FM Introduction Reference Material

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

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Financial Management Introduction

Proposal generates cash returns

Capital How will I raise money for the

Operations Manufacturing, Trading, or Service

Needed to carry out the business

Relate to the liabilities side of

•Obtaining Finance •Financial Accounting

Shareholders Employees/ Customers

Invested share Remuneration Quality and

Multiple stakeholders and their respective stakes

Funds Financial Institutions Funds

Suppliers of Funds Demanders of Funds

Funds Financial Markets Funds

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