Financial Management

Business Finance: Introduction to Business Finance, Meaning and Definition of Financial Management, Objectives of Financial Management- (Profit Maximization and Wealth Maximization), Modern Approach to Financial Management- (Investment Decision, Financing Decision, Dividend Policy Decision), Finance and its relation with other disciplines, Functions of Finance Manager

1. 201_FinancialManagement
UNIT1:
BusinessFinance:Introductionto
BusinessFinance,MeaningandDefinition
ofFinancialManagement,Objectivesof
Financial Management- (Profit
MaximizationandWealthMaximization),
Modern Approach to Financial
Management-(Investment Decision,
FinancingDecision,DividendPolicy
Decision),Financeanditsrelationwith
otherdisciplines,FunctionsofFinance
Manager

2. Financeisdefinedastheprovisionofmoneyat
thetimewhenitisrequired.
Everyenterprise,whetherbig,medium,small,
needsfinancetocarryonitsoperationsandto
achieveitstarget.
Infact,financeissoindispensabletodaythatit
isrightlysaidtobethebloodofanenterprise.
Withoutadequatefinance,noenterprisecan
possiblyaccomplishitsobjectives.
INTRODUCATION

3. Meaning of Financial Management
Financialmanagement referstothatpartofthe
management activity,whichisconcernedwith
theplanning,&controllingoffirm’sfinancial
resources.
Itdealswithfindingoutvarioussourcesforraising
fundsforthefirm.Financialmanagement is
practicedbymanycorporatefirmsandcanbe
calledCorporationfinanceorBusinessFinance.

4. ○AccordingtoGuthmann andDougall:
“Businessfinancecanbebroadlydefinedas
theactivityconcernedwiththeplanning,
raisingcontrollingandadministratingthe
fundsusedinthebusiness.”
○AccordingtoJoseph&Massie:“Financial
Management istheoperationalactivityofa
businessthatisresponsibleforobtainingand
effectivelyutilizingthefundsnecessaryfor
efficientoperations”
Definations

6. Afinancialmanagerhastoconcentrateonthefollowingareasofthe
financefunction.
EstimatingFinancialRequirements:Thefirsttaskofthefinancial
manager istoestimateshorttermandlong-termfinancial
requirementofhisbusiness.
DecidingCapitalStructure:Thecapitalstructurereferstothekindand
proportionofthedifferentsecuritiesforraisingfunds.Afterdeciding
aboutthequantumoffundsrequireditshouldbedecidedwhich
typeofsecurityshouldberaised
SelectingaSourceofFinance:Afterpreparingacapitalstructure,an
appropriatesourceoffinanceisselected.Varioussourcesfromwhich
financemayberaised,includessharecapital,debentures,financial
depositsetc
SelectingaPatternofInvestment:Whenfundhavebeenprocured
thenadecisionaboutinvestmentpatternistobetaken.The
selectionofinvestmentpatternisrelatedtotheuseofthefunds.
Functions of Financial Management

7. ProperCashManagement:Cashmanagement isanimportant
taskoffinancialmanager.Hehastoassessthevariouscash
needsatdifferenttimesandthenmakearrangementsfor
arrangingcash.
ImplementingFinancialControls:Anefficientsystemoffinancial
management necessitatestheuseofvariouscontroldevices.
Financialcontroldevicegenerallyusedare;ReturnInvestment,Ratio
analysis,BreakevenanalysisCostcontrolCostandinternalaudit.
ProperuseofSurpluses:Theutilizationofprofitsorsurplusesas
alsoanimportantfactorinfinancialmanagement.Ajudicious
useofsurplusesisessentialfortheexpansionanddiversification
plansandalsoprotectingtheinterestoftheshareholders.
Functions of Financial Management

8. Effectiveprocurementandefficientuseoffinanceleadto
properutilizationofthefinancebythebusinessconcern.It
istheessentialpartofthefinancialmanager.Hence,the
financialmanagermustdeterminethebasicobjectivesof
thefinancialmanagement.ObjectivesofFinancial
Management maybebroadlydividedintotwopartssuch
as:
1.Profitmaximization
2.Wealthmaximization.
Objectives of Financial Management-(Profit
Maximization and Wealth Maximization)

9. Theterm‘profitmaximization’impliesgenerationoflargestamount
ofprofitsoverthetimeperiodbeinganalysed,secondarytoProf.
PeterDrucker,businessprofitsplayafunctionalroleinthree
differentways.InthewordsofPeterDrucker.
i)profitsindicatetheeffectivenessofbusinessprofits
ii)theyprovidethepremiumtocovercostsofstayinginbusiness
iii) they ensure supply of future capital.
Profits are source of funds from which organizations are able to
defray certain expenses like replacement, obsolescence,
marketing etc.
Itisassumedthatprofitmaximizationcausestheefficientallocation
ofresourcesunderthecompetitiveimpactconditionsandprofit
isregardedasthemostappropriatemeasureofafirm’s
performance.
Profit Maximization

10. Profit maximization consists of the following important features.
1.Profit maximization is also called as cashing per share
maximization. It leads to maximize the business operation for
profit maximization.
2.Ultimate aim of the business concern is earning profit, hence, it
considers all the possible ways to increase the profitability of
the concern.
3.Profit is the parameter of measuring the efficiency of the
business concern. So it shows the entire position of the business
concern.
4.Profit maximization objectives help to reduce the risk of the
business.
FEATURES PROFIT MAXIMIZATION

11. The following important points are in support of the
profit maximization objectives of the business
concern:
(i)Main aim is earning profit.
(ii)Profit is the parameter of the business operation.
(iii)Profit reduces risk of the business concern.
(iv)Profit is the main source of finance.
(v)Profitability meets the social needs also.
Favorable Arguments for Profit Maximization

12. Thefollowingimportantpointsareagainstthe
objectivesofprofitmaximization:
(i)Profitmaximizationleadstoexploitingworkersand
consumers.
(ii)Profitmaximizationcreatesimmoralpracticessuch
ascorruptpractice,unfairtradepractice,etc.
(iii)Profitmaximizationobjectivesleadstoinequalities
amongthesakeholderssuchascustomers,
suppliers,publicshareholders,etc.
Unfavorable Arguments for Profit Maximization

13. Profitmaximizationobjectiveconsistsofcertaindrawbackalso:
(i)Itisvague:Inthisobjective,profitisnotdefinedpreciselyor
correctly.Itcreatessomeunnecessaryopinionregarding
earninghabitsofthebusinessconcern.
(ii)Itignoresthetimevalueofmoney:Profitmaximizationdoes
notconsiderthetimevalueofmoneyorthenetpresentvalue
ofthecashinflow.Itleadscertaindifferencesbetweenthe
actualcashinflowandnetpresentcashflowduringa
particularperiod.
(iii)Itignoresrisk:Profitmaximizationdoesnotconsiderriskofthe
businessconcern.Risksmaybeinternalorexternalwhichwill
affecttheoveralloperationofthebusinessconcern.
Drawbacks of Profit Maximization

14. Wealthmaximizationisoneofthemodern
approaches,whichinvolveslatestinnovations
andimprovementsinthefieldofthebusiness
concern.Thetermwealthmeansshareholder
wealthorthewealthofthepersonsthosewho
areinvolvedinthebusinessconcern.
Wealthmaximizationisalsoknownasvalue
maximization ornet present worth
maximization.Thisobjectiveisanuniversally
acceptedconceptinthefieldofbusiness.
Wealth Maximization

15. Itmeansthatbymaximizingstakeholder’s
wealththefirmisoperatingconsistently
towardmaximizingstakeholder’sutility.
Astakesolder’swealthinthefirmisthe
productofthenumbersoftheshares
owned,multipliedwithinthecurrent
stockpricepershare.
Stockholder’scurrentwealthinthefirm=
(No.Ofsharesowned)*(Currentstock
pricepershare)
Higherthestockpricepershare,the
greaterwillbetheshareholder’swealth.
Thusafirmshouldaimatmaximizingits
currentstockprice,whichhelpsin
increasingthevalueofsharesinthe
market.

16. 1.Itissuperior:Thisobjectiveissuperiortoprofitmaximizationasitsmain
aimistomaximiseshareholder’swealth.
2.Itispreciseandunambiguous:Itisbasedontheconceptofcash
flowsratherthanprofit.Theconceptofprofitintheprofit
maximizationobjectiveisvagueandambiguous.
3.Considerstimevalueofmoney:Wealthmaximizationobjectivetakes
intoaccountthetimevalueofmoneyasitconsiderstimingofcash
inflows.Thecashflowsoccurringatdifferentperiodoftimeare
discountedwithappropriatediscountrate.
4.Considersrisk:Thisobjectivealsoconsidersfutureriskassociatedwith
occurrenceofcashflows.Thisisdonewiththehelpofdiscounting
rate.Higherthediscountrate,highertheriskandvice-versa.
5.Ensuresefficientallocationofresources:Resourcesareallocated
wiselytoincreaseshareholder’swealth.
6.Ensureseconomicinterestofsociety:Whenwealthofshareholderis
maximized,itultimatelyupholdseconomicinterestofsociety.
Arguments in favor of Wealth Maximization objective

17. 1.Createsowner-managementproblem:Theconceptofwealthmaximization
createsowner-management problemasownerswanttomaximizetheir
profitsandmanagement wanttomaximizeshareholder’swealth.
2.Ignoresotherstakeholders:Thisobjectivehasbeencriticizedontheground
thatitisinclinedtowardswealthmaximizationofshareholdersonlyand
ignoresotherstakeholderssuchascreditors,suppliers,employeesetc.
3.Criteriaofmarketvalueisnotfair:Thecriteriaofwealthmaximizationis
basedonmarketvalueofshareswhichisnotacorrectmeasure.Because
valueofsharescouldincreaseordecreaseduetoothereconomicfactors
whicharebeyondthecontrolofthefirm.
4.Itisjustanotherformofprofitmaximization:Ultimateaimistoearn
maximumprofits.Withoutearningprofitswealthcannotbemaximized.
5.Managementaloneenjoycertainbenefits.
6.Itisnotsuitableforpresent-daybusinesses.
Unfavorable arguments for Wealth Maximization objective

18. DIFFERENCE BETWEEN PROFIT AND WEALTH
MAXIMIZATION
Goal Objective Advantages Disadvantages
Profit
maximization
Large amount of
profits
-Easy to calculate profits.
-Easy to determine the link
between financial decisions
and profits.
-Emphasizes the short term.
-Ignores risk or uncertainty.
-Ignoresthetimingof
returns.
-Requires immediate
resources.
Stockholder
wealth
maximization
Highest market
value of common
stock
-Emphasizes the long term.
-Recognizes risk or
uncertainty.
-Consider stockholders
return.
-Offers no clear relationship
between financial decisions
and stock price.
-Can lead to management
anxiety and frustration.

19. Differences Between Profit Maximization and Wealth
Maximization
Basis for Comparison Profit Maximization Wealth Maximization
Concept
The main objective of a
concern is to earn a larger
amount of profit.
The ultimate goal of the
concern is to improve the
market value of its shares.
Emphasizes on
Achieving short term
objectives.
Achieving long term
objectives.
Consideration of Risks and
Uncertainty
No Yes
Advantage
Acts as a yardstick for
computing the operational
efficiency of the entity.
Gaining a large market
share.
Recognition of Time Pattern
of Returns
No Yes

20. 1)FinancialManagement andProductionDepartment:Thefinancial
management andtheproductiondepartmentareinterrelated.The
productiondepartmentofanyfirmisconcernedwiththeproduction
cycle,skilledandunskilledlabour,storageoffinishedgoods,capacity
utilisation,etc.andthecostofproductionassumesasubstantial
portionofthetotalcost.
2)FinancialManagement andMaterialDepartment:Thefinancial
management andthematerialdepartmentarealsointerrelated.
Materialdepartmentcoverstheareassuchasstorage,maintenance
andsupplyofmaterialsandstores,procurementetc.
Thefinancemanagerandmaterialmanagerinafirmmaycome
togetherwhiledeterminingEconomicOrderQuantity,safetylevel,
storingplacerequirement,storespersonnelrequirement,etc.Thecosts
ofalltheseaspectsaretobeevaluatedsothefinancemanagermay
comeforwardtohelpthematerialmanager.
FINANCE AND ITS RELATION WITH OTHER DISCIPLINES

21. 3.FinancialManagement andPersonnelDepartment:Thepersonnel
departmentisentrustedwiththeresponsibilityofrecruitment,training
andplacementofthestaff.Thisdepartmentisalsoconcernedwiththe
welfareoftheemployeesandtheirfamilies.Thisdepartmentworkswith
financemanagertoevaluateemployees’welfare,revisionoftheirpay
scale,incentiveschemes,etc.
4.FinancialManagement andMarketingDepartment:Themarketing
departmentisconcernedwiththesellingofgoodsandservicestothe
customers.Itisentrustedwithframingmarketing,selling,advertising
andotherrelatedpoliciestoachievethesalestarget.Itisalsorequired
toframepoliciestomaintainandincreasethemarketshare,tocreate
abrandnameetc.Forallthisfinanceisrequired,sothefinance
managerhastoplayanactiveroleforinteractingwiththemarketing
department.
FINANCE AND ITS RELATION WITH OTHER DISCIPLINES

22. Financemanagerisanintegralpartofcorporatemanagement of
anorganization.Withhisprofessionexperience,expertise
knowledgeandcompetence,hehastoplayakeyrolein
optimalutilizationoffinancialresourcesoftheorganization.
1)ForecastingofCashFlow.Thisisnecessaryforthesuccessfulday
todayoperationsofthebusinesssothatitcandischargeits
obligationsasandwhentheyrise.Infact,itinvolvesmatchingof
cashinflowsagainstoutflowsandthemanagermustforecastthe
sourcesandtimingofinflowsfromcustomersandusethemto
paytheliability.
2)RaisingFunds:theFinancialManagerhastoplanformobilising
fundsfromdifferentsourcessothattherequisiteamountoffunds
aremadeavailabletothebusinessenterprisetomeetits
requirementsforshortterm,mediumtermandlongterm.
Functions of Finance Manager

23. 3)ManagingtheFlowofInternalFunds:HeretheManagerhastokeepa
trackofthesurplusinvariousbankaccountsoftheorganisationand
ensurethattheyareproperlyutilisedtomeettherequirementsofthe
business.Thiswillensurethatliquiditypositionofthecompanyis
maintainedintactwiththeminimumamountofexternalborrowings.
4)ToFacilitateCostControl:TheFinancialManagerisgenerallythefirst
persontorecognisewhenthecostsforthesuppliesorproductionprocesses
areexceedingthestandardcosts/budgetedfigures.Consequently,he
canmakerecommendationstothetopmanagement forcontrollingthe
costs.
5)ToFacilitatePricingofProduct,ProductLinesandServices:TheFinancial
Managercansupplyimportantinformationaboutcostchangesand
costatvaryinglevelsofproductionandtheprofitmarginsneededto
carryonthebusinesssuccessfully.
Functions of Finance Manager

24. 6)ForecastingProfits:TheFinancialmanagerisusuallyresponsiblefor
collectingtherelevantdatatomakeforecastsofprofitlevelsinfuture.
7)MeasuringRequiredReturn:Theacceptance orrejectionofan
investmentproposaldependsonwhethertheexpectedreturnfromthe
proposedinvestmentisequaltoormorethantherequiredreturn.
8)ManagingAssets:Thefunctionofassetmanagement focusesonthe
decision-makingroleofthefinancialmanager.Financepersonnelmeet
withotherofficersofthefirmandparticipateinmakingdecisions
affectingthecurrentandfutureutilizationofthefirm'sresources
9)ManagingFunds:Inthemanagement offunds,thefinancialmanager
actsasaspecialisedstaffofficertotheChiefExecutiveofthecompany.
Themanagerisresponsibleforhavingsufficientfundsforthefirmto
conductitsbusinessandtopayitsbills.
Functions of Finance Manager

25. 1)Explaintheobjectivesorgoalsoffinancialmanagement.
2)Explaintheconceptofwealthinthecontextofwealthmaximization
objective.
3)“Thewealthmaximizationobjectiveprovidesanoperationallyappropriate
decisioncriterion”–Analysethestatement.
4)Inwhatrespectistheobjectiveofwealthmaximizationsuperiortotheprofit
maximizationobjective?
5)Givetheargumentsforprofitmaximizationasanobjectiveofafirm.
6)Whataretheargumentsleveledagainstprofitmaximizationobjective?
7)Whataretheotherobjectivesoffinancialmanagement?

26. FIVE MARKS QUESTIONS
1)Define Financial management and its objectives?
2)Financial management means maximization of economic welfare of its
shareholders.
3)Compare and contrast profit maximizationand wealth maximization?
4)Critically examined wealth maximization is superior to profit maximisation.
5)What is financial management?
6)Define financial management. Explain its significance.
7)Explain the various areas of financial management.
8)Analyse the nature of financial management.
9)Describe the evolution of financial management.
10)Financial management –is it a science or an art.
11)What are key areas of financial management.
12)Explain the role of financial manager in the current scenario.