Category: Business Finance

  • Financial Management: Nature, Scope and Objectives

    Financial Management: Nature, Scope and Objectives

    Financial management is management principles and practices applied to finance. General management functions include planning, execution and control. Financial decision making includes decisions as to size of investment, sources of capital, extent of use of different sources of capital and extent of retention of profit or dividend payout ratio.

    Financial management, is therefore, planning, execution and control of investment of money resources, raising of such resources and retention of profit/payment of dividend.

    Howard and Upton define financial management as “that administrative area or set of administrative functions in an organization which have to do with the management of the flow of cash so that the organization will have the means to carry out its objectives as satisfactorily as possible and at the same time meets its obligations as they become due.

    Bonneville and Dewey interpret that financing consists in the raising, providing and managing all the money, capital or funds of any kind to be used in connection with the business.

    Osbon defines financial management as the “process of acquiring and utilizing funds by a business” .

    Considering all these views, financial management may be defined as that part of management which is concerned mainly with raising funds in the most economic and suitable manner, using these funds as profitably as possible.

    Nature of Financial Management

    Nature of financial management is concerned with its functions, its goals, trade-off with conflicting goals, its indispensability, its systems, its relation with other subsystems in the firm, its environment, its relationship with other disciplines, the procedural aspects and its equation with other divisions within the organisation.

    1. Financial Management is an integral part of overall management. Financial considerations are involved in all business decisions. So financial management is pervasive throughout the organization.
    2. The central focus of financial management is valuation of the firm. That is financial decisions are directed at increasing/maximization/ optimizing the value of the firm.
    3. Financial management essentially involves risk-return trade-off Decisions on investment involve choosing of types of assets which generate returns accompanied by risks. Generally higher the risk, returns might be higher and vice versa. So, the financial manager has to decide the level of risk the firm can assume and satisfy with the accompanying return.
    4. Financial management affects the survival, growth and vitality of the firm. Finance is said to be the life blood of business. It is to business, what blood is to us. The amount, type, sources, conditions and cost of finance squarely influence the functioning of the unit.
    5. Finance functions, i.e., investment, rising of capital, distribution of profit, are performed in all firms – business or non-business, big or small, proprietary or corporate undertakings. Yes, financial management is a concern of every concern.
    6. Financial management is a sub-system of the business system which has other subsystems like production, marketing, etc. In systems arrangement financial sub-system is to be well-coordinated with others and other sub-systems well matched with the financial subsystem.

    Scope of Financial Management

    The finance function encompasses the activities of raising funds, investing them in assets and distributing returns earned from assets to shareholders. While doing these activities, a firm attempts to balance cash inflow and outflow.

    It is evident that the finance function involves the four decisions viz., financing decision, investment decision, dividend decision and liquidity decision. Thus the finance function includes:

    1. Investment decision
    2. Financing decision
    3. Dividend decision
    4. Liquidity decision

    Investment Decision: The investment decision, also known as capital budgeting, is concerned with the selection of an investment proposal/ proposals and the investment of funds in the selected proposal. A capital budgeting decision involves the decision of allocation of funds to long-term assets that would yield cash flows in the future. Two important aspects of investment decisions are:

    (i) The evaluation of the prospective profitability of new investments, and

    (ii) The measurement of a cut-off rate against that the prospective return of new investments could be compared.

    Future benefits of investments are difficult to measure and cannot be predicted with certainty. Risk in investment arises because of the uncertain returns. Investment proposals should, therefore, be evaluated in terms of both expected return and risk. Besides the decision to commit funds in new investment proposals, capital budgeting also involves replacement decision, that is decision of recommitting funds when an asset become less productive or non-profitable. The computation of the risk-adjusted return and the required rate of return, selection of the project on these bases, forms the subject-matter of the investment decision.

    Long-term investment decisions may be both internal and external. In the former, the finance manager has to determine which capital expenditure projects have to be undertaken, the amount of funds to be committed and the ways in which the funds are to be allocated among different investment outlets. In the latter case, the finance manager is concerned with the investment of funds outside the business for merger with, or acquisition of, another firm.

    Financing Decision: Financing decision is the second important function to be performed by the financial manager.

    Broadly, he or she must decide when, from where and how to acquire funds to meet the firm’s investment needs. The central issue before him or her is to determine the appropriate proportion of equity and debt. The mix of debt and equity is known as the firm’s capital structure. The financial manager must strive to obtain the best financing mix or the optimum capital structure for his or her firm. The firm’s capital structure is considered optimum when the market value of shares is maximized.

    Dividend Decision: Dividend decision is the third major financial decision. The financial manager must decide whether the firm should distribute all profits, or retain them, or distribute a portion and return the balance. The proportion of profits distributed as dividends is called the dividend-payout ratio and the retained portion of profits is known as the retention ratio. Like the debt policy, the dividend policy should be determined in terms of its impact on the shareholders’ value. The optimum dividend policy is one that maximizes the market value of the firm’s shares. Thus, if shareholders are not indifferent to the firm’s dividend policy, the financial manager must determine the optimum dividend-payout ratio.

    Dividends are generally paid in cash. But a firm may issue bonus shares. Bonus shares are shares issued to the existing shareholders without any charge. The financial manager should consider the questions of dividend stability, bonus shares and cash dividends in practice.

    Liquidity Decision: Investment in current assets affects the firm’s profitability and liquidity. Current assets should be managed efficiently for safeguarding the firm against the risk of illiquidity. Lack of liquidity in extreme situations can lead to the firm’s insolvency. A conflict exists between profitability and liquidity while managing current assets. If the firm does not invest sufficient funds in current assets, it may become illiquid and therefore, risky. But if the firm invests heavily in the current assets, then it would loose interest as idle current assets would not earn anything. Thus, a proper trade-off must be achieved between profitability and liquidity. The profitability-liquidity trade-off requires that the financial manager should develop sound techniques of managing current assets and make sure that funds would be made available when needed.

    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.

  • Finance functions, Needs, Objectives, Importance

    Finance functions, Needs, Objectives, Importance

    The Finance function involves the management of an organization’s financial resources to achieve its objectives and maximize value. It encompasses activities such as financial planning, budgeting, accounting, and financial reporting. This function ensures effective allocation and utilization of funds, cost control, and financial risk management. Key tasks include managing cash flow, securing financing, and investing in profitable ventures. It also involves compliance with financial regulations and maintaining transparency with stakeholders. The finance function supports strategic decision-making by providing critical financial insights and performance metrics. Overall, it plays a vital role in sustaining the financial health and growth of an organization, ensuring that resources are used efficiently and objectives are met.

    • Long-Term Finance:

    This includes finance of investment 3 years or more. Sources of long-term finance include owner capital, share capital, long-term loans, debentures, internal funds and so on.

    • Medium Term Finance:

    This is financing done between 1 to 3 years, this can be sourced from bank loans and financial institutions.

    • Short Term Finance:

    This is finance needed below one year. Funds may be acquired from bank overdrafts, commercial paper, advances from customers, trade credit etc.

    Needs of Finance Functions

    • Helps Establish a Business:

    Without money, you cannot get labor, land and so on with the finance function you can determine what is required to start your business and plan for it.

    • Helps Run a Business:

    To remain in business you must cater for the day to day operating costs such as paying salaries, buying stationery, raw material, the finance function ensures you always have adequate funds to cater for this.

    • To Expand, Modernize, Diversify:

    Business needs to grow otherwise it may become redundant in no time. With the finance function, you can determine and acquire the funds required to do so.

    • Purchase Assets:

    You need money to purchase assets. This can be tangible assets like furniture, buildings or intangible like trademarks, patents etc. to get this you need finances.

    Objectives of Finance Functions

    • Investment Decisions:

    This is where the finance manager decides where to put the company funds. Investment decisions relate to management of working capital, capital budgeting decisions, management of mergers, buying or leasing of assets. Investment decisions should create revenue, profits and save costs.

    • Financing Decisions:

    Here a company decides where to raise funds from. They are two main sources to consider from mainly equity and borrowed. From the two a decision on the appropriate mix of short and long-term financing should be made. The sources of financing best at a given time should also be agreed upon.

    • Dividend Decisions:

    These are decisions as to how much, how frequent and in what form to return cash to owners. A balance between profits retained and the amount paid out as dividend should be decided here.

    • Liquidity Decisions:

    Liquidity means that a firm has enough money to pay its bills when they are due and have sufficient cash reserves to meet unforeseen emergencies. This decision involves management of the current assets so you don’t become insolvent or fail to make payments.

    Importance of Finance Functions

    • Identity Need of Finance:

    To start a business you need to know how much is required to open it. So, the finance function helps you know how much the initial capital is, how much of it you have and how much you need to raise.

    • Identify Sources of Finance:

    Once you know what needs to be raised you look at areas you can raise these funds from. You can borrow or get from various shareholders.

    • Comparison of Various Sources of Finance:

    After identifying various fund sources compare the cost and risk involved. Then choose the best source of financing that suits your business needs.

    • Investment:

    Once the funds are raised it is time to invest them. Investment decisions should be done in a manner that a business gets higher returns. Cost of funds procurement should be lower than the return on investment, this will show a wise investment was made.

    Finance Function Involves

    • Ensure enough funds at reasonable cost.
    • Ensure safety of funds.
    • Ensure efficient effective and profitable utilization of funds.
    • Ensure that finance funds don’t remain idle.
  • Finance and its Scope Financial Decisions

    Finance and its Scope Financial Decisions

    In this article, you’ll learn about Finance and its Scope Financial Decisions.

    What is Finance ?

    Finance is a term describing the study and system of money, investments, and other financial instruments. Some people prefer to divide finance into three distinct categories: public finance, corporate finance, and personal finance. There is also the recently emerging area of social finance. Behavioral finance seeks to identify the cognitive (e.g. emotional, social, and psychological) reasons behind financial decisions.

    Scope of financial management

    Some of the major scope of financial management are as follows:

    1. Investment Decision

    The investment decision involves the evaluation of risk, measurement of cost of capital and estimation of expected benefits from a project. Capital budgeting and liquidity are the two major components of investment decision. Capital budgeting is concerned with the allocation of capital and commitment of funds in permanent assets which would yield earnings in future.

    Capital budgeting also involves decisions with respect to replacement and renovation of old assets. The finance manager must maintain an appropriate balance between fixed and current assets in order to maximize profitability and to maintain desired liquidity in the firm.

    Capital budgeting is a very important decision as it affects the long-term success and growth of a firm. At the same time it is a very difficult decision because it involves the estimation of costs and benefits which are uncertain and unknown.

    2. Financing Decision

    While the investment decision involves decision with respect to composition or mix of assets, financing decision is concerned with the financing mix or financial structure of the firm. The raising of funds requires decisions regarding the methods and sources of finance, relative proportion and choice between alternative sources, time of floatation of securities, etc. In order to meet its investment needs, a firm can raise funds from various sources.

    The finance manager must develop the best finance mix or optimum capital structure for the enterprise so as to maximize the long- term market price of the company’s shares. A proper balance between debt and equity is required so that the return to equity shareholders is high and their risk is low.

    Use of debt or financial leverage effects both the return and risk to the equity shareholders. The market value per share is maximized when risk and return are properly matched. The finance department has also to decide the appropriate time to raise the funds and the method of issuing securities.

    3. Dividend Decision

    In order to achieve the wealth maximization objective, an appropriate dividend policy must be developed. One aspect of dividend policy is to decide whether to distribute all the profits in the form of dividends or to distribute a part of the profits and retain the balance. While deciding the optimum dividend payout ratio (proportion of net profits to be paid out to shareholders).

    The finance manager should consider the investment opportunities available to the firm, plans for expansion and growth, etc. Decisions must also be made with respect to dividend stability, form of dividends, i.e., cash dividends or stock dividends, etc.

    4. Working Capital Decision

    Working capital decision is related to the investment in current assets and current liabilities. Current assets include cash, receivables, inventory, short-term securities, etc. Current liabilities consist of creditors, bills payable, outstanding expenses, bank overdraft, etc. Current assets are those assets which are convertible into a cash within a year. Similarly, current liabilities are those liabilities, which are likely to mature for payment within an accounting year.