finance is the set of activities dealing with the management of funds

8/14/2019 Finance is the Set of Activities Dealing With the Management of Funds

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FINANCIAL

MANAGEMENT

INTRODUCTION OF FINANCE

SCOPE OF FINANCEFUNCTION

ASSIGNMENT PRESENTED BY:

GROUP B

AMIT SINGH

BHASKER SINGH

RAJENDRA SINGH II

SAKSHI GAUR

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SANDEEP VERMA

INTRODUCTION

Finance is the set of activities dealing with the management of funds.

More specifically, it is the decision of collection and use of funds. It is abranch of economics that studies the management of money and otherassets.

Finance is also the science and art of determining if the funds of anorganization are being used properly. Through financial analysis,companies and businesses can take decisions and corrective actionstowards the sources of income and the expenses and investments thatneed to be made in order to stay competitive.

Finance is a field of study of the relationship of three things; time, risk

and money.

The Time Value of Money is one of three fundamental ideas that shapefinance.

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The Time Value of Money explains why, "A dollar today is worth morethan a dollar tomorrow". This is primarily due to the market forloanable funds and inflation. If someone has a dollar today then they

also have the opportunity to loan/invest that dollar at some interestrate. Therefore, a dollar today in time would be worth $1.00 plus someinterest rate. That is more than a dollar by itself in the future. Anexample for inflation would be, lets says youhave $1 and you can buy10 candies today. For the same 10 candies tomorrow you have to pay$1.20. So, due to inflation for the same 10 candies today you pay lessthanyou would pay tomorrow

Inflation refers to the decrease in the purchasing power. Deflationrefers to the increase in the purchasing power. In layman terms,inflation causes not the value of money to decrease but the amount of

consumables/items that you can now purchase to decline in quantity.Look at the example above. $1 is still $1 but after inflation theindividual can probably buy only 8 candies for the same $1 amount.

There are two values of money. One is the Present Value of Money andthe other is the Future Value of Money.

Second is the concept of "opportunity cost"; i.e. if a person deploys hismoney on one item or investment then he has given up theopportunity to do something else with it.

Third is the concept of risk. Let us say, I have earmarked $10,000towards investments and I decide that I will invest in Microsoft. I put allmy money in Microsoft (MSFT) all $10,000 of it. As on 5th Oct., 2006each share of Microsoft trades at $27.94. So, I would be able topurchase 357.91 shares of MSFT. My returns are completely dependenton how MSFT stock performs in the market and this means that if aMicrosoft product (i.e. Vista), fails in the marketplace, MSFT stock goestumbling down and reduces my investment in MSFT.

Thus, Risk can be defined as the probability of my investment erodingits own self.

In equity, the risk factor is higher than in debt financing and hence asan investor I look for equity to give me higher returns as I have takenhigher risk. If I buy US Treasury notes for that value, the investment isalmost risk free as the US Govt. stands to guarantee it and hence thereturn (typically, expressed as the rate of interest) is low. Thedifference between the returns from equity and from debt (USTreasury, etc) is the Risk Premium.

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Risk Premium is the reward given to an investor to take more risk.

Cash Flows and Financial Decisions ofHouseholds

(1) Cash raised by selling financial assets

(2) Cash invested in real assets (tangible and intangible).

(3) Cash generated by real assets.

(4) Cash consumed and reinvested.

(5) Cash invested in financial assets.

Decisions: Manage Cash Flow (1), (2), (4), (5).

Real investment decision: (2), (3).

Consumption/financing decision: (1), (4).

Saving and financial investment decisions: (5).

Objective: Grow wealth and achieve optimalconsumption.

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Realeconomicactivities

Household

FinancialAssets/Liabilitie

s Bonds Stocks Mortgages

(1(2

(3

(5

(4


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Cash flows and Financial Decisions of Firms

(1) Cash rose from investors by selling financial assets.

(2) Cash invested in real assets (tangible and intangible).

(3) Cash generated by operations.

(4) Cash reinvested.

(5) Cash returned to investors (debt payments, dividends, :)

Decisions: Manage Cash Flow (1), (2), (4), (5).

Investment: (2) ) (3).

Financing: (1), (4).

Payout: (5).

Risk management: (1), (5).

Objective: Create value for shareholders.

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Firmsoperations

Financialmanager

Investors Individuals Institutions Etc

(1)

(4

(5

(2

(3


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Financial decisions and asset valuation:

Real investment decisions

How real assets are priced.

Financing and payout decisions

How financial assets are priced.

Financial decisions and asset management:

Risk management decisions

How to meet future investment/financing needs.

Personal savings/financing/financial investment decisions

How to meet personal consumption needs.

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FUNCTION

The five basic corporate finance functions are described as those

functions related to;

1) Raising capital to support company operations and investments(financing functions);

2) Selecting those projects based on risk and expected return that arethe best use of a company's resources (capital budgeting functions);

3) Management of company cash flow and balancing the ratio of debtand equity financing to maximize company value (financialmanagement function);

4) Developing a company governance structure to encourage ethicalbehavior and actions that serve the best interests of its stockholders(corporate governance function); and

5) Management of risk exposure to maintain optimum risk-returntrade-off that maximizes shareholder value (risk managementfunction).

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The finance function consists of the people, technology, processes, and

policies that dictate tasks and decisions related to financial resourcesof a company. Depending on the organization and the industry inwhich it operates, this function may be simple or complex. Somefinance functions are overstaffed that is, they rely on individuals toperform both advanced and simple tasks while others are highlyautomated relying on people for decision making and policy settingexclusively. Regardless of the ratio of people to technology, the goal ofthe finance function is to serve the organization's financial/accountingneeds while laying a platform for the future. This means handlingclerical tasks, providing information to the organization and settingfinancial policies and strategies that will serve the company in the

future. To succeed in these three broad areas, the small and emergingbusiness must be prepared to develop a finance function that bothsuits its needs and can adapt to the growth and changes of thebusiness. The first step is to develop an adequate finance function. Todo this, it is important to understand the component parts.

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COMPONENT PARTS

The finance function consists of two basic component types: (1)concrete components and (2) soft components. Concrete componentsinclude all aspects of infrastructure including technology, software

applications, and processes, as well as the people who manage them.Soft components include the standards, strategies, models, and visionthat drive the finance/accounting aspect of the business. Eachcomponent stands on its own to an extent; however, ultimately allcomponents must be woven together in a way that serves the overallorganization objectives. It is not enough that all component parts exist;rather they must exist in harmony with one another, yielding synergiesthat serve the company's needs today and provide for the future.

Concrete Components

The term infrastructure, in this context, refers to all relevant concretecomponents of the finance function. These components may alreadyexist in the organization in some fashion, although they are notthought of as infrastructure. Regardless of how they were classified,these components were assessed for their usefulness and eitherpurchased or developed. In order for certain tasks to be undertaken ona regular basis, tools and processes must be put in place to managethem. Items of infrastructure can be classified into three major

categories: (1) finance organization, (2) information systems, and (3)processes.

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Technology. Nothing is more important than providing people with theright tools for the job. This means appropriately configured computers,communication devices, and planning tools. Simply buying the besttechnology may not always be the answer. A mistake repeated everyday by executives and business owners is falling prey to a vendorclaim that if the smartest or best machine is purchased, the usersobjectives will be met. The nature of the tasks to be performed mustbe taken into account before staff is outfitted with technology. Willdesktop computers suffice or will staff need laptops instead? Willfinance staff need cell phones or other types of communication

linkage? How about planning devices do staff need personal digitalassistants or other wireless devices to share documents and

Information remotely? Knowing whether staff will be performing tasksin one central location or performing tasks on the road will drivedecisions for technology.

The term information systems refer to the backbone technologyservers, switches, operating systems, protocols, and softwareapplications that will drive the finance function. Distinguished fromtechnology defined earlier, information systems have a broader impact

on the entire platform of the organizations technological capability.This term is used more on a macro-level as opposed to the termtechnology. Information systems give organizations the ability togather data in the business environment and translate it to knowledge.They also provide the ability to communicate information and datawithin and outside the organization. Information systems provide abasis for evaluating customers while allowing them to providefeedback to the organization. This aspect of infrastructure also allowsthe organization to link with information systems of customers andcompanies in the same industry to achieve synergies in buying,forecasting, billing, and collecting customer payments.

Processes are the protocols and procedures that envelop informationsystems. They leverage the impact of information systems and bridgethe gap between raw systems capability and company specific needs.Processes cannot be generic but must be customized and suited for aparticular organizations needs. To develop processes, the businessowner/manager must have an acute knowledge of the organization andwhat it is trying to accomplish. To succeed in process development,

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knowledge of employee capability, thresholds of technology, and limitsof systems also must be firmly grasped.

Soft Components

Soft components of the finance function are the more advancedconsiderations of the function itself. Policies, standards, strategies, andanalysis paradigms are examples of soft components. Thesecomponents cannot be bought or replicated necessarily from anoutside source; rather they are developed internally. It is managementresponsibility to develop the soft components of the finance functionand maintain them as the company grows and adapts to itsenvironment. The existence and relevance of soft components aregood litmus tests for the strength of management. Companies that arelacking in this area put the organization at risk and leave developmentof the finance area to chance. Allowing the finance function to evolve

on its own without a vision driven by strategies and formed withstandards could create more problems than it solves.

Developing finance strategies, standards, and policies may be a luxuryfor the small and emerging business owner when compared to the day-to-day necessities of keeping the organization running. It is importantto note, however, that most soft components of the finance functionare not developed overnight. In fact, rarely are they complete orrelevant for very long. Soft components are always developing andchanging as the business organization changes. Developing themshould be embraced as an aspect of organizational culture. Although

an organization may be able to enjoy success in its early years withoutattending to these components of the finance function, eventuallyissues in the business itself or business environment will demandthem. For example, infrastructure may suit a small and emergingbusiness in the short run, but increasing demands for information andnew ways to serve customers may necessitate change in this area.Absent the vision for development or the strategy for addressing futuredata needs, the finance function always will be a step behind, whichwill result in perpetual short-term decision mode. This may be costly inthe long run as managers purchase unscalable technology to solve animmediate need, only to find them repurchasing more technology ashort time later to accommodate evolving needs.

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Well-thought-out soft components will make development of allaspects of the finance function second nature. For example,developing financial analysis paradigms that are relevant to the

organization business fundamentals will drive IS needs. Theseparadigms will in turn drive the level of qualifications of personnel.Strategies then can be developed that implement relevant softwareapplications, technological tools, communication devices, and so on.This web of impact illustrates how all aspects of the finance functioncascade off the soft components. Practically speaking, the small andemerging business owner may not be focused on the mid- and long-term time horizon. Therefore, codifying areas of vision, strategy, andpolicy in the finance area may not be practical. It is important to note,however, that being aware of developing soft components at the earlystage of the organization will greatly benefit the business

owner/manager as the business matures. The high rate of change inthe business in its early years may render soft components irrelevantovernight. Laying a foundation of thought and intent to develop thisaspect of the finance function will become that much easier as thebusiness owner/manager matures with the business and becomessavvier in developing strategy.

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SCOPE OF FINANCE

Scope of finance deals with the application of finance knowledge indifferent areas of organization.

Management of Real and Financial Assets-

An organization requires two types of assets to carry out its business.

A. Real Assets-

1. Tangible Real assets-Like machinery, building etc.

2. Intangible Real assets-Like Patent, copy right, technologicalcollaborations.

B. Financial Assets-

These assets also called financial securities stocks, bonds, debentures,and loan.

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Management of Financial Resources ofOrganization

These are two types of funds that firms can raise-

1. Equity Capital-

Equity capital is share capital, that supply this capital to theorganization are the legal owner of the company. A company can raisethe equity capital from two sources.

1. Common equity shapes-The holders of common equity shares arecalled ordinary share holders and residual profit is distributed to them

as their share from the company which is called dividend.

2. Preference Shares-Preference share holders get their dividend atfixed rate from the company.

2. Debt Capital-

This is capital supplied by Creditors and Lenders to the company interms of loans or by purchasing some debt securities of the company.Lenders are not the legal owner of the company and they get theirreturns from the company at fixed rate. Debt capital can be raised

from two sources.

1. Banks and Financial Institutions in term of Loan.

2. From general investors by issuing the debentures to them.

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finance is the set of activities dealing with the management of funds

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