Theory Slides FM Module 1

8/2/2019 Theory Slides FM Module 1

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Chapter 1 - An Introduction to Financial Management

Topics to be covered Introduction to finance, Objectives of financial management profit maximization and

wealth maximization. Changing role of finance managers. Organisation of finance function

.

Introduction to Finance

Need To run a business For input operations For managerial activity


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Introduction to Finance The finance function means the provision of finance at the time it is

wanted.

According to R.C Osborn finance function is the process ofacquiring and utilizing funds by a business.

According to F.W Paish Finance may be defined as the position ofmoney at the time it is wanted

The major difference between finance and accounting Accounting Accounting is a technique to monitor the financial performance of

any organization.

Accounting is one of the part of finance activity. Accounting means the money transactions are recording in proper

way. it is art of recording, classifying transactions.

Financing Financing is the identification of various sources of finance for a

project or future expansion plans.

Finance means the sources of funds and it covers all activities ofaccounting.

Finance means money. Financial Management


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According to Philliapatus Financial Management is management is

the operational activity of a business, that is responsible for

obtaining and effectively utilizing the funds necessary for efficient

operations.

According to Howard and Upton FM is the application of theplanning and control functions to the finance functions. FM involves

the application of general management principles to a particular

financial operation.

The three primary areas of finance Financial management (Corporate finance) deals with how firms

raise and use funds to make short-term and long-term investments. Investment deals with how the securities markets work and how to

evaluate and manage investments in stocks and bonds.

Financial Markets and Institutions includes the study of the bankingsystem and markets.


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Essential Elements of FM FM is one of the four distinct areas of overall business management,

viz production, finance, personnel, and marketing.

One of the important elements of FM is the careful selection of thesources of finance suitable under the given circumstances for

ensuring a proper capital structure for the organization.

Another important aspect of FM is the proper allocation andeffective utilization of the finance.

Profit maximization and wealth maximization Three key elements to the process of financial management

(1) Financial Planning Management need to ensure that enough funding is available at the

right time to meet the needs of the business. In the short term,

funding may be needed to invest in equipment and stocks, pay

employees and fund sales made on credit.

In the medium and long term, funding may be required forsignificant additions to the productive capacity of the business or to

make acquisitions.

(2) Financial Control


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Financial control is a critically important activity to help the businessensure that the business is meeting its objectives. Financial control

addresses questions such as:

Are assets being used efficiently? Are the businesses assets secure? Do management act in the best interest of shareholders and in

accordance with business rules?

(3) Financial Decision-making The key aspects of financial decision-making relate to investment,

financing and dividends:

Investments must be financed in some way however there arealways financing alternatives that can be considered. For example it

is possible to raise finance from selling new shares, borrowing from

banks or taking credit from suppliers A key financing decision is whether profits earned by the business

should be retained rather than distributed to shareholders via

dividends. If dividends are too high, the business may be starved of

funding to reinvest in growing revenues and profits further.

The Financial System

Objectives of Financial Management Profit Maximization- Ambiguity- Timing of Benefits


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- Quality of BenefitsMany people think the goal is to maximize profits.

Would this mean short-term profit, or long-term profit? Businesses are

sometimes criticized for being overly concerned about short-term profits

results rather than the long-term strategic positioning of the company. Wealth Maximization

a) Maximizing Firm Value

b) Maximizing Stock Price

The common stockholders are the owners of the corporation! The goal of the firm should be to maximize the stock price!

This is also known as value maximization or net present worth

maximization.

i) W= V-C

Where W Net present worthV Gross present worth

C Investment required to acquire the asset or to purchase the

course of action

ii) V=E/KWhere E size of future benefits available to the suppliers of the input

capital.

K The capitalization rate reflecting the quality and timing of

benefits attached to E

iii) E = G-(M+I+T)

Where G Average future flow of gross annual earnings expected from

the course of action, before maintenance charges, taxes and interest and

other prior charges like preference dividend.

M Average annual reinvestment required to maintain G at the

projected level.

T Expected annual outflow on account of taxes. I Expected flow of annual payments on account of interest,

preference dividends and other prior charges.

W= A1/(1+K)+A2/(1+K)2 + ..An/(1+K)n C Where A1,A2 .An represents the stream of cash flows expected to

occur from a course of action over a period of time.

K is the appropriate discount rate to measure risk and timing and C is the initial outlay to acquire that asset or pursue the course of

action.

Steps for Wealth Maximization In order to maximize the wealth, the firm should take the following

steps:

Avoid high level of risks.


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Pay dividends. Maintain growth in sales. Maintain the price of equity shares. Adapting sound investment policies. Merits of Wealth Maximization The concept of wealth maximization is very clear and not vague. The wealth maximization concept considers the time value of

money.

This concept takes into account even the dividend policy of thecompany. That is, this concept allows the dividend policy of the

company to have its effect on the market value of the equity

shares.

This concept is in total agreement with the objective of maximizingthe economic welfare of the shareholders of the company.

Superiority of the Objective of wealth Maximization over theobjective of profit maximization

Profit maximization concept is vague whereas wealth maximizationconcept is very clear, and not vague.

Profit maximization concept ignores the time value of money. Butwealth max concept recognizes the time value of money.

This concept is in total agreement with the objective of maximizingthe economic welfare of the shareholders of the company.

The concept of profit maximization ignores the factors of risk anduncertainty. On the other hand, wealth maximization concept takes

into account the risk factor by applying different rates of discount,

while discounting the cash flows from projects.

The objective of profit maximization is concerned only with themaximization of profits. But the objective of wealth maximization

also contributes to the maximization of other objectives of financial

management.


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Changing role of finance managers The role / job of financial managers in india has become more

important, complex and demanding.

The main role of finance managers are - Financial structure - Treasury operations - Management control - Investment planning - Mergers and acquisitions - Working capital management - Performance management - Risk Management The Role of the Financial Manager in a Corporation

Organization of Finance Function


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Theory Slides FM Module 1

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