Financial Manager imp ans

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1.Define financial management. Explain the nature and scope of financial

management?

A. Financial management is an integral part of overall management. It is concerned

with the duties of the financial managers in the business firm. The term financial

management has been defined b !olomon" #It is concerned with the efficient use of an important economic resource namel" capital funds$

Scope :

Howard and Upton % Financial management #as an application of general

managerial principles to the area of financial decision&ma'ing.

nature and scope of financial management%

The main ob(ective of financial management is to arrange sufficient finances for

meeting short term and long term needs. A financial manager will have toconcentrate on the following areas of finance function%

1. Estimating Financial Requirements: -

The first tas' of financial manager is to estimate short term and long&

term financial re)uirements of his business. For this purpose" he will prepare a

financial plan for present as well as for future. The amount re)uired for purchasing

fixed assets as well as for wor'ing capital will have to be ascertained.

2. Deciding Capital Structure: -

The capital structure refers to the 'ind and proportion of differentsecurities for raising funds. After deciding about the )uantum of funds re)uired" it

should be decided which tpe of securities should be raised. It ma be wise to

finance fixed assets through long&term debts and current assets through short&term

debts.

. Selecting a Source o! Finance: &

After preparing capital structure" an appropriate source of finance is

selected. *arious sources from which finance ma be raised include% share capital"

debentures" financial institutions" commercial ban's" public deposits etc. If finance is

needed for short period then ban's" public deposits and financial institutions ma be

appropriate. +n the other hand" if long&term finance is re)uired then" share capital"

and debentures ma be useful.

". Selecting a pattern o! #n$estment: &

,hen funds have been procured then a decision about investment

pattern is to be ta'en. The selection of an investment pattern is related to the use of

funds. A decision will have to be ta'en as to which asset is to be purchased. The



funds will have to be spent first on fixed assets and then an appropriate portion will

be retained for wor'ing capital. The decision&ma'ing techni)ues such as capital

budgeting" opportunit cost analsis etc. ma be applied in ma'ing decisions about

capital expenditures.

%. &roper cas' (anagement: & -ash management is an important tas' of finance manager. e has to

assess various cash needs at different times and then ma'e arrangements for

arranging cash. The cash management should be such that neither there is a shortage

of it and nor it is idle. An shortage of cash will damage the credit worthiness of the

enterprise. The idle cash with the business will mean that it is not properl used.

-ash flow statements are used to find out various sources and application of cash.

). #mplementing Financial Controls:&

An efficient sstem of financial management necessitates the use of various control devises. Financial control devises generall used are budgetar

control" brea' even analsis/ cost control" ratio analsis etc. The use of various

techni)ues b the finance manager will help him in evaluating the performance in

various areas and ta'e corrective measures whenever needed.

*. &roper use o! Surplus: &

The utili0ation of profit or surplus is also an important factor in financial

management. A (udicious use of surpluses is essential for expansion and

diversification plan and also in protecting the interest of shareholders. The finance

manager should consider the following factors before declaring the dividend/

a. Trend of earnings of the enterprise

+. Expected earnings in future.

c. ar'et value of shares.

d. !hareholders interest.

e. 2eeds of fund for expansion etc.

,ature o! Financial (anagement

Financial management is applicable to ever tpe of organi0ation" irrespective

of the si0e" 'ind or nature. Ever organi0ation aims to utili0e its resources in a best possible and profitable wa.

i ) Financial anagement is an integral part of overall management.

Financial considerations are involved in all business decisions. Ac)uisition"

maintenance" removal or replacement of assets" emploee compensation" sources

and costs of different capital" production" mar'eting" finance and personnel decision"



almost all decisions for that matter have financial implications. Therefore" financial

management is pervasive throughout the organisation.

ii The central focus of financial management is valuation of the firm. Financial

decisions are directed at increasing3maximi0ation3 optimi0ing the value of the

institution.

iii Financial management essentiall involves ris'&return trade&off. Decisions on

investment involve choosing of tpes of assets which generate returns accompanied

b ris's. 4enerall higher the ris' returns might be higher and vice versa. !o" the

financial manager has to decide the level of ris' the firm can assume and satisf with

the accompaning return. !imilarl" cheaper sources of capital have other

disadvantages. !o to avail the benefit of the low cost funds" the

firm has to put up with certain ris's" so" ris'&return trade&off is there

throughout.

i$ Financial management affects the survival" growth and vitalit of the institution.

Finance is said to be the life blood of institutions. The amount" tpe" sources"

conditions and cost of finance s)uarel influence the functioning of the institution.

$ Finance functions" i.e." investment" raising of capital" distribution of profit" are

performed in all firms & business or non&business" big or small" proprietar or

corporate underta'ings. 5es" financial management is a concern of ever concern

including educational institutions.

$i Financial management is a sub&sstem of the institutional sstem which has other

subsstems li'e academic activities" research wing" etc." In sstems arrangement

financial sub&sstem is to be well coordinated with others and other sub&sstems

well matched with the financial sub&sstem.

2. Discuss a+out t'e cost o! capital in +rie!l./

0. -ost of capital plas an important role in the capital budgeting decisions. It

determines the acceptabilit of all investment opportunities regardless of the

techni)ues emploed to (udge the financial viabilit of a pro(ect. -ost of capital

serves as capitali0ation rate used to determine capitali0ation of a new concern. -ostof capital is one rate of return the capital funds used should produce to (ustif their

use within the firm.

In the words of ale and !chall" in a general sense" cost of capital is

an discount rate used to value cash streams.

i Capital budgeting decisions. In capital budgeting decisions" the cost of capital is

often used as a discount rate on the basis of which the firm6s future cash flows are

discounted to find out their present values. Thus" the cost of capital is the ver basis



for financial appraisal of new capital expenditure proposals. The decision of the

finance manager will be irrational and wrong in case the cost of capital is not

correctl determined. This is because the business must earn least at a rate which

e)uals to its cost capital in order to ma'e at least a brea'&even.

ii Capital structure decisions: The cost of capital is also an important

consideration in capital structure decisions. The finance manager must raise capital

from different sources in a wa that it optimises the ris' and cost factors. The

sources of funds which have less cost involve high ris'. 7aising of loans ma"

therefore" be cheaper on account of income tax benefits" but it involves heav ris'

because a slight fall in the earning capacit of the compan ma bring the firm

near to cash insolvenc. It is" therefore" absolutel necessar that cost of each source

of funds is carefull considered and compared with the ris' involved with it.

In order to compute the overall cost of capital" the manager of funds has to ta'e the

following steps%

18 To determine the tpe of funds to be raised and their share in the totalcapitali0ation of the firm.

98 To ascertain the cost of each tpe of funds.

:8 To calculate the combined cost of capital if the firm b assigning weight to each

tpe of funds in terms of )uantum of funds so raised.

Determination ! Cost ! Capital 3 &ro+lems #n$ol$ed

It is not an earl tas' to determine the cost of capital of a firm. ,hile determining

the cost of capital of a firm" the funds manager is confronted with a large number of

problems both conceptual and practical.

i) Computation of cost of equity % The cost of e)uit capital is the minimum rate of

return that a compan must earn on that portion of its capital emploed" which is

financed b e)uit capital so that the mar'et price of the shares of the compan

remains unchanged. This implies that to find out the cost of e)uit capital one has to

)uantit the expectations of the shareholders from the particular e)uit shares. As it

is a difficult tas'" a precise measure of cost of e)uit capital is also an arduous tas'.

ii) Computation of cost of retained earnings and depreciation funds % The

cost of capital raised through these sources will depend on the approach adopted

for computing the cost of capital. As there are different views" the funds manager has

to face a difficult tas' in subscribing and selecting an appropriate

approach.iii) Marginal Vs average cost of capital : For decision ; ma'ing purposes" it is the

future cost of capital and not historical cost of capital which is relevant. If therefore

creates another problem whether to consider marginal cost of capital" i.e." cost of

additional funds or the average cost of capital.

iv) Problem of weights: The assignment of weights of each tpe of funds is a

complex issue. If a financial executive wants to ascertain the average cost of capital

than the problem of weights also arises. The finance manger has to ma'e a choice



between the boo' value of each source of funds and the mar'et value of each source

of funds. <oth have their an merits as well as wea'nesses.

(easurement o! 4'e Cost ! Capital:

The cost of the different sources of financing represents the components of

continued cost. Each firm has ideal capital mix of various sources of funds/ external

sources =debt" preferred stoc' and e)uit stoc'8 and internal sources =reserves and

surplus8. Determining of cost of capital involves relating the expected outcome of

the specific source of capital to the mar'et or boo' value of

that source. Expected income in thin context comprises interest" discount on debt"

dividends" E>! or similar other variables most suitable to the particular case. The

computation of the cost of capital involves two steps.

i8 The computation of the different elements of the cost in terms of the cost of the

different source of finance" and

ii8 the calculation of the overall cost b combining the specific cost into a compositecost.

. 5'at is time $alue o! mone. E6plain t'e tec'niques o! time $alue o! mone/

0. A time $alue o! mone calculation is a calculation that solves for one of several

variables in a financial problem.

7e)uired rate of return ris' free rate of return@ ris' premium

In a tpical case" the variables might be% a balance =the real or nominal value of a

debt or a financial asset in terms of monetar units8" a periodic rate of interest" the

number of periods" and a series of cash flows. =In the case of a debt" cash flows are

paments against principal and interest/ in the case of a financial asset" these are

contributions to or withdrawals from the balance.8 ore generall" the cash flows

ma not be periodic but ma be specified individuall. An of the variables ma be

the independent variable =the sought&for answer8 in a given problem. For example"

one ma 'now that% the interest is .BC per period =per month" sa8/ the number of

periods is =months8/ the initial balance =of the debt" in this case8 is 9B" units/

and the final balance is units. The un'nown variable ma be the monthl pament

that the borrower must pa.

It is the process of determining the future value of a lump sum amount at one

point of time

,e calculate the future value of a single cash flow compounded annuall b

>*F*71@7



F*future value" >* intial cash flow" iinterest rate per annum" n no.of

compounding periods.

If compounding I done for shorter compounding period" then%

F* >* =1@ i3m 8 m 6 n

Future value of multiple flows%

Instead of investing lump sum at one time if mone is invested in multiple

flows then how value of mone will be affected?

Ex% !uppose r >aw Invests 1"rs now =at the beginning of one ear8"

9"rs at the beginning of ear 9 and :"rs at the beginning of ear :" how

much these flows accumulate to at the end of ear : at a rate of 19C pa?

F*: 1 x F*IF=19":8 @ 9 x F*IF=19"98 @ : x F*IF=19"18

=1x1.GB8@=9x1.9BG8@=:x1.198H

7s9:

Future *alue of Annuit%

Annuit is the term used to describe a series of periodic flows of e)ual amounts.

The example of pament of Jife insurance premium = 9 per annum8 for next 9

ears can be classified as an annuit.

H8181=

F i

i

A FVA

n−+

=

The future value of a regular annuit for a period of n ears at a

rate of interest KiL is given b the formula%

8"= ni AxCVFA FVA =

>resent value of a single flow%

,ith this approach" we can determine the present value of a future cash flow or a

stream of future cash flows

This is mostl used for evaluating the financial viabilit of pro(ects.

!uppose if we invest 1 toda at 1C pa for a period of B ears" we 'now that we

will get 1 x F*IF=1"B8 1x1.11 1"11 at the end of B ears



!o" the present value of 1"11 is 1Formula of calculating present value of a

single flow is%

>resent value of an annuit

H81=

181=F

n

n

ii

i A PVA

+

−+=

The present value of an annuit KAL receivable at the end of

ever ear for a period of n ears at a rate of interest KiL is e)ual to%

>resent *alue of >erpetuit

>erpetuit is an annuit that occurs indefinitel.

It tells that how much shall we invest toda so that we can get e)ual amount ever

ear for indefinite time

>resent *alue of >erpetuit >erpetuit M Interest rate

*alues of an Annuit due

,hen annuit is calculated from the beginning of the ear it is called annuit due

In the case of annuit due or when pament is made at the beginning of the

ear" which means last pament has completed one ear at the time of calculation

Future value of annuit due

!uppose that ou deposit 1 in saving account at the beginning of each ear for

B ears to earn GC interest rate

Future value of an annuit due future value of an annuit x =1@i8

81H=8181=

F ii

i A FVA

n

+−+

=

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Financial Manager imp ans