Financial Management

Definitions:
FM mainly involves raising of funds and its effective utilization with the objective of
maximizing shareholders’ wealth.

A/c to Van Horne and Wachowicz, FM is concerned with the acquisition, financing and
management of assets with some overall goal in mind.

Overall there are three activities involved for the financial manager.

(1) Anticipating financial need, which means estimating of funds required for investment in
fixed and current assets.

(2) Acquiring financial resources, once the required amount capital is decided the next task
will be acquisition means how to obtain the funds.

(3) Allocating the funds in business, means allocation of available funds among best plans
of assets which are able to maximize shareholders’ wealth.

Hence the decisions of financial manager can be divided in to three viz., investment, financing
and dividend.

EVOLUTION OF FINANCIAL MANAGEMENT:

There are three phases for financial management showing how it emerged as a distinct field of
study.

1) The Traditional Phase: this phase lasted for about four decades which was very well
expressed in the book titled “the financial policy of corporation in 1920s”where the focus
of management was on the given aspects

• It treats the subject of finance from outsider’s point of view/

• It much emphasized on corporation finance and too little on problems of non

corporate.

• It placed heavy importance on long term financing.

2) The Transitional Phase: it started in early 1940s and continued up to mid 1950s. It was
more or less similar to the traditional phase only but the more emphasis was given to the
problem of working capital faced by the finance manager and capital budgeting
techniques were evolved in this phase only.
 3) The Modern Phase: it began in mid 1950s and concentrated on rational matching of funds
to their uses which leads to maximisation of share holders’ wealth. The areas of
advancement are in capital structure formation (considering COC), investment decisions,
dividend decisions etc.

SCOPE OF FM:

1) The Traditional approach:

The FM is a separate field of study emerged in the early 1990s. The role of financial
manager was limited to fund raising and administering required by the corporate
enterprises to meet their financial requirements. In a simple sense, the scope of FM in
traditional approach was very narrow. The field of financial management was interrelated
with aspects like

 Raising of funds from financial institutions

 Raising funds through financial instruments- shares and bonds from the capital
markets.

 The legal and accounting relationship between an enterprise and its source of
funds.

Criticisms to the traditional approach

1) Ignored day to day problems

2) Outsider-look-in approach

3) Ignored working capital financing

4) Ignored allocation of capital.

2) Modern Approach: it was started during mid1950s. Its scope is wider because it covers
conceptual and analytical framework for decision making. In short it covers both
procurement and allocation of funds. For effective allocation of funds a financial
manager has to take three crucial decisions

 Investment decisions ( Fixed or working capital)

 Financing decisions( Fixation of Capital Structure)

 Dividend decisions( Dividend pay out ratio)

 Interrelation between financing decisions

Investmen
t

Decision

Financing Dividend

Decision Decision

GOALS /OBJECTIVES OF FINANCIAL MANAGEMENT:

There are two widely accepted goals for FM (1) Profit Maximisation (2) Wealth Maximisation.

Profit Maximisation: Profit is primary motivating factor for any economic activity. Firm is
essentially being an economic organization, it has to maximize the interest of its stakeholders.If
an enterprise fails to make profit , capital invested is eroded and if this situation prolongs, the
enterprise finally ceases to exist. The overall objective of earning a satisfactory level of profit
maintains the soundness of the financial position.

Limitations: a) vague

b) Ignores time of value of money

c) Ignores quality of benefit.

Wealth Maximisation: On account of the given limitations above , the wealth maximisation for
shareholders is an appropriate goal for financial decision making. It is operationally feasible as it
satisfies all three requirements of a suitable objective namely exactness, quality of benefits and
the time value of money.

W= CIF1 + CIF2 + CIF3 + CIF4 + ….. CIFn _______ ICo

(1+r)1 (1+r)2 (1+r)3 (1+r)4 (1+r)n

Where,

W= Net present worth

CIF1, CIF 2, CIF 3, CIF 4= present streams of cash inflows expected to be occurred

ICo= Initial cash outflow.

r = expected rate of return.

A shareholder‘s wealth over a period of time can be computed by the following formula.

SW t = NS × MP t

SW= shareholder’s wealth at ‘t’ period

NS= no. of equity shares owned

MP= Market Price of share at ‘t’ period.

FINANCE FUNCTION
Board of Director

Managing Director

vice president operations Vice President Finance Vice president Sales

Treasurer Controller

Capital Cash Cash Data Processing

Budgeting Managemen accounting Manager
t Manager
Investment Credit
Financial Tax
Banking Manager
Accounting Manager
Manager
Portfolio Fund raising
Manager Manager Internal Financial
Auditor statement
Preparation
Inventory Preparing
Manager Budget
AIMS OF FINANCE FUNCTION:

1) ANTICIPATION OF FUNDS REQUIRED

2) ACQUIRE THE ANTICIPATED FUNDS
3) ALLOCATION OF FUNDS
4) INCREASE PROFITABILITY
5) MAXIMISING FIRM’S VALUE