Study with the several resources on Docsity
Earn points by helping other students or get them with a premium plan
Prepare for your exams
Study with the several resources on Docsity
Earn points to download
Earn points by helping other students or get them with a premium plan
Community
Ask the community for help and clear up your study doubts
Discover the best universities in your country according to Docsity users
Free resources
Download our free guides on studying techniques, anxiety management strategies, and thesis advice from Docsity tutors
MBA NOTES FOR FINANCIAL MANAGEMENT
Typology: Lecture notes
1 / 90
This page cannot be seen from the preview
Don't miss anything!
FINANCIAL MANAGEMENT
MBA I YEAR II SEMESTER
(JNTUA-R15)
CHADALAWADA NAGAR, RENIGUNTA ROAD, TIRUPATI (A.P) - 51750
MBA Semester – II Th C 4 4 (14E00204) FINANCIAL MANAGEMENT The objective of the course is to provide the necessary basic tools for the students so as to Manage the finance function. The students should be able to understand the management of the Financing of working capital needs and the long term capital needs of the business organization
1. The Finance function: Nature and Scope. Importance of finance function – The new Role in the contemporary scenario – Goals of finance function; Profit Vs Wealth Vs Welfare; – Wealth maximization and Risk-Return trade off. 2. The Investment Decision: Investment decision process – Project generation, project Evaluation, project selection and project implementation. Developing Cash Flow Data. Using Evaluation Techniques – Traditional and DCF methods. The NPV Vs IRR Debate. 3. The financing Decision: Sources of finance – a brief survey of financial instruments. The capital structure decision in practice: EBIT-EPS analysis. Cost of capital: The Concept – Average Vs Marginal cost of Capital. Measurement of cost of capital – Component Costs and Weighted Average Cost. The Dividend Decision: Major forms of Dividends 4. Introduction to working capital: Concepts and characteristics of working capital, Factors determining the working capital. Estimation of working capital requirements. Current Assets Management: Management of current assets – Cash, Receivables and Inventory. Cash budget, Credit terms – Financing current assets 5. Corporate Restructures: Corporate Mergers and acquisitions and take-over’s-Types of Mergers, motives for mergers, Principles of corporate governance. References Financial management – V.K.Bhalla ,S.Chand Financial Management, I.M. Pandey, Vikas Publishers. Financial Management--Text and Problems, MY Khan and PK Jain, Tata McGraw- Hill, Financial Management, Dr.V.R.Palanivelu, S.Chand Principles of Corporate Finance, Richard A Brealey etal. Tata McGraw Hill. Fundamentals of Financial Management, Chandra Bose D, PHI Financial Management, William R.Lasheir, Cengage. Financial Management – Text and cases, Bingham & Earhart, Cengage. Case Studies in Finance, Bruner.R.F, Tata McGraw Hill, New Delhi. Financial management, Dr.M.K.Rastogi, Laxmi Publications
In our present day economy, Finance is defined as the provision of money at the time when it is required. Every enterprise, whether big, medium or small needs finance to carry on its operations and to achieve its targets. In fact, finance is so indispensable today that it is rightly said to be the life blood of an enterprise.
MEANING OF FINANCE
Finance may be defined as the art and science of managing money. It includes financial service and financial instruments. Finance also is referred as the provision of money at the time when it is needed. Finance function is the procurement of funds and their effective utilization in business concerns. The concept of finance includes capital, funds, money, and amount. But each word is having unique meaning. Studying and understanding the concept of finance become an important part of the business concern
TYPES OF FINANCE Finance is one of the important and integral part of business concerns, hence, it plays a major role in every part of the business activities. It is used in all the area of the activities under the different names. Finance can be classified into two major parts:
Private Finance, which includes the Individual, Firms, Business or Corporate Financial activities to meet the requirements. Public Finance which concerns with revenue and disbursement of Government such as Central Government, State Government and Semi-Government Financial matters.
Definition:
Finance may be defined as the provision of money at the time when it is required. Finance refers to the management of flow of money through an organization.
According to WHEELER , business finance may be defined as “that business activity which is concerned with the acquisition and conservation of capital
funds in meeting the financial needs and overall objectives of the business enterprise.” According to GUTHMANN and DOUGALL, business finance may be broadly defined as “the activity concerned with the planning, raising, controlling and administering the funds used in the business.”
NATURE OF FINANCE FUNCTION:
The finance function is the process of acquiring and utilizing funds of a business. Finance functions are related to overall management of an organization. Finance function is concerned with the policy decisions such as like of business, size of firm, type of equipment used, use of debt, liquidity position. These policy decisions determine the size of the profitability and riskiness of the business of the firm. Prof. K.M.Upadhyay has outlined the nature of finance function as follows: i) In most of the organizations, financial operations are centralized. This results in economies. ii) Finance functions are performed in all business firms, irrespective of their sizes / legal forms of organization. iii) They contribute to the survival and growth of the firm. iv) Finance function is primarily involved with the data analysis for use in decision making. v) Finance functions are concerned with the basic business activities of a firm, in addition to external environmental factors which affect basic business activities, namely, production and marketing. vi) Finance functions comprise control functions also vii) The central focus of finance function is valuation of the firm.
Finance is something different from Accounting as well as Economics but it uses information of accounting for making effective decisions. Accounting deals with recording, reporting and evaluating the business transactions, whereas Finance is termed as managerial or decision making process.
Economics deals with evaluating the allocation of resources in economy and also related to costs and profits, demand and supply and production and consumption. Economics also consider those transactions which involve goods and services either in return of cash or not.
Economics is easy to understand when divided into two parts.
1. Micro Economics: It is also known as price theory or theory of the firm. Micro economics explains the behavior of rational persons in making decisions related to pricing and production.
Macro Economics is a broad concept as it takes into consideration overall economic situation of a nation. It uses gross national product (GNP) and useful in forecasting.
5. Proper cash management:
Cash management is an important task of finance manager. He has to assess various cash needs at different times and then make arrangements for arranging cash. Cash may be required to purchase of raw materials, make payments to creditors, meet wage bills and meet day to day expenses. The idle cash with the business will mean that it is not properly used.
6. Implementing financial controls:
An efficient system of financial management necessitates the use of various control devices. They are ROI, break even analysis, cost control, ratio analysis, cost and internal audit. ROI is the best control device in order to evaluate the performance of various financial policies.
7. Proper use of surpluses:
The utilization of profits or surpluses is also an important factor in financial management. A judicious use of surpluses is essential for expansion and diversification plans and also in protecting the interests of share holders. The ploughing back of profits is the best policy of further financing but it clashes with the interests of share holders. A balance should be struck in using funds for paying dividend and retaining earnings for financing expansion plans.
FINANCE FUNCTION – AIM
The objective of finance function is to arrange as much funds for the business as are required from time to time. This function has the following objectives.
Repayments, interest and dividends
Net cash flows investments
Due to recent trends in business environment, financial managers are identifying new ways through which finance function can generate great value to their organization.
1. Current Business Environment: The progress in financial analytics is because of development of new business models, trends in role of traditional finance department, alternations in business processes and progress in technology.
Finance function in this vital environment emerged with enormous opportunities and challenges.
2. New Business Model: At the time when internet was introduced, three new e- business models have evolved. They are business-to-business (B2B), business-to-
Finance markets
Capital markets money markets
Sources of finance Equity shares Debentures Commercial banks Insurances govt
CFO
Investments in fixed and currents asstes
ii) Technology: With the developments in technology, ERP, internet, data warehousing have also improved. Internet helps in increasing the sources of acquiring financial data, whereas ERP vendors are building their own financial analytics which helps I n evaluating the performance, planning and estimating, management and statutory reporting and financial consolidation.
Till now, data warehousing solutions used to emphasize on developing elements of analytical infrastructure such as data stores, data marts and reporting applications but in future these data ware housings provide advances analytical abilities to data stores.
iii) Integrated Analytics: To survive in this competitive environment, organizations must have advanced level of integrated financial analytics. Integrated financial analytics are useful for organizations to evaluate, combine and share information inside and outside the organization.
Hence, with the progress in role of finance function, the financial analytics are used in organizations effectively.
EVOLUTION OF FINANCE FUNCTION:
Financial management came into existence as a separate field of study from finance function in the early stages of 20 th^ century. The evolution of financial management can be separated into three stages:
1. Traditional stage (Finance up to 1940): The traditional stage of financial management continued till four decades. Some of the important characteristics of this stage are:
i) In this stage, financial management mainly focuses on specific events like formation expansion, merger and liquidation of the firm.
ii) The techniques and methods used in financial management are mainly illustrated and in an organized manner.
iii) The essence of financial management was based on principles and policies used in capital market, equipments of financing and lawful matters of financial events.
iv) Financial management was observed mainly from the prospective of investment bankers, lenders and others.
3. Modern stage (After 1950): The modern stage started in the middle of 1950’s and observed tremendous change in the development of financial management with the ideas from economic theory and implementation of quantitative methods of analysis. Some unique characteristics of modern stage are:
i) The main focus of financial management was on proper utilization of funds so that wealth of current share holders can be maximized.
ii) The techniques and methods used in modern stage of financial management were analytical and quantitative.
Since the starting of modern stage of financial management many important developments took place. Some of them are in the fields of capital budgeting, valuation models, dividend policy, option pricing theory, behavioral finance etc.
GOALS OF FINANCE FUNCTION
Effective procurement and efficient use of finance lead to proper utilization of the finance by the business concern. It is the essential part of the financial manager. Hence, the financial manager must determine the basic objectives of the financial management. Objectives of Financial Management may be broadly divided into two parts such as:
Main aim of any kind of economic activity is earning profit. A business concern is also functioning mainly for the purpose of earning profit. Profit is the measuring techniques
Share holders BOD CFO
(iii) It ignores risk: Profit maximization does not consider risk of the business concern. Risks may be internal or external which will affect the overall operation of the business concern.
2. Wealth Maximization
Wealth maximization is one of the modern approaches, which involves latest innovations and improvements in the field of the business concern. The term wealth means shareholder wealth or the wealth of the persons those who are involved in the business concern. Wealth maximization is also known as value maximization or net present worth maximization. This objective is an universally accepted concept in the field of business
Favorable Arguments for Wealth Maximization
(i) Wealth maximization is superior to the profit maximization because the main aim of the business concern under this concept is to improve the value or wealth of the shareholders.
(ii) Wealth maximization considers the comparison of the value to cost associated with the business concern. Total value detected from the total cost incurred for the business operation. It provides extract value of the business concern.
(iii) Wealth maximization considers both time and risk of the business concern.
(iv) Wealth maximization provides efficient allocation of resources.
(v) It ensures the economic interest of the society.
Unfavorable Arguments for Wealth Maximization
(i) Wealth maximization leads to prescriptive idea of the business concern but it may not be suitable to present day business activities.
(ii) Wealth maximization is nothing, it is also profit maximization, it is the indirect name of the profit maximization.
(iii) Wealth maximization creates ownership-management controversy.
(iv) Management alone enjoy certain benefits.
(v) The ultimate aim of the wealth maximization objectives is to maximize the profit.
(vi) Wealth maximization can be activated only with the help of the profitable position of the business concern.
The relationship that exists in an organization between share holders and management known as agency relationship. Agency relationship results when a principal hires an agent to perform part of his duties. In this type of relationship there is a chance of conflicts to occur between the principal and the agent. This conflict is termed as agency problem. The costs incurred by stockholders in order to minimize agency problem and maximize the owner’s wealth are called agency costs.
The two primary agency relationship exists in a business concern are:
Shareholders Vs Bondholders
Manager Vs Share holders
1) Agency conflict-I (Shareholders Vs Bondholders): Shareholders are the real owners of the concern, they pay fixed and agreed amount of interest to bondholders till the duration of bond is finished but bondholders have a proceeding claim over the assets of the company. Since equity investors are the owners of the company they possess a residual claim on the cash flows of the company. Bondholders are the only sufferers if decisions of the company are not appropriate.
Wealth is maximized, so that wealth of share-holders can be maximized.
Welfare maximization is done with the help of micro economic techniques to examine a locative distribution.
In wealth maximization stockholders current wealth is evaluated in order to maximize the value of shares in the market.
In welfare maximization, social welfare is evaluated by calculating economic activities of individuals in the society.
Wealth is measured in terms of market price of shares.
Welfare can be measured in two ways, either by pare to efficiency or in units or dollars.
Wealth maximization involves problems related to maximizing shareholder’s wealth or wealth of the firm
Wealth maximization involves problem of combining the utilities of different people.
As share holders are the real owners of the organization, they appoint managers to take important decisions with the objective of maximizing share holder’s wealth. Though organizations have many more objectives, but maximizing stock price is considered to be an important objective of all for many firms.
1) Stock price maximization and social welfare : It is advantageous for society, if firm maximize its stock price. But, firm must not have any intentions of forming monopolistic market, creating pollution and avoiding safety measures. When stock prices are maximized, it benefits society by:
i) To greater extent the owners of stock are society : In past, ownership of stock was with wealthy people in society. But now, with the tremendous growth of pension funds, life insurance companies and mutual funds, large group of people in society have ownership of stock either directly or indirectly. Hence, when stock price is increased, it ultimately improves the quality of life for many people in society.
ii) Consumers benefit: It is necessary to have effective low-cost businesses which manufacture good quality of goods and services at the cheapest cost possible to maximize stock price. Companies which are interested in maximizing stock price must satisfy all requirements of customers, provide good services and innovate new products finally; it must increase its sales by creating value for customers. Some people believe that firms increase the prices of goods while maximizing stock price. But it is not true; in order to survive in competitive market firms does not increase prices otherwise they may lose their market share.
iii) Employees benefit: In past years, it was an exception that decreases in level of employees lead to increase in stock price, but now a successful company which can increase stock price can develop and recruit more employees which ultimately benefits the society. Successful companies take advantage of skilled employees and motivated employees are an important source of corporate success.
2) Managerial Actions to Maximize Shareholder’s Wealth: In order to identify the steps taken by managers to maximize shareholder’s wealth, the ability of the organization to generate cash must be known. Cash flows can be determined in three ways, they are:
i) Unit Sales: In first determinant, managers can increase the level of their sales either by satisfying customers or by luck, but which will not continue in long run.
ii) After Tax Operating Margins: In second determinant, managers can generate cash flows by increasing operating profit which is not possible in competitive environment or by decreasing direct expenses.
iii) Capital Requirements: In third determinant, managers can increase cash flows by decreasing assets requirements which ultimately results in increase of stock price.
Investment and financing decisions have an impact on level, timing and risk of the cash flow of firm and finally on stock price. It is necessary for manager to make decisions which can maximize the stock price of the firm.
3) Maximizing Earnings Per Share is Beneficent or Not: In order to maximize stock price, many analyst focus on cash flows by evaluating the performance of the company and also focus of EPS as an accounting measure. Along with cash flow, EPS also plays an important role in identifying stockholder’s value.
RISK RETURN TRADE-OFF
The Risk-Return Trade-Off is an essential concept in finance theory. Risk implies the changes in expected return like sales, profits or cash flow and it also includes probability that problem.
Risk analysis is a procedure of calculating and examining the risk which is related to financial and investment decision of the company. Finance managers must focus on expected rate of return by comparing the level of risks involved in investment decision. When it is expected that rate of return will be high then it involves high level of risk and vice versa.
The decisions which involve risk-return trade off are explained below:
1) Capital Budgeting Decisions: Capital budgeting decision is important, as it involves proper allocation of funds. These decisions are made considerably for long period of time in order to get benefits in future. While taking capital budgeting decision, finance manager needs to evaluate the cost of capital and risk involved in it. Finance manager must have complete knowledge about the techniques used for evaluating such as Net Present Value (NPV), IRR, discounted cash flow, etc. Finance manager must have the capability of combining risk with returns in order to evaluate the potential of investment appropriately.
INVESTMENT DECISIONS
FINANCING DECISIONS
DIVIDEND DECISIONS
(iv) Profits are the main sources of finance for the growth of a business. So, a business should aim at maximization of profits for enabling its growth and development.
(v) Profitability is essential for fulfilling social goals also. A firm by pursuing the objective of profit maximization also maximizes socio-economic welfare.
WEALTH MAXIMIZATION
Wealth maximization is the appropriate objective of an enterprise. Financial theory asserts that wealth maximization is the single substitute for a stockholder’s utility. When the firm maximizes the stockholder’s wealth, the individual stockholder can use this wealth to maximize his individual utility. It means that by maximizing stockholder’s wealth the firm is operating consistently towards maximizing stockholder’s utility.
Goal Objective Advantages Disadvantages
Profit maximization
Large amount of profits - Easy to calculate profits.
Stockholder wealth maximization
Highest market value of common stock
Stockholder’s current wealth in a firm = (Number of shares owned) x (Current Stock Price Share)
Symbolically, 𝑊 0 =𝑁𝑃 0
