1 INTRODUCTION TO FINANCIAL MANAGEMEN Topic Introduction 1.1. Definitions 1.2 Evolution Nature and Scope 2.1 Basic Functions 2.2 Managerial Functions Objectives 3.1 Profit Maximisation 3.2 Wealth Maximisation Wealth-maximisation and Financial Decisions Functions of a Chiet Financial Officer Importance of Financial Management Limitations of Financial Management ‘Methods and Tools of Financial Management Financial Management v. Financial Accounting RM ae 1. Finance: According to Oxford dictionary, the word ‘finance’ m jatagement of money” i.e. earning, spending, saving and investing money. Thus, everyone ~ individual, business firm, Government ~ is concerned with finance. We are concerned with ‘business’ finance. . Business Finance: According to the Guthumann and Dougall (Corporate Financial Policy: NY. Prentice Hall, 1980}, “Business finance can broadly be defined as the activity concerned with planning, raising, controlling, administering of the funds used in the businessi Financial Manane EM, rangement ix defined by diferent authortin 1 gible mancial Managerent Financal MINT E er ee Bara Solomon (Th Mrrgement is concerted cient use of an important een an also be procured { inane Inconeraaudy of the problems involved in Myon, vy Instruments ike commers Use yp. (¥) Foreign direct investment ( ely = capital syian oF Nd : tnd tmanlat Monagerent, Law Book Comer, 1967 for ralsing funds from inte 4 Raymond } pcos As mani, planing. organising, directing, coord (2) Effective utilisation ae anager al activites elaing 268 Mom and application ofthe anc ry, ee ee contig an kepng wt its nant ORF "tenon the i Pillippatus 1 el eigen eeerted wrt ons ane the business anefinancing of short term and [ong t= credits for the firm, EET ance, MeGraw Hill, 1983]: Figy,, pecordingto them ‘application of general vessnagerial principles t0 the area of fina of an oe oes Ga nar ‘already studied the meaning of* rontice Hall, 1971] : Financial manage, Para 3 below. “Mana in the acquisition at «¢ Howard and Upton [Iniraduction to Buse Fin ‘management “is an decision-making.” ‘© Joseph L. Massie (Essentials of Management, PI it : Nie the operational activity of a business that is responsible for obtaining and effegie; management involves ~() Fin utilizing the funds necessary for efficient operations. +024 Financial Planning Zz Emencial Penang: a The Chins , ensure that enough fundin Financial management evolved gradually over the past '50 years. The evolution of financjjshort, medium Saeses iree phases: inventory, oF to smooth out ¢ it was considered necesuq Working capital requirements ‘management is divided into th (1) The Traditional Phase: Dur only during specific events suc faking financial decisions in the organisation, ‘ing this phase. financial managemer ‘ch as takeovers, mergers, expansion, Tiquidation, etc. Also, whe Purchases of fixed: assets (cay Ine Sontsiders (investment bankers, eo 20Sur that funsing = availa vara end money tothe business ete.) tothe business Were given more importance. 2.2.2 Financial Control 222 Financial Con’ (2) The Transitional Phase: During this phase, the day-to-day problems that financial manages ye control function ofthe The rar en importance. The general problems related tofunds analysis, planning and con analyse questions such a8: assets being used efficient were given more: attention in this phase. (3) The Modern Phase: Modern phase is still going on. The scope of financial management ha performance with expectet greatly increased now, It is important to carry out financial analysis for a company. This analyss zs Pru ecsion making. During this phase, many theories have bees developed ting ccs ee nn aa budgeting, option pricing, valuation models and als in several other importatn the modern times, fina financing and dividend. Im igalso concerned with the ‘is alsoconce pay outas dividends and) following types of finan« BEDS Decisions internal to th Financial Management basically deals with the procurement of funds and their effective ulizstin® ‘Whether toundertak in the business. The first basic function or aspect of financial management is procurement of funts® Whether to investin and the other is their effective utilization. » Research and develt (1) Procurement of funds: Funds can be i i i oF procured from different sources; their procuremest *°? Investment in a mat cari pein, for business concerns, Funds procured from different sources have ditlere"! Decisions involving € 7m ies in terms of risk, cost and control, © Whether toenter in a peeve et Ween. sled by iaping uty share peso ik tothe Sapa “The funds raise") Whether tocarry 0! + ee iano Rey shares may dilute the control of existing shareholde™ —jsinvestment decisic — en ae aes source boitiasad ‘but involves high risk as they are tober" Whether to sell off Se A re nee bbemade und, whether tell ol account before raising funds, considerations, which must be8K°"""" | ophe sate of subsidSe, hy ‘ 1s foy,"Yantroduction to Financial Management oy, | oe . "ess yt) (iD Fandsca alo bros hom tanks and natitutions subject to certain restrictions. feonog hf (iy)Instruments like commercial paper, dep discount bonds, [Link] enablew rane funds Use an] (v) Foreign direct investment (FDI) and Foreign Institutional investors (FH) aretise ator seates Figg es gai a om imernatonal sources, bees ADR's and GOR 7 ‘nang,| 2 Bffective utilisation of funds: Since all the funds are proc ating Sef peoasary forthe Finance manager take appropriates agg a cans therfore iis ating ang meses fr the nance manager to take appropriateand timely actions stat the fd do Nt urges} remain idle. Ifthese funds do not generate an income higher than thelr eoxethen thee 5d ageenereh es hs il the cost then there is no point hat * Tesul ON NOS “| already studied the meaning of ‘finance’ above in Para 1. We will. be studying the ‘financial objectives’ a |management involves ~ (i) Financial Planning (ii) Financial Control and (iii) Financial Decisions. 22.1 Financial Planning ‘The Chief Financial Officer (CFO) who is in charge of financial management will need to plan to censure that enough funding is available at the right time to meet the needs of the organisation for ‘ancial short, medium and long-term capital. In the short term, funds may be needed to pay for purchases of inventory, or to smooth out changes in receivables, payables and cash: the CFO has to ensure that “essary Wking capital requirements are met. Inthe mediuo or long term. the organisation mayhave planned "| purchases of fixed assets (capital expenditure) such as plant and equipment, for which the CFO must When . seopiy ensue tha funding is availabe 222 Control ‘agers |The control function of the CFO becomes relevant once funding has been raised. The CFO has to ‘ntrot |analyse questions such as - Are the various activities of the organisation meeting its objectives ? Are assets being used efficiently ? To answer these questions, the CFO may compare data on actual it has [performance with expected performance. Asis 229 Financial Decisions ‘rtant Inthe modern times, financial management includes the three main decisions namely investment, financing and dividend, Javestments in fixed and current assets must be planned. Financial management is also concerned with the financing and management of short-term and long term-funds, Financial §] management is also concerned with the dividend decision: how much of the profits should the company — |pay out as dividends and how much should it retain for investment to provide for future growth? The following types of financial decisions also need to be made- Decisions internal to the business enterprise tion | Whether to undertake new projects inds ° Whether to invest in new plant and machinery Research and development decisions isa |@ Investment in a marketing or advertising campaign ent (Decisions involving external parties Whether to enter in a joint venture with another enterprise : 1° le Whether to carry out a takeover or a merger involving another business aid investment decisions ny (Whether to sell off unprofitable divisions of the business ato (© Whether to sell old or surplus plant and machinery The sale of subsidiary companies— 7 Finenclal Management (iy, Ei OKA Sey m ee coca ey ‘nancial Managemeng of financial management: (i) Profit maximisation ah sere are two otest™ A 1) og MED Lee Toe Maximisatio. (i) Risk: i akesinio account Gi) Timing ease eke ae maxinann stan tetvewanbues wa elf rac (Shareefa 1 Canepa oly been ged ta he bjt of «company is ey 3: Agalost:Followingstethearpurnny conned. 1 Po fnanil management is so profi maximisation Thin imple gi G@ Link: Theres no dies ink betwee iota ae dean ina manne hl he ote of he cee i) Froratin: iim lado mage nec mans Wyre no eevaminlio Whether 1 yes inet 4, Superior :The Wealth maxinssine on cto aemnteeropenae 2, rorsfatowingarethearpurents iD {favour of profit maximisation objective - (8) Profit maximisation can be ach . " ‘ivity is earning prot that is, wealth maxi of {) Aim: Main aim of any kind of eonomic ae ity is earning profit. A business concern is tage €0 Aim ny fr the purpose of ering Pro asian shri) aoEmeny: Profit helps tomeasie the ciency ofthe concern {a ikélyo hort its Tong ter pret (Gi) Risk: Profitredues risk ofthe business concer, (©) Profit maximisation does not cc fi) Source: Profit isthemain source of finance. = ‘considers both risk and uncerit {o) Soca: Profitability meets the social nocd alo. (©) Theweathmasimiaion ae ea icv tell prois thn wath fab ieee (vii) Link: There isa direct link between financial decisions and profits. (@)A firm that wishes to maximise st the profit maximisation objectve- firm with the objective of prot 3. Against: Following are the arguments again: a Vague! The erm profit swage, thas feet meanings fr diferent people rf car ong term: ‘or short term, profit before tax or after tax, ‘operating profit or gross profit, accountin is or economic’ profits, cash profitsand soon. The term maximisation’ isalso vag ‘proper goal of a firm. The prof (Risk: Higher profits may be achieved by taking too much risk. ‘maximisation strategy. {Gi)Rate: The amount ofinverment nesded tear the proftisalso important. Profs ms (Re Weatrewnxst seated tothe volume of investment by working out; (a) Accounting return on capital employ {Dy Eamings pr share (c) Dividend yeld asa percentage of tock market value, a°¢°" (4) agieyretated: To achieve weal Gv) Short term: Profits « measure of short-term performance, whereas increase in vel (1 apeiron ‘measures the long term performance of the company. because the underlying object’ (9) Unethical: Profit motive may lead to exploitation of customers, workers, employees © shareholders’ wealth. The decisie intum, is linked withthe divide shareholders. ‘The maximisation of a firm's val ‘ignore ethical trade practices. (vi) Ignores CSR: Profit motive also ignores social considerations or corporate 0" means less dividends. The inter-+ responsibility(CSR) or general public welfare. the shareholders’ wealth is ex) ee Profit maximisation may benefit shareholders at the expenss eat es ct a Peres a Spropostl is accepted Whose ext (Gili) Timing of Return: The profit maximization objective does not make distinction bet" i of Ret x hhelps to maximise the profit ‘returns received in different time periods, It ignores the time value of money. Itvalues!="" (4) Figancing Decision: Funds © ‘received today and benefits received after a period as same. th different issues regarding cost profit maximization, therefore, is not an operationally feasible criterion. tpalance between long-term a1 funds, The optimum financing a ‘their wealth. ‘oncept: The usual a as eee sn» 4) Dividend Decision: The fn: Seana objective ofthe © at Bere PUY. wet {portion of the profi said! areholders in.a company? hey Noasar eres Til) Market valve of! sould be rae. the shares Ia compan ’sshares are traded on a stock market, the wealth of shareholders is ine" maximises sharholies Se at eames , which it pays-out as divi i e ‘ future profit growth and dividend owt * or reinvest inthe busines 0"Introduction to Financial Management 7 mount hp ck ‘© has to estimate the requirement of funds both " ce investment in fixed assets and for short-term ie. it Pescotng ite requlrmets of funds nyse the a fenton ot idgoae vcore ad of an Once the requirement of funds has been estimated, the CF ¢ : ed, the CFO has to take a rom which these funds would be ri hs tobe made between the loan funds and own funds. He has to raise ‘sui id ts ha fixed assets and oth i i ® pe ixed assets and other long term investments and to provide forthe needs of working (gy Capital Expenditure and Working Capital Management: The invesent of funds na new project has fo be made after careful assessment of various projects through capital budgeting. [sets management policies are tobe laid dow regarding various items of current assets eg. civable in coordination with sales manager, inventory in coordination with production manager. Dividend decision: The CFO has to decide as to how much profit to retain and what portion to pay as dividend depending onthe company’s policy Trend of earnings, tend of share market prices, requirement of finds for fiture growth, cash low situation et, are tobe considered. «Evaluating financial performance: The CFO has ocostantleview the nancial perfomance yoke various units of organisation generally in terms ofthe financial objectives and targets eg. Return on Investment (ROD). Such @ review helps the management in seeing how the funds have teen utilised in various divisions and what can be done to improve it. (Financial negotiation: The CFO play a very important role in carying out negotiations with tions, banks and public depositors for raising of funds on favourable terms. the financial institut Cash management: The CFO lays down the cash management and cash disbursement policies ‘vith a view to supply adequate funds to all units of organisation and to ensure that there is no excessive cash. Keeping in touch with stock exchange: and their impact on the price ofthe company share, (4) CFO is required to analyse major trends in stock market 1) Organizations: Financial Management (FM) is important to all types of organizations i treanistions; charitable organisations, NGO, trusts; Govt, undertakings, public sector undertakings and so on for managing funds. ) Shareholders: Shareholders rely on efletive FM to get optimum dividend and maximize their wealth. }) Lenders/Creditors: repayment of the principal amount as well ) Employees: Employees rely on effective bonus, incentives and their retirement benefits. :) Customers: Customers rely on FM for getting quality. Public: Public at large rely on effective corporate social responsibility. Government: FM ensures timely payment of taxes and other revenues, Management; Efficient FM helps the management in overall image building, increase in the ‘market share, optimising shareholders wealth and profit. Other departments: Finance department through eficent management of funds has tte that adequate funds are made available to all departments (production, marketing etc.) for their smooth functioning. 10) Successful Start-Up: Effective FM begins with a successful financial plan during the start-up iby fm te provide sufficient eapital to meet the requirement of fixed and fluctuating Lenders or creditors rely on effective FM for safety of their funds, timely Las interest on the same. FM for getting timely payment oftheir salary/wages, products at reasonable rates. FM to find general public welfare activities as a part ofioeay running of an enterprise vote got of he firm in clear terms idenctat deisions (Financing, Investment STS q(x in ing a iy (eopteeemey tpn make important decisions ike which act fb, when oy and wh icine perms nna a cea bac ma Se a sont omen (amass peas Dae ch mar een roo dane en i perpen ne NCO, Tos. Fouinmmngrae inti ty ces as Gone alae is ne Metre ee a eps Son aka “There are thes brood Tinitaton of financial management. Firstly a company may have ino escfanncal objectives which ae beyond the control of financial manager. Secondly, fa the stakcholdersand ther objectives may conflict with each ‘Letus study these in detail. (1) Empoyees: A company might tr to provide good wages and salaries, comfortable an snrking editions good taming and career development, and good pensions. This ey profitability: (@) Management: Management may be taking risky investment decisions sing outsides’ m inaoe them. Managers wll fen ak deisions to improve thir own circumstances, ven their decisions will incur expenditure and so reduce profs. High salaries, company cr ‘ther perks are all examples of managers promoting their own interests at the expense of shareholders. providea service tthe public. Providing a service is of course a key responsibility of eo andthe profits in exo Aividends or rained poe a ey thts povided yang Owing eel See Profs fort Pec Toinctease their wea 9) External Factors: Many finance company nests Voge invenman ‘[Link] companies canons ee financing. A movie company acs sana, publi issue of shares The te foo Financial decisions of mvestmen, Sesser | Insttatons, financial martes and noe hs Government poiies~tzonomies money ak financial decisions toa great exten. The ax nt either dividends or eaptal growth. The go some investment projets, Kimight also encour ‘The Company lawasrules fr eae ofchares ‘which imi the feedom of the CFO to ake op Jmmportant to increase the return to share Ihave proper mix ofebs, equity and retained ‘models ate used to determine the proper lof returns, internal rate of return, net pres ‘neevaluating capital expenditure proposal (3) Working Capital Management Tools: techniques are adopted such as ABC Ana ‘models, et., to improve liquidity and tom. (4) Evaluation of Performance: For eval {nto service-with the help of ratios an it Funds flow statement, cash flow tatems departments and local authorities for whom tion-financial objectives are thus more impo ‘than financial objectives, 6) Suppliers: Responsibil cumin conn teagan at cen Acris rote eae eae costs which reduce profitability, {fa company is unable to pay what it owes its c sell off the mortgaged assets or affect the interests of other stakeh bay ‘Though financial managemént and finane ent of funds and also with regards sens ut itay not be ab as a result of say, uncallestibe is based on cash flowstment HERBAL Sng, Intrction to Pimanciat at tnd we oF finds ae neces, oe J) Sharchotders: The m And the profits (in excons tah dividends or retained profi forthe ne will expect to increase th Pawan reas theit wealth using eo 8: Many financial company needs huge investment an eapital. Smal companies cannot rey financing. A movie compa are taken for achievin ture and the Fgh tan | OPEREC HA Pa dessins depend on eternal actors A tae a mst hve ‘orking capital managemen, tuwhentobuy and whethe public issue of sh he] public issue of shares. The sare ofthe ne ek fsats to be maintained in J financial decisions of investnce, ae re them elficently. ancing and divi end. The development of fron institutions, financial markets and nen lps a firm to decide hoy, Government policies ‘s(tusiness, NGO, Gove] Someimvestment projects, I'mightalsoeneemrey ee tet ogi i investment by fers Public Governor] The Company lawhas rules fr ele (Sartup running] Which Timi the redo of the shosmingsnd consoh| < (1) Financing Decisions Tools: Finance Manager has ta decide o the wealth ofthe shercholders, Fur ths judicious us offi fering ta ncetiven issue ofshars, debentures, invedinen eee CFO to take optimum decisions. cae, optimum capital structure to maximise ny may have importan} er Secondly, financial ‘omit with each other] 5 Analysis, PE Ratios and mathematical models are use to determine the proper debtequity mix to derive advantages etn weno thecontrol ofthe firm) Zhterprae ees ee ; 2) Investment De | comfortable and safe fon Tools: Inthe area of investment decisions, pay back method, average rate ‘sions. This may reduce) ofreturns, internal rate ofreturn, net present value, profitably ndecansoone hee hong inevaluating capital expenditure propel, (@) Working Capital Management Tools: Inthe aren of working capital management, certain techniques are adopted such as ABC Anahsis, Economie order quantities, Cash momtacrnae ceseven thourh) models, et., to improve liquidity and to maintain adequate circulating capital sarnzans eA 24) pvatuation of Performance: Fr evaltion of rm’s performance, ato analyse pressed ihe expense of the! "into service-with the help of ratios an investor can decide whether to invest in a firm or not. Funds flow statement, cash flow statement and projected financial statement helps lo whe finance manager in providing finds in right quantiiesand aright time outsiders’ money te a responsibility to lity of governmen: SS RNANCIAL MANAGEMENT FRANGALACCOUNTING = {ime a prodvct Though financial management and financial accountng are closely rte, stil hey dir in the Pestomers Reliable! catment of funds and also with regards to decision - making. De saci goccrting sho meafcrmaeas aioe labesali ames ane Theacerual based accounting data do not reflect fully the financial conditions of the organisation fas of trading! An organisation which has earned profit (sles les expenses) may said tobe profitable in the Ecompany shoul’) accounting sense but it may not be able to meet its current obligations due to shortage of liquidity fordance withthe) as a result of say, uncolletible receivables, Whereas, the treatment of funds, in financial management is based on cashflows. The revenues are recognised only when csh actly feeived (cash inflow) and expenses are recognised on actual payment, ash tow), Thus, cash flow based returns help financial managers to avoid insolvency and achieve desire Fsmaydecide 1c| financial goals, nt iswil adversel)| (2) Decision-making: The chief focus of an accountant is to collect data and pene ea : 4 ua | the financial manager's primary responsibilty relates to financial planing, conoing ont | decision-making. Thus, in a way it can be stated that financial management begins accounting ends. cial welfare eteSty r ‘uraduction to Financ Pinanctal Management -1(R YA.» agg | Financial Decisone no. Tople ™ - ; Me om vn {O01 Descriptive Questions: eet iceumenesa = maton Bo ena erm mr tet ne Sans Bio. oistincusnocrwer wes a " Distinguish Betwoon the Following sot wid vacant tn 11 | Proft maximization and Weal manirizaton 11 iveetment decisions snd Divend doc ione 1; SEGRE GESTION 8 4 1" EMOTES: Management ofall matiors relat io an orgarsat (a) Cash infows and outiowe. oF Se ea Ea Rare ea eala tecainaeci eee 1. What the meaning and nature of financial management? {ann: Pans) (geopuraie Sonal Reopen 1 Sate oneal” Barmeetray ol 3. Explainastohow the wealh maximisation objectives superortothe proftmaxinisatoncbjecis ga) Investment 1 [Ans.: Para 3.2 (4 “(c) Dividend : «. Cusninne oasranptemeen wath maxnston antral deers. Ana Pans, Whale owing conser a he freee tne tuncone oa Chl Franc Ofer. pan tcea)ghrchcter enh reason § EDR inprance of nrc management (ane: Pai) Weta fe wee 5. Grace lntatons fend ranagamon? “Ie, (@plancennpin eseurth and apne 1 Shine ne menos andtoas of Fnancal Menagomen Fn, Ste sojeche cl trarcl manepenet +. Stet etween Francia Management and Fane Accounting. Fant (eMesinie te evorane Eee IE Gaitecenaecoes = ‘Maximise the wealth of the owners by it {Bon obser of nancial anager Ca; Now. 02,09). [Ana Fan which owen in ot M4! 2 Deowete Pot rand mister ‘ mest ond Wels uvaneston eco fem. (oa Nox )wCDEICG ANS, {Ans.: Pare: (°C Gea 3. Explain the limitations of profit maximization obj of ir Re (Se asf Ade as pete of Franca Managemen: (CA (9) oracin he Darkest aan 4. “The profit maximization js not an operationally feasible criterion.” + TCA, us (0) Comparing the costs an benefits of ( 2012) M Yan pale) Anaya ad reporting ol aiance ve ject *(@) Assessing the costs and bene of ¢ 5. Explains tohow the weath maximisation objective i imi jective superior tothe proftmaximisaton Tce ol fnancial manager (CA inter, Nov. 89,03; May 03) : aseets 6: te sotto on ra Cans. Pare oe (a) erease the physical asets owned ; tena ecto ' ~~ the curent assets of he do thoy involve rsk-etum rade-of? (ICWA, Fi (Increase te caTO TE T su meiah [Ans.: Para+ (d) Increase the 8. What ae the main oun ‘esponsibilties of a chief financial oficer of an organisation? (CA, May ° 9. Outing the methods and toos of Financial Management. (CA Final-Nov. 1996)[Ans.: Pa‘