FINANCIAL MANAGEMENT

Today, undoubtedly the role of financial

managers have not only become exciting but
also challenging, because it entails effective
and quick decision making process, tact,
requisite skill, intelligence and foresight in order
to match the fast moving and technologically
complex corporate environment.
 FINANCIAL MANAGEMENT ?
 Financial management is an integral part of overall
management of an organization.
 The finance manager plays a vital role in the
company’s success.
 It is rather a difficult task to handle by individual who
is the heart of what is going on in the entire
organization.
 If finance is in the heart of everything that goes on in
the company, the person handling it must be
involved in every activity that the firm may perform.
 The financial manager has to be in touch with the
firms operations, marketing and the overall strategy
of the company.
 Definition of
Financial
Management
 FINANCIAL MANAGEMENT
The efficient and effective planning and
controlling of financial resources as to
maximize profitability and ensuring liquidity
for an individual (personal finance),
government (public finance) , and for
profit and non-profit organization/firm(
corporate or managerial finance)
 Evolution of
Financial
Management
 Evolution of Financial Management
The formation of large scale industrial corporations in
oil, steel, chemicals, and railroads created by early
industrialists such as Rockefeller, Carnegie, and Du
Pont gave rise to the emergence of financial
management as a separate field of study.
It was long conserved as a branch of economics until
1890s.
This explains why the theoretical concept of financial
management are drawn from economics
 Evolution of Financial Management
Traditional Phase
 Focus of financial  The transitional phase begins
management was mainly
on certain episodic events
like formation, issuance of
capital, major expansion,
merger, reorganization,
and liquidation in the life
cycle of the firm
 The approach was mainly
descriptive and
institutional.
 The instruments of
financing, the institutions
and procedures used in
capital markets and the
legal aspects of financial
events formed the core of
financial management
Trasitional Phase
around the early forties and
continues through the early
fifties and has the following
attributes
 Similar to that of the traditional
phase, greater emphasis was
placed on the day to day
problem faced by the finance
managers in the area of funds
analysis, planning and control
Modern Phase
 Globalization of markets led to the
emergence of financial engineering
which involve formation of optimal
solutions to problems confronted in
corporate finance.
 The most controversial result of this
innovation is the creation of
financial derivative instruments
which revolutionized the way
businesses look at risk management.
The scope of financial management
has broadened. The central concern
of financial management is
considered to be a rational matching
of funds to their uses in the light of
appropriate decision criteria
 Evolution of Financial Management
Traditional Phase
 The outsider’s point of view
was dominant.
 Financial management
was viewed mainly from
the point of the investment
bankers, lender, and other
outside interests.
 Areas such as sound
financial structure and
liquidity position of the firm
were emphasized
 There was an increased
regulation.
Trasitional Phase
 Problems were discussed
within limited analytical
framework and the firm is only
analyzed from the viewpoint
of an outsider such as lender
or investor, but it did not
emphasize decision making
within the firm
 The study of external financing
was still largely descriptive,
students did learn more about
analyzing cash flows of the
firm, and more was being said
about planning and control
theses flows from within
Modern Phase
 The approach of financial
management has become more
analytical and quantitative with the
application of economic theories
and quantitative with the
application of economic theories
and quantitative methods of
financial analysis
 The point of view of the managerial
decision maker has become
dominant
Importance of
Financial
Management
 Importance of Financial Management
 Making future decisions for the expansion and growth
of organization are made in financial management
by finance managers who possess expertise.
 Through financial management, organizations decide
about the utilization and procurement of funds, cash
flow management, liquidity management, risk
mitigation, debt management, and capital
budgeting and optimum asset management to make
organizations lucrative.
 The organization’s fate, is therefore, decided not by
the quantity and quality of its assets but rather by the
hands in which the organization entrusts most precious
assets.
 Importance of Financial Management
 Today, financial management is regarded as the life-
blood of the organization, once it clots the organization
dies.
 Right from the recording of financial transactions to the
preparation of financial statements, organization has to
make sure that proper procedures have been followed.
 This is because the organization has to ultimately
depend in the information for future planning and
forecasting and decision making.
 Financial Management, is therefore, the crucial element
of every business whether small or big.
 Nature of Financial Management
Financial management is an integral part of
overall management and not merely a staff
function.
Finance manager has to see things as a part of
a whole and make financial decisions within the
framework of overall corporate objectives and
policies.
Relationship with other Business Functions
 Economics  Law
 Accounting  Taxation
 Mathematics  Treasury Management
 Production Management  Banking
 Marketing  Insurance
 Personnel  Information technology
 Top Management
 Quantitative Methods
 Costing
 Scope of
Financial
Management
 Scope of Financial Management
- by Dr. S.C Saxena
Anticipation
 Financial management estimates the financial needs of the company.
Acquisition
 It collects finance for the company from different resources
Allocation
 It uses the collected finance to purchase fixed and current assets for the company
Appropriation
 It divides the company’s profits among the shareholders, debenture holders, etc. It
keeps a part of the profits as reserves
Assessment
 It also controls all the financial activities of the company.
 Financial management is the most important functional area of management. All other
functional areas such as production management, marketing management, personnel
management, etc. depends in financial management.
Functional Areas
of Financial
Management
Functional Areas of Financial Management
Determining sources of Project planning and
funds evaluation
Financial analysis Capital budgeting
Optimal capital structure Working capital
Cost- volume – profit management
analysis Dividend policies
Profit planning and Acquisitions and mergers
control Corporate taxation
Fixed assets management
 The Financial Management Process

Three Key Elements:

1. Financial Planning
Management need to ensure that enough
funding is available at the right time to meet the
needs of the business.
In the short term, funding may be needed to
invest in equipment and stocks, pay employees
and fund sales made on credit.
 The Financial Management Process
2. Financial Control
A critically important activity to help the business
ensure that the business is meeting its objectives.
Are the assets being used effectively?
Are the business assets secure?
Do management act in the best interest of
shareholders and in accordance with business
rules?
 The Financial Management Process
2. Financial Control
A critically important activity to help the business
ensure that the business is meeting its objectives.
Are the assets being used effectively?
Are the business assets secure?
Do management act in the best interest of
shareholders and in accordance with business
rules?
 The Financial Management Process
3. Financial Decision- Making
 The key aspects of financial decision making relate
to investment, financing and dividends
 Goal and
Objective of
the Firm
 Goal and Objective of the Firm
Objective setting is the most important phase
in business enterprises, since upon correct
objective setting, the entire structure of
strategies, policies and plans of a company
rests.
Profit Maximization
Shareholder Wealth Maximization
 Goal and Objective of the Firm:
Profit Maximization

Traditional and narrow

approach, which aims at,
maximizing the profit of the
concern
 Goal and Objective of the Firm: Profit Maximization
Favorable Arguments for profit maximization Unfavorable Arguments for profit
maximization
 A business concern is functioning mainly for the purpose of  Leads to exploiting workers and
earning profit consumers
 Profit is the parameter of the business operation. It is a test  Creates immoral practices such as
of economic efficiency corrupt practice, unfair trade
practice, etc.
 Profit reduces risk and uncertainty of the business concern  Leads to inequalities among the stake
holders such as customers, suppliers,
public shareholders, etc.
 Profit is the main source of finance for expansion and modernization.
Raising equity funds from the primary market is difficult
 Profitability meets the social needs too. It ensures maximum
dividends for shareholders, timely payment to creditors, more
wages and benefits to employees and maximization of capital to
the entrepreneur.

 Profit leads to a more productive stance. Profit enhances the

competitive spirit thus under such conditions, firms having more and
more profits are more dependable and can survive any
environment.
 Goal and Objective of the Firm:
Profit Maximization
Drawbacks:
It is vague
Ignores the time value of money
Ignores risk
Emphasizes the short run projects and short
run probability
May ignore social and moral responsibility
 Goal and Objective of the Firm:
Shareholder Wealth Maximization
Appropriate goal of a business firm in a capitalist
society. In a capitalist society, there is private
ownership of goods and services by individuals. Those
individuals own the means of production to make
money. The profits from the businesses in the economy
accrue to the individuals.
Other strategies which management develop to
create a competitive advantage should also create
the greatest value to the shareholders.
 Goal and Objective of the Firm:
Shareholder Wealth Maximization
 When business managers try to maximize the wealth
of their firm, they are actually trying to increase their
stock price.
 As stock price increases, the individual who holds
the stock wealth increases.
 As the stock price goes up, the value of the firm
increases and the net worth of the individual who
owns the stock increases.
 The real measure of Shareholder Value is when the
company creates value to its shareholder when
returns are greater than capital opportunity cost
 Goal and Objective of the Firm:
Shareholder Wealth Maximization
For  The rational investor reflect the long term effects of
Wealth the firms decisions
Maximization  Stock prices are the most observable by all
measures which can be used to find out the
performance of the firm
 Wealth maximization considers the comparison of
the value to cost associated with the business
concern
 Wealth maximization considers both time and risk of
the business concern
 Goal and Objective of the Firm:
Shareholder Wealth Maximization
Favorable  Wealth maximization provides efficient allocation
Arguments of resources and ensures the economic interest of
For the society
 It takes into consideration long run survival growth
Wealth
of the firm
Maximization
 It suggests the regular and consistent dividend
payment to the shareholder
 The financial decisions are taken with a view to
improve the capital appreciation of the share price
 Goal and Objective of the Firm:
Shareholder Wealth Maximization
Favorable  It considers all future cash flows, dividends and
Arguments earnings per share
For  Maximization of firm’s value is reflected in the
market price of share, since it depends on
Wealth
shareholders expectations as regards profitability,
Maximization long-run prospects, timing differences of returns,
risk, distribution of return etc. of the firm
 The shareholders always prefer wealth
maximization rather than maximization of inflow of
profits
 Maximizes the net present value of a course of
action to shareholders
 Goal and Objective of the Firm:
Shareholder Wealth Maximization
Favorable  Benefits are measured in terms of cash flow
Arguments
 It is the trading of stocks though which gains can
For be realized
Wealth  Wealth maximization is superior to the profit
Maximization maximization because the main aim of the business
concern under this concept is to improve the value
or wealth of the shareholders.
 Goal and Objective of the Firm:
Shareholder Wealth Maximization
Unfavorable
Arguments
Leads to prescriptive idea of the
business concern but may not be
For
suitable to present day business
Wealth activities
Maximization
Wealth maximization is nothing, it is
also profit maximization, it is the
indirect name of profit maximization
Creates ownership-management
controversy
 Goal and Objective of the Firm:
Shareholder Wealth Maximization
Unfavorable
Arguments
Management alone enjoy certain
benefits
For
Wealth
The ultimate aim of the wealth
Maximization maximization objectives is to maximize
the profit
Wealth maximization can be
activated only with the help of the
profitable position of the business
concern
 Goal and Objective of the Firm:
Shareholder Wealth Maximization
The Share Value creation model proposed by
Value Walters incorporates operational and
Creation strategic perspectives.
Model He suggested that activities of
strategic managements should be
planned against strategic
management criteria. In his view,
profitability should be measured net of
all changes.
 Goal and Objective of the Firm:
Shareholder Wealth Maximization
The Share How efficiently assets of a company
Value are used by the management is
Creation measured by:
 Asset Base Management,
Model
Operational Cash Flow measures the
ability of operating managers and
financial and investment requires senior
management for financing structuring.
 Goal and Objective of the Firm:
Shareholder Wealth Maximization
The Share According to this model the total
Value economic value of an entity is:
Creation Corporate Value = debt + shareholder
Model value
 Goal and Objective of the Firm:
Shareholder Wealth Maximization
The Share  Another model raised by McDonald raises important questions
about how directors and managers access accurate, non-
judgmental institutionally biased information to create company
Value strategic decision to create value to the shareholder.
 The McDonald model gives answer to this question to some
Creation extent.
 He interlinks the shareholder wealth creation with Value Creating
Model Management and presents VCM Model.
 He calls it value base management which combines behavioral
science with corporate finance and strategic marketing.
 The key element for the success of the VCM is the managerial
involvement and relies on external consultancies and group of
internal planners.
 Managers design their strategies based on customer portfolio
analysis.
 Goal and Objective of the Firm
Given the goal as stated above, an
obvious query comes up
What is the appropriate goal when
the firm has no traded stock?
Goal and Objective of the Firm

As long as we are dealing with for-

profit businesses, only a slight
modification is needed.
The total value of the stock in a
corporation is simply equal to the
value of the owner’s equity.
Goal and Objective of the Firm

Therefore, a more general way of sating

our goal is:

“Maximize the
value of the
existing owner’s
equity.”
 Financial Management Decisions
1. Investment decisions
Where do you invest the scarce resources of
your business?
What makes for a good investment?
2. Financing decision
Where do you raise the funds for these
investments?
Generically, what mix of owner’s money or
borrowed money do you use?
Financial Management Decisions
3. Dividend decision
How much of a firm’s funds should be
reinvested in the business and how much
should be returned to the owners?
4. Liquidity decision
How much should a firm invest in current
assets and what should be the components
with their respective proportions?
How to manage working capital?
 The Role of
Financial
Management in
Business
 The Role of Financial Management in
Business
To participate in the process of putting funds to
work within the business and to control their
productivity
To identify the need for funds and select sources
from which they may be obtained.
The functions of financial management may be
classified on the basis of liquidity, profitability
and management.
The Role of Financial Management in
Business
Liquidity
Forecasting cash flows
Raising funds
Managing the flow of internal
funds
The Role of Financial Management in
Business
Profitability
Cost control
Pricing
Forecasting future profits
Measuring the cost of capital
The Role of Financial Management in
Business
Management
***Has both the liquidity and
profitability aspects
Management of long term funds
Management of short term funds
Ten Axioms That
Form the Basics
of Financial
Management
 Ten Axioms That Form the Basics of
Financial Management
1. The Risk-Return Trade-Off
we don’t take on additional risk unless
we expect to be compensated with
additional return
2. The Time Value of Money
a peso received today is worth more
than a peso received in the future
3. Cash Flows – Not Profits – is King
Ten Axioms That Form the Basics of
Financial Management
4. Incremental cash flows
its only what changes that counts
5. The curse of competitive markets
why it’s hard to find exceptionally
profitable projects
6. Efficient capital market
the markets are quick and the prices
are right
Ten Axioms That Form the Basics of
Financial Management
7. The Agency Problem
Managers won’t work for the owners unless
it’s in their best interest
Managers vs. stockholders
Stockholders vs. creditors
• Example :managers could borrow money to
repurchase shares to lower the corporation’s
share base and increase shareholder return.
Stockholders will benefit; however, creditors
will be concerned given the increase in debt
that would affect the future cash flow.
Ten Axioms That Form the Basics of
Financial Management
8. Taxes bias business decisions
9. All risk are not equal and some cannot
some risk can be diversified away.
10. Ethical behavior is doing the right
thing, and ethical dilemmas are
everywhere in finance
 Ten Axioms That Form the Basics of
Financial Management
Sarbanes – Oxley act of 2002.
Made provisions for the formation of
the Securities and Exchange
Commission which now oversees
financial auditors
Financial Markets
 A broad term describing any marketplace where buyers
and sellers participate in the trade of assets such as
equities, bonds, currencies and derivatives.
Types of Financial Markets
1. Capital market
 Individuals and institutions trade financial
securities
2. Stock market
 Allows investors to buy and sell shares in publicly
traded companies.
Types of Financial Markets
3. Bond market
 A debt investment in which an investor loans money to
an entity which borrows the funds for a defined period
of time at a fixed interest rate.
4. Money market
 A segment of the financial market in which financial
instruments with high liquidity and very short maturities
traded.
5. Cash or Spot market
 With opportunities for both big losses and big gains
Types of Financial Markets
6. Derivatives markets
 A contract, the contract price is determined by the
market price of the core asset
7. Forex and the Interbank Market
Interbank market
 Financial system and trading of currencies among
banks and financial institutions, excluding retail
investors and smaller trading parties.
Forex market
 Where currencies are traded
 Activity:
 If a company’s board of directors wants management
to maximize shareholder wealth, should the CEO,s
compensation be set as fixed dollar amount, or should it
depend on how well the firm performs?
 If it is to be based on performance, how should
performance be measured?
 Would it be easier to measure performance by the
growth rate in reported profits or the growth rate in the
stock’s intrinsic value?
 What would be the better performance measure? Why?