CHAPTER 1 AND 2

Financial Management Introduciton

Financial Management Concepts

FM - decision making process concerned with planning, acquiring, managing and utilizing (PAMU) of funds in a
manner that achieves the firm's desired goals.
FM- Mgt of Monetary aspects of a Business

Processes:
1. Planning & Acquisition of Funds (Financing)
2. Mgt. and Utilization of Fund (Investing and Operating Decisions)

Primary Goal/Objective of FM:

Maximization of firm's wealth, thus, maximize also the shareholder's wealth

To make money and add value for the owners. To maximize the current value per share of the
existing stock or ownership in a business firm.

Short-Term and Medium-Term Objectives:

1. Maximization of retun on capital employed or return on investment (ROI)
2. Growth in earnings per share and price/eranings ratio through maximization of net income or profit and
adoption of optimum level of ledverage.
3. Minimization of finance charges

Long-term Objectives:
1. Growth in the market value of equity shares through mazimization of the frim's market share and
sustained growth in dividend to shareholders
2. Survival and sustained growth of the firm

Financial Decisions:
a. Investment Decisions - considering the most profitable project proposal
Examples: Determination of fixed assets to be acquired, asset replacement, purchase
or lease, etc. - Capital Budgeting
Principle:
The investment decisions should aim at investments in assets only when they are expected to earn a
return greater than a minimum acceptable return which is also called as hurdle rate (COC). In case
there are many investment options, choose the investment with the highest financial leverage.

Illustration: Financing and Investment

A B C
Financing For Investment 1,000,000 2,000,000 1,500,000
Bank Interest % 0.10 0.10 0.10
COC 100,000 200,000 150,000

Earnings Increase NI by 0.12 0.14 0.13

Earnings 120,000 280,000 195,000

Financial Leverage 20,000 80,000 45,000 (Earnings - COC)

Payback Period in years 8.33 7.14 7.69 (Investment / Earnings)

b. Financing Decisions - considering the cost of finance and risk attached (COC, debt-equity mix)
Example: Determination of the best capital structure (OCS) or mixture of debt and equity financing.
Principle:
The mix of debt and equity should maximize the value of investment made.

Illustration: Financing

A L C
Decision 1 100 = 40 + 60
 Decision 2 100 = 60 + 40

Consideration:
1. As the L increases Interest Increases, Risk of paying Suppliers also increases
2. As the C increases, Dividend obligation increases

c. Operating Decisions
Examples:
1. Dividend Decisions - determination of profit sharing through dividend distribution and payments
2. Working Capital Mgt.- ST Assets and ST Liabilities
Working Capital = CA - CL

Elements of Current Assets CMTIP

Elements of Current Liabilities A/P

Tools/Methods/Techniques in Financial Decisions:

1. FS Analysis
2. Working Capital Finance (Short-Term Financing)
3. Capital Budgeting
4. Risk and Rates of Returns
5. Capital Structure and Long-term Decisions

Financial Manager should:

Determine the ff:
a. Total funds requirements of the firm
b. The assets or resources to be acquired
c. The best pattern of financing the assets
Then
a. procurement of ST and LT funds from financial institutions
b. mobilization of funds through financial instruments such as equity shares, preference shares,
debentures, bonds, notes and etc,.
c. compliance with legal and regulatory provisions

Responsibility of Financial Manager or Finance Manager

To acquire funds needed by the firm and investing those funds in profitable ventures that will
maximize the firm's wealth, as well, as generating returns to the business concern.

Significance of FM
1. Broad applicability - applicable to all forms of business; like single proprietor, partnerhsips, and corp.
2. Reduction of chances of Failure - Business has a high chance of success if it will be managed on
sound principles of financial management. The strength of business lies in its financial discipline
3. Measurement of Return of Investment - FM studies the risk-return perception of the owners and the
time value of money. Anybody who invests his money will expect to earn a reasonable return
on his investment.
Principle:
The greater the time and risk associated with the expected cash flows, the greater is the
rate of return required by the owners.

Differences of Accounting Branches

1. Financial Management - PAMU of funds. Decisions are generated with the help of methods and techniques
in the analysis of accounting information
2. Management Accounting - A field of accounting that provides economic and financial information for internal
users, particularly the managers or decision makers in an organization
3. Financial Accounting - provide external users with information about the organization's financial position and
result of operations
4. Auditing - assurance purposes
Financial Management and Economics
Effect of Economics to Business
1. Microeconomics
Effect with the economic decisions of individual and firms
Concepts of Micro helps the F. Manager in decisions like pricing, taxation, determination of capacity
and operating levels, break-even analysis, CVP analysis, capital structure decisions, dividend distribution,
profitable product-mix decisions, etc.
2. Macroeconomics
Effect the economy as a whole in which a particular business concern is operating. The success of the
business firm is influenced by the overall performance of the economy.
a. Government's fiscal and monetary policies will influence financial planning
b. Other natioinal issues like - inflation rate, trade cycles, market competition, international business
condition, unionization of labor, domestic savings rate, growth rate of the economy, government
foreign policy and banking system.
 in a

it and

arn a
In case

nings)
yments

niques

internal

ion and
acity
stribution,

ness
ment