Financial management

Objectives of Financial Management

Prof. Rakesh M

VSMS

Puttur

Objectives of Financial ManagementProfit Maximisation:

Profit maximization is basically is a single-period or, at

most, a short-term goal, to be achieved within one year; it is

usually interpreted to mean the maximization of profits within a

given period of time. A corporation may maximize its short-term

profits at the expense of its long-term profitability

Wealth Maximisation:

If the market price of the shares increases, it can be said

that capital (wealth) invested by the shareholders has been

appreciating. On the contrary, fall in the market price of the

shares has an adverse effect on their wealth. Wealth of the

shareholders can be computed by the following formula:

Shareholder’s Current Wealth in a Company.

Changing role of financial Manager

Raising of funds

Investment decisions

Financing Decision

Profit Planning

Understanding Capital Markets

Forex Risk Management

Interface of Financial Management with other

functional areas.

1. Financial Management and Production

Department: The financial management and the

production department are interrelated. The

production department of any firm is concerned

with the production cycle, skilled and unskilled

labour, storage of finished goods, capacity

utilisation, etc. and the cost of production

assumes a substantial portion of the total cost.

The production department has to take various

decisions like replacing machinery, installation of

safety devices, etc. and all the decisions have

financial implications.

2. Financial Management and Material

Department: The financial management and the

material department are also interrelated. Material

department covers the areas such as storage,

maintenance and supply of materials and stores,

procurement etc. The finance manager and

material manager in a firm may come together

while determining Economic Order Quantity,

safety level, storing place requirement, stores

personnel requirement, etc. The costs of all these

aspects are to be evaluated so the finance

manager may come forward to help the material

manager.

3. Financial Management and Personnel

Department: The personnel department is

entrusted with the responsibility of recruitment,

training and placement of the staff. This

department is also concerned with the welfare of

the employees and their families. This department

works with finance manager to evaluate

employees’ welfare, revision of their pay scale,

incentive schemes, etc.

4. Financial Management and Marketing

Department: The marketing department is

concerned with the selling of goods and services

to the customers. It is entrusted with framing

marketing, selling, advertising and other related

policies to achieve the sales target. It is also

required to frame policies to maintain and

increase the market share, to create a brand

name etc. For all this finance is required, so the

finance manager has to play an active role for

interacting with the marketing department.

Primary Market

Primary market considered to be very important as it the

place where securities are offered to the public for the first time.

So, it is the place where securities are made.

It may happen that a company may need capital for its

business. Then the company approaches the primary market and

issue shares in an IPO (Initial Public Offering).

Investors buy the company's share and start sharing risk and

returns of the company from then onwards. The company thus gets

the capital it required to carry on investments.

After the capital is raised by the company , it gets listed on

the stock exchange where the stocks can be traded. The shares

are now traded in secondary market

Functions

Origination- Time of floating the issue

- Type of issue

- Price of the issue

Underwriting

Distribution

Secondary market is the place where the shares are traded after their

initial offering in the primary market. Therefore, the stock market is considered

as secondary market. Bombay Stock Exchange (BSE) and National Stock

Exchange (NSE) are secondary market.

Here, the investors trade among themselves without the involvement of

the issuing company. Typically, in primary market prices are set beforehand by

the issuing company. But in secondary market prices are not set rather they

depend on the forces of demand and supply of the securities.

Maximum trading is done in the secondary market. However, trading in the

secondary market does not have any effect on the capital structure of the

company. The primary market gives the company an opportunity to increase

capital they want to invest.

Secondary market

lA segment of the financial market in which

financial instruments with high liquidity and

very short maturities are traded. The money

market is used by participants as a means

for borrowing and lending in the short term,

from several days to just under a year.

lMONEY MARKET

T-billsT-bills are short-term securities that mature in one

year or less from their issue date. They are issued

with three-month, six-month and one-year

maturities. T-bills are purchased for a price that is

less than their par (face) value; when they mature,

the government pays the holder the full par value.

Effectively, ther interest is the difference between

the purchase price of the security and what you

get at maturity. For example, if you bought a 90-

day T-bill at $9,800 and held it until maturity, you

would earn $200 on your investment.

CDs

A savings certificate entitling the bearer to receive

interest. A CD bears a maturity date, a specified

fixed interest rate and can be issued in any

denomination. CDs are generally issued by

commercial banks.

For example, let's say that you purchase a

$10,000 CD with an interest rate of 5%

compounded annually and a term of one year. At

year's end, the CD will have grown to $10,500

($10,000 * 1.05).

Commercial paperCommercial paper is a short-term debt security

issued by financial companies and large

corporations. The corporation promises the buyer

a return, or profit, for making the loan. The return

is stated as an interest rate or percentage of the

loan, such as 5%.

Companies sell commercial paper when they

need a short-term loan to pay for such things as

accounts payable and inventories. The security is

generally sold at a discount, and redeemed at full

value. The gain is the interest payment.

Banker's acceptance

A short-term debt instrument issued by a firm that

is guaranteed by a commercial bank. Banker's

acceptances are issued by firms as part of a

commercial transaction. These instruments are

similar to T-Bills and are frequently used in money

market funds

Forex marketForeign exchange market is the market in which

foreign currencies are bought and sold. The

buyers and sellers include individuals, firms,

foreign exchange brokers, commercial banks and

the central bank.

Like any other market, foreign exchange market is

a system, not a place. The transactions in this

market are not confined to only one or few foreign

currencies. In fact, there are a large number of

foreign currencies which are traded, converted

and exchanged in the foreign exchange market.

Distinguishing features of foreign

exchange market

Large no of buyers and sellers

Political diversity

Forex Risk

Commodities market

A physical or virtual marketplace for buying,

selling and trading raw or primary products. For

investors' purposes there are currently about 50

major commodity markets worldwide that facilitate

investment trade in nearly 100 primary

commodities.

Commodities are split into two types: hard and

soft commodities. Hard commodities are typically

natural resources that must be mined or extracted

(gold, rubber, oil, etc.), whereas soft commodities

are agricultural products or livestock (corn, wheat,

coffee, sugar, soybeans, pork, etc.)

There are numerous ways to invest in commodities.

lAn investor can purchase stock in corporations

whose business relies on commodities prices

lPurchase mutual funds, index funds or exchange-

traded funds (ETFs) that have a focus on

commodities-related companies.

lThe most direct way of investing in commodities is

by buying into a futures contract.

Stock Market

The stock market lets investors participate in the

financial achievements of the companies whose

shares they hold. When companies are profitable,

stock market investors make money through the

dividends the companies pay out and by selling

appreciated stocks at a profit called a capital gain.

The downside is that investors can lose money if

the companies whose stocks they hold lose

money, the stocks' prices goes down and the

investor sells the stocks at a loss.

Lease

A lease is a contractual arrangement calling for

the lessee (user) to pay the lessor (owner) for use

of an asset. The narrower term rental agreement

can be used to describe a lease in which the asset

is tangible property.

Leasing

Financial Leasing or Capital Leasing

It is a commercial arrangement where:

lThe lessee (customer or borrower) will select an asset

(equipment, vehicle, software)

lThe lessor (finance company) will purchase that asset

lThe lessee will have use of that asset during the lease

lThe lessee will pay a series of rentals or installments for

the use of that asset

lThe lessor will recover a large part or all of the cost of

the asset plus earn interest from the rentals paid by the

lessee

lThe lessee has the option to acquire ownership of the

asset (e.g. paying the last rental, or bargain option

purchase price)

Operating Lease

Operating lease is a contract wherein the owner,

called the Lessor, permits the user, called the

Lesse, to use of an asset for a particular period

which is shorter than the economic life of the

asset without any transfer of ownership rights.

Leveraged Lease

A lease agreement that is partially financed by the lessor

through a third-party financial institution. In a leveraged

lease, the lending company holds the title to the leased

asset, while the lessor creates the agreement with the

lessee and collects the payment. The payments are then

passed on to the lender.

In a leveraged lease, if the lessee stops making

payments to the lessor, then the lessor stops making

payments to the financial institution (lender). This allows

the lender to repossess the property. The lessor may also

have the right to retain the property upon lessee default,

as long as the lessor continues making payments to the

lender.

Sale and Leaseback.

lAn arrangement where the seller of an asset leases back

the same asset from the purchaser. In a leaseback

arrangement, the specifics of the arrangement are made

immediately after the sale of the asset, with the amount

of the payments and the time period specified.

Essentially, the seller of the asset becomes the lessee

and the purchaser becomes the lessor in this

arrangement.

lA leaseback arrangement is useful when companies

need to un-tie the cash invested in an asset for other

investments, but the asset is still needed in order to

operate. Leaseback deals can also provide the seller with

additional tax deductions. The lessor benefits in that they

will receive stable payments for a specified period of

time.

Cross-border leasing

Cross-border leasing is a leasing arrangement

where lessor and lessee are situated in different

countries. This presents significant additional

issues related to tax avoidance and tax shelters

It is international leasing and is referredotherwise

as transactional leasing.

Relates to lease transaction betweendifferent a

lessor and lessee domiciled indifferent countries.

Illustration:-Leasing company in USA makes

available Air Bus on lease to AirIndia.

Hybrid securities

Hybrid securities are a broad group of securities that

combine the elements of the two broader groups of

securities, debt and equity.

Hybrid securities pay a predictable (fixed or floating) rate

of return or dividend until a certain date, at which point

the holder has a number of options including converting

the securities into the underlying share.

Therefore, unlike a share of stock (equity) the holder has

a 'known' cash flow, and, unlike a fixed interest security

(debt) there is an option to convert to the underlying

equity. More common examples include convertible and

converting preference shares.

Types1. Convertible bonds:A bond that can be converted into a

predetermined amount of the company's equity at certain times

during its life, usually at the discretion of the bondholder.

2.Prefered stock: A class of ownership in a corporation that has a

higher claim on the assets and earnings than common stock.

Preferred stock generally has a dividend that must be paid out

before dividends to common stockholders and the shares usually

do not have voting rights.

3.Profit Participating Loans:The profit participating loan is a special

form of a loan. The lender receives a participation in the profits or

turnover of the company in return for the provision of capital. This

participation can be confined to the purpose for which the loan was

provided or pertain to the whole business of the company.

Additionally, fixed interest payments can be included in the

contract.

4. Mezzanine Financing: Mezzanine financing, as

the name implies, is a form of financing that

functions by way of two other financing methods.

It is a financing agreement in which funds are

provided in a traditional loan but the lender can

assume an ownership if the loan is not paid back

on time and in full. Lenders who provide

mezzanine financing particularly look for

companies that have the potential to expand

successfully if equipped with adequate additional

capital.

Other sources of financing

1. Stocks

2. Debentures

3. Term loans

Private Equity: PE is a number of different types of investments

that can be made with private money. These investments may be

made to purchase a company, provide funding for a project, or

simply make a private investment because you aren’t interested

in stocks.

Venture Capital: VC is a specific investment strategy designed to

provide funding for startup companies. It’s a very popular

financing source for technology companies. It allows for fast

growth without needing revenue at an early stage. It’s highly

risky, but can be quite lucrative.

Angel Investing: Before you take your company to venture

capitalists you need to probably get some funding before. You

come to angel investors who provide similar startup financing,

only in smaller denominations. You may only need $100,000, and

for that you won’t find an interested VC firm, but you might find

and angel investor.

Warrants: A warrant is like an option. It gives the

holder the right but not the obligation to buy an

underlying security at a certain price, quantity and

future time. It is unlike an option in that a warrant

is issued by a company, whereas an option is an

instrument of the stock exchange. The security

represented in the warrant (usually share equity)

is delivered by the issuing company instead of by

an investor holding the shares

Warrants are often included in a new debt issue

as a "sweetener" to entice investors.

Convertibles:

Sources of financing

lShares

lDebetures

lTerm loans

lLease financing

lVenture Capital

lAngeel investing

lPrivate equity

lWarrants

lConvertibles

Module 2

TIME VALUE OF MONEY - TVM'.

DEFINITION OF 'TIME VALUE OF

MONEY - TVM'

The idea that money available at the present time

is worth more than the same amount in the future

due to its potential earning capacity. This core

principle of finance holds that, provided money

can earn interest, any amount of money is worth

more the sooner it is received.

Also referred to as "present discounted value".

http://www.investopedia.com/video/play/understan

ding-time-value-of-money/

Everyone knows that money deposited in a

savings account will earn interest. Because of this

universal fact, we would prefer to receive money

today rather than the same amount in the future.

For example, assuming a 5% interest rate, $100

invested today will be worth $105 in one year

($100 multiplied by 1.05). Conversely, $100

received one year from now is only worth $95.24

today ($100 divided by 1.05), assuming a 5%

interest rate.

Future value of moneyFormula

FV = PV(1+i)n

Present value of money

Formula

PV = FV / (1 + i)n