Financial Management-An Overview Oxford Higher Education: Prepared by Sumit Goyal-LPU

FINANCIAL MANAGEMENTAN OVERVIEW
Oxford Higher Education

Prepared By Sumit Goyal-LPU
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
Introduction
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?
Nature And Scope Of Financial

Management
Concerned with the management of financial resources.
Performs facilitation, reconciliation, and control
functions.
Covers all decisions having monetary implications.
Role Of Finance Function

Finance is central to all business activities.
Finance function reconciles the conflicting interests
of:
varied stakeholders and
different functional units.
Finance Managers Role

Raising of Funds
Allocation of Funds
Profit Planning
Understanding Capital Markets
Financial Goals
Profit maximization (profit after tax)
Maximizing earnings per share
Wealth maximization
Profit Maximization
Maximizing the rupee income of firm
Resources are efficiently utilized

Appropriate measure of firm performance
Serves interest of society also
Objections to Profit Maximization

It is Vague
It Ignores the Timing of Returns
It Ignores Risk
In new business environment profit maximization is
regarded as
Unrealistic
Difficult
Inappropriate
Immoral
Maximizing Profit after Taxes or

EPS
Maximising PAT or EPS does not maximise the economic
welfare of the owners.
Ignores timing and risk of the expected benefit
Maximizing EPS implies that the firm should make no
dividend payment so long as funds can be invested at
positive rate of returnsuch a policy may not always
work.
Shareholders Wealth
Maximization
Maximizes the net present value of a course of action to
shareholders.
Accounts for the timing and risk of the expected benefits.
Benefits are measured in terms of cash flows.
Fundamental objectivemaximize the market value
of the firms shares.
Risk-return Trade-of
Financial decisions of the firm are guided by the riskreturn trade-of.
The return and risk relationship: Return = Risk-free
rate + Risk premium
Risk-free rate is a compensation for time and risk
premium for risk.
Risk Return Trade-of
Risk and expected return move in tandem; the greater the risk, the greater
the expected return.
Agency Problems: Managers Versus
Shareholders Goals
There is a Principal Agent relationship

between managers and shareholders.
In theory, Managers should act in the best
interests of shareholders.
In practice, managers may maximise their
own wealth (in the form of high salaries
and perks) at the cost of shareholders.
Agency Problems: Managers Versus

Shareholders Goals
Managers may perceive their role as reconciling
conflicting objectives of stakeholders. This
stakeholders view of managers role may
compromise with the objective of SWM.
Managers may avoid taking high investment and
financing risks that may otherwise be needed to
maximize shareholders wealth. Such satisfying
behaviour of managers will frustrate the objective
of SWM as a normative guide.
This conflict is known as Agency problem
and it results into Agency costs.
Agency Costs
Agency costs include the less than optimum share value
for shareholders and costs incurred by them to monitor
the actions of managers and control their behaviour.
FINANCE DECISIONS FOR THE FIRM

Financial decision-making involves procurement of
funds and their optimal utilization through:
Financing
Investment
Dividend and
Working capital decisions.
Financing Decisions
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.
Financing Decisions
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?
Financing Decisions
Are taken in the light of their likely impact on
the wealth of the stockholders.
A right blend of debtequity affects the risk
return profile of the business.
Investment Decisions
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.
Investment Decisions
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.
Dividend Decisions
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.
Dividend Decisions
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.
Working Capital Decisions

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.
Integrated View Of Finance

Decision-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.
Financial Decision Making

Framework
Key Issues In
Financial Decision-making
Investment
Decision
What business to be in?

What growth rate is appropriate?
What assets to acquire?
Financing
Decision
What mix of debt and equity to be used?

Can we change value of the firm by changing the capital
mix?
Is there an optimal debtequity mix?
Dividend
Decision
How much of the profit should be distributed as 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
Capital
Decision
What level of inventory is ideal?

What level of credit should be given to the customers?
What level of cash should be maintained?
How can the blockage of funds in the current assets be
minimized without compromising with profits?
Objective Function In Finance

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.
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.
Financial Management And

Accounting
Financial Objectives And

Organizational Strategy

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FINANCIAL MANAGEMENTAN OVERVIEW

Oxford Higher Education

Integrated view of finance decision-making

Prepared By Sumit Goyal-LPU

Prepared By Sumit Goyal-LPU

Prepared By Sumit Goyal-LPU

Nature And Scope Of Financial

Prepared By Sumit Goyal-LPU

Role Of Finance Function

Prepared By Sumit Goyal-LPU

Finance Managers Role

Prepared By Sumit Goyal-LPU

Prepared By Sumit Goyal-LPU

Resources are efficiently utilized

Prepared By Sumit Goyal-LPU

Objections to Profit Maximization

Prepared By Sumit Goyal-LPU

Maximizing Profit after Taxes or

Prepared By Sumit Goyal-LPU

Prepared By Sumit Goyal-LPU

Prepared By Sumit Goyal-LPU

Risk Return Trade-of

Prepared By Sumit Goyal-LPU

Agency Problems: Managers Versus

There is a Principal Agent relationship

Prepared By Sumit Goyal-LPU

Agency Problems: Managers Versus

Prepared By Sumit Goyal-LPU

FINANCE DECISIONS FOR THE FIRM

Prepared By Sumit Goyal-LPU

Determine the financial risk.

Prepared By Sumit Goyal-LPU

Prepared By Sumit Goyal-LPU

Prepared By Sumit Goyal-LPU

Also referred to as capital budgeting decisions.

Prepared By Sumit Goyal-LPU

Prepared By Sumit Goyal-LPU

Working Capital Decisions

Prepared By Sumit Goyal-LPU

Integrated View Of Finance

Financial Decision Making

Prepared By Sumit Goyal-LPU

What business to be in?

What mix of debt and equity to be used?

How much of the profit should be distributed as dividends

What level of inventory is ideal?

Objective Function In Finance

Prepared By Sumit Goyal-LPU

FINANCIAL MANAGEMENT AND

Prepared By Sumit Goyal-LPU

Financial Management And

Prepared By Sumit Goyal-LPU

Financial Objectives And

Prepared By Sumit Goyal-LPU

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