1. Nature and Scope of Financial Management

2. Finance
Finance is the set of activities dealing with the management of funds
Finance is also the science and art of determining if the funds of an organization are being used properly
Finance studies and addresses the ways in which individuals, businesses, and organizations raise, allocate and use monetary resources over time, taking into account the risks entailed in their projects
Lawrence J. Gitman has defined finance as 'an art and science of managing money'. It implies that finance is Both art and science. Finance is a matured science since it provides knowledge as to how and at what time a firm should invest to outstrip other firms. On the other hand, finance is also an art. In modern time, finance has become more analytical. The new financial theories have been developed. Many data have been developed to prove these theories right or wrong. the financial mangers should examine the differentalternatives related to the raising and managing money. they should formulate the models to predict the results obtained from the use of any one alternative. In this way, the new theories, models and methods have made finance scientific. But the financial theories cannot be accurately compared with the 'Scientific Method' that applies to physics science. Physics predicts as to what happens from an action. for example, physics says that if a ball is thrown upward, that eventually falls down. This is not true in finance. For example, the financial analyst can predict from the historical trend that the rate of interest will change in a definite pattern. But, in reality, the rate of interest may change in different pattern. Despite this, financial guidelines and theories are useful in financial decision making. But any decision should be made by mixing those guidelines with self-skill. According to R.A. Stevenson, in modern time finance is a 'scientific art'. He opines 'finance is the science of knowing how to predict financial consequences and the art of knowing when to act'. It assists the financial managers of today to avoid the difficulties of tomorrow

3. Types of Finance Public finance (Government Finance)
Public finance means collection of money through taxes or other sources and management of revenue and expenditure by the government
Corporate finance (Business Finance)
Personal finance
Involve paying for education, financing durable goods, buying insurance, investing and saving for retirement etc.

4. Core Functions of a Firm
Marketing & Sales
Production & Operations
Finance

5. What is Corporate Finance
Corporate Finance refers to any decisions made by a firm that will have an impact on its financial position.
These decisions may be from production, marketing or any other department and are assumed to have a strategic impact.
These decisions are:
Investment Decisions
Financing Decisions
Dividend Decisions

6. Decisions of a firm Aditya Birla Group to invest $ 500 mn in Turkey
NTPC Ltd to invest Rs 18,346 crore in 2 projects
Groupe SEB buys 55% in Maharaja Whiteline
Srei Equipment Finance, a unit of SREI Infrastructure Finance is planning to raise Rs 700 million rupees via 5-year 7-month bonds at percent

7. Goodwill Hospital and Research Centre, a multi speciality hospital in Noida under the name " Ojjus Medicare", is entering the capital market to raise Rs 62 crore with its initial public offer on December 30, 2011
Liquor maker United Spirits said late on Wednesday its board approved raising up to $225 million via foreign currency convertible bonds ( FCCBs) to cut high cost debt and help improve earnings.
Nestlé India Ltd has declared second interim dividend of Rs per equity share for the year 2011

8. Objectives of Financial Management
The financial management is generally concerned with procurement, allocation and control of financial resources of a concern. The objectives can be-
To ensure regular and adequate supply of funds to the concern.
To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price of the share, expectations of the shareholders.
To ensure optimum funds utilization. Once the funds are procured, they should be utilized in maximum possible way at least cost.
To ensure safety on investment, i.e. funds should be invested in safe ventures so that adequate rate of return can be achieved.
To plan a sound capital structure-There should be sound and fair composition of capital so that a balance is maintained between debt and equity capital.

9. Scope of Financial Management
The scope of financial management can be broken down into three major decisions as functions of finance:
What long-term investments should the firm take on?
Where will we get the long-term financing to pay for the investment?
How will we manage the everyday financial activities of the firm?

10. Financial Management Decisions
(1) Investment Decision
Capital budgeting
What long-term investments or projects should the business take on?
Main elements:
Long term assets and their composition
Risk
The concept and measurement of the cost of capital
Magnitude of cash flows, timing and riskiness of the cash flows are crucial to consider

11. Importance of Investment decisions
They influence the firm’s growth in the long run
They affect the risk of the firm
They involve the commitment of large amount of funds
They are irreversible, or reversible at substantial loss
They are among the most difficult decisions to make

12. Financial Management Decisions
Working capital management
How do we manage the day-to-day finances of the firm?
Trade-off between profitability and liquidity
Overall Working Capital management
Efficient management of the individual current assets

13. Financial Management Decisions
(2) Financing Decision
Capital structure
How should we pay for our assets?
Should we use debt or equity?
Capital Structure theory
Capital Structure decision
(3) Dividend Policy Decision
How to deal with the profits of a firm?
How much profits should be distributed to the shareholders and how much to retain in the business?

14. Financial Goals
What a firm should attempt to achieve with its investments, financing and dividend policy decisions
Profit maximization (profit after tax)
Maximizing earnings per share
Wealth maximization
But WHOSE WEALTH?
The real reason behind failure in defining the proper objective is the conflict between stakeholders of the firm.

15. Stakeholders Stockholders or Owners Bondholders or Lenders Employees
Financial Markets
Society

16. Profit Maximization Maximizing the rupee income of firm
Resources are efficiently utilized
Appropriate measure of firm performance
Serves interest of society also
Objections to Profit Maximization
It is Vague
It Ignores the Timing of Returns
It Ignores Risk
In new business environment profit maximization is regarded as
Unrealistic
Difficult
Inappropriate
Immoral

17. Maximizing Profit after Taxes or EPS
Maximising PAT or EPS does not maximise the economic welfare of the owners.
Ignores timing and risk of the expected benefit
Market value is not a function of EPS.
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.

18. Shareholders’ 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.

19. • The capital market sceptics argue that stock prices fail
CRITIQUE AND DEFENCE OF SHAREHOLDER WEALTH MAXIMISATION GOAL
Critique
• The capital market sceptics
argue that stock prices fail
to reflect true values
Defence
• Financial economists argue
that stock prices are the
least biased estimates of
intrinsic values in developed
markets
• The balancers argue that a
firm should seek to
‘balance’ the interests of
various stakeholders
• Balancing the interests of
various stakeholders is not
a practical governing
objective
• Advocates of social
responsibility argue that a
business firm must assume
wider social responsibilities
• The only social
responsibility of business
is to create value and do so
legally and with integrity

20. Question
In your own words, explain the role and importance of financial management to a manufacturer whose objective is to improve quality

21. Solution
to make sure there are sufficient funds for the organisation to buy all the resources it needs to achieve its objectives i.e. appropriate quality of raw materials, correctly trained staff, well maintained machinery
to make sure there is enough money to recruit and train appropriately skilled staff to satisfy the objective of improving quality.
to make sure that all the costs/expenses are under control
to make sure that the organisation is performing profitably and efficiently without compromising quality
to reduce costs of raw materials by ensuring the best value for money from suppliers.

22. Functions of Financial Management
Estimation of capital requirements
Determination of capital composition
Choice of sources of funds
Investment of funds
Disposal of surplus
Management of cash
Financial controls

23. The Stakeholders and The Firm (The Ideal Picture)
Stockholders
Maximize Stockholder’s
Wealth
Hire/Fire &
Control Managers
Lend Money
Trace Economic Cost
& Returns
Bondholders
Managers taking
Financial Decisions
Society
Provide Debt Service &
Protect their Interests
No Negative
Social Impact
Real & True
Information
Market Price
= True Value
Financial Markets

24. What is Agency Theory
The Agency Theory was first introduced by Jensen and Meckling in 1976.
This theory explains how the conflict between various stakeholders can result in sub-optimal allocation of resources.
Agency relationship exists when one party (the principal) hires another party (the agency) to perform some services and in doing so, delegates DM (Decision Making) authority to the agent.
Shareholders are principal and CEO is the agent; if CEO is principal then managers are agents.

25. Why Agency Conflict Divergent Objectives
Non-observability of Agent’s Actions

26. The Stakeholders and The Firm (The Real Picture)
Stockholders
Maximize Managers Interest at
Stockholder’s Expense
Have Little Control
Lend Money
Cannot Trace Cost
Bondholders
Managers taking
Financial Decisions
Society
Exploitation by Owners &
Default in Payments
Negative
Social Impact
Delayed &
Misleading Information
Market Price
≠ True Value
Financial Markets

27. Agency Costs
Agency costs include the less than optimum share value for shareholders and costs incurred by them to monitor the actions of managers and control their behaviour.

28. Managing Managers/ Reducing Agency Costs
Managerial compensation
Attractive monetary and non monetary incentives
Incentives can be used to align management and stockholder interests
Close monitoring by stakeholders, board of directors and outside analysis
The threat of firing
The threat of takeover
Incentives – discuss how incentives must be carefully structured. For example, tying bonuses to profits might encourage management to pursue short-run profits and forego projects that require a large initial outlay. Stock options may work, but there may be an optimal level of insider ownership. Beyond that level, management may be in too much control and may not act in the best interest of all stockholders. The type of stock can also affect the effectiveness of the incentive.
Corporate control – ask the students why the threat of a takeover might make managers work towards the goals of stockholders.
Other groups also have a financial stake in the firm. They can provide a valuable monitoring tool, but they can also try to force the firm to do things that are not in the owners’ best interest.

29. The Stakeholders and The Firm (The Partial Solution)
Stockholders
Control by Incentive
& Other Systems
Maximize Stockholder’s
Wealth
Lend Money
Laws & Regulations
Bondholders
Managers taking
Financial Decisions
Society
Put Stringent Covenants
To Safeguard interests
Negative Social
Impact Reduced
Information from
Various Sources
& Legal Remedies
Market Price
≈ True Value
Financial Markets

30. Organisation of Finance Function
The importance of the finance function depends on the size of the firm. Financial management is an integral part of the overall management of the firm. In small firms, the finance functions are generally performed by the accounting departments. In large firms, there is a separate department of finance headed by a specialist known by different designations such as vice-president, director of finance, chief finance officer and so on.

31. Managing Director/Chairman
Board of Directors
Managing Director/Chairman
Vice-President/Director (Finance)/Chief Finance Officer (CFO)
Treasurer
Controller
Financial planning and fund-raising manager
Cash Manager
Credit Manager
Foreign exchange manager
Tax manager
Cost accounting manager
Capital expenditure manager
Pension fund manager
Corporate accounting manager
Financial accounting manager
Organization of Financial Management Function

32. Form of Business Organisation
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s-of-Business-Organization-Indian-Context

33. Impact of Financial and Economical Environment on Financial Management

34. Key macro-economic factors like the growth rate of the economy, the domestic savings rate, the role of the government in economic affairs, the tax environment, the nature of external economic relationships, the availability of funds to the corporate sector, the rate of inflation, the real rate of interests, and the terms on which the firm can raise finances define the environment in which the firm operates. No finance manager can afford to ignore the key developments in the macro economic sphere and the impact of the same on the firm.

35. What are the targets of macroeconomic policy?
Growth
Control of inflation
Full employment
External balance (or Balance of payments)