i). Which new proposals for employing capital should be accepted by the firm ?
ii). How much working capital will be needed to support the firm's operations ?
iii). Where should the firm go to raise long term capital and how much will it cost ?
iv). Should the firm declare dividend on its equity capital and if so, how large a dividend should be declared ?
v). What steps can be taken to increase the value of firm's equity capital?
The above issues are solved by taking three major decisions (1) Investment decision (2) Financing decision (3) Dividend decision. As objective of the Financial Management is to maximize the value (i.e. wealth of shareholders). the firm should strive for an optimal combination of the there interrelated decisions solved jointly .The decisions to invest in a new capital project, for example, necessities financing the investment. The financing decisions in turn, influences and is influenced by the dividend decision. The retained earnings used in internal financing represents dividends foregone by the shareholders. With a proper conceptual frame work, joint decisions that tend to be optimal can be reached .
1) Financial management is a process to
Function of fib dividend
g Estimate the requirement of found k
g How to arrange the found k financial
g How to invest or utilised k
2) It is the efficient managment of the financial assets. Its objectives are the maximization of wealth and profit maximization.
FINANCIAL TOOLS
Financial tools are the techniques that can be employed by the finance manager to solve the problem properly effectively and efficiently. The following are the financial tools:
1) Ratio analysis
2) Fund flow and cash flow analysis
3) Cash budget
4) ABC analysis
5) EOQ model
6) Ageing schedule
7) Projected financial statements
8) Long - term investment appraisal tools - pay back period, net present value, profitability index internal rate of return. etc.
9) Cost of capital
10) Leverages
11) Hedging
APPROCHES / MEANING OF F.M.
The basic message behind the statement " Financial Management is concerned with the solutions of the three major decisions a firm must make the investment decision, the financing decision and the dividend decision " is self evident.
A firm wants to earn profit because the founders of the firm believe that there is an opportunity to make profitable investment. This profitable investment need to be financed and profit distributed amongst those who have contributed the capital. Hence, there is need for decisions such as how to finance investment ? How to distribute profit among shareholders ?
Modern approach of financial management basically provides a conceptual and analytical framework for financial decision making. It emphasises on an effective use of fund. According to this approach the financial management can be broken down into three different decisions:
1) Investment Decisions;
2) Financing Decisions; and
3) Dividend Decisions
1) Investment Decisions : These involve the allocation of resources among various type of assets. what portion of the firm's fund should be invested in various current assets such as cash. marketable securities and receivable and what portion in fixed assets, such as inventories and plant and equipment. The assets mix affects the amount of income the firm can earn.For example, a manufacturer is in business to earn income with fixed assets such as machinery and not with current assets. However, placing too high a percentage of its assets in new building or new machinerymay leave the firm short of cash to meet an unexpected need or exploit sudden opportunity. The firm's financial manager must invest in fixed assets. but not too much. Besides determining the assets mix financial manager must also decide what type of fixed and current assets to acquire. All this covers area pertaining to capital budgeting and working capital management.
2) Financing Decision : It is the next step in financial management for executing the investment decisions once taken a look at the balance - sheet of a company indicates that it obtains finance from shareholders ordinary, preference, debentureholders, or long - term loans from the institutions, bank and other sources. There are variations in the provisions contained in preference shares, debentures, loans papers etc. Thus financing decisions i.e. the financing mix of capital structure. Efforts are made to obtain an otimal financing mix for a particular company. This necessitates study of capital structure as also the short and intermediate term financing plans of the company.
In more advanced companies financing decision today , has become fully - integrated with top - management policy formulation via capital budgeting, long - range planning , evalution of alternate uses of funds and establishment of measurable standards of performance in financial terms.
3) Dividend Decisions : The third major decision of financial management is the decision relating to the dividend policy. The dividend decision should be analysed in relation to the financing decision of a firm . Two alternatives are available in dealing with the profits of a firm; they can be retained in the business. Which courses should be followed - dividend or retention ? One: the dividend pay out ratio i.e. what proportion of net profits should be paid out to the shareholders. The decision will depend upon the preference of the shareholders and investment opportunities available within the firm. The second major aspect of the dividend decision is the factors determining dividend policy of a firm in practice
All the above decision of finance are inter - related with one another. Any decision undertaken by the firm in one area has its impact on other areas as well. For example acceptance of an investment proposal by a firm affects its capital structure and dividend decision as well. So these decision are inter - related and should be taken jointly so that financial decision is optimal. All the financial decision have ultimately to achieve the firm's goal of maximisation of shareholders wealth.
Modern Approach to corporate finance in an improvement on the Traditional Approach :
company finance is identified with raising of funds in meeting financial needs and fulfilling the set objectives of a company. At the outset in the early
years corporate finance was confined to :
1) Arrangement of funds from financial institutions.
2) Mobilising funds through financial institutions.
3) looking after the legal and accounting relationship between corporate unit and its sources of funds.
The traditional approach to corporate finance laid emphasis on the external fund. But the subject or corporate finance spreads itself wider and wider. In the changed scenario the scope and importance of corporate finance has been greatly widened. onalNow it not only includes the traditional and conventional role of taking decision viz, investment, financing and dividend but also covers the area of reviewing and controlling decision to commit funds to new and on going uses.
The field underwent a number of significant changes - new financial instrument and transactions like options on future contracts, foreign currency swaps, and interest rate swaps, GDR ( Global Depository Receipts ), globalisation of capital market, liberalisation measures taken by various government - all these have emphasised the need for effective and efficient modern approach to corporate finance.
The modern approach to corporate finance lay emphasis that the corporate unit must make the best and most efficient use of finances available to it. Accordingly the central theme of financial policy is the wise use of funds and a rational matching of advantage of potential uses against the cost of alternative potential useu with a desire to reach the set financial goals. It facilitates the key - how large should an undertaking be, in what form assets should beheld with capital market.
Given the existing legal, poltical and economic environment the modern approach entails a conceptual framework and is concerned with issues like -
(a) - financial goals or corporate unit;
(b) - adequacy of capita - maintaining minimum levels of capital to support the perceived risks ;
(c) - controls of client's money.
(d) - measuring the performance of the company.
(e) - position of the firm within the group.
Thus it is quit obvious that the modern approach to corporate finance is an extension as well as an improvement on the traditional approach.
Profitability may not always assure liquidity :
Profitability is the ratio of profit per rupee of sales/ investment. It reflects the firm's ability to generate profits per unit sales. If sales lack sufficient margin of profit, it is difficult for the business enterprise to cover its fixed costs, including fixed charges on debt and to earn profit for shareholders. The net profit margin indicates the firm's ability to generate profits after paying all taxes and expenses. The ratio reflects the ability of the firm to utilise its assets effectively.
Profitabitity thus is a measure of efficiency and the search for provides an incentive to achieve efficiency. It also indiean public acceptance of the firm's product and shows that the firm can produce competitively. In addition it is profits which generate resources for repaying debt incurred to finance the project and internal financing of expansion.
Liquidity on the other hand may be defined as the firm's ability to meet its short term and current obligations on the becoming due for payment. It reflects the ability to convert its assets into cash to pay its dues on schedule and in perquisite for the very survival of a firm. Liquidity is assessed through the use of ratio analysis. These ratio help analy the present cash solvency of a firm and its ability to remain solvent in the event of umexpected occurrence.
While short term creditors of the firm as interested in the short term solvency or liquidity of a firm, liquidity implies the ability to meet the demands of creditors and business. The three motives which affect the management's attitude towards liquidity are (1) Transaction motive ; the firm must maintain adequate cash to meet its short term liabilities covering a period of upto one year (2) Precautionary motive . idle cash must be maintained to meet unexpected demands for funds due to occurrence of unforescen circumstances ; and (3) Speculative motive ; the management may like to maintain adequate funds to take advantage of an unexpected bargain / deal when may come its way in the near future.
While both liquidity and profitability are efficient financial management of a firm, these are basically contradictory financial decision. Decision taken by the finance manager to increase profitability generally strain the liquidity position of a firm. For example a firm may opt for debt financing vis -a - vis equity financing due to the inbuilt tax ( leverage ) advantage. The decision however is likely to strain the liquidity position of the firm, due to the periodic interest and re - payment obligations. Equity financing however places no such obligation on the firm, and the decision to pay dividend is discretionary. With increase in debt component in the capital structure of a firm, the expeuted profitability goes up . Although endangering liquidity in the process. The financial manager's jb therefore entails maintaining a balance between liquidity and profitability. While maximising returns he must ensure maintenance of sale liquidity position for the firm.
Profitability is the ratio of profit per rupee of sales/ investment. It reflects the firm's ability to generate profits per unit sales. If sales lack sufficient margin of profit, it is difficult for the business enterprise to cover its fixed costs, including fixed charges on debt and to earn profit for shareholders. The net profit margin indicates the firm's ability to generate profits after paying all taxes and expenses. The ratio reflects the ability of the firm to utilise its assets effectively.
Profitabitity thus is a measure of efficiency and the search for provides an incentive to achieve efficiency. It also indiean public acceptance of the firm's product and shows that the firm can produce competitively. In addition it is profits which generate resources for repaying debt incurred to finance the project and internal financing of expansion.
Liquidity on the other hand may be defined as the firm's ability to meet its short term and current obligations on the becoming due for payment. It reflects the ability to convert its assets into cash to pay its dues on schedule and in perquisite for the very survival of a firm. Liquidity is assessed through the use of ratio analysis. These ratio help analy the present cash solvency of a firm and its ability to remain solvent in the event of umexpected occurrence.
While short term creditors of the firm as interested in the short term solvency or liquidity of a firm, liquidity implies the ability to meet the demands of creditors and business. The three motives which affect the management's attitude towards liquidity are (1) Transaction motive ; the firm must maintain adequate cash to meet its short term liabilities covering a period of upto one year (2) Precautionary motive . idle cash must be maintained to meet unexpected demands for funds due to occurrence of unforescen circumstances ; and (3) Speculative motive ; the management may like to maintain adequate funds to take advantage of an unexpected bargain / deal when may come its way in the near future.
While both liquidity and profitability are efficient financial management of a firm, these are basically contradictory financial decision. Decision taken by the finance manager to increase profitability generally strain the liquidity position of a firm. For example a firm may opt for debt financing vis -a - vis equity financing due to the inbuilt tax ( leverage ) advantage. The decision however is likely to strain the liquidity position of the firm, due to the periodic interest and re - payment obligations. Equity financing however places no such obligation on the firm, and the decision to pay dividend is discretionary. With increase in debt component in the capital structure of a firm, the expeuted profitability goes up . Although endangering liquidity in the process. The financial manager's jb therefore entails maintaining a balance between liquidity and profitability. While maximising returns he must ensure maintenance of sale liquidity position for the firm.
Principles of financial Decision Making :
All major business decisions have financial implications. For example , should the firm expand; what would be the best way to finance an expansion; which proposal would generate more revenue ; which would result in the greatest long - term benefit and how to produce it ? What price to charge for it ? Finance scholars and proffessional have developed a body of theory and a set of tools. These are the principles of financial decision making .
At the outset, there are two basic principles of financial decision making viz .
(1) Time value of money , i.e. value maximisation.
(2) risk / exected return trade off.
(A) Time value of money or value maximisation :
The time value of money refers to the fact that a rupee available for use immediately is more valueble than a rupee that will become available use only later.
This is the most basic principle in finance. Why a rupee today is worth more than a rupee a year from now ? For instance, the interest rate today on saving is 9% and the rupee deposited today will grow total value of Rs 1.09 in one year.
The saver is committing a present value of Re . 1 for a future value of Rs 1.09. The concept of the time value of money is extremely important for all financial decision.
(B) Risk / expected trade off :
All major business decisions have financial implications. For example , should the firm expand; what would be the best way to finance an expansion; which proposal would generate more revenue ; which would result in the greatest long - term benefit and how to produce it ? What price to charge for it ? Finance scholars and proffessional have developed a body of theory and a set of tools. These are the principles of financial decision making .
At the outset, there are two basic principles of financial decision making viz .
(1) Time value of money , i.e. value maximisation.
(2) risk / exected return trade off.
(A) Time value of money or value maximisation :
The time value of money refers to the fact that a rupee available for use immediately is more valueble than a rupee that will become available use only later.
This is the most basic principle in finance. Why a rupee today is worth more than a rupee a year from now ? For instance, the interest rate today on saving is 9% and the rupee deposited today will grow total value of Rs 1.09 in one year.
The saver is committing a present value of Re . 1 for a future value of Rs 1.09. The concept of the time value of money is extremely important for all financial decision.
(B) Risk / expected trade off :
Return is the percentage change in the value of an investment over a period of time. For a risky investment, the expected return is the planned or anticipated return from the invesment.
These consideration of risk and expected return lead to general principle of great importance. Investors make a risky investment only if the expected return from the risky investment justify the risk.
Imp note : All the above decision should be taken after considering risk and return relationship.
(1) Cost element - While taking financial decision, cost element should be taken into consideration. It is the most vital concept and represents a standard for allocating the firm's investible funds in the most optimum manner.
(2) Risk element - This is another important factor to be considered before arriving at an investment involves risk, its return is uncertain. Financial decision should be made only when the expected returns from the risky investment justify the risk.
(3) Liquidity and profitability - Financial managers should made decision which would capable of generating both liquidity and profitability. Liquidity is very important to meet short - term requirement. Further it is necessary for ensuring solvency. Profitability is required to meet objectives of share holders. But there is a tangle between profitability and liquidity. Therefore financial decision should be made in such a way which have a balanced mixture of liquidity and profitability.
(4) Leverage effects - The financing decision is a significant one as it influences the shareholder's return and risk. The new financing decision may affect a company's debt - equity mix. The effect of leverage may be favourable or unfavourable. EPS is the vital concept of company and therefore financial decisions should be made after analysing leverage affect .
(5) Prevailing environment in the company as well as in the industry - Financial decision should be made in accordance with the conditions prevailing both in the company as well as in the industry. This is necessary to meet the challenges of competitiors. In order to derive optimum advantage of the industry, competitors strategy on various decision like production, pricing should be carefully followed before making financial decisions.
Besides these factors, suitability and diversification factors also have to be kept in mind.
(6) Diversification
(7) Suilability
Financial management as a science or as an art :
Financial management is science or an art is a debatable issue. In true sense. neither it is pure science like physics, not it is an art like painting. It lies somewhere between two extremes. It is science because it is based on theoretical prepositions and procedures adopted in the business enterprises. The subject matter of the financial management in addition to theoretical propositions includes the body of rules and regulations. It also takes the help of statistical techniques, econometric models, operational research and computer technology for solving corporate financial problems.
These problems may be budgeting decisions, choice of investment acquisition or allocation of funds, locating sources of capital and various other areas In this way the nature of financial management is nearer to the applied science as it envisages the sue of classified and tested knowledge in solving business problems.
Despite the use of scientific method in the area of financial management there remains a wide application of value judgement in financial decision - making. Application of mathematical or computer based packages provide in many cases no solutions unless human thinking and skills are appiled or making choice. thus the application of human judgement sills skills become neceesary in many cases, such judgement is based on experience of a particular financial manager making the decisions. The application of human judgement in the decision making makes financial management an art along with its features of science. Thus in this way knowledge of facts, principal and concepts as well as personal involvement of finance manager along with application of skills in the analysis and decision-making process the financial management both science as well art.
Financial management is science or an art is a debatable issue. In true sense. neither it is pure science like physics, not it is an art like painting. It lies somewhere between two extremes. It is science because it is based on theoretical prepositions and procedures adopted in the business enterprises. The subject matter of the financial management in addition to theoretical propositions includes the body of rules and regulations. It also takes the help of statistical techniques, econometric models, operational research and computer technology for solving corporate financial problems.
These problems may be budgeting decisions, choice of investment acquisition or allocation of funds, locating sources of capital and various other areas In this way the nature of financial management is nearer to the applied science as it envisages the sue of classified and tested knowledge in solving business problems.
Despite the use of scientific method in the area of financial management there remains a wide application of value judgement in financial decision - making. Application of mathematical or computer based packages provide in many cases no solutions unless human thinking and skills are appiled or making choice. thus the application of human judgement sills skills become neceesary in many cases, such judgement is based on experience of a particular financial manager making the decisions. The application of human judgement in the decision making makes financial management an art along with its features of science. Thus in this way knowledge of facts, principal and concepts as well as personal involvement of finance manager along with application of skills in the analysis and decision-making process the financial management both science as well art.
Globalisation & Liberalisation & Financial Management :
Globalisation means integration of nationanl economy to the world economy. In economic sense globalisation refers borderless world where there is free flow of money and currencies. ideas and exertise , postering patnership and allian to serve the customers best financial decision making deals with financial matter of a corporate enterprise i.e. kind of assests to be acquired , patten captain structure and distribution of assets and investment
Globalisation means integration of nationanl economy to the world economy. In economic sense globalisation refers borderless world where there is free flow of money and currencies. ideas and exertise , postering patnership and allian to serve the customers best financial decision making deals with financial matter of a corporate enterprise i.e. kind of assests to be acquired , patten captain structure and distribution of assets and investment
(1) Complicates the task of investment decision : Presently the invetment decision making has become a complicated and tendious exercise. Corporate units now alongwith national conditions also takes into account global view i.e. foreign exchange risk exposure, economic, political, legal and tax parameters while making investment decisions. It demands higher level of expertise from finance executives to understand the situation and to arrive at optimal investment decision.
(2) Widens the scope raising the funds : Corporate units now have access to foreign market to raise the resources at competitive rates. Foreign intitutional investors and NRI may also participate in this process and this help in attaining the least cost capital structure.
(3) Dividend decision have to be taken in the light of global scenario and available portfolio opportunities, and internal needs of the corporate units.
Liberalisation is a process which is aimed at to create an atmosphere of free competition among different agent of production and distribution of goods and services, finance and trade both public and private, demestic and foreign, small and large alike. The major components of liberalisation process includes changes in industrial policy which amounted to redical transformation of the entire industrial environment. The major impact of liberalisation on the Indian industry include the following:
1. Optimum utilisation of financial, material and human resources;
2. Effective role of market mechanism in determination of allocation of resources;
3. Boost in trade and commerce;
4. Encouragament of foreign investment and integration of country's economy with global economy;
5. Increase in number of foreign collaborations and transfer of technologies;
6. Capital inflows and improvement in foreign reserve position;
7. Development of infrastructure.
8.Financial Markets :
It is a market where buyer's and sellers meet to exchange things for money. Financial markets can be divided into :
(a) Money Market
(b) Capital Market
Money Market refers to open - market operations in highly marketable instrument like bills of exchange etc.
Capital market is again can be divided into :
(a) PRIMARY MARKET
(b) SECONDARY MARKET
New issues of shares and debt securities are made in the primary market and existing securities are traded in the secondary market
Primary market can have following three segment :
(a) PUBLIC ISSUE
(b) RIGHT ISSUE
(c) PRIVATE PLACEMENT
Secondary market again can be divided into three segment :
(a) STOCK EXCHANGE [ 23 stock exchange in India ]
(b) National stock Exchange
(c) Over the counter Exchange of India.
9.GLOBALISSTION OF FINANCIAL MARKET :
With the economic reforms, in the financial sector in India, the financial markets of India have been integrate with the financial markets in other parts
of would. The financial liberalisation in India has enabled the India companies to source funds from the inter- national market through EVRO-ISSUES.
International market [Euro Marker] can again be dividend into :
a) INTERNATIONAL MONEY MARKET
b) INTERNATIONAL CAPITAL MARKET
Financial sector reforms and financial management :
Financial sector reform is one of the important component of economic reforms initiated by the government of india to boost its economy and also to intenrate ot to the world economy. “The reform objective in our out country in largely to promot adiversified efficient and a competitive financial system. It aims at raising the following the allocative efficiency of available saving increasing the return on investments and promoting the accelerated growth and development of the real sector, Specifi goals of the programme include:
i). to correct and improve the macro-economic policy setting within which banks operate. This involve monetary control reforms including rationalization of interest rates, redesigning direct credit programmes, and bringing down the level of resource pre-emptions:
ii). To improve the financial health and condition of banks by recapitalizing banks, restructurning the weak ones and improving the incetive under which banks function:
iii). To build financial institution and infrastructure relating to supervision . audit technology and leg framework.
iv). To improve the level of managerial competence and the quality of human resource by reviewing policies recruitiment , training , placement etc.
v). To improve access to financial saving.
vi). To reduce intermediating costs and distortions in the banking system.
vii). To promote competition through a level playing field and freer entry and exit in the financial sector.
viii). To develop transparent and efficient capital and money markets.
In India, financial sector reforms are confined to banking and financial institutions.
In recent years, the government of India along with other regulatory bodies have undertaken various steps to make financial sector more competitive , efficient, transparent and flexible. Some of these step in this reguard include following:
Reducing in statutory Liquidity ratio, cash reserve ratio and interest rate , SCP,CRR & interest .
Permission to set up banks under private sector .
Floating interest rate on financial assistance by some all India development banks.
Strengthening the supervisory process.
Instilling a greater element of competition.
Introduction of various financial institutions and instruments.
o
However, the financial sector reforms addressed on the issue like rate of interest and prudential norms.
(2) Widens the scope raising the funds : Corporate units now have access to foreign market to raise the resources at competitive rates. Foreign intitutional investors and NRI may also participate in this process and this help in attaining the least cost capital structure.
(3) Dividend decision have to be taken in the light of global scenario and available portfolio opportunities, and internal needs of the corporate units.
Liberalisation is a process which is aimed at to create an atmosphere of free competition among different agent of production and distribution of goods and services, finance and trade both public and private, demestic and foreign, small and large alike. The major components of liberalisation process includes changes in industrial policy which amounted to redical transformation of the entire industrial environment. The major impact of liberalisation on the Indian industry include the following:
1. Optimum utilisation of financial, material and human resources;
2. Effective role of market mechanism in determination of allocation of resources;
3. Boost in trade and commerce;
4. Encouragament of foreign investment and integration of country's economy with global economy;
5. Increase in number of foreign collaborations and transfer of technologies;
6. Capital inflows and improvement in foreign reserve position;
7. Development of infrastructure.
8.Financial Markets :
It is a market where buyer's and sellers meet to exchange things for money. Financial markets can be divided into :
(a) Money Market
(b) Capital Market
Money Market refers to open - market operations in highly marketable instrument like bills of exchange etc.
Capital market is again can be divided into :
(a) PRIMARY MARKET
(b) SECONDARY MARKET
New issues of shares and debt securities are made in the primary market and existing securities are traded in the secondary market
Primary market can have following three segment :
(a) PUBLIC ISSUE
(b) RIGHT ISSUE
(c) PRIVATE PLACEMENT
Secondary market again can be divided into three segment :
(a) STOCK EXCHANGE [ 23 stock exchange in India ]
(b) National stock Exchange
(c) Over the counter Exchange of India.
9.GLOBALISSTION OF FINANCIAL MARKET :
With the economic reforms, in the financial sector in India, the financial markets of India have been integrate with the financial markets in other parts
of would. The financial liberalisation in India has enabled the India companies to source funds from the inter- national market through EVRO-ISSUES.
International market [Euro Marker] can again be dividend into :
a) INTERNATIONAL MONEY MARKET
b) INTERNATIONAL CAPITAL MARKET
Financial sector reforms and financial management :
Financial sector reform is one of the important component of economic reforms initiated by the government of india to boost its economy and also to intenrate ot to the world economy. “The reform objective in our out country in largely to promot adiversified efficient and a competitive financial system. It aims at raising the following the allocative efficiency of available saving increasing the return on investments and promoting the accelerated growth and development of the real sector, Specifi goals of the programme include:
i). to correct and improve the macro-economic policy setting within which banks operate. This involve monetary control reforms including rationalization of interest rates, redesigning direct credit programmes, and bringing down the level of resource pre-emptions:
ii). To improve the financial health and condition of banks by recapitalizing banks, restructurning the weak ones and improving the incetive under which banks function:
iii). To build financial institution and infrastructure relating to supervision . audit technology and leg framework.
iv). To improve the level of managerial competence and the quality of human resource by reviewing policies recruitiment , training , placement etc.
v). To improve access to financial saving.
vi). To reduce intermediating costs and distortions in the banking system.
vii). To promote competition through a level playing field and freer entry and exit in the financial sector.
viii). To develop transparent and efficient capital and money markets.
In India, financial sector reforms are confined to banking and financial institutions.
In recent years, the government of India along with other regulatory bodies have undertaken various steps to make financial sector more competitive , efficient, transparent and flexible. Some of these step in this reguard include following:
Reducing in statutory Liquidity ratio, cash reserve ratio and interest rate , SCP,CRR & interest .
Permission to set up banks under private sector .
Floating interest rate on financial assistance by some all India development banks.
Strengthening the supervisory process.
Instilling a greater element of competition.
Introduction of various financial institutions and instruments.
o
However, the financial sector reforms addressed on the issue like rate of interest and prudential norms.
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