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Financial Management
UNIT – I

FINANCIAL MANAGEMENT

Introduction to Finance: Meaning – Definition – Scope – Objectives – Functions of

Financial Management – Profit Maximization and Wealth Maximization –Sources of
Finance – Short-term – Bank Sources – Long Term – Shares – Debentures – Preferred
Stock – Debt – Venture Capital
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Without finance, the heart and brain of business
cannot function implying thereby its natural death
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Inputs are made available only
with finance
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Financial Management is that managerial activity which is concerned with the
planning and controlling of the firm‟s financial resources
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Meaning and Definition of Finance/ Financial Management

Finance may be defined as the provision of money at the time when it is required
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It
concerns with the application of skills in the manipulation, use and control of money
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W
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SCOPE OF FINANCE FUNCTIONS
Classification of Finance

The subject of finance has been traditionally classified into four classes:
Finance

Public Finance
State Government
Local Government
Central Government

Private Finance

Institutional
Finance

International
Finance

Personal Finance
Business Finance
Finance of Non-Profit
Organization

1) Public Finance: Public finance deals with the requirements, receipts and

disbursements of funds in the government institutions like states, local selfgovernment and central government
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3) Institutional Finance: Institutional finance is related to capital formation and meets
the financial requirements of the economy
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4) International Finance: This area of finance focuses attention on flow of funds
beyond national boundaries
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Finance Function

Financial function is the most important of all business functions
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It is not possible to substitute or eliminate this function because the
business well close down in the absence of finance
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It starts with the setting up of an enterprises and remains at all times
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The first approach assumes that the expenditure decisions giving rise to the
demand for the capital within a business
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Another approach relates finance function to cash
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3
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OBJECTIVES OF FINANCIAL MANAGEMENT

The objective of finance functions is to arrange as much funds for the business as are
required from time to time
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The funds committed to various
operations should be effectively utilized
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To achieve this purpose sufficient funds
will have to be invested
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It is generally said that a concern‟s value is linked with its
profitability
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 Generate Cash: Generating cash thorough the appropriate business transactions
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 Adequate Return on Investment: Sufficient fund should be provided at right time
to meet the needs of the business
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Financial Management

Scope of Finance Function / Financial Management

Financial management has undergone significant changes over the years in its scope
and coverage
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Traditional Approach
: Procurement of Funds
2
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The finance management was treated as just provider of funds, when
organization was in need of them
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Evolution of Financial Management
 Traditional Phase (Up to 1940): This can be summarized as follows:

i)

ii)
iii)

Finance function was concerned with procuring of funds to finance the
expansion or diversification activities
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In order to finance business growth, there was an emergence of
institutional financing and banking giving rise to finance industry
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 Transitional Phase (After 1940): This phase in fact was an extension of the
traditional phase and continued up to early fifties when the scope of finance
function started expanding in big way
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 Modern Phase (Integrated View – After 1950): The modern phase is characterized
by the application of economic theories and the application of quantitative
methods of analysis
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Functions of Financial Management

The functions of raising funds, investing them in assets and distributing returns earned
from assets to shareholders are respectively know as financing decision, investment
decision and dividend decision
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The investment decision is broadly
concerned with the asset-mix or the composition of the assets of a firm
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He or she must decide when, where from and
how to acquire funds to meet the firm‟s investment needs
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The

financial manager must decide whether the firm should distribute all profits or
retain them or distribute a portion and retain the balance
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Basically, this is working capital management, is concerned with the
management of current assets
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A business being an
economic institution must earn profit to cover its costs and provide funds for growth
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Profit is a measure of efficiency of a
business enterprise
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Profit maximization
consists of the following important features:
1) Profit maximization is also called as cashing per share maximization
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3) It considers all the possible ways to increase the profitability of the business
concern
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5) Profit maximization objectives help to reduce the risk of the business
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 It is ambiguity – vague; it means different to different people – may be pre-tax
or post-tax
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The fact that a rupee
received today is more valuable than the rupee received later is ignored
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 It gives effect to change in organization structure
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It takes into
consideration the time value of money
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The wealth maximization approach can be more explicitly defined in the following
ways:
A1 + A2 + A3 + ……
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There is consideration of time value of
money
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Profit Maximization Versus Wealth Maximization

 Profit cannot be ascertained well in advance to express the probability of return
as future is uncertain
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 It represents value of benefits minus the cost of investment
 The firm‟s goal cannot be to maximize profits but to attain a certain level of
profit holding certain amount of shares
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 There must be balance between expected return and risk
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Dr
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Arts and Science College

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Financial Management
SOURCES OF FINANCE

The financial needs of a business are of a peculiar nature
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For instance, if the size of
business is large, the amount of funds required will also be large
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One year to five years Expenditure
on
modernization,
renovation, heavy advertising, etc
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SHORT-TERM SOURCES OF FINANCE

After establishment of a business funds are required to meet its day-to-day expenses
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They do not create a heavy burden of interest on the organization
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Short Term Sources of Finance
Indigenous Bankers

Installment Credit

Advances

Accrued Expenses and
Deferred Income

Accounts Payable
Bills Discounting

Trade Credit
Factoring

Indigenous Bankers: Private money-lenders and other country bankers used to be the

only source of finance prior to the establishment of commercial banks
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Advances: Some business houses get advances from their customers and agents against

orders and this source is a short-term source of finance of them
Accrued Expenses and Deferred Incomes : Accrued expenses are the expenses which

have been incurred but not yet due and hence not yet paid also
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However, they only
remain as liabilities until they are settled
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At present day commerce is built upon credit, the trade
credit arrangement of a firm with its suppliers is an important source of short-term
finance
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The seller draws a bill of exchange
on the buyer of goods on credit
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This method of
financing is to reduce the risk of default by debtors
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After trade credit, bank
credit is the most important source of financing capital requirements of firms in India
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Forms of Bank Source of Finance
1) Secured Term Loan: When a bank makes an advance in lump-sum against some

security it is called a loan
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2) Cash Credit: A cash credit is an arrangement by which a bank allows his customer
to borrow money up to a certain limit against some tangible securities
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Long-term funds are required to create production facilities through purchase of fixed
assets such as plant, machinery, land, building, etc
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The various sources of raising long-term funds include:
Long-term Sources of Finance
Equity Shares

Debt /Debentures

Preferred Stock /
Preference Shares

Retained Earnings

Loans from Financial Institutions

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Arts and Science College

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Financial Management
EQUITY SHARES

Equity shares are, earlier, known as ordinary shares or common shares
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DEBT/ DEBENTURES

A debenture is an instrument executed by the company under its common seal
acknowledging indebtedness to some persons to secure the sum advanced
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Types of Debentures

There are several types of debentures on the basis of the terms and conditions of the
issue of the debentures as follows:
i
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Bearer Debentures
2 On the basis of Security

3 On the basis of Redemption

4 On the basis of Conversion

5 On the basis of Priority
6 On the basis of Status

i
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Unsecured Debentures
i
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Irredeemable Debentures
i
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Non-convertible Debentures
i
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Ordinary Debentures
i
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Legal Debentures

7 Debentures with Pari Pasu Clause

Difference between Shares and Debentures
Basis of Difference
Shares

Debentures

Share is a part of owned
Debenture constitutes a loan
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for Reward is the payment of Reward is the payment of
dividend
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Capital Versus Loan

Reward
Investment
Fluctuations in the
The rate of dividend may vary
rate of Interest and
The rate of interest is fixed
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Dividends

Payment of dividend gets no Payment of interest gets

Payment of Interest
priority over the payment of priority over the payment of
/ Dividend

interest
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Dr
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, Associate Professor, Dr
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Arts and Science College

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Financial Management

Repayment
Principal

of

Secured by Charge
Restriction on Issue

Payment of share capital is
made after the repayment of
debentures
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Section 79 imposes certain
restriction on issue of share at
discount
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Debentures
are
usually
secured by a charge
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PREFERRED STOCK / PREFERENCE SHARES

Preference shares are those shares on which there is a preference right – to dividend
during the life time of the company and to repayment of capital on the winding up of
the company
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RETAINED EARNINGS

Retained earnings are also referred as ploughing back of profits means the
reinvestments by concern of its surplus earnings in its business
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Necessity of Retained Earnings

1
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3
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5
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Expansion and growth of business
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Making the company self-dependent and avoiding outside financing
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LOANS FROM FINANCIAL INSTITUIONS

Loans from financial institutions also referred to as „term finance‟ represent a source
of debt finance which is generally repayable in more than one year but less than 10
years
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Features of Loans from FIs
 Security: Term loans typically represent secured borrowing
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Other
assets of the firm may serve as collateral security
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are secured by way of mortgages, hypothecation, pledge and lien
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Also an amount of penalty will
be charged by the bank in case of default
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Dr
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, Associate Professor, Dr
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Arts and Science College

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Financial Management

Advantages of Loans from FI
Borrower’s Point of View

Lender’s Point of View

 In post-tax terms, the cost of term loan  Term loans earn a fixed rate of interest
is lower than the cost of equity or
and have a definite maturity period
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 Terms loans represent secured
 Terms loans do not result in dilution
lending
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interest of the lender
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vote
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negotiable securities
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Venture capital generally comes from well-off investors,
investment banks and any other financial institutions
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Characteristics of Venture Capital

1
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2
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3
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4
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Examples of Venture Capital Firms
1
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It‟s headquarters in California
which was founded in the year 1972
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India Office : Bengaluru, New Delhi, Mumbai
Sector Focus : Energy, Financial Enterprise, Healthcare and Mobile Startups

Dr
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, Associate Professor, Dr
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Arts and Science College

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Financial Management
2
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India Office : Bengaluru
Sector Focus : E-Commerce, Online Services, Software and Outsourcing
3
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It is an
Indian focused technology led venture fund
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Pre-seed Funding: This is the earliest stage of business development when the

founders try to turn an idea into a concrete business plan
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2
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Since there are no revenue streams yet, the company will need venture capital
to fund all of its operations
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Early-stage Funding : Once a business has developed a product, it will need
additional capital to ramp up production and sales before it can become self-funding
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Text Books

1
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Y and Jain P
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, 2014
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2
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Financial Management (Theory and Problems), 10 th
Edition, Tata McGraw Hill Education, New Delhi
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Maheswari S
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, 2012
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Dr
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, Associate Professor, Dr
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Arts and Science College

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