FINANCIAL MANAGEMENT

Module I: Introduction

Finance and Related Disciplines

The study of role of finance in the organization is with reference to financial management. The financial
management is the course which has drawn major focus points from the many more disciplines.

The following are the related disciplines:

1. Finance and Economics
The relationship in between these two disciplines are studied in two different headings i.e. Micro and Macro
economics.
The major part of the financial management is to raise the financial resource to the requirements. While raising the
financial resources, the availability is subject to the macroeconomic influences.
- Banking system
- Money and capital markets
- Financial intermediaries
- Monetary and credit policies

2. Finance and Accounting

The two are embedded with different disciplines. The finance is the discipline which is mainly based on the cash
basis of operations but the accounting is totally governed by the accrual system.
Accounting is mainly vested with the collection and presentation of data, but the finance is closely connected with
the decision making of the organization.
Till this moment, the differences are discussed only to know the role of finance over the accounting of any
organization. The following is the major relationship which lies in between the finance and accounting as follows
"Finance begins where accounting ends"

3. Finance and other related discipline like marketing, production etc.

 Finance and Marketing: These two are disciplines are interrelated to plan for introduction of new product. The
major reason is that the introduction of new product normally warrants huge sum of money for research and
development; which needs immense planning and execution to succeed over the other competitors
 Finance and Production: The changes in the production policy of the organization will impact the capital
expenditures. The fixed assets of the organization should be effectively utilized which neither over capitalization
nor under capitalization

Scope of Financial management

1. Investment Decision:
The investment decision involves the evaluation of risk, measurement of cost of capital and estimation of expected
benefits from a project. Capital budgeting and liquidity are the two major components of investment decision.
Capital budgeting is concerned with the allocation of capital and commitment of funds in permanent assets which
would yield earnings in future.
 Long term decisions (choice of alternative, analysis of risk & uncertainty, hurdle or cut-off rate) Capital Budgeting
 Short Term decisions (Profitability vs. Liquidity) Working Capital Management

2. Financing Decision:
Financing decision is concerned with the financing mix or financial structure of the firm. The raising of funds requires
decisions regarding the methods and sources of finance, relative proportion and choice between alternative sources,
time of floatation of securities, etc. In order to meet its investment needs, a firm can raise funds from various
sources.
The finance manager must develop the best finance mix or optimum capital structure for the enterprise so as to
maximise the long- term market price of the company’s shares. A proper balance between debt and equity is
required so that the return to equity shareholders is high and their risk is low.

3. Dividend Decision:
In order to achieve the wealth maximisation objective, an appropriate dividend policy must be developed. One
aspect of dividend policy is to decide whether to distribute all the profits in the form of dividends or to distribute a
part of the profits and retain the balance. While deciding the optimum dividend pay out ratio (proportion of net
profits to be paid out to shareholders).
The finance manager should consider the investment opportunities available to the firm, plans for expansion and
growth, etc. Decisions must also be made with respect to dividend stability, form of dividends, i.e., cash dividends or
stock dividends, etc

Objective of Financial management

1. Profit maximization (profit after tax)
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 maximisation is a simple and straightforward objective. It also ensures the survival and growth of
a business firm. But modern authors on financial management have criticised the goal of profit maximisation.
 Resources are efficiently utilized
 Appropriate measure of firm performance
 Serves interest of society also

2. Shareholder’s Wealth Maximization

Wealth or net present worth is the difference between gross present worth and the amount of capital investment
required to achieve the benefits being discussed. Any financial action which creates wealth or which has a net
present worth above zero is a desirable one and should be undertaken. the operating objective for financial
management is to maximise wealth or net present worth.”
 Maximizes the net present value of a course of action to shareholders.
 Accounts for the timing and risk of the expected benefits.
 Benefits are measured in terms of cash flows.
 Fundamental objective—maximize the market value of the firm’s shares.

Objections against the Profit Maximisation Objectives:

1. The concept is ambiguous or vague. It is amenable to different interpretations, e.g., long run profits, short run
profits, volume of profits, rate of profit, etc.

2. It ignores the timing of returns. It is based on the assumption of bigger the better and does not take into
account the time value of money. The value of benefits received today and those received a year later are not
the same.

3. It ignores the quality of the expected benefits or the risk involved in prospective earnings stream. The streams
of benefits may have varying degrees of uncertainty. Two projects may have same total expected earnings but if
the earnings of one fluctuate less widely than those of the other it will be less risky and more preferable. More
uncertain or fluctuating the expected earnings, lower is their quality.

4. It does not consider the effect of dividend policy on the market price of the share. The goal of profit
maximisation implies maximising earnings per share which is not necessarily the same as maximising market-
price share. According to Solomon, “to the extent payment of dividends can affect the market price of “the stock
(or share), the maximisation of earnings per share will not be a satisfactory objective by itself.”

5. Profit maximisation objective does not take into consideration the social responsibilities of business. It ignores
the interests of workers, consumers, government and the public in general. The exclusive attention on profit
 maximisation may misguide managers to the point where they may endanger the survival of the firm by ignoring
research, executive development and other intangible investments.

6. In new business environment profit maximization is regarded as

 Unrealistic
 Difficult
 Inappropriate
 Immoral.

Organization of Finance Function

 The exact organisation structure for financial management will differ across firms.
 The financial officer may be known as the financial manager in some organisations, while in others as the vice-
president of finance or the director of finance or the financial controller.
 Two more officers—the treasurer and the controller—may be appointed under the direct supervision of CFO to
assist him or her.
 The treasurer’s function is to raise and manage company funds while the controller oversees whether funds are
correctly applied.

Financial System and Environment in India

Components/ Constituents of Indian Financial system

The following are the four main components of Indian Financial system

1. Financial institutions
Financial institutions are the intermediaries who facilitates smooth functioning of the financial system by making
investors and borrowers meet. They mobilize savings of the surplus units and allocate them in productive activities
promising a better rate of return. Financial institutions also provide services to entities seeking advises on various
issues ranging from restructuring to diversification plans. They provide whole range of services to the entities who
want to raise funds from the markets elsewhere. Financial institutions act as financial intermediaries because they
act as middlemen between savers and borrowers. Were these financial institutions may be of Banking or Non-
Banking institutions.

2. Financial Markets
Finance is a prerequisite for modern business and financial institutions play a vital role in economic system. It's
through financial markets the financial system of an economy works.

The main functions of financial markets are:

1. to facilitate creation and allocation of credit and liquidity;
2. to serve as intermediaries for mobilization of savings;
3. to assist process of balanced economic growth;
4. to provide financial convenience

There are three Markets:

1. Money Market
It is a segment of the financial market in which financial instruments with high liquidity and very short maturities are
traded. The money market is used by participants as a means for borrowing and lending in the short term, from
several days to just under a year. Money market securities consist of negotiable certificate of deposits, bankers
acceptances, U.S. treasury bills, commercial paper
2. Capital market
Capital markets are a broad category of markets facilitating the buying and selling of financial instruments. In
particular, there are two categories of financial instruments that capital in which markets are involved. These are
equity securities, which are often known as stocks, and debt securities, which are often known as bonds. Capital
markets involve the issuing of stocks and bonds for medium-term and long-term durations, generally terms of one
year or more.

3. Government securities market.

3. Financial Instruments
Another important constituent of financial system is financial instruments. They represent a claim against the future
income and wealth of others. It will be a claim against a person or an institutions, for the payment of the some of the
money at a specified future date.

4. Financial Services
Efficiency of emerging financial system largely depends upon the quality and variety of financial services provided by
financial intermediaries. The term financial services can be defined as "activites, benefits and satisfaction connected
with sale of money, that offers to users and customers, financial related value".