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UNIT-1 Introduction to financial manaement

What is Finance?

At its core, finance is the art and science of managing money. It's about making decisions on:

  • When to buy: Identifying the right time to acquire assets or resources.
  • What to buy: Choosing which assets or investments to acquire.
  • When to sell: Determining the optimal time to liquidate assets.

It's used by everyone - individuals, businesses, and governments.

Key Concepts in Finance:

  • Business Finance: This is the specific area of finance related to companies. It focuses on acquiring capital, managing funds, and meeting a business's objectives. It involves planning, raising, controlling, and using funds.
  • Corporate Finance: A type of business finance that focuses on budgeting, financial forecasting, managing cash flow, analyzing investments, and raising capital for businesses. It involves incorporating modern technology and being mindful of the global market.
  • Financial Management: This is the day-to-day process of managing a company's money. It involves making decisions about how to obtain and use funds efficiently. It also relates to planning, organizing, directing, and controlling financial activities.

Types of Finance:

  • Private Finance: The management of money for individuals, businesses, and corporations.
  • Public Finance: The management of money for governments (central, state, etc).

Types of Financial Needs in Business

  • Long-Term Needs: Funds for more than 3 years, usually for major investments.
  • Medium-Term Needs: Funds needed for about 1 year.
  • Short-Term Needs: Funds needed for day-to-day operations.

Key Functions of Financial Management:

  • Investment Decisions: Deciding where to allocate money, both in long-term assets (like equipment) and short-term assets (like inventory).
  • Financing Decisions: Deciding how to raise money (through debt, equity, etc.).
  • Dividend Decisions: Deciding how much of the company's profits to give to shareholders, and how much to keep for growth.

Objectives of Financial Management:

  • Ensure adequate funds: Having enough money when it is needed.
  • Maximize returns for shareholders: Making sure shareholders get a good return on their investment.
  • Efficient use of funds: Using funds wisely.
  • Safety of investment: Investing in ventures that have a reasonable expectation of return.
  • Sound Capital Structure: Keeping a good balance between debt and equity.

Relationship of FM with other Functional areas of business

  • Economics: FM uses economic principles for making decisions.
  • Accounting: FM relies on accurate financial data from accounting.
  • Mathematics: FM uses mathematical analysis.
  • Production Management: FM is used for cost control and efficient production planning.
  • Marketing: FM impacts pricing and budget decisions.
  • Human Resource: FM impacts how a company invests in human capital, paying salary, etc.

Two Key Objectives of Financial Management (Debated):

  • Profit Maximization: This is the traditional objective, which focuses on maximizing a company's profits. It is criticized for being vague, ignoring time value of money, and not considering risk.
    • Arguments for: Earning profit is the main goal, is a business parameter, and leads to lower risk.
    • Arguments against: Leads to exploitation, immoral practices, and inequality between stakeholders.
    • Drawbacks: It's vaguely defined, ignores the time value of money, and doesn't consider risk.
  • Wealth Maximization: This is the modern approach, which focuses on maximizing the value of the company (often through shareholder value). It is generally preferred over profit maximization as it considers risk and time.
    • Arguments for: Increases value for shareholders, considers value and cost, considers time and risk, efficient use of resources, and good for society
    • Arguments against: Can be theoretical, a synonym for profit maximization, creates conflicts, and may only benefit management.

More Functions of Financial Management:

  • Estimate Capital Needs: Figuring out how much money the business will need.
  • Determine Capital Structure: Deciding the mix of debt and equity.
  • Choose Sources of Funds: Deciding how to raise money (shares, loans, etc).
  • Invest Funds: Deciding where to put the company's money to earn returns.
  • Manage Surplus: Deciding how to distribute profits (dividends, retained earnings).
  • Manage Cash: Keeping the business liquid enough to operate.

Financial Decisions:

These decisions involve everything about how a company manages its money.

  • Investment Decisions,
  • Financing Decisions,
  • Dividend Decisions,
  • Working Capital Decision

Which Comes First?

It's a "chicken or the egg" problem: You need a project to get funding, but you need funding to undertake a project. In reality, both are interlinked and happen together.

Factors That Influence Financial Decisions:

  • Internal Factors:
    • Nature of the Business
    • Size of the business
    • Legal Structure
    • Business cycle
    • Ownership
    • Earnings
    • Liquidity
    • Asset holdings
    • Term of Credit
    • Management
  • External Factors:
    • Economy
    • Market Conditions
    • Government Regulations
    • Taxes

Simplified Summary

Finance is about managing money. Businesses use it to get capital, invest in assets, and make profits. Financial management involves making decisions about how to spend and raise money. While profit was the main goal, maximizing the value of a company has become a more widely accepted goal. Financial decisions are influenced by both the inner workings of a company and the wider economic environment.

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