FINANCIAL MANAGEMENT

LEARNING OBJECTIVES
2

 Explain the nature of finance and its interaction with other

management functions
 Review the changing role of the finance manager and his/her
position in the management hierarchy
 Focus on the Shareholders’ Wealth Maximization (SWM)
principle as an operationally desirable finance decision
criterion
 Discuss agency problems arising from the relationship
between shareholders and managers
 Illustrate the organization of finance function
 What is Financial
Management?

Concerns the acquisition,

financing, and management of
assets with firms goals in mind.
 Students profile
 How many are from B.com
 How many are from BMS
 How many are from Science
5

What are the three major functions of any Business

Activity?
 Important Business Activities
6

 Production
 Marketing
 Finance
 Corporate Structure
Sole Proprietorship

Unlimited Liability
Personal tax on profits

Partnerships

Limited Liability
Corporate tax on profits + No tax
Corporations on dividends
Role of The Financial Manager
(2) (1)

Firm's Financial Financial

manager (4a)
operations markets

(3) (4b)

(1) Cash raised from investors

(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors
 FINANCIAL SYSTEM
Financial Institutions
Funds Funds
Commercial Banks
Insurance Companies
Deposits/shares
Mutual Funds Loans
Provident Funds
Non Banking Financial
Institutions
Fund Securities
s
Suppliers of Funds Demanders of
Individuals Funds Funds
Individuals
Businesses Private Placement Businesses
Governments Securities Governments

Funds Financial Markets Funds

Money Market
Securities Capital Market Securities
10

What are the two major classes assets?

 Real And Financial Assets
11

 Real Assets: Can be Tangible or Intangible

 Tangible real assets are physical assets that include
plant, machinery, office, factory, furniture and
building.
 Intangible real assets include technical know-how,
technological collaborations, patents and copyrights.
 Financial Assets are also called securities, are
financial papers or instruments such as shares and
bonds or debentures.
12

 Whatare the two major sources of term finance to

any Business Activity?
 Equity and Borrowed Funds
13

 Shares represent ownership rights of their holders.

Shareholders are owners of the company. Shares
can of two types:
 Equity Shares
 Preference Shares
 Loans, Bonds or Debts: represent liability of the
firm towards outsiders. Lenders are not owners of
the company. These provide interest tax shield.
14

What are the two types of share capital ?How they

differ?
 Equity and Preference Shares
15

 Equity Shares are also known as ordinary shares.

 Do not have fixed rate of dividend.
 There is no legal obligation to pay dividends to equity
shareholders.
 PreferenceShares have preference for dividend
payment over ordinary shareholders.
 They get fixed rate of dividends.
 They also have preference of repayment at the time of
liquidation.
 Semester end exam
Total marks -60 Time 3 Hrs
Total no of questions 6
Question 1 is compulsory
Write 3 out of remaining 5 questions
All questions carry 15 each
Internal Assessment 40 marks
 Projectand presentation 20 m
 Internal test 10 m
 Attendance 5m
 Class participation 5m
 Reference Books
 1. Financial Management – Brigham
 2. Financial Management – Khan & Jain
 3. Financial Management – Prasanna Chandra
 4. Financial Management – Maheshwari
 Reference Books
 5. Financial Management – S. C. Pandey
 6. Van Home & Wachowiz Fundamentals of
Financial Management (Prentice Hall of India)
 7. Sharan : Fundamentals of Financial
Management (Perason)
 Finance and Management
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Functions
 All business activities involve acquisition and use
of funds.
 Finance function makes money available to meet
the costs of production and marketing operations.
 Financial policies are devised to fit production and
marketing decisions of a firm in practice.
21

What is short term and long term?

 Finance Functions
22

Finance functions or decisions can be divided as

follows 
 Long-term financial decisions
• Long-term asset-mix or investment decision or capital
budgeting decisions.
• Capital-mix or financing decision or capital structure and
leverage decisions.
• Profit allocation or dividend decision
 Short-term financial decisions
• Short-term asset-mix or liquidity decision or working
capital management.
 Financial Procedures and
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Systems
 For effective finance function some routine functions have to
be performed. Some of these are:
 Supervision receipts and payments and safeguarding of cash
balances
 Custody and safeguarding of securities, insurance policies
and other valuable papers
 Taking care of the mechanical details of new outside
financing
 Record keeping and reporting
 Finance Manager’s Role
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 Raising of Funds
 Allocation of Funds
 Profit Planning
 Understanding Capital Markets
 Financial Goals
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 Profit
maximization (profit after tax)
 Maximizing earnings per share
 Wealth maximization
 Profit Maximization
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 Maximizing the rupee income of firm

 Resources are efficiently utilized
 Appropriate measure of firm performance
 Serves interest of society also
 Objections to Profit
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Maximization
It is Vague
It Ignores the Timing of Returns
It Ignores Risk
Assumes Perfect Competition
In new business environment profit maximization
is regarded as
 Unrealistic
 Difficult
 Inappropriate
 Immoral
 Maximizing Profit after Taxes or
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EPS
 Maximizing EPS implies that the firm should make
no dividend payment so long as funds can be
invested at positive rate of return—such a policy
may not always work.
 Ignores timing and risk of the expected benefit
 Market value is not a function of EPS.
 Maximising PAT or EPS does not maximise the
economic welfare of the owners.
 Shareholders’ Wealth
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Maximization
 Maximizes the net present value of a course of
action to shareholders.
 Accounts for the timing and risk of the expected
benefits.
 Benefits are measured in terms of cash flows.
 Fundamental objective—maximize the market
value of the firm’s shares.
 Wealth maximization
Wealth maximization means maximizing share/stock
holders wealth.
symbolically
share holder’s = no of shares ×Current stock price per share
wealth owned
 Need for a Valuation Approach
31

 SWM requires a valuation model.

 Financial manager must know,
 How much should a particular share be worth?
 Upon what factor or factors should its value depend?
 Risk-return Trade-off
32

 Financial decisions of the firm are guided by the

risk-return trade-off.
 Return and risk relationship:
Return = Risk-free rate + Risk
premium
 Risk-free rate is a compensation for time and risk
premium for risk.
 Risk Return Trade-off
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Risk and expected return move in tandem; the greater the risk, the greater
the expected return.
 Overview of Financial
34
Management
 Agency Problems: Managers Versus
Shareholders’ Goals
35

 Thereis a Principal Agent relationship between

managers and shareholders.

 Intheory, Managers should act in the best interests of

shareholders.

 In practice, managers may maximise their own

wealth (in the form of high salaries and perks) at the
cost of shareholders.
 Agency Problems: Managers Versus
Shareholders’ Goals
36

 Managers may perceive their role as reconciling conflicting

objectives of stakeholders. This stakeholders’ view of
managers’ role may compromise with the objective of SWM.

 Managers may avoid taking high investment and financing

risks that may otherwise be needed to maximize shareholders’
wealth. Such “satisfying” behaviour of managers will frustrate
the objective of SWM as a normative guide.

 Thisconflict is known as Agency problem and it results into

Agency costs.
 Agency Costs
37

 Agency costs include the less than optimum share

value for shareholders and costs incurred by them
to monitor the actions of managers and control
their behaviour.
 Financial Objectives
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 Firms’ primary objective is maximizing the welfare of

owners, but, in practice, they focus on the satisfaction of its
customers through the production of goods and services
needed by them.
 Wealth maximization is more appropriately a decision
criterion, rather than an objective or a goal.
 Financial Objectives
39

 Shareholders’ wealth maximization is the major

criterion ensuring that the decision meets the
minimum standard of the economic performance.
 In the final decision-making, the judgement of
management plays the crucial role.
 Wealth maximization criterion would simply indicate
whether an action is economically viable or not.
 Organisation of the Finance Functions
40

 Reason for placing the finance functions in the

hands of top management
 Financial decisions are crucial for the survival of the firm.
 Financial actions determine solvency of the firm
 Centralisation of the finance functions can result in a
number of economies to the firm.
 Status and Duties of Finance
41
Executives
 Exact organisation structure for financial
management will differ across firms.
 Financial officer may be known as the financial
manager in some organisations, while in others as
the vice-president of finance or the director of
finance or the financial controller.
 Organisation of Finance
42
Function

Organization for finance

Organization for finance function function in a multidivisional
company
Who is The Financial Manager?

Chief
ChiefFinancial
FinancialOfficer
Officer

Treasurer Comptroller
 Role of Treasurer and Controller
44

 Two officers—the treasurer and the controller—

may be appointed under the direct supervision of
CFO to assist him or her.
 Treasurer’s function is to raise and manage
company funds.
 Controller oversees whether funds are correctly
applied.
 Summary
45 Nature of finance and its interaction with
other functions
Role of the finance manager
Shareholders’ Wealth Maximization (SWM)
principle
Agency problems
Organization of finance function
46

True or False questions

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 Review Questions
 . What are the basic financial decisions? How do
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they involve risk-return trade-off?
. In what ways is the wealth maximising
objective superior to the profit maximisation
objective? Explain.
 " How should the finance function of an enterprise
be organised? What functions do the financial
officers perform?
 Review Questions
. How does the modern financial manager differ from
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the traditional financial manager? Does the modern
financial manager's role differ for the large diversified
firm and the small to medium size firm?
 "The function of financial management is to review
and control decisions to commit or recommit funds to
new or ongoing uses. Thus, in addition to raising
funds, financial management is directly concerned
with production, marketing and other functions within
an enterprise whenever decisions are made about the
acquisition or destruction of assets" . Elucidate.