Financial Management

M.B.A. 2nd Semester

By
Dr. Mohammad Anees

Department of Business Administration,

University of Lucknow,
Lucknow
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CC 202: FINANCIAL MANAGEMENT
Unit I:
Nature of Financial Management: Scope and objectives of finance, role and functions of finance manager, risk-return
trade off, shareholders’ wealth maximization, agency problem, General awareness of financial environment-financial
instruments, regulation and markets.
Unit II:
Investment Decisions: Analysis of Capital budgeting decisions, application of discounted and non-discounted
techniques in capital budgeting, time value of money, capital rationing, risk analysis in capital budgeting.
Unit III:
Financing Decisions: Cost of Capital and & Dividend Decision: Optimum capital structure, financial and operating
leverages, sources of long-Term Finance, cost of capital-components’ costs and Combined Cost (WACC), capital
structure theories.
Unit IV:
Dividend theories, Irrelevance of dividend, MM Hypothesis, relevance of dividend and Walter’s model, dividend
policy determinants, share repurchase or buyback, Issue of bonus share and its implications,
Unit V:
Working Capital Management: Principles of working capital management, Accounts Receivable management,
Inventory management and Cash management, factors influencing working capital requirement, computation of
working capital required in business firm.
References: -
Principles of Managerial Finance by Lawrence J. Gitman, Pearson
Financial Management and Policy by Van Horne, Dhamija, Pearson
Fundamentals of Financial Management by Dr. R.P. Rastogi, Taxman’s
Financial Management by Ravi M Kishore, Taxman’s
Financial Management-Text Problems and Cases by Khan and Jain, Mc Graw Hill

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What is Financial Management ?
Meaning and Concept
Financial management means optimization of
financial resources and activities of a business
concern in a way to realize the financial
objectives.
Important points:
1. Optimization
2. Financial resources
3. Financial activities- operating and strategic
4. Financial objectives
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Nature of financial Management
Scope and objectives of Financial Management
1. Financial management is one the functional
areas of management.
2. Financial management is multidisciplinary.
3. Financial activities are operative and strategic.
4. Financial management has its implications on
entire firm.
5. Knowledge of financial system is required
6. Objective of financial management- profit vs.
wealth maximization
7. Corporate finance vs. Financial Services
8. Financial management vs. Accounting
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Financial management is one of the functional
areas of management

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Financial management is multidisciplinary.

Accounting
Commerce information
and Economics
Markets

Financial
management
Production
Human and
Resource operations
management

Statistics

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Financial management has its implications
on entire firm.
1. Financial management involves in budgeting
for entire organization
2. Financial management involves cash flows of
entire organization
3. Financial planning and investment is for
entire organization
4. Financial management activities are
coordinating, supervisory, advisory and
facilitating.
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Knowledge of financial system for managers

Financial intermediaries
(bankers, consultants,
brokers etc)

Financial markets(money Financial instruments

market, capital market (cheque, FDR, share ,
and foreign exchange debenture etc)
market )
Financial
system

Financial services
(credit rating, Financial Regulation
banking, insurance (SEBI, RBI, IRDA etc.)
services etc.)

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Objective of financial management

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Corporate finance vs. Financial Services
Corporate Finance Involves:
– Financing
– Investing
– Dividend Distribution
– Working capital management
Financial services are intermediary services available
for corporate such as:
– Banking services
– Insurance services
– Merchant banking services
– Portfolio management
– Financial consultancy
– Venture capital
– Leasing and hire purchase
– Credit rating
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Financial Management vs. Accounting
1. Recall from accounting
Let’s recall that financial accounting is technical job whereas management
accounting is a managerial job
2. Financial management vs. accounting
The activities of financial management and management accounting are
overlapping.
3. Financial management focuses on cash flow management, procurement
and investment of funds.
4. On the other hand accounting focuses on preparation of accounts and
use of accounting information for the betterment (enhancing profit and
efficiency) of business.
5. To conclude accounting focuses on accounting information whereas
financial management focuses on short term and long term funds and its
proper utilization the betterment of business. Management accounting may
be viewed as a subset of financial management.
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 Objectives of Financial Management:
Profit vs. Wealth Maximization
Rationale:
There is a general discussion regarding
the objective of financial management
whether its objective is to maximize
profit or there should be some other
alternative and broader objective
wherein the profit should be included.
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 Analysis of profit maximization as an
objective of financial management
Arguments in favor of profit maximization as an
objective:
1. Profit is an easily understandable term
2. Profit maximization is a specific objective of
almost all businesses
3. Profit increases reserves and gives better return
to owners
4. Easily calculated term.
5. Can be related to sales to find out margin to
sales and can be related to investment to find out
Return on Investment (ROI).
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Arguments against profit as an objective of
Financial Management
1. Profit maximization is based on exploitative
tendencies.
2. There are different types of profits in accounting
and finance such as EBIDT, EBDT, EBT, PAT,
DPS, EPS, P/E, Profit Margin, ROI, EVA etc.
3. Profit maximization is a narrow and short term
approach.
4. Profit ignores the likely business risks.
5. Profit maximization does not ensure overall
growth of business.
6. Profit maximization approach ignores time value
money in financial decisions.
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 What is Wealth Maximization?
“Wealth maximization” is a term related with
shareholders or owners of corporate business.
Alternatively wealth maximization is also known
as “shareholders’ interest” or “shareholders’
welfare” maximization.
Experts of financial management have proved
that shareholders wealth maximization is the
most suitable objective of financial management.
It is therefore considered that wealth
maximization is an objective superior to profit
maximization objective.
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Wealth Maximization a Superior objective to profit
maximization. Why?
Wealth maximization has all those virtues which have been discussed as
limitations of profit maximization approach. These are as follows:
1. Wealth maximization fulfills time value of money requirement into
financial decisions.
2. All the financial decision are preferred on the basis of net present values.
3. It is in long term context.
4. Wealth maximization manages all types of business risks as it is based on
holistic approach of stakeholders theory.
5. Stakeholders’ theory identifies all stakeholders of business and satisfies
each of them.
6. With the help of stakeholders’theory overall business growth is ensured.
7. Wealth maximization is not exploitative rather it is welfare oriented.
8. Wealth maximization ensures long run survival, growth and leadership of
a business concern.

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Wealth maximization is a broader and a superior
objective to profit maximization:
A Pictorial Presentation

Wealth
maximization↓
Profit Maximization↓
Stakeholders’ Interest↓
Shareholders+ Government+
Employees + Customers+
society+ competitors, suppliers+
Creditors

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Guidelines to fulfill Wealth Maximization Objective

1. Financial decision on the basis of time value

of money consideration.
2. Risk- Return Trade off approach
3. Consideration for all stakeholders
4. Resolving agency problems
5. Use of most modern and scientific approach
in business management.
6. Focus on research and development
7. Value-addition approach.
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 How to know that wealth
maximization is taking place?

Stability
in share
prices

Incremental Increase into

impact on the
market value market price of
of shares shares
↑
↑

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 Role & Functions of Finance Manager
Role of a finance manager
Finance manager plays a very crucial role in any organization.
The role of a finance manager can be discussed with the help of
following points:
1. Finance manager looks for financial requirements of
business.
2. Plans for arrangement of funds from various short term and
long term sources.
3. Controls cash flows during business operations.
4. Co-ordinates various departments through budgeting.
5. Optimizes the collection and application of funds
6. Saves the organization from idle funds and idle assets.
7. Focuses on risk return trade off.
8. Realizes the financial objectives of business.
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Functions of Finance Manager
Core functions of finance manager
1. Financing
2. Investing
3. Dividend distribution
4. Working capital management
General functions of finance manager
1. Profit planning
2. Budgeting
3. Risk management
4. Productivity enhancement
5. Business expansion
6. Financial liaisoning
7. Cash flow management
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Financing
Financing means procuring long term funds from
different sources as given below:
1. Equity share capital
2. Preference share capital
3. Issue of debentures
4. Term loans from long term financial
institutions
5. Internal financing through retention of profits
Objective of financing:
Formulation of an optimum capital structure.
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What is an optimum capital structure?
an optimum capital structure is one which is
most appropriate for a given business and has
the following features:
1. Optimum cost of capital
2. Solvency
3. Flexibility
4. Conservatism
5. Control

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About Capital structure
Capital structure consists of various types of
long term funds broadly categorized into debt
and equity as follows:

Equity debt Equity

capital

Preference Term
capital loans
debt
Retained
capital
profits

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Risk Return Trade off in Financing
An optimum capital structure is the most appropriate
when there is a trade off between risk and return in each
source of long term source of fund considering the pros
and cons of each source or there is an optimum ratio
between debt and equity.

Capital Structure with debt equity mix

debt equity

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Investing
Investing means investment of long term funds
collected under financing into fixed assets after a
proper analysis of investment activity on the basis
of available information about such investment.
These information are:
1. Quantum of funds required in investment
2. Annual estimated return from investment
3. Cost of capital used in investment
4. Duration of investment
5. Use of an appropriate technique for analysis
Objective of Investing:
Selection of optimum assets for investment
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Risk Return Trade off in Investing Activity
Finance manager has to justify the investment
from risk and return point of view. It has to use a
suitable method for investment analysis. The
suitable method is one which considers time
value of money. It has to evaluate the project
from the following angles to accept it:
1. Profitability
2. Risk
3. Monetary constraint of investible fund
4. Weighted Average Cost of Capital (WACC)
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Dividend Distribution
Under dividend distribution function the finance manager has to take
decision regarding how much dividend should be distributed to equity
shareholders out the annual profits available with the company. It has to
take decision with the consideration of following factors:
1. Past record of dividend payment
2. Expectation of shareholders
3. Financial requirement of business
4. Legal bindings
5. Availability of profitable investment options
6. Availability of long term funds in the capital market
7. Availability of cash resources with the firm
8. Level of inflation and taxes payable the recipient
9. Stability in dividend payment
10. Bonus shares or stock dividends
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Objective and Risk Return Trade Off
Objective:
The objective of dividend distribution is to
formulate an optimum policy which is the most
appropriate for the firm.
Risk return trade off:
When all the concerning factors are properly
considered and weightage of each factor is
incorporate in the dividend policy it is called risk
return trade relating to dividend policy.
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 General Awareness of Financial
Environment in India
Financial environment can also be termed as
financial system which is made of the following:
1. Financial markets
2. financial intermediaries
3. Financial instruments
4. Financial services
5. Financial regulation

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 Requirement/significance of financial
system
1. Financial system assists finance manager in all
its functions.
2. Financial system is an integral part of industries
in any country.
3. Financial system in a broader framework
integrated with economic growth of a country.
4. Means of capital formation and utilization
5. Financial system is formally developed.
6. Formal financial system serves and protects the
interest of all participants.
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 Participants of financial system
Participants of financial system are:
1. Investors- individual and institutional
2. Speculators
3. Service providers
4. Bankers
5. Regulators/Government
6. Researchers
7. Clients/ customers
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 Financial Markets
Financial markets are:
1. Short tem financial markets
Such financial markets are also known as money markets. Money
market comprises of banks, general public and corporate.
1. Long term financial markets
Such financial markets are known as capital markets. Which are
further divided into primary and secondary capital markets.
Primary financial market is for new securities issue and
subscription.
Secondary capital market is for the trading of old securities which
are previously issued in primary capital market.
There are other financial markets such as Insurance markets and
international currency market.
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 Financial Intermediaries
Financial intermediaries are those institutions which
intermediate between two parties such as
client/customer and investors. Following financial
intermediaries work in the financial system:
1. brokers
2. Issue managers
3. Underwriters
4. Credit rating agencies
These financial intermediaries work for some fee to be
charged by them as their return.

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 Financial Instruments
Financial instruments are those documents which
are the proof of some investment or ownership of
some claim. Important financial instruments are as
follows:
1. Money market related instruments such as
cheque, treasury bill, draft, bill of exchange,
fixed deposit receipts, money market mutual
fund receipts, currency notes etc.
2. Capital market related instruments such as equity
and preference shares, debentures, bonds, mutual
fund receipts etc.

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 Financial Services
Various types of services rendered by financial
markets and financial intermediaries come under
this category. Important financial services are:
1. Banking services
2. Merchant banking services
3. Fee based and fund based services
4. Insurance services
5. Financial consultancy services
6. Foreign currency/exchange related services
7. Financial Broking services
8. Rating services
9. Portfolio and investment related services etc.
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 Financial Regulation
In order to make the entire financial system disciplined and
work in systematic and coordinated manner there is a
requirement to regulate and control the activities of all the
participants of financial system. This particular role is played
by financial regulation.
Some important financial regulators of financial system:
1. SEBI- Securities Exchange Board of India
2. IRDA- Insurance Regulatory and Development Authority
3. RBI- Reserve Bank of India
4. Ministry of Finance
5. Finance commission

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 Objectives of Financial Regulation
Financial regulation has its defined and specific
objectives to realize. Some of these objectives are
being categorized as below:
1. Protection of interest of investors
2. Third party risk or default risk management
3. Streamline the growth and development of
financial system.
4. Industrial growth
5. Ensure discipline in the markets.
6. Coordinate national financial system with
international financial system.
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 Importance of financial system for
a finance manager
It is necessary for a finance manager to be aware and
properly involve in the financial system in order to:
1. Successfully arrange funds from market
2. Successfully invest the idle funds in the market
3. Avail financial services available
4. Be compensated for any loss caused by the system
5. Understand financial trends
6. Default risk management
7. Financial engineering and diversified financial services
8. Liquidity management
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