Financial management

Module - 1

Introduction:

Either for individuals or business houses, financial management is important to achieve their goals, that is, the method to raise funds at the lowest cost and to get the maximum return on invested capital.

It is true that business needs more money to make more money, and it is possible only when it is properly managed

Hence efficient management of every business enterprises is closely linked with efficient management of its finance.

Business finance:Business finance refers to money and credit employed in business.

The need for business finance arises for the following purposes:To acquire fixed assetsTo purchase raw-materials/goodsTo acquire services of human beingTo meet other operating expensesTo adopt modern technologyTo meet contingenciesTo expand existing operationsTo diversifyTo avail of business opportunities

Finance:

Traditionally finance was only limited to procurements of the funds for the organization. The funds were needed to finance the expansion or diversification.

Modern theory of finance considered finance as a separate discipline and have a wider perspective. Its not only limited to procurement but increased its limit to cover efficient allocation and effective administration of fund. It has become an integral part of overall management.

Financial management:

Financial management is basically the application of general management principles to the areas of financial decision-making such as investment, financing, dividend & working capital with a view to maximize the wealth of the company. Thus, financial management answers the following basic questions:

Where to invest?From where to raise funds?How much earnings to be retained and how much to be

distributed?How to manage working capital?

Objectives of financial management:

The objective of financial management may be:To maximize profitTo maximize earning per shareTo minimize costTo maximize market shareTo maximize the current value of the company’s

stock

Profit maximization:Profit maximization implies maximizing the rupee income

of the firm.Arguments in favor of profit maximization:Profit is a yardstick of efficiency on the basis of

which economic efficiency of a business can be evaluated.It helps in efficient allocation and utilization of scarce

means because only such resources are applied which maximize the profits.

The rate of return on capital employed is considered as the best measurement of the profits.

Profit acts as motivator which helps the business organization to be more efficient through hard work.

By maximizing profits, social & economics welfare is also maximized.

Objections to profit maximization:

It is vagueIt ignores the timing of returnsIt ignores riskIt assumes perfect competitionIn new business environment profit

maximization is regarded as UnrealisticDifficult Inappropriateimmoral

EPS maximization as the objective of FM:

Maximizing EPS implies that the total earnings are retained and re-invested in the business of the firm and no portion of the earnings is distributed as dividend among the share holders so long as earnings can be re-invested at a rate of return higher than the opportunity cost of retained earnings.

Cost minimization as the objective of FM:

Costs minimization implies making the product/ service available at minimum cost.

Such policy may not always result in highest sales revenue of highest profit.

Since market value is not a function of cost, minimizing cost will not result in highest price for company's shares.

Hence, such a policy may not always work as primary goal of financial management.

Market share maximization as the objective of FM:

Market share maximizing implies maximizing sales revenue by serving maximum number of customer.

Such policy may not always result in highest profit.Since market value is not a function of market share,

maximizing market share will not result in highest price for company's shares.

Hence, such a policy may not always work as primary goal of financial management.

Value maximization as the objective of FM:

The primary objective of financial management is wealth maximization.

Value maximization implies:Maximizing value of the firmMaximizing shareholders valueMaximizing share price The goal is to maximize shareholders wealth. Wealth

maximizing means maximizing the Net present value of a course of action. The wealth of owners of a company is reflected by the market value of company's shares in the long run.

Arguments in favour of wealth maximization:

It maximizes the net present value of a course of action to shareholders.

It accounts for the timing and risk of the expected benefits

Benefits are measured in terms of cash flowsIt serves the fundamental objective i.e. maximizes the

market value of the firms shares.

Other objectives:

To ensure timely optimal procurement of adequate funds at reasonable cost after balancing the risk, cost and control considerations.

To ensure effective utilization of fundsTo ensure adequate supply of funds as and when

neededTo ensure safety of the funds through creation of

reserves, re-investment of profits etc.

Functions of a financial manager:

1. Primary functions: Estimating the capital requirements Financing or capital structure decision Utilization of funds or investment decision Disposal of surplus or dividend decision Management of cash Financial control

2. Subsidiary functions:

Ensuring the optimum level of inventory and receivables

Supplying funds to all the parts of the organizationEvaluating financial performance of various units of

the organizationCarrying out financial negotiations with financial

institutions, banks, underwriters and inter-corporate depositors( ICD)

Keeping track of stock exchange quotations and behavior of share prices.

Finance functions or decisions in financial management:

Financing decisionsInvestment decisions Dividend policy decision Liquidity Decision

Financing Decisions 

Financing Decisions are decisions regarding process of raising the funds. This function of finance is concerned with providing answers to various questions like -

What should be amount of funds to be raised?What are the various sources available to organization for

raising the required amount of funds? What should be proportion in which internal & external

sources should be used by organization?If organization, wants to raise funds from different

sources, it is required to comply with various legal & procedural formalities.

What kinds of changes have taken place recently affecting capital market in the country?

Investment decisions

Investment decisions are decisions regarding application of funds raised by organization. These relate to selection of the assets in which funds should be invested.

The assets in which funds can be invested are of 2 typesFixed assets:- are the assets which bring returns to

organization over a longer span of time. The investment decisions in these types of assets are “capital budgeting decisions.” Such decisions includeHow fixed assets should be selected to

make investment ? What are various methods available to evaluate investment proposals in fixed assets?

How decisions regarding investment in fixed assets should be made in situation of risk & uncertainty?

Current assets:- are assets which get generated during course of operations & are capable of getting converted in form of cash with in a short period of one year. Such decisions includeWhy need for working capital arises?What are factors affecting requirements of

working capital?How to quantity requirements of working capital?What are sources available for financing the

requirement of working capital?

Dividend Policy Decisions:

Dividend Policy Decisions:- Such decisions include:What are forms in which dividend can be paid to

share holders?What are legal & procedural formalities to be

completed while paying dividend different forms?

Liquidity Decisions:

Liquidity Decisions:- Current assets should be managed efficiently for safe guarding firm against of liquidity & insolvency.

In order to ensure that neither insufficient nor unnecessary funds are invested in current assets, the financial manager should develop sound technique of managing current assets.

Organization of finance function:

Functions of chief financial manager:Chief Financial manager is the top officer of finance department. In

America he is known as Vice-president Finance and in India he is called Chief Financial Controller. He performs following functions:(1) Financial Planning 

(2) Procurement of Funds (3) Co-ordination:- Financial manager establishes co-ordination

among the financial needs of various departments. He is a member of finance committee.(4) Control:- Financial manager examines whether the work is being performed as per pre-determined standards or not. He gets the reports prepared, controls the cost and analyses profits.(5) Business Forecasting: - Financial manager evaluates the effects of all national, international, economic, social and political events on industry and company.(6) Miscellaneous Functions: - It includes the management of assets, management of inventory, arrangement of data and management of bank deposits etc.

Functions of treasurer:

The following are the functions of treasurer. Provisions of finance:- It includes the estimation of funds

necessary for procurement preparing programmes and implementing them, establishing relation among various sources of funds, issuing the securities and managing debt etc.

Banking Function:- It includes opening bank accounts, depositing cash, payment of company liabilities, accounting cash receipts & payments, responsibility for transacting actual assets etc.

Custody:- The treasurer is the custodian of funds and securities.Management of credit and collection: - The treasurer

determines credit risk of customers and arranges for collection.InvestmentsInsurance

Functions of controller: Planning:- The controller prepares plan for controlling

the business activities which are the main constituents of management and in which proper arrangement regarding profit planning, capital expenditure planning, sales forecasting and expenditure budgeting is made.

Accounting Auditing: - Controller Manages internal auditing Reports Government Reporting: - Controller sends essential

information’s to the government by obeying the legal requirement.

Tax Administration: - Controller prepares statement on tax liability.

Economic Appraisal: - He determines and analyses the effect of economic and social factors on business.