financial management

1. Financial Management: Introduction
M S Narasimhan
Indian Institute of Management Bangalore
msn@iimb.ac.in

2. Issues at Macro Level
• Savings and Investments determines economic growth
• Savings and Investments take place in different segments of
the economy
• Market is required to connect these two segments of the
economy
• Markets for Capital consist of
– Money Market : Short-term capital is raised
– Capital Market : Long-term capital is raised
• Financial Managers are interested with the developments of
these markets as they are dealing with these markets
constantly for capital.

3. Issues at Micro Level
• Business Units need endless variety of real assets, which
includes tangible and intangible assets
• Money is required to buy real assets
• Companies sell pieces of papers called financial assets,
which include shares, bonds, bank loans, lease, etc.
• Shares, Bonds, ..., are sold to large number of investors
whereas loans, lease are negotiated with a few FIs
• Financial Managers assess capital requirement for real
assets and create financial products, price them and
sells to investors and banks

4. Role of Finance Function
Capital
Corporate Market Investors
Primary/Secondary Institutions
Functional Finance
Managers Function/ Investors
Managers

5. Key Issues in Finance Function
• Acquiring capital at the least cost
• Assessing financial viability of investments
• Managing Cash Flow
• Design suitable long-term dividend policy
• Balancing Finance and Business Risk
• Giving feedback periodically on investments
in various current assets
Finance Manager is a goal-keeper

6. Finance Function - Organisational Structure
Chief Financial Officer
Financial Policy
Corporate Planning
Treasurer Controller
Cash Mgt., Capital Accounting
Raising, Banking Taxation

7. Forms of Business Organizations
• Corporation
– Legal Entity
– Limited Liability
– Separation of shareholders (ownership) & Management (control)
• Sole Proprietorship
• Partnership, Limited Partnership and Limited Liability
Partnership
• Co-operative Societies/Societies
• Trusts
• Under an Act of Parliament

8. Agency Relationship
Managers
Agency
Cost
Equity holders Debt holders

9. Agency cost and Finance Function
• Conflict of interest between the three affects
maximisation objective of finance function
• Capital Budgeting
– Managers want to diversify and take up less risky project;
Equity holders prefer high risk project; Debt holders
prefer no expansion or equity funded expansion
• Capital Structure
– Managers prefer less debt (pecking order); equity holders
prefer high debt;
• Dividend Policy
– Managers/debt holder prefer low payout; SH high payout

10. Financial Managers & Agency Cost
• Financial Managers can address agency
problem
– by improving disclosure standards
– by designing suitable capital structure
– by designing suitable dividend policy
– by designing suitable ESOP/executive
compensation plans like EVA®

11. Financial Goal
• Maximizing Shareholders Wealth is a
simple financial goal for the managers to
pursue
• What does it mean?
– Look for investment opportunities that create
value more than their cost, adjusted for risk
• Other Financial Goals and their problems
– Maximizing Sales or Profit