Unit 1- Financial Management- An
Introduction
• Introduction: Introduction to Financial Management -
Goals of the firm - Financial Environments. Time
Value of Money: Simple and Compound Interest
Rates, Amortization, Computing more that once a
year, Annuity Factor.
Learning Outcomes:
After completion of this unit, the student will be able to:
Solve problems on future and present value of money in the context
Comprehend the linkage of finance function with other functions
Why Financial Management for
Bachelor of Technology
Definitions
• “Financial management is the activity concerned
with planning, raising, controlling and administering
of funds used for the short term and long terms needs
of business.” – Guthman and Dougal
“Financial management is the operational activity of
a business that is responsible for obtaining and
effectively utilizing the funds necessary for efficient
operations.”- Massie
The Nature and Purpose of Financial Management
Financial management is concerned with the efficient
acquisition and deployment of both short- and long-term
financial resources, to ensure the objectives of the
enterprise are achieved.
• Decisions must be taken in three key areas:
– Investment Decision- both long-term investment in non-
current assets and short-term investment in working capital.
(Capital Budgeting Process)
– Finance Decision- from what sources should funds be
raised?. (Capital Structure Process) FIN
– Dividends Decision- how should cash funds be allocated to
shareholders and how will the value of the business be
affected by this? (Dividend payout ratio and Retention policy)
• In taking these decisions, the financial manager
will need to take account of:
– The organisation's commercial and financial
objectives
– The broader economic environment in which the
business operates
– The potential risks associated with the decision and
methods of managing that risk.
Objectives of
Financial
Management
Functions of Financial Management
• Estimation of capital requirements: A finance manager
has to make estimation with regards to capital
requirements of the company. This will depend upon
expected costs and profits and future programmes and
policies of a concern. Estimations have to be made in an
adequate manner which increases earning capacity of
enterprise.
• Determination of capital composition: Once the
estimation have been made, the capital structure have to
be decided. This involves short- term and long- term debt
equity analysis. This will depend upon the proportion of
equity capital a company is possessing and additional
funds which have to be raised from outside parties.
• Choice of sources of funds: For additional funds to be
procured, a company has many choices like-
• Issue of shares and debentures
• Loans to be taken from banks and financial institutions
• Public deposits to be drawn like in form of bonds.
Choice of factor will depend on relative merits and demerits of each source and
period of financing.
• Investment of funds: The finance manager has to decide
to allocate funds into profitable ventures so that there is
safety on investment and regular returns is possible.
• Disposal of surplus: The net profits decision have to be
made by the finance manager. This can be done in two
ways:
• Dividend declaration - It includes identifying the rate of dividends and
other benefits like bonus.
• Retained profits - The volume has to be decided which will depend
upon expansional, innovational, diversification plans of the company.
• Management of cash: Finance manager has to make
decisions with regards to cash management. Cash is
required for many purposes like payment of wages
and salaries, payment of electricity and water bills,
payment to creditors, meeting current liabilities,
maintainance of enough stock, purchase of raw
materials, etc.
• Financial controls: The finance manager has not
only to plan, procure and utilize the funds but he also
has to exercise control over finances. This can be
done through many techniques like ratio analysis,
financial forecasting, cost and profit control, etc.
Finance Function
• There are three ways of defining the finance function.
– Firstly, the finance function can simply be taken as the task of
providing funds needed by an enterprise on favourable terms,
keeping in view the objectives of the firm.
– Another extreme view is that finance is concerned with cash.
This definition is much too broad and thus is not really
meaningful.
– The third view is based on a compromise between the two is
more useful for practical purposes. This definition treats the
finance function as the procurement of funds and their
effective utilisation in business. The finance manager takes
all decisions that relate to funds which can be obtained as
also the best way of financing an investment such as the
installation of a new machinery inside the factory-or office
building.
• In a broad sense, the finance function covers the
following six major activities:
1. Financial planning;
2. Forecasting cash inflows and outflows;
3. Raising funds;
4. Allocation of funds;
5. Effective use of funds; and
6. Financial control (budgetary and non-budgetary).
The last function is very important. Through financial
control the finance manager tries to bring performance
closer to the targets.
Scope of Finance Function:
• No doubt, the scope of finance function is wide
because this function affects almost all the aspects
of a firm’s operations. The finance function
includes judgments about whether a company
should make more investment in fixed assets or not.
• It is largely concerned with the allocation of a
firm’s capital expenditure over time as also related
decisions such as financing investment and
dividend distribution. Most of these decisions taken
by the finance department affect the size and timing
of future cash flow or flow of funds.
Classification of Finance Function
• Finance function can be classified into two broad
categories, viz.,
1. Executive finance function and
2. Incidental finance function.
• While the former requires administration skill in
planning and execution, the latter largely covers
works of a routine nature, which are necessary to
implement financial decisions at the executive
level.
Executive finance function
1. Determining asset-management policies
2. Determining the allocation of net profits
3. Estimating cash flow requirements and control of such
flows
4. Taking decision on needs and sources of new external
finance
5. Carrying on negotiations with outside financiers
6. Checking upon financial performance
• Interrelationship: It may be noted that all the six
functions are interrelated. This means that a change in
decision with respect to any one of the functions will call
for a change in decision relating to some or all other
functions.
• Incidental Function: The incidental finance functions
include supervision of cash inflows and outflows and
maintaining cash balances and record keeping.
Financial Planning
• Financial planning isn’t only a one-time process in
which you make a savings plan and then sit back and
wait to achieve your goals.
• Comprehensive, long-term financial planning does
involve establishing a preliminary plan, but it is
important to understand that financial circumstances,
challenges, and priorities may change over time. As you
approach the financial planning process, it’s essential to
remember that the process of setting goals and laying out
a blueprint for saving and investing is just the first step in
a larger financial journey—one that can help you realize
all of your goals and enjoy financial security both now
and in the years to come.
• seven key steps to include in your financial
planning.
• Define your short- and long-term goals
• Audit your current income, savings, and long-term savings
and investing plan
• Address shortfalls/adjust goals.
• Account for multiple future scenarios.
• Develop a comprehensive financial plan.
• Implement and monitor that plan.
• Adjust goals or other financial plans as your circumstances
change
Importance of Financial Planning
• Financial Planning is process of framing objectives,
policies, procedures, programmes and budgets regarding
the financial activities of a concern. This ensures effective
and adequate financial and investment policies. The
importance can be outlined as-
– Adequate funds have to be ensured.
– Financial Planning helps in ensuring a reasonable
balance between outflow and inflow of funds so that
stability is maintained.
– Financial Planning ensures that the suppliers of funds
are easily investing in companies which exercise
financial planning.
– Financial Planning helps in making growth and
expansion programmes which helps in long-run
survival of the company.
– Financial Planning reduces uncertainties with regards
to changing market trends which can be faced easily
through enough funds.
– Financial Planning helps in reducing the uncertainties
which can be a hindrance to growth of the company.
This helps in ensuring stability an d profitability in
concern.
Factors that can impact financial
planning in business
1. Revenue
2. Costs
3. Market conditions
4. Government regulations
5. Competition
6. Technological changes
Finance department and its functional
areas
1. Sales.
2. Marketing.
3. Finance and accounting.
4. Customer service.
5. Human resource.
6. Research and development.
7. Production.
8. Distribution.
Time Value of Money
• The time value of money suggests a preference of
having money as of now than at a future point of
time.
• The concept of time value of money helps in
arriving at the comparable value of the different
rupee amounts arising at different points of time
into equivalent values at a particular point of time
(present or future).
• Techniques of time value of money:
– 1. Compounding Technique
– 2. Discounting or Present Value Technique
• Technique # 1. Compounding Technique:
– The compounding technique is used to find out the
future value of different cash flows occurring at
different points of time. According to this technique,
interest earned on the initial principal or cash outflow
becomes part of the principal for calculating interest
for the next period.
– As a result interest is earned on interest as well as on
the initial principal. This interest earned on interest is
known as compounding effect and hence
compounding technique.
• Technique # 2. Discounting or Present Value
Technique:
– The present value approach works exactly in reverse
of the compounding technique. In the case of
compounding technique we ascertain the worth of all
cash flows at a future date while in case of present
value technique the worth of all future cash flows
(both receipts or payments) are calculated at the
present date by adjusting for time value of money.
– In this technique present worth of future cash flows
are calculated.
Discounting
PV with single cashflows
PV with multiple cash flows
PV with Annuities
Compounding
FV with single cashflows
FV with multiple cash flows
FV with Annuities
Compounding
• Calculate the value of an investment of Rs
1000 invested today after a period of 5 years at
interest rate of 8%, 10%, 12%.
• Assume mr. ankit has a debt to pay, where he
needs to pay 100,000 per annum for 5 years.
Calculate the total amount of money to be paid
after 5 years with 10% interest.
• Rs 500 is invested at the end of 6 month period in
a annuity that earns 4.8% compounded semi-
annually for the next 10 years. Calculate future
value of annuity. (if payment is made at begning
of the year multiple the answere with (1+r))
• Mr Ram has invested 1000, 2000, 3000 and 4000
in 4 respective years with a return of 15%, what
will be his future value by the end of 4 th year.
