Financial management is the operational activity of a business that is responsible for obtaining and effectively utilising the funds necessary for efficient operations Joseph and Massie Financial management is that managerial activity which is concerned with the planning and controlling of the firm’s financial resources
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Financial management is the operational activity of a business that is responsible for obtaining and effectively
utilising the funds necessary for efficient operations
Joseph and Massie
Financial management is that managerial activity which is concerned with the planning and controlling of the firm’s financial resources
a. Profit is the test of economic efficiencyb. It is difficult to survive with out profitc. It leads to efficient allocation of resourcesd. Profit ensure maximum social welfare(i,e maximum
dividend to shareholders, timely payment to creditors, more and more wages to employees, more employment opportunities etc)
DISADVANTAGES OF PROFIT MAXIMISATION
I . PROFIT MAXIMISATION
1. AmbiguityIt is vague and ambiguous concept
2. Timing of benefitIt ignores the time pattern of benefit
Alternative (A) Alternative (B)
Period I 5000 -
Period II 10000 10000
Period III 5000 10000
Total 20000 20000
3. Quality of benefits
Alternative A AlternativeB
RecessionPeriod(I)
900 -
Normal Period (II)
1000 1000
BoomPeriod (III)
1100 2000
Total 3000 3000
II . WEALTH MAXIMISATION
TIME VALUE OF MONEY
A B10000 loan
One Year
Market value of interest 10%
Reasons
1. More purchasing power2. An investor can profitably invest which make him to give a higher value
TIME VALUE OF MONEY
Compounding value concept(Future value of present money)
Discounting orPresent value concept(Present value of future money)
RISK AND RETURN
The chance of future loss that can be foreseenRisk :
The unforeseen chance of future loss or damage
Eg : Earth quake, Coup
Uncertainty :
It represents the benefits derived by a business from its operations
Return:
METHODS OF RISK MANAGEMENT
Avoidance of risk
Prevention of risk
Transfer of risk
Retention of risk
Insurance
CAPITAL BUDGETING
Investment in fixed assets
Benefits derived in future which spreads over no: of years
NEED FOR CAPITAL BUDGETING
Large investments
Irreversible nature
Difficulties of investment decision
Long term effect on profitability
EVALUATION OF INVESTMENT PROPOSALS
Traditional methods Discounted cash flow method
1. Payback period method 2. Average rate of return method
1. Net present value (NPV method)2. Internal rate of return method (IRR)3. Profitability index (PI method)
I. TRADITIONAL METHOD
1. Pay back period method or pay out or pay off period method
Representing the no of years required to recover the original investment
Under this method projects are ranked on the basis of length of payback period
Payback period = Initial investment
annual cash inflow
Note: Annual cash inflow is the annual earnings (Profit before depreciation and after tax)
Payback period = Initial investment cumulated annual cash inflow
Un even cash inflow
Investment proposals are judged on the basis of their relative profitability
Projects with higher rate of return is accepted
ARR = Average income after tax and depreciation x100 Average investment
Average investment = Original investment
2
Average investment = original Cost - Scrap value
2
+ additional W.C +Scrap value
2. Average rate of return method or Rate of return method or Accounting rate of return method
II. DISCOUNTED CASH FLOW METHODS
OR TIME ADJUSTED TECHNIQUE
1 Net present value method
Best method for evaluating the capital investment proposals