FINANCIAL

MANAGEMENT

Finance is provision of money at the time when it is

required. Every enterprise requires finance. Indispensable Lifeblood of business Finance is the art and science of managing money.

FINANCE

Finance

Public finance

- State government- Central government- Government institutions

Private finance

- Personal finance- Business finance- Finance of non-profit organizations

Financial management is an applied branch of

management that looks after the finance function of a business.

“Financial management is the operational activity of the business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations”.

Financial management

Financial management deals with how the

corporation obtains the funds and how it uses them”-- Hoagland

Financial Management

Financial management emerged as a distinct field of study at the turn

of 20th century. Its evolution can be divided into three broad phases:

Evolution

TraditionalTransitional Modern

Traditional phase lasted for about four decades. Following were its

important features:

1) The focus of financial management was mainly on certain episodic events like formation, issuance of capital, major expansion, merger, reorganization and liquidation in the lifecycle of the firm.

2) The approach placed great emphasis on long term problems.

3) Financial management was not considered to be a managerial function.

Traditional Phase

The Transitional Phase began around the early 1940s and

continued through the early 1950s.

Nature of financial management during was similar to that of the traditional phase.

Greater emphasis was placed on the day-to-day problems faced by financial managers in the areas of funds analysis, planning and control.

Transitional Phase

The distinctive features of the modern phase are:

1) The central concern is considered to be a rational matching of funds to their uses so as to maximize the wealth of the shareholders.

2) The approach is more logical.

Modern Phase

Approaches

Traditional Modern

• Procurement of funds needed by

business• Utilization of funds beyond its

purview

Traditional

Approach• Includes both raising of funds as

well as effective utilization.• Finance function does not stop only

by raising funds.

Modern approach

Thus, the new

approach is an

analytical way of

dealing with financial

problems of a firm.

Estimating financial requirements

Deciding capital structure

Selecting a source of finance

Selecting a pattern of investment

Proper cash management

Role of financial manager

Investment

Decision

Dividend Decision

Financing Decision

Liquidity Decision

Functions of financial management

Raising funds

• Financing decision

Investing in assets

• Investment decision

Distributing returns

• Dividend decision

Balancing flows

• Liquidity Function

Investment decisions involve capital expenditure; known

as capital budgeting decisions.

Risk arises due to uncertain returns.

So, evaluate proposals in terms of both expected returns and risks.

Investment Decision

Decide from where, when and how to acquire funds to

meet needs.

Determine appropriate proportion of debt and equity.

Financing decisions

Decide whether the firm should distribute all profits or

retain them or distribute a portion and retain a balance.

Dividend Decision

Dividend decision

Dividend payout ratio

Retention ratio

Investment in current assets affects the firm’s liquidity

and profitability.

Current assets to be managed effectively.

Liquidity Decision

Basic Objectives Other Objectives

Basic Objectives:

Objectives

Profit Maximization

Wealth Maximization

Profit maximization implies that a firm either produces

maximum output for a given amount of input.

Uses minimum input for producing a given output.

Profit earning is the main aim of every business activity.

Profit Maximization

Profit Maximization

Cover its costs and provide funds for growth.

Profit is the measure of efficiency

Help an organization to face market fluctuation.

Considered as the most appropriate measure of a firm’s performance.

Profits provide protection against risks.

Profit is a barometer through which the performance of a business

unit can be determined. Profit ensures maximum welfare of all the stakeholders. Profit maximization increases the confidence of management for

modernization, expansion and diversification. Profit maximization attracts the investors to invest. Profits indicate efficient utilization of funds. Profits ensure survival during adverse business conditions.

Points in favor of Profit maximization

It may encourage corrupt and unethical practices. It ignores time value of money. It does not take into account the element of risk. It attracts cut throat competition. Huge amount of profit may attract Government

intervention. Huge profits may invite problems from workers who may

demand increased wages and salaries. Customers may feel exploited. The term profit is vague and it cannot be defined

precisely.

Points Against Profit maximization

The goal of the management should be such all the stakeholders

are benefited. A financial action that has a positive NPV creates wealth for

shareholders and, therefore, is desirable. The wealth will be maximized if NPV criteria is followed in

making financial decisions. NPV is the difference between the present value of its benefits

and present value of its costs. If Pv(benefits)>Pv(costs)=Positive Pv(benefits)<Pv(costs)=Negative

Wealth Maximization

It considers the concept of time value of money. It takes care of the interests of all the stakeholders. It considers the impact of risk factor. It implies long run survival and growth of the firm. It leads to maximizing stockholders’ utility or value

maximization of equity shareholders through increase in stock price per share.

Points in Favor of Wealth Maximization

It may not be socially desirable.

Because of divorce between ownership and management, the latter may be more interested in maximizing managerial utility than shareholders wealth.

Point Against Wealth Maximization