FINANCIAL MANAGEMENT GHANASHYAM Module 1 INTRODUCTION TO FINANCIAL MANAGEMENT Meaning of Finance: The term finance is derived from the Latin word ‘finis' which means end/finish. Finance is the life blood of business. It is an art and science of managing money. Finance also refers to the science that describes the management, creation, and study of money, banking, credit, investments, assets, and liabilities Definition of Finance: According to Paul G Hasings, “Finance is the management of the monetary affairs of a company”. According to Bodie and Merton, “Finance is the study of how scarce resources are allocated over time”. Finance Function: ‘The term finance function can be defined as “Procurement of funds and their effective utilization in the business”. Finance functions are as follows; 4. Investment Decisions: It focuses on allocating resources to projects or assets that provide the best returns. It Includes capital budgeting for long-term investments and evaluating the risk- return trade-off 2. Financing Decisions: It determines the sources of funds, such as debt (loans, bonds) or equity (shares) and aims to balance the capital structure for minimizing costs and maximizing returns, 3. Working Capital Management: This manages short-term assets (cash, inventory) and liabilities (payables) and ensures liquidity for day-to-day operations and avoids financial disruptions. 4, Dividend Decisions: it decides how much profit to retain for reinvestment or distribute as dividends to shareholders. It also includes evaluating the impact of dividend policies on company value and investor satisfaction. 5. Financial Planning and Forecasting: It develops strategies to meet future financial goals. This involves budgeting, cash flow forecasting, and scenario analysis to prepare for uncertainties. 6. Risk Management: It identifies and mitigates risks like credit default, market volatility, and operational risks. 7. Financial Reporting and Analysis: It ensures transparency by preparing financial statements (income statement, balance sheet). It helps to analyse performance using financial ratios and historical trends to make informed decisions. 8, Tax Management: it plans to minimize tax liabilities within legal frameworks and tries to focus ‘on optimizing tax strategies and ensuring compliance with tax laws. B.Com, 5" Sem, ATNCC, Shivamogga. © scanned th OREN ScannerFINANCIAL MANAGEMENT GHANASHYAM Objectives of Finance Function: 1. Acquiring Sufficient Funds: The main aim of finance function is to assess the financial needs of an enterprise and then finding out suitable sources for raising them. If funds are needed for longer periods then long-term sources like share capital, debentures, term loans may be explored. 2. Proper Utilisation of Funds: Though raising of funds is important but their effective utilisation is more important. It should be ensured that funds do not remain idle at any point of time. The funds committed to various operations should be effectively utilised 3. Increasing Profitability: The planning and control of finance function aims at increasing profitability of the concem. To increase profitability, sufficient funds will have to be invested. Finance function should be so planned that the concern neither suffers from inadequacy of funds nor wastes more funds than required 4, Maximising Firm's Value: Finance function also aims at maximising the value of the firm. itis generally said that a concem’s value is linked with its profitability. Besides profits, the type of sources used for raising funds, the cost of funds, the condition of money market, the demand for products are some other considerations which also influence a firm's value. 5. Maintaining Liquidity: Finance function objective is to ensure the organization has enough cash or liquid assets to meet day-to-day expenses because, poor liquidity management can lead to insolvency and financial instability 6. Facilitating Decision-Making: Finance function provides accurate and timely financial information for strategic planning. These informed decisions enhance efficiency and reduce risks. 7. Project selection & Risk-return-trade-off: While allocating the huge capital funds, choosing the best project or the asset for investment of funds using the different capital budgeting techniques, keeping in mind the risk patterns to manage projects to keep them at profitable levels is another key function of finance, which is regarded as Risk-return-trade- off 8. Dividend pay-out: The rate of dividend declared and the stability of dividends i.¢., Dividend pay-out is the most important function of finance. 9. Reporting & Auditing: Information reporting of all audited documents to both to internal and external users is also an important finance function in every organization. 10.Budgeting and controlling: Through the preparation of various budget statements to estimate the financial requirements of a stipulated period to control the costs in the organization for long run survival is another finance function of the organization. Meaning of Financial Management: Financial management is the managerial activity which is related to planning, organizing, and controlling the firm's financial resources and it is an essential part of the management. As it is integrated with other departments, proper management should be at place for smooth operations of business. In simple, financial management deals with financial planning, acquisition of funds, use and allocation of funds and financial controls. B.Com, 5" Sem, ATNCC, Shivamogga. © scanned wt OHENScmnerFINANCIAL MANAGEMENT GHANASHYAM Definition of Financial Management According to S.C. Kuchal, “Financial Management deals with procurement of funds and their effective utilization in the business”. According to Soloman, “Financial Management is concerned with the efficient use of an important economic resource, namely capital Funds" Goals/Objectives of Financial Management: as | Eee Gaze 1 ) ae am =a) WD Wealth Maximisation Specific Objectives: a) Profit Maximization: Profit maximization refers to the process where in companies focus on maximizing their profit or getting the best possible profit in the particular kind of business. Under profit maximisation companies experience the best output and price levels in order to maximize its retum. In simple Profit maximization implies maximizing the Rupee income of the firm. Advantages or Arguments in favour of profit maximisation: 1. It is rational as well as natural objective: The benefits expected in the field of business are measured in terms of profit. When profit eaming is the aim of business then profit maximisation should be the natural objective 2. It helps for services: Economic & business conditions do not remain the same at all the times. That is why a business should try to earn more and more profit when the situation is favourable. 3. It helps for proper utilisation of resources: Profit maximisation helps for efficient utilisation of available resources. High productivity increases the profitability of an enterprise 4. It helps for growth and development of organisation: Profit is the main source of finance for the growth of a business. So business should aim at maximisation of profits for helping its growth and development. B.Com, 5" Sem, ATNCC, Shivamogga. © scanned wt OHENScmnerFINANCIAL MANAGEMENT GHANASHYAM 5. It helps for maximising social welfare: An organisation pursuing profit maximisation objective also maximizes social welfare because it ensures efficient allocation of scarce resources of the society 6. Financial decisions: Profit helps the management for taking financial decisions. b) Wealth Maximiz: The word ‘wealth” refers to the net present worth of the firm. Therefore, wealth maximisation is also stated as Net present worth of the firm. The concept of wealth maximization refers to the gradual growth of the value of assets of the firm in terms of benefits it can offer. The wealth maximization attained by an organization is reflected by the market value of shares. It is the method of creating wealth in an organization Advantages or Arguments in favour of wealth maximisation: 1. Wealth Maximisation Avoids the Ambiguity: The wealth maximisation criterion is based on the concept of cash flows generated by the decision rather than accounting profit. Measuring benefits in terms of cash flows avoid ambiguity associated with accounting profits 2. Quality of benefits: The quality of benefits depends on the certainty with which benefits are expected to be received in future. The more certain the expected returns (cash inflows) higher the value 3. Time value of money: Money received in the future is not as valuable as money received today. In case of wealth maximisation, money has time value. It means that the benefits received in earlier years should be valued more highly than benefits received later. 4. It protects the economic welfare of the shareholders: When the market values of shares are increased, automatically economic welfare of the shareholders is also increased, 5. It helps for achieving other objectives: Wealth maximisation objective helps for increasing sales, growth of market, face competition and survival. 6. Regular payment of dividend: Wealth maximisation policy has to pay dividend regularly. Payment of regular dividend increases the market value of shares. Il. General Objectives: a) Balance assets structure: A proper balance between the fixed and current assets is an important factor for efficient management of funds. This is one of the objectives of financial management where the size of current asset must permit the company to exploit the investments on fixed assets. b) Liquidity: Liquidity refers to available cash and it is an indication of positive growth of a company. It is an important factor for meeting the short and long term obligations of a firm. Hence company should maintain liquidity ¢) Proper planning of funds: Proper planning of funds includes acquisition and allocation of funds in the best possible manner i.e., minimum cost of acquisition of funds but maximum returns through wise decisions. B.Com, 5" Sem, ATNCC, Shivamogga. © scanned wt OHENScmnerFINANCIAL MANAGEMENT GHANASHYAM 4) Efficiency: Efficiency and effectiveness are very much necessary in controlling the flow of funds. The efficiency level should continuously increase for the betterment of organization. e) Financial discipline: Proper discipline should be practiced in matters relating to finance, its flow and control. This can be done through various techniques such as budgeting, fund flow ‘statements etc. Distinguish between Profit Maximization and Wealth Maximization: Profit Maximization Wealth Maximization Calculation of profit is not clear i.e., whether | Calculation of wealth is clear. itis considered short term or long term, even profit before tax | to be long term. The calculation is for long or after tax. term. It is not balanced. Wide gap between | itis balanced expected and actual eamings. Itis a narrow concept itis a broader concept Financial decisions are taken on the basis of | Decisions are taken on the basis of wealth profit maximisation. It ignores the community, | maximisation. government, workers and other persons concerned with the organisation It considers the total profit. While calculating | It considers totally the time value factor, Time profit and selecting the project, the length of | in evaluation the cash flows. time in earning profit is not considered at all The main goal is maximisation of profits. The main goal is wealth maximisation (or value maximisation). More risk and uncertainty No risk and uncertainty No balance between expected returns and | Balance between expected returns and risk. risk because higher expected returns involves more risk and uncertainty. Itignores the interests of the community. Its objective is to enhance the shareholders wealth. ancial Managemen’ 1, Evaluation of Financial Requirement: The first and foremost task of a finance manager is to estimate long term and short term financial requirements. The evaluation should be based on sound financial plan so that purchasing fixed assets and funds required for working capital will be ascertained in a right manner. 2. Formation of Capital Structure: After deciding the quantum of funds to be raised for the business, the task of the finance manager remains in framing the capital structure. Capital structure refers to the kind and proportion of different securities for raising such funds. 3. Sources of Finance: An appropriate source of finance is selected after the formation of capital structure. Various sources, from which finance may be raised, include share capital, debentures, financial institutions, commercial banks, public deposits etc. 4, Choice of Investment Plans: After procuring the required funds decision about the use of funds is to be made. i.e,, a decision about the proper allocation of funds in fixed assets and working capital has to be made. B.Com, 5" Sem, ATNCC, Shivamogga. © scanned wt OHENScmnerFINANCIAL MANAGEMENT GHANASHYAM 5. Cash Management: Cash is a liquid asset which has to be maintained appropriately so as to cater to the various needs of the business on time. For example, cash may be required to purchase raw materials, make payments to creditors, pay rent, bills etc. 6. Implementation of Financial Controls: Proper control is essential for efficient system of financial management. Various control devices such as return on investment, budgetary control, break even analysis etc. can be used as a measure to analyse the performance 7. Usage of Surpluses: The surplus gained in the business may boon the expansion and diversification in the business relatively increasing the confidence in the minds of the shareholders, consistently increasing the market value of shares which lead to wealth maximization. Functions of Financial Management: The functions of financial management are divided into two classes, namely; A. Managerial or Executive Function B. Incidental or Routine Functions. A. Managerial or Executive Function: These functions require administrative skill in planning, execution and control of financial activities. Executive functions include all those important financial decisions which require ‘specified administrative skill. They are as follows: 1. Fund requirement decision (Financial Forecasting): The Primary function of the financial management is to estimate how much different types of funds required i.e., short term and long term. Generally short term fund is required for working capital whereas long term fund is required for fixed capital or acquisition of fixed assets. 2. Financial Planning: Financial planning is done under three distinct sub-activities, namely; > Formulation of financial objectives. > Framing the financial policies. > Developing financial procedures are being performed for the preparation of both short term and long term plan are prepared. 3. Financing Decision: In order to meet the requirements of the firm, financial management has to decide or to take decisions on; when the fund is required? Where to acquire the funds from? How to acquire the funds? Ete 4. Investment Decisions: It is related to decide how much cash will be invested in Fixed Assets and how much in Current Assets which are normally convertible into cash within a year. 5. Dividend decision or Distribution of Profit: It involves the determination of the percentage of profits earned by the enterprise which is to be paid to shareholders. 6. Cash flow and Requirements: Adequate supply of cash is available at right time for smooth running of the business. Inflow of cash depends upon the sales and cash outflows or cash requirements depend upon the volume of sales. 7. Appraisal of Financial performance: It is the duty of financial manager to check the financial performance of the funds invested in the business enterprise. It requires the analysis of the operating period to evaluate the efficiency of the financial planning. B.Com, 5" Sem, ATNCC, Shivamogga. © scanned wt OHENScmnerFINANCIAL MANAGEMENT GHANASHYAM 8. Borrowing Policy decision: All organisations plan for the expansion of the business for which it requires additional funds. Financial manager has to make necessary arrangements for such funds by borrowing either from commercial Banks or financial institutions ete 9. To advise the Top management: Whenever the top management faces any financial problem, financial management has to advise for best solution. So, financial management diagnoses the problem, then advice the alternative solutions to the problems and selection of the best solutions. 10.To make efforts for increasing the productivity of the capital: Financial manager has to make all the efforts to increase the productivity of the capital by discovering the new opportunities of investment. B. Incidental or Routine Functions: Generally these functions are performed by clerical or assistant managers at lower levels. These functions are to be performed for the purpose of execution of decisions taken by the executives. They are as follows: 1. To ensure the supply of funds to all parts of the organisation: When the fund is provided, it helps in smooth operation of the activities of the organisation. 2. To Negotiate with Bankers, financial institutions and other suppliers of credit: These ate the different sources of funds. It is necessary for the company to Negotiate with them only to obtain the funds at the most favourable terms 3. To safeguard cash balance: Proper supervision of cash receipts and disbursement of cash is necessary to safeguard cash balance. 4. Proper custody and safe-keeping of important, valuable papers documents, securities, insurance policies, etc. 5. Record keeping and reporting. 6. To provide the information to the Top Management on present and prospective financial conditions of enterprise. 7. To keep Track of stock exchange quotations and behaviour of stock market prices. This will help the finance manager to plan for finance more effectively 1. Raising Funds: A firm can raise funds by the way of equity and debt. It is the responsibility of a finance manager to decide the ratio between debt and equity 2. Allocation of Funds: In order to allocate funds in the best possible manner, the following points must be considered. > The size of the firm and its growth capability > Status of assets whether they are long term or short term. > Mode by which the funds are raised. 3. . Profit Planning: Profit planning refers to proper usage of the profit generated by the firm. A healthy mix of variable and fixed factors of production can lead to an increase in the profitability of the firm. B.Com, 5" Sem, ATNCC, Shivamogga. © scanned wt OHENScmnerFINANCIAL MANAGEMENT GHANASHYAM 4, Understanding Capital Markets: Shares of a company are traded on stock exchange and there is a continuous sale and purchase of securities. Therefore a finance manger understands and calculates the risk Involved in this trading of shares and debentures. 5. Investment Planning: Investment planning focuses on effective investment strategies and to analyse the risk associate with it. Finance manager is responsible for analyse the risk and help management to reduce this risk so that it does not affect the financial goal of an organization. 6. Financial Structure: Finance manager analyse the government rules and regulation, bank norms, capability of the organization and the available options in the market to finance the company's assets. That helps management to decide which option is profitable for the organization. 7. Treasury Operations: Treasury operations is basically the overall responsibility for administering the banking functions of organization, cash management and investment services. These all activities are directiy linked with the growth of organization and profit. 8. Investor Communication: Finance department provides investors with an accurate account of the company’s affairs. This helps investors to make informed buy or sell decisions 9. Disposal of Surplus: A finance manager is also expected to make proper utilisation of surplus funds. He has to make a decision as to how much earnings are to be retained for future expansion and growth and how much to be distributed among the shareholders. 40.Management Control: Finance manager help organization to set the targets and helps organization to achieve that target by continuously monitoring the actual performance with set standards. Meaning of Financial Planning Financial plans are continuous process in the day-to-day activity of an organization's business. Financial planning is deciding in advance the course of actions for the future in respect of the financial management of a concern. In short, financial planning means the formulation of the financial plan of a concern. It involves the following activities: Estimating the requirements of funds. Deciding about the securities to be issued for raising funds. Setting the firm's financial objectives. Definitions of Financial Planning: According to Soloman and Pringle, “financial planning may refer to the process of determining the financial requirements and financial structure necessary to support a given set of plans in other areas. Thus, financial activities are necessary, if the firm is to achieve its primary goals”. According to Walker and Baughn, “Financial planning pertains only to the function of finance and includes the determination of the firm's financial objectives, financial policies and financial procedures” Need for Financial Planning a) It ensures timely availability of sufficient funds to meet various expenses and emergencies b) To indicate the amount of surplus resources available for expansion and investment. ¢) To provide liquidity of funds throughout the year. B.Com, 5" Sem, ATNCC, Shivamogga. © scanned wt OHENScmnerFINANCIAL MANAGEMENT GHANASHYAM d) To identify when, where and how much funds are required in business. e) To anticipate future requirement of funds in business. f) To create confidence in the minds of suppliers. g) It offers provision of finance for replacement of assets, to reduce uncertainty, to optimize the rate of return on investment etc. h) To provide etfective utilization of funds and consequently improve profitability and efficiency of business. Importance of Financial Planning: 1. Helps in Forecasting Financial Requirements: Financial planning forecasts needs for finances for future. Both current and future needs are estimated and then sources are planned to meet them, 2. Helpful in Fixing Proper Capital Structure: There are different sources from which funds can be raised. The fund requirement is for long term, medium term and short term periods. 3. Helpful in Operational Activities: The success or failure of production function is linked to the financial decisions for supplying funds when these are needed. The smooth flow of funds to operational activities will help in running these functions properly. 4, Optimum Utilisation of Funds: The plans the raising funds must be commensurate with requirements. A good plan facilitates maximum utilization of funds. There should not be either more or less funds as compared to financial needs. The funds should be optimally used. 5. Cost Effective: Financial planning should be such that cost of using the funds is lower. Equity and loans should be planned in such a way that the use of funds is cost effective. A reasonable ratio of debt and equity be planned to minimize cost of financing. 6, Ensures Co-ordination: Financial planning helps in co-ordinating various sources of funds and also in functional areas. It helps in allocating resources properly for different activities as per their requirements. 7. Ensures Financial Control: The standards of performance are fixed and evaluation is done on a regular basis. In case of deviations, corrective action is taken immediately. 8. Eliminates Wastages: Financial planning helps in eliminating wastages of resources. 9. Flexibility: Financial planning must allow the change or shift of funds to different sources for making best use of them. There should be a scope for return of money, if it is not required at some stage 10.Incorporates Contingencies: Some future events remain uncertain, provision should be made for contingencies. There may be a change in credit policy, prices of materials may go up. etc. A good financial plan will incorporate requirements for contingencies Steps in Financial Planning 4. Establishing Financial Objectives: The financial objectives of a company should be clearly determined. Both short-term and long-term objectives should be carefully prepared. The main purpose of financial planning should be to utilise financial resources in the best possible manner. B.Com, 5" Sem, ATNCC, Shivamogga. © scanned wt OHENScmnerFINANCIAL MANAGEMENT GHANASHYAM 2. Formulating Financial Policies: The financial policies of a concern deal with procurement, administration and distribution of business funds in a best possible way. The current and future needs for funds should be considered while formulating financial policies. 3. Formulating Procedures: The procedures are formed to ensure consistency of actions. The procedures follow the formulation of policies. If a policy is to raise short-term funds from banks, then a procedure should be laid to approach the lenders and the persons authorised to initiate ‘such actions. 4, Forecasting: Forecasting is an act of predicting the future economic conditions on the basis of past and future information. Financial forecasting is the process of estimating future financial requirements a business. Financial planning requires the forecast of the future in order to formulate financial policies and procedures 5. Providing for Flexibility: The financial planning should ensure proper flexibility in objective, policies and procedures so as to adjust according to changing economic situations. A rigid financial planning will not let the business use new opportunities. 6. Review of Financial Plan: There is a need to review and modify the financial pian from time to time. The plan should be reviewed and revised in the light of changed conditions. tations of Financial Planning: 1. Difficulty in Forecasting: Financial plans are prepared by taking into account the expected situations in the future. Since, the future is always uncertain and things may not happen as these are expected. 2. Difficulty in Change: Once a financial plan is prepared then it becomes difficult to change it. A changed situation may demand change in financial plan but managerial personnel may not like it. 3. Problem of Co-ordination: While estimating financial needs, production policy, personnel requirements, marketing possibilities are all taken into account. Unless there is a proper co- ordination among all the functions, the preparation of a financial plan becomes difficult 4, Rapid Changes: The growing mechanisation of industry is bringing rapid changes in industrial process. It becomes very difficult to adjust a financial plan for incorporating fast changing situations. Unless a financial plan helps the adoption of new techniques, its utility becomes limited, Principles of a Sound Financial Plan: 1. Principle to consider long-term corporate objectives: The financial planning must consider the long-term objectives of the company. The amount of capital received the sources of funds and the use of funds must be decided only after considering the objectives of the company 2. Principle of Simplicity: A financial planning must be simple to understand and easy to use. The capital structure must be simple. It must include a limited number of securities. If not, the investors will not invest their money in the company. 3. Principle of Realistic: A financial planning must be realistic and practical. It must show the exact financial requirements of the company. If not, there will be surplus or shortage of capital B.Com, 5" Sem, ATNCC, Shivamogga. © scanned wt OHENScmner