Unit 1 Financial Management

8/2/2019 Unit 1 Financial Management

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INTRODUCTION

BY - Devender singh



Financial Management “Financial management is concerned with the managerial

decisions that result in the acquisition and financing of short

term and long term credits for the firm”

“Financial Management deals with procurement of funds and

their effective utilization in the business”



Financial Management involves in two broad aspects:

a) Procurement of funds:

(1)Identification of sources of Finance

(2)Determination of Finance Mix

(3)Raising of funds(4)Division of profits between dividends & retention of profits.

b) Effective Utilization of Funds:

Finance managers’ is also responsible for effective utilization of funds.



Scope of Financial Management

We may divide the scope of Financial management under twodifferent approaches:

Traditional approach: under this approach the role of financemanager was restricted to only procurement of funds & it include:

(1)Study & analysis of the institution and other sources of finance whichcan be used for raising funds

(2)Study and analysis of financial instrument which can be used forraising funds

(3)Analysis of legal and accounting relationship between a firm and itssources of funds



Limitations of Traditional Approach Limited Scope

It ignored working capital financing

It ignored routine problems Limited use only corporate enterprise.



Modern Approach

Modern approach enlarged the scope of financial

management & it covers:

(1)What is the total volume of funds an enterprise

should commit?(2)What specific assets should an enterprise acquire?

(3)In what form should the firm hold its assets?

(4)What should be the composition of liabilities?



Modern Approach encompasses three major decisionsof financial management:

(1) Investment decisions

(2) Financing decisions

(3) Dividend Policy decisions



Functions of Finance Manager

(a) Formulation of objectives

(b) Forecasting and estimating capital requirement

(c) Designing the capital structure

(d) Determining the suitable source of finance

(e) Procurement of funds



(f) Investment of funds

(g) Dispersal of profits

(h) Maintaining the proper liquidity

(i) Maintaining relations with outside agencies

(j) Evaluating financial performance

(k) Keeping touch with stock exchange quotationsand behavior of share price



Tools & Techniques of Financial Management

Capital budgeting techniques

Cost of capitalLeverage

Cash Management

Receivables Management

Inventory Management



FINANCIAL SYSTEM

A set of complex and closely connected institutions,agents, practices, markets, transactions, claims, and

liabilities in the economy. It is a market for creation and exchange of financial

assets and services.

Indian financial system consists of financial markets,

financial instruments ,financial services , financialintermediaries and the regulatory framework.



Functions of the financial system Facilitates the pooling of funds and channelizing them

into productive avenues.

It provides with a huge information base . It provides a platform for transfer of resources, both

temporary and permanent.

It provides a payment mechanism for exchange of

goods and services. It ensures smooth functioning of all financial markets.

It helps individuals and corporates in managing andcontrolling risk.



Participants Of Financial system

1. FINANCIAL MARKETS :

Nature of Claim -Debt & Equity market

Seasoning of Claim- Primary & Secondary markets

Maturity of Claim- Money & Capital Markets

Organizational structure – OTC & Exchange TradedMarkets

Timing of delivery- Spot & Derivatives Markets



2. FINANCIAL INTERMEDIARIES : Banks

Financial Institutions

Insurance Companies

NBFCs – Housing Finance Cos., Hire Purchase &leasing Finance Cos., Venture Capital Finance Cos.

Financial Service Providers- Merchant Bankers, CreditRating Agencies, Depositories, etc.



3. FINANCIAL INSTRUMENTS:

a) MONEY MARKET INSTRUMENTS Commercial Paper Certificates of Deposits Treasury Bills Call or Term Money

b) CAPITAL MARKET INSTRUMENTS Equity Shares Preference Shares Debentures Bonds

4. REGULATORY INFRASTRUCTURE :

RBI SEBI



OBJECTIVE OF FINANCE

Finance is referred to as "Funds" or "Capital", when referring tothe financial needs of a corporate body.

To ascertain whether a company is efficient in financialmanagement, it has to have an overall goal.

Wealth maximization of Shareholders talks about the value of the company generally expressed in terms of the value of the stock.

Profit Maximization refers to how much rupee profit the

company makes.These are two most common goals that corporate aim at.

Although Profit maximization was the traditional concept, allfirms now look at maximizing wealth for their shareholders



Profit Maximization

This implies that the finance manager has to make his decisions inmanner so that the profits of the concern are maximized.

The guiding principle of profit maximization objective is to selectassets, projects and decisions which are profitable and reject thosewhich are not.

For maximizing the profit, either production is to be maximized fromlimited resources or the costs should be minimized for a particularlevel of production volume.

The Profit maximization objective is justified on the followinggrounds:

a) Maximization of Social Benefit.

b) Efficient Allocation and Uses of Resources.

c) Measurement of Success of Decisions.

d) Source of Incentive.



Profit Maximization

The process by which a firm determines the price and output levels thatgive the maximum profits.

This goal , however , is not as all inclusive as the Wealth maximizationas it suffers from the following limitations:

Concept of Profit ambiguous- Profit could mean PAT, PBT, EBIT ,etc.

Profit Maximization objective Ignores timing of benefit (Time valueof money)

it has a short-term focus

it ignores the timing of earnings.



Wealth Maximization

Wealth maximization means maximizing the wealth of theshareholders in terms of market value of the share and valueof the firm. This involves increasing the Earning per share of the shareholders.

Wealth maximization is regarded as operationally andmanagerially the better objective because:

(1) Time value of money

(2) The risk or uncertainty of future earning

(3) Effect of dividend policy on the market price of the share



Steps for achieving the objective of wealth

maximizationIn short the objectives of financial management are such that they should

be beneficial to owners, management, employees & customers.These objectives can be accomplished only by maximizing the value of

the firm through the following ways:

(1) Increase in profits(2) Reduction in cost(3) Sources of funds(4) Minimize risk(5) Long run value(6) Good track record of dividend payment

“ Wealth Maximization is superior criteria than profit maximization”



Profit Maximization Vs Wealth Maximization

“wealth maximization is superior criteria than profit maximization”

Profit Maximization Wealth Maximization

It does not specify the time ofexpected returns

It takes into account time value ofmoney

It does not take into considerationthe uncertainty of future earning

It takes into account the risk factor

It does not consider the effect ofdividend policy on market price ofshares

It takes into account

It ignores the interest of outsiders It considers the interests ofoutsiders

It does not differentiate betweenthe short term and long termprofits

It consider the fact



Financial management and other areas of Management

1. Financial management and marketing management

2. Financial management and personnel management3. Financial management and production management

4. Financial management and cost management

5. Financial management and financial Accounting.



Risk & Return Analysis

“ Higher the risk, higher the gain”

1. RETURN -

Return means the benefits which accrued on the investmentmade by the firm.

There are different approaches to measure the return namely:

a) Profit approachb) Income approachc) Cash flow approachd) Ratios approach



2. Risk -

“Risk may be defined as the variation of actual outcomefrom the expected outcome”

Risk = Actual Return – Expected Return

Types of Risk:

(1) Systematic Risk: also called non diversifiable anduncontrollable risk. It Includes :

(a) market risk(b) interest rate risk

(c) purchasing power risk



2. Unsystematic Risk : also called diversifiable andcontrollable risk which effects a particular firm orbusiness. It includes:

(1) Business Risk

(2) Financial Risk



Relationship between Risk and Return

Return is directly proportional to the amount of the risk taken by the firm.

Higher the risk, larger the return of the firm. Therelationship between the return and the risk canbe explained with the help of following equation:

Rate of return= risk free return+ premium forrisk taking



Time value of Money

Time value of money means that worth of a rupee receivedtoday is different from the worth of a rupee to be receivedin future.

Money has a time value on account of the following

reasons:

An investor can invest a rupee received today for a greater value to be received tomorrow or after a certain period

Generally individuals prefer current consumption

The money received today should have greater purchasingpower than the same to be received in future during boomor inflation



Time preference of moneyReasons attributed to the individual’s time preferencefor money :

1. Risk : there is uncertainty about the receipt of money in future.

2. Preference for present consumption.

3. Investment Opportunities.



Importance of time value of money

The concept of time value of money helps in arriving atthe comparable values of the different rupee amountarising at different point of time into equivalent values of a particular point of time.

The cash flows arising at different periods of time can bemade comparable by using any one of the following two

ways:

(1) By compounding the present money to a future date i.e.by finding out the value of the present money.

(2) By discounting the future money to present date i.e. by finding out present value (pv)of future money

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Unit 1 Financial Management