Financial Management

Chanderprabhu Jain College of Higher Studies & School of Law
Plot No. OCF, Sector A-8, Narela, New Delhi – 110040
(Affiliated to Guru Gobind Singh Indraprastha University and Approved by Govt of NCT of Delhi & Bar Council of India)
PAPER CODE BBALLB 114
Name of the Subject:
FINANCIAL MANAGEMENT
INTRODUCTION
UNIT-I

MEANING OF FINANCIAL MANAGEMENT
Financial Management means planning, organizing, directing and
controlling the financial activities such as procurement and utilization of
funds of the enterprise. It means applying general management principles
to financial resources of the enterprise.

OBJECTIVES OF FINANCIAL MANAGEMENT
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.

SCOPE OF FINANCIAL MANAGERS
• Investment decisions includes investment in fixed assets (called as capital
budgeting). Investment in current assets are also a part of investment
decisions called as working capital decisions.
• Financial decisions - They relate to the raising of finance from various
resources which will depend upon decision on type of source, period of
financing, cost of financing and the returns thereby.
• Dividend decision - The finance manager has to take decision with regards
to the net profit distribution. Net profits are generally divided into two:
a. Dividend for shareholders- Dividend and the rate of it has to be
decided.
b. Retained profits- Amount of retained profits has to be finalized which
will depend upon expansion and diversification plans of the
enterprise.

FUNCTIONS OF FINANCIAL MANAGEMENT
• Estimation of capital requirements: A finance manager has to make
estimation with regards to capital requirements of the company. This will
depend upon expected costs and profits and future programmes and
policies of a concern. Estimations have to be made in an adequate manner
which increases earning capacity of enterprise.
• Determination of capital composition: Once the estimation have been
made, the capital structure have to be decided. This involves short- term
and long- term debt equity analysis. This will depend upon the proportion
of equity capital a company is possessing and additional funds which have
to be raised from outside parties.
• Choice of sources of funds: For additional funds to be procured, a
company has many choices like-
a. Issue of shares and debentures
b. Loans to be taken from banks and financial institutions
c. Public deposits to be drawn like in form of bonds.

•Investment of funds: The finance manager has to decide to allocate funds
into profitable ventures so that there is safety on investment and regular
returns is possible.
•Disposal of surplus: The net profits decision have to be made by the
finance manager.
•Management of cash: Finance manager has to make decisions with regards
to cash management. Cash is required for many purposes like payment of
wages and salaries, payment of electricity and water bills, payment to
creditors, meeting current liabilities, purchase of raw materials, etc.

OBJECTIVE OF FINANCIAL MANAGEMENT
• Profit Maximisation
• Wealth Maximisation

TIME VALUE OF MONEY - TVM
• The time value of money (TVM) is the concept that money available at the
present time is worth more than the identical sum in the future due to its
potential earning capacity.
• This core principle of finance holds that, provided money can earn interest,
any amount of money is worth more the sooner it is received.
• TVM is also sometimes referred to as present discounted value.

CAPITAL BUDGETING DECISIONS
UNIT-II

CAPITAL BUDGETING
According to the definition of Charles T. Hrongreen, “capital budgeting is a
long-term planning for making and financing proposed capital out lays.

IMPORTANCE OF CAPITAL BUDGETING
• Huge investments
• Long Term
• Irreversible
• Long-Term Effect

CAPITAL BUDGETING - METHODS
(A) Traditional methods (or Non-discount methods)
(i) Pay-back Period Methods
(ii) Accounts Rate of Return
(B) Modern methods (or Discount methods)
(i) Net Present Value Method
(ii) Internal Rate of Return Method
(iii) Profitability Index Method

NATURE OF INVESTMENT DECISIONS
• The investment decisions of a firm are generally known as the capital
budgeting, or capital expenditure decisions.
• The firm’s investment decisions would generally include expansion;
acquisition decisions would generally include expansion, acquisition,
modernization and replacement of the long-term assets.
• Sale of a division or business (divestment) is also as an investment
decision.

NET PRESENT VALUE (NPV)
• The NPV is the sum of the present values of all relevant cash flows
discounted at the opportunity cost of capital (or WACC). This decision rule
for this technique is:
• Accept if the net present value is positive, reject if negative

PAYBACK PERIOD
• The payback period is the length of time it takes for a project to pay back
its initial capital investment. It may be shown in either years or months e.g.
2.5 years or 2 year 6 months. The decision rule for this technique is:
• Accept if it meets a predetermined figure.
• Choose the project that pays back the fastest.

ACCOUNTING RATE OF RETURN(ARR)
• The accounting rate of return is a return on capital employed (ROCE) ratio.
The decision rule for this technique is:
• Accept if ARR is greater than a target figure.
• Choose the project with the highest ARR.

INTERNAL RATE OF RETURN (IRR)
• The internal rate of return is the discount rate that gives a net present value
of 0. It is the annual rate of return earned by the project. The decision rule
for this technique is:
• Accept if the internal rate of return is greater than the opportunity cost of
capital, reject if less.

COST OF CAPITAL
UNIT-III

COST OF CAPITAL
According to Solomon Ezra, the cost of capital is the minimum required rate of
earnings of the cut off rate for capital expenditure.
According to James C. Vanhorne, the cost of capital represents a cut off rate
for the allocation of capital investment of projects. It is the rate of return on a
project that will have unchanged the market price of the stock.

COST OF CAPITAL – SIGNIFICANCE
• Capital budgeting decisions
• Capital structure decisions

CLASSIFICATION OF COST OF CAPITAL
Cost of capital may be classified into the following types on the basis of nature
and usage:
• Explicit and Implicit Cost.
• Average and Marginal Cost.
• Historical and Future Cost.
• Specific and Combined Cost.

CAPITAL STRUCTURE - MEANING
• According to the definition of Gerestenbeg, “Capital Structure of a
company refers to the composition or make up of its capitalization and it
includes all long-term capital resources”.
• According to the definition of James C. Van Horne, “The mix of a firm’s
permanent long-term financing represented by debt, preferred stock, and
common stock equity”.

CAPITAL STRUCTURE THEORIES
• Traditional Approach
• Net Income (NI) Approach
• Net Operating Income (NOI) Approach
• Modigliani and Miller Approach

FACTORS DETERMINING CAPITAL STRUCTURE
• Nature of the business
• Size of the company
• Legal requirements
• Requirement of investors
• Government policy

LEVERAGE
The term leverage refers to an increased means of accomplishing some
purpose. Leverage is used to lifting heavy objects, which may not be otherwise
possible. In the financial point of view, leverage refers to furnish the ability to
use fixed cost assets or funds to increase the return to its shareholders.
Leverage can be classified into three major headings according to the nature of
the finance mix of the company.
- Operating Leverage
- Financial Leverage
- Combined Leverage

LEVERAGE – IMPORTANCE
• Measurement Of Operating Risk
• Measurement Of Financial Risk
• Managing Risk
• Designing Appropriate Capital Structure Mix
• Increase Profitability

TYPES OF LEVERAGES
• Operating leverage
• Financial leverage
• Combined Leverage

MEANING OF DIVIDEND POLICY
• The term dividend refers to that part of profits of a company which is
distributed by the company among its shareholders.
• It is the reward of the shareholders for investments made by them in the
shares of the company.
• The investors are interested in earning the maximum return on their
investments and to maximize their wealth.

WORKING CAPITAL MANAGEMENT
UNIT-IV

WORKING CAPITAL
According to the definition of Weston and Brigham, “Working Capital refers
to a firm’s investment in short-term assets, cash, short-term securities, accounts
receivables and inventories”.
Working Capital may be categorised:
- Gross Working Capital
- Net Working Capital

IMPORTANCE OF WORKING CAPITAL
MANAGEMENT
1. Higher return on capital
2. Improved credit profile and solvency
3. Higher profitability
4. Higher liquidity
5. Increased business value
6. Favorable financing conditions
7. Uninterrupted production
8. Ability to face shocks and peak demand

INVENTORY MANAGEMENT
The dictionary meaning of the inventory is stock of goods or a list of goods.
In accounting language, inventory means stock of finished goods. In a
manufacturing point of view, inventory includes, raw material, work in
process, stores, etc.

OBJECTIVES OF INVENTORY MANAGEMENT
The major objectives of the inventory management are as follows:
• To efficient and smooth production process.
• To maintain optimum inventory to maximize the profitability.
• To meet the seasonal demand of the products.
• To avoid price increase in future.
• To ensure the level and site of inventories required.
• To plan when to purchase and where to purchase
• To avoid both over stock and under stock of inventory.

KINDS OF INVENTORIES
• Raw Material
• Work in Progress
• Consumables
• Finished Goods
• Spares

OBJECTIVES OF CASH MANAGEMENT
• To ensure sufficient liquidity
• To meet working capital requirements
• To be able to meet short term requirements forming part of administrative
activities for running a business.
• To not use capital funds for short term requirements, thereby leading to
capital erosion.
• An indirect objective would be to ensure stakeholders wealth maximization
which serves as the basic premise for all the objectives.

ACCOUNTS RECEIVABLE
Accounts Receivable (AR) is the proceeds or payment which the company will
receive from its customers who have purchased its goods & services on credit.
Usually the credit period is short ranging from few days to months or in some
cases maybe a year.

PROS OF ACCOUNTS RECEIVABLE
• In truth, every business financing option has its good and bad sides.
Accounts receivable financing is no exception:
• No Need for Collateral - It is a type of unsecured business
financing option that does not require any collateral in form of assets and
guarantors.
• Retain Ownership of Your Business - This type of financing does not
require you to give out part of your business ownership so as to acquire
finances

Financial Management

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