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unit I

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Finance for Non-

finance Executives
Unit-I

Dr. Shipra Agrawal


Assistant Professor
Dept. of Management Studies
Definition- Financial Management

According to Solomon (1978), “Financial


Management is Concerned with the
management decisions that result in the
acquisition and the efficient use of an
important economic resource, namely capital
fund”
Importance of Finance Function

• In addition to raising funds, financial


management is directly concerned with
production, marketing and other functions within
an enterprise

• Success of any organization depends upon the


quality of financial decision taken by it.
Scope of financial management
The scope and functions of financial management is classified in two
categories:

• Traditional approach

• Modern approach
• Traditional approach

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.
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.
Functions of Finance
There are three finance functions
• Investment decision

• Financing decision

• Dividend decision
Inter-relationship among Investment,
Financing and Dividend Decisions

• Investment Decision depends upon


financing decision for making the
necessary funds available and cost of
funds so raised

• Both financing and investment decisions


affect the earnings available for
shareholders and distribution of this
earning in the form of dividends.
Objectives/Decision Criterion of Financial
Management
• Profit Maximization

• Wealth Maximization
Profit Maximization
• Earning maximum revenue at minimum cost.
• It implies that a firm either produces maximum output for a given
amount of input, or uses minimum input for producing a given
output.
• It causes the efficient allocation of resources
• Considered as most appropriate measure of a firm’s performance.
• Source of Incentive

• Helpful in Facing Adverse Business Conditions

• Helpful in the Growth of the Firm

• Leads to maximum social welfare.


Criticism of Profit Maximization Criterion:
• It is vague
• It ignores timing of benefits
• It ignores the quality of benefits
• It goes against corporate responsibility
• Based on accounting profit which can be easily manipulated
Decision criterion should be….
• Exact, precise, clear
• Consider time vale of money
• Consider quality and quantity aspects of future benefits
• Should be applicable to all decision areas of FM
Shareholder’s Wealth Maximization

• Also known as value maximization or Net worth maximization


• It states that the management should maximize the present value
of the expected returns to the firm
• Present value calculated using discounting factor (cost of
capital) reflect both time and risk.
• The wealth of shareholders is reflected in the market price of the
shares.
• Financial decisions should be made in such a way market value
of firm’s share is maximized.
• Finance manager may achieve higher share prices by selecting
W= V-C
• W= Net Present worth
• V= Gross present worth
• C= Capital outflow
• Profitable projects are selected by comparing the present value of
future benefits with the cash outflow associated with a course of
action.
• If PV of Future benefits> cash outflow then that course of action
should be undertaken
• Cash flow is a clear and unambiguous concept.
• Discount rate used to calculate present value reflect time and risk

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