Financial management

Module - 1

Introduction:
Either for individuals or business houses, financial
management is important to achieve their goals, that is,
the method to raise funds at the lowest cost and to get
the maximum return on invested capital.
It is true that business needs more money to make more
money, and it is possible only when it is properly
managed
Hence efficient management of every business
enterprises is closely linked with efficient management
of its finance.

Business finance:
Business finance refers to money and credit employed in business.
The need for business finance arises for the following purposes:
To acquire fixed assets
To purchase raw-materials/goods
To acquire services of human being
To meet other operating expenses
To adopt modern technology
To meet contingencies
To expand existing operations
To diversify
To avail of business opportunities

Finance:
Traditionally finance was only limited to
procurements of the funds for the organization. The
funds were needed to finance the expansion or
diversification.
Modern theory of finance considered finance as a
separate discipline and have a wider perspective. Its
not only limited to procurement but increased its limit
to cover efficient allocation and effective
administration of fund. It has become an integral part
of overall management.

Financial management:
Financial management is basically the application of
general management principles to the areas of financial
decision-making such as investment, financing,
dividend & working capital with a view to maximize
the wealth of the company. Thus, financial
management answers the following basic questions:
Where to invest?
From where to raise funds?
How much earnings to be retained and how much to be
distributed?
How to manage working capital?

Objectives of financial management:

The objective of financial management may be:
To maximize profit
To maximize earning per share
To minimize cost
To maximize market share
To maximize the current value of the companys
stock

Profit maximization:
Profit maximization implies maximizing the rupee income of
the firm.
Arguments in favor of profit maximization:
Profit is a yardstick of efficiency on the basis of
which economic efficiency of a business can be evaluated.
It helps in efficient allocation and utilization of scarce means
because only such resources are applied which maximize the
profits.
The rate of return on capital employed is considered as the
best measurement of the profits.
Profit acts as motivator which helps the business
organization to be more efficient through hard work.
By maximizing profits, social & economics welfare is also
maximized.

Objections to profit maximization:

It is vague
It ignores the timing of returns
It ignores risk
It assumes perfect competition
In new business environment profit
maximization is regarded as Unrealistic
Difficult
Inappropriate
immoral

EPS maximization as the objective of FM:

Maximizing EPS implies that the total earnings are
retained and re-invested in the business of the firm
and no portion of the earnings is distributed as
dividend among the share holders so long as earnings
can be re-invested at a rate of return higher than the
opportunity cost of retained earnings.

Cost minimization as the objective of FM:

Costs minimization implies making the product/
service available at minimum cost.
Such policy may not always result in highest sales
revenue of highest profit.
Since market value is not a function of cost,
minimizing cost will not result in highest price for
company's shares.
Hence, such a policy may not always work as
primary goal of financial management.

Market share maximization as the objective of

FM:
Market share maximizing implies maximizing sales
revenue by serving maximum number of customer.
Such policy may not always result in highest profit.
Since market value is not a function of market share,
maximizing market share will not result in highest
price for company's shares.
Hence, such a policy may not always work as
primary goal of financial management.

Value maximization as the objective of FM:

The primary objective of financial management is wealth
maximization.
Value maximization implies:
Maximizing value of the firm
Maximizing shareholders value
Maximizing share price
The goal is to maximize shareholders wealth. Wealth
maximizing means maximizing the Net present value of
a course of action. The wealth of owners of a company
is reflected by the market value of company's shares in
the long run.

Arguments in favour of wealth maximization:

It maximizes the net present value of a course of
action to shareholders.
It accounts for the timing and risk of the expected
benefits
Benefits are measured in terms of cash flows
It serves the fundamental objective i.e. maximizes the
market value of the firms shares.

Other objectives:
To ensure timely optimal procurement of adequate
funds at reasonable cost after balancing the risk, cost
and control considerations.
To ensure effective utilization of funds
To ensure adequate supply of funds as and when
needed
To ensure safety of the funds through creation of
reserves, re-investment of profits etc.

Functions of a financial manager:

1.

Primary functions:
Estimating the capital requirements
Financing or capital structure decision
Utilization of funds or investment decision
Disposal of surplus or dividend decision
Management of cash
Financial control

2. Subsidiary functions:
Ensuring the optimum level of inventory and
receivables
Supplying funds to all the parts of the organization
Evaluating financial performance of various units of
the organization
Carrying out financial negotiations with financial
institutions, banks, underwriters and inter-corporate
depositors( ICD)
Keeping track of stock exchange quotations and
behavior of share prices.

Finance functions or decisions in financial

management:
Financing decisions
Investment decisions
Dividend policy decision
Liquidity Decision

Financing Decisions
Financing Decisions are decisions regarding process of
raising the funds. This function of finance is concerned
with providing answers to various questions like What should be amount of funds to be raised?
What are the various sources available to organization for
raising the required amount of funds?
What should be proportion in which internal & external
sources should be used by organization?
If organization, wants to raise funds from different
sources, it is required to comply with various legal &
procedural formalities.
What kinds of changes have taken place recently
affecting capital market in the country?

Investment decisions
Investment decisions are decisions regarding application of
funds raised by organization. These relate to selection of
the assets in which funds should be invested.
The assets in which funds can be invested are of 2 types
Fixed assets:- are the assets which bring returns to
organization over a longer span of time. The investment
decisions in these types of assets are capital budgeting
decisions. Such decisions include
How fixed assets should be selected to
make investment ? What are various methods
available to evaluate investment proposals in fixed
assets?
How decisions regarding investment in fixed assets
should be made in situation of risk & uncertainty?

Current assets:- are assets which get generated

during course of operations & are capable of getting
converted in form of cash with in a short period of
one year. Such decisions include
Why need for working capital arises?
What are factors affecting requirements of
working capital?
How to quantity requirements of working capital?
What are sources available for financing the
requirement of working capital?

Dividend Policy Decisions:

Dividend Policy Decisions:- Such decisions include:
What are forms in which dividend can be paid to
share holders?
What are legal & procedural formalities to be
completed while paying dividend different forms?

Liquidity Decisions:
Liquidity Decisions:- Current assets should be
managed efficiently for safe guarding firm against of
liquidity & insolvency.
In order to ensure that neither insufficient nor
unnecessary funds are invested in current assets, the
financial manager should develop sound technique of
managing current assets.

Organization of finance function:

Functions of chief financial manager:

Chief Financial manager is the top officer of finance department. In
America he is known as Vice-president Finance and in India he is
called Chief Financial Controller. He performs following functions:
(1) Financial Planning
(2) Procurement of Funds
(3) Co-ordination:- Financial manager establishes co-ordination
among the financial needs of various departments. He is a member
of finance committee.
(4) Control:- Financial manager examines whether the work is
being performed as per pre-determined standards or not. He gets
the reports prepared, controls the cost and analyses profits.
(5) Business Forecasting: - Financial manager evaluates the effects
of all national, international, economic, social and political events
on industry and company.
(6) Miscellaneous Functions: - It includes the management of
assets, management of inventory, arrangement of data and
management of bank deposits etc.

Functions of treasurer:
The following are the functions of treasurer.
Provisions of finance:- It includes the estimation of funds
necessary for procurement preparing programmes and
implementing them, establishing relation among various
sources of funds, issuing the securities and managing debt etc.
Banking Function:- It includes opening bank accounts,
depositing cash, payment of company liabilities, accounting
cash receipts & payments, responsibility for transacting actual
assets etc.
Custody:- The treasurer is the custodian of funds and securities.
Management of credit and collection: - The treasurer
determines credit risk of customers and arranges for collection.
Investments
Insurance

Functions of controller:
Planning:- The controller prepares plan for controlling
the business activities which are the main constituents of
management and in which proper arrangement
regarding profit planning, capital expenditure planning,
sales forecasting and expenditure budgeting is made.
Accounting
Auditing: - Controller Manages internal auditing
Reports
Government Reporting: - Controller sends essential
informations to the government by obeying the legal
requirement.
Tax Administration: - Controller prepares statement on
tax liability.
Economic Appraisal: - He determines and analyses the
effect of economic and social factors on business.