Introduction: Nature, Scope and objectives of Financial Management, Time value of money, Apprasial of project for profitability

1. FINANCIAL MANAGEMENT
Dr. R. SAROJADEVI
Assistant Professor
Department of Commerce
Karpagam Academy of Higher Education
(Deemed to be University)
Coimbatore-21.

2. OUTLINE OF FINANCIAL CONCEPTS
Meaning of Finance
Scope of Financial Management
Nature of FM
Functions or Objectives of FM
Time value of Money
Appraisal of project for profitability
Source of finance

3. MEANING OF FINANCE
 Finance may be defined as the art and science of
managing money.
 Its includes financial service and financial instruments.
Finance also is referred as the provision of money at the
time when it is needed. Finance function is the
procurement of funds and their effective utilization in
business concerns.
 The concept of finance includes capital, funds, money,
and amount. But each word is having unique meaning.
Studying and understanding the concept of finance
become an important part of the business concern.

4. DEFINITION
 According to GUTHMANN and DOUGALL, business
finance may be broadly defined as “the activity
concerned with the planning, raising, controlling and
administering the funds used in the business.
 According to WHEELER, business finance may be
defined as “that business activity which is
concerned with the acquisition and conservation of
capital funds in meeting the financial needs and
overall objectives of the business enterprise.”.

5. NATURE OF FINANCE FUNCTION
 The finance function is the process of acquiring and
utilizing funds of a business. Finance functions are
related to overall management of an organization.
Finance function is concerned with the policy decisions
such as like of business, size of firm, type of equipment
used, use of debt, liquidity position. These policy
decisions determine the size of the profitability and
riskiness of the business of the firm.
 The following the nature of finance,
 In most of the organizations, financial operations
are centralized. This results in economies.

6. CONT..
 ii) Finance functions are performed in all business firms,
irrespective of their sizes / legal forms of organization.
 iii) They contribute to the survival and growth of the
firm.
 iv) Finance function is primarily involved with the data
analysis for use in decision making.
 v) Finance functions are concerned with the basic
business activities of a firm, in addition to external
environmental factors which affect basic business
activities, namely, production and marketing.
 vi) Finance functions comprise control functions also
 vii) The central focus of finance function is valuation of
the firm.

7. SCOPE OF FINANCIAL MANAGEMENT
 Estimating financial requirements
The first task of a financial manager is to estimate short term and
long term financial requirements of his business. For that, he will
prepare a financial plan for present as well as for future. The amount
required for purchasing fixed assets as well as needs for working
capital will have to be ascertained.
Deciding capital structure:
Capital structure refers to kind and proportion of different securities
for raising funds. After deciding the quantum of funds required it
should be decided which type of securities should be raised. It may
be wise to finance fixed assets through long term debts. Even here if
gestation period is longer than share capital may be the most
suitable. Long term funds should be employed to finance working
capital also, if not wholly then partially. Entirely depending on
overdrafts and cash credits for meeting working capital needs may
not be suitable. A decision about various sources for funds should be
linked to the cost of raising funds.

8. CONT..
 Selecting a source of finance: An appropriate source of
finance is selected after preparing a capital structure
which includes share capital, debentures, financial
institutions, public deposits etc. If finance is needed for
short term periods then banks, public deposits and
financial institutions may be the appropriate. On the
other hand, if long term finance is required then share
capital and debentures may be the useful.
 Selecting a pattern of investment: When funds have
been procured then a decision about investment pattern
is to be taken. The selection of an investment pattern is
related to the use of funds. A decision will have to be
taken as to which assets are to be purchased? The
funds will have to be spent first on fixed assets and then
an appropriate portion will be retained for working
capital and for other requirements.

9. CONT..
 Proper cash management: Cash management is an important
task of finance manager. He has to assess various cash
needs at different times and then make arrangements for
arranging cash. Cash may be required to purchase of raw
materials, make payments to creditors, meet wage bills and
meet day to day expenses. The idle cash with the business
will mean that it is not properly used.
 Implementing financial controls: An efficient system of
financial management necessitates the use of various control
devices. They are ROI, break even analysis, cost control, ratio
analysis, cost and internal audit. ROI is the best control device
in order to evaluate the performance of various financial
policies.
 Proper use of surpluses: The utilization of profits or surpluses
is also an important factor in financial management. A
judicious use of surpluses is essential for expansion and
diversification plans and also in protecting the interests of
share holders.

10. FUNCTIONS OF FINANCIAL MANAGEMENT
 Assessing the Financial requirements. The main objective of
finance function is to assess the financial needs of an
organization and then finding out suitable sources for raising
them. The sources should be commensurate with the needs of
the business. If funds are needed for longer periods then long-
term sources like share capital, debentures, term loans may be
explored.
 2. Proper Utilization of Funds: Though raising of funds is
important but their effective utilisation is more important. The
funds should be used in such a way that maximum benefit is
derived from them. The returns from their use should be more
than their cost. It should be ensured that funds do not remain
idle at any point of time. The funds committed to various
operations should be effectively utilised. Those projects should
be preferred which are beneficial to the business.

11. CONT..
 Increasing Profitability. The planning and control of finance
function aims at increasing profitability of the concern. It is
true that money generates money. To increase profitability,
sufficient funds will have to be invested. Finance Function
should be so planned that the concern neither suffers from
inadequacy of funds nor wastes more funds than required. A
proper control should also be exercised so that scarce
resources are not frittered away on uneconomical operations.
The cost of acquiring funds also influences profitability of
the business.
 Maximizing Value of Firm. Finance function also aims at
maximizing the value of the firm. It is generally said that a
concern's value is linked with its profitability.

12. GOALS / OBJECTIVES OF FINANCIAL
MANAGEMENT
 Financial Management may be broadly divided into two
parts such as:
Wealth
Maximization
Profit
Maximization
Goals of FM

13. PROFIT MAXIMIZATION
 Main aim of any kind of economic activity is earning
profit.
 A business concern is also functioning mainly for the
purpose of earning profit.
 Profit is the measuring techniques to understand the
business efficiency of the concern. Profit
maximization is also the traditional and narrow
approach, which aims at, maximizes the profit of the
concern.
 Profit maximization consists of the following important
features

14. CONT..
 Profit maximization is also called as cashing per share
maximization. It leads to maximize the business operation for
profit maximization.
 Ultimate aim of the business concern is earning profit,
hence, it considers all the possible ways to increase the
profitability of the concern.
 Profit is the parameter of measuring the efficiency of the
business concern. So it shows the entire position of the
business concern.
 Profit maximization objectives help to reduce the risk of the
business.

15. CONT..
Wealth Maximization
Wealth maximization is one of the modern
approaches, which involves latest innovations and
improvements in the field of the business concern.
The term wealth means shareholder wealth or the
wealth of the persons those who are involved in the
business concern. Wealth maximization is also known
as value maximization or net present worth
maximization.

16. TIME VALUE OF MONEY
 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.

17. TYPES OF INTEREST
Compound Interest
Interest paid (earned) on any previous interest
earned, as well as on the principal borrowed
(lent).
Simple Interest
Interest paid (earned) on only the original
amount, or principal, borrowed (lent).

18. SIMPLE INTEREST FORMULA
Formula SI = P0(i)(n)
SI: Simple Interest
P0: Deposit today (t=0)
i: Interest Rate per Period
n: Number of Time Periods

19. SI = P0(i)(n)
= $1,000(.07)(2)
= $140
SIMPLE INTEREST EXAMPLE
Assume that you deposit $1,000 in an
account earning 7% simple interest for 2
years. What is the accumulated interest at
the end of the 2nd year?

20. FV = P0 + SI
= $1,000 + $140
= $1,140
Future Value is the value at some future time
of a present amount of money, or a series of
payments, evaluated at a given interest rate.
SIMPLE INTEREST (FV)
What is the Future Value (FV) of the
deposit?

21. The Present Value is simply the
$1,000 you originally deposited.
That is the value today!
Present Value is the current value of a
future amount of money, or a series of
payments, evaluated at a given interest
rate.
SIMPLE INTEREST (PV)
What is the Present Value (PV) of the
previous problem?

22. COMPOUND INTEREST
 Compound interest is the addition of interest to the principal sum of a
loan or deposit, or in other words, interest on interest. It is the result of
reinvesting interest, rather than paying it out, so that interest in the next
period is then earned on the principal sum plus previously
accumulated interest.

23. CONT..
 For example,
If an amount of $5,000 is deposited into a savings account at an
annual interest rate of 5%, compounded monthly, the value of the
investment after 10 years can be calculated as follows...
 Answer
P = 5000.
r = 5/100 = 0.05 (decimal).
n = 12.
t = 10.
If we plug those figures into the formula, we get the following:
A = 5000 (1 + 0.05 / 12) (12 * 10) = 8235.05.
So, the investment balance after 10 years is $8,235.05.

24. TYPES OF ANNUITIES
Ordinary Annuity: Payments or receipts
occur at the end of each period.
Annuity Due: Payments or receipts occur at
the beginning of each period.
 An Annuity represents a series of equal
payments (or receipts) occurring over a
specified number of equidistant periods.

25. EXAMPLES OF ANNUITIES
 Student Loan Payments
 Car Loan Payments
 Insurance Premiums
 Mortgage Payments
 Retirement Savings

26. APPRAISAL OF PROJECT FOR PROFITABILITY
The following techniques used for project appraisal.
 Internal Rate of Return
 Payback Period Method
 Net present value
Internal Rate of Return
The IRR represents the discount rate at which the NPV of an
investment is zero. As such it represents a breakeven cost of
capital.
Merits of IRR:
 It takes into account the time value of money
 It can be applied in situations with even and uneven cash
flows at different periods of time.
 The determination of cost of capital is not a pre-requisite for
the use of this method and hence it is better then Net present
value method, where the cost of capital cannot be
determined the easily.

27. CONT..
Demerits of IRR
 It is most difficult method of evaluation of investment
proposals.
 It is based on the assumption that the earnings are reinvested
at the internal rate of return for the remaining life of the
project.
 PAYBACK PERIOD METHOD
Pay-back method is also called pay-off of pay out method. Its
represents the number of years required to recover the original
investment by savings before depreciation but after the payment of
taxes.
 Merits of Payback Period method
 It us easy to calculate and simple to understand
 The short-term approach typified by the pay back method
reduces the possibility of loss through obsolescence.

28. CONT…
 Ti is preferred on the ground that returns beyond three or
four years are so uncertain as to disregard them
altogether in a planning decision.
Disadvantages of Payback period method
 Its completely ignores the annual cash inflows after the
pay back period.
 It does not take into account the Time value of money.
 It ignores the interest which is an important factor in
making sound investment decision.
 The following formula;
pay-back period method : Original Investment
__________________
Annual Cash inflow

29. CONT..
 For example,
A project cost Rs, 10,00,000 and yields an annual cash
inflow of Rs.2,00,000 for 10 Years. Calculate its Pay-back
period.
Solution
pay-back period method : Original Investment
__________________
Annual Cash inflow
: 1,00,000/ 2,00,000
= 5years
Therefore, Pay back period = 5 Years

30. NET PRESENT VALUE
Net present value (NPV) is the difference between the present
value of cash inflows and the present value of cash outflows
over a period of time. NPV is used in capital budgeting and
investment planning to analyze the profitability of a projected
investment or project.
Merits of NPV
 It takes into account the entire economic life of the project
investment and Income.
 It considers the time value of money and interest rate
 This can be applied with uniform cash flows and uneven
cash flows or cash flows at different periods of time.
 It is consistent with the objective of maximizing the welfare
of owners.

31. CONT..
 Limitations
 It is difficult to understand and complicated to
operate.
 It is easy to determine an appropriate discount rate.
 It is very difficult to forecast the exact economic life
of an investment.
 It may not gives satisfactory result when the project
involves different amounts of investments.

32. SOURCE OF FINANCE
 Long-term sources fulfill the financial requirements of a
business for a period more than 5 years. It includes various
other sources such as shares and debentures, long-term
borrowings and loans from financial institutions. Such
financing is generally required for the procurement of fixed
assets such as plant, equipment, machinery etc.
 Medium-term sources are the sources where the funds are
required for a period of more than one year but less than five
years. The sources of the medium term include borrowings
from commercial banks, public deposits, lease financing and
loans from financial institutions.
 Short-term sources: Funds which are required for a period
not exceeding one year are called short-term sources. Trade
credit, loans from commercial banks and commercial papers
are the examples of the sources that provide funds for short
duration.

33. INTERNAL SOURCES
 There are five internal sources of finance:
 Owner’s investment (start up or additional capital)
 Retained profits
 Sale of stock
 Sale of fixed assets
 Debt collection

34. INTERNAL SOURCES
OWNER’S INVESTMENT
 This is money which
comes from the owner/s
own savings
 It may be in the form of
start up capital - used
when the business is
setting up
 It may be in the form of
additional capital –
perhaps used for
expansion
 This is a long-term source
of finance
Advantages
 Doesn’t have to be repaid
 No interest is payable
Disadvantages
 There is a limit to the
amount an owner can
invest

35. INTERNAL SOURCES
RETAINED PROFITS
 This source of finance
is only available for a
business which has
been trading for more
than one year
 It is when the profits
made are ploughed
back into the business
 This is a medium or
long-term source of
finance
Advantages
 Doesn’t have to be
repaid
 No interest is payable
Disadvantages
 Not available to a new
business
 Business may not
make enough profit to
plough back

36. INTERNAL SOURCES
SALE OF STOCK
 This money comes in
from selling off unsold
stock
 This is what happens in
the January sales
 It is when the profits
made are ploughed
back into the business
 This is a short-term
source of finance
Advantages
 Quick way of raising
finance
 By selling off stock it
reduces the costs
associated with holding
them
Disadvantages
 Business will have to
take a reduced price
for the stock

37. INTERNAL SOURCES
SALE OF FIXED ASSETS
 This money comes in
from selling off fixed
assets, such as:
 a piece of machinery
that is no longer needed
 Businesses do not
always have surplus
fixed assets which they
can sell off
 There is also a limit to
the number of fixed
assets a firm can sell
off
 This is a medium-term
source of finance
Advantages
 Good way to raise
finance from an asset
that is no longer
needed
Disadvantages
 Some businesses are
unlikely to have surplus
assets to sell
 Can be a slow method
of raising finance

38. INTERNAL SOURCES
DEBT COLLECTION
 A debtor is someone who
owes a business money
 A business can raise
finance by collecting the
money owed to them
(debts) from their debtors
 Not all businesses have
debtors ie those who deal
only in cash
 This is a short-term
source of finance
Advantages
 No additional cost in
getting this finance, it is
part of the businesses’
normal operations
Disadvantages
 There is a risk that
debts owed can go bad
and not be repaid

39. DEFINITION OF EXTERNAL SOURCES OF FINANCE
External sources of finance refer to the cash flows
generated from outside sources of the organization,
whether from private means or from the financial
market. In external financing, the funds are arranged
from the sources outside the business. There are two
types of external sources of finance, i.e. long term
source of finance and short term sources of finance.
Further on the basis of nature, they can be classified
as:

40. CONT--
 Debt financing: The source of finance wherein fixed
payment has to be made to the lenders is debt financing. It
includes:
 Bank loans
 Corporate Bonds
 Leasing
 Commercial Paper
 Trade Credit
 Debentures
 Equity Financing: Equity is the major source of finance for
most of the companies which indicate the share in the
ownership of the firm and the interest of the shareholders. The
firms raise capital by selling its shares to the investors. It
includes:
 Ordinary shares
 Preference shares

41. EXTERNAL SOURCES
BANK LOAN
 This is money
borrowed at an agreed
rate of interest over a
set period of time
 This is a medium or
long-term source of
finance
Advantages
 Set repayments are
spread over a period of
time which is good for
budgeting
Disadvantages
 Can be expensive due
to interest payments
 Bank may require
security on the loan

42. EXTERNAL SOURCES
BANK OVERDRAFT
 This is where the business
is allowed to be overdrawn
on its account
 This means they can still
write cheques, even if they
do not have enough money
in the account
 This is a short-term source
of finance
Advantages
 This is a good way to cover
the period between money
going out of and coming into
a business
 If used in the short-term it is
usually cheaper than a bank
loan
Disadvantages
 Interest is repayable on the
amount overdrawn
 Can be expensive if used
over a longer period of time

43. EXTERNAL SOURCES
LEASING
 This method allows a
business to obtain assets
without the need to pay a
large lump sum up front
 It is arranged through a
finance company
 Leasing is like renting an
asset
 It involves making set
repayments
 This is a medium-term
source of finance
Advantages
 Businesses can have the
use of up to date
equipment immediately
 Payments are spread
over a period of time
which is good for
budgeting
Disadvantages
 Can be expensive
 The asset belongs to the
finance company

44. EXTERNAL SOURCES
TRADE CREDIT
 Trade credit is summed up
by the phrase:
buy now pay later
 Typical trade credit period is
30 days
 This is a short-term source
of finance
Advantages
 Business can sell the goods
first and pay for them later
 Good for cash flow
 No interest charged if
money is paid within agreed
time
Disadvantages
 Discount given for cash
payment would be lost
 Businesses need to
carefully manage their cash
flow to ensure they will have
money available when the
debt is due to be paid

45. EXTERNAL SOURCES
SHARE ISSUE
 This is sources of
finance suitable for a
limited company
 Involves issuing more
shares
 This is a long-term
source of finance
Advantages
 Doesn’t have to be
repaid
 No interest is payable
Disadvantages
 Profits will be paid
out as dividends to
more shareholders
 Ownership of the
company could
change hands

46. THANKING YOU