INTRODUCTION

Financial Management
• Financial Management influences all segments
of corporate activity, for both profit-oriented
firms and non-profit firms.
• It is involved in a range of activities like
acquisition of funds, the allocation of
resources, and the tracking of financial
performance.
• Therefore, it has acquired a vital role in every
type of organization.
 Financial Management
Three key elements in the process of financial
management are:
•Financial Planning
•Financial Control
•Financial Decision Making
 Financial Planning
• It is the process of estimating the capital
required.
• It involves framing of financial policies in
relation to procurement, investment and
administration of funds in an enterprise.
• It ensures that enough funding is available
at the right time to meet the needs of the
business.
 Importance of financial planning
• Adequacy of funds
• Stability of funds:
• Timely debt servicing
• Growth and Expansion
• Reducing uncertainties
 Financial Decision-making
• It involves decisions relating to investment,
financing and dividends that should be taken
with the sole objective of maximization of
shareholders’ wealth.
• Investments need to be financed after
considering the financing alternatives
available to the firm.
 Financial Control
• It involves all the policies and procedures that help an
organization to track, manage and report its financial
activities.
• It is a critically important activity to help a firm to ensure
that it is able to meet its objectives.
• Financial control addresses such questions as:
 Are assets being used efficiently?
 Are the assets secure?
 Does management act in the best interest of
shareholders and in accordance with best business
practices and rules?
 Evolution in finance

• Traditional Phase:
• Transitional Phase
• Modern Phase

• Traditional Phase:
 Period up to first four decades of 19th century covers this phase.
 Scope of financial management was confined to procurement of funds to
meet long-term needs of a business enterprise
 Financial management was viewed mainly from the point of the investment
bankers, lenders, and other outside interests.
 As a result, many financial institutions and commercial banks emerged and
mushroomed during this phase.
 Evolution in finance
• Transitional Phase:
 The decade after the Second World War covers this
transitional phase
 The transitional phase begins around the early
forties and continued through the early fifties.
 Though the nature of financial management during
this phase was similar to that of the traditional
phase, but greater emphasis was placed on the day
to day problems faced by the finance managers in
the area of funds analysis, planning and control.
 Evolution in finance
• Modern Phase:
 The period after 1950 is characterized by modern phase,
in which financial management registered a tremendous
development.
 Innovations, technological development and rapid
industrialization resulted in increasing the demand for
funds.
 In the mid-1950s, the emphasis shifted to utilization of
funds from raising of funds.
 As a result, the focus was shifted to the choice of
investment, capital investment appraisals and so on.
 Scope of financial management
• Traditional Approach
This approach broadly covers three aspects:
 Procurement of funds from financial institution
 Procurement of funds through financial
instruments such as shares, debentures, bonds
and other financial instruments.
 Looking after legal and accounting relations
between a corporation and its sources of funds.
Limitations of Traditional approach
• Outsider-looking-in approach:. The subject was woven around the
viewpoint of the suppliers of funds such as investors, financial institutions,
investment bankers etc., that is, outsiders.
• Ignored routine problems: The scope of financial management was
confined only to the episodic events such as mergers, acquisitions,
reorganizations, and so on.
• Ignored working capital financing: The focus was on the long-term financial
problems thus ignoring the importance of the working capital management.
• No emphasis on allocation of funds: This approach was confined to the
issues involving procurement of funds.
• Viewed Finance as staff speciality: It failed to view financial management
as integral part of overall management that seeks to achieve organizational
goals. Finance function was viewed as staff speciality that was concerned
with funds raising operations.
 Modern Approach

The modern approach focuses on following

questions:
• What is the total volume of funds that an
enterprise requires?
• What are the specific assets that an enterprise
should acquire?
• How should the requirement of funds be
financed?
 Modern Approach
According to Modern approach, there are
three major areas relating to the financial
operations of a firm, viz.,
 Investment Decisions
 Financing Decisions
 Dividend Decisions
 Modern Approach
Investment Decision:
 It revolves around spending capital funds
on assets that are expected to yield the
highest return for the firm over a desired period of
time
 A major part of capital funds is used to acquire long
term assets (fixed assets) while another part is used
to acquire short term assets(current assets).
 As a result investment decision tends to influence
the asset mix.
 Investment Decision
• The decisions relating to long term or fixed
assets are known as capital budgeting
decisions. It is long term planning for
acquisition of fixed assets to create the
operating infrastructure of a firm.
• The acquisition and management of short
term assets becomes the subject matter of
working capital management.
 Financing Decision
• It is concerned with mobilization of funds for investment
from different sources of finance, has a direct bearing on
the capital mix (or financial structure) of the firm.
• The raising of funds requires decisions regarding
the methods and sources of finance,
relative proportion and choice between alternative
sources,
time of floatation of securities,
 impact of capital structure on profitability and
liquidity and so on.
 Dividend Decision
 In order to achieve the wealth maximization objective,
an appropriate dividend policy must be designed.
 One aspect of dividend policy is to decide whether to
distribute all the profits in the form of dividends or to
distribute a part of the profits and retain the balance.
 The decision will depend upon the preferences of the
shareholders, investment opportunities available
within the firm and the opportunities for future
expansion of the firm.
 Interrelationship between the three
decisions
• All financial decisions influence one another and are inter-dependent.
• For instance, the decision to invest in some proposal cannot be taken in isolation
without having necessary finance available for the same.
• The cost of capital is considered by the finance manager before making an
investment.
• The decision regarding the investment is made only if the expected return from
the investment is more than the cost of funds used for this purpose.
• The financing decision in turn is influenced by and also influences the dividend
decision.
• If the retained earnings are used as internal source of finance, it deprives
shareholders of their dividends.
• Thus, the financing decision influences the dividend decision of a company.
• On the other hand, the dividend policy may determine the amount of profits
that will be ploughed back into the business and used as a source of finance.
Thus, dividend policy also influences the financing decision.
 Objectives of Financial
Management
• Profit Maximization
• Wealth Maximization
 Profit Maximization
Profitability maximization, as the criterion for financial
decision making, is justified by the following reasons:
• In a competitive market only those firms survive which
are able to make profit.
• Profit may be considered the most reliable measure of
the efficiency of a firm.
• This objective leads to efficient allocation of resources.
Funds, in the form of capital, being a scare resource
are directed towards profitable investment.
• It leads to maximizing the social welfare.
 Limitations
• Ambiguity
• Timing of Benefits
• Quality of Benefits:
 Wealth Maximization
• Wealth or value of a business is defined as the
market price of the equity capital that is held by
shareholders.
• A shareholder holds shares in the firm and his
wealth tends to improve if the share price of the
enterprise in the market increases which in turn is
a function of net worth.
• Wealth is equal to the present value of all future
cash flows less the cost. In essence, it is the net
present value of a financial decision.
 Profit maximization versus wealth
maximization
• The wealth maximization is based on cash flows and not profits.
• A short term horizon can fulfill the objective of earning profit but may not help in
creating wealth. It is because wealth creation needs a longer term horizon.
• Wealth maximization considers the concept of time value of money
• The wealth maximization criterion considers the risk and uncertainty factor by
using appropriate required rate of return to discount the future streams of cash
flows.
• This objective is uniformly applicable to all the aspects of financial management:
investment, financing and dividend policy
• Shareholders’ wealth maximization objective provides guideline for firm's decision
making and also promotes an efficient allocation of resources in the economic
system
• It directly addresses the requirements of prime stakeholders, that is, owners (or
equity holders). Shareholders are residual claimants in earnings and assets of the
company
 Drawbacks inherent in wealth
maximization objective
• A company may minimize its investment in safety equipment in
order to save cash, thereby putting workers at risk.
• A company may continually pit suppliers against each other in the
unmitigated pursuit of the lowest possible parts prices, resulting in
some suppliers going out of business.
• A company may only invest minimal amounts in pollution controls,
resulting in environmental damage to the surrounding area.
• Wealth maximization can be activated only with the help of the
profitable position of the business concern. The ultimate aim of
the wealth maximization can be realized by maximizing profits.
• Wealth maximization creates conflict of interest between
ownership and management
Financial Decision and
Risk-return trade off