01 Financial Management

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FINANCIAL MANAGEMENT: AN OVERVIEW

Introduction

The primary task of Financial Manager is to deal with funds. Management offunds is an important aspect of Financial Management. In a business undertaking orin an educational institution or in a hospital or in an art society or else where

management of funds is the primary concern of the Financial Management.

Finance is regarded as the lifeblood of a business enterprise. This is becausein the modern money-oriented economy finance is one of the basic foundations of all

kinds of economic activities. Without adequate finance no business can survive oraccomplish its obectives. In general! finance may be defined as the provision of

money at the time it is wanted. Thus! finance refers to making provision of money atthe time when it is required.

Meaning of Business Finance

"usiness finance is that business activity which is concerned with theacquisition and conservation of capital funds in meeting financial needs and overall

obectives of a business enterprise. In other words! it refers to the process of raising!providing and administering of money used in a business concern.

Wheeler defines business finance as #That "usiness activity! which is

concerned with the acquisition and conservation of capital funds in meeting thefinancial needs and over all obectives of business enterprise$.

In the words of %rather and Wert! #"usiness Finance deals primarily with

raising! administering and disbursing funds by privately owned business unitsoperating in non-financial fields of industry$.

Finance Function

Finance Function refers to the providing of funds needed by a businessconcern on most suitable terms. In other words! it refers to the raising of funds and

their effective utili&ation. It does not stop only by finding out sources and raising offunds but it also covers proper utili&ation of funds.

Obecti!es of Finance Function

The main aim of finance function is to arrange adequate funds as required bythe business enterprise from time to time.

The main obectives of finance function are' -

1. Acquiring sufficient funds

The main obective of financial function is to estimate the financial needs ofthe business and then finding out suitable sources for raising them. If funds

are required for long-term investments then long term sources like issue of

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shares! debentures! long-term loans! etc. may be preferred. If funds arerequired for working capital purposes then short-term sources like bank

credit! trade credit! factoring! etc. may be used.

2. Proper utilization of funds)nother important obective of finance function is proper utili&ation of funds.

The funds must be used in such a way that the ma*imum benefit is derivedfrom them. The returns must be more than their e*pected cost.

3. Increasing profitability

When funds are used effectively it may lead to increase in profitability. Thefinance function must ensure availability of sufficient funds at all times.

4. Maximizing concerns alue

Finance function also aims at ma*imi&ing the value of the firm. +sually thevalue of the firm is determined by its profitability. The value of the firm is also

influenced by other factors such as sources of funds! cost of capital! moneymarket conditions! etc.

Organi"ation C#art of Finance Function

The ,hief Finance *ecutive worked directly under the %resident or theManaging irector of the company. "esides routine work! he keeps the "oard of

irectors informed about all the phases of business activity! including economic!social and political developments affecting the business behavior. /e also furnishes

information about the financial status of the company by reviewing it from time totime. The chief finance e*ecutive may have different officers under him to carry out

his functions. "roadly! his functions are divided into two' 0i1 Treasury Functions and0ii1 ,ontrol Functions.

)n 2rgani&ation ,hart of Finance Function in a big organi&ation is given

below.

ORGANI$ATION C%ART OF FINANCE F&NCTION

BOARD OF DIRECTORS

PRESIDENT

V.P. (Production) V.P. (Finance) V.P. (Sales)

Treasurer Controller

Credit Management Corporate General Accounting

Cash Management TaxesBaning !elations "nternal Audit

Port#olio Management Budgeting

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Meaning ' (efinition of Financia) Manage*ent

The term Financial Management has been defined differently by differentauthors. Financial management refers to that part of the management activity! whichis concerned with the planning! and controlling of firm4s financial resources. It deals

with finding out various sources for raising funds and most appropriate use of such

funds.

Thus! financial management is considered as a subect! which deals inplanning and control of financial operations of corporate enterprises. This deals with

the procurement of funds and their effective utili&ation.

)ccording to 5olomon! #Financial Management is concerned with the efficientuse of an important economic resource! namely ,apital Funds$.

Obecti!es of Financia) Manage*ent

The basic obectives of financial management can be broadly classified into

two categories! namely' -a1 "asic 2bectivesb1 2ther 2bectives

Basic Obecti!es

The basic obectives of financial management have beena1 %rofit Ma*imi&ation and

b1 Wealth Ma*imi&ation

Profit Maximization

%rofit earning is the main aim of every economic activity. ) business being an

economic institution must earn profit to cover its costs and provide funds for growth.6o business can survive without earning profit. %rofit ma*imi&ation refers toincreasing the profit of a business organi&ation to the ma*imum e*tent possible. In

other words! it denotes the ma*imum profit to be earned by an organi&ation in agiven time period.

T#e fo))o+ing argu*ents are ad!anced in fa!or of ,rofit Ma-i*i"ation: .

a1 When profit earning is the main aim of the business then! profit ma*imi&ation

should be its main obective.

b1 %rofitability is a barometer for measuring efficiency and economic prosperityof a business enterprise.

c1 %rofits are the main sources of finance for the growth and development of a

business.d1 ) business will be able to survive under unfavorable situations like recession!

depression! sever competition! etc. only if it has some past earnings.e1 %rofitability is essential for fulfilling social needs also.

f1 %rofit ma*imi&ation attracts the investors to invest their savings in securitiesof the firm.

g1 %rofit indicates the efficient use of funds of the business concern.h1 The goodwill of the firm is based on profitability

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T#e fo))o+ing argu*ents are ad!anced against ,rofit Ma-i*i"ation: .

a1 The term profit is vague and it cannot be precisely defined. It means differentthings for different people.

b1 %rofit ma*imi&ation obective ignores the time value of money and does notconsider the magnitude and timing of earnings. It treats all earnings as equal

though they occur in different periods.c1 It does not take into consideration the risk of the prospective earning stream.d1 %rofit ma*imi&ation encourages corrupt practices to increase the profit.

e1 The effect of dividend policy on the market price of shares is also not

considered in the obective of profit ma*imi&ation.f1 %rofit ma*imi&ation attracts cutthroat competition.

g1 /uge amount of profit may invite government intervention.

!ealt" Maximization

Wealth ma*imi&ation refers to the increase in value of capital of the firm interms of market price. This increase in market price is determined by the volume of

capital! the capital structure! the cost of capital and rate of return to the investors.

%o+ to *a-i*i"e +ea)t#/

In order to ma*imi&e wealth! a firm should take the following steps' -1. Aoid "ig" leel of ris#s

The firm should avoid such proects! which involve high profits together withhigh risks.

2. Pay $iidends

%ayment of regular dividends increases the firm4s reputation and consequentlythe value of the firm4s shares.

3. Maintain %ro&t" in salesThe firm should have a large! stable and diversified volume of sales. This

protects the firm from adverse consequences of recessions! changes incustomer4s preferences or fall in demand for the firm4s products on account of

other reasons.

4. Maintain price of firm's equity s"ares

Ma*imi&ation of shareholders wealth is closely connected with thema*imi&ation of the value of the firm4s equity shares. ) firm can take a

number of steps to maintain the value of equity shares at reasonable levels.

Ad!antages of Wea)t# Ma-i*i"ation

a1 Wealth Ma*imi&ation considers the concept of time value of money.b1 Wealth Ma*imi&ation takes care of economic welfare of the owner! which is

reflected in the market share of a company.c1 Wealth Ma*imi&ation also takes care of creditors! employees! public and

management.d1 Wealth Ma*imi&ation guides the management in formulating realistic dividend

policy.

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(isad!antages of Wea)t# Ma-i*i"ation

The Wealth Ma*imi&ation has been critici&ed on the following grounds' -

a1 Wealth Ma*imi&ation is a prescriptive idea. The obective is not descriptive ofwhat the firms actually do.

b1 The obective of wealth ma*imi&ation is not necessarily socially desirable.

In conclusion! it can be said that the firm should follow the obective of wealth

ma*imi&ation to a e*tent it is viable in the conte*t of its social responsibility and

constraints imposed by the government.

Ot#er Obecti!es

"esides! the above basic obectives the following are the other obectives offinancial management.

(1 nsuring a fair return to a shareholder.

31 "uilding up resource for growth and e*pansion.71 nsuring ma*imum operational efficiency by efficient and effective utili&ation

of finances.81 nsuring financial discipline in the organi&ation.

Functions of Financia) Manage*ent

)t present Financial Management is not restricted to raising and allocating

funds. It also includes the study of financial institutions like stock e*change! capital

markets! etc. 5ome of the important functions performed by Financial Managementare' -

1( Planning t"e )inancial *eeds

The first task of a financial e*ecutive is to determine the finance needs of the

concern. The funds are needed to meet fi*ed assets and working capitalneeds. The requirement of fi*ed assets is related to the type of industry. The

working capital needs depend upon the scale of operation..

2( Acquisition of )unds)fter making the finance forecasting and planning! the ne*t step will be to

acquire funds. The finance e*ecutive must find out the various sourcesavailable for acquiring funds. These sources may be long-term or short-term.

The various long-term sources are issue of shares! debentures! long-termloans from financial institutions! etc. The various short-term sources are bank

credit i.e.! short-term loans! cash credit! overdraft facilities! discounting of

bills of e*change! trade credit! factoring! lease finance! etc.

3( Inestment of )unds

Investment decision refers to planning the deployment of available capital forthe purpose of ma*imi&ation the long-term profitability of the firm. It is the

firm4s decision to invest its current funds most efficiently in long-termactivities in anticipation of flow of future benefits over a series of year. ,apital

budgeting decisions are the most crucial and critical business decisionsbecause the success or failure of a concern based on these decisions.

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4( $iidend decisionividend is the portion of earning! which is distribution among the

shareholders. ividend policy on the other hand determines the division ofearning between payments to shareholders and retains earnings. Formulation

of a proper dividend policy is one of maor financial decision taken by thefinance e*ecutive.

+( !or#ing ,apital ManagementWorking capital refers to the e*cess of current assets over current liabilities.

In other words! it is net current assets or net working capital. Working capital

is essential to maintain the smooth running of business. 6o business cansurvive without adequate amount of working capital proper management of

working capital is an important area of financial management.

-( Analysis and Interpretation of )inancial tatement

The analysis and interpretation of financial statements is one of the importanttasks of a financial e*ecutive. /e is e*pected to know the short-term! long-

term solvency and profitability of the concern.

/( Profit planning and control

%rofit planning and control is an important responsibility of a financialmanagement. The profit planning and control also influence the declaration of

dividends! creation of reserves! replacement of assets! redemption of debts!

future productions! future e*pansions.! etc.

Ro)e of Finance Manager

The changed business environment has widened the role of a financemanager. The development of multi-national companies! innovation of information

technology! intense competition! etc. have increased the needs for financial planningand control. ) finance manager is e*pected to perform the following functions' -

1( )unds 0equirement $ecisionThis is the most important function performed by the finance manager. )

careful estimate has to be made about the total funds required for both thefi*ed and working capital requirements.

2( )inancing $ecision

This is an important decision for the finance manager. It is concerned withdetermination of the quantum of finance! the amount that can be raised from

each source and the cost and other consequences involved.

3( Inestment $ecision

This comprises decisions relating to investment in both fi*ed assets andcurrent assets. The finance manger has to evaluate different capitalinvestment proposals and select the best keeping in view the overall obective

of the enterprise.

4( $iidend $ecisionThe establishment of dividend policy is another important function of finance

manager. The dividend decision involves the determination of the percentage

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of profits earned by the enterprise! which is to be paid to shareholders andpercentage of profits that should be retained as retained earnings.

+( aluation $ecisions) number of merger and consolidation take place in the present competitive

industrial world. ) finance manager must assist the management in makingvaluations.

)part from the above main functions! following subsidiary functions are alsoperformed by the finance manager' -

a( o ensure supply of funds to all parts of t"e organizationIt is also the function of the finance manager to ensure supply of funds to

all parts of the organi&ation to help in smooth operations of the activitiesof the organi&ation.

b( o ealuate )inancial Performance

The financial performance of the various units of the organi&ation is to beevaluated from time to time to detect any fault in the financial policy.

c( o negotiate &it" an#er )inancial Institutions etc.The financial e*ecutive must negotiate with "anker! Financial Institutionsand other suppliers of credit.

d( o #eep trac# of toc# 5xc"ange

The financial e*ecutive must keep track of stock e*change quotations andbehavior of stock market prices! etc.

Financia) ,)anning

Finance is an important function of business. The application of planning tothis function is Financial %lanning. Financial %lanning is mainly concerned with the

economical procurement of funds and profitable use of such funds.

) financial plan is a statement of estimating the amount of capital and

determining its composition. It states' -

a1 The quantum of finance is the amount needed for implementing the businessplan.

b1 The patterns of financing i.e.! the form and proportion of various corporatesecurities to be issued to raise the required amount! and

c1 The policies to be pursued for the flotation of various corporate securities.

Need for Financia) ,)anning

The need for financial planning arises to ensure the following obectives' -

a1 To determine the quantum of finance to be raised.b1 To determine patterns of financing i.e.! the form and proportion of various

securities.c1 To determine policies to be pursued for the floatation of various corporate

securities.d1 To maintain liquidity throughout the year.

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e1 To ascertain the availability of surplus funds for e*penses or e*ternalinvestments.

f1 To ensure availability of sufficient cash for meeting e*penditure! emergenciesand fluctuations in the level of working capital.

g1 To eliminate waste resulting from comple*ity of operation.h1 To prepare plans to renew or replace the e*isting assets.

i1 To prepare policies and procedure to co-ordinate various financial operationsof the enterprise.

0te1s in Financia) ,)anning

Financial %lanning involves the following steps' -

1( 5stimating )inancial 6b7ectiesThe financial obectives of a company i.e.! both short-term and long-term

obectives must be clearly and carefully prepared.

2( )ormulating )inancial Policies

Financial policies are guides to all actions! which deal with procuring!administering! and disbursing the funds of business firms.

3( )ormulating ProceduresThe procedures are formed to ensure consistency of actions. The procedures

follow the formulation of policies.

4( Proiding for )lexibilityThe financial planning should ensure fle*ibility in obectives! policies and

procedures! so as to adust according to changing economic situations.

,rinci1)es Go!erning a Financia) ,)an

The financial plan should be prepared keeping in view the following principles.

1( implicity

) financial plan should be simple and easily understood by everybody. )complicated financial structure creates complications and confusions.

2( ,lear ,ut 6b7ecties

Financial planning should be done by keeping in view the overall obectives ofthe company. The obectives must be clear and unambiguous.

3( )lexibility

The financial plan should not be rigid. It should be fle*ible i.e.! capable ofbeing adusted according to the needs and circumstances. Fle*ibility is helpful

in making changes in plan with minimum possible delay.

4( 8ong9term ie&The financial plan should be formulated keeping in view the long-term needs

of the organi&ation rather than finding out easiest way of obtaining theoriginal capital.


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+( )oresig"tThe financial plan should be prepared keeping in view the future requirements

of capital for the business.

-( 8iquidityFinancial planning should ensure liquidity and solvency of the enterprise.

)dequate liquidity gives a degree of fle*ibility too.

/( ,ontingencies

The financial plan should keep in view the requirements of funds for

contingencies likely to arise in future.

:( 5conomyThe cost of raising the capital should be kept minimum. It should not impose

any unnecessary burden on the company. This is possible by having a properdebt- equity mi*.

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9. efine financial management.:. What is profit ma*imi&ation=

;. What is wealth ma*imi&ation=. Mention the steps in financial plan.(?.What is financing decision=

((.What is investing decision=(3.What is dividend decision=(7.*plain the need for financial planning.

(8./ow should the finance function of an enterprise be organi&ed= What

functions are performed by the financial manager in this direction=(9. In what respect is the obective of wealth ma*imi&ation superior to the profit

ma*imi&ation= )naly&e.(:.What are the various factors considered while drafting a financial plan for an

industrial concern=(;.What is financial planning= *plain the principles governing a sound financial

planning.(.#%rofit ma*imi&ation is the basic goal of a Finance Manager$. o you agree=

iscuss.3?.*plain the functions of a ,ontroller and a Treasurer.

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01 Financial Management

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