Chapter-1

AN OVERVIEW OF FINANCIAL MANAGEMENT

1.1 Introduction to Financial Management
• Business concern needs finance to meet their requirements in the economic
world. Any kind of business activity depends on the finance. Hence, it is called
as lifeblood of business organization. Whether the business concerns are big or
small, they need finance to fulfil their business activities.
• In the modern world, all the activities are concerned with the economic
activities and very particular to earning profit through any venture or activities.
The entire business activities are directly related with making profit. (According
to the economics concept of factors of production, rent given to landlord, wage
given to labour, interest given to capital and profit given to shareholders or
proprietors), a business concern needs finance to meet all the requirements.
• Hence finance may be called as capital, investment, fund etc., but each term is
having different meanings and unique characters. Increasing the profit is the
main aim of any kind of economic activity.
1.1.1 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.
Definition of Finance
• According to Khan and Jain, “Finance is the art and science of managing
money”.
• Webster’s Ninth New Collegiate Dictionary defines finance as “the Science
on study of the management of funds” and the management of fund as the
system that includes the circulation of money, the granting of credit, the
making of investments, and the provision of banking facilities.
DEFINITION OF BUSINESS FINANCE
• According to the Wheeler, “Business finance is that business activity which
concerns with the acquisition and conversation of capital funds in meeting
financial needs and overall objectives of a business enterprise”.

• According to the Guthumann and Dougall, “Business finance can broadly be

defined as the activity concerned with planning, raising, controlling,
administering of the funds used in the business”.
1.1.2 Classification 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:
Classifications of Finance
Classifications 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.
1.1.3. Evolution of finance
1.1.3. Evolution of finance
1.1.3. Evolution of finance
1.1.3. Evolution of finance
1.1.3. Evolution of finance
1.1.3. Evolution of finance
1.1.4. Sources of finance
• A source or sources of finance, refer to where a business gets money from to
fund their business activities. A business can gain finance from either
internal or external sources.

• Internal sources of finance:

• Internal sources of finance refer to money that comes from
within a business. There are several internal methods a
business can use, including owners capital, retained
profit and selling assets.
Internal sources of finance
• Owners capital refers to money invested by the owner of a
business. This often comes from their personal savings.
Personal savings is money that has been saved up by
an entrepreneur. This source of finance does not cost the
business, as there are no interest charges applied.

• Retained profit is when a business makes a profit, it can

leave some or all of this money in the business and reinvest it
in order to expand. This source of finance does not incur
interest charges or require the payment of dividends, which
can make it a desirable source of finance.
Internal sources of finance
• Selling assets involves selling products owned by the
business. This may be used when either a business no longer
has a use for the product or they need to raise money quickly.
Business assets that can be sold include for example,
machinery, equipment, and excess stock.
External sources of finance
• External sources of finance refer to money that comes from outside
a business. There are several external methods a business can use,
including family and friends, bank loans and overdrafts, venture
capitalists and business angels, new partners, share issue, trade
credit, leasing, hire purchase, and government grants.

• Family and friends - businesses can obtain a loan or be given

money from family or friends that may not need to be paid back or
are paid back with little or no interest charges.

• A bank loan is money borrowed from a bank by an individual or

business. A bank loan is paid off with interest over an agreed
period of time, often over several years.
External sources of finance
• Overdrafts - are where a business or person uses more
money than they have in a bank account. This means the
balance is in minus figures, so the bank is owed money.
Overdrafts should be used carefully and only in emergencies
as they can become expensive due to the high interest rates
charged by banks.
• Venture capital and business angels - refers to an
individual or group that is willing to invest money into a new
or growing business in exchange for an agreed share of the
profits. The venture capitalist will want a return on
their investment as well as input into how the business is
run.
• New partners - is when an additional person or people are
brought into the business as a new business partner. This
External sources of finance
• Share issue - a business may sell more of their
ordinary shares to raise money. Buying shares gives the
buyer part ownership of the business and therefore certain
rights, such as the right to vote on changes to the business.
• A trade credit must be agreed with a supplier and forms
a credit agreement with them. This source of finance allows
a business to obtain raw materials and stock but pay for
them at a later date. The payment is usually made once the
business has had an opportunity to convert the raw materials
and stock into products, sell them to its own customers, and
receive payment.
• Leasing - is a way of renting an asset that the business
requires, such as a coffee machine. Monthly payments are
made and the leasing company is responsible for the
External sources of finance
• Hire purchase - is used to purchase an asset, such as a
delivery van or piece of equipment. A deposit is paid and the
remaining amount for the asset is paid in monthly
instalments over a set period of time. The business does not
own the item until all payments are made.
• Government grants - are a fixed amount of money awarded
by the government. Grants are given to a business on the
condition that they meet certain criteria such as providing
jobs in areas of high unemployment. These do not usually
need to be paid back.
1.2. The nature and scope of financial management
• Finance create manufacturing capacities for production of goods; some
provide services to customers. They sell their goods or services to earn
profit. They raise funds to acquire manufacturing and other facilities. Thus,
the three most important activities of a business firm are:
• production
• marketing
• finance
• A firm secures the required capital and employs it (finance activity) in
activities, which generate returns on invested capital (production and
marketing activities).
1.2. The nature and scope of financial management
The nature and scope of financial management
• In organizations, managers in an effort to minimize the costs of procuring
finance and using it in the most profitable manner, take the following decisions:
• Investment Decisions: Managers need to decide on the amount of investment
available out of the existing finance, on a long-term and short-term basis. They
are of two types:
• Long-term investment decisions or Capital Budgeting mean committing
funds for a long period of time like fixed assets. These decisions are irreversible
and usually include the ones pertaining to investing in a building and/or land,
acquiring new plants/machinery or replacing the old ones, etc. These decisions
determine the financial pursuits and performance of a business.
• Short-term investment decisions or Working Capital Management means
committing funds for a short period of time like current assets. These involve
decisions pertaining to the investment of funds in the inventory, cash,
bank deposits, and other short-term investments. They directly affect the
liquidity and performance of the business.
The nature and scope of financial management
• Financing Decisions: Managers also make decisions
pertaining to raising finance from long-term sources (called
Capital Structure) and short-term sources (called Working
Capital). They are of two types:
• Financial Planning decisions which relate to estimating
the sources and application of funds. It means pre-
estimating financial needs of an organization to ensure the
availability of adequate finance. The primary objective of
financial planning is to plan and ensure that the funds are
available as and when required.
• Capital Structure decisions which involve identifying
sources of funds. They also involve decisions with respect to
choosing external sources like issuing shares, bonds,
borrowing from banks or internal sources like retained
The nature and scope of financial management
• Dividend Decisions: These involve decisions related to the
portion of profits that will be distributed as dividend.
Shareholders always demand a higher dividend, while the
management would want to retain profits for business needs.
Hence, this is a complex managerial decision.
1.3. The goal of a firm in 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:
• 1. Profit maximization
• 2. Wealth maximization
1.3. The goal of a firm in financial management
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.
1.3. The goal of a firm in financial management
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.