Chapter
1
INTRODUCTION TO
FINANCIAL MANAGEMENT
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Meaning of Business Finance:
Business Finance is that business activity
which is concerned with the acquisition
and conservation of capital funds in
meeting financial needs and overall
objectives of business enterprises.
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What is Financial Management?
Financial Management is broadly concerned with
the acquisition and use of funds by a business firm.
Its scope may be defined in terms of the following
questions :
How large should the firm be and how fast should it grow?
What should be the composition of the firm’s assets?
What should be the mix of the firm’s financing ?
How should the firm analyze, plan and control its financial
affairs?
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EVOLUTION OF FINANCIAL
MANAGEMENT
Financial management has emerged as a distinct field
of study only in the early part of this century as a result
of consolidation movement and formation of large
enterprises. Its evolution may be divided into three
phases viz.,

The Traditional phase,

The Transitional phase and

Modern phase
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Traditional Approach
• The traditional approach, which was popular in the early
stage, limited the role of financial management to raising
and administering of funds needed by the corporate
enterprises to meet their financial needs. It deals with the
following aspects :
–
Arrangement of funds from financial institutions
–
Arrangement of
funds through financial
instruments like share, bonds etc/.
–
Looking after the legal and accounting
relationship between a corporation and its
sources of funds.
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Main limitations of Traditional Approach
 External Approach
 Ignored routine problems
 Ignored non-corporate enterprise.
 Ignored working capital financing
 No Emphasis on allocation of funds
 Time value of money is not considered
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Modern Approach :
• According to modern approach the term financial
management provides a conceptual and analytical
framework for financial decision-making. That
means, the finance function covers both
acquisition of funds as well as their allocation.
• The new approach views the term financial
management in a broader sense. It is viewed as
an integral part of over-all management.
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Financial management, in the modern sense of
the term, divided into four major decisions :
Financial
Management
Investment
Decision
Financing
Decision
Dividend
Decision
Funds
Requirement
Decision
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SCOPE AND FUNCTIONS OF FINANCIAL
MANAGEMENT
1. Liquidity: It is ascertained on the basis of three important
considerations.
a) Forecasting cash flows  i.e., matching the
inflows against cash outflows
b) Raising funds  i.e., financial manager will have
to ascertain the sources from which funds may be
raised and the time when these funds are needed.
c) Managing the flow of internal funds.
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2. Profitability: While ascertaining profitability, the following
factors are taken into account.
a)
Cost control
b)
Pricing
c)
Forecasting future profits
d)
Measuring cost of capital
3. Management: Asset management has assumed an
important role in financial management. It includes : (a)
the management of long term funds. (b) The management
of short term funds.
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Functional Areas of Modern Financial
Management
 Determining Financial need
 Determining Sources of Funds
 Financial analysis
 Optimal Capital Structure
 Cost Volume Profit Analysis
 Functional Areas
 Of Financial
 Management
 Profit Planning and Control
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Functional Areas of Modern Financial
Management
•
•
•
•
•
•
•
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Fixed Assets Management
Project Planning and Evaluation
Capital Budgeting
Working Capital Management
Dividend Policies
Acquisition and Mergers
Corporate Taxation
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OBJECTIVE OF FINANCIAL MANAGEMENT :
Maximization of Profit : “Profit maximization” is a
term which denotes the maximum profit to be
earned by an organization in a given time period.
The profit- maximization goal implies that the
investment, financing and dividend policy decision
of the enterprise should be oriented to profit
maximization.
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Merits of the Profit – Maximization:
Best Criterion on Decision-Making: The goal of profit –
maximization is regarded as the best criterion of the
decision of making as it provides a yard-stick to judge the
economic performance of the enterprises.
Efficient allocation of Resources: It leads to efficient
allocation of scarce resources as they tend to be diverted
to those uses which, in terms of profitability, are the most
desirable.
Optimum Utilization: Optimum utilization of available
resource is possible.
Maximum Social Welfare
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Drawbacks of Profit maximisation :
 Time Factor Ignored
 it is Vague
 The Term ‘Maximum’ is also Ambiguous
 It Ignores Time Value
 it Ignores the Risk Factor
 In new business environment profit maximization is regarded as
 Unrealistic
 Difficult
 Inappropriate
 Immoral.
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Maximizing return or EPS
 Ignores timing and risk of the expected benefit.
 Market value is not a function of EPS. Hence
maximizing EPS will not result in highest price for
company's shares.
 Maximizing EPS implies that the firm should make no
dividend payment so long as funds can be invested at
positive rate of return—such a policy may not always
work.
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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 objective—maximize the market value
of the firm’s shares.
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Significance of Wealth- Maximization:
The company although it cares more for the economic welfare of
the shareholders, it cannot forget the others who directly or
indirectly work for the overall development of the company. Thus
Wealth- Maximization takes care of
 Lenders or creditors
 Workers or Employees
 Public or Society
 Management or Employer
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Significance of wealth - Maximization
 Other objective – Ensuring fair return to shareholder,
Building up reserves for growth and expansion,
ensuring financial discipline in the management
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Method of Financial Management/tools
 Cost of Capital
 Capital budgeting appraisal
 Ratio analysis
 ABC analysis
 Funds flow and Cash flow analysis
 Working capital management
 Trading on equity
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Organisation of the Finance Functions
 Reason for placing the finance functions in the hands of
top management
 Financial decisions are crucial for the survival of the
firm.
 The financial actions determine solvency of the firm
 Centralisation of the finance functions can result in a
number of economies to the firm.
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Functions of The Finance Controller/ Manager :
 Accounting
 Budgeting
 Internal Audit
 Finance Planning
 Profit Planning
 Investment Decisions
 Economic appraisal.
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Financial management – Process :
Financial Analysis
Financial Decision
Financial Planning
Financial Control
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