An Introduction to Financial Management 1.

To ensure regular and adequate supply of funds to

the concern.
Financial Management: An Overview 2. To ensure adequate returns to the shareholders
which will depend upon the earning capacity, market
Financial management is very important or
price of the share, expectations of the shareholders.
significant because it is related to funds of company.
3. To ensure optimum funds utilization. Once the
funds are procured, they should be utilized in
Financial management guides the finance manager
maximum possible way at least cost.
to make optimum position of funds. With study of
4. To ensure safety on investment, i.e, funds should
financial management, we can protect our business
be invested in safe ventures so that adequate rate of
from pre-carious mis-management of money.
return can be achieved.
Suppose, you are small businessman and you took
5. To plan a sound capital structure-There should be
short-term loan and financed fixed assets with this
sound and fair composition of capital so that a
loan. It means, you have to pay loan within one year
balance is maintained between debt and equity
but fixed assets cannot be sold within one year. In the
capital.
end of year, you have not enough money to pay this
Goal of the firm
long term debt and this will create risk to your
business's existence. You will become insolvent. This ➤In this book we will designate maximization of
is the simple example of mismanagement of money in shareholder wealth, by which we mean maximization
your small business, but we do large scale company of the total market value of the firm's common stock,
business, importance of financial management is to be the goal of the firm.
greater than small business. We should invest in fixed
asset if there is any other source of funds. In financial ➤ To understand this goal and its inclusive nature it is
management, we make optimum capital structure and first necessary to understand the difficulties involved
we should buy all fixed assets out of share capital with the frequently suggested goal of profit
money because, it will reduce the risk of repayment. maximization. While the goal of profit maximization
Financial Management means planning, organizing, stresses the efficient use of capital resources, it
directing and controlling the financial activities such assumes away many of the complexities of the real
as procurement and utilization of funds of the world and for this reason is unacceptable.
enterprise. It means applying general management
principles to financial resources of the enterprise. [Link] of the major criticisms of profit maximization is
that it assumes away uncertainty of returns. That is,
Scope/Elements projects are compared by examining their expected
values or weighted average profit.
1. Investment decisions includes investment in fixed
assets (called as capital budgeting). Investment in 2. Profit maximization is also criticized because it
current assets are also a part of investment decisions assumes away timing differences of returns.
called as working capital decisions.
2. Financial decisions - They relate to the raising of Profit maximization is unacceptable and a more
finance from various resources which will depend realistic goal is needed.
upon decision on type of source, period of financing,
cost of financing and the returns thereby. Maximization of shareholder wealth
3. Dividend decision The finance manager has to
take decision with regards to the net profit distribution. ➤ We have chosen the goal of shareholder wealth
Net profits are generally divided into two: maximization because the effects of all financial
a. Dividend for shareholders- Dividend and the rate decisions are included in this goal.
of it has to be decided.
➤ In order to employ this goal we need not consider
b. Retained profits- Amount of retained profits has
every price change to be a market interpretation of
to be finalized which will depend upon expansion
the worth of our decisions. What we do focus on is the
and diversification plans of the enterprise
effect that our decision should have on the stock price
4. Working capital management - ensuring the
if everything were held constant.
organization has sufficient liquidity to meet its short-
The agency problem is a result of the separation
term obligations.
between the decision makers and the owners of the
The ultimate goal of financial management is to firm. As a result managers may make decisions that
maximize the value of the organization while are not in line with the goal of maximization of
maintaining financial stability and supporting long- shareholder wealth.
term growth. It also plays a key role in ensuring
Legal forms of business organization
transparency, accountability, and sustainability in both
corporate and public sectors.
Sole proprietorship: A business owned by a single
person and that has a minimum amount of legal
Objectives of Financial Management
structure.
The financial management is generally concerned
Advantages
with procurement, allocation and control of financial
resources of a concern.
[Link] established with few complications
[Link] organizational costs
The objectives can be:
C Does not have to share profits or control with others a. Most difficult and expensive form of business to
Disadvantages establish
b. Control of corporation not guaranteed by partial
a. Unlimited liability for the owner ownership of stock
b. Owner must absorb all losses
c. Equity capital limited to the owner's personal The Corporation and the Financial Markets: The
investment Interactions
d. Business terminates immediately upon death of
owner The popularity of the corporation stems from the ease
Partnership: An association of two or more in raising capital that it provides.
individuals coming together as co-owners to operate a
business for profit. 1. Initially, the corporation raises funds in the financial
markets by selling securities.
Two types of partnerships 2. The corporation then invests this cash in return
generating assets.
General partnership: Relationship between partners 3. The cash flow from those assets is either
is dictated by the partnership agreement. reinvested in the corporation, given back to the
investors in the form of dividends or interest
Advantages payments, or used to repurchase stock which should
cause the stock price to rise, or given to the
a. Minimal organizational requirements government in the form of taxes.
b. Negligible government regulations B. A primary market is a market in which new, as
Disadvantages opposed to previously issued, securities are traded.
a All partners have unlimited liability C. An initial public offering (IPO) is the first time a
b. Difficult to raise large amounts of capital company's stock is sold to the public.
D. A seasoned new issue refers to a stock offering by
c. Partnership dissolved by the death or withdrawal of
a company that already has common stock traded.
general partner
E. The secondary market is the market in which stock
Limited partnership previously issued by the firm trades.
Ten Principles that form the foundation of
Advantages financial management.

a. For the limited partners, liability limited to the Principle 1: The risk-return tradeoff - we won't take
amount of capital invested in the company additional risk unless we expect to be compensated
b. Withdrawal or death of a limited partner does not with additional return. Almost all financial decisions
affect continuity of the business involve some sort of risk-return tradeoff.
c. Stronger inducement in raising capital
Disadvantages Principle 2: The time value of money - a dollar
received today is worth more than a dollar received in
a. There must be at least one general partner who the future.
has unlimited liability in the partnership
b. Names of limited partners may not appear in the Principle 3: Cash-Not Profits-is King. In measuring
name of the firm value we will use cash flows rather than accounting
c. Limited partners may not participate in the profits because it is only cash flows that the firm
management of the business receives and is able to reinvest.
d. More expensive to organize than general
Principle 4: Incremental cash flows it's only what
partnership, as a written agreement is mandatory
changes that count. In making business decisions we
There is also a Limited Liability Company (LLC) form
will only concern ourselves with what happens as a
of business. This is a cross between a partnership
result of that decision.
and a corporation. It retains limited liability for its
owners, but is run and taxed like a partnership. Principle 5: The curse of competitive markets - why
The corporation: An "impersonal" legal entity having it's hard to find exceptionally profitable projects. In
the power to purchase, sell, and own assets and to competitive markets, extremely large profits cannot
incur liabilities while existing separately and apart exist for very long because of competition moving in
from its owners. to exploit those large profits. As a result, profitable
projects can only be found if the market is made less
[Link] is evidenced by shares of stock
competitive, either through product differentiation or
Advantages by achieving a cost advantage.
a. Limited liability of owners
Principle 6: Efficient Capital Markets - The markets
b. Ease of transferability of ownership, i.e., by the sale
are quick and the prices are right.
of one's shares of stock
c. The death of an owner does not result in the Principle 7: The agency problem-managers won't
discontinuity of the firm's life work for the owners unless it's in their best interest.
d. Ability to raise large amounts of capital is increased The agency problem is a result of the separation
Disadvantages between the decision makers and the owners of the
firm. As a result managers may make decisions that
are not in line with the goal of maximization of
shareholder wealth.

Principle 8: Taxes bias business decisions.

Principle 9: All risk is not equal since some risk can

be diversified away and some cannot. The process of
diversification can reduce risk, and as a result,
measuring a project's or an asset's risk is very
difficult.

principle 10: Ethical behavior is doing the right thing,

and ethical dilemmas are everywhere in finance.

Ethical behavior is important in financial management,

just as it is important in everything we do.
Unfortunately, precisely how we define what is and
what is not ethical behavior is sometimes difficult.
Nevertheless, we should not give up the quest.