Introduction

to
Financial Management
 What is Financial
Management?

Any decision that involves a use of money is a Financial Management decision.

◦ In case of businesses, everything they do, has financial implications, and are financial
decisions.

What is financial Management?

◦ Integral system concerned with acquiring, managing, distributing & financing assets to
achieve (business) goals.
 Financial view of the firm

Assets
Liabilities
Assets
◦ Generate cash flow today includes long
Fixed claim on cash flows little or no
lived and short lived assets (working
role in management
capital) ◦ Fixed maturity
◦ E.g. Microsoft - windows and office ◦ Tax deductible
◦ Assets are either generating more
revenue or reducing the cost OR both for
the firm Equity
◦ Assets have economic benefits ◦ Residual claim on cash flows.
◦ Significant role in management
◦ Perpetual lives
Objective of Financial Management

What should be the objective of a firm?

◦ Maximize profit?
◦ Minimize costs?
◦ Maximize market share?
◦ Maximize the current value of the company’s stock?
Profit Maximization

There are objectives that focus on profitability rather than value.

The rationale
◦ profits can be measured more easily than value, and that
◦ higher profits translate into higher value in the long run.

Problems
◦ First, the emphasis on current profitability may result in short-term decisions that
maximize profits now at the expense of long-term profits and value.
◦ Second, the notion that profits can be measured more precisely than value may be
incorrect, given the leeway that accountants have to shift profits across periods.
◦ Many times, profit maximization is restated in terms of accounting returns (such as
return on equity or capital) rather than profits in amount or even as excess returns
(over a cost of capital).
Goal of the firm - Profit maximization

Advantages:
◦ Easy to understand

Limitations
◦ It is vague, ambiguous
◦ It ignores time value of money
◦ It ignores risk/ uncertainty
◦ Based on accounting profit
◦ It is a short term goal
◦ (Manager) Does not look at consequence of his/her actions on future performance.
Goal of the firm
EPS
• (PAT – Pref. dividend)/ No. of eq. shares

Maximization of sales

Maximization of Market share

The Objective in Decision Making
 Goal of the firm – Maximizing the
value of the firm/Share holders’
wealth maximization
Advantages
◦ It considers cash flows
◦ It considers timing of cash flows
◦ Cash flows and discount rates are adjusted for risk
◦ Easy to communicate
◦ Investors can easily understand
◦ Long term goal/ investment in only those assets which gives long term cash flows.

Limitations
◦ Share price may not give the true value of investments
◦ Difficult to satisfy all stake holders
◦ Agency problem
◦ Issue with discount rate
Why traditional corporate
financial theory focuses on
maximizing stockholder wealth.
The Classical Viewpoint
 Maximize the value of the business
firm
1. Investment decision (capital budgeting techniques):
◦ Invest in assets that earn a return greater than the minimum acceptable hurdle rate.
◦ Higher rate – higher for higher risk investments
◦ Lower rate – lower for low risk investments

◦ Return should reflect the magnitude and the timing of the cash flows as well as all side
effects.
◦ Investments can be revenue-generating investments (such as Disney opening a new
theme park) or they can be cost-saving investments (as would be the case if firm
adopted a new system to manage inventory). Some projects have large upfront costs (as
is the case with Disney), whereas other projects may have costs spread out across time.
 Maximize the value of the
business firm
2. Financing Decision
◦ Find right kind of debt for your firm and the right mix of debt and equity to fund
your operations.
◦ Optimal mix of debt & equity which maximizes firm value
◦ Right kind of debt that matches the tenor of your assets.
◦ Long term or short term
◦ Choice of currency
◦ Fixed or floating interest rates
 Maximize the value of the
business firm
3. Dividend decision
If you can not find investment that generates more return than your minimum
acceptable rate, then give back the cash to owners of your business
◦ How much cash you can return depends upon current & potential investment
opportunities.
◦ How you choose to return cash to the owners will depend whether they prefer dividends
or buybacks.
Forms of Business Organization
The Sole Proprietorship
The Partnership
The Corporation
Hypothetical Organization Chart
Board of Directors

Chairman of the Board and

Chief Executive Officer (CEO)

Vice President and

Chief Financial Officer (CFO)

Treasurer Controller

Cash Manager Credit Manager Tax Manager Cost Accounting

Capital Expenditures Financial Planning Financial Accounting Data Processing

Organisation of finance
Role of finance Manager
Emerging role of finance
manager
Investment planning –
Tax Management –
Working capital management – Inventory, Receivables, Cash.
Mergers, acquisitions, and restructuring
Risk management –
Investors relations -
Working capital

Current
Liabilities
Current Assets Net
Working
Capital

How much short-term cash flow

does a company need to pay its
bills?
Tracing Cash and Net Working Capital
Current Assets are cash and other assets that are expected to be
converted to cash within the year.
◦ Cash
◦ Marketable securities
◦ Accounts receivable
◦ Inventory
Current Liabilities are obligations that are expected to require
cash payment within the year.
◦ Accounts payable
◦ wages
◦ Taxes
◦ Short term borrowings
Net working capital = Current assets – current liabilities
Policies Related to Current Assets Investment

A Relaxed (flexible) policy would maintain a high ratio of

current assets to sales.
◦ Keeping large cash balances and investments in marketable securities
◦ Large investments in inventory
◦ Liberal credit terms

An aggressive (restrictive) short-term finance policy would

maintain a low ratio of current assets to sales.
◦ Keeping low cash balances, no or very less investment in marketable
securities
◦ Making small investments in inventory
◦ Allowing no or very less credit sales ( no/less accounts receivable)
Moderate Policy : It fall between the above two policies.
Determinants of Working Capital

Nature of Business
Production cycle
Credit Policy (Account receivables Mgt.)
Different Phases of industry/business
Nature of goods/services
Availability & stability of raw material …..etc.
Interlinkage of Finance Functions
with other Functions

Figure depicts the interlinkage of other functions with finance function