Introduction to Financial Mgt

• The life blood of a business enterprise is finance

• Finance is the backbone of every business

• Finance reigns supreme

• Master key to all manufacturing and merchandizing activities

Business finance

• Business activity concerned with the acquisition and conservation of capital funds in meeting financial needs and overall objectives of an enterprise

Meaning of FM

• Size of firm

• Growth required

• Firm’s financing mix

• Planning and control of financial affairs

Functions of FM• Liquidity

– Forecasting cash flows—matching inflows against cash outflows

– Raising funds—sources of funds raised and the time they have to be raised

– Manage flow of internal funds• Profitability

– Cost control– Pricing– Forecasting future profits– Measure cost of capital

• Management – Mgt of LT funds– Mgt of ST funds

Management of funds

• Long term funds– Capital structure– Cost of capital– Sources of long term

funds– Financial leverage– Dividend policy

• Long term assets– Capital budgeting– Operational leverage– Risk analysis

Working capital mgt

• Short term funds– ST liabilities like

creditors, overdraft, bills payable, ST loans

– Working capital mgt principles

– Working capital policy

• Short term assets– Receivables Mgt– Inventory mgt– Cash mgt

Importance of FM

• Successful promotion

• Smooth running of biz

• Decision making

• Measure of performance

Scope and functions of FM

• Traditional approach– Arrangement of funds from fin institutions– Arrangement of funds thru fin instruments like

shares, bonds, etc– Look after legal and accounting relationship– Accurate financial records, prepare reports

and manage cash

Limitations of Traditional approach

• External approach

• Ignored routine problems

• Ignored non-corporate enterprise

• Ignored working capital mgt

• No emphasis on allocation of funds

Modern approach

• Finance function covers both acquisition and mgt of funds and their allocation– Volume of funds, specific assets, financing

decisions

• 4 major decisions– Investment decision– Financing decision– Dividend policy decision– Funds requirement decision

Finance functions

• Investment or long term asset mix structure

• Financing or capital mix structure

• Dividend or profit allocation

• Liquidity or short term asset mix structure

Investment Decision

• Investment or capital budgeting decision involves the allocation of capital to long term funds

• Decisions evaluated in terms of both – return – risk

Financing Decision

• Plan and mobilize required funds from alternative sources at a reasonable cost

• Obtain the best financing mix or the optimum capital structure

Dividend Policy Decision

• Pay-outs to the shareholders

• Pay-out or retention depends on the growth prospects of the firm

Functional areas of FM

• Determining financial needs• Determining sources of funds• Financial analysis• Optimal capital structure• CVP analysis• Profit planning and control• Fixed assets mgt• Project planning and evaluation• Capital budgeting• Working capital mgt• Dividend policies• Acquisitions and mergers• Corporate taxation

Organization of finance functions

• Routine finance functions—custody of cash and bank accounts, collection or loans, payments of cash, etc

• Special financial functions—financial planning, budgeting, profit analysis, investment decisions, etc

FM process

• Financial analysis—preliminary stage, review to determine current fin performance and condition of biz, identification of particular fin problems, risks, constraints, assessment of SWOT

• Fin decision making—strategic investment decisions and strategic financing decisions

• Fin planning—availability of funds• Fin control—implementation of plans, monitoring

of progress and correct any deviations from plans

Financial decisions

• Investment decisions—allocation of capital, how funds can be invested in assets yielding benefits in future—involves risk and uncertainty

• Finance decisions—mobilization of finance for investment—form—equity, borrowings, timing of acquisition of capital, debt equity ratio

Financial decisions

• Dividend decision—profits to be ploughed back into biz, cash dividend to be paid, maintenance of stable dividend rate over the period

• Current assets mgt—maintain liquidity in biz, profitability of firm—trade-off between risk and return

Objectives of FM

• Maintenance of liquid assets

• Maximization of profits– Merits

• yard stick to judge performance• Efficient allocation of resources• Optimum utilization of resources• Maximum social welfare—dividend, timely

payments to creditors, better quality and prices

Objectives of FM

• Maximization of profits– Drawbacks

• Time factor ignored—ST or LT profits• Accounting profit or economic profit or PBT or PAT• Time value ignored• Risk factors ignored

• Wealth maximization– Maximizing the present value of a course of

action– Financial action resulting in positive NPV

creates and adds to existing wealth of orgn

Objectives of FM

• Ensure fair return to shareholders

• Build reserves for growth and expansion

• Ensure maximum operational efficiency by efficient and effective utilization of finance

• Ensure financial discipline in mgt

FM and other disciplines

• Marketing-finance interface—decisions have significant impact on firm’s profitability—impact of credit period extended to customers on profits of co—liberal credit terms throw profit plans out of gear

• Production-finance interface—prod mgr controls major part of investment in the form of equipment, materials and men– WIP

• Top mgt-finance interface—ensure LT goals are met

Liquidity Decision

• Current assets management

• Trade-off between profitability and liquidity