Financial Management

FINANCIAL MANAGEMENT

AN OVERVIEW

GOALS OF THE FIRM

• Maximizing the owners’ wealth

• Maximizing shareholders’ wealth

• Maximizing the price per share

• Market price of a share serves as a barometer for business performance

• It indicates how well management is doing on behalf of its’ shareholders

DEFINITION

• Financial Management is broadly concerned with the acquisition(investment), financing and management of assets by a business firm

OBJECTIVES OF FINANCIAL MANAGEMENT

Maximize owners' wealth

Market value of equity

SCOPE

• How large should the firm be?• How fast should the firm grow?• What should be the composition of the

firms’ assets?• What should be the mix of the firms’

financing?• How should the firm analyse, plan and

control its financial affairs?

Financial Analysis, Planning and Control

Balance Sheet

Long Term Financing

Short Term Financing

Fixed Assets

CurrentAssets

Managementof the Firm’s Asset Structure

Managementof the Firm’sFinancial Structure

KEY ACTIVITIES OF FINANCIAL MANAGEMENT

Capital Budgeting Decisions

Capital Structure Decisions

Dividend Decisions

Working Capital Decisions

Return

Risk

Market Value ofthe Firm

RISK RETURN TRADE OFF

FINANCE AND ECONOMICS• Macro Economics

– Necessary for understanding the environment in which the firm operates

• Micro Economics– Helpful in sharpening the tools of decision

making

•Growth rate of economy, tax environment, availability of funds, rate of inflation, terms on which the firm can raise finances

•Principle of marginal analysis is applicable to decision making

FINANCE AND ACCOUNTING

• Score Keeping vs. Value Maximising

• Accrual Method vs. Cash Flow Method

• Certainty vs. Uncertainty

BUSINESS

Sole proprietorship

Decision-making is simple

Can be set up easily & inexpensively

The owner receives all income from business.

Income is taxed at only one level (that of the owner).

Subject to few regulations

Unlimited liability.

Limited life of the proprietorship

The business has limited access to additional funds.

The general partners are decision-makers.

The owners (the partners) divide income according to partnership agreement.

Income is taxed once.

Set up with ease

Few government regulations

Unlimited liability for each partner.

A limited life of partnership.

Limited access to additional funds.

Distinct legal entity

Limited liability

The business enterprise has a life in perpetuity

Access to additional funds through the sale of new share of stock.

Income is distributed according to proportionate ownership.

The separation of ownership and decision-making.

Double taxation on income

Partnership Corporation

Corporation

Private Company Public Company

Minimum 2 personsMaximum Shareholders 50Public subscription not allowedRestricted rights to transfer shares

Promoters enjoy unchallengedcontrol over the firm

Firms ability to raise capital is limited

Minimum 7 personsMaximum Shareholders –unlimitedPublic subscription allowedFree transfer of shares

Firm can raise substantial funds

Cumbersome procedure forFormation

• Public Company is the most appropriate form of organisation as– Limited liability– Enormous growth potential– Free and easy transferability of shares

REGULATORY FRAMEWORK

• Industrial Policy of 1991

• Companies Act 1956

• Securities and Exchange Board of India Guidelines 1992

TAXES

Direct Taxes

Impact and incidence of the tax is on the

same person

Income Tax Wealth Tax

Gift Tax

Indirect Taxes

Impact and incidence of the tax is on

different persons

Excise DutySales Tax

Customs duty

Financial Institutions

Commercial BanksInsurance Companies

Mutual FundsProvident Funds

Non Banking FinancialInstitutions

Suppliers of Funds

IndividualsBusinesses

Governments

Financial Markets

Money MarketCapital Market

Demanders of Funds

IndividualsBusinesses

Governments

THE FINANCIAL SYSTEM

Transferring CapitalTransferring Capital

• Direct Transfer of Funds

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Transferring CapitalTransferring Capital

• Direct Transfer of Funds

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CashCash

Transferring CapitalTransferring Capital

• Direct Transfer of Funds

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CashCash

SecuritiesSecurities

Transferring CapitalTransferring Capital

• Direct Transfer of Funds

saverfirm

Financial Institutions

Commercial BanksInsurance Companies

Mutual FundsProvident Funds

Non Banking FinancialInstitutions

Suppliers of Funds

IndividualsBusinesses

Governments

Financial Markets

Money MarketCapital Market

Demanders of Funds

IndividualsBusinesses

Governments

THE FINANCIAL SYSTEM

Private Placement

Funds

Securities

Transferring CapitalTransferring Capital• Indirect Transfer using a Financial Intermediary

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Transferring CapitalTransferring Capital• Indirect Transfer using a Financial Intermediary

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Transferring CapitalTransferring Capital• Indirect Transfer using a Financial Intermediary

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Financial Institutions

Commercial BanksInsurance Companies

Mutual FundsProvident Funds

Non Banking FinancialInstitutions

Suppliers of Funds

IndividualsBusinesses

Governments

Financial Markets

Money MarketCapital Market

Demanders of Funds

IndividualsBusinesses

Governments

Funds

Deposits/shares

Funds

Loans

THE FINANCIAL SYSTEM

Private Placement

Funds

Securities

Transferring CapitalTransferring Capital

• Indirect Transfer using Investment Banker

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Transferring CapitalTransferring Capital

• Indirect Transfer using Investment Banker

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investmentbanker

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Transferring CapitalTransferring Capital

• Indirect Transfer using Investment Banker

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• Indirect Transfer using Investment Banker

saver

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• Indirect Transfer using Investment Banker

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saver

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FundsFunds

Transferring CapitalTransferring Capital

• Indirect Transfer using Investment Banker

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SecuritiesSecurities

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FundsFunds

Transferring CapitalTransferring Capital

• Indirect Transfer using Investment Banker

SecuritiesSecurities

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Financial Institutions

Commercial BanksInsurance Companies

Mutual FundsProvident Funds

Non Banking FinancialInstitutions

Suppliers of Funds

IndividualsBusinesses

Governments

Financial Markets

Money MarketCapital Market

Demanders of Funds

IndividualsBusinesses

Governments

Private Placement

Funds

Deposits/shares

Funds

Securities

Funds

Loans

Securities

Funds

Securities

THE FINANCIAL SYSTEM

Funds

Financial Institutions

Commercial BanksInsurance Companies

Mutual FundsProvident Funds

Non Banking FinancialInstitutions

Suppliers of Funds

IndividualsBusinesses

Governments

Financial Markets

Money MarketCapital Market

Demanders of Funds

IndividualsBusinesses

Governments

Private Placement

Funds

Deposits/shares

Funds

Securities

Funds

Loans

Funds

Securities

Funds Securities

Funds

Securities

THE FINANCIAL SYSTEM

INTEREST RATES

• Regulated

• Rates on deposits with commercial banks are subject to ceiling

• Rates chargeable by commercial banks and financial institutions are subject to floors

• Rates payable on small savings are fixed by the government

Growth Trends in the Indian Financial System

• Impressive growth post 1950 era• Emergence of wide array of Financial

Institutions• Introduction of a variety of financial

schemes and instruments to mobilise savings

• Remarkable growth in money markets• Deregulation in recent years