Financial Management
Introduction

Financial Management (FM)
• Finance relates to Money.
• Broder scope of money includes anything that has monetary value.
• Financial Management is management of investments and financing
mix of a business in an optimal manner.
Financing Mix Investments
Liabilities & Owner’s Equity Assets
Current Liabilities
Long term Debt
Owner’s Equity
Current Assets
Fixed Assets

Functions
Financing
•Debt
•Equity
Investment
•Current
Assets
•Fixed Assets
Dividend
Policy
•Dividend
Payment
•Retained
Earnings

Financing
• How much of debt to be used.
• Mix of debt and equity is referred to as capital structure.
• Debt holder transfers (operational/ business) risk to firm, and expect lower
return
• Firm transfers (operational/ business) risk to equity holders, who expect
higher returns for higher risks.
Source Risk for
Investor
Return for
Investor
Risk for firm Cost for Firm
Debt Lower Lower Higher Lower
Equity Higher Higher Lower Higher

Investment
• Where to invest?
• Fixed Assets – Capital Budgeting
• How much to invest in working capital.
• Current Assets – Working Capital Management
Investment Profits Risk
Fixed Assets Higher Higher
Current Assets Lower Lower

Dividend Policy
• How much to retain/ reinvest in business?
• How much to pay as dividend?
New
Investment/
Growth
Retained
Earnings/
Internal Equity
New
(External)
Equity
Additional
(External)
Debt

(Financial) Goal of a Firm
• What it should be????????

(Financial) Goal of a Firm – Cont.
• Profit Maximization
• Profits represent past performance – PIA Performance
• Accounting profits could be manipulated – Depreciation, R&D Exp, Straight
Misrepresentations.
• Profits are made available after long intervals – Quarterly at best.
• So what?????

(Financial) Goal of a Firm – Cont.
• Maximization of Shareholders Wealth
• Focused on Future Cash Flows
• Information available on daily basis – in Stock Markets.
• Reflects all available information – Efficient Market Hypothesis

Basic Principles of Finance
• Risk – Return Trade Off
• More Risk – More Return
• Time Value of Money
• A Dollar received today has more value than a dollar received tomorrow.
• Cash flows are important – Not accounting income/ profits.
• Only consider cash inflows and cash outflows.
• Non Cash items like Depreciation do not have direct relevance to financial
management (Depreciation is only relevant because of its tax benefits).
• Incremental (Marginal/ Differential) cash flows are important for
financial decision making.

Basic Principles of Finance – Cont.
• The Agency Problem
• Principal (Investor) – Agent (Manager) conflict.
• Managers keep self interest ahead of investor’s interest.
• The Curse of Competitive Markets
• No abnormal profits in the long run.
• Efficient Capital Markets
• Market Prices reflect all available information. Prices are always right and
quickly adjust to new information.
• Taxes are important considerations.
• We consider after tax cash flows.
• Tax payments and Tax benefits.

Basic Principles of Finance – Cont.
• All risk is not equal.
• Risk diversification
• Systematic (Market/ undiversifiable) vs. unsystematic (specific/ diversifiable)
risks
• Ethical behavior is doing the right thing.
• How would you feel if your action is published on front page of a main stream
news paper??