FINANCIAL MANAGEMENT:
AN OVERVIEW
SEMESTER I
- DR. CHETANA ASBE
UTILITY OF LEARNING
FINANCIAL MANAGEMENT
• In simple terms it means managing funds (in all
areas of life)
• Important for both individuals (personal) and
businesses (organization)
• Decisions related to budgeting, saving and
investing
• It evaluates the costs and benefits attached to a
financial decision
WHAT IS CORPORATE FINANCE?
• Every decision that a business makes has
financial implications.
• Any decision which affects the finances of a
business is a corporate finance decision.
• Defined broadly, everything that a business
does fits under the rubric of corporate
finance.
ALL MANAGERS ARE FINANCIAL MANAGERS
• The engineer, who proposes a new plant,
shapes the
investment policy of the firm
• The marketing analyst provides inputs in
the process of
forecasting and planning
• The purchase manager influences the level
of investment
in inventories
• The sales manager has a say in the
determination of the
receivables policy
• Departmental managers, in general, are
important links
ORGANISATION OF FINANCE FUNCTION
Chief Finance
Officer
Treasurer Controller
Financial Cost
Cash Credit
Accounting Accounting
Manager Manager
Manager Manager
Capital Fund Tax Data
Budgeting Raising Manager Processing
Manager Manager Manager
Portfolio Internal
Manager Auditor
FINANCIAL DECISIONS
IN A FIRM
I. Capital Budgeting (Investment decision)-
Which long-term investments or projects
should the business take on?
II.Capital Structure (Financing decision)-
Should we use debt or equity for paying for
the assets?
FINANCIAL DECISIONS
IN A FIRM
III.Working Capital Management- How do we
manage the day-to-day finances of the
firm?
IV.Dividend Policy- How much earning
should be distributed as dividend?
FINANCIAL DECISIONS
IN THE LIFE OF A FIRM
I. CAPITAL
BUDGETING
• Define the business
• How capital is allocated in the
firm- i.e., investing in long-lived
assets/fixed assets
• Evaluating costs and benefits
spread-out over time
I. CAPITAL
BUDGETING
• Features of capital expenditure:
i. They have long-term consequences
ii.They involve substantial outlays
iii.It may be difficult or
expensive to reverse them
I. CAPITAL
BUDGETING
• Focus should be on-
i.Magnitude of cash flows
ii.Timing of cash flows
iii.Riskiness of cash flows
iv.Options embedded in the investment
projects
II. CAPITAL
STRUCTURE
• Ways and means of financing the investment
projects
• Objective is to minimize the cost of financing
• Key considerations are:
i. Optimal debt-equity ratio
ii. Instruments of equity and debt finance
iii.Capital markets to be accessed
iv. Time of raising finance
v. Offer price of security
SOURCES OF LONG-
TERM FINANCE
• Equity
i.Equity Share Capital
ii.Preference Share Capital
iii.Internal Accruals/Retained Earnings
• Debt
i.Term Loans
ii.Bonds or Debentures
EQUITY CAPITAL
• Equity capital represents
ownership capital as equity
shareholders collectively own the
company.
• They enjoy the rewards and bear
the risks of ownership.
MERITS OF EQUITY
CAPITAL
• MERITS
i.No compulsion to pay dividends
ii.No maturity date
iii.Enhances creditworthiness
• DEMERITS
i.Dilution of control
ii.High cost of equity (dividends) and
issuing equity shares
PREFERENCE CAPITAL
• Preference capital represents a hybrid form
of financing. It partakes some
characteristics of equity and some
attributes of debt.
• Dividend is not an obligatory payment
• Dividend rate is fixed
• No voting right
INTERNAL ACCRUALS
• Internal accruals of a firm consist of
depreciation, amortization, and retained
earnings.
• MERITS
i.Readily available
ii.No dilution of control
• DEMERITS
i.Opportunity cost is high
ii.Amount raised may be limited
iii.Highly variable
TERM LOANS
• Term loans, given by financial institutions
and banks, represent a source of debt
finance which is generally repayable in 5 -
7 years.
• They are employed for expansion or
maintenance capital expenditure.
BONDS & DEBENTURES
• Debentures are a type of debt instrument that
are not secured by specific property or
collateral but are backed by the full faith and
credit of the issuer.
• Bonds are generally secured by assets.
• They are usually long-term loans that are
repayable on a fixed date.
• The rate of interest paid to the debenture
holders may be fixed or floating.
III. WORKING CAPITAL
MANAGEMENT
• Short-term financial management deals with
current assets and current liabilities
• Key considerations are:
Appropriate sources of short-term finance
Optimal level of inventory
Credit policy and terms
Cash balance to be maintained
Investment of temporary cash surpluses
SOURCES OF SHORT-
TERM FINANCE
• Accruals
• Trade credit
• Working capital advance by commercial banks
• Public deposits
• Inter-corporate loans
• Short-term loans from financial institutions
• Commercial paper
• Factoring
IV. DIVIDEND POLICY
• Dividend decision refers to the policy that the
management formulates for distribution of
earnings as dividends among shareholders
(dividend-payout ratio).
• It depends on the preference of shareholders.
• The firm must balance between the growth of the
company and the distribution to the shareholders.
• It has a critical influence on the value of the
firm.
RISK-RETURN
TRADEOFF
Capital Budgeting
Decisions
Return
Capital Structure
Decisions
Market Value
of the Firm
Dividend
Decisions
Risk
Working Capital
Decisions
GOAL/OBJECTIVE OF
FINANCIAL MANAGEMENT
• Maximize the long-term wealth of the shareholders
• Broader focus of financial management is to
include the interest of the stakeholders as well
as the shareholders
• The stakeholders include anyone who has a direct
link to the firm- employees, customers,
suppliers, creditors and owners
CRITIQUE AND DEFENCE OF SHAREHOLDER WEALTH
MAXIMISATION GOAL
Critique Defense
• The capital market • Financial economists
sceptics argue
argue that stock that stock prices are
prices fail the
to reflect true least biased
values estimates of
intrinsic values in
developed
markets
• The balancers argue • Balancing the
that a interests of
firm should seek to various stakeholders
‘balance’ the is not
interests of a practical governing
various stakeholders objective
• Advocates of social • The only social
responsibility argue responsibility of
GOAL OF FINANCIAL
MANAGEMENT
• Reliance Industries Ltd.- Mission- Create value for
all stakeholders
• Aditya Birla Group- Mission- To deliver superior
value to our customers, shareholders, employees and
society at large.
• ICICI Group- Mission- Create value for our
stakeholders
• Nestle South Africa- Vision and Values- ..delivering
improved shareholder value..
THE FUNDAMENTAL
PRINCIPLE OF FINANCE
• A business proposal-regardless of whether it is
a new investment or acquisition of another
company or a restructuring initiative –raises
the value of the firm only if the present value
of the future stream of cash benefits expected
from the proposal is greater than the initial
cash outlay required to implement the proposal.
CASH ALONE MATTERS
Investors provide the initial cash required to
finance the business proposal
Investors
The
•Shareholder Business
s Proposal
•Lenders
The proposal generates cash returns to
investors
FORMS OF BUSINESS ORGANISATIONS
Sole Proprietorship
• One owner
• Very simple
• Unlimited liability
• The firm has no separate status from a
legal and tax
point of view
Partnership
• Two or more owners
• Fairly simple
• Unlimited liability
• The firm has a separate status
Private Limited Company
• Minimum 2 and maximum 200 shareholders
• Not too complex
• Limited liability
• A distinct legal person
FORMS OF ORGANISATION
Public Limited Company
• Minimum seven and maximum unlimited
• Somewhat complex
• Limited liability
• Distinct legal person
• Free transferability of shares
Public Limited Company’s Attraction
• The potential for growth is immense because of
access to
substantial funds
• Investors enjoy liquidity because of free
transferability of
securities
• The scope for employing talented managers is
AGENCY PROBLEM
• While there are compelling reasons for
separation of
ownership and management, a separated
structure leads
to a possible conflict of interest between
managers and
shareholders.
• The lack of perfect alignment between the
interests of
managers and shareholders results in the
agency problem.
• To mitigate the agency problem, effective
QUICK QUIZ
1. Which are the four basic areas of corporate
finance?
2. Why is capital budgeting important?
3. What are the sources of long-term finance?
4. What are the three major forms of business
organization?
5. What is the goal of financial management?
6. Accrual or cash- which concept is followed
by financial management?
