Financial Management

1. An Introduction

Scope of Finance
3 most important activities of a firm
are
Production
Marketing
Finance
A firm secures the capital it needs
and employs it to generate a return
on its investment in its business

Real & Financial Assets

Tangible assets = Physical assets
Intangible assets = Know-how, technology,
patents, copyrights, goodwill,
Financial assets = securities = shares,
bonds, debentures, issued by the firm in the
primary market, and bought & sold among
investors in the secondary market; also
includes lease obligations, borrowings from
banks/financial institutions, and other
sources.

Equity & Borrowed Funds

Equity acquired thru sale of shares. Shares
represent ownership rights of shareholders
Preference shareholders receive dividends
at a fixed rate and have priority over
ordinary shareholders
Loans acquired from creditors for fixed
time at fixed interest rate
Interest paid is tax deductible, dividend is
not

Finance Functions
Investment decisions (long term)
Financing decisions (capital
mix/structure)
Dividend decisions (profit allocation)
Liquidity decisions (short term)

Investment Decision
Involves capital expenditure; also
called capital budgeting decisions
Involves allocation of capital to long
term assets for future cash flow yields
Involves evaluation of prospect of
profitability of investments; cut-off
rate to assess investment returns;
riskiness of expected returns

Financing Decision
Involves deciding firms capital structure;
mix of debt & equity; optimal capital
structure
How to borrow (kind)
From whom to borrow (source)
How to sell shares (private or public)
Whom to sell shares to
(stakeholders/public)
What kinds of shares to sell (ordinary/pref.)

Dividend Decision
How much profit to distribute, how
much to retain (dividend payout
ratio, retention ratio)
Optimum dividend policy
Cash dividends or bonus shares
No dividends or 100% payout

Liquidity Decisions
How much to invest in current assets
Efficient management of current
assets
Profitability vs. liquidity
Protection against insolvency
Working capital management
Working capital cycle
How much debt, how much equity

Finance Managers Role

Fund raising (traditional role)

Funds allocation (efficient & effective use)
Analytic problem solving
Opportunity cost of fund raising and
investing
Size of firm & rate of growth
Profit planning (break-even analysis)
Understanding capital markets

Financial Goal
Profit maximisation vs. wealth
maximisation
Interests of stakeholders
Time value of money
Risk & uncertainty
Definition of profit
Profit after tax
Earnings per share
Shareholder wealth maximisation
Risk-return trade-off

Agency Problems
Managers goal vs. shareholders
goals
Conflict of goals leads to avoidable
agency costs
Satisficing behaviour of managers

Firms Financial Goal, Mission &

Objectives
our business is not determined by
the producer, but by the consumer:
Peter Drucker
Mission = a broad statement of
values
Objectives = specific statement of
achievable goals/targets

Organisation of Finance
Functions
CFO decides major finance policy
matters
Treasurer manages funds (liability
management)
Controller manages & controls assets
(assets management)
Refer Figure 1.4 (page 18 of PTU
textbook)