Introduc on to Finance Management Notes and Sources of Financing

What is Finance Management?

Financial Management Comprises of:

 Forecasting
 Planning
 Organising
 Directing
 Co-ordinating and Controlling

All the activities relating to acquisition and application of the financial resources of
an undertaking in keeping with financial objective.

So, Finance Function = f (I, F, D) wherein

I = Investing Decisions
F= Financing Decision
D = Dividend Decision

Investing Decisions
Investing decisions are a crucial aspect of financial management and are closely tied
to the overall financial strategy of a business or an individual. These decisions
involve allocating funds to various investment options with the goal of maximizing
returns while managing risk.
Here's an explanation of investing decisions as a function of financial management:
Objective Alignment:
Investing decisions should align with the overall financial objectives of the entity,
whether it's a company or an individual. Objectives could include wealth
maximization, capital growth, income generation, or a combination of these.
Risk and Return Considerations:
Financial managers assess the risk and return associated with different investment
options. Higher returns often come with higher risk, and finding the right balance is
crucial. The risk appetite of the investor or the organization plays a significant role
in making investment decisions.

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Diversification:
Financial managers use diversification strategies to spread risk across various types
of assets or investment instruments. Diversifying the investment portfolio can help
reduce the impact of poor performance in any single investment.
Time Horizon:
Investment decisions are influenced by the time horizon for achieving financial
goals. Different investments have varying time frames for returns, and financial
managers consider the time sensitivity of their objectives.
Liquidity Requirements:
Financial managers evaluate the liquidity needs of the entity. They consider how
quickly assets can be converted into cash without significant loss, ensuring that
there is sufficient liquidity to meet short-term obligations.
Cost of Capital:
Companies assess their cost of capital when making investment decisions. This
involves evaluating the return required by investors to justify the cost of obtaining
funds for investment.
Capital Budgeting:
Investing decisions often involve capital budgeting, which includes evaluating and
selecting long-term investment projects. This may involve comparing the net
present value (NPV), internal rate of return (IRR), and payback period of different
projects.
Market Conditions:
Financial managers monitor market conditions and economic trends that may
impact investment decisions. External factors such as interest rates, inflation, and
geopolitical events can influence the performance of various assets.
Regulatory Compliance:
Investment decisions need to comply with relevant financial regulations and legal
requirements. Financial managers must be aware of and adhere to regulations
governing investments in specific industries or regions.
Environmental, Social, and Governance (ESG) Factors:

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Increasingly, financial managers consider ESG factors in investment decisions.

They assess how investments align with environmental, social, and governance
principles, reflecting a broader commitment to sustainability and ethical
considerations.
Monitoring and Adjusting:
Financial managers continuously monitor the performance of investments and
adjust the portfolio as needed. Regular reviews ensure that the investment strategy
remains aligned with changing financial goals and market conditions.
In summary, investing decisions in financial management involve a strategic
approach to allocating resources to different assets or projects with the aim of
optimizing returns and managing risk in accordance with the entity's financial
goals and constraints.

Financing Decisions:
Financing decisions are a crucial aspect of financial management that involves
determining the most appropriate sources of funds to meet the financial needs of a
business or individual. These decisions play a fundamental role in shaping the capital
structure and overall financial health of an entity.
Here's an explanation of financing decisions as a function of financial management:
Capital Structure Planning:
Financing decisions involve determining the optimal mix of equity and debt that will
make up the capital structure. Financial managers need to strike a balance between
equity, which represents ownership, and debt, which represents borrowed funds.
Cost of Capital Management:
Financial managers aim to minimize the cost of capital, which is the cost associated
with obtaining funds. This involves evaluating the cost of equity and the cost of debt
and determining the weighted average cost of capital (WACC).
Debt Issuance and Management:
Decisions related to issuing debt involve choosing the appropriate type of debt
instruments, such as bonds or loans, and negotiating favorable terms with lenders.
Financial managers also focus on managing and servicing the debt effectively.

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Equity Issuance and Management:

When considering equity financing, financial managers decide on the issuance of
new shares of stock. This may involve initial public offerings (IPOs), secondary
offerings, or private placements. The goal is to raise capital while maintaining or
enhancing shareholder value.
Dividend Policy:
Financing decisions include establishing a dividend policy, which involves
determining the portion of profits that will be distributed to shareholders as
dividends versus retained for reinvestment. The decision is influenced by the
organization's need for funds and the preferences of shareholders.
Short-Term Financing:
Financial managers must decide on appropriate sources of short-term financing to
meet operational needs. This may involve utilizing trade credit, bank loans, or other
short-term instruments to address working capital requirements.
Long-Term Financing:
For long-term projects and capital expenditures, financial managers assess the
feasibility of long-term financing options. This may include issuing bonds, obtaining
loans, or pursuing equity financing for projects with extended timelines.
Risk Considerations:
Financial managers evaluate the risk associated with different financing options.
This includes assessing the risk tolerance of the organization or individual and
choosing financing instruments that align with risk management objectives.
Leverage Management:
Decisions related to leverage involve determining the appropriate level of debt
relative to equity in the capital structure. Financial managers assess the impact of
leverage on the risk and return profile of the organization.
Financial Restructuring:
Financial managers may engage in financial restructuring, which involves making
changes to the capital structure to enhance efficiency and value. This could include
debt refinancing, share buybacks, or other initiatives to optimize the financial
structure.

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Compliance and Governance:

Financing decisions must comply with regulatory requirements and governance
standards. Financial managers ensure that the financing strategy aligns with legal
and ethical considerations.
Market Conditions and Investor Relations:
Financial managers consider market conditions and maintain effective
communication with investors. They assess the availability of funds in the market
and aim to present the organization as an attractive investment opportunity.
In summary, financing decisions in financial management encompass a range of
strategic choices related to obtaining funds to support the operations and growth of
an entity. These decisions impact the cost of capital, capital structure, and overall
financial stability of the organization or individual. The goal is to secure funds in a
manner that aligns with financial objectives while managing risk effectively.

Dividend Decisions
Dividend decisions are a crucial aspect of financial management, involving the
determination of how much of a company's earnings will be distributed to
shareholders in the form of dividends and how much will be retained for
reinvestment in the business. These decisions significantly impact the wealth of
shareholders and the financial health of the company. Here's an explanation of
dividend decisions as a function of financial management:
Dividend Policy Formulation:
Financial managers play a key role in formulating the dividend policy of the
company. This involves deciding on the percentage of earnings to be distributed as
dividends and the frequency of dividend payments.
Wealth Maximization:
The primary objective of dividend decisions is often to maximize shareholder
wealth. Financial managers evaluate the optimal dividend payout that balances the
interests of shareholders with the need for retained earnings for growth and
investment.
Stability of Dividends:

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Financial managers decide whether to maintain a stable dividend policy, where

dividends are paid consistently, or adopt a variable policy based on earnings
performance. The stability of dividends influences investor confidence and
expectations.
Dividend Yield Considerations:
Financial managers consider the dividend yield, which is the dividend per share
divided by the market price per share. This metric is important for income-seeking
investors and impacts the attractiveness of the company's stock.
Reinvestment Opportunities:
Dividend decisions are influenced by the availability of profitable reinvestment
opportunities. Financial managers assess whether retaining earnings for future
projects or share buybacks would generate higher returns than distributing
dividends.
Earnings Stability:
Dividend decisions are affected by the stability of a company's earnings. Companies
with stable and predictable earnings may be more inclined to adopt a regular
dividend policy, while those with variable earnings may opt for a more flexible
approach.
Tax Implications:
Financial managers consider the tax implications of dividend payments for both the
company and shareholders. In some cases, companies may choose to repurchase
shares or issue stock dividends as alternatives to cash dividends.
Cash Flow Considerations:
Dividend decisions are contingent on the company's cash flow position. Financial
managers assess whether there is sufficient cash to cover dividend payments without
compromising the company's liquidity and financial stability.
Investor Preferences:
Financial managers take into account the preferences of different classes of
investors. Some investors may prefer regular income through dividends, while others
may prioritize capital appreciation. Dividend decisions aim to strike a balance.
Legal and Regulatory Compliance:

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Dividend decisions must comply with legal and regulatory requirements. Financial
managers ensure that dividend distributions adhere to corporate laws and regulations
to avoid legal issues.
Residual Dividend Model:
Financial managers may use the residual dividend model, which suggests that
dividends should be paid from residual earnings after covering capital expenditures
and other investments. This approach emphasizes the importance of investment
opportunities.
Stock Repurchase Decisions:
Financial managers decide whether to allocate funds for stock repurchases. Stock
buybacks can be an alternative to or complement dividend payments, providing a
way to return value to shareholders.
Communication with Shareholders:
Financial managers play a role in effectively communicating the company's dividend
policy to shareholders. Clear communication helps manage expectations and
influences investor perceptions.
Earnings Retention for Growth:
Financial managers assess the need for earnings retention to fund growth initiatives.
Retaining earnings can provide the company with resources for capital expenditures,
research and development, and other strategic projects.
Dividend Reinvestment Plans (DRIPs):
Financial managers may consider implementing Dividend Reinvestment Plans,
allowing shareholders to reinvest their dividends in additional shares of the
company's stock. This encourages long-term ownership and capitalizes on the power
of compounding.
In summary, dividend decisions in financial management involve a careful
evaluation of factors such as shareholder wealth maximization, earnings stability,
reinvestment opportunities, tax implications, and legal compliance. Financial
managers aim to strike a balance between distributing dividends to shareholders and
retaining earnings for the sustainable growth and success of the company.

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More about Functions of Finance Management:

The main function of Finance Management is maximization of Shareholder’s
wealth. Financing Decisions involve Financing Decision, Investment decision and
Dividend Decision.
Financing Decision involve procurements of Funds. Funds can be procured from
different sources of finance. The details of Sources of Finance are as follows:
Sources of Funds / Procurement of Funds

Particulars Risk Cost Other aspects

Equity Low Expensive Not allowed as expense for
Income tax Purposes
Debentures High Low cost as Allowed as expense for
compared to equity income tax purposes
Funding from High Low cost as per Allowed as expense for
Banks prevailing Interest income tax purposes
rates
International High Depends and varies Depends on nature of
Funding from country to investment
country

Once the funds are procured, they are invested in projects considering risk and
returns. Company will evaluate projects and projects should be within bearable risk
limit of the company. Then The company should decide on the proportion of profits
that should be distributed as dividend and proportion of profit that should be retained
for future investments in the business. All decisions based on Risk and return
The Sources of Financial Funds based on the term of Finance are as follows:
Long Term Financial Funds
Equity Shares
Preference shares
Bonds
Debentures
Loan from Financial institutions and Banks
Venture Capital Financing

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Asset Securitisation
International Financing etc

Medium Term Financial Funds

Preference shares
Debentures
Bonds
Medium term Loans
Lease Financing etc

Short Term Financial Funds

Trade Credit
Accrued expenses
Deferred Revenue
Working capital loans
other short-term loans
Advance from customers etc

The Sources of Financial Funds based on the Source of Finance are as follows:
External Source
Equity Shares
Preference shares
Bonds
Debentures
Loan from Financial institutions and Banks
Venture Capital Financing
Asset Securitisation
International Financing
Trade Credit
Accrued expenses
Deferred Revenue
Working capital loans
Other short-term loans
Advance from customers

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Introduc on to Finance Management Notes and Sources of Financing

Internal Sources
Accumulated Profits
Reserves
Retained Earnings

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