INTRODUCTION

TO FINANCIAL
MANAGEMENT
“Money is like manure; it’s worth a thing unless it’s spread
around, encouraging young things

to grow”

- Thornton Wilder
 CONCEPT OF FINANCE MANAGEMENT

Financial Management = Finance + Management

Finance : Provision of money at the time when it is required.

Financial Management: Planning and Controlling of firm’s financial

resources
CONT..

“Financial Management is the Operational activity of a business that

is responsible for obtaining and effectively utilizing the funds
necessary for efficient operations” (Joseph and Massie).

“Financial management is that area of business management

devoted to a judicious use of capital and a careful selection of the
source of capital in order to enable a spending unit to move in the
direction of reaching the goals”(J.F. Brandley).
CONT..

• Every enterprise, whether micro, small and medium needs finance to

carry on its operations and to achieve its target.

• In fact, finance is so indispensable today that it is rightly said to be the

life blood of an enterprise.
 AN ORGANIZATION NEEDS FINANCE IN VARIOUS AREAS:

Production
Production

Marketing
Marketing

Human
Human Resource
Resource

Research
Research and
and Development
Development

Finance is needed at all levels and at all times then whether it is to

purchase assets, technology, goods, raw materials or for expansion or
hiring staff.
SCOPE OF FINANCIAL MANAGEMENT

 Traditional approach: Scope of finance function is restricted to

“procurement of funds” by corporate enterprise to meet their financial
needs.
 Modern approach: Is an analytical way of looking into financial problems of
the firm.
 The financial management covers both acquisition of funds as well as the
allocation of funds to various uses.
 It is concerned with the issues involved in raising of funds and efficient and
wise allocation of funds.
IMPORTANCE OF FINANCIAL MANAGEMENT

1. Helps in obtaining sufficient funds at a minimum cost.

2. Ensures effective utilization of funds.

3.
4. Tries to generate sufficient profits for expansion and modernization
of the enterprise and secure stable growth.

5. Ensures safety of funds through creation of reserves and

re-investment of profits.
FUNCTIONS OF FINANCIAL MANAGEMENT

 Estimating Financial Requirements:

To prepare a financial plan for present as well as future, the amount
required for purchasing fixed assets as well as current assets has to be
ascertained.

 Deciding Capital Structure:

Kind and proportion of different securities for raising funds, the
decision about various sources of funds has to be analyzed in term of
cost of raising funds.
CONT..
 Selecting a Source of Finance:
From various sources including share capital debentures, financial deposits
etc.
If finance is needed for short periods then banks, public’s deposits, financial
institutions may be appropriate.
If long-term finance is required the share capital, debentures may be useful.
 Selecting a Pattern of Investment:

A decision has to be taken as to which assets are to be purchased and which

fund will have to be spent first?
And how much do we have to retain for fixed assets and working capital.
CONT..
 Proper Cash Management:
Financial manager has to assess the various cash needs at different times
and then make arrangements for getting cash.
Cash is required to make payments to creditors, purchasing raw
material, to pay bills, and meet day to day expenses.

 Proper use of Surpluses:

 A judicious use of surpluses/profits is essential for the expansion and
diversification plans and also protecting the interest of the shareholders.
FUNCTIONS OF FINANCE ARE INFLUENCED BY THREE TYPES OF DECISIONS:
INVESTMENT DECISION

 Relates to the careful selection of assets in which funds will be invested by

the firm.

 Since funds are available in short supply, its proper utilisation is very
necessary

 Investment decisions can be classified under two heads:

• Long term investment decision
• Short term investment decision
CONT..

 Long term investment decision: Capital Budgeting

• Involves investment decisions in capital expenditure
• These are expenditures, the benefit of which is expected to be received
over a long period exceeding one year.

 Short term investment decision : Working Capital

• Relate to allocation of funds among cash and equivalents, receivables
and inventories.
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FINANCING DECISIONS
 Financing decisions involve the acquisition of funds needed to support
long-term investments.

 While taking this decision, financial management weighs the

advantages and disadvantages of the different sources of finance which
are:
 Equity share capital, preference share capital and the accumulated
profits.
 Borrowings from outsiders include borrowed funds like debentures
and loans from financial institutions.
WAYS TO RAISE FUNDS BY FIRMS

1. Traditional bank Loans

2. Equity funds
 Sells shares to acquire capital
 Owners of shares (shareholders) become part owner
 Return for stockholders are dividends and capital
gains
WAYS TO RAISE FUNDS BY FIRMS

3. Borrowed funds (debt)

 Firm can issue debentures.

 Debenture holders are called as Creditors and they do not become
owners of the company
 Debt holders get paid some fixed interest and get paid back the
amount lent on the date of maturity
 This interest is a legal obligation for the firm (unlike for equities)
 Interest paid is tax deductible for firms
DIVIDEND DECISIONS

 This decision relates to the appropriation of profits earned.

 It deals with decisions regarding dividend distribution and retained earnings

 While declaring dividend, a large number of considerations are kept

in mind such as:

 Trend of earnings
 Stability in dividends
CONT..

 Trend of share market prices

 Requirement of funds for future growth
 Cash flow situation

 Restrictions under the Companies Act

 Tax impact on shareholders etc.

 https://www.stockopedia.com/articles/should-holders-of-swedbank-ab-
expect-a-dividend-payout-178489/
THE OBJECTIVES OF FINANCIAL MANAGEMENT ARE:

Profit
Profit Maximisation
Maximisation

Value
Value Maximisation
Maximisation
 OBJECTIVES OF FINANCIAL MANAGEMENT:

Profit Maximisation
 One of the Leading goals

 Profit = Total Revenue (TR) – Total Costs (TC).

 Therefore, profit maximization occurs at the biggest gap

between total revenue and total costs.
 A firm can maximize profits if it produces at an output
where marginal revenue (MR) = marginal cost (MC)
CONT..

 Short run
 Risk - Return trade-off
 doesn’t considers future earning potential

 Fails to exercise any pressure on management for increasing the

future growth rate of the firm.
 Fails to meet the shareholder’s expectation
IT SUFFERS FROM THE FOLLOWING LIMITATIONS

• It is vague

• It ignores the timing of returns

• It ignores risk
WEALTH MAXIMIZATION

  Is the concept of increasing the value of a business in order to

increase the value of the shares held by its stockholders.

 It can be calculated by multiplying the number of shares by the

value of shares.
WEALTH MAXIMIZATION

 Maximizing the value of investment made by shareholders

 Creates goodwill of the company in the market

 Enhances the capital gain to shareholders by giving premium to

market prices
FACTORS AFFECTING FINANCIAL DECISIONS

Internal External
Factors Factors
EXTERNAL FACTORS

• Environmental factors within which a business enterprise has to

operate.

• Beyond the control and influence of the management.

CONT..

State of Economy
Structure of Capital and Money Markets
Government Policy
Taxation Policy
Requirement of Investors
Lending Policy of Financial Institutions
CONT..

State of Economy
• Economic condition of the country influences the financial
decisions.
• Business cycle is the natural rise and fall of economic growth that
occurs over time. The cycle is a useful tool for analyzing the
economy. It can also help you make better financial decisions.

https://www.indiabudget.gov.in/economicsurvey/doc/vol2chapter/echap01
_vol2.pdf
CONT..
Effects Expansion Plans:
 Under uncertain circumstances -- finance manager neither takes up new investment activities nor expansion
programs; If economy is likely to recover -- finance manager looks at investment opportunities. Selects
profitable projects.
Ease of Raising Capital:
 Prosperity - Investors have keen desire to invest more and more savings, the firm can garner desired
amount of funds from the market by floating securities.
 Depression- Raising outside capital poses grave problem. So, emphasis should be laid on internal financing.

Dividend Policy:
 Depression - Conservatism should be followed (as cash resources would be needed till the time sales soar
again);
 Boom -- Tendency among firms is to offer higher dividend rate.
CONT..
STRUCTURE OF CAPITAL AND MONEY MARKETS:

 Where it is well developed and organized, business entrepreneurs will not have much problem in
procuring even substantially large amount of capital.

 In its absence, entrepreneurs find it difficult to procure large amount of resources from the market. They
have to raise capital from closely held circles.

 In such a state of affairs, policy of internal financing is pursued so as to enable the firm to draw upon its
resources in times of need for funds.
CONT..
STATE REGULATIONS/ GOVT POLICY:

 Investment decisions have to be taken within legal framework provided by the state.
 In a socialist country like India, entrepreneurs are not free to take up any venture they like.
 For example in India, Industrial Policy Resolution 1956, spells out clearly the industrial fields in which the
Govt. will enter and those where private sector will have freedom to operate.
 As per SEBI guidelines, a new company set up by entrepreneurs without a track record is permitted to issue
capital to public only at par.
 Other companies have freedom in pricing their public issues, provided certain conditions are fulfilled.
 The equity capital to be subscribed, in any issue to the public, by promoters should not be less than 25
percent of the total issue of equity capital for amounts up to Rs. 100 crore and 20 percent of the issue for
amounts above Rs. 10 crore.
CONT..
TAXATION POLICY:
 Tax takes away bigger slice of business income, so it has impacts on investments substantially.

 For example, recently the Government of India decided to provide tax holiday facility to start-ups till
2022.
 Further, a finance manager, has to decide as to which method of depreciation should be followed that may
reduce tax burden.
 From the taxation point of view, Straight Line method is very useful since in this method depreciation is
charged at twice the normal depreciation rate which ultimately reduces the tax liability.
 Likewise, tax liability of a firm fluctuates depending upon method of inventory valuation. There are
different methods of inventory valuation, viz., LIFO, FIFO. A finance manager must ascertain in
advance as to which method will be helpful in minimising the tax burden.
 Influence on Capital Structure Decision. Other things being equal, debt financing is always cheaper from
taxation point of view because interest on debt is a tax deductible expenditure while dividends are not.
CONT..
REQUIREMENTS OF INVESTORS:

 Investors have varying degree of safety, liquidity and profitability notions.

 Investors who are conservative and liquidity conscious -- prefer certainty of return and
return of principal amount after the stipulated period of time.
 Investors who are not as liquidity conscious -- prefer profitability and equities.
 In times of economic turmoil and business depression even venturesome investors would
like to hold senior securities, while during the period of economic prosperity -- shares
receive premium even at the hands of those investors who are not so venturesome.
 Dividend policy must be geared to investors in general and existing stockholders and
potential stockholders in particular.
CONT..
LENDING POLICY OF FINANCIAL INSTITUTIONS:

 Financial institutions grant financial assistance on some terms and conditions.

 For instance: Financial Corporations in India usually insist on maintenance of

debt-equity ratio for medium and large scale project as 1.5:1 and promoter’s
contribution of 20-25 percent of the project cost while considering loan application
of a firm.
INTERNAL FACTORS

•Refer to those factors which are related with the internal conditions of the
firm

•Anything within the company and under the control of the company no
matter whether they are tangible or intangible.

•Thesefactors after being figured out are grouped into the Strengths and
Weaknesses of the company.
INTERNAL FACTORS
Nature and Size of Business
Expected Return, Cost and Risk
Composition of Assets
Ownership Structure
Trend of Earnings
Age of the Firm
Liquidity Position
Conditions of Debt Agreements
Working Capital Requirements
Management Attitude
CONT..
NATURE OF BUSINESS:

 In manufacturing and public utility concerns, bulk of the funds have to be

employed in acquiring fixed assets.

 in trading concerns substantially large amount of funds is invested in current

assets, and fixed assets claim a nominal proportion.

 Fixed assets requirements in capital goods industries would always be higher than
in consumer goods industries.
CONT..
SIZE OF BUSINESS:
 Larger amounts of funds are required to acquire fixed assets in larger concerns. Small
firms with their limited amount of capital can carry on their affairs by renting or leasing
plant and equipment and building.
 Smaller firms because of their poor credit position have limited access to capital and
money market in contrast to their larger counterparts. So, capital has to be arranged from
closely held circles.

 Even if smaller firms are able to raise equity share capital, they might not want to loose
control over the organization.
 Because of difficult access to external sources of financing, smaller organizations have to
depend on internal sources of financing and follow conservative dividend policy to retain
larger proportion of business earnings.
CONT..
EXPECTED RETURN AND RISK:

 There is a positive relationship between the amount of risk assumed and the amount of
expected return.
 Investments which carry low risks such as high grade bonds will offer a lower expected
rate of return than those which carry high risk such as equity stock of a new company.
 A rational investor would have some degree of risk aversion, he would accept the risk
only if he is adequately compensated for it.

 In other words, Where dispersion of outcomes is known and all projects are equal in
risk, Finance manager chooses one with highest revenues.
CONT…
ASSET STRUCTURE OF FIRM:

 Asset structure shows the distribution of the firm's asset base in different asset categories. In

heavy manufacturing, fixed assets such as buildings and factory machines dominate the asset
structure.

 Firms with sufficient amount of fixed assets must rely on debt to take advantage of cheaper
source of financing.
For example, public utilities and steel companies can depend heavily on debentures
for raising capital as they can mortgage their assets for securing loan.

 But trading concerns whose assets are mostly receivables and inventory values which are
dependent on the continued profitability of the firm should place less reliance on long-term
debt and should depend more on short-term debt for their financial requirements .
CONT..
STRUCTURE OF OWNERSHIP:

 In private companies whose ownership is concentrated in a few hands, the management

can find it easier to persuade the owners to accept strict dividend policy in the interest of
the firm.

 In public limited companies having large number of shareholders with varying desires
the finance manager must insist on the pursuance of liberal dividend policy.
CONT..
PROBABILITIES OF REGULAR AND STEADY EARNINGS:

 Where the firm’s past earnings have been reasonably stable and the same tendency is likely
to continue in future, reliance on debt may be desirable.

 Where earnings of the firm have been irregular in the past but when averaged over a period
of years give a fair margin over the preferred stock dividend, the management may issue
preferred shares to raise funds.

 When earnings of the firm fluctuated violently in the past and the future earnings cannot be
predicted with reasonable certainty, it will incur risk in issuing debt. So, common stock must
be issued.
COMT..
AGE OF THE FIRM:

 New enterprises have to encounter considerable problems in raising funds from the market. They
approach underwriters and stock brokers and pay them higher commission and brokerage for sale of
their securities.

 Also, they must avoid bringing in heavy dose of debt to avoid the burden of interest on loans, leaving a
little amount for dividend distribution and retention for further financing.

 Existing ventures may not face much problem in raising funds because of high credit standing in market.
So they can float debentures for their additional long-term financial requirements. They can also draw
upon a part of the reserves built out of the past earnings for covering their additional financial needs.
 Thus, there is every likelihood of relatively greater amount of dilution of debt in the capitalisation of older
firms.
CONT..
LIQUIDITY POSITION OF THE FIRM AND ITS WORKING CAPITAL REQUIREMENTS:

 Dividends should be given only if cash is readily available.

 Higher working capital requirements warrant the pursuance of conservative dividend

policy.

 Company whose loans taken in the past are due, must adjust dividend pattern accordingly.

 If firm relies on their earnings for financing the acquisition of fixed assets, dividend
distribution should not be very liberal.
INTERNAL FACTOR
CONDITIONS IN DEBT AGREEMENTS:

 The provisions of debt contracts should be carefully examined while deciding about the forms of raising
capital and establishing dividend policy as certain provisions prevent the use of additional debt or issue
of debentures of the earlier type.

MANAGEMENT ATTITUDE:

 Management attitudes concerning control of the enterprise and risk, impacts financial
decisions.
 Management desiring to maintain control of the firm -- debentures and Equity
Thank you