by Preeti Singh

An Introduction to financial Management

Principles of Financial Management

Risk and

Return Time

valueof money

Cash flow

Concept

Incremental

Cash Flow Analysis

Wealth Maximizati

on

What is Financial Management?• Financial Management is concerned with raising of funds.

• Creating value to the assets of the business enterprises by efficient allocation of funds.

• It is the integration of the flow of funds in the most optimum manner to maximize the returns of a firm by taking proper decisions in utilizing the funds.

• It has broad-spectrum activities and it is continuously concerned with producing an adequate return on a company/firm’s investments.

BASIC PRINCIPLES OF FINANCIAL MANAGEMENT

• Risk and Return • Time value of money • Cash flow concept • Incremental Cash Flow Analysis • Wealth Maximization

EVOLUTION OF FINANCIAL MANAGEMENT

• The evolution of the subject started in the twentieth century.

• It can be divided into two periods. • The traditional phase was from 1920 to 1950

and the modern phase began in 1950. • The traditional phase was called the outsider

looking approach and the modern phase is called the insider looking approach.

The Traditional Approach • Procurement of Funds: Procurement of

funds through an analysis of financial instruments, institutions and sources of funds.

• Outsider Looking Approach: It had a limited scope because its emphasis was on the supplier of funds.

• Capital Budgeting: The attention given by financial management was towards the procurement of funds for long-term use. Working capital was not considered at all.

• Financial Instruments: Procuring funds was through the issue of financial instruments like equity share, preference shares and debt securities.

• Status of the Subject: It was operational in nature, limited to preparing accounts, reports and procuring funds. Financial decision-making was not part of the function of the subject tools and techniques had not been developed.

Modern Approach

• Integrated Finance Function • Management Function • Status • Techniques

Scope And Functions Of A Financial Management/Manager

Liquidity of funds• A financial manager has to match inflows and outflows and thus

create liquidity.

Profitability• A financial manager has to measure the cost of capital raise by him

as a source for the funds of the company because cost of capital is linked with profitability of a company.

• He has to control costs in all operational areas of the company through costs control systems and costs accounting methods. He has to formulate pricing policies, sales policies and marketing policies to bring about profitability in the company.

Management • The financial manager has to coordinate different

activities of the company. • He has to deal with long term and short term

requirements of the company. • He has to analyze, plan and control the use of funds.

Balance conflicting goals Such as Financial Management has the scope of • Profitability and liquidity • Profit maximization and wealth maximization • Risk and return • Identification of groups

Identification of groups

The financial management has the scope of financial decision making for a large group of people. Such as

• Shareholders • Debt investors • Employees • Customers• Suppliers • Public• Government • Management

Economic value added (EVA)

• EVA is a financial tool, which provides to the organization knowledge of how much value the company is adding above the total cost of capital.

Agency Problem

FINANCIAL DECISION MAKING

Financial management is the study of the process of financial decision-making in the following 3 cases

• Investment decisions• Financing decision

• Dividend decisions

Investment Decisions

• Investment decisions deal with long term and short term finances of a firm. These can be termed as fixed assets and current assets.

• The long-term process covers the area of Capital Budgeting.

Working Capital Management • Financial manager ahs to take decision to be sure

that there is adequate working capital in the firm.

Financing Decisions • Financial management also deals with financing

issues, such as making the business profitable, by analyzing break-even points, fixed costs and variable costs.

Dividend Decisions • Financial management is also applied to the

requirement of the shareholders. • It is concerned with the amount of profit that

can and should be withdrawn to declare dividends to the owners of the capital of the company or the shareholders.

OBJECTIVES OF FINANCIAL MANAGEMENT

• It aims at optimum use of assets to maximize the profitability of the company.

• It has the objective of maximizing wealth of the shareholder.

Profit Maximization

• Profit maximization is concerned with appropriate selection of assets and its optimum utility thereof.

• An organization must be profitable to be an economic entity. Profitability shows efficiency and proper allocation of firm’s resources.

• Thus profit maximization is measure of a firm’s performance as it is a yardstick to measure the efficiency of a firm.

• Profit maximization concept ignores time value of money.

• The term ‘profit’ is not clear. Is it accounting profit or after tax profit? Would it be gross profit or net profit? Or is it indicative of earnings per share?

• It concentrates on profitability and it does not include the financing aspect.

• It does not analyze risks.

• It analyzes the firm’s utilization of resources rather than the interest of the shareholders. It does not reflect time value of money.

• Profit maximization is an accounting concept and does not consider the aspects of maximizing shareholders wealth. It does not show the internal position of the firm/company.

Maximization of Shareholders Wealth

• The shareholders wealth is reflected in the market value of its share.

• The shareholders economic value is the dividend that he receives presently.

• It is also the future dividend benefits • Capital appreciation of the share. • The market price of the share is a present

value of all the future cash flows in terms of benefits and dividends expected from the firm.

• The market price of the share can be optimized by the three important decisions of the financial manager

• Investment decisions• Financing decisions • Dividend decisionsThese decisions are taken through the cash flow concept

of finding out the present value of the share.

Profit Maximization Versus Wealth Maximization

• Profit maximization is important to judge and analyze the economic viability of a firm.

• Profit maximization is an important concept but profitability is an ambiguous term as it is not define whether the efficiency of the firm should be considered in terms of operating profit or net profit.

• It ignores the concept of time value of money. • It considers the profit concept, but not the cash flow

concept.

• The wealth maximization concept is a comprehensive term to include timing benefits, cash flow concept, as well as risk and return.

• The wealth maximization concept analyzes the earnings per share, present and future dividends to be given to shareholders thus giving an indication of the maximum utility of the wealth of the shareholders.

• Wealth maximization is universally accepted due to the fact that it is able to achieve the objectives of a firm and take decisions to favour owners, institutions, employees and equity shareholders.

Financial Management And Financial Accounting

• Cash flow approach • Time Value of Money • Treatment of Funds • Activities

Financial Management And Other Areas Of Study

Financial management draws a relationship with many areas of study.

• Financial Management and Economics • Financial management and Marketing

Management • Financial Management and Human Resources

Management • Financial Management and Production

Management

Financial Management and Economics:

• Financial management is closely related to macro and microeconomics.

• Financial management and macroeconomics are concerned with money and capital markets, financial intermediaries, banking system, monetary credit and fiscal policy.

• Macroeconomics prepares policies relating to the financial environment.

• The financial manager works and prepares policies for firms and other institutions depending upon the monetary and fiscal policies.

• He has to take financial decisions within these policies. He also has to make changes in his financing decisions if there are changes in macroeconomics policies.

• Microeconomics consists of concepts and theories relating to supply and demand, price, profitability and profit maximization strategies.

• Financial decisions have to continuously evaluate price of a product, sales revenue and financing decisions of a firm.

• It works in a complementary manner with both macro and microeconomics.

• A financial manager should have a good knowledge of economics.

• In fact financial management branched into its own discipline from economics.

Globalization and its Impact on Finance Function

• Globalization has brought economies together in terms of trade.

• Demand is created in one country and supply is sent from another country. This brings about foreign exchange and bank dealings of different countries.

• Cost of capital has to be projected and only profitable project can be taken.

• Capital budgeting should be done on international collaborative projects.