MEANING OF FINANCIAL MANAGEMENT

Financial management refers to efficient acquisition, allocation and usage of funds by a company
for its smooth working. Financial management is the application of the management principles to
financial resources for efficient management. It helps in planning, organizing, directing and
controlling financial activities in business. Comprehensively, financial management ensures
businesses optimize their funds since they are limited. Financial management is about analyzing
financial situation which helps in making financial decision as well as to set financial objectives.
DEFINITIONS OF FINANCIAL MANAGEMENT
1. According to Weston and Brighan, “Financial Management is an area of financial decision
making, harmonizing individual motives and enterprise goals”.
2. According to Howard and Upon, “Financial Management is the application of the planning
and controlling functions to the finance function”.
3. According to Ezra Soloman and Pringle John, “Financial Management is concerned with the
effective use of an economic resource namely capital fund”.
OBJECTIVES OF FINANCIAL MANAGEMENT
The financial management is generally concerned with procurement, allocation and control of
financial resources of a concern. Effective procurement and efficient use of finance leads to
proper utilization of the finance by the business concern. It is the essential part of the financial
manager. Hence, the financial manager must determine the basic objectives of the financial
management.
Objectives of Financial Management may be broadly divided into two parts such as:
1. Profit maximization
2. Wealth maximization.
Profit Maximization
Main aim of any kind of economic activity is earning profit. A business concern is also
functioning mainly for the purpose of earning profit. Profit is the measuring techniques to
understand the business efficiency of the concern. Profit maximization is also the traditional and
narrow approach, which aims at, maximizes the profit of the concern.
Profit maximization consists of the following important features:
1. Profit maximization is also called as cashing per share maximization. It leads to maximize the
business operation for profit maximization.
2. Ultimate aim of the business concern is earning profit, hence, it considers all the possible ways
to increase the profitability of the concern.
3. Profit is the parameter of measuring the efficiency of the business concern. So, it shows the
entire position of the business concern.
4. Profit maximization objectives help to reduce the risk of the business.
Favourable Arguments for Profit Maximization
The following important points are in support of the profit maximization objectives of the
business concern:
 (i) Main aim is earning profit.
(ii) Profit is the parameter of the business operation.
(iii) Profit reduces risk of the business concern.
(iv) Profit is the main source of finance.
(v) Profitability meets the social needs also.
Unfavourable Arguments for Profit Maximization
The following important points are against the objectives of profit maximization:
(i) Profit maximization leads to exploiting workers and consumers.
(ii) Profit maximization creates immoral practices such as corrupt practice, unfair trade
practice, etc.
(iii) Profit maximization objectives leads to inequalities among the stakeholders such as
customers, suppliers, public shareholders, etc.
Drawbacks of Profit Maximization
Profit maximization objective consists of certain drawback also:
(i) It is vague :In this objective, profit is not defined precisely or correctly. It creates
some unnecessary opinion regarding earning habits of the business concern.
(ii) It ignores the time value of money: Profit maximization does not consider the time
value of money or the net present value of the cash inflow. It leads certain differences
between the actual cash inflow and net present cash flow during a particular period.
(iii) It ignores risk: Profit maximization does not consider risk of the business concern.
Risks may be internal or external which will affect the overall operation of the
business concern.
Wealth Maximization
Wealth maximization is one of the modern approaches, which involves latest innovations and
improvements in the field of the business concern. The term wealth means shareholder wealth or
the wealth of the persons those who are involved in the business concern. Wealth maximization
is also known as value maximization or net present worth maximization. This objective is
universally accepted concept in the field of business Traditional Approach and Modern
Approach
Favourable Arguments for Wealth Maximization
(i) Wealth maximization is superior to the profit maximization because the main aim of
the business concern under this concept is to improve the value or wealth of the
shareholders.
(ii) Wealth maximization considers the comparison of the value to cost associated with
the business concern. Total value detected from the total cost incurred for the
business operation. It provides extract value of the business concern.
(iii) Wealth maximization considers both time and risk of the business concern.
(iv) Wealth maximization provides efficient allocation of resources.
(v) It ensures the economic interest of the society.
Unfavourable Arguments for Wealth Maximization
(i) Wealth maximization leads to prescriptive idea of the business concern but it may not
be suitable to present day business activities.
(ii) Wealth maximization is nothing, it is also profit maximization, it is the indirect name
of the profit maximization.
 (iii) Wealth maximization creates ownership-management controversy.
(iv) Management alone enjoys certain benefits.
(v) The ultimate aim of the wealth maximization objectives is to maximize the profit.
Other objectives of financial management
 To ensure regular and adequate supply of funds to the business.
 To ensure adequate returns to the shareholders on their investment.
 To ensure optimum and efficient utilization of funds in maximum possible way at least
cost.
 To ensure safety on investment, i.e, funds should be invested in safe ventures so that
adequate rate of return can be achieved.
 To plan a sound capital structure, there should be a sound and fair composition of capital
so that a balance is maintained between debt and equity capital.

NATURE OR FEATURES OR CHARACTERISTICS OF FINANCIAL MANAGEMENT

Nature of financial management is concerned with its functions, its goals, trade-off with
conflicting goals, its indispensability, its systems, its relation with other subsystems in the firm,
its environment, its relationship with other disciplines, the procedural aspects and its equation
with other divisions within the organisation.
1. Financial Management is an integral part of overall management. Financial considerations are
involved in all business decisions. So, financial management is pervasive throughout the
organisation.
2. The central focus of financial management is valuation of the firm. That is financial decisions
are directed at increasing or maximization or optimizing the value of the firm.
3. Financial management essentially involves risk-return trade-off. Decisions on investment
involve choosing of types of assets which generate returns accompanied by risks. Generally,
higher the risk, returns might be higher and vice versa. So, the financial manager has to decide
the level of risk the firm can assume and satisfy with the accompanying return.
4. Financial management affects the survival, growth and vitality of the firm. Finance is said to
be the life blood of business. It is to business, what blood is to us. The amount, type, sources,
conditions and cost of finance squarely influence the functioning of the unit.
5. Finance functions, i.e., investment, rising of capital, distribution of profit, are performed in all
firms - business or non-business, big or small, proprietary or corporate undertakings. Thus,
financial management is a concern of every concern.
6. Financial management is a sub-system of the business system which has other subsystems like
production, marketing, etc. In such arrangement, financial sub-system is to be well-coordinated
with others and other sub-systems well matched with the financial subsystem.
SCOPE OF FINANCIAL MANAGEMENT/FINANCE FUNCTION
The main objective of financial management is to arrange sufficient finance for meeting short
term and long-term needs. A financial manager will have to concentrate on the following areas of
finance function.
1.Estimating financial requirements: The first task of a financial manager is to estimate short
term and long-term financial requirements of his business. The amount required for purchasing
fixed assets as well as needs for working capital will have to be ascertained.
2.Deciding capital structure: Capital structure refers to kind and proportion of different securities
for raising funds. After deciding the quantum of funds required it should be decided which type
of securities should be raised. A decision about various sources for funds should be linked to the
cost of raising funds.
3. Selecting a source of finance: An appropriate source of finance is selected after preparing a
capital structure which includes share capital, debentures, financial institutions, public deposits
etc. If finance is needed for short term periods then banks, public deposits and financial
institutions may be the appropriate. On the other hand, if long term finance is required then share
capital and debentures may be the useful.
4. Selecting a pattern of investment: When funds have been procured then a decision about
investment pattern is to be taken. A decision will have to be taken as to which assets are to be
purchased? The funds will have to be spent first on fixed assets and then an appropriate portion
will be retained for working capital and for other requirements.
5. Proper cash management: Cash management is an important task of finance manager. He has
to assess various cash needs at different times and then make arrangements for arranging cash.
Cash may be required to purchase of raw materials, make payments to creditors, meet wage bills
and meet day to day expenses. The idle cash with the business will mean that it is not properly
used.
6. Implementing financial controls: An efficient system of financial management necessitates the
use of various control devices. They are ROI, break even analysis, cost control, ratio analysis,
cost and internal audit. ROI is the best control device in order to evaluate the performance of
various financial policies.
7. Proper use of surpluses: The utilization 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. A balance should be struck in using
funds for paying dividend and retaining earnings for financing expansion plans.

IMPORTANCE OF FINANCIAL MANAGEMENT

1. Helps organizations in financial planning

Fnancial planning is a crucial part of an integrated and sustainable organization because it
assists in branding the company among competitors. In addition, financial management helps
the company to ascertain fund requirements and decides the necessary steps to meet those
requirements.

2. Assists in acquiring funds from different sources

Another important role of financial management is to understand available sources and

acquire funds for the business. This acquisition must be made keeping in mind the cost and
liabilities.

3. Helps in investing an appropriate amount of fund

The very definition of financial management entails managing and allocating available
finances. The proper functioning of the finance department boosts the growth and efficiency
of the organization. When the funds are utilized in a precise manner, the financial
management can work toward holding the cost of capital and amplifying the company's worth.
This will ultimately solidify the financial standing of the organization.

4. Increases organizational efficiency

Financial management focuses on establishing a firm position for the company in the market.
It achieves this through a framework for increasing the investors' and shareholders' wealth.
The main objective of an organization is to perform well and optimize profits while stumping
up the economy.

5. Reduces delayed production

Production delays are the root cause of poor financial management. It causes inefficiency in
every department. Secure financial planning monitors production timelines and deadlines and
tries to reduce production delays.

6. Financial costs planning

This involves projections regarding the company's financial requirements to meet its short-
term and long-term objectives. Financial management executives provide a vision for daily
operations and enable planning for cost reduction and profit maximization.
7. Provides economic stability

Maintaining economic stability is a prerequisite for an organization to achieve constant

growth. Sound financial resources will help an organization expand its horizons and thrive in
the business. To achieve financial stability, it is important to have efficient financial
management in place.

8. Financial decisions making

Financial professionals assist the senior professionals in the company in forming rules and
creating policies by giving a precise report of the daily finances and data on appropriate key
performance indicators.

9. Guideline for earning maximum profits with minimum cost

Maximizing profits is the end goal for every organization. And the earrings and revenues are
solely based on the productive employment of financial resources. A solid financial
foundation comprises different attributes such as budget control, cost control, ratio analysis,
trend analysis, and cost-volume-profit numbers. Thus, financial management is crucial to
enhancing profits and minimizing operations costs.

10. Increases shareholders' wealth

Shareholders act as assets for an organization. They are investors in the company. This is why
a company's main objective should be to maximize its shareholders' wealth. It will retain the
funds and benefit the economy.

11. Encourages employees to save money

A transparent and sustainable financial management system enables employees to understand

the available resources. In addition, it authorizes professionals in every department to work
toward the company's betterment by functioning under a budget.

EVOLUTION OF FINANCE FUNCTION

 Financial management came into existence as a separate field of study from finance function in
the early stages of 20th century. The evolution of financial management can be separated into
three stages:
1.Traditional stage (Finance up to 1940): The traditional stage of financial management
continued till four decades. Some of the important characteristics of this stage are: i) In this
stage, financial management mainly focuses on specific events like formation expansion, merger
and liquidation of the firm. ii) The techniques and methods used in financial management are
mainly illustrated and in an organized manner. iii) The essence of financial management was
based on principles and policies used in capital market, equipment of financing and lawful
matters of financial events. iv) Financial management was observed mainly from the prospective
of investment bankers, lenders and others.
2.Transactional stage (After 1940): The transactional stage started in the beginning years of
1940‟s and continued till the beginning of 1950’s. The features of this stage were similar to the
traditional stage. But this stage mainly focused on the routine problems of financial managers in
the field of funds analysis, planning and control. In this stage, the essence of financial
management was transferred to working capital management.
3.Modern stage (After 1950): The modern stage started in the middle of 1950‟s and observed
tremendous change in the development of financial management with the ideas from economic
theory and implementation of quantitative methods of analysis. Some unique characteristics of
modern stage are: i) The main focus of financial management was on proper utilization of funds
so that wealth of current shareholders can be maximized. ii) The techniques and methods used in
modern stage of financial management were analytical and quantitative. Since the starting of
modern stage of financial management many important developments took place. Some of them
are in the fields of capital budgeting, valuation models, dividend policy, option pricing theory,
behavioral finance etc.

FUNCTIONS OF FINANCIAL MANAGEMENT

1.Estimation of capital requirements: A finance manager has to make estimation with regards to
capital requirements of the company. This will depend upon expected costs and profits and
future programmes and policies of a concern. Estimations have to be made in an adequate
manner which increases earning capacity of enterprise.
2.Determination of capital composition: Once the estimation have been made, the capital
structure have to be decided. This involves short-term and long-term debt equity analysis. This
will depend upon the proportion of equity capital a company is possessing and additional funds
which have to be raised from outside parties.
3.Choice of sources of funds: For additional sources of funds to be procured, a company has
many choices like a. Choice of Issue of shares and debentures, b. Loans to be taken from banks
and financial institutions, c. Public deposits to be drawn like in form of bonds.
4.Investment of funds: The finance manager has to decide to allocate funds into profitable
ventures so that there is safety on investment and regular returns is possible.
5.Disposal of surplus: The net profits decision has to be made by the finance manager. This can
be done in two ways:
a. Dividend declaration - It includes identifying the rate of dividends and other benefits like
bonus.
b. Retained profits -The volume has to be decided which will depend upon expansion,
innovational, diversification plans of the company.
6.Management of cash: Finance manager has to make decisions with regards to cash
management. Cash is required for many purposes like payment of wages and salaries. Water
bills, payment to creditors, meeting current liabilities, maintenance of enough stock, purchase of
raw materials, etc.
7. Financial controls: The finance manager has not only to plan, procure and utilize the funds but
he also has to exercise control over finances. This can be done through many techniques like
Ratio analysis, financial forecasting, cost and profit control, etc.
FINANCE FUNCTION MEANING
The finance function refers to practices and activities directed towards managing the business
finances. The finance function in business refers to the functions intended to acquire and manage
financial resources to generate profit. The financial resources and information optimized by these
functions contribute to the productivity of other business functions, planning, and decision-
making activities.
ORGANIZATION OF FINANCE FUNCTION
The finance functions is entrusted to top level management. The Board of Directors, who are at
the helm of affairs, normally constitutes a ‘Finance Committee’ to review and formulate
financial policies. Two more officers, namely ‘treasurer’ and ‘controller’ – may be appointed
under the direct supervision of CFO to assist him/her. In larger companies with modern
management, there may be Vice-President or Director of finance, usually with both controller
and treasurer. The organization of finance function is portrayed below:
The chief financial officer often distributes the financial management responsibilities between
the controller and the treasurer.
The controller normally has responsibility for all accounting-related activities. These include
such functions as
 Financial Accounting: This function involves the preparation of the financial
statements for the firm, such as the balance sheet, income statement, and the statement
of cash flows.
 Cost Accounting: This department often has responsibility for preparing the firm’s
operating budgets and monitoring the performance of the departments and divisions
within the firm.
 Taxes: This unit prepares the reports that the company must file with the various
government (local, state, and federal) agencies.
 Data Processing: The responsibilities involving corporate accounting and payroll
activities are done by the controller. The controller may also have management
responsibility for the company’s data -processing operations.
The treasurer is normally concerned with the acquisition, custody, and expenditure of
funds. These duties often include
 Cash and Marketable Securities Management This group monitors the firm’s short -
term finances forecasting its cash needs, obtaining funds from bankers and other
sources when needed, and investing any excess funds in short-term interest -earning
securities.
 Capital Budgeting Analysis This department is responsible for analyzing capital
expenditures that is, the purchase of long -term assets, such as new facilities and
equipment.
 Financial Planning This department is responsible for analyzing the alternative sources

of long-term funds, such as the issuance of bonds or common stock, that the firm will
need to maintain and expand its operations.
 Credit Analysis Most companies have a department that is responsible for determining
the amount of credit that the firm will extend to each of its customers. Although this
group is responsible for performing financial analysis, it may sometimes be located in
the marketing area of the firm because of its close relationship to sales.
 Investor Relations Many large companies have a unit responsible for working with
institutional investors (for example, mutual funds), bond rating agencies, stockholders,
and the general financial community.
 Pension Fund Management The treasurer may also have responsibility for the
investment of employee pension fund contributions. The investment analysis and
portfolio management functions may be performed either within the firm or through
outside investment advisors.
AGENCY PROBLEM
Agency problem refers to conflict of interest between two parties where one party is expected to
act on behalf of another party. It is a conflict of interest between an agent and a principal, where
an agent is a person or group who performs a task on behalf of someone else i.e., the principal. A
conflict of interest occurs when one party doesn't fulfill contractual obligations in favor of their
own personal or professional interests. Agency problem does not exist without having agency
relationship.
Agency problem can be considered as:
1. Managers Vs Owners
2. Creditors Vs Owners
3. Senior management Vs Junior management
4. Owners Vs Other parties
1. Managers Vs Owners:
In situation of joint stock company ownership is separated from management. For this motive,
owners directly cannot take part in managing. The obligation or responsibility of management is
on the hand of proficient manager. Sometimes proficient managers give importance to their own
interest without consideration to shareholder’s interest. As a consequence, conflict of interest
amongst managers and owners is formed.
2. Creditors Vs owners:
Creditors want to have principal and interest payment from owners timely. But owners are not
ready to pay the claim of the creditors from their own income if sufficient amount of profit is not
produced by the company. As a consequence, conflict arises.
3. Senior management Vs Junior management:
Sometimes conflict between senior management and Junior management arises. Senior
management involved with the policy creation. These policies are applied by lower level
management. As a consequence, conflict arises between management act as the agent.
4. Owners Vs Other parties:
Owners wants to take full advantage of wealth. On the other hand, suppliers, buyers, employees,
and other parties want to have increment of salary, high quality products with less prices, on time
payment of bill etc. As a consequence, the interest of owners is hampered.