FINANCIAL MANAGEMENT

Q.2: What are the goals of Financial Management needs to be

highlighted? What is Wealth maximization needs to be explained?
Distinguish between profits Maximization and Wealth maximization. In
what respect wealth maximization is superior to profit maximization
needs to be analyzed?

Goals Of Financial Management:

The goal of the financial management should be to achieve the objective of
the businesss owners, who are the suppliers of capital. In the case of
company, the owners are shareholders. The financial managers function is
not to fulfill his own objectives, which may include higher salaries earning
reputation or maintaining and advancing his personal power and prestige. It
is rather to manager is successful in this endeavour, he will also achieve
his personal objectives. It is generally agreed that the financial objectives
of the firm should be the maximisation of owners wealth. However there is
a disagreement as to how the economic welfare of owners can be
maximized. Two well known criteria which are put forth for this purpose are
a) profit maximisation, and b) wealth maximisation.
a) Profit Maximisation: Traditionally, the business has been considered as
an economic institution and profit has come to be accepted as a rationally
valid from criterion of measuring efficiency. As a goal, however, profit
maximisation suffers from certain basic weaknesses:
1) it is vague
2) it is a short-run point of view
3) it ignores risk, and
4) it ignores the timing of returns.

b) Wealth Maximisation: The maximisation of wealth is a more viable

objective of financial management. The same objective, if expressed in
other term would convey idea of net present worth maximisation. Any
financial action which creates wealth or which has a net present worth is a

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desirable one and should be undertaken. Wealth of the firm is reflected in
the maximisation of the present value of the firm. This value maybe readily
measured if the company has shares that are held byt the public, because
the market price of the share is indicative of the value of the company. And
to a shareholder, the term wealth is reflected in the amount of his current
dividends and the market price of share.
From the above clarification, on thing is certain that the wealth
maximisation is a long term strategy that emphasizes raising the present
value of the owners investment in a company and the implementation of
projects that will increase the market value of the firms securities. This
criterion, if applied, meets the objections raised against earlier criterion of
profit maximisation. The financial manager also deals with problem of
uncertainty by taking into account the trade- off between the various returns
and associated levels of risks. It also takes into account the payment of
dividends to shareholders. All these ingredients of the wealth maximisation.

Need Of Wealth Maximization:

This is also known as value maximization or net present worth
maximization. Net present value is the difference between the gross
present value of benefits from an investment proposal and the investment
required achieving these benefits. The gross present value of a course of
action is found out by discounting or capitalizing its benefits at a rate, which
reflects their timing or uncertainty. Any financial action with a positive net
present worth should be undertaken otherwise it should be rejected.
The need of Wealth Maximization includes;
1. It considers time value of money.
2. It takes care of uncertainty of expected benefits and the benefits are
measured in terms of cash flows and not accounting profits.
The wealth maximization objective is consistent with the objective of
maximization of economic welfare of shareholders. The wealth of

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shareholders id reflected by the market value of the company shares.
Hence, wealth maximization implies the maximization of the market value
of the companys shares, which is the fundamental objective of the firm.
Wealth Maximization V/s Profit Maximization:

1) The traditional approach of financial management was all about profit

maximization.
Modern Approach is about the idea of wealth maximization.

2) In Profit maximisation, the main objective of companies was to make

profits.
Wealth maximisation, involves increasing the Earning per share of the
shareholders and to maximize the net present worth.

3) Higher capitalisation rate is involved for balance between expected

return and risk. Such combination of expected returns with risk
variations and related capitalisation rate cannot be considered in the
concept of profit maximization.
For balance between expected return and risk, the possibility of higher
expected
yields are associated with greater risk to recognise such a
balance and wealth Maximization is brought in to the analysis.

4) Profit maximization refers to how much dollar profit the company

makes.

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Wealth maximisation refers to the value of the company generally
expressed in the value of the stock.

Conclusion:
Wealth maximisation is superior to profit maximisation because:
(i) Profit cannot be ascertained well in advance to express the probability
of return as future is uncertain. It is not at possible to maximize what
cannot be known.
(ii) The executive or the decision maker may not have enough confidence
in the estimates of future returns so that he does not attempt future to
maximize. It is argued that firm's goal cannot be to maximize profits but to
attain a certain level or rate of profit holding certain share of the market or
certain level of sales. Firms should try to 'satisfy' rather than to 'maximize'
(iii) There must be a balance between expected return and risk. The
possibility of higher expected yields are associated with greater risk to
recognise such a balance and wealth Maximization is brought in to the
analysis. In such cases, higher capitalisation rate involves. Such
combination of expected returns with risk variations and related
capitalisation rate cannot be considered in the concept of profit
maximization.
(iv) The goal of Maximization of profits is considered to be a narrow
outlook. Evidently when profit maximization becomes the basis of
financial decisions of the concern, it ignores the interests of the
community on the one hand and that of the government, workers and
other concerned persons in the enterprise on the other hand.
Keeping the above objections in view, most of the thinkers on the subject
have come to the conclusion that the aim of an enterprise should be
wealth Maximization and not the profit Maximization. It is useful to make a
distinction between profit and 'profitability'. Maximization of profits with a
view to maximising the wealth of shareholders is clearly an unreal motive.

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On the other hand, profitability Maximization with a view to using
resources to yield economic values higher than the joint values of inputs
required is a useful goal. Thus the proper goal of financial management is
wealth maximization.

Q4) What is share & Dividends? How the Dividends are paid against
the share? On What ground & mechanism company declare the

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dividends? Is the mechanism affecting the shareholder or supporting
the shareholder?

SHARES AND DIVIDENDS

Shares:
A share may be defined as one of the units into which the share capital of a
company has been divided. According to section 2 (46) of the companies
act, a share is the share in the capital of a company and includes stock
except where a distinction between stock and share is expressed or
implied.
In finance a share is a unit of account for various financial instruments
including stocks, mutual funds, limited partnerships, and REIT's. In British
English, the usage of the word share alone to refer solely to stocks is so
common that it almost replaces the word stock itself.
In simple Words, a share or stock is a document issued by a company,
which entitles its holder to be one of the owners of the company. A share is
issued by a company or can be purchased from the stock market.
By owning a share you can earn a portion and selling shares you get
capital gain. So, your return is the dividend plus the capital gain. However,
you also run a risk of making a capital loss if you have sold the share at a
price below your buying price.
A company's stock price reflects what investors think about the stock, not
necessarily what the company is "worth." For example, companies that are
growing quickly often trade at a higher price than the company might
currently be "worth." Stock prices are also affected by all forms of company
and market news. Publicly traded companies are required to report
quarterly on their financial status and earnings. Market forces and general
investor opinions can also affect share price.

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The person holding the share is known as a shareholder. He receives
dividend from the company as a consideration for investing his money into
the company. However, payment of dividend vests in the board of directors
of the company. The recommendation of the directors is our before the
general meeting of the shareholders who may reduce the rate of dividend
as recommended by the board but cannot increase it.
TYPES OF SHARES
A public company can issue two types of shares. They are (i) Preference
Shares and (ii) Equity Shares
Preference shares:
Preference shares (prefs) are legally shares, but they are very different
from ordinary shares. The economic effect of prefs is more like that of
bonds. Like convertibles, they are regarded as hybrids of debt and equity:
Dividends on preference shares have to be paid before dividends on
ordinary shares.
Dividends on ordinary shares may not be paid unless the fixed
dividends on preference shares is paid first.
Dividends are fixed like bond coupons, although there are usually
provisions to not pay, or delay payments.
Preference shareholders have a higher priority if a company is
liquidated than ordinary shareholders, although a lower priority than
debt holders.
In the case of cumulative prefs, if the dividend is not paid in full, the
unpaid amount is added to the next dividend due.
Preference dividends are fixed, so they do not participate in increases
(or decreases) in profits as ordinary shareholders do.

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Shares in a company which give their holders an entitlement to a fixed
dividend but which do not usually carry voting rights. The important
difference between preference and ordinary shares are:
1. The dividend on ordinary shares is uncertain and variable (high when
the company does well, poor or non-existent when it does badly).
Preference shareholders get a fixed dividend which, if not paid,
usually accrues until it can be.
2. Each ordinary share usually carries a vote. Preference shares do not
usually carry a vote unless dividends fall into arrears.
3. In the event of a winding up, preference shares are usually repayable
at par value, and rank above the claims of ordinary shareholders (but
behind bank and trade creditors).
Preference shares may be issued with the right of conversion into ordinary
shares. These are called convertibles.
Equity Shares:
These are shares which are not preference shares. They do not carry any
prererential right. They will rank after preference shares. For the purposes
of dividend and repayment of capital in the event if companys winding up.
The rate of dividend on these shares is not fixed. It depends on the
availability of divisible profits and the intention of the directors. The shares
have the chance of earning good dividends periods of adversity. The equity
shareholders control the company on account of their entitlement to vote at
the general meeting of the company. These shares are preferred by
persons who prefer risk to better return and also wish to have a say in the
management of the company. The equity share capital is also termed as
the venture capital on account of the risk involved in it.

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Methods of Valuation of Shares
The important methods adopted in valuation of shares are:

Net assets method or intrinsic value method

Dividend yield method
Earnings yield method
Return on capital employed method
Price / earning ratio method
Fair value method

Dividends:
Dividends are payments made by a corporation to its shareholder
members. It is the portion of corporate profits paid out to stockholders.
When a corporation earns a profit or surplus, that money can be put to two
uses: it can either be re-invested in the business (called retained earnings),
or it can be paid to the shareholders as a dividend. Many corporations
retain a portion of their earnings and pay the remainder as a dividend.
For a joint stock company, a dividend is allocated as a fixed amount per
share. Therefore, a shareholder receives a dividend in proportion to their
shareholding. For the joint stock company, paying dividends is not an
expense; rather, it is the division of an asset among shareholders. Public
companies usually pay dividends on a fixed schedule, but may declare a
dividend at any time, sometimes called a special dividend to distinguish it
from a regular one.
Cooperatives, on the other hand, allocate dividends according to members'
activity, so their dividends are often considered to be a pre-tax expense.

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Dividends are usually settled on a cash basis, as a payment from the
company to the shareholder. They can take other forms, such as store
credits (common among retail consumers' cooperatives) and shares in the
company (either newly-created shares or existing shares bought in the
market.) Further, many public companies offer dividend reinvestment plans,
which automatically use the cash dividend to purchase additional shares for
the shareholder.
Dividend is the return on the investment made in the shares (equity or
preference) and is paid out of the profits of the company. The shareholders
being the owners of the company are entitled to get their share of profit in
the form of dividend. While the rate of dividend in case of preference
shares is fixed, the dividend on equity shares varies from year to year
depending upon the profit for the year and the requirement to get back
profits. Dividend rate is used for valuation of share and is an indicator of
performance of the company.
Payment of Dividends against Shares:
How often dividends are paid can vary from one company to the next, but
in general they are paid whenever the company reports a profit. Since most
companies are required to report their profits or losses quarterly, this
means that most of them have the potential to pay dividends up to four
times each year. Some companies pay dividends more often than this,
however, and others may pay only once per year. The more time there is
between dividend payments can indicate financial and profit problems
within a company, but if the company simply chooses to pay all of their
dividends at once it may also lead to higher per-share payments on those
dividends.
Dividends are payments made by companies to their stockholders in
order to share a portion of the profits from a particular quarter or year.
The amount that any particular stockholder receives is dependent upon
how many shares of stock they own and how much the total amount being
divided up among the stockholders amounts to. This means that after a
particularly profitable quarter a company might set aside a lump sum to be

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divided up amongst all of their stockholders, though each individual share
might be worth only a very small amount potentially fractions of a cent,
depending upon the total number of shares issued and the total amount
being divided. Individuals who own large amounts of stock receive much
more from the dividends than those who own only a little, but the total pershare amount is usually the same. Dividends are payments made by a
company or corporation to its shareholders, usually after making profits.
The company may allocate some of its profits for future business
development or as reserves and pay another portion to its shareholders.
There are no fixed rules for paying dividend, but it is usually the board of
directors who recommend such a dividend. It could be paid quarterly, half
yearly, annually or even as an interim dividend. The amount paid will be
added to the recipients total income for tax purposes.
Dividends are paid by companies as a method of sharing their profitable
times with the stockholders that have faith in the company, as well as a way
of luring other investors into purchasing stock in the company that is paying
the dividends. The more a particular company pays in dividend payments,
the more likely it is to sell additional common stock after all, if the
company is well-known for high dividend payments then more people will
want to get in on the action. This can actually lead to increases in stock
price and additional profit for the company which can result in even more
dividend payments.

Mechanism of a Company to declare dividends:

Dividend can be declared out of four sources. Firstly It can be declared out
of the profits of the company for that year arrived at after providing for
depreciation in accordance with the provisions of the Act or secondly, out of
the profit of the company for any previous financial year or years
arrived at after providing for depreciation in accordance with those
provisions and remaining undistributed or thirdly, out of both or lastly, out of
the money provided by the Central Government or a State Government for
the payment of dividend in pursuance of a guarantee given by that
Government.

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In order to get the most out of the dividends that you receive on your
investments, it is generally recommended that you reinvest the dividends
into the companies that pay them. While this may seem as though you're
simply giving them their money back, you're receiving additional shares of
the company's stock in exchange for the dividend. This will increase future
dividend payments (since they're based upon how much stock that you
own), and can set you up to make a lot more money than the actual
dividend payment was for since increases in stock prices will affect the
newly-purchased stock as well.
Steps involved in the process of declaration and distribution of
dividend
1. Computation of Depreciation
Depreciation shall be provided either at the rate specified in Schedule XIV
or any other basis approved by the Central Government.
2. Compulsory Transfer of Profits to Reserves
Before declaring the dividend, the some part of the profit has to
compulsorily transferred to the Reserves of the Company. This amount is
based on the proposed rate of dividend.[2] However voluntary transfer of
higher percentage to reserves is permitted subject to the conditions
stipulated in the Act.
3. Board Resolution
The most important step in the process is the Board Resolution for
declaration of dividends. Unless the Board recommends the payment of
dividend, the same cannot be declared at an Annual General Meeting.
4. Annual General Meeting (AGM)
The item pertaining to declaration of dividend should be included in the
agenda of the notice for AGM which should be sent to members as well as
the creditors. An ordinary resolution is required for declaration of dividend.

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However shareholders cannot
recommended by the Board.

increase

the

amount

of

dividend

5. Time Limit for payment of Dividend

The dividend account should be opened with the companys bankers and
the dividend amount payable should be transferred to that account. Within
30 days of the AGM the dividend warrants should be sent to the
shareholders.
6. Transfer to unpaid dividend account
Within 7 days from the date of expiry of 30 days from the date of dividend
declaration, the amount remaining unpaid or unclaimed should be
transferred to the unpaid dividend account to be opened in a scheduled
Bank. Dividend which remains unpaid or unclaimed for a period of 7 years
shall be transferred to the Investor Education and Protection Fund within a
period of 30 days of its becoming due for the transfer.[3]
7. Circumstances under which dividend need not be paid:
a. Where it could not be paid because of operation of any law;
b. Where a shareholder has given direction to the company regarding
payment of dividend and those directions could not be complied with;
c. Where there is a dispute regarding the right to receive the dividend;
d. Where the dividend has been lawfully adjusted by the company against
any sum due from the shareholders; and
e. Where the dividend could not be paid not due to any default on part of
the company.
8. Tax Limit
In addition to the income tax chargeable in respect of the total income of a
company for any assessment year, any amount declared, distributed or
paid by such company by way of dividends (whether interim or otherwise)

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and also whether paid out of current or accumulated profits is charged with
additional tax at the rate of 15 %.[4] The liability of payment of tax is on the
principle officer of the company. The tax has to be paid within 14 days of
declaration, distribution or payment of any dividend whichever is the
earliest. The tax on distributed profit paid by the Company would be treated
as the final payment of tax in respect of dividend.
9. Special Provisions relating to Listed Company
In addition to the steps mentioned above the listed companies also have to
advance intimation regarding the venue of the Board Meeting to the stock
exchange where the securities are listed. Within 15 minutes of the closure
of the Board meeting, intimation is also to be sent to the stock exchange
containing the particulars of dividend. Details regarding the general
meeting for the declaration of dividend are also to be given to the Stock
Exchange.
Procedure for declaration and payment of dividends
1. Recommendation by the Board
Dividend can be declared only on the recommendation of the board of
directors (Board) of the company. The members cannot on their own
declare any dividend. The Board, after consideration and approval of the
financial statements of the company, determines the rate of dividend to be
declared and recommends the same to the shareholders.
2. Resolution at the annual general meeting
Dividend is declared by a company by a resolution passed at its AGM after
sanctioning the rate of dividend recommended by the Board. The members
may declare a lower rate of dividend than what is recommended by the
Board but they have no power to increase the amount or rate so
recommended by the Board.
3. Payment from profits of the Company

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It has to be ensured that dividend is paid out of the profits of the company
after providing for depreciation and if no depreciation is provided, ensure
that approval was obtained from the Central Government before declaring
the
dividend.
Payment within 42 days of declaration
(a) The amount of dividend including interim dividend shall be deposited in
a separate bank account within 5 days from the date of declaration of such
dividend.
(b) Dividend should be paid out of such bank account within 42 days of
declaration of such dividend.
(c) Failure to comply with this requirement subjects the company to penalty
under the Act unless such failure is because of the reason excepted under
the
Act.
Unpaid dividend
(a) Unpaid Dividend Account
The amount of dividend which remains unpaid or unclaimed after 30 days
from the date of declaration should be transferred to a special dividend
account, to be called Unpaid Dividend Account of the company within 7
days from the expiry of the 30 days period provided for payment of
dividend.
The company in default of this provision shall pay, from the date of such
default, 12% interest on the amount not transferred to the said account,
which interest shall ensure to the benefit of the members, in proportion to
the amount remaining unpaid to them.
(b) Investor Education and Protection Fund
Any amount in the Unpaid Dividend Account of the company which remains
unclaimed and unpaid for a period of 7 years from the date of transfer of
such amount to the Unpaid Dividend Account should be transferred to the
Investor Education and Protection Fund, within 30 days of the expiry of 7
years from the date of transfer to the Unpaid Dividend Account. But prior to
such transfer the company must have given individual intimation to the
concerned members of the amount of dividend remaining unclaimed which

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is liable to be transferred to such fund at least 6 months before the due
date of such transfer.
4. Permission of RBI
The permission of RBI is required in case of payment of dividend to nonresident
shareholders.
Declaration of Interim Dividend
(a) Interim dividend can be declared by the Board without requiring the
approval of the members of the company. However interim dividend can be
paid only if authorized by the articles of association of the company.
(b) A mere resolution declaring interim dividend does not create any liability
and may be rescinded at any time before actual payment. (distinction
between interim and final dividend)
5. Dividend Distribution Tax (DDT)
The DDT is liable to be paid by the company at the rate of 15.0% (plus a
surcharge of 10% and education cess at the rate of 3% on dividend
distribution tax and surcharge) on the total amount distributed as a
dividend. Thus the effective rate of dividend distribution tax is 16.995%.
In addition it is pertinent to note that dividends are not taxable in India in
the hands of the shareholders.

Affect on Shareholders due to mechanism of sharing dividends:

In terms of voting rights;
Subject to the provisions of section 89 and sub-section (2) of section 92, every member of a company limited by shares and holding any equity
share capital therein shall have a right to vote, in respect of such capital, on
every resolution placed before the company; and his voting right on a pool
shall be in proportion to his share of the paid-up equity capital of the
company. Subject as aforesaid and save as provided in clause (b) of this

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sub-section, every member of a company limited by shares and holding
any preference share capital therein shall, in respect of such capital, have a
right to vote only on resolutions placed before the company which directly
affect the rights attached to his preference shares.