Chapter 1 (fm)

UNIT1: INTRODUCTION TO FINANCIAL MANAGEMENT FM is a managerial activity concerned with planning and controlling of a firm’s financial resources.

FINANCE FUNCTIONS 1. Financing decision: Raising funds. 2. Investment decision: Investing them in assets. 3. Distribution decision: Distributing returns earned from assets to shareholders 4. A firm also tries to balance cash inflows and outflows which performing these functions known as liquidity decisions.

Overview of Finance Functions

Capital Budgeting 1. Strategic Planning: Define the businesses it wants to be in. 2. Allocation of Capital: Buildings, machinery, Equipments, R & D, Distribution Network, Brands. This is known as the Capital Budgeting Decision Two important aspects of investment decision include: (a) Evaluation of prospective yield/ profitability of new investments: Expected Return (b) Measurement of cut –off rate against which prospective rate is evaluated: Risk

Capital Structure The central issue is to determine the appropriate proportion of equity and debt known as a firm’s capital structure. Firm considers factors such as control, flexibility, loan covenants, legal aspects in deciding its optimum capital structure.

Dividend Decision The decision whether to distribute all profits, return them or distribute a portion and retain the balance. Optimum – dividend policy maximizes market value of shares.

Liquidity Decisions Current Asset Management affects a firm’s liquidity and profitability. Profitability – liquidity trade off requires a finance manager to develop sound techniques of managing current assets.

Interface between Finance and Other Functions FM is an integral part of job of managersplanning, allocation of resource, control. Specialists: • The treasurer-for financing and investment activities (obtaining finance, banking relationship, cash management, credit administration and capital budgeting) • The controller-accounting and control (financial accounting, internal audit, taxation, management accounting, control)

Organization of Finance Function

Organization of Finance Function (Multi – Divisional Company)

Other Finance Functions CFO’s has line and staff responsibilities. A no. of companies in India either has Finance Director or a Vice – President of Finance operating as CFO. Other functions routinely performed: • Supervision of cash receipts & payments and safeguarding of cash balances. • Custody and safeguarding of securities, insurance policies & other valuable papers. • Taking care of mechanical detail of new outside financing. • Record keeping & Reporting.

Financial Goals: Profit Maximization vs. Wealth Maximization • The financial goal of a firm should be Shareholder’s Wealth Maximization (SWM), reflected in the market value of shares. • In economic theory the behaviour of a firm is analyzed in terms of profit maximization-input/output. • However, profit maximization suffers from the following limitations: 4. It is ambiguous. 5. It ignores timing of returns 6. It ignores risk. • SWM is consistent with survival goal meeting the personal objectives of managers: recognition, power, status and personal wealth.

Shareholders Wealth Maximization • SWM mean maximizing the Net Present Value (NPV) or Wealth of a course of action. • The finance manager maximizes returns in relation to given risk. Management act as agents of owners and trustees of various stakeholders of an economic unit. • The financial reporting system must be designed to provide a timely and accurate picture of the firm’s activities. • The first step in decision making is to see that it is consistent with firm’s strategy (technology, leadership, productivity, market standing, image, employee satisfaction ) followed by second level criterion of SWM.