INTRODUCTION TO FINANCIAL

MANAGEMENT

MODULE 1 – Introduction to
Financial Management
CONTENTS
Nature, Purpose and Scope of Financial
Management
Relationship of Financial Objectives to
Organizational Strategy and Other
Organizational Objectives
Intended Learning Outcomes
Functions of Financial Management
Forms of Business Organization

At the end of Unit 1, you should be able to:

a. Explain the nature, goal and basic scope of financial

management

b. Discuss the significance of financial management

c. Discuss the importance of objective setting in a business enterprise

d. Describe the role of Financial Manager in achieving the primary goal of the firm

e. Explain the basic legal forms of business organizations

f. Identify the advantages and disadvantages of adopting forms of business organization

Lesson 1: Nature, Purpose and Scope of Financial

Managemenet

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 Activity (Let’s Get Started)

Do you prepare a personal budget? Do you keep track of your actual

spending against your budget? What happens if you do not manage your
money wisely?

Analysis (Let’s Think About it!)

Money management is a challenge to many people. To some, it is simply because of

lack of resources. And it affects the way they live.

Think of business organizations. What happens if they lack resources? Their

business operations may be disrupted. And that can have an unfavorable effect on
their performance and condition.

Abstraction (Let’s Explore)

NATURE OF FINANCIAL
MANAGEMENT

Financial Management also referred to as managerial finance, corporate finance, and business
finance, is a decision making process concerned with planning, acquiring and utilizing funds in a
manner that achieves the firm's desired goals. It is also described as the process for and the
analysis of making financial decisions in the business context Financial management is part of a
larger discipline called FINANCE which is a body of facts principles, and theories relating to
raising and using money by individuals, businesses, and governments This concerns both financial
management of profit-oriented business organizations particularly the corporate form of business,
as well as concepts and techniques that are applicable to individuals and to governments.

GOAL OF FINANCIAL MANAGEMENT

Assuming that we confine ourselves to for-profit businesses, the goal of financial management is to
make money and add value for the owners. This goal however, is a little vague and a more precise
definition is needed in order to have an objective basis for making and evaluating financial
decisions The financial manager in a business enterprise must make decision for the owners of the

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firm. He must act in the owners or shareholders best interest by making decisions that increase the
value of the firm or the value of the stock

The appropriate goal for the financial manager can thus be stated as follows:

The goal of financial management is to maximize the current value per share of the existing stock
or ownership in a business firm.

SCOPE OF FINANCIAL
MANAGEMENT

Traditionally, financial management is primarily concerned with acquisition financing and

management of assets of business concern in order to maximize the wealth of the firm for its
owners. The basic responsibility of the Finance Manager is to acquire funds needed by the firm and
investing those funds in profitable ventures that will maximize the firm's wealth, as well as, generating
returns to the business concern. Briefly, the traditional view of Financial Management looks into the
following functions that a financial manager of a business firm will perform:

1. Procurement of short-term as well as long-term funds from financial institutions

2. Mobilization of funds through financial instruments such as equity shares, preference shares,
debentures, bonds, notes, and so forth

3. Compliance with legal and regulatory provisions relating to funds procurement, use and
distribution as well as coordination of the finance function with the accounting function

With modern business situation increasing in complexity, the role of Finance Manager which
initially is just confined to acquisition of funds, expanded to judicious and efficient use of funds
available to the firm, keeping in view the objectives of the firms and expectations of the providers
of funds.

More recently though, with the globalization and liberalization of world economy, tremendous
reforms in financial sector evolved in order to promote more diversified, efficient and competitive
financial system in the country. The financial reforms coupled with the diffusion of information
technology have brought intense competition, mergers, take overs, cost management, quality
improvement, financial discipline and so forth.

Globalization has caused to integrate the national economy with the global economy and has
created a new financial environment which brings new opportunities and challenges to the
business enterprises This development has also led to total reformation of the finance function and
its responsibilities in the organization. Financial management has assumed a much greater
significance and the role of the finance managers has been given a fresh perspective

In view of modern approach, the Finance Manager is expected to analyze the business firm and
determine the following:

a. The total funds requirements of the firm

b. The assets or resources to be acquired and

c. The best pattern of financing the assets

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 TYPES OF FINANCIAL DECISIONS

The three major types of decisions that the Finance Manager of a modern business firm will be
involved in are:

1. Investment decisions

2. Financing decisions

3. Dividend decisions

All these decisions aim to maximize the shareholders wealth through maximization of the firm's
wealth.

INVESTMENT DECISIONS

The investment decisions are those which determine how scarce or limited resources in terms of
funds of the business firms are committed to projects. Generally, the firm should select only those
capital investment proposals whose net present value in positive and the rate of return exceeding
the marginal cost or capital. It should also consider the profitability of each individual project
proposal that will contribute to the overall profitability of the firm and lead to the creation of
wealth.

FINANCING DECISIONS

Financing decisions assert that the mix of debt and equity chosen to finance investments should
maximize the value of investments made.

The finance decisions should consider the cost of finance available in different forms and the risks
attached to it. The principle of financial leverage or trading on the equity should be considered
when selecting the debt-equity mix or capital structure decision If the cost of capital of each
component is reduced, the overall weighted average cost of capital and minimization of risks in
financing will lead to the profitability of the organization and create wealth to the owner.

DIVIDEND DECISIONS

The dividend decision is concerned with the determination of quantum of profits to be distributed
to the owners, the frequency of such payments and the amounts to be retained by the firm

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The dividend distribution policies and retention of profits will have ultimate effect on the firm's
wealth. The business firm should retain its profits in the form of appropriations or reserves for
financing its future growth and expansion schemes If the firm, however, adopts a very conservative
dividend payments policy, the firm's share prices in the market could be adversely affected. An
optimal dividend distribution policy therefore will lead to the maximization of shareholders'
wealth.

To summarize the basic objective of the investment financing and dividend decisions is to
maximize the firm's wealth. If the firm enjoys the stability and growth, its share prices in the
market will improve and will lead to capital appreciation of shareholders' investment and
ultimately maximize the shareholders' wealth.

SIGNIFICANCE OF FINANCIAL MANAGEMENT

The importance of financial management is known for the following aspects:

BROAD APPLICABILITY

Any organization whether motivated with earning profit or not having cash flow requires to be
viewed from the angle of financial discipline. The principles of finance are applicable wherever
there is cash flow. The concept of cash flow is one of the central elements of financial analysis,
planning, control, and resource allocation decisions. Cash flow is important because the financial
health of the firm depends on its ability to generate sufficient amounts of cash to pay its
employees, suppliers, creditors, and owners.

Financial management is equally applicable to all forms of business like sole traders, partnerships,
and corporations. It is also applicable to non-profit organizations like trust, societies, government
organizations, public sectors, and so forth

REDUCTION OF CHANCES OF FAILURE

A firm having latest technology, sophisticated machinery, high calibre marketing and technical
experts, and so forth may still fail unless its finances are managed on sound principles of financial
management. The strength of business lies in its financial discipline. Therefore, finance function is
treated as primordial which enables the other functions like production, marketing, purchase, and
personnel to be effective in the achievement of organizational goal and objectives

MEASUREMENT OF RETURN ON INVESTMENT

Anybody who invests his money will expect to earn a reasonable return on his investment. The
owners of business try to maximize their wealth. Financial management studies the risk-return
perception of the owners and the time value of money It considers the amount of cash flows
expected to be generated for the benefit of owners, the timing of these cash flows and the risk
attached to these cash flows. The greater the time and risk associated with the expected cash flow
the greater is the rate of return required by the owners.

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 Application (Let’s Do It!)

Which among the investing decision, financing decision, and dividend decision do
you think is more challenging to make? Explain.

Closure (Key Take Away)

The finance function is present in business organizations regardless of their type,

nature, or size. Big business firms usually have a separate unit that handles the
finance function. Two key officials under the Chief Financial Officer perform the
finance function – the treasurer and the controller. There are three major decisions
that companies make – investment, finance, and dividend decisions.

Summary

In Module 1, you were introduced the nature and scope of financial management.
Moreover, you learned about the finance function in the context of business
organizations.

Assessment

1. What is the purpose of financial management/ describe the kinds of activities

that financial management deals with.

2. What is the difference in perspective between finance and accounting?

3. Explain the shareholder wealth maximization goal of the firm and how it can
be measured.

4. Name and describe as many corporate stakeholders as you can.

5. What conflicts of interest can arise between managers and stockholders?

Lesson 2: Relationship of Financial Objectives to
organizational Strategy and Other Organizational
Objectives
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 Activity (Let’s Get Started)

Mrs Vanessa Wong operates a very successful retailing business in Hong Kong. Over the years, she
has established five retail shops on Hong Kong Island, in Kowloon and in the New Territories.
With economic recovery well under way, she plans to expand the local business; in addition, she is
also considering penetrating the Chinese mainland market in order to capitalize on the ever-
increasing purchasing power of Chinese consumers. Although she is financially healthy, Vanessa
feels her current financial resources may not be adequate for the planned expansion. She would
like to explore alternative business organization forms and has asked you to address the following
list of questions.

Analysis (Let’s Think About It!)

Abstraction (Let’s Explore!)

Example of Objectives in broad terms

 It is the goal of the company to be a leader in technology in the industry
 To achieve profit through a high level manufacturing efficiency
 To achieve a high degree of customer satisfaction

Strategic Financial Management

 Strategic planning is long range in scope and has its focus on the organization as whole.
 A company strategic or business plan reflects how it plans to achieve its goals and
objectives.
 Historical financial statements provide insight into the success of a company’s strategic
plan and are an important input of the planning process
Short and Medium Term
 Maximization of return on capital employed or return on investment.
 Growth in earnings per share and price/earnings ratio through maximization of net income
or profit and adoption of optimum level of leverage
 Minimization of finance charges.
 Efficient procurement and utilization of short term, medium term and long term funds
Long Term
 Growth in the market value of the equity shares through maximization of the firm’s market share
and sustained growth in dividend to shareholders
 Survival and sustained growth of the firm

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There have been a number of different, well-developed viewpoints concerning what the primary financial
objectives of the business firm should be. The competing viewpoints are:
 The owner’s perspective which hold that the only appropriate goal is to maximize shareholder or
owner’s wealth, and;
 The stakeholders’ perspective which emphasizes social responsibility over profitability (stakeholders
include not only the owners and shareholders, but also include the business’s customers, employees
and local commitments)

Responsibilities to Achieve the Financial Objectives

Investing
 The finance manager is responsible for determining how scarce resources or funds are
committed to projects.
 The investing function deals with managing the firm’s assets.
 This task requires both the mix and type of assets to hold.
 Investment decision should aim at investments in assets only when they are expected to
earn greater than a minimum acceptable return, also called handle rate.

Investing
 Example of Investing Decisions of Financial managers
 Evaluation and selection of capital investment proposal
 Determination of the total amount of fund that a firm can commit for investment
 Prioritization of investment alternatives
 Funds allocation and rationing
 Determination of the levels of investments in working capital
 Determination of fixed assets to be acquired
 Asset replacement decision
 Purchase or lease decisions
 Restructuring reorganization mergers and acquisition
 Securities analysis and portfolio management

Financing
 The finance manager is concerned with the ways in which the firm obtain and manages the
financing it needs to support its invention.
 Financing decisions call for good knowledge of cost of raising funds, procedures in hedging
risk, different financial instrument and obligation attached to them.Financing
 The finance manager will be involved in the ff. finance decisions:
 Determination of the financing pattern of the short-term, medium-term and long-term
funds requirements
 Determination of the best capital structure or mixture of debt and equity financing
 Procurement of funds through the issuance of financial instrument
 Arrangement with bankers, suppliers and creditors for its working capital, medium-term
and other long-term funds requirement
 Evaluation of alternative sources of funds.

Operating
 This third responsibility area of finance manager concerns working capital management.
 Managing the firm’s working capital is a day-to-day responsibility that ensures that the firm
has sufficient resources.
Operating
Issues that may have to be resolved in relation to managing a firms’ working capital

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 The level of cash, securities and inventory that should be kept on hand
 The credit policy
 Source of short-term financing
 Financing purchases of good

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