Financial Management

Financial Management
Finance is the life blood of business. Every organization, may it be a company, firm, college, school, bank or
university requires finance for running day to day affairs. As every organization previews stiff competition, it
requires finance not only for survival but also for strengthening themselves. Finance is essential for expansion,
diversification, modernization, establishment, of new projects and so on. Before discussing the nature and
scope of financial management, the meaning of 'finance' has to be explained.
Definition of Finance
In the words of John J. Hampton, the term finance can be defined as the management of the flows of money
through an organization, whether it will be a corporation, school, bank or government agency.
Financial Management - Significance

Financial management is the application of planning and control to the finance function. It helps in profit
planning, measuring costs, controlling inventories, accounts receivables. It also helps in monitoring the
effective deployment of funds in fixed assets and in working capital. Financial management helps in
ascertaining and managing not only current requirements but also future needs of an organization.
1. It ensures that funds are available at the right time and procurement of funds does not interfere with
the right of management
2. It influences the profitability,return on investment of a firm.
3. It influences cost of capital. Efficient fund managers endeavour to locate less cost source so as to enhance
profitability of organization.
4. It affects the liquidity position of firms.
5. It enhances market value of the firm through efficient and effective financial management.
6. Financial management is very much required for the survival, growth, expansion and diversification of
business.
7. It is required to ensure purposeful resource allocation.
Finance Manager - Functions

1) Forecasting of Cash Flow: This is necessary for the successful day to day operations of the business so that
it can discharge its obligations as and when they rise. In fact, it involves matching of cash inflows against
outflows and the manager must forecast the sources and timing of inflows from customers and use them to pay
the liability.
2) Raising Funds: The Financial Manager has to plan for mobilising funds from different sources so that the
requisite amount of funds are made available to the business enterprise to meet its requirements for short
term, medium term and long term.
3) Managing the Flow of Internal Funds: Here the Manager has to keep a track of the surplus in various
bank accounts of the organisation and ensure that they are properly utilised to meet the requirements of
the business. This will ensure that liquidity position of the company is maintained intact with the
minimum amount of external borrowings.
4) To Facilitate Cost Control: The Financial Manager is generally the first person to recognise when the costs
for the supplies or production processes are exceeding the standard costs (budgeted figures). Consequently, he
can make recommendations to the top management for controlling the costs.
5) To Facilitate Pricing of Product, Product Lines and Services: The Financial Manager can supply important
information about cost changes and cost at varying levels of production and the profit margins needed to carry
on the business successfully. In fact, financial manager provides tools of analysis of information in pricing
decisions and contribute to the formulation of pricing policies jointly with the marketing manager.
6) Forecasting Profits: The Financial manager is usually responsible for collecting the relevant data to make
forecasts of profit levels in future.
7) Measuring Required Return: The acceptance or rejection of an investment proposal depends on whether
the expected return from the proposed investment is equal to or more than the required return. An
investment project is accepted if the expected return is equal or more than the required return.
Determination of required rate of return is the responsibility of the financial manager and is a part of the
financing decision.
Goals of Financial Management

The goals can be classified as official goals, operative goals and operational goals. The official goals are the
general objective of any organization. They include mechanism of ROI and market value of the firms. The
operative goals indicate the actual efforts taken by an organization to implement various plans, policies and
norms. The operational goals are more directed, quantitative and verifiable. In fine, it can be inferred that the
official, operative and operational goals are set with a pyramidal shape, the official goals at the helm of
affairs (concerned with top level executives), operative goals at the middle level and operational goals at the
lower level.
It is argued that the achievement of central goal of maximisation of the owner's economic welfare
depends upon the adoption of two criteria, viz., i) profit maximisation; and (ii) wealth maximisation.
Arguments in favour of profit maximization

1. Profits are the major source of finance for the growth and development of its business.
2. Profitability serves as a barometer for measuring efficiency and economic prosperity of a business
entity.
3. Profits are required to promote socio-economic welfare.
Criticisms levelled against profit maximization

1) There are several goals towards which a business firm I organization should direct themselves profit -
maximization is one of the goals of the organization and not the only goal.
2) Maintenance of firm's share in the market, development and growth of the firm, expansion and
diversification are other goals of business concern.
3) Rendering social responsibility
4) Enhancing the shareholders' wealth maximization.
Wealth Maximisation
Wealth Maximisation refers to all the efforts put in for maximizing the net present value (i.e. wealth)
of any particular course of action which is just the difference between the gross present value of its
benefits and the amount of investment required to achieve such benefits. Wealth maximisation principle is
also consistent with the objective of maximising the economic welfare of the proprietors of the firm. This,
in turn, calls for an all out bid to maximise the market value of shares of that firm which are held by its
owners. As Van Horne aptly remarks, the market price of the shares of a company (firm) serves as a
performance index or report card of its progress. It indicates how well management is doing on behalf of
its shareholders.
The wealth maximization objective serves the interests of suppliers of loaned capital, employees,
management and society. This objective not only serves shareholders interests by increasing the value of
holding but also ensures security to lenders also. According to wealth maximization objective, the primary
objective of any business is to maximize share holders wealth. It implies that maximizing the net
present value of a course of action to shareholders.
This goal for the maximum present value is generally justified on the following grounds:
(i) It is consistent with the object of maximising owners economic welfare.
(ii) It focuses on the long run picture.
(iii) It considers risk.
(iv) It recognises the value of regular dividend payments.
(v) It takes into account time value of money.
(vi) It maintains market price of its shares
(vii) It seeks growth is sales and earnings.
FINANCIAL DECISIONS
The financial manager according to Ezra Solomon must find a rationale for answering the following three
questions.
1) How large should an enterprise be and how fast should it grow?
2) In what form should it hold its assets?
3) How should the funds required be raised?
It is therefore clear from the above discussion that firms take different financial decisions continuously
in the normal course of business
Financial Decisions - Types

We can classify these decisions into three major groups :
1.Investment decisions
2. Financing decision.
3. Dividend decisions.
4. Liquidity decisions.
1. Investment Decisions/Capital Budgeting Decisions

Investment Decision relates to the determination of total amount of assets to be held in the firm, the
composition of these assets and the business risk complexities of the firm as perceived by the investors. It is
the most important financial decision. Since funds involve cost and are available in a limited quantity, its
proper utilization is very necessary to achieve the goal of wealth maximisation. The investment decisions can
be classified under two broad groups; (i) long-term investment decision and (ii) Short-term, investment
decision. The long-term investment decision is referred to as the capital budgeting and the short-term
investment decision as working capital management.
2. Financing Decisions /Capital Structure Decisions

Once the firm has taken the investment decision and committed itself to new investment, it must decide the
best means of financing these commitments. A finance manager has to select such sources of funds which
will make optimum capital structure. The debt- equity ratio should be fixed in such a way that it helps
in maximising the profitability of the concern. The raising of more debts will involve fixed interest liability
and dependence upon outsiders. It may help in increasing the return on equity but will also enhance the risk.
The raising of funds through equity will bring permanent funds to the business but the shareholders will
expect higher rates of earnings. If the capital structure is able to minimise the risk and raise the profitability
then the market prices of the shares will go up maximising the wealth of shareholders.
3. Dividend Decision
The third major financial decision relates to the disbursement of profits back to investors who supplied capital
to the firm. The term dividend refers to that part of profits of a company which is distributed by it among its
shareholders. It is the reward of shareholders for investments made by them in the share capital of the company.
A decision has to be taken whether all the profits are to be distributed, to retain all the profits in business or to
keep a part of profits in the business and distribute others among shareholders. The higher rate of dividend
may raise the market price of shares and thus, maximise the wealth of shareholders.
4. Liquidity Decisions
Liquidity and profitability are closely related. Obviously, liquidity and profitability goals conflict in most
of the decisions. The finance manager always faces the task of balancing liquidity and profitability. The
term liquidity implies the ability of the firm to meet bills and the firm's cash reserves to meet emergencies.
Whereas the profitability means the ability of the firm to obtain highest returns within the funds available.
If a finance manager wants to meet all the bills, then profitability will decline similarly where he wants
to invest funds in short term securities he may not be having adequate funds to pay-off its creditors.

Financial Management

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Financial Management

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Financial Management

Financial Management - Significance

Finance Manager - Functions

Goals of Financial Management

Arguments in favour of profit maximization

Criticisms levelled against profit maximization

Financial Decisions - Types

1. Investment Decisions/Capital Budgeting Decisions

2. Financing Decisions /Capital Structure Decisions

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