8160 2. Definition, Mportance and Scope of FM

8/18/2019 8160 2. Definition, Mportance and Scope of FM

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Financial Management


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Important Business Activities2

ProductionMarketing

Finance


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Real And Financial Assets3

Real Assets: Can be Tangible or Intangible Tangible real assets are physical assets that include

plant, machinery, office, factory, furniture and building.

Intangible real assets include technical know-how,technological collaborations, patents and copyrights.Financial Assets are also called securities , arefinancial papers or instruments such as shares andbonds or debentures.


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Equity and Borrowed Funds4

Shares represent ownership rights of their holders.Shareholders are owners of the company. Shares can oftwo types:

Equity Shares Preference Shares

Loans, Bonds or Debts : represent liability of the firm

towards outsiders. Lenders are not owners of thecompany. These provide interest tax shield .


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Equity and Preference Shares5

Equity Shares are also known as ordinary shares . Do not have fixed rate of dividend. There is no legal obligation to pay dividends to equity

shareholders.

Preference Shares have preference for dividendpayment over ordinary shareholders.

They get fixed rate of dividends. They also have preference of repayment at the time of

liquidation.


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Finance and ManagementFunctions6

All business activities involve acquisitionand use of funds.Finance function makes money availableto meet the costs of production andmarketing operations.Financial policies are devised to fitproduction and marketing decisions of afirm in practice.


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Finance Functions7

Finance functions or decisions can bedivided as follows

Long-term financial decisions

• Long-term asset-mix or investment decision or capitalbudgeting decisions.• Capital-mix or financing decision or capital structure

and leverage decisions.• Profit allocation or dividend decision

Short-term financial decisions• Short-term asset-mix or liquidity decision or working

capital management.


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Financial Procedures andSystems8

For effective finance function some routinefunctions have to be performed. Some of theseare:

Supervision receipts and payments and safeguardingof cash balancesCustody and safeguarding of securities, insurancepolicies and other valuable papers

Taking care of the mechanical details of new outsidefinancingRecord keeping and reporting


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Finance Manager’s Role 9

Raising of Funds Allocation of Funds

Profit PlanningUnderstanding Capital Markets


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Financial Goals10

Profit maximization (profit after tax)Maximizing earnings per share

Wealth maximization


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Profit Maximization11

Maximizing the rupee income of firmResources are efficiently utilized

Appropriate measure of firm performance

Serves interest of society also


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Objections to ProfitMaximization12

It is VagueIt Ignores the Timing of ReturnsIt Ignores Risk

Assumes Perfect CompetitionIn new business environment profit

maximization is regarded as Unrealistic Difficult Inappropriate Immoral


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Maximizing Profit after Taxesor EPS13

Maximising PAT or EPS does notmaximise the economic welfare of theowners.

Ignores timing and risk of the expectedbenefitMarket value is not a function of EPS.

Maximizing EPS implies that the firmshould make no dividend payment so longas funds can be invested at positive rate ofreturn —such a policy may not alwayswork.


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Shareholders’ WealthMaximization14

Maximizes the net present value of acourse of action to shareholders. Accounts for the timing and risk of theexpected benefits.Benefits are measured in terms of cashflows.Fundamental objective —maximize themarket value of the firm’s shares.


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Need for a ValuationApproach 15

SWM requires a valuation model.The financial manager must know,

How much should a particular share be worth? Upon what factor or factors should its value

depend?


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Overview of FinancialManagement16


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Agency Problems: Managers VersusShareholders’ Goals

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There is a Principal Agent relationshipbetween managers and shareholders.

In theory, Managers should act in the bestinterests of shareholders.

In practice, managers may maximise their

own wealth (in the form of high salaries andperks) at the cost of shareholders.


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Agency Problems: Managers VersusShareholders’ Goals

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Managers may perceive their role as reconcilingconflicting objectives of stakeholders. Thisstakeholders’ view of managers’ role maycompromise with the objective of SWM.

Managers may avoid taking high investment andfinancing risks that may otherwise be needed tomaximize shareholders’ wealth. Such “satisfying” behaviour of managers will frustrate the objectiveof SWM as a normative guide .

This con f li c t is kn ow n as Agency p rob lem andi t resu l t s in to Ag ency cos t s .


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Agency Costs19

Agency costs include the less thanoptimum share value for shareholders andcosts incurred by them to monitor theactions of managers and control theirbehaviour.


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Financial Goals and Firm’s Missionand Objectives

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Firms’ primary objective is maximizing the welfareof owners, but, in operational terms, they focus onthe satisfaction of its customers through the

production of goods and services needed by them.Firms state their vision, mission and values inbroad terms.Wealth maximization is more appropriately adecision criterion , rather than an objective or agoal .Goals or objectives are missions or basicpurposes of a firm’s existence.


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Financial Goals and Firm’s Missionand Objectives

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The shareholders’ wealth maximization isthe second-level criterion ensuring that thedecision meets the minimum standard of theeconomic performance.In the final decision-making, the judgementof management plays the crucial role.The wealth maximization criterion wouldsimply indicate whether an action iseconomically viable or not.


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Organisation of the FinanceFunctions

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Reason for placing the finance functions inthe hands of top management

Financial decisions are crucial for the survival of the

firm. The financial actions determine solvency of the firm Centralisation of the finance functions can result in a

number of economies to the firm.


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Organisation of FinanceFunction23

Organization for finance functionOrganiza t ion for f inance funct ion

in a mu l t id iv is ional com pany


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Status and Duties of FinanceExecutives

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The exact organisation structure forfinancial management will differ acrossfirms.The financial officer may be known as thefinancial manager in some organisations,while in others as the vice-president offinance or the director of finance or thefinancial controller.


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Role of Treasurer andController25

Two officers —the treasurer and thecontroller —may be appointed under thedirect supervision of CFO to assist him orher.The treasurer’s function is to raise andmanage company funds while thecontroller oversees whether funds arecorrectly applied.

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8160 2. Definition, Mportance and Scope of FM