FINANCIAL MANAGEMENT

- An Introduction

Prof. K. Omprakash
Kakatiya University - Warangal
 What is finance?
• The study of money and how it is used.

• Finance considers the relationship of money to time and

risk.

• One of the main subsets of finance is the study of credit

and banking, as this involves money, time, and risk all
together.

• Finance may deal with personal or corporate issues, such

as how will an individual or company acquires the money
needed to perform a certain act.
 Concept of Finance

Finance is broadly defined as the art and

science of making decisions involving money
in a variety of contexts. Finance is studied so
that people can allocate their scarce
resources over time under conditions of
uncertainty.
 Concept of Finance

Finance in the context of any economic entity may be defined

as “ a function which is mainly concerned with two major and
crucial tasks. They are:

•Procurement or raising of funds in the most economical manner

that are needed to undertake the operations of an economic
entity in a smooth and efficient manner; and

•Allocation or utilization of funds so raised as profitably as

possible in the operations of the economic entity to achieve its
predetermined or desired objectives or goals.
 Classification of Finance
Proprietary
Business Finance
Finance
Partnership
Finance

Finance Public Finance Corporate

Finance

Personal
Finance
 What is financial management?

Financial management defined as follows:

“The management of all of the processes associated with

the efficient acquisition and deployment of both short- and
long-term financial resources in the context of a business
organization”.
 Financial Management…..
Financial management is the study and
practice of making rupee denominated
decisions within a single firm, i.e., micro-finance.
Every company needs a financial manager, even
a one-person operation. Financial managers are
concerned with the acquisition and allocation of
financial resources for a company. They spend
most of their time managing working capital
(short-term assets and liabilities).
 Functions of Financial Management

• Investment Decision (also called Long Term Asset Mix or

Capital Budgeting Decision)
• Financing Decision (also referred to as Capital Mix or
Capital Structure Decision)
• Dividend Decision (also called Profit Allocation Decision)
• Liquidity Decision (also known as Short Term Asset Mix
Decision or Working Capital Decision)
 Role of Financial Manager

• Raising of Funds

• Allocation of Funds

• Profit Planning

• Understanding Capital Markets

Role of Finance in an Organization
 What are the goals of finance?

• Profit maximization (profit after tax)

• Maximizing Earnings per Share

• Shareholder’s Wealth Maximization

 Goal of Profit Maximization

Profit maximization simply means maximizing

rupee income of a firm. The arguments in favor
of profit maximization as a goal of a firm are:

• Resources are efficiently utilized

• Appropriate measure of firm performance
• Serves interest of society also
 Is Profit Maximization
a operationally valid criterion?

Arguments against Profit Maximization are:

• It is Vague
• It Ignores the Timing of Returns
• It Ignores Risk
• Assumes Perfect Competition
• In new business environment profit maximization is
regarded as Unrealistic, Difficult, Inappropriate, and
Immoral.
 Maximizing Earnings Per Share

Arguments against Earnings Per Share (EPS)

Maximization are:
• Ignores timing and risk of the expected benefit
• Market value is not a function of EPS. Hence maximizing
EPS will not result in highest price for company's shares
• Maximizing EPS implies that the firm should make no
dividend payment so long as funds can be invested at
positive rate of return—such a policy may not always
work
 Shareholders Wealth Maximization

The primary financial goal of a firm is

shareholder wealth maximization, which
translates to maximizing stock price.

• Do firms have any responsibilities to society at

large?
• Is stock price maximization good or bad for
society?
• Should firms behave ethically?
 Is Sharehoder Wealth Maximization a
justifiable goal?
• Maximizes the net present value of a course of
action to shareholders.

• Accounts for the timing and risk of the expected

benefits.

• Benefits are measured in terms of cash flows.

• Fundamental objective—maximize the market

value of the firm’s shares.
 Is Stock Price Maximization the same as
Profit Maximization?
• No, despite a generally high correlation amongst
stock price, EPS, and cash flow.

• Current stock price relies upon current earnings,

as well as future earnings and cash flows.

• Some actions may cause an increase in earnings,

yet cause the stock price to decrease (and vice
versa).
 Agency Relationship

• An agency relationship exists whenever a

principal hires an agent to act on their behalf.
• Within a corporation, agency relationships exist
between:
• Shareholders and managers
• Shareholders and creditors
 Shareholders versus Managers
• Managers are naturally inclined to act in their
own best interests.

• But the following factors affect managerial

behavior:
• Managerial compensation plans
• Direct intervention by shareholders
• The threat of firing
• The threat of takeover
 Shareholders versus Creditors

• Shareholders (through managers) could take

actions to maximize stock price that are
detrimental to creditors.

• In the long run, such actions will raise the cost of

debt and ultimately lower stock price.
Factors that affect Stock Price

• Projected cash flows

to shareholders
• Timing of the cash
flow stream
• Riskiness of the cash
flows
 Basic Valuation Model

CF 1 CF 2 CF n
Value  1
 2
   n
(1  k) (1  k) (1  k)
n
CF t
  t
.
t  1 (1  k)

To estimate an asset’s value, one estimates the cash flow for

each period t (CFt), the life of the asset (n), and the appropriate
discount rate (k)

Throughout the course, we discuss how to estimate the inputs

and how financial management is used to improve them and
thus maximize a firm’s value.
 Factors affecting the Level and
Riskiness of Cash Flows

• Decisions made by financial managers:

• Investment decisions
• Financing decisions (the relative use of debt
financing)
• Dividend policy decisions

• The external environment

 Risk – Return Trade-off
• Risk and expected return move in tandem; the
greater the risk, the greater the expected return.
• Financial decisions of the firm are guided by the risk-
return trade-off.
• The return and risk relationship:
Return = Risk-free rate + Risk premium
• Risk-free rate is a compensation for time and risk
premium for risk.
THANK
YOU