introduction to financial management

Understanding Financial Management

Financial management is an integrated decision making process, concerned with acquiring, managing and financing assets to accomplish overall goals within a business entity.

Speaking differently, it is concerned with making decisions relating to investments in long term assets, working capital, financing of assets and so on.

What is Financial Management?

Financial management capacity is a cornerstone of organizational excellence.

Financial management pervades the whole organization as management decisions almost always have financial implications.

Meaning of Financial Management

Financial management entails planning for the future of a person or a business enterprise to ensure a positive cash flow, including the administration and maintenance of financial assets.

The primary concern of financial management is the assessment rather than the techniques of financial quantification.

Some experts refer to financial management as the science of money management.

Components of Financial Management

The five basic components of the Financial Management Framework are:

Planning and Analysis Asset and Liability Management Reporting Transaction Processing Control

Importance of Financial Management

Financial management is concerned with procurement and utilization of funds in a proper way. It is important because of the following advantages:

1. Helps in obtaining sufficient funds at a minimum cost.

2. Ensures effective utilization of funds.

3. Tries to generate sufficient profits to finance expansion and modernization of the enterprise and secure stable growth.

4. Ensures safety of funds through creation of reserves, re-investment of profits, etc.

Finance function

The finance function relates to three major decisions which the finance manager has to take:

Investment decisions

Finance decisions

Dividend decisions

Investment Decision

The investment decision relates to the selection of assets in which funds will be invested by a firm.The assets which can be acquired fall into two broad categories Long term assets (which yield return over a period over a time in future.) Capital Budgeting.Short term or current assets (convertible into cash usually within one year.) Working Capital Management.

Capital BudgetingCapital budgeting refers to selection of an asset or investment proposal or course of action whose benefits are likely to be available in future over the lifetime of the project. The main elements of capital budgeting are:Choice of the new assets out of the alternatives available or relocation of the capital when an existing asset fails to justify the funds committed.Capital budgeting decision is the analysis of risk and uncertainty.The concept and measurement of cost of capital.Most important & critical

Working Capital Management WCM is concerned with the management of current assets & current liabilities. The key strategies and considerations in ensuring a trade-off between profitability and liquidity is one of the major dimensions of WCM. The management of working capital has two basic ingredients An overview of working capital management as a wholeEfficient management of the individual current assets & liabilities such as cash, receivables, payables and inventory.

The Financing DecisionThe investment decision is broadly concerned with the assetsmix or the composition of the assets of the firm. The two aspects of financing decision are :The capital structure theory The capital structure decision A capital structure with a reasonable proportion of debt and equity capital is called the Optimal Capital Structure.

The Dividend DecisionThe dividend should be analyzed in relation to the financing decision of the firm. Two alternatives are available in dealing with the profits of a firm:They can be distributed to the shareholders in the form of the dividends They can be retained in the business itself.The decision as to which course should be followed depends largely on the significant dividend decision, the dividend pay out ratio, i.e. what proportion of net profits should be paid out to the shareholders.

OBJECTIVES OF FINANCIAL MANAGEMENT The objective provide a framework for optimum financial decision making. They are concerned with designing a method of operating the internal investment and financing of a firm.There are two widely discussed approaches under this, these are:Profit MaximisationWealth Maximisation

Profit MaximisationProfit /EPS maximisation should be undertaken and those that decrease profits or EPS are to be avoided. Profit is the test of economic efficiency. It leads to efficient allocation of resources, as resources tend to be directed to uses which in terms of profitability are the most desirable. Financial management is mainly concerned with the efficient economic resources namely capital. The main technical flaws of this criteria are :AmbiguityTiming of benefitsQuality of benefits.

Wealth Maximisation

Wealth maximisation is also known as Value or Net present worth maximisation. Its operational features satisfy all the three requirements of the operational of the financial course of action namely, exactness, quality of benefits, and the time value of money. Two important issues related to the value/share price maximisation are: Focus on stakeholders ,stakeholders include groups such as employees, customers, suppliers, creditors, owners and others who have a direct link to the firm. EVA (Economic Value Added) EVA is equal to the after-tax operating profits of a firm less the cost of the firm to finance investments.

Financial Management levels

Broadly speaking, the process of financial management takes place at two levels:At the individual level, financial management involves tailoring expenses according to the financial resources of an individual. From an organizational point of view, the process of financial management is associated with financial planning and financial control.

At the corporate level, the main aim of the process of managing finances is to achieve the various goals a company sets at a given point of time.

Changing Role of Finance ManagerRole of finance managers has increased tremendously and their tasks have become complicated following globalisation of business & increased competitionCritical responsibilitiesDesigning and fine-tuning a more responsive "Rolling Forecast" budgeting process. Breeding new economy businesses from within and releasing value through M&As, planning, negotiating and overseeing strategic alliances. Focus of finance shifts increasingly to create intangible assets rather than achieving accounting goals. Dramatic changes in resource allocation. Dynamically balancing investments between old and new economy ventures essential to fuelling growth and shareholder value.

Changing Role of Finance ManagerFinance manager is actively involved in anticipating industry trends, launching new ventures, valuing intangible assets, and managing business options far more dynamic.

The fortification of finance is the driver of change. From safeguarding the assets of the company to being answerable to investors, finance is the voice of organisation.

Functions of financial manager are:

Financial ForecastingInvestment decisionsManaging corporate asset structureThe management of incomeManagement of cashDeciding about new sources of financeTo contact and carry negotiations for new financingAnalysis and appraisal of financial performanceAdvising the top management

Incidental functions:

They are performed by low level assistants like accountants, account assistants etc. They include: Record keeping and reportingPreparation of various financial statementsCash planning and its supervisionCredit managementCustody and safeguarding different financial securities etc. Providing top management with information on current and prospective financial conditions of the business.

Interface of Financial Management with other functional areasFinancial management is an integral part of overall management and not merely a staff function. Finance influence the operations of other crucial functional areas of the firm such as production, marketing and human resources.Marketing-Finance Interface There are many decisions, which the Marketing Manager takes which have a significant financial implications. For example: 1)He should have a clear understanding of the impact the credit on the profits of the company.2)Weigh the benefits of keeping a large inventory of finished goods in anticipation of sales against the costs of maintaining that inventory.3) Other key decisions of the Marketing Manager, which have financial implications, are: Pricing, Product promotion and advertisement, Choice of product mix, Distribution policy & so on.

Interface of Financial Management with other functional areasProduction-Finance Interface In any manufacturing firm, the Production Manager controls a major part of the investment in the form of equipment, materials and men. He should so organize that the equipments are used most productively, the inventory of work-in-process or unfinished goods and stores and spares is optimized and the idle time and work stoppages are minimized.Production manager can hold the cost of the output under control and thereby help in maximizing profits. Similarly, he would have to make decisions regarding make or buy, buy or lease etc. for which he has to evaluate the financial implications before arriving at a decision.

Interface of Financial Management with other functional areasTop Management-Finance Interface Strategic planning and management control are two important functions of the top management. Finance function provides the basic inputs needed for undertaking these activities.

Human resource Finance interfaceHuman resource planning Cost to company calculation

INDIAN FINANCIAL SYSTEMEconomic growth and development of any country depends upon a well-knit financial system.Financial system comprises a set of sub-systems of financial institutions, financial markets, financial instruments and services which help in the formation of capital. Economic growth of the country happens by mobilizing surplus funds and utilizing them effectively for productive purpose. It provides a mechanism by which savings are transformed into investments

Financial institutions are the intermediaries who facilitates smooth functioning of the financial system by making investors and borrowers meet. They act as middlemen between savers and borrowers.They mobilize savings of the surplus units and allocate them in productive activities promising a better rate of return. Financial institutions also provide services to entities seeking advises 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 elsewhere.Financial institutions may be of Banking or Non-Banking institutions.

Financial institutions

Finance is a prerequisite for modern business and financial institutions play a vital role in economic system. It's through financial markets the financial system of an economy works.It a market where financial products, financial services and financial securities are traded.

The main functions of financial markets are:1. To facilitate creation and allocation of credit and liquidity;2. To serve as intermediaries for mobilization of savings;3. To assist process of balanced economic growth;4. To provide financial convenience

Financial Markets

Financial MarketsClassified into Money Market & Capital MarketMoney Market: Money Market basically deals with short term financial assets, which are close substitute to money. Functions of Money Market:Money Market ensures the development of trade and industry.It helps the development of capital market.It helps in smooth functioning of commercial banks. Capital Market: Capital market is the market for long term debt instruments and equity instruments. Capital market consists of Primary market and Secondary market

Financial InstrumentsAnother important constituent of financial system is financial instruments. They represent a claim against the future income and wealth of others. It will be a claim against a person or institutions, for the payment of the some of the money at a specified future date.

Financial Services:Efficiency of emerging financial system largely depends upon the quality and variety of financial services provided by financial intermediaries. The term financial services can be defined as "activites, benefits and satisfaction connected with sale of money that offers to users and customers, financial related value".

Primary MarketIt is a Market where securities offered to the public for the first time so also called as new issue market. In other words Market which deals with rising of fresh capital by companies through issue of securities like shares and debentures.In this market, the flow of funds is from savers(households) to borrowers (industries), hence, it helps directly in the capital formation of the country.Features of primary market are:It Is Related With New IssuesIt Has No Particular PlacePrimary markets are used by companies for the purpose of setting up new ventures/ business or for expanding or modernizing the existing business Basis for secondary marketVarious Methods Of Floating Capital are: i) Public issue, ii) Private Placement, iv) Right Issue v) offer for sale.

Public issueWhen a company raises funds by selling (issuing) its shares (or debenture / bonds) to the public through issue of offer document (prospectus), it is called a public issue.

1)Initial Public Offer: : When a (unlisted) company makes a public issue for the first time and gets its shares listed on stock exchange, the public issue is called as initial public offer (IPO).

2)Further public offer: When a listed company makes another public issue to raise capital, it is called further public / follow-on offer (FPO).

Offer for sale

Institutional investors like venture funds, private equity funds etc., invest in unlisted company when it is very small or at an early stage. Subsequently,when the company becomes large, these investors sell their shares to the public, through issue of offer document and the companys shares are listed in stockexchange. This is called as offer for sale.

The proceeds of this issue go the existing investors and not to the company.

Issue of Indian Depository Receipts (IDR):

A foreign company which is listed in stock exchange abroad can raise money from Indian investors by selling (issuing)shares. These shares are held in trust by a foreign custodian bank against which a domestic custodian bank issues an instrument called Indian depository receipts (IDR).

IDR can be traded in stock exchange like any other sharesand the holder is entitled to rights of ownership including receiving dividend.

Rights issue (RI):When a company raises funds from its existing shareholders by selling (issuing) them new shares / debentures, it is called asrights issue.The offer document for a rights issue is called as the Letter of Offer and the issue is kept open for 30-60 days. Existing shareholders are entitled to apply for new shares in proportion to the number of shares already held.For e..g. in a rights issue of 1:5 ratio, the investors have the right to subscribe to one (new) share of the company for every 5 shares held by the investor.Bonus Issue: The company issues new shares to its existing shareholders.As the new shares are issued out of the companys reserves (accumulated profits), shareholders need not pay any money to the company for receiving the new shares.For e..g. In a bonus issue of 5:1 ratio, the investor will receive five new shares of the company for each share the investor held

Private Placement

The private placement involves issue of securities, debt or equity, to selected subscribers, such as banks, FIs, MFs and high net worth individuals. It is arranged through a merchant/investment banker, who acts as an agent of the issuer and brings together the issuer and the investor(s). Since these securities are allotted to a few sophisticated and experienced investors the stringent public disclosure regulations and registration requirements are relaxed. Private placement has following advantageTime effectiveCost effectiveStructure effectiveAccess effective

Pricing of public issuepublic issues on the basis of pricing,can be classified into Book Built issues and Fixed Price issues. Book Building issueThe issuer company mentions the minimum and maximum price (price band) at which it will sell (issue) its shares.Thus the offer document (in this case, called theRed Herring Prospectus) contains only the price band instead of the price at which its shares are offered to the public. Within this price band the investor can choose the price at which the investor are willing to buy the shares and also the quantity. As this process is similar to bidding in an auction, the application form for book built issue is also known as the bid form.

Pricing of public issueBids by various investors are entered into the stock exchange system through the brokers (also called syndicate member ) terminal. The list of the bid received from investors at various price bands is known as the book and can be seen in the website(s) of the stock exchange for each investor category.Based on the total demand in the book, the cut off price is then decided by the issuer and merchant banker. The cut off price is the price at which the cumulative demand for shares, equals or exceeds the offer size is estimated. All investors who applied (bid) for shares at or above the cut off price will be allotted shares at the cut off price (issue price), proportionately.

Fixed price IssueIn this method the price will be fixed by the company for its securities before issue is brought to the market.The price at which the securities are offered/allotted is known in advance to the investor.Demand for the securities offered is known only after the closure of the issue.Payment is made at the time of subscription whereas refund is given after allotment.

Green Shoe optionIt denotes an option of allocating shares in excess of the shares included in the public issue. SEBI guidelines allow the issuing company to accept over subscriptions, subject to a ceiling, say 15% of the offer made to public.It is extensively used in international IPOs to stabilized the post-listing price of new issued shares.

Secondary MarketSecondary market is a market where securities which are already issued in private or public offering are traded. Alternatively, secondary market can refer to the market for any kind of used goods also referred has the aftermarket. In the secondary market, securities are sold by and transferred from one investor or speculator to another. It is therefore important that the secondary market be highly liquid and transparent.Before electronic means of communications, the only way to create this liquidity was for investors and speculators to meet at a fixed place regularly. This is how stock exchanges originated.

Features of Secondary MarketIt Creates LiquidityIt Comes After Primary MarketIt Has A Particular PlaceIt Encourage New InvestmentsAids in financing the industryEnsures safe & fair Dealing

Advantages and Disadvantages of secondary market

Advantages

Secondary markets offer advantages to both sellers and buyers. Sellers gain the advantage of effectively reducing the purchase price of products and investments by recouping a portion of what they originally paid.

Disadvantages

If secondary markets grow too large, they can eat into original sellers' sales and profit margins. Especially in the case of long-lasting goods such as automobiles and musical instruments, secondary markets can encourage a large percentage of shoppers to purchase used items rather than purchasing new.

Different between primary market and secondary market

Inprimary markets, securities are bought by way of public issue directly from the company.New issue are available in primary market.The primary is a middlemen.New issue of common stock;bonds and preferred stock are sold by companies.InSecondary marketshare are traded between two investors.Securities usually bought and sold through the secondary market.The secondary market are broker and dealer.The secondary market stock and bonds issues are sold to the public.

primary marketsecondary market

Types of financial Markets

Capital marketCapital market is a market where buyers and sellers engage in trade of financial securities like bonds, stocks, etc. The buying/selling is undertaken by participants such as individuals and institutions.

Stock market: The market in which shares of publicly held companies are issued and traded either through exchanges or over-the-counter markets.Also known as the equity market.The stock market makes it possible to grow small initial sums of money into large ones without doing business.

Capital MarketDedt Market : It is market where the issuance and trading of debt securities occurs. The bond market primarily includes government-issued securities and corporate debt securities.Most trading in the bond market occurs over-the-counter, through organized electronic trading networks, and is composed of the primary market and the secondary market.

Commodity marketCommodity market is a place where trading in commodities takes place. These are the markets where raw and primary products are exchanged. 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.)The two most important commodity exchanges in India areMulti-Commodity Exchange of India Limited (MCX),National Multi-Commodity & Derivatives Exchange of India Limited (NCDEX)

Foreign exchange(FOREX) MarketThe market in which participants are able to buy, sell, exchange and speculate on currencies. Foreign exchange is the mechanism by which the currency of one country gets converted into the currency of another country. The forex markets is made up of banks, commercial companies, central banks, investment management firms, hedge funds, and retail forex brokers and investors. The currency market is considered to be the largest financial market in the world, processing trillions of dollars worth of transactions each day.

Thank you

Presented by: Prof lokesh K N