APPROACHES TO FINANCIAL MANAGEMENT

Submitted to:
Dr. Yamala Papa Rao
Assistant Professor of Law
(Faculty of Corporate Law)

Submitted by:
Samrat Banerjee
Semester VII, Sec. A, Roll No. 137
B.A. LL.B. (Hons.)

Submitted On: Dec 8th, 2020

HIDAYATULLAH NATIONAL LAW UNIVERSITY

ATAL NAGAR, NAVA RAIPUR, CHHATTISGARH- 492002
 DECLARATION

I, the undersigned, solemnly declare that this Project work titled, “APPROACHES TO
FINANCIAL MANAGEMENT” is based on my own research work, carried out during the
course of my study, under the supervision and guidance of my faculty advisor.
I assert that the statements made and the conclusions drawn are the outcome of the said research
work. I further declare that, to the best of my knowledge and belief, proper references have
been given wherever necessary.

Samrat Banerjee
Semester VII, Section A
Roll No. 137

ii
 ACKNOWLEDGEMENT

I, Samrat Banerjee, feel elated, as it gives me immense pleasure to come with the work on
topic, “APPROACHES TO FINANCIAL MANAGEMENT”. Words fail to express my deep
sense of glee to my teacher, Dr.Yamala Papa Rao, Faculty Member for Corporate Law,
Hidayatullah National Law University, Raipur, who enlightened me on my every difficulty in
completion of task. I acknowledge the blessings and support which my mother and father gave
in finishing of this task.

I would like to forward my hearty thanks to my University and Vice-Chancellor for providing
all the necessary requirements which aided me to achieve my goal. I feel a deep sense of
thankfulness to all my seniors, my friends who helped me in achieving my target.

Samrat Banerjee
Semester VII, Section A
Roll No. 137

iii
 Contents

DECLARATION ............................................................................................................. II
ACKNOWLEDGEMENT ..............................................................................................III
INTRODUCTION ............................................................................................................ 1
RESEARCH PROBLEM ................................................................................................. 2
SCOPE & OBJECTIVE................................................................................................... 2
NATURE OF STUDY....................................................................................................... 2
APPROACHES TO FINANCIAL MANAGEMENT ...................................................... 3
TRADITIONAL APPROACH: .................................................................................... 3
MODERN APPROACH ............................................................................................... 4
Investment decisions ................................................................................................... 5
(2) Finance Decisions:................................................................................................. 7
Equity:........................................................................................................................ 8
Debt: .......................................................................................................................... 9
(3) Dividend Decisions: ................................................................................................. 9
III APPROACH: LIQUIDITY AND PROFITABILTY ................................................ 10
CONCLUSION............................................................................................................... 12
BIBLIOGRAPHY........................................................................................................... 12

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 INTRODUCTION

Financial Management is a vital activity in any organization. It is the process of planning,

organizing, controlling and monitoring financial resources with a view to achieve
organizational goals and objectives. It is an ideal practice for controlling the financial activities
of an organization such as procurement of funds, utilization of funds, accounting, payments,
risk assessment and every other thing related to money. 1

In other terms, Financial Management is the application of general principles of management

to the financial possessions of an enterprise. Proper management of an organization’s finance
provides quality fuel and regular service to ensure efficient functioning. If finances are not
properly dealt with an organization will face barriers that may have severe repercussions on its
growth and development. 2

Scope

Investment decisions includes investment in fixed assets (called as capital budgeting).

Investment in current assets are also a part of investment decisions called as working capital
decisions.

Financial decisions - They relate to the raising of finance from various resources which will
depend upon decision on type of source, period of financing, cost of financing and the returns
thereby.

Dividend decision - The finance manager has to take decision with regards to the net profit
distribution. Net profits are generally divided into two:

• Dividend for shareholders- Dividend and the rate of it has to be decided.

• Retained profits- Amount of retained profits has to be finalized which will depend
upon expansion and diversification plans of the enterprise

1 Lawrence Gitman and Chad J. Zutter (2019). Principles of Managerial Finance, 14th edition, Addison-Wesley
Publishing.
2
James Van Horne and John Wachowicz (2009). Fundamentals of Financial Management, 13th ed., Pearson
Education Limited.

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 Research Problem

What are the various approaches to financial management?

Scope & Objective

The research note aims to analyse approaches to financial management

Nature of study

This project has been made by employing Doctrinal and Scholastic method of Research & by
using primary & secondary sources of information.

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 APPROACHES TO FINANCIAL MANAGEMENT

This project will focus on the following three approaches:

1) TRADITIONAL APPROACH
2) MODERN APPROACH
3) LIQUIDITY AND PROFITABILITY

TRADITIONAL APPROACH:

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. The basic
responsibility of the Finance manager is to acquire funds needed by the firm and investing
those funds in profitable ventures that will maximize firm’s wealth, as well as, yielding returns
to the business concern.3

The success or failure of any firm is mainly linked with the quality of financial decisions. The
focus of Financial management is on efficient and judicious use of resources to attain the
desired objective of the firm.

The basic objectives of Financial management centres around (a) the procurement funds from
various sources like equity share capital, preference share capital, debentures, term loans,
working capital finance, and (b) effective utilization of funds to maximize the profitability of
the firm and the wealth of its owners.

3Catherine mayer, The Traditional Approach and The Modern Approach of Finance, smart finance news, (Feb
22, 2019, 10:04 am), https://www.smartfinance-news.com/digital-business/the-traditional-approach-and-the-
modern-approach-of-finance

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The responsibilities of the Finance managers are linked to the goals of ensuring liquidity,
profitability or both and are also related to the management of assets and funds of any business
enterprise.

The traditional view of financial management looks into the following functions, that a
Finance manager of a business firm will perform:

(a) Arrangement of short term and long-term funds from financial institutions.

(b) Mobilization of funds through financial instruments like equity shares, preferenc e shares,
debentures, bonds etc.

(c) Orientation of finance function with the accounting function and compliance of legal
provisions relating to funds procurement, use and distribution.

With the increase in complexity of modern business situation, the role of a Finance manager is
not just confined to procurement of funds, but his area of functioning is extended to judicious
and efficient use of funds available to the firm, keeping in view the objectives of the firm and
expectations of the providers of funds.

MODERN APPROACH

The globalization and liberalization of world economy has caused to bring a tremendous reform
in financial sector which aims at promoting diversified, efficient and competitive financial
system in the country. The financial reforms coupled with diffusion of information technology
has caused to increase competition, mergers, takeovers, cost management, quality
improvement, financial discipline etc. 4

Globalization has caused to integrate the national economy with the world economy and it has
created a new financial environment which brings new opportunities and challenges to the
individual business concern. This has led to total reformation of the finance function and its
responsibilities in the organization.

4
ibid

4
Financial management in India has changed substantially in scope and complexity in view of
recent Government policy. Today’s Finance managers are seized with problems of financial
distress and are trying to overcome it by innovative means. In the current economic scenario,
financial management has assumed much greater significance.

It is now a question of survival of entities in the total spectrum of economic activity, with
pragmatic readjustment of financial management. The information age has given a fresh
perspective on the role of f inancial management and Finance managers. With the shift in
paradigm it is imperative that the role of Chief Finance Officer (CFO) changes from Controller
to a Facilitator.

In view of modern approach, the Finance manager is expected to analyse the firm and to
determine the following:

(i) The total funds requirement of the firm,

(ii) The assets to be acquired, and

(iii) The pattern of financing the assets.

The Finance manager of a modern business firm will generally involve in the following three
types of decisions:

(1) Investment decisions,

(2) Finance decisions, and

(3) Dividend decisions.

(1) Investment Decisions:

Investment decisions
Investment decisions are those which determine how scarce resources in terms of funds
available are committed to projects. The project may be as small as purchase of equipment or
as big as acquisition of an entity. 5

5
Shivam N, Investment Decisions: Meaning, Need and Factors Affecting It, economic discussion.net,
https://www.economicsdiscussion.net/investment-decisions/investment-decisions-meaning-need-and-factors-
affecting-it/21976

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Investment in fixed assets requires supporting investment in working capital in the form of
inventory, receivables, cash etc. Investment which enhance interna l growth is termed as
‘internal investment’ and acquisition of entities represents ‘external investment’.

The investment decisions should aim at investment in assets only when they are expected to
earn a return greater than a minimum acceptable return, which is also called as ‘hurdle rate’.
The minimum return should reflect whether the money raised from debt or equity meets the
returns on investments made elsewhere on similar investments.

The hurdle rate has to be set at higher for riskier projects and has to reflect the financing mix
used i.e., the proportion of debt and equity. The Finance function involves not only in
investment decisions, but also in disinvestment decisions, for example withdrawing from
unsuccessful projects or restructuring with a strategic motive.

Investment decisions relate to the careful selection of viable and profitable investment
proposals, allocation of funds to the investment proposals with a view to obtain net present
value of the future earnings of the company and to maximize its value.

It is the function of a Finance manager to carefully analyse the different alternatives of

investment, determination of investment levels in different assets i.e., fixed assets and current
assets.

The investment decisions of a Finance manager cover the following areas:

(a) Ascertainment of total volume of funds, a firm can commit.

(b) Appraisal and selection of capital investment proposals.

(c) Measurement of risk and uncertainty in the investment proposals.

(d) Prioritizing of investment decisions.

(e) Funds allocation and its rationing.

(f) Determination of fixed assets to be acquired.

(g) Determination of levels of investments in current assets viz., inventory, receivables, cash,
marketable securities etc., and its management.

(h) Buy or lease decisions.

(i) Asset replacement decisions.

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(j) Restructuring, reorganization, mergers and acquisitions.

(k) Securities analysis and portfolio management etc.

(2) Finance Decisions:

The financing objective asserts that the mix of debt and equity chosen to finance investments
should maximize the value of investments made. The debt equity mix should minimize the
hurdle rate allows the firm to take more new investments and increase the value of existing
investments.6

Financing decisions relate to acquiring the optimum finance to meet financial objectives and
seeing that working capital is effectively managed. Financing decisions call for good
knowledge of costs of raising finance, procedures in hedging risk, different financial
instruments and obligations attached to them etc. Important principle to consider in financing
is that long-term assets should be financed with long-term debt and short-term assets should be
financed with short-term debt.

Firms that violate this basic rule do so at their own risk. It is one of the important functions of
a Finance manager is procurement of funds for the firm’s investment proposals and its working
capital requirements.

In fund raising decisions, he should keep in view the cost of funds from various sources,
determination of debt-equity mix, the advantages and disadvantages of debt component in the
capital mix, impact of taxation and depreciation in maximization of earnings per share to the
equity holders, consideration of control and financial strain on the firm in determining level of
gearing, impact of interest and inflation rates on the firm etc.

The Finance manager has to take a number of finance decisions and some of them are as
follows:

(a) Determination of degree or level of gearing.

(b) Determination of financing pattern of long-term funds requirement.

(c) Determination of financing pattern of medium and short-term funds requirement.

6
Thorton, Mike (2016). History of Money:Financial History,From Barter to Bitcoin. pp. Chapters 1-5.

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(d) Raising of funds through issue of financial instruments viz., equity shares, preference
shares, debentures, bonds etc.

(e) Arrangement of funds from banks and financial institutions for long-term, medium-term
and short-term needs.

(f) Arrangement of finance for working capital requirement.

(g) Consideration of interest burden on the firm.

(h) Consideration of debt level changes and its impact on firm’s bankruptcy.

(i) Taking advantage of interest and depreciation in reducing the tax liability of the firm.

(j) Consideration of various modes of improving the earnings per share and the market value
of the share.

(k) Consideration of cost of capital of individual components and weighted average cost of
capital to the firm.

For financing decisions, the capital structure is broadly divided into:

(a) Equity, and

(b) Debt.

Equity:
The raising funds through issue of shares attract flotation costs. The shareholder expects the
return in the form of dividends and capital appreciation of their investment reflected in the
increase in stock market price.

The dividend payments are made only if the distributable profits are available with the
company, after payment of interest charges and tax payments. Any further issue of shares by
the existing companies may dilute the controlling interest. 7

The equity is considered as low risk but most expensive way of funding the company’s projects.
The equity funds are not returnable except in the case of liquidation. However, the buy -back
of shares is allowed under the provisions of the Companies Act, 1956.

7
Maitland, F. W. (1909). Equity, Also, the Forms of Action at Common Law.

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The equity holders will participate in the policy decisions of the company. In company form
of business, only legal personality exists, hence all decisions are carried through the agents
who work for remuneration. Therefore, agency problems arise with the managers.

Debt:
The debt funds are raised in the form of debentures, bonds, term loans etc. The expectation of
the providers of debt is obtain return in the form of interest payments which should
commensurate with the risk attached to their investment. The debt is repaid as per the
agreement. The interest should be paid irrespective of the profitability of the firm.

The portion of debt component in capital structure will facilitate the trading on equity Le. the
interest on debt is payable at a fixed rate and if the firm’s return on capital employed is more
than the interest payable, the excess return over fixed interest will be added to the profits
available to equity providers.

But the high proportion of gearing i.e., excess reliance on debt funds will increase the financial
risk of the firm. The cost of debt is always lower than cost of equity, since any interest payable
will reduce the tax liability of the firm. The non-repayment of interest and principal amounts
in time may sometimes call for liquidation of the company.

(3) Dividend Decisions:

Dividend decisions concerned with the determination of quantum of profits to be distributed to
the owners and the frequency of such payments. The dividend decisions will effect in two ways
(a) the amount to be paid out and its influence on share price, and (b) the amount of profit to
be retained for internal investment which maximizes the value of firm and ultimately improves
the share value of the firm.

The level and regular growth of dividends represent a significant factor in determining a profit-
making company’s market value and the value of its shares in the stock market. The dividend
decisions of a Finance manager is mainly concerned with the decisions relating to the
distribution of earnings of the firm among its equity holders and the amounts to be retained by
the firm.

The Finance manager will involve in taking the following dividend decisions:

(a) Determination of dividend and retention policies of the firm.

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(b) Consideration of impact of levels of dividend and retention of earnings on the market value
of the share and the future earnings of the company.

(c) Consideration of possible requirement of funds by the firm for expansion and diversification
proposals for financing existing business requirements.

(d) Reconsideration of distribution and retentions policies in boom and recession periods.

(e) Considering the impact of legal and cash-flow constraints on dividend decisions.

In the words of Ezra Solomon “the function of Financial management is to review and control
decision to commit and recommit funds to new and ongoing uses. Thus, in addition to raising
funds, Financial management is directly concerned with production, marketing and other,
functions within an enterprise whatever decision are made about the acquisition or distribution
of assets”.

This statement will reflect the modern view of financial management. From the point of view
of modern corporate firm, financial management is related not only to fund raising but
encompasses the wider perspective of managing the finances for the company efficiently.
Hence, Financial management is nothing but managerial decision making on asset mix, capital
mix and profit allocation.

The corporate finance theory centres around three important objectives of a finance function:

(a) Allocation of funds i.e. investment decisions,

(b) Generation of funds i.e. financing decisions, and

(c) Distribution of funds i.e., dividend decisions.

III APPROACH: LIQUIDITY AND PROFITABILTY

Ezra Solomon states that “liquidity measures a company’s ability to meet expected as well as
unexpected requirements of cash to expand its assets, reduce its liabilities and cover up any
operating losses.” 8

8
https://www.accountingnotes.net/financial-management/3-main-approaches-to-financial-management-
management/10616

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The balancing of liquidity and profitability is one of the prime objectives of a Finance manager.
One of the important problems faced by Finance manager is the dilemma of liquidity vs.
profitability. Liquidity ensures the ability of the firm to honour its short-term commitments.

The liquidity means the firm’s ability to pay trade creditors as and when due, ability to honour
its bills payable on due-dates, ability to pay salaries and wages on time when it is due, ability
to meet unexpected expenses etc. It also reflects the firm’s ability to convert its assets into cash,
cash equivalents and other most liquid assets.

The liquidity of the firm indicates the ability of the organization to realize value in money, and
its ability to pay in cash the obligations that are due for payment. To maintain concern’s
liquidity, the Finance manager is expected to manage all its current assets and liquid assets in
such a way as to ensure its affectivity with a view to minimize its costs. Under profitability
objective, the Finance manager has to utilize the funds in such a manner as to ensure the highest
return.

Profitability concept signifies the operational efficiency of an organization by value addition

through the utilization of resources i.e., men, materials, money and machines. It refers to a
situation in terms of efficiency in utilization of resources to achieve profit maximization for
the owners.

There is an inverse relationship between profitability and liquidity. The higher the liquidity the
lower will be the profitability and vice versa. Liquidity and profitability are competing goals
for the Finance manager. Under liquidity management, the Finance manager is expected to
manage all its current assets including near cash assets in such a way as to ensure its affectivity
with a view to minimize costs.

Sometimes, even if the profit from operations is higher, the firm may face liquidity problems
due to the fact that the amount representing the profit may be in the form of either in fixed
assets like plant, buildings etc. or in the form of current assets like inventory, debtors – other
than in the form of cash and bank balances. In situations where the firm faces the liquidity
problems, will hamper the working of the company which result in lower profitability of the
firm.

If, more assets of the firm are held in the form of highly liquid assets it will reduce the
profitability of the firm. Lack of liquidity may lead to lower rate of return, loss of business
opportunities etc.

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Therefore, a firm should maintain a trade-off situation where the firm maintains its optimum
liquidity for greater profitability and the Finance manager has to strike a balance between these
two conflicting objectives. If, more assets of the firm are held in the form of highly liquid
assets, it will reduce the profitability of the firm.

CONCLUSION

Thus, to conclude Financial management is one of the most important aspects in business. In
order to start up or even run a successful business, you will need excellent knowledge in
financial management. It helps organisations in financial planning; assists organisations in the
planning and acquisition of funds; helps organisations in effectively utilising and allocating the
funds received or acquired; assists organisations in making critical financial decisions; helps
in improving the profitability of organisations; increases the overall value of the firms or
organisations; provides economic stability and encourages employees to save money, which
helps them in personal financial planning.

BIBLIOGRAPHY

• Institute of Company Secretaries of India, CS Executive, Financial and Strategic

Management Module, 2020.
• Companies Act, G.K. Kapoor, Taxmann, 2019.
• Investopedia
• EBC Reader

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