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INTRODUCTION
Finance is the life blood of an organization – Warren
Buffet
What is Finance? 2
Suppose you want to start up a business. No matter what
the nature of the proposed business is, its size or how it
will be registered, you will have to address some
fundamental questions:
How much investment is required to set up the business?
It includes preliminary expenditure, land and building,
plant and machinery, and furniture and fixture.
How will you raise the money? It includes long term
sources like equity and debt.
How will you finance your day-to-day activities? It
includes your inventory, giving credit to customers, and
some cash to take care of daily operations.
All this involves finance.
What is Financial Management? 3
While these are not the only areas of financial
decision making, they are certainly the important
ones.
Financial Management refers to the efficient and
effective utilization of finance (referred to as funds)
in such a manner so as to accomplish the objectives
of the organization.
It broadly involves two aspects - managing inflow
and outflow of funds.
As a financial manager you broadly try to pre-pone
your inflows and post-pone your outflows.
As a finance manager you also need to make a risk
– return trade off in every financial decision
because of agency problems.
What is Financial Accounting? 4
Financial accounting is basically the backbone of any
financial management system.
Without proper financial accounting records, finance
managers will not be in a position to take financial
management decisions.
Financial accounting is basically a process in which
financial transactions are condensed and classified and
recorded and summarized in the books of accounts
based on certain established principles to prepare the
Income statement and Balance sheet.
Management accounting uses this output to prepare
certain advanced MIS reports (e.g. fund flow statement,
ratio analyses) to aid in financial decision making.
Why do we need financial accounting?
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It assists in financial decision making.
It enables the organization to keep systematic records
and track the assets and liabilities of the organization.
It prevents chances of error or fraud in the form of
revenue and cost leakages.
It enables the assessment of liabilities towards direct
(Income tax) and indirect taxes (Excise duty and Sales
tax) and facilitates the filing of returns to tax
authorities.
It ensures transparency to major stakeholders.
It enables the management to assess the periodical
health of the organization.
It helps prevent asset liability mismatch (ALM).
Financial Accounting Vs Financial Management
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Users of Information : External – Internal
Type of Analysis : Whole – Part
Data Used : Raw Data – Semi finished Data
Nature of Analysis : Historical – Futuristic
Unit of Measurement : Quantitative – Qualitative
Frequency : Medium to Long Term – Short Term
Nature : Objective – Subjective
Precision : Very High – Low to Medium
Legal Compulsion : Very High – Low
Nature of Content : Low to Medium – Very High
Level of Management : Low – Medium to High
Economics Vs Financial Management 7
The macro economic environment defines the
setting within which a firm operates, and
undermines the conceptual underpinnings for
financial decision making.
The key macro economic variables that influences
a firms objectives are – inflation and interest rates.
A firms top-lines, bottom-lines, including share
prices are largely influenced by these two factors.
Other key macro economic factors that influences
a firm are – economic growth rate, tax
environment, currency stability, money supply,
supply of skilled man power, govt policy on land
acquisition, etc.
Without understanding of economics, financial
decisions become irrelevant redundant.
Important areas of financial decisions 8
Capital Budgeting – The process of analyzing,
appraising and taking decisions with regards to
investments in new projects or businesses or scaling
up existing businesses in the form of increasing
existing capacities.
Working Capital Management – It involves the
assessment of requirement of funds for carrying on
the day to day activities of the businesses, followed
by effective monitoring and control.
Investment Management – It involves the systematic
allocation of working capital rendered surplus during
off seasons and ploughing back of the same during
peak seasons based on established principles of risk
and return and diversification.
Important areas of financial decisions 9
(contd)
Capital Structure – It involves decisions regarding
the composition or mix of raising of long term funds
from equity shares – preference shares –
debentures.
Dividend Policy – It refers to establishing patterns in
dividend payment decisions of a firm to its equity
shareholders based on its goals and objectives.
Evolution of financial management 1
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The treatise of ‘Arthashashtra’ propounded by
Chanakya around circa 300 BC forms the basic back
bone of modern economics and finance.
Even today it is the basis of good governance and
prudent financial decision making.
Earliest evidences of modern double entry booking
keeping system dates back to around circa 16th
century.
Development of some of the earliest theories in finance
on valuation, capital structure, and dividend policy
began in the US in the 1960s.
In the 1990s onwards with the availability advanced
computing systems and e-databases, has made
possible a lot of research on risk analysis and its
mitigation.
Objectives of financial management 1
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Profit Maximization – The most traditional school of
thought in finance argues that a business entity
exists for the sole purpose of making profits and not
charity. Therefore profit maximization is the main
objective of finance.
Critique: Profit generally implies the surplus of
revenue over cash. However, profits can also be
earned by selling of fixed assets like land,
investments held by a firm or through other sources
like interests and dividends on investments or
commissions.
Such non-orthodox sources of generating profit does
not in any way enhance the health of the
organization as they are not regular sources nor
primary to its business.
Profit is also not well defined and vague.
Objectives of financial management (contd) 1
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Shareholder Wealth Maximization – According to
this school of thought since the equity shareholders
provide seed capital and are the ultimate risk
bearers of the firm, therefore financial decisions
should be taken in a manner that enhances equity
share prices as the profits ultimately belongs to the
shareholders.
Critique: The capital market skeptics argue that the
stock market displays myopic tendencies and are
often incorrectly priced.
Some argue that other important stakeholders are
ignored like employees, suppliers, customers, etc.
Most importantly, it ignores the society at large, as
a firm cannot exist in vacuum.
Objectives of financial management (end) 1
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Stakeholder Wealth Maximization – According to this
modern school of thought financial decisions should
be taken in a way to ensure not only the equity
shareholders, but all relevant stakeholders are
benefitted from it. The logic is while shareholders
provide only the risk capital, other stakeholders also
contribute largely to the success of any firm.
Critique: Balancing the interests of all the relevant
stakeholders is not practical. There is no way to
determine the right balance and will be left to
individual discretion.
Further, if a firms social objectives supersedes its
business objectives, it will fail to rival its
competitors and ultimately become sick.
What then is the right objective? 1
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Growth – It primarily refers to the extent the firm
has created or enhanced value over a period of
time. Growth can be measured in terms of sales,
profits, earnings per share, market capitalization,
etc. Modern organizations link growth with market
leadership and sustainability.
The broad objective is to grow at pace that
outsmarts its competitors.
Growth based on one measure is extremely
susceptible to risk.
Growth will not only ensure healthy profits but will
also maximize returns to shareholders and also
contribute to the society as a whole through CSR.
Growth therefore reins supreme over all objectives.
How to choose organization form? 1
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An organization is an artificial person. Therefore,
choosing the type of organizational form is important
as it has serious financial implications, especially from
the point of view of finance, taxation and control.
Sole Proprietorship – It is a business entity owned by a
single person and is subject to minimal government
regulations. It is simple, very easy to set up and set
up costs are nominal. The owner bears all the profits
and losses of the firm. Owners liabilities are unlimited.
Such firms have limited ability to raise capital and
attract talent.
It is relatively easy to transfer the assets and or sell of
the firm.
Partnership firm 1
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Partnership – A partnership firm requires a minimum of 2
(two) members to be set up and can have at the most 20
members (except in the case of NBFCs 10 members).
It is governed by the Indian Partnership Act, 1932.
Government regulations are slightly more complex and
set up costs are on the incremental side.
The partners share all the profits and losses of the firm.
Partners liabilities are unlimited individually and
collectively.
Partnership firms have somewhat greater ability to raise
capital, however attracting talent remains status quo.
It is the firm which owns the assets therefore, It is
relatively difficult to transfer the assets or sell of the firm.
A Company 1
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Company – It is registered under the Indian Companies
Act, 1956 (as revised 2013). A private company can at
the most have 50 shareholders, while for public
company there is no limit to the no. of shareholders.
Government regulations are very complex and set up
costs are also very high.
Public ltd Cos are regulated by SEBI.
The shareholders share all the profits and losses of the
firm however, their liabilities are limited.
A company has unlimited potential to raise capital, and
can also attract the brightest talent in the industry.
It is the firm which owns the assets therefore, It is very
difficult to transfer the assets and or sell of the firm.
Stakeholders can also sue for winding up.
Other issues in selecting organizational form 1
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Decision Making – In proprietorship firms decision
making is the fastest. In a partnership firm the
consent of all the partners is essential (except for
sleeping partners). Therefore, decision making
process slows down. In a company, since superiors
need to ratify decisions, often at multiple levels;
decision making is the slowest.
Confidentiality – In a proprietorship firm information
is shared with no one, therefore confidentiality is
very high. In case of a partnership firm,
confidentiality comes down. Since company’s need
to file their financial details with RoC and stock
exchanges, a lot of information is there in the public
domain.
Succession Planning – It is the smoothest in case of
a company.
Agency problem 1
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In proprietorship or partnership it is the owners or partners
who also manages the activities of the business entity.
However, in case of a company there is complete divorce
between ownership (or principal) and management.
Professional managers are usually appointed to manage
the day to day affairs of the business. There is an implicit
relationship of trust.
It is expected that the decisions taken by the managers (or
agents) should be well aligned with the dictum of the
owners. However, often there is a conflict between the two.
This is known as agency problem.
Agency problem needs to minimized through a holistic and
360 degree appraisal of their performance and rewards.
The finance vertical (contd) 2
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Entry Level (0 – 5 yrs) : In industry, entry level
finance functions typically involves around managing
working capital, which includes inventory, debtors
and cash. In a bank it could include: credit appraisal,
credit monitoring and control. In an IT or consulting
positions it could include financial or investment
analysis.
Mid Level (5 – 15 yrs): In industry, mid level finance
functions typically involves investment or treasury
management or may be heading a particular division
or even SBU. In such cases projects appraisal or
capital budgeting, including raising long term finance
(advisory capacity) becomes an important function.
In a bank it could include an operations or branch
head. In IT industry it could be a Sr Consultant.
The finance vertical (end) 2
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Senior Level (15 – above yrs) : In industry, senior
level finance functions (CFO) typically involves
designing of capital structure and dividend policy.
As the CFO is primarily responsible for RoI he also is
final approving authority for new projects or scaling
up existing businesses.
In a bank it could include senior positions at
regional – zonal – head office levels, where
decisions are taken with regards to exposures in
different industries, base rate across different
lending products and opening of new branches or
ATMs.
In IT / Consulting industry it could be of Country or
Functional heads, directly reporting to the BoD.
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