Goals of Financial Management 2nd Sem

8/8/2019 Goals of Financial Management 2nd Sem

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Goals of FinancialManagement

MMS 2nd Sem

Batch 2010 2012

VESIMSR


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Topics to be covered

Relationship between finance/ accounts/ economics

Scope of FM in terms of decision making

Objectives of FM

Main functions of financial managers.


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Basic Terminologies

Finance : The art and science of managing money

Financial Services: Concerned with the design and

delivery of advice and financial products to

individuals,businesses and governments

Financial Management: concerned with the duties

of the financial managers in the business firm

Financial Managers : Actively manage the financial

affairs of any type of business, namely, financial and

non financial, private and public, large and small,

profit seeking and not-for- profit.


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Early vs. contemporary

Early Raising of funds

Contemporary Procurement of funds

Efficient use of resources

Recommended readings Khan and Jain

Prassana Chandra


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Finance vs. economics

Difference between Micro and Macro

Economics.

FM uses concepts of marginal analysis. Macro economics provides insights to

Financial managers by which economic

activities are controlled.


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Finance Vs. Accounts

Accounting is key input in financial decision

making

Difference between finance and accounts Treatment of funds Accrual principle & cash flow

Decision making Collection of data & use of the

same


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Other Fields

Marketing

Production

Quantitative methods


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Financial decision Areas

*Investment analysis

*Working capital management

*Sources and cost of funds*Determination of capital structure

*Dividend policy

*Analysis of risk and return

Share Holders Wealth Maximization

Primary Disciplines

Accounting

Micro Economics

Macro Economics

Other Disciplines

Marketing

Production

Quantitative Methods

S

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p

p

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t

Results


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Scope of FM

Traditional Approach

Corporation Finance / Academic literature

Procurement of funds Aspects

Institutional Arrangement / Financial Institution

Financial Instruments

Legal and accounting Episodic Events


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Arguments against Traditional

approach

Procurement of funds Outsiders approach

Focused only on financing problems of

corporate. Too closely built around episodic events.

Focuses only on long term financing.

Did not consider allocation of capital.


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Modern Approach

Includes both acquisition and allocation offunds.

3 basic questions- What is the total volume of funds and enterprise

should commit?

What specific assets should an enterprise acquire?

How funds required be financed?

Hence three functions of Finance

Investment

Financing

Dividend


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Investment decision

Selection of asset

Long Term- capital Budgeting

Decisions involving acquisition of New asset andanalysis of Risk and Uncertainty

Uses Hurdle Rate

Short Term Working capital management

Trade off between profitability and liquidity


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Financing Decision

Capital structure

Proportion of The two basic forms of raising

capital Optimal Capital Structure


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Dividend Policy

3 components of Profit

Retained Earnings

Dividends

Corporate tax


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Key activities of the Financial

Manager

Performing Financial Analysis and Planning

Making Investment Decisions

Making Financing Decisions


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Objectives of FM

Provides a framework for optimal financial

decision making

Profit Maximization Decision

Wealth MaximizationD

ecision


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Profit Maximization

Signifies economic efficiency

Flaws Ambiguity of the expression of profit

Timing Of Benefits

Quality of Benefits

Example:

A ( lakhs) B (lakhs)

Period 1 50 _

Period 2 100 100

Period 3 50 100

Total profits 200 200

Q) Are both alternatives identical?


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Profit Maximization

Example

A ( cr) B (cr)

State of economy

Recession 9 0

Normal 10 10

Boom 11 20

Total 30 30

Q) Which alternative is better?


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Wealth Maximization

Other names Value Maximization/ Net

Present Worth Maximization

Uses concept of Cash Flows, as opposed toaccounting profits

Satisfies all 3 requirements

Exactness

Quality of Benefits

Time value of Money


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Wealth Maximization

2 adjustments made In cash flows

Incorporation of Risk- use of capitalization rate

Timing of Benefits

Capitalization rate is used to discount the cash

flows to the present values

NPV = Present values Capital outlay


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Wealth Maximization

An alternative is chosen if and only if NPV> 0

W= V C, W= wealth, V= Gross PV, C= capital

V= E/ K, E= Size of future benefits/ cash flows , K=

capitalization rate E= G ( M+I+T)

G= Avg future gross annual earnings b/f tax, int etc

M= Avg annual reinvestment reqd to maintain g at theprojected levels

T= taxesI = interest, Dividends

Short cut:

W = {A1/ (1+k) + A2/ (1+K)^2-----------------An/(1+K)^n} -

C


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Agency problem

Conflict of Goals between Management and Owners

Management is an agent of the owner, hence at

least min acceptable level of performance needs to

be given to satisfy shareholders goals

Incentives/ Perks

Monitoring

Bonding

Audit


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Organization of Finance

Function

BOD

MD/ Chairman

VP /Dir Finance

Treasurer Controller

Cap Exp

Mgr

Cash

Mgr

Credit

Mgr

Portfolio

Mgr

Cost

A/C

Data

Processor

TAX

Mgr

Fin

A/C

Goals of Financial Management 2nd Sem

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