Financial Management Notes
Subject Overview
Financial Management is the core paper on corporate finance decisions — raising capital, deciding what to invest in, and setting dividend policy. You'll cover financial management's goals and the time value of money, cost of capital and capital structure theories with leverage analysis, capital budgeting techniques (payback, ARR, NPV, IRR), and close with working capital management and dividend policy theories. This is a 6-credit core paper across 4 units, and it's the foundation for the Finance specialisation electives — Corporate Accounting, Financial Markets & Services — in Semesters 5 and 6.
Subject at a glance
4
Units
31
Topics
6
Credits
4
Infographics
Unit-wise Syllabus
4 units — open any unit for detailed topic-wise notes, diagrams and important exam questions
- Meaning
- nature and scope of financial management
- profit maximisation vs. wealth maximisation
- finance functions — investment
- financing
- liquidity and dividend decisions
- sources of long-term and short-term finance
- time value of money
Investment decision
Where to invest: capital budgeting
Financing decision
How to raise funds: debt or equity
Dividend decision
How much profit to pay out
Liquidity decision
Managing working capital
Study guide
This unit introduces financial management: its meaning, nature and scope, profit versus wealth maximisation, the finance functions (investment, financing, liquidity and dividend decisions), sources of long- and short-term finance and the time value of money. Always remember that wealth maximisation is the preferred goal and be able to say why.
- Meaning and significance of cost of capital
- cost of equity
- preference shares and debt
- weighted average cost of capital
- capital structure theories — NI approach
- NOI approach
- MM approach
- traditional approach
- financial and operating leverage
Cost of debt (after tax)
Kd = I (1 − t) / net proceeds
Cost of preference shares
Kp = preference dividend / net proceeds
Cost of equity (Gordon)
Ke = D1 / P0 + g
WACC
Σ (weight × cost of each source)
Financial leverage
EBIT / EBT
Study guide
You study the cost of capital (equity, preference shares and debt), weighted average cost of capital, capital structure theories (NI, NOI, MM and traditional approaches) and financial and operating leverage. Practise WACC and leverage numericals.
- Meaning
- importance and nature of investment decisions
- investment evaluation criteria
- non-discounted cash flow methods (payback, post-payback, ARR)
- discounted cash flow techniques — NPV
- IRR
- profitability index
Payback period
Initial investment / annual cash inflow
ARR
Average profit / average investment × 100
NPV
PV of inflows − initial outlay
Accept if NPV > 0
Profitability index
PV of inflows / initial outlay
Accept if PI > 1
IRR
Rate at which NPV = 0
Accept if IRR > cost of capital
Study guide
Investment decisions commit funds for years. You study evaluation criteria, non-discounted methods (payback, post-payback, ARR) and discounted methods (NPV, IRR, profitability index). Build cash flow tables carefully and compare methods on one project.
- Meaning
- significance
- types and approaches to working capital
- factors affecting working capital management
- issues in dividend decisions
- forms of dividend
- theories of relevance and irrelevance of dividends
- 1. Cash: Pays for raw materials
- 2. Raw materials: Go into production
- 3. Work in progress: Being made
- 4. Finished goods: Ready to sell
- 5. Debtors: Sold on credit; cash returns
Study guide
You study working capital (meaning, types, approaches and determinants) and dividend decisions (forms of dividend and theories of relevance and irrelevance). Be able to state the key idea of Walter's, Gordon's and the MM theory in one line each.
Why Financial Management Matters
Financial management is the backbone of corporate finance and a core MBA and finance career subject. NPV, IRR and WACC are asked in finance interviews and in professional exams.
How to Prepare for Financial Management
- Practise one NPV, IRR and WACC problem every day.
- Prepare a formula sheet and a comparison of capital structure theories.
- Follow a listed company and note its debt, equity and dividend decisions.
Financial Management: Frequently Asked Questions
What is WACC?
The weighted average cost of capital is the average cost of a firm's funds from all sources, weighted by their proportion in the capital structure.
What is the difference between profit maximisation and wealth maximisation?
Profit maximisation focuses on short-term earnings, while wealth maximisation aims to increase the long-term value of the firm to shareholders, taking risk and time into account.