An Overview of Financial Management | PAPER III – ACCOUNTING & FINANCIAL MANAGEMENT FOR BANKERS | MODULE C: FINANCIAL MANAGEMENT
Overview of Financial Management
1. Forms of Business Organisation
There are three main types: Sole Proprietorship, Partnership, and Corporation. Each has unique implications on control, liability, taxation, and financial management.
2. Financial Decision Making in a Firm
Key decisions include Investment (capital budgeting), Financing (capital structure), and Dividend decisions. These influence the value and sustainability of the firm.
3. Objectives of Financial Management
The primary objective is shareholder wealth maximization. Secondary objectives include profit maximization, ensuring liquidity, and maintaining solvency.
4. The Fundamental Principles of Finance
- Principle of Risk-Return
- Time Value of Money
- Cash Flow Principle
- Profitability and Liquidity Trade-off
- Diversification of Risk
5. Building Blocks of Modern Finance
- Efficient Market Hypothesis
- Portfolio Theory
- Agency Theory
- Capital Asset Pricing Model (CAPM)
- Modigliani-Miller Theorem
6. Risk-Return Trade-off
Higher returns are associated with higher risks. Investors must balance risk tolerance with expected returns.
Mathematical Example:
If Asset A offers a 10% return with 5% risk (standard deviation) and Asset B offers 15% return with 12% risk:
Sharpe Ratio = (Return - Risk-free Rate) / Risk
Assume Risk-free Rate = 3%
- Sharpe (A) = (10 - 3) / 5 = 1.4
- Sharpe (B) = (15 - 3) / 12 = 1.0
Asset A is preferable per risk-return trade-off.
7. Agency Problem in Financial Management
Occurs when there's a conflict between management's interests and shareholders' interests. Solutions include performance-based incentives, audits, and corporate governance.
8. Business Ethics & Social Responsibility
Involves conducting business fairly, transparently, and with accountability. Also includes environmental care, fair trade, and community development.
9. Organisation of the Finance Function
Typically led by the CFO, this includes Treasury, Controller, Internal Audit, Taxation, and Financial Planning departments.
10. Relationship of Finance to Economics and Accounting
Finance applies economic principles for decision-making under uncertainty. Accounting provides the financial data used for analysis.
11. Emerging Role of the Financial Manager in India
The financial manager's role has expanded to include strategic planning, risk management, sustainability reporting, and use of fintech tools.
MCQs (Multiple Choice Questions)
-
Which of the following is a financing decision?
a) Investing in a new plant
b) Paying dividends
c) Raising funds through equity
d) All of the above
Answer: c -
What is the primary objective of financial management?
a) Cost minimization
b) Revenue maximization
c) Profit maximization
d) Shareholder wealth maximization
Answer: d -
Which principle of finance states that a rupee today is worth more than a rupee tomorrow?
a) Cash Flow Principle
b) Time Value of Money
c) Risk-Return Trade-off
d) Agency Theory
Answer: b -
Which theory forms the basis of portfolio diversification?
a) CAPM
b) Efficient Market Hypothesis
c) Modern Portfolio Theory
d) Agency Theory
Answer: c -
What does a higher Sharpe ratio indicate?
a) Higher risk
b) Lower return
c) Better risk-adjusted return
d) Inefficiency
Answer: c -
Who typically leads the finance function in an organization?
a) CEO
b) CFO
c) COO
d) Treasurer
Answer: b -
Which of the following is an agency cost?
a) Audit fees
b) Loan interest
c) Rent
d) Insurance premium
Answer: a -
Business ethics include:
a) Bribery
b) Corruption
c) Transparency
d) Misreporting
Answer: c -
Finance is linked to accounting by:
a) Providing data for decision-making
b) Making journal entries
c) Filing tax returns
d) Auditing
Answer: a -
Which area has become a key responsibility of financial managers in India recently?
a) Payroll
b) Environmental reporting
c) Office maintenance
d) HR functions
Answer: b
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