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FINANCIAL MANAGEMENT
UNIT: 1 INTRODUCTION

MEANING OF FINANCE:

Finance may be defined as the art and science of managing money and other
Assets. It is derived from the Latin word “FINIS”.
It includes financial service and financial instruments. Finance also is referred as
the provision of money at the time when it is needed.

FINANCIAL MANAGEMENT:

Financial Management is also known as ‘Business Finance’ or ‘Corporate Finance’.

Meaning: Financial Management refers to an activity or a process which is

concerned with acquisition of funds, use of funds and distribution of profits by a
business firm.

Financial management refers to those managerial activities or efforts which are

concerned with the procurement and effective utilization of finance for the
attainment of the common objectives of the business enterprise.

DEFINITION OF FINANCIAL MANAGEMENT:

According to Joseph & Massie financial management is the operational activity of

a business that is responsible for ‘obtaining and effectively utilising the funds
necessary for efficient operation.

According to Ezra Solomon “Financial Management is concerned with the efficient use of
an important economic resource viz., capital funds”.

NATURE OF FINANCIAL MANAGEMENT:

The nature of Financial Management is revealed by the following characteristics of
financial management.
1. Deals with financial resources: Financial management deals with the
management of funds.
2. Separate discipline: Initially financial management was regarded as a
branch of economics. But today, it is considered as a separate discipline.
3. Multidisciplinary: Thenature ofFinancial Management is multidisciplinary.
Financial management depends upon various other disciplines.Such as
accounting, banking, economy etc.
4. Financial Management is one of the areas of business management:
Financial management does not function in isolation. It works in
combination with other areas of business management. Such as production,
marketing and personal.
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5. Widened scope: Scope during initial period the scope of financial

management was confined to the mere acquisition of funds. But today its
scope covers both acquisition and application of funds.
6. Centralized function: The financial decisions are taken by the top level
management.
7. Universal applicability: The financial management is acceptable to any
organization irrespective of the size, nature and type of ownership and
control.
8. Financial management is both an art and science: Financial management
not only requires the knowledge of use of Techniques or tools of financial
analysis but it requires the practical knowledge to apply them and interpret
the results.

SCOPE OF FINANCIAL MANAGEMENT:

The scope of financial management has undergone significant changes over the
years. Earlier the scope of financial management was limited to procurement of
funds only. But today the scope of financial management is extended to utilizingor
application of funds. Earlier financial management focus on only long term finance.
But in recent scenario financial management focus on working capital also. Earlier
the concept of financial management was called as ‘corporate finance’, but it now
evolved as a separate discipline called ‘financial management’. The key objective of
financial management is to organize the funds for both long-term and short-term
needs and application of these funds wisely in order to achieve organizational
objectives.

The financial manager has to perform the following activities to meet the
needs of the organization.
1. Evaluation of financial requirement: The first and foremost task of a
financial manager is to estimate the funds required for both long-term and
short-term financial requirements. He must ensure there should not be over
capitalization or under capitalization or excess of funds (idle funds) or
shortage of funds (deficit of funds).
2. Formation of capital structure: after estimating the quantum of funds
required, he has to frame the capital structure. Capital structure refers the
kind and proportion of different securities for raising such funds. Capital
structure decision is to be taken keeping in mind the cost of capital of each
source of fund. A proper blend of equity and debt should be made.
3. Sources of finance: After formation of capital structure, an appropriate
source of finance isto be selected from which Finance maybe raised. Ex:
shares, debentures, loans from commercial banksand Financial Institutions
public deposits etc.
4. Choice of Investment: After rising or procuring the required finance, next
the finance manager has to made decision about proper allocation of funds in
fixed assets and working capital. To choose the best option among the
available alternatives, the finance manager has to make use of certain capital
budgeting techniques and cost volume profit analysis etc.
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5. Cash management: The financial manager has to ensure liquidity in the

organization for smooth working of the organization. Cash is very essential for
running the organization efficiently. Ex: To purchase raw materials, to pay
wages, salaries etc. Cash inflows and cash outflows should be managed
efficiently.
6. Implementation of Financial Controls: After allocation of funds, the task of
financial manager will not end. Proper control on the funds or financial
resources is must for achieving objectives of financial management. For this
he has to make use of certain techniques such as budgetary control, Return
on investment, Break even analysis etc. Corrective measures are to be taken
whenever necessary.
7. Usage of surpluses: This falls under dividend decision of financial
management. The financial manager has to make decision regarding what
percentage of profit or surplus should be given to shareholders as dividend
and how much should be kept for the investment in the business for the
purpose of expansion, modernization, diversification of business etc.

GOALS OR OBJECTIVES OF FINANCIAL MANAGEMENT:

The objectives or goals of financial management can be classified into two

categories 1) Specific objectives or Basic objectives 2) General Objectives
or Other Objectives

 Specific objectives or Basic objectives

A. Profit Maximization: Profit maximization implies that the profits of the firm
aremaximized. No business can survive without earning profit. Profit is the
yardstick for measuring the efficiency of a business.
Profit maximization implies that the decisions or actions that increase the
profits of the firm has to be taken and actions are decisions that decrease the
profits of the firm should be avoided.
B. Wealth maximization: The concept of wealth maximization implies that
maximization of the wealth of the company and maximization of market value
of the equity shares. The wealth maximization attained by an organization is
reflected by the market value of equity shares.
It refers to maximization of the net present value of a course of action for
increasing shareholders wealth. NPV can be equated as the gross present
value of the benefits minus the amount invested to receive such benefits.
It states that present value of future cash inflows generated by a decision
should be more than the present value of the cash outflows required for that
decision.

 General Objectives or Other Objectives

1) Balanced asset structure: Proper balance between the fixed assets and
current assets is to be maintained. The size of the fixed assets is to be
decided scientifically.The size of the current assets must permit the company
to exploit the investment on fixed assets.
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2) Liquidity: Financial management must ensure regular and adequate supply

of funds to the concern.
3) Proper planning of funds: Financial management must ensure proper
acquisition and allocation of funds. Acquisition of funds at minimum cost and
allocation of funds to maximize the returns is to be made.
4) Sound capital structure: There should be proper blend of different sources
in capital structure. Proper balance is to be maintained in debt and equity
capital.
5) Safety and profitability: Financial management has to ensure safety to
funds invested at the same time it has to ensure adequate returns on
investment.
6) Efficiency: Efficiency and effectiveness are very much necessary in
controlling the flow of funds.
7) Financial discipline: Proper financial discipline to be practiced to control
financial scams and scandals.
FUNCTIONS OF FINANCIAL MANAGEMENT (6 A’S):
 Anticipating financial requirements
 Acquiring financial resources
 Allocating funds in business
 Administrating the allocation of funds
 Analysing the performance of finance
 Accounting and reporting to the management.

EMERGING ROLE OF FINANCIAL MANAGER IN INDIA:

Finance manager is a person who heads the department of Finance. Finance
manager is a person who manages the financial activities of an organization and
accountable for an organization. Primary focus of financial manager is on
profitability.
The following functions of financial manager depicts the role of finance manager.
1. Estimation of the financial requirements: Financial manager has to anticipate
and estimate the total financial requirements of an organization. Funds for both
meeting capital expenditure and revenue expenditure are to be
estimated.Preparing the sound financial plan is very important function of
financial manager.

2. Selection of right sources of funds: After estimating the total funds of a

business required for a business organization, the finance manager has to select
the right sources of funds at right time and at right cost. Each source of funds
associated with different types of costs. Equity has the cost of dividend while
debentures or borrowingshas the cost of interest. He has to balance the own
capital (equity) and borrowed capital (debt) for the best advantage of the firm.
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3. Allocation of funds: After mobilizing the funds the finance manager has to
allocate and distribute the funds to capital and revenue expenditure. Different
proposals are to be evaluated in terms of risks and returns associated with
them.
4. Analysis and interpretation of financial performance: It is another important
task of finance manager. He is expected to watch or monitor the performance of
each portfolio. Performance can be measured in terms of profitability and
returns on the investment. For this he can use ratio analysis and comparison of
actual with standard performance.

5. Capital budgeting: Investments in long term assets are known as capital

budgeting decisions. He has to evaluate investment proposals by using the
technique for such as payback period, ARR, IRR, NPV etc.

6. Working Capital Management: Working capital refers to the capital required for
the day-to-day operations of a business enterprise, particularly to complete the
operating cycle. Working Capital Management is concerned with the
management of current assets. He has to consider profitability and liquidity
while managing the working capital.

7. Profit planning and control: Profit is the purpose of any business. It is the
yardstick with which the performance of a business concern is measured. Profit
is the surplus of revenue over the expenses of a business enterprise. Thus the
financial manager must try to control the expenses and thereby increase profit.
Break even analysisand cost-volume-profit analysis are the tools required in
profit planning and control.

8. Fair return to the investors: It is the obligation of a business enterprise to

protect the interest of shareholders. Returns are the profits available to
investors. Equity shareholders generally expect fair amount of profit and capital
appreciation for their investment. Fai rate of return to investors encourages the
public to increase their savings to invest in securities. This promotes the capital
formation in a country and pave the way for Industrial Development.

9. Maintaining Liquidity and wealth maximization: It is another important task

of financial manager. Liquidity of a firm increases borrowing capacity of a
business enterprise. Increased liquidity strengthen the firm's ability to meet its
short-term obligations.
EMERGING ROLE OF FINANCE MANAGER IN INDIA:
In addition to the traditional role or functions, the financial manager has to look
into the areas where he has to work with the changing environment. Finance
manager must be more vibrant, dynamic and should have continuous learning
attitude. The following functions of financial manager depicts the emerging role
of finance manager in India.
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 Forecasting and planning: it is the basic function of financial manager. It

deals with drafting out a future course of action & deciding the most
appropriate course of actions for achievement of pre-determined Goals.
 Executing financing and investment decisions: one of the key
responsibilities of a financial manager is determining capital requirements of
the company and also to decide capital structure the company needs and
further identify the sources to fulfill capital requirements.
 Co-ordination and control: the financial manager must interact with other
departments to ensure that the firm is operated as efficiency as possible
 Management of financial resources: the finance manager needs to ensure
the supply of adequate, timely and cheap fund to the various parts of the
organization. Make proper decisions with regards to cash management.
 Maximise profit & minimise cost: a company can earn maximum profits
even in the long-term, by taking proper financial decisions and by using the
finance resources of the company properly.
 Raising and allocation of funds: in order to meet the obligation of the
business, it is important to have enough cash and liquidity. A firm can raise
funds by the way of equity and debt.
 Profit planning: profit planning is one of the prime functions of any business
organization. Profit planning refers to proper usage of the profit generated by
the firm.
 Understanding capital markets: shares of a company are traded on stock
exchange and there is a continuous sale and purchase of securities. Hence a
clear understanding of capital market is an important function of a finance
manager.
 Cash management : This helps the firm to meet all types of obligation to the
target group like investors, creditors, employees, management, government
and society.
FINANCIAL PLANNING:
Meaning of financial planning:
Financial planning pertains to the functions of finance and includes the
determination of the firm’s financial objectives, financial policies, and financial
procedures.
Financial plan is a statement estimating the amount of capital and
determining its composition
Definition of financial planning: Financial planning can be defined as the
process of estimating the funds required and determining the form and
proportion of securities to raise these funds and setting firm’s financial
objectives and framing the policies and procedures to achieve these objectives.
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PRINCIPLES OF SOUND FINANCIAL PLANNING:

The financial plan should be prepared keeping in view the following principles
1) Principle of simplicity: The financial plan must not be complex. It must be
simple to understand and easy to use.

2) Principle of long term view: The financial plan must consider the long term
objectives of business enterprise rather than just to focus on short term
requirements of the concern.

3) Foresight: the financial plan should be prepared keeping in view the future
requirements of capital of business. Technological improvements, demand
forecast other secular changes should be kept in view while drafting the
financial plan.

4) Optimum use: the financial plan should provide for meeting the genuine
needs of the company. The company should avoid unnecessary spare funds,
wasteful use of capital.

5) Principle of provision for contingencies: Contingencies are events, which

may or may not happen in the future. A financial plan must make certain
provisions to meet unforeseen or unexpected expenses. It does not mean that
large amount of funds should be kept idle to meet the contingencies. But
planner should make proper forecasts of the contingencies likely to arise in
the future.

6) Principle of flexibility: Financial plan must be flexible rather than rigid. It

must be flexible so that it can be altered or revised or changed according to
the changing needs of the business concern. The company must be able to
change the financial plan according to the changing circumstances.

7) Principle of liquidity: Liquidity is the ability of an enterprise to make cash

available whenever required for making payment. There should be adequate
liquidity in the enterprise. The company must have sufficient cash to meet its
day-to-day requirements. But it should not be too low or too high.

8) Principle of Economy: the cost of raising the required capital should be the
minimum. It should not impose disproportionate burden on the company.

Other principles: Realistic, Objectivity, Principle of safety, Principle of balanced

capitalization are the other principles of financial planning.
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FACTORS DETERMINING THE FINANCIAL PLANNING:

A financial plan is primarily a statement estimating the amount of capital and
determining its composition. It should be framed carefully. The following points
should be kept in mind while framing a financial plan.
1) Nature of industry: The requirements of funds may vary from Industry to
Industry. The type of business, the size of the business, stability of business,
earning capacity etc. These factors to be considered while estimating the
financial requirements.

2) Availability of sources: The various sources of funds and their pros and
cons of all available sources should be properly analyzed while deciding the
sources of funds.

3) Future plans: A financial plan should be designed keeping in view the future
plans of business. For example a firm planning expansion and diversification
in the near future requires flexible financial plan.

4) Status of the organisation: The standing position of business enterprise

such as, goodwill, credit worthiness, past performance, attitude of the
management, and earning capacity are also to be considered in financial
planning.

5) Economic conditions: Economic conditions prevailing in the national and

international markets are also to be considered. Favorable conditions helps
in rising funds whileunfavorable conditions make difficult to raise the funds.

6) Government control: Government laws and regulations, tax policy,

restrictionsand relaxations, support etc. are to be considered while framing
the financial plan.

LIMITATIONS OF FINANCIAL PLANNING:

There are some limitations of financial planning. They are as follow.
1) Complexity in prediction or forecasting: Financial plans are prepared by
estimating or forecasting the trends in future. But future is uncertain and it
is very difficult to predict or forecast the Future correctly.

2) Difficulty in changing plan: changes in the economic situation requires

change in financial plan which makes finance manager resist to changes. It
becomes very difficult to change the plans since the changes take place at
faster pace.

3) Quick changes in economy: The changes in business environment and in

the economy make the financial plans outdated. To incorporate these changes
financial plans should be flexible.
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4) Lack of coordination: Financial plan is to be prepared with coordination of

other departments
ents in the organisation
organisation. But lack of coordination
rdination among the
departments make it difficult tto obtain precise financial plan.
5) Time
ime consuming and expensive process:process Formulation
ormulation of financial plan
takes a lot of time and requires expertise knowledge and also sometimes it
requires new technologies
technologies. So all these made extensive and time consuming.

STEPS IN FINANCIAL PLANNING

PLANNING:
Financial planning refers to pre
pre-determination of financial activities so that
t the
objectives
ctives of the firm are achieved. Financial
Financial planning implies forecasting the
financial needs of the organisation identify suitable sources of funds and ensure
their efficient utilization.
The steps involved in financial planning are ;

1) Establishing
tablishing financial objectives: The he financial objectives of a company
should be clearly determine
determined. Bothoth long term and short term objectives
should be clearly prepared.
prepared The main purpose of financial planning should be
to utilize financial resources in tthe best possible manner.

2) Formulation
ormulation of financial policies:
policies The e financial policies of a concern
co deal
with the procurement, a administration, and distribution of business funds in
the best possible way.. Ex:
Ex:-
Policies
olicies regarding quantum of funds
Policies regarding pattern of capitalisation
Policies regarding selection of sources of funds
Policies regarding allocation of funds

3) Forecasting: A fundamental requisite of financial planning is the collection of

facts. However,, where financial plans concern the ffuture,
uture, “facts” are not
available. Therefore, the financial management has to forecast the future
variability of factors.

4) Formulation
ormulation of financial procedures
procedures: The he procedures followthe formulation
of policies. Iff a policy is to raise short term funds from Bank then procedure
tells us the process of getting the short term funds
funds.
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These steps are optional*

5) Implementation of financial plan: The next step is to implement the
financial plan.Financial planning is to be implemented properly and
performance is to be evaluated with the objectives and corrective action needs
to be taken whenever required.
6) Reviewing financial plan: Financial management has to review the financial
plan so as to make changes in financial plan to suit the requirements of the
changes in economic and business situations.

NEED FOR FINANCIAL PLAN / OBJECTIVES OF FINANCIAL PLAN:

 To ensure supply of sufficient funds to the business enterprise

 To minimize the cost of capital
 To ensure liquidity and profitability
 To ensure flexibility in firms operations
 To make provisions for contingencies