LECTURE 11

FINANCIAL
MANAGEMENT
 LEARNING OUTCOMES
From this lecture, students are able to:

• Define the meaning of financial management

• Elaborate the importance of financial
management
• Identify types of financial management
 Definition of Financial
Management

• Managerial activities which deals with planning

and controlling of firms and financial sources

• Financial management is an area of financial

decision making, harmonising individual motives
and enterprise goals
 Importance of Financial
Management

1. To provide financial information about the

reporting entity that is useful to existing and
potential investors, lenders and other creditors in
making decisions about providing resources to the
entity.

2. Capital maintenance is a competing objective of

financial reporting.
3. Ascertainment of result of above recorded
transactions:
 Accountant prepares profit and loss account to
know the result of business operations for a
particular period of time.
 Expenses > Revenue = Loss.
 Helps the management and different stakeholders
in taking rational decisions.
 Eg: If business is not proved to be remunerative or
profitable, the cause of such a state of affair can be
investigated by the management for taking
remedial steps.
4. Systematic recording of transactions: known as
book-keeping.
 Recorded transactions are classified and
summarized logically for the preparation of
financial statements and for their analysis and
interpretation.
5. Ascertainment of the financial position of
business:
 What he owes (liability) to the outsiders
 What he owns (assets) on a certain date
 Accountant prepares a financial position statement
of assets and liabilities of the business at a
particular point of time
 Helps in ascertaining the financial health of the
business.
6. Providing information to the users for rational decision-
making:
 Communicates the financial result of an enterprise to various
stakeholders by means of financial statements.
 Aims to meet the financial information needs of the decision-
makers and helps them in rational decision-making.
7. To know the solvency position: by preparing the balance
sheet.
 Gives the information regarding concern’s ability to meet its
liabilities in the short run (liquidity position) and also in the
long-run (solvency position) as and when they fall due.
 Estimate
Required
Capital

Monitoring Determine
Financial capital
Activities structure
Type of
Financial
Management
Evaluate
Distribute
and Select
Profits or
Sources of
Surplus
Funds
Allocate
and
Control
Funds
 Estimate required capital
• Financial managers’ first duty is to forecast
the amount of required capital.

• There are several areas for using financial

planning and implementation such as
establishment, expansion, and modernization
of business, investment in fixed assets and
meet daily working capital requirements.
 Determine capital structure
• After determining the requirement of capital
funds, a decision has to be made regarding
the type and proportion of different sources of
funds.
• Financial manager has to evaluate the
appropriate mix of debt and equity capital and
various short and long-term debt ratios.
• The main objective is to maximize
shareholders wealth with a minimum cost of
capital.
 Evaluate and select
sources of funds
• Financial manager will have several options
from which he can raise capital for the
company.
• He will choose that option which will provide
greater earning possibility in less cost.
• He will compose leverage to maximizing the
shareholder’s value.
 Allocate and control funds

• Financial manager determine the necessary

amount of funds in each of financial area and
allocate the funds accordingly.
• Any change in the financial decision that
increases or decrease in allocated amount can
be implemented at times.
• The manager always tries to keep the
standard of the business firm.
 Distribute profits or surplus

• After a certain time, the business experience

profits.
• Here management decides whether to
distribute the profits or retain it for future use.
• Business can combine dividend and retain
earning to distribute the profits.
 Monitoring financial activities

• Financial manager has to be remaining alert all

the time about financial activities and business
position.
• Any flaws in the financial aspect can affect the
overall business decision.
• Manager should continuously monitor the
financial activities of the firm.
 Financial
Statement

Income Balance Cash Flow

Statement Sheet Statement
 Income Statement
• Income Statement, also known as the Profit
and Loss Statement
• Statement, reports the company's financial
performance in
• terms of net profit or loss over a specified
period.
• Income Statement is composed of the following two
elements:

– Income: What the business has earned over a

period (e.g. sales revenue, dividend income, etc)

– Expense: The cost incurred by the business over

a period (e.g. salaries and wages, depreciation,
rental charges, etc)
 The profit or loss is determined by:
 Sales (revenue/income) – Cost of Sales – total
expenses + total income – tax paid = profit/loss
– If there's a negative balance, it's a loss
– if there's a positive balance, it's a profit
 Balance Sheet
• Balance Sheet, also known as the
Statement of Financial Position, presents
the financial position of an organization
at a given date.
ASSET LIABILITY EQUITY

• Usually on the left side • Usually on the right • Usually on the right
of balance sheet side of balance sheet side of balance sheet

• Divided into 2: • Divided into 2: • The value left over for

• Current assets/ • Short term liabilities shareholders if a
short-term asset: or current liabilities company (or any
(eg: Cash, Accounts (eg: Account entity) would utilize its
Receivable, Payable, Accrued assets to meet its
Inventories, Prepaid Expenses) < 1 year liability obligations.
Expenses) < 1 year • Long term liabilities
• Non-current assets / (eg: Bank loan) > 1 • Equity = Asset -
Long term assets/ year Liability
Fixed assets: (eg:
Plants, Equipment,
Furniture)
 Cash Flow Statement
• Cash Flow Statement, presents the movement in cash
and bank balances over a period. The movement in
cash flows is classified into the following segments:
– Operating activities
– Investing activities
– Financing activities
• Operating Activities: Represents the company’s core
business including sales and expenses. Basically any
activity that affects net income for the period.

• Investing Activities: Represents cash flow from the

purchase and sale of assets other than inventories
(e.g. purchase of a factory plant)

• Financing Activities: Represent changes in the firm’s

use of debt and equity such as issue of new shares,
payment of dividends.
 Example 1: in the beginning of September, Ellen
started out with $5 in her bank account. During that
same month, Ellen borrowed $20 from Tom. At the
end of the month, Ellen bought a pair of shoes for $7.
Ellen's cash flow statement for the month of
September looks like this:
 Cash inflow: $20
 Cash outflow: $7
 Opening balance: $5
 Closing balance: $20 – $7 + $5 = $18
Eg 2: In the beginning of June, WikiTables, a company that buys and
resells tables, sold 2 tables. They'd originally bought the tables for $25
each, and sold them at a price of $50 per table. The first table was paid
out in cash however the second one was bought in credit terms.
WikiTables' cash flow statement for the month of June looks like this:

Cash inflow: $50 - How much WikiTables received in cash for the first
table. They didn't receive cash for the second table (sold in credit terms).
Cash outflow: $50 - How much they'd originally bought the 2 tables for.
Opening balance: $0
Closing balance: $50 – $50 + $0 = $0 - Indeed, the cash flow for the
month of June for WikiTables amounts to $0 and not $50.
Important: the cash flow statement only considers the exchange of actual
cash, and ignores what the person in question owes or is owed.
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