Financial Management & Corporate Finance | Introduction to Financial Management | AKTU Digital

Hi friends, I am Harsh Awasthi, Assistant Professor, Department of MBA, Noida Institute of Engineering and Technology, Greater Noida. Today we will discuss about the financial management and corporate finance. So let's start with the finance. So first of all we need to understand what is finance. It can be described as a set of activities which is associated with money and markets. When we talk about money, we could be thinking about currency, we could be thinking about cash and other aspects, likewise plastic money, marketable securities, which is going to be taken into consideration when we talk about the money. And second term is the market. Market could be the space where people are transacting, where people are interacting, where transactions are going to take place. So when the transactions at a place are going to happen with some consideration of finance, that is money in any of its form, it is an outset of the finance. Now we can talk about from the another aspect that finance is a function where we talk about managing the funds. Funds and money can be interchangeably used. That could be the cash, that could be the fund. Cash is the current form of that and fund is the another form to which we talk about. Now we talk about the three most important activities in the organization, which are somewhere related to the finance of the organization. So they are production, number one, marketing as number two and finance itself as number three. In production, we are going to process the input into the output. In the marketing, under its related activities, sales and advertising, we are going to put our produces into the hands of the customers based on their needs. And in the finance, we are going to manage overall funds and the cash of the company so that company can survive and its lifeline is intact. Now let's learn about financial management. It is concerned as an activity which is related to the planning and controlling of firm's financial resources. Financial resources are very much needed for any of the firm, for any of the business organization to run its day-to-day business as well as to run its long-term objectives. If we talk about the financial management as a separate discipline, that has been evolved somewhere around 1890 or we can say 1900, where the philosophers, the financial practitioners separated it or try to separated it from the main stream economics. Till then, it was drawing most of its concepts, theories, practices from the economics only. We can talk about Adam Smith here when he wrote his magnum opus, An Inquiry into the Wealth of the Nations, that was the outset of the economics into a practitioner's life and after that in 1900 somewhere, even today itself, we are going to draw number of concepts of financial management from the main stream economics. If we talk about the finance functions and the decisions, they are supposed to be most crucial, they are supposed to be most critical for any organization. When I talk about crucial and critical, it means that they are going to attract or they are going to draw a lot of attention, expertise and value for the organization and ultimately this finance function is going to create and sustain the value for the organization. Now let's talk about some ideas behind finance. Its turnover is vanity, turnover is something what business is doing across the year, what is coming into its pocket, whatever is going to be collected by the business into a period of its accounting period or we can say taxation period. Then we talk about profit is sanity. Vanity is something how it's appearing. Sanity is related to sane decisions. Sanity is related to the aspect which is really pragmatic and practical. We cannot hypothesize the profits, we have to plan them. So while talking about the vanity as a turnover, we have to take the sane decisions, we have to take the cautious decisions, we have to take the informed decisions so that the business can ensure the profits. Lastly, the cash is sane. Let's talk about accounting. When you make any transaction of sale, it could be of two types. First is cash sale and second is the credit sale. In case of cash sale, the cash is collected instantly and business realizes its profit. But when a business conducts a credit sale, it becomes a debt. Now the recovery of debt could be good, could be doubtful. If debt is recovered within the due course of time, so it's good. The cash is collected and profit is realized though some time has been taken and that time can be managed by the prior experience of the organization. But if the bad debts are not collected, sales has been done into the credit form, money has not come to the organization and bad debts are not collected, it's loss and that's why if it's collected, it's like a king. So remember, turnover is vanity, profit is sanity and cash is king. So when we talk about the financial management, though it's a very broader aspect, but from the very starting point, we must be concerned with that how I am going to ensure the liquidity into the business so that my entire business operations are going to run in a smooth fashion, in a smooth manner. This I have to ensure as a financial manager or a business owner. Now let's talk about the financial decisions. In any of the firm, there are major four categories of financial decisions. Number one is investment decision. Investment decision is where to invest because when we think about investing, starting any business that is a very crucial question because there could be a number of ideas in my mind being an entrepreneur, then where to invest. There could be certain appraisal criteria, there could be certain deciding factors based on which I could be deciding that where I am going to invest. That could be which business is going to give me my money back into the shortest possible time out of many. Which business is going to give me the maximum rate of return on my capital employed? Which business is going to make me more profitable? So there are a number of criteria to which we will be discussing into the later chapters in greater detail. First investment decision, where to invest, also known as the capital busting decision is of crucial importance. Secondly financial decision, financing decision, asset mix decision, capital structure decision, number of terms are used for this decision. Now when I have decided that what kind of business I have to open, in what kind of business I have to venture in, then I have to ensure the availability of the funds. Either I need my own money or I need to get it financed by someone. So when I am clear, being a business manager, being an entrepreneur, being a financial manager, that in what business I have to venture in, in what project I have to venture in, then I have to find out the sources so that I can put that idea into a reality. So that is capital structure decision or financing decision. In other words, it can be said how to source the funds. So when we talk about how to source the funds, it is also from where to source those funds. I could be using my own money, being my equity, I could be borrowing it from someone, it could be a financial institution, that could be a debt, that could be a loan. But talking about the financing decision is again one of the critical decisions because when a business manager or an entrepreneur is going to use the mix of both, its own equity as well as the debt, borrowed funds, it could be good, but if I am going to invest entirely my money, being an entrepreneur, then there could be risks, I could be losing the interest from the capital. If I am going to use 100 percent debt, it's cheap, it's easy to borrow, I could be facing a condition of financial distress. Financial distress is known as a position or a condition of a business where the business is not able to honour or not able to service two major responsibilities which are related to the debt. Number one is repayment of the principal amount and second repayment of the interest amount or servicing the principal amount and servicing the interest amount. Thirdly, there is dividend decision. Dividend is distributed to the shareholders, stakeholders who have given the money, who have given the funds to the organization when it was needed. We can talk the liquidity decision as well as dividend decision simultaneously. Liquidity and profitability, then dividend. Whenever a business practice is started or business is started, the prime objective is to earn the profit and we can also draw from the accounting a going concern concept. Once a business is established, it is assumed that it will run for a fairly long time and service the interest of its stakeholders for the longer time. Businesses are not established with a vision of to shut them down. Once a business has been started, activities are going to take place, sales is going to happen, money is going to be received by the company. Now that sales could be either the cash sale or the credit sale. When cash or credit sale both are going to happen, we are going to realize the money at that time. Now I have to ensure my profitability. I have to ensure that what amount is going to be realized by me as an entrepreneur, as a business. When money is there with the business, with the entrepreneur and it's a combination of equity and debt where the entrepreneur had used its own money as well as it had borrowed from someone, shareholders' equity, owners' equity and shareholders' equity, then when I was needing the money at the time, I was not having it. The people who gave it to me, who financed it for me, am I able to show any kind of gesture to them? So dividend is that when I am going to have surplus funds or not even the surplus funds, so am I going to demonstrate my gratitude towards those stakeholders, those shareholders who gave me money when I was needing it and I was not having it. So out of my profit, I am going to give them something. Now there are two questions, whether I should retain the entire earnings or I should distribute them fully and thirdly or I should distribute them partly. Now if I am not going to retain them, then I could be again facing the situations where I would be asking the money when required from the others, the shareholders, the stakeholders I could be going to the financial institutions, but if I am not going to distribute anything to my shareholders when they financed money for my business or for me as an entrepreneur, so when next time I need it, to whom I will ask? So dividend decision and liquidity decision both are related, until unless a company is not going to realize the profits, it's not going to ensure the profitability, it's going to be a very difficult task for the business, for the firm, for the organization to distribute the dividends. So we have to keep in mind all these four decisions, first investment decision, where to invest, second financing decision, how to source the funds and from where to source them, third dividend decision that if I am realizing the profits, whether to distribute them or to retain them and liquidity decision that is based on the time and risk, what amount of risk I am going to take and in what time my money is going to be realized actually as money. Now there are two concepts in the financial management, one is profit maximization which is there and second is the shareholders wealth maximization. As I told earlier, once a business is established, it is assumed that it will run for a fairly long time and obviously every entrepreneur, every business owner is going to establish a business for earning some amount of profit, it's not charity. Yeah, if I am oriented toward doing charity, that's another issue. If I want to go in the philanthropy, that is another issue. But if I am going to start a business of any kind, primarily my purpose is to earn profit and to make others earn money and profit, whatever terminology I can be using for that. Being a business, being an entrepreneur. So profit earning is the prime objective of the business, this is to be noted. Everybody who starts a business wants to earn profit, investment, then profit, returns. Price system is the most important organ of the market economy. Whatever we are going to purchase, whatever transactions are going to happen in a marketplace, they are identified by their price. If we talk about the marketing where we talk about four Ps, product, price, place and promotion, so after the product there is a price. Price is a related identity of any product and number of decisions towards purchasing a product or exactly towards executing a transaction are entirely dependent on the price. Prices can be negotiated. Once negotiated, negotiation starts. If it falls in my purview, if it falls in my margin, I could be ready to sell my product, I could be ready to buy that product, to sell that product as a seller, to buy that product as a consumer or a customer. Now the underlying concept behind the profit maximization is efficiency. Efficiency is known as the ratio between the input and the output. What amount of input is going to be infused into a production process and what amount of output is going to be produced? This ratio is known as the efficiency. Two aspects could be there that with the given amount of input, I am going to produce the maximum output. It could be putting some pressure, putting some strain on my resources. If I can control it, then it's okay. If it cannot be controlled, then my processes, my services, my activities can be getting compromised. Second, for a given amount of output to be produced, what amount of input I am going to use? It's another aspect. First was for with a given amount of input, I am trying to produce the maximum amount of output and here I am trying to find out that for producing a given amount of output, what is the optimal amount of input which should be used? Because in this aspect, I am not going to think about any strain, any pressure. Let me come here. First of all, it was input and output and I want my output maximum with the minimum amount of input. Second, I have decided my output. Now what is the quantity of the input which is required to produce this amount of output? That is the optimal one. I won't be having no pressure on my resources, there would be no strain. This is known as the optimal utilization. There are some limitations of this concept. It's vague because here only I am going to talk about the profit, earning my own profit. Whatever I have invested, I just want return on that. Perhaps it could not be liked by other stakeholders also. In long term, I might also not be liking this. Second is timing of returns. In profit maximization, the motive is not there on the timing of returns. Whenever return is going to happen, I am going to get it. I am not going to time them. I am not going to plan them being a business, being an entrepreneur. These could be some kind of speculative activities. This could be described as, this could be deemed as, thirdly ignores risk. When I am completely intended to earn the profit being a business, being an entrepreneur, then perhaps I could be taking any amount of risk for earning that profit. So here I have to be very much cautious that how I am going to take the account of risk, how I am going to time those returns and how I am not going to make it so that it could be described as vague. So when we talk from this perspective, it should be acceptable. It should be timely monitored, timely patterned and there should be complete execution and complete counter of the risk, whatsoever amount of risk is going to be there. Whatever kind of risk are there, we are going to eliminate them. We are putting our efforts to eliminate those risks. So from that point of view, we proceed to the next concept that is shareholders wealth maximization. Shareholders wealth maximization talks about the maximizing net present value of a course of action to the shareholders. Now what is this course of action? Course of action is my activity. What I am going to do being a finance manager, being a business owner, being an entrepreneur, being a corporate finance manager, what are my activities, what are my decisions out of those four, investment, financing, dividend and liquidity so that my stakeholders and shareholders value is not going to be compromised. When we talk about the net present value, it is known as the difference between the present value of benefits and the present value of its cost. What a shareholder is going to invest at the point of time today and what is the value of at this point of time that is today itself. If the value of the shareholder which is going to be received by that shareholder is more than the cost of its investments, obviously it is a good concept and every shareholder would like to invest in that activity. It is again unambiguous measure what firm should seek to maximize in making investment and financing decision on behalf of the shareholders. Firm is going to work as an agent of the management or the business. Now firm has to take care of the money of the shareholders. So when we are moving from the perspective that we are intended to maximize the shareholders wealth, it is acceptable. It becomes very clear. Now we talk about the financial goals of the firm. Number one is sales growth. Every of the firm, every of the business once established want to increase its sales. More sales, more revenue, more profits, more distribution of funds among the stakeholders. Reasonable return on capital because when we are going to say the maximum return on the capital that could be again putting some strain on the resources, be it the mental resource, be it the money resource. Internal financing. It is advisable that we must think about the internal financing. The activities of the firm should be financed by its own internal finances. That could be from the way of the retained earnings, what profits were retained. But it was a critical decision what to retain and what to distribute under the dividend decision. And lastly the value creation. Value creation should be sustainable. It's not something that we have once established a business and we are having no any concerns about that. It should be creating the sustainable value for the organization in its entire lifespan. Now we can talk about the functions of the financial management. Here we can see six functions. So first of all we have to estimate the required capital. That was the investment decision and the financing decision both. When I am going to start any business then I have to estimate what amount of capital is going to be required for execution of my activities. Then determining the capital structure. Capital structure means that whatever fund would be required in what shape it would be utilized into the business, whether that would be in a form of equity or in the debt or a combination of equity and the debt. Then we evaluate and select the sources of the funds. When we talk about and when we proceed towards sourcing the funds then we evaluate them. We select the best one. We try to select the cheapest one. But while selecting the cheapest one it should not be taken into consideration whether it's going to put any strain or pressure on the organization. So I have to go for those funds which are going to be there for a sustainable period of time putting no any strain or pressure on the organizational resources. Then allocate and control the funds. Allocating the funds is very critical decision. Financial manager or the business owner must be very much comfortable and very much expert about allocating the funds because the business is going to run number of activities. We cannot say that every activity is of equal importance. Every activity is creating equal value for the organization. Some activities could be creating lesser value. Some could be creating higher value. We can talk about a T20 principle the parity and equilibrium. So business manager should be very cleverly allocating the funds to those activities which are creating more value. The higher amount of funds and lower amount of funds to those which are creating lower value. Now it's a long term decision whether I am going to change that mix of value creation or not. But ultimately until unless as a business or an entrepreneur I am not going to produce some sustainable amount of money as a profit as a liquidity then I should not be of no I should not be of any use. Then distribute the profits or the surplus. Number of responsibilities and liabilities are there within the business. We have to pay for the expenditures. We have to pay for the dividends. Now these are the liabilities to which we have to pay. So we have to distribute the profits. When profit is there in the business it is coming with the liabilities. They are associated with that. Though there could be non-operating incomes also but a business is better judged on the basis of its operating income that what was the main course action of the organization and how it's going to be efficiently managing its main course action, its main business object. Then we can talk about monitoring and financial monitoring the financial activities. Monitoring the financial activities means when I had allocated the funds in those activities which are having higher amount of value and lesser funds to those which are having lesser amount of value I have done it. Now I have to take control of that. I have to make a check on that. I have to monitor every activity. I have to put the evaluative measures so that whatever I have planned and whatever I am doing my standard practice and my actual practice least amount of deviations are going to happen there and at that time I am going to feel comfortable being a business manager or being a firm, being an entrepreneur. So these are very different functions of the financial management. So I hope this session has been informative to you and thank you for this.