FINANCE

Finance is the practice of fund management

or allocation of assets and liabilities over time
under the conditions of certainty and
uncertainty.
 Financial Management
Financial Management entails planning for the
future for a person or a business enterprise to
ensure a positive cash flow. It includes the
administration and maintenance of financial
assets. Besides, financial management covers
the process of identifying and managing risk.
 Developments in Financial Management

 Early 1900s - emphasis was on the legal

aspects of mergers, the formation of new
firms, and the various types of securities firms
could issue to raise capital.
 During the depressions of the 1930s -
emphasis shifted to bankruptcy and
reorganization, to corporate liquidity, and to
the regulation of security markets
During the 1940s and early 1950s – finance
continued to be taught as a descriptive, institutional
subject, viewed more from the standpoint of an
outsider rather than from that of a manager.
Late 1950s – focus shifted to managerial decisions
regarding the choice of assets and liabilities with the
goal of maximizing the value of the firm.
 1990s to date – focus on value maximization
continued but two trends have become increasingly
important: the globalization of business and the
increased use of information technology.
 Scope of Financial Management
Financial management has a wide scope.
According to Dr. S. C. Saxena, the scope of
financial management includes the following
five 'A's.
1. Anticipation : Financial management
estimates the financial needs of the company.
That is, it finds out how much finance is required
by the company.
2. Acquisition : It collects finance for the company
from different sources.

3. Allocation : It uses this collected finance to

purchase fixed and current assets for the company.

4. Appropriation : It divides the company's profits

among the shareholders, debenture holders, etc. It
keeps a part of the profits as reserves.
5. Assessment : It also controls all the financial activities
of the company. Financial management is the most
important functional area of management. All other
functional areas such as production management,
marketing management, personnel management, etc.
depends on Financial management. Efficient financial
management is required for survival, growth and
success of the company or firm.
 Objectives of financial management

The term ‘objective’ refers to a goal or decision

for taking financial decisions.
 Profit maximization
 Wealth maximization
 Profit maximization

 The term profit maximization is deep rooted

in the economic theory.
 It is need that when firms pursue the policy
of maximizing profits.
 Society’s resources are efficiently utilized.
 Profit maximization

 The firm should undertake those actions that

would profits and drop those actions that
would decrease profit.
 The financial decisions should be oriented to
the maximization of profits.
 Profit provides the yardstick for measuring
performance of firms.
 Profit maximization
It makes allocation of resources to profitable
and desirable areas.
 It also ensures maximum social welfare.
 Wealth maximization

Wealth maximization or net present value

maximization provides an appropriate and
operationally feasible decision criterion for
financial management decisions.
 PROFIT MAXIMIZATION VS. WEALTH
MAXIMIZATION
• Profit maximization is short term approach and
it refers to how much money the company
makes whereas wealth maximization is a long
term approach and it refers the value of the
company.
• Profit maximization is a subset of wealth.
• Profit maximization ignores timing, cash flows
and risk but in wealth maximizing those are the
key decisions variables.
Goal of the Firm: Maximize Profit?

Which Investment is Preferred?

Profit maximization may not lead to the highest possible share price
for at least three reasons:
1. Timing is important—the receipt of funds sooner rather than later is preferred
2. Profits do not necessarily result in cash flows available to stockholders
3. Profit maximization fails to account for risk
Goal of the Firm: Maximize
Shareholder Wealth
Decision rule for managers: only take actions that are
expected to increase the share price.
 FINANCIAL MANAGEMENT DECISIONS

•Capital budgeting: The left side of the balance sheet which shows the firms
long term investments and the process of planning and managing a firm’s long term
investments is called capital budgeting.

• Capital structure: The right side of the balance sheet, indicate ways in
which the firm obtains and manages the long term financing it needs to support its
long term investments. The specific mixture of long term debt and equity the firm
uses to finance its operations is called a firm’s capital structure.

• Working capital management: It indicates firms short terms asset and

liabilities. Managing the firm’s working capital is a day to day activity that ensures
that the firm has sufficient resources to continue its operations and avoid costly
interruptions. This involves a number of activities related to the firm’s receipt and
disbursement of cash.
 Developing a financial forecast
Identify the requirements for your situation.
 Obtain all the facts, determine assumptions
within facts.
 Identify missing information, relevance,
problems; assess materiality.
 Identify financial patterns (trends, averages,
forecasts).
Determine if additional research is needed; identify
significant macro issues or events; identify
assumptions needed for missing information.
 Build the forecast.
 Test forecast for sensitivity, review for
reasonableness and ability to monitor.
 Assess effectiveness of plan in meeting the
objectives (pros/cons) n Consider alternative
solutions.
Consider alternative solutions.
 Responsibility of the Finance Manager

Efficiently manage entity resources.

 Effectively mitigate risks to attain entity
objectives.
Maintain a sound financial condition within
the limits of available resources.
 Comply with applicable policies, laws and
regulation.
 AGENCY RELATIONSHIPS
• A principal-agent relationship is an arrangement in which an agent
acts on the behalf of a principal. For example, shareholders of a
company (principals) elect management (agents) to act on their
behalf.

• Agency problem is the conflict of goals between a firm’s

shareholders and its managers. It arises when managers place
personal goals ahead of the goals of shareholders.

• Agency costs arise from agency problems that are borne by

shareholders and represent a loss of shareholder wealth.

• Within a corporation, agency relationships exist between:

– Shareholders and managers
– Shareholders and creditors
 Corporate Control to reduce Agency Problem

Principals must provide incentives so that management acts in

the principals’ best interests and then monitor results.
1. Managerial Compensation: To partially compensate the management
and board members by offering stock to them so that they take decisions
that maximizes the value of the firm.
a. Performance Shares: A type of incentive plan in which managers are
awarded share of stock on the basis of the firm’s performance over given
intervals with respect to earnings per share or other measures.
b. Stock Options: Allows managers to purchase stock at some future time
at a given price
Corporate Control to reduce Agency Problem

2. The Threat of Firing:

• It is an effective measure today because ownership now a
days not widely distributed as in the past.
• Management control over voting mechanism is also not so
strong as in the past
• Today it is easier for dissident shareholders to gain enough
votes to overthrow the managers.
 Corporate Control to reduce Agency Problem

3. Hostile Takeover threat: The fear of taking

over the firm by the by some other big firms
against the desire of the managers, if the
firm is inefficiently managed. This threat may
encourage the management to run the firm
as per the desire of the shareholders.