Financial Management Introduction
by
Vipul Mehta
Investors
Investors provide initial cash Business
• Shareholders
to fund the proposal Proposal
• Lenders
Proposal generates cash returns
to investors and to you
Basic Financial Questions
Capital What Capital Investments will I
Budgeting make?
Capital How will I raise money for the
Structure proposed Capital Investment?
Working
Capital
How will I handle day-to-day
Mgmt financial activities?
Goal Owners’ wealth maximization
Operations Manufacturing, Trading, or Service
Needed to carry out the business
operations. They are reflected on
the asset side of the balance
sheet – long term (fixed) & short
Economic Resources term (current) assets. Decisions
pertaining to their procurement
are refered to as
investing/capital budgeting
or working capital decisions
Relate to the liabilities side of
the balance sheet. Concerned
Financial Resources with the raising of long-term and
short-term financial resources.
Decisions related to their
procurement are referred to as
To Summarize financing decisions
Organization of the Finance Function
Chief Finance
Officer
Treasurer Controller
•Obtaining Finance •Financial Accounting
•Banking Relationship •Internal Auditing
•Cash/Credit Management •Taxation
•Capital Budgeting
Shareholders vs Stakeholders
Shareholders vs Stakeholders
Shareholders are the people who own shares
and hence are liable for dividends – they ‘own’ part of the company
Stakeholders are the people who do not own shares yet
influence and are influenced by a company’s existence
Stakeholders and
their stakes in
publicly-held
companies
Shareholders Employees/ Customers
Lenders Management Government Community
Invested share Remuneration Quality and
capital and and career prices of goods
dividends growth and service
offered
Tax dues from Social
Principal lent the company responsibility of
and interest and compliance business
of laws
Multiple stakeholders and their respective stakes
The Financial System
Funds Financial Institutions Funds
Commercial Banks
Insurance Companies
Deposits/Shares Mutual Funds Loans
Non-banking Financial
Companies
Suppliers of Funds Demanders of Funds
Individuals Individuals
Businesses Businesses
Governments Governments
Funds Financial Markets Funds
Money Market
Securities Capital Market Securities
Financial Assets
Assset: any possession that has value in exchange
Financial Assets are Intangible in nature
Terms ‘Financial assets’, ‘Instrument’, ‘Security’ are used
interchangeably
Types of financial assets: Debt security, Equity security etc
10-year bond issued by Government of India @7%, 7-year
debenture issued by Reliance Industries @8%
Equity shares issued by NIIT through an initial public offering
And others…
Financial Markets
Market for creation and exchange of financial assets or
securities
Functions of Financial Markets:
Facilitate price discovery
Continual interaction among buyers and sellers help in establishing the
prices of securities
Provide liquidity
Allow companies to raise long-term funds from investors with short-term
and medium-term investment horizons
Reduce the cost of transacting
Search costs - cost of searching a potential buyer
Information costs - cost of evaluating the investment merits of securities
Classification of Financial Markets
Type of Financial Claim:
Debt Market – market for fixed claims (debt instruments)
Equity Market – market for residual claims (equity
instruments)
Maturity of claims
Money Market – short-term financial claims
Capital Market – long-term financial claims
New or outstanding issues
Primary Market – Trading of new securities
Secondary Market – Trading of existing securities
Classification of Financial Markets
Timing of delivery:
Cash or Spot Market: Delivery of securities occurs
immediately
Forward or Futures Market: Delivery of securities occurs
at a predetermined time in future
Organizational Structure
Exchange-traded Market: Centralized organization with
standardized procedures
Over-the-counter Market: Decentralized organization with
customized procedures
Ethics in Business and Finance
Financial Statements
Fictitious Revenues
Improper or Fraudulent Disclosures
Creative accounting – form of fraudulent financial reporting so as to
provide misleading information
Financial Markets
Insider trading
The Principal Agent Problem
Agency Issues
In large public limited companies, management of company
by Shareholders is not possible
Scattered shareholders
Shareholders not competent enough to manage
Hence Management is employed to manage the resources of
the company keeping in mind the interests of the
shareholders
Thus the Management acts as Agent of the owners (Principal)
Hence there is a Principal-Agent relationship between
owners and management
Agency Costs
Management is expected to manage the resources of the company
in the best interest of the shareholders
However in real life, this is not always the case
Eg, insider trading, Enron scandal
Agency problems occur on account of conflicts of interest
between shareholders and management
To avoid such issues, certain control mechanisms need to be
placed
For example
Incentives to management – bonuses, stock options, profit sharing
Monitoring and control – audit fees, credit rating fees
All such control mechanisms entails costs termed as Agency Costs
These costs are borne by the shareholders from their own pockets
