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Financial Management

Prerequisites The prerequisite for this course is basic understanding of financial system.

Some Quotes Before looking into the financial management, let us look at the lighter side of money. Some hilarious quotes about money. • “Money is like a sixth sense – and you can’t make use of the other five without it.” – William Somerset Maugham • “The safest way to double your money is to fold it over and put it in your pocket.” – Kin Hubbard • “Money is the best deodorant.” – Elizabeth Taylor1 • “If you think nobody cares if you’re alive, try missing a couple of car payments.” – Earl Wilson • “Inflation is when you pay fifteen dollars for the ten-dollar haircut you used to get for five dollars when you had hair.“ ~Sam Ewing • “Too many people spend money they haven’t earned, to buy things they don’t want, to impress people they don’t like.” – Will Smith •  “There’s a way of transferring funds that is even faster than electronic banking. It’s called marriage.” — James Holt McGavran

Course Objectives This is an introductory course in corporate finance. The course has three main objectives: • Develop an Understanding of financial environment of business. • Understand the basic issues involved in how firms should raise funds for their real investments (financing). • Develop an understanding of the tools that are used to value investment projects and companies (investment decision). • Evaluate how investment and financing decisions are related and its effect on dividend. • Evolving skills for interpretation business information and application of financial theory in corporate financial decisions

Course Outline

1. The financial environment of business Corporate Finance, Finance Functions. Structures of the Financial System. Meaning of Financial Management –Objectives, Scope and Functions of Financial Management, Financial Planning and Forecasting, Interface with other Departments-

2. Financing decision Calculating Cost of Capital , Calculating Cost of Specific Funds, Calculating Weighted Average Cost of Capital, Capital Structure Decision, Theories of Capital Structure, Capital structure theories, Interrelationship with cost of capital, Factors Affecting Capital Structure,

3. Investment Decision • Concept and Computation of Time Value of Money, Capital Budgeting -Introduction, Importance of Capital Budgeting, Rationale of Capital Budgeting Proposals, Capital Budgeting Process, Investment Evaluation, Appraisal Criteria, Working Capital Management Introduction, Components of Working Capital, Operating Cycle, Determinants of working Capital, Estimation of working Capital.

4. Dividend Decision: • Practices and Forms of Dividend in a Company, factors affecting dividend decision, Theories of dividend.

5. Analysis and interpretation of Financial Statements using various techniques.

Unit I

Chapter Outline • Financial Environment • Corporate Finance • Finance Functions • Structures of the Financial System • Meaning of Financial Management • Objectives, Scope and Functions of Financial Management • Financial Planning and Forecasting • Interface with other Departments

What is Finance ? • Finance stands for provision of money as and when required. • Process of raising, providing and istering all money/funds to be used in a corporate enterprise. • Is concerned with the acquisition and conservation of capital funds in meeting the financial need and overall objectives of business enterprise. • The one word which can easily substitute finance is “exchange.”

Financial Environment • It refers financial sector or financial system of a country. It comprises various financial institutions, instruments, policies and services concerning in the financial sector.

Corporate finance • Corporate finance is the area of finance dealing with the sources of funding and the capital structure of corporations and the actions that managers take to increase the value of the firm to the shareholders, as well as the tools and analysis used to allocate financial resources. • It is concerned with budgeting, financial forecasting, cash management, credit istration, investment analysis and fund procurement of the business concern

Finance Function • Finance function is one of the major parts of business organization, which involves the permanent, and continuous process of the business concern. Finance is one of the interrelated functions which deal with personal function, marketing function, production function and research and development activities of the business concern. • At present, every business concern concentrates more on the field of finance because, it is a very emerging part which reflects the entire operational and profit ability position of the concern. Deciding the proper financial function is the essential and ultimate goal of the business organization. Finance manager is one of the important role players in the field of finance function. He must have entire knowledge in the area of ing, finance, economics and management. His position is highly critical and analytical to solve various problems related to finance. A person who deals finance related activities may be called finance manager

Scope of Finance Function Estimating financial requirements. Capital structure decisions. Selecting source of finance. Selecting pattern of investment. Proper Cash management. Implementing financial controls. Proper use of surpluses.

Aims of Finance function Acquiring sufficient funds. Proper utilisation of funds. Increasing profitability. Maximising firm’s value.

Financial Management • The ways and means of managing money. • Planning, acquisition, allocation, and utilisation of financial resources with the aim to achieve objectives of the firm. • Is the application of planning and controlling functions to the finance function.

Objectives of Financial Management Objectives of Financial Management may be broadly divided into two parts such as 1. Profit Maximization 2. Wealth Maximisation

Profit Maximization • Profit maximization is also the out-moded and narrow approach, which aims at, maximizing the profit of the concern. Profit maximization consists of the following important features. • Some favourable and unfavourable arguments of profit maximisation is as follows.

Favourable Arguments for Profit Maximization The following important points are in of the profit maximization objectives of the business concern: • Main aim is earning profit. • Profit is the parameter of the business operation. • Profit reduces risk of the business concern. • Profit is the main source of finance. • Profitability meets the social needs also.

Drawbacks of Profit Maximization Profit maximization objective consists of certain drawbacks also: • It is vague: Profit is not defined precisely or correctly. • It ignores the time value of money: Profit maximization does not 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. • It ignores risk: Profit maximization does not consider risk of the business concern. Risks may be internal or external which will affect the overall operation of the business concern.

Wealth Maximization • Wealth maximization is one of the modern approaches, which involves latest innovations and improvements in the field of the business concern. The term wealth means shareholder wealth or the wealth of the persons those who are involved in the business concern. This objective is a universally accepted concept in the field of business.

Favourable Arguments for Wealth Maximization • 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. • Wealth maximization considers the comparison of the value to cost associated with the business concern. Total value detected from the total cost incurred for the business operation. It provides exact value of the business concern. • Wealth maximization considers both time and risk of the business concern. • Wealth maximization provides efficient distribution of resources. • It ensures the economic interest of the society.

Unfavourable Arguments for Wealth Maximization • Wealth maximization may not be suitable to present day business activities which are oriented towards profit derivation. • Wealth maximization is nothing, it is also profit maximization, and it is the indirect name of the profit maximization. • Management alone enjoys certain benefits. • Wealth maximization can be triggered only with the help of the profitable position of the business concern.

Profit

Vs

• The term profit is vague.

Wealth • Its an prescriptive idea.

• Ignores the time value of money.

• Not necessarily socially desirable.

• Ignores Risk factor.

• Controversy objectives Maximize stockholders wealth or wealth of firm.

• Dividend policy.

Ownership and management are separated.

Scope of Financial Management • The scope of financial management involves processes and procedures d with managing a company's cash flow, inventory, fixed assets and debtors, according to ing Education. Financial management requires company representatives to collect payment from clients in a timely manner, pay expenses accordingly and create financial plans to ensure cash flow

Functions of Financial Management • Estimation of capital requirements • Determination of capital composition • Choice of sources of funds • Investment of funds • Disposal of surplus • Management of cash • Financial controls

Functional areas of FM Determining financial needs. Selecting the source of funds. Financial analysis and Interpretation. C-V-P analysis. Capital budgeting. Working capital management. Profit planning and control. Dividend policy.

FM Process FM is a dynamic decision-making process include a series of interrelated activities involving: Financial planning Financial decision-making Financial analysis Financial control

Considerations Nature of Industry. Credit rating of the concern. Future plans- Expansion and diversification. Availability of sources. General economic conditions. Government control.

The Key Functions of A Finance Manager Finance manager performs the following major functions: • Forecasting Financial Requirements • Acquiring Necessary Capital • Investment Decision • Cash Management • Interrelation with Other Departments Finance manager handles various functional departments such as marketing, production, personnel, system, research, development, etc. He must maintain a good rapport with all the functional departments of the business organization.

Financial Planning • Financial Planning is the process of estimating the capital required and determining it’s competition. It is the process of framing financial policies in relation to procurement, investment and istration of funds of an enterprise.

Objectives: • Availability of adequate funds. • Balancing of costs and risks. • Flexibility. • Simplicity. • Long term view. • Liquidity. • Optimum use. • Economy

Objectives of Financial Planning Financial Planning has got many objectives to look forward to: • Determining capital requirements- This will depend upon factors like cost of current and fixed assets, promotional expenses and long- range planning. Capital requirements have to be looked with both aspects: short- term and long- term requirements. • Determining capital structure- The capital structure is the composition of capital, i.e., the relative kind and proportion of capital required in the business. This includes decisions of debt- equity ratio- both short-term and long- term. • Framing financial policies with regards to cash control, lending, borrowings, etc. • A finance manager ensures that the scarce financial resources are maximally utilized in the best possible manner at least cost in order to get maximum returns on investment

Importance of Financial Planning • Financial Planning is process of framing objectives, policies, procedures, programmes and budgets regarding the financial activities of a concern. This ensures effective and adequate financial and investment policies. The importance can be outlined as• Adequate funds have to be ensured. • Financial Planning helps in ensuring a reasonable balance between outflow and inflow of funds so that stability is maintained. • Financial Planning ensures that the suppliers of funds are easily investing in companies which exercise financial planning. • Financial Planning helps in making growth and expansion programmes which helps in long-run survival of the company. • Financial Planning reduces uncertainties with regards to changing market trends which can be faced easily through enough funds. • Financial Planning helps in reducing the uncertainties which can be a hindrance to growth of the company. This helps in ensuring stability an d profitability in concern.

Interface with other Departments Financial management is one of the important parts of overall management, which is directly related with various functional departments like personnel, marketing and production. Financial management covers wide area with multidimensional approaches 1. Financial Management and Economics 2. Financial Management and ing 3. Financial Management or Mathematics 4. Financial Management and Production Management 5. Financial Management and Marketing 6. Financial Management and Human Resource

Cont…. 1. Financial Management and Economics Economic concepts like micro and macroeconomics are directly applied with the financial management approaches. Investment decisions, micro and macro environmental factors are closely associated with the functions of financial manager. Financial management also uses the economic equations like money value discount factor, economic order quantity etc. Financial economics is one of the emerging area, which provides immense opportunities to finance, and economical areas. 2. Financial Management and ing ing records includes the financial information of the business concern. Hence, we can easily understand the relationship between the financial management and ing. In the olden periods, both financial management and ing are treated as a same discipline and then it has been merged as Management ing because this part is very much helpful to finance manager to take decisions. But now a day’s financial management and ing discipline are separate and interrelated.

Cont…. 3. Financial Management or Mathematics Modern approaches of the financial management applied large number of mathematical and statistical tools and techniques. They are also called as econometrics. 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 Production management is the operational part of the business concern, which helps to multiple the money into profit. Profit of the concern 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.The financial manager must be aware of the operational process and finance required for each process of production activities.

Cont…. 5. Financial Management and Marketing Produced goods are sold in the 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. Hence, marketing and financial management are interrelated and depends on each other. 6. Financial Management and Human Resource Financial management 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 to the human resource department. Hence, financial management is directly related with human resource management.

Organization of the Financial Management Function

Board of Directors President (CEO) VP Marketing

VP Finance

Treasurer Capital Budgeting Cash Management Credit Management Dividend Disbursement Fin Analysis/ Planning Pension Management Insurance/Risk Mngmt Tax Analysis/Planning

VP Operations

Controller Cost ing Cost Management Data Processing General Ledger Government Reporting Internal Control Preparing Fin Stmts Preparing Budgets 39

Structures of the Financial System

End of Chapter

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