Financial Management III Semester B.

Com

FINANCIAL MANAGEMENT
FINANCE- Meaning
Finance is defined as the provision of money at the time when it is required. The finance can
be basically classified into two:
1. Public finance
2. Private finance
Public finance deals with requirements, receipts and disbursements of funds in the
government institutions likes states, local self governments and central government.
Private finance concerned with requirements, receipts and disbursements of funds in the
case of individuals, a profit seeking business organisation and a non- profit business
organisation.
Private finance can be again classified into business finance, personal finance and finance
of non profit organisation.
Business Finance
Business finance can be defined as an activity of or process which is concerned with
acquisition of funds, use of funds and distribution of profits of a business firm. Business
finance can be again divided into 3 ie, sole trader finance, partnership finance and
corporate finance.
FINANCIAL MANAGEMENT
Financial management refers to that part of the management activity which is concerned
with the planning and controlling of firm’s financial resources.
Importance of financial management
1. Helps in financial planning and successful completion of an enterprise.
2. Helps in acquisition of funds as and when required at the minimum possible cost
3. Helps in proper use and allocation of funds
4. Helps in taking sound financial decisions
5. Helps in improving the profitability through financial control
6. Helps in increasing the wealth of the investors and nation
7. Helps in promoting and mobilising individual corporate savings
Finance function
It is the most important of all business functions, because the need for money is continuous.
AIMS OF FINANCE FUNCTION
1. Acquiring Sufficient Funds. The main aim of finance function is to assess the financial
needs of enterprise and then finding out suitable sources for raising them. The sources
should commensurate with the needs of the business. If funds are needed for longer periods
then long-term sources like share capital, debentures, term loans may be explored. A
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concern with longer gestation period should rely more on owner’s funds instead of interest-
bearing securities because profits may not be there for some years.
2. Proper Utilisation of Funds. The funds should be used in such a way that maximum
benefit is derived from them. The return from their use should be more than their cost. It
should be ensured that funds do not remain idle at any point of time. The funds committed
to various operations should be effectively utilised. Those projects should preferred which
are beneficial to the business.
3. Increasing Profitability. The planning and control of finance function aims at increasing
profitability of the concern. It is true that money generates money. To increase profitability,
sufficient funds will have be invested. Finance function should be so planned that the
concern neither suffers from inadequacy of fund nor wastes more funds than required. A
proper control should also be exercised so that scarce resources are r. frittered away on
uneconomical operations. The cost of acquiring funds also influences profitability of
business.
4. Maximising Firm’s Value. Finance function also aims at maximising the value of the firm.
A concern’s value is linked with its profitability. Besides profits, the type of sources used for
raising funds, the cost of funds, the condition of money market, the demand for products
are some other considerations which also influence a firm’s value.

SCOPE OF FINANCIAL MANAGEMENT

1. Estimating Financial Requirements.
The first task of a financial manager is to estimate short-term and long-term financial
requirements of his business. For this purpose, he will prepare a financial plan for present
as well as for future. The amount required for purchasing fixed assets as well as needs of
funds for working capital will have to be ascertained. The estimations should be based on
sound financial principles so that neither there are inadequate nor excess funds with the
concern. The inadequacy of funds will adversely affect the day-to-day working of the
concern whereas excess funds may tempt a management to indulge in extravagant
spending or speculative activities.

2. Deciding Capital Structure.

The capital structure refers to the kind and proportion of different securities for raising
funds. After deciding about the quantum of funds required it should be decided which type
of securities should be raised. It may be wise to finance fixed assets through long-term
debts. Even here if gestation period is longer, then share capital may be most suitable. Long-
term funds should be employed to finance working capital also, if not wholly then partially.
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Entirely depending upon overdrafts and cash credits for meeting working capital needs may
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not be suitable. A decision about various sources for funds should be linked to the cost of

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Financial Management III Semester B.Com

raising funds. If cost of raising funds is very high then such sources may not be useful for
long. A decision about the kind of securities to be employed and the proportion in which
these should be used is an important decision which influences the short-term and long-
term financial planning of an enterprise.
3. Selecting a Source of Finance.
After preparing a capital structure, an appropriate source of finance is selected. Various
sources from which finance may be raised, include : share capital, debentures, financial
institutions, commercial banks, public deposits, etc. If finances are needed for short periods
then banks, public deposits and financial institutions may be appropriate; on the other
hand, if long-term finances are required then share capital and debentures may be useful. If
the concern does not want to tie down assets as securities then public deposits maybe a
suitable source. If management does not want to dilute ownership then debentures should
be issued in preference to shares. The need, purpose, object and cost involved may be the
factors influencing the selection of a suitable source of financing.
4. Selecting a Pattern of Investment.
When funds have been procured then a decision about investment pattern is to be taken.
The selection of an investment pattern is related to the use of funds. A decision will have to
be taken as to which assets are to be purchased. The funds will have to be spent first on
fixed assets and then an appropriate portion will be retained for working capital. Even in
various categories of assets, a decision about the type of fixed or other assets will be
essential. While selecting a plant and machinery, even different categories of them may be
available. The decision-making techniques such as Capital Budgeting, Opportunity Cost
Analysis etc. may be applied in making decisions about capital expenditures. While
spending on various assets, the principles of safety, profitability and liquidity should not be
ignored. A balance should be struck even in these principles. One may not like to invest on a
project which may be risky even though there may be more
profits.

5. Proper Cash Management.

Cash management is also an important task of finance manager. He has to assess various
cash needs at different times and then make arrangements for arranging cash. Cash may be
required to (a) purchase raw materials, (b) make payments to creditors, (c) meet wage bills ;
(d) meet day- to-day expenses. The usual sources of cash may be: (a) cash sales , (b)
collection of debts, (c) short-term arrangements with banks etc. The cash management
should be such that neither there is a shortage of it and nor it is idle. Any shortage of cash
will damage the creditworthiness of the enterprise. The idle cash with the business will
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mean that it is not properly used. It will be better if Cash Flow Statement is regularly
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prepared so that one is able to find out various sources and applications. If cash is spent on

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Financial Management III Semester B.Com

avoidable expenses then such spending may be curtailed. A proper idea on sources of cash
inflow may also enable to assess the utility of various sources. Some sources may not be
providing that much cash which we should have thought. All this information will help in
efficient management of cash.
6. Implementing Financial Controls.
An efficient system of financial management necessitates the use of various control devices.
Financial control devices generally used are, : (a) Return on investment, (b) Budgetary
Control, (c) Break Even Analysis., (d) Cost Control, (e) Ratio Analysis (i’) Cost and Internal
Audit. Return on investment is the best control device to evaluate the performance of
various financial policies. The higher this percentage better may be the financial
performance. The use of various control techniques by the finance manager will help him
in evaluating the performance in various areas and take corrective measures whenever
needed.
7. Proper Use of Surpluses.
The utilisation of profits or surpluses is also an important factor in financial management. A
judicious use of surpluses is essential for expansion and diversification plans and also in
protecting the interests of shareholders. The ploughing back of profits is the best policy of
further financing but it clashes with the interests of shareholders. A balance should be
struck in using funds for paying dividend and retaining earnings for financing expansion
plans, etc. The market value of shares will also be influenced by the declaration of dividend
and expected profitability in future. A finance manager should consider the influence of
various factors, such as : (a) trend of earnings of the enterprise, (b) expected earnings in
future, (c) market value of shares, (d) need for funds for financing expansion, etc. A
judicious policy for distributing surpluses will be essential for maintaining proper growth
of the unit.

OBJECTIVES OF FINANCIAL MANAGEMENT

Financial management is concerned with the procurement and use of funds. Its main aim is
to use business funds in such a way that the firm’s value is maximised. The main objective
of a business is to maximise the owner’s economic welfare and it can be achieved by;
1. Profit maximisation
2. Wealth maximisation
Profit maximisation
Profit earning is the main aim of every economic activity. Profit is a measure of efficiency of
a business enterprise. The accumulated profits enable a firm to face risks like fall in prices,
competition from other units, etc. There are so many arguments in favour and against profit
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maximisation
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Financial Management III Semester B.Com

For:
ƒ When profit earning is the aim of business then the profit maximisation should be
the objective.
ƒ Profitability is the barometer of efficiency of a business organisation.
ƒ Profits are the main sources of finance for the growth of the business. So it should
aim maximising profits
ƒ Profitability is essential for fulfilling social goals.
Against:
ƒ The term profit is vague and it cannot be defined.
ƒ It ignores the time value of money and not considers the magnitude and timing of
earnings.
ƒ It does not consider the prospective earnings stream.
ƒ The effect of dividend policy on the market price of share is not considered.
ƒ Profit maximisation leads to exploiting workers and consumers
ƒ Immoral and leads to malpractices and corruptive actions
ƒ It leads to inequalities and lowers human values which are an essential part of an
ideal social system.
Wealth maximisation
When the firm maximises the stockholders wealth, the individual stockholder can use this
wealth to maximise his individual utility. In other words by maximising stockholder’s
wealth the firm is operating consistently towards maximising stockholder’s utility.
There are so many arguments in favour and against wealth maximisation, like;
For:
ƒ It serves the interest of all stakeholders of the business [shareholders, creditors,
employees etc]
ƒ Consistent with the objective of owner’s economic welfare
ƒ It implies the long term survival and growth of the business
ƒ It considers the risk factor and time value of money
ƒ The effect of dividend policy on market price of share is also considered
ƒ It leads to maximising shareholders utility
Against:
ƒ It is not socially desirable
ƒ It does not give an idea about, what the firm should do to maximise the wealth
ƒ It is not clear that whether the wealth of the shareholders or the wealth of the firm is
to be increased.
ƒ The objective faces difficulty when the management is separated from ownership
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Financial Management III Semester B.Com

FINANCIAL DECISIONS
It refers to the decisions concerning the financial matters of a business firm. They can be
broadly classified as under;
1. Investment decisions
2. Financing decisions
3. Dividend decisions
Investment decisions
It refers to the determination of total amount of assets to be held in the firm, the proportion
of the assets and business risk associated with it. In other words it is a decisions related to
the investment in fixed assets and current assets and the proportion of these two in the
business firm. Investment decisions are broadly classified into;
a. Long term investment decisions
b. Short term investment decisions
Long term investment decisions are known as the capital budgeting and short term
investment decisions are known as working capital management.
Financing decisions
It means the selection of the sources of fund which will make the optimum capital
structure. At the time of raising of finance the financial managers has to strike a balance
between various sources so that the overall profitability of the business firm and wealth of
the shareholders are maximised.
Dividend decisions
Dividend refers to that part of the profit of the company, which is distributed among its
shareholders. A dividend decision includes whether all the profit are to be distributed or
retain all the profit in the business or retain a part of the profit and distribute the rest as
dividend.

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Financial Management III Semester B.Com

TIME VALUE OF MONEY

The concept time value of money explains that the value of money received today is more
than the value of same amount of money received after a certain period. In other words
money received in the future is not as valuable as money received today. As per the time
value of money concept, the sooner one receives, the money the better it is. The value of
current receipt of money is higher than the future receipt of money after one year. This
phenomenon is known as time preference of money.
Reasons for time preference of money
1. The future is uncertain and involves risk. Therefore an individual can never be
certain of getting cash inflow in future and hence he will like to receive the money
today itself, instead of waiting for the future.
2. For people the present needs are more urgent than the future needs.
3. Opportunities available to invest the money received at the earlier days at the some
interest or otherwise to enhance the future earnings.
Techniques of Time Value of Money
There are 2 techniques to adjust time value of money;
1. Compounding technique
2. Discounting technique.
1. COMPOUNDING TECHNIQUE
The time preference for money encourages a person to receive money at present instead of
waiting for future. But he may like to wait if he duly compensated for the waiting time by
way of money at the end of a period. The future value of money at the end of a period can
be calculated by using the formula.
V1=V0(1+i)n
Where;
V1= future value of money at the end.
V0= value of money at the beginning
i = interest rate
n= no. of years
Doubling Period
Doubling period means the length of period within which an amount is going to take
double at a certain rate of interest. Doubling period can be calculated be following either
Rule 72 or Rule 69
Rule 72
Doubling period = 72/ Rate of interest
Rule 69
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Doubling period = 0.35+(69/ Rate of interest)

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Financial Management III Semester B.Com

Multiple compounding
Multiple compounding period means the compounding the interest more than once in a
year like, half yearly or quarterly.
VO= V1(1+i/m)m x n
where;
V1= future value of money at the end of a period
V0= value of money at the beginning
i = rate of interest
n= no. of years
m= frequency of compounding per year
Effective rate of interest
Effective rate of interest means the additional growth in the rate of interest due to multiple
compounding. It is because the actual rate of interest realised [effective rate of interest] in
multiple compounding is more than the normal rate of return.
EIR= (1+i/m)m-1
Where;
i = the normal rate of interest
m= frequency of compounding per year
Future value of series of payments
Vn= R1(1+i)n-1+ R2(1+i)n-2 + R3(1+i)n-3
Where;
Vn=future value of series of payments
R1= payment after first period
R2= payment after second period
R3= Payment after third period
i= rate of interest
n= no. of years
Compounded value of annuity
An annuity is a series of equal payments lasting for some specified duration. When cash
inflows occur at the end of each period the annuity is called a regular annuity or deferred
annuity.
Vn= R [(1+i)n-1+( 1+i)n-2+( 1+i)n-3]
or
Vn= R [ACF i,n]
Where;
Vn= future value of annuity
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R= equal payments
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n= No .of years

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Financial Management III Semester B.Com

i = rate of interest
ACF= annuity compound factor
Compounded value of annuity due
If the cash inflow occurs at the beginning of each period the annuity is called annuity due.
Vn= R [ACF i,n]( 1+i)
Where;
Vn= future value of annuity
R= equal payments
n= No .of years
i = rate of interest
ACF= annuity compound factor
2. DISCOUNTING TECHNIQUE
The present value is exact the opposite of compound value or future value. While the future
value shows how much sum of money becomes at future period, present value shows what
the present value of some future sum of money. The present value of money to be received
in future will always be less. The present value of a future sum of money can be calculated
as follows;
V0= Vn/ (1+i)
or
V0= Vn X DF i,n
Where;
V0= present value of money
Vn= future value of money
i = rate of interest
DF= discount factor
N= no.of years
Present value of series of payments
V0= [R1/(1+i)] +[R2/(1+i)2] +[R3/(1+i)3] +[R4/(1+i)4]
Where;
Vn=future value of series of payments
R1= payment after first period
R2= payment after second period
R3= Payment after third period
i= rate of interest
n= no. of years
Present value of annuity
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An annuity is a series of equal payments lasting for some specified duration.

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V0= R [ADF i,n]

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Financial Management III Semester B.Com

Where;
Vn=future value of series of payments
R= series of equal payments
i= rate of interest
n= no. of years
Present value of annuity due
If the cash inflow occurs at the beginning of each period the annuity is called annuity due.
V0= R [ADF i,n]( 1+i)
Where;
Vn=future value of series of payments
R= series of equal payments
i= rate of interest
n= no. of years
ADF= annuity discounting factor

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