Financial management

1. Financial management Rajendra Prasad Nepal

2. Content Outline • Concept • Importance • Objectives • Natures • Function • Functional Areas • Key Elements • Role of CFO • Relation with other discipline

3. Income and Expenses • Income - Cash Inflow - Money Comes to you (us) • Source of Income: Three way to earn Income: • Selling Labor/idea (Working} • Selling capital (Investing) • Renting Capital (Lending to get income) • Expenses - Cash outflow:Money goes from you (US) • Housing, Transportation, entertainment, assets

4. Surplus vs Deficit • Income greater than Expenses = Budget Surplus we like (desired Situation). We invest • Income less than Expenses = Budget Deficit we don’t like (Undesired Situation). Cut your Expenses or Increase your Income (search 2nd Job).

5. Finance • Finance may be defined as the position of money at the time it is wanted. • Financing consists in the raising, providing, managing of all the money, capital or funds of any kind to be used in connection with the business. • The term ‘business finance’ is very comprehensive. • It implies finances of business activities. • The term, ‘business’ can be categorized into three groups: commerce, industry and service. It is a process of raising, providing and managing of all the money to be used in connection with business activities.

6. Why do we need Finance? • To start Business/Organization. Establishment. • To run a business. Survival. • To Expand, to modernize, to diversify. • To buy assets: Tangible, Intangible (Tangible- touchable ie machinery, furniture. Intangible- untouchable ie trade mark, goodwill). • To run day to day business activities.

7. Financial Management • Management of Finance or the funds. Manage Money. • Two words: Finance and Management. • Finance how to acquire and utilize. How to get and use. • Management: Planning, Organizing, Directing and Control (PODC).

8. Financial Management • Financial Management is Planning, Organizing, Directing and Controlling of Raising of funds, Investment of funds and Distribution of funds for achieving goals of organization. OR • Financial Management is Planning, Organizing, Directing and Controlling of the procurement, utilization of funds and disposal of profit so that individual, organizational and social objectives are achieved. • (Money: from where to acquire? Where to invest? for why and how? How to utilize profit? so that individual, organizational and social objectives are achieved).

9. Financial Management • Financial Management is concerned with PODC of financial activities of the business. It is the study of problems involved in the use and acquisition of Funds. • Financial Management is one of the functional areas of management. • Financial management is at the heart of running a successful business. It affects every aspect, from managing cash flow and tracking business performance to developing plans that ensure that business owners can make the most of opportunities.

10. Importance of Financial Management • Financial management is an integral part of overall management rather than merely a staff activity concerned with fund raising operations. • Financial manager occupies a central position in any business firm • Financial management involves the application of all managerial functions. • Planning, organizing , directing and controlling the use of financial resources in order to ensure optimum efficiency of operations and establish cordial relations with financiers, suppliers, workers and members. Co-ordination of operations of different departments of the business. Control through appropriate measures to secure financial discipline in the use of available financial resources.

11. Importance of Financial Management • Financial management is important mainly because it helps to make decisions towards the maximization of value of the firm . Financial management helps: • Financial Planning and Setting Clear Goal • Deciding Sources Of Financing / Acquisition of Funds. • Efficient Utilization Of Resources • Making Dividend Decision • In brief, Financial Planning, Acquisition of Funds, Proper Use of Funds, Financial Decision, Improve Profitability, Increase the Value of the Firm, Promoting Savings.

12. Objectives of Financial Management There are two schools of thought • Traditional: Profit maximization • Modern: Wealth maximization • The term ‘profit maximization’ implies generation of largest amount of profits over the time period. (Large amount of profits) • Wealth Maximisation refers to all the efforts put in for maximizing the net present value (i.e. wealth) of any particular course of action which is just the difference between the gross present value of its benefits and the amount of investment required to achieve such benefits. (Highest market value of common stock)

13. Objectives of Financial Management • Traditional thinkers believe that profit is appropriate yardstick to measure operational efficiency of an enterprise. They are of the view that a firm should undertake only those activities that increase the profit. • The primary objective of a business is to earn profit; hence the objective of financial management is also profit maximisation. If profit is given undue importance, a number of problems can arise, such as • It does not take into account the time pattern of returns. • It fails to take into account the social consideration to workers, customers etc.

14. Objectives of Financial Management • To day, most of large business under taking witness a divergence between ownership and management and business is dependent largely on loan and borrowed funds and only a small fraction being financed out of owners funds. Hence, profit maximization will only act as a narrow objective. • In view of above, modern thinkers consider wealth maximization as key objective of financial management. This is also known as ralue maximization or net present worth maximizations.

15. Objectives of Financial Management • In wealth maximisation business firm maximise its market value, it implies that business decision should seek to increase the net present value of the economic profit of the firm. • It is the duty of the finance manager to see that the share holders get good return on the share (EPS Earning per Share). Hence, the value of the share should increase in the stock market. • The wealth maximisation objective is generally in accord with the interest of the various groups such as owners, employees etc.

16. Objectives of Financial Management The other objectives of financial management include • To build up reserves for growth and expansion, • To ensure a fair return to shareholders and • To ensure maximum operational efficiency by efficient and effective utilization of finances.

17. Nature of Financial Management Financial management is applicable to every type of organization, size, kind or nature. Every organization aims to utilize its resources in a best possible and profitable way. • It is a centralized function • Helpful in decisions of top management • It applicable to all types of concerns. • It needs financial planning, control and follow-up. • Its function is different from accounting function • It is an essential organ of business management. • It related with different disciplines like economics, accounting, law, information technology, mathematics etc.

18. Nature of Financial Management • Financial Management is an integral part of overall management. Financial considerations are involved in all business decisions. Acquisition, maintenance, removal or replacement of assets, employee compensation, sources and costs of different capital, production, marketing, finance and personnel decision, almost all decisions for that matter have financial implications. • Financial management is a sub-system of the institutional system which has other subsystems like academic activities, research wing, etc., In systems arrangement financial sub-system is to be well coordinated with others and other sub-systems well matched with the financial sub-system.

19. Nature of Financial Management • Financial management essentially involves risk-return trade-off. Decisions on investment involve choosing that types of assets which generate returns accompanied by risks. Generally higher the risk returns might be higher benefits and vice versa. • Financial management is a concern of every concern. Finance functions, i.e., investment, raising of capital, distribution of profit, are performed in all firms - business or non-business, big or small, proprietary or corporate undertakings.

20. Nature of Financial Management • The central focus of financial management is valuation of the firm. Financial decisions are directed at increasing/ maximization/ optimizing the value of the institution. • Financial management affects the survival, growth and vitality of the institution • Financial management of an institution is influenced by the external legal and economic environment. The legal constraints on using a particular type of funds or on investing in a particular type of activity, etc., affect financial decisions of the institution. Financial management is, therefore, highly influenced/constrained by external environment.

21. Nature of Financial Management • The nature of finance function is influenced by the special characteristic of the business. In a predominantly technology oriented institutions it is the R & D functions which get more dominance, while in a university or college the different courses offered and research which get more priority and so on.

22. Function of Financial Management Function of Financial Management basically means the decisions involved in a business firm (organization). The main decisions involved in a business firm are: • Investment Decision. • Financing Decision including Dividend decision.

23. Investment decision / Capital Budgeting Decisions • Investment Decision relates to the determination of total amount of assets to be held in the firm, the composition of these assets and the business risk complexities of the firm as perceived by the investors. It is the most important financial decision. Since funds involve cost and are available in a limited quantity, its proper utilization is very necessary to achieve the goal of wealth maximasation.

24. Investment decision • Investment decision more specifically related with: Management of working Capital, Capital Budgeting Decisions, Management of Merger, reorganization, disinvestment etc, Buy or Lease decision, Securities Analysis and portfolio management (Portfolio management refers to managing investments in the form of bonds, shares, cash, mutual funds etc so that he earns the maximum profits) . • Identify need of finance. How much do I have? How much do I Need? • Identify Source of income. (Borrow funds or Shareholder funds) • Comparison in-between different source. (Risk and Cost). • Investment: where are funds may be invested?

25. Investment decision • The investment decisions can be classified under two broad groups; (i) long-term investment decision and (ii) Short-term, in vestment decision. • The long-term investment decision is referred to as the capital budgeting and the short-term investment decision as working capital management. • Capital budgeting is the process of making investment decisions in capital expenditure. These are expenditures, the benefits of which are expected to be received over a long period of time exceeding one year.

26. Investment decision • The investment decision is important not only for the setting up of new units but also for the expansion of present units, replacement of permanent assets, research and development project costs, and reallocation of funds, in case, investments made earlier, do not fetch result as anticipated earlier. • Investment Decision relates to the determination of total amount of assets to be held in the firm, the composition of these assets and the business risk complexities of the firm as perceived by the investors.

27. Financing decision/ Capital structure decision. • It includes both financing and dividend decision. • How should the business firm/ organization/ company pay for the investments it makes?. • It also known as capital structure decision. • It involves the choosing the best source of rising funds and deciding optimal mix of various source of finance. • A business firm can not depend upon only one source of finance.Hence a varied financial structure is developed. But before using any particular source of capital, its relative cost of capital, degree of risk and control etc should be thoroughly examined.

28. Financing decision • The major sources of long term capital are shares and debentures. • Firms regularly make new investments, the needs for financing and financial decisions are on going, Hence, a firm will be continuously planning for new financial needs. • The financing decision is not only concerned with how best to finance new asset, but also concerned with the best overall mix of financing for the firm.

29. Financing decision • A finance manager has to select such sources of funds which will make optimum capital structure. • The important thing to be decided here is the proportion of various sources in the overall capital mix of the firm.

30. Dividend decision • The third major financial decision relates to the disbursement of profits back to investors who supplied capital to the firm. • What should be done with the profit of the business? • The Dividend decision is concerned with determining how much part of the earning should be distributed among the shareholders by way of dividend and how much should be retained in the business for meeting the future needs of funds internally.

31. Dividend decision • The term dividend refers to that part of profits of a company which is distributed by it among its shareholders. • It is the reward of shareholders for investments made by them in the share capital of the company. • The dividend decision is concerned with the quantum of profits to be distributed among shareholders.

32. Dividend decision • A decision has to be taken whether ail the profits are to be distributed, to retain all the profits in business or to keep a part of profits in the business and distribute others among shareholders. • The higher rate of dividend may raise the market price of shares and thus, maximize the wealth of shareholders. • The firm should also consider the question of dividend stability, stock dividend (bonus shares) and cash dividend.

33. Liquidity Decisions • Liquidity and profitability are closely related. • The finance manager always perceives / faces the task of balancing liquidity and profitability. • The term liquidity implies the ability of the firm to meet bills and the firm’s cash reserves to meet emergencies. Whereas the profitability means the ability of the firm to obtain highest returns within the funds available. • If a finance manager wants to meet all the bills, then profitability will decline similarly where he wants to invest funds in short term securities he may not be having adequate funds to pay-off its creditors. Lack of liquidity in extreme situations can lead to the firm’s insolvency.

34. FUNCTIONAL AREAS OF FINANCIAL MANAGEMENT • Capital Budgeting • Working Capital Management • Dividend Policies • Acquisitions and Mergers • Corporate Taxation • Determining Financial Needs • Determining Sources of Funds • Financial Analysis • Optimal Capital Structure • Cost Volume Profit Analysis • Profit Planning and Control • Fixed Assets Management • Project Planning and Evaluation.

35. Key elements of Financial Management • There are three key elements to the process of financial management: • Financial Planning • Financial Control • Financial Decision-making (The key aspects of financial decision-making relate to investment, financing and dividends)

36. Chief Finance Officer/ Finance Manager • CFO is an integral part of corporate management of an organization. He occupies a very important position. He is expecting to manage the funds in such a manner as to ensure their proper utilization. • With his profession experience, expertise knowledge and competence, he has to play a key role in optimal utilization of financial resources of the organization. • As the size of organization grow and volume of financial transactions increases, his role and functions assumes greater importance.

37. Major functions of Chief Finance Officer Primary functions Subsidiary functions Maintaining liquidity Profitability Evaluation of financial performance & reporting Upkeep of records and other routine • Management functions: Planning, Organizing, Directing, Coordination, Controlling • Functions relating to finance: i. Acquisition/raising of funds ii. Allocation/ investment of funds iii. Distribution of income (profit)

38. Major functions of Chief Finance Officer Functions of Modern Age CFO : • Achieving corporate goals – Besides goals of organization. goals of different departments have to be achieved. • Financial projections– for next 5-10 years consisting of cost and revenues for coming long term period keeping in view companies long term plans. • Corporate Governance – for image building in the eyes of all stake holders of the company, transparency in systems / procedure and adherence of laws as well as rules and regulations.

39. Major functions of Chief Finance Officer 4. Merger and acquisitions initiative – for - Including new product lines - Technological tie-up/ collaboration with foreign firms - Financial restructuring for incrcasing profitability - Tie-up arrangements for greater penetration in new markets in the country & abroad. 5. Risk management – Preparing strategies for combating risks arising out of - internal & - external factors . A CFO has to keep close eyes on risk factors. 6. Financial engineering - A CFO has to keep himself abreast with new techniques of financial analysis and new financial instruments coming in market. In financial engineering, a CFO has to work on finding out solutions to the problem through complex mathematical models and high speed computer solutions.

40. Major functions of Chief Finance Officer • Estimating requirement of funds. • Decision regarding Capital Structure. • Investment decisions • Divident decision • Managing Assets • Managing Funds • Maximising wealth of company. • Evaluating financial performance with return on investment • Financial negotiations with Bank, Financial Institutions etc • Keeping touch with Stock Exchanges • Managing the Flow of Internal Funds

41. Relationship with other discipline • Financial Accounting: It is concerned with the preparation of reports which provide information to users outside the firm. The main objective of these-reports is to inform stockholders, creditors and other investors how assets are controlled by a firm. In the light of the financial statements and certain other information, the accountant prepares funds film statement, cash flow statement and budgets. • Cost Accounting: It deals primarily with cost data. It is the process of classifying, recording, allocating and reporting the various costs incurred in the operation of an enterprise. It includes a detailed system of control for material, labour and overheads. Budgetary control and standard casting are integral part of cost accounting. The purpose of cost accounting is to provide information to the management for decision making, planning and control. It facilitates cost reduction and cost control. It involves reporting of cost data to the management.

42. Relationship with other discipline • Management Accounting: It refers to accounting for the management. It provides necessary information to assist the management in the creation of policy and in the day to day operations. It enables the management to discharge all its functions, namely, planning, organizing, staffing, direction and control efficiently with the help of accounting information. Functions of management accounting include all activities connected with collecting, processing, interpreting and presenting information to the management. • Financial Management is concerned with raising funds providing a return to investors.

43. Relationship with other discipline • Financial accounting: Historic,concerned with identification, decording, classifying, summarising and analysis financial transaction (ratio, trend) • Cost accounting: Deals primarily with cost data. Provide information to the management for decision making, planning and control. Facilitates cost reduction and control. • Management Accounting: Providing relevent information to management for assisting the in decision making • Financial Management: Futuristic, Focus on cash Flow, Play with risk and hope for both maximization wealth and profit.