Introduction to Financial Management

1. Unit 1 : Introduction To Financial Management

Finance: it is a flow of money.

Management: control or managing of money

Financial management: it is the process of managing or controlling flow of money or fund.

In the technique word: financial management it is a process of acquitting of funds from

various sources to meet the business needs in order to accomplish overall objectives of the
firm.

1. Maximization of wealth.
2. Maximization of profit.

Financial management it is consider as a life blood of all business enterprises and it also
consider as arms and leg business activities.

Finance can be classified into two types: -

1. Private finance: It deals with requirements receipts and discernment of funds to an

 Individual
 Business finance and
 Non- profit organization or corporation firms finance

Business finance sub classified into three types: -

 Sole proprietors finance

 Partnership firm finance and
 Joint stock company
2. Public finance: - It deals with requirement receipts distributions of fund to the
government institutions by
 Local self-government
 State government
 Central government

Importance of finance: -

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1.Finance is helpful for modernization, diversification expansion and development of

enterprises.

2.Availability of adequate finance increases the credit worthiness (repayment of loan of the
concern int the high of the supplies traders and general public.

3.The issue of a large number of securities as provided wide investment opportunities to the
investors.

4.By insuring wide distribution of funds finance contribution to balance regional

development in the country.

5.Finance if essential for undertaking research activities, market survey publicity,

transportation, communication and for efficient marketing of a product.

6.By contributing to the renovation and modernization of industry finance contribute to the
production and supplies goods at fair prices to the society.

Business finance/finance function

It is a process of raising, providing and managing of funds or money used in the business.
In short it is the process of acquisition of funds and the effective utilization.

Importance of finance

In the words of Henry ford, “money is an arm or a leg. You either we it or lose it.” This
statement is very simple and meaningful which shows the significance of finance or money.

In modern money oriented economy, finance is one of the basic foundations of all kinds of
economic activities. It is the master key which provides access to all the sources for being
employed in manufacturing and merchandising activities.

Business finance use to make more money, only when it is properly managed. Hence,
efficient management of its finance, thus, finance is regarded as the life blood of business
enterprise and finance is the back bone of every business.

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The following are the points which show the importance of finance in the company: -

1. ᴓ finance is helpful for modernization, diversification, expansion and development of

an enterprise.

2. ᴓ it is essential for undertaking research, market survey, paragraph, publicity and for
efficient marketing of product.

3. ᴓ availability of sufficient finance increases the credit worthiness of concern in the

eye of the supplier, traders and in the general public.

4. ᴓ the issue of a large number of securities has provided wide investment opportunities
to the investors.

5. ᴓ by ensuring wide distribution of funds, finance contribute to balanced regional

development in the country.

6. ᴓ by contribution to the renovation and modernization of industries, finance

contributes to the production and supply of goods at fair prices to the society.

Principles/aims/functions/steps of finance function

1. Anticipation of funds needed: -

The main aim of finance function is to forecast events in business and not
financial implication, selection of assets or projects takes place only after proper
evaluation which is helpful to anticipation of funds is the first aim of finance function.
2. Allocation or utilization of funds: -
The main aim of finance function is to assess the required needs of course the
prime objective or traditional finance function. Efficient allocation of investment
avenues meant investment if funds in profitable projects which means a project or an
asset that provides return which is higher than the cost of funds. Apart from this
assets are balanced by weigh their profitability [refers to earning of profit] and
liquidation [means closeness to money].

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3. Administrating the allocation of funds: ones the funds are allocated or utilized, on
various investment opportunities. It is a basic aim of the financial management watch
the performance of each rupee i.e., has been invested.
4. Increase profitability: proper planning, managing and controlling of finance function
aims at increasing profitability of the firms. Proper planning of anticipation of funds,
selection of investment of avenues and allocation of funds helps to increase the profit.
Financial management has to arrange sufficient funds at least at the right time and
investing on the right asset. So that they can control the operations like cash receipts
and payments also helps to increase profits. Hence financial functions need to match
the cost and returns from the funds.
5. Maximizing wealth of the firms: the prime objective of any finance function in any
organization is to maximizing the firm‟s value by taking right decision. But
maximization of shareholder‟s wealth is possible only when the firm is able to
increase profit, hence finance managers whatever, decision he takes, it should be the
objectives of maximization of owner‟s wealth.
6. Acquiring sufficient funds: the firm has to acquire sufficient funds by raising from
suitable sources of finance which may be long term sources like short term loans from
banks, retainer earning etc.

Organization structure of Finance :

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*Represents vice presidents of various departments outside of accounting and finance such as
production, personnel, and research and development.

**In addition to reporting to the chief financial officer, the internal auditor typically reports
independently to the board of directors and/or the audit committee (made up of select
members of the board of directors).

Chief Financial Officer

The chief financial officer (CFO) is in charge of all the organization‟s finance and accounting
functions and typically reports to the chief executive officer.

Controller

The controller is responsible for managing the accounting staff that provides managerial
accounting information used for internal decision making, financial accounting information
for external reporting purposes, and tax accounting information to meet tax filing
requirements. The three accountants the controller manages are as follows:

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 Managerial accountant. The managerial accountant reports directly to the controller

and assists in preparing information used for decision making within the organization.
Reports prepared by managerial accountants include operational budgets, cost
estimates for existing products, budgets for new product lines, and profit and loss
reports by division. (Note that some people use the term cost
accountant interchangeably with managerial accountant. Others consider cost
accounting a specific function of managerial accounting that focuses on measuring
costs. In this text, we use the term managerial accountant and assume that cost
accountants focus on measuring costs.)
 Financial accountant. The financial accountant reports directly to the controller and
assists in preparing financial information, in accordance with U.S. GAAP, for those
outside the company. Reports prepared by financial accountants include a quarterly
report filed with the Securities and Exchange Commission (SEC) that is called a 10Q
and an annual report filed with the SEC that is called a 10K.
 Tax accountant. The tax accountant reports directly to the controller and assists in
preparing tax reports for governmental agencies, including the Internal Revenue
Service.

Treasurer

The treasurer reports directly to the CFO. A treasurer‟s primary duties include obtaining
sources of financing for the organization (e.g., from banks and shareholders), projecting cash
flow needs, and managing cash and short-term investments.

Internal Auditor

An internal auditor reports to the CFO and is responsible for confirming that the company has
controls that ensure accurate financial data. The internal auditor often verifies the financial
information provided by the managerial, financial, and tax accountants (all of whom report to
the controller and ultimately to the CFO). If conflicts arise with the CFO, an internal auditor
can report directly to the board of directors or to the audit committee, which consists of select
board members.

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Objectives of financial management or goals of business finance:

A. Specific objectives B. General objectives

1. Profit maximization.
2. Wealth maximization.

1.Profit maximization: -

Earning profits by a corporate or a company is a social obligation. Profit means is

the only means through which an efficiency of organization can be measures profits also
serve as a protection against risks which cannot be ensure it is an economic obligation to
cover cost of funds and provide funds to expansion and growth.

Profit maximization ensures maximum welfare to the share-holders, employee and prompt
payment to creditors of a company.

Advantages of profit maximization: -

 It is a barometer through which the performance of a business unit can be measured.

 It attracts him investors to invest their saving in securities.
 It indicates that the fund is efficiently used for different requirements.
 It increases the confidence of management in expansion and diversification
programmers of a company.
 It ensures maximum welfare to the share-holders. Employees and prompt payment to
creditors of a company.

Disadvantages of profit maximization: -

 Profit is not a clear term. It is accounting profit? Economic profit? Profit before tax?
After tax? Net profit? Gross profit or earning per share ?.
 Profit maximization does not consider the element of risks.
 Huge profit attracts government intervention.
 Huge profit invites problems from workers. They demand high salary and fringe
benefits.
 Profit maximization attracts cut throat competition.

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 Profit maximization is a narrow concepts ; later it affects the long term liquidity of a
company.
 It does not consider the impact of time value of money.
 It encourages corrupt practices to increase the profits.
 Modern concept of marketing does not encourage profit maximization.
 The true and fair picture of the organization is not reflected through profit
maximization.

2.Wealth maximization: -

It refers to gradual growth of the value of assets of the firms in terms of benefits it
can produce. Any financial action can be judged in terms of the benefits it produces less cost
of action. The wealth maximization attained by a company is reflected in the market value of
share. In short term, it is the process of creating wealth of an organization. This will
maximize the wealth of share holders.

1.Wealth maximization is the net present value of a financial decision [investment decision]:
- Net present value will be equal to the gross present value of the benefits of that mines the
amount invested to receive such benefits.

Nap= Gpv of benefits investment or

Npv= present cash inflow – cast outflow

A. Any financial results in positive Npv, creates wealth to organization.

B. If the Npv is negative, it reduces the existing wealth of the shareholders.

The total cash inflow of the organization must always be more than the cash outflows.
The surplus inflow of cash indicates the size of wealth, which was added to the total value of
the assets.

2.When earning per share (Eps. And profit after tax are considered as indicator of welfare of
shareholders [equity shareholders]

Eg; the company has 50,000 shares of Rs: 10 each has an earnings per share of Rs: 0.40 with
a profit of Rs: 20,000. Assume that, the company has issues an additional capital of Rs:
50,000 shares of Rs: 10 each for its financial requirement. Now profit will increase upon Rs:

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30,000 after taxes, resulting in a net increase of Rs: 10,000. Though the additional profit of
Rs: 10,000 is increased, the earning per share has come down Rs: 0.30.

This does not add to the wealth, and hence does not serve the interest of owners, due to
this reason; the finance manager always concentrates on wealth maximization, cash flows and
time value of money.

3.Wealth maximization has been explainer differently by practical financial executive.

“When the company‟s profits are more, he advises the management to keep certain, amount
of profit for future requirements for expansion through which he increases the production and
market share. The benefits gainer will be passed on not only to the equity shareholders but
also passed to the creditors, better payment taxes to the government and attain self-
sufficiently and earn good reputation in the market, which will be reflected by market value
of shares in the stock exchange. This is the situation where investors can maximize their
value of investment.

Symbolically, it is expressed as woo=no

Woo=wealth of the firm,

N = number of share owner and,

p˳= price per share in the market.

Significance of wealth maximization

The company cares more for economic welfare of the shareholders, it cannot forget
the other who directly or indirectly contribute efficiency for the overall development of the
company, namely,

1.Creditors/lenders: it redress to financial institution, commercial banks, private money

lenders, debentures and trade creditors. The company has to meet their obligation of paying
interest and principal on dues dates. The earning of the company assures prompt recovery of
their investment, so that the lenders can increase their confidence level by financing more to
the company. This would help the company to earn good reputation and can increase their
„liquidity‟.

2.Workers/employees: they are the back bone of the industry. They are the main contribution
to the growth and success of one industry. It is the basic obligation of the company to keep

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the workers in good humour and harmony. This can be achieved only by providing fairs
wages, good working conditions with appropriate welfare measures. This would help the
company to earn „good reputation‟ and can increase their „liquidity‟.

3.Society/public: -

4.Management the success of the business mainly depends on the decisions taken by the
management. The finance manager has to make and guide the management in taking „right
decision at the right time‟ and also control over [maximum control over] the movement of
funds and invest the funds in the profitable avenues to reach maximum profit. This will
increase the confidence in the minds of equity shareholders.

Advantages of wealth maximization: -

 Wealth maximization is a clear term. Here, the present value of cash flows is taken in
to consideration. The net effect of investment and benefits can be measured clearly.
 It considered the concepts of time value of money present cash inflow and cashes
outflows help the management to achieve the overall objective of company.
 It considered as a universal accepted concepts, because it takes care of interest of
financial instructions owners, employees, management and society at large.
 It guides the management in formulating a consistent strong dividend policy to reach
maximin returns to equity shareholders.
 It considers/studies the impact of risk factor, while calculating the Npv at a particular
discount rate adjustment is being made to cover the risk that is associated with the
investment.

Disadvantages or criticisms of wealth maximization

1. It is a prescriptive idea. The object is not descriptive of what the firms actually do.
2. The object is not necessarily socially desirable.
General objectives: -
1. Ensuring maximum operational efficiency through planning directing and controlling
of the utilization of funds.
2. Enforcing financial discipline in the organization in the use of financial through the
co-ordination of the operations of the various decisions in the organization.
3. Building up of adequate reserve for financial growth and expansion.
4. Ensuring a fair return to the share-holders on their investments.

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Financial decision refers to the decision concerning financial matters of a business concern.
The functions of finance involve three important decision i.e.

1. Investment decisions.
2. Financing decisions and
3. Dividend decisions.

All three decisions directly contribute to the corporate goals of wealth maximizations.

1.Investment decisions: it refers to the activity of deciding the pattern of investment. It covers
both short term investment decision and long-term investment decisions.

 Capital budgeting is the process of making investment decisions in capital

expenditure. These ae the expenditures, the benefits of which are expected to be
received over a long period of time exceeding one year. The finance manager has to
assess the profitability of various before investing of the funds. The investment
proposals should be examined in terms of expected profitability, costs involved and
risks associated with the project. Investment decision not only concentrate on setting
up of new units but also for expansion of present units, replacement of assets, research
and development project costs and reallocation of funds. Short term investment
decision is one which ensures higher profitability, proper liquidity and sound
structural health of the organization.

2.Financing decisions: it is another important decision where a business concern to maximum

care in financing to different proposals. The combination of debt to equity directly
contributes to profitability of a business unit and reduces/financial risk. The instrument that
is to be selected must aim of maximizing the returns t the investors and to protect the interest
of creditors. Suppose, if a finance manager would like to have more debt and less equity.
This bring more dividends to shareholders and results in increased price of the shares in the
market and may lead to wealth maximization but the cost of borrowed funds (i.e. interest on
debentures) may increase the risk of the business concern most of the earned funds will be
used on the payment of interest on the borrowed funds which is also called as “financial
risk”. Hence he should be intelligent and tactful in deciding the ration between debts of
equity.

3.Divident decision: this relates to dividend policy. Dividend is a part of profits, which are
available for distribution to equity shareholders payment of dividends, should be analyzed in

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relation to the financial decision of a firm. There are two options available in dealing with
net profits of a firm, i.e., distribution of profits as dividends to the ordinary shareholder‟s
where there is no need of retain earning in the firms itself if they require for financing of any
business activity financial manager should determine optimum dividend policy, which
maximizes market value of shares and there by market value of the firm.

Financing planning

It is the process of estimating the total financial requirements of the firm and determining the
sources of in its capital structure (d:e) is called financial planning . Or

It is the primary function of the management financial plan is a statement estimating the
amount of capital required determination of finance mix and formulating of policies for
effective administration of financial plan.

Financial planning states,

A. The amount of capital required to be raised.

B. The proportion of debt equity.
C. Policies for effective administrative financial plan
 Financial planning results in the formulation the financial plan. It is primarily a
statement of estimating the capital and determining its composition [contents]
 The quantum of finance i.e., the amount needed for implementing the business plans.
 The pattern of financing, i.e., the form and proportion of various corporate securities
to be issued to raise the required amount and
 The policies to pursue for the flotation of various corporate securities particularly
regarding the time of their floatation.

Need for financial planning

 To maintain the liquidity throughout the year.

 To indicate the surplus resources [reserves] available for expansion or external
investments.
 To minimize the cost of fund raising procuring the funds under the most favorable
terms.

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 To maintain proper balancing of costs and risks involved in raising funds to protect
the interest of the investors.
 To ensures simplicity of financial structure.
 To ensures proper utilization of funds rises.
 To see to it that the shareholders get proper return on their investment.
 It ensures flexibility so as yo adjust as per requirements.

Characteristics\principles of sound financial plan: -

1) Simplicity: - The financial plan should be simple financial structure so that, it can be
easily understood even by a laymen [common man]. The types of securities should be
minimum which can be managed easily.
2) Foresight: - financial plan should be prepared only after taking into consideration of
today and future needs for funds. It is a difficult task as it requires an accurate forecast
of the future scale of operation of the company. Technological improvement, demand
forecast, resource availability and other secular changes should be kept in view while
drafting the financial plan.
3) Long term view\needs: - the financial plan should be formulated and conceived by the
promotes\management keeping in view the long-term needs of the company rather
than the easiest way of obtaining the original capital. This is because the original
financial plan would continue to operate for a long period even after the formulation
of the company.
4) Optimum use: - the financial plan should provide for meeting the genuine needs of the
company. The business should neither be starved of funds not should it have
unnecessary spare funds, waste full use of capital it as bad as in adequate capital. A
proper balance should be maintained between long-term and short-term funds since
the surplus of one would not be able to offset the shortage of the other.
5) Contingencies: - it should keep in view the requirements of funds for contingencies.
It does not, however, mean that capital should be kept unnecessarily idle for meeting
contingencies. Management is foresight will considerably reduce this risk.
6) Flexibility: - the financial plan should have a degree of flexibility also. It is helpful in
making changes or revising the plan according to pressure of circumstances with
minimum possible delay.

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7) Liquidity: - liquidity us the ability of the enterprise to make available the ready cash
whenever to make disbursement. Adequate liquidity also flexibility to the financial
plan. Liquidity ensures the credit worthiness and goodwill of the firm.
8) Economy: - economy means funds should be raised at minimum cost. Cost
minimization depends on the selection of various sources of finance and optimum mix
of debt-equity.

Steps\factors affecting financial planning: -

1) Estimating the capital requirements: - fixed cost incurred on fixed assets Eg:- plant
and machinery, land and building, furniture etc. Cost of intangible assets: - cost
incurred on patent, copy rights, technology collaboration and goodwill trademark etc.
Amount invested on current assets like cash at bank; cash in hand, debtors, bills
receivables, stocks, and materials etc.
Cost of promotion: - registration charges, stamp duty, legal charges, promoter‟s
remuneration, etc.
Cost of financing: - cost incurred for printing of prospectus moa, Aoa, shareholders
application, underwriters commission, brokerage etc.
2) Determining the sources of funds: -

Setting of objectives: -

The financial objectives any business enterprises is to employ the capital in whatever
proportion necessary to increase the productivity of the remaining factor of production
over the long run. The use of capital varies from firm to firm, the objective is identical in
all the firms, and the objective is identical in the entire firm. Business enterprises operate
in a dynamic society and in order to take advantages to changing economic conditions.
Financial planners should establish both short-run and long run objectives.

Policy formulation: -

The financial policies of a concern deal with procurement, administration and disbursement
of fund in a best possible way. The current and future needs of funds should be considered
and future needs for funds should be considered while formulating financial policies.

The financial policies may be of the following types: -

1) Policies regarding the size of capitalization. [Amount of capital to be raised].

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2) Policy governing the capital structure [debt-equity mix].

3) Policy regarding collection and credit.
4) Dividend policy.
5) Policy regarding management of working capital or current assets.
3) Laying down the financial procedures: - for the proper execution of the financial
policies, detailed procedures incorporating rules and regulations are required to be
laid down. The financial procedures are very helpful to the middle level executives to
know their responsibilities.
4) Financial forecasting: - forecasting or estimating the future variability of factors.
Forecasting is don in regards to output, sales, costs, and profits etc.
5) Review of financial plan: - the financial plan should be reviewed from time to time in
the light of changing economic, social, political and business environment.
Long term and short term financial plans: -
Financial plans may be dividend in to two types: -
They are,
1) Long term financial plan.
2) Short term financial plan.
1) Long term financial plan: - it is a plan which covers a period of 5 years or more. It
is concerned with the formulating of long term financial goals of the enterprises.
The following financial instruments are utilized to develop a long term financial
plan. They are: -
 Equity share.
 Preference share.
 Debentures.
 Retained earnings.
 Bonds
 Own funds.
 Ventures capital.
 Leasing.
 Hire-purchase.
2) Short term financial plan: - it is the financial plan which covers a period of one
year or less.

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It is concerned with the planning or determination of short term financial activities

to accomplish long term financial objectives.
Finance manager
Finance manager is person who heads the department of finance.

Role or functions of finance manager (15marks)

 He should anticipate and estimate the total financial requirements of the firms.
 He has to select the right sources of funds at right time and at eight cost.
 He has to allocate the available funds in the profitable avenues.
 He has to maintain liquidity position of the firm at the peak.
 He has to administrate the activities of working capital management.
 He has to analyze financial performance and plan for it growth.
 He has to protect the interest of interest of creditors, shareholders and the employees.
 He has to concentrate more on fulfilling the social obligation of a business unit.
 Estimation of capitalization requirement of organization.
 To make an appropriate decision with regard to invest or utilize funds.
 Decision with regard to dividend policy.
 Financial manager helps to maintain co-ordination relationship between the employer
and employee.
 Financial manager helps in optimum utilization of death and equity ratio of capital of
business.
 Maximization wealth of increasing the value of firm.
 It helps to maximize the value of shareholders.
 Financial manager helps in making prompt payment to the creditors.
 Financial manager helps in effective administration of the financial plan.
 Financial manager to reduces the cost of production and maximize it the profit.
 Financial manager advice the management to maintain reserves or retained earnings
in the firm for meeting or future needs of the firm.
 Financial manager helps in comparing the earning per share of the compotators with
their firms.
 Financial manager avoid unnecessary utilization of funds.
 Financial manager helps the firm to maintain flexibility as well as simplicity of the
firm.

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 It ensures prom payment of tax to the government.

 Financial manager refers to review of financial plan.
 Ensure prompt payment to the government.
 Financial manager helps the firm to know about the value of money, financial risk of
the firm.
 It ensures more credit worthiness of the business.
 Financial manager helps the firm to know about the consignees events.

Characteristics of a sound financial plan or principles of sound financial plan or steps

be considered while preparation of financial plan:

i. Simplicity: the financial plan should simple so that the investors are attracted towards
investment. There should not be many types pf securities otherwise the business
capital structure will become complicated. The financial plan of the business should
be such that not only in present, but also in the future finance is available.
ii. Flexibility: the financial plan of the business should be flexible so that adjustments
can be made in to business requirements. The financial plan should not be expensive
for the enterprise.
iii. Foresightedness: the financial plan not only over the present requirement but also the
future requirements can be fulfilled.
iv. Liquidity: for the effective running of a business the business should have adequate
liquidity. The shortage of liquidity has adverse effect on goodwill and sometimes it
lead to liquidation of a business.
v. Useful: the financial plan should use the financial sources fully and gainfully.
vi. Completeness: the financial plan should be complete and it should cover every future
contingency.
vii. Economical: the financial plan should be economical both in rising and utilization of
funds. Issue expenses should be less.
viii. Communication: a sound financial plan should be a good source of information to the
investors and finance providers.
ix. Implementation: the financial plan should be implemented without difficulty and its
benefits should go to the enterprise.
x. Control: the capital structure and financial plan should ensure continuation of the
control of the enterprise in the present hands.

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xi. Fewer risks: the financial plan should be prepared in such a way that is less risk in the
enterprise.
xii. Provision for contingencies: a good financial plan has adequate provisions for
business oscillation and anticipated contingencies.
xiii. Intensive use of capital: effective utilization of capital is as much important as the
procurement of adequate funds. This is possible by maintaining equilibrium in fixed
and working capital. Surplus of fixed and working capital should not be used as
substitution to shortages of another. Such practices should not be encouraged as they
would drag the company use of capital for a fair capitalization.

Factors affecting financial planning: -

1) Nature of a business: more finance is required for capital intensive business and less
finance is required for labour intensive business.
2) Flow of income of business: if regular flow of income in a business it can run with
less capital. If flow of income fluctuating, more capital is needed.
3) Risk in a business: if the business is involves in high risk then it require more owner
capital because the available of debt capital is less.
4) Plans of expansions: the financial plan is not prepared on the basis of present prepared
on the basis of present requirement but in case – future requirement5s are also
considered.
5) Status and size of a business: if a business has good reputations can easily obtain
finance.
In case if a firm does not have a good fame or size of a business of the firm then it is
quite difficult to achieve finance for the business.
6) Government control: the financial plans should be prepared on the basis of
government policies, control and legal requirements.
7) Alternative sources of finance: financial plan depends upon the availability of the
alternative finance for the business that helps the firm to choose the profitable finance
to the business.
8) Flexibility: the financial planning is flexible that it is very easy to carry out the
expansion and diversification programmers. If it is not flexible then it is difficult to
achieve it.

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