Introduction to FM financial management studies

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1. Chapter 1 – Financial Management (An Overview)

2. Finance Function Finance is the art and science of managing money.

3. THE FUNDAMENTAL PRINCIPLE OF FINANCE A business proposal-regardless of whether it is a new investment or acquisition of another company or a restructuring initiative –raises the value of the firm only if the present value of the future stream of net cash benefits expected from the proposal is greater than the initial cash outlay required to implement the proposal. CASH ALONE MATTERS Investors Investors provide the initial cash required The business proposal • Shareholders to finance the business proposal • Lenders   The proposal generates c ash returns to investors  

4. EVOLUTION OF FINANCIAL MANAGEMENT • Financial management emerged as a distinct field of study at the turn of the 20 th century. Its evolution may be divided into two broad phases - the traditional phase, and the modern phase. • The modern phase began in mid-1950s and has been marked by infusion of ideas from economic theory and application of quantitative methods • The distinctive features of the modern phase are: Central concern : Acquiring and utilization of fund, Shareholder wealth maximization Approach : Analytical and quantitative

5. Scope of Financial Management The financial management can be broken down into three major decisions as functions of finance: investment decision, financing decision, and dividend policy decision

6. Investment Decision Investment decision relates to the selection of assets in which funds will be invested by a firm. The assets which can be acquired fall into broad groups: Long-term assets Short-term or current assets Capital budgeting relates to the selection of an asset whose benefits would be available over the project's life. Working capital management is concerned with the management of current assets.

7. Financing Decision Financing decision relates to the choice of the proportion of debt and equity sources of financing. There are two aspects of the financing decision: capital structure theory capital structure decision The term capital structure refers to the proportion of debt (fixed-interest sources of financing) and equity capital (variable-dividend securities/ source of funds).

8. Dividend Policy Decision Two alternatives are available in dealing with the profits of a firm: they can be distributed to the shareholders in the form of dividends they can be retained in the business itself The decision as to which course should be followed is referred to as dividend policy decision.

9. Finance and Related Disciplines Finance and Economics Finance and Accounting Finance and Other Related Disciplines

10. Finance and Economics Finance is closely related to both Macroeconomics Microeconomics Macroeconomics provides an understanding of the institutional structure in which the flow of finance takes place. Microeconomics provides various profit maximisation strategies based on the theory of the firm. A financial manager uses these to run the firm efficiently and effectively .

11. Finance and Accounting Financial manager depends on accounting as a source of information/data relating to the past, present and future financial position of the firm. Finance is concerned with cash flows , while the accounting provides accrual-based information . The focus of finance is on the decision making but accounting concentrates on collection of data .

12. Finance and Other Related Disciplines Apart from economics and accounting, finance also draws – for its day-to-day decisions – on supportive disciplines such as Marketing, Production and Quantitative methods.

13. Impact of Other Disciplines on Financial Management

14. Key Activities of the Financial Manager Evaluation of financial needs Choose an appropriate source of fund Determining structure of capital Making investment decisions Appropriate cash management Practice financial controls Appropriate use of surplus

15. Objectives of Financial Management There are two widely-discussed approaches: Profit (total)/ Earning Per Share (EPS) maximization approach Wealth maximization approach

16. Profit / EPS Maximization Decision Criterion According to this approach, actions that increase profits (total)/ EPS should be undertaken and those that decreases profits/ EPS are to be avoided. The main technical flaws of this criterion are ambiguity, timing of benefits, and quality of benefits.

17. Wealth Maximisation Decision Criterion This is also known as value maximization or net present worth maximization. Its operational features satisfy all the three requirements of a suitable operational objective of financial course of action, namely, exactness, quality of benefits and the time value of money Two important issues are related to the value/ share price-maximization, namely economic value added and focus on stakeholders Economic value added is equal to after-tax operating profits of a firm less the cost of funds used to finance investments. Stakeholders include groups such as employees, customers, suppliers, creditors, owners and others who have a direct link to the firm.

18. Points of Difference Profit Maximization Wealth Maximization Definition It is the management of financial resources through a range of activities to increase the profits of the company. It manages financial resources in such a way that these increase the value of the overall stakeholders of the company.  Process of Maximization It is attained through the process of increasing the earning capacity of the company. Wealth is maximized by increasing the value of stocks for the shareholders and stakeholders. Term of the Goal It is a short-term goal.  It is a long-term goal. Risks Involvement Risks and uncertainties do not form part of the entire process of profit maximization. It recognises the need for assessing all possible risks and uncertainties. Benefits of Maximization It ensures the survival and growth of the business. It aims to stimulate and attain a substantial growth rate by enhancing its share market holding in the economy. Time Value of Money Profit maximization does not take into account the time value of money. Wealth maximization acknowledges it. Center of Focus It focuses on efficiency improvement with less cost and maximum profitable output. It heavily concentrates on increasing and improving the share market price of the company. Extend and Time of Benefits The growth of the company through profit maximization is limited to the current financial year. The benefits of Wealth Maximization extend beyond the current year with a huge market share and a higher market price of the share. Main Motive A company with a profit maximization goal prefers to maximise and rely solely on the profits. A company with a Wealth Maximization goal is to increase the value of the shareholders' wealth.

19. SHAREHOLDER ORIENTATION IN INDIA In the wake of liberalisation, globalisation, and institutionalisation of the capital market, there is a greater incentive to focus on creating value for shareholders. The following observations are clear indications. Dhirubai Ambani : In everything that we do, we have only one supreme goal, that is to maximise your wealth as India's largest investor family. Anand Mahindra : All of us are beginning to look at companies as owned by shareholders. The key is to raise shareholder returns

20. Agency Problems An agency problem is a conflict of interest between an agent and a principal, where an agent is a person or group who performs a task on behalf of someone else, the principal. A conflict of interest occurs when one party doesn't fulfill contractual obligations in favor of their own personal or professional interests. It's best practice for the agent to make decisions that yield the best outcome for the principal, even if an alternative decision may positively benefit them instead. The agency problem can be prevented/ minimized by acts of market forces and agency costs

21. Market Forces Market forces act to prevent/ minimize agency problems in two ways: behaviour of security market participants and hostile takeovers. Hostile takeover is the acquisition of the firm (target) by another firm (the acquirer) that is not supported by management.

22. Agency Costs Agency costs are costs borne by shareholders to prevent/ minimise agency problems as to contribute to maximise owners wealth. To respond to potential market forces by preventing/ maximizing agency problems and contributing to the maximization of owner’s wealth/ value, the shareholders/ owners have to incur four types of costs: monitoring, bonding, opportunity and structuring

23. Organisation of Finance Function In large firms, there is a separate department of finance headed by a specialist known by different designations such as vice-president, director of finance, chief finance officer and so on. The main concern of the treasurer is with the financing activities of the firm. The functions of the controller are related mainly to accounting and control.

24. Organisation of Financial Management Function

25. Emerging Role of Finance Managers in India The key challenges are in the areas of financial structure, foreign exchange management, treasury operations, investor communication, management control and investment planning.