Learning Outcome

Identify and recognize the various functions performed in any

organization with the help of finance
 Financial management:
2
meaning

 Financial Management is that managerial activity

which is concerned with the planning and
controlling of firm’s financial resources.
 SCOPE of the financial
management
3

 The scope of the financial management is to secure the

capital needed by the enterprise, and employ it in
production and marketing activities, in such a way that it
can generate the sufficient returns on invested capital,
with an intention to maximise the wealth of the owners.
The financial manager plays the crucial role in the
modern enterprise by supporting investment decision,
financing decision, and also the profit distribution
decision. He/she also helps the firm in balancing cash
inflows and cash outflows, and in turn to maintain the
liquidity position of the firm.
 Scope of Finance
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Important activities of a business firm:

 Production
 Marketing
 Finance

A firm’s secures whatever capital it needs and

employs it (finance activity) in activities ,which
generate returns on invested capital ( production
and marketing activities).
 Scope of Finance
5

Important activities of a business firm:

 Production
 Marketing
 Finance

A firm’s secures whatever capital it needs and

employs it (finance activity) in activities ,which
generate returns on invested capital ( production
and marketing activities).
 Finance Functions
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Finance functions or decisions can be divided as

follows
 Long-term financial decisions
• Investment decision or capital budgeting decisions.
• Financing decision or capital structure and leverage
decisions.
• Dividend decision
 Short-term financial decisions
• Liquidity decision or working capital management.
 Key Issues In
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Financial Decision-making
Investment • What business to be in?
Decision • What growth rate is appropriate?
• What assets to acquire?
Financing • What mix of debt and equity to be used?
Decision • Can we change value of the firm by changing the capital
mix?
• Is there an optimal debt–equity mix?
Dividend • How much of the profit should be distributed as dividends
Decision and how much should be ploughed back
• Can we change value of the firm by changing the amount
of dividend?
• What should be the mode of dividend payment

Working • What level of inventory is ideal?

Capital • What level of credit should be given to the customers?
Decision • What level of cash should be maintained?
• How can the blockage of funds in the current assets be
minimized without compromising with profits?
Financial Management – An Overview Chapter 1
 Investment Decisions
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Chapter 1

 Aim at selecting the most productive

avenues that maximize the ROI.
 Examples include:
• Expansion
• Modernization and replacement
• R&D expenditure.
 Also referred to as capital budgeting
decisions.
 Are critical for long-term survival and
growth.
 Investment Decisions
9

Chapter 1

 Are taken in the light of their probable

impact on the wealth of shareholders.
 Involve huge capital outlay.
 Have long-term implications.
 Are usually irreversible.
 Financing Decisions
10

Chapter 1

 Vaguely referred to as capital structure

decisions.
 Mainly concerned with:
• Identifying the suitable sources of funds
• Tapping of these sources.
 Determine the financial risk.
 Thrust is to bring down the cost of
financing.
 Financing Decisions
11

Chapter 1

 The main issues involved are:

• Where from to procure the requisite funds?
• What should be the optimal mix of various
sources of capital?
• How much should be the proportion of short-
term and long-term funds?
• How do the expectations of providers of each
source of capital change with alteration in the
capital mix?
 Financing Decisions
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Chapter 1

 Are taken in the light of their likely

impact on the wealth of the stockholders.
 A right blend of debt–equity affects the
risk return profile of the business.
 Dividend Decisions
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Chapter 1

 Are mainly concerned with deciding the mix of

profits to be distributed as dividends and those to
be ploughed back for future financing needs of
business.
 Depend on trade off between future financing
needs of the firm and current consumption
requirements of the shareholders.
 Generally, firms in sectors with a high-growth
rate follow a policy of high retention and low
payout.
Financial Management – An
Overview
 Dividend Decisions
14

Chapter 1

 Determining the payout ratio and the method of

dividend payment are the two concerns of
dividend policy.
 The payout ratio is decided in the light of its
probable impact on shareholders’ wealth
 Normally, firms follow a policy of stable
dividends
 Dividend policy is considered as a residue of
investment and financing policy.

Financial Management – An
Overview
 Working Capital Decisions
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Chapter 1

 Are concerned with the management of

current assets.
 The two key decision points in working
capital management are:
• Level of investment in current assets
• Financing of current assets.

Financial Management – An
Overview
 Finance Manager’s Role
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 Raising of Funds
 Allocation of Funds
 Profit Planning
 Understanding Capital Markets
 Financial Goals
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 Profit
maximization (profit after tax)
 Maximizing earnings per share
 Wealth maximization
 Objections to Profit
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Maximization
It is Vague
It Ignores the Timing of Returns
It Ignores Risk
Assumes Perfect Competition
In new business environment profit maximization
is regarded as
 Unrealistic
 Difficult
 Inappropriate
 Immoral
 Maximizing Profit after
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Taxes or EPS
 Maximising PAT or EPS does not maximise the
economic welfare of the owners.
 Ignores timing and risk of the expected benefit
 Market value is not a function of EPS.
 Maximizing EPS implies that the firm should make
no dividend payment so long as funds can be
invested at positive rate of return—such a policy
may not always work.
 Shareholders’ Wealth
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Maximization- SWM
 Maximizes the net present value of a course of
action to shareholders.
 Accounts for the timing and risk of the expected
benefits.
 Benefits are measured in terms of cash flows.
 Fundamental objective—maximize the market
value of the firm’s shares.
 Wealth maximising objective
superior to the profit maximisation
objective
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 The wealth maximising objective means maximising the net

present value, i.e., wealth of the owner. The net wealth of the
owner is the difference between the present value of its
benefits and the present value of its costs. Any action that has
a positive NPV creates wealth for the owner.
 The profit maximising objective tries to maximise the profit
after tax, i.e., net profit, which in the long term may reduce
the net worth of the owner.The profit maximisation concept
basically ignores the time value of money and the risk
involved in firm's activities, which are very well taken care by
wealth maximisation concept.
 Overview of Financial
22
Management