UNIT-1 Introduction to financial manaement

What is Finance?

AtFinance, at its core, finance is the art and science of managing money. It'It encompasses a broad range of activities related to the acquisition, allocation, and utilization of funds. It is not merely about making money; it's about making strategic decisions on:to maximize value and achieve specific financial objectives. This applies to all levels, from individuals managing their personal budgets to multinational corporations making complex investment decisions and governments allocating public funds. Specifically, finance is concerned with:

• When to buy: IdentifyingThis involves assessing market conditions, analyzing potential risks and returns, and identifying the rightoptimal timetiming for acquiring assets, resources, or investments. For example, a company might delay purchasing new equipment if interest rates are expected to acquire assets or resources.rise.
• What to buy: ChoosingThis whichinvolves evaluating various opportunities and selecting the assets or investments that best align with financial goals, risk tolerance, and strategic objectives. For instance, a portfolio manager will decide between allocating funds to acquire.stocks, bonds, or real estate.
• When to sell: DeterminingThis involves determining the optimalright time to liquidate assets.assets or investments to realize profits, minimize losses, or reallocate resources. An investor might decide to sell a stock after it has reached its target price.

It'sFinance usedis bya everyonevital -function individuals,for businesses,everyone, regardless of their scale of operation. It is a key driver of economic activity, innovation, and governments. growth.

Key Concepts in Finance:

• Business Finance: ThisBusiness finance is the specificspecialized areafield ofwithin finance related to companies. Itthat focuses on acquiringthe capital,monetary managingaffairs of business organizations. It's concerned with the entire lifecycle of business funds, from sourcing to deployment. Its key functions include:
  • Acquiring Capital: Obtaining the necessary funds to operate and meetinggrow, through various methods like loans, equity, or bonds.
  • Managing Funds: Efficiently utilizing funds for day-to-day operations, long-term investments, and strategic initiatives.
  • Meeting Objectives: Ensuring financial decisions align with the overall goals and mission of the business, such as maximizing shareholder value or achieving a business'stargeted objectives.growth Itrate.
  involves
  • planning,Financial raising,Planning: controlling,Formulating strategies for long-term funding, growth, and usingexpansion.
  funds.
• Corporate Finance: A typespecific area of business finance that focuses on budgeting,the financial forecasting,decisions made by corporations. It deals with the financial resources of a company and how best to manage them. Key aspects of corporate finance include:
  • Budgeting: Planning and managing casha flow,company's analyzing investments,expenses and raisingrevenues.
  capital
  • forFinancial businesses.Forecasting: ItPredicting involvesfuture incorporatingfinancial performance to inform strategic decisions.
  • Cash Management: Efficiently managing the flow of cash within a company.
  • Credit Administration: Managing and controlling credit extended to customers.
  • Investment Analysis: Evaluating and selecting profitable investment opportunities.
  • Fund Procurement: Obtaining necessary funding from diverse sources, such as debt, equity, or hybrid securities.
  • Technological Integration: Adopting modern technologytechnologies and beingapplications mindfulto improve financial decision-making.
  • Global Perspective: Considering the impact of the global market.economic environment on financial operations.
• Financial Management: ThisThe iscore management function responsible for overseeing the day-to-dayfinancial processactivities of managingan aorganization. company'sFinancial money.management Itensures involvesthe makingefficient decisionsallocation aboutand howutilization of funds to obtainachieve the organization's goals. This involves:
  • Planning: Setting financial goals and usedeveloping strategies to achieve them.
  • Organizing: Structuring the financial resources and operations of the organization.
  • Directing: Guiding financial activities towards achieving organizational objectives.
  • Controlling: Monitoring financial performance and taking corrective actions when needed.
  • Efficient Use of Capital: Ensuring the business uses funds efficiently.effectively, Itminimizing also relates to planning, organizing, directing,waste and controllingmaximizing financialreturns.
  activities.
  • Capital Funds Management: Dealing with the efficient use of an organization's capital resources.

Types of Finance:

• Private Finance: The management of moneyfinancial resources by private entities, such as:
  • Individuals: Personal budgeting, investments, savings, and borrowing.
  • Businesses: Funding for individuals,operations, businesses,investments, and corporations.expansion.
  • Corporations: Large-scale financial decisions related to capital structure, acquisitions, and investments.
  • This sector includes any financial activity not related to government.
• Public Finance: The management of financial resources by governmental bodies, including:
  • Central Government: National-level fiscal policies, tax revenue, and public spending.
  • State Government: State-level financial matters, including taxation, budgeting, and allocation of resources.
  • Semi-Government: Public sector organizations with some degree of autonomy and their own financial operations, such as utility authorities.
  • This focuses on how public money foris governmentscollected (central,and state,spent.
  etc).

Types of Financial Needs in BusinessBusiness:

• Long-Term Needs: FundsFinancial requirements that extend beyond three years. These funds are generally used for:
  • Capital Expenditures: Investments in major assets like land, buildings, and equipment.
  • Strategic Projects: Funding for morelarge-scale thanprojects 3that years,will usuallyaffect the long-term direction of the business.
  • Mergers and Acquisitions: Financing for majorthe investments.purchase of other companies.
• Medium-Term Needs: FundsFinancial neededrequirements that typically last for about 1one year. These funds are used for:
  • Equipment Replacement: Funding to replace existing assets.
  • Expansion Projects: Funding for growth initiatives that are not long-term strategic projects.
  • Debt Refinancing: Refinancing of loans or debt.
• Short-Term Needs: Financial needs for a relatively short period, usually to meet daily operating requirements. These funds are used for:
  • Working Capital Management: Funds neededto formanage day-to-day operations.expenses like inventory, payroll, and accounts payable.
  • Meeting Operating Expenses: Ensuring funds are readily available to pay for daily costs.
  • Handling Fluctuations: Funding to cope with peaks and troughs in customer demand.

Key Functions of Financial Management:

• Investment Decisions: Deciding wherehow to allocate money,capital bothacross invarious assets. This includes:
  • Capital Budgeting: Evaluating long-term assetsinvestments (in fixed assets, like equipment)machinery, infrastructure, and new plants, by analyzing the potential risks and returns.
  • Working Capital Decisions: Determining the optimal level of investment in short-term assets, such as inventory, accounts receivable, and cash, which are critical for day-to-day operations.
  • Asset Selection: Choosing the specific assets (likethat inventory).will best support the company's strategic goals.
• Financing Decisions: DecidingDetermining how to raise moneythe necessary capital for the organization. This involves:
  • Capital Structure: Finding the right mix of debt (throughloans) debt,and equity,equity etc.).(ownership) to fund operations.
  • Source of Finance: Deciding whether to use bank loans, bond issuance, venture capital, or other forms of financing.
  • Cost of Capital: Analyzing the cost of different sources of funds.
  • Financing Period: Selecting optimal time periods for financial obligations.
• Dividend Decisions: DecidingDetermining how much ofprofit to distribute to shareholders versus how much to reinvest in the company'scompany. profitsThis involves:
  • Dividend Policy: Setting the policy for how much profit will be returned to give to shareholders,investors and how much towill keepbe kept for growth.reinvestment.
  • Dividend Rate: Selecting the specific amount of dividend that will be paid out per share.
  • Retained Profit Allocation: Deciding how much profit will be kept for growth and expansion.
  • Balancing Shareholder Returns and Business Needs: Deciding how much to give back to shareholders while ensuring sufficient funds to finance growth initiatives.

Objectives of Financial Management:

• Ensure adequateAdequate funds:Funds: HavingMaintaining enoughsufficient moneycash whenflow itto ismeet needed.operational requirements, take advantage of opportunities, and weather unforeseen financial challenges.
• Maximize returnsReturns for shareholders:Shareholders: Making surefinancial shareholdersdecisions getthat aincrease goodshareholder returnwealth onthrough theirhigher investment.dividends and stock prices over time.
• Efficient useUse of funds:Funds: UsingAllocating funds wisely.effectively to minimize waste, optimize performance, and achieve the greatest value for each dollar spent.
• Safety of investment:Investment: InvestingDirecting infunds venturesto secure investments that haveprovide a reasonablestable expectationreturn, ofavoid return.significant losses and are properly monitored.
• Sound Capital Structure: KeepingEstablishing a goodbalanced balancemix betweenof debt and equity.equity, ensuring a stable financial base and optimizing the cost of capital.
• Optimized Capital Utilization: Ensuring that all resources are utilized to their maximum capacity to boost earnings.

Relationship of FM with other Functional areas of business

• Economics: FMFinancial management uses economic principlesconcepts forto makingguide decisions.financial analysis, forecasting, and decision-making, such as supply and demand, inflation, and interest rates.
• Accounting: FMFinancial management relies on accurate financial data fromgenerated accounting.by accounting systems. These data provide information for financial reporting, analysis, and control.
• Mathematics: FMFinancial usesmanagement employs mathematical and statistical techniques for financial modeling, forecasting, and quantitative analysis.
• Production Management: FMFinancial isdecisions usedimpact forproduction, as resources need to be allocated to manage cost controlefficiently and efficient production planning.strategically.
• Marketing: FMMarketing impactsplans pricingrequire financial analysis and budgetbudgeting decisions.to measure campaign effectiveness and determine the cost of different initiatives.
• Human Resource: FMFinancial impactsmanagement howis aresponsible companyfor investsmanaging incosts associated with human capital,capital payingsuch salary,as etc.payroll, benefits and retirement plans.

Two Key Objectives of Financial Management (Debated):

• Profit Maximization: ThisThe traditional objective of business is theto traditionalmaximize objective,profit. whichThis focusesapproach on maximizing a company's profits. It is criticized for being vague, ignoring time value of money, and not considering risk.considers:
  • ArgumentsEarning for:Per Share (EPS): EarningMaximizing profitprofits isper share as the main goal,objective.
  is
  • Increased Operational Efficiency: Focusing on activities that will increase profits, cutting costs, and boosting sales.
  • Business Performance Metric: Using profit as a yardstick to measure how effective a business parameter,is and leads to lower risk.running.
  • ArgumentsRisk against:Reduction: LeadsBelieving tohigh exploitation,profits immoralact practices,as anda inequalitybuffer betweenagainst stakeholders.potential business risks. However, it faces criticism:
  • Drawbacks:Vague Definition: It'sThe vaguelyterm "profit" is poorly defined, leading to misunderstandings and potential issues in how the business operates.
  • Ignoring Time Value of Money: This objective ignores the time value of money,money and doesn'tdoes not consider risk.the net present value of cash flows which could differ significantly.
  • Neglecting Risks: Ignores risks associated with business operations, as some high-risk projects could be very profitable but not viable for a business.
• Wealth Maximization: ThisThe ismodern approach aims to increase the modernoverall approach,value whichof the company and the financial well-being of its stakeholders. It focuses onon: maximizing
  • Shareholder Wealth: Enhancing the value of the company (for shareholders, often throughreferred shareholderto value).as value maximization or net present worth maximization.
  • Value-Cost Analysis: Comparing the present value of benefits versus the cost, providing a clear picture of the actual value.
  • Risk and Time Consideration: Incorporating risks and the time value of money in financial decisions.
  • Efficient Resource Allocation: Ensuring that company resources are allocated efficiently to support value creation.
  • Economic Interest of the Society: Ensuring long-term growth for the economy by creating value for the company. It is generallystill preferreddebated overby some:
  • Theoretical Approach: Some may consider wealth maximization as an abstract idea that may not be suitable for all businesses.
  • Synonym for Profit Maximization: Some argue that wealth maximization is simply profit maximization asunder ita considersdifferent risk and time.
    • Arguments for: Increases value for shareholders, considers value and cost, considers time and risk, efficient use of resources, and good for societyname.
    • ArgumentsConflicts against:of Interest: CanIt is argued that wealth maximization can create conflict between managers and owners, who may have different goals.
    • Management Benefit: Some believe only management benefits from the idea, creating potential issues with other stakeholders.
    • Profit as Requirement: Some argue that a company must be theoretical,profitable to implement a synonymwealth formaximization profitstrategy, maximization,making createsthem conflicts,dependent andon mayeach only benefit management.other.

  More Functions of Financial Management:

  • Estimate Capital Needs: Figuring outAssessing how much moneycapital thea businesscompany willneeds need.for operations, expansions, and other financial obligations, including both long-term and short-term requirements.
  • Determine Capital Structure: Deciding the optimal mix of debt and equity.equity to fund the company. This includes considering the interest rate for debt and the dividend payouts that equity will require.
  • Choose Sources of Funds: DecidingSelecting howthe most appropriate sources of funding based on cost, availability, and risk. This may include choosing to raiseissue moneyshares (shares,or take out loans, etc).among other options.
  • Invest Funds: Deciding where to putallocate the company'company’s money to earnsecure returns.its financial future and increase its financial standing. This may mean investing in profitable projects, acquisitions, or infrastructure.
  • Manage Surplus: DecidingDetermining how to distributeuse profitssurplus (dividends,funds, retainedwhich earnings).includes both dividend payments to investors and reinvestments for business growth.
  • Manage Cash: KeepingOverseeing thecash businessflow, liquidensuring enoughthere's sufficient liquidity to operate.meet daily expenses and other payment obligations.

  Financial Decisions:

  TheseFinancial decisions involveare everythingall the choices made within the business that affect its finances. These can be broken down into:

  • Investment Decisions: Decisions about how ato companyuse managesthe itscompany's money.money to acquire assets, such as fixed assets or investments. They include:

    • Investment Decisions,Capital Budgeting Decisions: Deciding which long-term projects to pursue (e.g. purchasing new equipment, expanding into new markets).
    • Financing Decisions,Asset Selection: Identifying specific assets that align with the strategic goals of the organization.
    • Dividend Decisions,
    • Working Capital DecisionManagement decisions on the usage of short term assets to keep the company in operation and generate returns.

  • Financing Decisions: Decisions on how to raise the money needed for the company (e.g. debt versus equity). This includes:

    • Capital Structure Decisions Determining the optimal mix of debt and equity for financing activities.
    • Source of Financing: Considering all the different options that are available to the business and making a selection.

  • Dividend Decisions: Decisions about how to distribute profits to shareholders versus how much to keep for reinvestment (e.g. declaring dividends, retaining profits).

    • Dividend Policy: Deciding the approach to dividend distributions for the business.
    • Profit Reinvestment: Determining how much profit will be retained for long-term growth and projects.

  • Working Capital Decisions: These deal with managing short-term assets and liabilities, ensuring the company has enough money to operate. These decisions include:

    • Cash Management Decisions Determining how cash flow will be managed within the business.
    • Inventory Management Deciding how much inventory the company needs to maintain operations.
    • Accounts Receivable Management How the business will manage collections of credit extended to customers.

  Which Comes First?

  It'sThe relationship between investment and financing is often referred to as a "chicken or the egg" problem:problem. You need a promising project to getattract funding, but you need funding to undertakestart a project. In reality,practice, investment and financing are closely linked and typically occur concurrently as part of the financial planning process. The overall direction of a business depends on both are interlinked and happenthese together.decision processes go hand in hand.

  Factors That Influence Financial Decisions:

  Financial decisions are influenced by many factors, both within the company and in the external business environment.

  • Internal Factors:
    • Nature of the BusinessBusiness: The type of business (e.g. manufacturing, services, or trading) affects the types of assets the company will require and hence its financial needs.
    • Size of the businessbusiness: Larger companies have different financial needs and strategies than smaller companies.
    • Legal StructureStructure: The structure of a company, such as sole proprietorship, partnership, or corporation, affects its ability to raise capital and manage financial obligations.
    • Business cycleCycle: Economic conditions like growth or recession impact a company's capacity for investment, expenses and ability to raise capital.
    • Ownership Ownership: How ownership is spread amongst stakeholders and its influence on the decision making process.
    • Earnings Earnings: A company's earnings stability affects its ability to raise capital, pay dividends, and undertake investments.
    • Liquidity Liquidity: How easily a company can convert assets into cash and meet its short-term debts influences its financial decisions.
    • Asset holdingsholdings: The balance of current vs fixed assets a company has impacts the sources of funding it needs.
    • Term of CreditCredit: The length of credit terms offered to customers as well as extended by suppliers can impact the short term financial decisions of the business.
    • Management Management: Management's approach to risk and growth can influence their appetite for investment and financing.
  • External Factors:
    • Economy Economy: Economic conditions affect a company’s operating costs, revenue, and capacity to secure capital.
    • Market ConditionsConditions: The overall conditions in the market impact a company’s ability to obtain funding and manage its cash flows.
    • Government RegulationsRegulations: Policies and guidelines by the government influence a company’s capacity for investment and the overall financial landscape.
    • Taxes Taxes: Tax policies impact business profits and affect decisions on dividends, financing, and investments, leading to tax planning strategies.

  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.