UNIT 1

Understanding the meaning of financial management, financial

system and basics of valuation:
Introduction to Financial Management; Introduction to the Financial
System; The concept of Time value of money; Valuation of Bonds
and Shares.
EVOLUTION OF FINANCE AS A DISCIPLINE
To begin the study of financial management, what is needed is to address two
central issues :

• What is Financial Management and What is the

role of financial manager?
• What is financial decision making and What is
the goal of Financial Management?
 Finance upto 1950 – The traditional Phase
• Initially, finance was a part of economics and no separate attention was paid
to finance. Business owners were more concerned with operational activities.
The finance managers were concerned with record keeping, preparing
different and managing cash. A finance manager was called upon in
particular only when his speciality was required to locate new sources of
funds whenever there was need felt for the funds. The traditional phase can
be summarized as follows:
(i) Finance function was only concerned with procuring of funds to finance
the expansion or diversification activities.
(ii) Finance function was viewed particularly from the point of view of
supplier of funds i.e. the lenders, both individuals and institutions.
 Finance upto 1950 – The traditional Phase
(iii) The focus of attention was on the long term resources and only the
long term finance was of any concern. The concept of working capital was
non-existent.
(iv) The treatment of different aspects of finance was more of descriptive
nature rather than analytical.

Gradually, the scope of finance function widened and day-to-day problems

of finance was also incorporated. Funds analysis and control on a regular
basis, rather than on casual basis.
 After 1950- An integrated view of Finance Function
• Significant contributions were made by following theories:
i. THEORY OF PORTFOLIO MANAGEMENT
Developed by Harry Markowitz in 1952.
It deals with portfolio selection with risky investments.
It includes statistical concepts to quantify risk-return of portfolios.
Risk of one investor is viewed in totality rather than risk in one security.
This theory led to development of CAPM which deals with pricing of risky
assets and the relationship with risk and return.
ii. THE THEORY OF LEVERAGE AND VALUATION OF FIRM
Developed by Modigliani and Miller in 1958.
They introduced analytical approach as to how financial decision making in any
firm can be oriented towards maximization of the value of firm and the
 MODERN PHASE
The scope has widened to include the optimum utilization of funds
through analytical decision making.
The finance function is now viewed from the point of view of insiders
i.e. those who are taking decision in the firm.
The knowledge of securities, financial markets and institutions is also
necessary and scope of finance manager has expanded.
The study has widespread and many new theories as well as refinement
to existing theories may be in the offing.
 FINANCIAL MANAGEMENT : MEANING
• The term financial management is concerned with flow of funds in any firm.
It is concerned with financial decision making and thereby deals with raising
of funds and their optimum utilization.
• According to Hoagland, “Financial management is concerned mainly with
such matters as, how a business corporation raises its finance and how it
makes use of it.”
• According to Soloman, “Financial management is concerned with the
efficient use of an important economic resource, namely, Capital Funds.”
 FINANCIAL MANAGEMENT
Legal and Procedural constraints

Financing Decisions:
1) Investment Decisions
2) Financing Decisions
3) Dividend Decisions
4) Others

Affect

Risk Return

Value of the Firm

 IMPORTANCE OF FINANCIAL MANAGEMENT
1. Helps organizations in financial planning
• Financial management helps the company to ascertain fund requirements and decides
the necessary steps to meet those requirements.
2. Assists in acquiring funds from different sources
• To understand available sources and acquire funds for the business. This acquisition
must be made keeping in mind the cost and liabilities.
3. Helps in investing an appropriate amount of fund
• The proper functioning of the finance department boosts the growth and efficiency of
the organization. When the funds are utilized in a precise manner, the financial
management can work toward holding the cost of capital and amplifying the company’s
worth.
4. Increases organizational efficiency
• Financial management focuses on establishing a firm position for the company in the
market. It achieves this through a framework for increasing the investors' and
shareholders' wealth. The main objective of an organization is to perform well and
 IMPORTANCE OF FINANCIAL MANAGEMENT
5. Reduces delayed production
• Production delays are the root cause of poor financial management. It causes inefficiency in every
department. Secure financial planning monitors production timelines and deadlines and tries to
reduce production delays.
6. Financial costs planning
• This involves projections regarding the company's financial requirements to meet its short-term
and long-term objectives. Financial management executives provide a vision for daily operations
and enable planning for cost reduction and profit maximization.
7. Provides economic stability
• Maintaining economic stability is a prerequisite for an organization to achieve constant growth.
Sound financial resources will help an organization expand its horizons and thrive in the business.
To achieve financial stability, it is important to have efficient financial management in place.
8. Financial decisions making
• Financial professionals assist the senior professionals in the company in forming rules and
creating policies by giving a precise report of the daily finances and data on appropriate key
performance indicators.
 IMPORTANCE OF FINANCIAL MANAGEMENT
9. Guideline for earning maximum profits with minimum cost
• Maximizing profits is the end goal for every organization. And the earrings and
revenues are solely based on the productive employment of financial resources. A
solid financial foundation comprises different attributes such as budget control, cost
control, ratio analysis, trend analysis, and cost-volume-profit numbers. Thus, financial
management is crucial to enhancing profits and minimizing operations costs.
10. Increases shareholders' wealth
• Shareholders act as assets for an organization. They are investors in the company.
This is why a company's main objective should be to maximize its shareholders'
wealth. It will retain the funds and benefit the economy.
11. Encourages employees to save money
• A transparent and sustainable financial management system enables employees to
understand the available resources. In addition, it authorizes professionals in every
department to work toward the company's betterment by functioning under a budget.
 SCOPE OF FINANCIAL MANAGEMENT
1. Capital Budgeting
• The company's financial management executives are responsible for making predictions
regarding all the business transactions and costs of operations. Based on this estimate, they
generate the probable estimate of fixed capital and working capital required by the company
in a particular period.
2. Capital Structure
• After projecting the financial budget, the financial management experts must formulate a
plan for structuring this capital. First, they have to control the transactions and divide the
available money into different parts, such as the owner's risk capital, borrowed capital, and
short-term and long-term debt-equity ratio.
3. Financial Decision
• Financial decisions include all sorts of choices regarding sources to generate funds,
investment decisions, and cash flow management. The business can raise funds from
different sources like investors, shareholders, banks, public deposits, and other financial
lenders. Financial professionals also make plans for wise investment of these funds to
improve the company's return on investment.
 SCOPE OF FINANCIAL MANAGEMENT
4. Working Capital Management
• It requires three primary tasks to maintain a solid financial position for the
company:
• First, financial executives record the company's assets and liabilities to
ascertain the cash flow. This cash flow is used to cover short-term operational
costs and short-term liabilities.
• The finance department scans different ratios to manage the working capital.
These include the working capital ratio, the collection ratio, and the inventory
ratio.
• Proper working capital management enables cash flow and revenue
maintenance, allowing the organization to utilize its resources in profitable
directions.
 SCOPE OF FINANCIAL MANAGEMENT

5. Dividend Decision
A company has two options: pay dividends to shareholders or hold on to the
profits. Financial management meaning focuses on the decision between these
two options that will support the company's growth. Dividends are payouts to
shareholders and are calculated using Earning Per Share.
6. Profit management
Sometimes, companies keep aside some funds as a reserve. This is taken from
the business's earnings. In addition, some amount of funds is either pulled out
or reinvested. The financial department's responsibility is to draw out the
strengths and shortcomings of different sources for using the company's
profits and earnings before coming to a conclusion.
OBJECTIVES/ GOALS OF FINANCIAL MANAGEMENT
• PROFIT MAXIMIZATION
The process of increasing the profit earning capability of the company is referred
to as Profit Maximization. It is mainly a short-term goal and is primarily restricted
to the accounting analysis of the financial year. It ignores the risk and avoids the
time value of money. It primarily concerns the company’s survival and growth in
the existing competitive business environment.
• WEALTH MAXIMIZATION
The ability of a company to increase the value of its stock for all the stakeholders
is referred to as Wealth Maximization. It is a long-term goal and involves multiple
external factors like sales, products, services, market share, etc. It assumes the
risk. It recognizes the time value of money given the business environment of the
operating entity. It is mainly concerned with the company’s long-term growth and
hence is concerned more about fetching the maximum chunk of the market share
to attain a leadership position.
 PROFIT MAXIMIZATION VS WEALTH
MAXIMIZATION
KEY POINTS PROFIT MAXIMIZATION WEALTH MAXIMIZATION
DEFINITION It is defined as the management of financial It is defined as the management of financial
resources aimed at increasing the profit of resources aimed at increasing the value of
the company. the stakeholders of the company.
FOCUS Focuses on increasing the profit of the Focuses on increasing the value of the
company in short term. stakeholders of the company in long term.
RISK It does not consider the risks and It considers the risks and uncertainty
uncertainty inherent in the business model inherent in the business model of the
of the company company
USAGE It helps in achieving efficiency in the It helps in achieving a larger value of a
company’s day to day operations to make company’s worth, which may reflect in the
the business profitable. increased market share of the company.
 FINANCIAL MANAGEMENT AND OTHER AREAS OF
MANAGEMENT
A) Financial Management and Production department
• Production department is concerned with provision of production facilities,
production cycle, skilled and unskilled labour, storage of finished goods,
capacity utilization etc. The production department may be required to take
various decisions like increase in capacity utilization, installation of safety
devices, replacing machinery etc. All these decisions have financial
implications.
B) Financial Management and Materials department
• Materials management is concerned with procurement, storage,
maintenance and supply of materials and stores. The finance manager and
material manager may come together while determining EOQ, safety level,
storing place requirements etc. The cost of all decisions should be evaluated
against expected savings.
 FINANCIAL MANAGEMENT AND OTHER AREAS OF
MANAGEMENT
C) Financial management and Personnel department
• Personnel department is entrusted with responsibility of recruitment,
training and placement of the staff for the firm. The personnel department
has to work with the finance manager while evaluating different schemes
of training programmes, employees welfare, economy in manpower,
computerization, incentive schemes, revision of pay scales, etc.

D) Financial management and Marketing department

• Marketing department is entrusted with the responsibility of framing
marketing, selling, advertisement and other related policies to achieve the
sales target. The financial implications of the proposed advertisement
policy, price-war manoeuvres, liberalization of credit policy, etc.
 FUNCTIONS OF FINANCIAL MANAGER
• The primary activities of a financial manager are :
(i) Performing financial analysis and planning
It is concerned with:
a) Transforming data into a form that can be used to monitor financial condition,
b) Evaluating the need for increased (reduced) productive capacity
c) Determining the additional/ reduced financing required.
The main objective of this is to assess cash flows and develop plans to ensure adequate cash
flows to support achievement of firm’s goals.
(ii) Making investment decisions
Investment decisions determine both the mix and the type of assets held by a firm. The mix
refers to the amount of current assets and fixed assets. Consistent with mix, the financial
manager must determine and maintain optimal levels of current assets. He should also
decide the best fixed assets to acquire and when existing fixed assets need to be modified/
 FUNCTIONS OF FINANCIAL MANAGER
(iii) Making financial decisions
It is concerned with short-term and long-term financing. Many of these
decisions are dictated by necessity, but some require in-depth analysis of
available financing alternatives, their costs and long-term implications.
EMERGING ROLE OF FINANCE MANAGERS IN INDIA
(a) Financial structure
(b) Foreign exchange management
(c) Treasury operations
(d) Investor communication
(e) Management control
(f) Investment planning
 TIME VALUE OF MONEY
The concept of time value of money is one of the fundamental pillars
of financial management.
In a way the concept of time value of money implies that cash flow
occurring at different time periods cannot be compared or added
together because their values are different.
Cash flow occurring at initial years are more valuable than the cash
flows occurring in later years in future.
Time value of money means that the sum of rupee received today has
more value than the same amount to be received in future.
REASONS FOR TIME VALUE OF MONEY
There are three primary reasons for time value of money :-
1) Reinvestment opportunities
2) Uncertainty and Risk
3) Preference for current consumption
 TECHNIQUES OF INCORPORATING
TIME VALUE OF MONEY
• The approach wherein we convert all cash flows into FUTURE
POINT OF TIME or into their FUTURE VALUE is termed as
Compounding technique.
• The approach wherein we convert all cash flows into PRESENT
POINT OF TIME or into their PRESENT VALUE is termed as
Discounting technique.
• It must be noted that both the techniques lead to same decision
ultimately regarding the options or alternatives to chose.
• Annuity Due is a series of equal cash flows occurring at the beginning
of every year for a given number of years.
 PRACTICE SUMS- COMPOUNDING TECHNIQUE

A. FUTURE VALUE OF A LUMP SUM AMOUNT

(SINGLE SUM OF MONEY)
1) Mr. X deposits ₹100000 on 1st January 2015 in a bank at 12% rate of
interest compounded annually for two years. Find out the future value of
the deposit as on 31st December 2016.
2) Mr X deposits ₹ 200000 on 1st January 2015 in a bank at 14% p.a. rate
of interest compounded semi-annually for two years. Find out the future
value of the deposit as on 31st December 2016.
3) Find out the effective annualised rate of interest if the rate of interest is
12% p.a. and compounding is done on quarterly basis.
PRACTICE SUMS- COMPOUNDING TECHNIQUE
B. FUTURE VALUE OF AN ANNUITY
(SERIES OF EQUAL CASH FLOWS)
1) Mr Raja opens a recurring account in a Bank where he deposits ₹
2000 every year for 10 years at 10% p.a. what is the future value of
his amounts deposited in the bank.
2) Mr. R opens a recurring account in Bank where he deposits ₹20000
every year for 10 years at 12% p.a. What is the future of his amounts
deposited in the Bank.
PRACTICE SUMS- DISCOUNTING TECHNIQUE

A. PRESENT VALUE OF A LUMP SUM AMOUNT

(SINGLE SUM OF MONEY)
1) Mr. A is to receive ₹ 30000 at the end of 5 years from now. If the
interest rate is 10%p.a., find out the present value of ₹ 30000.
2) Mr Tiwari is expecting to receive ₹20000, ₹30000 and ₹50000 at the
end of first year, second year and third year from now. If the interest rate
is 10% p.a. calculate the total present value of the amounts received by
Mr. Tiwari over next three years.
PRACTICE SUMS- DISCOUNTING TECHNIQUE
B. PRESENT VALUE OF AN ANNUITY
(SERIES OF EQUAL CASH FLOWS)
1) Mr. A has to receive ₹ 5000 each year at the end of each year for
next five years. The interest rate is 10% p.a. How much is the
present value of the total amount which Mr. A is going to receive in
five years time?
C. PRESENT VALUE OF A PERPETUITY
1) Mr A invests ₹ 20000 every year indefinitely in a recurring bank
deposit account, which earns him 5% p.a. Find out the present value of
such perpetuity.
 PRACTICE SUMS- ANNUITY DUE
1) Mr. Anuj deposits ₹ 40000 in the beginning of every year for 10
years at the rate of 8% p.a. How much will he get after the expiry of
10 years?
2) Anu deposits ₹ 40000 in the beginning of every year for 10 years at
the rate of 8% p.a. What is the present value of total deposits made
by Anu?
THANK YOU