Fundamentals of _ Financial Management Latest Aiton= New Syllabus of Guj. Uni. (Infroce from December - 2013) T. Y. B. Com. Semester - VI . Fundamentals of Financial Management ION AND FINANCIAL PLANNING importance and scope of financial managem 1, financial goals: profit versus value maximization. Finance function: relatior hip between finance function and other functional areas of m: ment. role of fit ce Manager. meaning of financial planning. and steps in UNIT-2: CAPITALIZATION AND CAPITAL STRUCTURE Capitalization: meaning. effe capitalization and watered stock. portance and determin: benefits and risks. op: ancial pl and remedies of under capitalization, over Capital structure: Meani ‘Trading on equity: meani lev ion of capital structure. leverage and financial we: meaning and degree of combined leverage (no numerical), Sources of long term finance: equity. debenture: and preference shares: meanir and limitations of each. : WORKING CAPITAL MANGEMENT Concepts and types of working capital — factors determining worki requirement, Principl UNIT of working capital management. components bles, inventory creditors, bank overdraft and others, disadvantages of inadequate working capital UNIT-4 :COST OF CAPITAL AND CAPITAL BUDGETING Cost of Capital: Meaning and importance, computation of cost of capital for debentures or bonds, equity and preference capital and retained earning Weighted cost of capital. capital: cash, receiva Capital Budgeting: meaning, characteristics, process, techniques, meaning. utility and limitations of various methods — Average rate of return, pay back period, net present value and PI References 1. Elements of Financiai Management, by S.N.Maheshwari 2. Principles of Financial Management, by N.P.Agrawal, R.K.Tailor, Pioneer Publications 2008. 3. Working Capital Management, by N.P.Agrawal, B.K.Mishra, RBSA Publishers 4. Financial Management by P.V.Kulkami, B.G.Satyaprasad, Himalaya Publishing house 5. Financial Management by 8.C.Kuchhal; CONTENTS aps \ ggernoal UNIT-01 Finance Function & Financial Planning .... Financial Management : Meaning and Importance........ Scope of Financial Management Objectives / Goals of Financial Management .... Functions of Finance : Meaning and Approaches Interrelation of Finance Function with Other Areas of Management Roles of Finance Manager voces Financial Planning : Meaning and Characteristics Stages / Procedure of Financial Planning Objective Study Self Study UNIT -02 Capitalization & Capital Structure ........ Capitalisation Capitalisation : Meaning and Methods... Under Capitalisation : Meaning, Causes, Effects and Remedies Over Capitalisation : Meaning, Causes, Effects and Remedies. Difference between Over and Under Capitalisation. Watered Capital : Meaning, Causes, Effects and Remedies .. Capital Structure Capital Structure : Meaning and Characteristics... Factors Determining Capital Structure . Types of Capital Structure . Importance of Capital Structure .. Meaning of Trading on Equity. When Trading on Equity Can Become Profitable ? Limitations of Trading on Equity . Leverage: Meaning and Types Concept of Operating Leverage. Concept of Financial Leverage .. Concept of Combined Leverage Effects of Financial Leverage on Shareholder's Risk Financial Leverage is Double Edged Weapon. Sources of Long Term Finance : (A) Equity Share : Meaning, Importance and Limitations. (2) Preference Share : Meaning, Importance and Limitations (C) Debenture : Meaning, Importance and Limitations .. Objective Study Self StudyUnit - 01 Finance Function Financial Planni Financial Management : Meaning and Roles of Finance Manager Importance 7. Financial Planning : Meanit 2. Scope of Financial Management Characteristics 3. Objectives / Goals of Financial|8. Stages / Procedure of Fi Management Planning 4, Functions of Finance ** Objective Study 5. Interrelation of Finance Function with |** Self Study other areas of Management 1. Financial Management : Meaning and importance 1. Introduction : Finance is the life blood of business. It is problem of financial resources are considered at the time of establishment even at the time of liquidation. Therefore, it can be said that the begining of the unit are linked with the finance. Because of industrial revolution § of industry came into existence. Production started in anticipation of de problem of finance became more complicated. For solution of these co a special branch of the management, finance management has evolved. 2. Meaning of Finance Management : In finance management, financial requirements, its procurement, efficient use of the obtains considered. Various factors related to all these problems and keeping such activities are included. > According to the opinion of Haward and Upton, *‘/n financ: thought for planning, procurement, control regarding finance is management brings the solution of problems arising in réspect of esi K.T-VI. FMM = 4 1UNIT - 03 Working Capital Management ........ Working Capital : Meaning and Characteristics. Concepts of Working Capital Types of Working Capital Factors Determining Working Capital Requirement. Principles of Working Capital Management Components of Working Capital . (A) Cash . (8) Receivable (C) Inventory (D) Creditors (E) Bank Overdraft . Disadvantages of inedieauate Working Capital . Objective Study : i Self Study .. UNIT - 04 Cost of Capital & Capital Budgeting .. EY = Cost of Capital 1. Cost of Capital : Meaning and Characteristics .... 2. Different Concept of Cost of Capital /3. Marginal Cost of Capital and Historical Cost of Capital 4. Importance of Cost of Capital. 5. Computation of Cost of Capital for ‘Debenture or Bonds 6. Computation of Cost of Equity Share Capital 7. Computation of Cost of Preference Share Capital 8. Computation of Cost of Retained of Eaming .. 9. Weighted Cost of Capital ** — Iliustrations .... [TA Capite! Budgeting 1 Capital Buriyeting : .. . Meaning and Chavacteristics Objectives of Capital Budgeting Factors affecting Capital Budgeting . Process of Capital Budgeting... Techniques / Methods of Capital Budgeting (A) Average Rate of Return Method (B) Pay-back Period... (C) Net Present Value .. (D) PI (Profitability Index) illustations ... Objective Study .. Self Study .. Uni. Papers 2, as. 4. 5,Financial Management : Meaning and Importance Scope of Financial Management Objectives / Goals of Financial Management Functions of Finance Interrelation of Finance Function with PUnit-01 |< Unit - 01 Finance Function & Financial Planning Roles of Finance Manager Financial Planning : Meaning and Characteristics Stages / Procedure of Financial Planning Objective Study Self Study other areas of Management 1. Financial Management : Meaning and Importance It is true that are considered at the time of establishment of unit and 1. Introduction : Finance is the life blood of business. problem of financial resources even at the time of liquidation. Therefore, it can be said that the begining and the end ize of the unit are linked with the finance. Because of industrial revolution giganti of industry came into existence. Production started in anticipation of demand, Hence, problem of finance became more complicated. For solution of these complications, as a special branch of the management, finance management has evolved. 2, Meaning of Finance Management : In finance management, problems of financial requirements, its procurement, efficient use of the obtained finance is considered, Various factors related to all these problems and keeping control on all ties are included. such acti > According to the opinion of Haward and Upton, “Ji finance management thought for planning, procurement, control regarding finance is made. Finance management brings the solution of problems arising in respect of establishment of K.TAVE FMM = 1 1 K.C-14 a a a a a atrue but for this, customer service centres are required. It is i ee finance management the idea of customer service centre teat (8) To face business competitions : To stand im the business product of right quality at a myht price and at a right tit market. With the help of finance functions, efficient puré control become possible. So a business unit can face the DESIRES (9) Goodwill : With the help of an ideal finance management e can perform its financial Tiabiites regularly and further customers 9° © nip qualitative goods at reasonable rate. This will increase the goodwill of @ bus! er activities ‘Thus. in business, finance management is an important activity. Oth $lood of business depend on financial matters. Hence, finance is compared wi ve circulation or life line of business and industr 2. Sc 1. Introduction : of Financial Management Scope of financial management is also w ide just Tike production, marketing and human resources management. Thefe are two 0 main components, of financial management : (1) Acquisition of finance and (2) Utilisation of finance. Functions connected with both the components can be included in the scope of the scope of financial management in to ce functions?” financial management. Some experts classi two section : (1) Managerial finance function. (2) Administrative finan [EM Managerial Function of Finance Management : The managerial finance functions can be noted and described as under : (1) Planning of Finance : A unit will need money to acquire fixed and current assets. It will be necessary to plan the sources from which finance will be obtained. Moreover, in financial planning the size, location, the amount of assets and primary expenses of a firm and such other matiers are required to be considered. In addition to these, future development and uncertainty must also be considered. (2) Acquisition of Finance ; Acquisition of finance according to financial estimate is an important function. The main sources of finance are equity shares, debentures, public deposits, financial institutions, bank loans, cash credit, overdraft and foteign capital. The factors to be considered in this connection are as under x (1) Mt must be determined whether the need for finance is short-term or long- (2) Anattempt must be made to obtain finance in proper time and at minimum expense. erm.— ae ee Finance Funetion & Financial Planning (7) Customer service centres : ‘Customer satisfaction true but for this, customer service centres are required. It is very finance management the idea of customer service centre becomes (8) To face business competitions : To stand in the business Product of right quality at a right price and at a right time should be p market. With the help of finance functions, efficient purchasing and control become possible. So a business unit can face the business (9) Goodwill : With the help of an ideal finance management a b can perform its Tiancial liabilities regularly and further customers are qualitative goods at reasonable rate. This wi it Thus, in business, finance management is an important activity. Other activities | depend on financial matters. Hence, finance is compared with the blood circulation or life line of business and industry of busines ASE + 2. Scope of Financial Management 1, Introduetion : Scope of financial management is also wide just like production, marketir rid human resources management. There are two main components of financial management : (1) Acquisition of finance and (2) Utilisation of finance. Functions connected with both the components can be included in the scope of financial management. Some experts cla sify the scope of financial management in to two section : (1) Managerial finance function. (2) Administrative finance functioii Managerial Function of Finance Management : The managerial finance functions can be noted and described as under : (1) Planning of Finance : A unit will need money to acquire fixed and . Twill be ne current as ‘essary to plan the sources from which finance will be obtained. Moreover, in financial planning the size. location. the amount of assets and prin expenses of a firm and such other matters are required to be considered. In st also be considered, Acqu ‘ording to financial n important function. The main sources of finance are equity shares, debentures, public deposits, institutions, bank loans, cash credit, overdraft p capital. The faztors to be considered in this connection are as ee (1) It must be determined whether the need for finance iss! : long-term addition to these, future development and uncertainty m (2) Acquisition of Finance ition of finance a estimate is finanei: and forei (2) Anattempt must be made to obtain finance in proper tim expense. o %4 - Fundamentals of Financial Management 3) The rate of interest and the mode of repayment are also considered. (4) The management should try to determine an ideal capital structure and proper capital investment. (3) Effective Utilization of Finance : The in the context of determined objectives. For example, if the working capital obtained pital obtained should be utilized ets, a shortage of working through a bank overdraft is used in obtaining current a capital will emerge leading the unit to a financial crisis, In the present age, financial management includes capital budgeting, statement of income and expenditure, classification of expenses, statements showing profitability of investments, ratios and cash budget system to arrive at an effective use of finance, (4) Distribution of Income : The profits remaining after taxes can be distributed in the following ways : (1) Dividend to s reholders (2) Distribution of profits to persons other than shareholders. e. g. Distribution of profits to employees (3) Reinvestment of profits into business. The share of profits is disbursed to employees and according t0 the contract worked out with them. So this point does not remain very important. But the remaining two options are very important for financial managers. Every executive considers financial situation and then arrives at distribution of dividend. (8) Formation of Financial Policy : The basic and mportant function is to frame financial policy. For financial transactions of every department, financial policy is framed. Under it. purchase on cash and credit. the time for settling account of goods the polic son cash and h discount and so on are determined. obtained on credit are determined. In sales section y for sa credit, the time for payments, rate of (6) Tax planning : Tax planning depends on the financial reports received from the various departments. The reserve fund is to be kept as taxation provision is hould be based on long-term worked out under tax planning. The tax planning s considerations, This may lead to a situation of minimum tax liabilities. For example, euidance of experts Reliance managed it with proper tax planning. The advice and should be obtained in the matter of tax planning, (7) Maintaining Cash Liquidity : It is necessary to maintain cash liquidity h liquidity. a unit will not be able to perform current liabilities. So it will lose the to perform the current liabilities of a unit in time. In the absence of adequate sh liquidity will make it difficult to purchase permanent So cash flow prestige. The high level of ¢ assets and it will create an adverse effect on the profitability of the unit. statememts, sales and purchase budgets should be prepa red to ma intain cash liquidity at the most optimum level.Finance Function & Financial Planning 5 (8) Financial Control : To determine whether functions proceed accordi gto financial plan or not, the financial control is necessary. The financial control includes finane Al reports of various departments, analysis of the reports and arran internal audit ment of he financial control also includes analysis of financial accounting, ratios and al other measures of budgetary control (9) Re-establishment of assets : Maintenance of assets according to rules & ulations and policy can be treated as administrative finance function. But thoughts placement of assets can be treated as managerial finance function. While thinking of this problem financial management should consider the estimated life of assets and technological changes. The policy decided regarding financial problems is treated as more important rather than the functions of financial control. For implementation of finance policy. problem of internal audit and control must be thought out properly. For this purpose, budget, various ccounting methods, audit, break even chart ete, are used in our country. Big companies appoint financial controller for their finance division separately. Administ ive Finance Functions of Pin nce Management : If finance management is not implementing the functions of finance, then decided goal of the unit will not become successful. Therefore, administrative function of fi ce_is required to be thou tout. ‘The administrative function such as to follow the process for procuring the required finance as decided by the ma agement according to financial plan, to conduct the daily financial transactions or to maintain documents regarding it can be treated as pre condition for success of mani jal functions of finance. Such administrative functions are deseribed as under : (1) Procedure of Obtaining Money : For obtaining finance from determined sources at specific procedure must be followed. When a loan is to be obtained trom bank or @ financial institution an application should be filled with specific details. When shares or debentures are to be sued the procedure prescribed under the provisions of Companies Act and SEBI (Security Exchange Board of India) must be followed. Moreover, when goods are sold on credit, collection of money is also done at the administrative level. (2) Making Payments : The task of making payments to traders and other creditors in time according to rules and regulations fixed by the financial managers is also importint. The more efficient is this function, the better will be the prestige of the unit, Q. Explain in brief the administrative functions of inance Management.6 Fundamentals of Financial Management (3) Checking of Documents : When goods are sold on credit or money is borrowed on credit the question of securities arises. The documents given or accepted as securities are checked. This t k of financial management is administrative in nature. (4) Administration of Bills Payable : The record of instruments on which payments are to be made must be maintained in a separate register. The timely payment of matured instruments is an important administrative function. The register of payable instruments is especially useful in determining the current liability of a company. (5) Administration of Bills Receivable : For bills receivable too it is “necessary to maintain a separate register. It will indicate the money receivable and the dates on which each payment would mature. (6) To maintain Bank Reconciliation Statement The cash register must be reconciled with a bank pass-book. This is too an important administrative function. Any error on the part of the company or bank be easily detected by this function. (7) Accoun: prepared indicating income and expenditure after considering monetary transactions. While doing this bu of Income and Expenditure : In every business, accounts are ness, traditions and legal provisions are followed. (8) Preparing Financial Reports : The financial reports about income and expenditure, position of investment, current liabilities and so on are prepared to enable top management to maintain control over financial activities. (9) Preparing Statements for Management Accountant : The task of preparing statements about payments due, payments of interest, commission and so on are prepared at the administrative level. This enables management accountant to carry on proper procedures about monetary matters. (10) Procedure of Insurance : Insurance is taken against different risks. In case of loss or damage, claims are filed with the insurance company. All these functions fall within the administrative jurisdiction of financial management. (11) Prepa nancial Statements : On the basis of decisions arrived at by nancial managers the papers and statements conta ning resolutions, details of loans, letters about collection are also maintained at the administrative level of financial management. In administrative financial function, procurement of finance and, its utilisation functions are covered. From junior clerk to accountant and auditor are related with these functions. This function is necessary for maximum utilisation of finance.Finance Function & Financial Planning 3. Objectives / Goals of Financial Management The production ts not at all possible without financral resourses Money 6 at tat ment y to each other and hence thé Resource Management has taken a fot the centre of all the activities in the business. So when we talk about manag resources, we erally talk about mana: # finance The objects of finance manag are contradic of deep thinking and great horizon in undertaking The managers try to attain the following objects es keeping finance in the ventre A) Maxumisation of Income (C) Effective use of assets (B) Satisfactory return on investment (D) Social services oriented objectives. Maw activity carried on with objective of profit in business. It means that the businersmen would manage the business in such a way that he earns masimum profi nisation of Income : According to Prof. Dixit - ~ Ay economic and have to love the least.” To maximise the income, the finance manager gives importance to the following two objectives : (1) Maxinusation of profit (2) Maumisaton of wealth (1) Maximisation of profit : According to ecomomiat the mas profit is the barometer of efficiency. The business units are able to sustain their musation of existence only with the help of it, The development programmes can be dove by them only, The following arguments are made in the favour of maximasation of profit, (1) The object of economic activity is to increase income. The business i an economic activity and hence its objective 1s also maximnsation of projet. Hence, profit becomes ne essary for any business unit (2) Product, technique and technology can only be developed with the help of money and money can be obtained by profits only, The sick units are not able to undertake this programme due to lack of finance (3) The development and expansion projects of the business are only possible with the help of the resources created by profits 7 A (4) The staff benefit schemes such as canteen facility, medical aid, libraries, games & sports. eduction ete. can only be implemented if the company has cnough of finance and that could be only collected, if we do have adequate amount of finance. (5) To perform social responsibilites, the unit hay abe to do many social activities and for this to increase the profit ty absolutely necessary > The limitations of Maximisation of Profit: There are certain limitations of the maximasation of profit which could be quoted ws under '- O. Write short uote on ‘Objective of Maximisation of Income."Finance Function & Financial Planning 7 3. Objectives / Goals of Financial Management The production is not at all possible without financial resou ull the a resources, we generally talk about managing finane: es. Money is at the centre of s in the business. So when we talk about ma . agement of . The objects of finance management aken a lot are contradictory to each other and hence the Resource Management has of deep thinking and great horizon in undertaking The managers try to attain the following objectives keeping finance in the (C) Effective use of assets “Any economic ion of Income ith objective of profit in business. It means that the businessmen M According to Prof. Dixit - activity carried on \ would manage the business in such a way that he earns maximum profit and have to the income, the finance manager gives importance to the (1) Maximisation of profit (2) Maximisation of wealth ccording to economist the maximisation of lose the least." To maximis following two objectives (1) Maximisation of profit : / profit is the barometer of efficiency. The business units are able to sustain their existence only with the help of it. The development programmes can be done by them only. The following arguments are made in the favour of maximasation of profit. (1). The object of economic activity is to increase income. The business is an economic activity and hence its objective is also maximisation of project. Hence, protit for any business unit. technique and technology can only be developed with the help of can be obtained by profits only. The sick units are not able to becomes neces: 2) Produc money and mor ar undertake this programme due to lack of finance. (3) The development and expansion projects of the business are only possible with the help of the resources created by profi Poe + (4). The staff benefit schemes such as canteen facility, medi I aid, librarie games & sports. eduction ete. ¢ finance and that could be only collected, if we do have a n only be implemented if the company has enough of dequate amount of finance. (5) To perform social responsibilities, the unit has also to do many: social activities and for this to increase the profit is absolutely necessary > The limitations of Maximisation of Profit : There are certain limitations of the maximasation of profit which could be quoted as under Q. Write short note on ‘Objective of Maximisation of Incomree a Q) (3) (4) (7) (8) 7 Fundamentals of Financial Management Due to the objective of profit maximisation certain other objectives are ignored which also leads to exploitation of employees & workers. If the profits are increased by deteriorating the quality of goods or by increasing the prices of the goods then there is a possibility of exploitation of customers also, If the prices of the commodities rises due to artificial scarcity then the exploitation of whole society takes place. In the objective of profit maximisation the factor of time has been ignored, Hence, how much profit is to be carned during which period of time is not taken into consideration. The idea of total profit, is not clear. Projected profit is a wide term which includes, (a) Gross profit (b) Nett profit (c) Profit after tax (d) Profit before tax, ete... Jn_the idea of profit, the future isks and instability of income is not given dequate importance. In the situation of monopoly, the rise in profit is natural. So, it could not be accepted as a tool to measure efficiency. The maximisation of profit cannot be decided by earning per share also. Hence, according to Peter Drucker “Profit is requirement of survival”’. Profit is must for a business but the other objectives of business must not clash with the objective of profit (2) Maximisation of Wealth : In the present era for the economic development the maximisation of wealth has got an edge. | According to Solomon and Springle “The idea of maximisation of income is not as much important in the business as maximization of wealth. The main aim of the business is to increase the long term value of th the business and the real value of the business means the value of wealth or as 7 a) ets The following arguments have been made in favour of maximisation of wealth. The objects of maximisation of wealth is in co-ordination with the objects of. economic development. | With the increase in wealth of the business unit there is an increase in the value of share. This is profitable to the shareholders of the company. The economic position of the business becomes very strong with the help of maximisation of profit. Hence, the creditors also gets a lot of security, in the ase the efficiency of business, With the maximisation of wealth the resources of socicty would be distributed - on the most appropriate base. With the increase in wealth of the unit there would be a gradual inerea: facilities available to the workers. This will incr Q. Write short note on ‘Objective of Maximisation of wealth.Finance Function & Financial Planning 9 (6) The object of wealth maximisation is in co-ordination of social responsibility This will reduce the possibility of failure of business. These all decreases the problems of unemployment in the society In short it could be said that wealth maximisation means to increase the assets of the unit - and to increase the value of the shares of the company gradually. The management with foresight not only give importance to profit but accepts th a of wealth maximisation. Stull there are certain drawbacks of the maximisation of wealth which could be stated as under = a) In these objectives the future income is estimated on the basis of present value. (2) The risks of future are considered while determining the rate of discount but at the same time the risks of future G) The increase in wealth is the object which deals with long term. Hence. very attractive short term projects © not fixed. unnot be accepted (4) There is an idea of inereasing the assets gradually in the business, But duc to_ there is a possibility of many assets becoming outdated e.g. new technolog: computers, software, ete. El ssa employ the capi The main activity of the dire: sossible use of the capital of the owners and Rive them Maximum return on inve SS units the owners factory Returns on Investment : In the busin al and takes the risk. They should get the return of holding the risk. tors id managers of the firm should be to make the best nent poss So this maximum return on investment to the owners are two different things _-Example + \n company A the capital employed is %%.0,00,000 and the pro earned is % 100,000. In company B the capital. employed is % 600,000 and it makes profit of % 80,000. Here the profit of company A is more than that of company B. But if we see according to percentage return there is 10% returns in company A., (10% of 10,00,000 is % 100,000) and that in company B it is 13.3% (13.3% of 600,000 1s 80,000). Hence, though profit is less in company B, it is better if we take the criteria of ctor has been widely accepted. The aim of profit maximisation and to give return on investment Calculation of Returns on Investments : The calculation of return on investment is shown by the following two methods : Net profit (after tax) 2a ae Ole 0 stment Total investments (assets) * 100 4) Return on Inv fii) Return orf Investment les Net profits Sales x 100 ‘Total assets K.TOVL FMMFinance Function & Financial Planning 9 (6) The object of wealth maximisation is in co-ordination of social responsibility. This will reduce the possibility of failure of business. These all decreases the problems of unemployment in the society. In short it could be said that wealth maximisation means to increase the assets of the unit - and to increase the value of the shares of the company gradually. The management with foresight not only give importance to profit but accepts the idea of Il there are certain drawbacks of the maximisation of wealth alth maximisation. S h could be stated as under : the future income is estimated on the basis of present value, whi (1) In these objectiv (2) The risks of future are considered while determining the rate of discount but at the same time the risks of future are not fixed. (3) The increase in wealth is the object which deals with long term. Hence, very attractive short term projects cannot be accepted. = ssets gradually in the business. But due to (4) There is an idea of increasing the new technology. there is a possibility of many assets becoming outdated eg. computers, software, etc. [Eq] Satisfactory Returns on Investment : In the business units the owners employ the capital and tak . They should get the return of holding the risk. ‘The main activity of the directors and managers of the firm should be to make the best hem maximum return on investment. s the ris! possible use of the capital of the owners and Biv So this factor has been widely accepted. The aim of profit ma maximum return on investment to the owners are two different things. Example : In company A the capital employed is € 10,00,000 and the profit arned is % 100,000. In company B the capital. employed is % 600,000 and it makes profit of @ 80,000. Here the profit of company A is more than that of company B. But if we see according to percentage return there is 10% returns in company A., (10% of 10,00,000 is % 100,000) and that in company B it is 13.3% (13.3% of 600,000 is $0,000). Hence, though profit is less in company B, it is better if we take the criteria of ximisation and to give return on investment c investment is shown by the following two methods : Net profit (afier tax) \__4i) Return on Investment = a ay x 100 ales Net profits ii) Return of Invesument = For cas ® Sales ® 100 alculation of Returns on Investments : The calculation of return on K.T-VL FMAM ~ 210 Fundamentals of Financial Management Objective of Effective Utilization of Assets : The fact is clear that if there is effective utilization of an assets in business only then more return on investment could be gained. But with effective use of the assets certain obstacles are to be overcome. They include maintana | nce of assets, repairs, renovation, re-placement ete, The care should be taken that more capital does not get wrongly utilized in assets. If there are more workers, more raw materials, more current assets in the production department then there would be considerable inere in investment in the production department. If the sale on credit increases then that will increase the gross sales but the proportion of bad debts will also rise. This has got an adverse effect on ROL. By keeping more stock than it will results in high maintenance cost. Not only that but, if there is a change in fashion the stock will become outdated in the market. This would result in great loss for the business unit. By keeping more cash on hand the liquidity position of the company is strengthened but on the other hand as it is not invested at the proper place the return on investment have to be lost. In short, unnecessary investment in assets must be d reased. For effective usage of the Assets the following points must be considered : (1) Decision regarding ownership purchase or purchase by lease and installments must be made aficr careful study of rate of interest, return etc. (2) The assets must be purchased by keeping in mind the projected (targetted) production. (3) The extra or unnecessary assets must be sold and the surphis resources must be invested in more profitable projects. (4) The employees must be trained, so that the maximum use of assets takes place. ee (5) For effective use of assets due care must be taken for maintenance and repairs of assets. (6) Current assets like stock must he stored proper! Social Service Objectives The object of social responsibility of the the leading companies as to fullfit social service motives. These are the motives whit the unit has to fulfil without taking into account the financial rewards or profits. Thi objective must co-ordinate with the wealth maximi: ion objective of the company: By keeping the social objective the social prestige of the company increas ults in smooth production, & promotion activities. Hence it is very right said that by the social objective the company opens the door of future profits with earning, the present profits.Finance Function & Financial Planning i a For financial managers it is very difficult to. maintain. a, balance between maximum earning and social service objective. Because both these objective are not profitable in the direct sense but that is a need of the changing scenario. One has to consider this objective in order to have good name and reputation. The profit maximisation and wealth maximization objectives of business are very important for the development of business. If the investments are to be directed towards industries, the investors must be given adequate return on investment. For this purpose the Assets of the firm must be- utilized properly. 4. Functions of Finance : Meaning and Approaches 1. Introduction : Finance is the life blood of the business. Without finance, no business or enterprise can be commenced. From the beginning of the enterprise till its end, finance is constantly required. For implementation of various plans and for achieving goals of business, finance is essential. Any profitable and ambitious plan become a dream in the absence of finance, Shortage of finance will disturb the production planning. Similarly, unutilised excess finance will become burden for ness enterprises, requirement of more and more finance are business enterprise. In bu: increasing for purchase of raw materials, payment of wages and for payment of selling and other administrative expenses. Besides, finance is required for modernisation and development of business. 2. What is Finance Function ? : ‘Finance" sa worSgfrom French language. The meaning of this word is ever changing. In the past ‘finance’ was considered as payment for release of the kidnapped person. Then ‘finance’ was considered as ‘income of state’. In 17th century, the term ‘Finance’ was considered as ‘moneylenders’. But now it is considered as ‘Financial Management’. The meaning and definition of finance change according to the circumstances. > According to Howard and Upton set of administrative functions in an organisation related with the arrangement of cash “Finance is that administrative area as and credit, so that the organisation may have the means to carry out its objective as satisfactory as possible." > According to Guthmann and Dougall ‘Business Finance can be broadly defined as the activity as concerned with the planning, organising, controlling and administering of funds used in the business. @. Explain meaning of finance function and its various approaches. Q. Explain ‘Traditional approach of finance function.Finance Function & Financial Planning ° 1 For financial managers it is very difficult to maintain.a, balance between maximum earning and social service objective. Because both these objective are not profitable in the direct sense but that is a need of the changing scenario. One has to consider this objective in order to have good name and reputation. The profit maximisation and wealth maximization objectives of business are vestments are to be directed very important for the development of business. If th towards industries, the investors must be given adequate return on investment. For this purpose the Assets of the firm must be- utilized properly. 4. Functions of Finance : Meaning and Approaches 1, Introduction : Finance is the life blood of the business. Without finance, no business or enterprise can be commenced. From the beginning of the enterprise till its end, finance is constantly required. For implementation of various plans and for achieving goals of business, finance is essential. Any profitable and ambitious plan become a dream in the absence of finance. Shortage of finance will disturb the production planning. Similarly, unutilised excess finance will become burden for business enterprise. In business enterprises, requirement of more and more finance are increasing for purchase of raw materials, payment of wages and for payment of selling and other administrative expenses. Besides, finance is required for modernisation and development of business. 2. What is Fi The meaning of this word is ever changing. In the past ‘finance’ was considered as ance Function ? : ‘Finance’ is a worg from French language. wi payment for release of the kidnapped person. Then ‘finance’ was considered as ‘income of state’. In 17th century, the term ‘Finance’ was considered as ‘moneylenders’. But now it is considered as ‘Financial Management’. The meaning and definition of finance change according to the circumstances. > According to Howard and Upton “Finance is that administrative area as set of administrative functions in an organisation related with the arrangement of cash and credit, so that the organisation may have the means to carry out its objective as satisfactory as possible." > According to Guthmann and Dougall “Business Finance can be broadly defined as the activity as concerned with the planning, organising, controlling and administering of funds used in the business."” Q. plain meaning of finance function and its various approaches. plain Traditional approach of finance function.12 Fundamentals of Financial Manageme; > According to R. C. Osborne “The finance function is the process of acquiring and utilising funds by a business." In short, finance function is connected with the obtainin according to the requirements of a business unit, For this purpose, financial planning and financial controls are the main functions. 3. Traditional Approach of Finance Function : In common definition, the concept of finance function is very narrow and traditional- “Acquisition of finance according to the objectives of business." In this definition the second aspect, i.e, s of a business and utilising finance utilisation of finance is not taken into consideration. As such the suck unit depends on both, acquisition and utilisation of finance. In traditional approach of finance, following activities are included : (1) Estimates for requirement of finance are made by considering the business activities. For this purpose, short-term and long-term financial requirements are taken into consideration. (2) After estimating financial requirements, sources for procurement of finance are thought of by comparative study of ordinary shares, preference shares, debentures, loans, bank overdrafts, cash credits, public deposits, ete. (3) Function of procurement of finance should be completed at less expenses and in a short period. Special attention is required to be given to interest, commission and administrative expenses. (4) Management should sec that sources of finance should not be such, that may be burdensome in future. If required, guidance should be obtained from finance advisers. 7 4. Limitations of Traditional Approach of Finance Functions : They can be pointed out as under :- (1) Use of finance is not considered : In the traditional function of finance, idea of procurement of finance is considered but the idea of its efficient utilisation is not considered. In fact, if the unit which does noc make use of finance efficiently, will not remain in existence for a long period in the business world. (2) Administrative finance function is not considered : In the traditional approach. there is an idea of collecting finance from various financial institutions an s, administrative staff are also linked with th depositors. But in fact compan financial transaction. (3) Only form of company is considered : In the traditional function of nance, the idea of financial resources are presented by keeping in mind the only form of company, in fact, in the form of sole proprictors and partnership also, functions of finance dre important,Finance Function & Financial Planning 13 (4) Ds approach. the financ development schemes, re-construction, desolution etc. and only long-term financial functions are followed, while requirements of finance function in any business firm is ly requirement is not considered : According to the traditional is required in a specific event like establishment, registration. a daily ev (5) Fina keeping of effective control on it is not considered in traditional approach of finance. (6) No analytical approach : In this tradition approach, analysis of use of s. distribution of income, planning for taxation, future reserves etc. nt. nee control is neglected : Idea of efficient use of finance and financial resource are not taken into account. Thus, an idea of, traditional approach of finance is narrow and limited. > Prof. S.C. Kuchhal also states that ‘/t is generally considered that such a definition is too new to be of any use. Financial function is certainly wider than that of procurement or supply.” 5. Modern Concept of concept, finance function includes both the aspects i.e. acquisition and utilisation of nance. Kimboll opines that "Finance function means to obtain finance and its proper utilisation and an arrangement of proper distribution or allocation of finance. The modern concept of finance is very dynamic. This concept includes Finan- acquisition and utilisation of fund, distribution nance Funetion : According to the modern cial Planning, forecasting of fund flow, 1 control From the above definition, it can be clearly saidthat the moder concept of finance is much wider than the traditional approach. Fot making effective use of finance, administration of finance is treated as more important. It includes following matters : (1) Procurement of finance : After obtaining the future financial requirements of the unit, management will try to obtain it at minimum cost and convenient conditions from proper source. At the time of procurement of finance, ratio of fixed and working capital is considered. This function is adopted both by the traditional approach and the modern approach. (2) Financial planning : Decision regarding, how much percentage in which plan and when the use of procured finance is to be made, etc. is called finance planning and it use of procured finance is made po: timate for present and s accepted by the modern approach of finance. Because of this idea, maximum sible. Q. Write short note on ‘Modern Concept of Finance Function,”14 Fundamentals of Financial Management (3) Distribution of Income : The question of distribution of income obtained from business activities is also accepted by modern approach. Question regarding distribution of income such as how much amount is to be distributed as dividend, how much amount is to be carried over as reserve fund, how much amount will be paid as taxes, how much amount is to be reinvested, ete. are very important (4) Financial control : The modern approach of finance function emphasizes on importance of efficient use of finance and for this purpose financial control is treated as essential. Amongst various methods of finance control, more emphasis is given on analysis of ratios and budgetary system. From the above explanation, it is very clear that the modern concept of finance functions is very broad. 5. Interrelation of Finance Functions with Other Areas of Management Financial function affects other functions and similarly other functions affect the financial functions. Administrative functions and other functions are closely related to each other. Thus, finance is the foundation stone of entire business and success of other branches of management depends on financial functions. (1) Production Function and Financial Function : Production function and financial function are directly related, (1) Discussion about which product is to be manufactured, is required to be considered from the viewpoint of finance. (2) The method and quantity of production are also related to the finance More finance is required if the capital oriented production technology is to be adopted. Less finance is required if the labour oriented production technology is to be adopted. (3) How much to produce ? Quantity of more or less of production is related with finance. If the production is to be made in large quantity, more finance is required while if production is to be made in less quantity, financial requirement will be reduced. (4) Employees directly connected with the production, supervisors and their salary connected with the finance management. (5) For production control, quality control etc. requirement of finance is necessary. (2) Purchase Function and Finance Function : Purchase function also affects finanéé function as follows :- Q. Explain interrelation of Finance Management with other areas of Management.14 Fundamentals of Financial Management (3) Distribution of Income : The question of distribution of income obtained from business activities is also accepted by modern approach. Question regarding distribution of income such as how much amount is to be distributed as dividend, how much amount is to be carried over as reserve fund, how much amount will be paid as taxes, how much amount is to be reinvested, ete. are very important (4) Financial control : The modern approach of finance function emphasizes on importance of efficient use of finance and for this purpose financial control is treated as essential. Amongst various methods of finance control, more emphasis is given on analysis of ratios and budgetary system. From the above explanation, it is very clear that the modern concept of finance functions is very broad. 5. Interrelation of Finance Functions with Other Areas of Management Financial function affects other functions and similarly other functions affect the financial functions. Administrative functions and other functions are closely related to each other. Thus, finance is the foundation stone of entire business and success of other branches of management depends on financial functions. (1) Production Function and Financial Function : Production function and financial function are directly related, (1) Discussion about which product is to be manufactured, is required to be considered from the viewpoint of finance. (2) The method and quantity of production are also related to the finance More finance is required if the capital oriented production technology is to be adopted. Less finance is required if the labour oriented production technology is to be adopted. (3) How much to produce ? Quantity of more or less of production is related with finance. If the production is to be made in large quantity, more finance is required while if production is to be made in less quantity, financial requirement will be reduced. (4) Employees directly connected with the production, supervisors and their salary connected with the finance management. (5) For production control, quality control etc. requirement of finance is necessary. (2) Purchase Function and Finance Function : Purchase function also affects finanéé function as follows :- Q. Explain interrelation of Finance Management with other areas of Management.Finance Function & Financial Planning 15 (1) Whether to purchase raw materials on cash or credit and how much credit period is given, etc. are directly related with the finance, functions. (2) Whether to purchase in retail or wholesale ? For taking decision of this question, finance management is also important. In wholesale or seasonal e, more investment of finance will be needed, while in retail purchase relatively less finance is required. (3) Purchase policy i.e. make or buy decision, centralized or decentralized purchasing etc. are also required to be considered in finance functions. (3) Sales Function and Finance Function In sales function, sales planning, sales promotion, sales control, advertisement and activities related to distribution are included. The success or failure of these activities depends on finance function. : ay Q) (3) (4) (5) (4) Every business unit has to conduct market research in the initial stage. Market research can be conducted through the employees or private institutions. For this purpose, arrangement of finance is required to be made. The question of selling on cash or credit directly relates with the finance. In cash sales policy, cash flow will remain easy, while in credit sales policy, control on cash flow is required to be maintained. Sales, brokerage, commission ete. are also related with finance function. For the various sales promotion activities such as gift scheme, prize scheme, free service, reduction in price, hire purchase, instalment scheme, etc. pre-thinking of required finance should be taken into consideration. The function of advertisement in sales managdwent becomes important. If expenses of advertisement are increasing, finance required for that function becomes essential to think of. : Personnel Management Function and Finance Function : For keeping physical presence of the employees in the unit and to motivate them for work the requirement of finance arises. For payment of various incentives to staff like bonus, allowances, gratuity and for other welfare activities finance is required. a) (2) (3) For payment of wages, allowances, bonus, overtime etc. to employees pre-thinking of the unit’s financial position is necessary. Besides this, problems of increase in salary of employees, provident fund, gratuity are related to finance function. Financi: 1 factors for various welfare activities of the employees such as transportation, medical facilities, edu ional and sports become important. Only financially sound units can implement the various welfare activities of the employces16 Fundamentals of Financial Managemen: 6. Role of Finance Manager 1. Introduction : For efficient implementation of any acti ity, planning control and co-ordination are necessary and for that the nedd of proper organisation arises. For finance function also, separate and efficient organisation becomes essential! Financial organisation is framed by taking into consideration the number of factors e.g. volume of finance, size of business unit, nature of business, ownership of unit, ete 2. Role of Finance Manager of an Organisation : In comparison of other managers of the unit, fi ance manager has to look after important activities o| planning. control and co-ordination. In modern age, whether a unit is small or big, the position of finance manager is impot nt. He has to perform as under mentioned activities (1) To estimate the needs of required finance, (2) To procure required finance from various sources, (3) To distribute finance amongst various departments. If the finance manager performs the functions properly, the position of firm becomes stable. Finance Manager is related With following matters : (1) Total invested amount of funds of the firm (2) Allocation of the funds for purchase of different assets (3) To frame capital structure in such a way that value of firm increases. However, finance manager is a part of the organisation. He should take his, decision considering the development and profitability of the unit and send recommendations to top level management. Besides this, finance mana wer has to pay attention towards daily functions also. 3. Functions of Finance Manager :- (1) He is a top administrative executive. He is required to take number of decisions for financial matters. (2) He has to examine if finance is sufficient or not. of business should (3) He has to take care that scarcity of finance activiti¢e not be closed. (4) He has to prepare a plan for the use of funds, to keep control on it and make analysis of it. Q. Explain the roles of Financial Manager.Finance Function & Financial Planning (5) Finance manager has to make arrangement in such a way that sufficient balance amount remains in unit. . (6) He has to make arrangement for procurement of funds at the lowest cost. (7) Finance Man ager has to make proper arrangement for unit's cash, materials, creditors and other current assets. (8) He has to analyse the outside factors affecting the company’s financial position. 4. Function of Assistant Finance Manager : In large units it is not possible to perform all the functions related with finance by the finance manager. Under these circumstances, some roles are performed by their assistants. roles of assi tants to finance manager as treasurer and controller can be enumerated as under (1) Roles as a Treasurer :- (A) Functions regarding Financial Planning-:- (1) Tosi @ ¢ (3) Planning for borrow (4) abmit the report of financial results to chief officer. h Planning. ng of mone} stimate regarding income - expenditure of cash. (5) To give suggestion for rate of dividend. (B) Funetions regarding Cash Management :- (1) To keep account of cash transaction, ‘wy (2) Management of petty-cash (3) To open necessary A/c. in bank and to make transactions with them, (C) Functions regarding credit management or ree ivable (1) Calculation of risk of sale on credit to customers. (2) Collection from the customers, (3) To decide the policy of cash di (2) Role as a ‘ount and terms of credit inancial Controller : According to Earnest Dale the financial controller should perform the following functions, (1) Internal audit (2) Analysis of information and to control (3) Budgetary control on financial activities (4) Specific control activities e, Tax-planning, Ratio analysis ete. (3) Inventory ae control (6) prepare financial reports and registe! K.T.-VL F.M.M = 3 — eoo SS eS 18 Fundamentals of Financial Management 7. Financial Planning : Meaning and Characteristics tar ONY 1: Introduction : Goals can be achieved by managing the finance throu financial planning. In the case of individ s, planning for retirement, saving {0 children’s education, owner se of business. 1 ship house ete. can be included. In the isfaction to customers, to provide best service to the socicty. | provide maximum incre ¢ the standard of living by research and development ete. are the goals. |) achieve any goal what type of and how much capital will be required from whic sources is must be considered. The capital should be obtained and what to do for th maximum use of the capital ete. matters are considered in financial planning. 2. Meaning of Financial Planning : Finance is an important func! business. The application of planning to this function is called financial planning Financial planning is mainly concerned with the economical procurement and profitable use of funds. According to Guthman and Dougall, “Financial planning is concerne with raising, controlling and administering of funds used in business.” In the words | of Bourneville and Dewey, “Financial planning consists in the raising, providing « managing of all the money, capital of funds of any kind to be used.in connection wit) the business." Financial planning is an important element of the overall planning 0 business enterprise. Financial planning includes the following: (1) Estimating the amount of capital required for financing the business enterprise, (2) Determining capital structure, (3) Framing of policies for the administration of capital; (4) Formulation the programmes to provide the most effective use of capital 3. Characteristics of a Good / Sound Financial Planning : The main characteristics of a good financial planning are as follows: (1) Simplicity: The financial plan should be as simple as possible so that it can be easily understood even by a layman, properly executed and administered. complicated financial plan creates unnecessary complications and confusion. (2) Flexibility: The financial plan should not be rigid, but rather flexible enough to acCommodate the changes which may be introduced in it as and when necessary. The rigid composition of the financial plan may cause unnecessary irritation and may limit the future development of the business unit. (3) Based on Clear-cut objectives: The financial plan should be based 0” the clear ~ cui Objectives of the company. It should aim to procure adequate funds at the lowest cost so that the profitability of the business is improved. jon of is Q. What is Financial Planning ? Explain its Characteristics. Q. Explain the Meaning and Characteristics of Financial Planning.Finance Function & Financial Planning 19 (4) Solvency an liquidity: The financial plan should ensure solvency and liquidity of the business enterprise. Solvency requires that short-term and long-term should be made on due dates positively. This will ensure credit worthiness lequate payment and goodwill to the business enterprise. Liquidity means maintenance o balance in hand. Sometimes insufficiency of cash may make a business enterprise bankrupt. 6 & burden of raising various types of capital should be minimum. (6) Minimum dependence on outside sources: A long-term financial planning should aim at minimum dependence on outs retaining a part of the profits for ploughing back. (7) Contingencies Anticipated: The financial plan should be able to anticipate various contingencies which may arise in the near future. The financial plan should mical : The financial plan should be quite economical i.e., the cost ide resources. This can be possible by make adequate provision for meeting the challenge of unforeseen events. (8) Government financial policy and regulations: The financial plan should 1 policy and regulations. It be prepared in accordance with the government financ should not violate it under any circumstances. (9) Intensive use of capital: Financial planning should ensure intensive use of capital. As far as possible, a proper balance between fixed and working capital should be maintained. (10) Profitability: A financial plan should be draftedgjn such 2 way that the profitability of the business enterprise is not adversely affected. (11) Planning Foresight: Financial planning should have due foresight and vision of access the future needs, scope and scale of operation of the business enterprise. incial planning should be done in such a manner that any adjustment the business proceeds, On the basi; needed in the future may be made without much difficulty the financial adjustment s become necessary which should be adjustable properly as and when desired. (12) Ratio between owners and borrowed capital: The capital requirement 1, (2) Borrowed capital or debts. of business can be satisfied by (1) Equity Share capita For procuring owners capital, equity shares are issued, while borrowed capital can be obtained through preference shares, debentures, loan or through public deposits. Generally al. When ratio of borrowed 2:1 ratio should be maintained for owned and borrowed capi capital increasing, the business risk also increasing.Fundamentals of Financial Management n risk and return: 20 (13) Balance bety The ratio of investment in various projects of business unit and rate of return on investment is different, Rate of return should be higher where the risk element s more. There is correlation between ris return and therefore balance should be maintained at the time of financial pl | (4) Optimum capi nning. alisation: While preparing financial planning, pre thinking is necessary about the position of capitalisation. Sometime defective financial planning results in over or under capitalisation. Hence financial management should try for | optimum capitalisation. 4. Conclusion : Defective financial planning result in under or ove: i capitalisation. It directly affect the rate of dividend. Hence, it is necessary to keep balance between fixed and working capital as well as owners and borrowed capital. All ! though this both the type of capital depends on nature of business. In risky business volume of equity share capital always remain more because, declare dividend on equity capital is not compulsory. 8. Stages / Procedure of Financial Planning | 1, Introduction : Wrong decisions about’ financial matters and de financial planning creates financial crises i tive business unit. Because of that reason it becomes difficult to perform financial liabilities for management. As a result continuity and prestige of business disturbed. Hence it can be truly said that success or failure of business unit depends on effective financial planning. Before framing financial planning. management should study various factors in the context of financial objectives of business units. 2. States / Procedure of Financial Planning : Financial management should follow the procedure of financial planning which consists of following six steps (1) Determining your current financial situation. (2) Developing financial goals. ~~ ~~ (3) Identifying alternative courses of action. (4) £E (5) Creating and implementing a financial action plan, and (6) Re-evaluating and revising the plan. a . Step 1: Determine current finance’ valuating alternatives. I situatio. First of all management should determine current financial situation with regard to income, savings, living expenses, and debts. Preparing a list of current asset and debt balances and amounts spent for various items creates foundation for financial planning activities Explain the meaning and stages of financial planniFinance Function & Financial Planning 21 Step 2: Develop financial goals + Management should periodically analyse units. This involves identifying how you feel about money and why You f The purpose of this analysis is to differentiate the needs from the wants. Specific financial foals are vital to financial planning. Others can suggest financial goals for business; however management must decide which goals to pursue. Financial goals of business unit can range from spending all of current income to developing an extensive savings and investment program for future financial security. Step 3 : Identify alternative courses of action : Developing alternatives is crucial for making good d s and goals of business 1 that way ancial valu sions. Although many factors will influence the available alternatives, possible courses of action usually fall into these categories: (1) Continue the same course of action, (3) Change the current situation. (2) Expand the current situation. (4) Take a new course of action. Not all of these categories will apply to every decision situation; however, they do represent possible course of action. Creativity in decision making is vital to effective choices. Considering all of the possible alternatives will help management to make more effective and satisfying decisions Step 4: Evaluate Alternatives : Management need to evaluate possible courses of action, taking into consideration the life situation, personal values and current economic conditions. Every decisions closes the choice of alternatives. F ren ample, a decision to invest in stock may mean minagement cannot take a vacation. A decision to go toYwhool full time may mean management cannot work full time. Opportunity cost is what management give up by making a choice. This cost, commonly referred to as the trade-off of a decision, cannot always be measured in rupees. Decision making will be an ongoing part of personal and financial situation. gement will need to consider the lost opportunities that will res sions of management. ult from the Uncertainty is a part of every decision. Selecting a college major and choosing a career field involve risk, Other decisions involve a very low degree of risk, such as putting money in a savings account or purchasing items that cost only a few rupees. The chances of losing something of great value are low in these situations. difficult. The bes way to consider risk is to gather information based on the experience and the experiences, In many financial decisions, identifying and evaluating risk of others and to use financial planning information sources.