Understanding

Financial Management
Financial management is an integrated
decision making process, concerned with
acquiring, managing and financing assets to
accomplish overall goals within a business
entity.

Speaking differently, it is concerned with

making decisions relating to investments in
long term assets, working capital, financing
of assets and so on.
 Meaning of Financial Management
. Financial management is that managerial activity
which is concerned with the planning and controlling
of firm’s financial resources.
• Financial management entails planning for the future
of a person or a business enterprise to ensure a
positive cash flow, including the administration and
maintenance of financial assets.
• Some experts refer to financial management as the
science of money management.
 DEFINITIONS OF FINANCIAL
MANAGEMENT:
• According to Weston and Brighan, “Financial
Management is an area of financial decision
making, harmonising individual motives and
enterprise goals”.
• 2. According to Howard and Upon, “ Financial
Management is the application of the planning
and controlling functions to the finance function”.
• 3. According to Ezra Soloman and Pringle John,
“Financial Management is concerned with the
effective use of an economic resource namely
capital fund”.
 Importance of Financial Management
Financial management is concerned with procurement and
utilization of funds in a proper way. It is important because of
the following advantages:

1. Helps in obtaining sufficient funds at a minimum cost.

2. Ensures effective utilization of funds.

3. Tries to generate sufficient profits to finance expansion and

modernization of the enterprise and secure stable growth.

4. Ensures safety of funds through creation of reserves,

re-investment of profits, etc.
 Role of a Finance manager/ Major Areas of
Decision Making

The finance function relates to three major decisions which the

finance manager has to take:

• Investment decisions

• Finance decisions

• Dividend decisions
Investment decision:

This decision relates to the careful selection of assets in

which funds will be invested by the firm. It Involves buying,
holding, reducing, replacing, selling & managing assets.

Common questions involving Investments include:

• In what lines of business should the firm engage?
• Should the firm acquire other companies? Merger &
Acquisitions
• What sort of property, plant, equipment should the firm
hold?
• Should the firm modernise or sell an old production facility?
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The investment decisions can be classified in
the two broad categories:
(i) Long –term investment decisions.
(ii) Short-term investment decisions.
The long term investment decision is referred to
as the capital budgeting and the short term
investment decision as working capital.
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The investment proposals should be evaluated
in terms of expected profitability, costs
involved and the risks associated with the
projects. The investment decisions are
important not only for the setting up of new
units but also for the expansion of present
units, replacement of permanent assets, R&D
projects etc.
 Continue………….
On the other hand, Short-term investment
decisions relates to the allocation of funds as
cash and cash equivalents, receivables and
inventories. Such a decision is influenced by
trade off between liquidity and profitability.
A sound short-term investment
decision is one which ensures higher
profitability, proper liquidity and sound
structural health of the organisation.
 Financing decisions:
Once the firm has taken the investment decisions and committed
itself to new investments, it must decide the best means of
financing these commitments. Since, firms regularly make new
investments, the needs for financing and financial decisions are on
going. Hence a firm will be continuously planning for new financial
needs. The financing decision is not only concerned with how best to
finance new assets, but also concerned with the best overall mix of
financing for the firm.
The important thing to be decided here is the proportion of various
sources of finance in the overall capital mix of the firm.
 Dividend decisions:

• This decision relates to the appropriation of

profits earned. The two major alternatives
are to retain the profits earned or to
distribute these profits to shareholders.
• Dividend is the part of profit which is
distributed by the company among its
shareholders.
While declaring dividend, a large number of
considerations are kept in mind such as:
❖ Trend of earnings
❖ Stability in dividends
❖ The trend of share market prices
❖ The requirement of funds for future growth
❖ The cash flow situation
❖ Restrictions under the Companies Act
❖ The tax impact on shareholders etc.
 Divid
on
ecisi

Investment decision

end d
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Finan

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Three Legged Tool Analogy: Broad Classification of Decision Activities
 Objectives of Financial Management

The objectives or goals of financial management are-

(a) Profit maximization,

(b) Wealth maximization.

Objectives of Financial Management

(1)Profit maximization: Maximization of profits is generally regarded as

the main objective of a business enterprise.

(2)Wealth Maximization: Maximization of profits is regarded as the

proper objective of the firm but it is not as inclusive a goal as that of
maximizing its value to its shareholders.
 Financial Planning
Financial planning means deciding in advance how much to spend, on
what to spend, according to the funds at your disposal.
Thus, there are two aspects of financial planning:

❖ How much funds are required to finance current and fixed assets and
future expansion project?
❖ From where will these funds come?

Financial planning takes into consideration the growth, performance,

investments and requirement of funds for the business for a given
period of time.
Capitalization Capital Management
structure of capital
 Capitalisation
Capital is the basis of all financial decisions
and the term capitalization has been derived
from it .

• Capital means the total funds invested in the business and

includes owners’ funds , long term loans and other reserves
which are represented by assets.

• Capitalization is the valuation of this capital and will include

owners funds, borrowed funds, long term loans, reserves and any
surplus earnings.
 Three possible situations of Capitalisation

Fair capitalization Over Under

capitalization capitalization
Business employs
correct amount of Business employs
Business employs
capital more capital than
less capital than
warranted
warranted
 Over Capitalisation

There are three main indicators of over capitalization:

i. When the amount of capital invested in the business exceeds the

real value of its assets.

ii. When the earnings are not justified by the amount of

capitalization i.e. a fair return is not realized on capital employed.

iii. When a business has more net assets than it requires

 Under Capitalisation

Under capitalization is the reverse of over capitalization.

A company becomes under capitalized when :

• The future earnings are under estimated at the time of

promotion.

• Unforeseen increase in earnings

 Functions of Financial Management

Functions of financial management can be divided into two

groups:

• Executive (or managerial)functions

• Incidental or routine functions

 Executive functions:

These functions involve financial, investment and dividend decision making.

Executive functions involve the following decisions:

• Financial Forecasting
• Investment decisions
• Managing corporate asset structure
• The management of income
• Management of cash
• Deciding about new sources of finance
• To contact and carry negotiations for new financing
• Analysis and appraisal of financial performance
• Advising the top management
Incidental functions:

They are performed by low level assistants like

accountants, account assistants etc. They
include:

• Record keeping and reporting

• Preparation of various financial statements
• Cash planning and its supervision
• Credit management
• Custody and safeguarding different financial securities etc.
• Providing top management with information on current
and prospective financial conditions of the business.