FINANCIAL MANAGEMENT-

AN OVERVIEW
 CONTENTS
 Introduction
 Nature and Scope of Financial Management
 Role of finance function
 Finance decisions for the firm
• Investment decisions
• Financing decisions
• Dividend decisions
• Working capital decisions
 Integrated view of finance decision-making
 Financial decision making framework
 CONTENTS

 Key issues in financial decision making

 Objective function in finance
 Agency cost and Corporate Governance
 Financial Management and Accounting
 Financial objectives and organisational
strategy
 I NTRODUCTION
 Basic issues in finance are essentially the
same for diverse businesses.
 The key issues in finance are:
• Where to raise financial resources from?
• Wherein to invest the resources?
• How best to manage the production-
distribution function?
• How much of profit to distribute and how
much to retain?
N ATURE A ND S COPE O F F INANCIAL
M ANAGEMENT

 Concerned with the management of

financial resources.
 Performs facilitation, reconciliation,
and control functions.
 Covers all decisions having monetary
implications.
 The finance manager is on the top and
not on the tap.’
R OLE O F F INANCE F UNCTION

 Finance is central to all business

activities.
 Finance function reconciles the
conflicting interests of:
• varied stakeholders and
• different functional units.
 C ORPORATE S TRUCTURE

Sole Proprietorships
Unlimited Liability
Personal tax on profits
Partnerships

Limited Liability

Corporations Corporate tax on profits +

Personal tax on dividends
 R OLE OF T HE F INANCIAL
M ANAGER
(2) (1)

Firm's Financial Financial

(4a)
operations manager markets

(3) (4b)

(1) Cash raised from investors

(2) Cash invested in firm
(3) Cash generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors
 W HO IS T HE F INANCIAL
M ANAGER ?

Chief Financial Officer

Treasurer Comptroller
 O WNERSHIP VS .
M ANAGEMENT

Difference in Information Different Objectives

 Stock prices and returns  Managers vs. stockholders

 Issues of shares and other  Top mgmt vs. operating

securities mgmt

 Dividends  Stockholders vs. banks and

lenders
 Financing
FINANCE DECISIONS FOR
THE FIRM

 Financial decision-making involves

procurement of funds and their
optimal utilization through:
• Investment
• Financing
• Dividend and
• Working capital decisions.
 I NVESTMENT D ECISIONS

 Aim at selecting the most productive avenues

that maximize the ROI.
 Examples include:
• Expansion
• Modernization and replacement
• R&D expenditure.

 Also referred to as capital budgeting decisions.

 Are critical for long-term survival and growth.
 I NVESTMENT D ECISIONS

 Are taken in the light of their probable

impact on the wealth of shareholders.
 Involve huge capital outlay.
 Have long-term implications.
 Are usually irreversible.
 F INANCING D ECISIONS

 Vaguely referred to as capital structure

decisions.
 Mainly concerned with:
• Identifying the suitable sources of funds
• Tapping of these sources.
 Determine the financial risk.
 Thrust is to bring down the cost of
financing.
 F INANCING D ECISIONS

 The main issues involved are:

• Where from to procure the requisite funds?
• What should be the optimal mix of various
sources of capital?
• How much should be the proportion of
short-term and long-term funds?
• How do the expectations of providers of
each source of capital change with
alteration in the capital mix?
 F INANCING D ECISIONS

 Are taken in the light of their likely

impact on the wealth of the
stockholders.
 A right blend of debt–equity affects the
risk return profile of the business.
 D IVIDEND D ECISIONS

 Are mainly concerned with deciding the mix of

profits to be distributed as dividends and those to
be ploughed back for future financing needs of
business.

 Depend on trade off between future financing

needs of the firm and current consumption
requirements of the shareholders.

 Generally, firms in sectors with a high-growth rate

follow a policy of high retention and low payout.
 D IVIDEND D ECISIONS
 Determining the payout ratio and the method of
dividend payment are the two concerns of
dividend policy.
 The payout ratio is decided in the light of its
probable impact on shareholders’ wealth
 Normally, firms follow a policy of stable dividends
 Dividend policy is considered as a residue of
investment and financing policy.
 W ORKING C APITAL
D ECISIONS

 Are concerned with the management of

current assets.
 The two key decision points in working
capital management are:
• Level of investment in current assets
• Financing of current assets.
I NTEGRATED V IEW O F F INANCE
D ECISION - MAKING

 The four key decision areas in finance are

the part of an integrated decision making
framework in finance.
 They are directly linked and reinforce
each other.
 All the decisions have a common
objective function-shareholders’ wealth
maximization.
F INANCIAL D ECISION M AKING
F RAMEWORK
 K EY I SSUES I N
F INANCIAL D ECISION - MAKING
Investmen • What business to be in?
t Decision • What growth rate is appropriate?
• What assets to acquire?
Financing • What mix of debt and equity to be used?
Decision • Can we change value of the firm by changing the capital
mix?
• Is there an optimal debt–equity mix?
Dividend • How much of the profit should be distributed as
Decision dividends and how much should be ploughed back
• Can we change value of the firm by changing the
amount of dividend?
• What should be the mode of dividend payment
Working • What level of inventory is ideal?
Capital • What level of credit should be given to the customers?
Decision • What level of cash should be maintained?
• How can the blockage of funds in the current assets be
minimized without compromising with profits?
 O BJECTIVE F UNCTION I N
F INANCE

 The goal of wealth maximization is the

widely accepted goal of the business.
 It reconciles the varied, often conflicting,
interest of the stakeholders.
 It is free from the limitations that other
objectives are faced with.
 A GENCY C OSTS A ND
C ORPORATE G OVERNANCE

 The stakeholders in business are multiple, their

stakes are varied and their objectives are often
conflicting.

 Conflict of interest between the varied

stakeholders causes agency problems.

 To resolve such agency problems monitoring

and control mechanisms become imperative.
 AGENCY COSTS AND
CORPORATE GOVERNANCE

 Such mechanisms entail costs that are

termed as agency costs.
 Agency costs take the form of either
incentives to management like bonuses,
stock options or monitoring and control
costs like audit fees, credit rating fees etc.
 AGENCY COSTS AND
CORPORATE GOVERNANCE

 Corporate governance is another

mechanism to protect the interest of
the shareholders.
 Set of rules, processes, and customs
that enable the effective management
of firms in the best interest of
shareholders are termed as corporate
governance.
FINANCIAL MANAGEMENT AND
ACCOUNTING

 Financial management is intricately

related to financial and management
accounting.
 The accounting information provides
inputs for financial decision making.
 Financial decisions in turn get
reflected in the accounting
statements.
F INANCIAL M ANAGEMENT A ND
A CCOUNTING
F INANCIAL O BJECTIVES A ND
O RGANIZATIONAL S TRATEGY