Course Code and Title: DM102 – Financial Management

Lesson Number: (Week 2) Lesson 1:

Topic: Introduction to Financial Management
 Definition of Financial Management
 The role of Finance in Business
 The Functions of Financial Manager
 Forms of Business Organizations

Introduction:

Business concern needs finance to meet their requirements in the economic world. Any
kind of business activity depends on the finance. Hence, it is called as lifeblood of business
organization. Whether the business concerns are big or small, they need finance to fulfill their
business activities. In the modern world, all the activities are concerned with the economic
activities and very particular to earning profit through any venture or activities. The entire
business activities are directly related with making profit. (According to the economics concept
of factors of production, rent given to landlord, wage given to labor, interest given to capital and
profit given to shareholders or proprietors), a business concern needs finance to meet all the
requirements. Hence finance may be called as capital, investment, fund etc., but each term is
having different meanings and unique characters. Increasing the profit is the main aim of any
kind of economic activity.

Learning Objectives:
At the end of this lesson, you should be able to:
1. explain the evolution of finance as a recognized field of study;
2. discuss the goals and functions of Financial Management; and
3. describe the primary activities of the Financial manager in achieving the goal of
organization

4. appreciate the role of finance in business

Pre-Assessment:

Choose the letter of the best answer. Write your answer on the sheet provided.
1. Which is/are the goal/s of business?
2. This function of Financial management involves decisions concerning the allocation
of funds to various projects.
a. Liquidity function c. Dividend function
b. Financial function d. Investment function
3. The customary feature of this form of business is that the owner is inseparable from the
business.

a. Sole Proprietorship c. Partnership

b. Corporation d. None of the above

4. It is an area of financial decision-making, harmonizing individual motives and enterprise

goals.

a. Finance c. Corporation
b. Business d. Financial management
5. They have the responsibility of overseeing the finances of major companies, agencies and
everything in between.

a. Restaurant manager c. Store manager

b. Finance Manager d. Control manager

Lesson Presentation:

DEFINITION OF FINANCE

What is Finance?
Finance is the science of managing funds, it's about how to manage investment and
control firm's funds, financial management has been the concern of many investors as which
project to be invested and selecting the best alternative to invest regarding the possible risk
and return trade-offs.

Finance is defined by Webster’s Dictionary as “the system that includes the circulation of
money, the granting of credit, the making of investments, and the provision of banking
facilities.” Finance has many facets, which makes it difficult to provide one concise definition.

DEFINITION OF BUSINESS FINANCE

 According to the Wheeler, “Business finance is that business activity which concerns with
the acquisition and conversation of capital funds in meeting financial needs and overall
objectives of a business enterprise”.

According to the Guthumann and Dougall, “Business finance can broadly be defined as
the activity concerned with planning, raising, controlling, administering of the funds used in
the business”.

In the words of Parhter and Wert, “Business finance deals primarily with raising,
administering and disbursing funds by privately owned business units operating in
nonfinancial fields of industry”.

Corporate finance is concerned with budgeting, financial forecasting, cash management,

credit administration, investment analysis and fund procurement of the business concern and
the business concern needs to adopt modern technology and application suitable to the
global environment.

CONCEPTS AND FUNCTION OF BUSINESS FINANCE

Areas of Finance
1. Financial Management
also called corporate finance, focuses on decisions relating to how much and what types
of assets to acquire, how to raise the capital needed to purchase assets, and how to run
the firm so as to maximize its value

2. Capital Markets
relate to the markets where interest rates, along with stock and bond prices, are
determined. It is the part of a financial system concerned with raising capital by dealing
in shares, bonds, and other long-term investments.

3. Investments
relate to decisions concerning stocks and bonds and include a number of activities: (1)
Security analysis deals with finding the proper values of individual securities (i.e.,
stocks and bonds). (2) Portfolio theory deals with the best way to structure portfolios,
or “baskets,” of stocks and bonds. Rational investors want to hold diversified portfolios
in order to limit risks, so choosing a properly balanced portfolio is an important issue
for any investor. (3) Market analysis deals with the issue of whether stock and bond
markets at any given time are “too high,” “too low,” or “about right.”
Primary Goals of business
While many companies focus on maximizing a broad range of financial objectives, such as
growth, earnings per share, and market share, these goals should not take precedence over
the main financial goal, which is to create value for investors. The primary goals of a business
concern must therefore be as follows:

1. to earn profit;
2. to increase its own value as an economic entity; and
3. to improve the quality of life in the community

DEFINITION OF FINANCIAL MANAGEMENT

Financial management is an integral part of overall management. It is concerned with the

duties of the financial managers in the business firm.

The term financial management has been defined by Solomon, “It is concerned with the
efficient use of an important economic resource namely, capital funds”.

The most popular and acceptable definition of financial management as given by S.C. Kuchal
is that “Financial Management deals with procurement of funds and their effective utilization in
the business”.

Howard and Upton : Financial management “as an application of general managerial

principles to the area of financial decision-making.

Weston and Brigham : Financial management “is an area of financial decision-making,

harmonizing individual motives and enterprise goals”.

Joshep and Massie : Financial management “is the operational activity of a business that is
responsible for obtaining and effectively utilizing the funds necessary for efficient operations.

Thus, Financial Management is mainly concerned with the effective funds management in the
business. In simple words, Financial Management as practiced by business firms can be
called as Corporation Finance or Business Finance.

GOALS OF FINANCIAL MANAGEMENT

The goals of financial management could be synonymous to the goals of enterprise. One
may consider that the utmost aspiration of the company is to yield the highest possible profit for
the firm. If this answer is accepted, then the company would be evaluating each decision they
make based on the amount of income that would be flowing into the company.

1. Maximization the value of the firm (Valuation Approach)

- this means that the main goal of financial management is to maximize not the profit
alone, but the overall value of the firm; thus, it is called the Valuation Approach.
Therefore, in considering investment proposals or decisions, the financial manager
should not only consider profit, he/she must also consider, among other things, the
following:
 risk attached to the investment proposal or the company’s operation;
 time design as to when and how the profits will flow into the company, which
refers to when the profits flow into the company and furthermore, when will there
be an upsurge or decline of profit; and
 the quality and reliability of the profits reported by the firm.

2. Maximization of shareholders’ wealth

- it is considered to be the expensive goal of the firm. This, however, is not an easy
task. Managers have no direct control of the market value of the firm’s stocks.
- the main focus is not so much with the day-to-day movements of the stock market
price, but more so on the amplification of the long-term wealth of the shareholders.

3. Social responsibility and ethical behavior

- Social responsibility is an issue that needs to be considered. Can one reconcile the
need of the firm for wealth maximization and the need of the firm to be socially
responsible? Stated differently, can a firm be socially responsible while focusing on
maximizing the shareholders’ wealth or maximizing the overall value of the firm?

Scope of financial management

Financial Management compromise of the following key areas

Financial functions

This function deals with decisions on how to raise funds to finance the activities of the
organization.
The short term sources of funds include; bank overdrafts, factoring, commercial papers,
account payable delays, sale and leaseback, and account receivables collections.

The long term sources of funds include; ordinary share capital, preference share capital, long
term loans (debt capital) and leases.

Before choosing the source of funds, a financial manager must consider factors such as cost,
tax effects, dilution of ownership and control, financial risks, collateral securities, access to
capital markets, nature of project to be financed and other conditions and restrictive
covenants.

Investment function

This function involves decisions concerning the allocation of funds to various projects. A
financial manager needs to evaluate the various projects to venture into considering both their
returns and the level of risk.

Investment decisions are difficult to make as they involve assessment of the future which is
difficult to predict with precision and most of the investments are irreversible.

Liquidity function

These are decisions involving the management of working capital to avoid liquidity problems.it
generally involves investment into current assets and current liabilities.

Current assets are those assets that can easily be converted into cash within a year. Current
liabilities mature for payment within a financial year.

Dividend function

This involves decisions on how much of the total earnings of the organization should be paid
out as dividends to the shareholders and how much should be retained by the organization for
re-investment.

The dividend decision should be in line with the dividend policy of the organization, which is
contained in the article of association. The finance manager should ensure that the
organization has an optimal dividend pay-out ratio.

Role of financial managers

 1. Accounting and bookkeeping. A financial manager prepares or supervises the
preparation of the various financial statements, activity reports, and forecasts. He
should also ensure that there is an effective accounting system in the organization.
2. Estimating the amount of capital required for purchase of assets, growth, and
expansion of the business and meeting working capital requirements
3. Ensures that debt and equity ratios are maintained and balanced when raising funds
from various sources.
4. Analyse the market trends to identify available opportunities for both investment and
expansion of the business
5. Financial control. A financial manager exercises financial control through the use of
techniques like an internal audit.
6. Forecasts cash flowing into the business and cash flowing out of the business to
ensure that there is no shortage of funds or even surplus cash within the firm. Funds
must be available to meet the day to day expenses of the firm, such as wages to
employees.

ALTERNATIVE FORMS OF BUSINESS ORGANIZATION

1. Sole Proprietorship
 considered as the oldest, most common, and simplest form of business
organization.
 a form of business entity where there is only one owner.
 the customary feature of a sole proprietorship is that the owner is inseparable
from the business.
 Advantages of a Sole Proprietorship
a. Easy to set-up
b. Requires a small amount of capital to start
c. Profits all accrue to the owner
d. Total control on the part of the owner
 Disadvantages of a Sole Proprietorship
a. Unlimited personal liability
b. Limited management skills
c. Limited access to capital
d. Lacks continuity in case of death or incapacity of owner
2. Partnership
 In a contract of partnership, two or more persons bind themselves to contribute
money, property, or industry to a common fund, with the intention of dividing
the profit among themselves.
 Characteristics of a partnership
a. Mutual contribution
b. Division of profits or losses
c. Co-ownership of contributed assets
d. Mutual agency
e. Limited life
f. Unlimited Liability
g. Income Taxes
h. Partners’ Equity accounts

 Disadvantages of a Partnership
a. Profits are shared
b. Easily dissolved and thus unstable compared to a corporation
c. Mutual agency and unlimited liability may create personal obligations to
partners
d. Less effective than a corporation in raising large amounts of capital

3. Corporation
 A corporation is a business owned by its stockholders.
 Advantages of a Corporation
a. Has a legal capacity to act as a legal entity
b. Shareholders have limited liability
c. Continuity of existence
d. Management is centralized in the board of directors
e. Greater ability to acquire funds
 Disadvantages of a Corporation
a. Relatively complicated in formation and management
b. Greater degree of government control and supervision
c. Requires a relatively high cost of formation and operation.
d. Subject to heavier taxation other than other forms of business organizations
AGENCY RELATIONSHIPS
Whenever a person or group of persons (principal) employs another group of persons
(agency) to render service(s) and at the same time delegate decision making authority to the
agent, an agency relationship exists. In financial management parlance, agency relationship
exists between the company’s shareholders and managers and between creditors and owners.

Agency Conflicts
It is common knowledge that a shareholder’s primary goal is wealth maximization. There
could be a conflict of interest if the manager is also a partial owner of the same firm. The
manager’s primary goal is to maximize the size of the firm, and by doing so, he stabilizes job
security for himself and for all the employees of the firm, and ultimately, increase his position,
status, perquisites, and salary; thus, the shareholder’s primary goal of wealth maximization
might be set aside. It can be argued that since there are managers owning small portion of the
corporate share, they are hungry for salary increases and perquisites at the cost of
shareholders that are not managers.

Agency Costs
There are means by which managers can be persuaded to maximize the company’s
stock price or wealth and act for the shareholders’ best interests. However, this entails costs
which may come in terms of audit costs, which are geared toward monitoring managerial
actions and restructuring the company that would regulate undesirable managerial actions.

Reference:
http://vcmdrp.tums.ac.ir/files/financial/istgahe_mali/moton_english/financial_management_%5Bwww.accfile.com%5D.pdf

https://www.wikiaccounting.com/what-is-financial-
management/#:~:text=Financial%20management%20deals%20with%20the,funds%20to%20the%20various%20stakeholders.

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