NATURE, PURPOSE, AND SCOPE

OF FINANCIAL MANAGEMENT
NATURE OF FINANCIAL MANAGEMENT
Financial Management, also referred to as managerial finance, corporate
finance, and business finance, is a decision making process concerned with
planning, acquiring and utilizing funds in a manner that achieves the firm’s
desired goals. It is also described as the process for and the analysis of making
financial decisions in the business context.
Goal of Financial Management
Assuming that we confine ourselves to for-profit business, the goal of financial
management is to make money and add value for the owners. This goal,
however, is a little vague and a more precise definition is needed in order to
have an objective basis for making and evaluating financial decisions.
The goal of financial management is to maximize the current value per share of
the existing stock or ownership in a business firm.
The stated goal considers the fact that the shareholders in a firm are the
residual owners. Because the goal of financial management is to maximize the
value of the share(s), there is a need to learn how to identify investments,
arrangements and distribute satisfactory amount of dividends or share in the
profits that favorably impact the value of the share(s).
Broader Goal of Business
Financial managers must reconcile social and environmental requirements
with profit-making motive. Adherence to social values may not produce the
most efficient use of assets or the lower costs, but it will enhance the image of
the firm. Looking after the interest in community, setting up training facilities,
casing for the safety and welfare of the workers, providing free college
education for the dependents of the employees can produce long-term
benefits in the form of higher productivity and more harmonious relationships
between labor and management.
Scope of Financial Management
Traditionally, financial management is primarily concerned with acquisition,
financing and management of assets of business concern in order to
maximize the wealth of the firm for its owners. With modern business
situation increasing in complexity, the role of finance manager which
essentially is just confined to acquisition of funds, expanded to judicious and
efficient use of funds available to the firm, keeping in view the objectives of
the firms and expectations of the providers of funds.
In view of the modern approach, the finance manager is expected to analyze
the business firm and determine the total funds requirements of the firm, the
assets or resources to be acquired, the best pattern of financing the assets
and how best to satisfy the investors’ expected return on their investment.
Types of Financial Decisions
The three major types of decisions that the finance manager of a modern
business firm will be involved in are:

1. Investment Decisions
2. Financing Decisions
3. Dividend Decisions

All these decisions aim to maximize the shareholders’ wealth through

maximization of the firm’s wealth.
● Investment Decisions
The investment decisions are those which determine how scarce or
limited resources in terms of funds of the business firms are committed
to projects. It should consider the profitability of each individual project
proposal that will contribute to the overall profitability of the firm and
lead to the creation of wealth.
● Financing Decisions
Financing decisions assert that the mix of debt and equity chosen to
finance investments should maximize the value of investments made. If
the cost of capital of each component is reduced, the overall weighted
average cost of capital and minimization of risks in financing will lead to
the profitability of the organization and create wealth to the owner.
● Dividend Decisions
The dividend decision is concerned with the determination of quantum of
profits to be distributed to the owners, the frequency of such payments
and the amounts to be retained by the firm. The business firm should
retain its profits in the form of appropriations or reserves for financing its
future growth and expansion schemes.

To summarize, the basic objective of the investment, financing and dividend

decisions is to maximize the firm’s wealth. If the firm enjoys the stability and
growth, its share prices in the market will improve and will lead to capital
appreciation of shareholders’ investment and ultimately maximize the
shareholders’ wealth.
Significance of Financial Management
● BROAD APPLICABILITY

Any organization whether motivated with earning profit or not having

cash flow requires to be viewed from the angle of financial discipline. The
principles of finance are applicable wherever there is cash flow. The
concept of cash flow is one of the central elements of financial analysis,
planning, control, and resource allocation decisions. Cash flow is
important because the financial health of the firm depends on its ability
to generate sufficient amounts of cash to pay its employees, suppliers,
creditors and owners.
● REDUCTION OF CHANCES OF FAILURE
A firm having latest technology, sophisticated machinery, high caliber marketing
and technical experts, and so forth may still fail unless its finances are managed
on sound principles of financial management. The strength of business lies in its
financial discipline. Therefore, finance function is treated as primordial which
enables the other functions like production, marketing, purchase, and
personnel to be effective in the achievement of organizational goal and
objectives.
● MEASUREMENT OF RETURN ON INVESTMENT
Anybody who invests his money will expect to earn a reasonable return on his
investment. Financial management studies the risk-return perception of the
owners and the time value of money. The greater the time and risk associated
with the expected cash flow, the greater is the rate of return required by the
owners.
RELATIONSHIP BETWEEN FINANCIAL MANAGEMENT,
ACCOUNTING AND ECONOMICS
● FINANCIAL MANAGEMENT AND ACCOUNTING

Financial management is a separate management area. In many organizations,

accounting and finance functions are intertwined and the finance function is often
considered as part of the functions of the accountant. However, financial management
is something more than an art of accounting and bookkeeping.

The financial manager will make use of the accounting information in the analysis and
review of the firm’s business position in decision making. In addition to the analysis of
the financial information, a finance manager uses the other methods and techniques
like capital budgeting techniques in decision making to maximize the value of the firm’s
wealth and value of the owners’ wealth.
● FINANCIAL MANAGEMENT AND ECONOMICS
Financial managers can make better decisions if they apply these basic
economic principles. For example, economic theory teaches us to seek
the best allocation of resources. To this end, financial managers are given
the responsibility to find the best and least expensive sources of funds
and to invest these funds into the best and most efficient mix of assets.
Financial managers do a better job when they understand how to
respond effectively to changes in supply, demand, and prices (firm-related
micro factors), as well as the overall economic factors (macro factors). The
sale of products at a profit depends heavily on how well managers are
able to analyze and interpret supply and demand conditions.