An Introduction to financial

Management
by
Preeti Singh

Principles of Financial
Management

Risk
and
Return
Time value
of money

Cash flow
Concept

Incremental
Cash Flow
Analysis

Wealth
Maximization

What is Financial
Management?
Financial Management is concerned with raising of
funds.
Creating value to the assets of the business
enterprises by efficient allocation of funds.
It is the integration of the flow of funds in the most
optimum manner to maximize the returns of a firm
by taking proper decisions in utilizing the funds.
It has broad-spectrum activities and it is
continuously concerned with producing an
adequate return on a company/firms investments.

BASIC PRINCIPLES OF
FINANCIAL MANAGEMENT

Risk and Return

Time value of money
Cash flow concept
Incremental Cash Flow Analysis
Wealth Maximization

EVOLUTION OF FINANCIAL
MANAGEMENT
The evolution of the subject started in
the twentieth century.
It can be divided into two periods.
The traditional phase was from 1920
to 1950 and the modern phase began
in 1950.
The traditional phase was called the
outsider looking approach and the
modern phase is called the insider
looking approach.

The Traditional Approach

Procurement
of
Funds:
Procurement of funds through an
analysis of financial instruments,
institutions and sources of funds.
Outsider Looking Approach: It had
a limited scope because its emphasis
was on the supplier of funds.
Capital Budgeting: The attention
given by financial management was
towards the procurement of funds for
long-term use. Working capital was
not considered at all.

 Financial
Instruments:
Procuring
funds was through the issue of financial
instruments
like
equity
share,
preference shares and debt securities.
Status of the Subject: It was
operational in nature, limited to
preparing
accounts,
reports
and
procuring funds. Financial decisionmaking was not part of the function of
the subject tools and techniques had
not been developed.

Modern Approach

Integrated Finance Function

Management Function
Status
Techniques

Scope And Functions Of A

Financial
Management/Manager
Liquidity of funds

A financial manager has to match inflows and outflows and

thus create liquidity.

Profitability
A financial manager has to measure the cost of capital raise
by him as a source for the funds of the company because
cost of capital is linked with profitability of a company.
He has to control costs in all operational areas of the
company through costs control systems and costs
accounting methods. He has to formulate pricing policies,
sales policies and marketing policies to bring about
profitability in the company.

Management
The financial manager has to coordinate
different activities of the company.
He has to deal with long term and short term
requirements of the company.
He has to analyze, plan and control the use of
funds.
Balance conflicting goals
Such as Financial Management has the
scope of
Profitability and liquidity
Profit maximization and wealth maximization
Risk and return
Identification of groups

Identification of groups
The financial management has the
scope of financial decision making for
a large group of people. Such as
Shareholders
Debt investors
Employees
Customers
Suppliers
Public
Government
Management

Economic value added

(EVA)
EVA is a financial tool, which provides
to the organization knowledge of how
much value the company is adding
above the total cost of capital.

Agency Problem

FINANCIAL DECISION
MAKING
Financial management is the
study of the process of financial
decision-making in the following
3 cases
Investment decisions
Financing decision
Dividend decisions

Investment Decisions
Investment decisions deal with long term
and short term finances of a firm. These can
be termed as fixed assets and current
assets.
The long-term process covers the area of
Capital Budgeting.

Working Capital Management

Financial manager ahs to take decision to be
sure that there is adequate working capital
in the firm.

Financing Decisions
Financial management also deals with
financing issues, such as making the
business profitable, by analyzing breakeven points, fixed costs and variable costs.

Dividend Decisions
Financial management is also applied to
the requirement of the shareholders.
It is concerned with the amount of profit
that can and should be withdrawn to
declare dividends to the owners of the
capital of the company or the shareholders.

OBJECTIVES OF FINANCIAL
MANAGEMENT
It aims at optimum use of assets to
maximize the profitability of the company.
It has the objective of maximizing wealth
of the shareholder.

Profit Maximization
Profit maximization is concerned with
appropriate selection of assets and its
optimum utility thereof.
An organization must be profitable to
be an economic entity. Profitability
shows efficiency and proper allocation
of firms resources.
Thus profit maximization is measure of
a firms performance as it is a yardstick
to measure the efficiency of a firm.

 Profit maximization concept ignores time

value of money.
The term profit is not clear. Is it
accounting profit or after tax profit?
Would it be gross profit or net profit? Or
is it indicative of earnings per share?
It concentrates on profitability and it
does not include the financing aspect.
It does not analyze risks.

 It analyzes the firms utilization of

resources rather than the interest of
the shareholders. It does not reflect
time value of money.
Profit maximization is an accounting
concept and does not consider the
aspects of maximizing shareholders
wealth. It does not show the internal
position of the firm/company.

Maximization of Shareholders
Wealth
The shareholders wealth is reflected in
the market value of its share.
The shareholders economic value is the
dividend that he receives presently.
It is also the future dividend benefits
Capital appreciation of the share.
The market price of the share is a
present value of all the future cash flows
in terms of benefits and dividends
expected from the firm.

 The market price of the share can be optimized

by the three important decisions of the financial
manager
Investment decisions
Financing decisions
Dividend decisions
These decisions are taken through the cash flow
concept of finding out the present value of the
share.

Profit Maximization Versus

Wealth Maximization
Profit maximization is important to judge and
analyze the economic viability of a firm.
Profit maximization is an important concept
but profitability is an ambiguous term as it is
not define whether the efficiency of the firm
should be considered in terms of operating
profit or net profit.
It ignores the concept of time value of
money.
It considers the profit concept, but not the
cash flow concept.

 The wealth maximization concept is a

comprehensive term to include timing benefits,
cash flow concept, as well as risk and return.
The wealth maximization concept analyzes the
earnings per share, present and future
dividends to be given to shareholders thus
giving an indication of the maximum utility of
the wealth of the shareholders.
Wealth maximization is universally accepted
due to the fact that it is able to achieve the
objectives of a firm and take decisions to
favour owners, institutions, employees and
equity shareholders.

Financial Management And

Financial Accounting

Cash flow approach

Time Value of Money
Treatment of Funds
Activities

Financial Management And

Other Areas Of Study
Financial
management
draws
a
relationship with many areas of study.
Financial Management and Economics
Financial management and Marketing
Management
Financial
Management
and
Human
Resources Management
Financial Management and Production
Management

Financial Management
and Economics:
Financial management is closely related to macro and
microeconomics.
Financial management and macroeconomics are concerned
with money and capital markets, financial intermediaries,
banking system, monetary credit and fiscal policy.
Macroeconomics prepares policies relating to the financial
environment.
The financial manager works and prepares policies for firms
and other institutions depending upon the monetary and
fiscal policies.
He has to take financial decisions within these policies. He
also has to make changes in his financing decisions if there
are changes in macroeconomics policies.

 Microeconomics consists of concepts and theories

relating to supply and demand, price, profitability and
profit maximization strategies.
Financial decisions have to continuously evaluate
price of a product, sales revenue and financing
decisions of a firm.
It works in a complementary manner with both macro
and microeconomics.
A financial manager should have a good knowledge of
economics.
In fact financial management branched into its own
discipline from economics.

Globalization and its

Impact on Finance
Function
Globalization has brought economies
together in terms of trade.
Demand is created in one country and
supply is sent from another country. This
brings about foreign exchange and bank
dealings of different countries.
Cost of capital has to be projected and only
profitable project can be taken.
Capital budgeting should be done on
international collaborative projects.