Financial Management: Definitions & Functions

• Financial management is a managerial activity concerned with planning and controlling a firm's financial resources.

Definitions of Financial Management:

• Howard and Uptron: Financial management is applying general managerial principles to financial decision-making.
• Weston and Brighem: Financial management is an area of financial decision-making that harmonizes individual motives and enterprise goals.
• Solomon Ezra & J. John Pringle: Financial management is concerned with the efficient use of capital funds.
• J.L. Massie: Financial management is the operational activity responsible for obtaining and utilizing funds effectively for efficient business operations.

Wealth Maximization in Financial Management:

• Financial Management aims to maximize shareholder wealth by maximizing the firm's value
• This is reflected in Earnings Per Share (EPS) and the market price of its shares.

Functions of Financial Management:

• Financial management functions are broadly categorized into:
  • Investment decisions
  • Financing decisions
  • Dividend decisions

Investment Decisions:

• Investment decisions involve selecting assets for investment, including both long-term (fixed) and short-term (current) assets.
• Long-term investment decisions are known as capital budgeting.
• Short-term investment decisions are referred to as working capital management.

Financing Decisions:

• Financing decisions involve determining the capital mix or capital structure of a firm i.e. the proportion of debt and equity capital.
• Financing decisions consider the cost of capital, risk, and return to shareholders.

Dividend Decisions:

• Dividend decisions involve determining the distribution of profits to shareholders, including the dividend pay-out ratio.
• These decisions depend on shareholder preferences, investment opportunities within the firm, and opportunities for future expansion.

Sources of Finance:

• Sources of finance for businesses include:
  • Equity
  • Debt
  • Debentures
  • Retained earnings
  • Term loans
  • Working capital loans
  • Letters of credit
  • Euro issues
  • Venture funding.

Bonds:

• Bonds are issued by organizations to raise money by borrowing, generally for periods longer than one year.
• A bond represents a form of debt where investors pay the issuers, and the terms are defined for a specific timeframe.

Types of Bonds:

• Plain Vanilla Bond: It is a bond with standard features, a fixed coupon, a defined maturity, and is usually issued and redeemed at face value, also known as a straight or bullet bond.
• Zero Coupon Bond: The bonds do not have periodic interest payments, and it is issued at a discount and repaid at face value upon maturity.
• Deep Discount Bond: Type of zero-interest bond offered for sale at a discounted value, and is redeemed at face value on maturity.
• Perpetual Bond: These bonds pay a coupon rate on face value until the company's life and those with maturity above 100 years also can be considered perpetual.

Debentures:

• Debenture is an acknowledgment of debt taken by an organization from the public, used by companies and governments based on reputation, with a fixed interest rate.

Convertible Debentures:

• Convertible debentures can be converted into equity shares after a period
• Non-convertible debentures cannot be converted into equity shares.

Redeemable Debentures:

• Redeemable debentures have a specific redemption date, with the company legally bound to repay the principal.
• Irredeemable debentures, also called perpetual debentures, do not have a redemption date.

Pari-Passu Debentures:

• Pari-passu means equal in all respects.
• Debentures with a pari pasu clause ensure that debenture holders receive repayment on a pro rata basis if the company has insufficient funds or assets.

Equity Shares:

• Equity shares are a firm's primary source of finance, issued to the public, and do not have preferential rights for capital or dividend repayment.
• Equity shareholders are owners of the company with rights to residual income and control over business affairs.

Preference Shares:

• Preference shares are preferred over equity shares for surplus or dividend payments, and preference shareholders are paid first if the company decides to pay dividends.
• Owners of preference shares get a fixed dividend.
• In liquidation, they are paid after bondholders and creditors, but before equity holders.

Cumulative Preference Shares:

• A cumulative preference share accumulates arrears of dividends, which must be paid before any dividend to equity shareholders
• Example: Dividends for 2017 and 2018 have not been paid;the directors must prioritize arrears dividends for 2017 and 2018 before paying equity shareholders for 2019.

Participating Preference Shares:

• They are entitled to a fixed rate for dividend, to participate in the balance of profits with equity shareholders after they get a fixed rate of dividend.

Leasing:

• Leasing defines a right to use equipment or capital goods on payment of periodical amount.
• Lessor: Actual owner of equipment permitting use to the other party on payment of periodical amount.
• Lessee: Party who acquires the right to use the equipment on payment of periodical amount.

Operating Lease:

• Primary lease period is short, and the lessor can't realize the equipment and other incidental charges' full cost.
• Computers and other office equipment generally form subject matter of many operating lease agreements.

Financial Lease:

• A financial lease agreement has a long-term nature, which is generally the full economic life of the leased asset.
• Financial lease involves the act of transferring almost all the risks incidental to ownership and benefits arising therefrom.

Sales and Lease Back Leasing:

• An asset that exists is sold to the lessor for cash, this enables for the asset to be acquired for use under financial lease agreement from the lessor.
• Lessee continues to make economic use of assets against payment of lease rentals while ownership vests with the lessor.

Leveraged Lease:

• A leveraged lease is an agreement where the lessor finances the lease by taking a loan from a lender.
• The party leasing the asset pays the lessor monthly, and lessor remits the payments to the financing company.
• This allows the lessor to provide a lease and profit even if the individual leasing the asset does not have the income to obtain the lease outright.

Break Even Lease Rental (BELR):

• Break-Even Lease Rental can be from both point of views i.e. from lessee's view as well as lessor's point of view.
• Break Even Lease Rental (BELR) from Lessee's point of view - Rental at which the Lessee is indifferent between borrowing and buying option and lease financing option and the Net Advantage of Leasing (NAL) will be zero.
• Break Even Lease Rental (BELR) from Lessor's point of View - Minimum (floor) lease rental, which he should accept and also NAL should be zero.

Financial Planning:

• Financial planning analyzes financial flows, forecasts investment, financing, and dividend decision consequences, and weighs alternative effects.

Watered Capital:

• Watered Capital is where all the excess of total capitalisation is over the long term assets of the company.
• Simply speaking 'water' is in the capital when a part is not represented by assets.
• Watered capital shows when a company pays more for the assets or when there is no adequate consideration in the form of assets in not received for securities issue.

Optimal Capital Structure:

• Financial managers have to establish an optimum capital structure and make a maximum rate of return on investment.
• He has to think of the operating and financial leverages of his firm.
• Operational leverage is from operating expenses, while financial leverage exists because of debt in a firm's capital structure.

Equity Share Capital:

• Equity shares shows ownership of the company ,and has no maturity
• It is a permanent source of funding, Equity dividends are paid to the shareholders out of after-tax profits
• Equity share capital does not contain any mandatory payments to shareholders

Preference Share Capital:

• Also is owners capital but has a maturity period
• In India, the preference shares are redeemed in 20 years from issue date.
• Divided payable on preference shares is fixed

Debentures (as a source of capital):

• Debenture shows basic debt instrument that they may issue from borrowing company where they promise to pay interest at a specific ammount
• It specifys the repayment for the borrowed product, at any speficed time.

Theories of Capital Structure:

• Equity and debt capital are the two major long term funds for a firm.
• These structures will suggest the proportion of debt capital
• This structure are based on retention ratio is nil.

Net Income Approach in Capital structure theories:

• David Durand suggested that, there is any relationship between the Capital Structure and value of the firm as, firms may increase its total value
• It believes that Cost of Debt (kd) is less then cost of Equity (Ke) , weighted average cost of capital decreases, this leads firms to increase and expand.

Net Operating Income (NOI) Approach in capital structures:

• David Durand suggest under NOI, is firms total value has no value
• Under this approach the Ko that is constant and constant irrespective of leverage, segregation of debt has no value

Traditional Approach to Capital Strucutres:

• It explaains there has to certain debt-equity mixes to cause the market value, it can result the cost od capital to decline so that it can improve the value.
• But if there is debt , it decreases market value

Modigliani Miller in Capital Structure(MM):

• MM says the taxes/capital has no correlation and doesnt affect capital structure
• M-M has 2 prositions such as overall capital cost which is independent in independent strcuture. The total is expected capitalized
• Proposition I can explain as V=C+D .

Arbitrage Process in capital structure:

• According to M-M two firms are identical in capital , and cant have different cost of investment or capial.
• Where market values are mixed there arbitrage processes must find the solution for what that the time taken on invesmtent.

Leverage:

• Leverage originally related to science, it represents financial variable to change.
• Under Operating Leverage operating leverage can magnify effect on sales and EBIT, were higher the propotion higher the degree.

Cost of Debt:

• Debt can be both perpetual and redeamable debts
• Its compuation that it may issued through Premium or discount

Weighted Average cost of Capital:

• It is the average which shows the sources of finance, whether a firm is having an higher expense or loss
• It can be used where sources of finance are low and weights are in the total

Indifference points:

• points show on which both EPS and the EBIT are balanced in both firms with financial risk
• According to Van HOme Indifference means that EBIT and EPS must be the same even where has high debt or bad debt

Financial Planning:

• refers point to level on sales so that finance can be broken in terms of interest or taxed
• It refers to level that any type of finance can satisafy for example; satisafaction means EBIT should reuslt from level or at least zero.

Rule of 72

• It is the rule whether whether an invesmtent takes to doubke, where they rate must also be fixed to get a rough idea of invesmtent
• Foir examole; 5% rate of dividend it will make value of 14.4 years.

Discounted

• to decide proper time for business is that the projects shoul dbe divided properly. It
• Then we divide them using cash inflows.

###Working capital:

• refers to circulating in operations in business, that it covers liabilities
• That working caputal has it to be used or referred

Net Working Capital:

• It all total the current circilations from the business asset
• It measures liabilities

Profitability Index:

• It is the ratio shown cash to present value and then it determines what should be projected
• it helps show the value of rupees per rupee, or inital value..

Maximum Permissible Banking Finanace.

• Its Tandem commitee has suggestes to determine if this finances banks
• The borrowing method must minimum of 25%, if this gap is met it can be used term for borrowing .

Impact of Overtrading on What are the workings in Capital

• Overrtading is situation wehre businesses expand beyond finance and are not available
• Such type of situations may lead liquid pressure may impact creditors

Impact of Over Caplization

• Due to under/under insufucuant funds it can be hard or tough, finance mamages takes steps to capitalization.

Conservatice

• Firstly , conservative financing that leads to short terms.

###Economic Ordering Quantity

• The most importaint quantity that is a point, cost must meet up through the order

Maximum Stock:

• The maximum above that the stock will be exceeded.

Minimum Stock :

• The minmin level is that the below stock should be fall

ABC Analysis

• Its a method wehre contorll can go according to basic principle whether contorls may be close for what was lost.

###HSNL CLASIFICATION

• Its ABC Analysis, where they may cosider value, they show how material is classfied.

Baumol Modal

• BAUMOL helps to decide the finance. There are both cash and management proejcts.

###Divedined

• Shows profits of the shareholders and all what investos are looking for as what rewards are provided

Relevance consept

• They share a school of thoguht, where dividends affect value.

###Walter MOdal

• Shows One of the earliest indicators that choose.

Internatioan fisher effect

• This theory has interest of finance and then they see where or when interest rate gets changed ,it is most closely realted to POwer parity .

###Economic Risk

• Its a transfer risk mainly on focuses.