Nature of FM & Role of CFO

CHAPTER 1
INTRODUCTION OF FINANCIAL
MANAGEMENT
WHAT IS FINANCIAL MANAGEMENT?
Financial management is that managerial

activity which is concerned with the
planning and controlling of the firm’s
financial resources.
Important Business Activities
 Finance
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 Human Resource Production
 Production
 Marketing Human
Marketing
Resource
Finance
Financial Management, 12e I M Pandey

Real And Financial Assets
 Real Assets: Can be Tangible or Intangible

 Tangible real assets are physical assets that include
plant, machinery, office, factory, furniture and
building.
 Intangible real assets include technical know-how,
technological collaborations, patents and copyrights.
 Financial Assets are also called securities, are
financial papers or instruments such as shares and
bonds or debentures.

Equity and Borrowed Funds
 Shares represent ownership rights of their holders.

Shareholders are owners of the company. Shares
can of two types:
 Equity Shares
 Preference Shares
 Loans, Bonds or Debts: represent liability of the
firm towards outsiders. Lenders are not owners of
the company. These provide interest tax shield.

Equity and Preference Shares
 Equity Shares are also known as ordinary shares.

 Do not have fixed rate of dividend.
 There is no legal obligation to pay dividends to equity
shareholders.
 Preference Shares have preference for dividend
payment over ordinary shareholders.
 They get fixed rate of dividends.
 They also have preference of repayment at the time of
liquidation.

Finance and Management
7
Functions
 All business activities involve acquisition and use

of funds.
 Finance function makes money available to meet
the costs of production and marketing operations.
 Financial policies are devised to fit production and
marketing decisions of a firm in practice.

Scope of Finance Functions
Finance functions or decisions can be divided as

follows
 Long-term financial decisions
• Investment (or capital budgeting) decisions.
• Financing (or capital structure) decisions.
• Dividend (or profit allocation) decisions
 Short-term financial decisions
• Liquidity (or working capital management) decision.

Investment Decision
A firm’s investment decisions involve capital

expenditures. They are, therefore, referred as capital
budgeting decisions.
 A capital budgeting decision involves the decision of
allocation of capital or commitment of funds to long-
term assets that would yield benefits (cash flows) in the
future.
 Capital budgeting also involves replacement decisions,
that is, decision of recommitting funds when an asset
becomes less productive or non-profitable.

Financial Decision
 Finance Manager must decide when, where from
and how to acquire funds to meet the firm’s

investment needs.
 The central issue before him or her is to determine
the appropriate proportion of equity and debt.
 The mix of debt and equity is known as the firm’s
capital structure.
 The financial manager must strive to obtain the best
financing mix or the optimum capital structure
for his or her firm

Dividend Decision
 The financial manager must decide whether the firm
should distribute all profits, or retain them, or distribute a

portion and retain the balance.
 The proportion of profits distributed as dividends is called

the dividend-payout ratio and the retained portion of
profits is known as the retention ratio.
 The optimum dividend policy is one that maximizes the

market value of the firm’s shares. Thus, if shareholders are
not indifferent to the firm’s dividend policy, the financial
manager must determine the optimum dividend-payout
ratio.

Finance Manager’s Role
 Raising of Funds

 Allocation of Funds
 Profit Planning
 Understanding Capital Markets

Financial Goals
 Profit maximization
(profit after tax)

 Maximizing earnings per share
 Wealth maximization

Profit Maximization
 Maximizing profits of firm

 Resources are efficiently utilized
 Appropriate measure of firm performance
 Serves interest of society also

Objections to Profit Maximization
15
It is Vague
It Ignores the Timing of Returns

It Ignores Risk
Assumes Perfect Competition
In new business environment profit maximization
is regarded as
 Unrealistic
 Difficult
 Inappropriate
 Immoral

Shareholders’ Wealth Maximization
16
 Maximizes the net present value of a course of

action to shareholders.
 Accounts for the timing and risk of the expected
benefits.
 Benefits are measured in terms of cash flows.
 Fundamental objective—maximize the market
value of the firm’s shares.

Risk-return Trade-off
17
 Financial decisions of the firm are guided by the

risk-return trade-off.
 The return and risk relationship:
Return = Risk-free rate + Risk premium
 Risk-free rate is a compensation for time and risk
premium for risk.

Risk Return Trade-off
18

Risk and expected return move in tandem; the greater the risk, the greater
the expected return.

Overview of Financial Management
19

Financial Goals and Firm’s Mission and
Objectives
20
 Firms’ primary objective is maximizing the welfare of owners,

but, in operational terms, they focus on the satisfaction of its
customers through the production of goods and services
needed by them.
 Firms state their vision, mission and values in broad terms.
 Wealth maximization is more appropriately a decision
criterion, rather than an objective or a goal.
 Goals or objectives are missions or basic purposes of a firm’s
existence.

Financial Goals and Firm’s Mission and
Objectives
21
 The shareholders’ wealth maximization is the second-

level criterion ensuring that the decision meets the
minimum standard of the economic performance.
 In the final decision-making, the judgement of
management plays the crucial role.
 The wealth maximization criterion would simply
indicate whether an action is economically viable or
not.

Organisation of the Finance Functions
22
 Reason for placing the finance functions in the

hands of top management
 Financial decisions are crucial for the survival of the
firm.
 The financial actions determine solvency of the firm
 Centralisation of the finance functions can result in a
number of economies to the firm.

Organisation of Finance Function
23

Organization for finance function
Organization for finance function in a multidivisional company

Status and Duties of Finance Executives
24
 The exact organisation structure for financial

management will differ across firms.
 The financial officer may be known as the financial
manager in some organisations, while in others as
the vice-president of finance or the director of
finance or the financial controller.
 For e.g. At BHEL, a director of finance at the
corporate office heads the Finance Function

Role of Treasurer and Controller
25
 Two officers—the treasurer and the controller—

may be appointed under the direct supervision of
CFO to assist him or her.
 The treasurer’s function is to raise and manage
company funds while the controller oversees
whether funds are correctly applied.

Chief Finance Officer
26

Chief Finance Officer(CFO)
27

 The chief financial officer is a member of the C-suite,
a term used to describe the most important executives
in a company. Alongside the CFO, these roles include
the chief executive officer (CEO), the chief operating
officer (COO), and the chief information
officer (CIO).

Some Important Points
28
CEO vs. CFO

 The Chief Executive Officer (CEO) is a company’s
highest-ranking executive. Depending on corporate
structure, the CEO may be responsible for all aspects
of a company’s operational and fiscal health, or a
president may share some duties
 CFOs are the most senior financial officers in an
organization. They report directly to the CEO and
work closely with the board of directors.

Some Important Points
29
CFO vs. Finance Controller

 The financial controller is generally in charge of the
accounting function in an organization and reports to the
CFO. A controller may be part of a team that includes
bookkeepers, accounts receivable/payable clerks, payroll
specialists, tax preparers and accountants.
 The CFO relies on the reporting generated by
accounting and the financial controller to advise the
CEO and board on the company’s strategic financial
direction.
Chief Finance Officer(CFO)
30

A Chief Financial Officer (CFO) is a senior executive
responsible for managing the financial actions of their
company. They are often in charge of tracking cash
flow, analyzing strengths/weaknesses in the
company’s finances and overseeing all aspects of its
financial success.

Role of CFO
31
 The primary job

responsibility of the

Chief Financial
Officer (CFO) is to
optimize the financial
performance of a
company, including its
reporting, liquidity,
and return on
investment.

Role of CFO
32

1. REPORTING
 Financial reports including balance sheets and P&L
and cash flow statements help both internal and
external stakeholders understand the financial state of
the business, and it’s up to the CFO to attest that these
statements are accurate and complete in accordance
with generally accepted accounting principles
(GAAP).

Role of CFO
33
2. LIQUIDITY

 Liquidity refers to an organization’s ability to pay off its
short-term liabilities — those that will come due in less than
a year — with readily accessible, or liquid, funds.
 The CFO needs to ensure the company is able to meet its
financial commitments and manage cash flow in the most
efficient way.
 CFOs are concerned with ensuring that customer payments
are made in full and on time and controlling expenses so
that enough cash is on hand to meet financial obligations.

Role of CFO
34

3. RETURN ON INVESTMENT
 Part of a CFO’s strategic focus is on ensuring a strong
return on investment (ROI) for their organizations. ROI
is a measure of the likelihood of receiving a return on
amount invested and the precise amount of that return.
 CFOs add context to evaluate whether a project will
deliver sufficiently robust ROI to be worth the
investment.

Role of CFO
35
4. FORECASTING

 CFOs don’t only report what is a significant part of their value
to an organization is their ability to accurately predict likely
future outcomes. That includes financial forecasting and
modeling based not only on the company’s past performance
but on internal and external factors that may affect revenue
and expenses.
 Internal factors include sales trends, labor and HR-related
costs, the price of raw materials and more, while external data
inputs could include opportunity cost for capital, shifts in
market demand, emerging competitors and advances in
technology.
Key Takeaways
36
 A chief financial officer is a top-level executive.

 The CFO is a financial controller who handles
everything relating to cash flow, financial planning,
and taxation issues.
 A CFO is often the highest financial position and the
third-highest position in a company, playing a vital
role in the company's strategic initiatives.
 Financial reports completed under a CFO must adhere
to financial standards.

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CHAPTER 1

Financial management is that managerial

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

 Real Assets: Can be Tangible or Intangible

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

 Shares represent ownership rights of their holders.

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

 Equity Shares are also known as ordinary shares.

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

Finance functions or decisions can be divided as

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

A firm’s investment decisions involve capital

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

Copyright © 2021 Pearson India Education Services Pvt. Ltd

 The proportion of profits distributed as dividends is called

 The optimum dividend policy is one that maximizes the

Financial Management, 12e I M Pandey

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

 Maximizing profits of firm

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

 Maximizes the net present value of a course of

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

 Financial decisions of the firm are guided by the

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

Copyright © 2021 Pearson India Education Services Pvt. Ltd

 Firms’ primary objective is maximizing the welfare of owners,

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

 The shareholders’ wealth maximization is the second-

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

 Reason for placing the finance functions in the

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

Copyright © 2021 Pearson India Education Services Pvt. Ltd

Financial Management, 12e I M Pandey

 The exact organisation structure for financial

Copyright © 2021 Pearson India Education Services Pvt. Ltd