Financial Management

Unit 1

Finance is regarded as life blood of a business enterprise. This is because in the modern
money-oriented economy, finance is one of the basic foundations of all kinds of economic
activities.

In general, finance may be defined as the provision of money at the time it is wanted.
Business Finance is that business activity which is concerned with acquisition and conservation
of capital funds in meeting financial needs and overall objectives of a business enterprise.

Meaning

Financial management study about the process of procuring and judicious use of financial
resources with a view to maximimising the value of the firm thereby the value of the owners is
maximized. Financial management is primarily concerned with acquisition, financing and
management of assets of business concern in order to maximize the wealth of the firm for its
owners.

Financial Management

Financial means procuring sources of money supply and allocation of these sources on the basis
of forecasting monetary requirements of the business. The word ‘Management’ refers to
planning, organizations, co-ordination and control of human activities and physical resources for
achieving the objectives of an enterprise. Thus, financial management is that part of business
management which is concerned with the planning and controlling of a firm’s financial resources
i.e. management of finance function. In other words, financial management is the ways and
means of managing money i.e. the determination, acquisition, allocation and utilization of
financial resources usually with the aim of achieving some particular goals or objectives.

Nature of Financial Management

1. Essential part of Business Management.

2. Continuous administrative function.

3. Scientific and analytical.

4. Centralised Nature.

5. Different From accounting.

6. Wide scope.
Functions of Financial Management

1. Financial Planning.

2. Financial Control.

3. Acquisition of Funds.

4. Allocation of Funds.

5. Distribution of Income.

6. Liquidity Function.

7. Profitability Function.

8. Evaluation of Performance.

9. Coordination with other departments.

Importance of Financial Management

1. Determinant of business success.

2. Optimal Utilization of Resources.

3. Focal point of Decision making.

4. Measurement of performance.

5. Basis of planning, coordination and control.

6. Advisory role.

7. Valuable to various parties like business managers, shareholders, investors, financial

institutions, government, etc.
Finance Function

Finance function is the process of acquiring and utilizing funds by a business. Thus, the main
finance function is the procurement of necessary funds for the business. Two approaches of
finance function:

• Traditional Approach; and

• Modern Approach

Traditional Approach of Finance Function

The basic objectives of financial management centres around:

(a) The procurement of funds from various sources.

(b) Effective utilization of funds to maximize profitability of the firm.

But with increase in complexity of modern business situation, the approach to financial
management has changed.

The traditional approach of financial management has limited the role of the finance manager
in the initial stages. According to this approach, the main function of finance was confined to the
procurement of funds. In brief, the main features of this approach were as follows:

1. Raising Funds: The main function of finance was to procure and manage required funds
from various sources for achieving the predetermined objective of the enterprise. This
necessitated for the finance manager to establish contacts with various institutions.
2. Episodic Function: Finance function was not related to day-to-day operations of the
enterprise, but it was concerned with procurement of funds to finance promotion,
expansion or diversification of activities. Thus, the occurrence of finance function was
episodic in nature.
3. Outsider-looking-in Approach: The function of finance was to lay more emphasis on
the guidance of investors rather than the internal management of the enterprise.
Therefore, it is also known as outsider-looking-in approach.
4. Long-term Financing: This approach emphasises more upon sources and problems of
long-term financing. It does not take into consideration the problems of working capital
management or short-term financing.
5. Descriptive Nature: The treatment of different aspects of finance was more of a
descriptive nature rather than analytical. In fact, there was no analytical financial
decision-making as such.

Modern Approach of Finance Function

The traditional approach of finance function was very descriptive. It was very much like an
encyclopedia and was not sufficiently analytical. It emphasised on episodic financing and lacked
the necessary theoretical support. Consequently, it outlived its utility in the changing business
situations.

According to this modern approach, finance function means activities relating to planning,
procurement, control and administration of funds used in the business. This new approach with
broadened view, incorporates all the financial activities of an enterprise. In this new approach,
the objectives of an enterprise can be achieved by proper financial planning, raising capital
economically, rational investment and effective use of funds.

Financial Decisions

In financing decisions, a financial manager has to decide about the amount of capital required;
proportion of debt and equity capital (capital structure) and selection of the sources of funds. The
amount of capital required is ascertained by forecasting the investment in fixed, current and
intangible assets. Capital structure is determined by the proportion of debt and equity capital in
total capital invested. Summarizing, the above we have the following financing decision: -

1. Determining degree of gearing.

2. Determining of financing pattern long-term funds requirement.

3. Determining of financing pattern medium and short-term funds requirement.

4. Raising funds through issue of financial instrument.

5. Arrangement of funds from banks and financial institutions.

6. Arrangement of finance for working capital requirement.

7. Consideration of interest burden on the firm.

8. Study of impact of stock market and economic condition of country on modes of

financing.

Investment Decisions

Investment decisions pertain to the allocation of funds raised with a view to acquire assets. These
assets are of two types i.e. fixed assets and current assets. Decisions regarding investment in
fixed or long-term assets are based on the cost and benefits or returns arising from these assets.
These are called capital budgeting decisions. Decisions regarding investment in current or short-
term assets are taken keeping in view the profitability and liquidity.Thus investment decisions
broadly includes: -

1. Ascertainment of total volume of funds, a firm can commit.

2. Appraisal and selection of capital investment proposals.

 3. Measurement of risk and uncertainty.

4. Funds allocation.

5. Determining fixed assets to be acquired.

6. Determining level of investment in current assets.

7. Restructuring, reorganization, mergers and acquisitions

8. Asset replacement decisions.

Dividend Decisions

Dividend decisions pertains to allocation of income and is very important function of financial
manager. The term ‘dividend’ refers to that part of profits of a company which is distributed by it
among its shareholders. It is the reward to shareholders for investment made by them in the share
capital of the company. Hence, the financial manager has to decide about the portion of net
profits that should be retained in the business and the portion of the net profits which should be
distributed to shareholders in the form of cash dividend.

Manager’s Role

In modern approach, some of the key functions of a manager are as follows:

1. Raising of funds.

2. Allocation of funds.

3. Profit planning: - It includes operating decisions in the areas of pricing, costs,

volume of output, etc.

4. Understanding capital markets.

ORGANISATION FOR FINANCE FUNCTION

Board of Directors

Managing Director

Productio Personnel Financial Marketing

n Director Director Director Director

Treasur
Controller
er

Credit Planning Inventory

Auditing Manageme and Managem
nt budgeting ent

Performanc
Accountin
Retirement Cost control e
g
benefits Evaluation
ORGANISATION CHART OF FINANCE FUNCTION OF A BIG COMPANY

Board of Directors

Managing
Director/President

Finance Director/ Chief

Finance Officer

Financial
Internal Auditor Treasurer
Controller

Manager Management Cash

Corporate
Accounts Accountant Manager
Finance &
Funding
Foreign Manager
Manager Manager Exchange
Credit Taxation Manager
EMERGING ROLE OF FINANCE MANAGERS IN INDIA

Functions of a financial manager are as follows: -

1. Financial Planning and Forecasting.

2. Funds Management.

3. Disposal of profits.

4. Maximization of shareholders’ wealth.

5. Interpretation and Reporting.

6. Lebal obligations.

7. Advisory role.

8. Financial Public relations.

9. Responsibilities to various parties.

Chief Finance Officer

The information age has given a fresh perspective on the role of financial management and
finance managers, with the shift in paradigm it is imperative that the role of chief finance officer
(CFO) changes from a controller to a facilitator.

As a facilitator, he transforms into a ‘strategic leader’ who is able to

1. Use the networking systems.

2. Face the external complexities.

3. Strategic financial planning.

4. Hedging foreign exchange risk.

5. Raising low cost funds from global market.

6. Meeting the regulatory provisions of international financial markets.

7. Dissemination of financial information about the firm.

8. Improve the market efficiency.

9. Improve capital productivity.

The various important functions of a financial controller in a large business firm consist of the
following:

1. Provision of capital - To establish and execute programmes for the

provision of capital required by the firm.

2. Investor relations - Establishing and maintaining adequate market for

the company’s securities.

3. Short-term financing - To maintain adequate sources for company’s current

borrowing from commercial banks and other lending institutions.

4. Banking and custody.

5. Credit and collection.

6. Investments.

7. Insurance.

8. Planning for control - To establish, co-ordinate and administer an

adequate plan for the control of operations.

9. Reporting and interpreting.

10. Evaluating and consulting.

11. Tax administration - To establish and administer tax policies and

procedures.

12. Government reporting- To supervise the preparation of reports to government

agencies.

13. Protection of assets - To ensure protection of assets for the business

through internal control, internal auditing and proper insurance coverage.

14. Economic appraisal - To appraise continuously economic, social forces

and government influences, and to interpret their effect upon the business.

15. Managing funds - To maintain sufficient funds to meet the financial

obligations.

16. Measuring of return - To determine required rate of return for investment

proposals.

17. Cost control - To facilitate cost control and cost reduction by

establishment of budgets and standards.
 18. Price setting - To supply necessary information for setting of
prices of products and services of the concern.

19. Forecasting profits - To collect relevant data to make forecast of future

profit levels.

20. Forecast cashflow - To forecast the sources of cash and its probable
payments and to maintain necessary liquidity of concern.

Summarizing the role and responsibilites of a CFO: -

1. Corporate Goals.

2. Financial Projections.

3. Review of financial statements.

4. Resource management.

5. Corporate Governance.

6. Mergers and Acquicitions.

7. Risk Management.