FINANCIAL MANAGEMENT-Unit I

Chapter 1

Meaning
It is the art and science of managing money. Financial management is a managerial activity concerned with planning and controlling of the firm's financial resources to generate returns on its invested funds.

Continue
Financial Management is concerned with the acquisition, financing, and management of assets with some overall goal in mind.

It is concerned with the duties of the financial managers in the business firm.

Scope of FM
The scope and functions of financial management are divided into two broad categories: Traditional approach Modern approach

Traditional Approach
It refers to the initial stages of Financial managements evolution as a separate branch of study. According to this approach, the scope of financial management is confined to the raising of funds. It was treated in the narrow sense of procurement of funds by corporate enterprise to meet their financial needs.

 The scope of finance function in the traditional approach has now been discarded as it suffers from serious criticisms.
The traditional approach omits the discussion on the important aspects like cost of the capital, optimum capital structure, valuation of firm, etc.

Modern Approach
In the modern approach emphasis shifted from episodic financing to the managerial financial problems, from raising of funds to efficient and effective use of funds. The broader view of the modern approach of the finance function is the wise use of funds.

 The financial management is concerned with the solution of the major areas relating to the financial operations of a firm, viz., investment, and financing and dividend decisions. The financial manager should be concerned about determining the size and nature of the technology, setting the direction and growth of the business, shaping the profitability, amount of risk taking, selecting the asset mix, determination of optimum capital structure, etc.

Investment Decisions
Most important of the three decisions.
What specific assets should be acquired? Long-term assets which will yield a return over a period of time in future, Short-term - current assets which are convertible into cash in the normal course of business usually within a year. Risk return trade off

Liquidity decisions
It is related to short term investments. It is concerned with the management of the current assets . The main objective of this decision is the trade - off between profitability and liquidity.

Financing Decisions
Determine how the assets will be financed

What is the best type of financing?

What is the best financing mix?

Dividend decisions
Whether the firm should distribute all profits or retain it in the firm or distribute part and retain the balance. The optimum dividend policy is one, which maximizes the market value of share.

Objectives of FM
A finance manager must have a well defined objective in the light of which he has to take various decisions. All the decisions of the finance manager will then be made in pursuit of that objective.

 The following two are often considered as the objectives of the financial management: 1. The maximization of the profit of the firm 2. The maximization of the shareholders wealth

Profit Maximization
For any business firm, the maximization of the profits of often considered as the implied objective. Out of different mutually exclusive options only that one should be selected which will result in maximum increase in profit.

 This profit can be measured in terms of the total accounting profit available to the shareholders. There are various problems with the profit maximization as the objective of financial management. Some of these are as follows:

 It ignores the risk.

It concentrates on the profitability only and ignores the financing aspect of that decision. (Ex: Borrow beyond capacity). It ignores the time value of money. The profit maximization as an objective is vague and ambiguous(Ex:Short term or long term, PBT or PAT)

 On the basis of above points it may be concluded that the profit maximization fails to be an operationally feasible objective of financial management.

 This objective is generally expressed in term of maximization of the value of the share of the firm. The value or the economic value of the firm is defined as the present value of the future cash flows generated by a decision, discounted at appropriate rate of discount which reflects the degree of risk associated with it.

 Measure of wealth considers cash flows rather than the profits of the company.
The present values of the future cash flows are in the form of DIVIDENDS and other benefits expected from the firm. The MARKET PRICE of the share reflects this present value. Therefore, the economic value of the shareholders wealth is the market price of the share.

 So all the financial decisions will be taken in such a way that the shareholder receive highest combination of dividends and the increase in the market price of the share.
This objective makes the interest of the shareholders compatible with that of the management.

 It not only focuses on the short term profits but also considers the long term perspective.
It considers the time value of money. It considers the risk involved in taking all the three decisions i.e. financing decision, investment decision and dividend decision. In operational terms it is practical and easily observed measure.

Comparison of Profit Maximization & Wealth Maximization Objective Properties Return Risk Time Value Clarity Relationship with mgmt. PM Yes No No No Less compatible WM yes yes yes yes More compatible

FM& Other Areas Of Mgmt

Financial management is an integral part of overall management, is not a totally independent area. It draws heavily on related disciplines and fields of study, such as economics, accounting, marketing, production and quantitative methods

Finance And Economics

The relevance of economics to financial management can be described in the light of the two broad areas of economics: Macro economics Microeconomics

FINANCE AND ACCOUNTING

The relationship between finance and accounting conceptually speaking has two dimensions: They are closely related to the extent that accounting is an important input in financial decision making There are key differences in viewpoints between them

 Finance and accounting differ in respect of their purposes. The accounting is collection and presentation of financial data. It provides consistently developed and easily interpreted data on the past, present and future operations of the firm.
The financial manager uses such data for financial decision making. It doesnt mean that accountants never make decisions or financial managers never collect data. But the primary focus of the functions of accountants is on collection and presentation of data while the financial managers major responsibility relates to financial planning, controlling and decision making. Thus, in a sense, finance begins where accounting ends.

FM and Production

In a manufacturing firm, the production manager controls the investment in the form of equipment,
material and men. He should so organize his department that he should maximize the output.

FM and Marketing
Determination of the appropriate price for the firms product is of importance both to the marketing and the finance managers and, therefore, should be a joint decision of both.

FM and Personnel management

The recruitment, training and placement of staff are the responsibility of the personnel department. However, all this requires finances and, therefore, the decisions regarding these aspects cannot be taken by the personnel department in isolation of the finance department.

FM and top management

Strategic planning and management control are two important functions of the top management. Finance function provides the basic inputs needed for undertaking these activities.

Organization of the Financial Management Function

Board of Directors
President (Chief Executive Officer)
Vice President Operations

VP of Finance

Vice President Marketing

Organization of the Financial Management Function

VP of Finance
Treasurer
Capital Budgeting Cash Management Credit Management Dividend Disbursement Fin Analysis/Planning Pension Management Insurance/Risk Mngmt Tax Analysis/Planning

Controller
Cost Accounting Cost Management Data Processing General Ledger Government Reporting Internal Control Preparing Fin Stmts Preparing Budgets Preparing Forecasts