Overview
This lecture introduces the concept of financial management by explaining finance and management separately, then combining them to define financial management, its characteristics, objectives, functions, principles, and scope.
Finance and Management Concepts
- Finance involves banking, leverage, credit, capital markets, money, and investments.
- Finance is the management of money and valuables that can be easily converted to cash.
- Activities in finance include investing, saving, forecasting, and budgeting money.
- Finance is divided into personal, corporate, and public finance.
- Management involves coordinating people and resources (the five Ms: men, machines, materials, money, methods) for common objectives.
- Management is a continuous, goal-oriented, group activity, and operates at top, middle, and lower levels.
Financial Management: Definition and Meaning
- Financial management combines finance and management to plan and control financial resources.
- It is essential for starting, running, and sustaining any business.
- Involves the procurement and effective utilization of funds, balancing cost, risk, and control.
- Focuses on achieving financial objectives through planning and controlling financial activities.
Evolution and Characteristics of Financial Management
- Three phases: traditional (occasional events), transitional (day-to-day problems), and modern (theory-driven analysis).
- Modern financial management is an integral, continuous, interdisciplinary function, combining law, economics, accounting, statistics, and management.
- It influences all business activities and environments (social, economic, political).
- Involves forming rational policies, decision-making, and expert personnel.
Objectives of Financial Management
- Macro-level: efficient use of scarce resources, safe operation, risk avoidance, procuring funds.
- Micro-level: goal-oriented structure, achieving department and organizational goals.
- Four key objectives: profit maximization, operational (timely finances, effective use), social (timely payments, relationships), and research (exploring new sources).
- Primary objectives: profit maximization and wealth maximization (value/NPV).
Profit Maximization vs. Wealth Maximization
- Profit maximization emphasizes short-term gains, may ignore risks and timing.
- Advantages include ease of calculation and incentives for growth.
- Disadvantages include short-term focus, ignoring uncertainty, and timing.
- Wealth maximization focuses on long-term value, considers risk/timing, and stakeholders.
- Wealth maximization advantages: long-term security and stakeholder balance; disadvantages: unclear link to stock price, possible management frustration.
Scope and Nature of Financial Management
- Liquidity function: cash flow forecasting, timely funding, internal fund management.
- Profitability function: cost calculation, pricing, profit forecasting, minimizing costs.
- Funds management: managing both short and long-term funds.
- Encompasses planning, organizing, directing, controlling of financial activities.
Functions and Elements of Financial Management
- Financial planning ensures funds are available when needed.
- Financial control involves efficient use of assets and safeguarding them.
- Decision-making includes investments, financing, and dividends.
- Executive functions: forecasting needs, managing income, asset structure, investment decisions, cash management, sourcing new finance, performance appraisal, negotiations, and advisory.
- Routine functions: record-keeping, reporting, financial statements, cash supervision, safeguarding securities, credit management, providing financial information.
Principles of Financial Management
- Organize and track finances, including all assets and debts.
- Spend less than you earn and create a budget.
- Invest early to benefit from time value of money.
- Limit debt to assets that produce income or retain value.
- Continuously educate yourself about investments.
- Understand and balance risk and return (risk-return trade-off).
- Diversify investments to reduce risk.
- Maximize employment benefits (insurance, tax advantages).
- Manage taxes wisely, not just avoid them.
- Plan for emergencies with adequate savings.
Key Terms & Definitions
- Finance — Management of money, banking, and investments.
- Management — Coordinating resources to meet organizational objectives.
- Financial Management — Planning and controlling the financial resources of an organization.
- Profit Maximization — Achieving the highest possible financial gain in the short term.
- Wealth Maximization — Increasing long-term value for shareholders, usually measured by stock price or NPV.
- Liquidity — Availability of cash or assets easily convertible to cash.
- Capital Budgeting — Process of evaluating and selecting long-term investments.
Action Items / Next Steps
- Review key objectives, characteristics, and principles of financial management.
- Prepare for questions on differences between profit and wealth maximization.
- Complete assigned reading on financial planning and control (if provided in syllabus).