FM Unit 1.ppt it include all the releventinformation regarding the concepts.

itis a beneficial topic for the understanding of FM

1. CONCEPT OF FINANCECONCEPT OF FINANCE
In our present day economy, finance is In our present day economy, finance is
defined as the provision of money at the defined as the provision of money at the
time when it is required. Every enterprise, time when it is required. Every enterprise,
whether big, medium or small, needs whether big, medium or small, needs
finance to carry on its operations and to finance to carry on its operations and to
achieve its targets. In fact, finance is so achieve its targets. In fact, finance is so
indispensable today that it is rightly said to indispensable today that it is rightly said to
be the lifeblood of an enterprise. Without be the lifeblood of an enterprise. Without
adequate finance, no enterprise can adequate finance, no enterprise can
possibly accomplish its objectives. possibly accomplish its objectives.

2. The subject of finance has been The subject of finance has been
traditionally classified into two classes: traditionally classified into two classes:
1.1.Public financePublic finance
2.2.Private finance Private finance

3. MEANING OF BUSINESS FINANCEMEANING OF BUSINESS FINANCE
Business finance is related to the arrangement Business finance is related to the arrangement
of the finance of such enterprises which are of the finance of such enterprises which are
running their business to earn profits. In the running their business to earn profits. In the
broader senses, business finance includes all broader senses, business finance includes all
the activities related to the arrangement of the the activities related to the arrangement of the
finance of all business concerns or finance of all business concerns or
organizations, such as sole proprietor, organizations, such as sole proprietor,
partnership concerns, private and public joint partnership concerns, private and public joint
stock companies or corporation, etc.stock companies or corporation, etc.

4. “ “ Business finance is that business activity which Business finance is that business activity which
is concerned with the acquisition and is concerned with the acquisition and
conservation of capital funds meeting financial conservation of capital funds meeting financial
needs and over all activities or objectives of a needs and over all activities or objectives of a
business enterprises”.business enterprises”.
WheelerWheeler


““Business finance can be broadly defined as the Business finance can be broadly defined as the
activity concerned with the planning, raising, activity concerned with the planning, raising,
controlling and administering the funds used in controlling and administering the funds used in
the business.” the business.”
Guthmann and Dougall Guthmann and Dougall

5. SCOPE OF FINANCE FUNCTION / SCOPE OF FINANCE FUNCTION /
FINANCIAL MANAGEMENTFINANCIAL MANAGEMENT
The main objective of financial management The main objective of financial management
is to arrange sufficient finances for meeting is to arrange sufficient finances for meeting
short term and long term needs. These short term and long term needs. These
funds are procured at minimum costs so funds are procured at minimum costs so
that profitability of the business is that profitability of the business is
maximized. Financial management in the maximized. Financial management in the
modern sense of the term can be split into modern sense of the term can be split into
three major decisions as functions of three major decisions as functions of
finance- investment decisions, financing finance- investment decisions, financing
decisions and dividend decisions. decisions and dividend decisions.

6. 1.1.Investment decisions:Investment decisions: Investment Investment
decisions are concerned with selecting the decisions are concerned with selecting the
right type of assets in which funds will be right type of assets in which funds will be
invested by the firm. The assets which can invested by the firm. The assets which can
be acquired fall into two group: (a) Long be acquired fall into two group: (a) Long
term assets (fixed assets), which would term assets (fixed assets), which would
yield a return over a period of time in yield a return over a period of time in
future, and (b) short term assets (also future, and (b) short term assets (also
known as current assets), which are in known as current assets), which are in
normal course of business operations normal course of business operations
convertible into cash usually within a year. convertible into cash usually within a year.

7. 2.2.Financing decisions:Financing decisions: Financial manager Financial manager
has to make a decision regarding raising of has to make a decision regarding raising of
finance (funds) i.e., he has to decide the finance (funds) i.e., he has to decide the
source mix or capital structure or leverage. source mix or capital structure or leverage.
The two important sources of financing are The two important sources of financing are
debt and equity. Debt is fixed interest debt and equity. Debt is fixed interest
source of financing and equity is variable source of financing and equity is variable
dividend source of financing. It, thus, dividend source of financing. It, thus,
becomes important for financial manager becomes important for financial manager
to decide the appropriate mix of debt and to decide the appropriate mix of debt and
equity in such a way as to maximize the equity in such a way as to maximize the
shareholders wealth. shareholders wealth.

8. 3.3.Dividend decisions:Dividend decisions: The third major The third major
decision of financial management is the decision of financial management is the
decision relating to declaration and decision relating to declaration and
payment of dividend. Financial manager payment of dividend. Financial manager
has to advise the top management (Board has to advise the top management (Board
of Directors) as what portion of profits of Directors) as what portion of profits
should be distributed as dividend to the should be distributed as dividend to the
shareholders and what portion should be shareholders and what portion should be
retained in the business for further retained in the business for further
investments. In this sense, dividend investments. In this sense, dividend
decision becomes a part of financing decision becomes a part of financing
decision as well as part of investment decision as well as part of investment
decision. decision.

9. OBJECTIVES OF FINANCIAL OBJECTIVES OF FINANCIAL
MANAGEMENTMANAGEMENT
Objectives of financial management can be Objectives of financial management can be
explained from two points of view—Macro explained from two points of view—Macro
level theory and Micro level theory. level theory and Micro level theory.
According to macro level theory, the According to macro level theory, the
objective of financial management is to objective of financial management is to
manufacture a product or to create service manufacture a product or to create service
by making intensive, best and efficient use of by making intensive, best and efficient use of
available scarce resources and to make such available scarce resources and to make such
product / service available to the society at product / service available to the society at
appropriate / reasonable price, so that the appropriate / reasonable price, so that the
whole society is benefited. whole society is benefited.

10. On the contrary, according to micro On the contrary, according to micro
level theory, the financial objective is level theory, the financial objective is
determined as per the individual view determined as per the individual view
point of a company, firm or enterprise. point of a company, firm or enterprise.
There are two mutually opposite There are two mutually opposite
thoughts regarding objectives of thoughts regarding objectives of
financial management at micro level. financial management at micro level.

11. 1.1.Profit maximization objectives: Profit maximization objectives: There is a There is a
very simple logic for treating profit as very simple logic for treating profit as
objective of financial management. Profit is objective of financial management. Profit is
the test of economic performance and its the test of economic performance and its
efficiency. It is also a vehicle for efficient efficiency. It is also a vehicle for efficient
allocation and optimum utilization of allocation and optimum utilization of
society’s limited resources. This ensures society’s limited resources. This ensures
the maximum social welfare. Thus, profit the maximum social welfare. Thus, profit
maximization objective is justified on the maximization objective is justified on the
following grounds: following grounds:

12. A.A.Rationality: Rationality: When a person performs an When a person performs an
economic activity in a rational way, he tries economic activity in a rational way, he tries
to maximize the utility. It is argued that this to maximize the utility. It is argued that this
utility is measured in terms of benefits or utility is measured in terms of benefits or
profits. profits.
B.B.Maximisation of social benefit: Maximisation of social benefit: A business A business
enterprise does not aim to earn profit at the enterprise does not aim to earn profit at the
cost of society; rather profits make the cost of society; rather profits make the
enterprise healthy enough to meet out social enterprise healthy enough to meet out social
responsibility. An enterprise can maximize responsibility. An enterprise can maximize
the social welfare through expenditure on the social welfare through expenditure on
social activities like education, health, labour social activities like education, health, labour
welfare, entertainment, housing, etc. welfare, entertainment, housing, etc.

13. C.C.Efficient allocation and uses of resources: Efficient allocation and uses of resources:
Profit enables the efficient allocation of Profit enables the efficient allocation of
resources. Financial manager may shift resources. Financial manager may shift
resources from less profitable projects to more resources from less profitable projects to more
profitable projects and this would increase the profitable projects and this would increase the
efficiency of fund utilization. efficiency of fund utilization.
D.D.Measurement of success of decisions: Measurement of success of decisions: Profit Profit
is considered a good measure of the success of is considered a good measure of the success of
an enterprise and also of financial decisions. An an enterprise and also of financial decisions. An
enterprise can earn profit only through efficient enterprise can earn profit only through efficient
production, sales and performance. production, sales and performance.

14. E.E.Source of incentive: Source of incentive: Profit acts as a source of Profit acts as a source of
incentive in the business. Enterprise try to be incentive in the business. Enterprise try to be
more efficient as compared to other enterprises more efficient as compared to other enterprises
just to maximize the profits. Thus, profit is the just to maximize the profits. Thus, profit is the
base of business efficiency. base of business efficiency.
2.2.Wealth maximization objectives:Wealth maximization objectives: It is also called It is also called
value maximization objective or net present value maximization objective or net present
worth maximization. The word ‘Wealth’ or ‘Value’ worth maximization. The word ‘Wealth’ or ‘Value’
signifies worth to the owners of business (i.e., signifies worth to the owners of business (i.e.,
market price of equity shares). Value market price of equity shares). Value
maximization objective is based on the concept of maximization objective is based on the concept of
cash flows, i.e., benefits are measured in terms of cash flows, i.e., benefits are measured in terms of
cash inflows and costs are expressed in terms of cash inflows and costs are expressed in terms of
cash outflow. cash outflow.

15. FUNCTIONS OF FINANCE FUNCTIONS OF FINANCE
MANAGER IN MODERN AGEMANAGER IN MODERN AGE
In the present business context, a In the present business context, a
financial manager is expected to perform financial manager is expected to perform
the following functions. the following functions.

16. 1.1.Financial forecasting and planning:Financial forecasting and planning: A A
financial manager has to estimate the financial manager has to estimate the
financial needs of a business. How much financial needs of a business. How much
money will be required for acquiring money will be required for acquiring
various assets? The amount will be needed various assets? The amount will be needed
for purchasing fixed assets and meeting for purchasing fixed assets and meeting
working capital needs. working capital needs.
2.2.Acquisition of funds: Acquisition of funds: After making After making
financial planning, the next step will be to financial planning, the next step will be to
acquire funds. There are a number of acquire funds. There are a number of
sources available for supplying funds. These sources available for supplying funds. These
sources may be shares, debentures, sources may be shares, debentures,
financial institutions, commercial banks, etc. financial institutions, commercial banks, etc.

17. 3.3.Investment of funds: Investment of funds: The funds should be The funds should be
used in the best possible way. The cost of used in the best possible way. The cost of
acquiring them and the returns should be acquiring them and the returns should be
compared. The channels which generate compared. The channels which generate
higher returns should be preferred. The higher returns should be preferred. The
technique of capital budgeting may be technique of capital budgeting may be
helpful in selecting a project.helpful in selecting a project.
4.4.Helping in valuation decisions: Helping in valuation decisions: A number A number
of mergers and consolidations take place in of mergers and consolidations take place in
the present competitive industrial world. A the present competitive industrial world. A
finance manager is supposed to assist finance manager is supposed to assist
management in making valuation etc. management in making valuation etc.

18. 6.6.Maintain proper liquidity:Maintain proper liquidity: Every concern Every concern
is required to maintain some liquidity for is required to maintain some liquidity for
meeting day to day needs. Cash is the meeting day to day needs. Cash is the
best source for maintaining liquidity. It is best source for maintaining liquidity. It is
required to purchase raw materials, pay required to purchase raw materials, pay
workers, meet other expenses, etc. A workers, meet other expenses, etc. A
finance manager is required to determine finance manager is required to determine
the need for liquid assets and then the need for liquid assets and then
arrange liquid assets in such a way that arrange liquid assets in such a way that
there is no scarcity of funds. there is no scarcity of funds.

19. INTER-RELATIONINTER-RELATION OF FINANCIAL OF FINANCIAL
DECISIONSDECISIONS
We have studied above the three major We have studied above the three major
groups of financial decisions, viz., groups of financial decisions, viz.,
investment decisions, financing decisions investment decisions, financing decisions
and dividend decisions. Although these are and dividend decisions. Although these are
different kinds of financial management different kinds of financial management
decisions yet these decisions are inter-decisions yet these decisions are inter-
related because the underlying objective related because the underlying objective
of all these decisions is the same, i.e., of all these decisions is the same, i.e.,
maximization of shareholders wealth. maximization of shareholders wealth.

20. CONCEPT OF TIME VALUE OF CONCEPT OF TIME VALUE OF
MONEYMONEY
The simple concept of time value of money is The simple concept of time value of money is
that the value of the money received today is that the value of the money received today is
more than the value of same amount of more than the value of same amount of
money received after a certain period. In money received after a certain period. In
other words, money received in the future is other words, money received in the future is
not as valuable as money received today. not as valuable as money received today.
The sooner one receives money, the better it The sooner one receives money, the better it
is. is.

21. Taking the case of rational human Taking the case of rational human
being, given the option to receive a being, given the option to receive a
fixed amount of money at either of the fixed amount of money at either of the
two time periods, he will prefer to two time periods, he will prefer to
receive it at the earliest. If you are given receive it at the earliest. If you are given
choice of receiving Rs.1000 today or choice of receiving Rs.1000 today or
after one year, you will definitely opt to after one year, you will definitely opt to
receive today than after one year. receive today than after one year.

22. REASONS FOR TIME PREFERENCE REASONS FOR TIME PREFERENCE
OF MONEYOF MONEY
1.1.The future is always uncertain and The future is always uncertain and
involves risk. involves risk.
2.2.People generally prefer to use their People generally prefer to use their
money for satisfying their present money for satisfying their present
needs in buying more food, or clothes needs in buying more food, or clothes
or another car, than deferring them or another car, than deferring them
for future. for future.

23. 3.3.Money has time value because of the Money has time value because of the
opportunities available to invest money opportunities available to invest money
received at earlier dates at some interest or received at earlier dates at some interest or
otherwise to enhance future earnings. For otherwise to enhance future earnings. For
example, if you have Rs.100 today, you can example, if you have Rs.100 today, you can
put it in your bank account and earn put it in your bank account and earn
interest. After one year the interest would interest. After one year the interest would
be Rs.8 (taking rate of interest at 8% p.a.) be Rs.8 (taking rate of interest at 8% p.a.)
and you would have Rs.108 at the end of and you would have Rs.108 at the end of
the year. So, if you have a choice between the year. So, if you have a choice between
Rs.100 today or after one year, it is the Rs.100 today or after one year, it is the
same as a choice between Rs.108 next year same as a choice between Rs.108 next year
or Rs.100 next year. Any rational person or Rs.100 next year. Any rational person
would prefer the larger amount. would prefer the larger amount.

24. TECHNIQUES OF TIME VALUE OF TECHNIQUES OF TIME VALUE OF
MONEYMONEY

25. RISK AND RETURN ANALYSISRISK AND RETURN ANALYSIS
There is a positive relationship between There is a positive relationship between
the amount of risk assumed and the the amount of risk assumed and the
amount of expected return. Greater the amount of expected return. Greater the
risk, the larger the expected return and risk, the larger the expected return and
larger and chances of substantial loss. larger and chances of substantial loss.
Investments which carry low risks such Investments which carry low risks such
as Government securities will offer a as Government securities will offer a
low expected rate of return than those low expected rate of return than those
which carry high risk such as equity which carry high risk such as equity
stock of a new company. stock of a new company.

26. The financial manager must understand The financial manager must understand
the concepts of risk and return and the concepts of risk and return and
their relationship. The concepts and their relationship. The concepts and
relationship of risk and return and is relationship of risk and return and is
organized into five sections as follows:organized into five sections as follows:

27. 1.1.Risk and return of a single assetRisk and return of a single asset
2.2.Risk and return of a portfolioRisk and return of a portfolio
3.3.Portfolio selectionPortfolio selection
4.4.Capital Asset Pricing Model (CAPM)Capital Asset Pricing Model (CAPM)
5.5.Arbitrage Pricing Theory (APT)Arbitrage Pricing Theory (APT)