Unit 1: Introduction- Financial Management

FINANCIAL
MANAGEMENT
Dr.Bharath V
bharath.v@kristujayanti.com

Course Content
Unit 1: Introduction
• Finance: meaning, scope; financial management: objectives, merits,
criticism, functions of financial management, factors influencing financial
decisions, Role of finance manager, functions of financial manager, Recent
trends in Financial Management
Unit 3: Capital Structure and Leverages
• Capital structure: meaning, optimum capital structure, factors determining
capital structure, theories of Capital structure (Theory only), problems on
EBIT-EPS analysis; Leverages: operating leverage, financial leverage,
combined leverage.
Unit 2: Time Value of Money & Cost of Capital
• Time value of money: meaning, relevance; Future value and Present value of
cash flow (Single and annuity flow). Cost of capital: meaning; sources of
capital and computation of cost of capital: term loan, debentures, preference
and equity shares, retained earnings, weighted average cost of capital.
2

Unit 5: Dividend Decisions
Dividend decisions: meaning, factors influencing dividend, forms of dividends,
Dividend theories: Relevance Theory: Walter model, Gorden model, Irrelevance
theory: MM Hypothesis
Unit 4: Long term and short-term investment Decisions
Capital budgeting: meaning, significance, process, project classification and
investment criteria: payback method, ARR method, net present value, IRR
method, profitability index; Working capital: meaning, factors influencing
working capital requirements, components of working capital, Estimation of
working capital requirements.
Reference Books
1. MY Khan and P K Jain, Financial Management Text Problems, and cases, Eighth edition
(2018), McGraw-Hill Education Pvt Ltd.
2. I M Pandey, Financial Management, Twelfth Edition(2021), Pearson Publication.
3. Prasanna Chandra, Financial Management Theory and Practices, Tenth edition (2019),
McGraw-Hill Education Pvt Ltd.
4. Shashi K Gupta, (2019) Financial Management, Ninth Edition, Kalyani publications.
5. Kotreshwar G (2014) Capital Budgeting, Chandana Publication.

Concept of Finance
• Finance is basically the art and science of managing
monetary resources of a business concern and is
extremely crucial for the survival of a business entity.
• Basic approaches
• Basic premise is that the finance function is broad-based and
related to each and every activity taking place in a business.
• Demand for finance is created separately out of expenditure
decisions taken within a business.
• Manager’s forecasting an appropriate level of the company’s fund
requirement.
• The finance manager’s job is to procure finance at optimum level
at the lowest cost.
4

Nature of Finance Function
• Finance function mostly integrated and centralised in
every business organisation, as it brings cost advantages
to the company.
• Irrespective of size, nature, legal status, every org. has a
finance function, as it puts across certain amount of
control on other activities and function of the org.
• Finance and its related activities paly a very significant
role in the long-term growth and survival of the org.
• Finance function helps in managerial decision making,
through analysis and interpretation of financial data.
5

• Finance function is interrelated to other primary functions
of business as well, such as marketing, production
planning, human resource etc. these function are very
much dependent on finance and get affected by external
factors of environment.
• Basically, “value of a firm” is one of the important aspects
of the finance function.
6

Importance of finance in General areas
• Public Finance
• Private Finance
• Institutional Finance
• International Finance
7

Importance of finance in non-finance areas
• FM and Economics
• FM and Accounting
• FM and Mathematics
• FM and Production management
• FM and Marketing
• FM and Human resource
8

Scope of Finance Function
• Estimating Financial Requirements
• Deciding capital structure
• Selecting a source of finance
• Selecting a pattern of investment
• Proper cash management
• Proper use of surpluses
• Implementing financial controls
9

FINANCIAL MGT. ??
• Financial denotes the process of identifying, obtaining and
allocating sources of money.
• Management is the process of planning, organizing,
coordinating and controlling various resources for the
accomplishment of organizational goal.
• Finally, A process of evaluating financial decisions with
the objective of value maximisation.

Definition of Financial Management
Financial Management is managerial activity which is concerned
with the planning and controlling of the firm’s financial
resources.
Financial management is the activity concerned with planning,
raising, controlling and administering of funds used in the
business.” – Guthman and Dougal
“Financial management is that area of business management
devoted to a judicious use of capital and a careful selection of the
source of capital in order to enable a spending unit to move in the
direction of reaching the goals.” – J.F. Brandley
11

Features of Financial Management
1. Financial Management is an integral part of overall management.
Financial considerations are involved in all business decisions. So
financial management is pervasive throughout the organization.
2. The central focus of financial management is valuation of the firm.
That is financial decisions are directed at increasing/maximization/
optimizing the value of the firm.
3. Financial management essentially involves risk-return trade-off
Decisions on investment involve choosing of types of assets which
generate returns accompanied by risks.
4. Financial management affects the survival, growth and strength of
the firm. Finance is said to be the life blood of business. It is to
business, what blood is to us.
5. Financial management is a sub-system of the business system
which has other subsystems like production, marketing, etc.
12

13
6. Nature of financial management is multi-disciplinary. Financial
management depends upon various other factors like accounting,
banking, inflation, economy, etc. for the better utilization of
finances.
7. The finance manager is often called the Controller; and the
financial management function is given name of controllership
function.
8. No production, purchases or marketing are possible without being
duly supported by requisite finances.
9. Financial Management commands a higher status vis-a-vis all
other functional areas of general management.

Role of Finance in a Typical Business Organization
14

Organization of Finance
TREASURER
• Increase profit
• Maximize output
• Minimize cost
• Profit = Sales - expense
CONTROLLER
• Accounting
• Audit
• Budgeting
• Taxation

Scope of Financial Management
The major scope of financial management is as follows:
1. Investment Decision : Where to invest?
2. Financing Decision : Sources of money for investment.
3. Working Capital Decision: Day to day activities.
4. Dividend Decision : Distributing profit to stakeholders.

Finance Functions
• Decision functions
• Control Functions

1. Decision functions
•Investments
•Financing
•Dividend
•Working Capital
•Risk Management

Investment Decision
•Capital Projects
•Mergers and Acquisitions
•Stock portfolio investments
•Patents..etc

Financing Decision
•Equity Capital
•Debt Capital
•Leverage Management
•Cost of Capital

Dividend Decision
•Dividend Policy
•Interim Dividends
•Stock Dividends

Working Capital Decision
• Current Assets Management
( inventory, cash & receivables)
• Working Capital Financing

Risk Management Decision
•Insurance
•Derivatives

2. Control Functions
•Accounting
•Auditing
•Taxation
•Treasury Operations
•Risk Analysis

•Phase-I [Early 1900s]
•Accounting
•Procurement of Funds
•Phase II [1930-45]
•Liquidity Management
•Reorganization
•Insolvency

Evolution…….
• Phase III [1945-1985]
Mergers and Acquisitions
Leverage Management
Cost of Capital
Phase IV [1985-2000]
Risk management
Derivatives Market Instruments
Phase V [21st Century]
Wealth Creation
MVA( Market value Added)
EVA (Economic Value Added)

MARKET VALUE ADDED (MVA)
• Shareholder wealth is maximized by maximizing the
difference between the market value of the firm’s stock
and the amount of equity capital that was supplied by
shareholders. This difference is called the Market Value
Added (MVA).
• MVA measures the effects of managerial actions since the
very inception of a company,
• MVA = Market value of stock - Equity capital supplied by
shareholders
28

• Example, consider our illustrative company, Allied Food
Products. In 2024, its total market equity value was
Rs.1,150 Crores, while its balance sheet showed that
stockholders had put up only Rs.896 Crores. Thus,
Allied’s MVA was Rs.1,150 - Rs.896 =Rs.254 Crores.
• This Rs. 254 Crores represents the difference between
the money that Allied’s stockholders have invested in the
corporation since its founding—including retained
earnings—versus the cash they could get if they sold the
business.
• The higher its MVA, the better the job management is
doing for the firm’s shareholders.
29

ECONOMIC VALUE ADDED (EVA)
• Economic Value Added (EVA) focuses on managerial
effectiveness in a given year.
• EVA is an estimate of a business’s true economic profit for
the year, and it differs sharply from accounting profit.
• EVA is net operating profit after taxes (NOPAT) minus the
(after-tax) weighted average cost of capital (WACC)
multiplied by total assets (TA) minus current liabilities (CL)
(net assets).
30

MVA
Calculation
2024 2023
Price per share 23 26
No. of Shares (MM) 50 50
Market value of equity 1150 1300
Book value of equity 896 840
MVA= MV - BV 254 460
EVA
calculation
EBIT 283.8 263.0
Tax rate 40% 40%
NOPAT= EBIT (1-T) 170.3 157.8
Total investor supplied
operating capital
1800 1520
After tax cost of capital
(%)
10.0 10.3
Cost of capital (rs.) 180 156.6
EVA= (NOPAT – CC) -9.7 1.2
31

Objectives of Financial Management
The major objectives of financial management is as follows:
1. Profit / EPS Maximization
• Increase output for the business
• Reduce costs.
2. Wealth maximization
• Create value addition for shareholders.
3. Economic Value Added (EVA)
• Increase economic profit for the firm
4. Focus on stakeholders
• Welfare for the stakeholders.
5. Maintaining liquidity
• Ensure adequate funds to mitigate needs.

Financial
Goal
Profit
Maximisation
Wealth
Maximisation

Profit Maximization
Profit Maximization is the main objective of business because:
(i) Profit acts as a measure of efficiency and
(ii) It serves as a protection against risk.
Arguments in favour of Profit Maximization
(i) When profit earning is the main aim of business the ultimate objective should
be profit maximization.
(ii)Future is uncertain. A firm should earn more and more profit to meet the future
contingencies.
(iii)The main source of finance for growth of a business is profit. Hence, profit
maximization is required.
(iv)Profit maximization is justified on the grounds of rationality as profits act as a
measure of efficiency and economic prosperity.

Arguments in against of Profit Maximization
• Ambiguity: in measurement creates confusion and mistrust.
• Timing of benefits: neglects the time value of money, leading
to poor investment choices.
• Impact on social welfare: undermines ethical and sustainable
business practices.
• Financing and dividend aspects: affect long-term growth
and stakeholder satisfaction.
• Risk factors are ignored: exposing businesses to potential
losses and financial instability.
35

Wealth Maximization
Wealth Maximization, also known as Value
Maximization, is a financial management objective
that focuses on increasing the value of a business
for its shareholders.
Unlike profit maximization, which targets short-
term earnings, wealth maximization emphasizes
long-term sustainable growth and the overall
financial health of the organization.

Key Features of Wealth Maximization
• Focus on Long-Term Value: Wealth maximization prioritizes
strategies that enhance the company's market value and
shareholder wealth over time.
• Considers Risk and Uncertainty: Decisions are evaluated
based on potential risks, ensuring that investments are aligned
with the company’s risk tolerance.
• Accounts for the Time Value of Money (TVM):Future cash
flows are discounted to present value, ensuring the decisions
reflect their real worth today.
• Considers Stakeholder Interests: It balances the needs of
shareholders, employees, customers, and the broader
community.
• Sustainability: Encourages ethical practices, corporate social
responsibility (CSR), and environmental stewardship to
maintain a positive brand image and long-term profitability.
37

Wealth Max. = Value Max.
Value = Present Value (PV)
PV =
 where,
CF = Cash flow income
g = Growth of CF
k = Discount factor : 1) Cost of Capital
2) Risk
t
t
t
n
t K
g
C
)
1
(
)
1
(
1 




Wealth Max.
Alternatively,
V = C
k-g
Above formula implies :
PV = f ( C, g , and k )
X No.of ES Outstanding

Case Study: XYZ Tech Corp
• XYZ Tech Corp had an option to:
• Launch a low-cost, high-margin product with limited market potential
(profit maximization).
• Invest in research and development (R&D) for a cutting-edge
technology with long-term market potential but higher upfront costs
(wealth maximization).
• The company chose the R&D route, incurring significant
initial expenses. Over five years, the new technology
captured 40% of the market, increased shareholder returns
by 200%, and positioned the company as an industry leader.
• Wealth maximization ensured long-term growth, competitive
advantage, and stakeholder satisfaction.
40

Wealth Max. Vs Profit Max.
Basis of difference Profit Max. Wealth Max.
Purpose Maximise the profitability Increase the market value
of the shares
Concept Narrow Broad
Time Span Short Term Long term
Rationale Maximum level of
accumulated profits for
growth
Enhancing shareholder’s
wealth and continue their
relationship and loyalty
Time value of money Does not consider TVM Consider the TVM and its
implications
Selection of projects Does not consider Cost of
capital
It consider Cost of capital
Risk factors Does not consider the risk
factors
It consider the risk factors
Dividend policy it ignores Does consider
Formulae P=Total Rev. – total costs W= No. of share owned x
CMP
41

Changing role of Finance Managers
Traditional role
• Investment planning.
• Budgeting.
• Cash & fund management.
• Financing decisions.
Modern role
• M&A Valuation.
• Foreign exchange management.
• Derivatives investment &
management.
• FDI
• Portfolio management.
• Tax planning

Unit 1: Introduction- Financial Management

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