Chapter-1:Financial Management & its Environment

1. Introduction of Financial Management.

1.1 Scope of financial Management.
1.2 Nature of financial Management.
1.3 Objectives of Financial Management (Goals)
1.4 Finance functions
1.5 Significance and Limitations of financial Management
1.6 Responsibilities of financial Manager.(CFO)
1.7 Changing role of CFO

1.0 Introduction: A business is an activity concerned with earning the

profits. Finance is life blood of business, It is required for establishing &
operating the business effectively. Sometimes business fails, but this not
due to inadequate finance rather mismanagement of financial resources.

Financial management is that managerial activity which is concerned with

the planning and controlling of the Financial resources. In other words
Financial management is the ways & means of managing money ie the
determination, acquisition, allocation and utilization of financial resources
usually with the aim of achieving some particular goals or objectives,

“Financial management is the application of the planning & control functions

of the finance functionin -Howard & Upton.

“Financial management is the operational activity of a bu that is responsible

for obtaining and effectively utilising the funds necessary for effective
operations. – Joseph L. Massie

Thus financial management is the planning, organising, directing and

controlling of the procurement and utilization of funds & safe disposal of
profit to the end so that individual, organisational & social objectives are
accomplished.

1.1. Scope of Financial Management

 These are also known as Functions of financial Management. For the
purpose of students convenience we can classify them in three parts as
follows:-

1.1.1Primary/Executive functions. These relate to financial decision-

making therefore expertise of managerial personnel is required for such
functions. Some are as follows:-

(a) Financial Planning:- It is concerned with decision making. The

financial managers are required to formulate financial plan on basis of
past & future, financial requirements. It involves three steps as
follows:
 Determining financial objectives;
 Formulating financial policies &
 Making adjustments & re-adjustments.
(b) Acquasation of funds :- The main function of Financial management
is to ensure adequate supply of funds from the right source at right
cost and at right time to fulfill funding needs. It can be raised from
 sources such as equity shares, prefrence shares. Bonds etc. The source
with lowest cost of capital is choosen.
(c) Allocation of Funds:- After acquiring funds it is required to
effectively distribute them. This is done through capital budgeting.
When there are insufficient funds in current assets then there can be
situation of illiquidity & vice-versa the profitability is affected.So
allocation should be based on Liquidity -profitability trade-off.
(d)Distribution of income: Net profit after tax is distributed among
shareholders as a return on their investment or retained in the
business for expansion or distributed among employees. The decision
should be based on wealth maximization principle
(e) Control of funds:- It is most important function of financial
management. Progress of financial measures is evaluated time-to time
& in case of deviations corrective measures are taken. For this
standard performance has to be developed. The finance manager
should establish a reporting system for better control.

1.1.2. Subsidiary functions. Along with primary functions following

Executive functions are be performed
(a) Liquidity Function:- For smooth operation of business adequate
liquidity is need to be maintained. This enables a firm to meet out daily
obligations. Cash is the best source of maintaining liquidity. For this
purpose cash requirement to be Forecasted. For this cash budgeting &
other forecasting methods are used, so that optimal cash balance can
be maintained.
(b) Profitability Function:- For giving maximum returns to
shareholders, profitability should be maximised. For achieving this
purpose profit planning price fixation, cost of capital, etc.. techniques
are used.
(c) Evaluation function:- After that financial performance need to be
evaluated by financial manager & report is submitted to Board of
Directors. This helps in finding out deviations & reasons for it. This is
done by ratio analysis, trend analysis, fund-flow, Cash-flow, CVP
analysis etc
(d) Co-ordination with other Departments :All activities of
business are related to finance, so the success of business depands
upon co-ordination of finance department with other departments. It is
duty of finance manager to maintain uniformity in decisions taken by
different departments of the organisation.
 1.1.3 Incidental or Routine function: This refers to clerical or
routine functions which are necessary for the execution of
decisions taken by finance manager. These includes following:-
 Administration of pension & welfare plans.
 Maintenance of accounts & preparation of reports
 Administration of internal audit,
 Compliance with govt regulations.
 Establishing financial public relations.
 Supervision of cash receipts & payments
 Proper custody of valuable papers, securities & insurance policies.

The chief financial executive is responsible for decision-making regarding

these functions. These are performed by Lower level executives.
Following steps are taken for the purpose:-

 Setting up rules of procedure

 Selecting forms to be used
 Establishing standards
 Evaluation of performance.

From above explanation we can conclude that scope of finance is very

wide and affects other functions like production marketing, sales etc.
So the finance manager should take proper care while formulating
financial policies,

1.2. Nature of Financial management

Financial management is a continuous business function rather than
episodic function. Based on this approach the Nature or Characteristics
of financial management can be stated as under:-
1.2.1 Continuous function:- As per modern approach great emphasis is
given to proper management of funds Due to the reason financial
management has become a continuous administrative function. The Financial
manager performs the functions of capital budgeting Working Capital
Management which are continuous in nature.

1.2.2. Indispensable Part of Management:-The financial Management is a

vital & integral part of overall management. Every activity of business is
linked with finance such as purchase of raw material, payment of wages,
advertising expenses, etc. The decision regarding all there is taken by
finance manager after considering various aspects.

1.2.3 Scientific & Analytical :Now-a-days financial management is

becoming more & more scientific & analytical in nature. In modern times for
analysis and evaluation of various available alternatives we use
mathematical & statistical tools. It not only requires analytical skill but also
thorough knowledge of techniques & tools of financial analysis

1.2.4. Centralised Nature : Finance function is just like human heart whose
basic nature is centralised. It controls & coordinates other functional areas of
management. So, it is better to have centralisation of finance function, which
will ultimately help in achievement of objective of firm.

1.2.5 Different from Accounting:- Most of the persons regard accounting

& finance as same thing & use then interchangeably. But there are two
different terminologies. Accounting is just accumulation of data whereas
Financial management is determination , acquisition, allocation & utilization
of financial resources to achieve objectives or goal of firm.

1.2.6 Wide Scope The scope of financial management is very wide &
complex. It is not confined only to raising of capital from long-term sources ,
but also from short-term sources as well as their allocation, optimal
utilization & control.

1.2.7. Universal function:- It is a Universal & pervasive function, It is

applicable to all types of organisations whether small or large all over the
world. It is applicable to any kind of undertaking or organisation regardless of
its aim or constitution.

1.3 Objectives/Goals of FM
Objectives /targets/aim/ goal/purpose of financial management can also be
called as approaches to FM. The main objective of firm are survival & growth.

1.3.1 Profit Maximisation :Means maximising the rupee income of firms.

According to this approach actions that increase profits should be at
undertaken & those that decrease profits are to be avoided. This criterion
implies that the investment, financing & dividend policy decisions of firm
should be oriented towards maximisation of profits. This is. a traditional
belief that profits are the appropriate yardstick to measure operational
efficiency of an enterprise. The view is criticized by modern thinkers on
following grounds.

 Unclear definition of profit.

 No consideration for time value of money.
 Uncertainty of Returns.
 Assumes perfect competition
 Ignorance of risk factors
 The objective was developed when min businesses were self-financed
& self-Controlled, but today scenario is different
 It does not take into consideration the social considerations as well as
the obligations.

1.3.2. Shareholders Wealth Maximization- It is an appropriate criterion

to choose among the alternative financial actions. Shareholders Wealth
Maximisation means maximising Net Present Value (NPV) of a course of
action. NPV is difference between the present value of benefits and present
value of its cost. A financial action that has (+) ve NPV creates wealth to
shareholder & therefore is desirable, while an action resulting in (-)ve NPV
should be rejected since it would destroy shareholder present value or
wealth
Where, A1, A2… An represent the stream of cash flows expected

K=appropriate discount rate to measure risk& timing.

C=initial outlay to acquire asset.

According to modem thinkers, objective of financial management is to

maximize the present wealth of can organisation. So to maximise the wealth
of shareholder or market value of share a firm must,

 manage customers properly

 Increase employee capabilities and information System
 Increase the market share ie growth
 Avoid high risk
 Maintain a satisfactory dividend policy.
 Balance between debt & equity financing

From above it can be concluded that wealth maximisation principle is better

as-

1. It measures income in terms of cash flows.

2. Recognises time value of money
3. Analyses risk & uncertainty
4. Not in conflict with other programmes.

1.4Finance function

Finance function is the process of acquiring & utilising funds by a business.

In the current scenario function has much widened. Therefore in order to
understand it we have to study following 2 approach
1.4.1 The traditional approach of finance function was very descriptive. It
was much like an encyclopaedia & was not analytical. The finance function
was viewed as the task of providing the funds needed by enterprise in the
light of objectives of business. This has Limited the rode of Financial
manager. Therefore it was bitterly criticised & discarded for In the following
reasons.

(a) Outsiders point of view

(b)Ignores Routine Problems
(c) Ignores Non-Corporate Enterprises
(d)Ignores Working Capital Financing
(e) Conceptual Omissions-
 Financing mix
 Relation between cost of capital & valuation of firm.

1.4.2 The modern approach tried to solve these problems. Acc. to modern
approach, the finance function means activities relating to planning,
procurement, control and administration of funds used in the business i.e.
activities like

(i) determination of capital requirements of the firm

(ii) procurement of necessary funds so that optimal capital structure can be

decided (iii)allocation of funds among different assets, &
(iv) financial control for the effective utilization of funds

are covered under the purview of this approach. This requires a financial
manager to take these important decisions:-

(a) Financing Decision- A manager has to decide about the amount of

capital required i.e. What should be the proportion of debt & equity
capital & selection of the sources of funds. Selection of source depends
upon the cost of financing nature of cost (fired/flexible) & period of
raising.
(b)Investment decision:- It is concerned with allocation of funds on
assets. Decisions regarding investment in Long-term assets are based
on costs & benefits arising from these assets. Investment in current
assets are taken keeping in view the profitability and liquidity. A
finance manager needed to maintain trade-off between Liquidity &
profitability.
(c) Dividend Decision. It is concerned with the allocation i.e distribution
of income. Dividend is part of profits which is distributed among share
holders. A Finance manager has to decide the portion of net profit
which should be distributed among shareholders. Higher rate of
dividend maximises shareholders wealth & hence generally desired by
Shareholders

These three decisions of Financial management are inter- related whose

net result would be the optimum utilisation of funds. Hence the combined
result of these financial decisions is called Finances Function..

1.5 .1 Significance/ Importance of Financial Management: The

main objective of FM is the Maximum utilisation of Financial resources
with maximum profit . During last 50years, due to rapid industrial
growth and LPG policy, the financial activities have undergone
tremendous changes. The financial management, therefore gained
much importance over the time. The importance of Financial
Management is being discussed under following heads:

1.Helps organizations in financial planning: To understand what

financial management is and examples of financial management, you must
know that financial planning is a crucial part of an integrated and sustainable
organization because it assists in branding the company among competitors.
In addition, financial management helps the company to ascertain fund
requirements and decides the necessary steps to meet those requirements.
2. Assists in acquiring funds from different sources: Another important
role of financial management is to understand available sources and acquire
funds for the business. This acquisition must be made keeping in mind the
cost and liabilities.

3. Helps in investing an appropriate amount of fund :The very

definition of financial management entails managing and allocating available
finances. The proper functioning of the finance department boosts the
growth and efficiency of the organization. When the funds are utilized in a
precise manner, the financial management can work toward holding the cost
of capital and amplifying the company’s worth. This will ultimately solidify
the financial standing of the organization.

4.Increases organizational efficiency: Financial management focuses on

establishing a firm position for the company in the market. It achieves this
through a framework for increasing the investors’ and shareholders’ wealth.
The main objective of an organization is to perform well and optimize profits
while stumping up the economy.

5. Reduces delayed production: Production delays are the root cause

of poor financial management. It causes inefficiency in every
department. Secure financial planning monitors production timelines
and deadlines and tries to reduce production delays.

6. Financial costs planning: This involves projections regarding the

company’s financial requirements to meet its short-term and long-
term objectives. Financial management executives provide a vision for
daily operations and enable planning for cost reduction and profit
maximization.
7. Provides economic stability: Maintaining economic stability is a
prerequisite for an organization to achieve constant growth. Sound
financial resources will help an organization expand its horizons and
thrive in the business. To achieve financial stability, it is important to
have efficient financial management in place.
8. Financial decisions making: Financial professionals assist the senior
professionals in the company in forming rules and creating policies by
giving a precise report of the daily finances and data on appropriate
key performance indicators.
9. Guideline for earning maximum profits with minimum cost:
Maximizing profits is the end goal for every organization. And the
 earrings and revenues are solely based on the productive employment
of financial resources. A solid financial foundation comprises different
attributes such as budget control, cost control, ratio analysis, trend
analysis, and cost-volume-profit numbers. Thus, financial management
is crucial to enhancing profits and minimizing operations costs.
10. Increases shareholders Wealth: Shareholders act as assets
for an organization. They are investors in the company. This is why a
company’s main objective should be to maximize its shareholders’
wealth. It will retain the funds and benefit the economy.
11. Encourages employees to save money: A transparent and
sustainable financial management system enables employees to
understand the available resources. In addition, it authorizes
professionals in every department to work toward the company’s
betterment by functioning under a budget.

1.5.2Limitations of Financial Management. The role of Financial

Management is changing continuously. It has become quite important & is
a part management, yet it has to face certain challenges and constraints.
The limitations of Financial Management are:

(i)It is difficult to know the financial effects of various managerial

decision. & co-ordinate all decision.
(ii) Based on financial records. The technique of financial analysis are
based on financial records on & records are concerned with past. So the
decisions based on these records may be faulty
(iii) Lack of knowledge of related subjects: The objectives of FM can
be achieved only when Financial Manager have knowledge about
management, statistics, management accounting, economics have etc. It
they don’t have knowledge of related fields than they can’t take right
decision.
(iv) Lack of objectivity. The decisions in Financial management are
affected by the personal view’s & feeling of financial managers & when
the effect is move it can lead to poor results
(v) Developing subject: It is not a completely developed subject and is
still developing. There is still ambiguity between experts regarding views
and theories. The standards are also changing.
(vi) Expensive. It is quite expensive and sometimes uneconomical to
install FM in every organisation as it requires heavy investment which
only large concerns can afford & small organisations are not able to bear
the burden.
 (vii) No alternate for Administration: FM suggests best alternates for
decisions to top management but ultimately decisions and corrective
measures are being taken by management and not by financial manager.
So FM is not alternate for Administration.

1.6. Responsibilities of finance Manager In modern business

organisation is regarded finance manager is as the highest official in finance
department and is also known as chief financial officer. His responsibilities
vary widely from one organisation to another depending upon size & nature
of business. He is responsible for the following tasks:

1.6.1 Financial Planning & Forecasting:- :- The main task of financial

manager is to forecast future financial needs & then prepare a sound
financial plan. It is the duty of financial manager to decide when the firm
needs money & the investment pattern. This helps the company to meet out
all obligations on time & maintain goodwill in market.

1.6.2 Fund Management: The primary function of finance manger is fund

management which includes acquisition of funds, Allocation of funds &
utilization on of funds

1.6.3 Disposal of earnings: Optimal disposal of earnings is an equally,

important task of finance manager. To maximise shareholders return the
finance manager have to declare i.e. Pay dividend. A finance manager has to
balance the expectations of investors & the desire to retain earnings

1.6.4. Maximisation of shareholders wealth The Finance manager

should try to increase the market price of shares in order to maximize
shareholders wealth. The market price of a co’s share are influenced by
present and future earnings per share, dividend policy etc. 1.6.5 Legal
Obligation It is task of finance manager to comply with legal obligations
such as tax laws, rules, regulations, & other legal formalities framed by the
govt. and local bodies

1.6.6 Professional Advice: Finance manager is responsible for the

provision of effective financial information and professional advice
1.6.7 Good Public Relation Finance manager should try to build-up good
financial image & its relationship with financial community. The financial
manager should cultivate good relations with existing & potential investors.

1.6.8 Interpretation and reporting : It is responsibility of Financial

manager to analyse and compare planned operations and standards with
actual performance. He also needs to inform about the financial effects of
these to owners and management at all levels.

1.6.9 Responsibilities towards various parties: There are various

parties interested in the welfare of the organization such as owner,
employees, customers and creditors. Financial manager is responsible
towards these parties in various ways.

1.6.10 Other Responsibilities:- Besides the above mentioned

responsibilities, the finance manager has to perform certain other functions
as follows:

(a) Co-ordination and control between departments

(b) Determination of credit policies.

(c)Recording of all contracts & to lease etc.

(d)Responsible towards employees, creditors etc.

(e) Understanding Capital Market.

1.7 CHANGING ROLES AND RESPONSIBILITIES OF CFO

Traditionally, the primary function of the Chief Financial Officer (CFO) was
that of ‘finance’ wherein que the CFO’s responsibility was to ensure that the
company stayed financially healthy and could meet its obligations at
anytime. In other words, the CFO was the “guardian of the books”. His
function was limited to accounting, legal audit, resource mobilization etc. But
during the last few years, rapid growth of computing technology and tele
communication, liberalization of economy, globalization of business, global
demand of IT services, corporate governance etc have ushered in the roles
and responsibilities of the CFO. As a result, the CFO has to face many
challenges.

1.Corporate Goals : The budget represents goals and missions of the

company as displayed by the resources required to attain these goals and
the expected financial benefits. The budget becomes the scorecard by which
the company as a whole, and its various departments individually are
measured. The CFO can’t build budgets that work without knowing the
company’s goals. Therefore, the CFO must ensure that appropriate systems
are in place to measure the attainment of corporate and departmental goals.

2. Financial Projections: Financial projections show how the company will

execute the vision of its future. Financial projections are used internally to
evaluate alternative opportunities and to ensure that resources are
available to meet future plans. The. CFO needs to evaluate the basis for
the company’s operating budget. He must analyse the reasoning behind
revenue projections, and be sure that cost structure shown will support
these projections. Projections will highlight the need for additional
resources as the company grows. The CFO should also prepare five year
projections incorporating the company's long-term plans.
3. Review of Financial Statements: The company’s financial statement is
the microscope focused on the health of the company. The CFO’s job is to
ensure the accuracy, timeliness and usefulness of these statements. The
CFO must guarantee the integrity of the numbers, deliver statements
properly (within first few days of each month), ensure that the statements
are meaningful and teach others how to use them.
4. Resources Management :Cash flow is the lifeblood of every company.
The CFO must ensure that excellent systems are in use to monitor and
forecast the company’s demand for cash. He should establish as many
potential sources of cash as possible and needs to be ready to draw on
these sources. The CFO should also review the company’s investment
policy, balancing liquidity, risk and return.
5. Corporate Governance: Corporate governance describes the principles
and practices adopted by a company to ensure sound management of the
company within the letter and spirit of the law. The CFO has to ensure
that the company practices high standards of corporate governance and
is respected by its various stakeholders and regulators.
6. Mergers and Acquisition Initiatives : These initiatives include the
successful introduction of new product lines, increased penetration of
existing products in current or new markets or alliances with suppliers,
customers or other third parties. The role of the CFO in these initiatives is
designing and implementing the initiative, profitable growth in revenue
and creativity.
7. Risk Management: The CFO has to be fully aware of all the risks-both
internal and external that his organization faces. The complexity of
modern business has resulted in the development of sophisticated tools
 for risk management. The CFO has to understand and evaluate the
various risk management tools available and employ suitable ones to
mitigate the risk of the company.

Thus, the new age CFO looks beyond the processing of financial statements
and the management of funds. He has to make a difference to the
organization by effectively managing the shareholders valor, so that both
internal and gaternal stakeholders may be reached with a view to increase
awareness and improve performance.