Financial Management

Unit I

Introduction to financial Management – Nature, Scope,

Functions of financial Management- Finance manager’s role-
Concept of value and return – Time value of money,
Compounding and discounting – Concept of risk and return
 Introduction to Finance
• Art and Science of managing money.
• Part of Planning and cost controlling of Firms Financial
resources.
• Branch Of Economics till 1890 & Separated recently. Theory
of Financial Mgt Provide the Managers with Conceptual &
Analytical Insight.
Definition :-
Business finance or Financial Mgt is that “ Business
Activity which is concerned with the acquisition &
conservation of Capital Funds in meeting financial needs &
Overall Objectives of business enterprises
Financial managers actively
Financial Services: Design Financial Management
manage the financial affairs
and delivery of advice and is concern with the
of any type of business
financial products to duties of the financial
managers in the either private and public ,
individuals, businesses and profit-seeking or not-for-
govt.,
business firm
profit
 Finance and other Disciplines
Fin Mgr has to understand the broad economic environment
specifically
• Recognize and understand how • Recognize and understand how
monetary policy affects the cost monetary policy affects the cost
and the availability of funds. and the availability of funds.
• Be versed in fiscal policy and its • Be versed in fiscal policy and its
effects on the economy effects on the economy
• Be aware of various financial • Be aware of various financial
institutions/outlets institutions/outlets
• Understand the consequences • Understand the consequences
of the various level of of the various level of
economics activity and changes economics activity and changes
in the economic policy for their in the economic policy for their
decision environment and so on. decision environment and so on.
 Finance function
Function of raising funds, investing them in assets and distributing returns to
shareholders are known as financing decisions, investment decision and
dividend decision. A firm attempt to balance cash inflow and outflows while
performing these functions which is called as liquidity decisions. Finance
function are divided into long term short-term decisions and include
Long-term financial decision Short-term financial decision
 Long term asset mix or Investment • Short term asset mix or
decision liquidity decision
 Capital mix or Financing decision
 Profit allocation or Dividend decision

Investment decision or capital budgeting involves the decision of allocation of

capital or commitment of funds to long term assets.
- evaluation of prospective profitability.
- measurement of a cut-off rate against that the prospective return of
new investment could be compared based on expected return & risk.
Finance decision deals with when, where and how to acquire funds to meet firms
investment needs. Central issue is to determine the proportion of equity and
debt mix known as capital structure.

A firm should decide whether to distribute all profits or retain them, or distribute
a portion. The optimum dividend policy is one that maximizes the market value of
the firm shares. Most profitable companies pay cash dividend regularly.

Current assets should be managed efficiently for safeguarding the firm against
the dangers of illiquidity and insolvency.
 Objectives of financial management
Investment and financing decisions are unavoidable and continuous,
in order to make rationally the firm goal is must. Widely accepted
financial goal of the firm is to maximization of owners economic
wealth.
Profit maximization
• Profit maxi. mean maximizing the rupee income of firm.
• Market economy indicate goods and service society needed.
Where goods with greater demand will command higher price,
result higher profit. Ultimately attract competitor to start and
equilibrium price reached. Price system directs managerial effort
and determine profitability.
The economic theory explained by Adam Smith explain the behavior
of a firm is analyzed in terms of profit maximization. While
maximizing profit, a firm either produce maximum output for given
amount of input to uses minimum input for producing given output.
 Point favor of profit
• Profit is a yardstick of efficient on the basic of which economic
efficiency of a business can be evaluated.
• It helps in efficient allocation and utilization of scarce means
because only such resources are applied which maximize the
profit.
• The rate of return on capital employed is considered as the
best measurement of the profit.
• Profits act as motivator which helps the business organizations
to be more efficient through hard work.
• By maximizing the profit, social and economic welfare is also
maximized.
 Role of financial manager
Financial manger is a person who significantly responsible for all
finance functions. Being the member of top management he is
responsible for shaping the future of enterprises.
Raising of funds : In the modern approach role of Fin Mgr. is not
limited to fund raising activity, he has to raise from combination of
various sources and more intensely felt in the case of an episodic
event like mergers, consolidations, reorganizations and
recapitalizations.
Allocation of funds : the central issue of financial policy is the wise
use of funds, and the central process involved is a rational matching
of advantages potential uses against the cost of alternative potential
sources so as to achieve the broad financial goals which an
enterprise sets for itself.
Profit Planning : Functions of financial manager include profit
planning. It refers to the operating decisions in the area of pricing,
costs, volume of output and the firm’s selection of product lines.
Profit planning is a pre-requisite for optimizing investment and
financing decisions.
Understanding Capital Markets: Fin mgr has to deal with capital
market where the firm’s securities are traded. Risk measurement,
valuation , dividend distribution should be understood by him. It is
through their operations in capital market the investor
continuously evaluate the actions of the financial manager.
 Concept of Value and return
Financial decisions such as purchase of assets or procurement of funds
affects the firms cash flows in different time periods. If firm borrows, it
receives fund now and commits an obligation to pay interest and
repay principal in future. Even during issue of equity, the cash balance
increases, but as firm pays dividend in future outflow occurs. Cash
flows become logically comparable when they are appropriate
adjusted for their different in timing and risk.
The welfare of owners would be maximised when net worth or net
present value is created. The net present value is the time value
concept.
Meaning of time value of money (TVM)
TVM is defined as the value derived from the use of money over time
as a result of investment. i.e the “worth of a rupee received today is
different from the worth of rupee to be received in future”
Reason for time preference of money
(i) Risk : There are financial and non-financial risks involved over
time. Future there is uncertainty about the receipt of money in
future. Longer the time period of return, the greater is the risk.
Hence, present money is preferred.
(ii) Preference for present consumptions : Most of the persons and
companies prefer present consumption due to urgency of need
e.g. consumer durables or otherwise.
(iii) Inflations : Inflations erodes the value of money. In an inflationary
situations, rupee todays represents a greater purchasing power
than a rupee one year later. For eg. If the present petrol price is
Rs.50 p.lt., 10 litre cqn be purchased with Rs.500. if it increases to
60, we can buy only 8.33 litres.
(iv) Investment opportunities : Individuals and companies have
preference for present money because od availabilities of
opportunities of investment
Methods of analysis
Concept of time value of money gives comparable values of
different rupee amounts at different point of time into equivalent
values at a particular point of time. This can ne either
(i) Compounding or (ii) Discounting
Compounding refers to ascertainment of future value of present
money . It is same as the concept of compounding interest,
wherein the interest earned in the preceding year is reinvested at
the prevailing rate of interest for the reaming period. The
accumulated (principal + interest) at the end of period becomes
the principal amount for calculating the interest for the next
period.