By Zubair Inam Barbhuiya

1. Introduction to Financial Management
 What is the goal of Financial Management?
The goal of Financial Management arises from the purpose of the firm.
In a market based economy the purpose of the firm is to create value for society and ‘do so
legally and with integrity.’
‘The contribution to society is maximized by maximizing the value of the firm’.
The market value of the firm increases with improvement in its competitiveness which is
reflected in increases in its share price and consequently increases the wealth of its
shareholders.
MV = MVE + MVD ,
where MV=market value of firm,MVE=market value of equity shares, MVD=market value of
long term debt
If market value and book value of debt is same, then maximizing value of firm implies
maximizing market value of the equity share or shareholders’ wealth.

2. Introduction to Financial Management
Competitiveness has to necessarily take into account, besides shareholders, the interests of
other stakeholders, namely, customers, employees, suppliers, creditors, government and
society at large; in other words, all those who have a direct link with the firm.
The stakeholders view is considered part of the firm’s ‘social responsibility’ and implies that
a firm can better achieve its goal of shareholders wealth maximization with the cooperation
of, rather than conflict with, its other stakeholders.
 What are the limitations Profit Maximization as the goal of Financial
Management?
a) Profit is subject to different interpretations depending upon the firm and its accounting
policies.
b) It focuses on the absolute value of profits & does not take into account timing of the
profit and its duration.
c) It overlooks the risk factor. In other words, it does not distinguish between an investment
that gives a certain profit and one that gives a variable profit with different expectations.

3. Introduction to Financial Management
 What are the key activities of Financial Management?
The three broad activities of financial management are :
a) Financial Analysis, Planning & Control involving i) assessing the financial performance
and condition of the firm, ii) planning the financial future of the firm, iii) estimating the
financing needs, iv) establishing appropriate control systems to ensure that managerial
actions are compatible with the goals of the firm.
b) Management of the Firm’s Asset Structure --- Asset side of Balance Sheet--- which
involves i) determining the capital budget, ii) working capital management which involves a)
cash management, b) establishing the credit policy, c) controlling he inventory level.
c) Management of the Firm’s Financial Structure--- Liability side of Balance Sheet--- which
involves i) establishing the debt-equity ratio or financial leverage, ii) choosing the
instruments of financing, iii) determining the dividend policy, iv) negotiating with various
suppliers of finance.

4. Introduction to Financial Management
 Broadly, the principal decisions that the finance manager has to take can be categorized
under :
a) Investment Decision
b) Financing Decision
c) Dividend Decision
All these decisions are inter-related as subsequent discussions will elaborate.
 What is Risk – Return Tradeoff ?
Financial decisions usually involve alternative courses of action.
Should a firm set up a large plant or a small plant that can be expanded later?
Should the debt equity ratio of the firm be 2:1 or 1:1?
Should the firm pursue a liberal credit policy or a tight one?
What should be the inventory policy?
 In order to make the financial decision, the following questions need to be answered:
What is the expected return?
What is the risk?
How will it influence the value the firm?

5. Introduction to Financial Management
 What is the relationship between the Accounting & Finance functions ?
The accounting and finance functions are closely related and falls within the responsibilities of the Chief
Financial Officer, whatever be the designation. However there are important differences between the two
as given below:
i) Score keeping vs. Value Maximizing
The primary objective of accounting is to measure the performance of the firm and assess its financial
condition. Whereas, the principal goal of financial management is to create shareholder value by
investing in positive net present value projects and minimizing the cost of financing. The accountant’s
role is to provide accounting data on the firm’s past and present which can be used for decision making.
ii) Accrual vs. Cash Flow Method
The accountant prepares the accounting reports based on the accrual method which recognizes
revenues when the sale occurs regardless whether the cash is realized or not and matches expenses to
sales regardless whether cash is paid or not. The finance manager focuses on value of cash flows and
their timing and risk as these determine value.
iii) Certainty vs. Uncertainty
Accounting deals mainly with the past and records what has happened. It is more objective. Finance is
concerned mainly with the future and involves decision making under imperfect information and

6. Introduction to Financial Management
CFOChief Finance
Officer
Treasurer Controller
Financial Acctg
Cost Acctg
Taxation
Data Proc.
Credit/Cash
LT Funds
Capital
Budgeting
Portfolio

7. Introduction to Financial Management
 What is the Agency Problem?
In a firm the shareholders are the Principal and the Manager is the Agent. The Agency
problem is the likelihood that managers may place personal goals ahead of the firm’s goals,
that is, the interests of the shareholders.
Market forces act to prevent/minimize Agency problems in two ways : a) behaviour of
security participants, namely, shareholders holding large blocks of the firms shares, b)
hostile takeovers.
 What are Agency Costs?
To deal with the Agency problem, shareholders have to incur following types of costs:
a) Monitoring --- the monitoring expenses relate to payment for audit and control systems
to ensure that managerial behaviour is in the best interests of the shareholders;
b) Incentive and Performance Plans --- expenses incurred to motivate Managers to act in the
best interest of the shareholders.
c) Opportunity Costs --- to ensure that profitable opportunities are not missed, firms appoint
external Directors and Management Consultancy firms to advise the Board on strategic
options, the costs of which have to be borne by the firm.