Lawrence J. Gitman has defined finance as 'an art and science of managing money'. It implies that finance is Both art and science. Finance is a matured science since it provides knowledge as to how and at what time a firm should invest to outstrip other firms. On the other hand, finance is also an art. In modern time, finance has become more analytical. The new financial theories have been developed. Many data have been developed to prove these theories right or wrong. the financial mangers should examine the differentalternatives related to the raising and managing money. they should formulate the models to predict the results obtained from the use of any one alternative. In this way, the new theories, models and methods have made finance scientific. But the financial theories cannot be accurately compared with the 'Scientific Method' that applies to physics science. Physics predicts as to what happens from an action. for example, physics says that if a ball is thrown upward, that eventually falls down. This is not true in finance. For example, the financial analyst can predict from the historical trend that the rate of interest will change in a definite pattern. But, in reality, the rate of interest may change in different pattern. Despite this, financial guidelines and theories are useful in financial decision making. But any decision should be made by mixing those guidelines with self-skill. According to R.A. Stevenson, in modern time finance is a 'scientific art'. He opines 'finance is the science of knowing how to predict financial consequences and the art of knowing when to act'. It assists the financial managers of today to avoid the difficulties of tomorrow
Incentives – discuss how incentives must be carefully structured. For example, tying bonuses to profits might encourage management to pursue short-run profits and forego projects that require a large initial outlay. Stock options may work, but there may be an optimal level of insider ownership. Beyond that level, management may be in too much control and may not act in the best interest of all stockholders. The type of stock can also affect the effectiveness of the incentive. Corporate control – ask the students why the threat of a takeover might make managers work towards the goals of stockholders. Other groups also have a financial stake in the firm. They can provide a valuable monitoring tool, but they can also try to force the firm to do things that are not in the owners’ best interest.
Finance is the set of activities dealing with the management of funds Finance is also the science and art of determining if the funds of an organization are being used properly 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
Public finance (Government Finance) Public finance means collection of money through taxes or other sources and management of revenue and expenditure by the government Corporate finance (Business Finance) Personal finance Involve paying for education, financing durable goods, buying insurance, investing and saving for retirement etc.
Marketing & Sales Production & Operations Finance
Corporate Finance refers to any decisions made by a firm that will have an impact on its financial position. These decisions may be from production, marketing or any other department and are assumed to have a strategic impact. These decisions are: ◦ Investment Decisions ◦ Financing Decisions ◦ Dividend Decisions
Aditya Birla Group to invest $ 500 mn in Turkey NTPC Ltd to invest Rs 18,346 crore in 2 projects Groupe SEB buys 55% in Maharaja Whiteline 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
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 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. Nestlé India Ltd has declared second interim dividend of Rs. 27.00 per equity share for the year 2011
The financial management is generally concerned with procurement, allocation and control of financial resources of a concern. The objectives can be- To 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.
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 Magnitude of cash flows, timing and riskiness of the cash flows are crucial to consider
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
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 (3) Dividend Policy Decisiono How to deal with the profits of a firm?o How much profits should be distributed to the shareholders and how much to retain in the business?
What a firm should attempt to achieve with its investments, financing and dividend policy decisions Profit maximization (profit after tax) Maximizing earnings per share Wealth maximizationBut WHOSE WEALTH?The real reason behind failure in defining the proper objective is the conflict between stakeholders of the firm.
Stockholders or Owners Bondholders or Lenders Employees Financial Markets Society
Maximizing the rupee income of firm Resources are efficiently utilized Appropriate measure of firm performance Serves interest of society also Objections to Profit Maximizationo It is Vagueo It Ignores the Timing of Returnso It Ignores Risko In new business environment profit maximization is regarded aso Unrealistico Difficulto Inappropriateo Immoral
Maximising PAT or EPS does not maximise the economic welfare of the owners. Ignores timing and risk of the expected benefit Market value is not a function of EPS. 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.
Maximizes the net present value of a course of action to shareholders. Accounts for the timing and risk of the expected benefits. Benefits are measured in terms of cash flows. Fundamental objective—maximize the market value of the firm’s shares.
CRITIQUE AND DEFENCE OF SHAREHOLDER WEALTH MAXIMISATION GOAL Critique Defence • The capital market sceptics • Financial economists argue argue that stock prices fail that stock prices are the to reflect true values least biased estimates of intrinsic values in developed markets • The balancers argue that a • Balancing the interests of firm should seek to various stakeholders is not ‘balance’ the interests of a practical governing various stakeholders objective • Advocates of social • The only social responsibility argue that a responsibility of business business firm must assume is to create value and do so wider social responsibilities legally and with integrity
In your own words, explain the role and importance of financial management to a manufacturer whose objective is to improve quality
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 to make sure there is enough money to recruit and train appropriately skilled staff to satisfy the objective of improving quality. to make sure that all the costs/expenses are under control to make sure that the organisation is performing profitably and efficiently without compromising quality to reduce costs of raw materials by ensuring the best value for money from suppliers.
Estimation of capital requirements Determination of capital composition Choice of sources of funds Investment of funds Disposal of surplus Management of cash Financial controls
Stockholders Hire/Fire & Maximize Stockholder’s Control Managers Wealth Lend Money Trace Economic Cost & ReturnsBondholders Managers taking Financial Decisions Society Provide Debt Service & No Negative Protect their Interests Social Impact Real & True Market Price Information = True Value Financial Markets
The Agency Theory was first introduced by Jensen and Meckling in 1976. This theory explains how the conflict between various stakeholders can result in sub-optimal allocation of resources. 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. Shareholders are principal and CEO is the agent; if CEO is principal then managers are agents.
Divergent Objectives Non-observability of Agent’s Actions
Stockholders Have Little Control Maximize Managers Interest at Stockholder’s Expense Lend Money Cannot Trace CostBondholders Managers taking Financial Decisions Society Exploitation by Owners & Negative Default in Payments Social Impact Delayed & Market Price Misleading Information ≠ True Value Financial Markets
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.
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 1.28
Stockholders Control by Incentive Maximize Stockholder’s & Other Systems Wealth Lend Money Laws & RegulationsBondholders Managers taking Financial Decisions Society Put Stringent Covenants Negative Social To Safeguard interests Impact Reduced Information from Various Sources Market Price & Legal Remedies ≈ True Value Financial Markets
The importance of the finance function depends on the size of thefirm. Financial management is an integral part of the overallmanagement of the firm. In small firms, the finance functions aregenerally performed by the accounting departments. In largefirms, there is a separate department of finance headed by aspecialist 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) Treasurer Controller Financial Cash Credit Foreign Cost Tax accounting planning and Manager Manager exchange manager fund-raising manager manager manager Capital Pension Corporate Financialexpenditur fund accounting accountinge manager manager manager manager Organization of Financial Management Function
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.
Growth Control of inflation Full employment External balance (or Balance of payments)