Transcript Nature and Scope of Financial Management

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Finance is the set of activities dealing with the management of
funds
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Finance is also the science and art of determining if the funds of
an organization are being used properly
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Finance studies and addresses the ways in which individuals,
businesses, and organizations raise, allocate and use monetary
resources over time, taking into account the risks entailed in their
projects
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Public finance (Government Finance)
Public finance means collection of money through taxes
or other sources and management of revenue and
expenditure by the government
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Corporate finance (Business Finance)
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Personal finance
Involve paying for education, financing durable goods,
buying insurance, investing and saving for retirement
etc.
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Marketing & Sales
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Production & Operations
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Finance
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Corporate Finance refers to any decisions made by a
firm that will have an impact on its financial position.
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These decisions may be from production, marketing or
any other department and are assumed to have a
strategic impact.
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These decisions are:
◦ Investment Decisions
◦ Financing Decisions
◦ Dividend Decisions
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Aditya Birla Group to invest $ 500 mn in Turkey
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NTPC Ltd to invest Rs 18,346 crore in 2 projects
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Groupe SEB buys 55% in Maharaja Whiteline
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Srei Equipment Finance, a unit of SREI Infrastructure
Finance is planning to raise Rs 700 million rupees via
5-year 7-month bonds at 12.60 percent
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Goodwill Hospital and Research Centre, a multi speciality
hospital in Noida under the name " Ojjus Medicare", is
entering the capital market to raise Rs 62 crore with its initial
public offer on December 30, 2011
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Liquor maker United Spirits said late on Wednesday its board
approved raising up to $225 million via foreign currency
convertible bonds ( FCCBs) to cut high cost debt and help
improve earnings.
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Nestlé India Ltd has declared second interim dividend of Rs.
27.00 per equity share for the year 2011
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The financial management is generally concerned with
procurement, allocation and control of financial resources of a
concern. The objectives can beTo ensure regular and adequate supply of funds to the concern.
To ensure adequate returns to the shareholders which will depend
upon the earning capacity, market price of the share, expectations
of the shareholders.
To ensure optimum funds utilization. Once the funds are
procured, they should be utilized in maximum possible way at
least cost.
To ensure safety on investment, i.e. funds should be invested in
safe ventures so that adequate rate of return can be achieved.
To plan a sound capital structure-There should be sound and fair
composition of capital so that a balance is maintained between
debt and equity capital.
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The scope of financial management can be broken down into
three major decisions as functions of finance:
◦ What long-term investments should the firm take on?
◦ Where will we get the long-term financing to pay for the
investment?
◦ How will we manage the everyday financial activities of the
firm?
(1) Investment Decision
 Capital budgeting
What long-term investments or projects should the
business take on?
Main elements:
◦ Long term assets and their composition
◦ Risk
◦ The concept and measurement of the cost of capital
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Magnitude of cash flows, timing and riskiness of the
cash flows are crucial to consider
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They influence the firm’s growth in the long run
They affect the risk of the firm
They involve the commitment of large amount of funds
They are irreversible, or reversible at substantial loss
They are among the most difficult decisions to make
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Working capital management
◦ How do we manage the day-to-day finances of the
firm?
Trade-off between profitability and liquidity
Overall Working Capital management
Efficient management of the individual current assets
(2) Financing Decision
 Capital structure
◦ How should we pay for our assets?
◦ Should we use debt or equity?
Capital Structure theory
Capital Structure decision
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(3) Dividend Policy Decision
How to deal with the profits of a firm?
How much profits should be distributed to the
shareholders and how much to retain in the business?
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What a firm should attempt to achieve with its investments,
financing and dividend policy decisions
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Profit maximization (profit after tax)
Maximizing earnings per share
Wealth maximization
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But WHOSE WEALTH?
The real reason behind failure in defining the proper objective is
the conflict between stakeholders of the firm.
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Stockholders or Owners
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Bondholders or Lenders
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Employees
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Financial Markets
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Society
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Maximizing the rupee income of firm
Resources are efficiently utilized
Appropriate measure of firm performance
Serves interest of society also
Objections to Profit Maximization
It is Vague
It Ignores the Timing of Returns
It Ignores Risk
In new business environment profit maximization is regarded as
Unrealistic
Difficult
Inappropriate
Immoral
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Maximising PAT or EPS does not maximise the economic
welfare of the owners.
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Ignores timing and risk of the expected benefit
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Market value is not a function of EPS.
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Maximizing EPS implies that the firm should make no
dividend payment so long as funds can be invested at
positive rate of return—such a policy may not always
work.
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Maximizes the net present value of a course of action to
shareholders.
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Accounts for the timing and risk of the expected benefits.
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Benefits are measured in terms of cash flows.
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Fundamental objective—maximize the market
value of the firm’s shares.
CRITIQUE AND DEFENCE OF SHAREHOLDER WEALTH MAXIMISATION GOAL
Critique
• The capital market sceptics
argue that stock prices fail
to reflect true values
Defence
• Financial economists argue
that stock prices are the
least biased estimates of
intrinsic values in developed
markets
• The balancers argue that a
firm should seek to
‘balance’ the interests of
various stakeholders
• Balancing the interests of
various stakeholders is not
a practical governing
objective
• Advocates of social
responsibility argue that a
business firm must assume
wider social responsibilities
• The only social
responsibility of business
is to create value and do so
legally and with integrity
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In your own words, explain the role and importance of
financial management to a manufacturer whose
objective is to improve quality
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to make sure there are sufficient funds for the organisation to
buy all the resources it needs to achieve its objectives i.e.
appropriate quality of raw materials, correctly trained staff,
well maintained machinery
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to make sure there is enough money to recruit and train
appropriately skilled staff to satisfy the objective of improving
quality.
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to make sure that all the costs/expenses are under control
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to make sure that the organisation is performing profitably and
efficiently without compromising quality
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to reduce costs of raw materials by ensuring the best value for
money from suppliers.
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Estimation of capital requirements
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Determination of capital composition
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Choice of sources of funds
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Investment of funds
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Disposal of surplus
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Management of cash
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Financial controls
Stockholders
Hire/Fire &
Control Managers
Maximize Stockholder’s
Wealth
Lend Money
Bondholders
Managers taking
Financial Decisions
Provide Debt Service &
Protect their Interests
Trace Economic Cost
& Returns
Society
No Negative
Social Impact
Real & True
Information
Financial Markets
Market Price
= True Value
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The Agency Theory was first introduced by Jensen and Meckling
in 1976.
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This theory explains how the conflict between various
stakeholders can result in sub-optimal allocation of resources.
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Agency relationship exists when one party (the principal) hires
another party (the agency) to perform some services and in doing
so, delegates DM (Decision Making) authority to the agent.
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Shareholders are principal and CEO is the agent; if CEO is
principal then managers are agents.
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Divergent Objectives
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Non-observability of Agent’s Actions
Stockholders
Have Little Control
Maximize Managers Interest at
Stockholder’s Expense
Lend Money
Cannot Trace Cost
Bondholders
Exploitation by Owners &
Default in Payments
Managers taking
Financial Decisions
Society
Negative
Social Impact
Delayed &
Misleading Information
Financial Markets
Market Price
≠ True Value
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Agency costs include the less than optimum share value
for shareholders and costs incurred by them to monitor
the actions of managers and control their behaviour.
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Managerial compensation
◦ Attractive monetary and non monetary incentives
◦ Incentives can be used to align management and stockholder
interests
◦ Close monitoring by stakeholders, board of directors and
outside analysis
◦ The threat of firing
◦ The threat of takeover
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Stockholders
Control by Incentive
& Other Systems
Maximize Stockholder’s
Wealth
Lend Money
Laws & Regulations
Bondholders
Managers taking
Financial Decisions
Put Stringent Covenants
To Safeguard interests
Information from
Various Sources
& Legal Remedies
Financial Markets
Society
Negative Social
Impact Reduced
Market Price
≈ True Value
The importance of the finance function depends on the size of the
firm. Financial management is an integral part of the overall
management of the firm. In small firms, the finance functions are
generally performed by the accounting departments. In large
firms, there is a separate department of finance headed by a
specialist known by different designations such as vice-president,
director of finance, chief finance officer and so on.
Board of Directors
Managing Director/Chairman
Vice-President/Director (Finance)/Chief Finance Officer (CFO)
Controller
Treasurer
Financial
planning and
fund-raising
manager
Capital
expenditure
manager
Cash
Manager
Credit
Manager
Foreign
exchange
manager
Pension
fund
manager
Tax
manager
Corporate
accounting
manager
Organization of Financial Management Function
Cost
accounting
manager
Financial
accounting
manager
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
http://business.gov.in/starting_business/loc
ation_industry.php
http://www.scribd.com/doc/40015911/Form
s-of-Business-Organization-Indian-Context
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Key macro-economic factors like the growth
rate of the economy, the domestic savings
rate, the role of the government in economic
affairs, the tax environment, the nature of
external economic relationships, the
availability of funds to the corporate sector,
the rate of inflation, the real rate of interests,
and the terms on which the firm can raise
finances define the environment in which the
firm operates. No finance manager can afford
to ignore the key developments in the macro
economic sphere and the impact of the same
on the firm.
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Growth
Control of inflation
Full employment
External balance (or Balance of payments)