What is Finance Management (FM)?

Every business transaction affects a firm in two ways: first, it brings some benefit to the firm, and second, it incurs some cost to the firm for such benefit. In other words, every transaction makes a change in the firms wealth position. It simultaneously brings in and takes out resources. For example, when an asset is bought in the business, the firm is richer by that piece of asset after, and at the same time, it loses cash balance e ual to the price it has paid for the asset. !ow if this asset can create an income, which is greater than its purchase price, we can call this a good investment. "imilarly, if the purchase price could be negotiated below the market price of the asset, this income will be a little larger. #hus raising finance as re uired at a low cost and spending that for maximi$ing gains is exactly what management of finance means. %ore efficiently one can do that, more efficient a financial manager one is. Why Non-Finance Executives Should Know Finance? &lmost every managerial decision has some financial implication. "imilarly every financial decision of a firm impacts a wide number of crucial managerial decisions. #his simple fact could be an ade uate dose of motivation for the bon'finance executives to learn finance and sharpen their decision'making faculty. It is obviously not that executives of other managerial areas should be champions of financial management too. (ut hardly to deny the fact that a reasonable and working knowledge in the sub)ect should be of much help for the purpose of making better uality decisions. *ith a better understanding of finance, they will certainly be able to do their )ob more efficiently than ever before. +nowledge of finance will surely be surely a competitive advantage to them.

What are the asic !rinci"les in FM? ,et us start with (alance "heet. #he alance Sheet of a firm has two sides: #ssets side and $ia%ilities & 'a"ital side. &ssets side shows firms assets position, i.e., what investments the firm has made till date, while the liabilities and - capital side gives us the picture of how the firm has managed to raise finance for such investments. #herefore, the basic activity of F% is managing the investment and financing structures of the firm. #he following diagram shows the basic anatomy of a (alance "heet. $ia%ilities & 'a"ital Long-term Finance Short-term Finance #ssets Long-term Investments Short-term Investments

&s is evident then that the finance function moves around managing the finance and investment sides of a (alance "heet. If these two functions are done efficiently, and then

only a firm can expect to generate a comfortable surplus of income, followed by a comfortable distribution of the surplus or profit so earned. #hus we note there are three basic principles of finance management: ./ Financing Principle, 2) Investment Principle, and 3) Income Distribution or Dividend Principle. #hus we can find a three'step activity line for successful financial management of a business firm: 'hoose the %est investment route( )nvestment !rinci"le Select least ex"ensive *inancing sources( Financing !rinci"le +enerate and distri%ute "ro*it in a way that enhances mar,et "rice o* com"any-s equity shares( .ividend !rinci"le/ What are the ma0or Financial .ecisions a *irm necessarily has to address? ,ong'term Financial 0ecisions, which are known as 1apital "tructure 0ecisions2 "hort'term Financial 0ecisions, which are the *orking 1apital 0ecisions2 ,ong'term Investment 0ecisions, which are known as 1apital (udgeting 0ecisions2 and "hort'term Investment 0ecisions are the 1urrent &ssets 0ecisions.

Who is a Financial Manager and what he .1ES? & Financial %anager is a person who is responsibly carry out the finance functions of the firm. In a modern business firm, the finance manager plays a very crucial role. #he enterprises fortune largely depends on the finance managers role. 3is ma)or activities include: Raising unds or the irm: #his function the finance manager performs by selecting the best but the least expensive source or a combination of sources. %ore he does it efficiently, less would be the hurdle rate for the firm. !llocating unds: #his is the next crucial function for a finance manager. #he profitability of the firm widely depends on the efficient allocation of firms resources. 3e tries to select the most competitive investment portfolio to maximi$e the firms return. Pro it planning: 4rofit planning refers to the decision making in the areas of product pricing, cost determination, selecting the product line, and the right kind of output volume. #he extent of fixed and variable costs in the cost structure of the firm is of paramount importance. In fact, the profit planning is an essential prere uisite to the earlier functions. 3owever, this function is not certainly an exclusive finance function. 5ther managers also play e ually important role.

 "atching and analy#ing capital mar$et situation: 1apital market is wherefrom the firm raises its funds. #he firm has to tap resources from the capital market by selling its securities to the investors. "o if he fails to keep in touch with the changes taking place in the market, the firm will not be able to consider the best route of finance. #hat is why the managers feel so concerned about the "ensex movements. 2is,-2eturn 3rade-1**( # asic 'once"t in Finance Every business involves risk. #he return expected depends on the uantum of risk borne. If the firm bears greater risk, it will certainly expect greater return, and vice versa. (ecause if money is invested where return is more uncertain, for bearing this uncertainty naturally more return will be expected. #hus risk and return are perfectly correlated. #his correlation is positive since both risk and return move in the same direction. #his is known as risk'return trade'off. In real life decisions we are to make choices from among a number of alternative solutions. In such cases we need to examine the possible risk'return implications of the alternatives considered for the ultimate decision. ,et us have an example. &s we know borrowing is always a cheaper source of finance, one of the reasons is we can deduct the interest payment from the firms profit. &nd therefore the firm has to pay lesser income tax. "o more debt capital means, more such tax benefit, which reduces the cost of capital of the firm. (ut at the same time more borrowing means more risk exposure. #herefore unless we can make huge amount of profit, we should not go for big borrowing. In other words, the firm can take advantage this low cost finance only when it is making higher profits. 5therwise, in case of an economic downturn, the interest payment will be simply a burden to the firm since it is to be paid even if the firm has not earned ade uate profit. #hus the risk'return implications of different levels of borrowing needs to be thoroughly considered before we take a final decision on choosing the right kind of financing mode for the firm. What should %e the +oal o* FM? 7oal of managing finance in a firm always happens to be maximi$ing the market price of its e uity. In fact, the management of the firm should exert all its efforts toward shareholders value maximi$ation. &lthough there are many other groups of stakeholders in a company, such as, debenture'holders, employees, management etc., shareholders value maximi$ation serves everybodys purpose. &ll other groups are ultimately benefited through increases in the market value of company shares since if the market capitali$ation of the firm increases, it naturally ensures better servicing the other groups too.