Financial Management

Financial Management is basically decision making regarding

understanding the appropriate time when the funds are needed, how
much, from which source and how the funds would be used
effectively so that the profit can be achieved.

Objective Of Financial Management - Wealth Maximization

 Maximization of the market price of shares

The share holders when invest money in the company, they have two
objectives
1) They want good and regular return each year( dividend)
2) They want the market price of their shares to be maximise
 Financial Planning
• It is a fundamental part of FM
• Financial planning is the job of determining how a company
will have the funds for accomplishing its strategic goals and
objectives.
• It is the process of framing financial policies in relation to
procurement, investment and management of funds of an
enterprise.
• Financial planning is a long term planning aimed at
generating greater return on assets, growth in market share
and at solving expected problems.
Objectives of Financial Planning
1. Ensuring availability of funds
2. Estimating the time and sources of
funds
3. Generating capital structure
4. Avoiding unnecessary funds
 Process of Financial Planning
1. Determining your current financial situation
2. Developing financial goals
3. Identifying alternative courses of action
4. Evaluating alternatives
5. Creating and implementing a financial action plan
6. Reevaluating and revising the plan
 Long Term Sources of Finance
 Long term sources of finance are those sources from where
the funds are raised for a long period of time, usually more
than one year.
 are required for modernization, expansion, diversification
and development of business operations.
 Sources of long term finance
 Equity share capital
 Preference share capital
 Debentures
 Long term loans from financial institutions
 Short term sources of finance
 Short term finance in business usually refers to the additional
money a business requires for doing its business for short terms,
which is usually for a maximum period of one year.
 These funds are usually used for day to day operations such as
payment of wages, inventory ordering, advertisement expenses etc
 Sources of short term finance
1) Trade credit – credit extended by the supplier of goods or
services to his/her customer in the normal course of business
2) Commercial paper - It is an unsecured money market
instrument issued in the form of a promissory note. Companies
that enjoy high ratings from rating agencies often use CPs to
diversify their sources of short term borrowings.
3) Line of credit – It is most appropriate for temporary working capital needs.
An amount is sanctioned by the issuing bank or financial institution. (100000)
Within the limit of this amount , the business can make payment and keep
depositing once payment from customer is received. It works like a revolving
credit and best part of this is the interest is charged on the utilized amount
only and not on the approved amount.
4) Factoring – The factor becomes responsible for all credit control and debt
collection from the buyer and provides protection to the firm from all bad
bebts and losses.
5) Public Deposits – The deposits that are raised by organisations directly from
the public. Rates of interest offered on public deposit are usually higher than
that offered on bank deposits
6) Inter-Corporate Deposits (ICDs):
A deposit made by one firm with another firm is known as Inter-Corporate
Deposit (ICD). Generally, these deposits are made for a period up to six
months.
 Financial distress
Financial Distress is a situation when a company is struggling
to generate enough profits to meet its financial obligations.
There could be various reasons for such a situation. However,
some of the most common ones are illiquid assets, high
fixed costs, unfavorable macro trends and so on.
Some of the signs of a company facing financial distress are –
unable to pay creditors and third parties, facing challenges to
pay monthly bills and salaries. When a company is in such a
situation, it not only affects the higher management, the
employees might also suffer from lower morale and higher
stress due to the company not being able to meet its
obligations.
 Shareholders Wealth and Managerial
Behavior
Shareholders are the owners of the company, have potential profit if the
company does well or potential loss if the company does poorly. Therefore, it’s
a priority for shareholder value maximization which is defined: “Maximizing
shareholder wealth means maximizing the flow of dividends to shareholders
through time”
Why does a corporation maximize shareholder value?
 shareholders are persons sacrificing the immediate consumption to put their
capital also hand over their savings for managers by purchasing the shares of
company with the promise of a flow of cash in the form of dividends in the long
run and not necessarily payback in short time.
 An another constituency of contributing to value for company is stakeholder,
Freeman defines it: “Stakeholder is any group or an individual who can affect or
is affected by the achievement of an organization’s purpose”(Freeman, 1984,
p.53). Stakeholders here include customers, suppliers, employees, creditors,
directors, communities, environment, government officials… The different
stakeholder groups have different interests. A corporation following the
stakeholders’ interest goal indicates that the manager makes decision based on
all interests of stakeholders.
 Value based management
Definition - Value based management is the management approach that
ensures corporations are run consistently towards one value i.e. maximizing
shareholders value.
VBM is a management philosophy that states management should foremost
consider the interests of shareholders in its business actions. This framework
encompasses the processes for creating, managing, and measuring value.
It is important to note VBM differs from a profit-focused way of managing
business. Specifically, VBM means that the decisions that you make today are
not simply driven by short-term profit. Instead, we consider the longer-term
effects that the decisions will have on organizational sustainability and
profitability, reflected in future cash flows.
 VBM asks people within a company to think like owners and to make
decisions that will ultimately benefit the owners. Managers and executives
must constantly look for investment and growth opportunities that will create
value—and use the company’s capital in ways that ensure long-term,
sustainable success.
Process of Value based management

 What are the benefits of Value Based Management?

Can maximize value creation consistently.
It increases corporate transparency.
It helps organizations to deal with globalized and deregulated capital
markets.
Aligns the interests of (top) managers with the interests of shareholders and
stakeholders.
Facilitates communication with investors, analysts and communication with
stakeholders.
Improves internal communication about the strategy.
Prevents undervaluation of the stock.
It sets clear management priorities.
Facilitates to improve decision making.
It helps to balance short-term, middle-term and long-term trade-offs.
Encourages value-creating investments.
Improves the allocation of resources.
 Economic Value Added (EVA)
 EVA is the calculation of what profits remain after the
costs of a company's capital—debt and equity—are
deducted from operating profit.
 Economic value added (EVA) is a measure of a
company's financial performance based on the residual
wealth calculated by deducting its cost of capital from its
operating profit, adjusted for taxes on a cash basis.
 EVA can also be referred to as economic profit, as it
attempts to capture the true economic profit of a
company. This measure was devised by management
consulting firm Stern Value Management, originally
incorporated as Stern Stewart & Co.
 Formula Of EVA
EVA = NOPAT – ( Total Invested Capital * WACC)
Where, NOPAT = Net Operating Profit After Tax
WACC = Weighted Average Cost of Capital
Total Invested Capital = Capital Employed
= Equity + Reserves & Surplus + debt
capital