Financial Management Overview PDF

Chapter 1 FINANCIAL MANAGEMENT : AN OVERVIEW Financial Management Financial management may be defined as planning for funds requirement and controlling the utilization. Financial management refers to the efficient and effective management of money (funds) in such a manner as to accomplish...

Chapter 1 FINANCIAL MANAGEMENT : AN OVERVIEW Financial Management Financial management may be defined as planning for funds requirement and controlling the utilization. Financial management refers to the efficient and effective management of money (funds) in such a manner as to accomplish the objectives of the organization. One needs money to make money. Finance is the life-blood of business and there must be a continuous flow of funds in and out of a business enterprise. Areas of Finance Personal finance Public finance Institutions and financial markets Corporate/Managerial finance THE FUNDAMENTAL PRINCIPLE OF FINANCE A business proposal-regardless of whether it is a new investment or acquisition of another company or a restructuring initiative –raises the value of the firm only if the present value of the future stream of net cash benefits expected from the proposal is greater than the initial cash outlay required to implement the proposal. Investors Investors provide the initial cash required The business proposal Shareholders to finance the business proposal Lenders The proposal generates cash returns to investors  Financial Decisions in a Firm ( Risk Return Trade off) Capital Budgeting Decisions Capital Structure Risk Decisions Market Value of Firm Working Capital Decisions Return Dividend Decisions  FINANCIAL DECISIONS IN A FIRM Capital Working Dividend Capital Budgeting Capital Decision Structure Management( (Investment (Finance (Maximizing Short term Decision) Decision) return) Finance) Financial Goals Shareholder’s Wealth Maximization Maximizing Earnings per Share Maximization of Return on Equity Profit maximization: It implies that a firm either produces maximum output for a given amount of input, or uses minimum input for producing a given output.  SHAREHOLDER ORIENTATION IN INDIA In the wake of liberalisation, globalisation, and institutionalisation of the capital market, there is a greater incentive to focus on creating value for shareholders. The following observations are clear indications. Dhirubai Ambani : In everything that we do, we have only one supreme goal, that is to maximize your wealth as India's largest investor family. Anand Mahindra : All of us are beginning to look at companies as owned by shareholders. The key is to raise shareholder returns Objections to Profit Maximization: ▪ Different stakeholders have different objectives that may conflict with each other. ▪ The manager of the firm has the difficult task of balancing and reconciling these conflicting objectives ▪ In the new business environment, profit maximization is regarded as Unrealistic, Difficult & Inappropriate ▪ It ignores Time value of money & risk involved ▪ It is Vague: The definition of the term ‘profit’ is ambiguous. Does it mean PAT or PBT? Does it mean long-term ?  Example: ▪ Company XYZ has 20,000 shares outstanding, profit after taxes of Rs. 80,000. Hence earnings per share is Rs. 4. ▪ If the company issues 20,000 additional shares at Rs. 50 per share and invests the proceeds (Rs. 10,00,000) at 5% after taxes, then the total profits would increase to Rs. 1,30,000. (80000 + 50000) (Profit is Maximized) Is it beneficial to the shareholders? ▪ No, as the earnings per share will fall to Rs. 3.25 (1,30,000/40,000) ▪ This clearly indicates that maximizing profits after taxes does not necessarily serve the best interests of owners. Agency Theory ▪ In various businesses the responsibility of management is entrusted to professional mangers who may have little or no equity stake in the firm. ▪ Thus, the ownership and management in such businesses lie in separate hands. ▪ The decision taking authority in a company lies in the hands of managers. ▪ Shareholders principals ▪ Managers agents ▪ Thus their exists a principal-agent relationship. ▪ The conflict between interests of shareholders and managers is referred to as agency problem. AGENCY PROBLEM While there are compelling reasons for separation of ownership and management, a separated structure leads to a possible conflict of interest between managers and shareholders. The lack of perfect alignment between the interests of managers and shareholders results in the agency problem. To mitigate the agency problem, effective monitoring has to be done and appropriate incentives have to be offered. Finance and Related Disciplines & Areas It draws heavily on related disciplines and fields of study, namely, economics, accounting, marketing, production and quantitative methods. Finance & Economics-Micro and Macro Economics (GDP growth rate, savings rate, fiscal deficit, interest rates, inflation rate, exchange rates, tax rates, and so on have an impact on the firm) Finance & Accounts (value maximizing, preparing the accounting reports , cash flows etc) Finance & Other managerial functions Organization of Finance Function Treasurer Controller Obtaining Finance Financial Accounting Banking Relationships Internal Auditing Cash Management Taxation Credit Administration Management accounting & Capital Budgeting Control Role of Financial Manager Raising of Allocation of Funds Funds Understanding Profit Planning Capital Markets Role of Financial Manager 1. Funds Raising: - The traditional approach dominated the scope of financial management and limited the role of the financial manager simply to funds raising. - It lacked a conceptual framework for making financial decisions, misplaced emphasis on raising of funds, and neglected the real issues relating to the allocation and management of funds. Episodic Financing: Financing at the time of some major events like mergers, consolidations, reorganizations, recapitalizations, etc. 2. Funds Allocation: - The new or modern approach to finance is an analytical way of looking into the financial problems of the firm. The financial manager is now concerned with the efficient allocation of funds. He has to answer the following questions: a) How large should an enterprise be, and how fast should it grow? b) In what form should it hold its assets? Role of Financial Manager 3. Profit Planning: - The functions of the financial manager may be broadened to include profit-planning function. - It refers to the operating decisions in the areas of pricing, costs & volume of output. 4. Understanding Capital Markets: - Capital markets bring investors(lenders) and firms (borrowers) together. - He or she should fully understand the operations of the capital markets and the way in which the capital markets value securities. - For example: If a firm uses excessive debt to finance its growth, investors may perceive it as risky. The value of the firm’s share may therefore decline. - Similarly investors may not like the decision of a highly profitable, growing firm to distribute dividend. They may like to reinvest the profits in attractive opportunities. EMERGING ROLE OF THE FINANCIAL MANAGER IN INDIA The job of the financial manager in India has become more important, complex and demanding due to the following factors: Liberalisation Globalisation Technological developments Volatile financial prices Economic uncertainty Tax law changes Ethical concerns over financial dealings Shareholder activism CHALLENGES OF THE FINANCIAL MANAGER IN INDIA The key challenges for the financial manager appear to be in the following areas: Investment planning and resource allocation Financial structure Mergers, acquisitions, and restructuring Working capital management Performance management Risk management Corporate governance Investor relations