FINANCIAL MANAGEMENT

MEANING & DEFINITION

Thefinancial managementmeans:
To collectfinancefor the company at a low cost and
To use this collected finance for earning maximum profits.
Thus, financialmanagementmeans toplanand control the finance of the
company. It is done to achieve the objectives of the company.
According to Dr. S. N. Maheshwari, "Financial management is concerned
with raising financial resources and their effective utilisation towards
achieving the organisational goals."
According to Richard A. Brealey, "Financial management is the process of
putting the available funds to the best advantage from the long term point
of view of business objectives."

OBJECTIVES OF FINANCIAL MANAGEMENT

Profit maximization: The finance manager tries to earn maximum profits
for the company in the short-term and the long-term.
Wealth maximization: Wealth maximization means to earn maximum
wealth for the shareholders. So, the finance manager tries to give a
maximum dividend to the shareholders. He also tries to increase the market
value of the share
Proper estimation of total financial requirements:The finance
manager must estimate the total financial requirements of the company. He
must find out how much finance is required to start and run the company. He
must find out the fixedcapital and working capital requirements of the
company.
Proper utilisation of financeThe finance manager must make optimum
utilisation of finance. He must use the finance profitable.
Helps to reduce operating risks, reduce cost of capital, creating reservesand
increase efficiency

Proper mobilisation: Mobilisation is collection of finance. The finance

manager must decide about the sources of finance. There must be a proper
balance between owned finance and borrowed finance.
Maintaining proper cash flow: The company must have a proper cash flow to
pay the day-to-day expenses such as purchase of raw materials, payment of
wages and salaries, rent, electricity bills, etc. If the company has a good cash
flow, it can take advantage of many opportunities such as getting cash discounts
on purchases, large-scale purchasing, giving credit to customers, etc. A healthy
cash flow improves the chances of survival and success of the company.
Prepare capital structure: Financial management also prepares the capital
structure. It decides the ratio between owned finance and borrowed finance
Financial discipline: Financial discipline means:

To

invest finance only in productive areas. This will bring high returns (profits) to the
company.
To avoid wastage and misuse of finance.

SCOPE OF FINANCIAL MANAGEMENT

Anticipation: Financial management estimates the financial needs of the
company. That is, it finds out how much finance is required by the company.
Acquisition: It collects finance for the company from different sources.
Allocation: It uses this collected finance to purchase fixed and current
assets for the company.
Appropriation: It divides the company's profits among the shareholders,
debenture holders, etc. It keeps a part of the profits as reserves.
Assessment: It also controls all the financial activities of the company.
Financial management is the most important functional area of
management. All other functional areas such asproduction management,
marketing management, personnel management, etc. depends on Financial
management. Efficient financial management is required for survival,
growth and success of the company or firm.

FUNCTIONS OF FINANCIAL MANAGEMENT

Functions of Financial Management
Functions offinancial managementcan be broadly divided into two
groups.

EXECUTIVE FUNCTIONS OF FINANCIAL

MANAGEMENT
1. Estimating capital requirements:
The company must estimate its capitalrequirements at the promotion stage.
The company must estimate its fixed capital needs and working capital need.
If not, the company will become over-capitalized or under-capitalized.
2. Determining capital structure:
Capital structure is the ratio between owned capital and borrowed capital.
If the company has too much owned capital, then the shareholders will get
fewer dividends.
If the company has too much of borrowed capital, it has to pay a lot of interest.
It also has to repay the borrowed capital after some time.

3. Estimating cash flow:

Cash flow refers to the cash which comes in and the cash which goes out of
thebusiness.
The cash comes in mostly from sales. The cash goes out for business expenses.
The finance manager must estimate the future sales of the business. This is
called Sales forecasting. He also has to estimate the future business expenses.
4. Investment Decisions:
The business gets long-term cash from equity shares, debentures, term loans
from financial institutions, etc.
It gets short-term loans from banks,fixed deposits, dealer deposits, etc.
Long-term cash must be used for purchasing fixed assets. Short-term cash
must be used as a working capital.

5. Allocation of surplus:
Surplus means profits earned by the company. When the company has a
surplus, it has three options, viz.,
It can pay dividend to shareholders.
It can save the surplus. That is, it can have retained earnings.
It can give bonus to the employees.
6. Deciding Additional finance:
Sometimes, a company needs additional finance for modernisation, expansion,
diversification, etc.
The finance manager has to decide on following questions.
When the additional finance will be needed?
For how long will this finance be needed?
From which sources to collect this finance?
How to repay this finance?
Additional finance can be collected from shares, debentures, loans from
financial institutions, fixed deposits from public, etc.

7. Negotiating for additional finance:

The finance manager has to negotiate for additional finance. That is, he has
to speak to many bank managers.
He has to persuade and convince them to give loans to his company.
8. Checking the financial performance:
This is a very important finance function.
It must be done regularly.
Investors will invest their money in the company only if the financial
performance is good.
The finance manager must compare the financial performance of the
company with the established standards.
He must find ways for improving the financial performance of the company.

ROUTINE FUNCTIONS OF FINANCIAL

MANAGEMENT
The routine functions are also called asincidentalfunctions.
Routine functions are clerical functions.
They help to perform the Executive functions of financial management.
Six routine functions of financial management (FM) are: Supervision of cash receipts and payments.
Safeguarding of cash balances.
Safeguarding of securities, insurance policies and other valuable papers.
Taking proper care of mechanical details of financing.
Record keeping and reporting.
Credit Management.

SHORT TERM SOURCES OF FINANCE

1. Bank overdraft:
Bank overdraft is a facility given by banks to its business customers, people
having current accounts.
Through this facility the customers can overdraw their accounts to a greater
value than the balance in the account.
To overdrawn amount is agreed in advance with the bank manager.
The bank assigns a limit to overdraw from the account and the business can
meet its short term liabilities by writing cheques to the extent of limit allowed.

Advantage

Disadvantage

No need for collaterals or security.

More flexible and the overdraft

Interest rates are usually variable and

higher than bank loans
Cash flow problems can arise if the
bank asks for the overdraft to be repaid
at a short notice

amount can be adjusted every month

according to needs.

2. Trade Credit:

Usually in business dealing supplier give a grace period to their customers to pay for the
purchases.
This can range from 1 week to 90 days depending upon the type of business and industry.
Credit just like any other source of finance has interest element hidden which most are
not able to recognise.
The discount may be offered to encourage early payment and the receiving company may
not advantage of the discount the cost arise. It is not a cheap source of finance.
On occasions, trade credit is used is used because the buyer is not aware of the real costs
involved- if he were, he might turn to other sources of trade finance.

This is an important source of capital for many small companies

Advantages of Trade Credit

1 Convenience and availability of trade credit

2 Greater flexibility as a means of financing

3. Factoring of debts:

It involves the business selling its bills receivable to a debt factoring

company at a discounted price. In this way the business get access to
instant cash.
Factoring involves raising funds on the security of the companys debts, so
that cash is received earlier than if the company waited for the debtors to
pay. Most factoring companies offer these three services:
Sales ledger accounting, despatching invoices and making sure bills are
paid.
Credit management, including guarantees against bad debts.
The provision of finance, advancing clients up to 80% of the value of the
debts that they are collecting.

4. Invoice Discounting

This is purely a financial arrangement which benefits the liquidity position

of the enterprise.
Invoice discounting is the transferring of invoice to a finance house in
exchange with immediate cash.
The company makes an offer to the finance house by sending it the respective
invoices and agreeing to guarantee payment of any debts that are purchased.
If the finance house accepts the offer, it makes immediate cash payment of
about 75%, which means that at a specified future date, say 90 days, the loan
must be repaid.
The company is responsible for collecting the debt and for returning the
amount advanced, whenever the debt is collected.

5. Counter Trade

Counter trade is a method of financing trade, but goods rather than money are
used to fund the transaction.
It is a form of barter. Goods are exchanged for the other goods.
This form of business for private enterprises is diminishing in local trading but
for international trade is still a popular way of funding the business activities.

LONG TERM SOURCES OF FINANCE

Long term sources of finance are those that are needed over a longer period of
time - generally over a year.
The reasons for needing long term finance are generally different to those
relating to short term finance.
Long term finance may be needed to fund expansion projects - maybe a firm is
considering setting up new offices in a European capital, maybe they want to
buy new premises in another part of the UK, maybe they have a new product
that they want to develop and maybe they want to buy another company.
The methods of financing these types of projects will generally be quite
complex and can involve billions of pounds.

1. Hire purchase:
It involves purchasing an asset paying for it over a period of time.
Usually a percentage of the price is paid as down payment and the rest is
paid in installments for the period of time agreed upon.
The business has to pay an interest on these installments.
2. Leasing:
Leasing involves using an asset, the ownership does not pass to the user.
Business can lease a building or machinery and a periodic payment is made
as rent, till the time the business uses the assets.
The business does not need to purchase the asset.
Advantage
The business can benefit from

Disadvantage
The total cost of leasing may

the asset without purchasing it. end up higher than the

Usually the maintenance of the purchasing of asset

3. Shares

Issue of shares is the main source of long term finance.

Shares are issued by joint stock companies to the public.

A company divides its capital into units of a definite face value, say of Rs. 10 each or
Rs. 100 each. Each unit is called a share.
A person holding shares is called a shareholder.
Preference Shares are the shares which carry preferential rights over the equity
shares. These rights are(a) receiving dividends at a fixed rate,(b) getting back the
capital in case the company is wound-up.
Investment in these shares are safe, and a preference shareholder also gets dividend
regularly.
Equity shares are shares which do not enjoy any preferential right in the matter
ofpayment of dividend or repayment of capital.
The equity shareholder gets dividend only after the payment of dividends to the
preference shares. There is no fixed rate of dividend for equity shareholders.

4. Debentures
Whenever a company wants to borrow a large amount of fund for a long but
fixed period, it can borrow from the general public by issuing loan certificates
called Debentures.
The total amount to be borrowed is divided into units of fixed amount say of
Rs.100 each. These units are called Debentures.
These are offered to the public to subscribe in the same manner as is done in
the case of shares.
A debenture is issued under the common seal of the company. It is a written
acknowledgement of money borrowed.
It specifies the terms and conditions, such as rate of interest, time
repayment, security offered, etc.
Redeemable Debentures, Irredeemable Debentures, Convertible Debentures,
Non-convertible Debentures

5. Deferred Credit
A deferred credit could mean money received in advance of it being earned,
such as deferred revenue, unearned revenue, or customer advances.
A deferred credit could also result from complicated transactions where a
credit amount arises, but the amount is not revenue.
A deferred credit is reported as a liability on the balance sheet. Depending
on the specifics, the deferred credit might be a current liability or a
noncurrent liability. In the past, it was common to see a noncurrent liability
section with the heading Deferred Credits.

6. Retained Earnings
Like an individual, companies also set aside a part of their profits to meet
future requirements of capital.
Companies keep these savings in various accounts such as General Reserve,
Debenture Redemption Reserve and Dividend Equalization Reserve etc.
These reserves can be used to meet long term financial requirements.
The portion of the profits which is not distributed among the shareholders
but is retained and is used in business is called retained earnings or
ploughing back ofprofits.
As per Indian Companies Act., companies are required to transfer a part
oftheir profits in reserves.The amount so kept in reserve may be used to buy
fixed assets. This is called internal financing.

7. Term Loans
Provided by FIs/banks
Can be in domestic/foreign currency, liability on FC loans translated to
rupees for payment
Are typically secured against fixed assets/ hypothecation of movable
properties, prime security/ collateral security
Definite obligations on interest and principal repayment; interest paid
periodically; based on credit risk and pegged to a floor rate
Carry restrictive covenants for future financial and operational decisions of
the company, its management, future fund raising, projects, periodic reports
called for

TERM LOANS
Pros
Interest on debt is tax deductible
Does not result in dilution of
control
Do not partake in value created
by the firm
Issue costs of debt is lower
Interest cost is normally fixed,
protection against high
unexpected inflation
Has a disciplining effect on
management

Cons

Entails fixed obligation for interest and principal, non payment can
even lead to bankruptcy/ legal action
Debt contracts impose restrictions on firms financial and operational
flexibility

Increases financial leverage, excess raises cost of equity to the firm

If inflation rate dips, cost of debt higher than expected

CAPITAL MARKET MEANING &

CONSTITUENTS
Markets for buying and selling equity and debt instruments.
Capital markets channel savings and investment between suppliers of capital
such as retail investors and institutional investors, and users of capital like
businesses, government and individuals.
Capital markets are vital to the functioning of an economy, since capital is a
critical component for generating economic output.
Capital markets include primary markets, where new stock and bond issues
are sold to investors, and secondary markets, which trade existing securities.
Capital markets have numerous participants including individual investors,
institutional investors such as pension funds and mutual funds,
municipalities and governments, companies and organizations and banks and
financial institutions
It supplies industry with fixed and working capital and finances mediumterm and long-term borrowings of the central, state and local governments.

IMPORTANCE/SIGNIFICANCE OF CAPITAL
MARKET
Mobilisation Of Savings And Acceleration Of Capital Formation:- The
reasonable return and liquidity in stock exchange are definite incentives to
the people to invest in securities. This accelerates the capital formation in the
country.
Raising Long - Term Capital :- The existence of a stock exchange enables
companies to raise permanent capital. The stock exchange resolves the
conflict of interests by offering an opportunity to investors to buy or sell their
securities, while permanent capital with the company remains unaffected.
Promotion Of Industrial Growth :- The stock exchange is a central market
through which resources are transferred to the industrial sector of the
economy. The existence of such an institution encourages people in mobilising
funds for investment in the corporate securities.
Ready And Continuous Market :- The stock exchange provides a central
convenient place where buyers and sellers can easily purchase and sell
securities.

Reliable Guide To Performance :- The capital market serves as a reliable

guide to the performance and financial position of corporates, and thereby
promotes efficiency.
Proper Channelisation Of Funds :- The prevailing market price of a
security and relative yield are the guiding factors for the people to channelise
their funds in a particular company. This ensures effective utilisation of funds
in the public interest.
Provision Of Variety Of Services :- The financial institutions functioning
in the capital market provide a variety of services such as grant of long term
and medium term loans to entrepreneurs, provision of underwriting facilities,
assistance in promotion of companies, participation in equity capital, giving
expert advice etc.
Development Of Backward Areas :- Capital Markets provide funds for
projects in backward areas.
Easy Liquidity :- With the help of secondary market investors can sell off
their holdings and convert them into liquid cash. Commercial banks also
allow investors to withdraw their deposits, as and when they are in need of

Foreign Capital :- Capital markets makes possible to generate foreign

capital. Indian firms are able to generate capital funds from overseas
markets by way of bonds and other securities. Government has liberalised
Foreign Direct Investment (FDI) in the country. This not only brings in
foreign capital but also foreign technology which is important for economic
development of the country.
Revival Of Sick Units :- The Commercial and Financial Institutions
provide timely financial assistance to viable sick units to overcome their
industrial sickness. To help the weak units to overcome their financial
industrial sickness banks and FIs may write off a part of their loan.

FUNCTIONS OF CAPITAL MARKETS

1. Mobilization of Savings and channelizing them into Most
Productive Use: Financial markets act as a link between savers and
investors. Financial markets transfer savings of savers to most appropriate
investment opportunities.
2.Continuous Availability of Funds: Capital market is place where the
investment avenue is continuously available for long term investment
3.Provide Liquidity to Financial Assets: In financial markets financial
securities can be bought and sold easily so financial market provides a
platform to convert securities in cash.
4.Reduce the Cost of Transaction:
Financial market provides complete information regarding price,
availability and cost of various financial securities. So investors and
companies do not have to spend much on getting this information as it is
readily available in financial markets.

5. Capital Formation: Capital formation is net addition to the existing stock of

capital in the economy. Through mobilization of ideal resources it generates
savings; the mobilized savings are made available to various segments such as
agriculture, industry, etc. This helps in increasing capital formation.
6. Speed up Economic Growth and Development: Capital market enhances
production and productivity in the national economy.
7. Provision of Investment Avenue: Capital market raises resources for
longer periods of time. Thus it provides an investment avenue for people who
wish to invest resources for a long period of time
8. Proper Regulation of Funds: Capital markets also helps in proper
allocation of resources. It can have regulation over the resources so that it can
direct funds in a qualitative manner.
9. Service Provision: As an important financial set up capital market provides
various types of services. It includes long term and medium term loans to
industry, underwriting services, consultancy services, export finance, etc.
These services help the manufacturing sector in a large spectrum.

CONSTITUENTS OF CAPITAL MARKET

Any Capital Market has two logical segments viz. primary and secondary.
A primary market is that segment of the market where new securities are
issued. These issues may not just be equity issues, they can also be debt
securities issued by companies in the form of bonds.
Secondary market is that segment of the market where trading of securities
issued in primary market happens.
Any efficient capital market of a country has many important player each
playing a vital role in smooth functioning of the market. Above is the pictorial
representation of the constituents in any mature capital market.

Issuer is a legal
entity that
develops,
registers and
sells securities
for the purpose
of financing its
operations.

a government official or
body that monitors the
behavior of companies
and the level of
competition in
particular industries

A merchant bank is a
financial institution that
provides capital to companies
in the form of share
ownership instead of loans.
also provides advisory on
corporate matters to the
firms they lend to.

DP an agent of
the depository.
They are the
intermediaries
between the
depository and
the investors.

a company, bank
or an institution
that holds and
facilitates the
exchange of
securities.

FUNDAMENTAL ANALYSIS
Fundamental analysis is a technique that attempts to determine a security's
value by focusing on underlying factors that affect a company's actual
business and its future prospects.
Fundamental analysis serves to answer questions, such as:
Is the company's revenue growing?
Is it actually making aprofit?
Is it in a strong-enough position to beat out its competitors in the future?
Is it able to repay itsdebts?
Is management trying to "cook the books"?
Fundamental analysis is all about getting an understanding of a company,
the health of its business and its future prospects.
It includes reading and analyzing annual reports and financial statements
to get an understanding of the company's comparative advantages,
competitors and its market environment.

By analyzing the financial reports from companies you will get an

understanding of the value of different companies and understand the
pricing in the stock market.
After analyzing these factors you have a better understanding of whether
the price of the stock is undervalued or overvalued at the current market
price.
Fundamental analysis can also be performed ona sectors basis and in
theeconomy as a whole.
Fundamental analysis is performed on historical and present data, but with
the goal of making financialforecasts.
There are several possible objectives:
to conduct a companystock valuationand predict its probable price
evolution,
to make a projection on its business performance,
to evaluate its management and make internal business decisions,
to calculate itscredit risk.

TECHNICAL ANALYSIS
Technical Analysis is the forecasting of future financial price movements
based on an examination of past price movements.
Like weather forecasting, technical analysis does not result in absolute
predictions about the future.
Instead, technical analysis can help investors anticipate what is "likely" to
happen to prices over time.
Technical analysis uses a wide variety of charts that show price over time.
Technical analysis is applicable to stocks, indices, commodities, futures or
any tradable instrument where the price is influenced by the forces of
supply and demand
Technicians (sometimes calledchartists) are only interested in the price
movements in the market.

Technical analysts essentially look for trends in the

market.
Their basic assumption is that price of a stock
already has all information priced into it and that a
stock is either always 'trending' up, down, or
sideways.
Prices move in patterns and price action repeats
itself. Charts are frequently used by technical
analysts to help m
Technical analysis uses historical stock statistics,
usually price and volume data, to forecast future
prices.
In layman's terms, a technical analyst finds a
pattern in a stock's data, makes the assumption
that the pattern is going to repeat into the
foreseeable future, and accordingly places his/her
trade in the direction signalled by the pattern

VENTURE CAPITAL
VC is the money provided by investors to startup firms and small businesses
with perceived long-term growth potential.
This is a very important source of funding for startups that do not have access to
capital markets.
It typically entails high risk for the investor, but it has the potential for aboveaverage returns.
Venture Capital is a form of "risk capital". In other words, capital that is invested
in a project (in this case - a business) where there is a substantial element of risk
relating to the future creation of profits and cash flows.
Venture capital provides long-term, committed share capital, to help unquoted
companies grow and succeed. If an entrepreneur is looking to start-up, expand,
buy-into a business, buy-out a business in which he works, turnaround or
revitalise a company, venture capital could help do this.
Venture capital combines the qualities of a banker, stock market investor and
entrepreneur in one.

FEATURES OF VENTURE CAPITAL

High Degrees of Risk: Venture capital represents financial investment in a
highly risky project with the objective of earning a high rate of return.
Equity Participation: Venture capital financing. is, invariably, an actual or
potential equity participation wherein the objective of venture capitalist is to
make capital gain by selling the shares once the firm becomes profitable
Long Term Investment Venture capital financing is a long term investment.
It generally takes a long period to encash the investment in securities made by
the venture capitalists.
Participation in Management In addition to providing capital, venture
capital funds take an active interest in the management of the assisted firms.
Achieve Social Objectives VC projects generate employment, and balanced
regional growth indirectly due to setting up of successful new business.
Investment is liquid A venture capital is not subject to repayment on demand
as with an overdraft or following a loan repayment schedule. The investment is
realised only when the company is sold or achieves a stock market listing.

FUTURES
A standardized, transferable, exchange-traded contract that requires delivery
of a commodity, bond, currency, or stock index, at a specified price, on a
specified future date.
Unlike options, futures convey an obligation to buy.
The risk to the holder is unlimited, and because the payoff pattern is
symmetrical, the risk to the seller is unlimited as well.
Dollars lost and gained by each party on a futures contract are equal and
opposite.
Futures contracts are forward contracts, meaning they represent a pledge to
make a certain transaction at a future date.
The exchange of assets occurs on the date specified in the contract.
Also, in order to insure that payment will occur, futures have a margin
requirement that must be settled daily. Finally, by making an offsetting trade,
taking delivery of goods, or arranging for an exchange of goods, futures
contracts can be closed.

OPTIONS
A financial derivative that represents a contract sold by one party (option
writer) to another party (option holder).
The contract offers the buyer the right, but not the obligation, to buy (call) or
sell (put) a security or other financial asset at an agreed-upon price (the
strike price) during a certain period of time or on a specific date (exercise
date).
Call options give the option to buy at certain price, so the buyer would want
the stock to go up.
Put options give the option to sell at a certain price, so the buyer would want
the stock to go down.
Traders use options to speculate, which is a relatively risky practice, while
hedgers use options to reduce the risk of holding an asset.

DEMAT (DEMATERIALIZED)

DEMAT Account refers to a deposit made at an Indian financial institution that

can be used for investing in shares of stocks and other financial assets.
Securities are held electronically in a DEMAT Account, thereby eliminating the
need for physical paper certificates.
The move from physical certificates to electronic book keeping. Actual stock
certificates are slowly being removed and retired from circulation in exchange
for electronic recording.
a DEMAT Account became available after India adopted the DEMAT system for
the electronic storing of stock shares and other securities in 1996.
Such accounts require that an investor open an account with an investment
broker linked to a savings or other funded account.
Access to a DEMAT Account requires both an Internet and transaction
password, and such accounts allow for the transfer of securities without any
physical certificates changing hands.