INTRODUCTION

TO
FINANCIAL
MANAGEMENT
AAK 1
 FINANCIAL
MANAGEMENT
• FINANCIAL MANAGEMENT
MEANS ENTIRE GAMUT OF
MANAGERIAL EFFORTS
DEVOTED TO THE MANGEMENT
OF FINANCE – BOTH ITS
SOURCE AND USES OF THE
ENTERPRISE.
 OBJECTIVES OF
FINANCIAL MANAGEMENT

1.PROFIT MAXIMISATION

2.WEALTH MAXIMISATION
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 PROFIT
MAXIMISATION
• ACTIONS THAT INCREASE
THE PROFITS SHOULD BE
UNDERTAKEN AND THOSE
THAT DECREASE PROFITS
SHOULD BE AVOIDED.
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 CRITICISM OF PROFIT
MAXIMISATION
• AMBIGUITY SHORT-TERM/LONG-TERM
BEFORE TAX/AFTER TAX, ROCE/ROI.
• TIMING OF BENEFITS
TIME PATTERN OF BENEFITS (PROFITS)
PROFITS (Rs) PROFITS (Rs)
A B
PERIOD 1 5000 -
PERIOD 2 10000 10000
PERIOD 3 5000 10000
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TOTAL 20000 20000
 QUALITY OF BENEFITS
• UNCERTAINITY ABOUT EXPECTED
PROFITS
PROFITS(Rs) PROFITS(Rs)
A B
PERIOD 1 900 -
PERIOD 2 1000 1000
PERIOD 3 1100 2000
TOTAL 3000
AAK
3000 6
 WEALTH
MAXIMISATION
• (EZRA SOLOMAN) – UNIVERSITY
ACCEPTED AS IT REMOVES ALL THE
TECHNICAL FLAWS OF PROFIT
MAXIMISATION CRITERION.
• OTHER OBJECTIVES
GIVING FAIR RETURN TO SHAREHOLDERS.
BUILDING UP RESERVES FOR GROWTH AND
EXPANSIONS.
ENSURING MAXIMUM OPERATIONAL
EFFICIENCY.
ENSURING FINANCIAL DISCIPLINES IN THE
ORGANISATION. AAK 7
 SCOPE OF FINANCIAL
MANAGEMENT
• TRADITIONAL APPROACH (TA) : THE TERM
“CORPORATION FINANCE” IS FINANCING OF
CORPORATE ENTERPRISES i.e. NARROW SENSE
OF PROCUREMENT OF FUNDS BY CORPORATE
ENTERPRISES.
• IT ENCOMPASES THREE INTER-RELATED
ASPECTS:
 INSTITUTIONS
 INSTRUMENTS
 LEGAL AND ACCOUNTING RELATIONSHIP BETWEEN
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A FIRM AND ITS SOURCES OF FUNDS.
TRADITIONAL APPROACH (TA)
• TA EVOLVED DURING 1920’s AND 1930’s
DOMINATED THE ACADEMIC THINKING
DURING THE 1940’s AND THROUGH
EARLY 1950’s.
• TA DISCARDED DUE TO CERTAIN
LIMITATIONS :
OUTSIDERS – LOOKING-IN APPROACH
FOCUS ON CORPORATE ENTERPRISES.
FOCUS ON LONG TERM FINANCING.
IGNORED DAY TO DAY
AAK
FINANCIAL PROBLEMS.
9
• TA ALSO IGNORED SOLOMAN’s ISSUES :

 SHOULD AN ENTERPRISE COMMIT

CAPITAL FUNDS TO CERTAIN PURPOSES.
 DO THE EXPECTED RETURNS MEET THE
FINANCIAL STANDARDS OF
PERFORMANCE.
 HOW SHOULD THESE STANDARDS BE SET.
 WHAT IS THE COST OF CAPITAL FUNDS TO
THE ENTERPRISE.
 HOW DOES THE COST VARY WITH THE
MIXTURE OF FINANCING METHODS USED.
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 MODERN APPROACH
• FINANCE FUNCTION COVERS BOTH
ACQUISITION OF FUNDS AS WELL AS THE
ALLOCATION.

• CONTENTS :
WHAT IS THE TOTAL VOLUME OF FUNDS AN
ENTERPRISE SHOULD COMMIT.
WHAT SPECIFIC ASSETS SHOULD AN
ENTERPRISE ACQUIRE.
HOW SHOULD THE FUNDS REQUIRED BE
FINANCED. AAK 11
FUNCTIONS OF FINANCE
• INVESTMENT DECISIONS

• FINANCING DECISIONS

• DIVIDEND DECISIONS
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 FUNCTIONS OF FINANCE
INVESTMENT DECISIONS
LONG TERM (YIELD A RETURN OVER A LONG
PERIOD)
• CAPITAL BUDGETING
SHORT TERM (CONVERTIBLE INTO CASH
USUALLY WITHIN A YEAR)
• WORKING CAPITAL MANGEMENT
FINANCING DECISIONS
DIVIDEND POLICY DECISIONS
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 INVESTMENT DECISIONS
• CAPITAL BUDGETING : LONG-TERM
INVESTMENT DECISIONS

• CHOICE OF THE NEW ASSET OUT OF

ALTERNATIVES

• RISK AND UNCERTAINITY

• CUT-OFF RATE/HURDLE
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RATE 14
INVESTMENT DECISIONS
• WORKING CAPITAL MGT. : CURRENT
ASSETS
• TRADE OFF BETWEEN PROFIT
AVAILABILITY AND RISK
• TRADE OFF BETWEEN PROFITABILITY
AND LIQUIDITY.
• THE INDIVIDUAL CURRENT ASSETS
SHOULD BE EFFICIENTLY MANAGED.
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 FINANCING AND
DIVIDEND DECISIONS
• FINANCING DECISIONS DEAL WITH THE
FINANCING MIX OR CAPITAL STRUCTURE
WHICH REFERS TO THE PROPORTION OF
DEBT AND EQUITY CAPITAL.

• DIVIDEND POLICY DECISIONS DEAL WITH

THE PROFITS OF A FIRM i.e. WHETHER THEY
CAN BE DISTRIBUTED OR RETAINED (DIVIDEND
PAYOUT RATIO). DECISIONS DEPEND ON
PREFERENCES OF SHARE HOLDERS AND
INVESTMENT OPPORTUNITIES
AAK
AVAILABLE WITH
16
THE FIRM.
 FINANCIAL DECISION AREAS
1. INVESTMENT PRIMARY DISCIPLINES
ANALYSIS
SUPPORT • ACCOUNTING
2. WORKING CAPITAL
MANAGEMENT • MACROECONOMICS

3. SOUCES AND COST • MICROECONOMICS

OF FUNDS
4. DETERMINATION
OTHER RELATED
OF CAPITAL
DISCIPLINES
STRUCTURE SUPPORT
• MARKETING
5. DIVIDEND POLICY
• PRODUCTION
6. ANALYSIS OF
RISKS AND • QUANTITATIVE
RETURNS METHODS
RESULTING IN AAK 17
SHAREHOLDER WEALTH MAXIMISATION
 ROLE OF FINANCE
MANAGER
1. MOBILIZATION OF FUNDS
• PLAN AND MOBILIZE THE
REQUIRED FUNDS.
• LIAISING WITH BANKS.
• DEALS WITH MERCHANT
BANKING AGENCIES.
• WEIGHS THE COST OF FUNDS.
2. DEPLOYMENT OF FUNDS
DECIDES ON THE MANNER OF
DEPLOYMENT OF FUNDS IN VARIOUS
ASSETS SUCH AS LAND AND BUILDING,
MACHINERY, MATERIALS ETC.
SOMETIMES AN INVESTMENT
COMMITTEE IS FORMED AND
INVESTMENT PROPOSALS ARE MADE
ALONG MARKETING, TECHNICAL AND
FINANCIAL DIMENTIONS.
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3. CONTROL OVER THE USE OF
FUNDS
MONITORS THE USE OF PROPOSALS
AND PROCEEDS ACCORDING TO THE
PLAN. THIS IS FINANCIAL CONTROL.
HE SENDS CONTROL REPORTS TO
THE MD. THESE HELPS MANAGEMENT
TO TAKE TIMELY CORRECTIVE
ACTIONS TO ENSURE PLANNED
RESULTS.
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4. RISK – RETURN TRADE OFF
HE HAS TO ACHIEVE THE RIGHT
BALANCE BETWEEN RISK AND
RETURN. VARIOUS INVESTMENT
OPPORTUNITIES HAVE TO BE
ANALYSED ACCORDING TO THEIR
WORTH AND THE COST
INVOLVED.
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INTERFACE BETWEEN FINANCE
AND OTHER FUNCTIONS

1. MARKETING – FINANCE INTERFACE

2. PRODUCTION – FINANCE
INTERFACE
3. TOP MANAGEMENT – FINANCE
INTERFACE
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 1. MARKETING – FINANCE
INTERFACE
MAJOR DECISIONS :
• CLEAR UNDERSTANDING OF IMPACT OF
CREDIT EXTENSION.
• WEIGHING THE BENEFITS OF KEEPING A
LARGE INVENTORY.
• PRODUCT PROMOTION AND
ADVERTISEMENT.
• CHOICE OF PRODUCT MIX.
• DISTRIBUTIN POLICY.
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 2. PRODUCTION –
FINANCE INTERFACE
MAJOR DECISIONS :
• ORGANIZING THE EQUIPMENTS.
• OPTIMIZING THE INVENTORY.
• MINIMIZING THE WORK STOPAGES.
• MAKE OR BUY.
• BUY OR LEASE.
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 3. TOP MANAGEMENT –
FINANCE INTERFACE
MAJOR FUNCTIONS :

• STRATEGIC PLANNING.

• MANAGEMENT CONTROL.

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 CHALLENGES IN FINANCIAL
MANAGEMENT
• SHORT TERM FUND MANAGEMENT
• COST AND BENEFIT ANALYSIS IN
FOREIGN EXCHANGE TRANSACTIONS.
• OPTIMUM MIX BETWEEN DEBT AND
EQUITY.
• APPROPRIATE DIVIDEND AND BONUS
POLICIES.
• ENSURING MANAGEMENT CONTROL.
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 IMPORTANT FORMS OF
BUSINESS ORGANIZATIONS

1.SOLE PROPERIETORSHIP
2.PARTNERSHIP
3.COMPANY

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 1. SOLE
PROPRIETORSHIP
OWNED BY A SINGLE
PERSON. OWNER IS LIABLE
FOR ALL REWARDS,
PROFITS AND LOSSES.

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ADVANTAGES
• EASY AND INEXPENSIVE TO SET UP.
• FEW GOVERNMENTAL REGULATIONS.
• NO FIRM TAX.
DISADVANTAGES
• FIRM LIFE IS LIMITED.
• UNLIMITED PERSONAL LIABILITIES.
• NO OUTSIDE FUND RAISING.
• HIGH INCOME TAX.
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 2. PARTNERSHIP

OWNED BY TWO OR
MORE PERSONS. RISK
AND PROFIT BEARING IS
BASED ON THE
PARTNERSHIP
AGREEMENT OR DEED.
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ADVANTAGES
• SET UP EASILY AND INEXPENSIVELY.
• RELATIVELY FREE FROM
GOVERNMENTAL REGULATIONS.
• PARTNER’s EXPERTISE AND EXPERIENCE
IS USEFUL.
DISADVANTAGES
• LIFE DEPENDS UPON THE AGREEMENT.
• CONFLICT BETWEEN THE PARTNERS.
• UNLIMITED PERSONAL LIABILITIES.
• LIMITED ABILITY TOAAKRAISE FUNDS. 31
 3. COMPANIES
GROUP OF PERSONS WORKING
TOGETHER, TOWARDS THE
COMMON OBJECTIVE IS A
COMPANY. REGISTERED
COMPANY MEANS A COMPANY
INCORPORATED UNDER THE
COMPANIES ACT, 1956.
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TYPES OF COMPANIES
• PRIVATE COMPANIES

• PUBLIC COMPANIES

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• PRIVATE COMPANIES

MINIMUM PAID UP CAPITAL

OF RUPEES 1Lac. RESTRICTED
RIGHT TO TRANSFER ITS
SHARE. MAXIMUM NUMBER OF
MEMBERS IS FIFTY. NO
INVITATION TO THE PUBLIC
FOR SUBSCRIPTION SHARES
OR DEBENTURES.
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• PUBLIC COMPANIES

MINIMUM PAID UP
CAPITAL OF 5 Lac
RUPEES. NO
RESTRICTION FOR
MAXIMUM NUMBER OF
MEMBERS. CAN ISSUE
SHARES. AAK 35
ELEMENTS OF REGULATORY
FRAMEWORK
1. INDUSTRIAL POLICY
2. INDUSTRIAL LINCENSING PROVISIONS
3. ESTABLISHMENT OF CENTRAL
ADVISORY COUNCIL
4. FOREIGN EXCHANGE MANAGEMENT
ACT, 1999
5. MONOPOLIES AND RESTRICTIVE
PRACTICES ACT 1969
6. COMPANIES ACT, 1956
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 1. INDUSTRIAL POLICY
SALIENT PROVISIONS
• TO PROMOTE DEVELOPMENT OF SMALL
SCALE AND VILLAGE INDUSTRIES.
• INVOLVES PARTNERSHIP BETWEEN THE
GOVERNMENT AND PRIVATE
ENTERPRISES.
• CONTRIBUTE TO THE ESTABLISHMENT
OF THE INDUSTRIES.
• REDUCTION OF REGIONAL DISPARITIES.
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 2. INDUSTRIAL LINCENSING
PROVISIONS AND PROCEDURES
IMPORTANT PROVISIONS :
• ABOLISHMENT OF INDUSTRIAL
LINCENSING, FOR SECURITY AND
STRATEGIC CONCERNS.
• UNITS ARE PERMITTED TO MANUFACTURE
ANY NEW ARTICLE.
• GOVT. CAN ORDER INVESTIGATION AND
MAY TAKEOVER THE MANAGEMENT.
• GOVT. CAN CONTROL THE PRICES,
METHODS OF PRODUCTION AND MODE OF
DISTRIBUTION. AAK 38
3. ESTABLISHMENT OF CENTRAL ADVISORY
COUNCIL AND DEVELOPMENT COUNCIL
MAIN FUNCTIONS :
• TO ADVISE ON THE MATTERS
CONCERNING THE DEVELOPMENT AND
REGULATION OF SCHEDULED
INDUSTRIES.
• TO PERFORM ASSIGNED FUNCTIONS TO
INCREASE THE EFFICIENCY OR
PRODUCTIVITY IN THE SCHEDULED
INDUSTRY BOTH IN TERMS OF ECONOMY
AND IN THE INTEREST OF THE
COMMUNITY. AAK 39
 4. FOREIGN EXCHANGE
MANAGEMENT ACT, 1999
SALIENT FEATURES :
• FULL FREEDOM TO AN INDIAN RESIDENT.
• NON RESIDENT INDIANS PERMITTED TO
HOLD SHARES AND PROPERTIES.
• EXCHANGE DRAWN CAN BE USED FOR
PURPOSE OTHER THAN SPECIFIED.
• DEALINGS ONLY IN ACCORDANCE WITH
THE PROVISIONS.
• FURNISHING OF DECLARATION TO RBI BY
EXPORTERS. AAK 40
 5.MONOPOLIES AND
RESTRICTIVE PRACTICES ACT,
1969
MAJOR FEATURES :
• ELIMINATION OF PRE- ENTRY
RESTRICTIONS.
• RESTRICTIONS ON ACQUISITIONS
AND TRANSFER OF SHARES
REMOVED.
• POWERS OF THE MRTP
COMMISSION WIDENED.
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 6. COMPANIES ACT, 1956
MAJOR OBJECTIVES :
• ENSURE MINIMUM STANDARD OF
BUSINESS INTEGRITY.
• ELICIT FULL AND FAIR DISCLOSURE OF
INFORMATION.
• ENFORCE PROPER PERFORMANCE OF
DUTIES.
• INVESTIGATE AND INTERVENE IN THE
AFFAIRS OF COMPANIES.
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IMPORTANT PROVISIONS :
• ONLY PREFERENCE AND EQUITY SHARES
CAN BE ISSUED.
• EXISTING SHAREHOLDERS TO BE GIVEN
PREFERENCE IN FURTHER ISSUES.
• NO RE- ISSUANCE OF BUY- BACK SHARES.
• SWEAT EQUITY SHARES ISSUED TO
EMPLOYEES OR DIRECTORS ON
DISCOUNT.
• NO LOANS OR INVESTMENTS EXCEEDING
60% OF PAID UP CAPITAL.
• DIVIDENDS CAN BE DECLARED ONLY OUT
OF PROFITS. AAK 43