Financial Managment m1-2010

FINANCIAL MANAGMENT
MODULE-1
MODULE-1
1. Introduction to finance
2. Objectives of financial managemt profit max
wealth max.
3. Changing role of finance managers
4. Organization of finance function
DEFINITION OF FINANCIAL MANAGEMENT
 The subject of financial management deals with the managerial activity which is
concerned with the planning and controlling of firm’s financial resources.
 According to Van Horne & Wachowicz, “Financial Mgt is concerned with the
acquisition, financing & mgt of assets with some overall goal in mind.”
 To quote, Joseph & Massie, “Financial mgt is the operational activity of a business
that is responsible for obtaining & effectively utilizing the funds necessary for
efficient operations”.
 To conclude, “finance is the backbone of every business”

INTRODUCTION TO FINANCE
 FINANCE is the art & science of managing money
 FINANCIAL SERVICES is concerned with the design & delivery of advice &
financial products to individuals, businesses & governments.
APPROACHES/EVOLUTION OF FM
Traditional Approach Transitional Approach Modern Approach

TRADITIONAL PHASE (1920’S)
 Lasted for 4 decades
 It focused on 4 selected as aspects:
1. It treats the entire subject of finance from the outsiders point of view (invt. Bank,
lenders, others) rather than the financial decision maker in the firm.
2. Focus on corporate finance (procurement of funds)
3. Sequence of treatment was on certain episodic events like:
 Formation-issuance of capital-major expansion -merger-reorganization

-liquidation during the Life Cycle of an enterprises.
 Heavy emphasis on long-term financing & lacks emphasis on the problems of

working capital management
TRANSITION PHASE
 It began in the early 1940’s -1950’s
 Similar to earlier phase
 Emphasis is given to the day-to-day (working capital) problems faced by the

financial managers.
 Capital budgeting techniques were developed.

MORDERN PHASE
 Began in the mid 1950’s

 Commendable devpt. With combination of ideas from economic & statistics has led
the F.M to be more analytical & quantitative.
 Focused more on efficient & wise allocation of funds to various uses & defined in a
broad sense
 In addition to the above aspects ………
 Supply of funds to all divisions of organization
 Supervision of cash inflows and outflows
 Evaluation of performance of various divisions
 Keeping touch with the stock exchange, market price of shares.
 Record keeping
 Maintaining liquidity.
SCOPE OF FINANCIAL MANAGEMENT
1 Investment decision (acquiring of asset) Long Term Assets
(asset mix decision) Short Term/Assets
a) Capital budgeting (selection of invt proposal-profitable)
b) Working capital management (trade-off b/w profitability and risk)
2 Financing decision (financing-mix / capital structure)
3 Dividend policy decision (dividend-pay out ratio)

Three broad activities of Finance
Management:
1. Capital Budgeting
2. Capital structure
3. Working capital management.
FUNCTIONAL AREAS OF FINANCIAL MANAGMENT
1. Determining financial need

2. Determining Sources of funds.
3. Financial Analysis
4. Optimal capital structure
5. Cost volume profit analysis.
6. Profit planning and control
7. Fixed assets management.
8. Project planning and evaluation.
9. Capital budgeting
10. Working capital management
11. Dividend policies
12. Acquisitions and mergers.
13. Corporate taxation
OBJECTIVES OF FM
 Profit maximization
 Wealth maximization-Share holder orientation
 Sales maximization
 To maximize economic Value Added (EVA)

 Maximization of profits.
Simply means maximizing the rupee income of the firm. This
objective is justified by the following points.
a. Business is an economic activity carried on for making profits.
b. It also maximizes social economic welfare
c. Only profit maximize will survive in the long run.
d. Profit is the proof of success.
e. Profit is the best source of funds for expansion, growth and innovation.
f. Profit is essential for earning goodwill, recognition and prestige in the
market.
g. Reward for risk taking.
There are several reasons as to why some firms don’t want to
have profit maximization as the objective:
1. To attain industry leadership
2. To prevent competition
3. To avoid government intervention
4. To ensure customer satisfaction
5. To avoid labor unrest
6. To maintain sufficient liquidity.

PROFIT MAXIMIZATION
 ARGUMENTS INFAVOUR OF PROFIT MAXIMIZATION

1. It is a measure of economic efficiency
2. Ensures maximum welfare toall stakeholders
3. Increases confidence of the management
4. Attract investors
5. Indicates efficient use of funds
 ARGUMENTS AGAINST PROFIT MAXIMIZATION
1. It is a vague term
2. Does not consider time value of money
3. Does not take into account risk
4. Encourages corrupt practices
5. More profit attract government intervention
6. Cutthroat competition
7. Problems from employees
8. True picture of organization-not reflected.
Limitations:
1. It is vague
2. It ignores the time value of money
3. It ignores risk
4. It overlooks quality aspect of future activities
5. No dividend
WEALTH MAXIMIZATION
 Prof. Ezar Solomon adopted wealth- maximization/ value maximization objective

which removes all the drawbacks of the profit maximization objectives.
 The wealth or ‘Net Present Worth’ of a course of actions is the diff. b/w gross
present worth& the amount of capital investment required to achieve the benefit.
 Gross Present-worth represents the present value of expected cash benefits.
 In simple, it means maximizing the present value of a course of action.
Steps for wealth maximization:
1. Avoid high level of risks

2. Pay dividend
3. Maintain growth in sales
4. Maintain the price of firm’s equity shares
Implications of Wealth Maximization
1. Supplier of loan capital/lenders/creditors

2. Employees/workers
3. Society/public
4. Management/employer
WEALTH MAXIMIZATION-MAXIMIZES MARKET CAPITAL
 Features
1. Increase in Profit
2. Reduction in cost
3. Judicious mix of funds
4. Minimum risk
 ARGUMENTS IN FAVOUR
1. It is a broad term
2. Considers time value of money & risk factors
3. Focus on stakeholders interest
4. Helps in framing a strong dividend policy
MANAGERS VERSUS SHAREHOLDERS’ GOALS
 A company has stakeholders such as employees, debt-holders, consumers,
suppliers, government and society.
 Managers may perceive their role as reconciling conflicting objectives of

stakeholders. This stakeholders’ view of managers’ role may compromise with the
objective of SWM.
 Managers may pursue their own personal goals at the cost of shareholders, or may
play safe and create satisfactory wealth for shareholders than the maximum.
 Managers may avoid taking high investment and financing risks that may
otherwise be needed to maximize shareholders’ wealth. Such “satisfying”
behaviour of managers will frustrate the objective of SWM as a normative guide.
FINANCIAL GOALS AND FIRM’S MISSION AND
OBJECTIVES
 Firms’ primary objective is maximizing the welfare of owners, but,

in operational terms, they focus on the satisfaction of its customers
through the production of goods and services needed by them
 Firms state their vision, mission and values in broad terms
 Wealth maximization is more appropriately a decision criterion,

rather than an objective or a goal.
 Goals or objectives are missions or basic purposes of a firm’s

existence
FINANCIAL GOALS AND FIRM’S MISSION AND OBJECTIVES
 The shareholders’ wealth maximization is the second-level

criterion ensuring that the decision meets the minimum
standard of the economic performance.
 Inthe final decision-making, the judgement of management

plays the crucial role. The wealth maximization criterion
would simply indicate whether an action is economically
viable or not.
AGENCY PROBLEM
 Conflicts of interest among stockholders, bondholders and mangers.
 Agency theory: the analysis of principal-agent relationships, in which one person,
an agent, acts on behalf of another person, a principal.
 Agency problem arises due to the separation of ownership & control of business
firms.
 In theory, the S.H’s being the owners of the firm, control its activities.
 In practice, however, the large modern corporation has a diffuse & fragmented set of
S.H’s & control often lies in the hands of directors.
 The separation of ownership & control raises worries that the mgt team may pursue
objectives attractive to them, but which are not necessarily beneficial to the S.H’s-
this is termed ‘managerialism’. This conflict is what is known as the principal-agent
problem (agency problem)
 Agency costs: the incremental costs of having an agent make decisions for a
principal
 Monitor managers’ behaviour &
 Create incentive schemes & control for managers to pursue S.H’s Wealth
maximization.
GOAL CONGRUENCE
 Linking rewards to shareholders wealth improvements- share option or allot
share
 Sackings: threat of being sacked with the accompanying humiliation & financial
loss may encourage mgrs not to diverge-S.H.W.M
 Selling shares and the take-over threat- fear of being taken over- establish some
sort of backstop position to prevent S.H W considerations being totally ignored.
 Corporate governance regulations: legislation-designed to encourage directors to

act in S.H’s interests.
 Information flow: to acctg profession, stock exchange, the regulating agencies &
the investing public force firms to release more accurate, timely & detailed
information. This helps to monitor wealth-destroying actions by wayward mangers
early.
Qualities of Financial manager
1. He should be a man of honest and high degree of integrity.

2. He should be well educated.
3. Should be aware of policies and plans of top management.
4. Should have an up to date knowledge of capital market, SE,
taxes, laws.
5. Should have knowledge of various financial instruments and
markets.
6. Should maintain close contact with banks and FI.
7. Should maintain close contacts with other departments of
organisation.
8. Should have leadership, communication, organising and
motivating skills.
ORGANIZATION OF THE FINANCE FUNCTIONS
BOARD OF DIRECTORS
MANAGING DIRECTOR FINANCE COMMITTEE
VICE PRESIDENT VICE PRESIDENT VICE PRESIDENT

PRODUCTION FINANCE SALES
TREASURES FINANCIAL CONTROLLER
Financial planning Cash Credit Foreign Capital

& fund-raising mgr manager manager exchange manager Expenditure manager
Cost accounting Corporate Financial Internal Performance

Tax manager
manager accounting mgr accounting mgr auditor evaluation
FINANCIAL MANAGER’S ROLE
 FUNDS RAISING
 FUNDS ALLOCATION
 PROFIT PLANNING
 UNDERSTANDING CAPITAL MARKETS

EMERGING / CHANGING ROLE OF THE FINANCIAL MANAGER IN INDIA:
 Investment planning
 Financial structure
 Mergers, acquisitions, and restructuring
 Working capital management
 Performance management
 Risk management
 Corporate governance
 Investor communication

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FINANCIAL MANAGMENT

 To conclude, “finance is the backbone of every business”

 FINANCE is the art & science of managing money

Traditional Approach Transitional Approach Modern Approach

 It focused on 4 selected as aspects:

2. Focus on corporate finance (procurement of funds)

3. Sequence of treatment was on certain episodic events like:

 Formation-issuance of capital-major expansion -merger-reorganization

 Heavy emphasis on long-term financing & lacks emphasis on the problems of

 It began in the early 1940’s -1950’s

 Similar to earlier phase

 Emphasis is given to the day-to-day (working capital) problems faced by the

 Capital budgeting techniques were developed.

 Began in the mid 1950’s

a) Capital budgeting (selection of invt proposal-profitable)

b) Working capital management (trade-off b/w profitability and risk)

2 Financing decision (financing-mix / capital structure)

3 Dividend policy decision (dividend-pay out ratio)

1. Determining financial need

 Wealth maximization-Share holder orientation

 To maximize economic Value Added (EVA)

3. To avoid government intervention

4. To ensure customer satisfaction

5. To avoid labor unrest

6. To maintain sufficient liquidity.

 ARGUMENTS INFAVOUR OF PROFIT MAXIMIZATION

2. It ignores the time value of money

4. It overlooks quality aspect of future activities

 Prof. Ezar Solomon adopted wealth- maximization/ value maximization objective

1. Avoid high level of risks

1. Supplier of loan capital/lenders/creditors

 Managers may perceive their role as reconciling conflicting objectives of

 Firms’ primary objective is maximizing the welfare of owners, but,

 Firms state their vision, mission and values in broad terms

 Wealth maximization is more appropriately a decision criterion,

 Goals or objectives are missions or basic purposes of a firm’s

 The shareholders’ wealth maximization is the second-level

 Inthe final decision-making, the judgement of management

 Corporate governance regulations: legislation-designed to encourage directors to

1. He should be a man of honest and high degree of integrity.

MANAGING DIRECTOR FINANCE COMMITTEE

VICE PRESIDENT VICE PRESIDENT VICE PRESIDENT

TREASURES FINANCIAL CONTROLLER

Financial planning Cash Credit Foreign Capital

Cost accounting Corporate Financial Internal Performance

 UNDERSTANDING CAPITAL MARKETS

 Mergers, acquisitions, and restructuring

 Working capital management

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