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An overview of financial

management

Chapter 1

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Finance Finance may be defined as the art

and science of managing money

Area of finance:

The major areas of finance are-

I. financial service

II. managerial finance/corporatefinance/financial management

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Financial management is the

managerial activity which is concernedwith the planning and controlling of thefirms financial resources

The most important activities of abusiness firm are

- Production

- Marketing

- Finance

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Financial manager actively manage the

financial affairs of any type of businessnamely

- financial and non financial

- private and public

- large and small- Profit seeking and non-profit seeking

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Finance and related

disciplines Financial management is an

integral part of overall

management- finance and economics

- finance and accounting

- finance and other related disciplines

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Finance and economics The relevance of economics to financial

management can be described in the light of

the two broad areas of economics

- micro economics

- macro economics

The marginal analysis: it suggest that financial

decisions should be made on the basis of

comparision of marginal revenue and marginalcost

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Finance and accounting

Relation:

- accounting function is a necessary

input into the finance function

- the end product in accountingconstitutes financial statements

- it shows past performance and future

directions of the firm

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Finance and accounting Differences:

there are two differences between

finance and accounting- treatment of funds

- decisions making

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Finance and other related discipline

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Scope of financial management

The investment decision The financing decision

The dividend policy decision

Key functions of the financial managers: Performing financial manager

Making investment decisions

Making financing decisions

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Profit maximization criteria Ambiguity Timing of benefits

Quality of benefits

Timing of benefits:

A alternative is better than B alternative in terms of profitMenu

Time Alternative A (tk in lakh) Alternative B (tk in lakh)

Period 1 50 ---

Period 2 100 100

Period 3 50 100

Total 200 200

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Profit maximization criteria Quality of benefits:

Obviously alternative A is better than alternative Bin terms of risks and uncertainty

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State of economy Alternative A (tk in lakh) Alternative B (tk in lakh)

Recession(Period 1) 9 ---

Normal (Period 2) 10 10Boom(Period 3) 11 20

Total 30 30

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Wealth maximization criteria

Risk-return relationship

Return=risk free rate+ risk premium

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Expected Return

Risk Premium

Risk-free Return

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Time value of money

Chapter 2

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Time value of money means that the

value of a unit of money is different in

different time period

There are two techniques for doing this

- compounding technique

- discounting technique

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Rationale

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Shortcut formula:

A= P(1+i)n

Where,A= end amount, P= principal, i= interest rate

n= number of yearsMenu

Annual compoundingYear 1 2 3

Beginning amount 1000 1500 1102.50

Interest rate 0.05 0.05 0.05

Amount of interest 50 52.50 55.125Beginning principal 1000 1050 1102.50

Ending principal 1050 1102.50 1157.625

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Semi-AnnualMeans that there are two compounding periods in a year

Shortcut formula:

A= P(1+i/2)2n

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Year 6 months 1 year 18 months 2 years

Beginning amount 1000.00 1030.00 1060.90 1092.73

Interest rate 0.03 0.03 0.03 0.03

Amount of interes 30.00 30.90 31.83 32.78

Beginning principal 1000.00 1030.00 1060.90 1092.73

Ending principa 1030.00 1060.90 1192.73 1125.51

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Quarterly compounding Quarterly compounding means thatthere are four compounding periods

within the year

In these cases the rate of interest in

each compounding period will be 1.5%

that is (1/4 of 6 per cent)

Shortcut formula:

A= P( 1+i/4)4n

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Graphic illustration of

compounding values0 1 2 3 4 5

500 1000 1500 2000 2500.00

2100.00

1654.50

1158.00

608.00

8020.50

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Present value or discounting

technique Present value is the current value of a

future amount

Discounting is determining the present

value of a future amount

Mathematical formulation:

P = A { 1/(1+i)n }

Shortcut formula: P= A ( PVIF)

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Series of cash flows

Mixed stream: is a stream of cash flows

that reflects no particular pattern

Formula:

P=