Financial Management

(20-272-0401)

Module I: Financial Management - An overview

Financial Management - An overview: Concept of Business Finance, Meaning of Financial
Management, Financial Decisions, Goals of Financial Management, Objectives of Financial
Management, Risk-return tradeoff, Organization of the Finance Function.

Financial Management
In simple terms, financial management is the business function that deals with investing the
available financial resources in a way that greater business success and return-on-investment
(ROI) are achieved. Financial management professionals plan, organize and control all
transactions in a business. They focus on sourcing the capital whether it is from the initial
investment by the entrepreneur, debt financing, venture funding, public issue, or any other
sources. Financial management professionals are also responsible for fund allocation in an
optimized way to ensure greater financial stability and growth for the organization.

*Financial Management means planning, organizing, directing, and controlling the financial
activities such as procurement and utilization of funds of the enterprise. It means applying
general management principles to the financial resources of the enterprise.
Importance of Financial Management
The financial management of an organization determines the objectives, formulates the policies,
lays out the procedures, implements the programs, and allocates the budgets related to all
financial activities of a business. Through a streamlined financial management practice, it is
possible to ensure that there are sufficient funds available for the company at any stage of its
operations. The importance of financial management can be assessed by taking a look at its core
mandate:

● Availability of sufficient funds

● Maintaining a balance between income and expenses to ensure financial stability
 ● Ensuring efficient and high ROI
● Creating and executing business growth and expansion plans
● Safeguarding the organization against market uncertainties through ensuring buffer funds
Let’s take a deeper look at the scope of financial management to gain a greater understanding of
its importance.

Financial Management Scope

Financial management in a company is governed by the principle that it must protect the
financial interests of the investors, and shareholders, and ensure business growth. Apart from
securing their interests, the financial managers are also expected to ensure greater ROI that
generates more wealth for all shareholders. There are certain objectives of financial management
which are universally accepted by experts and business leaders, and these clearly outline the
financial management scope and functions.

*Scope/Elements of Financial Management

Investment decisions include investment in fixed assets (called capital budgeting). Investment in
current assets is also a part of investment decisions called working capital decisions.
Financial decisions- They relate to the raising of finance from various resources which will
depend upon the decision on the type of source, period of financing, cost of financing, and the
returns thereby.
Dividend decision- The finance manager has to decide concerning the net profit distribution. Net
profits are generally divided into two:
Dividend for shareholders- Dividend and the rate of it has to be decided.
Retained profits- The amount of retained profits has to be finalized which will depend upon the
expansion and diversification plans of the enterprise.

Objectives of Financial Management

Certain specific and highly impactful objectives that financial managers aim to attain are:
Assessing Capital Needs
Financial managers need to evaluate factors such as cost of current and fixed assets, cost of
marketing, need for buffer capital, long-term operation, human resources cost, etc. Successful
businesses have clearly defined short-term and long-term financial requirement projections in
place.
Determination of Capital Structure
A company’s capital structure is the framework that determines decisions such as the debt-equity
ratio in the short as well as long term.
Creation of Effective Financial Policies
There is a need to frame efficient financial policies that govern cash control, the lending and
borrowing processes, and so on.

Resource Optimization
Great financial managers can navigate through different scenarios by making optimum use of the
available financial resources. This would reduce the cash burn and increase the cash churn to
generate maximum ROI.

** 1. Profit Maximization
The basic objective of financial management is to achieve optimal profit, both in the short and
long run. It even includes wealth maximization, where every shareholder’s value or hold over
dividends should increase. These outcomes are related to business performance, which means
that the better a business performs, the higher the market value of its shares will be.
2. Proper Mobilization
Effective mobilization is one of the most important objectives of financial function. It means that
managers need to make decisions regarding the allocation and utilization of various funds.
Whether it’s shares or debentures, finance managers need to estimate an organization’s
requirements and make financial decisions accordingly.
3. Improved Efficiency
Proper utilization of finance also encourages proper distribution. From creating inventories to
investing in profitable businesses, mobilization and utilization of finances lead to better business
decisions. This also allows managers to dedicate resources and distribute them among
departments, increasing the overall efficiency of an organization.
4. Business Survival
The primary goal of financial management is ensuring an organization’s survival. As the term
suggests, businesses need to survive the competitive market and the best way to do so is to
manage their financial resources. Managers need to make big decisions after due diligence. They
may consult with external members or agencies if needed. Every decision makes a difference as
it impacts the business.
5. Balanced Structure
As financial managers prepare capital structure, it creates balance among different sources of
capital. This balance is essential for liquidity, flexibility, and stability. This further decides the
ratio between owned capital and borrowed capital.

* financial management is generally concerned with procurement, allocation, and control of

financial resources of a concern. The objectives can be-

To ensure a regular and adequate supply of funds to the concern.

To ensure adequate returns to the shareholders which will depend upon the earning capacity, the
market price of the share, and expectations of the shareholders.
To ensure optimum funds utilization. Once the funds are procured, they should be utilized in the
maximum possible way at the least cost.
To ensure safety on investment, i.e, funds should be invested in safe ventures so that an 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.

Goals of Financial Management

Common goals of financial management
The goal of a financial manager is to keep the company or organization solvent and successful.
There are several elements to this goal:
Maximize current value
The financial manager or managerial team works to maintain the highest value possible for the
company's assets. In a publicly owned company, this means maintaining the highest possible
value per stock in the company.

Maintain growth
The financial manager aims to increase the company's value over time. They help to achieve this
by producing and implementing financial plans.

Maximize profit
Maximizing profit may involve locating opportunities to invest, acquire a competitor or develop
new products. This can involve communications with other divisions such as marketing or
research and development to create efficient strategies.

Minimize cost
As they monitor spending, a financial manager looks for opportunities to minimize the costs of
doing business, such as overhead, manufacturing, and distribution costs. They then communicate
these potential changes to the respective management teams.

Avoid bankruptcy
Finally, the financial manager aims to keep the company solvent, meaning it has enough money
to continue operations and avoid bankruptcy.

Components of financial management

These are the three areas of financial management that help financial managers fulfill their goals:

Controlling
The financial manager maintains or creates profitability by controlling the organization's money,
keeping up with expenses, and making any necessary adjustments to how the company is
spending money. They track these changes and adjustments relative to projected outcomes so
that the company moves toward achieving its goals and long-term profitability.

Reporting
The financial manager aims to maintain the company's compliance with legal reporting
requirements. They do this by creating regular, accurate financial reports and staying
knowledgeable about all relevant regulations. This is important because businesses report their
finances to the government for taxation and public record purposes, and reporting these things
accurately helps the business maintain a positive image.

Planning
To keep the company profitable, the financial manager makes projections and models for the
financial future of the company. Their strategy can include long-term money management and
investment, plans for expansion, or strategic choices in other parts of the company that has a
financial impact.

Financial manager duties

The specific duties of a financial management position depend on the size of the company. In a
smaller company, one person might be responsible for most or all of the financial management
tasks. In a larger company, several positions or an entire department accomplish these tasks
together. Financial management duties include:

Tracking money
To keep a company solvent, a financial manager has to track how much money it has at any
given time. Financial managers complete these tasks to track a company's assets:

Reviewing statements: Reviewing banking activity, statements and reports allows the financial
manager to spot discrepancies.
Managing credit: As a company extends or utilizes credit, the financial manager keeps track of
these transactions.
Creating improvement in budget areas: When the financial manager sees where costs are
exceeding expectations or simply where there could be a financial improvement, they
communicate and implement these changes.
Assessing financial performance: Financial managers measure how the company is performing
relative to budgets and projections.
Managing documents
Financial management involves the creation and maintenance of many documents, which
include:

Developing company's master budget: Also called the budget variance analysis, a company's
master budget brings the company's expenses and profits together.
Writing reports: The financial manager also creates other reports as needed, tracking the
company's performance in broad or detailed scopes.
Utilizing technology: Since automation assists with record-keeping, the financial manager
knows how to use databases and software to track funds and interpret large amounts of
information.
Establishing compliance
The financial manager must know and bring the company into compliance with all relevant
financial regulations. Here are some tasks that might include:

Managing payroll: The financial team maintains the payroll, which may include some
time-tracking responsibilities at smaller institutions. Depending on the company's size, the
financial manager may also report the payroll information to the Equal Employment Opportunity
Commission.
Filing taxes: The financial team manages the filing of taxes for the organization, including
federal taxes, state taxes, sales taxes, employment taxes, and excise taxes.
Maintaining compliance with public reporting regulations: The Sarbanes-Oxley Act governs
the reporting of publicly-held firms' finances. It requires that the company file annual reports
publicly, that an outside auditor review the company's internal financial controls, and that
management sign off on these statements and be accountable for their accuracy. In a
publicly-traded company, the financial management team is responsible for these reports.
Maintaining industry-specific compliance: In addition to any general regulations and reports, a
financial manager must also keep track of any regulations that are specific to the agency.
Non-profit organizations that provide healthcare or contract with a government usually have
specific regulations to follow.
Creating strategies
The financial management team works to strategize and project the financial future of the
company. This process can involve:

Developing and interpreting financial models: The financial team builds specific models to
show how the business can operate in the future. They can use these models to deliver progress
updates within the company.
Creating specific plans: With models and reports in mind, the financial manager creates plans
for dealing with deficits or any differences between projections and actual costs.
Analyzing risk: With financial experience and knowledge of the company's history, the financial
manager analyzes the risk of potential activities and may participate in pricing and negotiation
for new contracts.
Identifying opportunities: The financial manager keeps up to date with industry trends, trades,
and standards. With this knowledge, it's possible to identify investment opportunities, potential
mergers, and acquisitions that might help the company.
Maintaining relationships
The managerial component of being a financial manager extends to managing personnel. Here
are some of a financial manager's interpersonal tasks:

Supervising other financial employees: At large companies with financial services

departments, the financial management positions involve overseeing other financial and
accounting professionals.
Maintaining professional relationships: Financial management requires the maintenance of
good working relationships with others. This involves any executives in the company and other
departments, particularly purchasing and production departments, but also extends to any other
agencies or clients that the organization may work with.
Functions of Financial Managers and Advisors
To achieve these objectives, the financial managers and advisors must perform certain functions.
These include:

Fundraising
For any business to grow confidently and have a good market reputation, an adequate amount of
cash and liquidity is critical. Therefore, businesses raise funds through equity or debt financing.
Financial managers take decisions on maintaining a healthy balance between debt and equity to
ensure that the company’s financial health is not impacted.

Fund Allocation
Smart fund allocation is as critical to a business's financial health as fund-raising itself. The
funds that a company has must be allocated in the best way possible after due diligence on:

● Business size and growth potential

● Whether the assets are short-term or long-term before spending on them
● Mode of fundraising
Profit Planning
Unless it is a social organization, earning more profits would be among any business’s primary
goals. The profits a company makes determine its financial health and future growth. Therefore,
adequate usage of the money generated as profit is needed. Whether they have to be plowed back
to acquire assets and expand coverage, or to be spent on marketing, acquiring other businesses,
or invested to act as a buffer resource, all these considerations are made by financial leaders.
Understanding Capital Markets
A company’s shares are publicly traded on stock exchanges, and the transactions, as well as the
change in a listed company’s market capitalization, are a constant phenomenon. Good financial
managers have to be well-versed with the capital market dynamics, and the risks associated.
Whether dividends are to be given to the shareholders when the business generates profits or
reinvested into the business, is one of the crucial decisions that can impact shareholders’
sentiments and the company’s goodwill.
Functions of Financial Management
1. Estimation of capital requirements: A finance manager has to estimate the capital
requirements of the company. This will depend upon expected costs and profits and
future programs and policies of concern. Estimations have to be made in an adequate
manner which increases earning capacity of the enterprise.
2. Determination of capital composition: Once the estimation has been made, the capital
structure has 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 funds to be procured, a company has many
choices like-
● Issue of shares and debentures
● Loans to be taken from banks and financial institutions
● Public deposits are to be drawn in form of bonds.
Choice of factor will depend on the relative merits and demerits of each source and
period of financing.

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 are possible.
5. Disposal of surplus: The net profits decision has to be made by the finance manager.
This can be done in two ways:
● Dividend declaration - It includes identifying the rate of dividends and other
benefits like bonuses.
● Retained profits - The volume has to be decided which will depend upon the
expansion, innovational, and diversification plans of the company.
6. Management of cash: The finance manager has to make decisions about cash
management. Cash is required for many purposes like payment of wages and salaries,
payment of electricity and 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.

CONCEPT OF BUSINESS FINANCE

Definition of Business Finance
Business finance is the funding a business needs for commercial purposes. It is the money
business owners require to start, run or expand a business.
This finance can come from a number of different places. Some of these include:

Investments: Investors may choose to invest capital in a business in the hopes of seeing their
investment rise after a set amount of time.

Business Loans: Some business owners prefer to borrow money from a bank for example in the
form of a loan and repay it over an agreed period of time.

Crowdfunding: There has been a rise in crowdfunding websites such as Kickstarter,

Crowdfunder, and Patreon. So many businesses are turning to the public as a source of finance.

Grants: A grant is a set amount of money that the government, a company, or another
organization can award. Grants are advantageous as you do not have to pay the money back.
Although they tend to be very difficult to acquire.
Meaning of Business Finance
Finance is the foundation of any business. It is near impossible to succeed without strong
finances in place.
You use finance to purchase assets, goods, and raw materials. Essentially anything that will push
your business forward.
This is why finance and funds are known as the lifeblood of any business. You simply cannot
function properly unless you have an adequate amount of money accessible to you and your
business.
The Importance of Business Finance
Capital is the most important tool when it comes to bridging the gap between your production
and your sales. Business finance can be used for a number of important purposes. These include:

Financial Statements
When dealing with business finance, it’s important to go through your financial statements and
connect the dots. This is between your profit and loss as well as your balance sheet and cash flow
statements. You can then conclude from your documents if there is a shortage of capital.
Business finance can provide the tools to plan strategies for correcting the shortage.

Strategic Planning
Every business should have a solid strategy in place. This is used for planning and providing the
financial groundwork for your projections and plans.
If you are looking to expand your business, you will use business finance to tell you how much
you’ll have to spend to get things moving.
These strategic plans help you to determine whether or not your company is meeting its long and
short-term goals.

Finance
It’s not uncommon to run into cash flow difficulties. When this happens, business finance is a
vital tool for managing and understanding your financing options.
By incorporating this information into your financial statements, you can make more educated
decisions about how much capital to borrow. You can also decide which options make the most
sense and your repayment schedule.

Promotion
It’s all well and good having a great product and business model, but to be a successful business
you need people to be aware of you.
The best way to do this is through promotion and marketing. There is a large demand for market
research so most of the time this does not come cheap. So it’s important to set aside a section of
your fiance to be put towards making sure your product is accessible to your target market.
FINANCIAL DECISIONS

Financial decisions are the decisions that managers take with regard to the finances of a
company. These are crucial decisions for the financial well-being of the company. These
decisions can be in terms of acquisition of assets, financing and raising funds, day-to-day capital
and expenditure management, etc. Financial decisions, therefore, affect both the assets and
liabilities of a company. They can lead to profits, revenue generation, and receipt of funds and
assets for the company. They can also be in terms of expenditure, the creation of liabilities, and
an exodus of funds for a company.
And of course, all these financial decisions can be both for the long-term and short-term.
Long-term financial decisions are decisions that are taken for a period of more than a year or
more. These may include capital budgeting and investment decisions, as well as the raising of
long-term capital and loans, which may run for 5-10 years.
Short-term financial decisions are decisions that are taken for a short period of time, usually less
than a year. These decisions pertain to working capital management, arranging short-term funds
and credits, the provision of dividends, etc.
Key Financial Decisions
We will discuss below the most important financial decisions that these professional managers
usually make:

1. Investment Decisions
2. Financing Decisions
3. Dividend Decisions
Investment Decisions
Investment decisions are decisions that relate to the investment in different types of assets,
instruments, securities, etc. Managers decide how to invest the company’s funds in different asset
classes, depending on the needs of the organization. Assets can be both short-term and long-term.
As each company has scarce financial resources, it is crucial to decide which asset to invest in
first. Managers must make the tough call of postponing investing in some assets that are not
strictly necessary at present, or that may not give the desired return.
Long-Term Investment Decisions
Capital budgeting decisions are decisions to invest in long-term assets to improve the overall
production/servicing capacity of the organization. They often require heavy capital expenditure
and are always for a longer term. Therefore Capex decisions need to be made very wisely. Any
commitment to such assets is irreversible and leads to the blockage of a significant amount of
capital. In addition, returns on such investments are very late and can take long periods of time,
over a year, before such an investment yields positive returns. These expenditures include the
establishment of a new unit or the expansion of an existing unit, the purchase or replacement of
new machinery, investments in research and development, etc.

Short-Term Investment Decisions

Short-term investment decisions are decisions regarding the day-to-day operations and
management of the company. We may loosely call it the working capital management of the
company. Managers must ensure that the company has sufficient liquidity for its day-to-day
activities. The managers must ensure that these funds do not dry up and there is no hindrance or
bottleneck to the day-to-day activities of the company. They must also decide on the sources of
short-term financing and prioritize expenditure according to the availability and urgency of the
funds. Short-term investment decisions also concern receivables and payables, as well as the
acquisition and use of inventories.
Factors Affecting Investment Decisions
Factors that affect the investment decisions are:
Return on Investment (ROI)
Return on investment is one of the most important factors influencing any investment decision.
Managers will invest in projects with a higher ROI and lower risk than other projects.
Cash Flows
Managers will choose to invest in projects with higher positive cash flows, which will keep their
liquidity position intact and comfortable.
Availability of Capital
The availability of both short-term and long-term capital in the company influences its
investment decisions. Interest rates, repayment period, time of maturity of the project, quantum
and start of return, etc., also influence the choice of one project over another.
Financing Decisions
Financing decisions are decisions that are made to ensure the financing of the company. They
relate to the raising of equity as well as debt for the company to fund its investment decisions. It
is a continuous and ongoing process, as each company regularly needs funding. Because a
growing company’s needs do not cease, instead go on increasing to keep pace with the growth.

Capital Structure
Financial managers have to make important decisions to form a proper capital structure. The
capital structure of a firm is made up of equity and debt. They have to work out a perfect balance
between the two so as to maximize shareholders’ value and the profitability of the firm. Going
for higher equity capital reduces the tension of repayment as they become part of the firm’s own
capital. But then shareholders must receive higher returns in the form of dividends, which will
lead to dilution of ownership and voting rights.
On the other hand, debt includes loans from banks and financial institutions, debentures, etc.
Higher debt increases the interest burden and makes the capital structure riskier. Furthermore, the
company cannot rely on this source of finance permanently, as lenders can reclaim their money
at any time. Any weak period of performance can play spoilsport with the company and put on it
under multifold pressure.
Optimal Mix of Debt and Equity
Financial managers have to chalk out an optimal mix of debt and equity. In doing so, they have
to take care of various factors such as the cost of financing, the risk involved, the floating cost in
case of issuing equity, the company’s cash-flow position in the immediate future, the state of the
economy, debt, and equity markets, etc.
Dividend Decision
Under dividend decisions, whenever a company makes a profit, it decides to reward its
shareholders in return for their investment, trust, and confidence in the company. This reward is
called a dividend. At the same time, managers must decide to retain part of the profit for the
future needs of the company. This is known as retained earnings.
Managers have to make the important decision of how many portions of the profit the company
should pay out in dividends and what part they should keep with them. Giving away higher
dividends makes the stock attractive and increases the market price and the overall market value
of the company. But they also have to take into account earnings and their stability, the growth
prospects of the company, its cash flow status, dividend taxes, and above all, its funding
requirements, etc.

RISK-RETURN TRADEOFF

The risk-return tradeoff states that the potential return rises with an increase in risk. Using this
principle, individuals associate low levels of uncertainty with low potential returns, and high
levels of uncertainty or risk with high potential returns. According to the risk-return tradeoff,
invested money can render higher profits only if the investor will accept a higher possibility of
losses.
Understanding Risk-Return Tradeoff
The risk-return tradeoff is the trading principle that links high risk with high reward. The
appropriate risk-return tradeoff depends on a variety of factors including an investor’s risk
tolerance, the investor’s years to retirement, and the potential to replace lost funds. Time also
plays an essential role in determining a portfolio with the appropriate levels of risk and reward.
For example, if an investor can invest in equities over the long term, that provides the investor
with the potential to recover from the risks of bear markets and participate in bull markets, while
if an investor can only invest in a short time frame, the same equities have a higher risk
proposition.
Investors use the risk-return tradeoff is one of the essential components of each investment
decision, as well as to assess their portfolios as a whole. At the portfolio level, the risk-return
tradeoff can include assessments of the concentration or the diversity of holdings and whether
the mix presents too much risk or a lower-than-desired potential for returns.

KEY TAKEAWAYS
● The risk-return tradeoff is an investment principle that indicates that the higher the risk,
the higher the potential reward.
● To calculate an appropriate risk-return tradeoff, investors must consider many factors,
including overall risk tolerance, the potential to replace lost funds, and more.
 ● Investors consider the risk-return tradeoff on individual investments and across portfolios
when making investment decisions.
* What is the Risk-Return Tradeoff?
The risk-return trade-off states that the level of return to be earned from an investment should
increase as the level of risk goes up. Conversely, this means that investors will be less likely to
pay a high price for investments that have a low-risk level, such as high-grade corporate or
government bonds. Different investors will have different tolerances for the level of risk they are
willing to accept so some will readily invest in low-return investments because there is a low risk
of losing the investment. Others have a higher risk tolerance and so will buy riskier investments
in pursuit of a higher return, despite the risk of losing their investments. Some investors develop
a portfolio of low-risk, low-return investments and higher-risk, higher-return investments in
hopes of achieving a more balanced risk-return trade-off.

A canny investor delves into the fundamentals of a prospective investment to gain insights into
the actual amount of risk associated with it. If this investor perceives that the actual risk level
differs from the general perception, then this difference can be exploited to achieve
above-average returns.
Organization of the Finance Functions

Today, the finance function has obtained the status of a science and an art. As finance function
has far-reaching significance in the overall management process, a structural organization for
further function becomes an outcome of an important organizational problem. The ultimate
responsibility of carrying out the finance function lies with the top management. However, the
organization of finance function differs from company to company depending on their respective
requirements. In many organizations, one can note different layers among the finance executives
such as Assistant Manager (Finance), Deputy Manager (Finance), and General Manager
(Finance). The designations given to the executives are different. They are

Chief Finance Officer (CFO)

Vice-President (Finance)
Financial Controller

General Manager (Finance)

Finance Officers

Finance, being an important portfolio, the finance functions is entrusted to top 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 the CFO to assist him/her. In larger companies
with modern management, there may be a Vice-President or Director of finance, usually with
both controller and treasurer. The organization of finance function is portrayed below:
It is evident from the above that the Board of Directors is the supreme body under whose
supervision and controls the Managing Director, Production Director, Personnel Director,
Financial Director, and Marketing Director perform their respective duties and functions.
Further, while auditing credit management, retirement benefits, and cost control banking,
insurance, investment function under the treasurer, planning, and budgeting, inventory
management, tax administration, performance evaluation, and accounting functions are under the
supervision of the controller.
The function of the treasurer of an organization is to raise funds and manage funds. The treasures
functions include forecasting the financial requirements, administering the flow of cash,
managing credit, flotation of securities, maintaining relations with financial institutions, and
protecting funds and securities.