FINANCIAL MANAGEMENT

FINANCE / FINANCIAL MANAGEMENT

Finance or Financial Management : Is science of Money Management
▪ Finance is defined as the management of money and includes activities like investing, borrowing, lending, budgeting, saving,
and forecasting.

▪ Later, scope of finance became broader, and it started being defined as science of financial resource management.

▪ Now, it is defined as study of sources of funds and utilization of funds.

▪ Financial Management can also be defined as planning, organizing, directing and controlling the financial activities or funds
of the enterprise.
There are three main domains of finance:
(1) Personal finance : Study of sources and utilization of funds at an individual level

(2) Corporate finance: Study of sources and utilization of funds at a business or an entity level

(3) Public/government finance: Study of sources and utilization of funds at government or national level
WHAT IS MONEY ?
 WHAT IS MONEY
❑ Money is a Medium of Exchange that is accepted by people for the payment of goods and services.

❑ Money is anything that is accepted by general consent as medium of exchange.

❑ Understanding Money: What would happen if we don’t have Money?

• We would have to exchange goods and services against goods and services: BARTER SYSTEM

• Every item someone wanted to purchase would have to be exchanged for something that person could provide.

• Matching Problem: A carpenter wanting food would need to search for person wanting to exchange food for his services.

• Storage Problem: We cannot store perishable items for future use or exchange.

• Divisibility Problem: Goods and services are not conveniently divisible.

• Uniformity Problem: No uniform measure of price.

❑ Hence, we need a Uniform, Divisible and Durable Medium of Exchange which is accepted by everyone, MONEY.

❑ With money we only need market to buy and sell goods and services for a common medium of exchange.
 FUNCTIONS OF MONEY
❑ Money has taken different forms through the ages; Cowry Shells in Africa, Large Stone
Wheels on the Pacific island of Yap, and Strings of Beads called Wampum used by Native
Americans and early American settlers.

What do these forms of money have in common?

❑ To be accepted as money, anything should be able to carry out the following functions:

1. Medium of Exchange: It should be accepted as payment of goods and services. People

should have faith in money so that they can transact goods and services for money.

2. Store of Value: It should not lose value or must hold value over time. If you are given Rs.
1000 for any work, you can store the value for future use. But if you are given some grains,
value would not be stored for long. There are other stores of value like land, gold, shares but
money is the most liquid store of value. (Money not a perfect store of value, it also loses value
due to inflation)

3. Unit of Account: It should be used as unit in measurement of economic or financial

transactions. E.g. price of goods and services are expressed in terms of money.
 Durability
Portability
Divisibility
CHARACTERISTICS
OF MONEY
Uniformity
Limited Supply
Acceptability
 HISTORY OF MONEY

1. Barter System :
▪ Transaction of goods and services for goods and services.
▪ It had problems like Matching, Durability, Divisibility, Portability
2. Commodity Currency:
▪ Cowrie Shells, Beads, Grains, Precious Metal and Metal Coins
▪ It had problems like Portability, High Scarcity
 HISTORY OF MONEY
3. Paper Money:
▪ Started when gold traders started issuing paper receipts for deposit of gold or other precious metal.
▪ These paper receipts were used as paper money for transactions.
▪ Later, countries created Central Banks which issued paper currencies based on reserve of precious metals, mainly Gold.
▪ Central Banks started issuing currency without gold reserve called Fiat Currency. It is backed purely by the guarantee of government
and faith on government.
4. Electronic Money/Plastic Money (Cards):
▪ People started using various forms of cards like debit card and credit card for transactions.
▪ With advent of internet various digital fund transfers and payments using bank account is also being used for transactions.
5. Cryptocurrency/Digital Currency:
▪ The rise of blockchain technology sparked the emergence of cryptocurrencies like Bitcoin.
▪ Cryptocurrencies are form of digital currency in which transactions are verified and records maintained at decentralized system using
blockchain technology.
▪ Cryptocurrencies aren’t yet very “money like” because they are not widely accepted.
 CENTRAL BANK DIGITAL CURRENCY (CBDC)
❑ Digital form of fiat currency which is regulated by central banks.
❑ They are like cryptocurrencies, except that their value is fixed by the central bank
and equivalent to the country's fiat currency.

❑ It is expected to replace the current fiat paper currency regime.

❑ The main goal of CBDCs is to provide businesses and consumers with privacy,

transferability, convenience, accessibility, and financial security.

❑ CBDCs could also decrease the cost of maintenance that a complex financial system

requires, reduce cross-border transaction costs, and provide those who currently use

alternative money-transfer methods with lower-cost options.

❑ More than eleven countries, including a number in the Caribbean, and Nigeria, have already launched CBDCs, while pilot testing

in China now reaches 260 million people and covers 200 scenarios from e-commerce to government stimulus payments.
COURSE COVERAGE AND
EVALUATION CRITERIA
 CHAPTER 1:
INTRODUCTION TO
FINANCIAL MANAGEMENT
 INTRODUCTION TO FINANCIAL MANAGEMENT

Finance or Financial Management : Is science of Money Management

▪ Finance is defined as the management of money and includes activities like investing, borrowing, lending, budgeting, saving,
and forecasting.

▪ Later, scope of finance became broader, and it started being defined as science of financial resource management.

▪ Now, it is defined as study of sources of funds and utilization of funds.

▪ Financial Management can also be defined as planning, organizing, directing and controlling the financial activities of funds
of the enterprise.
There are three main domains of finance:
(1) Personal finance : Study of sources and utilization of funds at an individual level

(2) Corporate finance: Study of sources and utilization of funds at a business or an entity level

(3) Public/government finance: Study of sources and utilization of funds at government or national level
 INTRODUCTION TO FINANCIAL MANAGEMENT

❑ Our course is concerned with Corporate Finance which is also called Business Finance or Managerial Finance.

❑ We will study about sources and utilization of funds by a corporate or a business organization.

❑ It broadly involves two aspects – Inflow (sources) and Outflow (utilization) of funds.
 PRINCIPLES OF FINANCIAL MANAGEMENT
Corporate Finance or broadly Financial Management is built on three
principles or decisions
❑ Investment principle/Investment Decision
❑ Financing principle/Financing Decision and
❑ Dividend principle/Dividend Decision
➢ The investment principle determines where businesses invest their
resources,
➢ Financing principle governs the mix of funding used to fund these
investments, and
➢ Dividend principle answers the question of how much earnings should
be reinvested back into the business and how much returned to the
owners of the business.
 PRINCIPLES OF FINANCIAL MANAGEMENT

Utilization of Funds
Investing Decisions
(Fixed Assets, Machineries, Plants,
Factories, Inventories)
ABC Handicrafts Pvt Ltd Procurement of Funds
Financing Decisions
(Share Capital, Short Term Loan,
Long Term Loan, Bonds)

Distribution
of Profit to
Shareholder
s
Dividend
Decision
 1. INVESTMENT PRINCIPLE/DECISION
➢ It is concerned with where to invest the funds of a company
➢ Long term investment decision – investment in long term assets, entering into new business,
acquiring other businesses, new machines, new product, replacement of machine, etc.
➢ Short term investment decision - level of stock, stock holding period, receivables management,
credit period management

Capital Budgeting or Long-Term Investment Working Capital Management or Short Term Investment

❑ Process of planning and managing a firm’s long-term Decision

investments.
❑ Management of short term assets like inventories, receivables
❑ Financial manager identifies investment opportunities that
are worth more to the firm than they cost to acquire. ❑ Planning or managing firm’s short term assets and needs.

Example: A chocolate firm deciding whether or not to open a

new factory is a capital budgeting decision.
 2.FINANCING PRINCIPLE/DECISION
❑ Every business, no matter how large and complex, is ultimately funded with a mix of
borrowed money (debt) and owners' funds (equity).

❑ How the firm obtains and manages the long-term financing it needs to support its long-

term investments is financing decision.

❑ It is concerned with Capital Structure which is the specific mix of short-term debt, long-

term debt and equity.

❑ Raising long-term financing can be expensive, so the different possibilities must be

considered carefully.

❑ Financial manager should aim to obtain the optimal capital structure.

 3.DIVIDEND PRINCIPLE/DECISION
❑ It is the decision related to whether to distribute net profit to shareholders or
not.
❑ It is also concerned with how much to distribute as dividend and how much
retain in company.
OBJECTIVE OF FINANCIAL MANAGEMENT
What should be the firm’s objective?

• Maximize market value or shares?

• Maximize sales revenue or market share?

• Maximize profits?

• Minimize costs?

• To avoid bankruptcy and financial distress?

• Maintain steady earnings growth?

• Maximize CEO wealth?

 OBJECTIVE OF FINANCIAL MANAGEMENT
❑ Initially, Profit Maximization was thought to be the overall objective of a firm.
❑ The goal of profit maximization is to generate the highest possible level of profit within a given time frame, regardless of the long-
term consequences for the company or its shareholders.
❑ Profit maximization strategy may involve investing in high-risk, high-reward opportunities in the hopes of generating a large profit
in the short term.
❑ It focuses on increasing profit only.
Drawbacks of Profit Maximization
❑ Profit maximization is a short-term concept.
❑ Profit maximization focuses on highest possible profit in short period.
❑ Profit maximization ignores risk.
❑ Ignores other stakeholders such as owners, managers, customers, creditors, employees.
❑ It ignores environmental and social impact of the organization
❑ Unfair practice to maximize profit.
 OBJECTIVE FINANCIAL MANAGEMENT
Value Maximization/Wealth Maximization as objective of Financial Management
• Whatsapp was acquired by
It is maximization of value of a firm i.e. maximizing the value of shares of a company
Meta at valuation of USD 19
❑ Share price depends on many factors including profit of a firm.
❑ It depends on factors like management quality, image with public, environmental impact, risk Billion

associated with business, timing of returns.

❑ It also considers well being of other stakeholders like managers, employees, creditors, customers,
etc.
• Uber made profit for the first
❑ Considers risk and uncertainty factors.
❑ Any decision (investment, financial, or dividend) that increases the value of a business is time in July 2023.

considered a good one, whereas one that reduces firm value is considered a poor one. • It has accumulated losses of
❑ Shareholders' wealth maximization can be achieved by considering the present and potential more than $ 35 Billion.
future earnings per share, timing of returns, dividend policy and other factors that affect the
• It’s market cap is $ 95 Billion.
market price of the company's stock.
Most Valuable Companies in the World
ORGANIZATIONAL STRUCTURE
 ROLES OF A MODERN DAY CFO

❑In recent times roles of CFO has broadened from traditional treasurer and controller
roles.
❑CFOs are involved as key decision maker and advisor in each area of decision making.
❑Now, CFOs are actively involved in strategic planning and decision making.
❑CFOs are now focal person in setting and monitoring strategic goals and objectives.
❑CFOs act as advisors to other departments relating to financial and economic scenario.
❑Risk management has become important role of CFOs. (What are the emerging risks
and how to manage them)

In 2022, 33% of
CFOs of S&P 500
companies became
CEOs
 FORMS OF BUSINESS ORGANIZATION - SOLE
PROPRIETORSHIP

Business owned by one person

• Advantages
• Easiest to start
• Least regulated
• Single owner keeps all of
the profits
• Taxed once as personal
income
• Disadvantages
• Limited to life of owner
• Equity capital limited to
owner’s personal wealth
• Unlimited liability
• Difficult to sell
ownership interest
 FORMS OF BUSINESS ORGANIZATION -
PARTNERSHIP

Business owned by two or more persons

• Advantages • Disadvantages
• Two or more owners
• More capital available
• Relatively easy to start
• Income taxed once as
personal income
• Unlimited liability
• General partnership
• Limited partnership
• Partnership dissolves
when one partner dies
or wishes to sell
• Difficult to transfer
ownership
 FORMS OF BUSINESS ORGANIZATION -
CORPORATION
A legal “person” distinct from owners

• Advantages
• Limited liability
• Unlimited life
• Separation of ownership and
management
• Transfer of ownership is easy
• Easier to raise capital
• Disadvantages
• Separation of ownership and
management (agency problem)
• Double taxation (income taxed at
the corporate rate and then
dividends taxed at personal rate,
while dividends paid are not tax
deductible)
 THE AGENCY PROBLEM

• Agency relationship
• Principal hires an agent to represent its interests
• Stockholders (principals) hire managers (agents) to run the company
• Agency problem
• Conflict of interest between principal and agent
• Management goals and agency costs
 ASSIGNMENTS

• Describe about three major decisions in Financial

Management?
• What is the objective of Financial Management?
• How is wealth maximization superior to profit
maximization? Explain with real life examples.
THANK YOU