What this man does???

What do think …what is the most important work of CFO of a company?

To understand THAT, we have a discuss…

Scope and Objectives of Financial Management

Prof. C. P. Gupta

SCOPE AND OBJECTIVES OF FINANCIAL MANAGEMENT

To appreciate …

Let’s have a look at the BALANCE SHEET

Particulars 2011 2012 Particulars 2011 2012EQ UITY AN D LIABILITIES: A SSETSSH A REH O LD ER'S FU N D S N O N -CU RREN T A SSETS

Share Capital 4,277.76 4,277.76 FIXED A SSETS:Reserves and Surplus 93,226.67 1,08,678.97 Tangible assets 18,481.67 21,567.82

97,504.43 1,12,956.73 Producing Properties 43,575.66 46,376.83 Intangible assets 157.88 112.33

N O N -CU RREN T LIA BILITIES Capital W ork-in-Progress 13,976.90 18,298.06 D efered tax liabilities (N et) 9,950.39 11,197.87 Exploratory/D evelopm ent W ells in Progress 7,747.21 8,581.23 O ther long term liabilities 582.46 561.99 83,939.32 94,936.26 Long term provisions 20,823.51 21,313.06

31,356.37 33,072.92 N on current investm ents 5,182.75 4,364.34 Long- term loans and advances 23,993.85 25,449.81

CU RREN T LIA BILITIES D eposits under Site Restoration Fund Schem e 8,115.51 9,182.57 Short-term borrow ings - 4,500.00 O ther non-current assets 862.43 1,210.21 Trade payables 5,225.30 5,261.24 O ther current liabilities 13,005.53 13,694.12 CU RREN T A SSETSShort term provisions 925.78 2,242.59 Current investm ents 0.05 851.91

19,156.61 25,697.95 Inventories 4,118.98 5,165.44 Trade receivables 3,994.68 6,194.82 Cash and Cash Equivalents 14,481.09 20,124.57 Short-term loans and advances 2,673.39 3,123.71 O ther current assets 655.37 1,123.98

25,923.55 36,584.41

TO TA L 1,48,017.41 1,71,727.61 TO TA L 1,48,017.41 1,71,727.61

BALAN CE SH EET O F O IL AN D N ATURAL G AS CO RPO RATIO N LIM ITED AS AT 31ST M ARCH …(Rs. in Crores)

READ & THINK!!!

HAVE YOU EVER WONDERED WHAT DECISIONS OF A FIRM DETERMINE THE STRUCTURE OF A BALANCE SHEET?

Particulars 2011 2012 Particulars 2011 2012EQ UITY AN D LIABILITIES: A SSETSSH A REH O LD ER'S FU N D S N O N -CU RREN T A SSETS

Share Capital 4,277.76 4,277.76 FIXED A SSETS:Reserves and Surplus 93,226.67 1,08,678.97 Tangible assets 18,481.67 21,567.82

97,504.43 1,12,956.73 Producing Properties 43,575.66 46,376.83 Intangible assets 157.88 112.33

N O N -CU RREN T LIA BILITIES Capital W ork-in-Progress 13,976.90 18,298.06 D efered tax liabilities (N et) 9,950.39 11,197.87 Exploratory/D evelopm ent W ells in Progress 7,747.21 8,581.23 O ther long term liabilities 582.46 561.99 83,939.32 94,936.26 Long term provisions 20,823.51 21,313.06

31,356.37 33,072.92 N on current investm ents 5,182.75 4,364.34 Long- term loans and advances 23,993.85 25,449.81

CU RREN T LIA BILITIES D eposits under Site Restoration Fund Schem e 8,115.51 9,182.57 Short-term borrow ings - 4,500.00 O ther non-current assets 862.43 1,210.21 Trade payables 5,225.30 5,261.24 O ther current liabilities 13,005.53 13,694.12 CU RREN T A SSETSShort term provisions 925.78 2,242.59 Current investm ents 0.05 851.91

19,156.61 25,697.95 Inventories 4,118.98 5,165.44 Trade receivables 3,994.68 6,194.82 Cash and Cash Equivalents 14,481.09 20,124.57 Short-term loans and advances 2,673.39 3,123.71 O ther current assets 655.37 1,123.98

25,923.55 36,584.41

TO TA L 1,48,017.41 1,71,727.61 TO TA L 1,48,017.41 1,71,727.61

BALAN CE SH EET O F O IL AN D N ATURAL G AS CO RPO RATIO N LIM ITED AS AT 31ST M ARCH …(Rs. in Crores)

READ & THINK!!!

WHO IS RESPONSIBLE TO MAKE

DECISIONS THAT DETERMINE ASSETS

SIDE AND THE LIABILITIES SIDE OF A

BALANCE SHEET??

2009 2010 2009 2010

Amount Amount Amount Amount

2,138.89 2,138.89 61,355.61 71,553.78 76,596.53 85,143.72 50,941.23 55,905.28 78,735.42 87,282.60 10,414.37 15,648.50

26.74 5.98 75,729.71 84,312.22 39,571.72 44,029.00

7,802.24 8,918.21 36,157.99 40,283.21 11,696.46 10,241.35

16,008.97 16,400.67 5,068.74 5,549.68 63,337.56 71,722.75

13,015.09 12,087.56 5,090.32 5,772.03 8,090.01 7,412.40

1,351.65 630.45 4,060.67 4,678.57 4,083.80 3,058.64 12,140.55 10,827.93 6,955.66 7,403.11 26,004.38 27,169.77 3.24 2.86 54,599.96 53,771.32

650.61 841.32

1,23,678.45 1,32,107.42 1,23,678.45 1,32,107.42

MISCELLANEOUS EXPENDITURE (TO THE EXTENT NOT WRITTEN OFF OR ADJUSTED)

TOTAL ASSETS

CURRENT LIABILITIES AND PROVISIONSCURRENT LIABILITIESPROVISIONS

BALANCE SHEET OF OIL AND NATURAL GAS CORPORATION LIMITED AS AT 31ST MARCH … (Rs. in Crores)

LIABILITIES ASSETS

SUB-TOTAL

INVENTORIESDEBTORS NET OF PROVISIONCASH & BANK BALANCESDEPOSIT WITH BANK UNDER SITE RESTORATION FUND SCHEMELOANS AND ADVANCESOTHER CURRENT ASSETS

FIXED ASSETS

INVESTMENTS

CURRENT ASSETS, LOANS AND ADVANCESINTEREST ACCRUED

PRODUCING PROPERTIESGROSS COSTLESS: DEPLETION AND IMPAIRMENT

NET PRODUCING PROPERTIESCAPITAL WORKS IN PROGRESS (NET)EXPLORATORY/DEVELOPMENT WELLS IN PROGRESS (NET)

FIXED ASSETSGROSS BLOCKLESS: DEPRECIATION AND IMPAIRMENT

NET BLOCK

LIABILITY FOR ABANDONMENT COST

TOTAL LIABILITIES

SHARE CAPITALRESERVES AND SURPLUS

SUB-TOTALLOAN FUNDS

UNSECURED LOANS

DEFERRED TAX LIABILITY (NET)

SHAREHOLDERS' FUNDS:

READ & THINK!!!

HAVE YOU EVER WONDERED WHAT DECISIONS OF A FIRM DETERMINE THE STRUCTURE OF A BALANCE SHEET?

2009 2010 2009 2010

Amount Amount Amount Amount

2,138.89 2,138.89 61,355.61 71,553.78 76,596.53 85,143.72 50,941.23 55,905.28 78,735.42 87,282.60 10,414.37 15,648.50

26.74 5.98 75,729.71 84,312.22 39,571.72 44,029.00

7,802.24 8,918.21 36,157.99 40,283.21 11,696.46 10,241.35

16,008.97 16,400.67 5,068.74 5,549.68 63,337.56 71,722.75

13,015.09 12,087.56 5,090.32 5,772.03 8,090.01 7,412.40

1,351.65 630.45 4,060.67 4,678.57 4,083.80 3,058.64 12,140.55 10,827.93 6,955.66 7,403.11 26,004.38 27,169.77 3.24 2.86 54,599.96 53,771.32

650.61 841.32

1,23,678.45 1,32,107.42 1,23,678.45 1,32,107.42

MISCELLANEOUS EXPENDITURE (TO THE EXTENT NOT WRITTEN OFF OR ADJUSTED)

TOTAL ASSETS

CURRENT LIABILITIES AND PROVISIONSCURRENT LIABILITIESPROVISIONS

BALANCE SHEET OF OIL AND NATURAL GAS CORPORATION LIMITED AS AT 31ST MARCH … (Rs. in Crores)

LIABILITIES ASSETS

SUB-TOTAL

INVENTORIESDEBTORS NET OF PROVISIONCASH & BANK BALANCESDEPOSIT WITH BANK UNDER SITE RESTORATION FUND SCHEMELOANS AND ADVANCESOTHER CURRENT ASSETS

FIXED ASSETS

INVESTMENTS

CURRENT ASSETS, LOANS AND ADVANCESINTEREST ACCRUED

PRODUCING PROPERTIESGROSS COSTLESS: DEPLETION AND IMPAIRMENT

NET PRODUCING PROPERTIESCAPITAL WORKS IN PROGRESS (NET)EXPLORATORY/DEVELOPMENT WELLS IN PROGRESS (NET)

FIXED ASSETSGROSS BLOCKLESS: DEPRECIATION AND IMPAIRMENT

NET BLOCK

LIABILITY FOR ABANDONMENT COST

TOTAL LIABILITIES

SHARE CAPITALRESERVES AND SURPLUS

SUB-TOTALLOAN FUNDS

UNSECURED LOANS

DEFERRED TAX LIABILITY (NET)

SHAREHOLDERS' FUNDS:

READ & THINK!!!

WHO IS RESPONSIBLE TO MAKE

DECISIONS THAT DETERMINE ASSETS

SIDE AND THE LIABILITIES SIDE OF A

BALANCE SHEET??

This man!!!

PUT IN SIMPLE WORDS AND TELL – “what is the basic function of a Finance Manager in a business firm?”

Put in simple words – “what is the basic function of a Finance Manager in a business firm?”

Manage the Balance

Sheet of the Company.How should a

finance manager manage the Balance Sheet of a Company is a subject matter

of FINANCIAL MANAGEMENT!!!

Financial Management ...

FINANCIAL MANAGEMENT…???

The theory of Financial Management or Corporate Finance is the theory of financial decision making by business firms.

It can be described as the study of the decisions that every firm has to make related to financial matters.

It is that managerial activity which is concerned with the planning and controlling of the firm’s financial resources.

It can be viewed as proper management of flows of funds in a firm.

To be precise- the main task of Financial Management is to…

MANAGE FLOWS OF FUNDS/CASH THROUGH OUT THE ORGANIZATION TO ENHANCE THE VALUE OF A FIRM.

Why Should a student of management study Financial

Management...??? Management Students are interested in the subject because among the most crucial decisions of a firm are those which relate to finance, and an understanding of the theory of financial management provides them with conceptual and analytical insights to make those decisions skillfully.

They should study Financial Management because it provides necessary tools to appreciate the financial dimensions of managerial decisions. Its study helps in training the minds of managers so that they can handle skillfully financial implications of managerial decisions.

FOCUS/NATURE OF FINANCIAL MANAGEMENT

It focuses basically on corporate – that is, the vehicle to achieve objectives of an entity. It is assumed to be Joint Stock Company; and hence, it is sometimes is known as CORPORATE FINANCE.Implication of it is - all managerial decisions will be assumed to be made by the MANAGEMENT which is an agent of shareholders.

It is all-pervasive managerial function in a firm. It has to be integrated with Production, Marketing and Personnel functions of the management.Implication of it is - financial decision-making should be integrated with other managerial functions.

FOCUS/NATURE OF FINANCIAL MANAGEMENT(continued…)

It is all decision-making; nothing except decision-making.Implication of it is - one has to make best possible decisions and for that use all that is needed and this makes it a multi-dimensional subject.

What is expected from a finance manager?

To provide necessary funds so that no productive and beneficial activity should be sacrificed for want of funds.

To ensure that scarce funds of the firm should be optimally utilised.

To plan and control in a coordinated manner so that the requirements of all the departments could be met effectively.

Do not act as a bull-dog but as a watch-dog.Do not act as a strict controller and auditor but as a facilitator and motivator.

What is expected from a finance manager?(continued…)

Do not allow the funds of a firm to remain unutilised.

Do not let anyone in the firm to waste funds.

Do not let anyone to commit any fraud on funds.

Do not let the system to be rigid enough so as to sacrifice profitable activities/opportunities of the firm.

Act as an effective channel between financial markets on one side and the company on the other side.

Ensure that necessary legal requirements are satisfied while taking any financial decision.

FINANCE MANAGER

Basic nature of Financial Management as a Course of

studyIt is a decision-making course – that is

to say, each topic in it is concerned with a managerial decision problem.

All decision problems dealt in it are having finance (money or funds) as an important dimension.

Its approach to decision-making is quantitative in nature. That’s to say, it make use of numbers heavily.

It is primarily normative in nature.

To understand it properly, one should be comfortable with the following:Decision-makingQuantitative Methods of decision makingBehaviour of financial and economic variables

Impact of financial variables on the performance of a firm

Impact of environmental variables on financial variables of a firm

To take better financial decisions, one must be aware of necessary legal, economic and financial environment.

Basic nature of Financial Management as a Course of

study(continuation…)

MAIN DECISIONS to be made by a finance manager

Investment Decisions: Long-term Decisions

Financing Decisions: Capital Structure Decisions

Dividend Decisions: Profit Distribution Decisions

Liquidity Decisions: Working Capital or Short-term Decisions

While taking all these decisions, what is the ultimate corporate goal is attempted to be achieved?

OBJECTIVES BEFORE A FINANCE MANAGER…???

Profit MaximisationProfit after tax (PAT) MaximisationEarning per share (EPS) MaximisationSales MaximisationMarket Share MaximisationFirm’s Wealth MaximisationShareholders’ Wealth/Value Maximisation

PROFIT MAXIMISATION For any business firm, the natural objective is

Profit Maximisation and as such can be pursued to guide financial decisions of a finance manager. This objective has the following advantages:It is a well understood objective.It achieves sustainability for a firm as without profits, none can sustain itself for long.

Profit is also considered as a yardstick of efficiency.

In a free and competitive market, profit is the best driving and motivating force behind all economic decisions.

The theory of ‘Invisible Hand’ that ensures optimum allocation of resources for a society in a free and competitive market also depends upon the objective of Profit Maximisation.

It is an objective that is compatible with society’s objective as well as firm’s objective.

Disadvantages of Profit Maximisation – as an

objective It works perfectly well when markets are perfectly competitive and free. But, in real life, markets are full of a number of imperfections and as a consequence, profit can not be used as a yardstick of efficiency and hence, can guide various economic decisions to ensure best utilisation of resources for the firm as well as for the society.

Profit is a vague term as it means so many things to different people that finance manager fails to appreciate which profit should be maximised. Should it be profit to all stakeholders or profit to only owners; before tax or after tax; short-term profits or long-term profits; total profits or per share profits; operating profit or net profit; Accounting profit or Economic profit; and profit reported to shareholders or profit reported to tax authorities?

This objective ignores risk and uncertainty attached with profit. If a firm is earning huge profits at a very high degree of risk, then it may be dangerous for the very existence of the firm in the periods to come? For instance, should a finance manager divert funds to speculative activities and maximise the profits of a firm?

It ignores the time value of money as it does not make a distinction between profits received in future and at present. Also, it ignores the timings when the costs are incurred and when the profits are earned.

Profit Maximisation objective concentrates only on the profitability aspects of various decisions but ignores the financing decisions that are involved in them. As such, it fails to ignore the costs and the risks involved in financing decisions that are important.

Disadvantages of Profit Maximisation – as an objective

(continued…)

OTHER OBJECTIVES...Profit after tax (PAT) MaximisationEarning per share (EPS) MaximisationThese two are having more or less same

disadvantages as the objective of Profit Maximization has.

Sales MaximisationMarket Share Maximisation………………??????????

Firm’s Wealth Maximisation

This objective also means to maximize the STAKEHOLDERS’ WEALTH.

According to it, the finance manager should decided the things in such a manner that the wealth that would be claimed by all the stakeholders - creditors, lenders, employees, society, shareholders, etc. - should be maximum.

... ….?????

...….?????

Shareholders’ Wealth/ Value Maximisation

Creation of shareholders’ Value in fact takes care of PROFIT, SUCCESSFUL MARKETING STRATEGIES, HAPPY CREDITORS and LENDERS.

Ensuring balances among the objectives of the various stakeholders is not a practical objective to be achieved.

Since managers are accountable to the shareholders and they employ them, managers should work for the maximum benefits of the shareholders.

Shareholders’ value consists of dividend payments and the market value of shares. They both are accurately observable in case of listed companies.

Shareholders’ Wealth/ Value Maximisation(continued…)

If we assume that stock markets are efficient then the valuation of the shares reflects the fundamentals and risk involved of a company. Thus, market provides a suitable measure to judge the performance and hence, an objective worth pursuing.

Also, the market takes into account the long-term view to determine the share prices.

This objective takes care of the time value of money.

This objective provides an objective and well defined quantitative yardstick for evaluating financial decisions.

FINANCIAL ASSETS vs

REAL ASSETS

……??????

BASIC AXIOMS OF FINANCIAL MANAGEMENT

Money has time value/opportunity cost.Every financial decision involves a trade-off between RISK and RETURN.

Financial markets are EFFICIENT.Accounting Profit is not relevant profit concept for financial decisions. Profits based on cashflows are more relevant for Financial Decision-Making.

Options have a VALUE.Incremental/differential cashflows are important for financial decision-making.

Remember that ...

LET’S NOW UNDERSTAND -WHAT IS RETURN?

RETURN IS …

RETURN...RETURN presents-

benefitsgainsprofitsinterest yieldthe extra we get when we invest some money.

It is a positive parameter in the sense that more of it is more desirable.

LET’S NOW UNDERSTAND -

WHAT IS RISK?

RISK IS ………

RISK IS UNDERSTOOD AS A NEGATIVE PARAMETER… HAVING DIFFERENT SHADES!!!

Risk is a threat. Risk prevents the project to

realise its expected goals. Risk is a fear. Risk is pessimism. Risk is expected loss. Risk is a chance of loss. Risk comes out from unexpected

undesirable events. Risk is unwanted. Risk is variation, fluctuation

and volatility. Risk is dynamic. Risk arises due to

uncertainty. Risk is because of change. Risk is an odd thing out.

RISK IS USUALLY MEASURED AS ...

the PROBABILITY OF LOSS the EXPECTED LOSS VARIATIONS & FLUCTUATIONS:

RangeMean Absolute Deviation Standard Deviation/Variance/Coefficient of Variation

Semi-VarianceVariance from Subjective Expected Value

Co-variance the SENSITIVITY OF RETURN TO POSSIBLE CHANGES - percentage changes.

TYPES OF RISK Systematic RiskUnsystematic RiskMarket RiskInterest Rate RiskPurchasing Power Risk or Inflation RiskForeign Exchange RiskBusiness Risk - Operating LeverageFinancial Risk - Financial LeverageManagement RiskIndustry RiskEconomy/Country RiskCredit Risk/Default RiskSystem Risk

IS THERE ANY RELATION BETWEEN

RISK AND RETURN?

HOW MAXIMIZATION OF SHAREHOLDERS’ WEALTH TAKES INTO ACCOUNT THE RISK OF A COMPANY?

RELATION BETWEEN RETURN AND RISK

Can we say that a person who has taken high risk will get higher return?

Should a person go for higher risk if he/she has to earn higher return?

Should a person be compensated by higher return for taking higher risk?

Is it HIGH RISK HIGH RETURN? Or, Is it HIGH RETURN HIGH RISK?

PESO PROBLEM: A situation in which what appear to be abnormally high returns on an investment are in fact compensation for bearing the risk of an event that has not yet taken place.

What next…?

FORMS OF BUSINESS ORGANISATION

SOLE PROPRIETORSHIPPARTNERSHIPJOINT STOCK COMPANY

PRIVATE COMPANY: it has a minimum paid-up capital of one lakh rupees; minimum two members; maximum 50 members and by its articles, restricts the right to transfer its shares; prohibits any invitation to the public to subscribe for any shares in, or debentures of, the company; prohibits any invitation or acceptance of deposits from to persons other than its members, directors or their relatives.

FORMS OF BUSINESS ORGANISATION (continued…)

JOINT STOCK COMPANY

PUBLIC COMPANY: It is not a private company; it has minimum number of members 7 and maximum no limit; has a minimum paid-up capital of five lakh rupees; and is a private company which is a subsidiary of a company which is not a private company.

CO-OPERATIVE

AGENCY PROBLEM In proprietorship, partnership and cooperatives, the owners are actively involved but normally, in joint stock companies, owners(shareholders) and management are two different entities.

This separation leads to AGENCY PROBLEM. It means that the management which is supposed to act as an agent of the owners starts acting as a principal. The management may decide the things for its own benefits rather than for the benefit of the company’s owners. Some examples are-Managers prefer to expend a lower level of efforts.

Managers are tempted to under-invest.They are interested in protecting their jobs.

AGENCY PROBLEM(CONTINUED...)

Lack of perfect alignment between the objectives of the management and those of the owners results in AGENCY COST.

Agency Problem is one of the serious problems. It may cause sub-optimum decisions; it may force the managers to adopted unfair and fraudulent practices. The firm may have to incur a cost to mitigate the ill effects of it and thus, it may lower down the value of shareholders.

To solve this problem means how to ensure a natural congruency between the goals of the management and the owners.

AGENCY PROBLEM(CONTINUED...)

To mitigate the agency cost, effective monitoring is to be done along with appropriate incentives that have to be offered to the management.

Some examples of the ways to mitigate the cost of Agency Problem are - More transparency and frequent reporting of important decisions and their effects.

More powers to shareholders.Have more institutional investors.Performance linked bonus.stock-options.Sweat Equity.