Department of Management Studies

Financial Management
Overview of Financial Management

Dr. T.VIJAYAKUMAR
MBA(HR),MBA(Finance),M.com, MA(SoC),MSc(psy),ML,Ph.D.
Professor
Department of Management Studies
Loyola Institute of Technology & Sciences, Thovalai
Definition of Financial Management

– Managerial activities which deals with planning and

controlling of firms and financial sources.

– Financial management is an area of financial

decision making, harmonsing individual motives
and enterprise goals.
-

Weston Brigham
Scope of financial management

 The
scope and functions of financial
management is classified in two categories.
- Traditional approach
- Modern approach
Traditional approach

 According to this approach, the scope of the finance

function is restricted to “procurement of funds by
corporate enterprise to meet their financial needs.

 The term ‘procurement’ refers to raising of funds

externally as well as the inter related aspects of raising
funds.
Traditional approach

 The inter related aspects are the institutional

arrangement for finance, financial instruments through
which funds are raised and legal and accounting
aspects between the firm and its sources of funds.

 In traditional approach the resources could be

raised from the combination of the available
sources.
Limitations of traditional approach

 This approach is confirmed to ‘procurement of

funds’ only.

 Itfails to consider an important aspects i.e.

allocation of funds.

 It deals with only outside I.e. investors,

investment bankers.
Limitations of traditional approach

 The internal decision making is completely

ignored in this approach.

 The
traditional approach fails to consider the
problems involved in working capital
management.
 The traditional approach neglected the issues
relating to the allocation and management of
funds and failed to make financial decisions.
Modern approach

 The modern approach is an analytical way of

looking into financial problems of the firm.
 According to this approach, the finance
function covers both acquisition of funds as
well as the allocation of funds to various uses.
 Financial management is concerned with the
issues involved in raising of funds and efficient
and wise allocation of funds.
Main Contents of Modern approach

 How large should an enterprise be and how far

it should grow?
 In what form should it hold its assets?
 How should the funds required be raised?

- Financial management is concerned with

finding answer to the above problems.
Functions of Finance

 There are three finance functions

 Investment decision
 Financing decision
 Dividend decision
Investment Decision

 Investment decision relates to selections of

asset in which funds will be invested by a firm.

 The
asset that can be acquired by a firm may
be long term asset and short term asset.
Investment Decision

 Decision with regard to long term assets is

called capital budgeting.

 Decision with regard to short term or current

assets is called working capital management.
Capital Budgeting

 Capital budgeting relates to selection of an

asset or investment proposal which would yield
benefit in future. It involves three elements.

 The measurement of the worth of the proposal

Capital Budgeting

 Evaluation of the investment proposal in terms

of risk associated with it and

 Evaluation of the worth of the investment

proposal against certain norms or standard. The
standard is broadly known as cost of capital
Financing Decision

 Determination of the proportion of equity and

dept is the main issue in financing decision.

 Once the best combination of debt and equity is

determined, the next step is raising appropriate
amount through available sources.
Working Capital Management

 Working capital management or current asset

management is an important part of investment
decision.
 Proper management of working capital ensures
firm’s liquidity and solvency.
 A conflict
exists between profitability and liquidity
while managing current asset.
Working Capital Management

 Ifa firm does not invest sufficient funds in

current assets it may become illiquid and may
not meet its current obligations.
 If the current asset are large, the firm would
lose its profitability and liquidity.
 The financial manager should develop proper
techniques of managing current assets so that
neither insufficient nor unnecessary funds are
invested in current assets.
Management of Working Capital

 Themanagement of working capital has two

aspects.

- Overview of working capital management

and

- Efficient management of individual current

asset such as cash, receivable and inventory.
Financing Decision

 Financing decision is concerned with the

financing mix or capital structure.

 The mix of debt and equity is known as capital

structure.
Dividend Decision

 A firm distribute all profits or retain them or

distribute a portion and retain the balance with
it.
 Which course should be allowed? The decision
depends upon the preference of the
shareholders and investment opportunities
available to the firm.
Dividend Decision

 Dividenddecision has a strong influence on the

market prize of the share.

 So the dividend policy is to be determined in

terms of its impact on shareholder’s value.

 Theoptimum dividend policy is one which

maximizes the value of shares and wealth of
the shareholders.
Dividend Decision

 Thefinancial manager should determine the

optimum pay out ratio I.e. the proportions of net
profit to be paid out to the shareholders.

 Theabove three decisions are inter related. To

have an optimum financial decision the three
should be taken jointly.
Objectives of financial management

 The term ‘objective’ refers to a goal or decision

for taking financial decisions.
 Profit maximisation
 Wealth maximisation
Profit maximisation

 The term profit maximisation is deep rooted in

the economic theory.

 Itis need that when firms pursue the policy of

maximising profits.

 Society’s resources are efficiently utilised.

Profit maximisation

 The firm should undertake those actions that

would profits and drop those actions that would
decrease profit.
 The financial decisions should be oriented to the
maximisation of profits.
 Profitprovides the yardstick for measuring
performance of firms.
Profit maximisation

 Itmakes allocation of resources to profitable

and desirable areas.

 It also ensures maximum social welfare.

Wealth maximisation

 Wealth maximisation or net present value

maximisation provides an appropriate and
operationally feasible decision criterion
for financial management decisions.
Sources of Finance

 Capitalrequired for a business can be classified

under two main categories, viz.,
- Fixed Capital, and
- Working Capital.
- every business needs funds for two purposes.
- for its establishment and to carry out its day-
to- day operations.
Sources of Finance

 Long term funds are required to create production

facilities through purchase of fixed assets such
as
- plant,
- machinery,
- land,
- building,
- furniture, etc.
Sources of Finance

- Investment in these asset represent that part of

firm’s capital which is blocked on permanent
or fixed basis and is called fixed capital.


Funds are also needed for short-term
purposes for the purchase of raw materials,
payment of wages and other day to day
expenses, etc. These funds are known as
working capital.
Sources of Finance/Funds

 In our present day economy, finance is defined

as the provision of money at the time when it
is required.

 Every enterprise, whether big or medium or

small, needs finance to carry on its operations
and to achieve its targets.
Sources of Finance/Funds

 In fact finance is so indispensable today that is

rightly said that it is the life blood of enterprise.
 With out adequate finance, no enterprise can
possibly accomplish its objectives.
 In every concern there are two methods of raising
finance, viz.,
- Raising of owned capital,
- Rising of borrowed capital
 Sources of Finance/Funds
 The financial requirements may be for a long term, medium term or short term.

Financial Requirements

Short-Term Medium-Term Long-Term

Bank Credit Issue of Debentures Issue of shares
Customer advances Issue of Preference shares Issue of Debentures
Trade Credit Bank Loan Ploughing back of
Public deposit / Fixed profits
deposit Loan from
Loans from financial institutions spec.financial
Issue of shares

 The company’s owned capital is split into large

number of equal parts,such a part being
called a “share”.
 Theperson holding the share as shareholder
and becomes part-owner of the company.
 Forthis reason, the capital so raised is known
as “owned capital” and the shares are called
“ownership securities”.
Issue of shares

 The share capital of the company is ideal for

meeting the long term requirements.
 Itneed not be paid back to the shareholders
within the life time of the company.
 The only exception is the sum raised by the
issue of redeemable preference shares.
Types of shares

 A public company can issue two types of

share.
 Equity share
 Preference share
Equity share

 Equity share has number of special features

 The dividend on these shares are paid after the

dividend on preference share has been paid.

 The rate of dividend depends upon the amount

of profits available and the intention of
directors.
Equity share

 TheEquity shareholders have the chance of

earning good dividends in times of prosperity
and run the risk of earning nothing in times
of adversity.
 The equity shareholders have a residual
claim on the company’s asset in case of
liquidation.
 Thecompany is controlled by the equity
shareholders and they are entitled to vote in
Preference shares

 Preference shares are those which carry

preferential right over other class of shares
with regard to payment of dividend and
repayment of capital.
 The rate of dividend on preference share is a
fixed one.