Financial Management:

Introduction
Prof .Ritu Sapra
 Meaning
• Financial Management Financial management
is mainly concerned with the proper
management of funds. The finance manager
must see that funds are procured in such a
manner that risk, cost and control
considerations are properly balanced and
there is optimum utilization of fund
 Meaning of Financial Management

• Financial Management means planning,

organizing, directing and controlling the
financial activities such as procurement and
utilization of funds of the enterprise. It means
applying general management principles to
financial resources of the enterprise.
 Defination
• According to Soloman , “Financial
management is concerned with the efficient
use of economic resources”.
• According to Phillippatus , “Financial
management is concerned with management
decision that result in acquisition and
financing of long-term and short-term credits
for the firm
 Scope of financial management
• The scope and functions of financial
management is classified in two categories.
• - Traditional approach
• - Modern approach
 Traditional approach
• The traditional approach Evolved during the 1920’s
and 1930’s known as ‘Corporation Finance’. 
• According to this approach, the scope of the finance
function is restricted to “procurement of funds by
corporate enterprise to meet their financial needs.
• The term ‘procurement’ refers to raising of funds
externally as well as the inter related aspects of
raising funds.
 Traditional approach
• In traditional approach the resources could be
raised from the combination of the available
sources.
• The inter related aspects are the institutional
arrangement for finance, financial instruments
through which funds are raised and legal and
accounting aspects between the firm and its
sources of funds.
Limitations of traditional approach
• This approach is confirmed to ‘procurement of funds’ only.
• It fails to consider an important aspects i.e. allocation of
funds.
• It deals with only outside I.e. investors, investment bankers.
• The internal decision making is completely ignored in this
approach.
• The traditional approach fails to consider the problems
involved in working capital management.
• The traditional approach neglected the issues relating to the
allocation and management of funds and failed to make
financial decisions.
 Modern approach
• The modern approach is an analytical way of
looking into financial problems of the firm.
According to this approach, the finance
function covers both acquisition of funds as
well as the allocation of funds to various uses.
Financial management is concerned with the
issues involved in raising of funds and efficient
and wise allocation of funds
 Main Contents of Modern approach

• How large should an enterprise be and how

far it should grow?
• In what form should it hold its assets?
• How should the funds required be raised?
• Financial management is concerned with
finding answer to the above problems.
 Scope/Elements

• Investment decisions includes investment in fixed assets (called as

capital budgeting). Investment in current assets are also a part of
investment decisions called as working capital decisions.
• Financial decisions - They relate to the raising of finance from various
resources which will depend upon decision on type of source, period
of financing, cost of financing and the returns thereby.
• Dividend decision - The finance manager has to take decision with
regards to the net profit distribution. Net profits are generally divided
into two:
– Dividend for shareholders- Dividend and the rate of it has to be decided.
– Retained profits- Amount of retained profits has to be finalized which will
depend upon expansion and diversification plans of the enterprise
 Investment Decision

• One of the most important finance functions is to intelligently allocate

capital to long term assets. This activity is also known as capital budgeting. It
is important to allocate capital in those long term assets so as to get
maximum yield in future. Following are the two aspects of investment
decision
• Evaluation of new investment in terms of profitability
• Comparison of cut off rate against new investment and prevailing
investment.
• Since the future is uncertain therefore there are difficulties in calculation of
expected return. Along with uncertainty comes the risk factor which has to
be taken into consideration. This risk factor plays a very significant role in
calculating the expected return of the prospective investment. Therefore
while considering investment proposal it is important to take into
consideration both expected return and the risk involved.
 Financial Decision

• Financial decision is yet another important function which a financial manger must
perform. It is important to make wise decisions about when, where and how
should a business acquire funds. Funds can be acquired through many ways and
channels. Broadly speaking a correct ratio of an equity and debt has to be
maintained. This mix of equity capital and debt is known as a firm’s capital
structure.
• A firm tends to benefit most when the market value of a company’s share
maximizes this not only is a sign of growth for the firm but also maximizes
shareholders wealth. On the other hand the use of debt affects the risk and return
of a shareholder. It is more risky though it may increase the return on equity funds.
• A sound financial structure is said to be one which aims at maximizing shareholders
return with minimum risk. In such a scenario the market value of the firm will
maximize and hence an optimum capital structure would be achieved. Other than
equity and debt there are several other tools which are used in deciding a firm
capital structure.
 Dividend Decision

• Earning profit or a positive return is a common aim of all the

businesses. But the key function a financial manger performs in
case of profitability is to decide whether to distribute all the
profits to the shareholder or retain all the profits or distribute
part of the profits to the shareholder and retain the other half
in the business.
• It’s the financial manager’s responsibility to decide a optimum
dividend policy which maximizes the market value of the firm.
Hence an optimum dividend payout ratio is calculated. It is a
common practice to pay regular dividends in case of
profitability Another way is to issue bonus shares to existing
shareholders.
 Objectives of Financial management

• The objective provide a framework for

optimum financial decision making. They are
concerned with designing a method of
operating the internal investment and
financing of a firm.there are two widely
discussed approaches under this, these are:
Profit Maximisation Wealth Maximisation
 Profit Maximisation
• Profit Maximisation Profit /EPS maximisation should
be undertaken and those that decrease profits or EPS
are to be avoided. Profit is the test of economic
efficiency. It leads to efficient allocation of resources,
as resources tend to be directed to uses which in
terms of profitability are the most desirable.
Financial management is mainly concerned with the
efficient economic resources namely capital. The
main technical flaws of this criteria are :  Ambiguity
 Timing of benefits  Quality of benefits
 Wealth Maximisation
• Wealth maximisation is also known as Value or Net present
worth maximisation. Its operational features satisfy all the
three requirements of the operational of the financial course of
action namely, exactness, quality of benefits, and the time
value of money. Two important issues related to the
value/share price maximisation are: Focus on stakeholders
,stakeholders include groups such as employees, customers,
suppliers, creditors, owners and others who have a direct link
to the firm.
• EVA (Economic Value Added) –EVA is equal to the after-tax
operating profits of a firm less the cost of the firm to finance
investments.
Wealth maximization vs profit maximization

• The financial management has come a long

way by shifting its focus from traditional
approach to modern approach.
The modern approach focuses on wealth
maximization rather than profit maximization.
This gives a longer term horizon for
assessment, making way for sustainable
performance by businesses.
 Sources Of Finance
• Sources of Finance :Capital required for a business
can be classified under two main categories, viz
• Fixed Capital, and - Working Capital. - every business
needs funds for two purposes. - for its establishment
and to carry out its day-to-day operations.
• Long term funds are required to create production
facilities through purchase of fixed assets such as
:plant, - machinery, - land, - building, - furniture, etc.
 Cont---
• Investment in these asset represent that part
of firm’s capital which is blocked on permanent
or fixed basis and is called fixed capital.
• Funds are also needed for short-term purposes
for the purchase of raw materials, payment of
wages and other day to day expenses, etc.
These funds are known as working capital
 Cont---
• In fact finance is so indispensable today that is
rightly said that it is the life blood of enterprise.
• With out adequate finance, no enterprise can
possibly accomplish its objectives.
• In every concern there are two methods of
raising finance, viz.,
• Raising of owned capital,
• Rising of borrowed capital
 Issue of shares
• The company’s owned capital is split into large
number of equal parts,such a part being called
a “share”.
• The person holding the share as shareholder
and becomes part-owner of the company.
• For this reason, the capital so raised is known
as “owned capital” and the shares are called
“ownership securities”.
 Issue of shares
• The share capital of the company is ideal for
meeting the long term requirements.
• It need not be paid back to the shareholders
within the life time of the company.
• The only exception is the sum raised by the
issue of redeemable preference shares.
 Types of shares
• A public company can issue two types of
share.
• Equity share
• Preference share
 Equity share
• Equity share has number of special features
• The dividend on these shares are paid after
the dividend on preference share has been
paid.
• The rate of dividend depends upon the
amount of profits available and the intention
of directors
 Equity share
• The Equity shareholders have the chance of
earning good dividends in times of prosperity
and run the risk of earning nothing in times of
adversity .
• The equity shareholders have a residual claim
on the company’s asset in case of liquidation.
• The company is controlled by the equity
shareholders and they are entitled to vote in
the meetings of the company.
 Preference shares
• Preference shares are those which carry preferential
right over other class of shares with regard to payment
of dividend and repayment of capital.
• The rate of dividend on preference share is a fixed one
• Preference Share are not traded on secondary market
but they are one of the best primary market
instrument for investors. 1. There are not easily
available: Usually, preference shares are most
commonly issued by companies to institutions.
• Section 55 of Companies Act, 2013 read with
rule 9 of the 
Companies (Share Capital and Debentures) R
ules, 2014
 deals with issue & redemption of preference
share.
 Procedure of the issue:-
• Check whether issuing preference shares is authorized under the
Articles of the Company or not, if it is not so authorized then first
needs to amend the Articles of the Company.
• Conduct Board Meeting and call the General Meeting for this
purpose.
• An Explanatory Statement shall annexed with Notice calling the
General Meeting, and it shall contain the relevant facts regarding the
issue such as:-
– Size of the Issue, No. of Preference Shares, Nominal Value of the Shares
– Nature of the shares i.e. Cumulative/Non-cumulative, Participating/Non-
participating, Convertible/Non-convertible etc.
– Objective & Manner of the issue.
– Price at which shares are proposed to be issued & basis on which price
• Terms of issue, rate of dividend, terms &
tenure of redemption.
• Current shareholding pattern of the Company
• Expected dilution of Equity Shares upon
conversion (only if the nature of the issue is
convertible preference shares).
 Restrictions on issue of Preference Shares
under the Act:-
• There is a clear restriction on the Company to issue
irredeemable preference shares. A Company shall redeem
its preference shares within the time period of 20 years
from the date of issue.
• However if a Company could not redeem its preference
share with-in this time period due to unavoidable reasons
then it may pass Special Resolution with 3/4th Majority
and file petition to the NCLT and on the order of NCLT may
issue preference shares of same kind with similar rate of
dividend for some time period instead of redemption of
existing one.