KAMMAVARI SANGHAM GROUP OF INSTITUTIONS (R) -1952

K.S. SCHOOL OF ENGINEERING AND MANAGEMENT

DEPARTMENT OF MANAGEMENT STUDIES AND RESEARCH

CENTRE

COURSE MATERIAL

Name: Meghana C

Subject Name and Subject Code: 22MBA22

Designation: Assistant Professor

Department: DEPARTMENT OF MANAGEMENT STUDIES AND

RESEARCH CENTRE
Module-1
Introduction: Financial Management: Definition and scope- objectives of
Financial Management- role and functions of finance managers. Interface of
Financial Management with other functional areas. Indian Financial System:
Structure-types-Financial markets- Financial Instruments -Financial
institutions and financial services- Non-Banking Financial
Companies(NBFCs). Emerging areas in Financial Management: Risk
Management- Behavioural Finance- Financial Engineering- Derivatives
(Theory).

Suggested Learning Resources:

1. Financial Management: Text, Problems & Cases M.Y. Khan & P.K. Jain,
TMH,7/e, 2017
2. Financial Management: Theory and Practice, Prasanna Chandra, TMH,
10/e, 2019
3. Financial Management Dr. G. Nagarajan & Dr. Binoy Mathew, Jayvee
Digital Publishing, 2/e, 2022
4. Financial Management, Prahlad Rathod, Babitha Thimmaiah and Harish
Babu, HPH, 1/e, 2015.
5. Financial Management, I.M. Pandey, Vikas Publishing, 11/e.
Meaning of Financial Management:
Financial management refers to the strategic planning, organizing, directing, and
controlling of financial undertakings within an organization. It involves managing
financial resources efficiently to achieve the organization's objectives and
maximize shareholder wealth.

Definition:
Financial management can be defined as the process of planning, organizing,
directing, and controlling the financial activities such as procurement and
utilization of funds of the enterprise\

Scope of Financial Management:

1.Investment Decisions:
Investment decisions refer to the decisions regarding where to invest so as to earn
the highest possible returns on investment. Investment decisions can be taken for
both long term as well as short term.
Long term investment decisions also known as Capital Budgeting decisions affect
a business’ long term earning capacity and profitability. For example, investment
in a new machine, purchase of a new building, etc. are long term investment
decisions.
Short term investment decisions also known as working capital decisions affect a
business’ day to day working operations.
For example, decisions regarding cash or bill receivables are short term investment
decisions.

2. Financial Decisions
Such decisions involve identifying various sources of funds and deciding the best
combination for raising the funds. The main sources for raising funds are
shareholders' funds (referred as equity) and borrowed funds (referred as debt).
Based on the cost involved, risk and profitability a company must judiciously
decide the combination of debt and equity to be used. For example, while debt is
considered to be the cheapest source of finance, higher debt increases the financial
risk. Financial decisions taken by a company affects its overall cost of capital and
the financial risk.
3. Dividend Decisions
The decision involves the decision regarding the distribution of profit or surplus of
the company. A company can distribute its profit to the equity share holders in the
form of dividends or retain it with itself. Under dividend decision, a company
decides what proportion of the surplus to distribute as dividends and what
proportion to keep as retained earnings. It is aimed at maximising the shareholders'
wealth while keeping in view the requirement of retained earnings that are needed
for re-investment.

4. Working capital management:

It involves managing an organisation's day-to-day finances, including cash,
accounts receivable, and accounts payable.

5. Capital structure management:

Capital structure management is about finding the right balance between debt and
equity to fund a company’s activities. The composition of a company’s capital,
known as its capital structure, is a crucial aspect of financial management. The two
primary components of capital structure are Debt and equity capital. The sound
capital structure management is about focusing on cost of capital, risk
management, maximizing shareholder value, financial flexibility, etc

Objectives of Financial Management:

1. Profit Maximization

The first and foremost objective of effective financial management is to maximize

the organization’s profit. It can be measured by year on year growth on a consistent
basis. The financial manager is responsible to look for profit maximization. This is
not the sole objective, but maximizing profits is a fundamental goal of financial
management. It gives an idea of how strong the company is with respect to the
market and competitors.

2. Wealth Maximization
Wealth maximization is all about tapping the untapped resources. With respect to
financial management, the key objective is to maximize shareholder wealth. This
involves enhancing the long-term value of the firm, considering both the capital
gains from stock appreciation and the dividends distributed.

3. Liquidity

Liquidity is crucial in financial markets because it allows for the smooth

functioning of buying and selling activities. Financial management aims to
maintain an optimal level of liquidity to meet short-term obligations and capitalize
on investment opportunities. It is a key consideration for investors, businesses, and
financial institutions. It plays a crucial role in determining the efficiency and
stability of financial markets and the overall health of the economy.

4. Optimal Utilization of Funds

The sound financial management is determined by the optimal utilization of funds.

It is the key objective in ensuring the smooth flow of finance in the organization.
This includes allocating resources to projects and initiatives that offer the best
returns, and ensuring the organization’s resources are used effectively.

5. Risk Management

Managing financial risks is a proactive objective. Financial managers strive to

identify, assess, monitor and mitigate various financial risks, including market
risks, credit risks, and operational risks to protect the organization’s financial
health and maintain its resilience in the face of uncertainties.

6. Ensuring Financial Stability

With growth and profitability, achieving and maintaining financial stability is a

core objective. This involves establishing a balance between debt and equity,
ensuring a stable capital structure, and avoiding excessive financial leverage.
Role and Functions of Finance Manager:

1. Estimating the Amount of Capital Required:

This is the foremost function of the financial manager. Business firms require
capital for:

(i) purchase of fixed assets,

(ii) meeting working capital requirements, and:

(iii) modernization and expansion of business.

The financial manager makes estimates of funds required for both short-term and
long-term.

2. Determining Capital Structure:

Once the requirement of capital funds has been determined, a decision regarding
the kind and proportion of various sources of funds has to be taken. For this,
financial manager has to determine the proper mix of equity and debt and short-
term and long-term debt ratio. This is done to achieve minimum cost of capital and
maximise shareholders wealth.

3. Choice of Sources of Funds:

Before the actual procurement of funds, the finance manager has to decide the
sources from which the funds are to be raised. The management can raise finance
from various sources like equity shareholders, preference shareholders, debenture-
holders, banks and other financial institutions, public deposits, etc.

4. Procurement of Funds:
The financial manager takes steps to procure the funds required for the business. It
might require negotiation with creditors and financial institutions, issue of
prospectus, etc. The procurement of funds is dependent not only upon cost of
raising funds but also on other factors like general market conditions, choice of
investors, government policy, etc.
5. Utilization of Funds:
The funds procured by the financial manager are to be prudently invested in
various assets so as to maximise the return on investment: While taking investment
decisions, management should be guided by three important principles, viz., safety,
profitability, and liquidity.

6. Disposal of Profits or Surplus:

The financial manager has to decide how much to retain for ploughing back and
how much to distribute as dividend to shareholders out of the profits of the
company. The factors which influence these decisions include the trend of earnings
of the company, the trend of the market price of its shares, the requirements of
funds for self- financing the future programmes and so on.

7. Management of Cash:
Management of cash and other current assets is an important task of financial
manager. It involves forecasting the cash inflows and outflows to ensure that there
is neither shortage nor surplus of cash with the firm. Sufficient funds must be
available for purchase of materials, payment of wages and meeting day-to-day
expenses.

8. Financial Control:
Evaluation of financial performance is also an important function of financial
manager. The overall measure of evaluation is Return on Investment (ROI). The
other techniques of financial control and evaluation include budgetary control, cost
control, internal audit, break-even analysis and ratio analysis. The financial
manager must lay emphasis on financial planning as well.

Meaning of Finance Manager:

A financial manager is someone who oversees the financial health of an

organization and helps ensure financial sustainability. They supervise many
important functions such as monitoring cash flow, managing expenses, producing
accurate financial data, and strategizing for profit.
 1. Financial Services

Management of financial instruments (assets or securities) and liability

management firms provide services to assist in obtaining the necessary finances as
well as ensuring that they are invested effectively.

India’s financial services include:

1. Banking Services- Any little or large service given by banks, such as lending
money, depositing money, providing debit/credit cards, opening accounts, and so
on.
2. Insurance Services- Insurance services include services such as issuing insurance,
selling policies, insurance undertakings, and brokerages, among others.
3. Investment Services- Asset management is a common example of investment
services.
4. Foreign Exchange Services- Foreign exchange services include currency
exchange, foreign exchange, and so on.

Types of Financial Services

Financial services encompass a broad range of activities and offerings provided by

financial institutions to manage money and facilitate various financial transactions.
These services can be broadly classified into two categories: fund-based financial
services and fee-based financial services.

a) Fund-Based Financial Services

Fund-based financial services involve the management and utilization of
funds. These services typically involve direct investment, lending, and
borrowing activities.

Key types of fund-based financial services include:

 1. Commercial Banking:

Loans and Advances: Providing various types of loans (e.g., personal,

business, mortgage) to individuals and businesses.
Deposits: Accepting deposits from customers, including savings accounts,
fixed deposits, and recurring deposits.

2. Leasing and Hire Purchase:

Leasing: Providing assets on lease to businesses and individuals, allowing

them to use the asset without owning it.
Hire Purchase: Financing the purchase of assets where the buyer pays in
installments and gains ownership after the final payment.

3. Asset Management:

Mutual Funds: Pooling funds from investors to invest in diversified

portfolios of securities.
Pension Funds: Managing retirement funds and ensuring adequate returns
for future pension payouts.

4. Insurance:

Life Insurance: Providing financial protection against the risk of death,

offering death benefits to beneficiaries.
General Insurance: Covering non-life risks such as health, property, and
liability insurance.

5. Factoring and Forfaiting:

Factoring: Purchasing accounts receivables from businesses at a discount,

providing immediate liquidity.
Forfaiting: Buying export receivables from exporters, providing them with
immediate cash flow.

6. Housing Finance:
 Home Loans: Providing loans for purchasing, constructing, or renovating
residential properties.

b) Fee-Based Financial Services

Fee-based financial services involve providing advisory and other services

for a fee, without directly involving the management of funds. These
services primarily focus on expertise and consultancy.

Key types of fee-based financial services include:

1. Financial Advisory Services:

Investment Advisory: Offering advice on investment strategies, asset

allocation, and portfolio management.
Wealth Management: Providing comprehensive financial planning and
wealth management services to high-net-worth individuals.

2. Brokerage Services:

Stockbroking: Facilitating the buying and selling of securities on behalf of clients.

Commodity Broking: Assisting clients in trading commodities such as gold,

silver, and agricultural products.

3. Credit Rating Services:

Credit Rating Agencies: Assessing the creditworthiness of individuals, companies,

and financial instruments, providing ratings that help investors make informed
decisions.

4. Corporate Advisory Services:

Mergers and Acquisitions: Advising companies on mergers, acquisitions, and
corporate restructuring.

Project Finance: Offering consultancy on financing large-scale projects, including

feasibility studies and risk assessment.

Importance of Financial Services:

The successful functioning of any financial system depends upon the range of
financial services offered by financial service organisations. The importance of
financial services may be understood from the following points:

1. Economic growth: The financial service industry mobilises the savings of the
people, and channels them into productive investments by providing various
services to people in general and corporate enterprises in particular. In short, the
economic growth of any country depends upon these savings and investments.

2. Promotion of savings: The financial service industry mobilises the savings of

the people by providing transformation services. It provides liability, asset and size
transformation service by providing huge loan from small deposits collected from a
large number of people. In this way financial service industry promotes savings.

3. Capital formation: Financial service industry facilitates capital formation by

rendering various capital market intermediary services. Capital formation is the
very basis for economic growth.

4. Creation of employment opportunities: The financial service industry creates

and provides employment opportunities to millions of people all over the world.

5. Contribution to GNP: Recently the contribution of financial services to GNP

has been increasing year after year in almost countries.

6. Provision of liquidity: The financial service industry promotes liquidity in the

financial system by allocating and reallocating savings and investment into various
avenues of economic activity. It facilitates easy conversion of financial assets into
liquid cash.
Dividend Decision:

The dividend is that portion of the profit that is distributed to the shareholders.
The decision involved here is how much of the profit earned by the company
after paying the taxes is to be distributed to the shareholders. It also includes the
part of the profit that should be retained in the business. When the current income
is re-invested, the retained earnings increase the firm’s future earning capacity.
This extent of retained earnings also influences the financing decision of the firm.
The dividend decision should be taken keeping in view the overall objective of
maximizing shareholders’ wealth.

Factors affecting Dividend Decision

There are various factors that affect the dividend decision. These are as follows:
 Amount of Earnings: Dividends are paid out of the current and previous
year’s earnings. More earnings will ensure greater dividends, whereas fewer
earnings will lead to the declaration of a low rate of dividends.

 Stability of Earning: A company that is stable and has regular earnings can
afford to declare higher dividend as compared to those company which
doesn’t have such stability in earnings.

 Stability of Dividend: Some companies follow the policy of playing a stable

dividend because it satisfies the shareholders and helps in increasing
companies reputation. If earning potential is high, it is declared as a high
dividend, whereas if the earning is temporary or not increasing, then it is
declared as a low or normal dividend.

 Growth Opportunities: Companies with growth opportunities prefer to retain

more money out of their earnings to finance the new project. So, companies
 that have growth prospects in near future will declare fewer dividends as
compared to companies that don’t have any growth plan.

 Cash flow Position: Payment of dividends is related to the outflow of cash. A

company may be profitable, but it may have a shortage of cash. In case the
company has surplus cash, then the company can pay more dividends, but
during a shortage of cash, the company can declare a low dividend.

 Taxation Policy: The rate of dividends also depends on the taxation policy of
the government. In the present taxation policy, dividend income is tax-free
income to the shareholders, so they prefer higher dividends. However,
dividend decision is left to companies.

 Stock market reaction: The rate of dividend and market value of a share are
directly related to each other. A higher rate of dividends has a positive impact
on the market price of the shares. Whereas, a low rate of dividends may hurt
the share price in the stock market. So, management should consider the effect
on the price of equity shares while deciding the rate of dividend.

Investment Decision:

An investment decision meaning can be understood as the process of evaluating

and selecting the best options for investing your money to realise all your financial
dreams. This process takes into account many factors, such as financial situation,
goals, investment horizon, risk tolerance, market conditions, inflation and interest
rates, and returns and risks associated with different investment options. An
investment decision determines how you allocate and manage your assets.

Factors Affecting Investment Decisions

 Risk Tolerance – This is one of the major factors in the investment decision-
making process. It refers to how comfortable an individual is with the possibility
 of losing money. People often believe that risk tolerance only considers how
comfortable a person is with the possibility of losing money, but that’s not the
only factor that defines it. Other factors such as age, financial situation and
stability, income, and investment goals also influence how much risk a person
can take
 Market Conditions – Factors such as interest rates, stock market trends,
inflation, and national and geopolitical events like wars influence how the
market performs. These conditions can impact investment returns, risks, and
opportunities. For example, a high inflation rate will lower your real rate of
return. Similarly, changes in interest rates affect the cost of borrowing and thus
the attractiveness of different fixed-instrument investment options.
 Investment Goals – Financial goals drive our investment decisions. Generally,
these goals are divided into three parts – Long-, mid-, and short-term goals. We
select investment options that align with financial goals like saving for
retirement, buying a house, or funding children’s education.
 Financial Situation – Your financial situation is defined by how much you
earn, your expenses, how much you have saved, ongoing investments, and any
outstanding debts. One can only invest according to their current financial
situation. For example, a person who is burdened with debt would need to
prioritise paying off their debt before making new investments. In contrast,
someone with a stable income, savings, and minimal debt would have more
freedom to explore different investment options.
 Time Horizon – Time or investment horizon means how long you plan to hold
an investment before you would actually need the funds. Individuals investing
with a long-term mindset can take on more risk, and invest in attractive options
such as equity funds. Those with a shorter time horizon might prefer safer
investments with more liquidity like debt funds.
 Diversification – To diversify means to spread investments across different
types of assets and industries to minimise risk. When making investment
decisions, it is important to include a mix of asset classes, such as stocks, bonds,
and mutual funds, and invest in various sectors. This way, if any losses made in
a poor investment can be offset by gains in another.
 Tax Implications – Tax rules are often different for different investment
options. While some investments are heavily taxed, some even offer advantages
like ELSS or PPF. Taxes can significantly impact your investment’s real rate of
return, so understanding the tax implications of your investments helps you
maximise your after-tax returns, and even reduces your taxable income.
 Interest Rates – Interest rates generally impact fixed-income investment
options like bonds and liquid funds the most. When the interest rate rises, the
value of existing debt instruments can decrease. And when the rates fall, they
can increase their value.
 Economic Outlook – The county’s GDP growth, employment trends, inflation
rates, and other economic metrics also affect the market and investment
decisions. If the economic outlook is positive, investors can be encouraged to
make more aggressive investments.

Financing Decision

The financing decision is about the amount of finance to be raised from various
long-term sources, this determines the various sources of finance, as well as it also
provides the cost of each source of finance. The main sources of finance are:
 Shareholders’ Funds
 Borrowed Funds
The shareholders’ funds or owners’ funds consist of equity capital and retained
earnings, whereas borrowed funds refer to finance raised as debentures or other
forms of debt. The borrowed funds contain risk because they involve a commitment
of fixed interest payment, although there will be loss in the organisation. On the
other hand, owners’ funds have less risk because there is no such commitment
regarding payment of dividends and replacement of the capital amount. Financing
decisions involve analysing the risk and cost associated with each source of finance.
Both sources have their own merits and demerits.

Factors Affecting Financing Decision

There are various factors that affect the financing decision. These are as
follows:

1. Cost:
The cost of raising funds from different sources is different. A financing manager
generally prefers the cheapest source of finance.

2. Risk:
The risk associated with different sources of finance is a different borrowed fund
has a high degree of risk, as compared to the owners. The financial manager
considers the risk involved with each source before taking a financing decision.
In the case of equity, the risk is low, and in the case of debt, the risk is high.

3. Floatation Cost:
Floatation cost refers to the cost, which is involved in the issue of securities. In
the case of equity, floatation cost is low, and in the case of debt, floatation cost is
high. Some of the examples are underwriting commission, broken range stamp
duty, etc. The firm prefers securities with the least floatation cost.

4. Cash Flow Position:

A company with a strong cash flow position can take the advantage of debt
because interest payment and re-payment of principal amount can be preferred by
companies when there will be a shortage of cash.

5. Level of Fixed Operating Costs:

Owner’s fund is preferred by firms with a higher level of operating costs, like
rent, salaries, insurance premiums, etc., because interests payment on debt will
further add to the cost burden. And in case of moderate or low fixed operating
costs, firms can go for borrowed funds.

6. Control Consideration:
The issue of more equity shares may lead to a dilution of management control
over the business. Debt financing has no such implication. Companies that are
afraid of taking over will prefer debt. It means if existing shareholders want to
retain complete control of the company, then the debt should be preferred.
However, if they don’t mind the loss of control, then the company may go for
equity. So we can say that equity dilutes control, whereas debt doesn’t affect
control.

7. State of Capital Market:

The condition of the stock market also helps in making the source of finance. In
the case when the stock market is rising, during this period it is also easy to raise
funds for the issue of shares because people are interested to invest in equity
shares. But in case of a depressed market, company may face difficulties for issue
equity shares.

Difference between Profit Maximization and Wealth maximization:

Basis Profit Maximization Wealth Maximization

Focuses on short-term gains by Aims for long-term value

Objective maximizing net income. creation for shareholders.

Time Horizon Short-term orientation. Long-term orientation.

Primarily on maximizing Considers a broader set of

Emphasis profits. factors beyond profits.

Considers factors such as

Mainly concerned with
risk management,
revenue generation, cost
Inclusion of sustainability, and corporate
control, and profitability.
Factors social responsibility (CSR).

Holistic Tends to be more narrow and Offers a holistic approach

Approach focused on financial metrics. by considering financial and
non-financial aspects for
 Basis Profit Maximization Wealth Maximization

sustained success.

Aims to enhance
May benefit shareholders shareholder wealth through
through increased dividends long-term value creation
Shareholder and stock prices. and sustainable business
Value practices.

Less flexible, as it may More flexible, allowing

prioritize short-term gains at adaptation to changing
the expense of long-term market conditions and
Flexibility considerations. ensuring long-term viability.

Generally, it involves a
It may involve higher risk
balanced approach to risk
tolerance for the sake of
management to ensure long-
immediate profits.
Risk Tolerance term stability.

Return on Investment
Price-to-earnings (P/E)
(ROI), Net Profit Margin,
ratio, price-to-book (P/B)
Inventory Turnover Ratio, and
ratio, and earnings per share
Accounts receivable Turnover
(EPS) are important ratios
Ratio are all relevant metrics in
for wealth maximization.
Financial Ratios this case.

Corporate Typically, CSR may be a Emphasizes CSR as an

Social secondary consideration. integral part of business
Responsibility strategy, considering the
(CSR) impact on society and the
Basis Profit Maximization Wealth Maximization

environment.