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Introduction to Financial
Management

UNIT 1 INTRODUCTION TO FINANCIAL
MANAGEMENT
Structure
Nos.
1.0
1.1
1.2
1.3
1.4

Introduction
Objectives
Evolution of Financial Management
Significance of Financial Management
Principles of Financial Management
1.4.1
1.4.2
1.4.3
1.4.4

1.5
1.6
1.7

5
6
6
6
8

Investment Decision
Financing Decision
Dividend Decision
Liquidity Decision

Objectives of Financial Management
Economic Profit vs. Accounting Profit
Agency Relationship
1.7.1
1.7.2

1.8
1.9
1.10
1.11
1.12
1.13

Page

9
11
11

Problems Related with Agency Relationship
Costs of the Agency Relationship

The Changing Financial Landscape
Organisation of Financial Management
Tasks and Responsibilities of Modern Financial Manager
Summary
Self-Assessment Questions/Exercises
Solutions/Answers

12
13
13
15
15
15

1.0 INTRODUCTION
Finance is the application of economic principles and concepts to business decision making and problem solving. The field of finance broadly consists of three categories: Financial Management, Investments and Financial Institutions. i)

Financial Management: This area is concerned with financial decision making within a business entity. Financial management decisions, include maintaining optimum cash balance, extending credit, mergers and acquisitions, raising of funds and the instruments to be used for raising funds and the instruments to be used for raising funds etc.

ii)

Investments: This area of finance focuses on the behaviour of financial markets and pricing of financial instruments.

iii)

Financial Institutions: This area of finance deals with banks and other financial institutions that specialises in bringing supplier of funds together with the users of funds. There are three categories of financial institutions which act as an intermediary between savers and users of funds, viz., banks, developmental financial institution and capital markets.

Financial management is broadly concerned with the acquisition and use of funds by a business firm. The scope of financial management has grown in recent years, but traditionally it is concerned with the following:






How large should a firm be and how fast should it grow?
What should be the composition of the firm’s assets?
What should be the mix of the firm’s financing?
How should the firm analyse, plan and control its financial affairs?

The past two decades have witnessed several rapid changes on the economic and corporate front which have an important bearing on how firms are run and managed. On the one hand we have witnessed economies of several countries opening up

5

Financial Management
and Decisions

thereby throwing new opportunities and on the other hand we have also witnessed that the growth rate of developed countries are stagnating or even declining. The impact of these changes is that the firms have to move out of the saturated markets and explore new markets.

1.1 OBJECTIVES
After going through this unit, you should be able to:

understand the role and scope of financial management;

understand the evolution of financial management;

understand the various decisions taken by financial managers, and •
understand the concept of economic and accounting profit.

1.2 EVOLUTION OF FINANCIAL
MANAGEMENT
The evolution of financial management may be divided into three broad phases: i)
ii)
iii)

The traditional phase
The transitional phase
The modern phase.

In the traditional phase the focus of financial management was on certain events which required funds e.g., major expansion, merger, reorganisation etc. The traditional phase was also characterised by heavy emphasis on legal and procedural aspects as at that point of time the functioning of companies was regulated by a plethora of legislation. Another striking characteristic of the traditional phase was that, a financial management was designed and practiced from the...
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