Professional Documents
Culture Documents
CORE CONCEPTS
OF FINANCIAL
MANAGEMENT
UNIT ONE
CHAPTER ONE
INTRODUCTION
Lesson 1
Chapter 1
Introduction
Unit 1
Core concepts in financial management
After reading this lesson you will be able to understand the following: -
A very warm welcome to all my students in second semester of MBA course. I will be
teaching you financial management; I must tell you that I find this subject as the most
interesting subject and all my efforts will be to make it very interesting for you as well.
Lets discuss
Almost every firm, government agency, and organization has one or more financial
managers who oversee the preparation of financial reports, direct investment activities,
and implement cash management strategies. As computers are increasingly used to record
and organize data, many financial managers are spending more time developing strategies
and implementing the long-term goals of their organization.
The duties of financial managers vary with their specific titles, which include controller,
treasurer or finance officer, credit manager, cash manager, and risk and insurance
manager. Controllers direct the preparation of financial reports that summarize and
forecast the organization’s financial position, such as income statements, balance sheets,
and analyses of future earnings or expenses. Regulatory authorities also in charge of
preparing special reports require controllers. Often, controllers oversee the accounting,
audit, and budget departments. Treasurers and finance officers direct the organization’s
financial goals, objectives, and budgets. They oversee the investment of funds and
manage associated risks, supervise cash management activities, execute capital-raising
strategies to support a firm’s expansion, and deal with mergers and acquisitions. Credit
managers oversee the firm’s issuance of credit. They establish credit-rating criteria,
determine credit ceilings, and monitor the collections of past-due accounts. Managers
specializing in international finance develop financial and accounting systems for the
banking transactions of multinational organizations.
Cash managers monitor and control the flow of cash receipts and disbursements to meet
the business and investment needs of the firm. For example, cash flow projections are
needed to determine whether loans must be obtained to meet cash requirements or
whether surplus cash should be invested in interest-bearing instruments. Risk and
insurance managers oversee programs to minimize risks and losses that might arise from
financial transactions and business operations undertaken by the institution. They also
manage the organization’s insurance budget.
Financial institutions, such as commercial banks, savings and loan associations, credit
unions, and mortgage and finance companies, employ additional financial managers who
oversee various functions, such as lending, trusts, mortgages, and investments, or
programs, including sales, operations, or electronic financial services. These managers
may be required to solicit business, authorize loans, and direct the investment of funds,
always adhering to Federal and State laws and regulations.
Branch managers of financial institutions administer and manage all of the functions of a
branch office, which may include hiring personnel, approving loans and lines of credit,
establishing a rapport with the community to attract business, and assisting customers
with account problems. Financial managers who work for financial institutions must keep
abreast of the rapidly growing array of financial services and products.
In addition to the general duties described above, all financial managers perform tasks
unique to their organization or industry. For example, government financial managers
must be experts on the government appropriations and budgeting processes, whereas
healthcare financial managers must be knowledgeable about issues surrounding
healthcare financing. Moreover, financial managers must be aware of special tax laws
and regulations that affect their industry.
Financial managers play an increasingly important role in mergers and consolidations,
and in global expansion and related financing. These areas require extensive, specialized
knowledge on the part of the financial manager to reduce risks and maximize profit.
Financial managers increasingly are hired on a temporary basis to advise senior managers
on these and other matters. In fact, some small firms contract out all accounting and
financial functions to companies that provide these services.
The role of the financial manager, particularly in business, is changing in response to
technological advances that have significantly reduced the amount of time it takes to
produce financial reports. Financial managers now perform more data analysis and use it
to offer senior managers ideas on how to maximize profits. They often work on teams,
acting as business advisors to top management. Financial managers need to keep abreast
of the latest computer technology in order to increase the efficiency of their firm’s
financial operations.
We all have heard about the term finance, let us discuss on what does it mean and why
do you as a student of MBA want to study it?
Finance can be defined as the art and science of managing money. Virtually all
individuals and organizations earn or raise money and spend or invest money.
Finance is concerned with the process, institutions, markets, and instruments
involved in the transfer of money among and between individuals, businesses, and
governments.
To make informed decisions about where to get and put money in order to maximize
value in both personal and business decisions.
One good reason is “ to prepare yourself for the workplace of the future”. More and more
businesses are reducing management jobs and squeezing together the various layers of
the corporate pyramid. This is being done to reduce costs and boost productivity. As a
result, the responsibilities of the remaining management positions are being broadened.
The successful manager will need to be much more of a team player that has the
knowledge and ability to move not just vertically within an organization but horizontally
as well. Developing cross-functional capabilities will be the rule, not the exception. Thus,
a mastery of basic financial management skills is key ingredient that will be required in
the work place of your not too distant future.
Finance is the study of money management, the acquiring of funds (cash) and
the directing of these funds to meet particular objectives. Good financial management
helps businesses to maximize returns while simultaneously minimizing risks.
Hardly anybody wants to work in a field where there is no room for experience,
creativity, judgment and a pinch of luck but study of finance is not so. There are many
reasons that the financial manager’s job is challenging and interesting. Here are four
important ones.
-Securities Markets
-Understanding Values
-Time and uncertainty
-Understanding People.
* Markets for short-term claims with original maturity of one year or less.
* High-grade securities with little or no risk of default.
* Examples:
1.Treasury Bills.
2. Commercial Paper.
3.Certificates of Deposit.
* Market for long-term securities with original maturity of more than one year.
*Securities may be of considerable risk.
*Example:
1.Stocks
2.Corporate bonds
3.Government bonds
Primary Markets
A primary market is a market for newly created securities. The proceeds from the sale of
securities in primary markets go to the issuing entity. A security can trade only once in
the primary market.
Secondary Markets
A secondary market is a market for previously issued securities. The issuing firm is not
directly affected by transactions in the secondary markets. A security can trade an
unlimited number of times in secondary markets. The volume of trade in secondary
markets is such higher than in primary markets.
Investment Bankers
These generally participate in the secondary markets. A broker helps investors in buying
or selling securities. A broker charges commissions, but never takes title to the security.
A dealer buys securities from sellers, and sells them to buyers.
Financial Intermediaries
These are institutions that assist in the financing of firms. Example include; commercial
banks and pension funds. These institutions invest in securities of other firms, but they
are themselves financed by other financial claims. On the other hand, it is a sort of
indirect financing in which savers deposit funds with the banks and financial institutions
rather than directly buying bonds or shares and the financial institutions, in turn lend the
money to ultimate borrowers. The Commercial Banks, Financial Institutions, Finance and
Investment Companies, Insurance Companies, Unit Trust, Pension Funds etc., are
examples of financial intermediaries.
The financial manager cannot avoid coping with time and uncertainty. Firms often
have the opportunity to invest in assets which cannot pay their way in the short run and
which expose the firm and its stockholders to considerable risk. The investment, if
undertaken, may have to be financed by debt, which cannot be fully repaid for many
years. The firm cannot walk away from such choices- someone has to decide whether the
opportunity is worth more than it costs and whether the additional debt burden can be
safely borne.
The financial manager needs the opinions and cooperation of many people. For
instance, many new investment ideas come from plant managers. The financial manager
wants these ideas to be presented fairly; therefore, the proposers should have no personal
incentives to be either overconfident or overcautious. Take another example. In some
firms the plant manager needs permissions from the head office to buy a company car but
not to lease it, and the line of least resistance may be to lease the car. In other firms the
plant manager needs permission from the head office to buy or lease, and the line of least
resistance may be to travel everywhere by cab. The financial manager has to be aware of
these effects and has to devise procedures that will avoid as far as possible any conflicts
of interest.
These are not the only reasons that financial management is interesting and also
challenging.
Concept of Finance
Different finance scholars have interpreted the term ‘finance’ in real world variably.
More significantly, as noted at the very outset of this chapter, the concept of finance has
changed markedly with change in times and circumstances. For convenience of analysis
different viewpoints on finance can be categorized into following three major groups:
F.1. The first category incorporates the views of all those who contend that finance
concerns with acquiring funds on reasonable terms and conditions to pay bills
promptly. This approach covers study of financial institutions and instruments from
which funds can be secured, the types and duration of obligations to be issued, the timing
of the borrowing or sale of stocks, the amounts required, urgency of the need and cost.
The approach has the virtue of shedding light on the very heart of finance function.
However, the approach is too restrictive. It lays stress on only one aspect of finance. The
traditional scholars hold this approach of finance
F.2. The second approach holds that finance is concerned with cash. Since almost all
business transactions are expressed ultimately in terms of cash, every activity within the
enterprise is the primary concern of a finance manager. Thus, according to this approach,
finance manager is required to go into details of every functional area of business
activity, be it concerned with purchasing, production, marketing, personnel,
administration, research or other associated activities. Obviously, such a definition is too
broad to be meaningful.
F.3. A third approach to finance, held by modern scholars, looks at finance as being
concerned with procurement of funds and wise application of these funds.
Protagonists of this approach opine that responsibility of a finance manager is not only
limited to acquisition of adequate cash to satisfy business requirements but extends
beyond this to optimal utilisation of funds. Since money involves cost, the central task of
a finance manager while allocating resources is to match the benefits of potential uses
against the cost of alternative sources so as to maximise value of the enterprise. This is
the managerial approach of finance which is also known as problem-centered approach,
since it emphasizes that finance manager in his endeavor to maximise value of the
enterprise has to deal with vital problems of the enterprise, viz., what capital expenditures
should the enterprise make? What volume of the funds should the enterprise invest? How
should the desired funds be obtained?
Let us move on to financial management, you all being students of management know the
meaning of management. So let us discuss financial management now.
Financial management is an integral part of overall management and not merely a staff
function. It is not only confined to fund raising operations but extends beyond it to cover
utilisation of funds and monitoring its uses. These functions influence the operations of
other crucial functional areas of the firm such as production, marketing and human
resources. Hence, decisions in regard to financial matters must be taken after giving
thoughtful consideration to interests of various business activities. Finance manager has
to see things as a part of a whole and make financial decisions within the framework of
overall corporate objectives and policies.
The financial management of a firm affect its very survival because the survival of the
firm depends on strategic decisions made in such important matters such as product
development, market development, entry in new product line, retrenchment of a product,
expansion of the plant, change in location, etc. In all these matters assessment of financial
implications is inescapable.
Another striking feature of financial management that explains its generic nature is the
imperativeness of the continuous review of the financial decisions. As a matter of fact,
financial decision-making is a continuous decision-making process, which goes on
throughout the corporate life. Since a firm has to operate in an environment that is
dynamic, it has, therefore, to interact constantly with various environmental forces in
addition to changing conditions of the firm and adapt and adjust its objectives and
strategies including financial policies and strategies. A one-time financial plan not
subjected to periodic review and modifications in the context of changed conditions will
be a fiasco because conditions may change to such an extent that the plan is no longer
relevant and acts as a hindrance rather than help. Financial planning should, therefore, not
be static. It has to be continuously adapted to changing conditions.
As you all are MBA students it is essential for you to know the interface between finance
and other functions let us discuss. You all are studying other management subjects also
let us relate those with finance.
Till now you might have understood about the pervasive nature of finance. Let us discuss
in greater detail the reasons why knowledge of the financial implications of their
decisions is important for the non-finance managers. One common factor among all
managers is that they use resources and since resources are obtained in exchange for
money, they are in effect making the investment decision and in the process of ensuring
that the investment is effectively utilized they are also performing the control function.
Marketing-Finance Interface
There are many decisions, which the Marketing Manager takes which have a significant
impact on the profitability of the firm. For example, he should have a clear understanding
of the impact the credit extended to the customers is going to have on the profits of the
company. Otherwise in his eagerness to meet the sales targets he is liable to extend liberal
terms of credit, which is likely to put the profit plans out of gear. Similarly, he should
weigh the benefits of keeping a large inventory of finished goods in anticipation of sales
against the costs of maintaining that inventory. Other key decisions of the Marketing
Manager, which have financial implications, are:
Pricing
Product promotion and advertisement
Choice of product mix
Distribution policy.
Production-Finance Interface
As we all know in any manufacturing firm, the Production Manager controls a major part
of the investment in the form of equipment, materials and men. He should so organize his
department that the equipments under his control are used most productively, the
inventory of work-in-process or unfinished goods and stores and spares is optimized and
the idle time and work stoppages are minimized. If the production manager can achieve
this, he would be holding the cost of the output under control and thereby help in
maximizing profits. He has to appreciate the fact that whereas the price at which the
output can be sold is largely determined by factors external to the firm like competition,
government regulations, etc. the cost of production is more amenable to his control.
Similarly, he would have to make decisions regarding make or buy, buy or lease etc. for
which he has to evaluate the financial implications before arriving at a decision.
The firm's finance (treasurer) and accounting (controller) activities are typically
within the control of the financial vice president (CFO). These functions are
closely related and generally overlap; indeed, managerial finance and accounting
are often not easily distinguishable. In small firms the controller often carries out
the finance function, and in large firms many accountants are closely involved in
various finance activities. However, there are two basic differences between
finance and accounting; one relates to the emphasis on cash flows and the other to
decision making.
Now that you have related finance with other functions can you discuss on the role of a
financial manager?
Role of finance managers has increased tremendously and their tasks have become
complicated following cataclysmic changes in recent times in the entire global
economic environment and the world market place resulting in globalisation of
business and increased competitiveness" The multinational corporations of today
conduct their operations world-wide as if the entire world were a single entity with a
major thrust on quality, cost and speed."
The combined impact of all these measures has resulted in swelling wave of transnational
from Japan, USA, Germany and France pouring in India in every conceivable product
segment posing serious challenges to the very survival of Indian corporate who were
hitherto operating in highly sheltered and closed economy.
In order to face these challenges and to ensure their survival many Indian corporate giants
have desperately formed strategic alliances with global majors and some of them
embarked hurriedly on internal restructuring.
In translating this strategy into action the finance manager has to play a very effective
and integrated role by helping the top management in making financial decisions to
reduce cost, improve productivity and maximise corporate value.
To handle the new responsibilities the finance manager must have clear conception of
the corporate objectives of his organization as he has to act in conformity with these
objectives. Furthermore, he has to evaluate the effectiveness of financial decisions in
the light of some standards. Corporate objectives of the organisation provide such
standards. The finance manager should also have stronger grasp of the nature, functions
and scope of financial management.
Further, he needs a variety of qualitative and quantitative skills so as to carry out his
complex and diverse responsibilities.
We all know it very well that environment keeps changing and thus brings in new
challenges every time, let us discuss on the new challenges been faced by finance
manager.
FOREIGN EXCHANGE: Finance Managers will have to weigh the costs and
benefits of playing with foreign exchange particularly now that the Indian
economy is going global and the future value of the rupee visa a vis foreign
currency has become difficult to predict.
MAINTAINING SHARE PRICES: In the premium equity era, firms must ensure
that share prices stay healthy. Finance managers will have to devise appropriate
dividend and bonus policies.
FINANCIAL MANAGEMENT –
JULY 2004 – DEC 2004
Instructors: RU Faculty
Lecture Times:
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Slide 2
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Slide 3
PRESCRIBED TEXT
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Slide 4
TEACHING METHODOLOGY
Lecture presentations will generally consist of notes (presentation,
slides, and whiteboard) and in-class discussions and problem
solving. The course pedagogy will involve the use of the case
method. Problems and selected solutions will also be given to
students. Suggested practice problems from the end of chapter
questions in the text are identified in the detailed course outline.
Students are required to read all assigned chapters prior to the
lecture period during which the topic is to be discussed.
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Slide 5
Purpose
The purposes of these Guidelines are:
To provide students with an input into the structure and
content of the course;
To focus on the rights and obligations of both student
and instructor;
To foster collaborative learning and to encourage
individuals to take responsibility for their learning both
during and after the completion of the course.
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Slide 6
The Student
STUDENTS ACCEPT the individual and collective responsibility of
obtaining and becoming familiar with a copy of the Course Outline.
STUDENTS AGREE to avail themselves of copies of the required
readings and to duly undertake the assigned readings.
STUDENTS AGREE to be in possession of the computer skills
necessary to send and retrieve MS Word, Excel, and PowerPoint
documents via the Internet.
STUDENTS AGREE to regularly conduct searches via the World
Wide Web or journals maintained by the library of the University.
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Slide 7
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Slide 8
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Slide 9
Group Work
Students will form themselves into groups for purposes of
doing their course assignments and for purposes of
collaborative learning.
Each member will fully participate in the work of the group
ensuring that (s)he makes an equitable contribution to the
work of the group.
Each group member will honestly, fairly, and
independently evaluate his work and that of her/his fellow
group members using forms provided by the instructor and
will return those forms to the instructor at the time
prescribed by the course outline.
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Slide 10
COURSE CONTENT
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