Principle of Finance

Chapter - I
Dr S.M.Tariq Zafar
M.Com, PGDMM, PhD (Social Sector Investment)
[email protected],
[email protected]
 What is Principles of Finance?

Principles of Finance generally focus on what internal and external

participant like manager, investor and government agencies do with
this financial information. It is an introductory course to various
financial fields and is comparable in content to courses that other
institutions label as “Corporate Finance or Financial Management”
 History of Finance?

Finance is not a new phenomena but it is as old as human civilization. The

historical evidence proves that word Finance is originated in France. It was
later adopted by English speaking communities in 18th century to mean the
“Management of Money”. In present era finance is not merely a word but it
has become important academic discipline and is organised as a branch of
Economics. It is a soul of economy. To perform any kind of economic
activity we need resources and among all resources finance is the most
important. It is pooled in form of money either in the form of currency notes
or in other valuables. It is a prerequisite to acquire all physical resources
which are necessary to perform productive activities and to run a business
such as sales, purchase, compensations, and reserve for contingencies and so
on.
 What can Replace word Finance:

The word Finance can be easily replaced by the word “Exchange”. Critically
Finance is nothing but a power of exchange of valuable resources. It is multi
dimensional management of money and other valuables which can be easily
converted into cash. Barter trading is an exchange of goods and is also a kind
of fiancé activity. Thus we can assume that Finance is an art of managing
various resources like Money, Assets, Investments and Securities etc.
 What is Finance:
In general finance is a task of providing necessary funds required by the
economic entities like companies, firm’s individuals and others in order to
achieve their strategies economic activities. It is a broad term that describes
two related activities that is procurement and utilization of funds. It
encompasses the oversight, creation and study of money, banking credit,
investment, assets and liabilities that make financial system. It is been
divided into three main sub categories: Public Finance which includes
government expenditure, Budget procedure, tax systems, Stabilization policy
and instruments, debt issues and other government concerns. Corporate
Finance involves managing revenues and debts for a business and its assets
and liabilities. Personal Finance defines all financial decisions and activities
of an individual or household including budgeting, insurance, mortgage
planning, savings and retirement planning. Social Finance typically refers to
investment made in social enterprises like charitable organizations and
cooperatives.
 Social Financing:

Social Finance typically refers to investment made in social enterprises like

charitable organizations and cooperatives. These social investments are not
the donations but are in the form of equity or debts financing in which
investor expect financial rewards and social advantage. Modern form of
social financing includes micro financing like Special loans to small
business entrepreneurs in underdeveloped economies.
  What is Financial Management?

Financial management is an overall planning of an organization as how a

business should earn and spend money. It is an analysis of money and
investment and includes decisions about Raising Capital, Borrowing money
and Budgeting. It also involves setting financial goals and analyzing
available financial data. It starts with recording all the income and
expenditure of a company in a given period of time and later using the
recorded data to analyze the health of an organization. These financial
recordings are categorised as a profit and loss accounts, Balance Sheet, Cash
Flo and Fund Flow Statements, and budgets.
 Scope of Financial Management:
Investment Decision: It includes decision of investment in fixed assets and
current assets. Decision of making investment in fixed assets is a part of
capital budgeting and investment decision in current assets is a part of
Working Capital.
Financial Decisions’: In this decisions are related to procuring the funds
from various resources. Type of source, period of financing, optimal capital
structure, cost of capital and the returns thereby.
Dividend Decision: The finance manager of the company has to take the
decision of net profit distribution. In general net profit is divided into two
parts:
Dividend for Share Holders: - In this decision is to be taken in respect to
dividend and its rate.
Retained Profits (Earnings): In this decisions are taken to finalise as to
how much profit will be retained. This decision depends upon the
organization expansion, modernization and diversification plans.
 Objectives of Financial Management:
The financial management is specifically concerned with procurement,
allocation and control of organization financial resources. These specific
concerns are its core objectives which are as follows.
To ensure regular and adequate supply of funds for organization smooth
functioning
To ensure returns according to the stakeholders expectations
To ensure optimum funds utilization with minimum cost
To ensure safety on investment by investing them in safe venture so that
adequate rate of return can be achieved.
To plan optimum capital structure by developing balance between debt and
equity
 Functions of Financial Management:
Estimation of Capital Requirements: A finance manager has to make
estimation with regards to capital requirements of the company. This will
depend upon expected costs and profits and future programmes and policies of a
concern. Estimations have to be made in an adequate manner which increases
earning capacity of enterprise.
Determination of capital composition: Once the estimation have been made,
the capital structure have to be decided. This involves short- term and long- term
debt equity analysis. This will depend upon the proportion of equity capital a
company is possessing and additional funds which have to be raised from
outside parties.
Choice of Sources of Funds: For additional funds to be procured, a company
has many choices like-
Issue of shares and debentures
Loans to be taken from banks and financial institutions
Public deposits to be drawn like in form of bonds.
Choice of factor will depend on relative merits and demerits of each source and
period of financing.
Cont:
Investment of Funds: The finance manager has to decide to allocate funds
into profitable ventures so that there is safety on investment and regular returns
is possible.
Disposal of Surplus: The net profits decision have to be made by the finance
manager. This can be done in two ways:
Dividend declaration - It includes identifying the rate of dividends and
other benefits like bonus.
Retained profits - The volume has to be decided which will depend upon
expansional, innovational, diversification plans of the company.
Management of Cash: Finance manager has to make decisions with regards
to cash management. Cash is required for many purposes like payment of
wages and salaries, payment of electricity and water bills, payment to creditors,
meeting current liabilities, maintenance of enough stock, purchase of raw
materials, etc.
Financial Controls: The finance manager has not only to plan, procure and
utilize the funds but he also has to exercise control over finances. This can be
done through many techniques like ratio analysis, financial forecasting, cost
and profit control, etc.
 Advantages of good Financial Management:
Good financial management will help organisation in following ways:
It helps organization in making effective and efficient use of resources
It helps organization in achieving the objectives and fulfilling the
commitments to stakeholders
It helps organization to become more accountable to donors and other
stakeholders
It gain the respect and confidence of funding agencies, partners and
beneficiaries
It gain advantage in competition for increasingly scarce resources
prepare for long-term financial sustainability.

 
 What makes Financial Management Effective:

These four components make financial management effective:

•A clear and futuristic finance strategy
•An effective and efficient financial plan for maximizing value and
wealth of the company
•A strong, strategic, and futuristic financial management system
•An effective and conducive internal environment
 Financial Management System:

There is no fix model of financial management. It differs from company to

company depending upon its size, nature of operations and economic
activities company is involve. The entire financial management system
moves on some basics principles and rules in order to achieve the good
practice in financial management. It is instrumental to identify certain
principles while developing organizational financial system. These
principles will serve as a blue print or a track which is to be followed by the
managers and promoters of the economic entity. The outcome of these
principles will also serve in budgeting and decision making.
 What are Basic Financial Management Skills?
To become good financial expert and to perform efficiently these following
skills are must
Ability to understand the key financial concept
Ability to understand the financial reporting process
Ability and expertise to analyze and interpret financial statements
Ability to prepare, analyze and manage budget
Ability and expertise to perform cost analysis
 
Guiding Principles for Financial Management Systems:
Accounting Standards: For better, effective and systematic record keeping
and documentation organization must adopt Globally Accepted Accounting
Standards
Consistency: Organizations financial policies and its adopted financial
systems must remain consistent over time.
Transparency: Organization must adopt transparent policy and be open
about its work and its finances and must also inform its all stakeholders.
Accountability: organization must be accountable to its all stake holders
and it must be able to justify as how it has used the available resources and
how and what it has achieved.
Integrity: In organization everything should be integrated systematically.
All organization participants must operate with honesty and propriety.
Financial Stewardship: Organization must use its provided financial
resources for optimum and must take care of its all available financial
resources.
 
Important Points to be considered while Financial Planning:
Up to what extent we are satisfied with our budget and budgeting process
and financial planning
What are organizational financial objectives which are set by the financial
management system to achieve.
What are our core financial principles for financial management?
How organizations staff react to the adopted system. Do the practice it. Is it
a effective tool and mechanism
Does organizations financial management systems is efficient and sound
enough to promote effective financial decisions, especially in resource
allocation and its utilization
 Is Finance is an Art or a Science:
It is “both” an art and a science. Finance is a part of economics and is
closely related to a scientific area like statistics and mathematics and most
of the modern financial economist use scientific and mathematical tool to
analyze financial data. On other side financial industry also use non
scientific elements that like it to an art. It is found that Capital Asset Model
(CAPM) and Efficient Market Hypothesis (EMH) largely attempt and
explain the behaviour of the stock market in rational manner with logic and
without any emotion and completely ignore elements such as market
sentiment and investor sentiment. On contrary stock market disaster like
“Black Monday” October 1987, “Black Thursday” 24 October 1929 is not
properly explained by scientific theories such as EMH. Human elements of
fear played critical role in these market falls and this dramatic fall in the
stock market is often called a “Panic”. It is also been found through tracking
the records of investors that market are not entirely efficient and therefore
not entirely scientific. Thus to be a successful equity investor one needs to
understand both the science behind the numbers crunching and the art
behind the stock picking.
 What is Strategic Financial Management?
Strategic financial management refers to specific planning as how to use the
procure funds and how to manage companies financial resources to attain
the predetermined objectives and how to maximise the value of shares and
return to the investors. It precisely define the objectives of the company’s
business along with identifying and quantifying its resources, it devise a
plan for utilizing finance and other resources at optimal level to achieve
companies goals and establish ultimate procedure to collect and analyze
financial data and later using the collected and analyzed date to make
decision and it also develop effective tracking and follow up system to
attain short term and long term goals with an overarching focus on
maximising the profitability of a company and its value and to analyze
variance between budget and actual results to identify short comings and
problems and take appropriate corrective actions.
 Elements of Strategic Financial Management:
Strategic financial management is implemented in all operations of the
organization. It involves elements strategically designed according to the
nature of organization to make the maximum and efficient use of the
company financial resources. The key elements of strategic financial
management include, planning, budgeting, risk management, review and
evaluation. In making organizational plan it is necessary to make careful
budgeting of its financial resources and operating expenses. Budgeting
develop financial efficiency and help in reducing the operating cost. It
includes ensuring sufficient liquidity to cover running operating expenses
without accessing external financial resources. It also directs how an
organization can invest its earnings to achieve its long term goals efficiently
and effectively. Strategic Financial Management also involves risk
assessment and risk management. Through risk management organization
evaluates the potential financial exposure which it incurs by making capital
expenditures (CAPEX). Since strategic financial management focus on
attaining companies long term business goals, it is important to develop and
practice regular procedure to review and evaluate as how well the
organization is performing and moving on set track.
 What Financial Manager do?
Financial manager play instrumental role in an organization. There role are
changing with technological development. Financial manager core
responsibilities is to monitor companies financial aspects. But in competitive
environment they are performing additional responsibility of data analysis and
advising to the management as how to maximise profits. They often work on
teams and act as business and financial advisor to top managements. They
typically do the following:
Responsible to prepare financial statements, reports of business and economic
activities', and forecasts
Responsible to monitor, evaluate and analyze financial details to ensure that
legal requirements are met
Responsibility to supervise, coordinate, cooperate, train and guide employees
who do financial reporting and budgeting
Responsible to review and comparatively analyze company financial reports
and seek ways to reduce costs
Responsible too analyze market trends and movements to find opportunities for
expansion or for acquiring other companies
Responsible to facilitate management make financial decisions
 Types of Financial Managers:
Finance Controller: Is responsible to supervise the preparation of financial
reports in summarized manner to forecast the organizational financial
position. Financial reports such as income and expenditure statements,
balance sheets, and analyses of future earnings or expenses. Financial
Controllers represent company in legal matter and prepare reports required
by governmental agencies that regulate businesses. In general finance
controllers oversee the accounting , audit, and budget departments.
Treasurers and Finance Officers: are responsible to direct and control
their organization's budgets to meet its financial goals. They take care of
companies investment in available opportunities. They prepare strategies to
procure funds and raise capital (such as issuing stocks or bonds) to support
the firm's expansion. They also prepare financial plans for mergers,
acquisitions and take over.
Credit Managers: is responsible to oversee the companies credit business.
They develop suitable credit-rating criteria, determine credit ceilings, and
control the collections of receivables.
 
Cash Managers: These managers are responsible to monitor and control the
inflow and outflow of companies cash in order to meet out the company's
day to day and investment needs. For example, cash manager projects, as
how much cash is required as working capital and how much they have.
Weather company have excess cash and it is needed to invest it for growth
rather than keeping it ideal or company need external loan to run its
business activities.
Risk Managers: These managers control financial risk like currency or
commodity price changes. For the purpose the apply hedging and other
strategies to limit or offset the probability of a financial loss and company’s
exposure to financial uncertainty.
Insurance Managers: These managers plan how to minimise company’s
losses by obtaining insurance against risks such as the need to make
disability payments for an employee who gets hurt on the job, and any costs
imposed by a lawsuit against the company.
THANKS