FM-Lecture 1.ppt

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FINANCIAL MANAGEMENT

Financial Management is that specialised function ofgeneral management which is related to the procurement of

finance and its effective utilisation for the achievement of

common goal of the organisation.

Financial Management is the operational activity of a businessthat is responsible for obtaining and effectively, utilizing the

funds necessary for efficient operations.- Joseph and Massie.From the above definitions, it is clear that financial

management is that specialised activity which is responsible for

obtaining and affectively utilizing the funds for the efficient

functioning of the business and, therefor, it includes financial

planning, financial administration and financial control.

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SCOPE OF FINANCIAL MGMT.

1. Financial Management in New Companies: A new company spendslarge amount on production and marketing but it should not ignoreproper use of its fund by managing cash, inventory, debtors and fixedassets

2. Financial Management in Old Companies: Old company can survivein long run, if it is capable to pay debt timely, to pay salary on time

and to pay other daily expenses. Because old company has goodreputation in financial market, so financial managements some partlike working capital management is very significant

3. Financial Management in NGO: Only NGO are working not for profitaim. Its aim is not to earn money but to survive. For long runexistence NGO need to properly manage its cost

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Scope of financial mgmt. Contd.

Financial management, at present is not confined to raising andallocating funds. The study of financial institutions like stock exchange,

capital, market, etc. is also emphasized because they influenced under

writing of securities & corporate promotion. Company finance was

considered to be the major domain of financial management. The scope

of this subject has widened to cover capital structure, dividend policies,

profit planning and control and depreciation policies. It covers areas like:

Determining financial needs:- Funds are needed to meet promotional

expenses, fixed and working capital needs. The requirement of fixed

assets is related to types of industry. A manufacturing concern will

require more investments in fixed assets than a trading concern. The

working capital needs depend upon scale of operations. Larger the scale

of operations, the higher will be the needs for working capital.

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Choosing the sources of funds:- A number of sources may be available for

raising funds. A concern may be resort to issue of share capital and

debentures. Financial institutions may be requested to provide long-termfunds. The working capital needs may be met by getting cash credit or

overdraft facilities from commercial bands.

Financial analysis and interpretation:- The analysis & interpretation of financial

statements is an important task of a finance manager. He is expected to know

about the profitability, liquidity position, short term and long-term financialposition of the concern. For this purpose, a number of ratios have to be

calculated.

Cost-volume profit analysis:- This is popularly known as CVPrelationship. For

this purpose, fixed costs, variable costs and semi variable costs have to be

analyzed. Fixed costs are more or less constant for varying sales volumes.Variable costs vary according to the sales volume. Semi-variable costs are

either fixed or variable in the short-term. The financial manager has to ensure

that the income of the firm will cover its variable costs

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Working capital management:- Working capital refers to that part offirms

capital which is required for financing short-term or current assets such as

cash, receivables and inventories. It is essential to maintain proper level of

these assets. Finance manager is required to determine the quantum ofsuch assets.

Dividend policy:- The investors are interested in earning the maximum

return on their investments whereas management wants to retain profits

for future financing. These contradictory aims will have to be reconciled in

the interests of shareholders and the company. Dividend policy is animportant area of financial management because the interest of the

shareholders and the needs of the company are directly related to it.

Capital budgeting:- It is an expenditure the benefits of which are expected

to be received over a period of time exceeding one year. It is expenditure

for acquiring or improving the fixed assets, the benefits of which areexpected to be received over a number of years in future. Capital budgeting

decisions are vital to any organization. Any unsound investment decision

may prove to be fatal for the very existence of the concern

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DECISIONS BY A FINANCIAL MANAGER

FM is concerned with the acquisition, financing, and management

of assets with some overall goal in mind.

Investment Decisions deal with questions like:

What is the optimal firm size?

What specific assets should be acquired?

What assets (if any) should be reduced or eliminated?

Financing Decisions: Determine how the assets (LHS of balance

sheet) will be financed (RHS of balance sheet)What is the best type of financing?

What is the best financing mix?What is the best dividend policy (e.g., dividend-payout ratio)?

How will the funds be physically acquired?

Asset Management Decisions

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OBJECTIVES OF FINANCIAL MGMT.

Profit Maximization: Profit maximization is considered as

the goal of financial management. In this approach, actions thatIncrease profits should be undertaken and the actions that

decrease the profits are avoided. The term 'profit' is used in two

senses

As per first concept it refers to the amount and share of nationalIncome that is paid to the owners of business. The second way is

an operational concept i.e. profitability. This concept signifies

economic efficiency. It means profitability refers to a situation

where output exceeds Input. It means, the value created by the

use of resources is greater that the Input resources. Thus in all

the decisions, one test is used I.e. select asset, projects and

decisions that are profitable and reject those which are not

profitable.

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OBJECTIVES OF FINANCIAL MGMT. Contd.

Wealth Maximization: Wealth maximization decisioncriterion is also known as Value Maximization or Net Present-

Worth maximization.

This involves increasing the Earning per share of the shareholders and to

maximize the net present worth. Wealth is equal to the difference

between gross present worth of some decision or course of action and the

investment required to achieve the expected benefits.

The Wealth Maximization approach is concerned with the amount of cash

flow generated by a course of action rather than the profits.

Value of business = EPS (EPS = Net Earnings / Outstanding Shares ) /Capitalization rate

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An equation for net income

Net sales revenue

Cost of goods sold (O/P Inventory + Purchases C/L Inventory)

= Gross profit SG&A expenses (selling, General and Administrative Expenses)

= EBITDA

Depreciation & amortization(writing off an intangible asset that is being)

= EBIT

Interest expense (cost of borrowing money)

= EBT

Tax expense = Net income (EAT)

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Wealth Maximization versus Profit Maximization

Timing profit maximization does not take into account

the timing of earnings, while wealth maximization does

Risk wealth maximization takes risk into account the

associated risk but profit maximization does not

Dividend payments if profit maximization was the goal,

a firm would never pay dividends

Qualitative factors profit maximization does not take

into account future activities such as sales growth, stability

and diversification.

Stock price maximization since investors want to

maximize their own wealth, they prefer the firm adopt

strategies that will maximize stock price

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Profit maximization features1. Profit maximization is also called as cashing per share

maximization. It leads to maximize the business operation for

profit maximization

2. Ultimate aim of the business concern is earning profit, hence, it

considers all the possible ways to increase the profitability of the

concern

3. Profit is the parameter of measuring the efficiency of the

business concern. So it shows the entire position of the business

concern

4. Profit maximization objectives help to reduce the risk of the

business

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Favourable Arguments for Profit MaximizationMain aim is earning profit

Profit is the parameter of the business operationProfit reduces risk of the business concern

Profit is the main source of finance

Profitability meets the social needs also

Unfavourable Arguments for Profit MaximizationProfit maximization leads to exploiting workers and consumers

Profit maximization creates immoral practices such as corrupt practice, unfair

trade practice, etcProfit maximization objectives leads to inequalities among the sake holders

such as customers, suppliers, public shareholders, etc

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Drawbacks of Profit Maximization

(i) It is vague: In this objective, profit is not defined precisely or

correctly. It creates some unnecessary opinion regarding earning

habits of the business concern

(ii) It ignores the time value of money: Profit maximization doesnot consider the time value of money or the net present value of

the cash inflow. It leads to certain differences between the actual

cash inflow and net present cash flow during a particular period

(iii) It ignores risk: Profit maximization does not consider risk of thebusiness concern. Risks may be internal or external which will affect

the overall operation of the business concern

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Favourable Arguments for Wealth Maximization

1. Wealth maximization is superior to the profit maximization because

the main aim of the business concern under this concept is to

improve the value or wealth of the shareholders

2. Wealth maximization considers both time and risk of the business

concern3. Wealth maximization provides efficient allocation of resources

4. It ensures the economic interest of the society as total cost of

project undertaken is compared to its value for the organization and

the society as whole

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Unfavourable Arguments for Wealth Maximization

Wealth maximization is nothing, it is also profit maximization, it is the

indirect name of the profit maximization

Wealth maximization creates ownership-management controversy

The ultimate aim of the wealth maximization objectives is to

maximize the profit

Wealth maximization can be activated only with the help of the

profitable position of the business concern

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AGENCY PROBLEM---Management versus Stockholders

Management serves as an agent to the stockholders (owner)

Stockholders delegate authority to management to act on their

behalf and are expected to act in their best interest

Managements objectives may differ from those of stockholders

In many large corporations, where ownership is largely diversified,the situation arises where management may act in their own best

interests rather than in the best interests of the stockholders

Management may attempt to amass income, power and prestige

Appropriate incentives such as stock options, bonuses andperquisites, should be given to managers to ensure they act in the

best interest of the stockholders

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ROLE/FUNCTIONS OF FINANCE MANAGER

Finance manager is one of the important role players in the field of finance

function. He must have entire knowledge in the area of accounting, finance,

economics and management. His position is highly critical and analytical to

solve various problems related to finance.

1.Forecasting Financial Requirements He should estimate, how much

finances required to acquire fixed assets and forecast the amount needed to

meet the working capital requirements in future

2. Acquiring Necessary Capital After deciding the financial requirement, the

finance manager should concentrate how the finance is mobilized and

where it will be available

3.Investment Decision The finance manager must carefully select best

investment alternatives and consider the reasonable and stable return from

the investment. He must be well versed in the field of capital budgeting

techniques to determine the effective utilization of investment

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ROLE/FUNCTIONS OF FINANCE MANAGER Contd.

4. Cash Management Proper cash management is not only essential for

effective utilization of cash but it also helps to meet the short-term

liquidity position of the concern

5. Interrelation with Other Departments Finance manager deals with

various functional departments such as marketing, production, personnel,research & development, etc. Finance manager should have sound

knowledge not only in finance related area but has to be well versed in

other areas too. He must maintain a good relationship with all the

functional departments of the business organization

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IMPORTANCE OF FINANCIAL MANAGEMENT

Financial Planning Long-term profit planning aimed at generating greater

return on assets, growth in market share, and at solving foreseeable

problems

Acquisition of Funds Financial management involves the acquisition of

required finance to the business concern. Acquiring needed funds play a

major part of the financial management, which involve possible source of

finance at minimum cost

Proper Use of Funds Proper use and allocation of funds leads to improve

the operational efficiency of the business concern. When the finance

manager uses the funds properly, they can reduce the cost of capital and

increase the value of the firm.

Financial Decision Financial decision will affect the entire business

operations of the concern because there is a direct relationship with

various department functions such as marketing, production personnel, etc

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IMPORTANCE OF FINANCIAL MGMT. Contd.

Improve Profitability Financial management helps to improve the

profitability position of the concern through effectiveness utilization of

funds with the help of strong financial control devices such as budgetary

control, ratio analysis and cost volume profit analysis

Increase the Value of the Firm Ultimate aim of any business concern is to

achieve maximum profit. Higher profitability leads to the maximization of

the wealth of investors as well as the nation

Promoting Savings Savings are possible only when the business concern

earns higher profitability and maximizing wealth. Effective financial

management helps to promoting and mobilizing individual and corporate

savings. Nowadays

financial management is also popularly known as business finance or

corporate finances. The business concern or corporate sectors cannot

function without the importance of the financial management.

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Areas of financial Mgmt.

1. Financial Management and Economics Economic concepts like microand macroeconomics are directly applied with the financial management

approaches. Financial management also uses the economic equations like

money value discount factor, economic order quantity etc.

2. Financial Management and Accounting Accounting records include the

financial information of the business concern. Hence, we can easily

understand the relationship between the financial management and

accounting. In the olden periods, both financial management and

accounting are treated as a same discipline and then it has been merged

as Management Accounting because this part is very much helpful tofinance manager to take decisions. But nowadays financial management

and accounting discipline are separate and interrelated.

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Areas of financial Mgmt. Contd.

3. Financial Management and Mathematics Economic order quantity,discount factor, time value of money, present value of money, cost of capital,

capital structure theories, dividend theories, ratio analysis and working

capital analysis are used as mathematical and statistical tools and techniques

in the field of financial management

4. Financial Management and Production Management Profit of theconcern depends upon the production performance. Production

performance needs finance, because production department requires raw

material, machinery, wages, operating expenses etc. These expenditures are

decided and estimated by the financial department and the finance manager

allocates the appropriate finance to production department.

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Areas of financial Mgmt. Contd.

5. Financial Management and Marketing Produced goods are sold inthe market with innovative and modern approaches. For this, the

marketing department needs finance to meet their requirements. The

financial manager or finance department is responsible to allocate the

adequate finance to the marketing department

6.Financial Management and Human Resource Financialmanagement is also related with human resource department, which

provides manpower to all the functional areas of the management.

Financial manager should carefully evaluate the requirement of

manpower to each department and allocate the finance to the human

resource department as wages, salary, remuneration, commission,bonus, pension and other monetary benefits

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FM-Lecture 1.ppt

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