Financial Management 1

THE CONCEPT OF FINANCE

In simple language finance is money. To start any business,

we need capital. Capital is the amount of money required to
start a business. The mobilization of finance is an important
task for an entrepreneur therefore; finance is one of the
significant factors which determine the nature and size of any
enterprise. This is to be noted that identification of sources of
finance from time to time to finance the assets of an
enterprise is critical as it avoids the financial hardships of an
enterprise. The finance is required to acquire various fixed
assets and current assets. This course discusses the meaning
of finance types of finance need of finances, objectives, and
functions of financial management is detail
Finance is the study of money. Finance means to arrange
payment for. It is basically concerned with the nature, creation,
behavior, regulation and problems of money. It focuses on how
the individuals, businessmen, investors, government and
financial institutions deal. We need to understand what money
is and does is the foundations of financial knowledge. In this
content it is relevant to study the structure and behavior of
financial system and the role of financial system in the
development of economy and the profitability of business
enterprises.
Classification of finance
The finance is classified into three categories
I. Personal finance
II. Public finance
III. Business finance
I. Personal finance: - This deals with the mobilization of funds from own
sources. Here funds may imply cash and non-cash items also.
II. Public finance: - This kind of finance deals with the mobilization or
administration of public funds. It includes the aspects relating to the
securing the funds by the government from public through various
methods viz. taxes, borrowings from public and foreign markets.
III.Business finance: - Financial management actually concerned with
business finance. Business finance is pertaining to the mobilization of
funds by various business enterprises. Business finance is a broad term
includes both commerce and industry. It applies to all the financial
activities of trade and auxiliaries of trade such as banking, insurances,
mercantile agencies, service organizations, and the manufacturing
enterprises.
The following are the basic forms of organizations

a) Sole trading
b) Partnership
c) Corporation
d) Co-operative
In olden days the individual as a sole trader used to bring in his capital
and manage with the help of family members. This system has suffered with
certain constraints like limited resources, lack of expertise etc. Later,
partnership form come into existences to overcome some of the defects of
sole trading. The partners used to contribute in the form of money, assets
expertise, management etc and profits will be shared on agreed terms.
With the growth of industrialization, many business establishments have
preferred to set up corporate form of organization to overcome the major
defects of sole trading and partnership form of organization. In case of
corporate form of organization the finances are raised through shares,
bonds, banks, financial institutions, suppliers etc. We do come across
another form of organization i.e. co-operatives. The co-operatives raise
funds through the members, government and financial institutions. Thus
business finances can be classified into four categories
I. Proprietary finance
II. Partnership finance
III. Corporate finance
IV. Industrial finance
I. Proprietary finance – This refers to the procurement of finds by the
individuals, organizing themselves as sole traders.
II. Partnership finance – It is concerned with the mobilization of
finances by the partners of a business organizations/partnership
firms
III. Corporation finance – It deals with the raising of finances by
corporate organizations. It includes the financial aspects of the
promotion of new enterprises and their administration during early
period, the accounting, administration problems arising out of growth
and expansion.
IV. Industrial finance – This deals with raising of finances from all
sources. It is the study of principles relating to securing the finances
from the financial institutions and other institutional sources like
banks and insurance companies
SOURCES OF FINANCE
The finance required for any organization could be primarily
divided into two one is long-run finance to acquire the fixed
assets that are useful to the business organization over a
period of time i.e. more than a year, usually we call fixed
capital. The other one is short-term finance which is required
to keep running the fixed assets or to made them finance
which is required to keep running the fixed assets or to make
them working. This is called the working capital.
Long-term sources – The important long-term sources are
common stock, preference stock bonds, loans from financial
institutions and foreign capital.
Short-term sources – The short-term sources are bank loans,
public deposits trade credits provisions and current liabilities.
The requirements of above nature could be financed either through
external sources or internal sources if it is an existing company.
1. External – These are the funds drawn from outsiders. Among them the
prominent are discussed below.
Share Capital – This is the primary source of finance to a corporate form
of organization. It is the sale of equity or common stock and preference
stock to the public. Which serves as a permanent capital to an
organization. These holders will get dividend in return for their investment.
Common stock – The holders of these shares are owners of the company.
They are the risk takers. They get dividend when the company earns
profits, otherwise they do not get any dividend. Whatever profit is left after
meeting all the expenses belongs to them. In the event of closure of the
company they are the last people to get their claim.
Preference stock – Preference shares carry two preferential rights one is
to get a fixed dividend at the end of each year irrespective of the profits,
other one is to get back the original investment first when the company
goes into liquidation.
Change par bonds – Another source of finance to a company is issue of
bonds/ debentures. These holders are eligible to get fixed interest at the
end of each year. The holders of these bonds do not wish to take any risk
public deposits. The term is also mentioned while issuing bonds.
Public deposits – This is another mode of finance where the company will
advertise and accept deposits for specified period at a fixed rate of interest.
Borrowings – The companies may borrow funds from banks, financial
institutions etc for their requirements at the interest chargeable by the
lender institution.
Foreign capital – The concept of liberalization is attracting many foreign
companies to participate in the domestic companies. It can be either in the
form of direct participation in the capital or collaboration in a project in the
equity of the company and also provide loans some time.
Trade credits – The common means of short-term external finance is trade
credits Normally, every company gets its raw material and other supplies on
credit basis. This is known as trade credit. This is an important source of
financing.
2. Internal Sources – This is applicable for only those companies which are in
existence. By virtue of their existence, they are in a advantageous position to
generate some of the finance internally.
 Retained earnings – These are the funds that are retained out of the profits
for meeting future contingencies. It can be either to meet the uncertainty or
future growth and expansion of business. The company would be free to utilize
this source. The retained profits enable a company to withstand seasonal
reactions and business fluctuations. The large accumulated savings facilitate a
stable dividend policy and enhance the credit standing of the company.
However, the quantum of retained earnings depend on the volume of the profits
made by the company.
Provisions – Generally companies, in order to meet the legal and other
obligations, create some funds for future use. These are known as provisions.
They include depreciation, taxation, dividends and various current and non-
current liabilities. The amount set apart in these form would be required to be
paid only on certain dates. Till then the company can use them for its own
purpose. For instance, taxes payable to the government are used in the
business until these are paid on due date. Therefore, though for a short-while
provisions would serve as a good source of internal finance.
The Four Major Decisions in Corporate Finance/Financial management
 
1. The Allocation (Investment) decision

Where do you invest the scarce resources of your business?

What makes for good investment?

2. The Financing decision

Where do you raise the funds for these investments?
Generically, what mix of owner's money (equity) or borrowed money (debt) do
you use?

3. The Dividend Decision

How much of a firm's funds should be reinvested in the

business and how much should be returned to the owners?

4. The Liquidity decision

How much should a firm invest in current assets and what should be the
components with their respective proportions? How to manage the working
capital?
Decisions Internal to the business enterprise
 Whether to undertake new projects
 Whether to invest in new plant and machinery
 Research and development decisions
 Investment in a marketing or advertising campaign
Decision involving external parties
 Whether to carry out a takeover or a merger involving
another business
 Whether to engage in a joint venture with another enterprise
Disinvestment decisions
 Whether to sell off unprofitable segments of the business
 Whether to sell old or surplus plant machinery
 The sale of subsidiary companies
Why study financial management?
Diverse career opportunities: Studying financial management opens
up a lot of diverse career opportunities. It could be in the private or
public sector. Some of the career options include investment banking,
entrepreneurship, financial analysis, financial and managerial
accounting, and strategic financial management. It is also beneficial
for those people who are interested in starting their own business.
Doing a financial management course or obtaining a finance degree
can help people get promotions or better accounting jobs.
Improve interpersonal skills: Doing a course in this field will allow
you to build better communication and teamwork skills through
developing relationships with your colleagues. 
Builds personality: Doing a course in this field also helps in
improving your soft skills. This is because people who wish to work in
this sector must be extroverts, and should be able to talk about
finance for hours altogether. This helps in improving their personality,
knowledge, and communication.
Greater job prospects: According the USA’s Bureau of Labour Statistics
(BLS), there has been a spike in demand for finance manager jobs in US
due to a “growing range of financial products and the need for in-depth
knowledge of geographic regions”. This is further proven by the fact that
the demand for careers in financial management has increased by 14%,
careers in financial advising by 32%, and careers in financial analysis by
23%.
Higher salary packages: People working in this sector are usually paid
very well, whether it is at the entry level or at the management level.
Additionally, this is a highly skilled job role that is always in demand,
even during recessions.

Career growth: There is always an opportunity to develop your

professional skills and climb the career ladder. You can quickly acquire
in-depth knowledge of financial management systems and financial
management software once in this field. If you possess this knowledge
and great aptitude skills, this field is perfect for you
Scope of studying Financial Management
Doing a management course related to finance or gaining a
finance degree offers excellent career opportunities. Take a look
at some of these diverse career options:
 Corporate manager;
 Investment banker;
 Financial advisor;
 Financial analyst;
 Financial examiners;
 Financial managers;
 Personal financial planners;
 Budget analysts;
 Investor relations associate or executive;
 Credit analyst.
Why is Financial Management important?
This form of management is important for various reasons.
Take a look at some of these reasons:
 Helps organizations in financial planning;
 Assists organizations in the planning and acquisition of
funds;
 Helps organizations in effectively utilizing and allocating
the funds received or acquired;
 Assists organizations in making critical financial decisions;
 Helps in improving the profitability of organizations;
 Increases the overall value of the firms or organizations;
 Provides economic stability;
 Encourages employees to save money, which helps them in
personal financial planning.
CHALLENGES IN FINANCIAL MANAGEMENT
Treasury Operations: Short -term fund management must be more
sophisticated. Finance managers could make speculative gains by anticipating
interest rate movements.
Foreign Exchange: Finance Managers will have to weigh the costs and benefits
of transacting in foreign exchange particularly now that the Indian economy is
going global and the future value of the rupee has became difficult to predict.
Financial Structuring: An optimum mix between debt and equity will be
essential. Firms will have to tailor financial instruments to suit their and
investors‟ needs. Pricing of new issues is also an important task for the
Finance Manager's portfolio now.
Maintaining Share Prices: In the premium equity era, firms must ensure that
share prices stay healthy. Finance managers will have to devise appropriate
dividend and bonus policies.
Ensuring Management Control: Equity issues at premium mean management
may lose control if it is unable to take up its share entitlements. Strategies to
prevent this and also initiate other steps to prevent dilution of management
control are vital.
Financial management refers to the strategic planning,
organizing, directing, and controlling of financial
undertakings in an organization or an institute. It also
includes applying management principles to the financial
assets of an organization, while also playing an important
part in fiscal management. Take a look at the objectives
involved:
 Maintaining enough supply of funds for the organization;
 Ensuring shareholders of the organization to get good
returns on their investment;
 Optimum and efficient utilization of funds;
 Creating real and safe investment opportunities to invest
in.
Financial management is also made up of certain elements. These include:
 Financial planning: This is the process of calculating the amount of capital
that is required by an organization and then determining its allocation. A
financial plan includes certain key objectives, which are:
o Determining the amount of capital required;
o Determining the capital organization and structure;
o Framing of the organization’s financial policies and regulations.
Financial control: This is one of the key activities in financial management.
Its main role is to assess whether an organization is meeting its objectives or
not. Financial control answers the following questions:
 Are the organization’s assets being used competently?
 Are the organization’s assets secure?
 Is the management acting in the best financial interests of the
organization and the key stakeholders?
 Financial decision-making: This involves investment and financing
with regards to the organization. This department takes decisions
about how the organization should raise finance, whether they should
sell new shares, or how the profit should be distributed.
The financial management department of any firm is handled by a
financial manager. This department has numerous functions such as:
 Calculating the capital required: The financial manager has to
calculate the amount of funds an organization requires. This depends
upon the policies of the firm with regards to expected expenses and
profits. The amount required has to be estimated in such a way that
the earning capability of the organization increases.
 Formation of capital structure: Once the amount of capital the firm
requires has been estimated, a capital structure needs to be formed.
This involves debt equity analysis in the short-term and the long-
term. This depends upon the amount of the capital the firm owns,
and the amount that needs to be raised via external sources.
 Investing the capital: Every organization or firm needs to invest
money in order to raise more capital and gain regular returns. Hence,
the financial manager needs to invest the organization’s funds in safe
and profitable ventures.
 Allocation of profits: Once the organization has earned a good
amount of net profit, it is the financial manager’s duty to efficiently
allocate it. This could involve keeping a part of the net profit for
contingency, innovation, or expansion purposes, while another part of
the profit can be used to provide dividends to the shareholders.
 Effective management of money: This department is also
responsible for effectively managing the firm’s money. Money is
required for various purposes in the firm such as payment of salaries
and bills, maintaining stock, meeting liabilities, and the purchase of
any materials or equipment.
 Financial control: Not only does the financial manager have to plan,
organize, and obtain funds, but he also has to control and analyze the
firm’s finances in the short-term and the long-term. This can be done
using financial tools such as financial forecasting, ratio analysis, risk
management, and profit and cost control.
Concept of Financial Management:
One way or the other, every day, everyone engages in financial
management without knowing it at best. People call it economizing. An
average housewife while spending money seeks alternative ways of getting
more value. Financial management as a discipline has come out of
economics to become a standalone profession, Financial Management
means planning, organizing, directing and controlling the investment,
financing, and dividend decisions so as to help the business achieve its
objectives. To facilitate the same it makes use of statistical, mathematical
and economic tools.

In simple terms it is an intelligent quest for optimal use of financial and

other economic resources. It is a combination of mathematical and
scientific precisions with variables from the ever complex human
behavior
Financial management refers to the efficient and effective
management of money (funds) in such a manner as to accomplish
the objectives of the organization. It is the specialized function
directly associated with the top management. The significance of
this function is not seen in the 'Line' but also in the capacity of
'Staff' in overall of a company. It has been defined differently by
different experts in the field.
It includes how to raise the capital, how to allocate it i.e. capital
budgeting. Not only about long term budgeting but also how to
allocate the short term resources like current liabilities. It also
deals with the dividend policies of the share holders..
Financial management can be defined as the management of the
finances of an organization in order to achieve the financial
objectives of the organization. The usual assumption in financial
management for the private sector is that the objectives for the
company are to maximize shareholders wealth.
Definitions of financial management
Financial management is an integral part of overall management. It is
concerned with the duties of the financial managers in the business firm.
The term financial management has been defined by Solomon, “It is
concerned with the efficient use of an important economic resource namely,
capital funds”. The most popular and acceptable definition of financial
management as given by S.C. Kuchal is that “Financial Management deals
with procurement of funds and their effective utilization in the business”.
Howard and Upton : Financial management “as an application of general
managerial principles to the area of financial decision-making.
Weston and Brigham : Financial management “is an area of financial
decision-making, harmonizing individual motives and enterprise goals”.
Joshep and Massie : Financial management “is the operational activity of a
business that is responsible for obtaining and effectively utilizing the funds
necessary for efficient operations.
Thus, Financial Management is mainly concerned with the effective funds
management in the business. In simple words, Financial Management as
practiced by business firms can be called as Corporation Finance or Business
Finance
General Objectives of Financial Management
The financial management is generally concerned with
procurement, allocation and control of financial resources of a
concern. The objectives can be-
 To ensure regular and adequate supply of funds to the concern.
 To ensure adequate returns to the shareholders which will
depend upon the earning capacity, market price of the share,
expectations of the shareholders.
 To ensure optimum funds utilization. Once the funds are
procured, they should be utilized 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 sound and
fair composition of capital so that a balance is maintained
between debt and equity capital.
Specific objectives of financial management
Effective procurement and efficient use of finance lead 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
Favorable 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.
Unfavorable 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.
 
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 an universally accepted concept in the field of
business.
Favorable 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
Unfavorable 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.
(vi) Wealth maximization can be activated only with the help
of the profitable position of the business concern.
NON-FINANCIAL OBJECTIVES
A company may have important non-financial objectives, which will limit the
achievement of financial objectives. Examples of non-financial objectives are as
follows.
The welfare of employees
A company might try to provide good wages and salaries, comfortable and safe
working conditions, good training and career development, and good pensions. If
redundancies are necessary, many companies will provide generous redundancy
payments, or spend money trying to find alternative employment for redundant staff.
The welfare of management
Managers will often take decisions to improve their own circumstances, even though
their decisions will incur expenditure and so reduce profits. High salaries, company
cars and other perks are all example of managers promoting their own interests
The provision of a service
The major objectives of some companies will include fulfillment of a responsibility to
provide a service to the public. Examples are the privatized British Telecom and
British Gas. Providing a service is of course a key responsibility of government
departments and local authorities.
The fulfillment of responsibilities towards customers
Responsibilities towards customers include providing in good time a product or
service of a quality that customers expect, and dealing honestly and fairly with
customers. Reliable supply arrangements, also after-sales service arrangements,
are important.
The fulfillment of responsibilities towards suppliers
Responsibilities towards suppliers are expressed mainly in terms of trading
relationships. A company‘s size could give it considerable power as a buyer. The
company should not use its power unscrupulously. Suppliers might rely on
getting prompt payment, in accordance with the agreed terms of trade
The welfare of society as whole
The management of some companies is aware of the role that their company has
to play in exercising corporate social responsibility. This includes compliance
with applicable laws and regulations but is wider than that. Companies may be
aware of their responsibility to minimize pollution and other harmful
externalities‘(such as excessive traffic) which their activities generate. In
delivering green 'environmental policies, a company may improve its corporate
image as well as reducing harmful externality effects. Companies also may
consider their positive 'responsibilities, for example to make a contribution to the
community by local sponsorship.
Other non-financial objectives are growth, diversification
and leadership in research and development. On-financial
objectives do not negate financial objectives, but they do
suggest that the simple theory of company finance, that the
objective of a firm is to maximize the wealth of ordinary
shareholders, is too simplistic. Financial objectives may
have to be compromised in order to satisfy non-financial
objectives.
SCOPE OF FINANCIAL MANAGEMENT
Financial management is one of the important parts of overall
management, which is directly related with various functional
departments like personnel, marketing and production.
Financial management covers wide area with multidimensional
approaches. The following are the important scope of financial
management.
1. Financial Management and Economics
Economic concepts like micro and macroeconomics are directly applied
with the financial management approaches. Investment decisions,
micro and macro environmental factors are closely associated with the
functions of financial manager. Financial management also uses the
economic equations like money value discount factor, economic order
quantity etc. Financial economics is one of the emerging area, which
provides immense opportunities to finance, and economical areas.
2. Financial Management and Accounting
Accounting records includes the financial information of the business
concern. Hence, we can easily understand the relationship between the
financial management and accounting. In the olden periods, both
financial management and accounting are treated as a same discipline
and then it has been merged as Management Accounting because this
part is very much helpful to finance manager to take decisions. But
nowadays financial management and accounting discipline are separate
and interrelated.
3. Financial Management or Mathematics
Modern approaches of the financial management applied large number
of mathematical and statistical tools and techniques. They are also
called as econometrics. Economic order quantity, discount factor, time
value of money, present value of money, cost of capital, capital
structure theories, dividend theories, ratio analysis and working capital
analysis are used as mathematical and statistical tools and techniques
in the field of financial management.
4. Financial Management and Production Management
Production management is the operational part of the business concern,
which helps to multiple the money into profit, Profit of the concern
depends upon the production performance. Production performance
needs finance, because production department requires raw material,
machinery, wages, operating expenses etc. These expenditures are
decided and estimated by the financial department and the finance
manager allocates the appropriate finance to production department.
The financial manager must be aware of the operational process and
finance required for each process of production activities.
5. Financial Management and Marketing
Produced goods are sold in the market with innovative and modern
approaches. For this, the marketing department needs finance to meet
their requirements. The financial manager or finance department is
responsible to allocate the adequate finance to the marketing
department. Hence, marketing and financial management are
interrelated and depends on each other
6. Financial Management and Human Resource
Financial management is also related with human resource
department, which provides manpower to all the functional
areas of the management. Financial manager should
carefully evaluate the requirement of manpower to each
department and allocate the finance to the human resource
department as wages, salary, remuneration, commission,
bonus, pension and other monetary benefits to the human
resource department. Hence, financial management is
directly related with human resource management.
APPROACHES TO FINANCIAL MANAGEMENT
Traditional Concept:
In the beginning of the present century, which was the starting point for the
scholarly writings on Corporation Finance, the function of finance was considered
to be the task of providing funds needed by the enterprise on terms that are most
favorable to the operations of the enterprise. The traditional scholars are of the
view that the quantum and pattern of finance requirements and allocation of
funds as among different assets, is the concern of non-financial executives.
According to them, the finance manager has to undertake the following three
functions
A) arrangement of funds from financial institutions;
B) arrangement of funds through financial instruments, Viz., shares, bonds, etc
C) looking after the legal and accounting relationship between a corporation and
its sources of funds. The traditional concept found its first manifestation, though
not systematically, in 1897 in the book ‘Corporation Finance’ written by Thomas
Greene. It was further impetus by Edward Meade in 1910 in his book,
‘Corporation Finance’. Later, in 1919, Arthur Dewing brought a classical book on
finance entitled “The Financial Policy of Corporation.”
The traditional concept evolved during 1920s continued to dominate academic
thinking during the forties and through the early fifties. However, in the later fifties
the traditional concept was criticized by many scholars including James C. Van
Horne, Pearson Hunt, Charles W. Gerstenberg and Edmonds Earle Lincoln due to
the following reasons:
1.The emphasis in the traditional concept is on raising of funds, This concept takes
into account only the investor’s point of view and not the finance manager’s view
point.
2. The traditional approach is circumscribed to the episodic financing function as it
places overemphasis on topics like types of securities, promotion, incorporation,
liquidation, merger, etc.
3. The traditional approach places great emphasis on the long-term problems and
ignores the importance of the working capital management.
4. The concept confined financial management to issues involving procurement of
funds. It did not emphasis on allocation of funds.
5. It blind eye towards the problems of financing non-corporate enterprises has yet
been another criticism.
In the absence of the coverage of these crucial aspects, the traditional concept
implied a very narrow scope for financial management. The modern concept
provides a solution to these shortcomings.
Modern Concept:
The traditional concept outlived its utility due to changed business
situations since mid-1950’s. Technological improvements, widened
marketing operations, development of a strong corporate structure, keen
and healthy business competition – all made it imperative for the
management to make optimum use of available financial resources for
continued survival of the firm.
The financial experts today are of the view that finance is an integral part
of the overall management rather than mere mobilization of the funds.
The finance manager, under this concept, has to see that the company
maintains sufficient funds to carry out the plans. At the same time, he
has also to ensure a wise application of funds in the productive purposes.
Thus, the present day finance manager is required to consider all the
financial activities of planning, organizing, raising, allocating and
controlling of funds. In addition, the development of a number of decision
making and control techniques, and the advent of computers, facilitated
to implement a system of optimum allocation of the firm’s resources.
These environmental changes enlarged the scope of finance
function. The concept of managing a firm as a system
emerged and external factors now no longer could be
evaluated in isolation. Decision to arrange a fund was to be
seen in consonance with their efficient and effective use.
This systems approach to the study of finance is being
termed as ‘Financial Management’. The term ‘Corporation
Finance’ which was used in the traditional concept was
replaced by the present term ‘Financial Management.’
The modern approach view the term financial management
in a broad sense and provides a conceptual and analytical
framework for financial decision-making. According to it, the
finance function covers both acquit ion of funds as well as
their allocation.
IMPORTANCE OF FINANCIAL MANAGEMENT
Finance is the lifeblood of business organization. It needs to meet the
requirement of the business concern. Each and every business concern
must maintain adequate amount of finance for their smooth running of the
business concern and also maintain the business carefully to achieve the
goal of the business concern. The business goal can be achieved only with
the help of effective management of finance. We can’t neglect the importance
of finance at any time at and at any situation. Some of the importance of the
financial management is as follows:
Financial Planning
Financial management helps to determine the financial requirement of the
business concern and leads to take financial planning of the concern.
Financial planning is an important part of the business concern, which
helps to promotion of an enterprise.
Acquisition of Funds
Financial management involves the acquisition of required finance to the
business concern.
Acquiring needed funds play a major part of the financial management,
which involve possible source of finance at minimum cost.
Proper Use of Funds
Proper use and allocation of funds leads to improve the operational
efficiency of the business concern. When the finance manager uses the
funds properly, they can reduce the cost of capital and increase the
value of the firm.
Financial Decision
Financial management helps to take sound financial decision in the
business concern.
Financial decision will affect the entire business operation of the
concern. Because there is
a direct relationship with various department functions such as
marketing, production personnel, etc.
Improve Profitability
Profitability of the concern purely depends on the effectiveness and
proper utilization of funds by the business concern. Financial
management helps to improve the profitability position of the concern
with the help of strong financial control devices such as budgetary
control, ratio analysis and cost volume profit analysis.
Increase the Value of the Firm
Financial management is very important in the field of increasing the
wealth of the investors and the business concern. Ultimate aim of any
business concern will achieve the maximum profit and higher
profitability leads to maximize the wealth of the investors as well as the
nation
Promoting Savings
Savings are possible only when the business concern earns higher
profitability and maximizing wealth. Effective financial management
helps to promoting and mobilizing individual and corporate savings.
Nowadays financial management is also popularly known as business
finance or corporate finances. The business concern or corporate sectors
cannot function without the importance of the financial management.
 
FUNCTIONS OF FINANCIAL MANAGEMENT
The finance functions are very important in the management of a business
organization. Irrespective of any difference in structure, ownership and
size, the financial organization of the enterprise ought to be capable of
ensuring that the various finance functions planning and controlling are
carried at the highest degree of efficiency. The profitability and stability of
the business depends on the manner in which finance functions are
performed and related with other business functions.
The finance functions may be broadly divided into two categories.
1.Executive finance functions and
2.Non-executive/Routine finance functions
The routine functions are repetitive in nature and the focus of financial
management will be on the executive functions.
The finance function mainly deals with the following three decisions:
1.Investment Decision.
2.Financing Decision.
3. Dividend Decision. 4. Liquidity decisions
Each of these functions must be considered in relation to the objective of
the firm. The optimal combination of these finance functions will
maximize the value of the firm to its shareholders. Fig. 1.1 given below,
clearly depicts how the decisions relating to three finance functions lead
to the maximization of the market value of the firm
1. Investment Decision

The investment decision relates to the selection of assets in which funds

will be invested by a firm. The assets which can be acquired fall into two
broad groups: (i) long-term assets which will yield a return over a period
of time in future, (ii) short-term or current assets defined as those assets
which are convertible into cash usually within a year. Accordingly, the
asset selection decision of a firm is of two types. The first of these
involving fixed assets is popularly known as ‘Capital Budgeting’. The
aspect of financial decision-making with reference to current assets or
short-term assets is designated as ‘Working Capital Management.
Capital Budgeting: Capital budgeting refers to the decision making process by
which a firm evaluates the purchase of major fixed assets, including buildings,
machinery and equipment. It deals exclusively with major investment proposals
which are essentially long-term projects. It is concerned with the allocation of
firm’s scarce financial resources among the available market opportunities. It is
a many-sided activity which includes a search for new and more profitable
investment profitable investment proposals and the making of an economic
analysis to determine the profit potential of each investment proposal.
Capital Budgeting involves a long-term planning for making a financing
proposed capital outlays. Most expenditures for long-lived assets affect a firm’s
operations over a period of years. They are large and permanent commitments,
which influence firm’s long-run flexibility and earning power. It is a process by
which available cash and credit resources are allocated among competitive long-
term investment opportunities so as to promote the highest profitability of
company over a period of time. It refers to the total process of generating,
evaluating, selecting and following up on capital expenditure alternatives.
Capital budgeting decision, thus, may be defined as the firm’s decision to invest
its current funds most efficiently in long term activities in anticipation of an
expected flow of future benefits over a series of years.
Because of the uncertain future, capital budgeting decision involves risk.
The investment proposals should, therefore, be evaluated in terms of
both expected return and the risk associated with the return. Besides a
decision to commit funds in new investment proposals, capital budgeting
also involves the question of recommitting funds when an old asset
becomes non-profitable. The other major aspect of capital budgeting
theory relates to the selection of a standard or hurdle rate against which
the expected return of new investment can be assessed.
Working Capital Management: Working Capital Management is
concerned with the management of the current assets. The finance
manager should manage the current assets efficiently for safe-guarding
the firm against the dangers of liquidity and insolvency. Involvement of
funds in current assets reduces the profitability of the firm. But the
finance manager should also equally look after the current financial
needs of the firm to maintain optimum production. Thus, a conflict
exists between profitability and liquidity while managing the current
assets. As such the finance manager must try to achieve a proper trade-
off between profitability and liquidity.
2. Financing Decision:
In this function, the finance manager has to estimate carefully the total
funds required by the enterprise, after taking into account both the
fixed and working capital requirements. In this context, the financial
manager is required to determine the best financing mix or capital
structure of the firm. Then, he must decide when, where and how to
acquire funds to meet the firm’s investment needs.
The central issue before the finance manager is to determine the
proportion of equity capital and debt capital. He must strive to obtain
the best financing mix or optimum capital structure for his firm. The
use of debt capital affects the return and risk of shareholders. The
return on equity will increase, but also the risk. A proper balance will
have to be struck between return and risk. When the shareholders
return is maximized with minimum risk, the market value per share will
be maximized and firm’s capital structure would be optimum. Once the
financial manager is able to determine the best combination of debt and
equity, he must raise the appropriate amount through best available
sources
The following points are to be considered while determining the
appropriate capital structure of a firm:
1. Factors which have bearing on the capital structure.
2. Relationship between earnings before interest and taxes (EBIT) and
earnings per share (EPS).
3. Relationship between return on investment (ROI) and return on
equity (ROE).
4. Debt capacity of the firm.
5. Capital structure policies in practice.
3. Dividend Decision:
It is a fact that in spite of the various other factors which influence the
market value of shares, dividend payment has been considered to be the
foremost. In this context, the finance manager must decide whether the
firm should distribute all profits or retain them, or distribute a portion
and retain the balance. Sometimes, the profits of the company are fully
diverted towards its capital expenditure or establishment of new projects
so as to minimize further borrowings. While there may be some
justification in diverting profits to some extent, the claims of shareholders
for dividends cannot be completely overlooked.
The finance manager has to develop such a dividend policy which divides
the net earnings into dividends and retained earnings in an optimum way
to achieve the objective of maximizing the market value of firm.
Optimum dividend policy requires decision on dividend payment rates so
as to maximize the market value of shares. The payout ratio means what
portion of earning per share is given to the shareholders in the form of
cash dividend. In the formulation of dividend policy, management of a
company must consider the relevance of its policy on bonus shares.
Dividend policy influences the dividend yield on shares. Since company's
rating in the Capital market have a major impact on its ability to procure
funds by issuing securities in the capital markets, dividend policy, a
determinant of dividend yield has to be formulated having regard to all
the crucial element in building up the corporate image. The following
need adequate consideration in deciding on dividend policy:
1. Preference of share holders - Do they want cash dividend or Capital
gains?
2. Current financial requirements of the company.
3. Legal constraints on paying dividends.
4. Striking an optimum balance between desires of share holders and
the company's funds requirements.
4. Liquidity Decision
Liquidity decisions are concerned with Working Capital Management. It
is Concerned with the day –to –day financial operation that involve
current assets and current liabilities.
The important element of liquidity decisions are:
1. Formulation of inventory policy
2. Policies on receivable management.
3. Formulation of cash management strategies
4. Policies on utilization of spontaneous finance effectively.
CONFLICT OF GOALS
In a corporate form of organization share holders will appoint the
directors and managing director to carry on the business on their
behalf. They represent the management. In a complex organization
various parties are interested in the affairs of a business. The parties
interested in the business are owners, creditors, customers, government
etc. The management may not necessarily act in the interest of owners
and may pursue its personal goals. In addition, they have to strike a
balance between the interest of owners and other parties interest, who
has stake in the business organization.
There can, however, arise situations where a conflict may occur between
the shareholders and the management goals. For example, management
may play safe and create satisfactory wealth for shareholders than the
maximum.
ORGANIZATION OF FINANCE DEPARTMENT
A well-organized finance department is absolutely essential for the
efficient financial management of an enterprise. If finance department
does not operate well, the whole organizational activity will be ruined.
Hence, it is essential that the finance department should be well
organized with nucleus staff from the time of project stage, so that expert
guidance and advise regarding the various proposals are available to the
management in planning and managing the project.
The finance function, although, is controlled by the top management,
there will be a separate team to look after these activities and this
function will be sub-divided according to the needs. A common structure
of the finance department cannot be evolved as the size of the firm and
nature of the business vary, from firm to firm.
Role of Finance Manager:
The finance manager, who is mainly responsible for managing the
finances of a firm, plays a dynamic role in the development of a modern
organization. For the effective conduct of finance function he is
responsible for assisting the managers and supervisors in carrying out
these activities and for ensuring that their line instructions confirm to
the relevant specialist policy. The Finance Manager besides supervising
the routine functioning of his department, also keeps the Board of
Directors informed on all phases of business activity, including the
economic, technological, social, cultural, political and legal environment
effecting business behavior.
The finance manager generally holds one of the senior-most positions in
the company, directly reporting to the President. He is primarily
responsible for the entire cost, finance, accounting and taxation
departments in addition to the overall administration and secretarial
departments.
The functions and responsibilities of the finance manager of a
company generally include the following:
i) To determine the extent of financial resources needed, and the way
these needs are to be met;
ii) To formulate programs to provide most effective profit volume-cost
relationship;
iii) To analyze financial results of all operations, reporting the fact to the top
management and make recommendations concerning future operations;
iv) To carry out special studies with a view to reducing costs and improving
efficiency and profitability;
v) To examine feasibility studies and detailed project reports mainly from
the point of view of overall economic viability of the project;
vi) To be the principal coordinating officer for preparing and operating long-
term, annual and capital budgets;
vii) To lay down suitable purchase procedures to ensure adequate control
over all purchases of raw material and equipment's, etc.,
viii)To advise the chief executive on pricing, policies, interdepartmental
issues including charging of overheads to jobs, etc;
i) To advise on all service matters to staff, such as scale of pay, dearness
allowance, bonus, gratuity etc;
ii) To act as principal officer in charge of accounts, including cost and
stores accounts and internal audit;
iii) To ensure that annual accounts are prepared in time according to the
provisions of the company law, and to attend to external audit;
iv) To be the custodian of the cash and the principal disbursing officer of
the enterprise;
v) To be responsible for attending to all tax matters;
vi) To ensure that market surveys are carried out by the management;
vii) To furnish prospective costs of products, to enable the management to
determine the optimum product max; and
viii)To prepare various period reports to be submitted to various
authorities including financial institutions government.
On other hand Finance manager performs the following major functions:
1. Forecasting Financial Requirements
It is the primary function of the Finance Manager. He is responsible to estimate the
financial requirement of the business concern. He should estimate, how much
finances required to acquire fixed assets and forecast the amount needed to meet the
working capital requirements in future.
2. Acquiring Necessary Capital
After deciding the financial requirement, the finance manager should concentrate how
the finance is mobilized and where it will be available. It is also highly critical in
nature.
3. Investment Decision
The finance manager must carefully select best investment alternatives and consider
the reasonable and stable return from the investment. He must be well versed in the
field of capital budgeting techniques to determine the effective utilization of
investment. The finance manager must concentrate to principles of safety, liquidity
and profitability while investing capital.
4. Cash Management
Present day’s cash management plays a major role in the area of finance because
proper cash management is not only essential for effective utilization of cash but it
also helps to meet the short-term liquidity position of the concern.
 
The nature and scope of financial management
The role of the Financial Manager is to make the right decisions in
order to achieve the
objectives of the company in the future.
The four key areas that the Financial Manager is concerned with
are as follows:
(a) The raising of long-term finance:
The company needs finance for investment and in order to expand.
Finance can be raised from shareholders or from debt – it is the job of
the Financial Manager to be aware of the different sources of finance
and to decide which source to use.
(b) The investment decision:
Decisions have to be made as to where capital is to be invested. For
example, is it worth launching a new product? Is it worth expanding
the factory? Is it worth acquiring another company?
It is the Financial Manager’s role to decide on which criteria to employ
in making this kind of investment decision.
(c) The management of working capital:
In order for the company to operate, it will have to accept a certain level
of receivables and it will have to carry a certain level of inventory.
Although these are needed to operate the business successfully, they
require long-term investment of capital that is not directly earning
profits.
Receivables and inventory are just two components of working capital
(working capital= current assets less current liabilities) and it is a job of
the Financial Manager to ensure that the working capital is managed
properly i.e. that it is high enough to enable to company to operate
efficiently, but that it does not get out of control and end up wasting
money for the company.
(d) The management of risk:
One of the roles of the Financial Manager is to manage the risk due to
changing exchange rates if the business trades abroad, and to manage
the risk due to changes in interest rates if the business borrows or
deposits money.
END OF CHAPTER ONE
Questions
1.What is financial management all about?
2. Explain why judging the efficiency of any financial decision requires
the existence of a goal
3. What are three major functions of the financial manager?
4. Contrast the objective of maximizing earnings with that of
maximizing wealth
5. If all the companies had an objective of maximizing shareholders
wealth, world people overall tend to be better or worse off?