Financial management is broadly concerned with the acquisition and use of funds by a business firm.

Its scope
may be defined in terms of the following questions :

How large should the firm be and how fast should it grow ?

What should be the composition of the firms assets ?

What should be the mix of the firms financing ?

How should the firm analyse, plan, and control its financial affairs ?

EVOLUTION OF FINANCIAL MANAGEMENT

Financial management emerged as a distinct field of study at the turn of this century. Its evolution may be
divided into three broad phases (though the demarcating lines between these phases are somewhat
arbitrary) : the traditional phase, the transitional phase, and the modern phase

The traditional phase lasted for about four decades. The following were its important features :

The focus of financial management was mainly on certain episodic events like formation, issuance of
capital, major expansion, merger, reorganization, and liquidation in the life cycle of the firm.

The approach was mainly descriptive and institutional. The instruments of financing, the institutions
and procedures used in capital markets, and the legal aspects of financial events formed the core of
financial management.

The outsiders point of view was dominant. Financial management was viewed mainly from the point
of the investment bankers, lenders, and other outside interests.

A typical work of the traditional phase is The Financial Policy of Corporations1 by Arthur S. Dewing. This
book discusses at length the types of securities, procedures used in issuing these securities, bankruptcy,
reorganisations, mergers, consolidations, and combinations. The treatment of these topics is essentially
descriptive, institutional, and legalistic.

The transitional phase being around the early forties and continued through the early fifties. Though the
nature of financial management during this phase was similar to that of the traditional phase, greater
emphasis was placed on the day-to-day problems faced by finance managers in the areas of funds
analysis, planning, and control. These problems, however, were discussed within limited analytical
frameworks. A representative work of this phase is Essays on Business Finance by Wilford J. Eiteman et
al.

The modern phase began in the mid-fifties and has witnessed an accelerated pace of development with
the infusion of ideas from economic theory and application of quantitative methods of analysis. The
distinctive features of the modern phase are :

The scope of financial management has broadened. The central concern of financial management is
considered to be a rational matching of funds to their uses in the light of appropriate decision criteria.

The approach of financial management has become more analytical and quantitative.

The point of view of the managerial decision maker has become dominant.

Since the being of the modern phase many significant and seminal developments have occurred in the
fields of capital budgeting, capital structure theory, efficient market theory, option pricing theory, arbitrage
pricing theory, valuation models, dividend policy, working capital management, financial modeling, and
behavioural finance. Many more exciting developments are in the offing making finance a fascinating and
challenging field.

Chief Finance Officer

 Treasurer Controller

Cash Credit Financial Cost

Manager Manager Accounting Accounting
Manager Manager

Capital Fund Tax Data

Budgeting Raising Manager Processing
Manager Manager Manager

Portfolio Internal
Manager Auditor

What odes financial management involve ?

The critical activity of the financial management process is that of financial decision-
making, specifically decisions aimed at creating maximum value for the owners of the
business. Decisions about spending, investing, or borrowing money, for example, are
important financial decisions with which most of us are from time to time concerned. In
the operation of a business enterprise the key function of the financial manager involves
evaluating these of decisions. As we have seen in the Coffee Ventures scenario, the
financial manager will be primarily concerned with two main types of interrelated
decisions :

1 investment decisions; and

2 financing decisions.

Investment decisions identifying the assets or projects in which the firms limited financial
resources should be invested. Financing decisions involve deciding on the most cost-
effective method of financing the chosen investments. Should debt or equity finance be
used, or perhaps a mix of both ?
 The assets in which the firm invests can be real assets, such as fixed tangible assets
(e.g. property and equipment), intangible assets (e.g. register patents and trademarks)
and financial assets (e.g. shares and bank deposits).

Most of the assets which appear on a firms balance sheet are of the tangible type
building, equipment, inventories, and so on. Intangible assets on the balance sheet will
include registyered patents, trademarks, and often brand names.

However, many of what are considered to be investments in intangible assets cannot

appear on a balance sheet. These would include expenditures in such areas as
research and development, marketing and advertising staff training and development,
customer service and quality.

Undoubtedly investments of this nature are vital in todays competitive business

environment and add considerably to the reputational capital of a firm in the financial
markets, but from a purely technical accounting point of view these expenditures cannot
be capitalised, that is, treated as assets in the balance sheet. Expenditures of this type
are charged as expense items to the profit and loss account as they are incurred.

We will now take a closer look at the respective characteristics of investment and
financing decisions.

Investment decisions

These can be broken down into :

1 strategic investment decisions (SIDs); and

2 tactical / operational investment decisions.

Strategic investment decision

These are concerned with investing in the long-term, wealth-creating assets of the
business, such as investments in fixed tangible assets (e.g. land and buildings) or the
acquistion of other businesses.

Strategic investment decisions will normally involve committing very substantial sums of
money to selected investment projects for long periods into the future, usually in the face
of considerable risk and uncertainty. Yet, as we shall see later, it is the strategic
investment decisions which have the potential for creating real value for the business,
and thus wealth for its owners.

It is the quality of its strategic investment decision which are absolutely crucial to the
long-term success of a business. Strategic investment decision-making is the subject of
Part 4, Chapters 10 to 12.

Tactical / operational investment decisions

These relate to investing in medium to short-term assets such as stocks, debtors,

bank, and money market deposits. These are the assets which are essential to the firms
 day-to-day operations. Short-term investment decision-making is presented in part 7,
Chapters 17 to 19.

Financing decisions

These can similarly be analysed as :

1 strategic financing decisions; and

2 tactical / operational financing decisions.

Strategic financing decisions

These involve determining the most suitable long-term financing arrangements for the
firm - the arrangements for financing its long-term, wealth-creating assets. The primary
source of long-term financing for the firm is the capital markets, the role of which is
discussed in Chapter 4.

The strategic financing decision typically involves deciding what is the most appropriate
mix or bend of equity and long-term debt finance in the firms capital structure
sometimes called the capital structure decision. Capital structure decisions, and their
links, if any, to the value of the firm, is a very controversial issue in financial
management, an issue which is addressed in Chapter 13.

An essential and important part of the strategic financing relates to a firms dividend
policy, and is often referred to separately as the dividend decision. Dividend policy
involves deciding how much of the firms earnings should be paid out to shareholders in
the form of dividends in return for their investment in the firm, and how much should be
retained to finance the firms future investment plans.

Like capital structure, the relevant or otherwise of dividend policy in the determination of
a firms vale is also a controversial topic in financial management and is explored in
chapter 14.

Tactical and operational financing decisions

These concern how best to finance the firms investment in its medium and short-term
assets respectively. For example, deciding on the most appropriate method(s) of
financing the investment needed in current assets such as stocks and debentures.
Short-term financial decision-making is one of the themes in Part 7.

The skill and competence with which investment and financing decisions are made will
distinguish the effective financial manager from the ineffective financial manager. Taken
together the outcomes of theses two main types of decisions will determine the
value of the firm and as we have seen, the goal of maximising the market value of the
firm is the focus for corporate financial decision-making.