Financial Management

MBA ZG 521

Session 1
(Contact Hours 1, 2)
Foundations of Financial Management

Krishnamurthy Bindumadhavan, Fellow (IIM),

CFA, FRM
Professor, Management - Finance
Email: [email protected]
BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Agenda

• Introductions

• Course objectives/ outcomes

• Textbooks/ Resources

• Evaluation scheme

• Overview of Financial Management

• Interface between Finance and other Functions

• Shareholder wealth maximization

• Basic Principles of Financial Management

• Understanding Indian Financial System

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Introduction
Krishnamurthy Bindumadhavan, Fellow (IIM), CFA, FRM
• Fellow, IIM, Kashipur
• Received the CFA charter in 2002
• Awarded FRM title in 2008
• Bachelor of Engineering, MBA
• Worked for over 7 years as Senior Analyst/ Consultant to leading Corporations,
Banks; preparing candidates for CFA/ FRM exams
• Worked for 8 years at Capital One, a top 10 US bank and one of the World’s
largest diversified financial services firms
• Worked in both strategic roles as well as operational roles including credit
strategy, product strategy and risk operations
• Drove innovation in risk management to add value of over $50 Million
• Last assignment with Capital One was General Manager, Risk Operations, Asia
• 5+ years of prior experience in Banking technology, primarily with TCS/ TUL
BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Course Objectives

No. Objectives
Gain basic understanding of the underlying concepts and building blocks related to
CO1 financial management. Develop understanding of the tools relevant to financial
management including time value of money and financial statements analysis.

Understand business risk, financial risk, break even analysis, and impact of leverage on risk.
CO2 Understand the relationship between risk and return and the drivers of risk.

Understand the application of cost of capital and do the necessary calculations of the
CO3 components of cost of capital and WACC; Basic principles of capital budgeting, categories
of capital budgeting projects, discounted and non-discounted cash flow evaluation
methods and their limitations, analysis of risks involved in capital budgeting projects.

Definition of working capital; Composition and determination of working capital; Financing

CO4 and management of current assets; Cash management.

Understanding the major theories of capital structure and their implications; How to set
CO5 target capital structure; Dividend policy and its impact on firm value.

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Learning Outcome Statements
No. Learning Outcomes

LO1 Able to analyze and interpret the three key Financial Statements so as to assess the health of a firm/
business.

LO2 Apply Time Value of Money concepts for valuation.

LO3 Distinguish between the different types of risk faced by a firm and express the relationship between
risk and return.

LO4 Able to calculate all the components of cost of capital as well as the overall WACC for a firm.

LO5 Able to evaluate Capital Budgeting projects and make Accept/ Reject decisions based on NPV/ other
business rules.

LO6 Able to formulate corporate Financial Policies in the areas of Working Capital/ Cash Management,
Capital Structure, and Dividend Policy so as to maximize firm value.

LO7 Demonstrate solutions to "real" business/ financial problems by employing excel/ financial modeling in
a optimal/ effective manner.

LO8 Analyze/ Evaluate real life business/ financial situations and identify/ apply the appropriate
framework/ concepts to solve it in a optimal/ effective manner.

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Textbook/ Resources
T1 Fundamentals of Financial Management, 6th Edition
(2014), by Prasanna Chandra, published by McGraw Hill
Education (India) Private Limited

R1 Financial Management Theory and Practice, 8th Edition

(2012), by Prasanna Chandra, published by McGraw Hill
Education (India) Private Limited
R2 Financial Management and Policy, 13th Edition (2009), by
Van Horne J.C., published by PHI Learning
R3 In addition (for some sessions) we will be referring to
selected articles from top journals relevant to the topics at
hand; links and/ or references to the same will be
provided later by the instructor

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Evaluation Scheme
Name Type Duration Weight Day, Date, Session, Time

Quizzes (two) Online - 10% One quiz before Mid Semester

and another after mid semester
Experiential Online - 15% Financial Statements Analysis;
Learning Before Mid Semester
Assignment #1 (Excel based financial modelling)
Experiential Online - 5% Working capital simulation; After
Learning Mid Semester
Assignment #2
All above are EC1

Mid-Semester Closed 2 hours 30% TBD (EC2)

Test Book
Comprehensive Open Book 2 hours 40% TBD (EC3)
Exam

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Finance

• Finance is the study of how people and

businesses evaluate investments and raise capital
to fund them

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Finance vs. Accounting
Accounting Finance
Definition Preparation of accounting records and Efficient and productive
financial statements management of financial
resources (assets and
liabilities )
Purpose Measuring, preparing, analyzing, and Analysis of financial
interpreting financial statements. To statements to make
collect and present financial information. decisions on working capital
issues such as level of
inventory, cash holding,
credit levels, financial
strategy, managing and
controlling cash flow.
Goal To see how the company is performing, To forecast and model the
to monitor day to day accounting future performance of the
operations, and for taxation purposes. business. Financial
Planning.
5 year forecast, etc.
Tools Balance sheet, profit and loss Performance reports, ratio
statement, and cash flow statements. analysis, risk analysis,
estimating break evens,
returns on investment, etc.

Accounting is about looking at the past whereas Finance is about looking at the future
BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Basic areas of Finance

• Corporate Finance
• Decisions relating to the efficient management of a firm

• Investment analysis and management

• Analysis and valuation of financial assets (stocks, bonds, etc.),
risk versus return, and asset allocation

• Financial institutions management

• Management of banks, insurance companies, brokerage
houses, etc.

• International or Multinational Finance

• International perspective; becoming more and more
important in the context of globalization
BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Why Study Financial Management?
(What’s in it for me?)

• Knowledge of finance is critical for making good decisions (professional/ personal )

• Finance is an integral part of corporate world

• Marketing
• Budgets, marketing financial products (or marketing research)
• Management
• Strategic thinking, job performance, profitability

• Financial Goals and Metrics Help Firms Implement Strategy and Track Success

• Example: Few years back, GM made the strategic decision to invest $740 million to
produce the Chevy Volt (electric+ car)

•Such decisions require the expertise of various management disciplines including

marketing, accounting, operations management, and finance and not just technology!

• Most key personal decisions require financial knowledge/understanding

• Example: buying a house or car, planning for retirement, children’s education, etc.
BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Function of Financial Manager
1a.Raising funds
2.Investments

Financial Financial
Operations 1b.Obligations
Manager Markets
(plant, (stocks, debt
equipment, securities) (investors,
3.Cash from i.e. people
projects) operational
with
activities
4.Reinvesting 5.Dividends or surplus
interest funds)
payments

Key role of Finance function is to manage the cash flow

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Major Financial Decisions
1) Investment Decision 2) Financing Decision*

Financial Financial
Operations Manager Markets

How much to invest? Source of funds?

What assets/ projects Debt?
to invest in? Equity?
(Capital Budgeting) (Capital Structure)
3) Working Capital Management Decision
How best to manage the cash flows from day to day operations?
* Another related decision is the Dividend decision
BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956
Business Organizational Forms

Business Forms

Sole Partnerships
Corporations Hybrids
Proprietorships

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Summary of Organization Forms:
(What’s in it for me?)

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Why Study Financial Management?
(What’s in it for me?)

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Goal of financial management
• The goal of the financial manager must be consistent with
the mission of the corporation
• What should be the goal of a modern corporation?
1. Maximize revenues?
2. Minimize costs?
3. Maximize profits?
4. Maximize shareholder wealth?
• “To achieve sustainable growth, we have established a
vision with clear goals: Maximizing return to shareholders
while being mindful of our overall responsibilities” (part of
Coca-Cola’s mission statement)
• Google?

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Corporate Mission

•While managers have to cater to all the stakeholders (such as

consumers, employees, suppliers etc.), they need to pay
particular attention to the owners of the corporation i.e.
shareholders.

•If managers fail to pursue shareholder wealth maximization,

they will lose the support of investors and lenders. The
business may cease to exist and ultimately, the managers will
lose their jobs!

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Ethics in Finance

o What do we mean by Ethics?

o Examples of recent financial scandals

o J.P. Morgan Chase $7 Billion Trading Mishap

o Libor Rate Rigging Scandal

o Satyam Scandal

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Agency Problem

•Agency relationship

• Principal (shareholders) hires an agent (CEO, CFO,

Managers) to represent its interests
• Stockholders (principals) hire managers (agents) to run the
company

•Agency problem

• Conflict of interest between principal and agent

• Example: Not pursuing risky project for fear of losing jobs, expensive
perks, expanding the business for increasing scope/ scale of power

• All else equal, agency problems will reduce the firm value.

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

How to Reduce Agency
Problems?
1. Monitoring
(Examples: Reports, Meetings, Auditors, board of
directors, financial markets, bankers, credit agencies)

2. Compensation plans
(Examples: Performance based bonus, salary, stock
options, benefits)

3. Others
(Examples: Threat of being fired, Threat of takeovers,
Stock market, regulations such as SOX)

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Key financial principles

1. Time value of Money

2. Risk return trade-off

3. Cash flows are the key source of value (After tax, Incremental)

4. Efficient Capital Markets

5. Competitive Markets

6. All risks are not equal (diversifiable vs. undiversifiable)

7. Principal Agent issue

8. Ethics

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Financial markets

• The main goal of financial markets is to

take the savings from those who do not
wish to consume (savings surplus units)
and to channel them to those who wish to
invest more than what they presently have
(saving deficit units)

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Financial markets and
financial system
Financial system
Return on
Return on
investments
Financial investments
markets
money money

Saving surplus Saving deficit

units (savers) units (investors)

money money
Ф Financial
intermediaries
Return on Return on
investments investments

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Financing decisions

Financing
decisions

Internal corporate External sources

financing of funds

Direct financing Indirect financing

Retained earnings (financial markets (financial
Instruments) Intermediaries)

Stocks Loans

Debt instruments
(bonds, CPs etc.)

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Financial markets

Financial markets

Organized exchanges
Primary markets Money market
Over-the-counter
Secondary markets Capital market

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Primary and secondary
markets
• Primary market – primary issues of
securities are sold, allows governments,
banks, corporations to raise money by
directly selling financial instruments to the
public. Such issues are referred as IPO’s

• Secondary market – allows investors to

trade financial securities among
themselves. Examples: BSE, NSE, etc.

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Money and capital markets

Money market instruments – short-term assets

(typically maturity less than 1 year):
• Certificates of deposits (CDs)
• Commercial papers (CPs)
• Treasury bills

Capital markets – long-term assets (maturity longer

than 1 year) are traded:
• Stocks
• Corporate bonds
• Long-term government bonds

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Organized exchanges and
over-the-counter
• Organized exchanges – most stocks, bonds and
derivatives are traded on organized exchanges. It has a
trading floor where floor traders execute transactions in
the secondary market for their clients.

• Stocks not listed on the organized exchanges are traded

in the over-the-counter (OTC) market. OTC market
facilitates secondary market transactions and unlike an
organized exchange, the OTC market doesn’t have a
trading floor. The buy and sell orders are typically
completed through a telecommunications/ computer
network.

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Recent Developments

• Digital Disruption!

• Peer to Peer Lending (P2P) – Online platform that

eliminates the middle man.

• Instead of the bank acting as a intermediary, the

platform brings lenders and borrowers together so
that both can benefit

• Lending Club

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Indian Financial System

•Banking - RBI, Commercial banks, Co-operative banks, Post

office savings banks

•Non-banking - LIC, GIC, UTI, Housing development finance

companies-HDFC, HUDCO

•Developmental - ICICI, IDBI, IFCI, NABARD, SIDBI, Tourism

finance corporation SFCs

•Regulatory Institutions - SEBI, RBI, IRDA- Insurance Regulatory

and Development Authority, etc.

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956

Homework

• Review the relevant chapters from textbook

• Look at mission statement of Google, your organization,

others that you are interested in

• Make sure you have access to laptop/ computer with Excel;

we will need it for experiential learning components in
subsequent classes. (Excel 2010 or later versions required.)

• Email me your expectations from this course:

• [email protected]

BITS Pilani, Deemed to be University under Section 3 of UGC Act, 1956