Dr.

Akhilesh Das Gupta Institute of Technology & Management

BBA Department

Name of Faculty: Mr. Sachin Jindal

Subject Code: BBA

Subject Title: Financial Management

Notes
Unit-1
Meaning of Financial Management:

Financial Management means planning, organizing, directing and controlling

the financial activities such as procurement and utilization of funds of the
enterprise. Financial Management means planning, organizing, directing and
controlling the financial activities such as procurement and utilization of funds
of the enterprise. It means applying general management principles to financial
resources of the enterprise.

Scope of Financial Management:

 Investment Decision
 Financing Decision
 Dividend Decision
 Working Capital Decision

Objectives of Financial Management:

 Profit Maximization
 Wealth Maximization
 Proper estimation of total financial requirements
 Proper mobilization
 Proper utilization of finance
 Maintaining proper cash flow
 Survival of company
 Creating reserves
Scope/Elements of Financial Management
1. Investment decisions: it includes investment in fixed assets (called as
capital budgeting). Investment in current assets is also a part of
investment decisions called as working capital decisions. CAPEX means
expenditures incurred on fixed assets where the profits will occur over the
years by using those fixed assets.
2. Financing decisions- They relate to the raising of finance from various
resources which will depend upon decision on type of source, period of
financing, cost of financing and the returns thereby.
There are two aspects of financing decision;
i) Theory of capital structure: shows the relationship between the use of
debt and returns to the shareholders which is also termed as financial risk.
A capital structure with reasonable proportion after and equity capital is
called as the optimum capital structure. ii) Capital structure decision:
Determination of appropriate capital structure
3. Dividend decision- The finance manager has to take decision with regards to
the net profit distribution. Net profits are generally divided into two:
Dividend for shareholders- Dividend and the rate of it has to be decided.
Retained profits- Amount of retained profits has to be finalized which will
depend upon expansion and diversification plans of the enterprise.
Functions of Financial Management
1. Estimation of capital requirements: A finance manager has to make
estimation with regards to capital requirements of the company. This will
depend upon expected costs and profits and future programmes and
policies of a concern. Estimations have to be made in an adequate manner
which increases earning capacity of enterprise.
2. Determination of capital composition: Once the estimation has been
made, the capital structure have to be decided. This involves short- term
and long- term debt equity analysis. This will depend upon the proportion
of equity capital a company is possessing and additional funds which
 have to be raised from outside parties.
3. Choice of sources of funds: For additional funds to be procured, a
company has many choices like-
4. Issue of shares and debentures
5. Loans to be taken from banks and financial institutions
6. Public deposits to be drawn like in form of bonds.
7. Choice of factor will depend on relative merits and demerits of each
source and period of financing.
8. Investment of funds: The finance manager has to decide to allocate funds
into profitable ventures so that there is safety on investment and regular
returns is possible.
9. Disposal of surplus: The net profits decision has to be made by the
finance manager. This can be done in two ways:
10.Dividend declaration - It includes identifying the rate of dividends and
other benefits like bonus.
11.Retained profits - The volume has to be decided which will depend upon
expansion, innovational, diversification plans of the company.
12.Management of cash: Finance manager has to make decisions with
regards to cash management. Cash is required for many purposes like
payment of wages and salaries, payment of electricity and water bills,
payment to creditors, meeting current liabilities, maintenance of enough
stock, purchase of raw materials, etc.
13.Financial controls: The finance manager has not only to plan, procure and
utilize the funds but he also has to exercise control over finances. This
can be done through many techniques like ratio analysis, financial
forecasting, cost and profit control, etc.

Nature of Financial Management

1. Financial management is an integral part of overall management:
Acquisition, maintenance, replacement of assets, sources and costs of different
capital, production, marketing, finance and personal decisions are the activities
in a firm.
2. The Central focus of financial management is valuation of firm. That is
financial decisions are directed at optimizing the value of the firm.
3. It involves risk return, trade off. Decisions on investment involve choosing
the type of assets, which generate returns accompanied by risks. Generally
higher the risk, returns must be greater and vice-versa.
4. It affects the survival, growth and vitality of the firm. The amount, type,
sources, conditions and cost of finance influence the functioning of the unit.
5. It is the concern of every concern – small or big, individual or corporate
undertakings.
6. It is a sub-system of the business system, which has other sub-systems like
production, marketing etc.
7. The external legal and economic environment influences it. The investor
preferences, stock market conditions etc affect financial decisions of the
business.
8. Finance functions are generally centralized, i.e., more decisions is taken at
the top level and ensure unified directions to investment and financing
functions.
Objectives of financial management: Two important objectives of financial
management:
A. Profit maximization: The process of increasing the profit earning
capability of the company is referred to as Profit Maximization. It is
mainly a short-term goal and is primarily restricted to the accounting
analysis of the financial year. It ignores the risk and avoids the time
value of money. It primarily concerns the company’s survival and
growth in the existing competitive business environment. Profit
Maximization, as its name suggests, refers to the company's profit
should be increased. Profit maximization is the primary goal of concern
since profit acts as the measure of efficiency.
 Profit maximization objectives and comparisons:
 Focus on increasing a company's profits
 Don't consider the time value of money
 Don't examine uncertainties and risks regarding cash flows
 Are short-term
 Are superior in economics
 Don't consider your firm's dividend policy's effect on market price shares
 Neglect the interests of shareholders in decisions
 Are a traditional approach to financial management
Profit maximization is the ability of a business or company to earn
maximum profit with low cost which is considered as the main goal of any
business and also considered as one of the objectives of financial
management. Profit maximization is a short term objective of the firm and is
necessary for the survival and growth of the enterprise.
The advantages of Profit Maximization are as follows: –
 Economic Existence: – The foundation of profit maximization theory is
profit and profit is essential for the economic survival of any company or
business.
 Performance Standard: – Profit determines the standard of performance of
any business or company. When a business is unable to earn profit, it fails to
fulfill its main goal and creates a risk to its existence.
 Economic and Social Welfare: – Profit maximization theory plays a role in
economic and social welfare indirectly. When a business makes a profit, it
makes proper use and allocation of resources that result in capital, fixed
assets, labor and payments for the organization. Thus, economic and social
welfare is done.
 Prediction of Real-World Behavior: – Using leverage maximization allows
you to predict the behavior of companies in a real-world situation. Firms deal
without too much difficulty and with reasonable accuracy. This makes profit
maximization useful for explaining and predicting business behavior.
 Knowledge of Business Firms: – The profit motive is most influential in the
dealings of business firms. For small firms with strong competition, they
 must act as profit maximization to increase their sales and reduce costs to
avoid competition.
Drawbacks:
1. Ambiguity: The term profit is a vague and ambiguous concept. Profit may be
short term or long term; it may be before tax or after tax, may be return on
capital employed or total assets or shareholder’s equity. There is a question as to
which profit should a firm consider.
2. Timing of benefit: It ignores the differences in the time of the benefits
received. It does not value the cash flow highly when received early. In practice
benefits received sooner are more valuable than benefits received later. Receipt
of funds immediately should always be preferred to future promise of funds
because these earnings or returns could be reinvested for other projects to
provide greater future earnings.
3. Risk: It ignores risk. Investors are generally risk averters so they expect
returns with minimum risk. It does not consider time, economy and other factors
making the returns highly uncertain. The risk that actually occurs may differ
from those expected. A trade-off exists between return and risk. Return and risk
are the key determinants of share price. Higher profit pushes share price higher,
whereas higher risk tends to result in a lower share price because shareholders
will be paid higher return when there is high risk.
B. Wealth maximization: Wealth Maximization aims to accelerate the entity's
value. The goal of the finance function is to maximise the wealth of the owners
for whom the firm is being carried on. The wealth of corporate owners is
measured by the share price of the stock which is turn is based on the timing of
return, cash flows and risk. While taking decisions, only that action that is
expected to increase share price should be taken. The market price of shares
(excluding impact of speculation) serves as the standard to judge whether
financial decisions have been taken and implemented efficiently or not.
Wealth maximization objectives:
 Focuses on increasing the value of shares for stockholders
 Considers the time value of money
  Examines uncertainties and risks regarding cash flows
 Are long-term
 Are superior in financial management
 Consider your firm's dividend policy's effect on market price shares
 Incorporate the interests of shareholders in decisions
 Are a modern approach to financial management
Merits: 1. It is based on the concept and cash flow generated by decision. Thus
it avoids ambiguity. 2. It considers both quality and quantity dimensions of
benefits. Amount of return and risk taken is analyzed. Time value of money is
considered. Cash flow stream is calculated by discounting. 3. The discount role
reflects risk and returns. Higher discount rate means high risk because it takes a
longer time to get back the return. 4. It implies maximization of the market price
of the shares which means value/ wealth/ NPV maximization. 5. It focuses on
EVA - economic value added 6. Focus on stakeholders: Maintaining positive
shareholders relationship minimizes conflict and litigation. So, a firm can better
achieve its goal of shareholder’s wealth maximization with cooperation with
stakeholders. Stakeholders, customers, supplier, employees and bank loans
provider etc.
Demerits: 1. Shareholder’s interest: The goal of maximizing share prices does
not imply that managers should seek to improve the value of the common stock
at the expense of debt/debenture holders. 2. Social responsibility: As economic
agents whose actions have considerable impact on the society, business firms
must take into account the implications of their policies and actions on society
as a whole. The expectations of workers, consumers and various interest groups
create a greater influence that must be respected to achieve long run wealth
maximization and also for their survival.

Other Objectives of Financial Management

The financial management is generally concerned with procurement, allocation
and control of financial resources of a concern. The objectives can be-
To ensure regular and adequate supply of funds to the concern.
To ensure adequate returns to the shareholders which will depend upon the
earning capacity, market price of the share, expectations of the shareholders.
To ensure optimum funds utilization. Once the funds are procured, they should
be utilized in maximum possible way at least cost.
To ensure safety on investment, i.e, funds should be invested in safe ventures so
that adequate rate of return can be achieved.
To plan a sound capital structure-There should be sound and fair composition of
capital so that a balance is maintained between debt and equity capital.

Financial Management Relationship with other Functional Areas

1. Financial Management and Production Department: The financial

management and the production department are interrelated. The production
department of any firm is concerned with the production cycle, skilled and
unskilled labour, storage of finished goods, capacity utilisation, etc. and the cost
of production assumes a substantial portion of the total cost. The production
department has to take various decisions like replacing machinery, installation
of safety devices, etc. and all the decisions have financial implications.

2. Financial Management and Material Department: The financial

management and the material department are also interrelated. Material
department covers the areas such as storage, maintenance and supply of
materials and stores, procurement etc. The finance manager and material
manager in a firm may come together while determining Economic Order
Quantity, safety level, storing place requirement, stores personnel requirement,
etc. The costs of all these aspects are to be evaluated so the finance manager
may come forward to help the material manager.
3. Financial Management and Personnel Department: The personnel
department is entrusted with the responsibility of recruitment, training and
placement of the staff. This department is also concerned with the welfare of the
employees and their families. This department works with finance manager to
evaluate employees’ welfare, revision of their pay scale, incentive schemes, etc.
4. Financial Management and Marketing Department: The marketing
department is concerned with the selling of goods and services to the customers.
It is entrusted with framing marketing, selling, advertising and other related
policies to achieve the sales target. It is also required to frame policies to
maintain and increase the market share, to create a brand name etc. For all this
finance is required, so the finance manager has to play an active role for
interacting with the marketing department.

Financial Management and Financial Accounting: Both Accounting vs

Financial Management are popular choices in the market; let us discuss some of
the major differences:

1. Accounting is more about identifying, measuring, processing, classifying,

and recording financial transactions whereas financial management
involves the effective and efficient management of finances and
economic resources
2. The key objective of accounting is providing financial information using
standard procedures and rules whereas the objective of financial
management is profit maximization and wealth maximization.
3. Accounting reports the financial information to both internal and external
users such as creditors, investors, analysts, management, and regulators
whereas financial management is used internally by the management of
the organization for the planning and decision purpose.
4. Accounting has three broad categories – financial accounting,
management accounting, and cost accounting whereas financial
management is a process with financial planning and budgeting, financial
reporting, accounts record keeping, and financial controls.
5. Accounting involves reporting past financial transactions in the
meaningful form of financial statements whereas financial management
involves planning about the future by analyzing and interpretation of
financial statements.
6. Accounting gives the financial position of the Company whereas
financial management gives a holistic view of the business activities and
provides insight into the future generation of wealth.
7. In accounting, the measurement of a fund is based on an accrual basis
whereas treatment of funds in financial management is based on cash
flows.
8. Purpose of accounting is to collect and present the data in a meaningful
manner whereas financial manager uses this data for financial decision
making purpose.
Comparison between Financial Accounting vs. Financial Management

The basis of Accounting Financial Management

comparison

Basic Accounting is a systematic Financial management “as

Definition process of identifying, an application of general
recording, measuring, managerial principles to
classifying, verifying, the area of financial
summarizing, interpreting decision-making.
and communicating
financial information.

Primary User Both internal and external Majorly management of

users such as creditors, the Company and
investors, analysts, shareholders.
management, owners and
investors, management,
employees, customers, the
government, and
regulators.

Importance Accounting involves in Financial management

reporting financial involves the assets and
information using resources of the Company
standard procedures and and their effective
rules in a meaningful form utilization.
 of financial statements.

Objective Reporting financial Profit maximization and

information wealth/value maximization.

Measurement Accrual basis Cash flow basis

of fund

Purpose Purpose of accounting is Financial management

to collect and present the involves to uses this data
data in a meaningful for financial decision
manner making purpose.

Timeframe Quarterly, Half-Yearly, and Management can do this

Yearly activity at any time.

Time focus Past-oriented Future-oriented

Reports Summary reports in the Detailed report on the

form of financial future course of action.
statements

What is Risk and Return in Financial Management?

When it comes to investing, risk and return come hand-in-hand – you cannot
have one without the other. As an investor, typically, you need to take on more
investment risk in order to realize higher investment returns. While this is not
always the case, in general, investors should expect this relationship to hold. If
an investor is unwilling to take on investment risk, they should not expect
returns above the risk-free rate of return.
Risk Explained
There are many ways to define risk. However, in the context of financial
management and investing, it can be defined as either the probability of losing
‘X’ amount of an investment over a given time period or as the return volatility
of an investment over a given time period.
When an investor considers purchasing a very high-risk investment, they should
expect to lose some or possibly even all their investment. For example, if an
investor owns shares (stock) in a high-risk company and that company goes
bankrupt, they are likely to lose all of their investment.
Return volatility is typically defined by standard deviation. This statistical
figure measures the dispersion of a dataset relative to its mean, calculated as the
square root of the variance.
Standard deviation is usually applied to an investment’s annual return to gauge
return volatility. A greater standard deviation indicates greater investment
volatility and, therefore, greater risk.
Return Explained
A return (also referred to as a financial return or investment return) is usually
presented as a percentage relative to the original investment over a given time
period. There are two commonly used rates of return in financial management.
Nominal rates of return that include inflation

Real rates of return that exclude inflation

An investment return can come in a wide range of forms, including capital
gains, interest, dividends, or rental income in the case of real estate. Again,
these investment returns are usually presented as a percentage. In its simplest
form, nominal investment returns can be calculated using three variables:
The initial investment
The ending value of investment
The investment time period
Let’s assume an initial investment of $100 that grows to $120 in one year. The
investment return is calculated as follows:
Nominal rate of return = ($120 / $100) – 1 = 0.2 or 20%
As mentioned above, this is the nominal rate of return. Let’s now assume that
the inflation rate during this one-year period was 3%. We calculate the real rate
of return by taking the nominal rate of return and subtracting the inflation rate.
Real rate of return = 20% – 3% = 17%
Real rates of return better reflect the purchasing power of investment returns.
The Risk-Return Relationship
In general, higher investment returns can only be generated by taking on higher
investment risk. However, this does not hold in every single scenario. For
example, by diversifying a portfolio of investment assets, a comparable return
can often be generated with less risk than an undiversified investment portfolio.
That being said, there is a limit to the effectiveness of diversification as a
portfolio grows increasingly large.
The risk-return trade-off is a foundational investment principle. There are many
different types of investments and asset classes, such as money market
securities, bonds, public equities, private equity, private debt, and real estate, to
name but a few. All of these asset classes come with varying levels of
investment risk. Having investments with different risk-return profiles helps
meet the different risk appetites of various investor groups.
Risk-free bonds, are issued by governments and, in most cases, are considered
“risk-free” since a government can print money to pay off its debts. Because of
this, risk-free bonds are the safest asset and consequently have the lowest
investment return.
Moving up the risk-return spectrum, we can see that each asset class gets
riskier. (Investment Grade Bond, High Yield Bond and Equities) However, the
potential investment return associated with each asset class also increases.
Private equity which involves investments in private companies that are not
publicly traded on an exchange. These investments are typically riskier than
public equities and include additional risks such as liquidity risk. However,
because of these additional risks, private equity also offers investors the highest
potential investment returns.

What Is Economic Value Added (EVA)?

Economic value added (EVA) is a measure of a company's financial
performance based on the residual wealth calculated by deducting its cost of
capital from its operating profit, adjusted for taxes on a cash basis. EVA can
also be referred to as economic profit, as it attempts to capture the true
economic profit of a company.
EVA is the incremental difference in the rate of return (RoR) over a company's
cost of capital. Essentially, it is used to measure the value a company generates
from funds invested in it. If a company's EVA is negative, it means the
company is not generating value from the funds invested into the business.
Conversely, a positive EVA shows a company is producing value from the
funds invested in it.
The formula for calculating EVA is:
EVA = NOPAT - (Invested Capital * WACC)
Where:
NOPAT = Net operating profit after taxes
Invested capital = Debt + capital leases + shareholders' equity
WACC = Weighted average cost of capital
(WACC* capital invested) is also known as finance charge
Calculating the Finance Charge
Finance Charge = Capital invested * WACC
WACC = Ke*E/ (E+D) + Kd (1-t)*D/ (E+D), where Ke = required return on
equity and Kd (1-t) = after tax return on debt
What Is Market Value Added?
Market value added (MVA) is a calculation that shows the difference between
the market value of a company and the capital contributed by all investors, both
bondholders and shareholders. In other words, it is the market value of debt and
equity minus all capital claims held against the company. It is calculated as:
MVA = V - K
where MVA is the market value added of the firm, V is the market value of the firm,
including the value of the firm's equity and debt (its enterprise value), and K is the
total amount of capital invested in the firm.
MVA is closely related to the concept of economic value added (EVA), representing
the net present value (NPV) of a series of EVA values.

Understanding Market Value Added (MVA)

When investors want to look under the hood to see how a company performs for its
shareholders, they first look at MVA. A company’s MVA is an indication of its
capacity to increase shareholder value over time. A high MVA is evidence of
effective management and strong operational capabilities. A low MVA can mean the
value of management’s actions and investments is less than the value of the capital
contributed by shareholders. A negative MVA means the management's actions and
investments have diminished and reversed the value of capital contributed by
shareholders.

Examples of MVA
Companies with high MVA can be found across the investment spectrum.
Alphabet Inc., (GOOGLE) the parent of Google, is among the most valuable
companies in the world with high growth potential. Its stock returned 1,293% in its
first 10 years of operation. While much of its MVA in the early years can be
attributed to market exuberance over its shares, the company has managed to more
than double it from 2015 to 2019. Alphabet’s MVA has grown from $354.25 billion in
2015 to $606.20 billion in December 2017 to $809.01 billion in December 2019 to
$1.19 trillion in 2020.