Chapter - 1: Financial Management - An Introduction

Chapter - 1
Financial Management
-An Introduction
Business Activities
Production
Marketing
Finance
Finance function is the most important of
all business functions.
I. M. Pandey, Financial
Management, 9th ed., Vikas.
Financial Management involves sourcing of funds,
making appropriate investments and promulgating the
best mix of financial and dividends in relation to the value
of the firm.
Financial management is concerned with the managerial
decisions that result in the acquisition and financing of
short term and long term credits for the firm". Here it
deals with the situations that require selection of specific
assets (or combination of assets), the selection of
specific problem of size and growth of an enterprise.
Here the analysis deals with the expected inflows and
outflows of funds and their effect on managerial
objectives
Approaches to Finance Function

The Traditional Approach
The Modern Approach
According to traditional approach, the scope
of finance function was confined to only
procurement of funds needed by a business
on most suitable terms. The utilization of funds
was considered beyond the purview of finance
function.
Modern Approach
(Inside-Outside approach)
The modern approach views finance function in broader
sense.
It includes both raising of funds as well as their effective
utilization under the purview of finance.
Proper utilization of funds was given more importance in
modern approach.
Finance function according to this approach covers
financial planning, raising of funds, allocation of funds,
financial control.
Modern approach considers the three basic

management decisions i.e. investment , financing and
dividend decision with the scope of finance function.
Evolution of Corporate Finance

Corporate finance emerged as distinct field of
study only in the early part of 21st century.
The Economic recession of 1930;s rendered
difficulties in raising finance from banks and
other financial institutions.
This time finance managers had a responsibility
of ensuring that the enterprise was having
optimal usage of funds, avoiding unnecessary
expansion programmes and maintaining the
loyalty of existing customers.
Evolution of Financial Management

The post World war II era necessitated reorganization of
industries and the need for selecting sound financial
structure. In early 1950s emphasis shifted from
profitability to liquidity and from institutional finance to day
to day operations of the firm.
The modern phase began in mid-fifties and the discipline
of corporation finance or financial management has now
become more analytical and quantitative .
The 1990s saw the introduction of numerous financial
instruments replacing hard cash as transfer of funds. The
2000s have brought globalization through merger of
firms, increase competition access to international
markets and need for quality products.
Areas of Financial Management
Investment decision
Financing
Allocation of capital to investment proposals

Managing existing investments efficiently
Determining the best mix of capital structure
Methods of obtaining long and short-term finance.
Dividend decisions
Percentage of earnings to stockholders

Stability of dividend
Stock dividend
Finance Functions
Investment or Long Term Asset Mix
Decision
Financing or Capital Mix Decision
Dividend or Profit Allocation Decision
Liquidity or Short Term Asset Mix
Decision
Scope of Financial Management
Estimating Financial Requirements

Deciding capital Structure
Selecting a Source of Finance
Selecting a pattern of Investment
Cash Management
Implementing Financial Controls
Proper use of Surpluses
10
Objectives of Financial
Management
Profit maximization (profit after tax)
Shareholders Wealth Maximization
11
Profit Maximization
Profit earning
is the main aim of every
economic activity. No business can survive
without earning profit. Objective of financial
management is same as the objective of a
company that is to earn profit.
Maximizing the Rupee Income of Firm

Resources are efficiently utilized
Profits are the main source of finance for growth of
business.
Appropriate measure of firm performance
Serves interest of society also
12
Objections to Profit
Maximization
It is Vague
It Ignores the Timing of Returns
It Ignores Risk
Assumes Perfect Competition
In new business environment profit
maximization is regarded as
Unrealistic
Difficult
Inappropriate
Immoral.
13
Maximizing EPS
Ignores timing and risk of the expected
benefit
Market value is not a function of EPS.
Hence maximizing EPS will not result in
highest price for company's shares
Maximizing EPS implies that the firm
should make no dividend payment so long
as funds can be invested at positive rate of
returnsuch a policy may not always work
14
Shareholders Wealth
Maximization
Maximizes the net present value of a

course of action to shareholders.
Accounts for the timing and risk of the
expected benefits.
Benefits are measured in terms of cash
flows.
Fundamental objectivemaximize the
market value of the firms shares.
15
Risk-return Trade-off
Risk and expected return move in tandem; the
greater the risk, the greater the expected
return.
Financial decisions of the firm are guided by
the risk-return trade-off.
The return and risk relationship:
Return = Risk-free rate +
Risk premium
Risk-free rate is a compensation for time and
risk premium for risk.
16
Managers Versus
Shareholders Goals
A company has stakeholders such as employees, debtholders, consumers, suppliers, government and society.
Managers may perceive their role as reconciling
conflicting objectives of stakeholders. This stakeholders
view of managers role may compromise with the objective
of SWM.
Managers may pursue their own personal goals at the
cost of shareholders, or may play safe and create
satisfactory wealth for shareholders than the maximum.
Managers may avoid taking high investment and financing
risks that may otherwise be needed to maximize
shareholders wealth. Such satisfying behaviour of
managers will frustrate the objective of SWM as a
normative guide.
17
Financial Goals and Firms

Mission and Objectives
Firms primary objective is maximizing the welfare

of owners, but, in operational terms, they focus on
the satisfaction of its customers through the
production of goods and services needed by them
Firms state their vision, mission and values in
broad terms
Wealth maximization is more appropriately a
decision criterion, rather than an objective or a
goal.
Goals or objectives are missions or basic purposes
of a firms existence
18
Financial Goals and Firms

Mission and Objectives
The shareholders wealth maximization is
the second-level criterion ensuring that
the decision meets the minimum standard
of the economic performance.
In the final decision-making, the
judgement of management plays the
crucial role. The wealth maximization
criterion would simply indicate whether an
action is economically viable or not.
19
Organization of the Financial

Management Function
Board of Directors
President
(Chief Executive Officer)
Vice President
Operations
VP of
Finance
Vice President
Marketing
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Organization of the Financial

Management Function
VP of Finance
Treasurer
Controller
Capital Budgeting
Cash Management
Credit Management
Dividend Disbursement
Fin Analysis/Planning
Pension Management
Insurance/Risk Mngmt
Tax Analysis/Planning
Cost Accounting
Cost Management
Data Processing
General Ledger
Government Reporting
Internal Control
Preparing Fin Stmts
Preparing Budgets
Preparing Forecasts
21
Organisation of the Finance

Functions
Reason for
functions in
management
placing the
the hands
finance
of top
Financial decisions are crucial for the survival

of the firm.
The financial actions determine solvency of
the firm
Centralisation of the finance functions can
result in a number of economies to the firm.
22
Role of The Financial Manager

(2)
(1)
Financial
manager
Firm's
operations
(4a)
Financial
markets
(4b)
(3)
(1) Cash raised from investors
(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors
23
Status and Duties of Finance

Executives
The exact organisation structure for
financial management will differ across
firms.
The financial officer may be known as
the financial manager in some
organisations, while in others as the
vice-president of finance or the director
of finance or the financial controller.
24
Role of Treasurer and Controller

Two more officersthe treasurer and
the controllermay be appointed
under the direct supervision of CFO to
assist him or her.
The treasurers function is to raise and
manage company funds while the
controller oversees whether funds are
correctly applied.
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Inter-relation of Financial Decision

Investment
Decision
Financing
Decision
Dividend
Decision
Risk Return Relationship

(Trade off)
SWM
26

Chapter - 1: Financial Management - An Introduction

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Chapter - 1: Financial Management - An Introduction

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Chapter - 1

Approaches to Finance Function

Modern approach considers the three basic

Evolution of Corporate Finance

Evolution of Financial Management

Areas of Financial Management

Allocation of capital to investment proposals

Percentage of earnings to stockholders

Scope of Financial Management

Estimating Financial Requirements

Maximizing the Rupee Income of Firm

Maximizes the net present value of a

Financial Goals and Firms

Firms primary objective is maximizing the welfare

Financial Goals and Firms

Organization of the Financial

Organization of the Financial

Management, 9th ed., Vikas.

Organisation of the Finance

Financial decisions are crucial for the survival

Role of The Financial Manager

Status and Duties of Finance

Role of Treasurer and Controller

Inter-relation of Financial Decision

Risk Return Relationship

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