Nature of

Financial
Management

Definition of Financial
Managemet
Financial Management involves the
application of general management
principles to a particular financial
operations.
It is concerned basically with two
steps:

 1. Raising of funds most economically

2. Planning future operations and

controlling current performances and
future developments through
financial
means

Scope of finance

Scope of finance
Traditional approach and
modern approach

Traditional approach
It refers to its subject matter,in
academic literature in the initial
stages of its evolution.as a separate
branch of economic study.
It evolved during the 1920s and 1930s
and dominated academic thinking
during the forties and through the
early fifties.it has now discarded as it
suffers from limitations.

Traditional
approach(Features)
-Emphasis was on raising of funds
Episodic Finance Function
-It was only outsider looking approach
It was from the point of view of
investors
No importance to the decision making

Traditional approach contd.

Over emphasis on the topics of
securities
Over emphasis on promotion and
incorporation of companies
Mergers and acquisitions in the
nature of hostile mergers and
forced takeovers

Traditional approach contd.

Emphasis on Long term finance
only
Emphasis on only corporate
entities

Weaknesses of Traditional
approach
It ignored the central issues of financial
management.
These issues are reflected in the
following fundamental questions which
a finance manager should address,like:
Should an enterprise commit capital
funds to certain purpose? What is the
cost of capital of funds to the
enterprise?

Weaknesses Contd.
It failed to consider day to day
managerial problems.
It ignored management overemphasis
to lender
It neglected the consideration of the
question of allocation of capital into
different assets
It ignored optimum combination of
finance

Modern approach
It provides a solution to those
shortcomings.
It views the term financial management in
a broad sense and provides a conceptual
and analytical framework for financial
decision making.The main contents of this
are
what is the total volume of funds an
enterprise should commit?what specific
asset a firm should acquire?

Modern approach
How should the funds required be
financed?
How large an enterprise be and how
fast should it grow?
What should be the composition of
its liabilities?
In what form should it hold asset?

Finance Functions
Investment or Long Term Asset Mix
Decision
Financing or Capital Mix Decision
Dividend or Profit Allocation
Decision
Liquidity or Short Term Asset Mix
Decision
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Finance Managers Role

15

Raising of Funds
Allocation of Funds
Profit Planning
Understanding Capital Markets

1st decision of
of modern approach

Investment decisions:it refers

to the selection of asset in which funds
will be invested by a firm.it has two
broad groups.
Long- term asset which yield a return
over a period of time in future.
Short term asset which in the normal
course of business are convertible into
cash

In long term category,

acquisition of assets is
popularly known in financial
literature as
Capital budgeting: it relates
to the selection of an asset or
investment proposal which likely to
be available in future over the
lifetime of the project.

The aspect of financial

decisions making with
reference to current assets is
termed as
Working capital management:
concerned with management of current
asset. it is an important and integral
part of short term survival for long term
success.

2nd decision
Financing decision:it is concerned
with the financing-mix or capital
structure.
The term capital structure refers to the
proportion of debt(fixed interest source of
financing)and equity capital(variable
dividend securities).it relates to the
choice of the proportion of these sources
to finance the investment requirements.

3rd decision
Dividend policy :it should be analysed in
relation to the financing decision of a firm.they
can be distributed to the shareholders in the
form of dividend or they can be retained in
business itself. The decision as to which course
should be followed depends largely on a
significant elements in the dividend
decision,the dividend payout ratio..that is what
proportion of net profits should be paid out to
the shareholders.
The final decision Will depend upon the
preference of the shareholders and investments
opportunity available within the firm

Objective of financial
management.

Financial Goals or Objectives of

financial management
Profit maximization
wealth maximization

Profit maximization
According to this approach,actions that
increase profits should be undertaken
and those that decrease profits are to
be avoided.it implies that
investment,financing and dividend
policy decisions should be oriented to
the maximization of profit.
Term profit can be used in two
senses.as a owner-oriented and where
output exceeds inputs.

Profit maximization
Owner oriented profit: it refers to the
amount and share of income which is
paid to the owners those who supply
equity capital.
Output exceeds input: the value created
by the use of resources is more than the
total of the input resources.
It means that firm should be guided in
financial decisions making by projects
&decisions which are profitable.

Objections to Profit
Maximization

It is Vague
It Ignores the Timing of Returns
It Ignores Risk
Assumes Perfect Competition
In new business environment profit
maximization is regarded as

25

Unrealistic
Difficult
Inappropriate
Immoral.

Shareholders Wealth
Maximization
Maximizes the net present value of a course
of action to shareholders.
Accounts for the timing and risk of the
expected benefits.
Benefits are measured in terms of cash
flows.
Measuring profit in cash flow avoids the
ambiguity associated with accounting profit
Fundamental objectivemaximize the
market value of the firms shares.
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Basic Tools of Wealth

maximisation
(I) Ensuring a fair return to
shareholders
(II) Building up reserves for growth and
expansion
(III) Ensuring maximum operational
efficiency by efficient and
effective
utilization of resources

Risk-return Trade-off
Risk and expected return move in
tandem; the greater the risk, the greater
the expected return.
Financial decisions of the firm are guided
by the risk-return trade-of.
The return and risk relationship:
Return = Riskfree rate + Risk premium
Risk-free rate is a compensation for time
and risk premium for risk.
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Managers Versus Shareholders

Goals
A company has stakeholders such as employees, debtholders, consumers, suppliers, government and society.
Managers may perceive their role as reconciling conflicting
objectives of stakeholders. This stakeholders view of
managers role may compromise with the objective of SWM.
Managers may pursue their own personal goals at the cost of
shareholders, or may play safe and create satisfactory
wealth for shareholders than the maximum.
Managers may avoid taking high investment and financing
risks that may otherwise be needed to maximize
shareholders wealth. Such satisfying behaviour of
managers will frustrate the objective of SWM as a normative
guide.
29

Financial Goals and Firms

Mission and Objectives
Firms primary objective is maximizing the
welfare of owners, but, in operational terms,
they focus on the satisfaction of its customers
through the production of goods and services
needed by them
Firms state their vision, mission and values in
broad terms
Wealth maximization is more appropriately a
decision criterion, rather than an objective or a
goal.
Goals or objectives are missions or basic
purposes of a firms existence

In short financial discipline

in the organisation
Results in maximum value of
the share of the firm

End of presentation
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