Financial Management Overview

FINANCIAL
MANAGEMENT
OVERVIEW
UNIT-I
• Finance is the lifeline of any business.
• Financial Management means planning, organizing, directing and
controlling the financial activities such as procurement and
utilization of funds of the enterprise.
• Definitions
• “Financial management is the activity concerned with planning, raising,

controlling and administering of funds used in the business.” – Guthman and
Dougal
SCOPE OF FINANCIAL MANAGEMENT
Objectives of Financial Management
• To ensure regular and adequate supply of funds to the concern

• To ensure adequate returns to the shareholders
• To ensure optimum funds utilization
• To ensure safety on investment
• To plan a sound capital structure
Goals of Financial Management
• I. PROFIT MAXIMISATION
• Profit maximization means maximising the rupee or any other currency such as dollar,
pound or both income of firms.
• Profit is a primary motivating force for any economic activity. Firms essentially being an
economic organisation, it has to maximise the interest of its stakeholders.
• Profit is the positive and fruitful difference between revenues and expenses of a business
enterprise over a period of time.
• If an enterprise fails to make a profit, capital invested is eroded
/wrinkled/windswept and this situation prolongs, the enterprise ultimately ceases to exist.
• The overall objective of business enterprise is to earn at least satisfactory returns on the
funds invested, consistent with maintaining a sound financial position .
Limitations
• 1. Vague:
• 2. Ignores Time Value of Money:
• 3. Ignores Quality of Benefits
SHAREHOLDERS WEALTH MAXIMISATION
• Shareholders Wealth Maximisation means maximising the net present value (or wealth) of a course
of action to shareholders.
• The Net Present Value (NPV) of course of action is the difference between the present value of its
benefits and present value of its costs.
• For example, take Infosys Co., whose share price is increasing year by year, even by issue of bonus
shares, and the company is trying to put its shares at popular trading level.
Therefore, the wealth maximisation principle implies that the fundamental objective of a firm is
to maximise market value of its shares.
In other words, the market value of the firm is represented by its market price, which in turn is a
reflection of a firm’s financial decisions.
Hence market price acts as a firm’s performance indicator.

Principles of Financial Management
• Financial management is the process of managing the funds both for individuals and organizations to ensure
proper utilization of funds. Core principles of finance are applicable in the case of principles of financial
management.
1) Trade-off Risk and Return
2) Formation of Optimal Capital Structure
3) Diversification of both Investment and Borrowing
4) Aware of Time Value of Money
5) Forecast Cash Flows
6) Take a Right Insurance Plan

 Concentration on Wealth Maximization
 Reinvest Rather than Consume
 Determine Cost of Capital
 Financial Decision Align with Business Life Cycle

Financial Intermediaries
• A financial intermediary is typically an institution that facilitates the channelling of funds between lenders and borrowers
indirectly.
• Types of financial intermediaries
 Banks
 Mutual Savings Banks
 Savings Banks
 Building Societies
 Credit Unions
 Financial Advisers or Brokers

 Insurance Companies
 Collective Investment Schemes
 Pension Funds
 Cooperative Societies
 Stock exchanges
UNIT-II
• Financial statements aim at providing financial
information about a business enterprise to meet the
information needs of the decision-makers.
Financial statements prepared by a business
enterprise in the corporate sector are published and
are available to the decision-makers.
Advantages of Ratio Analysis
• Helps to understand efficacy of decisions.

• Simplify complex figures and establish relationships
• Helpful in comparative analysis
• Identification of problem areas
• Enables SWOT analysis:
• Various comparisons
1. Ignores Price-level Changes
2. Ignore Qualitative or Non-monetary Aspects
3. Variations in Accounting Practices
4. Forecasting
5. Lack of ability to resolve problems
6. Lack of standardised definitions
7. Lack of universally accepted standard levels
8. Ratios based on unrelated figures

Types of Ratios
• LIQUIDITY RATIOS
 Current Ratio
• Current Ratio = Current Assets : Current Liabilities or
• Current Assets/ Current Liabilities
 Quick or Liquid Ratio

• Quick Ratio = Quick Assets: Current Liabilities or
• Quick Assets / Current Liabilities

SOLVENCY RATIOS
1. Debt-Equity Ratio;
2. Debt to Capital Employed Ratio;
3. Proprietary Ratio;
4. Total Assets to Debt Ratio;
5. Interest Coverage Ratio.

 Debt-Equity Ratio =Long-term Debt / Shareholders’ Funds
 Debt to Capital Employed Ratio = Long-term Debt/Capital Employed(or Net Assets)
 Proprietary Ratio = Shareholders’, Funds/Capital employed (or net assets)
 Total assets to Debt Ratio = Total assets/Long-term debts
PROFITABILITY RATIOS
. Gross Profit Ratio
 2. Operating Ratio
 3. Operating Profit Ratio
 4. Net Profit Ratio
 5. Return on Investment (ROI) or Return on Capital Employed (ROCE)
 Earnings Per Share (EPS)

Common Size Statement Analysis
• What is Common Size Statement?
• Common size statement is a form of analysis and
interpretation of the financial statement. It is also known
as vertical analysis. This method analyses financial
statements by taking into consideration each of the line
items as a percentage of the base amount for that
particular accounting period
•Common size statements are always
expressed in the form of percentages.
Therefore, such statements are also called 100
per cent statements or component percentage
statements as all the individual items are
taken as a percentage of 100.
Types of Common Size Statements
•There are two types of common size

statements:
 Common size income statement
 Common size balance sheet
1. Common Size Income Statement
• Thisis one type of common size statement where the sales is

taken as the base for all calculations. Therefore, the calculation of
each line item will take into account the sales as a base, and each
item will be expressed as a percentage of the sales.
• Use of Common Size Income Statement
It helps the business owner in understanding the following points

Whether profits are showing an increase or decrease in relation to the sales obtained.
Percentage change in cost of goods that were sold during the accounting period.
Variation that might have occurred in expense.
If the increase in retained earnings is in proportion to the increase in profit of the business.
Helps to compare income statements of two or more periods.
Common Size Balance Sheet:
•A common size balance sheet is a statement in which balance

sheet items are being calculated as the ratio of each asset in
relation to the total assets. For the liabilities, each liability is being
calculated as a ratio of the total liabilities.
• Preparing Common Size Balance Sheet
 Take the total of assets or liabilities as 100.

 Each individual asset is expressed as a percentage of the total assets, i.e., 100 and different liabilities
are also calculated as per total liabilities. For example, suppose total assets are around Rs. 4 lakhs,
and inventory value is Rs. 1 lakh. In that case, it will be counted as 25% of the total assets.
• Limitations of Common Size Statement
 It is not helpful in the decision-making process as it does not have any approved benchmark.
 For a business that is impacted by fluctuations due to seasonality, it can be misleading.
Cash Flow Statement
• Cash Flow Statement:
• Cash flow statement is a statement showing the changes in

financial position of a business concern during different intervals
of time in terms of cash and cash equivalents.
Objectives of Cash Flow Statement
o Useful in short-term financial planning.

o Useful inefficient cash management.
o Helpful in formulation of business policies.
o Assists in preparation of cash budget.
o Used for assessment of cash flow from various activities, viz operating,
investing and financing activities.
• Limitations of Cash Flow Statement
o Based on historical cost principle.
o Based on secondary data.
o Ignores non-cash transactions.
o No adherence of basic accounting principles.
• Classification of Business Activities:
• Accounting Standard-3 (Revised) requires that the changes

resulting in inflows and outflows of cash and cash equivalents
will be classified into following three activities:
 Cash flow from operating activities.
 Cash flow from investing activities.
 Cash flow from financing activities
Cash Flow from Operating Activities:
Cash Flow from Investing Activities:
Cash Flow from Financing Activities
UNIT-IV
Capital budgeting
• Investment decision relates to the determination of total amount of assets to be held in the firm, the
composition of these assets and the business risk complexions of the firm as perceived by its investors
.It is the most important financial decision that the firm makes in pursuit of making shareholders
wealth.
•
• Investment decision can be classified under two broad groups.

•
 Long –term investment decision i.e. Capital budgeting.
• Short-term investment decision i.e. Working Capital Management

CAPITAL BUDGETING PRROCESS:
• A Capital Budgeting decision involves the following process:
 Identification of investment proposals.

 Screening the proposals.
 Evaluation of various proposals.
 Fixing priorities.
 Final approval and preparation of capital expenditure budget.
 Implementing proposal.
 Performance review.
METHODS OF CAPITAAL BUDGETING
•I. Traditional methods
 Payback period method or pay out or pay off method (PBP)
 Accounting Rate of Return method or Average Rate of Return (ARR)
• II. Time adjusted method or discounted method
 Net Present Value method (NPV)
 Profitability Index method (PI)
 Internal Rate of Return method (IRR)

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FINANCIAL

• “Financial management is the activity concerned with planning, raising,

• To ensure regular and adequate supply of funds to the concern

Hence market price acts as a firm’s performance indicator.

1) Trade-off Risk and Return

2) Formation of Optimal Capital Structure

3) Diversification of both Investment and Borrowing

4) Aware of Time Value of Money

5) Forecast Cash Flows

6) Take a Right Insurance Plan

 Reinvest Rather than Consume

 Determine Cost of Capital

 Financial Decision Align with Business Life Cycle

• Types of financial intermediaries

 Mutual Savings Banks

 Financial Advisers or Brokers

 Collective Investment Schemes

• Helps to understand efficacy of decisions.

2. Ignore Qualitative or Non-monetary Aspects

3. Variations in Accounting Practices

5. Lack of ability to resolve problems

6. Lack of standardised definitions

7. Lack of universally accepted standard levels

8. Ratios based on unrelated figures

• Current Assets/ Current Liabilities

 Quick or Liquid Ratio

• Quick Assets / Current Liabilities

2. Debt to Capital Employed Ratio;

4. Total Assets to Debt Ratio;

5. Interest Coverage Ratio.

. Gross Profit Ratio

 3. Operating Profit Ratio

 4. Net Profit Ratio

 5. Return on Investment (ROI) or Return on Capital Employed (ROCE)

 Earnings Per Share (EPS)

•There are two types of common size

• Thisis one type of common size statement where the sales is

It helps the business owner in understanding the following points

•A common size balance sheet is a statement in which balance

 Take the total of assets or liabilities as 100.

• Limitations of Common Size Statement

• Cash Flow Statement:

• Cash flow statement is a statement showing the changes in

o Useful in short-term financial planning.

• Accounting Standard-3 (Revised) requires that the changes

• Investment decision can be classified under two broad groups.

 Long –term investment decision i.e. Capital budgeting.

• Short-term investment decision i.e. Working Capital Management

• A Capital Budgeting decision involves the following process:

 Identification of investment proposals.

 Evaluation of various proposals.

•I. Traditional methods

 Payback period method or pay out or pay off method (PBP)

 Accounting Rate of Return method or Average Rate of Return (ARR)

• II. Time adjusted method or discounted method

 Net Present Value method (NPV)

 Profitability Index method (PI)

 Internal Rate of Return method (IRR)

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