Introduction to financial management

Introduction to Financial

Management

CONTENTS

Meaning and Scope of Financial Management Goals/Objectives of Financial Management – Profit

Maximization vs. Wealth Maximization Finance Functions Place of Finance Function in the Organizational Structure Relation of Finance with Economics

Relation to Accounting Interface with other Functions

Supplementary Noteworthy Aspects Related to Financial Management

Methods and Tools of Financial Management Forms of Business Organization

Financial Management

Finance can be defined as the art and science of managing money.

Financial management is concerned with raising financial resources and their effective utilization towards achieving the organization goals.

In simple meanings, “To utilization money and to make profitability is called financial management.”

Scope of Financial Management

Financial Analysis, Planning and Control

Profit planningFinancial forecasting

Financial control

Goals/Objectives of Financial Management – Profit Maximization

• Profit maximization concept should be considered in relation to risks involved. There is a direct relationship between risk and profit. Many risky propositions yield high profit.

• Higher the risk, higher is the possibility of profits. If profit maximization is the only goal, then risk factor is altogether ignored.

• Profit maximization, as an objective does not take into account time pattern of return.

Modern Approach – Wealth Maximization

• The alternative to profit maximization is wealth maximization. This is also known as Value maximization or Net Present Worth maximization. Value is represented by the market price of the company's equity shares.

• The share market prices of a company's shares do reflect the value, which the various parties put on a company. Normally, the value is a function of two factors:

• 1. The likely rate of Earnings Per Share (EPS) of a company and

• 2. The capitalization rate

• EPS are calculated by dividing the periods total earnings available for the firm's common shares by the number of shares of common shares outstanding. The likely rate of earnings per share

• (EPS) depends on the assessment as to how profitably a company is going to operate in the future.

• The capitalization rate – capitalization rate is used to estimate the investor’s potential return on his or her investment.

• This is done by dividing the income the property will generate by the total value of the property.

• Capitalization rate = yearly income/ Total value.

Modern Approach – Wealth Maximization

• Stakeholders - Stakeholders are groups such as employees, customers, suppliers, creditors, owners and others who have a direct economic link to the firm.

• Role of Ethics - Ethics is standards of conduct or moral judgment. Today, the business community in general and the financial community in particular are developing and enforcing ethical standards, purpose being to motivate business and market participants.

• It is necessary for achieving the firms goal of owner wealth maximization.

Modern Approach – Wealth Maximization

Finance Functions

• Financial Management is indeed, the key to successful business operations. Without proper administration and effective utilization of finance, no business enterprise can utilize its potentials for growth and expansion.• In the contents of modern approach, the discussions on financial management can be

divided into three major decisions viz., (1)Investing; (2) Financing; and

(3) Dividend decision.

Finance Functions

• Investing (a) Management of current assets (cash, marketable

securities, receivables and inventories) (b) Capital budgeting (identification, selection and

implementation of capital projects) (c) Managing of mergers, reorganizations and divestments

• Financing (a) Identification of sources of finance and determination of

financing mix (b) Cultivating sources of funds and raising funds

Finance Functions

• Dividend Decision• This is the third financial decision, which

relates to dividend policy. Dividend is a part of profits, that are available for distribution, to equity shareholders. Payment of dividends should be analyzed in relation to the financial decision of a firm. There

Organizational Chart of Finance Function

Relation to Accounting

• The firm's finance (treasurer) and accounting (controller) activities are closely related and generally overlapped.

• Normally, managerial finance and accounting are not often easily distinguishable.

• In small firms, the controller often carries out the finance function and in large firms many accountants are also involved in various finance activities.

• There are two basic differences between finance and accounting:

• Emphasis on cash flows• Relating to decision-making

Relating to decision-making

• Emphasis on cash flows: The accountant's primary function is to develop and report data for measuring the performance of the firm, assuming its financial position and paying taxes using certain standardized and generally accepted principles. The accountant prepares financial statements based on accrual basis.

• Relating to decision-making: Accountants devote most of their operation to the collection and presentation of financial data. The primary activities of the financial manager in addition to ongoing involvement in financial analysis and planning are making investment decisions and making financing decisions.

Interface with other Functions

Manufacturing Financea) Manufacturing function necessitates a large investment.

Productive use of resources ensures a cost advantage for the firm.b) Optimum investment in inventories improves profit margin.c) Many parameters of the production cost having effect on

production cost are possible to control through internal management thus improving profits.

Marketing Financea) Many aspects of marketing management have financial

implications e.g., hold inventories to provide off the shelf service to customers and thus increase sales; extension of credit facility to customers to increase sales.

b) Marketing strategies to increase sales have additional cost impact, which needs to be weighed carefully against incremental revenue.

Interface with other Functions

Personnel Finance• In the global competitive scenario, business

firms are moving to leaner and flat organizations.

• Investments in Human Resource Development are also bound to increase.

Forms of Business Organization

Sole Proprietorship• A sole proprietorship is a business owned by one person who

runs for his own profit. Majority of the business firms are sole proprietorships. The typical sole proprietorship is a small business

• Example: bakeshop, personal trainer or plumber.Partnership• A partnership firm is a business run by two or more persons for

profit. Partnership accounts for the next majority of business and they are typically larger than sole proprietorship. Finance, legal and real estate firms often have large number of partners.

Forms of Business Organization

Company Form• A company form of business is a legal entity,

separated from the owners, with perpetual succession.

• Just like an individual, the company can sue and be sued, make and be party to contracts and acquire property in its own name.

• The company form of organization is the dominant form of business organization in terms of receipts and profits.

Strengths and Weaknesses of the Common Forms of Business

Organizations

Strengths and Weaknesses of the Common Forms of Business

Organizations

Summary Financial Management is broadly concerned with the acquisition and use

of funds by a business firm. It has been traditionally argued that the objective of a company is to earn

profit. This means that the finance manager has to make decision in a manner that the profit is maximized.

The alternative to profit maximization is wealth maximization. This is also known as Value maximization or Net Present Worth maximization.

The important aspects of the finance function have to be carried on by the top management i.e., the Managing Director and the Board of Directors.

Finance is defined as the lifeblood of an organization. It is a common thread, which binds all the organizational functions as each function when carried out creates financial implications.

The three most common forms of business organization are sole proprietorship, partnership and the company.

In the area of financing, funds are procured from long-term sources as well as short-term sources.

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