Introduction to financial management

1. Introduction
to
Financial Management

2. What is Financial Management?
Any decision that involves a use of money is a Financial Management decision.
◦ In case of businesses, everything they do, has financial implications, and are financial
decisions.
What is financial Management?
◦ Integral system concerned with acquiring, managing, distributing & financing assets to
achieve (business) goals.

3. Financial view of the firm
Assets
Assets
◦ Generate cash flow today includes long
lived and short lived assets (working
capital)
◦ E.g. Microsoft - windows and office
◦ Assets are either generating more
revenue or reducing the cost OR both for
the firm
◦ Assets have economic benefits
Liabilities
Fixed claim on cash flows little or no
role in management
◦ Fixed maturity
◦ Tax deductible
Equity
◦ Residual claim on cash flows.
◦ Significant role in management
◦ Perpetual lives

5. Objective of Financial Management
What should be the objective of a firm?
◦ Maximize profit?
◦ Minimize costs?
◦ Maximize market share?
◦ Maximize the current value of the company’s stock?

6. Profit Maximization
There are objectives that focus on profitability rather than value.
The rationale
◦ profits can be measured more easily than value, and that
◦ higher profits translate into higher value in the long run.
Problems
◦ First, the emphasis on current profitability may result in short-term decisions that
maximize profits now at the expense of long-term profits and value.
◦ Second, the notion that profits can be measured more precisely than value may be
incorrect, given the leeway that accountants have to shift profits across periods.
◦ Many times, profit maximization is restated in terms of accounting returns (such as
return on equity or capital) rather than profits in amount or even as excess returns
(over a cost of capital).

7. Goal of the firm - Profit maximization
Advantages:
◦ Easy to understand
Limitations
◦ It is vague, ambiguous
◦ It ignores time value of money
◦ It ignores risk/ uncertainty
◦ Based on accounting profit
◦ It is a short term goal
◦ (Manager) Does not look at consequence of his/her actions on future performance.

8. Goal of the firm
EPS
• (PAT – Pref. dividend)/ No. of eq. shares
Maximization of sales
Maximization of Market share

9. The Objective in Decision Making

10. Goal of the firm – Maximizing the
value of the firm/Share holders’
wealth maximization
Advantages
◦ It considers cash flows
◦ It considers timing of cash flows
◦ Cash flows and discount rates are adjusted for risk
◦ Easy to communicate
◦ Investors can easily understand
◦ Long term goal/ investment in only those assets which gives long term cash flows.
Limitations
◦ Share price may not give the true value of investments
◦ Difficult to satisfy all stake holders
◦ Agency problem
◦ Issue with discount rate

11. Why traditional corporate financial
theory focuses on maximizing
stockholder wealth.

12. The Classical Viewpoint

16. Maximize the value of the business firm
1. Investment decision (capital budgeting techniques):
◦ Invest in assets that earn a return greater than the minimum acceptable hurdle rate.
◦ Higher rate – higher for higher risk investments
◦ Lower rate – lower for low risk investments
◦ Return should reflect the magnitude and the timing of the cash flows as well as all side
effects.
◦ Investments can be revenue-generating investments (such as Disney opening a new
theme park) or they can be cost-saving investments (as would be the case if firm
adopted a new system to manage inventory). Some projects have large upfront costs (as
is the case with Disney), whereas other projects may have costs spread out across time.

17. Maximize the value of the business firm
2. Financing Decision
◦ Find right kind of debt for your firm and the right mix of debt and equity to fund
your operations.
◦ Optimal mix of debt & equity which maximizes firm value
◦ Right kind of debt that matches the tenor of your assets.
◦ Long term or short term
◦ Choice of currency
◦ Fixed or floating interest rates

18. Maximize the value of the business firm
3. Dividend decision
If you can not find investment that generates more return than your minimum
acceptable rate, then give back the cash to owners of your business
◦ How much cash you can return depends upon current & potential investment
opportunities.
◦ How you choose to return cash to the owners will depend whether they prefer
dividends or buybacks.

19. Forms of Business Organization
The Sole Proprietorship
The Partnership
The Corporation

20. Hypothetical Organization Chart
Chairman of the Board and
Chief Executive Officer (CEO)
Vice President and
Chief Financial Officer (CFO)
Treasurer Controller
Cash Manager
Capital Expenditures
Credit Manager
Financial Planning
Tax Manager
Financial Accounting
Cost Accounting
Data Processing
Board of Directors

21. Organisation of finance

22. Role of finance Manager

23. Emerging role of finance
manager
Investment planning –
Tax Management –
Working capital management – Inventory, Receivables, Cash.
Mergers, acquisitions, and restructuring
Risk management –
Investors relations -

24. Working capital
How much short-term cash flow
does a company need to pay its
bills?
Net
Working
Capital
Current Assets
Current
Liabilities

25. Current Assets are cash and other assets that are expected to
be converted to cash within the year.
◦ Cash
◦ Marketable securities
◦ Accounts receivable
◦ Inventory
Current Liabilities are obligations that are expected to require
cash payment within the year.
◦ Accounts payable
◦ wages
◦ Taxes
◦ Short term borrowings
Tracing Cash and Net Working Capital
Net working capital = Current assets – current liabilities

26. A Relaxed (flexible) policy would maintain a high ratio of
current assets to sales.
◦ Keeping large cash balances and investments in marketable securities
◦ Large investments in inventory
◦ Liberal credit terms
An aggressive (restrictive) short-term finance policy would
maintain a low ratio of current assets to sales.
◦ Keeping low cash balances, no or very less investment in marketable
securities
◦ Making small investments in inventory
◦ Allowing no or very less credit sales ( no/less accounts receivable)
Moderate Policy : It fall between the above two policies.
Policies Related to Current Assets Investment

27. Determinants of Working Capital
Nature of Business
Production cycle
Credit Policy (Account receivables Mgt.)
Different Phases of industry/business
Nature of goods/services
Availability & stability of raw material …..etc.

28. Interlinkage of Finance Functions
with other Functions
Figure depicts the interlinkage of other functions with finance function