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INTRODUCTION TO FINANCIAL MANAGEMENT

Meaning of Finance

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Arrangement of money is finance. Business Finance is that business activity which is concerned with the acquisition and conservation of capital funds in meeting financial needs and overall objectives of business enterprises. Finance is the art and science of arrangement of finance. Monetary resources; funds, especially those of a government or corporate body.

What is Financial Management

Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprise with the objective of maximizing shareholders’ wealth. Financial management is that specialized activity which is responsible for obtaining and effectively utilizing the funds for the efficient functioning of the business. Therefore it includes financial planning, financial administration and financial control to achieve organisational goal.

Definition of Financial Management

“Financial Management is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations.” – Joseph and Massie. “Financial Management is concerned with the acquisition, financing and management of assets with some overall goal in mind” – Van Horne and Wachowicz.

Functions of Financial Management
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Estimation of capital requirements. Determination of capital composition. Choice of sources of funds. Investment of funds. Disposal of surplus. Management of cash. Financial controls.

Scope of Financial Management

Traditional Approach:

Raising and administering of funds Maintaining legal and accounting relationships by the firm with its sources of funds (creditors).

Modern Approach:


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Funds Requirement Decision – Capitalization Financing Decision – Capital Structure Investment Decision – Capital Budgeting and Working Capital Management Dividend Decision – Dividend Policy

Traditional Approach

The traditional approach, which was popular in the early stage, limited the role of financial management to raising and administering of funds needed by the corporate enterprises to meet their financial needs. It deals with the following aspects. Arrangement of funds from financial institutions. Arrangement of funds through financial instruments like share, bonds etc. Looking after the legal and accounting relationship between a corporation and its sources of funds.


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The Scope of financial management in traditional approach is narrow. The main limitations of traditional approach are as under: Outsider-looking-in-approach. Ignored routine problems. Ignored non corporate enterprise. Ignored working capital financing. No emphasis on allocation of funds. Time value of money is not considered.

Modern Approach

According to modern approach, the term financial management provides a conceptual and analytical framework for financial decision-making. Finance function is concerned with raising funds and their effective utilization both. The new approach views the term financial management in a broader sense. It is viewed as an integral part of over-all management.


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The main contents of the new approach are: What is the total volume of funds an enterprise should commit? What specific assets should an enterprise acquire? How should the funds required be financed? The above three questions are related to the three decisions of financial management – Financing Decision, Investment Decision and Dividend Decision.

Finance Functions

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There are three finance functions or finance decisions: Financing Decision. Investment Decision. Dividend Decision.

Financing Decision

Here the financial manager has to determine the proportion of debt and equity in capital structure. It should be such which maximizes the shareholders’ wealth. The objective is to minimize cost of capital. It is a one-time decision and it is nonrecurring function.

Investment Decision

Investment decisions are concerned with investment of financial resources into long term assets. This investment is made for expansion, modernization, setting up of new plant, R & D expenditure, and replacement of old machinery. It relates to the selection of assets on which a firm will invest funds. Investment decisions are strategic decisions for the company as it involves investment of funds for long time period but company will start to realize return from that investment after a long time period.

Dividend Decision

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Here the payment of dividends should be analyzed in relation to the financial decision of a firm. There are two options available in dealing with net profits of a firm: Whether the firms should distribute dividend or retain the profits. Proportion of dividend out of total earnings to be distributed.

Role of a Financial Manager
The finance manager is primarily responsible for effective utilization of financial resources of the company. He has perform the following roles to fulfill his responsibilities. 1.Fund raisingFinance manager has to decide how much fund should be raised from debt market and how much fund should be raised from capital market.

2.Fund AllocationFund allocation deals with how much funds should be invested in long term assets and how much fund should be invested in short term assets.

3.Profit PlanningProfit planning refers to the operating decisions in the areas of pricing, costs, volume of output. 4.Understanding of Financial MarketA finance manager should have complete knowledge of financial market.

Objectives of Financial Management
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To ensure regular and adequate supply of funds to the concern. To ensure adequate returns to the shareholders and this will depend upon the earning capacity, market price of the share, expectations of the shareholders. To ensure optimum funds utilization. To ensure safety on investment, i.e. funds should be invested in safe ventures. To plan a sound capital structure so that a balance is maintained between debt and equity capital.

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There are two widely accepted goals: Profit Maximization. Wealth Maximization

Profit Maximization

Maximization of profits is the main objective of a business enterprise. Each company collects its finance by the issue of shares to the public and the public in turn hope of getting medium profits as dividend. The company will be able to do so only when the company’s goal is to earn maximum profits out of its available resources. Higher profits are the barometer of company’s efficiency on all fronts i.e. production, sales and management.

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Limitations of Profit Maximization: Vague: the term profit does not clarify what exactly it means. Does it mean short-term or long-term, total profit or net profit, profit before tax (PBT) or profit after tax (PAT), return on capital employed (ROCE). Ignores Time Value of Money: Time value of money refers a rupee receivable today is more valuable than a rupee which is going to be received in future period. Profit maximization goal does not help in distinguishing between the returns receivable in different periods.

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Ignores Quality of Benefits: Quality refers to the degree of certainty with which benefits can be expected. The more certain expected benefits, the higher are the quality of the benefits and vice versa.

Shareholders Wealth Maximization

It has been widely accepted by the finance managers, because it overcomes the limitations of profit maximization. Wealth Maximization means maximizing the net wealth of the company’s shareholders. The wealth maximization principle implies that the fundamental objective of a firm should be to maximize the market value of its shares. The value of the company’s shares is represented by their market price.

It considers time value of money, translates cash flows occurring of different periods into a comparable value of cash flows. Hence wealth maximization is considered superior to the profit maximization. Thus in the modern era objective of profit maximization has shifted to shareholders wealth maximization.