1

NATURE AND SCOPE OF

FINANCIAL MANAGEMENT
CHHAPTER OBJECTIVES
Meaning, evolution and importance.
Finance functionapproaches and scope.
Relationship of finance with other business functions.
Ohjectives of financial management.
Economic value added and market value added
Financial decisions investment,
approach.
-

financing and dividend decisions

Risk-return trade off.
Functions of a finance manager.
Financial engineering
Organisation of the finance function.

INTRODUCTION
In our present day economy, finance is defined as the provision of money at the time when it is
required. Every enterprise, whether big, medium or small, needs finance to carry on its operations and to achieve
its targets. In fact, finance is so indispensable today that it is
rightly said to be the lifeblood of an enterprise.
Without adequate finance, no enterprise can possibly accomplish its
objectives.
Thesubject offinance has been traditionally classified into two classes: ( Public Finance; and (i
Private Finance. Public finance deals with the requirements, receipts and disbursements of funds in the
gOvernment institutions like states, local self-governments and central government. Private finance is concerned
with requirements, receiptS and disbursements of funds in case of an individual, a profit seeking business
organisation and a non-profit organisation. Thus, private finance can be classified into : () Personal finan.ce;
iy Business finance; and (ii) Finance of non-profit organisations.

FINANCE

PUBLIC FINANCE PRIVATE FINANCE

- PERSONAL FINANCE
GOVERNMENT INSTITUTIONS
- BUSINESS FINANCE
STATE GOVERNMENTS
- FINANCE OF NON-PROFIT ORGANISTIONS
-LCAL SELF-GOVERNMENTS
CENTRAL,GOVERNMENT
Personal finance deals with the analysis of principles and practices involved in managing one's own
daily need of funds. The study of principles, practices, prbcedures, and problems concerning financial
anagement of profit making organisations engaged in the field of industry, trade, and commerce is undertaken
under the discipline of business finance. The finance of non-profit organisation is concerned with the practices,
 Nature and Sco oJ Finuncial Managem
1.2 emeni
educational, sociall and other
procedures and problems involved in financial management of charitable, religious,
similar organisations.

MEANING OF BUSINESS FINANCE

composed It is
finance of business activies.
term business finance' connotes
Literally speaking, the
essential to understand
the or
meanng tne two worde rds,
of two words (1) busincss, and (ii) finance Thus, it is and meaning of the tem
the whole concept
to develop
busincss and finance, which is the starti point
business finance.
All creative human activIties relatine
'state of being busy'. to
n e word "business' literaly means a
are Known business
human wants
as

the production and distribution of goods and services

for satisfying such as, transpar
of
in production and exchange goods,
also includes all those activities which indirectly help incudes industry, trade and
the term "business
Broadly speaking,
etc.
nsurance. banking and warehousing,
commerce.
it IS required. Finance refersto
the time when
the provision of money
at
inance may be defined as concerns with
the application of skills in th
It
tne management of flows of money through an organisation. the term "tinance differenth
interpreted
Different authorities have
manipulation. use and control of money.
finance
However, there three main approaches to
are most suitahle
as to providing
of funds needed by a business on
views finance of financisl
(1) The first approach of funds and to the study
confines finance to the raising
terms. This approach be procured.
institutions and instruments
from where funds can
finance to cash.
(ii) The second approach relates with raising of funds
and their effective
views finance as being concerned
(ii) The third approach
utilisation business and finance
we can develop the meaning
of the two terms
Having studied the meaning which is concerned with acquisition
of funds, use
finance' as an activity or a process with financial
of the tem "business
business finance usually deals
business firm. Thus,
of funds and distribution of profits by
a
controls.
use and allocation
of funds and financial
planning. acquisition of funds, viz ;
sub-classified into three categories,
Busincss finance can further be
or company finance.
firm fînance, and (1ii) corporation
(1) sole-proprietory finance, (ii) partnership
BUSINESS FINANCE

COMPANY OR
PARTNERSHIP FIRMS
SOLE-PROPRITORY
FINANCE CORPORATION FINANCE
FINANCE

finance is based upon the three forms of organisation tor

major
The above classification of business finances, controls
firm. In sole proprietorship form of organisation, a single individual promotes.
a business on the otner
He also bears the whole risk of business. A partnership,
and manages the business enterprise.
or more persons to carry on as co-owners
of a business and to share its prolis
hand, is an association of'two of the expansion of sole-trade business
or Dy
a
losses. It come into existence cither as a result
and may
or more persons. The liability of the partners
is unlimited and they collectively stau
agreement between two of persond
who
A joint stock company or a corporation is an association many
the risks of the business. are

contribute money or money'sworth to a common stock and it in some trade or business and wno
employ emg
In the words of Chief Justice Marshall, "a corporation is an artificial b
profit and loss arising there from
.
Ossesses

in of the law. Being a mere creation of law, it po

invisible, intangible and existing only contemplation very

ot its creation confers upon it either expressly or as incidental

only the properties which the charter
existence. Corporation is a legal entity having limited liability, perpetual succession and a commo
seal

corporation is regarded as something different from its owners. The assets of the cor corporation are owne
 Nature and Scope of Financial Management 1.3

it rather than its members, and a corporation's liabilities are the obligations of the corporation, not the owners
or the members.

As the present day business activities are predominantly carried on by company (corporation)
form of organisation, there is a need to give emphasis to the financial practices and problems of the
incorporated enterprises and that is why., some authorities do not make any distinction between business
finance and corporation finance. Further, the principles of business finance can be applied to both small
(proprietory) and large (corporation) forms of business enterprises.

DEFINITION OF CORPORATION/BUSINESS FINANCEFINANCIAL MANAGEMENT

Corporation finance or broadly speaking business finance can be defined as the process of raising,
providing and administering of all money/funds to be used in a corporate (business) enterprise.
Wheceler defines business finance as, "That business activity which is concerned with the acquisition
and conservation of capital funds in meeting the financial needs and overall objectives of business enterprise."
According to Guthmann and Dougall, "Business finance can be broadly defincd as the activity
concemed with the planning, raising, controlling and administering the funds used in the business."
In the words of Prather and Wert, "Business finance deals primarily with raising, administering and
disbursing funds by privately owned business units operating in non-financial fields of industry"
According to the Encyclopedia of Social Sciences, "Corporation finance deals with the financial
problems of corporate enterprises, These problems include the financial aspects of the promotion of new
enterprises and their administration during early development, the accounting problems connected with the
distinction between capital and income, the administrative questions created by growth and expansion, and
finally, the financial adjustments required for the bolstering up or rehabilitation of a corporation which has come
into financial difficulties".
Thus, the scope of corporation finance is so wide as to cover the financial activities of a business
enterprise right from its inception to its growth and expansion and in some cases to its winding up also.
Corporation finance, usually, deals with financial planning, acquisition of funds, use and allocation of funds,
and financial controls.
To sum up in simple words, we can
say that financial management as practiced by corporate
(business) firms can be called corporation finance or business finance. Finance function has become so
important that it has given birth to Financial Management as a separate subject. Financial management refers
to that part of the management
activity which is concerned with the and
planning of firm's financial
controlling
resources. It deals with finding out various sources for raising funds for the firm. The sources must be suitable
and economical for the needs of the business. The most appropriate use of such funds also forms a part of
financial management. As a separate managerial activity, it has a recent origin. This draws heavily on Economics
for its theoretical concepts.
In the words of Weston and Brigham, "Financial management is an area of financial decision-making,
harmonising individual motives and enterprise goals."
J.F.Bradley defines financial management as, "The area of the business management devoted to a
judieious use of capital and a careful selection of sources of capital in order to enable a spending unit to move
in the direction of reaching its goals."
According to J.L. Massie, "Financial management is the operational activity of a business that is
responsible for obtainting and effectively utilising the funds necessary for efficient
operations."
Howard and Upon are of the opinion that financial management is the application of the planning and
control functions to the finance function.

EVOLUTION OF CORPORATION FINANCE/FINANCIAL MANAGEMENT

Corporation finance emerged as a distinct field of study only in the early part of this century as a result
 1.4 Nature and Scope ofFinancial Manaoe
nagemen
o fconsolidation movement and formation of large sized business undertakings. In the initial stages.
of t
evolution of corporation finance, emphasis was placed on the study of sources and forms of financing the i
Sized business enterprises. The grave economic recession of 1930's rendered difficulties in raising financo
banks and other financial institutions. Thus, emphasis was laid upon improved methods of planning and con. from
Sound financial structure of the firm and more concern for liquidity. The ways and means of evaluatino
credit worthiness of firms were developed. the
The post World War Il era necessitated reorganisation of industries and the need for selecting so
Tinancial structure. In the early 50's the emphasis shifted from the profitability to liquidity and from sound
finance to day to day operations of the firm. The techniques of analysing capital investment in the fortional
capital budgeting' were also developed. Thus, the scope of financial management widened to include
process of decision-making within the firm. the
The modem phase began in mid-fifties and the discipline of corporation finance or financial managem
has now become more analytical and quantitative. 1960's witnessed phenomenal advances in the theory ement
at
portfolio analysis' by Microwitz, Sharpe, Lintner etc. Capital Asset Pricing Model (CAPM) was developed
1970's. The CAPM suggested that some of the risks in investments can be neutralised by
holding of diversified
portfolio of securities. The Option Pricing Theory' was also developed in the form of the Binomial Model
the Black-Scholes Model during this period. The role of taxation in and
personal and eorporate finance was
emphasised in 80's. Further, newer avenues of raising finance with the introduction of new capital mare
instruments such as PCD's, FCD's, PSB's and CPP°s etc. were also introduced. Globalisation of
markets has
witnessed the emergence of Financial Engineering' which involves the
design, development and implementation
of innovative financial instruments and the formulation of creative
optimal solutions to problems in finance. The
techniques of models, mathematical programming and simulations are presently being used in corporation
finance and it has achieved the prime place of
importance. We may conclude that financial management has
evoived from a branch of economics to a distinct
subject of detailed study of its own.
IMPORTANCE OF CORPORATION FINANCE /FINANCIAL MANAGEMENT
Finance is the life blood and nerve centre of a
business, just as circulation of blood is essential in
the human body for maintaining life, finance is essential to smooth running of the business. It has been
very
rightly termed as universal lubricant which keeps the enterprise dynamic. No business, whether big, medium
or small be started without an adequate amount of finance.
can
an idea
to business, finance is needed to
Right from the very beginning, i.e. conceiving
promote or establish the business, acquire fixed assets, make
investigations such as market surveys, etc., develop
product, keep men and machine at work, encourage
management to make progress and create values. Even an existing concern may require further finance Tor
making improvements or expanding the business. Thus, the importance of finance cannot be
and the subject of business finance has become over-emphasised
utmost important both to the academicians and
managers. The academicians find interest in the subject because the practising
and the practising managers are interested in subject is still in its developing stag
the subject because among the most crucial decisions of a
are those related to finance. i
The importance of
corporation finance (which is a constituent of business finance) has arisen
of the fact that present day business activities are becaus
predominantly
organisation. The advent of corporate enterprises has resulted into
carried on company or corporate
To
(i) the increase in size and influence of the business
(ii) wide distribution of corporate enterprises,
ownership,
(ii) separation of ownership and management.
and
The above three factors have further
increased the importance of o ners
(shareholders) in a corporate enterprise are widely scattered and the corporation finance. As
tne
separated from the
ownership, the management has to ensure the maximisation of management is separated iro and
growth of a firm depends upon adequate return on its investment. owner's economic welfare. The success
The investors or shareholders can be ted
auo
 Nature and Scope of Financial Management
1.5
by a firm only by maximisation of their wealth through the application of principles and procedures as laid
down by Corporation Finance
The knowledge of the discipline of
Corporation Finance is important not only to the practising
managers, but also to others who deal with a corporate enterprise, such as investors,
lenders, bankers,
creditors, etc.. as there is always a scope for the management to manipulate and 'window dress'
the financial
statements
In the
present day capitalistic regime, the size of the business enterprises is
increasing resulting into
corporate empires empowered with a lot of social and political influence. This makes
the more important. corporation finance all
Further, if we refer to corporation finance as the financial
management of corporation
inortance of financial management can well be described as the importancepracticed by business firms, the
finance.
Financial management is
applicable to every type of organisation, irrespective of its size, kind or nature.
It is as useful toa small concern
big unit. A trading concern gets the same utility from
as to a
its application
as a manutaruring unit may expect. This subject is important and useful for all types of ownership
organisations. W:e there is a use of finance, financial management is helpful. Every management aims to utilise
its funds in a best pussible and
profitable way. So this subject is acquiring a universal applicability.
Financial management is indispensable to any organisation as it helps in :
(i) financial planning and successful promotion of an
enterprise
(ii) acquisition of funds as and when
required at the minimum possible cost;
(ii) proper use and allocation of funds
(iv) taking sound financial decisions
v) improving the profitability through financial controls;
vi) increasing the wealth of the investors and the nation ; and
(vii) promoting and mobilising individual and corporate savings.
FINANCE FUNCTION
Finance function is the most important of all business functions. It remains a focus of
all activities.
It is not possible to substitute or eliminate this function because the
business will close down in the absence
of finance. The need for money is continuous. It starts with the
setting up of an enterprise and remains at
all times. The development and
expansion of business rather needs more commitment for funds. The funds will
have to be raised from various sources. The sources will be selected in relation to the
with them. The receiving of money is not enough, its utilisation is more
implications attached
important. The money once received
will have to be returned also. If its use is proper then its return will be
easy otherwise it will create difficulties
for repayment. The management should have an idea of
using the money profitably. It may be easy to raise
funds but it may be difficult to repay them. The inflows and outflows of funds should be
properly matched.
APPROACHES TO FINANCE FUNCTION
A number of approaches are associated with finance function but for the sake of convenience, various
approaches are divided into two broad categories
I. The Traditional Approach
2. The Modern Approach
. The Traditional Approach: The traditional approach to the finance function relates to the initial
Stages of its evolution during 1920s and 1930s when the term 'corporation finance' was used to describe what
s known in the academic world today as the 'financial management'. According to this approach, the scope,
o finance function was confined to only procurenment of funds needed by a business on most suitable terms.
he utilisation of funds was considered beyond the purview of finance function. It was felt that decisions
regarding the application of funds are taken somewhere else in the organisation. However. institutions and
nstruments for raising funds were considered to be a part of finance function. The scope of the finance function.
 Nature and Scope of Financial Manageme
1.6 ment

market institutions, instruments and practioces

thus, revoived around the study of rapiily growing capitai
involved in raising of external finds.
now been discarded as it sufa
The traditional apprcach to the scope and functions of finace has
from many serious limitations
that complctely ignores internal decision making as to the pran proper
(i) t is outsider-looking in approach
utilisation of funds.
on procuremcni of long-term
funds. Thus, it ignored th
i The focus of traditional approach was
important issue of working capital finance and management.
is cornpletely ignored.
(i The issue of allocation of funds, which is so important today
1) k does not iay focus on day to day financial probiems of an organisation.
2. The Modern Approach: The modern approach views finance function in broader sense. It includes
both raising of funds as well as their effective utilisation under the purview of finance. The finance function
does not stop only by finding out sources of raising enough funds. their proper utilisation is also to be
considered. The cost of raising funds and the returns from their use should be compared. The funds raised
should be abic to give more retuns than the costs involved in procuring them. The uilisation of funds requires
decisien making. Finance has to be considered as an integral part of overali managernent. So finance function
of funds, financial control
according to this approach, covers financial planning, raising of funds, allocation
etc. The new approach is an analytical way of dealing with financial problems of a firm. The techniquesof
nodels. mathemaiical progranuning, simulations and financial engincering are used in financial management to
solve complex proviems of present day finance. The modern approach considers the three basic management
decisions, i e.. investrnent decisions, firancing decisions and dividend decisions within the scope of iinance
function.

AIMS OF FINANCE FUNCTIOON

The primary aim of finance function is to arrange as much funds for thc business as are required from
time to time. This function has the following aims
I. Acquiring Sufficient Funds. The main aim of finance function is to assess the financial neds
of an enterprise and then finding out suitable sources for raising them. The sources should be commensurate
with the necds of the business. If funds are needed for longer periods then long-tern sources like share capital,
debenures. term loans mey be explored. A concern with longer gestation period should rely more on owners
funds instead of interest-bearing securities because profits may not be there for some years.
2. Proper Utilisation of Funds. Though raising of funds is important but their effective utilisation
is more important The funds should be used in such a way that maximum benefit is derived from them. The
returns from their use should be more than their cost. it should be ensured that funds do not remain idle at
any point of time. The funds committed to various operations should be effectively utilised. Those projects
should he preierred which are beneficial to the business.
3. Increasing Profitability. The planning and control of finance function aims at increasing profitability
of the concern. It is true that money generates money. To increase profitability, sufficient funds wil! have o
be invested. Finance function shouid be so pianned that the concern neither suffers from inadequacy ofufunds
nor wastes more funds than
required. A proper control should also be exercised so that scarce resources ar
not frittered away on uncconomical operations. The cost of acquiring funds also influences profitability ot tn
business. Ifthe cost of raising funds is more, ihen protability wili go dowa. Finance function also requre
matching of cost and returns from funds.
4. firm. .
Maximising Firm's Vaiue. Finance function also aims at maximising the value or n
is generally said that a concern's valuc is iinked with its profitability. Even though profitability nces

a finm's value bui it is not all.

Besides profits, the type of sources used for raisiing funds, the cost
the condition of money market, the demad for products are some other considerations which aiso o
a iirm's value.
 Nature and
Scope ofTinancial Managcmeni
1.7
SCOPE OR CONTENT OF FINANCE FUNCTION
/FINANCIAL MANAGEMENT
The main objective of financial management is to
arrange sufficient finances for. meeting short-term
and long-tcrm nceds These fiunds are procured at minimum costs so that
maximiscd. With these in mind,
profitability of the business is
things a Financial
Manager will have to concentrate on the following areas
of finance fiunction.
1. Estimating Financial
Requirements. The first task ofa financial manager is to estimate short-term
and long-ierm financial requirements of his busincss. For this
purpose, he will prepare a financial pian for present
as well as for futurc. The anount
required for purchasing fixed assets as well as needs of funds for working
capital will have to be ascertained. The estimations should be based on sound financial principles so that neither
there are inadequate nor excess funds with the concern. The
inadequacy of funds wil! adversely affect the
day-to-day working of the concern whcrcas excess funds may tempt a management to induBge in extravayant
spending or speculative activities
2.
Deciding Capital Structure. The capital structure refers to the kind and proportion of different
securities for raising funds. ARer deciding about the quanum of funds required it should be decided which
type of securities should be raised. It may be wise to f+nance fixed,assets through long-term debts. Even here
if gestation period is longer, then share capital may be most suitable.
Long-term funds should be employed
to finance working capital also, if not whoily then partially. Entirely depending upon overdrafts and cash credits
for meeting working capital necds may not be suitable. A decision about various sources for funds should
be linked to the cost of raising funds. 1f cost'of raising funds is very high then such sources may not be useful
for long A decision about the kind ofsccuritics to be employed and the proportion in which these should be
used is an important decision which influences the short-term and long-term financial planning of an enterprise.
3. Seiecting a Source of Finance. After preparing a capital structure, an appropriate source of finance
is selected. Various sources from which finance may be raised, include: share capital, debentures, financial
institutions, commercial banks, public deposits, etc. If finances are needed for short periods then banks, public
deposits and financial institutions may be appropriate; on the other hand, if long-term finances are required
then share capital and debentures may be useful. If the concern does not want to tie down assets as securities
then pubiic deposits may be a suitable source. If management does not want to dilute ownership then
debentures should be issued in preference to shares. The need, purpose, object and cost involved may be the
factors influencing the selection of a suitable source of financing.

SCOPE OR CONTENT OF FINANCE FUNCTION

I Estimating Financial Requirements
2. Deciding Capital Structure
3. Selecting a Source of Finance
4 Selecting a Pattern of Investment
5. Proper Cash Managenent
6. Implementing Financial Controls
7. Proper Use of Surpluses

4. Sclecting a Pattern of Investment. When funds have been procured then a decision about
nvestment pattern is to be taken. The selection of an investment pattern is related to the use of funds. A
iecision will have to be taken as to which assets are to be purchased ? The funds will have to be spent first
n fixed assets and then an appropriate portion will be retained for working capital. Even in various categories
f assets, a decision about the type of fixed or other assets will be essential. While selecting a plant and
nachinery, even different categories of them may be available. The decision-making techniques such as Capital
udgeting, Opportunity Cost Analysis ets. may be applied in making decisions about capital expenditures
not be ignored.
hile spending on various assets, the principies of safety, profitability and liquidity should
 Nature and Scope of Tinancal Managemo.
emem
1.8
not like to invest
on a project which ma
may
in thcse principles. One may be
A balance should be struck
even

even though there may

he more profits.
risky important task of inancc manager He
Cash Management. Cash management is also an
5. Proper cash. Cash m
at different times and then
make arrangements lor arranging
has to assess various cash needs meet wage bills; (d)
may
(a) purechase raw materials., (h)
make payments to creditors, (c) neu
be required to cash sales (b) collection of debts, (c) sh
dav-to-day epenses. The usual sources of cash may be (a) : ,

there is a shortao
or|.
banks The cash management should be such that neither of
tem arrangements with ctc.
the creditworthiness of the enterprise. The idle cash u
it and nor ii is idle. Any shortage of cash will damage
better if Cash Plow Statement is regularly prepard
the business will mean that it is not properly uscd. It will be
so that one is able to find out various sources and applications. If cash is spent on avoidable expenses then
such spending may be curtailed. A proper idea on sources of cash intlow may also enable to asses the

much cash which we should have thouoh

utilty of Various sources. Some sources may not be providing that
All this ntormation will help in eflicient managemcnt of cash.
6. Implcmenting Financial Controls. An efficient system of financial management necessitates the
use of various control devices. Financial control devices generally used are, : () Return on investnment, (6)
Budgetary Control, (c) Break Even Analysis., (d) Cost Control, (e) Ratio Analysis () Cost and Internal Audit
Return on investment is the best control device to evaluate the performance of various financial policies. The
higher this percentage. better may be the financial performance. The use of various control techniques by the
finance manager will help him in evaluating the performance in various areas and take corrective measures
whenever needed.
7. Proper Use of Surpluses. The uitlisation of profits or surpluses is also an important factor in
financial management. A judicious use of surpluses is essential for expansion and diversification plans and also
in protecting the interests of shareholders. The ploughing back of profits is the best policy of further financing
but it clashes with the interests of shareholders. A balance should be struck in using funds for paying dividend
and retaining earnings for financing expansion plans, etc. The market value of shares will also be infuenced
by the declaration of dividend and expected profitability in future. A finance manager should consider the
infiuence of various factors, such as : (a) trend of
earnings of the enterprise, (b) expected earnings in future
(cj market value of shares,
(d) need for funds for financing expansion,
etc. A judicious policy for distributing
surpluses will be essential for maintaining proper growth of the unit.

RELATIONSHIP OF FINANCE WITH OTHER BUSINESS

FUNCTIONS/DISCIPLINES
Business function' means functional activities that an
enterprise undertakes in achieving its desired
objectives. These functions may be classified on the basis of its
operational activities.
BUSINESS FUNCTIONS OF A
MANUFACTURING UNDERTAKING

PURCHASE PRODUCTION DISTRIBUTIONACCOUNTING |

FLUNCTION PERSONNEL RESEARCH AND
FUCTION FUCTION FUCCION FUNCTION DEVELOPMENT
FUNCTION
Finance function of a business is
in the absence of efficient closely related to its other functional areas. Funds will be cd
production and in the absence of proper wab
funds judiciously in the business. Most of the marketing, the firm will not be able to eng
basis of availability of funds. However, important decisions of a business enterprise are taken the
finance function in
business. Financial policies of a firm should be practice should not limit the general runningoo the
other functional areas. The relationship between devised in such aand
finance function other so
manner business functions of an entetps of
as to match
the requirenmc
is discussed below orise

1. Purchase Function. Materials required for production of commodities should be proc

 Nature and Scope ofFinancial Management
1.9

economic terms and should be utilised in efficient manner to achieve maximum

the finance manager plays a key role in
productivity. In this function
providing finance. In order to minimise cost and exercise maximum
control, various material management techniques such as economic order quantity (EOQ), determination of stock
level. perpetual inventory system etc. are applied. The task of the finance
manager is to arrange the availability
of cash when the bills for purchase become due.
2.Productivity Function. Production function occupies the dominant position in business activities
and it is continuous process. The production cycle depends largely on the
a
marketing function because
production is justified when they are resulted in revenues through sales. Production function involves heavy
investment in fixed assets and in working capital. Naturally, a tighter control by the finance manager on the
investment in productive assets becomes necessary. It must be seen that there is neither over-capitalisation nor
under-capitalisation. Cost-benefit criteria should be the prime guide in allocating funds and therefore finance
and production manager should work in unison.
3. Distribution Function. As goods produced are meant for sale, distribution function is an important
business activity. It is more important because it provides continuous inflow of cash to meet the outflow thereof.
So while choosing different distributing channels, media of advertisement and sales promotion devices, the cost
benefit criterion should be the guiding factor. If cost reduction in distribution function is effected without
compromising efficiency, it will lead to increased benefit to the enterprise in the form of higher profit and to
the consumers in the form of lower cost. As every aspect of distributory function involves cash outflow and
every distributing activity is aimed at bringing about inflow of cash, both the functions are closely inter-related
and hence should be carried out in close unison.
4. Accounting Function. Charles Gastenberg visualises the influence of scientific arrangement of
records, with the help of which inflow and outflow of funds can be efficiently managed and stocks and bonds
can be efficiently marketed. Moreover, the efficiency of the whole organisation can be greatly improved with
corect recording of financial data. All the accounting tools and control devices, necessary for appraisal of
finance policy can be correctly formulated if the accounting data are properly recorded. For example, the cost
of raising funds, expected returns on the investment of such funds, liquidity position, forecasting of sales, etc.
can be effectively carried out if the financial data so recorded are reliable. Hence, the relationship between
accounting and finance is intimate and the finance manager has to depend heavily on the accuracy of the
accounting data.

FINANCIAL PROVIDES
AW DATA
ACCOUNTING
MANAGEMENT PROVIDES FINANCIAL TO DECISIONS
ACCOUNTING INFORMATION MANAGEMENT TAKE
COST 1. FINANCING
ACCOUNTING ROVIDES RAW DATA

PROCESSES AND 2. INVESTMENT

ANALYSES DATE
RECEIVED 3. DIVIDEND

DATA GENERATION

(ACCOUNTING AND FINANCIAL MANGEMENT RELATIONSHIP)

in the domain of business

5. Personnel Function. Personnel function has assumed a prominent place
carried out efiiciently unless there is a sound personnel policy
management. No business function can be
business activity boils down to
backed up by efficient management of personnel. Success or failure of every
sound personnel policy includes
the efficiency of otherwise of the men entrusted with the respective function. A
incentives schemes, promotional opportunity, human resource development and other
proper wage structure,
to the employees. All these matters affect finance. But
the finance manager should know
fringe benefits provided incurred on personnel
that organisation can afford to pay only what it can bear. It means that expenditure
return on such investment through labour productivity
should be considered in
management and the expected
 TaAN a SNd Nmeel poti Therefoe, the w iatioan between the tinane athd nesonet teparment shauata
Reveurrt and Devekpment. n the word t innoratious amd cmpetin aC, ependituns.
eSeud and dneopmeni isa podrtie investment an'R atthi D itseit is art a t
tN TiRR. nles there is a mstant
to sINat and growth a
enknur ix mqwom onent amd uphicatiun, ot atn
casimy produt
rNANtaoftewer verieties the tir is bouUnt tw be graduaity out aarketet and v t ot and
sNTRNs enrndidnrr om
existence Ho ever,
R ani D nvov es a heavier amount,
fam r saNd a case, t
disproptinate to the tmaneial
epmaciy of hthe
tiaanciath eripples the cnterprise and
the enendinre ulnmateiv ends
tiasea in a
t i Nher
hant avi cuting iown eperdituwe of R and D biwks the scope of
dvestiation of the pmder Sa thenr mst be a balanee between the amount necessary for improvemnent and
D word and the funds avaikable tr sach a contimuing R anand
purpose. Usualiy, this balanee is stnack out by joiming a effort
finace manayer ani the peison at the heln ot RD
7 Fnaucial Nnagement and Eronomics. Fmancial management draws
heavily on Eronomies for i
theonetical vonnepts. The devekpnent ot the theory of finance began as an t t shoot of the study ot
A finance manager has to de tiamiiar with the two areas economis
of cconomies, i e. mierocconomics and nacroeconomas
Microecoromies deuls wih th onomiv darisions ot ndividuals and fiumms, whereas macrocconomics
the cconommy
looks a
a hele in whieh a partivular bustness uhit is
as
operatinN The concepts of nmicroeconomics hein
a finance nanager in ieveloping docision amndels like fixation of prices. cost volume proft analysis, breakc
anahsis inventery management decisions, long-tem investent deisions ealled capital budgeting, cash and
eabies managRNT Moiels or working capitaB management decisions ete. A firm is also intluenced
by the
overal pertomanee of the ceoaomy as it is dependent upon the money and capital markets for the
procuremient
of invesubie funis. The tinance manager should. thus, mcognise and understand the
macrocconomie theories
nnetar and fiscal poicices and their impact on the economy as a whole and the tim in particular

OBJECTIVES OF FINANCIAL MANAGEMENT OR GOALS OF BUSINESS FINANCE

Financial marnagement is concemed vith procurement and use of funds. Its main aim is to use busines
funds in such a way that the firm's value carnings are maximised. There are various altematives availabie
for using business funds. Each altemative course has to be evaluated in detail. The pros and cons of various
decisions have to looked into before making a final selection. The decisions will have to take into consideration
the
commercial strategy the otf Financial management provides a framework for selecting a proper
business.
course of action and deciding a viable commercial strategy. The main objective ot a business is to mavimise
the owner's economic weltare. This objective can be achieved by
1. Profit Maximisation, and
2. Wealth Maximisation
1. Profit Maximisation. Protit earning is the main aim of every economie activity. A business bemg
an economic institution must earn profit to cover its costs and provide funds for growth. No business can
survive without earning profit. Profit is a measure of efficiency of a business enterprise, Profits also serve as
a protection against risks which cannot be ensured. The accumulated profits enable a business to face risks
like fali in prices, competition from other units. adverse government policies etc. Thus, protit maximisation is
considered as the main objective of business. The following arguments are advanced in tavour of potit
maximisation as the objective of business:
i)When protit-earning is the aim of business then profit maximisation should be the obvious
objective
(ii) Protitability is a barometer for measuring etticiency and economic prosperity of a business
enterprise, thus. profit maximisation is justified on the grounds ofrationality
ii) Economic and business conditions do not remain same at all the times. There may be adve
business conditions like recession, depression, severe competition etc. A business will be
t0survive under unlavourable situation, only if it has some past earnings to rely upon. Theretu
a business should try to earn more and more when situation is favourable
 Naure and Scope
ofFinancial Managemen!
1.11
(iv) Profits the main sources of finance for the
are
at
maximisation of profits for enabling its growth and
growth of a business. So, a business should aim
(v) Profitability is essential for fiulfilling social development.
goals
maximisation also maxinuses socio-cconomic welfare.
also. A firm
by pursuing the objcctive of profit
However. profit maximisation objective has been criticised on
objective of profit many grounds A firm pursuing the
max imisation
stats exgploiting workers and the
consumers. iHence, it is immora! and
a number of leads to
corrupt practices. Further, it ieads to colossal
esseniial part of an idcal sociai system. t is also inequalities and lowers human values which are an
the coniitions of periect argued that profit maximisation shouid be the
competition
and in the wake
of objective in
objective of a fim. The concept ef limiied
impertect competition today, it cannot be the
legitimate
liability in the present day business has separated
management. A company is finaneed by shareholders, creditors and financial instiutions and is
ownership and
professional managers. Workers, custonners, government and controlled by
1o reconcile the society are also concerned with it. So, one has
conflicting
interests of al! these parties connected with the
firm. Thus, profit maximisation as
an objective of financiai
management has been considered inadequate.
Even as an
operational criterion for maximising owner's economic welfare,
been rejeeted because
of the following drawbacks: profit maximisation has
i) Ambiguity. The term 'profit' is vague and it cannot be
for different peopie. Should we consider short-term precisely defined. It means different things
profits or long-term
profits ? Does it mean total profits or
earnings per share ? Should we take profits before tax or after tax ? Does it mean operaiing
available for shareholders ? Further, it is profit or profit
possible that profits may increase but
example, ifa company has presently 10,000 equity shares issued and earns a earnings per share decline. For
per share are 10. Now; if the profit of 7 1,00,000 the
earnings
company further issues 5,000 shares and makes a total profit
by T 20,000, but the earnings per share will decline to 7 8. of 7
the total profits have increased 1,20,000,
Even if. we take the
meaning of profits as earnings per share and maximise the earnings per share, it
does not necessarily in the market value of shares and the
mean increase
owner's economic welfare.
(ii)
Ignores Time Value of Money. Profit maximisation
does not consider the objective ignores the tirne vaiue of and money
magnitude
and timing of earnings. It treats all
earnings as equal
though they occur in
different periods. It ignores the fact that cash received
received after, say, three years. The stockholders
today is more important than the same amount of cash
may prefer a regular return from investment even if it is is
smalier than the expected higher returns afier a
long period.
ii) lgnores Risk Factor. It does not take into consideration the risk of the prospective
stream. Some projects than others. The
earnings
are more risky earning streams wili also be risky in the fornier han the
atter. Two firms may have samc
cxpected earniigs per share, but if the earniug streana of one is more risky
then the nmarket value of its shares will be
comparatively less.
(iv) Dividend Poiicy. The effect of dividend policy on the market price of shares is also not considered
in the objective of profit maximisatio. In case,
earnings per share is the only objective then an enterprise may
not think of
paying dividend at all because retaining profits in the business or investing them in the market
may satisfy this aim.
2. Wealth Maximisation. Wealth maximisation is the appropriate objective of an
enterprise. Financial
theory asserts that wealth maximisation is the single substitute for a stockholder's utility. When the firm
maximises the stockholder's wealth, the individual stockholder can use this wealth to maximise his
individual
utility. It means that by maximising stockholder's wealth the firm is operating consistently towards maximising
stockhoider's uility.
A stockholder's current wealtis in the firm is the product of the number of shares owned, multiplied
with the current stock price per share

Number of
Stockholder's current we2lth in a firmm shares (Curent stock
owned price per share
Symbolically, W=NP,
 Nature and Scope of Financial Management
1.12
stock price per share the greater
stockholder owns, the higher the
Given the number of shares that the
its current stock price. This objective
a firm should aim at maximising
will be the stockholder's wealth. Thus, serves as a performance index
the market. The share's market price
helps in increasing the value of shares in well management is doing
on behalf of the shareholder
or card of its progress. It also indicates how
report
We can conclude that:

refersto Maximum current stock price per share

Maximum Utility Maximum stockholder's wealth-

should be in the long run. The long run

market price of the shares
However, the maximisation of the of short
to reflect the normal
market value of the shares irrespective
Implies a period which is long enough
term fluctuations.
must be put in for maximising the
wealth maximisation, all efforts
While pursuing the objective of
c o u r s e of action. Every
financial decision should be based on cost-benefit
current present value of any particular wealth. On the other hand,
more than the cost, the
decision will help in maximising the
analysis. If the benefit is
of maximising wealth.
decision will not be serving the purpose
if cost is more than the benefit the
wealth maximising policy as an
Maximisation. There is a rationale in applying
Implications of Wealth of loaned capital, employees,
It serves the interests of suppliers
operating financial management policy. and long-term suppliers of funds
who have
Besides shareholders, there are short-term
management and society. so that they
lenders are primarily interested in liquidity position
financial interests in the concern. Short-term
interest from the earnings and also have
their payments in time. The long-term lenders get a fixed rate of
get maximisation ojbective not only serves
shareholder's
a priority over shareholders in
return of their funds. Wealth
also try
interests by increasing the value of holdings
but ensures security to lenders also. The employees may
and efficiency is the primary
to acquire share of company's
wealth through bargaining etc. Their productivity
will be served if
survival of management for a longer period
consideration in raising company's wealth. The The
is the elected body of shareholders.
the interests of various groups are served properly. Management The
shareholders may not like to change a management if
it is able to increase the value of their holdings.
economic
for raising the wealth of the company. The
efficient allocation of productive resources will be essential
economical and efficient use.
interest of society are served if various resources are put to
The following arguments are advanced in favour of
wealth maximisation as the goal of financial

management stakeholders in the firm ; i.e.

i) It the interests of owners, (shareholders) as well as other
serves

suppliers of loaned capital, employees, creditors and society.

i) It is consistent with the objective of owners economic welfare.
i) The objective of wealth maximisation implies long-run survival and growth of the firm.
(iv) It into consideration the risk factor and the time value of money as the current present value
takes
of any particular course of action is measured.
()The effect of dividend
policy on market price of shares is also considered
taken to increase the market value of the shares.
as the decisions are

(vi) The goal of wealth maximisation leads towards maximising stockholder's utility or value maximisation
of equity shareholders through increase in stock price per share.
Criticism of Wealth Maximisation. The wealth maximisation objective has been criticised by certan
financial theorists mainly on
following accounts
(i) It is a prescriptive idea. The objective is not descriptive of what the firms actually do.
(i) The objective of wealth maximisation is not necessarily socially desirable.
(ii) There is some controversy as to whether the objective is to maximise the stockholders wealth or
the wealth of the firm which includes other financial claimholders such as debenturehola
preferred stockholders, etc.
(iv) The objective of wealth maximisation may also face difficulties when ownership and nent

are separated as is the case in most of the

manage
large corporate form of organisations. When manag
 Nature and Scope of Financial Management 1.13

act as agents of the real owners (equity shareholders), there is a possibility for a conflict of interest
between shareholders and the managerial interests. The managers may act in such a manner which
maximises the managerial utility but not the wealth of stockholders or the firm.
In spite of all the criticism, we are of the opinion that wealth maximisation is the most appropriate
objective of a firm and the side costs in the form of conflicts between the stockholders and debentureholders,
firm and society and stockholders and managers can be minimised.
Financial Management and Profit Maximisation
The primary aim of a business is to maximise shareholders' wealth. This can be done by increasing
the quantum of profits. Financial management helps in devising ways and exercising appropriate cost controls
which utilimately help in incrcasing profitability. The following elements are involved in maximising profits.
)Increase in Revenues. For maximising its profits, a firm will have to increaserevenue receipts.
Revenues will go up only when sales increase. There should be all out efforts to increase the sales. All possible
markets should be exploited so that demand for products increases. This should be followed by increasing
production for meeting increased demand. In a competitive economy, profits can be increased either by raising
the price of products or by increasing the volume of sales. The second alternative will be more appropriate.
(i) Controlling Costs. Another way of increasing profit is to control or reduce costs. This will
increase the margin of profit per unit. The costs may be controlled by controlling material wastages, increasing
labour efticiency, reducing overhead cost by increasing production etc.
(ii) Minimising Risks. A business operates under a number of uncertainties. Business is done th
an eye on future which itself is uncertain and difficult to predict. There are many risks, both business and
financial.
It is generally said, more the risk and more the gain. In spite of this, those financial decisions should
be taken which will not involve more risks but at the same time may help in increasing profitability. A financial
manager will have to balance the pros and cons of various decisions so that risk element is kept under control.

MEASURING SHAREHOLDERS VALUE CREATION : EVA AND MVA

The two new measures used to determine whether an investment positively contributes to the
shareholders wealth are
1. Economic Value Added (EVA)
2. Market Value Added (MVA)
1. ECONOMIC VALUE ADDED EVA)
Economic value added is a measure of performance evaluation that was originally employed by Stern
Stewart & Co. It is very popular measure today which is used to measure the surplus value created by an
investment or a portfolio of investments. EVA has been considered as a better measure of divisional performance
as compared to the Return on Assets ROA or ROI. It is also being used to determine whether and investment
positively contributes to the shareholders wealth. The economic value added of an investment is simply equal
to the after tax operating profits generated by the investment minus the cost of funds used to finance the
investment.
EVA can be calculated as below:

EVA = (Net Operating profit after tax - Cost of capital x Capital invested)

or, EVA = Return on investment - Cost of capital x Capital employed

is positive. It
According to this approach, an investment can be accepted only if the surplus (EVA)
IS only the positive EVA that will add value and enhance the shareholders wealth. However, to calculate the
cconomic value added we need to estimate the net operating profit after tax and cost of funds invested. Suppose
an investment generates net operating profit after tax of 20 lakhs and the cost of financing investment is
16 lakhs. The economic value added by the investment shall be 4 lakh and it should be accepted.
 Nature and Scope of t inancial Management
1.14

2. MARKET VALUE ADDED (MVA)

values of future EVAs.
the total of all the preseni
The market valuead added (MVA) is
sum

EVA EVA EVA o*******

MVA(1+0 (1+C) (1+C

between the current market value
defined as the difference
The market value added (MVA) can also be of the firm is simply the sum
firm and the book value of capital employed by the firm. The market value
of the the book value of capital
market value of a firm exceeds
of markei value of its equity and debt. Iln case, the
sane manner, if the
value of capital employed exceeds the
it is said to have a positive MVA. In the
employed,
market value of the firm, it is said to have a negative MVA.

FINANCIAL DECISIONS
There are many
financial matters of a business firm.
Financial decisions refer to decisions concerning shareholder's wealth, viz.,
kinds of financial management decisions that the
firm makes in pursuit of maximising
distribution of firm's income etc. We can classify
these
kind of assets to be acquired, pattern of capitalisation,
decisions into three major groups
1. Investment decisions.
2 Financing decisions.
3. Dividend decisions.
Investment Decision reiates to the determination of
total amount of assets
. Investment Decisions.
business risk complexions of the firm as perceived
o be held in the firm. the composition of these assets and the limited
decision. Since funds invoive cost and are available in a
by its investors. It is the most important financial
the goal of weaith maximisation.
quantity. its proper utilisation is very necessary to achieve Long-term investment
The investment decisions can be classified under two broad groups (i)
decision is referred to as the
decision and (i) Short-term investment decision. The long-term investment
as working capital management.
capital budgeting and the short-term investment decision
decisions in capital expenditure. These are
Capital budgeting is the process of making investment
of time exceeding one year.
expenditures, the benefits of which are expected to be received over long period
a
before committing the funds. The
The finance manager has to assess the profitability of various projects
costs involved and the risks
investment proposals should be evaluated in terms of expected profitability,
of new units
associated with the projects. The investment.decision is important not only for the setting up
but also for the expansion of present units, replacement of permanent assets, research and development project
costs, and reallocation of funds, in case, investments made earlier do not fetch result as anticipated earlier
Short-term investment decision, on the other hand, relates to the allocation of funds as among cash
and equivalents, receivables and inventories. Such a decision is influenced by trade off between liquidity and
profitability. The reason is that, the more liquid the asset, the less it is likely to yield and the more profitable
an asset, the more illiquid it is. A sound short-term investment decision or working capital management policy
is one which ensures higher profitability, proper liquidity and sound structural health of the organisation.
2. Financing Decisions. Once the firm has taken the iivestment decision and committed itself to new
investment it must decide the best means of financing these commitments. Since, firms regularly make new
in vestments, the needs for financing and financial decisions are on going. Hence, a firm will be continuously
planning for new financial needs. The financing decision is not only concerned with how best to finance new
assets, but also concerned with the best overall mix of financing for the firm.
A finance manager has
to select such sources
offunds which will make optimum capital structure
important thing to be
decided here is the proportion of various sources in the overall
capital mix of the ti
The debt-equity ratio should be fixed in such a
way that it helps in maximising the profitability of ihe concet
The raising of more debts will involve fixed interest
liability and dependence upon outsiders. It may help
 Nature and Scope of Financial Management 1.15

increasing the return on equity but will also enhance the risk. The raising of funds through equity will bring
permanent funds to the business but the sharehoders will expect higher rates of earnings. The financial manager
has to strike a balance between various sources so that the overall profitability of the concern improves. If the
capital structure is able to minimise the risk and raise the profitability then the market prices of the shares will
go up maximising the wealth of shareholders.
3. Dividend Decision. The third major financial decision relates to the disbursement of profits back
to investors who supplied capital to the firm. The term dividend refers to that part of profits of a company which
is distributed by it among its shareholders. It is the reward of shareholders for investments made by them in the
share capital of the company. The dividend decision is concerned with the quantum of profits to be distributed
among shareholders. A decision has to be taken whether all the profits are to be distributed, to retain all the profits
in business or to keep a part of profits in the business and distribute others among shareholders. The higher rate
of dividend may raise the market price of shares and thus, maximise the wealth of shareholders. The firm should
also consider the question of dividend stability, stock dividend (bonus shares) and cash dividend.

INTER-RELATION OF FINANCIAL DECISIONS

We have studied above the three major groups of financial decisions, viz., investment decisions,
financing decisions and dividend decisions. Although these are different kinds of financial management
decisions vet these decisions are inter-related because the underlying objective of all these decisions is the
same, i.e maximisation of shareholders' wealth. Ail these decisions influence one another and are inter-
dependent. For exampie, the decision to invest in some proposal cannot be talken in isoiation without having
necessary finance availabie for the same. The financing decision in turn is influenced by and also infiuences
the dividend decision. in case the profits are retained for financing of the investment, the profits available ior
distribution to the shareholders as dividends are reduced. An efficient financial management thus, has to take
the optimai joint decision by evaluating each of the decision involved in relation to its effcet on shareholder's
wealth and by considering the joint impact of these decisions on the market value of the company's shares.

INVESTMENT
DECISION

FINANCING DIVIDEND
DECISION DECISION

(INTER-RELATION OF FINANCIAL DECISION)

FINANCIAL MANAGEMENT
IS CONCERNED WITH
INVESTMENT DECISION DIVIDEND DECISIONS
FINANCING DECIsSION

ANALYSES.

RISK AND RETURN RELATIONSHIP

(TRADE OFF)

TOACHIEVE THE GOAL OF

WEALTH MAXIMISATION
 1. 16
Nature and Scope ofFinancial Manageme.
DECISIONS
FACTORs INFLUENCING FINANCIAL
There are a number of (both external as well as internal) factors that influence the financial decisior
A list ofthe important extemal as well as internal factors influencing the decisions is given below
Sions,
External Factors:
State of economy
Structure of capital and money markets.
Requirements of investors
Government policy
Taxation policy
Lending policy of financial institutions.
Internal Factors:
Nature and size of business
Expected return, cost and risk
Composition of assets
Structure of ownership
Trend of earnings
Age of the firm
Liquidity position
Working capital requirements
Conditions of debt agreements.
RISK-RETURN TRADE OFF
Financial decisions of a firm often involve alternative courses of action. A finance
manager has to select
amongst the various alternatives available to him. For example, while making an-investment decision, he has to
decide whether, the firm should go in for a
machinery having capacity of 50,000 units or 2,00,000 units. In the
same manner the
financing decision may involve a choice between a debt equity ratio of 1:1 or 2:1, the dividend
decision may be concermed with the quantum of
profits to be distributed. The alternative courses of action imply
different risk-return relationship as there is positive
relationship between the amount of risk assumed and the
amount of expected return. A machine with
higher capacity may give a higher expected return but involves a
higher risk of investment, whereas the machine with lower capacity may have a lower expected return and a
lower risk of investment. A higher
debt-equity ratio may help in increasing the return on equity but will also
enhance the financial risk.
The following figure shows the
relationship between various financial decisions and the risk-return
trade off and market value of the firm.

INVESTMENT DECISIONS
- CAPITAL BUDGETING

WORKING CAPITAL MANAGEMENT

RISK

FINANCING DECISIONS MARKET

CAPITAL STRUCTURE VALUE OOF
THE FIRM

RETURN
DIVIDEND DECISIONS
- DIVIDEND POLICY

(RISK RETURN TRADE OFF)

The financial manager has to strike a balance between various sources so that the overall
of the firm and its market value increases. proritau
 Nature and Scope ofFinancial Management 1.17

While making a financial decision, one has to answer the basic questions
What is the expected return ? What is the risk involved ? How
would the decision influence the market
value of the firm ?

FINANCIAL MANAGEMENT PROCESS

The financial
management process begins with the financial planning and decisions. While implementing
these decisions, the firm has to acquire certain risk and return characteristics. These characteristics determine
the market price of shares and shareholder wealth. The process must include the feedback system to enable
it take corrective measures, itf required. The figure below
depicts the process of financial management

FINClAL PLANNING
AND CONTROL

FEED BACK

FINANCIAL DECISIONS
RISK AND RETURN MARKET PRICE SHAREHOLDER
INVESTMENT DECISION
2. FINANCING DECISION CHARACTERISTICS OF SHARE WEALTH
3. DIVIDEND DECISiON OF THE FIRM Po WOF NPo

(FINANCIAL MANAGEMENT PROCESS)

FUNCTIONAL AREAS OF FINANCIAL MANAGEMENT

Financial management, at present, is not confined to raising and allocating funds. The study of financial
instituiions like stock exchange, capital market etc. is also emphasised because they influence underwriting of
securities and corporate promotion. Company finance was considered to be the major domain of financial
management The scope of this subject has widened to cover capital structure, dividend policies, profit planning
and control, depreciation policies, etc. The techniques of financial analysis like financial statements analysis, funds
statements. ratio analysis etc. are also helpful in analysing financial strength of the enterprise. Some of the
functional areas covered in financial management are discussed as such
I. Determining Financial Needs. A finance manager is supposed to meet financial needs of the
enterprise. For this purpose, he should determine financial needs of the concern. Funds are needed to meet
promotional expenses, fixed and working capital needs The requirement of fixed assets is related to the type
of industry. A manufacturing concern will require more investments in fixed assets than a trading concern. The
working capital needs depend upon the scale of operations, larger the scale of operations, the higher will be
the needs for working capital. A wrong assessment of financial needs may jeopardise the survival of a concem.
2. Selecting the Sources of Funds. A number of sources may be available for raising funds. A
concern may resort to issue of share capital and debentures. Financial institutions may be requested to provide
long-term funds. The working capital needs may be met by getting cash credit or overdraft facilities from
commercial banks. A finance manager has to be very careful and cautious in approaching different sources.
The terms and conditions of banks may not be favourable to the concern. A small concern may find difficulties
in raising funds for want of adequate securities or due its a suitable
to reputation. The selection of
source
of funds will influence the profitability of the concern. This selection should be made with great caution.
3. Financial Analysis and Interpretation. The analysis and interpretation of financial statements is
about the
an important task of a finance manager. He is expected to know profitability, liquidity position, short
term and long-term financial position of the concern. For this purpose, a number of ratios have to be calculated.
The interpretation of various ratios is also essential to reach certain conclusions. Financial analysis and
interpretation has become an important area of financial management.
 1.18
Nature and Scope of Financial
Mana.
4,Cost-Volume-Profit Analysis. Cost-volume-profit analysis is an important tool anagement
It answers questions like, what is the behaviour of;ofitt
fit planning
of
be able to recover its costs ? How much a firm should
cost and volume ? At what
point of production at
a firm will
produce to earn a desired profit ? To
volume profit relationship, one should now the behaviour understand
of costs. "The costs may be subdivided and ocost
costs, variable costs and semi-variable costs. Fixed costs remain constant as
irrespective of changes
production will not influence fixed costs. Variable costs, on the prodtuesction
An increase or decrease in volume of in
vary in direct proportion change in production. Scmi-variable costs remain constant for a
to other h
become variable for a short period. These costs period and hand,
ththen
proportion.
change with the change in output but not in
the sam
same
The first concernofa finance manager will be to
rccover all costs. He will
point at the carliest. It is a point of no-profit no-loss. aspire to achieve break-even
Any
to the concern. The
volume of sales, to earn a desired production beyond brcak-even point will bring profits
ielptul deciding the volume of output or sales. The profit, can also be ascertained. This analysis is very
in
for taking important decisions about production knowledge of cost-volume profit analysis is
essentiat
and profits.
FUNCTIONAL AREAS OF FINANCIAL
MANAGEMENT
1. Determining Financial Needs
2 Selecting the Sources of Funds
3. Financial Analysis and Interpretation
4. Cost-Volume-Profit Analysis
5. Capital Budgeting
6. Working Capital Management
7. Profit Planning and Control
8. Dividend Policy
5. Capital Budgeting. Capital budgeting is the process of
expenditures. it is an expenditure the benefits of which are making investment decisions in capital
exceeding one year. it is an expenditure incurred for expected to be received over a
period of time
which are expected to be received over acquiring or
improving the fixed assets, the benefits of
a number
any organisation. An unsound investment decision
of years in future. Capital
budgeting decisions are vital to
nay prove to be fatal for the very existence
The crux of capital of the concern.
factor which influences the
budgeting is the allocation of available
resources to various
capital budgeting decision is the profitability of the proposals. The crucial
For making correct
capital
prospective investment.
of methods like pay back budgeting decisions, the knowledge of its
techniques is essential. A number
period method, rate of return method, net present value
method and profitability index method method, internal rate of returm
may be used for making capital
6. Working budgeting decisions.
Capital Management. Working capital is the life blood and nerve
Just as circulation of blood is essential in centre of a business.
the human body for
maintain the smooth running of business. No maintaining life, working capital is essential to
business can run
working capital. Working capital refers to that part of the firm's successfully without an adequate amount or
term or current assets such as capital which is required for financing shor
cash, receivables andinventories. It is cessential to maintain a
these asscts. Finance
manager is required to determine the proper level or
of such assets. Cash is
day-to-day needs and purchase inventories etc. The scarcityquantum
of cash may
required to me
a concern. The receivables
management is related to the volume of adversely affect the reputation of
there may be a need to give more credit production and sales. For increasing Sal
facilities. Though sales may go
involved in it may have to be weighted against the up but the risk of bad debts ana
benefits. Inventory control is also an
working capital management. 1he inadequacy of inventory important tac
may cause delays or stoppages of work.
E
 Nature and Scope of Financial Management .

inventory, on the other hand, may result in blocking of money in stocks. more costs in stock maintaining etc.
Proper management of working capital is an important area of financial management.
7. Profit Planning and Control. Profit planning and control is an important responsibility of the
financial manager. Profit maxnisation is. generally, considered to be an important objective of a business. Profit
is also used as a tool for evaluating the performance of management. Profit is deternined by the volume of
revenue and expenditure. Revenue may accrue from sales, investments in outside securities or income from
other sources. The expenditures may include manufacturing costs, trading expenses, office and administrative
expenses, selling and distribution expenses and financial costs. The excess of revenue over expenditure
determines the amount of profit. Profit planning and control directly influence the declaration of dividend.
creation of surpluses, taxation etc. Break-cven analysis and cost-volume-profit relationship are some of the tools
used in profit planning and control.
8. Dividend Poliey. Dividend is the reward of the sharcholders for investments made by them in the
shares of the company. The investors are interested in carning the maximunm return on their investments whereas
management wants to retain profits for further financing. These contradictory aims will have to be reconciled
in the interests of shareholders and the company. The company should distribute a reasonable amount as
dividends to its members and retain the rest for its growh and survival. A dividend policy is influenced by
a number of factors such as magnitude and trend of eainings, desire and type of shareholders, future
requirements of the company. govemment's economic policy, taxation policy, etc. Dividend policy is an
important area of financial management because the interests of the shareholders and the needs of the company
are directly related to it.

FUNCTIONS OF A FINANCE MANAGER

The changed business environment in the recent past has widened the role of a financial manager.
The increasing pace of industrialisation, rise of larger-scale units, innovations in information
processing
techniques, intense competition etc. have increased the need for financial pBanning and control. The size and
extent of business activities are
dependent upon the availability of finances. Financial reporting may be used
as a technique fo control.
In the present business context, a financial manager is expected to perform the following functions.
1. Financial Forecasting and Planning. A financial manager has to estimate the financial needs
business. How much money will be required for of a
acquiring various assets ? The amount will be needed for
purchasing fixed assets and meeting working capital needs. He has to plan the funds needed in the future.
these funds will be acquired and How
applied is an important
function of a finance manager.
2. Acquisition of Funds. After making financial planning, the next step will be to acquire funds. There
are a number of sources available for
supplying funds. These sources may be shares, debentures, financial
institutions, commercial banks, etc. The selection
of an appropriate source is a delicate task. The choice ofa
wrong source for funds may create difficulties at a later stage. The pros and cons of various sources should
be analysed before making a final decision.
3. Investment of Funds. The funds should be used in the best
them and the returns should be compared. The channels which
possible way. The cost of acquiring
The technique of capital budgeting may be
generate higher returns should be preferred.
helpful in selecting a project. The objective of maximising
will be achieved only when funds are profits
efficiently used and they do not remain idle at any time. A financial
manager has to keep in mind the principles of safety, liquidity and soundness while
4.
investing funds.
Helping in Valuation Decisions. A number of mergers and consolidations take
competitive industrial world. A finance manager is supposed to assist place in the present
this purpose, he should understand various methods of mainagement making valuation etc. For
in
are arrived at.
valuing shares and other assets so that correct values
5. Maintain Proper Liquidity. Every concern is
required to maintain some liquidity for
to-day needs. Cash is the best source for maintaining
liquidity. It is required to meeting day-
purchase raw
materiais, pay
 20
Nature and Scope of Financial Management
Workers, meet other expenses, etc. A finance manager is required to determine the necd for
liquid assets and
then arrange liquid assets in such a way that there is no searcity of funds.

FINANCIAL ENGINEERING
Developments in corporate and banking sector have given rise to a new concept of finar.
wiui
engineering. The term financial engineering has been defined differently by different people. According to John
Finnerty, Financial engineering involves the design, the development and the implementation of innovative
financial instruments and problems and the formulation of creative solutions to problems in finance." In
simpte
words. financial engineering aims at the following:
)Designing and developing new financial instruments/products
() Formulating new processes
(i) Formulating creative solutions to financial problems.
Financial engineering's basic objective is to reduce the cost of a firm's financing, reduring firm's
financial risks and avail of tax benefits by formulating innovative financial products such as swaps,
mortgage-
backed product. zero coupon bond or the introduction of junk bonds to finance leveraged buyouts. Italso
involves modification of old productslidea into a new product. For example, applying the concept of future
trading to a commodity or a financial instrument, or the creation of a mutual fund with new features or joining
together the features of existing financial products and processes to suit a particular set of circumstances.
Financial engineering is not only applicable to the corporate sector and institutions but also applicable
to the consumers. For example, innovative life insurance policies are designed to suit the consumer needs. In
the corporate sector, financial engineers are always involved in finding solutions to the problems in corporate
finance. investment and money management, trading and risk management. To raise finance for the company,
they deveiop and design innovative financial instruments with special features or suggest use of combination
of instruments to be used for the purpose. Financial engineers study in detail the problem. understand the nature
of desired result and then come out with an appropriate solution.
Financial engineer's need also arises at the time of mergers and acquisitions. Recently, the introduction
of junk bonds and bridge financing to secure the funds necessary for takeovers and leveraged buyouts (LB0s)
is the task performed by financial engineers.
The services offinancial engineers are also required in securities and derivative products trading. Most
ofthe trading strategies developed by the financial engineers are of an arbitrage nature be it time, instruments
legal formalities or tax rates and risk etc. The role that the financial engineers have played in investment and
money management has been remarkable. They have developed systems for transforming high risk yielding
instruments into low risk yielding instruments by using devices such as repackaging and over collateralization.
A number of investment instruments developed by financial engineers include money market mutual funds
(MMMF), swaps, repos etc.
Financial engineers also help in risk management. They carefully identify all the financial risks to which
structure solutions to corporate risk
a firm is cxposed to and examine them in detail. Finally, they design and
exposures in order to achieve the desired objectives.

ORGANISATION OF THE FINANCE FUNCTION

to set up
The finance function is very vital for every type of business enterprise. There is a necd
function s
a sound and cfficient organisation to achieve its goals. However, organisation of finance
standardised one. It varies from enterprise to enterprise, depending upon its nature, size and other requi
In a small concern, whose operations are simple and there is little delegation of authority no separate ext
iS appointed to handle finance function. It is the owner who performs all these functions himself. But in meu

and large scale concerns. a separate department to organise all financial activities may be created ato by
under the direct supervision of Board of Directors or a highly placed official. This function may ber the
the
a committec or a top management executive. All inmportant financial decisions are taken by the commite
cxecutive but routine decisions are left to the lower levels of management.
 Nature and Scope of Financial Management
1.21
The finance function is
centralised because of its importance. The
the survival of the concern. Any bad decision on financial decisions are crucial for
financial aspects will
concern. The centralisation of finance function will result in adversely affect the reputation of the
certain economies in
fixed assets, etc. raising funds, purchasing of
In largeconcerns, for organising finance functions, the
Controller and Treasurer are
Financialcontroller performs the functions of planning and controlling. appointed.
budgeting. protit analysis, cost and inventory preparation of annual reports, capital
and accounting and payroll. The main functions
of the treasurer include raising of additional management,
funds, cash management, receivables management, audit of
accounts. protecting funds and securities and
etc. The organisation of finance function
maintaining relations with banks and other financial institutions,
may be diagrammatically shown as below

BOARD OF DIRECTORS

MANAGING DIRECTOR
FINANCE COMMITTEE

VICE PRESIDENT PRODUCITON VICE PRESIDENT FINANCE| VICE PRESIDENT SALES

FiNANCIAL CONTROLLER
TREASURES

PLANNING
ANNUAL
A REPORTS BUDGETING PROFIT ACCOUNTING
CONTROL ANALYSis AND PAYROLL|

ADDITIONAL CASH PROTECT FUNDS RELATIONS WITH

FUNDS AUDIT BANK& FINANCIAL
MANAGEMENT AND SECURITIES
INSTITUTIONS

The Controller Vs. Treasurer

The terms 'controller' and 'treasurer' are used in the United States of America for financial
executives
in firm, where various functions of corporate finance/financial management are divided into
a

functions and treasurership functions. The basic controllership

responsibility of the treasurer is to provide, manage and protect
the fim's capital whereas the controller has the
responsibility to check that the funds are used efficiently. The
controller performs the functions of budgeting, control,
accounting, reporting and interpretation etc. The table
below lists some of the important functions of the treasurer and the controller

Treasurer
Controller
Provision of capital (both long-term & short-term) 1. Accounting
Relations with banks & financial institutions
Preparation of financial reports
Cash management Reporting and interpreting
Receivables management Planning and control
5. Protect funds and securities (insurance) 5. Internal audit
6.Investor relations 6. Tax administration
7. Audit
7. Economic appraisal & reporting to Government

However, it may be noted that many a times the functions of treasurer and controller
other. Activities of the treasurer are overlap with each
performed by the controller and vice-versa. In India, controller is generally
termed as financial controller or the management accountant. But the
designation of treasurer has not becomes
 1.22 Nature and Scope of Financial Mangge
menu
popular and some of his functions are performed by company secretary. A large number of companies in
appoint finance managers to discharge the duties of the treasurer or both of the controller and treasurer India
big companies even appoint the chief financial officer (CFO) to supervise the functions of these two finaSom
executives.
financial

Review Questions

A. Objective Type Questions

1. State whether each of the following statements is True or False
() Corporation finance is a wider term than business finance.
(i) Corporation finance deals with the company form of organisation.
(ii) In the present days, corporation finance is also referred to as business finance and financial
management.
(iv) Corporation finance is a part of public finance.
(v) Corporation finance emerged as a distinct field of study in the beginning of eighteenth
century.
(vi) The principles of corporation finance can be applied to every type of organisation.
[Ans. ( False;
2. State
(i) True; (i) True; (v) False; (v) False; (vi) True]
whether each of the following statements is True or False.
() Traditional approach confines finance function only to raising of funds.
(in The main aim of finance function is to maximise the profits.
(i) Finance function is one of the most important functions of business management.
(iv) Cash management is an important task of the finance manager.
)Investment decisions are outside the purview of financial decisions.
[Ans. () True; (ii) False; (ii) True; (iv) True; (v) False.]
3. Select the most appropriate answer
(0 The appropriate objective of an enterprise is
() Maximisation of sales.
(6) Maximisation of owner's wealth.
(c) Maximisation of profits.
(i) The job of a finance manager is confined to
(a) Raising of funds.
(6) Management of cash.
) Raising of funds and their
(ii) Financial decisions involve.
effective utilisation.

(a) Investment, financing and dividend decisions.

(6) Investment, financing and sales decisions.
(c) Financing, dividend and cash decisions.
[Ans. () (b); (i) (c); (iin) (a)]
B. Short Answer Type Questions
1. Define corporation finance.
2. What do you understand by business
finance ?
3. Write a brief note on scope of
4. What is the
corporation finance.
importance corporation finance ?
of
5. Write a note on
approaches to finance function.
6. What is financial
management ?
7. What are the objectives of finance function ?
8. Describe in brief the aims of finance
function.
9. Name the areas of finance function.
Nature and Scope of Financial Management 1.23

10. Write a note on profit maximisation Vs. wealth maximisation.

11. Outline the functional areas of financial management.
12. Write a note on organisation of finance function.
13. What is financial management process ?
14. Write a brief note on the importance of finance function.
15. Why is maximising wealth a better goal than maximising profits ?
16. Is it fair to say that the overall goal of a firm is profitability with the limiting factor of liquidity.
17. Write a short note on Financial Engineering.
18. Write a brief note on risk-return trade off.
C. Essay Type Questions
1. What do you mean by business finance ? Discuss various approaches to finance function.
2. Finance function is concened with allocating funds to specific assets and obtaining the best
mix of financing in relation to the overall valuation of the firm." Discuss.
3. What is finance function ? What are its objectives ?
4. What is financial management ? What major decisions are required to be taken in finance ?
5. Critically analyse the functions of Financial Manager in a large scale industrial establishment.
6. (a) What are the responsibilities of the financial manager in a modern business organisation ?
(b) What are the prominent areas of financial decision making?
7. "Maximisation of profits is regarded as the proper objective of investment decision, but it is not

as exclusive as maximising shareholders' wealth." Comment.

function in a business
8. What do you mean by business finance ? What is the scope of finance
or wealth-
enterprise ? Should the goal of financial decision-making be profit-maximisation
maximisation ?
9. Explain the objectives of financial management.
decisions.
10. What do you understand by financial decisions ? Discuss the major financial
11. How should the finance of an enterprise be organised ? Discuss
12. (a) Explain the concept of 'wealth' in the context of wealth maximisation objective.
(b) Explain the role and scope of finance function. inter-related." Comment.
13. Investment, financing and dividend decisions are all
show how the
14. wealth maximisation to be the objective of the financial management,
Assuming this objective.
financing, investment and dividend decisions of a company can help to attain
15. Define finance function and discuss some of the most important
financial problems that
(a)
face a decision maker today.
Give a specimen organisation chart for the finance
function in a large corporate enterprise.
(bj its other functions." Discuss.
16. "Finance function of a business is closely related to