Unit I

Introduction to Financial Management

Financial Management
Financial Management means planning, organizing, directing and
controlling the financial activities such as procurement and utilization
of funds of the enterprise. It means applying general management
principles to financial resources of the enterprise.
Scope/ Elements of Financial Management
• Investment decisions includes investment in fixed assets (called as capital
budgeting). Investment in current assets are also a part of investment
decisions called as working capital decisions.
• Financial decisions - They relate to the raising of finance from various
resources which will depend upon decision on type of source, period of
financing, cost of financing and the returns thereby.
• Dividend decision - The finance manager has to take decision with regards
to the net profit distribution. Net profits are generally divided into two:
• Dividend for shareholders- Dividend and the rate of it has to be decided.
• Retained profits- Amount of retained profits has to be finalized which will depend
upon expansion and diversification plans of the enterprise.
Objectives of Financial Management
The financial management is generally concerned with procurement, allocation and
control of financial resources of a concern. The objectives can be-
• To ensure regular and adequate supply of funds to the concern.
• To ensure adequate returns to the shareholders which will depend upon the
earning capacity, market price of the share, expectations of the shareholders.
• To ensure optimum funds utilization. Once the funds are procured, they should
be utilized in maximum possible way at least cost.
• To ensure safety on investment, i.e, funds should be invested in safe ventures so
that adequate rate of return can be achieved.
• To plan a sound capital structure-There should be sound and fair composition of
capital so that a balance is maintained between debt and equity capital.
Functions of Financial Management
• Estimation of capital requirements: A finance manager has to make
estimation with regards to capital requirements of the company. This
will depend upon expected costs and profits and future programmes
and policies of a concern. Estimations have to be made in an
adequate manner which increases earning capacity of enterprise.
• Determination of capital composition: Once the estimation have
been made, the capital structure have to be decided. This involves
short- term and long- term debt equity analysis. This will depend
upon the proportion of equity capital a company is possessing and
additional funds which have to be raised from outside parties.
Cont….
• Choice of sources of funds: For additional funds to be procured, a
company has many choices like-
• Issue of shares and debentures
• Loans to be taken from banks and financial institutions
• Public deposits to be drawn like in form of bonds.
• Choice of factor will depend on relative merits and demerits of each
source and period of financing.
• Investment of funds: The finance manager has to decide to allocate
funds into profitable ventures so that there is safety on investment
and regular returns is possible.
Cont….
• Disposal of surplus: The net profits decision have to be made by the finance
manager. This can be done in two ways:
• Dividend declaration - It includes identifying the rate of dividends and other benefits like
bonus.
• Retained profits - The volume has to be decided which will depend upon expansional,
innovational, diversification plans of the company.
• Management of cash: Finance manager has to make decisions with regards to
cash management. Cash is required for many purposes like payment of wages
and salaries, payment of electricity and water bills, payment to creditors, meeting
current liabilities, maintenance of enough stock, purchase of raw materials, etc.
• Financial controls: The finance manager has not only to plan, procure and utilize
the funds but he also has to exercise control over finances. This can be done
through many techniques like ratio analysis, financial forecasting, cost and profit
control, etc.
Cont….
Corporate Finance
• Corporate finance is the division of finance that deals with financing,
capital structuring, and investment decisions. Corporate finance is
primarily concerned with maximizing shareholder value through long
and short-term financial planning and the implementation of various
strategies. Corporate finance activities range from capital investment
decisions to investment banking.
• Corporate finance departments are charged with governing and
overseeing their firms' financial activities and capital investment
decisions.
Cont….
Characteristics of Corporate Finance
• Corporate finance is often associated with a firm's decision to
undertake capital investments and other investment-related
decisions.
• Corporate finance manages short-term financial decisions that affect
operations.
• In addition to capital investments, corporate finance deals with
sourcing capital.
• It also includes whether shareholders should receive
dividends. Additionally, the finance department manages current
assets, current liabilities, and inventory control.
Finance Functions
Investment Decision
• One of the most important finance functions is to intelligently
allocate capital to long term assets. This activity is also known as
capital budgeting. It is important to allocate capital in those long-term
assets so as to get maximum yield in future. Following are the two
aspects of investment decision
• Evaluation of new investment in terms of profitability
• Comparison of cut off rate against new investment and prevailing
investment.
Cont….
• Since the future is uncertain therefore there are difficulties in calculation of
expected return. Along with uncertainty comes the risk factor which has to
be taken into consideration. This risk factor plays a very significant role in
calculating the expected return of the prospective investment. Therefore
while considering investment proposal it is important to take into
consideration both expected return and the risk involved.
• Investment decision not only involves allocating capital to long term assets
but also involves decisions of using funds which are obtained by selling
those assets which become less profitable and less productive. It wise
decisions to decompose depreciated assets which are not adding value and
utilize those funds in securing other beneficial assets. An opportunity cost
of capital needs to be calculating while dissolving such assets. The correct
cut off rate is calculated by using this opportunity cost of the required rate
of return (RRR).
Financial Decision
• Financial decision is yet another important function which a financial
manger must perform. It is important to make wise decisions about
when, where and how should a business acquire funds. Funds can be
acquired through many ways and channels. Broadly speaking a
correct ratio of an equity and debt has to be maintained. This mix of
equity capital and debt is known as a firm’s capital structure.
• A firm tends to benefit most when the market value of a company’s
share maximizes this not only is a sign of growth for the firm but also
maximizes shareholders wealth. On the other hand the use of debt
affects the risk and return of a shareholder. It is riskier though it may
increase the return on equity funds.
Cont….
• A sound financial structure is said to be one which aims at maximizing
shareholders return with minimum risk. In such a scenario the market
value of the firm will maximize and hence an optimum capital
structure would be achieved. Other than equity and debt there are
several other tools which are used in deciding a firm capital structure.
Dividend Decision
• Earning profit or a positive return is a common aim of all the
businesses. But the key function a financial manger performs in case
of profitability is to decide whether to distribute all the profits to the
shareholder or retain all the profits or distribute part of the profits to
the shareholder and retain the other half in the business.
• It’s the financial manager’s responsibility to decide an optimum
dividend policy which maximizes the market value of the firm. Hence
an optimum dividend payout ratio is calculated. It is a common
practice to pay regular dividends in case of profitability Another way
is to issue bonus shares to existing shareholders.
Liquidity Decision
• It is very important to maintain a liquidity position of a firm to avoid
insolvency. Firm’s profitability, liquidity and risk all are associated with
the investment in current assets. In order to maintain a tradeoff
between profitability and liquidity it is important to invest sufficient
funds in current assets. But since current assets do not earn anything
for business therefore a proper calculation must be done before
investing in current assets.
• Current assets should properly be valued and disposed of from time
to time once they become non profitable. Currents assets must be
used in times of liquidity problems and times of insolvency.
Objectives of Finance Functions
• Investment Decisions– This is where the finance manager decides
where to put the company funds. Investment decisions relate to
management of working capital, capital budgeting decisions,
management of mergers, buying or leasing of assets. Investment
decisions should create revenue, profits and save costs.
• Financing Decisions– Here a company decides where to raise funds
from. They are two main sources to consider from mainly equity and
borrowed. From the two a decision on the appropriate mix of short
and long-term financing should be made. The sources of financing
best at a given time should also be agreed upon.
Cont….
• Dividend Decisions– These are decisions as to how much, how
frequent and in what form to return cash to owners. A balance
between profits retained and the amount paid out as dividend should
be decided here.
• Liquidity Decisions– Liquidity means that a firm has enough money to
pay its bills when they are due and have sufficient cash reserves to
meet unforeseen emergencies. This decision involves management of
the current assets, so you don’t become insolvent or fail to make
payments.
Classification of Finance Function
• Long-Term Finance– This includes finance of investment 3 years or
more. Sources of long-term finance include owner capital, share
capital, long-term loans, debentures, internal funds and so on.

• Medium Term Finance– This is financing done between 1 to 3 years,

this can be sourced from bank loans and financial institutions.

• Short Term Finance – This is finance needed below one year. Funds
may be acquired from bank overdrafts, commercial paper, advances
from customers, trade credit etc.
Why a Business Needs The Finance
Functions?
• Helps Establish a Business– Without money, you cannot get labor,
land and so on with the finance function you can determine what is
required to start your business and plan for it.

• Helps Run a Business– To remain in business you must cater for the
day to day operating costs such as paying salaries, buying stationery,
raw material, the finance function ensures you always have adequate
funds to cater for this.
Cont….
• To Expand, Modernize, Diversify– A business needs to grow
otherwise it may become redundant in no time. With the finance
function, you can determine and acquire the funds required to do so.

• Purchase Assets-You need money to purchase assets. This can be

tangible assets like furniture, buildings or intangible like trademarks,
patents etc. to get this you need finances.
Importance of Finance Functions
• Identify Need of Finance-To start a business you need to know how
much is required to open it. So, the finance function helps you know
how much the initial capital is, how much of it you have and how
much you need to raise.

• Identify Sources of Finance-Once you know what needs to be raised

you look at areas you can raise these funds from. You can borrow or
get from various shareholders.
Cont….
• Comparison of Various Sources of Finance– After identifying various
fund sources compare the cost and risk involved. Then choose the
best source of financing that suits your business needs.

• Investment-Once the funds are raised it is time to invest them.

Investment decisions should be done in a manner that a business gets
higher returns. Cost of funds procurement should be lower than the
return on investment, this will show a wise investment was made.
The Role of the Finance Function in Organizational Processes
The Finance Function and the Project Office
• Contemporary organizations need to practice cost control if they are
to survive the recessionary times. Given the fact that many top tier
companies are currently mired in low growth and less activity
situations, it is imperative that they control their costs as much as
possible. This can happen only when the finance function in these
companies is diligent and has a hawk eye towards the costs being
incurred. Apart from this, companies also have to introduce
efficiencies in the way their processes operate, and this is another
role for the finance function in modern day organizations.
Cont….
• There must be synergies between the various processes, and this is where
the finance function can play a critical role. Lest one thinks that the finance
function, which is essentially a support function, has to do this all by
themselves, it is useful to note that, many contemporary organizations
have dedicated project office teams for each division, which perform this
function.
• In other words, whereas the finance function oversees the organizational
processes at a macro level, the project office teams indulge in the same at
the micro level. This is the reason why finance and project budgeting and
cost control have assumed significance because after all, companies exist
to make profits and finance is the lifeblood that determines whether
organizations are profitable or failures.
The Pension Fund Management and Tax
Activities of the Finance Function
• The next role of the finance function is in payroll, claims processing,
and acting as the repository of pension schemes and gratuity. If the
US follow the 401(k) rule and the finance function manages the
defined benefit and defined contribution schemes, in India it is the
EPF or the Employee Provident Funds that are managed by the
finance function. Of course, only large organizations have dedicated
EPF trusts to take care of these aspects and the norm in most other
organizations is to act as facilitators for the EPF scheme with the local
or regional PF (Provident Fund) commissioner.
Cont….
• The third aspect of the role of the finance function is to manage the
taxes and their collection at source from the employees. Whereas in
the US, TDS or Tax Deduction at Source works differently from other
countries, in India and much of the Western world, it is mandatory for
organizations to deduct tax at source from the employees
commensurate with their pay and benefits.
• The finance function also has to coordinate with the tax authorities
and hand out the annual tax statements that form the basis of the
employee’s tax returns. Often, this is a sensitive and critical process
since the tax rules mandate very strict principles for generating the
tax statements.
Payroll, Claims Processing, and Automation
• The other role of the finance function is to process payroll and associated
benefits in time and in tune with the regulatory requirements.
• Claims made by the employees with respect to medical, and transport
allowances have to be processed by the finance function. Often, many
organizations automate this routine activity wherein the use of ERP
(Enterprise Resource Planning) software and financial workflow
automation software make the job and the task of claims processing easier.
Having said that, it must be remembered that the finance function has to
do its due diligence on the claims being submitted to ensure that bogus
claims and suspicious activities are found out and stopped. This is the
reason why many organizations have experienced chartered accountants
and financial professionals in charge of the finance function so that these
aspects can be managed professionally and in a trustworthy manner.
Cont….
• The key aspect here is that the finance function must be headed by
persons of high integrity and trust that the management reposes in
them must not be misused. In conclusion, the finance function
though a non-core process in many organizations has come to occupy
a place of prominence because of these aspects.
The Finance Function Involves
• Ensure enough funds at reasonable cost.
• Ensure safety of funds.
• Ensure efficient, effective and profitable utilization of funds.
• Ensure that finance funds don’t remain idle.
Steps into Finance Functions
1. Drawing a financial plan and forecasting financial needs

2. Raising necessary funds

3. Putting funds into proper use.

Major Activities of Finance Functions
1. Financial planning;
2. Forecasting cash inflows and outflows;
3. Raising funds;
4. Allocation of funds;
5. Effective use of funds;
and
6. Financial control (budgetary and non-budgetary).
Scope of Finance Function
• The scope of finance function is wide because this function affects
almost all the aspects of a firm’s operations. The finance function
includes judgments about whether a company should make more
investment in fixed assets or not.
• It is largely concerned with the allocation of a firm’s capital
expenditure over time as also related decisions such as financing
investment and dividend distribution. Most of these decisions taken
by the finance department affect the size and timing of future cash
flow or flow of funds.
Characteristics of Finance Function
1. Executive finance function: requires administration skill in planning
and execution

And

2. Incidental finance function: include supervision of cash inflows and

outflows and maintaining cash balances and record keeping.
Structures of the Financial System
• The financial system is the main part of running the economy
smoothly. financial system provides the flow of finance in the
economy. which leads to the development of the country financial
system show the strength of the country.
• Indian Financial System: It is a combination of financial institutions,
financial markets, financial instruments and financial services to
facilitate the transfer of funds. Financial system provides a payment
mechanism for the exchange of goods and services. It is a link
between saver and investor.
Cont….
Indian Financial System
• The Structure of Indian Financial System is about A financial system is
a system that system which allows the exchange of funds between
investors, lenders, and borrowers.

• Indian Financial systems operate at national and global levels.

• They consist of complex, closely related services, markets, and

institutions intended to provide an efficient and regular linkage
between investors and depositors.
Cont….
Financial institutions
• Financial institutions are the intermediaries who facilitate the smooth
functioning of the financial system by making investors and borrowers
meet. They mobilize savings of the surplus units and allocate them in
productive activities promising a better rate of return. Structure of Indian
• Financial System also provides services to entities (individual, business,
government) seeking advice on various issues ranging from restructuring to
diversification plans. They provide whole range Of services to the entities
who want to raise funds from the markets or elsewhere. The financial
Institutions is very important for the function of a financial system.
• Types of Financial Institutions
Financial institutions can be classified into two categories
- Banking Institutions
- Non-Banking Financial Institutions
Financial Markets
• Financial Markets may be broadly classified as negotiated loan markets and open
The negotiated loan market is a market in which the lender and the borrower
personally negotiate the terms of the loan agreement, e.g. a businessman
borrowing from a bank or from a small loan company.
• On the other hand, the open market is an impersonal market in which
standardized securities are treated in large volumes. The stock market is an
example of an open market. The financial markets, in a nutshell, the credit
markets catering to the various credit needs Of the individuals, links and
institutions. Credit is supplied both on a short as well as a long
• On the basis of the credit requirement for short-term and long-term purposes,
financial markets are divided into two categories
Types of the financial market
- Money Market
- Capital Market
Financial Instruments
• This is an important component of the financial system. Financial
instruments are monetary contracts between parties. The products which
are traded in a financial market are financial assets, securities or other
types of financial instruments. There is a wide range of securities in the
markets since the needs of investors and credit seekers are different.
• Financial instruments can be real or virtual documents representing a legal
agreement involving any kind of monetary value. Equity-based financial
instruments represent ownership of an asset. Debt-based financial
instruments represent a loan made by an investor to the owner of the
asset.
• Types of Financial Instruments
- Cash Instruments
- Derivative Instrument
Financial Services
• It consists of services provided by Asset Management and Liability
Management Companies. They help to get the required funds and
also make sure that they are efficiently invested. They assist to
determine the financing combination and extend their professional
services up to the stage of servicing of lenders.
• Types of Financial Services
- Banking
- Wealth Management
- Mutual Funds
- Insurance
Financial Market
• Financial Market refers to a marketplace, where creation and trading
of financial assets, such as shares, debentures, bonds, derivatives,
currencies, etc. take place. It plays a crucial role in allocating limited
resources, in the country’s economy. It acts as an intermediary
between the savers and investors by mobilising funds between them.

• The financial market provides a platform to the buyers and sellers, to

meet, for trading assets at a price determined by the demand and
supply forces.
Functions of Financial Market
• It facilitates mobilisation of savings and puts it to the most productive uses.
• It helps in determining the price of the securities. The frequent interaction
between investors helps in fixing the price of securities, on the basis of their
demand and supply in the market.
• It provides liquidity to tradable assets, by facilitating the exchange, as the
investors can readily sell their securities and convert assets into cash.
• It saves the time, money and efforts of the parties, as they don’t have to waste
resources to find probable buyers or sellers of securities. Further, it reduces cost
by providing valuable information, regarding the securities traded in the financial
market.
• The financial market may or may not have a physical location, i.e. the exchange
of asset between the parties can also take place over the internet or phone also.
Classification of Financial Market
Cont….
1. By Nature of Claim
• Debt Market: The market where fixed claims or debt instruments, such as
debentures or bonds are bought and sold between investors.
• Equity Market: Equity market is a market wherein the investors deal in
equity instruments. It is the market for residual claims.

2. By Timing of Delivery
• Cash Market: The market where the transaction between buyers and
sellers are settled in real-time.
• Futures Market: Futures market is one where the delivery or settlement of
commodities takes place at a future specified date.
Cont….
3. By Maturity of Claim
• Money Market: The market where monetary assets such as commercial
paper, certificate of deposits, treasury bills, etc. which mature within a
year, are traded is called money market. It is the market for short-term
funds. No such market exist physically; the transactions are performed over
a virtual network, i.e. fax, internet or phone.
• Capital Market: The market where medium- and long-term financial assets
are traded in the capital market. It is divided into two types:
• Primary Market: A financial market, wherein the company listed on an exchange, for
the first time, issues new security or already listed company brings the fresh issue.
• Secondary Market: Alternately known as the Stock market, a secondary market is an
organised marketplace, wherein already issued securities are traded between
investors, such as individuals, merchant bankers, stockbrokers and mutual funds.
Cont….
4. By Organizational Structure
• Exchange-Traded Market: A financial market, which has a centralised
organisation with the standardised procedure.
• Over-the-Counter Market: An OTC is characterised by a decentralised
organisation, having customised procedures.

# Since last few years, the role of the financial market has taken a
drastic change, due to a number of factors such as low cost of
transactions, high liquidity, investor protection, transparency in pricing
information, adequate legal procedures for settling disputes, etc.
(6) A’s of Financial Management
1. Anticipating Financial Needs: Short-term weekly cash flow
projections accompanied by 12–18-month driver-based financial
models reveal a company’s liquidity needs. Both tools need to be
updated regularly.
2. Acquiring Financial Resources: Most businesses already have
existing banking relationships. My favorite practice is to keep the
lenders updated monthly after the financial are updated (quarterly at a
minimum). Around 90 days before the LOC is up for renewal, a bank
package including recent financial history, new strategies, and
projections should be completed and then presented to the lender. I’ve
been doing this for years with nearly a 100% close rate on renewals and
new financing for term loans.
Cont….
3. Allocating Funds in Business: Our spending is typically driven by an
annual plan or budget. We spend accordingly. When great
opportunities arise, we look for cash to make these investments. In
small business, asset/cash allocation is more informal compared to its
big company counterparts.
4. Administering the Allocation of Funds: The best and only practice is
rock-solid accounting and financial controls. For the LOC, processes
should be in place for drawing and paying down line if not done
automatically by the bank.
Cont….
5. Accounting and Reporting to the Management: The best and right
practice is to have financials completed by the second or third day of
the new month. The financials accordingly need to be timely, accurate,
and meaningful.
6. Analysing the Performance of Finance: Remember the financial
modeling addressed at the outset? Actuals should be compared to plan
once the financials have been released each month. Projections and
stress testing should follow. Financial analysis is ongoing.
Financial Planning and Forecasting
• A financial forecast is an estimation, or projection, of likely future
income or revenue and expenses, while a financial plan lays out the
necessary steps to generate future income and cover future expenses.
Alternatively, a financial plan can be looked at as what an individual
or company plans to do with income or revenue received.

• While both processes orient financial activity toward the future, a

financial plan is a road-map drafted now that can be followed over
time and a financial forecast is a projection or estimate of future
outcomes predicted today.
Financial Plan
• A financial plan is a process a company lays out, typically broken down into
a step-by-step format, for utilizing its available capital and other assets to
meet its goals for growth or profit based on a reasonable financial forecast.
A financial plan can be considered synonymous with a business plan in that
it lays out what a company plans to do in terms of putting resources to
work to generate maximum possible revenues.
• Individuals can also take advantage of a financial plan. An annual financial
plan is a guidebook of sorts that tells you where you’re at financially right
now, what your goals are looking ahead and what areas or issues need to
be addressed so that you can meet those goals. The plan covers every
aspect of your financial life, from investing to taxes to your outlook for
retirement. While your starting point in developing your plan may be
different based on your age, income, debts, and assets, the most important
components of an annual financial plan are the same.
Financial Forecast
• Financial forecasting is critical for business success. To effectively manage working
capital and cash flow, a company must have a reasonable idea of how much
revenue it plans to receive over a given time period and what its necessary
expenses will be over that same period of time. Financial forecasts are commonly
reviewed and revised annually as new information regarding assets and costs
becomes available. The new data enables an individual or business to make more
accurate financial projections. It is easier for established companies that generate
steady revenues to make accurate financial forecasts than it is for new businesses
or companies whose revenue is subject to significant seasonal or cyclical
fluctuations.
• For an individual, a financial forecast is an estimate of his income and expenses
over a period of time. Based on that forecast, the individual can then construct a
financial plan that includes saving, investing, or planning for obtaining additional
income to augment his personal finances—as well as anticipating expenditures
that would deplete them.
All the Best..