INTRODUCTION TO FINANCIAL MANAGEMENT

Financial Management — objectives — profit maximization, wealth maximization — finance function — role of finance manager — strategic financial management — economic value added — time value of money.

1. Master of Business Administration BUS 2C 11 Financial Management Prepared By: Mohammed Jasir PV Asst. Professor MIIMS

2. Module 1 Financial Management — objectives — profit maximization, wealth maximization — finance function — role of finance manager — strategic financial management — economic value added — time value of money.

3. Finance According to F.W.Paish , Finance may be defined as the position of money at the time it is wanted . In the words of John J. Hampton, the term finance can be defined as the management of the flows of money through an organization, whether it will be a corporation, school, bank or government agency.

4. FINANCIAL MANAGEMENT Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprise . It means applying general management principles to financial resources of the enterprise

5. Financial Management – Definition According to Weston and Brigham, financial management is an area of financial decision making, harmonizing individual motives and enterprise goals.

6. In the words of Phillippatus , financial management is concerned with the managerial decisions that result in the acquisition and financing of long-term and short-term credits for the firm. As such it deals with the situations that require selection of specific assets / combination of assets, the selection of specific liability / combination of liabilities as well as the problem of size and growth of an enterprise. The analysis of these decisions is based on the expected inflows and outflows of funds and their effects upon managerial objectives.

7. OBJECTIVES OF FINANCIAL MANAGEMENT Its objectives must be consistent with the overall objectives of business. The overall objective of financial management is to provide maximum return to the owners on their investment in the long- term. This is known as wealth maximization . Wealth maximization means maximizing the market value of investment in shares of the company.

8. In order to maximize wealth, financial management must achieve the following specific objectives (a) To ensure availability of sufficient funds at reasonable cost (liquidity). (b) To ensure effective utilization of funds (financial control). (c) To ensure safety of funds by creating reserves, re-investing profits, etc. (minimization of risk). (d) To ensure adequate return on investment (profitability ).

9. Contd.. (e) To generate and build-up surplus for expansion and growth (growth). (f) To minimize cost of capital by developing a sound and economical combination of corporate securities (economy). (g) To coordinate the activities of the finance department with the activities of other departments of the firm (cooperation).

10. Profit Maximization Very often maximization of profits is considered to be the main objective of financial management. Profitability is an operational concept that signifies economic efficiency. Some writers on finance believe that it leads to efficient allocation of resources and optimum use of capital. It is said that profit maximization is a simple and straightforward objective. It also ensures the survival and growth of a business firm. But modern authors on financial management have criticized the goal of profit maximization.

11. FUNCTIONS OF FINANCIAL MANAGEMENT Estimating the Amount of Capital Required Determining Capital Structure Choice of Sources of Funds Procurement of Funds Utilizations of Fund Disposal of Profits or Surplus Management of Cash Financial Control

12. 1. Estimating the Amount of Capital Required: This is the foremost function of the financial manager. Business firms require capital for : i ) purchase of fixed assets, ii ) meeting working capital requirements, and iii ) modernization and expansion of business. The financial manager makes estimates of funds required for both short-term and long-term.

13. 2. Determining Capital Structure : Once the requirement of capital funds has been determined, a decision regarding the kind and proportion of various sources of funds has to be taken. For this, financial manager has to determine the proper mix of equity and debt and short-term and long-term debt ratio. This is done to achieve minimum cost of capital and maximize shareholders wealth

14. 3. Choice of Sources of Funds Before the actual procurement of funds, the finance manager has to decide the sources from which the funds are to be raised. The management can raise finance from various sources like equity shareholders, preference shareholders, debenture- holders, banks and other financial institutions, public deposits, etc.

15. 4. Procurement of Funds: The financial manager takes steps to procure the funds required for the business. It might require negotiation with creditors and financial institutions, issue of prospectus, etc. The procurement of funds is dependent not only upon cost of raising funds but also on other factors like general market conditions, choice of investors, government policy, etc.

16. 5. Utilizations of Funds: The funds procured by the financial manager are to be prudently invested in various assets so as to maximize the return on investment. While taking investment decisions, management should be guided by three important principles, viz., safety , profitability , and liquidity .

17. 6. Disposal of Profits or Surplus : The financial manager has to decide how much to retain for plugging back and how much to distribute as dividend to shareholders out of the profits of the company. The factors which influence these decisions include the trend of earnings of the company, the trend of the market price of its shares, the requirements of funds for self- financing the future programmers’ and so on.

18. 7. Management of Cash : Management of cash and other current assets is an important task of financial manager. It involves forecasting the cash inflows and outflows to ensure that there is neither shortage nor surplus of cash with the firm. Sufficient funds must be available for purchase of materials, payment of wages and meeting day-to-day expenses.

19. 8. Financial Control Evaluation of financial performance is also an important function of financial manager. The overall measure of evaluation is Return on Investment (ROI). The other techniques of financial control and evaluation include budgetary control, cost control, internal audit, break-even analysis and ratio analysis. The financial manager must lay emphasis on financial planning as well.

20. Basic Financial Decisions Investing Decision Financing Decision Dividend Decision

21. Investing Decision Related to investment Both long-term and short-term Long Term Capital Budgeting Investment in Long-term Fixed Asset Short-term W/c mgt Cash, bank, deposits, receivables.

22. Financing Decision Related to collection of fund (Source) Debt – equity mix Rising of fund both Long-term fund Capital Structure Short-term fund Working capital Mainly two type Financial Planning (Estimating the requirement) Capital structure Decision (Identifying the sources)

23. Dividend Decision Decision related to profit Distributing profit as dividend Retained Earnings – Surplus – Reserve – Plugging back

24. ROLE OF FINANCE MANAGER

25. ROLE OF FINANCIAL MANAGER Fund rising Fund allocation Profit planning ( it refers to operating decision in areas in pricing costs volume of output and the firms selection of product lines. it is a bonus for optimizing investment and financing decisions ) Understanding the capital market

26. Contd … Prepare financial statements, business activity reports, and forecasts Monitor financial details to ensure that legal requirements are met Supervise employees who do financial reporting and budgeting Review company financial reports and seek ways to reduce costs Analyze market trends to find opportunities for expansion or for acquiring other companies Help management to make financial decisions.

27. Broadly speaking, financial managers have to have decisions regarding 4 main topics within a company Investment decisions / Capital Budgeting Decision - (long and short term investment decisions). For example: the most appropriate level and mix of assets a company should hold. Financing decisions / Capital Structure - The optimal levels of each financing source - E.g. Debt - Equity ratio. Liquidity decisions - Involves the current assets and liabilities of the company - one function is to maintain cash reserves. Dividend decisions - Disbursement of dividend to shareholders and retained earnings

28. Functions of Finance Manager 1. Forecasting Of Cash Flow. 2. Raising Funds 3. Managing The Flow Of Internal Funds 4. To Facilitate Cost Control 5. To Facilitate Pricing Of Product, Product Lines And Services 6. Forecasting Profits 7. Measuring Required Return 8. Managing Assets 9. Managing Funds 10. Make Arrangements For The Purchase Of Assets

29. Forecasting of Cash Flow. This is necessary for the successful day to day operations of the business so that it can discharge its obligations as and when they rise. In fact, it involves matching of cash inflows against outflows and the manager must forecast the sources and timing of inflows from customers and use them to pay the liability 2. Raising Funds: the Financial Manager has to plan for mobilising funds from different sources so that the requisite amount of funds are made available to the business enterprise to meet its requirements for short term, medium term and long term.

30. 3. Managing the Flow of Internal Funds: Here the Manager has to keep a track of the surplus in various bank accounts of the organisation and ensure that they are properly utilised to meet the requirements of the business. This will ensure that liquidity position of the company is maintained intact with the minimum amount of external borrowings. 4 . To Facilitate Cost Control: The Financial Manager is generally the first person to recognise when the costs for the supplies or production processes are exceeding the standard costs/budgeted figures. Consequently, he can make recommendations to the top management for controlling the costs.

31. 5. To Facilitate Pricing of Product, Product Lines and Services: The Financial Manager can supply important information about cost changes and cost at varying levels of production and the profit margins needed to carry on the business successfully. In fact, financial manager provides tools of analysis of information in pricing decisions and contribute to the formulation of pricing policies jointly with the marketing manager. 6 . Forecasting Profits: The Financial manager is usually responsible for collecting the relevant data to make forecasts of profit levels in future.

32. 7. Measuring Required Return: The acceptance or rejection of an investment proposal depends on whether the expected return from the proposed investment is equal to or more than the required return. An investment project is accepted if the expected return is equal or more than the required return. Determination of required rate of return is the responsibility of the financial manager and is a part of the financing decision.

33. 8. Managing Assets: The function of asset management focuses on the decision-making role of the financial manager. Finance personnel meet with other officers of the firm and participate in making decisions affecting the current and future utilization of the firm’s resources. As an example, managers may discuss the total amount of assets needed by the firm to carry out its operations. They will determine the composition or a mix of assets that will help the firm best achieve its goals. They will identify ways to use existing assets more effectively and reduce waste and unwarranted expenses. The decision-making role crosses liquidity and profitability lines. Converting the idle equipment into cash improves liquidity. Reducing costs improves profitability

34. 9. Managing Funds: In the management of funds, the financial manager acts as a specialised staff officer to the Chief Executive of the company. The manager is responsible for having sufficient funds for the firm to conduct its business and to pay its bills. Money must be located to finance receivables and inventories, 10. make arrangements for the purchase of assets, and to identify the sources of long-term financing. Cash must be available to pay dividends declared by the board of directors. The management of funds has therefore, both liquidity and profitability aspects .

35. Functions of Finance According to Paul G. Hasings , “finance” is the management of the monetary affairs of a company. It includes determining what has to be paid for and when, raising the money on the best terms available, and devoting the available funds to the best uses. Kenneth Midgley and Ronald Burns state: “Financing is the process of organising the flow of funds so that a business can carry out its objectives in the most efficient manner and meet its obligations as they fall due.”

36. Functions of Finance It is the process of acquiring and utilizing funds of a business. These are related to overall management of an organization. It is concerned with the policy decisions such as like of business, size of firm, type of equipment used , use of debt, liquidity position. These policy decisions determine the size of the profitability and riskiness of the business of the firm

37. Finance functions can be grouped as outlined below: Financial planning Financial control Financing decisions Investment decision Management of income and dividend decision Incidental functions

38. Finance Function – Objectives 1. Assessing the Financial Requirements 2. Proper Utilisation of Funds 3. Increasing Profitability 4. Maximising Value of Firm

39. Strategic Financial Management The term "strategic"  refers to financial management practices that are focused on long-term success , as opposed to "tactical" management decisions, which relate to short-term positioning.

40. Strategic Financial Management It refers to specific planning of the usage and management of a company's financial resources to attain its objectives as a business concern and return maximum value to shareholders over the long run. 

41. Breaking down the definition It’s a planning Related to finance of a company How to use or manage the finance of company For a long-term For attain maximum value to shareholders Wealth maximisation

42. Strategic financial management involves precisely defining A company's business objectives or goals, Identifying and quantifying its available or potential resources, and Prepare a plan for utilizing  finances  and other capital resources to achieve its goals

43. After the initial planning phase, strategic management requires Establishing ongoing procedures for collecting and analyzing data, Making consistent financial decisions, Tracking and analysing differences, between budgeted and actual results To identify problems and, Take appropriate corrective actions as A dynamic process of adjustment and fine-tuning.

44. Key Elements Of Strategic Financial Management Budgeting Risk management Ongoing review and evaluation.

45. Strategic financial management It is the study of finance with a long term view considering the strategic goals of the enterprise. Financial management is nowadays increasingly referred to as "Strategic Financial Management" so as to give it an increased frame of reference . To understand what strategic financial management is about, we must first understand what is meant by the term "Strategic". Which is something that is done as part of a plan that is meant to achieve a particular purpose.

46. Therefore, Strategic Financial Management are those aspect of the overall plan of the organisation that concerns financial managers. This includes different parts of the business plan, for example marketing and sales plan, production plan, personnel plan, capital expenditure, etc. These all have financial implications for the financial managers of an organisation. The objective of the Financial Management is the maximisation of shareholders wealth. To satisfy this objective a company requires a "long term course of action" and this is where strategy fits in.

47. STRATEGIC FINANCIAL PLANNING It involving financial policy has direct interact with scope and resources deployment .financial policies –investment and financial choices- should there for be considered at the corporate level ,and should not be treated as functional area policy decisions to be decided at lower level

48. STEPS IN FINANCIAL PLANNING Analyzing the past performance Analyzing the operating characteristics Determine the corporate strategic and investment needs Forecasting the cash flow from operations Analyzing financing alternatives Analyzing the consequences of financial plan Evaluating consistency of financial policies

49. ECONOMIC VALUE ADDED (EVA) It is a residual measure of financial performance. it is defined as the operating profit after tax less the charge for the capital, both equity and debt ,used in a business. it represents the value added to the share holders by generating operating profits in excess of the cost of capital employed in the business .

50. EVA increases if operating profits can be made to grow without enquiry more capital, greater efficiency it is a management tool that disclose the impact of both strategic and both operational decision of the management. It can prove as an effective tool for increasing share holders wealth by integrating EVA in for key areas such as 1 measuring business performance 2 guiding managerial decision making 3 aligning managerial incentives with share holders interest 4 improving financial and business literacy EVA = net operating after tax – cost of capital employed

51. TIME VALUE OF MONEY The discounted cash flow criteria of investment evaluation are based on the concept of time value of money. The time value of money have its logic in the fact that investors have ample investment opportunity available to them. Therefore the one rupee received today is not of the same in the value as one rupee received after a period of time ,since one rupee received can be invested at a rate of interest there are basically to ways of counting the time value of money 1- computing 2-discounting

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