Financial system

Company Company
Individual Individual
Institution Institution

Financial system
 Financial System

Indian Financial System

Financial Financial
Financial market
institution instruments

Bank NBFC
Long term Medium term Short term

Money market Capital market

 Corporation and financial market and their networks
1. Primary markets

Corporation Investors
cash

securities
Secondary
markets
2
Corporation
Securities
invest in
traded
return among
Cash
generating cash distributed investors
Cash flow
re-from
assets invested
operation back to investor 3

Taxes
Government
 Financial management

Finance lies at the root of economic activity.

In modern phase financial management involves

analytical and quantitative approach towards
decision making process.
 Financial decision
• Investment decision, which is concerned with
the selection of an investment proposal and
the investment of funds in the selected
proposal.
• Working capital decision deals with current
asset and current liabilities.
• Financing decision is concern with raising of funds that finance
assets. Best mix of funds form optimum capital structure.
• Dividend decision is regarding the proportion of profit
distributed among the shareholders. Optimum dividend policy is
to maximize shareholders value.
 Financial engineering
Financial engineering involves the design, the development and
implementation of innovative financial instruments and problems
and the formulation of creative solutions to problems in finance.

Financial engineering aims at :

1.Designing and developing new financial instruments/
products.
2.Formulating new process
3.Formulating creative solution to financial problems.
4.Its main objective to reduce the cost of firm’s financing.
 Finance manager’s role
• Fund raising
• Fund allocation
• Investment of funds
• Valuation decision
• Profit planning
 Factors influencing financial
decision

Microeconomic factor related to the internal

condition of the firm like:
• Nature and size of the enterprise.
• Level of risk and stability in earning.
• Liquidity position
• Pattern of ownership
 Objectives of financial decision
• Profit Maximization
• Wealth Maximization
 Profit Maximization
It is a process by which a firm determines the price and output level
that returns greater profit.

In profit maximization, firm produces maximum output with

given input or uses minimum input with given output.

Underlying logic behind the profit maximization is EFFICIENCY.

 Criticism to profit maximization
• It can not be sole objective of big firm.
• No proper definition
• It ignores timing of return.
• It ignores risk.
 Wealth maximization
Wealth maximization means maximizing
net present value ( or Wealth) of a course of
action.
Here benefits are measured in terms of cash
flows.
Fundamental objective of a firm is to
maximize market value of share.
It needs a valuation approach
 Risk-Return Trade Off

A proper balance between risk and return

should be maintained to maximize the market
value of the share.

Return= Risk free rate + Risk Premium

 Profit Maximization Vs Wealth
Maximization
Accounting profit, is the difference between revenues and
costs, recorded according to accounting principles, where
costs are primarily the actual costs of doing business. The
implicit costs—opportunity cost are not taken into
consideration in accounting profit.

Economic profit is the difference between revenues and

costs, where costs include both the actual business costs
(the explicit costs) and the implicit costs.
Economic value-added is another name for the firm’s
economic profit. Key elements of estimating economic
profit are:
1. calculating the firm’s operating profit from financial
statement data, making adjustments to accounting profit
to better reflect a firm’s operating results for a period,
2. calculating the cost of capital, and
3. comparing operating profit with the cost of capital.
Market value added (MVA), focuses on the market value
of capital, as compared to the cost of capital. The key
elements of market value added are:
1. Calculating the market value of capital,
2. Calculating the amount of capital invested (i.e., debt
and equity), and
3. Comparing the market value of capital with the capital
invested.
But then…

Satyam Scam
 350
300
250
200
Satyam stock prices

150
100
50
0
1 2 3 4 5 6

Time period
 Share holders wealth maximization
and social responsibility

• Firms are responsible for welfare of the

employees, customer and community.
• Proper business ethics.
 Agency problem
The conflicts between the interest of shareholders and
mangers is known as agency problem.

This problem arises when:

1. Excessive pre-requisites are allowed to managers
2. Informational asymmetry.
3. Creditors put restrictive covenants on debt agreement.
4. Managers tenure is short
 Factors influencing financial
decision

Microeconomic factor related to the internal

condition of the firm like:
• Nature and size of the enterprise.
• Level of risk and stability in earning.
• Liquidity position
• Pattern of ownership
Principles of Financial Management

• Risk-Return trade-off
• Time value of money
• Cash-not Profit-Is King
• Efficient capital market
• Agency problem
• Taxes bias business decision
 Board of Directors

CEO

VP-Marketing VP-Production
VP-Finance
and operation

Treasurer
Responsibilities
1. working capital
management
2. Financial planning
3. Raising of capital
Controller
Responsibilities
1. Taxes
2. Financial statements
3. Cost accounting
4. Data processing