Finance

& Its Horizon

 What is Finance?
 The study of arranging funds and of using the
funds to maximize return on it.
 At the micro level, finance is the study of financial
planning, asset management, and fund raising for
businesses and financial institutions.
 At the macro level, finance is the study of financial
institutions and financial markets and how they
operate within the financial system in both the
domestic and global economies.
 What is Finance?

System Process of Finance

Identifying the Need and Nature
Financial
Planning

of fund
Identification of Sources of Fund
Screening out Alternative
Sources on Cost-benefit Basis
Rising of Fund from Cost-
effective (least cost) Source.

Investment Option Analysis:

Investment
Decision

Short term Mid-term Long-term

Phase

Investment of Fund
Decision Phase
Dividend & LT

Distribution of Cash Inflows (i.e.

fund Mgt

return from investment)

Profit Planning and Long Term

Fund Management Decision
 What is Finance?
Classification of finance:
-Private finance
-Personal finance
-Business finance
-Non-business finance

-Public finance
 What is Finance?
Principles of Finance:
- Risk and return trade off.
- Time value of money
- Hedging
- Diversity
 What is Financial Management?

Financial Management: refers to how the firms are arranging

funds from different sources and using the funds to maximize the
stock holders wealth. It also deals with working capital
management.(managing current assets and liabilities).
 Financial Manager?
“Financial manager refers to any one who is responsible for
all significant investment and financing decisions”
Financialmanagers are responsible for answering the
following important questions
 What long-term investments should the firm take on?
 Where will we get the long-term financing to pay for
the investment?
 What should be the dividend payout ratio?
 How will we manage the everyday financial activities
of the firm?
Financial Manager?
 Financial Management Decisions
Most important of the financial managers
decisions:
 Investment decisions
 Financing Decisions
 Dividend Decisions
 LT Assets Management Decision
 Working Capital Management
 Investment Decisions

 What is the optimal firm size?

 What specific assets should be

acquired?

 What assets (if any) should be

eliminated?
 Financing Decisions
 What is the best type of financing?
 Financing sources may be of:
 Institutional vs. Non institutional

 Formal vs. Informal

 Owners Equity vs. Debt capital

 Internal vs. External

 Capital market vs. Bank financing

 Short term vs. intermediate term vs. long term.

 Dividend Decisions
 How much to pay to shareholder?

 Depends on:
 Future investment need [ H need L dividend]

 Long term corporate practice

 Industry practice

 Growth philosophy – internal vs. external growth philosophy

 Tax system

 Nature of shareholders:

 Young investors wants capital gain

 Old investors wants more cash dividend.

 Asset Management Decisions
 How do we manage existing assets
efficiently?
 Whether the existing assets are fully
utilized or there is idle capacity?
 Increase in production may result in
economics of scale and vise-versa.
 Incorrect depreciation method of assets
have negative impact on income.
 WC Management Decisions
 How do we efficiently manage
Operation on daily basis?
 Involve inventory management
 Cash Management and Modeling
 Credit Management
 Working capital cycle management.
 Financial Manager in the Organization

 Shareholders vs. Stakeholders?

 Those who provides fund as owners of the business
– shareholders.
 Any group, individual, institutions, entity who
affects the business or whose decision affect the
business directly or indirectly- stakeholders.
 Generally elected or selected members to oversee
management on behalf of shareholders – BOD.
 The chairman of the board – President.
 Company achieves shareholders objectives.
 Financial Manager in the Organization
 Vice president Finance?
 Responsible for overall management of financial
affairs of the organization.
 He monitors two important group of personnel
 Treasurer: who provides financial decision
services.
 Controller: who provides reporting services.
 Financial Manager in the Organization
 Treasures?
 Responsible for financial decision making.
 Financial Planning and Fund Raising Manager:
 Makes long term strategic as well as short term
financing planning i.e. budgeting.
 Manages IPO process and performs job related to
fund raising from banks.
 Cash Manger:
 Manages cash inflows and cash outflows

 Prepares cash budget.

 Very important in firm with short cash cycle.

Financial Manager in the Organization
 Credit Manager:
 Develops credit policies.

 Evaluates credit applications, grant credit facilities

and manages collection or recovery.
 Extremely important for financial companies.

 Capital Expenditure Manager:

 Manages capital budgeting i.e. long-term projects

 Responsible for assets acquirement and assets

disposal as required at various stages of companies
life cycle.
 Ensures firm’s capacity building to help growth.
Financial Manager in the Organization

 Pension Fund Manager:

 Manages pension funds for the firm

 Over time the requirements are decreasing as

special pension fund manager are growing.
 Foreign Exchange Manager:
 Manages foreign exchange risk.

 Very important to firm with cross broader

transactions i.e. MNCs. .
 Financial Manager in the Organization

 Controller?
 Responsible for accounting information services.
 Financial Accounting Manager:
 Responsible for financial reporting.

 Develops annual reports of the firm.

 Tax Manager:
 Works as internal auditors

 Prepares tax returns.

 Financial Manager in the Organization
 Controller?
 Cost Accounting Manager:
 Keep record of costs of production.

 Develops mechanism for continually reducing cost

of production.
 Very important for Manufacturing firm

 A Note:
 The importance of each post depends on the
nature of business.
 However success depend on a team work.
 Agency Problem
“The potential conflict of interest between the
owner (Principal) and manager (agent) is
known as agency problem”

“Agency problem is likelihood of that

managers may place personal goals ahead
of corporate goals”
Types of agency problems:

a. Shareholders and board of directors

b. Board of directors and managers
c. Managers and staff
d. Owners and others.

 2002, Prentice Hall, Inc.

 Financial Goals of a Company
 Maximize sales.  Maximize return on
 Maximize cash sales, investment,
flow. equity.
 Maximize market  Ensure earnings
share. stability.
 Maximize profit.  Achieve target goals
 Minimize costs. for sales, profits,
market share or
return.
Goal of the firm-

(A) Profit Maximization

-By reducing cost

-By providing quality goods and
services
-By creating additional demand
 2002, Prentice Hall, Inc.
Goal of the firm-

(A) Profit Maximization

Rationale behind profit
maximization:
- Profit is yardstick to measure
efficiency
-Proper utilization of resources
 2002, Prentice Hall, Inc.
 Goal of the Firm

Profit Maximization?

this goal ignores:

-TIMING of Returns
-Time value of money
-UNCERTAINTY of Returns
 Goal of the Firm

(B) Shareholder Wealth

Maximization?

this is the same as:

a) Maximizing Firm Value

b) Maximizing Stock Price
 Legal Forms of
Business
1) Sole Proprietorship
A business owned by a single individual.
 Owner maintains title to the firm’s assets.
 Owner has unlimited liability.

2) Partnership
 Similar to a sole proprietorship, except
that there are two or more owners.
 Legal Forms of
Business
2a) General Partnership
 All partners have unlimited liability.

2b) Limited Partnership

 Consistsof one or more general partners,
who have unlimited liability, and
 One or more limited partners (investors)
whose liability is limited to the amount of
their investment in the business.
 Legal Forms of
Business
3) Corporation
A business entity that legally functions
separate and apart from its owners.
 Owners’ liability is limited to the amount
of their investment in the firm.
 Owners hold common stock certificates,
and ownership can be transferred by
selling the certificates.
 The Corporation and
Financial Markets

Corporation cash Investors

securities
reinvest
Secondary
markets
Cash flow dividends,
etc.

tax

Government
 The Corporation and
Financial Markets
Primary Market
Market in which new issues of a
security are sold to initial
buyers.
Secondary Market
Market in which previously
issued securities are traded.
 The Corporation and
Financial Markets
Initial Public Offering
(IPO)
The first time the firm’s stock is
sold to the general public.
Seasoned New Issue
A new stock offering by a firm
that already has stock that is
traded in the secondary market.