Unit 1 Financial Management

Structure:
1.1 Introduction Objectives
1.2 Meaning and Definition of Financial Management
1.3 Goals of Financial Management Profit maximisation Wealth maximisation
Wealth maximisation vs. profit maximisation
1.4 Finance Functions Financing decisions Investment decisions Dividend decisions
Liquidity decisions
1.5 Organisation of Finance function
1.6 Interface between Finance and Other Business Functions Relation
between Finance and accounting Finance and marketing Finance and
production (operations) Finance and HR
1.7 Summary
1.8 Glossary
1.9 Terminal Questions
1.10 Answers
1.11 Case Study

1.1 Introduction
Financial management of a firm is concerned with procurement and effective
utilisation of funds for the benefit of its shareholders. It embraces all those
managerial activities that are required to procure funds at the least cost and their
effective deployment.
Reliance and Infosys are examples of admired Indian companies that employ
effective financial management skills to their businesses. They have been rated well
by the financial analysts on many crucial aspects that enabled them to create value
for their shareholders. They employ the best technology, produce good quality goods
or render services at the least cost, and continuously contribute to the shareholder’s

wealth. The
three core elements of financial management are:
a. Financial planning Financial planning is done to ensure the availability of capital
investments to acquire the real assets. Real assets are lands, buildings, plants
and equipments. Capital investments are required for establishing and running
the business smoothly.
b. Financial decisions
 Decisions need to be taken on the sources from which the funds required for
the capital investments could be obtained.
  There are two sources of funds -debt and equity. In what proportion the funds
are to be obtained from these sources is to be decided for formulating the
financing plan.
c. Financial control Financial control involves managing the costs and expenses of
a business. For example, it includes taking decisions on the routine aspects of
day-to-day management of collecting money which is due from the firm’s
customers and making payments to the suppliers of various resources.
In this unit, you will learn about these core elements of financial management.
Objectives:
After studying this unit, you should be able to:  analyse the meaning of business
finance  describe the goals of financial management  discuss the functions of
finance  explain the interface between finance and other managerial functions of a
firm

1.2 Meaning and Definition of Financial Management

Financial management is the art and science of managing money. Regulatory and
economic environments have undergone drastic changes due to liberalisation and
globalisation of Indian economy. These have changed the profile of Indian finance
managers. Indian finance managers have transformed themselves from License Raj
managers to well-informed, dynamic, proactive managers capable of taking
decisions of complex nature.
Traditionally, financial management was considered as a branch of knowledge that
focused on the procurement of funds. Formation, merger and restructuring of firms
and legal and institutional frame work, instruments of finance occupied the prime
place in this traditional approach.
The modern approach transformed the field of study from the traditional, narrow
approach to a dynamic and extensive approach. The core of modern approach
evolved around the procurement of the least cost funds and its effective utilisation for
maximisation of shareholder’

s wealth.
Self Assessment Questions
What has changed the profile of Indian finance managers?
Finance management is considered as a branch of knowledge with focus on the __________.
 1.3 Goals of
Financial
Management

Financial management means maximisation of economic welfare of its shareholders.

Maximisation of economic welfare means maximisation of
wealth of its shareholders. Shareholder’swealth maximisation is reflected in
the market value of the firm’s shares. Experts believe that, the goal of financial management
is attained when it maximises the market value of shares. There are two versions of the goals
of financial management of the firm –Profit Maximisation and Wealth Maximisation.
Let us now discuss the goals of financial management in detail.
1.3.1 Profit maximisation
Profit maximisation is based on the cardinal rule of efficiency. Its goal is to maximise the
returns with the best performance is evaluated in terms of profitability. Profit maximisation is
the traditional and narrow approach, which aims at maximising the profit of the concern.
Allocation of resources and
output investor
performance can be traced to the goal of profit maximisation has been criticised on many
accounts:
maximisation.
Profit

Sikkim Manipal University

Page No. 3

 The concept of profit lacks clarity. What does profit mean?

o Is it profit after tax or before tax?
o Is it operating profit or net profit available to shareholders?  In this sense, profit is neither
defined precisely nor correctly. It creates unnecessary conflicts regarding the earning habits
of the business concern. Differences in interpretation of the concept of profit thus expose the
weakness of profit maximisation.  Profit maximisation neither considers the time value of
money nor the net present value of the cash inflow. It does not differentiate between profits of
current year with the profits to be earned in later years.  The concept of profit maximisation
fails to consider the fluctuations in profits earned from year to year. Fluctuations may be
attributed to the business risk of the firm. Risks may be internal or external which will affect
the overall operation of the business concern.  The concept of profit maximisation
apprehends to be either accounting profit or economic normal profit or economic
supernormal profit. Profit maximisation as a concept, even though has the above-mentioned
drawbacks, is still given importance as profits do matter for any kind of business. Ensuring
continued profits ensure maximisation of
shareholder’s wealth.

Figure 1.1: Goals of Financial Management

1.3.2 Wealth maximisation

The term wealth means shareholder’s

wealth or the wealth of the persons those

who are involved in the business concern. Wealth maximisation is also known as
value maximisation or net present worth maximisation. This objective is an
universally accepted concept in the field of business.
Wealth maximisation is possible only when the company pursues policies that would
increase the market value of shares of the company. It has been accepted by the
finance managers as it overcomes the limitations of profit maximisation.
The following arguments are in support of the superiority of wealth
maximisation over profit maximisation:
 Wealth maximisation is based on the concept of cash flows. Cash flows are a
reality and not based on any subjective interpretation. On the other hand, profit
maximisation is based on accounting profit and it also contains many subjective
 elements.
 Wealth maximisation considers time value of money. Time value of money
translates cash flow occurring at different periods into a comparable value at zero
period. In this process, the quality of cash flow is considered critical in all
decisions as it incorporates the risk associated with the cash flow stream. It finally
crystallises into the rate of return that will motivate investors to part with their hard
earned savings. Maximising the wealth of the shareholders means positive net
present value of the decisions implemented.
Let us now look at some of the key definitions.
 Positive net present value can be defined as the excess of present value of cash
inflows of any decision implemented over the present value of cash out flow.
 Time value factor is known as the time preference rate; that is, the sum of risk
free rate and risk premium.
 Risk free rate is the rate that an investor can earn on any government security for
the duration under consideration.
 Risk premium is the consideration for the risk perceived by the investor in
investing in that asset or security.
 Required rate of return is the return that the investors want for making investment
in that sector.
Caselet:
X Ltd is a listed company engaged in the business of FMCG (Fast
Moving Consumer Goods). ‘Listed’
allowed to be traded officially on the portals of the stock exchange. The Board of
Directors of X Ltd took a decision in one of its board meetings to enter into the
business of power generation. When the company informed the stock exchange at
the conclusion of the meeting about the decision taken, the stock market reacted
unfavourably. The result was
that the next day’s closing of

quotation was 30% less than that of the previous

day. Why did the market react unfavourably?
Investors in FMCG company might have thought that the risk profile of the new
business that the company wants to take up is higher compared to the risk profile of
the existing FMCG business of X Ltd, expecting a
higher return. Then, the market v
declining.
Therefore, the risk profile of the company gets translated into a time value factor.
The time value factor so translated becomes the required rate of return.

1.3.3 Wealth maximisation vs. profit maximisation

Let us now see how wealth maximisation is superior to profit maximisation.
 Wealth maximisation is based on cash flow. It is not based on the
accounting profit as in the case of profit maximisation.
 Through the process of discounting, wealth maximisation takes care of
the quality of cash flow. Converting uncertain distant cash flow into
comparable values at base period facilitates better comparison of
projects. The risks that are associated with cash flow are adequately
reflected when present values are taken to arrive at the net present
value of any project.
 Corporates play key in today’s compa role etitive business scenario. In an organisation,
shareholders typically own the company, but the management of the company rests with the
board of directors. Directors are elected by shareholders. Company management procures
funds for expansion and diversification of capital markets.
In the liberalised set up, society expects corporates to tap the capital markets
effectively for their capital requirements. Therefore, to keep the investors
happy throughout the performance of value of shares in the market,
management of the company must meet the wealth maximisation criterion.
 When a firm follows wealth maximisation goal, it achieves maximisation of
market value of share. A firm can practise wealth maximisation goal only
when it produces quality goods at low cost. On this account, society gains
because of the societal welfare. Maximisation of wealth demands on the
part of corporates to develop new products or render new services in the
most effective and efficient manner. This helps the consumers, as it brings
to the market the products and services that a consumer needs.
 Another notable feature of the firms that are committed to the
maximisation of wealth is that, to achieve this goal they are forced to
render efficient service to their customers with courtesy. This enhances
consumer welfare and benefit to the society.
 From the point of evaluation of performance of listed firms, the most
remarkable measure is that of performance of the company in the share
market. Every corporate action finds its reflection on the market value of
shares of the company. Therefore, shareholder’wealth maximisation

s
could be considered as a superior goal compared to profit maximisation.

 Since listing ensures liquidity to the shares held by the investors,

shareholders can reap the benefits arising from the performance of
company only when they sell their shares. Therefore, it is clear that
maximisation of market value of shares will lead to maximisation of the net
 wealth of shareholders.
Therefore, we can conclude that maximisation of wealth is probably the more
appropriate goal of financial management in today’s context.

Though
this cannot be a goal in isolation, it is important to understand that profit
maximisation as a goal, in a way, leads to wealth maximisation.

Self Assessment Questions

_______ is based on cash flows.
________ considers time value of money

1.4 Finance Functions

Finance functions deal with the functions performed by the finance manager. They
are closely related to financial decisions. In the course of performing these functions,
finance manager takes several decisions and performs various important functions:
 Financing decisions  Investment decisions  Liquidity decisions  Dividend
decisions

Figure 1.2: Finance Manager¶V Decisions

Let us now discuss these points in detail.
1.4.1 Financing decisions
Financing decisions relate to the composition of relative proportion of various sources of
finance. The sources could be:
(a) Shareholder’s Fund: Equity Share Capital, Accumulated Profits.
(b) Borrowing from outside agencies: Debentures, Loans from Financial Institutions.
Financial management weighs the merits and demerits of
different sources of finance while taking financing decision.
Irrespective of the choice of source, be it singular or a
combination of both, there is a cost involved. The cost of
equity is the minimum return the shareholders would have
received if they had invested elsewhere. Borrowed funds
cost involves interest payment.
Both types of funds, thus, incur cost, and this is the cost of
capital to the company. Hence, it can be said that the cost
of capital is the minimum return expected by the company.
Financing decisions relate to the acquisition of such funds
at the least cost. In order to calculate the specific cost of
each type of capital, recognition should be given to two
dimensions of cost:
 Explicit Cost
 Implicit Cost
A firm's explicit costs are the actual cash payments it
makes to those who provide resources. Explicit costs are
rent paid on land hired, wages paid to the employees, and
interest paid on capital. In addition to this, a firm also pays
insurance premium and taxes and sets aside depreciation
charges.
Explicit cost of any source of capital may be defined as the
discount rate that equates the present value of funds
received by the firm net of underwriting costs, with the
present value of expected cash outflows. These outflows
may be interest payments, repayment of principal, or
dividend. It can also be stated as the Internal Rate of
Return a firm pays for financing.
Implicit costs are the opportunity costs of using resources
owned by the firm or provided by the firm's owners. To the
firm, the implicit costs mean the money payments that self-
employed resources could have earned in their best
alternative uses.
Implicit cost is the rate of return associated with the best
investment opportunity for the firm and its shareholders
that will be foregone if the project presently under
consideration by the firm was accepted. Opportunity costs
are technically referred to as implicit cost of capital.
Implicit cost is not a visible cost but it m

operations,
especially when
it is exposed to
business and
financial risk.
The distinction between implicit and explicit cost is important from the point
of view of the computation of cost of capital.
In India, if a company is unable to pay its debts, creditors of the company
may use legal means to sue the company for winding up and is normally
known as risk of insolvency. A company which employs debt as a means of
financing generally faces this risk especially when its operations are
exposed to high degree of business risk.
In all financing decisions, a firm has to determine the capital structure, i.e.
composition of debt and equity.
Debt is cheap because interest payable on loan is allowed as deduction in
computing taxable income on which the company is liable to pay income tax
to the Government of India.
Whenever funds are to be raised to finance investments, capital structure
decision is involved. A demand for raising funds generates a new capital
structure since a decision has to be made as to the quantity and forms of
financing.
Capital structure refers to the mix
of a fir
term sources of funds for meeting capital requirement.) Capital structure

decision refers to deciding the forms of financing (which sources to be

tapped), their actual requirements (amount to be funded), and their relative

proportions in total capitalisation.

Normally, a finance manager tries to choose a pattern of capital structure

which minimises the cost of capital We

and maxi
will learn more on capital structure and related aspects in Unit 7.

Caselet
The interest rate on loan taken is 12%, tax rate applicable to the company is
50%, and then when the company pays Rs.12 as interest to the lender,
taxable income of the company will be reduced by Rs.12.
In other words, when the actual cost is 12% with a tax rate of 50%, the
effective cost becomes 6%. Therefore, the debt is cheap. But, every
instalment of debt brings along with it corresponding insolvency risk.
Another thing notable in connection to this is that the firm cannot avoid its
obligation to pay interests and loan instalments to its lenders and debentures.
An investor in a company’s sha

res has two objectives for investing:  Income from capital appreciation (capital
gains on sale of shares at market price)
 Income from dividends The ability of the company to offer both these
incomes to its shareholders determines the market price of the company’s
shares.
The most important goal of financial management is maximisation of net
wealth of the shareholders. Therefore, management of every company should
strive hard to ensure that its shareholders enjoy both dividend income and
capital gains as per the expectation of the market.
Therefore, to declare a dividend of 12%, a company has to earn a pre-tax
profit of 19%. On the other hand, to pay an interest of 12%, the company has
to earn only 8.4%. This leads to the conclusion that for every Rs.100 procured
through debt, it costs 8.4%, whereas the same amount procured in the form
of equity (share capital) costs 19%. This confirms the established theory that
equity is costly but debt is cheap and risky source of funds to the corporate.
Financing decision involves the consideration of managerial control, flexibility
and legal aspects, and regulatory and managerial elements.

Solved Problem ± 1
Dividend = 12% on paid up value
Tax rate applicable to the company = 30%
Dividend tax = 10%
Compute the profit that the company must earn before tax, when a

company pays Rs.12 on paid up capital of Rs.100 as dividend.

Solution
Since payment of dividend by an Indian company attracts dividend tax, the
company when it pays Rs.12 to shareholders, must pay to the Govt of India
10% of Rs.12 = Rs.1.2 as dividend tax.
Therefore dividend and dividend tax sum up to Rs.12 + Rs.1.2 = Rs.13.2.
Since this is paid out of the post tax profit, in this question, the company
must earn:

1.4.2 Investment decisions

To survive and grow, all organisations have to be innovative. Innovation
demands managerial proactive actions. Proactive organisations
continuously search for innovative ways of performing the activities of the
organisation. Innovation is wider in nature. It could be:

 Expanding by entering into new markets.

 Adding new products to its product mix.
 Performing value added activities to enhance customer satisfaction.
 Adopting new technology that would drastically reduce the cost of

production.  Rendering services or mass production at low cost or restructuring the

organisation to improve productivity. These innovations change the profile
of an organisation. These decisions are strategic because they are risky.
However, if executed successfully with a clear plan of action, investment
decisions generate super normal growth to the organisation.
A firm may become bankrupt if the management fails to execute the
decisions taken. Therefore, such decisions have to be taken after taking into
account all the facts affecting the decisions and their execution.
There are two critical issues to be considered in these decisions. They are:

 Evaluation of expected profitability of the new investments.

 Rate of return required on the project.

The Rate of Return required by an investor is normally known as the hurdle

rate or the cut off rate or the opportunity cost of capital.
Investments in buildings and machineries are to be conceived and executed
by a firm to enter into any business or to expand its business. The process
involved is called Capital Budgeting. Capital Budgeting decisions demand
considerable time, attention, and energy of the management. They are
strategic in nature as the success or failure of an organisation is directly
attributable to the execution of Capital Budgeting decisions taken.
Investment decisions are also known as Capital Budgeting decisions and
hence lead to investments in real assets. The key function of the financial
management is the selection of the most profitable assortment of capital
investment. It is also one of the most important area of decision making for
the financial manager because any action taken by the manager in this area
affects the working and the profitability of the firm in future.
The impact of long-term capital investment decisions
is far reaching. It protects the interests of the
shareholders and of the enterprise because it avoids
over-investment and under-investment in fixed
assets. By selecting the most profitable projects, the
management facilitates the wealth maximisation of
equity shareholders. We will take a detailed look at
Capital Budgeting in Unit 8.

1.4.3 Dividend decisions

Dividends are payouts to shareholders. Dividends
are paid to keep the shareholders happy. Dividend
decision is a major decision made by the finance
manager.
Dividend is that portion of profits of a company which
is distributed among its shareholders according to the
resolution passed in the meeting of the Board of
Directors. This may be paid as a fixed percentage on
the share capital contributed by them or at a fixed
amount per share. The dividend decision is always a
problem before the top management or the Board of
Directors as they have to decide how much profits
should be transferred to reserve funds to meet any
unforeseen contingencies and how much should be
distributed to the shareholders.
Payment of dividend is always desirable since it
affects the goodwill of the concern in the market on
the one hand, and on the other, shareholders invest
their funds in the company in a hope of getting a
reasonable return. Retained earnings are the sources
of internal finance for financing of
corporate’s future projects but payment of di
cash to shareholders. Although both -expansion and
payment of dividend are desirable, these two are in
conflicting tasks. It is, therefore, one of the important
functions of the financial management to constitute a
dividend
policy which can balance these two contradictory view points and allocate
the reasonable amount of profits after tax between retained earnings and
dividend. All of this is based on formulation of a good dividend policy.

Since the goal of financial management is maximisation of wealth of

shareholders, dividend policy formulation demands the managerial attention
on the impact of its policy on dividend and on the market value of its shares.
Optimum dividend policy requires decision on dividend payment rates so as
to maximise the market value of shares. The payout ratio means what
portion of earnings per share is given to the shareholders in the form of cash
dividend. In the formulation of dividend policy, the management of a
company will have to consider the relevance of its policy on bonus shares.
Dividend policy influences the dividend yield on shares. Dividend yield is an
important determinant of an investor’s attitud
his portfolio management decisions.
The following issues
need adequate
consideration in deciding
on dividend policy: 
Preferences of
shareholders –Do they
want cash dividend or
capital gains?  Current
financial requirements of
the company.  Legal
constraints on paying
dividends.  Striking an
optimum balance
between desire of
shareholders and the
company’s funds .
requirements
Companies attempt to maintain a stable dividend policy whereby a stable
rate of dividend is maintained. This also ensu
value of shares stays higher. The main reasons why a stable dividend is
preferred are:

(a) A regular and stable dividend payment may serve to resolve uncertainty in the
minds of shareholders, and it creates confidence among shareholders.
(b) Many investors are income conscious and favour a stable dividend.
(c) Other things being in balance, the market price invariably vary with the rate of
dividend declared by the company on its equity shares. The value of shares of a
company that has a stable dividend policy does not
fluctuate as much, even if the earnings of the company fluctuate now and then.
(d) A stable dividend policy encourages investments from institutional investors.

In this way, stability and regularity of dividends not only affects the market
price of shares but also increases the general credit of the company that
pays the company in the long run. Dividend decisions are thus highly
significant.
1.4.4 Liquidity decisions
The liquidity decision is concerned with the management of the current
assets, which is a pre-requisite to long-term success of any business firm.
This is also called as working capital decision. The main objective of the
current assets management is the trade-off between profitability and liquidity,
and there is a conflict between these two concepts. If a firm does not have
adequate working capital, it may become illiquid and consequently fail to
meet its current obligations thus inviting the risk of bankruptcy. On the
contrary, if the current assets are too enormous, the profitability is adversely
affected. Hence, the major objective of the liquidity decision is to ensure a
trade-off between profitability and liquidity. Besides, the funds should be
invested optimally in the individual current assets to avoid inadequacy or
excessive locking up of funds. Thus, the liquidity decision should balance the
basic two ingredients, i.e. working capital management and the efficient
allocation of funds on the individual current assets.
In other terms, liquidity decisions deal with working capital management. It is
concerned with the day-to-day financial operations that involve current assets
and current liabilities.
The important elements of liquidity decisions are:
 Formulation of inventory policy
 Policies on receivable management
 Formulation of cash management strategies
 Policies on utilisation of spontaneous finance effectively

We will look at these elements individually, in detail, over the course of this
book.
1.5 Organisation of finance function
Financial decisions and functions are strategic in character and therefore, an efficient
organisational structure is required to administer the same.
The organisation of finance functions implies the division and classification of
functions relating to finance because financial decisions are of utmost significance to
firms. Finance is like blood that flows throughout the organisation. In all
organisations, CFOs play an important role in ensuring proper reporting based on the
substance of the shareholders of the company.
Although in case of companies, the main responsibility to perform finance function
rests with the top management. Yet the top management (Board of Directors), for
convenience, can delegate its powers to any subordinate executive who is known as
Director of Finance, Chief Financial Controller/Officer, Financial Manager, or Vice
President of Finance. Moreover, it is finally the duty of the Board of Directors to
perform the finance functions. There are various reasons behind it to assign the
responsibility to them. Financing decisions are quite important for the survival of the
firm. The growth and expansion of business is always affected by financing policies.
The loan paying capacity of the business depends upon the financial operations.
For the survival of the firm, there is a need to ensure both long-term and short-term
financial solvency.
Weak functional performance by financial department will weaken production,
marketing, and HR activities of the company. The result would be the organisation
becoming anaemic. Once anaemic, unless crucial and effective remedial measures
are taken up, it will pave way for corporate bankruptcy. Under the CFO, normally two
senior officers manage the treasurer and controller functions.

Activity 1
List out the functions of Chief Financial Officer that can make or mar the
company’s success.
Hint: All the finance functions are to be discussed.
A Treasurer performs the following functions:
 Obtaining finance and utilising funds  Liaison with term lending and other
financial institutions  Managing working capital  Managing investment in real
assets
A Controller performs the following functions:
 Accounting and auditing  Management control systems  Taxation and
insurance  Budgeting and performance evaluation  Maintaining assets intact to
ensure higher productivity of operating
capital employed in the organisation
In India, CFOs have a legal obligation under various regulatory provisions to certify
the correctness of various financial statements and information reported to the
shareholders in the annual report. Listing norms, regulations on corporate
governance, and other notifications of Government of India have adequately
recognised the role of finance function in the corporate setup in India.

Self Assessment Questions

________ leads to investment in real assets.
____ relate to the acquisition of funds at the least cost.
Formulation of inventory policy is an important element of _______.
Obtaining finance is an important function of _________.
What are the two critical issues to be considered under investment
decisions?
Define rate of return.
One of the most important decisions made by a finance manager dealing with maximisation
of . shareholder’s

1.6 Interface between Finance and Other Business Functions

1.6.1 Relation between Finance and accounting
In the hierarchy of the finance function of an organisation, the controller reports to
the CFO. Accounting is one of the functions that a controller discharges. Accounting
is a part of Finance. For computation of return on investment, earnings per share and
for various ratios of financial analysis, the data base will be accounting information.
Without a proper accounting system, an organisation cannot administer the effective
function of financial management.
The purpose of accounting is to report the financial performance of the business for
the period under consideration. All the financial decisions are futuristic based on
cash flow analysis. All the financial decisions consider quality of cash flow as an
important element of decisions. Since financial decisions are futuristic, they are taken
and put into effect under conditions of uncertainty. Assuming the condition of
uncertainty and incorporating the effect on decision making results in use of various
statistical models. In the selection of the statistical models, element of subjectivity
creeps in.
The relationship between finance and accounting has two dimensions:
(a) They are closely associated to the extent that accounting is an important input in
financial decision making
(b) There are definite differences between them

Accounting is a necessary input for the finance function as it generates information

through the financial statements. The data contained in these financial statements
assists the financial managers in assessing the past performance and providing
future directions to the firm and in meeting certain legal obligations. Thus accounting
and finance are functionally inseparable.
The key differences between finance and accounting related to the treatment of
funds and decision making are discussed below:
(a) Treatment of funds: The measurement of funds in accounting is always based on the
accrual concept, whereas, in case of finance, the treatment of funds is based on cash flow.
That means, here the revenue is recognised only when cash is actually received or actually
paid.
(b) Decision making: The purpose of accounting is collection and presentation of
financial data. The financial manager uses this data for financial decision making. It does not
mean that accountants never make decisions or financial managers never collect data. But the

primary focus of the function of accountants is collection and presentation of

data in financial statements while the financial manager's major responsibility
 relates to financial planning, controlling, and decision making. Thus, we can say
that the role of finance begins where accounting ends.
1.6.2 Finance and marketing
Marketing decisions, generally, have financial implications. Pricing, product
promotion and advertisement, choice of product mix, distribution policy, selections of
channels of distribution, deciding on advertisement policy, remunerating the
salesmen, etc. all have financial implications. In fact, the recent behaviour of rupee
against US dollar (appreciation of rupee against US dollar), affected the cash flow
positions of export-oriented textile units, BPOs and other software companies.
It is generally believed that the currency in which marketing manager invoices the
exports decides the cash flow consequences of the organisation if the company is
mainly dependent on exports. Marketing cost analysis, a function of finance
manager, is the best example of application of principles of finance on the
performance of marketing functions by a business unit. Formulation of policy on
credit management cannot be done unless the integration of marketing with finance
is achieved. Deciding on credit terms to achieve a particular level of sales has
financial implications because sanctioning liberal credit may result in huge and bad
debt. On the other hand, conservative credit terms may depress the sales.
Relation between inventory and sales: Co-ordination of stores administration with
that of marketing management is required to ensure customer satisfaction and good
will. But investment in inventory requires the financial clearance because funds are
locked in, and the funds so blocked have opportunity cost of capital.
1.6.3 Finance and production (operations)
Finance and operations management are closely related. Decisions on plant layout,
technology selection, productions or operations, process plant size, removing
imbalance in the flow of input material in the production or operation process and
batch size are all operation management decisions. Their formulation and execution
cannot be done unless they are evaluated from the financial angle. The capital
budgeting decisions are closely related to production and operation management.
These decisions make or mar a business unit. Failure to understand the implications
of the latest technological trend on capacity expansions has cost even blue chip
companies.

Many textile units in India became sick because they did not provide sufficient
finance for modernisation of plant and machinery. Inventory management is crucial to
successful operation management. But management of inventory involves a number
of financial variables.

In any manufacturing firm, the Production Manager controls a major part of the
investment in the form of equipment, materials, and men. He should organise his
department in such a way that the equipments under his or her control are used most
productively, the inventory of work-in-process or unfinished goods, stores and spares
are optimised, and the idle time and work stoppages are minimised. If the production
manager can achieve this, he or she would be holding the cost of output under
control and thereby help in maximising profits. He or she has to appreciate the fact
that while the price at which the output can be sold is largely determined by external
factors such as competition, market, government regulations, etc., the cost of
production is more amenable to his or her control. Similarly, he or she would have to
make decisions regarding make or buy, buy or lease, etc., for which he or she has to
evaluate the financial implications before arriving at a decision.

1.6.4 Finance and HR

Financial management is also related to human resource department as it provides
manpower to all the functional areas of the management. Financial manager should
carefully evaluate the requirement of manpower to each department and then
allocate the required finance to the human resource department as wages, salary,
remuneration, commission, bonus, pension, and other monetary benefits to the
human resource department.
Attracting and retaining the best manpower in the industry cannot be done unless
they are paid salary at competitive rates. If an organisation formulates and
implements a policy for attracting competent manpower, it has to pay the most
competitive salary packages to them. However, by attracting competent manpower,
capital and productivity of an organisation improves. Hence, financial management is
closely associated with human resource management.

Caselet:
Infosys does not have physical assets similar to that of Indian Railways. But if both were to
come to capital market with a public issue of equity,
Infosys would command better inv
Railways. This is because the value of human resource plays an
important role in valuing a firm. The better the quality of man power in an
organisation, the higher the value of the human capital and consequently the higher
the productivity of the organisation. Indian Software and IT enabled services have
been globally acclaimed only because of the manpower they possess. But it has a
cost factor -the best remuneration to the staff.

1.7 Summary
Let us recapitulate the important concepts discussed in this unit:
 Financial Management is concerned with the procurement of the least cost funds,
and its effective utilisation for maximisation of the net wealth of the firm.
 There exists a close relation between the maximisation of net wealth of
shareholders and the maximisation of the net wealth of the company.
 The broad areas of decision are Financing decisions, Investment decisions,
Dividend decisions, and Liquidity decisions.

1.8 Glossary
Dividend: Portion of profits of a company which is distributed among its

shareholder.
Explicit costs: The actual cash payments it makes to those who provide
resources.

Financial management: Concerned with procurement and effective

utilisation of funds.
Implicit costs: The opportunity costs of using resources owned by the firm
or provided by the firm's owners.

Opportunity cost of capital: The Rate of Return required by an investor is

normally known as the hurdle rate or the cut-off rate.
Wealth: Shareholder wealth.

1.9 Terminal Questions

What are the goals of financial management?

How does a finance manager arrive at an optimal capital structure?
Examine the relationship of financial management with other functional areas of a firm.
Examine the relationship between finance and accounting.
Examine the relationship between finance and marketing.

1.10 Answers

Self Assessment Questions

Liberalisation and globalisation of Indian economy
Procurement of funds
Wealth maximisation
Wealth maximisation
Investment decisions
Financing decisions
Liquidity decisions
Treasurers
The two critical issues are:
 Evaluation of expected profitability of the new investment
 Rate of return required on the project

Rate of return is normally defined as the hurdle rate or cutoff rate or opportunity cost of the
capital.
Dividend decision

Terminal Questions
Financial management means maximisation of economic welfare of its shareholders. The two
goals of financial management are 1) profit maximisation and 2) wealth maximisation. Refer
1.3
Financing decisions relate to the composition of relative proportion of various sources of
finance. Whenever funds are to be raised to finance investments, capital structure decision is
involved. Refer 1.4.1
The relationship between financial management and other areas of a firm can be explained by
the. Refer 1.6
Accounting is a necessary input for the finance function as it generates information through
the financial statements. Refer 1.6.1
Marketing decisions, generally, have financial implications. Refer 1.6.2

1.11 Case Study: Hindustan Unilever Limited

Introduction:
Hindustan Unilever Limited (HUL) is India's largest Fast
Moving Consumer
Goods Company with a heritage of over 75 years in India
and touches the
lives of two out of three Indians.

With over 35 brands spanning 20 distinct categories such

as soaps,
detergents, shampoos, skin care, toothpastes,
deodorants, cosmetics, tea,
coffee, packaged foods, ice cream, and water purifiers,
the Company is a
part of the everyday life of millions of consumers across
India. Its portfolio
includes leading household brands such as Lux,
Lifebuoy, Surf Excel, Rin,

Wheel, Fair & Lovely, Pond’s, Vaseline, Lakmé

Pepsodent, Closeup, Axe, Brooke Bond, Bru, Knorr, Kissan, Kwality Wall’s,
and Pureit.

The Company has over 16,000 employees and has an

annual turnover of
around Rs.19,401 crore (financial year 2010 -2011). HUL
is a subsidiary of

Unilever, one of the world’s leading suppli

goods with strong local roots in more than 100 countries across the globe
with annual sales of about €44 billion in 20
shareholding in HUL.
Unilever has a long history in sustainability and the use of
marketing and market research to promote behaviour
change. In November 2011, for the first time, it published
its own model of effective behaviour change. For those
who are interested, the details of this model can be seen
at http://www.hul.co.in/mediacentre/news/2011/inspiring-
sustainableliving.aspx
History of the Company:
In the summer of 1888, visitors to the Kolkata harbour noticed crates full of Sunlight
soap bars, embossed with the words "Made in England by Lever Brothers". With it
began an era of marketing branded Fast Moving Consumer Goods (FMCG).
Soon after followed Lifebuoy in 1895, and other famous brands like Pears, Lux, and
Vim. Vanaspati was launched in 1918 and the famous Dalda brand came to the
market in 1937. In 1931, Unilever set up its first Indian subsidiary, Hindustan
Vanaspati Manufacturing Company, followed by Lever Brothers India Limited (1933)
and United Traders Limited (1935). These three companies merged to form HUL in
November 1956; HUL offered 10% of its equity to the Indian public, being the first
among the foreign subsidiaries to do so. Unilever now holds 52.10% equity in the
company. The rest of the shareholding is distributed among about 360,675 individual
shareholders and financial institutions.
The erstwhile Brooke Bond's presence in India dates back to 1900. By 1903, the
company had launched Red Label tea in the country. In 1912, Brooke Bond & Co.
India Limited was formed. Brooke Bond joined the Unilever fold in 1984 through an
international acquisition. The erstwhile Lipton's links with India were forged in 1898.
Unilever acquired Lipton in 1972 and in 1977 Lipton Tea (India) Limited was
incorporated.
Pond's (India) Limited had been present in India since 1947. It joined the Unilever
fold through an international acquisition of Chesebrough Pond's USA in 1986.
Since the very early years, HUL has vigorously responded to the stimulus of
economic growth. The growth process has been accompanied by judicious
diversification, always in line with Indian opinions and aspirations.
The liberalisation of the Indian economy, started in 1991, clearly marked an inflexion
in HULs and the Group's growth curve. Removal of the regulatory framework allowed
the company to explore every single product and opportunity segment, without any
constraints on production capacity.
Simultaneously, deregulation permitted alliances, acquisitions, and mergers. In one
of the most visible and talked about events of India's corporate history, the erstwhile
Tata Oil Mills Company (TOMCO) merged with HUL, effective from April 1, 1993. In
1996, HUL and yet another Tata company, Lakme Limited, formed a 50:50 joint
venture, Lakme Unilever Limited, to market Lakme's market-leading cosmetics and
other appropriate products of both the companies. Subsequently in 1998, Lakme
Limited sold its brands to HUL and divested its 50% stake in the joint venture to the
company.
HUL formed a 50:50 joint venture with the US-based Kimberly Clark Corporation in
1994. Kimberly-Clark Lever Ltd, which markets Huggies Diapers and Kotex Sanitary
Pads. HUL has also set up a subsidiary in Nepal, Unilever Nepal Limited (UNL), and
its factory represents the largest manufacturing investment in the Himalayan
kingdom. The UNL factory manufactures HULs products like soaps, detergents, and
personal products both for the domestic market and exports to India.
The 1990s also witnessed a string of crucial mergers, acquisitions, and alliances on
the Foods and Beverages front. In 1992, the erstwhile Brooke Bond acquired Kothari
General Foods, with significant interests in Instant Coffee. In 1993, it acquired the
Kissan business from the UB Group and the Dollops Ice cream business from
Cadbury India.
As a measure of backward integration, Tea Estates and Doom Dooma, two
plantation companies of Unilever, were merged with Brooke Bond. Then in 1994,
Brooke Bond India and Lipton India merged to form Brooke Bond Lipton India
Limited (BBLIL), enabling greater focus and ensuring synergy in the traditional
Beverages business. 1994 witnessed BBLIL launching the Wall's range of Frozen
Desserts. By the end of the year, the company entered into a strategic alliance with
the Kwality Ice cream Group families and in 1995 the Milk food 100% Ice cream
marketing and distribution rights too were acquired.
Finally, BBLIL merged with HUL, with effect from January 1, 1996. The internal
restructuring culminated in the merger of Pond's (India) Limited (PIL) with HUL in
1998. The two companies had significant overlaps in personal products, speciality
chemicals and exports businesses, besides a common distribution system since
1993 for personal products. The two also had a common management pool and a
technology base. The amalgamation was done to ensure for the Group, benefits from
scale economies both in domestic and export markets and enable it to fund
investments required for aggressively building new categories.
In January 2000, in a historic step, the government decided
to award 74 percent equity in Modern Foods to HUL,
thereby beginning the divestment of government equity in
public sector undertakings (PSU) to private sector partners.
HULs entry into bread is a strategic extension of the
company's wheat business. In 2002, HUL acquired the
government's remaining stake in Modern Foods.
In 2003, HUL acquired the cooked shrimp and pasteurised
crabmeat business of the Amalgam Group of Companies, a
leader in value added marine products exports.
HUL launched a slew of new business initiatives in the
early part of 2000s. Project Shakti was started in 2001. It is
a rural initiative that targets small villages populated by less
than 5000 individuals. It is a unique win-win initiative that
catalyses rural affluence even as it benefits business.
Currently, there are over 45,000 Shakti entrepreneurs
covering over 100,000 villages across 15 states and
reaching to over 3 million homes.
In 2002, HUL made its foray into Ayurvedic health and
beauty centre category with the Ayush product range and
Ayush Therapy Centres. Hindustan Unilever Network,
Direct to home business was launched in 2003
and this was followed by the launch of ‘Purei
In 2007, the Company name was formally changed to
Hindustan Unilever Limited after receiving the approval of
share holders during the 74th AGM on 18 May, 2007.
Brooke Bond and Surf Excel breached the Rs 1,000 crore
sales mark the same year followed by Wheel which
crossed the Rs.2, 000 crore sales milestone in 2008.
On 17th October, 2008, HUL completed 75 years of
corporate existence in India.

Following are excerpts from the company’s Annual

Report 2010 – 2011:
Financial Highlights:
Net Sales: Rs. 19,401 crore Net Profit: Rs.2, 306 crore EPS (Basic): Rs.10.58 EVA: Rs.1, 750
crore
Financial Management Unit 1

Total expenditure:

Finan
cial
Perfo
 rman
ce ±
10
year
track
recor
d (Rs.
Crore
s)
P&L account
2001
2002
2003
2004
2005
2006
2007
2008-09 (15 months)
2009-10
2010-11
Gross Sales*
11,781.30
10,951.61
11,096.02
10,888.38
11,975.53
13,035.06
14,715.10
21,649.51
18,220.27
20,305.54
Other Income
381.79
384.54
459.83
318.83
304.79
354.51
431.53
589.72
349.64
586.04
Interest
(7.74)
(9.18)
(66.76)
(129.98)
(19.19)
(10.73)
(25.50)
(25.32)
(6.98)
(0.24)
Profit Before Taxation @
1,943.37
2,197.12
2,244.95
1,505.32
1,604.47
1,861.68
2,146.33
3,025.12
2,707.07
2,730.18
Profit After Taxation @
1,540.95
1,731.32
1,804.34
1,199.28
1,354.51
1,539.67
1,743.12
2,500.71
2,102.68
2,153.25
Earnings Per Share of Re. 1#
7.46
8.04
8.05
5.44
6.40
8.41
8.73
11.46
10.10
10.58
Dividend Per Share of Re. 1#
5.00
5.16
5.50
5.00
5.00
6.00
9.00
7.50
6.50
6.50

* Sales before Excise Duty Charge @ Before Exceptional/Extraordinary items # Adjusted for
bonus

Sik
kim
Ma
nip
al
Uni
ver
sity
Pag
e
No.
27
Balance Sheet
2001
2002
2003
2004
2005
2006
2007
2008-09 (15 months)
2009-10
2010-11
Fixed Assets
1,320.06
1,322.34
1,369.47
1,517.56
1,483.53
1,511.01
1,708.14
2,078.84
2,436.07
2,468.24
Investments
1,635.93
2,364.74
2,574.93
2,229.56
2,014.20
2,413.93
1,440.80
332.62
1,264.08
1,260.68
Net Deferred Tax
246.48
269.92
267.44
226.00
220.14
224.55
212.39
254.83
248.82
209.66
Net Current Assets
(75.04)
(239.83)
(368.81)
(409.30)
(1,355.31)
(1,353.40)
(1,833.57)
(182.84)
(1,365.45)
(1,304.6 6)

3,127.43
3,717.17
3,843.03
3,563.82
2,362.56
2,796.09
1,527.76
2,483.45
2,583.52
2,633.92
Share Capital
220.12
220.12
220.12
220.12
220.12
220.68
217.74
217.99
218.17
215.95
Reserves & Surplus
2,823.57
3,438.75
1,918.60
1,872.59
2,085.50
2,502.81
1,221.49
1,843.52
2,365.35
2,417.97
Loan Funds
83.74
58.30
1,704.31
1,471.11
56.94
72.60
88.53
421.94
–
–

3,127.43
3,717.17
3,843.03
3,563.82
2,362.56
2,796.09
1,527.76
2,483.45
2,583.52
2,633.92
Others

HUL Share Price on BSE (Rs. Per Share of Re. 1)*

223.65
181.75
204.70
143.50
197.25
216.55
213.90
237.50
238.70
284.60
Market Capitalisation (Rs. Crores)
49,231
40,008
45,059
31,587
43,419
47,788
46,575
51,770
52,077
61,459

* Based on year-end closing prices quoted in the Bombay

Stock Exchange, adjusted for bonus shares.

Excerpts from the report on Human Resources:

“…Your Company’s Human Resource agenda for t strengthening four key areas:
building a robust talent pipeline, enhancing individual and organisational
capabilities for future-readiness, driving greater employee engagement and
strengthening employee relations further through progressive people practices at
the shop
floor…” “…In the first half of 2010, a comprehensiv
Assessment was undertaken to understand their readiness to partner
the business ambition in the medium term and a holistic people strategy
was drawn up, which was the basis of the work done in the key areas
mentioned above. This Human Resource agenda not only looks at the

current needs of the business, but also en preparedness for the future…”
“…The Company participates in a Global People Survey every 2 years, which is a leading
indicator of employee morale and motivation, with Employee Engagement being one of the
key dimensions measured. For the current year, the employee participation rate for this
survey was over 99% (with an employee base of approximately 15000) and your
Company were ranked among the top performing companies across
Unilever globally in all dimensions. This was on account of a number of
proactive and innovative initiatives to engage our employees, the most
significant being continuous and consistent business linked
engagement, a vision for the future of the business and clarity and

transparency to individuals on their own car

Discussion Questions:
Do you think that HUL has preferred the profit maximisation approach over the wealth
maximisation approach? Justify your answer. (Hint: Refer to wealth maximisation)
How do you think an effective interaction between the HR and finance department of a firm
helps in achieving its goals? You may draw instances from the case provided above. (Hint:
Refer to Finance & HR))
Study the pattern of total expenditure as given in the annual report. Which core element of
financial management is this based on? (Hint: Refer to Financing decisions)
HUL is known for its marketing power. Wide bouquets of brands are handled under their
purview, as we have seen above. What is the correlation between finance and marketing
management? How is their relationship significant to the achievement of final goals of the
company? (Hint: Refer to Finance and Marketing)

(Source: HUL Annual Report 2010 – 2011, www.hul.co.in)

References:
 Khan, M. Y. and Jain P. K. (2007). Financial Management, Text, Problems &
Cases, 5th Edition, Tata McGraw Hill Company, New Delhi.
 Maheshwari, S.N.(2009)., Financial Management –Principles & Practice, 13th
Edition, Sultan Chand & Sons.
 Van Horne, James, C (2002), Principles of Financial Management, Pearson
Education.
 Prasanna, Chandra (2007), Financial Management: Theory and Practice, 7th
Edition, Tata McGraw Hill.
E-Reference:
 HUL Annual Report 2010 – 2011, www.hul.co.in retrieved on 10/12/ 2011