Financial Management – An Overview

Prof. Anirban
Christ College Institute of Management

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore
 Syllabus
• Module 1:
– Activities of Financial Management
– Risk & Return trade-off,
– Valuation etc
– Indian Financial System - Markets, institutions &
instruments - Regulatory framework
– Basic Techniques of Financial Management
• Time value of Money
• Valuation of Securities
• Portfolio Analysis, CAPM, APM & Options.

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Syllabus
• Module 2
– Sources of Finance
– Long Term Sources ( Shares, Bonds, Term
Loans etc)
– Working Capital sources
– Miscellaneous topics

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Syllabus
• Module 3
– Working Capital Management
– Operating Cycle
– A/R Management
– Cash Management
– Determinants of Working Capital etc.

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Syllabus
• Module 4
– Investment Decisions
– Capital Budgeting
• Basics, Cash Flows Various techniques ( NPV,
IRR, ARR etc)
– Risk & Sensitivity analysis, Decision Tree
– Cost of Capital

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Syllabus
• Module 5
– Capital Structure & Dividend decisions
– Leverages
– Capital Structure Théories ( NI, NOI, M&M)
– Planning the Capital Structure
– EBIT-EPS, ROI-ROE analysis

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Syllabus
• Module 6
– Dividend Theories (Walter, Gordon, M& M)
– Dividend policies in practice
– Dividends, Bonus shares etc.
• Module 7
– Special Topics: Leasing, International
Finance etc

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 LEARNING OBJECTIVES
• The advantages and disadvantages of organizing
a business as a corporation.
• Meaning, Scope and objectives of Financial
Management and Financial Goals.
• The role of the financial manager in a
corporation.
• Principal-agent problems, agency costs and
information asymmetries.
Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore
 Corporation

What is a corporation?

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Corporate Structure
Sole Proprietorships
Unlimited Liability
Personal tax on profits
Partnerships

Limited Liability
Corporations Corporate tax on profits +
Personal tax on dividends

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

Financial Management – What’s that?

• Financial Management is concerned

with the efficient use of an important
resource, namely capital fund.
• It deals with the procurement of
funds and their effective utilization.

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Definition
• Financial Management is concerned with the
management decision, i.e. planning, raising (acquisition),
controlling and administrating the funds( Short & Long
Term) used in the business.
• So financial management is concerned with 4 types of
decision :
– Investment of Finance
– Raising of Finance
– Working Capital Decision
– Dividend Decision
Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore
 Objectives
• Maintenance of Liquid Assets.
• Profit Maximization.
• Maximization of wealth.
• Fair returns to the shareholders.
• Building up reserves for growth and expansion.
• Ensuring maximum operational efficiency by
efficient & effective utilization of finances.
• Ensuring financial discipline in the organization.
• Conversion and expansion of the amount of
investment of capital through proper financial
policy and program.

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Scope
• Financial Management as an academic
discipline has under gone significant
changes over years as regards its scope and
coverage.
• There are basically 2 approaches to describe
the Scope of Finance:
– Traditional Approach
– Modern Approach

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Traditional Approach
• Arrangement of funds from different
financial institutions.
• Procurement of funds through selling of
shares and debentures.
• Looking after legal and accounting
relationship between the funds and its
sources.

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Modern Approach
• Determination of necessary amount of finance
for investment i.e. sources of supply of finance
or the Capital Mix.
• Amount of Investment to be made in various
classes of assets, i.e. Planning for investment or
Long term Asset Mix.
• Dividend Policy or Profit Allocation.
• Liquidity or Short Term Asset Mix Decision.
Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore
 Financial Goals
• Profit maximization (profit after tax)
• Maximizing Earnings per Share
• Shareholder’s Wealth Maximization

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Profit Maximization

Maximizing the Rupee Income of Firm

– Resources are efficiently utilized
– Appropriate measure of firm performance
– Serves interest of society also

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Maximizing EPS
• Ignores timing and risk of the expected
benefit
• Market value is not a function of EPS. Hence
maximizing EPS will not result in highest
price for company's shares
• Maximizing EPS implies that the firm should
make no dividend payment so long as funds
can be invested at positive rate of return—
such a policy may not always work
Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore
Shareholders’ Wealth Maximization
• 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.
Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore
 Role of a Finance Manager
• A finance manager is a person who is
responsible in a significant way to carry out
the finance function.
• The Finance manager’s concern is to,
– Determine the total amount of funds to be
employed by a firm.
– Allocate this funds efficiently to various assets.
– Obtain the best mix of financing.

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Who is The Financial Manager?

Chief
ChiefFinancial
FinancialOfficer
Officer

Treasurer Comptroller
Provision of finance Planning & Control
Investor relationship. Reporting & Interpretation
Short term financing Tax Administration
Banking & Custody Government Reporting
Credit and Collection Protection of Assets
Investment Economic Appraisal
Insurance Internal Auditing
Capital Budgeting, Cash Management etc…… Financial & Management Accounting

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Role of The Financial Manager
(2) (1)

Firm's Financial Financial

(4a)
operations manager markets

(3) (4b)

(1) Cash raised from investors

(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors
Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore
 Finance Manager’s Role
• Financial Planning & Structure
– Raising of Funds
– Allocation of Funds
– Profit Planning
– Investment Planning
– Management Control
– Policy Maker
– Treasury Operation
• Understanding Capital Markets
• Investor Communication
• Foreign Exchange etc….

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Risk-return Trade-off
• Risk and expected return move in tandem; the
greater the risk, the greater the expected return.
• Financial decisions of the firm are guided by
the risk-return trade-off.
• The return and risk relationship:
Return = Risk-free rate +
Risk premium
• Risk-free rate is a compensation for time and
risk premium for risk.

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

• Risk Return Tradeoff
Capital
Budgeting

Capital Return Market

Structure Value
Maximization Of
Financial Finance Dividend The
of
Management Decisions Decisions
Share Value Risk Firm
Working
Capital
Decisions

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore
 What is Financial System???
• The financial system comprises a variety of
intermediaries, markets and instruments which are
foster savings and channels them to their most
efficient use.
• The system consists of individuals, intermediaries
markets and users of savings.
• Economic activity and growth are greatly
facilitated by the existence of a financial
developed in terms of the efficiency of the market
in mobilizing savings and allocating them among
competing users.
Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore
 funds funds
Financial institutions

deposits Commercial banks loans

Insurance companies
Mutual funds
Provident funds
NBFCs

Suppliers of funds Demanders of funds

Individuals funds Individuals

Private placement securities
Businesses Businesses
Govt.s Govt.s

Financial markets
funds
Money market funds
Capital market
securities
Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore
securities
 Functions of the financial system
• Provides the payment system for the exchange of
goods and services.
• Enables the pooling of funds for undertaking large
scale enterprises.
• Provides a mechanism for spatial and temporal
transfer of resources.
• Provides a way for managing risk and uncertainties.
• Generates information, helps in decision making.
• Helps in dealing with the incentive problem.

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Contd….
• Regulation of currency
• Banking functions
• Custody of cash reserves
• Credit control
• Administer national, fiscal and monetary
policy
• Supply and demand of funds
• Maintaining liquidity
Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore
 Financial assets
• Any asset which is tangible or intangible
whose possession has a value in exchange.
– Tangible assets- the value of which depends on
its physical properties.
– Intangible assets- a claim to some future
benefits

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Financial markets
• It is a market for the creation and
exchange of financial assets. Any
person who buys and sells financial
assets will participate in financial
markets in one way or the other.

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Functions of financial markets
• Facilitates price discovery- interaction
between buyers and sellers and establish the
prices of the financial assets.
• Provide liquidity – investors can readily sell
their financial assets. In absence of this
characteristic the motivation of the investors
would have greatly reduced.
• Reduce cost of transferring- in terms of
search and information costs.

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Classification of financial markets
Debt market
Nature of claim
Equity market

Money market
Maturity of claim
Capital market

Primary market
Seasoning of claim
Secondary market

Cash market
Timing of delivery
Forward market

Organisational Exchange trade market

structure
Over the counter market
Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore
 Money market

Short term money Bond/ govt. security

market (t-bills, CDs, market
CPs, call money
etc.)

Unorganised market
money lenders/ indigenous banks

Investors Financial
Commercial banks
Co-operatives institutions

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Financial market returns
• Interest rates - rate of return promised by
borrower to the lender. It depends upon unit
of account, maturity period, default risk.
• Capital markets – in case of equity markets
it is a major factor.

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Rate of return of risky assets
• Interest rates represent promised returns on
debt instruments
• Return on equity comes from cash dividend
and capital gains.
r = [Cash dividend + {Ending price – Beginning
price}] / Beginning price

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Determinants of rates of return
• Expected productivity of capital
• Degree of uncertainty characterising the
productivity of capital
• Time preference of people
• Degree of risk aversion

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Equilibrium in financial markets

• Forces of demand and supply to determine

the market price or the rate of interest
– Supply for loanable funds and determination of
interest rate
– Demand for securities and determination of
prices

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Regulation of interest rates
• Govt. determines the interest rates in some
cases. This is done to-
– Facilitate govt. borrowing
– Preferential lending rates
– Mobilise substantial savings

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Trends
• Interest rates have been increasing mainly
due to lack of funds and inflation
• Short term rates are lower than long term
rates
• Term finance is lower than working capital
finance

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Financial intermediaries
• They provide services and products that
customers may not be able to get more
efficiently by themselves.
• The important products and services are
savings account, mortgages, insurance,
credit rating etc.

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Rationale for financial intermediaries

• Diversification
• Low transaction cost
• Economies of scale
• Confidentiality
• Signaling

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Regulatory infrastructure
• RBI
– Clearing system for banks
– Implements credit and monetary policies
– Banker’s bank
– Regulates foreign exchange transactions
– Moderates exchange value of rupee
– Integrates unorganised sector with the organised sector
– Banks in rural areas
– Allocation of credit
– Promotes DFIs
Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore
 Contd…
• SEBI
– Regulates stock exchanges and other securities
market
– Register and regulate capital market
intermediaries
– Regulate working of mutual funds
– Promotes self regulatory orgs. and invester
education
– Prohibits unfair trade practices, insider trading

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Financial development measures
• Finance ratios= Total finance claims
National income
• Financial interrelations ratio =
Total financial claims
Net physical capital formation
• New issue ratio = Primary issue
Net physical capital formation

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Contd…
• Intermediation ratio =
issues of financial institutions
total financial issues in the economy

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 International Capital Markets
International Bond Mkt International Equity Mkt

Foreign Bonds Euro Bonds Foreign Equity Euro Equity

-Yankee Bonds -Euro / dollar -ADR -GDR

-Samurai Bonds -Euro / Yen -IDR

-Euro / Pounds
-Bulldog Bonds

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore

 Trends ….
• The SLR applicable to commercial banks is being
lowered.
• Market determined interest rates are increasing.
• Financial institutions have now rely more on
capital markets.
• Prudential regulations and supervisions are being
emphasized in financial markets and financial
institutions.
• IFS is getting gradually integrated with the WFS.
• Financial innovation is getting momentum etc…

Prof. Anirban Ghatak, Senior Lecturer, CCIM, B’lore