the current assets are large, the firm would lose its
profitability and liquidity.

Management of Working Capital
 The management of working capital has two
aspects.
- Efficient management of individual current
asset such as cash, receivable and inventory.
- Overview of working capital management and

FINANCING DECISION
 Financing decision is concerned with the
financing mix or capital structure.

FINANCING DECISION
 Determination of the proportion of equity and debt is the
main issue in financing decision.
 Once the best combination of debt and equity is determined, the
next step is raising appropriate amount through available sources.
 The mix of debt and equity is known as capital structure.

DIVIDEND DECISION
 A firm distribute all profits or retain them or distribute a
portion and retain the balance with it.
 Which course should be allowed? The decision
depends upon the preference of the shareholders and
investment opportunities available to the firm.

 Dividend decision has a strong influence on the
market price of the share.
 So the dividend policy is to be determined in
terms of its impact on shareholder’s value.
 The optimum dividend policy is one which
maximizes the value of shares and wealth of
the shareholders.

Dividend Decision
 The financial manager should determine the optimum
pay out ratio i.e., the proportions of net profit to be paid
out to the shareholders.
 The above three decisions are inter related. To have an
optimum financial decision the three should be taken
jointly.

OBJECTIVES OF FINANCIAL MANAGEMENT
 The term ‘objective’ refers to a goal or decision
for taking financial decisions.
 Profit maximisation
 Wealth maximisation

PROFIT MAXIMISATION
 The term profit maximisation is deep rooted in
the economic theory.
 It is needed when firms pursue the policy of
maximising profits.
 Society’s resources are efficiently utilised.

 The firm should undertake those actions that
would increase profits and drop those actions
that would decrease profit.
 The financial decisions should be oriented to the
maximisation of profits.
 Profit provides the yardstick for measuring
performance of firms.

 It makes allocation of resources to profitable
and desirable areas.
 It also ensures maximum social welfare.

Favourable Arguments for Profit Maximization
The following important points are in support of the profit
maximization objectives of the business concern:
 (i) Main aim is earning profit.
 (ii) Profit is the parameter of the business operation.
 (iii) Profit reduces risk of the business concern.
 (iv) Profit is the main source of finance.
 (v) Profitability meets the social needs also.

Limitations
 The term profit is vague
 Ignores Time Value of Money
 Ignores the Risk
 Ignores Quality, image, technological advancements
etc.
 Profit maximisation as an objective is too narrow (It fails to take
into account the social considerations such as the obligations to
various interests of workers, consumers, society, as well as ethical
trade practices).

WEALTH MAXIMISATION
 Wealth maximisation or net present value maximisation
provides an appropriate and operationally feasible
decision criterion for financial management decisions.

 According to this objective, the managers should take decisions
that maximize the shareholders' wealth. In other words, it is to
make the shareholders as rich as possible.
 Shareholders' wealth is maximized when a decision generates net
present value. The net present value is the difference between
present value of the benefits of a project and present value of its
costs.

Using Solomon’s symbols and methods, the net present worth can be
calculated as shown below:
 W = V – C
Where, W = Net present worth; V = Gross present worth; C = Investment
(equity capital) required to acquire the asset or to purchase the course of
action.
 V = E/K
Where, E = Size of future benefits available to the suppliers of the input
capital;
K = The capitalization (discount) rate reflecting the quality (certainty/
uncertainty) and timing of benefit attached to E.

IMPORTANCE OF FINANCIAL MANAGEMENT
 (i) Success of Promotion Depends on Financial Administration
 (ii) Smooth Running of an Enterprise
 (iii) Financial Administration Co-ordinates Various Functional Activities
 (iv) Focal Point of Decision Making
 (v) Determinant of Business Success
 (vi) Measure of Performance
 (vii) Determination of fixed assets
 (viii) Determination of current assets
 (ix) Determination of Capital Structure

NEW ROLE OF FINANCE FUNCTION IN THE CONTEMPORARY SCENARIO
 Continuous focus on margins and ensure that the organisation stays
committed to value creation.
 Work across the functional divide of the company and exhibit leadership
skills.
 Understand what's driving the numbers and provide operation insights,
including a sense of external market issues and internal operating trends,
and become key strategy player.
 Aware and use the highly innovative financial instruments.
 Know the emergence of capital market as central stage for raising money.
 Adding more value to the business through innovations in impacting
human capital.

 Must balance the need to cut overhead with the need to create a finance
organisation able to meet long-term goals by designing financial processes,
systems and organisation that can support the business in the future and initiating
cost reductions that further cut organisational fat, but not operational muscle.
 Liaison (link) to the financial community, investors and regulators (rating agencies,
investment and commercial bankers and peers), which are valuable information
sources for strategic and tactical decisions.
 Assess probable acquisitions, contemplating initial negotiation, carrying out due
diligence, communicating to employees and investors about the horizontal
integration.
 Deal with the post-merger integration in the light of people issues.

 Deal with the new legislation (New Companies Bill, Limited Liability
Partnership), and regulations merely add more formality and, to an extent,
bureaucracy, to what most already subscribe to as best practices in
financial reporting.
 Be one of the undisputed arbiter in matters of financial ethics, with the
backing of legislation and stiff penalties.
 Finance managers are central to changes in audit and control practices.
Corporate governance is a key issue that must be continuously monitored
and he/she should not push the limit of the P&L and growth.
 Be aware of the proposed changes in financial reporting systems such as
International Financial Reporting Standards (IFRS), Goods and Services
Tax (GST), Direct Tax Code (DTC) and Extensible Business Reporting
Language (XBRL). Adapting and optimising within changing tax reforms
would become imperative for then and their organisations.

Unit 1-fm-intrduction-1 ppt

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Unit 1-fm-intrduction-1 ppt