Essential Financial Management Concepts Explained

Posted on Jan 25, 2026 in Accounting and Finance

Essential Financial Management Concepts

Q1: Define Financial Management

Financial Management is the planning, organizing, directing, and controlling of financial activities such as procurement and utilization of funds to achieve the financial goals of a business. It ensures efficient use of funds and maximization of the firm’s value.

Q2: What is Wealth Maximization?

Wealth Maximization means maximizing the market value of shareholders’ equity. It focuses on long-term growth, profitability, and increasing the value of the firm.

Q3: What is Capital Rationing?

Capital Rationing refers to the situation where a company has limited capital and must select the best projects that provide the maximum return, even if profitable projects exceed the available funds.

Q4: What is Annuity?

An Annuity is a series of equal payments made at regular intervals (e.g., monthly, quarterly, annually). Examples include EMI, insurance premiums, and pension payments.

Q5: What is Annuity Due?

An Annuity Due is an annuity where equal payments are made at the beginning of each period. Example: Rent paid at the beginning of the month.

Q6: What is Perpetuity?

Perpetuity is an annuity where equal payments continue forever with no end. Example: Preference dividends (if assumed perpetual).

Q7: What is Capital Budgeting?

Capital Budgeting is the process of evaluating and selecting long-term investment projects such as purchase of equipment, expansion, or new product development.

Q8: Explain the Formula of Net Present Value (NPV)

NPV Formula:

NPV = ∑ \frac{CF_t}{(1+r)^t} – C_0

Where:

  • $CF_t$: Cash flow in year $t$
  • $r$: Discount rate
  • $C_0$: Initial investment

Explanation:

NPV is the difference between the present value of cash inflows and the present value of cash outflows. A positive NPV means the project should be accepted; a negative NPV means the project should be rejected.

Q9: What is Internal Rate of Return (IRR)?

Internal Rate of Return (IRR) is the discount rate at which the NPV of a project becomes zero. It represents the project’s expected rate of return.

Q10: What is Leverage?

Leverage refers to the use of fixed-cost funds (like debt or fixed operating costs) to increase the return to equity shareholders.

Q11: What are the Different Types of Leverage?

  1. Operating Leverage – arises due to fixed operating costs.
  2. Financial Leverage – arises due to fixed financial costs (interest).
  3. Combined Leverage – combined effect of operating and financial leverage.

Q12: What is Cash Management?

Cash Management refers to planning and controlling cash inflows and outflows to maintain adequate liquidity and minimize idle cash.

Q13: What are the Motives for Holding Cash?

According to Keynes, there are three motives:

  1. Transaction Motive – to meet day-to-day expenses.
  2. Precautionary Motive – to meet unexpected emergencies.
  3. Speculative Motive – to take advantage of business opportunities.

Q14: What are Treasury Bonds?

Treasury Bonds are long-term debt securities issued by the Government to raise funds. They carry a fixed interest rate and are considered risk-free investments.

Q15: What are the Two Important Roles of a Finance Manager?

  1. Financing Decision – deciding the best mix of debt and equity.
  2. Investment Decision – selecting profitable investment opportunities (capital budgeting).