INTRODUCTION TO

1 FINANCIAL MANAGEMENT

THEORY AND ILLUSTRATIONS

oUTLINE
No. Topic Page
1. Introduction 1

1.1 Definitions
1.2 Evolution
2. Nature 2
2.1 Basic Functions
2.2 Managerial Functions
3. Objectives
3.1 Profit Maximisation
3.2 Wealth Maximisation
3.3 Conflict in Profit Versus Wealth Maximization Principle
3.4 How Wealth Maximisation is Superior Objective
Wealth-maximisation and Financial Decisions
5. Functions of a Chief Financial Officer
5.1 Basic or Main Functions
5.2 Emerging Functions
6. Importance of Financial Management 9

7. Limitations of Financial Management 10

8. Methods and Tools of Financial Management 11
9. Financial Management v. Financial Accounting 12

1 . INTRODUCTION

1.1 DEFINITIONS
. Finance: According to Oxford dictionary, the word 'finance' connotes 'management ofmoney
i.e. earning, spending, saving and investing money. Thus, everyone individual, businessfirm
Government - is concerned with finance. We are concerned with 'business' tinance.
2. Business Finance: According to the Guthumann and Dougall [Corporate Financial Policy:
 Corporte Finance (M. Com. Part - I : SEM-n

be defined as the activity concerned

N.Y. Prentice Hall, 19801, "Business finance can broadly the business"
funds used in
with planning, raising, controlling, administering ofthe
3. Financial Management: Financial Management is defined by different authorities as followe
Ezra Solomon /7he Theory of Financial Management: Columbia University Press (N.Y
use of an important economic
(1978)]: "Financial management isconcerned with eflicient
resource namely - capital funds. It is the study of the problems involved in the use and
acquisition of funds"
Raymond J. Chambers /Financial Management, Law Book Company, 1 967/: "Financial
management comprises the forecasting, planning, organising, directing, co-ordinating and
financial resources of
controlling of all activities relating to acquisition and application of the
an undertaking in keeping with its financial objective."
Phillippatus: "Financial Management is concerned with the managerial decisions that result
credits for the firm."
in the: cquisition and financing of short term and long term
Howard and Upton [lntroduction to Business Finance, MeGraw Hill, 1953]: Financial
to the area of financial
management "is an application of general managerial principles
decision-making.
99

Joseph L. Massie [Essentials of Management, Prentice Hall, 1971]: Financial management

is the operational activity of a business that is responsible for obtaining and effectively
utilizing the funds necessary for efficient operations.

1.2 EVOLUTION
Financial management evolved gradually over the past 50 years. The evolution of financial
management is divided into three phases:
1) The Traditional Phase: During this phase, financial management was considered necessary
only during specific events such as takeovers, mergers, expansion, liquidation, ete.Also, when
taking financial decisions in the organisation, the needs of outsiders (investment bankers, people
who lend money to the business etc.) to the business were given more importance.
2) The Transitional Phase: During this phase, the day-to-day problems that financial managers
faced were given importance. The general problems related to funds analysis, planning and control
were given more attention in this phase.
(3) The Modern Phase: Modern phase is still going on. The scope of financial management has
greatly increased now. It is important to carry out financial analysis for a company. This analysis
helps in decision making. During this phase, many theories have been developed regarding efficient
markets, capital budgeting, option pricing, valuation models and also in several other important
fields in financial management.

2. NATURE

2.1 BASIC FUNCTIONS

Financial Management basically deals with the procurement offunds and their effective utilization
in the business. The first basic function or aspect of financial management is procurement of funds
and the other is their eflective utilization.
(1) Procurement of funds: Funds can be procured from different sources; their procurement is a
complex problem for business concerns. Funds procured from different sources have different
characteristies in terms of risk, cost and control.
i) The funds raised by issuing equity share poses no risk to the company. The funds raised are
quite expensi ve. The issue ofnew shares may dilute the control of existing shareholders.
(i) Debenture is relatively cheaper source offunds, but involves high risk as they are to be repaid
in accordance with the terms of agreement. Also interest payment has to be made under any
circumstances. Thus there are risk, cost and control considerations, which must be taken into
account before raising funds.
Introduction to Financial Management 3
(i) Funds can also be proaured from banks and financial institutions subject to certain restrictions.
iv) Instruments like commercial paper, deep discount bonds, etc. also enable to raise furnds.
(v) Foreign direct investment (FDI) and Foreign Institutional Investors (FI) are two major routes
for raising funds from international sources, besides ADR's and GDR's.
(2) Effective utilisation of funds: Since all the funds are procured at a certain cost, therefore it is
necessaryfor the finance manager to take appropriate and timely actions so that the funds do not
remain idle. Ifthese funds are not utilised in the manner so that they generate an income higher
than the cost of procuring them then there is no point in running the business.

2.2 MANAGERIAL FUNCTIONS

According to the modern approach, Financial management is the (i) management of(i)the finances
of an organisation (iii) in order to achieve thefinancial objectives of the organisation. We have
already studied the meaning of 'finance' above in Para 1. We will be studying the 'financial objectives
in Para 3 below. 'Management' involves planning, control and decision-making. Thus, Financial
management involves -(i) Financial Planning (ii) Financial Control and (ii) Financial Decisions.

2.2.1 Financial Planning

The Chief Financial Officer (CFO) who is in charge of financial management will need to plan to
ensure that enough funding is available at the right time to meet the needs of the organisation for
short, medium and long-term capital. In the shortterm, funds may be needed to pay for purchases of
inventory, or to smooth out changes in receivables, payables and cash: the CFO has to ensure that
working capital requirements are met. In the medium or long term, the organisation mayhaveplanned
purchases of fixed assets (capital expenditure) such as plant and equipment, for which the CFO must
ensure that funding is available.

2.2.2 Financial Control

The control function of the CFO becomes relevant once funding has been raised. The CFO has to
analyse questions such as- Are the various activitiesofthe organisation meeting its objectives ? Are
assets being used efficiently ? To answer these questions, the CFO may compare data on actual
performance with expected performance.
2.2.3 Financial Decisions
The nature of financial management has undergone changes over the years. Until the middle of this

century,it was limited to procurement of funds for promotion, expansion, merger, etc. ofa firm. In
the modern times, financial management includes the three main decisionsnamely - investment,
financing and dividend. Investments in fixed and current assets must be planned. Financial management
is also con cerned with the financing and management of short-term and long term-funds. Financial
management is also concerned with the dividend decision: how much of the profits should the company
should it retain for investment to provide for future growth? The
pay out as dividends and how much
following types of financial decisions also need to be made-
Decisions internal to the busines enterprise
Whether to undertake new projects
Whether to invest in new plant and machinery

Research and development decisions

Investment in a marketing or advertising campaign
Decisions involving external parties
Whether to enter in ajoint venture with another enterprise

Whether carry out a takeover

to or a merger involving another business
Disinvestment decisions
Whether sell of unprofitable divisions
to of the
business

Whether to sell old or surplus plant and machinery

The sale of subsidiary companies
 Corporte Finance (M.Com.
Part -

I: SEM.1-1)

3. OBJECTIVES
management (i)
Profit maximisation and (ii) Wealt
th
There are two objectives of financial
Maximisation.

3.1 PROFIT MAXIMISATION

business was sell- financed and sele.
taken as objective when
1. Concept: Profit maximisation was that the objective of a company
is to earn profis
controlled. It has traditionally been argued
also profit maximisation. This implies that the
hence the objective of financial management is the concern are
finance manager has to make his decisions
in a manner so that the profits of
to see whether or not it gives maximum
maximised. Each action, therefore, is to be examined
profit.
maximisation objective
-

2. For: Following are the arguments in favour of profit

A business concern is also
Aim: Main aim
(i) kind economic activity is earning profit.
ofany of
functioning of earning profit.
mainly for the purpose
(i) Efficiency: Profit helps to measure the efficiency ofthe
concern.

(ii) Risk: Profit reduces risk of the business concern.

(iv) Source: Profit is the main source of finance.
(v) Social: Profitability meets the social needs also.
(vi) Easy: It is easier to calculate profits than wealth or value.
(vii) Link: There is a direct link between financial decisions and profits.
3. Against: Following are the arguments against the profit maximisation objective-
) Vague: The term profit is vague. It conveys diferent meanings to different people. Profit can
be long term or short term, profit before tax or after tax, operating profit or gross profit,
accounting profits or 'economic' profits, cash profits and so on. The term 'maximisation' is
also vague.
(i) Risk: Higher profits may be achieved by taking too much risk.
(ii) Rate: The amount ofinvestment needed to earn the profit is also important. Profits must be
related to the volume ofinvestment by working out: (a) Accounting return on capital employed
(b) Earnings per share (c) Dividend yield as a percentage of stock market value, and so on.
(iv) Short term: Profit is a measure of short-term performance, whereas increase in wealth
measures the long term performance of the company.
(v) Unethical: Profit motive may lead to exploitation of customers, workers, employees and
ignore ethical trade practices.
(vi) Ignores CSR: Profit motive also ignores social considerations or corporate social
responsibility (CSR) or general public welfare.
(vii) Ignores non-shareholders: Profit maximisation may benefit shareholders at the expense of
other stakeholders such as customers, employees or
suppliers.
(viii) Timing of Return: The profit maximization objective does not make distinction between
returns received in different time
periods. It gives no consideration to the time value of money
It values benefits received today and benefits received
after a period as same.
The profit maximization, therefore, is not an
operationally feasible criterion.
3.2 WEALTH MAXIMISATION
. Concept: The usual assumption in financial management for the
financial objective of the company is to maximise private sector is that the primay
shareholders in a
shareholders' wealth. The wealth of tne
company comes from: (i) Dividends received and
shares. If a company's shares are traded on a stock (ii) Market value of
when the share price goes up. The price of a
market, the wealth of shareholders is increasc
company's shares will go up when the compa
 ntroduction to Financial Management 5

makes altractive profits, which it pays out as dividends or re-in vests in the business to achieve
future profit growth and dividend growth.
2. For: Ihe Wealth maximisation objectiveofa firm is considered superior to its Profit maximisation
objective on the following grounds-
(a) Profit maximisation can be achieved in the short term at the expense of the long term goal.
that is, wealth maximisation. For example, a risky investment may give large profits in the
short term but lead to huge losses in the long run. Also, a firm that wants to show a short term
proht may for example, postpone major repairs or replacement, although such postponement
is likely to hurt its long term profitability.
(b) Prolit maximisation does not consider risk or uncertainty. whereas wealth maximisation
considers both risk and uncertainty.
(e) The wealth maximisation objective ofa firm considers all future cash flows, dividends, earning
pershare, risk ofa decision etc. whereas profit maximisation objective ignores the time value
of money, discounting, etc.
(d) A firm that wishes to maximise the shareholders wealth may pay regular dividends whereas a
firm with the objective of profit maximisation may avoid making dividend payment to its
shareholders.
The maximisation of a firm's value as reflected in the market price of a share is viewed as a
proper g0al of a firm. The profit maximisation can be considered as a part of the wealth
maximisation strategy.
(i) LongTerm: It takes into consideration the long term.
(ii) Risk: It takes into account the risk or uncertainty.
(ii) Timing: It considers the Time Value of
Money
(iv) Shareholders: It favours the interest of the shareholders.
3. Against: Following are the arguments against wealth maximisation objective -
(i) Link:There is no direct link between financial decisions and share prices.
(i) Frustration: It may lead to management anxiety and frustration.

3.3
3.3 CONFLICT IN PROFIT VERSUS WEALTH MAXIMIZATION PRINCIPLE
Profit maximisation is a short-term objective and cannot be the sole
best a limited objective. If profit is given undue importance, a number
objective of a company. It is at
term profit is vague, profit maximisation has to be
of problems can arise like the
attempted with a realisation of risks involved, it
does not take into account the time pattern of returns and as an
objective it is too narrow
Whereas, on the other hand, wealth maximisation, as an objective, means that the
its resources in a good manner. If the share value is to company is using
stay high, the company has to reduce its costs
and use the resources properly. If the company follows the
goal of wealth
that the company will promote only those policies that will lead to an etficientmaximisation, means
it
allocation ofresources.
3.4 HOw WEALTH MAXIMISATION ISSUPERIOR OBJECTIVE
Afim's financial management may often have the following as their
of firm's objectives: (i) The maximisation
profit. (ii) The maximisation of firm's value/ wealth.
(1) Drawbacks of Profit Maximisation Objective: The maximisation
as an
of profit is often considered
implied objective of a firm. To achieve the aforesaid objective various type of
decisions may be taken. Options resulting into maximisation of financing
firm's decision makers. They even sometime may adopt
profit may be selected by the
short run which may prove to be unhealthy for the
policies yielding exorbitant profits in
growth, survival and overall interests of the
firm. The profit of the firm in this case is measured in terms
to its shareholders. of its total accounting profit availabie
 Corporte Finance (M.
Com Part- I: SEM.
2) Superiority of Wealth Maximisation Objective: The value/wealth of a thrm is defined as th
the focal judgmen
the firm's stock. market price ofa firm's stock represents
market price of The
fhrm is. It takes into acco
O all market participants as to what the share. theparticular
value of the unt
timing and risk of these earnings, th
present and prospertive future earnings per
dividend poliey ofthe firm and many other factors that bear upon the market price ofthe stoc
The value maximisation objetive ofa firm is superior to its profit maximisation objective due to

tollowing reasons.
) Comprehensive: The value maximisation objective ofa firm considers all future cash flow
dividends, earning per share, risk of a decision etc. whereas profit maximisation objective
does not consider the etfect of EPS, dividend paid or any other returns to shareholders or the

wealth of the shareholder.

i) Dvidends: Afirm that wishes to maximise the shareholders wealth may pay regular dividends
whereas a firm with the objectiveof profit maximisation may refrain from dividend payment
to its shareholders.
ii) Shareholders: Shareholders would prefer an increase in the firm's wealth against its generation
of increasing flow of profits.
(iv) Market Price: The market price of a share reflects the shareholders expected return,
considering the long-term prospects of the firm, reflects the diferences in timings of the
returns. considers risk and recognizes the importance of distribution ofreturns.
The maximisation of a firm's value as retlected in the market price ofa share is viewed as a
proper goal of a firm. The protit maximisation can be considered as a part of the wealth
maximisation strategy.

WEALTH-MAXIMISATION AND FINANCIAL DECISIONS

(1) Inter-related: To achieve wealth maximisation, the finance manager has to make important
decisions in respect of investment, financing and dividend. These decisions are inter-related
because the underlying objective of these three decisions is the same, i.e. maximisation of
shareholders' wealth. The decision to invest in a new project needs finance. The
in turn, is linked with the dividend decision because retained
financing decision,
earnings used in internal financing
means less dividends. The
inter-relationship of financial decisions and how they help in maximising
the shareholders' wealth is explained below.
(2) Investment Decision: The investment of long term funds is made after a careful assessment of
the various projects through capital budgeting and risk
analysis. However, only
proposal is accepted whose expected return is the highest compared to its cost
that investment
of financing. This
helps to maximise the profitability of the company and its wealth.
(3) Financing Decision: Funds can be raised from various sources.
Each source of funds involves
different issues regarding cost, risks and control. The finance
balance between long-term and short-term funds and a manager has to maintain a proper
mix of loan funds and owner's
funds. The optimum financing mix will ncrease return to proper
their wealth. equity shareholders and thus maximise
(4)Dividend Decision: The finance manager assists the
top
portion of the profit should be paid to the shareholders management in deciding as to wha
should be retained in the business for internal by way of dividends and what portion
maximises shareholders' wealth. financing. An optimal dividend
pay-out ratio
5)Cash Flows: As discussed above, corporate financial
decisions, investments decisions and dividend decisions.decisions are of three types financing
inflow, both investment and dividend decisions While financing decisions
involve involve cash
alternative financial strategies- either cash outflow. Firms
treat cash inflow and cash may have two
decisions; or treat the cash intlow and cash outflow outflow decisions as independent
decisions as
interdependent decisions.
Introduction to V'inancial Managemem
treat casih outiow
(6)C'axh nflow and C'ash )utfow asIndependent Decislons: A firm may
decision. The lirm may d e c i d
(investnicnt)deeision as independent ofthe casdh inflow (linancing) or the capital structurC
an il it is profitable regardlens ofthe souree of finance
ant tnvestinen,
When a trni consicders investment decisions And tinancing decisions to be independent unctios,
irrelevant to the value ot the n
the inancing and the anmount of funds tinanced are
source of
and its cost of capital. lence, investment decisions and dividend decisions which requrc a
outtlows can be tuken up without any constraint. The profitability of' the investment is the oniy

consideration. In this approuch, the dividend decision is

also considered to e
mportant Investments are not made at the
cost ofdividends,
hdeendent of firm's investnnent decisions,
the fiunds are limited,
both dividenu
anddividends are not paid at the cost ofin vestments, Eiven if a
Dividend decisions depend on tirm
s

and
nvestment needs are met through external financing. decisions. At times, tn
and financing
profits and dividend history rather than its investment
and then govern the financing decisions
Oa

dividend decisions are taken first

investment and
firm.
nflow and Cash Outflow as Inter-dependent Decisions: When investment decision
(7) Cash
and financing decisions are considered to be mutually dependent functions, the source or unds

and the amount of financing are important value considerations. A firm's

debt-equity ratio (Di
ratio) indicating its risk and return profile, and hence its overall value becomes an importan
as a result, the dividend
factor. The dividend and investment decisions become inter-dependent and,
decision becomes a residual function. A growing firm generally adopts such policy. It pays
needs of the firm.
dividends only when (and if) enough cash is left after meeting the investmentinvestments, rather
Such firms prefer to use their retained earnings, having a lower cost, for new
than for dividends. Investors in such firms obtain their returns in the form of capital gains by
selling their shares at a high price.
(8) Examples:

EXHIBIT 1:INTERDEPENDENT DECISIONS-EXAMPLES

Basic Decislon Linked Decision 1 Linked Decision -2
(1) (2) (3)
Investment Financing Dividends
A company would like It will need to raise funds in If the company fails to raise
to undertake a large order to take up these sufficient funds from outside
number of profitable projects. the company, it would need
investment projects. to cut dividends in order to
increase internal funding.
Dividends Financing Investment
A company wants to A lower level of available If external financing is
pay a large dividend to internal cash flows might force restricted through partially
shareholders. the company to seek extra financing the dividend, the
funds via external financing. company might need to
postpone some of the
investment
projects.
Financing Investment Dividends
A company has been Due to the high cost of The company's ability to pay
using a higher level of financing, the number of dividends in the future may
external funding. attractive investment projects be adversely affected.
might be reduced.

(9) Summary: The above discussion makes it clear that investment, financing and dividend decisions
areinterrelated and are to be taken jointly keeping in view their joint effect on the shareholders
wealth. The Chart given below sums up the above discussion.
8 Corporte Finance (M.Com. Part -
I:
SEM-In
Financial Management

Maximisation of Share Valuee

Financlal Decisionns

Financing Decisions Investment Decisions Dividend Decisions

Trade-Off Risk
Return -
An Overview of Financial Management

5. FUNCTIONS OF A CHIEF FINANCIAL OFFICER

5.1 BASIC OR MAIN FUNCTIONs
The main objective of Chief Finance Officer (CFO0), who handles financial management of a company
Is to procure funds in such a way that the risk, cost and control considerations are properly balanced
and to ensure their optimum utilisation. To achieve these objectives the CFO performs the following
functionsS:
(1) Estimating the requirement of Funds: The CFO has to estimate the requirement of funds both
for long-term purposes i.e. investment in fixed assets and for short-term i.e. for working capital.
Forecasting the requirements of funds involves the use of techniques of budgetary control and
long-range planning.
(2) Capital Structure: Once the requirement of funds has been estimated, the CFO has to take a
decision regarding various sources from which these funds would be raised. A proper balance
has to be made between the loan funds and own funds. He has to raise sufficient long term funds
to finance fixed assets and other long term investments and to provide for the needs of working
capital.
(3) Capital Expenditure and Working Capital Management: The investment of funds in a new
project has to be made after careful assessment of various projects through capital budgeting.
Assets management policies are to be laid down regarding various items of current assets e.g.
receivable in coordination with sales manager, inventory in coordination with production manager.
(4) Dividend decision: The CFO has to decide as to how much to retain and what portion to pay as
dividend depending on the company's policy. Trend of earnings, trend of share market prices.
requirement of funds for future growth, cash flow situation etc., are to be considered.
(5) Evaluating financial performance: The CFO has to constantly review the financial performance
of the various units of organisation generally in terms of the financial objectives and targets e g
ROI. Such a review helps the management in seeing how the funds have been utilised in various
divisions and what can be done to improve it.

(6) Financial negotiation: The CFO plays a very important role in carrying out negotiations witn
the financial institutions, banks and public depositors for raising of funds on favourable terms.
(7Cash management: The CFO lays down the cash management and cash disbursement policIes
a view to supply adequate
funds to all units of organisation and to ensure that there is no
with
excessive cash.
R) Keeping touch with stock exchange: cEO is required to analyse major trends in stock marke

and their impact on the price ofthecompany share.

 9
Introduction to Financial Management

5.2 EMERGING FUNCTIONS

() Emerging role of facilitator in information age: In the in formation age the role ofChief Finance
Officer (CFO) has changed from a controller to a facilitator. In the emergent
role CFO acts as a
calalyst to facilitate changes in an environment where the organisation succeeds through self
managed teams. The CFO must transform himselfto front-end organiser and leader who spends
a
more time in networking, analysing the external environment, making strategic decisions, managing
an operational toa
and protecting cash flows. In due course, the role of CFO will shift from
excused from his routine
strategic level. Of course on an operational level the CFO cannot be
duties. The knowledge requirements for the evolution of a CFO will extend from being
aware

about capital productivity and cost of capital to human resources initiatives and competitive
environment analysis. He has to develop general management skills for a wider focus encompassing
all aspects of business that depend on or dictate finance.
India: In the modern enterprise, the CFO occupies a key
(2) Role of CFO in changing scenario in
position and his role is becoming more and more pervasive and significant in solving the finance
funds from a number of
problems. The traditional role of the CF0 was confined just to raising of
sources, but the recent development in the socio-econom ic and political scenario throughout the
now responsible for
world has placed him in a central position in the business organisation. He is
allocation of
shaping the fortunes of theenterprise, and is involved in the most vital decision of
environment which changes
capital like mergers, acquisitions, etc. He is working in a challenging
internet in the field of
continuously. Emergence of financial service sector and development of
information technology has also brought new challenges before the Indian CFO. Development of
new financial tools, techniques, instruments and products and emphasis on public sector
undertaking to be self-supporting and their dependence on capital market for fund requirements
have all changed the role of a CFO. His role, especially, assumes significance in the present day
context of liberalization. deregulation and globalization.
(3) Emerging Issues / Priorities affecting the Future Role of CFO
(1) Regulation: Regulation requirements are increasing and CFOs have an increasingly personal
stake in regulatory adherence.
i) Globalisation: The challenges of globalisation are creating a need for finance leaders to
develop a finance function that works effectively on the global stage and that embraces diversity
(ii) Technology: Technology is evolving very quickly, providing the potential for CFOs to
reconfigure finance processes and drive business insight through 'big data' and analytics.
(iv) Risk: The nature ofthe risks that organisations face is changing, requiring more effective
risk management approaches and increasingly CFOs have a role to play in ensuring an
appropriate corporate ethos.
(v) Transfor mation: There will be more pressure on CFOs to transform their finance functions
to drive a better service to the business at zero cost impact.
(vi) Stakeholder Management: Stakeholder management and relationships will become important
as increasingly CFOs become the face of the corporate brand.
(vii) Strategy: CFO will have a greater role to play in strategy validation and execution, because
the environment is more complex and quick changing.
(vii) Reporting: Reporting requirements will broaden and continue to be burdensome for CFOs.
(ix) Talent and Capability: A brighter spotlight will shine on talent, capability and behaviours
in the top finance role.

6. IMPORTANCE OF FINANCIAL MANAGEMENT

(1) Organizations: Financial Management (FM) is important to all types of organizations i.e. business
organisations; charitable organisations, NGO, trusts; Govt. undertakings, public sector
undertakings and so on for managing funds.
(2) Shareholders: Shareholders rely on eftfective FM to get optimum dividend and maximize their
wealth.
 Finance (M. Com.
P'art
- I: SEM.
Corporte
their funds, tima
10
creditors rely on
eflective FM for salety of imely
Lenders or on the same.
as interest
Lenders/Creditors:
(3) amount as
well of their salary/wauo
repayment of the principal
FM for getting
timely payment ges,
eflective
(4) Employees: Employees
rely on

incentives and their retirement benefits at r e a s o n a b i e

rates.
bonus,
quality products
(5) Customers: Customers rely on FM for getting public
welfare
activities as a partod
of
FM to fund general
large relyon
eflective
(6) Public: Public at
corporate social responsibility. revenues.
and other
Government: FM timely payment oftaxes
ensures
building, ncrease in the
(7) in overall image
Efficient FM helps the management
(8) Management:
shareholders wealth and profit.
market share, optimising of funds has to ensure
through eflicient management
Finance department marketing etc.) for their
(9) Other departments: departments (production,
available to all
that adequate funds are made

smooth functioning.
successful financial plan
during the start-up
Effective FM begins with a
(10) Successful Start-Up: of fixed and tluctuating
suflicient capital to meet the requirement
a n e w firm to provide
stage of
capital.
Sound Financial decisions for procurement
and use offunds are necessary
(11) Smooth Running:
for the smooth day-to-day running ofan enterprise.
shareholders wealth),
firm in clear terms (maximisation ofthe
(12) Goal: FM defines the goal ofthe taken for achieving the
Investment and Dividend) are
so that all financial decisions (Financing,

goal structure and the right balance

Decisions: FM helps the firm decide the capital
(13) Financing
between risk and returns.
budgeting, working capital management
(14) Investment Decisions: FM techniques (such capital
as

decisions like which asset to buy,

when to buy and whether
techniques) helps to make important current assets to be
maintained in a
new one or not, level of
to replace the existing asset with
and how to utilize them eficiently.
firm, how to finance fixed as well as current assets,
decide how
(dividend policies) helps a firm to
(15) Dividend Decision: Financial management
much to pay as dividend and how much to retain
in the firm. It also suggests answering questions
stock dividend) should the dividend be paid.
such as when and in what form (cash dividend or
to all types of organisations (business, NGO, Govt.)
To sum up, Financial management is important
customers, Public, Government,
for all stakeholders (shareholders, lenders, creditors, employees,
all stages of a business life-cycle (start-up, running,
Management, other departments); throughout and control).
growth); and during all stages of management (goal-setting, planning, decision-making
7. LIMITATIONS OF FINANCIAL MANAGEMENT

There are three broad limitations offinancial management. Firstly, a company may have important
non-financial objectives, which are beyond the control of financial manager. Secondy, financial
management cannot satisfy allthe stakeholders and their objectives may conflict with each other
Thirdly, financial decisions are influenced by many external factors beyond the control of the firm
Let us study these in detail.

(1) Employees: A company might try to provide good wages and salaries, comfortable and sale
working conditions, good training and career development, and good pensions. This may reduce
profitability.
2) Management: Management may be taking risky investment decisions using outsiders' money to
finance them. Managers will often take decisions to improve their own circumstances, even thougn
theirdecisions will incur expenditure and so reduce profits. High salaries, company cars
other perks are all examples of managers promoting their own interests at the expense of and
tne
shareholders.
Introduction to Financial Management
lo
fulfilment of a responsibility
(3) Public: The major objectives of some companies will include
provide a service to the public. Providing a service is of course a key responsibility of government
thus more important
departments and local authorities for whom non-financial objectives
are

than financial objectives.

(4) Customers: Responsibilities towards customers include providing in good time a product or
with customers. Reliable
Service ofa qualitythat customers expect, and dealing honestly and fairly
non-financial objectives, which
Supply arrangements, and after-sales service arrangements are
may be given more importance than financial measures like cost-cutting.
(5) Suppliers: Responsibilities towards suppliers are expressed mainly in terms of trading

buyer. The company should

relationships. A company's size could give it considerable power as a
in accordance
not use its power unscrupulously. Suppliers might rely on getting prompt payment,
with the agreed terms of trade.
(6) Society: Corporate Social Responsibility (CSR) for anti-pollution, social wel fare etc.
measures

involve additional costs which reduce profitability and wealth.

decide to
(7) Creditors: Ifa company is unable to pay what it owes its creditors, the creditors may
to be wound
exercise their to sell off the mortgaged assets or to apply for the company
security
up. This will adversely affect the interests of other stakeholders.
(8) Shareholders: The money that is provided by long-term creditors will be invested to earn profits,
and the profits (in excess of what is needed to pay interest on the borrowing) will provide extra
dividends or retained profits for the shareholders of the company. In other words, shareholders
will expect to increase their wealth using creditors' money.
(9) External Factors: Many financial decisions depend on external factors. A large construction
hence more long term
company needs huge investment in fixed as well as current assets and
capital. Small companies cannot raise much share capital or loans and must have more internal
financing. A movie company faces very high risk of failure and cannot raise capital through
public issue of shares. The state of the economy (growing, recession, stagnant etc.) affects
the
financial decisions of investment, financing and dividend. The development of financial
institutions., financial markets and new financial instruments affects financing decisions.
Government policies - economic, monetary, industrial, imports, exports, taxation etc, - influence
financial decisions to a great extent. The tax structure might influence investors' preferences for
either dividends or capital growth. The government might provide funds towards the cost of
some investment projects. It might also encourage private investment by offering tax incentives
The Company law has rules for issue ofshares, debentures, investments, dividends, reserves etc.
which limit the freedom of the CFO to take optimum decisions.

8. METHODS AND ToOLS OF FINANCIAL MANAGEMENT

(1) Financing Decisions Tools: Finance Manager has to decide optimum capital structure to maximise
the wealth ofthe shareholders. For this judicious use offinancial leverage or trading on equity is
important to increase the return to shareholders. In planning the capital structure, the aim is to
have proper mix of debt, equity and retained earnings. EPS A nalysis, PE Ratios and mathematical
models are used to determine the proper debt-equity mix to derive advantages to the owners and
enterprise.
(2) Investment Decision Tools: In the area of investment decisions, pay back method, average rate
ofreturns, internal rate ofreturn, net present value, profitability index are some of the methods
in evaluating capital expenditure proposals.
(3) Working Capital Management Tools: In the area of working capital management. certain
techniques are adopted such as ABC Analysis, Economic order quantities, Cash management
models, etc., to improve liquidity and to maintain adequate circulating capital.
(4) Evaluation of Performance: For evaluation of firm's performance, Ratio analysis is pressed
into service-with the help of ratios an investor can decide whether to invest in a firm or not.
Fundsflow statement, cashflow statement and projected financial statements help a lot to the
finance manager in providing funds in right quantities and at right time.
 Finance (M.Com. Part -
I: SE
12 Corporte M-Il)
FINANCIAL MANAGEMENT V. FINANCIAL ACCOUNTING
Though tinaneial management and financial accounting are closely
related. still they differ
er in uthe
treatment
of funds and also with regards to decision making.
() Treatment of Funds: In accounting. the measurement funds based
of is on al
the accrual principle.
principle
The accrual hased acvounting data do not reflect fully the financial conditionsofthe organisation
1on.
An organisation which has earned profit (sales less expenses) may said to be profitable in th
avounting sense but it may not be able to meet its current obligations due to shortage ofliquidi
as a result of
say. uncollectible receivables. Whereas, the treatment of funds, in financial
al
managenment is based on cash flows. The revenues are recognised only when cash is
rreived (i.e. cash intlow) and
actualv
Thus. cash flow based returns
expenses are recognised actual payment (1.e. cash outflow)
on

help financial managers to avoid insolvency and achieve desired

financial goals.
2) Decision-making: The chief focus of an accountant is to collect data and present the data
the financial manager's primary while
responsibility relates to financial
planning, controlling and
decision-making. Thus. in way it can be stated that financial
a
accounting ends. management begins where financial