FINANCIAL MANAGEMENT

TIME/ROOM-10:00-1:00/M301

Meaning of Financial Management

Financial Management means planning, organizing, directing and

controlling the financial activities such as procurement and utilization of
funds of the enterprise. It means applying general management
principles to financial resources of the enterprise.

Scope/Elements

1. Investment decisions includes investment in fixed assets (called as

capital budgeting). Investments in current assets are also a part of
investment decisions called as working capital decisions.
2. Financial decisions - They relate to the raising of finance from
various resources which will depend upon decision on type of
source, period of financing, cost of financing and the returns
thereby.

Dividend decision - The finance manager has to take decision with

regards to the net profit distribution. Net profits are generally divided
into two:

a. Dividend for shareholders- Dividend and the rate of it has to

be decided.
b. Retained profits- Amount of retained profits has to be
finalized which will depend upon expansion and
diversification plans of the enterprise.

Objectives of Financial Management

The financial management is generally concerned with procurement,

allocation and control of financial resources of a concern. The objectives
can be-
1. To ensure regular and adequate supply of funds to the concern.
2. To ensure adequate returns to the shareholders which will depend
upon the earning capacity, market price of the share, expectations
of the shareholders.

3. To ensure optimum funds utilization. Once the funds are procured,

they should be utilized in maximum possible way at least cost.

4. To ensure safety on investment, i.e., funds should be invested in

safe ventures so that adequate rate of return can be achieved.
 5. To plan a sound capital structure-There should be sound and fair
composition of capital so that a balance is maintained between
debt and equity capital.

Functions of Financial Management

1. Estimation of capital requirements: A finance manager has to

make estimation with regards to capital requirements of the
company. This will depend upon expected costs and profits and
future programmes and policies of a concern. Estimations have to
be made in an adequate manner which increases earning capacity
of enterprise.
2. Determination of capital composition: Once the estimation have
been made, the capital structure have to be decided. This involves
short- term and long- term debt equity analysis. This will depend
upon the proportion of equity capital a company is possessing and
additional funds which have to be raised from outside parties.

3. Choice of sources of funds: For additional funds to be procured,

a company has many choices like-

a. Issue of shares and debentures

b. Loans to be taken from banks and financial institutions

c. Public deposits to be drawn like in form of bonds.

Choice of factor will depend on relative merits and demerits of each

source and period of financing.

4. Investment of funds: The finance manager has to decide to

allocate funds into profitable ventures so that there is safety on
investment and regular returns is possible.
5. Disposal of surplus: The net profits decisions have to be made by
the finance manager. This can be done in two ways:

a. Dividend declaration - It includes identifying the rate of

dividends and other benefits like bonus.

b. Retained profits - The volume has to be decided which will

depend upon expansional, innovational, diversification plans
of the company.

6. Management of cash: Finance manager has to make decisions

with regards to cash management. Cash is required for many
purposes like payment of wages and salaries, payment of electricity
and water bills, payment to creditors, meeting current liabilities,
maintenance of enough stock, purchase of raw materials, etc.
Financial controls: The finance manager has not only to plan, procure
and utilize the funds but he also has to exercise control over finances.
This can be done through many techniques like ratio analysis, financial
forecasting, cost and profit control, etc.

Definition of Financial Planning

Financial Planning is the process of estimating the capital required and

determining it’s competition. It is the process of framing financial policies
in relation to procurement, investment and administration of funds of an
enterprise.

Objectives of Financial Planning

Financial Planning has got many objectives to look forward to:

a. Determining capital requirements- This will depend upon factors

like cost of current and fixed assets, promotional expenses and
long- range planning. Capital requirements have to be looked with
both aspects: short- term and long- term requirements.
b. Determining capital structure- The capital structure is the
composition of capital, i.e., the relative kind and proportion of
capital required in the business. This includes decisions of debt-
equity ratio- both short-term and long- term.

c. Framing financial policies with regards to cash control, lending,

borrowings, etc.

A finance manager ensures that the scarce financial resources are

maximally utilized in the best possible manner at least cost in order to
get maximum returns on investment.

Importance of Financial Planning

Financial Planning is process of framing objectives, policies, procedures,

programmes and budgets regarding the financial activities of a concern.
This ensures effective and adequate financial and investment policies.
The importance can be outlined as-

1. Adequate funds have to be ensured.

2. Financial Planning helps in ensuring a reasonable balance between
outflow and inflow of funds so that stability is maintained.
 3. Financial Planning ensures that the suppliers of funds are easily
investing in companies which exercise financial planning.

4. Financial Planning helps in making growth and expansion

programmes which helps in long-run survival of the company.

5. Financial Planning reduces uncertainties with regards to changing

market trends which can be faced easily through enough funds.

6. Financial Planning helps in reducing the uncertainties which can

be a hindrance to growth of the company. This helps in ensuring
stability and profitability in concern.

Finance Functions

The following explanation will help in understanding each finance function in

detail

Investment Decision

One of the most important finance functions is to intelligently allocate

capital to long term assets. This activity is also known as capital
budgeting. It is important to allocate capital in those long term assets so
as to get maximum yield in future. Following are the two aspects of
investment decision

a. Evaluation of new investment in terms of profitability

b. Comparison of cut off rate against new investment and prevailing
investment.

Since the future is uncertain therefore there are difficulties in calculation

of expected return. Along with uncertainty comes the risk factor which
has to be taken into consideration. This risk factor plays a very
significant role in calculating the expected return of the prospective
investment. Therefore while considering investment proposal it is
important to take into consideration both expected return and the risk
involved.

Investment decision not only involves allocating capital to long term

assets but also involves decisions of using funds which are obtained by
selling those assets which become less profitable and less productive. It
wise decisions to decompose depreciated assets which are not adding
value and utilize those funds in securing other beneficial assets. An
opportunity cost of capital needs to be calculating while dissolving such
assets. The correct cut off rate is calculated by using this opportunity
cost of the required rate of return (RRR)

Financial Decision

Financial decision is yet another important function which a financial

manger must perform. It is important to make wise decisions about
when, where and how should a business acquire funds. Funds can be
acquired through many ways and channels. Broadly speaking a correct
ratio of an equity and debt has to be maintained. This mix of equity
capital and debt is known as a firm’s capital structure. A firm tends to
benefit most when the market value of a company’s share maximizes this
not only is a sign of growth for the firm but also maximizes shareholders
wealth. On the other hand the use of debt affects the risk and return of a
shareholder. It is more risky though it may increase the return on equity
funds. A sound financial structure is said to be one which aims at
maximizing shareholders return with minimum risk. In such a scenario
the market value of the firm will maximize and hence an optimum capital
structure would be achieved. Other than equity and debt there are
several other tools which are used in deciding a firm capital structure.

Dividend Decision

Earning profit or a positive return is a common aim of all the businesses.

But the key function a financial manger performs in case of profitability
is to decide whether to distribute all the profits to the shareholder or
retain all the profits or distribute part of the profits to the shareholder
and retain the other half in the business. It’s the financial manager’s
responsibility to decide an optimum dividend policy which maximizes the
market value of the firm. Hence an optimum dividend payout ratio is
calculated. It is a common practice to pay regular dividends in case of
profitability another way is to issue bonus shares to existing
shareholders.

Liquidity Decision

It is very important to maintain a liquidity position of a firm to avoid

insolvency. Firm’s profitability, liquidity and risk all are associated with
the investment in current assets. In order to maintain a tradeoff between
profitability and liquidity it is important to invest sufficient funds in
current assets. But since current assets do not earn anything for
business therefore a proper calculation must be done before investing in
current assets. Current assets should properly be valued and disposed of
from time to time once they become non profitable. Currents assets must
be used in times of liquidity problems and times of insolvency.