FINANCIAL

MANAGEMENT Module 1

Meaning, nature and scope of Finance, Financial Goal, Profit vs. Wealth Maximization, Finance
Function- Investment, Financing and Dividend Decisions. (Case Study on commenting the
objectives and financial goals of two companies based on the annual reports) (Theory)
MEANING OF FINANCIAL MANAGEMENT

Financial management is that managerial activity which is concerned

with planning and controlling of the firm’s financial resources. In
other words it is concerned with acquiring, financing and managing
assets to accomplish the overall goal of a business enterprise (mainly
to maximise the shareholder’s wealth).

“Financial Management comprises of forecasting, planning,

organizing, directing, co-ordinating and controlling of all activities
relating to acquisition and application of the financial resources of an
undertaking in keeping with its financial objective.
DEFINITION OF FINANCIAL MANAGEMENT
Definition given by Phillippatus is “Financial Management is concerned with
the managerial decisions that result in the acquisition and financing of short
term and long term credits for the firm.”

In the words of Prof. Ezra Solomon, “Financial management is concerned with
the efficient use of an important economic resource, namely, capital funds”.

Form the above definitions, it is clear that the financial management refers to
those specialized managerial activities or efforts which are concerned with
the estimation of the finance, long-term as well as short-term, needed by a
business enterprise, determination of the sources suitable under the given
circumstances, the collection and provision of funds in time and control over
the utilization of funds.
OBJECTIVES OF FINANCIAL MANAGEMENT

Objectivesof
FinancialManagement

Profit Wealth/ Value

Maximisation Maximisation
Profit Maximisation

• It has traditionally been argued that the primary objective of a

company is to earn profit; hence the objective of financial
management is also profit maximisation.

• This implies that the finance manager has to make his decisions in a
manner so that the profits of the concern are maximised. Each
alternative, therefore, is to be seen as to whether or not it gives
maximum profit.
The following arguments are advanced in favor of Profit
Maximization: -

• When profit earning is the main aim of the business then, profit maximization should
be its main objective.
• Profitability is a barometer for measuring efficiency and economic prosperity of a
business enterprise.
• Profits are the main sources of finance for the growth and development of a business.
• A business will be able to survive under unfavorable situations like recession,
depression, sever competition, etc. only if it has some past earnings.
• Profitability is essential for fulfilling social needs also.
• Profit maximization attracts the investors to invest their savings in securities of the
firm.
• Profit indicates the efficient use of funds of the business concern.
• The goodwill of the firm is based on profitability
Limitation of Profit Maximization objective
1. The term profit is vague. It does not clarify what exactly it means.
It conveys a different meaning to different people. For example, profit may be
in short term or long term period; it may be total profit or rate of profit etc.

2.Profit maximisation has to be attempted with a realisation of risks

involved.
There is a direct relationship between risk and profit. Many risky propositions
yield high profit. Higher the risk, higher is the possibility of profits. If profit
maximisation is the only goal, then risk factor is altogether ignored. This
implies that finance manager will accept highly risky proposals also, if they
give high profits. In practice, however, risk is very important consideration and
has to be balanced with the profit objective.
3. Profit maximisation as an objective does not take into account the time pattern of returns.
Proposal A may give a higher amount of profits as compared to proposal B, yet if the returns of proposal A begin to flow say 10
years later, proposal B may be preferred which may have lower overall profit but the returns flow is more early and quick.
Project A- 10000 20000 30000 40000 = 100000
Project B 5000 15000 30000 60000 = 110000

4.Profit maximisation as an objective is too narrow.

It fails to take into account the social considerations as also the obligations to various interests of workers, consumers, society,
as well as ethical trade practices. If these factors are ignored, a company cannot survive for long. Profit maximization at the
cost of social and moral obligations is a short sighted policy.

5.Profit maximization encourages corrupt practices to increase the profit.

6. Profit maximization attracts cut-throat competition.

7. Huge amount of profit may invite government intervention.

Wealth / Value Maximisation
The shareholder value maximization model holds that the primary goal of the
firm is to maximize market value of equity stocks and shareholders wealth.
We will first like to define what is Wealth / Value Maximization Model.

Wealth = Present value of benefits – Present Value of Costs

So for measuring and maximizing shareholders wealth finance manager should
follow:
Cash Flow approach not Accounting Profit
Cost benefit analysis
Application of time value of money.
SWM tries to maximise value of company

Value of a firm (V) = Number of Securities (N) × Market price of securities

(MP)
Or
V = Value of equity (Ve ) + Value of debt (Vd )
How to maximize wealth?
1.Avoid high level of risks - The firm should avoid such projects, which involve high
profits together with high risks.

2.Pay Dividends - Payment of regular dividends increases the firm’s reputation and
consequently the value of the firm’s shares.

3.Maintain Growth in sales -The firm should have a large, stable and diversified
volume of sales. This protects the firm from adverse consequences of recessions,
changes in customer’s preferences or fall in demand for the firm’s products on
account of other reasons.

4.Maintain price of firm’s equity shares -Maximization of shareholders wealth is

closely connected with the maximization of the value of the firm’s equity shares. A
firm can take a number of steps to maintain the value of equity shares at
reasonable levels.
Some of the other goals a business enterprise may follow are:-

Some of the other goals a business enterprise may follow are:-

• Achieving a higher growth rate
• Attaining a larger market share
• Gaining leadership in the market in terms of products and technology
• Promoting employee welfare
• Increasing customer satisfaction
• Improving community life, supporting education and research, solving
societal problems, etc.
FINANCE FUNCTIONS/ FINANCE
DECISION
Value of a firm will depend on various finance functions/decisions. It
can be expressed as :
V = f (I,F,D).

• The finance functions are divided into

1.long term functions/decisions
2.short term functions/decisions
Long term Finance Function
Decisions.
(a)Investment decisions (I)
• These decisions relate to the selection of assets in which funds will be invested by
a firm.
• Funds procured from different sources have to be invested in various kinds of
assets.
• Long term funds are used in a project for various fixed assets and also for current
assets.
• The investment of funds in a project has to be made after careful assessment of
the various projects through capital budgeting.
• A part of long term funds is also to be kept for financing the working capital
requirements.
(b)Financing decisions (F)
• These decisions relate to acquiring the optimum finance to meet
financial objectives.
• The financial manager needs to possess a good knowledge of the
sources of available funds and their respective costs
• he needs to ensure that the company has a sound capital structure, i.e. a
proper balance between equity capital and debt.
• Financing decisions also call for a good knowledge of evaluation of risk,
e.g. excessive debt carried high risk for an organization’s equity because
of the priority rights of the lenders.
• A major area for risk-related decisions is in overseas trading, where an
organisation is vulnerable to currency fluctuations, and the manager
must be well aware of the various protective procedures such as hedging
.
c) Dividend decisions(D):

• These decisions relate to the determination as to how much dividends

can paid out of the profits of an organisation as income for its
owners/shareholders.
• The owner of any profit- making organization looks for reward for his
investment in two ways, the growth of the capital invested and the cash
paid out as income;
• The dividend decision has two elements – the amount to be paid out
and the amount to be retained to support the growth of the organisation.
• the regular growth of dividends represent a significant factor in
determining company’s market value, i.e. the value placed on its shares
by the stock market.
Short- term Finance
Decisions/Function.
d) Working capital Management (WCM)
• Generally short term decision are relating to management of current
asset and current liability (i.e., working capital Management).
• Working capital refers to the excess of current assets over current
liabilities. In other words, it is net current assets or net working
capital.
• Working capital is essential to maintain the smooth running of
business. No business can survive without adequate amount of
working capital proper management of working capital is an
important area of financial management.
• Liquidity vs prifitability.
Role of Finance Manager
1)Funds Requirement Decision
This is the most important function performed by the finance manager. A careful
estimate has to be made about the total funds required for both the fixed and
working capital requirements.

2)Financing Decision
This is an important decision for the finance manager. It is concerned with
determination of the quantum of finance, the amount that can be raised from each
source and the cost and other consequences involved.

3)Investment Decision
This comprises decisions relating to investment in both fixed assets and current
assets. The finance manger has to evaluate different capital investment proposals
and select the best keeping in view the overall objective of the enterprise.
4)Dividend Decision
The establishment of dividend policy is another important function of finance
manager. The dividend decision involves the determination of the percentage of
profits earned by the enterprise, which is to be paid to shareholders and percentage of
profits that should be retained as retained earnings.

5)Valuation Decisions
A number of merger and consolidation take place in the present competitive industrial
world. A finance manager must assist the management in making valuations.
 subsidiary functions of finance
manager: -
a)To ensure supply of funds to all parts of the organization
It is also the function of the finance manager to ensure supply of funds to all parts
of the organization to help in smooth operations of the activities of the
organization.
b)To evaluate Financial Performance
The financial performance of the various units of the organization is to be
evaluated from time to time to detect any fault in the financial policy.
c)To negotiate with Banker, Financial Institutions, etc.
The financial executive must negotiate with Banker, Financial Institutions and other
suppliers of credit.
d)To keep track of Stock Exchange
The financial executive must keep track of stock exchange quotations and behavior
of stock market prices, etc.