Financial Management

What is Financial Management(FM)?

• FM is the management of financial resources –
how to best find and use investments and
financing opportunities in an ever-changing
and increasingly complex environment.
 Why study FM?
• First of all, financial management is a core life
skill; almost every one needs to understand
some concepts of finance to manage his/her
business & personal finances.
• It is generally and quite rightfully said, “Money
makes the world go round”. Finance is like a life-
blood for a company. Even the best of the
companies and CEOs go out of the business
because of poor financial management policies.
 Why study FM?
• Professionals need to have an understanding
of the financial concepts to understand and
contribute to the overall corporate strategy.
• Financial Engineering is an upcoming field that
requires people with CS, math/science, and
finance background. Financial engineering is
the application of engineering methods to
finance
 Why study FM?
• One important area of study is the design,
analysis, and construction of financial
contracts to meet the needs of enterprises.
This field is experiencing an increased demand
for professionals, especially those who are
trained in both the underlying
mathematics/computer technologies and
finance.
 Why study FM?
• Apart from this, I will give you an overview of
upcoming research and trends in finance like
behavioral finance, neurofinance, complexity
economics models.
• We will also talk important financial markets
and institutions as well as the shadow banking
system.
 Prerequisites
• Financial Accounting
 READING MATERIALS
• Fundamentals of Financial Management, 13th
or Latest Edition, James C. Van Horne and John
M.Wachowicz .JR
• Financial Management – Theory and Practice,
11th Edition, Eugene F. Brigham and Lou s C.
Gapenski
 READING MATERIALS
• Financial Times
• New York Times, Business Section
• Wall Street Journal
• Business Section of Daily Dawn, The News and
The Nation
• Institute of New Economic Thinking (INET)
• Bank of England (BOE)
• Bank of International Settlements(BIS)
 Major Areas & Concepts of Financial
Management
Finance: Finance is the science of managing financial
resources in an optimal pattern i.e. the best use of
available financial sources. Finance consists of three
interrelated areas:
• Money & Capital markets, which deals with securities
markets & financial institutions.
• Investments, which focuses on the decisions of both
individual and institutional investors as they choose
assets for their investment portfolios.
• Financial Management, or business finance which
involves the actual management of firms.
 Major Areas & Concepts of Financial
Management
• Following are some of the important areas and
concepts of financial management, which would
be discussed in detail in the lectures to come.
• Analysis of Financial Statements
Analysis of financial statement is one of the
most common techniques of financial analysis,
in which the financial performance and financial
health of a company are analyzed based on its
past performance.
 Major Areas & Concepts of Financial
Management
• The following financial statements are used in the
analysis process.
• Profit & Loss Statement or Income Statement
Income statement reflects the operating efficiency
or profitability of a company as a result of its
operations along with the net profit available to the
shareholders for a given year (usually one
accounting period). This statement provides the
analyst with some insight into the financial
performance of the company.
 Major Areas & Concepts of Financial
Management
Balance Sheet
Balance Sheet is a snap-shot of an
organization’s financial health at a particular
time. It shows what assets are owned by the
business and the sources of acquiring these
assets.
 Major Areas & Concepts of Financial
Management
Statement of Shareholders’ equity
Statement of shareholders’ equity provides
the share of the owners in the business.
Statement of Cash Flows
Statement of cash flows explicitly reflects the
cash movement (inflows and outflows) during
the operations in an accounting period.
 Major Areas & Concepts of Financial
Management
• Taken together, these statements give an accounting
picture of the firm’s operations and financial position.
Financial statements report what has actually
happened to the assets, earnings, and dividends over
the years.
• The analysis of the information contained in these
statements help management of the organization to
evaluate the performance and activities of the concern;
it also helps the investors and creditors to have an idea
of the profitability potential and creditworthiness of
the business.
Investment Decisions & Capital Budgeting

Investment decisions are the most critical as

they usually involve huge sums of money and
these decisions are likely to bring prosperity or
doom to a business. A company’s future
income depends on how much investment is
made, in what type of assets, and how these
assets add to the overall value of the
company.
Investment Decisions & Capital Budgeting

• Capital budgeting is a term strictly related to

investment in fixed assets; here, the term
capital refers to the fixed assets that are used
in production, while budget is a plan which
details projected cash inflows and outflows
over some future period.
Investment Decisions & Capital Budgeting

• The following concepts and techniques are

employed while analyzing investment
decisions.
• Interest rate formulas
• Time Value of Money
• Discounted Cash Flows
• Net Present Value
• Internal Rate of Return
 Risk & Return:
• Investors, individual or institutional, invest
their money with the expectations of earning
a return on their investment. While investors
wish and attempt to earn maximum return,
they are constrained by risk. How the risks and
returns are related and how do investors make
a choice of their portfolios is important for
investment decision making.
 Risk & Return:
• Following concepts and theories would be
discussed while discussing the risk-return
choices of the investor:
• Uncertainty
• Risk
• Portfolio Theory
• Capital Asset Pricing Model
 Corporate Financing & Capital Structure

• When a firm plans to expand, it needs capital

or funds. Acquisition of funds is considered to
be a primary responsibility of a finance
department in an organization.
• There are numerous ways to acquire funds,
i.e., finances can be raised in the form of debt
or equity.
 Corporate Financing & Capital Structure

• The proportion of debt and equity constitutes

the capital structure of the firm. Financial
experts attempt to find a combination of debt
and equity that could increase the overall
value of the company, i.e., they try to find the
optimal capital structure.
 Corporate Financing & Capital Structure

• The following concepts would be used to

understand how an optimal Capital structure
could be attained.
• Cost of Capital
• Leverage
• Dividend Policy
• Debt Instruments
 Valuation
• Asset or company valuation is important not
only for financial managers, but also for
creditors and investors. It is important to know
the value of the company or its assets to make
important financing and investment choices.
 Valuation
• Different valuation techniques and factors that
influence the value of a company or its
financial instruments would be discussed in
this section.
• Share
• Bond
• Option
• Other Derivatives
Working Capital & Inventory Management:

• Working capital and inventory management

pertains to the effective management of
current assets. As we will see, an optimal and
effective utilization of working capital and
inventory increases the operating efficiency of
the firm.
International Finance & Foreign Exchange

• With the increasing importance of

international trade and global markets, the
role of international finance has increased
manifold. In a global environment, the finance
managers have more choices pertaining to
investing and financing than ever before.
International Finance & Foreign Exchange

• However, it is important to understand the

implications of working in a global
environment, since fluctuations in the
currency rates can convert a good financing or
investment decision into a bad one. This
section of the course would discuss the
international financial environment and the
financial implications of working in a global
environment.
Organizational Structure
 Organizational Structure
Business Legal Entities
• Sole Proprietorship :
• It is an unincorporated business owned by one
individual. Going into a business as a sole
proprietor is simple – one merely has to begin
business operations. Proprietorship consists of
80% of the total number of businesses
worldwide.
 Sole Proprietorship
Advantages:
• It is easily & inexpensively formed.
• It is subject to few government regulations.
• The business pays no corporate income tax;
only personal income tax is paid by the
proprietor.
 Sole Proprietorship
Limitations:
• It is difficult for a proprietorship to obtain large
sums of capital.
• The proprietor has unlimited personal liability for
the business debts, which can result in losses hat
exceed the money invested by him in the business.
• The life of the business organized as
proprietorship is limited to the life of the
individual who created it.
 Partnership
• A partnership exists whenever two or more
persons associate to conduct a non-corporate
business. It could be registered or
unregistered.
 Partnership
Advantages:
• Low cost involved
• Ease of formation.
 Partnership
Limitations:
• Unlimited Liability.
• Limited life of the organization.
• Difficulty of transferring ownership.
• Difficulty of raising large amounts of capital.
 Corporation
• A corporation is a limited company and a
separate legal entity registered by the
government. It is separate & distinct from its
owners & managers. It Can be Private Limited
(Pvt. Ltd.) or Public Limited (which may be
listed on Stock Exchange). The businesses in
the form of corporations control 80% of global
sales of products and services.
 Corporation
Advantages:
Unlimited life:
• A corporation can continue even after the death of its original
owners.
Easy transferability of ownership interest:
• Ownership interests can be divided into shares of stock, which in turn
can be transferred far more easily than can proprietorship &
partnership interests.
Limited Liability:
• The liability of the shareholders is limited up to the extent of nominal
value of shares held by them. Creditors and banks cannot confiscate
personal properties of director & shareholders in case of its
bankruptcy.
 Corporation
Limitations:

• Double Taxation:
Corporate earnings may be subject to double taxation – the
earnings of the corporation are taxed at corporate level,
and then any earnings paid out as dividends are taxed again
as income to the stockholders.
• Legal Formalities:
Setting up a corporation, and filing many official
documents, is more complex and time consuming than for
a proprietor ship or a partnership.