Strategic Financial

Management
MBA 2ND SEMESTER

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Prepared and compiled by

Mr. Animesh Patel

M.Com Commerce
Two Times National Eligibility Test(NET)Qualified for Assistant
professor
Madhya Pradesh State Eligibility Test (M.P.SET) Qualified

Doctoral Entrance Test Qualified for Ph.D.

Topic Name:- Concept of Financial management

Sub Topic Name:- Meaning of Finance

or

Financial
Management
MEANING OF STRATEGIC 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).
In today’s world where positive cash flow is more important than book profit, Financial
Management can also be defined as planning for the future of a business enterprise to ensure a
positive cash flow.

Some experts also refer to financial management as the science of money

management. It can be defined as: “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.

Another very elaborate 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.”
Two basic aspects of strategic financial
management
There :- of financial management Viz. Procurement of funds and an
are two basic aspects
effective use of these funds to achieve business objective.

Procurement of funds

Aspects of Financial
Management Utilization of funds
Procurement of Funds
Since funds can be obtained from different sources therefore their procurement is
always considered as a complex problem by business concerns. Some of the
sources for funds for a business enterprise are:
(a)Equity: The funds raised by the issue of equity shares are the best from the risk point
of view for the firm, since there is no question of repayment of equity capital except
when the firm is under liquidation. From the cost point of view, however, equity
capital is usually the most expensive source of funds. This is because the dividend
expectations of shareholders are normally higher than prevalent interest rate and also
because dividends are an appropriation of profit, not allowed as an expense under the
Income Tax Act. Also the issue of new shares to public may dilute the control of the
existing shareholders.

(b)Debentures: Debentures as a source of funds are comparatively cheaper than the

shares because of their tax advantage. The interest the company pays on a debenture
is free of tax, unlike a dividend payment which is made from the taxed profits.
However, even when times are hard, interest on debenture loans must be paid
whereas dividends need not be. However, debentures entail a high degree of risk
since they have to be repaid as per the terms of agreement. Also, the interest
payment has to be made whether or not the company makes profits.

(c)Funding from Banks: Commercial Banks play an important role in funding of the
business enterprises. Apart from supporting businesses in their routine activities
(deposits, payments etc.) they play an important role in meeting the long term and
short term needs of a business enterprise.
Different lending services provided by Commercial Banks are depicted as
follows:-
(d) International Funding: Funding today is not limited to domestic market. With liberalization and
globalization a business enterprise has options to raise capital from International markets also. Foreign
Direct Investment (FDI) and Foreign Institutional Investors (FII) are two major routes for raising funds
from foreign sources besides ADR’s (American depository receipts) and GDR’s (Global depository
receipts). Obviously, the mechanism of procurement of funds has to be modified in the light of the
requirements of foreign investors.

(e) Angel Financing: Angel Financing is a form of an equity-financing where an angel investor is a
wealthy individual who provides capital for start-up or expansion, in exchange for an ownership/equity
in the company. Angel investors have idle cash available and are looking for a higher rate of return than
what is given by traditional investments. Typically, angels, as they are known as, will invest around 25
to 60 per cent to help a company get started. This source of finance sometimes is the last option for
startups which doesn’t qualify for bank funding and are too small for venture capital financing.
Effective Utilisation of Funds
The finance manager is also responsible for effective utilisation of funds. He has to point out
situations where the funds are being kept idle or where proper use of funds is not being made. All the
funds are procured at a certain cost and after entailing a certain amount of risk. If these funds are not
utilised in the manner so that they generate an income higher than the cost of procuring them, there
is no point in running the business. Hence, it is crucial to employ the funds properly and profitably.
Some of the aspects of funds utilization are:
(a)Utilization for Fixed Assets: The funds are to be invested in the manner so that the company
can produce at its optimum level without endangering its financial solvency. For this, the finance
manager would be required to possess sound knowledge of techniques of capital budgeting. Capital
budgeting (or investment appraisal) is the planning process used to determine whether a firm's
long term investments such as new machinery, replacement machinery, new plants, new products,
and research development projects would provide the desired return (profit).

(b) Utilization for Working Capital: The finance manager must also keep in view the need for
adequate working capital and ensure that while the firms enjoy an optimum level of working capital
they do not keep too much funds blocked in inventories, book debts, cash etc.
 Sources of funds classification
On the basis of On the basis of source of
On the basis of period
ownership generation

Long – term:-
Owner’s funds
• Equity shares
• Equity share Externals sources
• Retained Earning
• Retained earning • Equity share capital
• Preference shares
• Debentures
• Retained earning
• Loan from financial
institution and loan from Borrowed Funds External sources
banks • Debentures • Loan from banks
Medium – term:- • Loan from banks • Preference shares
• Loan from banks and • Loan from financial • Public deposits
from Financial institution • Debentures
Institution • Public deposits • Lease financing
• Public deposits & Lease • Lease financing • Commercial paper
financing • Commercial paper. • Trade credit
Short term funds • Factoring.
Trade credit
Factoring,
Commercial paper.
EVOLUTION OF FINANCIAL MANAGEMENT
Financial management evolved gradually over the past 50 years. The evolution of financial
management is divided into three phases. Financial Management evolved as a
separate field of study at the beginning of the century.
The three stages of its evolution are:
The Traditional Phase: During this phase, financial management was considered
necessary only during occasional events such as takeovers, mergers, expansion,
liquidation, etc. Also, when taking financial decisions in the organisation, the
needs of outsiders (investment bankers, people who lend money to the business and
other such people) to the business was kept in mind.
The Transitional Phase: During this phase, the day-to-day problems that financial
managers faced were given importance. The general problems related to funds
analysis, planning and control were given more attention in this phase.

The Modern Phase: Modern phase is still going on. The scope of financial management
has greatly increased now. It is important to carry out financial analysis for a
company. This analysis helps in decision making. During this phase, many theories
have been developed regarding efficient markets, capital budgeting, option
pricing, valuation models and also in several other important fields in financial
management.
 Long term Finance Function Decisions:

1) Investment decision
The funds available may be invested in any project. The financial management provides a
framework to make investment wisely.
Investment decision relates to:
2) Management of working capital
2) Capital budgeting decision
3) Management of mergers, reorganization and disinvestment
4) Buy or lease decisions
5) Securities analysts and portfolio management

The investment in fixed assets and management of current assets is major investment related
problems in a company. Assets represent investment (or uses) of funds. Investment decision
includes the decisions primarily relating to assets composition- fixed as well as current assets.
2) Financing Decision The second function of financial management deals with
financing pattern of the firm. The financing decision is mainly concerned with
identification of sources of finance and determining financing mix and cultivating
sources of funds and raising funds. The two main sources of funds are shareholders
funds (owners’ equity) and borrowed funds. The cost of funds, determination of debt
equity mix, impact of tax, depreciation, consideration of control and financial strain,
interest rate and inflation are some of the factors that affect the financing decision. A
balance is to be maintained between owners’ funds and outsiders’ funds and long
term and short term funds. A firm usually makes use of both internal and external
funds. The employment of these sources in various combinations is called ‘financial
leverage’. Different types of analysis are required for this decision e.g., leverage
analysis, EBIT – EPS analysis.

3)Dividend Decision: This decision relates to disposition of distributable profit

between dividends and retained earnings. Retained earnings being a source of
funding, dividend decision is concerned as part of financing decision of the firm. The
impact of levels of dividends and retention of earnings on market value of share and
future earnings of the firm, funds required for future expansion, impact of legal and
cash flow constraints and the future boom or recession are some factors that affect
this decision. Retention of earnings depends upon reinvestment opportunities
available and the opportunity to generate satisfactory rate of return for the
shareholders. Dividends may be paid in cash or in the form of bonus shares. These
and other aspects of dividend decision will be explained in detail later in this course.
OBJECTIVES OF FINANCIAL MANAGEMENT :-

Efficient financial management requires the existence of some objectives or goals

because judgment as to whether or not a financial decision is efficient must be made
in the light of some objective. Although various objectives are possible but we assume
two objectives of financial management for elaborate discussion. These are:
ROLE OF FINANCE EXECUTIVE
Modern financial management has come a long way from the traditional corporate finance.
As the economy is opening up and global resources are being tapped, the opportunities
available to finance managers virtually have no limits. A new era has ushered during the
recent years for chief financial officers in different organisation to finance executive
is known in different name, however their role and functions are similar. His role
assumes significance in the present day context of liberalization, deregulation and
globalisation.
His responsibilities include:
(a)Financial analysis and planning: Determining the proper amount of funds to employ in
the firm, i.e. designating the size of the firm and its rate of growth.

(b)Investment decisions: The efficient allocation of funds to specific assets.

(c)Financing and capital structure decisions: Raising funds on favourable terms as

possible i.e. determining the composition of liabilities.

(d)Management of financial resources (such as working capital).

(e)Risk management: Protecting assets.
The figure below shows how the finance function in a large organization
may be organized.
M&A :- Merger and acquisition
AGENCY PROBLEM AND AGENCY COST :-
Agency problem:-
Though in a sole proprietorship firm, partnership etc., owners participate in management
but in corporates, owners are not active in management so, there is a separation
between owner/ shareholders and managers. In theory managers should act in the
best interest of shareholders however in reality, managers may try to maximise
their individual goal like salary, perks etc., so there is a principal agent
relationship between managers and owners, which is known as Agency Problem.
In a nutshell, Agency Problem is the chances that managers may place personal goals
ahead of the goal of owners. Agency Problem leads to Agency Cost.

Agency cost :-

Agency cost is the additional cost borne by the shareholders to monitor the
manager and control their behaviour so as to maximise shareholders wealth.
Generally,

Agency Costs are of four types (i) monitoring (ii) bonding (iii) opportunity (iv)
structuring.
Following efforts have been made to address these issues:-
♦ Managerial compensation is linked to profit of the company to some extent
and also with the long term objectives of the company.
♦ Employee is also designed to address the issue with the underlying
assumption that maximisation of the stock price is the objective of the
investors.
♦ Effecting monitoring can be done.
Scope of strategicFinancial Management
Financial management encompasses four major areas:

Planning
The financial manager projects how much money the company will need in
order to maintain positive cash flow, allocate funds to grow or add new
products or services and cope with unexpected events, and shares that
information with business colleagues. Planning may be broken down into
categories including capital expenses, T&E and workforce and indirect and
operational expenses.

Budgeting
The financial manager allocates the company’s available funds to meet costs,
such as mortgages or rents, salaries, raw materials, employee T&E and other
obligations. Ideally there will be some left to put aside for emergencies and to
fund new business opportunities.
Managing and assessing risk
Line-of-business executives look to their financial managers to assess and provide
compensating controls for a variety of risks, including:
A) Market risk Affects the business’ investments as well as, for public companies,
reporting and stock performance. May also reflect financial risk particular to the
industry, such as a pandemic affecting restaurants or the shift of retail to a direct-to-
consumer model.

B) Credit risk The effects of, for example, customers not paying their invoices on time and
thus the business not having funds to meet obligations, which may adversely affect
creditworthiness and valuation, which dictates ability to borrow at favorable rates.

Liquidity risk
Finance teams must track current cash flow, estimate future cash needs and be prepared to
free up working capital as needed.

Operational risk
This is a catch-all category, and one new to some finance teams. It may include, for
example, the risk of a cyber-attack and whether to purchase cybersecurity insurance, what
disaster recovery and business continuity plans are in place and what crisis management
practices are triggered if a senior executive is accused of fraud or misconduct.
Procedures
The financial manager sets procedures regarding how the finance team will process
and distribute financial data, like invoices, payments and reports, with security and
accuracy. These written procedures also outline who is responsible for making financial
decisions at the company — and who signs off on those decisions.
Meaning of Business Financial Planning
Financial Planning is the process of estimating the capital required and determining it’s
competition. It is the process of framing financial policies in relation to procurement,
investment and administration of funds of an enterprise.

Objectives of Financial Planning

Financial Planning has got many objectives to look forward to:

Determining capital requirements- This will depend upon factors like cost of current and
fixed assets, promotional expenses and long- range planning. Capital requirements have to be
looked with both aspects: short- term and long- term requirements.

Determining capital structure- The capital structure is the composition of capital, i.e., the
relative kind and proportion of capital required in the business. This includes decisions of
debt- equity ratio- both short-term and long- term.

Framing financial policies with regards to cash control, lending, borrowings, etc.
A finance manager ensures that the scarce financial resources are maximally utilized
in the best possible manner at least cost in order to get maximum returns on investment.
importance of strategic financial management:
Resource Allocation: Financial management helps in effective allocation of
resources, including capital, labour, and materials. This ensures that resources are
utilized efficiently to achieve organizational goals.

Decision Making: Sound financial management provides the necessary information

for decision-making. It helps executives and managers make informed choices
regarding investments, budgeting, pricing, and other critical aspects of the business.

Profitability: Financial management plays a central role in maximizing profitability.

By analysing financial statements, identifying cost-effective strategies, and optimizing
revenue streams, organizations can enhance their bottom line.

Risk Management: Financial management involves assessing and managing various

financial risks, such as market volatility, interest rate fluctuations, and credit risks.
This helps organizations develop strategies to mitigate potential financial losses.

Solvency and Liquidity: Financial management ensures that an organization

maintains an optimal balance between solvency and liquidity. Solvency ensures long-
term survival, while liquidity ensures short-term financial stability.
Compliance and Accountability: Financial management involves adhering to regulatory
requirements and accounting standards. Proper financial management ensures that
organizations comply with legal and ethical standards, promoting transparency and
accountability.

Strategic Planning: Financial planning is integral to the strategic planning process. It helps
organizations set realistic goals, allocate resources effectively, and develop a roadmap for
future growth.

Investor Relations: Effective financial management is crucial for building and maintaining
positive relationships with investors and stakeholders. Transparent financial reporting and
strategic financial planning can instill confidence among investors and attract new ones.

Cost Control: Financial management aids in controlling costs and improving cost-efficiency. By
monitoring expenses, organizations can identify areas for cost reduction or optimization
without compromising the quality of products or services.

Capital Budgeting: Financial management involves evaluating and selecting long-term

investment projects. This process, known as capital budgeting, helps organizations allocate
resources to projects that offer the highest return on investment.

Financial Stability: Well-managed finances contribute to the overall stability of an

organization. This stability is crucial during economic downturns or unexpected challenges, as