Ashish Narayan

ReLearners

Financial

Management
BBA Semester 3
 1
Chapter 1

Fundamentals Of Financial
Management
Meaning of Financial Management
Financial Management is a vital activity in any organization. According to
Hoagland "Financial Management is concerned mainly with such matters as, how
a business corporation raises its finance and how it makes use of it."
For any business, it is important that the finance it procures is invested in a
manner that the returns from the investment are higher than the cost of finance.

Definitions of Financial Management

According to Guthman and Dougal

“Financial management is the activity concerned with planning, raising,

controlling and administering of funds used in the business.”

According to J.F. Brandley

“Financial management is that area of business management devoted to a

judicious use of capital and a careful selection of the source of capital in order to
enable a spending unit to move in the direction of reaching the goals.”

According to Massie

“Financial management is the operational activity of a business that is

responsible for obtaining and effectively utilizing the funds necessary for efficient
operations.”

Importance Of Financial Management

1. The success of Promotion
2. Smooth Running of the Enterprise
3. Finance for Expansion
4. Cash Planning
 2

Thoughts of various Schools

➔ Some experts believe that financial management is all about providing
funds needed by a business on terms that are most favourable, keeping its
objectives in mind. Therefore, this approach concerns primarily with the
procurement of funds which may include instruments, institutions, and
practices to raise funds. It also takes care of the legal and accounting
relationship between an enterprise and its source of funds.
➔ Another set of experts believes that finance is all about cash. Since all
business transactions involve cash, directly or indirectly, finance is
concerned with everything done by the business.
➔ The third and more widely accepted point of view is that financial
management includes the procurement of funds and their effective
utilization. For example, in the case of a manufacturing company, financial
management must ensure that funds are available for installing the
production plant and machinery. Further, it must also ensure that the
profits adequately compensate the costs and risks borne by the business.

Scope of Finance Function

1. Financing Decision/Procurement of Funds

2. Investment Decision/Investment of Funds
3. Dividend Decision/Income Management

ReLearners | Ashish Narayan

 3
1. Financing Decision
Managers also make decisions pertaining to raising finance from long-term
sources (called Capital Structure) and short-term sources (called Working
Capital). They are of two types:
1. Financial Planning Decisions
2. Capital Structure Decisions

1.1. Financial Planning decisions

Relate to estimating the sources and application of funds. It means

pre-estimating the financial needs of an organization to ensure the availability of
adequate finance. The primary objective of financial planning is to plan and
ensure that the funds are available as and when required.

1.2. Capital Structure decisions

Involve identifying sources of funds. They also involve decisions with respect to
choosing external sources like issuing shares, bonds, borrowing from banks or
internal sources like retained earnings for raising funds.

2. Investment Decisions
Managers need to decide on the amount of investment available out of the
existing finance, on a long-term and short-term basis. They are of two types:
1. Long-term investment decisions or Capital Budgeting
2. Short-term investment decisions or Working Capital Management

2.1. Long-term investment decisions or Capital Budgeting

It means committing funds for a long period of time like fixed assets. These
decisions are irreversible and usually include the ones pertaining to investing in a
building and/or land, acquiring new plants/machinery or replacing the old ones,
etc. These decisions determine the financial pursuits and performance of a
business.

2.2. Short-term investment decisions or Working Capital

Management

It means committing funds for a short period of time like current assets. These
involve decisions pertaining to the investment of funds in the inventory, cash,

ReLearners | Ashish Narayan

 4
bank deposits, and other short-term investments. They directly affect the liquidity
and performance of the business.

3. Dividend Decisions
➔ These involve decisions related to the portion of profits that will be
distributed as dividends. Shareholders always demand a higher dividend,
while the management would want to retain profits for business needs.
Hence, this is a complex managerial decision.
➔ The alternatives available to the organisation to distribute the profits in the
form of dividends on one hand and retention of profits in the business have
a reciprocal relationship with each other.

Classification Of Finance Function

Finance functions can be divided into two parts.
1. Executive Finance Function
2. Incidental Finance Function

1. Executive Finance Function Includes

1. Financial planning
2. To determine the asset-management policy
3. To determine the requirement of Finance and External Sources of Finance
4. Negotiation for obtaining funds
5. Distribution of Net Profit
6. Estimation and Controlling Cash Flow
7. Controlling Financial Performance

2. Incidental Finance Function Includes

1. Supervision over the receipt and payment of cash
2. Safeguarding of cash balance
3. Custody and safeguarding of Securities, Insurance, policies and other
valuable documents
4. Taking care of financial and administrative matters
5. Record keeping
6. Reporting

ReLearners | Ashish Narayan

 5

Role of Financial Manager

1. Funds Raising
2. Funds Allocation
3. Profit Planning
4. Understanding Capital Markets

Functions of Controller
1. Planning and Budgeting
2. Accounting
3. Internal control
4. Tax administration
5. Inventory control
6. Appraisal and Reporting

Functions of Treasurer
1. Provision of Capital
2. Credit management
3. Investors' relations
4. Investment
5. Banking and custody
6. Auditing

Objectives of Finance Function

1. Profit Maximisation
2. Wealth Maximisation

1. Profit Maximisation
➔ Profit is a test of economic efficiency
➔ It leads to the efficient allocation of resources available
➔ It ensures maximum social welfare

Limitations Of Profit Maximisation Objective

➔ The concept of Profit is vague
➔ It ignores the time value of money
➔ It ignores risk

ReLearners | Ashish Narayan

 6
➔ It leads to inequality of income and wealth

2. Wealth Maximisation
➔ It maximizes the market value of its shares.

Advantages Of Wealth Maximisation Objective

➔ The concept is clear
➔ It considers TVM
➔ It considers risk element for valuation

Difference Between Profit & Wealth Maximisation

Profit Maximisation Wealth Maximisation

It does not take into account the time It takes into account the time value of
value of money. money.

It does not take into consideration the It takes into account the effect of
uncertainty of future earnings. dividend policy on the Market Price of
shares.

It does not consider the effect of It takes into account the effect of
dividend policy on the Market Price of dividend policy on the Market Price of
shares. shares.

It does not differentiate between It considers the different strategies for

short-term and long-term profits. long-term and short-term profits.

ReLearners | Ashish Narayan