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Introduction toFinancial Management
PGDM Tri I
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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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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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 enterpriseshould 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 Maximization Decision
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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 to
accounting 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