FINANCIAL

MANAGEMENT
Dr. Harpreet Singh Bagga
CDIPS
INTRODUCTION

 In our present day economy, Finance is defined as the provision of money at

the time when it is required.
 Every enterprise, whether big, medium or small needs finance to carry on its
operations and to achieve its targets.
 In fact, finance is so indispensable today that it is rightly said to be the life
blood of an enterprise.
MEANING OF FINANCE

 Finance may be defined as the art and science of managing money.

 It includes financial service and financial instruments.
 Finance also is referred as the provision of money at the time when it is
needed.
 Finance function is the procurement of funds and their effective utilization in
business concerns.
 The concept of finance includes capital, funds, money, and amount. But each
word is having unique meaning.
 Studying and understanding the concept of finance become an important part
of the business concern
 TYPES OF FINANCE
 Finance is one of the important and integral part of business concerns, hence,
it plays a major role in every part of the business activities. It is used in all
the area of the activities under the different names. Finance can be classified
into two major parts:
TYPES OF FINANCE

 Private Finance, which includes the Individual, Firms, Business or Corporate

Financial activities to meet the requirements.

 Public Finance which concerns with revenue and disbursement of

Government such as Central Government, State Government and Semi-
Government Financial matters.
Financial Management

 This aspect of finance has been traditionally known as 'Business Finance' and
'Corporation Finance'.
 Business concerns are all the time facing a lot of problems for searching the
optimum method of raising and utilising the amount of fund needed for
operating their economic activities.
 In a competitive environment, business concerns try to make the use of their
funds judiciously for attaining their objectives.
 A number of techniques and tools have been evolved through which business
concern may raise funds at minimum cost and may invest in projects assuring
maximum returns.
 At present, all such techniques and tools are studied in a separate subject
known as Financial Management'.
Meaning of Financial Management

 Business Finance' or 'Corporate Finance' term is now being studied as

Financial Management under modern approach.
 In this sense, financial management is considered to be a significant
component of General Management. In fact, it is the functional area of
General Management.
 Financial Management signifies financial planning, procurement of finance,
asset management and establishing the balance between different sources of
finance.
DEFINITION OF FINANCIAL MAMAGEMENT
 In the words of Howard and Upton, "Financial Management is the application
of planning and controlling functions to finance function."
 According to Weston and Brigham, "Financial Management is an area of
financial decision-making, harmonizing individual motives and enterprise
goal."
 . In the words of J. S. Massie, "Financial Management is the operational
activity of the business that is responsible for obtaining and effectively
utilising the funds necessary for efficient operations."

 All these definitions reveal that Financial Management includes financial

planning, arranging the required finance, financial control, assets
management, etc.
Objective of Financial Management

 The objective of finance function is to arrange as much funds for the business
as are required from time to time. This function has the following objectives.
 Assessing the Financial requirements. The main objective of finance
function is to assess the financial needs of an organization and then finding
out suitable sources for raising them. The sources should be commensurate
with the needs of the business. If funds are needed for longer periods then
long-term sources like share capital, debentures, term loans may be
explored.
 Proper Utilization of Funds: Though raising of funds is important but their
effective utilisation is more important. The funds should be used in such a
way that maximum benefit is derived from them. The returns from their use
should be more than their cost. It should be ensured that funds do not remain
idle at any point of time. The funds committed to various operations should
be effectively utilised. Those projects should be preferred which are
beneficial to the business.
Objective of Financial Management

 Increasing Profitability. The planning and control of finance function aims at

increasing profitability of the concern. It is true that money generates money.
To increase profitability, sufficient funds will have to be invested. Finance
Function should be so planned that the concern neither suffers from
inadequacy of funds nor wastes more funds than required. A proper control
should also be exercised so that scarce resources are not frittered away on
uneconomical operations.

 Maximizing Value of Firm. Finance function also aims at maximizing the

value of the firm. It is generally said that a concern's value is linked with its
profitability.
SCOPE OF FINANCIAL MANAGEMENT
A financial manager will have to concentrate on the following areas of
finance function.
 Estimating financial requirements:
The first task of a financial manager is to estimate short term and long term
financial requirements of his business. For that, he will prepare a financial
plan for present as well as for future. The amount required for purchasing fixed
assets as well as needs for working capital will have to be ascertained.
 Deciding capital structure:
Capital structure refers to kind and proportion of different securities for
raising funds. After deciding the quantum of funds required it should be decided
which type of securities should be raised. It may be wise to finance fixed assets
through long term debts. Even here if gestation period is longer than share capital
may be the most suitable. Long term funds should be employed to finance working
capital also, if not wholly then partially. Entirely depending on overdrafts and
cash credits for meeting working capital needs may not be suitable. A decision
about various sources for funds should be linked to the cost of raising funds.
SCOPE OF FINANCIAL MANAGEMENT
 Selecting a source of finance: An appropriate source of finance is selected after
preparing a capital structure which includes share capital, debentures, financial
institutions, public deposits etc. If finance is needed for short term periods then
banks, public deposits and financial institutions may be the appropriate. On the
other hand, if long term finance is required then share capital and debentures
may be the useful.
 Selecting a pattern of investment: When funds have been procured then a
decision about investment pattern is to be taken. The selection of an investment
pattern is related to the use of funds. A decision will have to be taken as to
which assets are to be purchased? The funds will have to be spent first on fixed
assets and then an appropriate portion will be retained for working capital and
for other requirements.
 Proper cash management: Cash management is an important task of finance
manager. He has to assess various cash needs at different times and then make
arrangements for arranging cash. Cash may be required to purchase of raw
materials, make payments to creditors, meet wage bills and meet day to day
expenses. The idle cash with the business will mean that it is not properly used.

SCOPE OF FINANCIAL MANAGEMENT

 Implementing financial controls:An efficient system of financial management

necessitates the use of various control devices. They are ROI, break even
analysis, cost control, ratio analysis, cost and internal audit. ROI is the best
control device in order to evaluate the performance of various financial
policies.
 Proper use of surpluses:The utilization of profits or surpluses is also an
important factor in financial management. A judicious use of surpluses is
essential for expansion and diversification plans and also in protecting the
interests of share holders. The ploughing back of profits is the best policy of
further financing but it clashes with the interests of share holders. A balance
should be struck in using funds for paying dividend and retaining earnings for
financing expansion plans.
FUNCTIONS OF FINANCIAL MANAGEMENT
 (A) Executive Functions

Finance function, according to modern approach to Financial Management,

includes three types of decisions-investment, financing and dividend.
Making reasonable forecast of financial requirements and arranging the sources
for the supply of funds, making effective and maximum use of funds provided by
the investors, increasing the value of 'equity' of owners of the business, etc., are
the objectives of financial management for which the following functions are
carried out
(A) Executive Functions

 1.Financial Forecasting: Financial forecasting is the primary function of financial

management because it is the foundation stone of financial planning. In the case
of new enterprises such forecasts are initially made by the promoters. However, in
the case of going concern financial requirements in respect of every project are
being forecast by financial executives only. Such financial forecasting needs the
applications of various statistical, mathematical and accounting techniques.
 2. Financial Planning: After making financial forecast, financial planning is done
under which three distinct sub-activities: (i) formulation of financial objectives,
(ii) framing the financial policies, and (iii) developing financial procedures are
being performed. Both short-term and long-term plans are prepared with respect
to each of the above sub-activities.
 3. Financing Decisions: Financing decisions, basically a finance function also
happens to be an important function of Financial Manager or financial
management. This function involves the determination of financial sources,
comparative study of their cost of capital, examining the impact on shareholders'
equity, etc.
(A) Executive Functions

 4. Financial Negotiations: It is also the function of financial management to

contact all the possible suppliers of funds (ie., sources from which capital is
to be raised) and to finalise the contract through negotiations/talks or other
methods. In this process a number of statutory provisions, rules and
assumptions are to be executed in action. A number of financial institutions,
bankers, underwriters, etc., are to be consulted for reaching an agreement.
 5. Investment Decisions: Decisions regarding investing the available funds in
several assets are also treated as functions of financial management. It is the
function of financial management to determine the volume of investments in
fixed assets (long-term investments) and volume of investments in current
assets (short-term investments). Financial manager has to take appropriate
and proper decision in this regard. At the same time, providing depreciation
on fixed assets, arranging for their replacements and determining the
optimum level of investments in current assets are also the functions of
financial managements.
(A) Executive Functions

 6. Management of Income: This function is also an important function of

Financial Management. Management of income comprises correct
measurement of income, distribution of income in correct proportion and
following the appropriate dividend policy. This also be construed as functions
of Financial Manager.
 7. Management of Cash flows: Proper flow of cash in a business is an
essential condition for the survival of any business. Thus, it is the function of
financial management to frame and adopt a fair policy regarding the cash
flows (both inflows and outflows) and to manage properly the situation of
cash surpluses/deficiencies.
 8. Appraisal of Financial Performance: It is equally the function of financial
management to analyse and evaluate the financial performance of the
business concern after a definite interval and to communicate the results to
top management. A number of tools and techniques may be used for such
analysis and appraisal.
(A) Executive Functions

 9. To Make efforts for Increasing the Productivity of the Capital: Financial

manager has to make all possible efforts to enhance the productivity of the
capital by discovering the new opportunities of investments.
 10. To Advise the top Management: Whenever the top management faces
any financial problem, financial management has to advise for best solution.
Financial Management can also advise in respect of proper diagnosis of the
problem, alternative solutions to the problems and election of the best
solutions.
(B) Routine Functions

 This class of financial management's function consists of those daily activities

which are being performed by lower-level employees. Such
activities/functions have a distinct and separate importance, because top
authorities take financial decisions with the help of such functions. Normally,
the following functions are included in this category:
 (i) Record keeping,
 (ii) Preparation of various financial statements,
 (iii) Arranging the cash balance as per requirement, (iv) Managing the credit,
 (iv) Safety of significant financial documents.
Risk-Return Trade Off

The financial decisions of the firm are inter-related and they affect market
value of shares. The relationship between risk and return can be expressed as
follows:

Return = Risk free rate + Risk Premium

 Risk free rate is the return which an investor can earn without any risk. For
example, if bank gives 10% interest on deposits, it is a risk free rate because
there is no risk in such investment. If we want to earn a higher return, we
shall have to take some risk by investing funds in some other projects.
 Risk free rate is a compensation for time for which an investor sacrificed his
fund in favour of bank or any other institution and risk premium for risk which
he is ready to bear. Higher is the risk, higher will be the return. A proper
balance between risk and return should be maintained to maximize the
market value of shares. Such a balance is called risk - return trade off.
 Risk-Return Trade Off

The relationship among market value, financial decisions and risk-return trade-off can
be explained with the help of following
Financial Management

Maximization of Share Value

Financial Decision

Investment Decision Liquidity Decisions Financing Decision Dividend Decision

Trade Off
Return Risk
GOALS OF FINANCIAL MANAGEMENT

 Effective procurement and efficient use of finance lead to proper utilization

of the finance by the business concern. It is the essential part of the financial
manager. Hence, the financial manager must determine the basic objectives
of the financial management. Objectives of Financial Management may be
broadly divided into two parts such as:

A. Profit maximization
B. Wealth maximization.
Profit Maximization

 Main aim of any kind of economic activity is earning profit. A business concern
is also functioning mainly for the purpose of earning profit. Profit is the
measuring techniques to understand the business efficiency of the concern.
Profit maximization is also the traditional and narrow approach, which aims
at, maximizes the profit of the concern. Profit maximization consists of the
following important features.
1.Profit maximization is also called as cashing per share maximization. It leads
to maximize the business operation for profit maximization.
2.Ultimate aim of the business concern is earning profit, hence, it considers all
the possible ways to increase the profitability of the concern.
3.Profit is the parameter of measuring the efficiency of the business concern.
So it shows the entire position of the business concern.
4.Profit maximization objectives help to reduce the risk of the business.
Favorable Arguments for Profit Maximization

 The following important points are in support of the profit maximization

objectives of the business concern:
1.Main aim is earning profit.
2.Profit is the parameter of the business operation.
3.Profit reduces risk of the business concern.
4.Profit is the main source of finance.
5.Profitability meets the social needs also.
Unfavorable Arguments for Profit Maximization

 The following important points are against the objectives of profit

maximization:
1. Profit maximization leads to exploiting workers and consumers.
2.Profit maximization creates immoral practices such as corrupt practice,
unfair trade practice, etc.
3.Profit maximization objectives leads to inequalities among the sake holders
such as customers, suppliers, public shareholders, etc.
Wealth Maximization

 Wealth maximization is one of the modern approaches, which involves latest

innovations and improvements in the field of the business concern.
 The term wealth means shareholder wealth or the wealth of the persons
those who are involved in the business concern.
 Wealth maximization is also known as value maximization or net present
worth maximization.
 This objective is an universally accepted concept in the field of business
Favorable Arguments for Wealth Maximization

 Wealth maximization is superior to the profit maximization because the main

aim of the business concern under this concept is to improve the value or
wealth of the shareholders.
1.Wealth maximization considers the comparison of the value to cost
associated with the business concern. Total value detected from the total
cost incurred for the business operation. It provides extract value of the
business concern.
2.Wealth maximization considers both time and risk of the business concern.
3.Wealth maximization provides efficient allocation of resources.
4.It ensures the economic interest of the society.
Unfavorable Arguments for Wealth Maximization

Wealth maximization leads to prescriptive idea of the business concern

but it may not be suitable to present day business activities.
1.Wealth maximization is nothing, it is also profit maximization, it is the
indirect name of the profit maximization.
2.Wealth maximization creates ownership-management controversy.
3.Management alone enjoy certain benefits.
4.The ultimate aim of the wealth maximization objectives is to
maximize the profit.
5.Wealth maximization can be activated only with the help of the
profitable position of the business concern.