FINANCIAL MANAGEMENT

Instructor: Artt Evander B. Dula

LESSON OBJECTIVES

a. Explain the meaning and

importance of finance
b. Describe the inter-relation among
financial decisions
c. Explain the functional areas of
modern financial management
d. Discuss the functions of finance
e. Describe the financial objectives
INTRODUCTION TO
FINANCE
What is Finance?
INTRODUCTION

• Business concern needs finance to meet their

requirements in the economic world. Any kind of
business activity depends on the finance. Hence, it is
called as lifeblood of business organization. Whether the
business concerns are big or small, they need finance to
fulfill their business activities.

• In the modern world, all the activities are concerned

with the economic activities and very particular to
earning profit through any venture or activities. The
entire business activities are directly related with
making profit.
 1
1.1 MEANING OF
FINANCE
MEANING OF
FINANCE
• Financial management comprises the tools and capabilities used
to produce monetary resources and the management of those
monetary resources. The language of finance allows different
businesses to compare monetary results.

• Finance may be defined as the art and science of managing

money. It includes financial service and financial instruments.

• Finance also is referred as the provision of money at the time

when it is needed. Finance function is the procurement of funds
and their effective utilization in business concerns.

• The concept of finance includes capital, funds, money and

amount.
DEFINITION OF FINANCE

According to Khan and Jain, “Finance is the art and

science of managing money”.

According to Oxford dictionary, the word ‘finance’

connotes ‘management of money’. Webster’s Ninth New
Collegiate Dictionary defines finance as “the Science on
study of the management of funds’ and the management
of fund as the system that includes the circulation of
money, the granting of credit, the making of investments,
and the provision of banking facilities.
DEFINITION OF BUSINESS FINANCE

According to the Wheeler, “Business finance is that business

activity which concerns with the acquisition and conversation of
capital funds in meeting financial needs and overall objectives of a
business enterprise”.

According to the Guthumann and Dougall, “Business finance can

broadly be defined as the activity concerned with planning, raising,
controlling, administering of the funds used in the business”.

In the words of Parhter and Wert, “Business finance deals

primarily with raising, administering and disbursing funds by
privately owned business units operating in nonfinancial fields of
industry”.
TYPES OF FINANCE

Finance can be divided into:

Public Finance – deals with the requirements, receipts and

payments of funds in the government institutions, central
governments, state governments and local self-
governments.

Private Finance – deals with the requirements, receipts,

and payments of funds in case of individuals, business
organizations and non-profit organizations.
DEFINITION OF BUSINESS FINANCE

FINANCE

Private
Public Finance
Finance

-Government
Institutions
-Personal Finance
-Central Governments -Business Finance
-State Governments -Finance of Non-Profit
-Local Self-Governments Organizations
EFINITION OF FINANCIAL MANAGEMENT

Financial Management is an integral part of the overall

management. It is concerned with the duties of the financial
managers in the business firm.

• It is concerned with the efficient use of an important

economic resource, namely capital funds.
• It deals with procurement of funds and their effective
utilization in the business.
• An application of general managerial principles to the
area of financial decision making.
• An area of financial decision-making, harmonizing
individual motives and enterprise goals.
NATURE OF FINANCIAL MANAGEMENT

• Financial management refers to the part of management

activity, which is concerned with the planning and
controlling of firm’s financial resources.

• The nature of financial management is the relationship

with economics and accounting, its functions and its
scope.

• The modern approach to financial management is to find

out how much money is required by the company in
question, and then to source at least that amount.
NATURE OF FINANCIAL MANAGEMENT

• When raising finance, a financial management team

should ensure that they strike a balance of owned and
borrowed funds.

• Working capital will be required for the day-to-day

running of the company and for emergencies.
1
1.2 IMPORTANCE AND
SCOPE OF FINANCIAL
MANAGEMENT
IMPORTANCE OF FINANCIAL MANAGEMENT

• Financial Planning
• Acquisition of Funds
• Proper Use of Funds
• Financial Decision
• Improve Profitability
• Increase the Value of the Firm
• Promoting Savings
SCOPE OF FINANCIAL MANAGEMENT

• Financial Management and Economics

• Financial Management and Accounting
• Financial Management and Mathematics
• Financial Management and Production
Management
• Financial Management and Marketing
• Financial Management and Human Resource
LIQUIDITY VS. PROFITABILITY (RISK-RETURN TRADE-OFF)

• Liquidity means that the firm has:

- Adequate cash to pay bills as and when they fall
due, and;
- Sufficient cash reserves to meet emergencies and
unforeseen demands, at all time.

• Profitability requires that the funds of the firm be so

utilized as to yield the highest return.
NATURE OF FINANCIAL MANAGEMENT

• Risk: The variability of the expected return from the

investment.
• Return: Measured as a gain or profit expected to be
made, over a period, at the time of making the
investment.

Profit is the measuring techniques to understand the

business efficiency of the concern.
FUNCTIONAL AREAS OF MODERN FINANCIAL MANAGEMENT

• Determining Financial Needs

• Choosing the Sources of Funds
• Financial Analysis and Interpretation
• Cost-Volume Profit Analysis
• Working Capital Management
• Dividend Policy
• Capital Budgeting
ROLE OF FINANCE MANAGER

• The finance manager handles finance.

• The role of finance manager is pivotal.
• The finance manager is responsible in shaping the
fortunes of the enterprise.
• The finance manager has a positive role to play in every
type of the organization.
ROLE OF FINANCE MANAGER

• Influences Fortunes of the Firm: The history of

failures of organizations is interesting. Many firms have
failed, not because of inefficiency of production, inability
in marketing or non-availability of funds but due to the
absence of competent finance manager.
ROLE OF FINANCE MANAGER

• Exists Everywhere: The role of finance manager, in

modern times, can be well said, universal and pervasive.
Hardly, we find any activity, which does not involve
finance. Even entertainment in a firm requires financial
management due to financial implications. In modern
business, no decision is taken without the consultation of
finance.
1
1.4 FUNCTIONS OF
FINANCE
FUNCTIONS OF FINANCE

Financial decisions or finance functions are closely inter-

connected. All decisions mostly involve finance. When a
decision involves finance, it is a financial decision in a
business firm. In all the financial areas of decision-making,
the role of finance manager is vital.
FUNCTIONS OF FINANCE

Finance functions can be divided into three major decisions,

which the firm must make, namely the investment
decision, the finance decision, and the dividend
decision.
INVESTMENT DECISION

• Investment decisions relate to selection of assets in

which funds are to be invested by the firm. Investment
alternatives are numerous. Resources are scarce and
limited.

• Investment decisions relate to the total amount of assets

to be held and their comparison in the form of fixed and
current assets.
INVESTMENT DECISION

The investment decision is the most important one among

the three decisions. It relates to the selection of assets in
which funds are invested by the firm. The assets, which can
be acquired, fall into two broad groups:

• Long-term assets which will yield a return over a period of

time in future.
• Short-term current assets which are convertible into cash
in the normal course of business usually within a year.
INVESTMENT DECISION

Long-term Investment Decisions: The long-term capital

decisions are referred to as capital budgeting decisions,
which relate to fixed assets.

The fixed assets are long term, in nature. Basically, fixed

assets create earnings to the firm. They give benefit in
future. It is difficult to measure the benefits as future is
uncertain.
INVESTMENT DECISION

Short-term Investment Decisions: The short-term

investment decisions are, generally, referred as working
capital management. The finance manager has to allocate
among cash and cash equivalents, receivables and
inventories.
FINANCING DECISION

• Financial manager must decide the mode of raising the

funds to meet the firm’s investment requirements.
• The major issue in this decision is to determine the
proportion of equity and debt capital.
• Once investment decision is made, the next step is how
to raise finance for the concerned investment.
• Finance decision is concerned with the mix or
composition of the sources of raising the funds required
by the firm.
• In finance decision, the finance manager is required to
determine the proportion of equity and debt, which is
known as capital structure.
FINANCING DECISION

• There are two main sources of funds:

1. Borrowed funds are to be paid interest, irrespective of

the profitability of the firm. Interest has to be paid, even if
the firm incurs loss and this permanent obligation is not
there with the funds raised from the shareholders.

2. Shareholder funds are permanent source to the firm.

The shareholder’s funds could be from equity shareholders
or preference shareholders
FINANCING DECISION

Equity share capital is not repayable and does not have

fixed commitment in the form of dividend.

Preference share capital has a fixed commitment, in the

form of dividend and is redeemable, if they are redeemable
preference shares.

Dividend is the reward of the shareholders for investment

made by them in the shares of the company.
LIQUIDITY DECISION

• The liquidity decision is concerned with the management

of the current assets, which is a pre-requisite to long-term
success of any business firm. The main objective of the
current assets: management is the trade – off between
profitability and liquidity.

• If the firm does not have adequate working capital, it

may become illiquid and consequently fail to meet its
current obligations thus inviting the risks of bankruptcy.
LIQUIDITY DECISION

• On the contrary, if the current assets are too large, the

profitability is adversely affected. Hence, the key strategy
and the main consideration in ensuring the a trade-off
between profitability and liquidity is the major objective
of the liquidity decision.

• Liquidity decision is concerned with the management of

current assets. Basically, this is working capital
management.
LIQUIDITY DECISION

• When more funds are tied up in current assets, the firm

would enjoy greater liquidity. In consequence, the firm
would not experience any difficulty in making payments
of debts, as and when fall due.

• A proper balance must be maintained between liquidity

and profitability of the firm.
DIVIDEND DECISION

• The financial manager must decide whether the firm

should distribute all profits or retain it in the firm or
distribute part and retain the balance.

• The dividend decision should be taken in terms of its

impact on the shareholders’ wealth.

• Financial management involves the solution of the three

decisions of the firm according to the modern approach.
DIVIDEND DECISION

• Dividend: The term ‘dividend’ relates to the portion of

profit, which is distributed to shareholders of the
company. It is a reward or compensation to them for their
investment made in the firm.

• The dividend can be declared from the current profits or

accumulated profits. Normally, companies distribute
certain amount in the form of dividend, in a stable
manner, to meet the expectations of shareholders and
balance is retained within the organization for expansion.
1
1.5 FINANCIAL
OBJECTIVES
FINANCIAL OBJECTIVES

• Financial manager must determine the basic objectives of

financial management. Objectives of financial
management may be broadly divided into two parts such
as:

1. Profit Maximization
2. Wealth Maximization
PROFIT MAXIMIZATION

• Main aim of any kind of economic activity is earning

profit.

• A business concern is also functioning mainly for the

purpose of earning profit.

• Profit is the measuring techniques to understand the

business efficiency of the concern.

• Profit maximization is also the traditional and narrow

approach, which aims at, maximizes the profit of the
concern.
PROFIT MAXIMIZATION

Profit maximization consists of the important features:

• Profit maximization is also called as cashing per share

maximization. It leads to maximize the business
operation for profit maximization.

• Ultimate aim of the business concern is earning profit;

hence, it considers all the possible ways to increase the
profitability of the concern.
PROFIT MAXIMIZATION

Profit maximization consists of the important features:

• Profit is the parameter of measuring the efficiency of the

business concern. So it shows the entire position of the
business concern.

• Profit maximization objectives help to reduce the risk of

the business.
PROFIT MAXIMIZATION

Favorable Arguments for Profit Maximization

The important points are in support of the profit

maximization objectives of the business concern:

• Main aim is earning profit.

• Profit is the parameter of the business operation.
• Profit reduces risk of the business concern.
• Profit is the main source of finance.
• Profitability meets the social needs also.
PROFIT MAXIMIZATION

Unfavorable Arguments for Profit Maximization

The important points are against the objectives of profit

maximization:

• Profit maximization leads to exploiting workers and

consumers.
• Profit maximization creates immoral practices such as
corrupt practice, unfair trade practice, etc.
• Profit maximization objectives leads to inequalities
among the stakeholders such as customers, suppliers,
public shareholders, etc.
PROFIT MAXIMIZATION

Drawbacks Arguments for Profit Maximization

Profit maximization objective consists of certain drawback

also:

• It is Vague: In this objective, profit is not defined

precisely or correctly.
• It ignores the Time Value of Money: Profit
maximization does not consider the time value of money
or the net present value of the cash inflow.
• It ignores Risk: Profit maximization does not consider
risk of the business concern.
WEALTH MAXIMIZATION

• Wealth maximization is one of the modern approaches,

which involves latest innovations and improvements in
the field of the business concern.

• The term wealth means shareholder wealth or the wealth

of the persons those who are involved in the business
concern.
WEALTH MAXIMIZATION

Favorable Arguments for Wealth Maximization

• Wealth maximization is superior to the profit

maximization because the main aim of the business
concern under this concept is to improve the value or
wealth of the shareholders.

• Wealth maximization considers the comparison the value

to cost associated the business concern.

• Wealth maximization considers both time and risk of the

business concern.
WEALTH MAXIMIZATION

Favorable Arguments for Wealth Maximization

• Wealth maximization provides efficient allocation of

resources.

• It ensures the economic interest of the society.

WEALTH MAXIMIZATION

Unfavorable Arguments for Wealth Maximization

• Wealth maximization leads to prescriptive idea of the

business concern but it may not be suitable to present
day business activities.
• Wealth maximization is nothing, it is also profit
maximization, it is the indirect name of the profit
maximization.
• Wealth maximization creates ownership-management
controversy.
• Management alone enjoys certain benefits.
• The ultimate aim of the wealth maximization objectives is
THANK YOU!