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.

Financial management is about planning income and expenditure, and making decisions that will enable you to survive financially.

Financial management includes financial planning and budgeting, financial accounting financial analysis, financial decision-making and action Financial planning is about: Making sure that the organisation can survive Making sure the money is being spent in the most efficient way Making sure that the money is being spent to fulfil the objectives of the organisation Being able to plan for the future of the organisation in a realistic way. Financial Accountability In non-profit organisations, the money that you are using is held in trust on behalf of the community that you serve. The money is not the personal possession of the individual staff members. They have to account for how they used the money, to show that it was used to benefit the community.

In a profit-making organisation, it is easy to hold management accountable. We simply ask: did they make a profit?

In a non-profit making organisation we ask: did they use the money to benefit the community in the best possible way?

Financial accountability can be broken down into two components:

Financial Accountability Being able to account for the way the money is spent to: donors boards and committees members, and the people whom the money is meant to benefit Financial Responsibility: Not taking on obligations the organisation cannot meet Paying staff and accounts on time Keeping proper records of the money that comes into the organisation and goes out of the organisation

Financial management entails planning for the future of a person or a business enterprise to ensure a positive cash flow. It includes the administration and maintenance of financial assets. Besides, financial management covers the process of identifying and managing risks. The primary concern of financial management is the assessment rather than the techniques of financial quantification. A financial manager looks at the available data to judge the performance of enterprises. Managerial finance is an interdisciplinary approach that borrows from both managerial accounting and corporate finance. Definitions "Financial management is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations". - Joseph and Massie. "Financial management is an area of financial decision-making, harmonizing individual motives and enterprise goals". -Weston and Brigham. "Financial management is the area of business management devoted to a judicious used of capital and a careful selection of sources of capital in order to enable a business firm to move in the direction of reaching its goals".-J.F.Bradlery. Financial management is the application of the planning and control Functions to the finance function". - Archer and Ambrosia.

"Financial management may be defined as that area or set of administrative functions in an organization which relate with arrangement of cash and credit so that the organization may have the means to carry out its objective as satisfactorily as possible." - Howard Financial Management: Levels Broadly speaking, the process of financial management takes place at two levels. At the individual level, financial management involves tailoring expenses according to the financial resources of an individual. Individuals with surplus cash or access to funding invest their money to make up for the impact of taxation and inflation. Else, they spend it on discretionary items. They need to be able to take the financial decisions that are intended to benefit them in the long run and help them achieve their financial goals. From an organizational point of view, the process of financial management is associated with financial planning and financial control. Financial planning seeks to quantify various financial resources available and plan the size and timing of expenditures. Financial control refers to monitoring cash flow. Inflow is the amount of money coming into a particular company, while outflow is a record of the expenditure being made by the company. Managing this movement of funds in relation to the budget is essential for a business. At the corporate level, the main aim of the process of managing finances is to achieve the various goals a company sets at a given point of time. Businesses also seek to generate substantial amounts of profits, following a particular set of financial processes. Financial managers aim to boost the levels of resources at their disposal. Besides, they control the functioning on money put in by external investors. Providing investors with sufficient amount of returns on their investments is one of the goals that every company tries to achieve. Efficient financial management ensures that this becomes possible. Strong financial management in the business arena requires managers to be able to: Interpret financial reports including income statements, Profits and Loss or P&L, cash flow statements and balance sheet statements Improve the allocation of working capital within business operations Review and fine tune financial budgeting, and revenue and cost forecasting Look at the funding options for business expansion, including both long and short term financing

Review the financial health of the company or business unit using ratio analyses, such as the gearing ratio,profit per employee and weighted cost of capital Understand the various techniques using in project and asset valuations Apply critical financial decision making techniques to assess whether to proceed with an investment Understand valuations frameworks for businesses, portfolios and intangible assets

Functions of Financial Management

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. 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. Choice of sources of funds: For additional funds to be procured, a company has many choices likeIssue of shares and debentures Loans to be taken from banks and financial institutions 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. 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. Disposal of surplus: The net profits decision have to be made by the finance manager. This can be done in two ways: Dividend declaration - It includes identifying the rate of dividends and other benefits like bonus. Retained profits - The volume has to be decided which will depend upon expansional, innovational, diversification plans of the company.

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, maintainance 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.

Evolution of Financial Management

The main stream of academic writing and teaching followed the scope and pattern suggested by the narrower and by now traditional definition of the finance function. Financial management, as it was then more generally called, emerged as a separate branch of economics. The traditional approach to the entire subject of finance was from the point of view of the investment banker rather than that of the financial decision-maker in an enterprise. The traditional treatment placed altogether too much emphasis on corporation finance and too little on the financing problems of non-corporate enterprises. The sequence of treatment was built too closely around the episodic phases during the life cycle of a hypothetical corporation in which external financial relations happened to be dominant. Matters like promotion, incorporation, merger, consolidation, recapitalization and reorganization left too little room for problems of a normal growing company. Finally, it placed heavy emphasis on long-term financial instruments and problems and corresponding lack of emphasis on problems of working capital management. The basic contents of the traditional approach may now be summarized. The emphasis in the traditional approach is on raising of funds The traditional approach circumscribes episodic financial function The traditional approach places great emphasis on long-term problems It pays hardly any attention to financing problems of non-corporate enterprises. It is difficult to say at what stage the traditional approach was replaced by modern approach. It is clear, however, that Ezra Solomon, Thomas L. Rein, Edward S. Meade and Arthur Stone Dewing among others were profoundly impressed by subjects like promotion, securities, floatation,

reorganization, consolidations, liquidation, etc. Their works laid emphasis on these topics. They did not consider routine managerial problems relating to financing of a firm, problems of profit planning and control, budgeting, finance and cost control, and working capital management which constitute the crux of the financial problems of modern financial management. The central issue of financial policies is a wise use of funds and the central process involved is a rational matching of advantages of potential uses against the caution of advantages of potential uses against the caution of alternative potential sources so as to achieve broad financial goals which an enterprise sets for itself. The new or modern approach is an analytical way of looking at the financial problems of a firm. Financial problems are a vital and an integral part of overall management. In this connection, Ezra Solomon observes: If the scope of financial management is re-defined to cover decisions about both the use and the acquisition of funds, it is clear that the principal content of the subject should be concerned with how financial management should make judgments about whether an enterprise should hold, reduce, or increase its investments in all forms of assets that require company funds. With the advent of industrial combination the financial manager of corporation was confronted with the complexities of budgeting and financial operations. The size and composition of the capital structure was of particular importance. The major concern of financial management was survival. Its attitude to long-term trade was hostile. It looked upon dividend as a residual payment. The discipline of financial management was conditioned by changes in the socioeconomic and legal environment. Its emphasis shifted from profitability analysis to cash flow generation; and it developed an interest in internal management procedures and control. In the circumstances, cost, budget forecasting, aging of accounts receivable and monetary management assured considerable importance. With technological progress, financial management was almost forced to improve its methodology. Such things as cost of capital, optimal capital structure, effects of capital structure upon cost of capital and market value of a firm were incorporated in the subject. Moreover, financial management laid emphasis on international business and finance, and showed a serious concern for the effects of multi-nationals upon price level movements. The concern for liquidity and profit margins was indeed tremendous throughout the several phases of financial

management. Modern financial management, however, is basically concerned with optimal matching of uses and sources of corporate funds that lead to the maximisation of a firms market value.

OBJECTIVES OF FINANCIAL MANAGEMENT

a) Profit Maximization In economics, profit maximization is the (short run) process by which a firm determines the price and output level that returns the greatest profit. There are several approaches to this problem. The total revenuetotal cost method relies on the fact that profit equals revenue minus cost, and the marginal revenuemarginal cost method is based on the fact that total profit in a perfectly competitive market reaches its maximum point where marginal revenue equals marginal cost

The monopolist's profit maximizing level of output is found by equating its marginal revenue with its marginal cost, which is the same profit maximizing condition that a perfectly competitive firm uses to determine its equilibrium level of output. Indeed, the condition that marginal revenue equal marginal cost is used to determine the profit maximizing level of output of every firm, regardless of the market structure in which the firm is operating.

In order to determine the profit maximizing level of output, the monopolist will need to supplement its information about market demand and prices with data on its costs of production for different levels of output. As an example of the costs that a monopolist might face, consider the data in Table 1 . The first two columns of Table1 represent the market demand schedule that the monopolist faces. As the price falls, the market's demand for output increases. The third column reports the total revenue that the monopolist receives from each different level of output. The fourth column reports the monopolist's marginal revenue that is just the change in total revenue per 1 unit change of output. The fifth column reports the monopolist's total cost of providing 0 to 5 units of output. The sixth and seventh columns report the monopolist's average total costs and marginal costs per unit of output. The eighth column reports the monopolist's profits, which is the difference between total revenue and total cost at each level of output.
TABL Monopoly Output, Revenues, Costs, E1 and Profits

Output Price 0 1 $14 12

Total revenue $0 12

Marginal revenue $12

Total Average total Marginal cost cost cost $2 6 $6 $4

Monopoly profits 2 6

Output Price

Total revenue

Marginal revenue

Total Average total Marginal cost cost cost

Monopoly profits

2 3 4 5

10 8 6 4

20 24 24 20

8 4 0 4

8 12 20 35

4 4 5 7

2 4 8 15

12 12 4 15

The monopolist will choose to produce 3 units of output because the marginal revenue that it receives from the third unit of output, $4, is equal to the marginal cost of producing the third unit of output, $4. The monopolist will earn $12 in profits from producing 3 units of output, the maximum possible. Arguments in favour of profit maximization: 1. Profit is the test of economic efficiency: It is a measuring rod by which the economic performance of the company can be judged. 2. Efficient allocation of fund: Profit leads to efficient allocation of resources as resources tend to be directed to uses which in terms of profitability are the most desirable. 3. Social welfare: It ensures maximum social welfare i.e., maximum dividend to shareholders, timely payments to creditors, more and more wages and other benefits to employees, better quality at cheaper rate to consumers, more employment society and maximization of capital to the entrepreneur. 4. Internal resources for expansion: It will consume a lot of time to raise equity funds in a primary market. Retained profits can be used for expansion and modernization. 5. Reduction in risk and uncertainty: Once after availing huge profits the company develops risk bearing capacity. The gross present value of a course of action is found by discounting and low capitalizing is benefits at a rate which reflects their timing and uncertainty. A financial action which has positive net present value creates wealth and therefore is desirable. The negative present value should be rejected.

6. More competitive: More and more profits enhance the competitive spirit thus, under such conditions firms having more and more profits are considered to be more dependable and can survive in any environment. 7. Desire for controls: More and more profits are desirable and imperative for the management t make optimum use of available financial resources for continued survival. Objections to Profit Maximization: 1. It is argued that profit maximization assumes perfect completion, and in the face of imperfect modern markets, it cannot be a legitimate objective of the firm. 2. It is also argued that profit maximization, as a business objective, developed in the early 19 th century for single entrepreneurship. Only aim of single owner was to enhance his individual wealth. But the modern business environment is characterized by limited liability and a difference between management and ownership. Share holders and lenders today finance the firm but it is controlled and directed by professional management. In the new business environment, profit maximization is regarded as unrealistic, difficult, inappropriate and immoral. 3. It is also feared that profit maximization behavior in a market economy may tend to produce goods and services that are wasteful and unnecessary from the societys point of view. 4. Firms producing same goods and services differ substantially in terms of technology, costs and capital. In view of such conditions, it is difficult to have a truly competitive price system, and thus, it is doubtful if the profit maximizing behavior will lead to the optimum social welfare. 5. Profit cannot be ascertained will in advance to express the probability of return as future is uncertain. It is not possible to maximize something that is unknown. Moreover the term profit is vague and not clearly expressed. 6. The executive or the decision maker may not have enough confidence in the estimates of future returns so that he does not attempt further to maximize. It is argued that a firms goal cannot be, to maximize profits but to attain a certain level or certain share of the market or certain level of sales. 7. The criterion of profit maximization ignores the time value factor it considers the total benefits or profits into account while considering a project whereas the length of time in earning that profits is not considered at all. Some additional drawbacks can be summarized as below

(a) It is Vague
It is not clear in what sense the term profit has been used. It may be total profit before tax or after tax or profitability rate. Rate of profitability may again be in relation to Share capital; owners funds, total capital employed or sales. Which of these variants of profit should the management pursue to maximise so as to attain the profit maximisation objective remains vague? Furthermore, the word profit does not speak anything about the short-term and long-term profits. Profits in the shortrun may not be the same as those in the long run. A firm can maximize its shortterm profit by avoiding current expenditures on maintenance of a machine. But owing to this neglect, the machine being put to use may no longer be capable of operation after sometime with the result that the firm will have to defray huge investment outlay to replace the machine. Thus, profit maximization suffers in the long run for the sake of maximizing short-term profit. Obviously, long-term consideration of profit cannot be neglected in favor of short-term profit.

(b) It Ignores Time Value factor

Profit maximization objective fails to provide any idea regarding timing of expected cash earnings. For instance, if there are two investment projects and suppose one is likely to produce streams of earnings of Rs. 90,000 in sixth year from now and the other is likely to produce annual benefits of Rs. 15,000 in each of the ensuing six years, both the projects cannot be treated as equally useful ones although total benefits of both the projects are identical because of differences in value of benefits received today and those received a year two years after. Choice of more worthy projects lies in the study of time value of future flows of cash earnings. The interest of the firm and its owners is affected by the time value or. Profit maximization objective does not take cognizance of this vital factor and treats all benefits, irrespective of the timing, as equally valuable.

(c) It Ignores Risk Factor

Another serious shortcoming of the profit maximization objective is that it overlooks risk factor. Future earnings of different projects are related with risks of varying degrees. Hence, different projects may have different values even though their earning capacity is the same. A project with fluctuating earnings is considered more risky than the one with certainty of earnings. Naturally, an investor would provide less value to the former than to the latter. Risk element of a project is also dependent on the financing mix of the project. Project largely financed by way of

debt is generally more risky than the one predominantly financed by means of share capital. In view of the above, the profit maximization objective is inappropriate and unsuitable an operational objective of the firm. Suitable and operationally feasible objective of the firm should be precise and clear cut and should give weightage to time value and risk factors. All these factors are well taken care of by wealth maximization objective.

Wealth Maximization:
Wealth maximization is a modern approach to financial management. Maximization of profit used to be the main aim of a business and financial management till the concept of wealth maximization came into being. It is a superior goal compared to profit maximization as it takes broader arena into consideration. Wealth or Value of a business is defined as the market price of the capital invested by shareholders.

Wealth maximization simply means maximization of shareholders wealth. It is combination of two words viz. wealth and maximization. Wealth of a shareholder maximize when the net worth of a company maximizes. To be even more meticulous, a shareholder holds share in the company /business and his wealth will improve if the share price in the market increases which in turn is a function of net worth. This is because wealth maximization is also known as net worth maximization. Finance managers are the agents of shareholders and their job is to look after the interest of the shareholders. The objective of any shareholder or investor would be good return on their capital and safety of their capital. Both these objectives are well served by wealth maximization as a decision criterion to business. How to calculate wealth? Wealth is said to be generated by any financial decision if the present value of future cash flows relevant to that decision is greater than the costs incurred to undertake that activity. Wealth is equal to the present value of all future cash flows less the cost. In essence, it is the net present value of a financial decision. Wealth = Present Value of cash inflows Cost. Where, Present = CF1 + CF1 +.+ CFn

Value of cash inflows

(1 + K)

(1 + K) 2

(1 + K) n

Why wealth maximization model is superior to profit maximization?

Wealth maximization model is a superior model because it obviates all the drawbacks of profit maximization as a goal to financial decision.

Firstly, the wealth maximization is based on cash flows and not profits. Unlike the profits, cash flows are exact and definite and therefore avoid any ambiguity associated with accounting profits. Secondly, profit maximization presents a shorter term view as compared to wealth maximization. Short term profit maximization can be achieved by the managers at the cost of long term sustainability of the business. Thirdly, wealth maximization considers the time value of money. It is important as we all know that a dollar today and a dollar one year latter do not have the same value. In wealth maximization, the future cash flows are discounted at an appropriate discounted rate to represent their present value. Wealth maximization has been accepted by the finance managers, because it overcomes the limitations of profit maximization. Wealth maximization means maximizing the net wealth of the companys share holders. Wealth maximization is possible only when the company pursues policies that would increase the market value of shares of the company. Fourthly, the wealth maximization criterion considers the risk and uncertainty factor while considering the discounting rate. The discounting rate reflects both time and risk. Higher the uncertainty, the discounting rate is higher and vice-versa. In the light of modern and improved approach of wealth maximization, a new initiative called Economic Value Added (EVA) is implemented and presented in the annual reports of the companies. Positive and higher EVA would increase the wealth of the shareholders and thereby create value.

Economic Value Added = Net Profits after tax Cost of Capital.

There are some arguments which are superior in wealth maximization:

Wealth maximization is based on the concept of cash flows. Cash flows are a reality and not based on any subjective interpretation. On the other hand there are many subjective elements in the concept of profit maximization. It considers time value of money translates cash flows occurring of different periods into a comparable value of cash flows is considered critically in all decisions as it incorporates the risk associated with the cash flow stream.
An example of Wealth maximization: X LTD is listed company engaged in the business of FMCG (fast moving consumer goods). Listed means the companys share are allowed to be traded the officially on the portals of the stock exchange, the board of directors of X LTD. Take a decision in one of the bond meeting to enter into the business of power generation. When the company informs the stock exchange of the conclusion of the meeting of the decision taken the stock market reacts unfavorably with result that the next days closing of quotation was 30% less than of the previous day. The question now is why the market reacted in this manner. Investors in this FMCG Company might have thought that the risk profile of the new business (power) that the company wants to take up is higher compared to the risk profile of the existing FMCG business as X LTD. when they want a higher return, market value of companys share declines. Therefore the risk profile of the company gets translated into a time value factor. The time value factor so translated becomes the required rate of return. Required rate of return is the return that the investors want for making investment in that sector. Any project which generates positive net present value creates wealth to the company. When a company creates wealth from a course of action it has initiated the share holders benefit because such a course of action will increase the market value of the companys share.

Advantages of Wealth Maximization

Wealth maximization is a clear term. Here, the present value of cash flow is taken into consideration. The net effect of investment and benefits can be measured clearly. (Quantitatively)

It considers the concept of time value of money. The present values of cash inflows and outflows helps the management to achieve the overall objectives of a company. The concept of wealth maximization is universally accepted, because, it takes care of interests of financial institution, owners, employees and society at large. Wealth maximization guide the management in framing consistent strong dividend policy, to earn maximum returns to the equity holders.

The concept of wealth maximization considers the impact of risk factor, while calculating the Net Present Value at a particular discount rate, adjustment is made to cover the risk that is associated with the investments.

Criticisms of Wealth Maximization The concept of wealth maximization is being criticized on the following grounds: The objective of wealth maximization is not descriptive. The concept of increasing the wealth of the stockholders differs from one business entity to another. It also leads to confusion in, and misinterpretation of financial policy because different yardsticks may be used by different interests in a company. As corporations have grown bigger and more powerful, their influence has become more pervasive; they have created an imbalance which is widely believed to have been instrumental in generating a movement to promote more socially conscious business behaviour. Academicians and corporate officers alike have urged the advisability of more socially conscious business management. Financial management will then have to rise equal to the acceptance of social responsibility of business. Financial management should not only maintain the financial health of a business,but should also help to produce a rate of earning which will reward the owners adequately for the use of the capital they have provided. To the creditors, the management must ensure administration, which will keep the business liquid and solvent. Moreover, financial management will have to ensure that expectations raised by the corporation are fulfilled with a proper use of several tools at is disposal. In other words, it should ensure an effective management of finance so that it may bear the desired fruits for the organization. If it is properly supported and nurtured by efficient activities at all stages, it will positively ensure desired results. Financial management should take into account the enterprises legal obligations to its employees. It should try to have a healthy concern which can maintain regular employment under favorable working conditions. However, a good financial management alone cannot

guarantee that a business will succeed. But it is a necessary condition for business success, though not the only one. It may, however, be described as a pre-requisite of a successful business. In other words, there are various other factors which may support or frustrate financial management by supportive or non- supportive policies. Wealth maximization is as important objective as profit maximization. The operating objective for Financial Management is to maximize wealth or the net present worth of a firm. Wealth maximization is an objective which has to be achieved by those who supply loan capital, employees, society and management. The objective finds its place in these segments of the corporate sector, although the immediate objectives of Financial Management may be to maintain liquidity and improve profitability. The wealth of owners of a firm is maximized by raising the price of the common stock. This is achieved when the management of a firm operates efficiently and makes optimal decisions in areas of capital investments, financing, dividends and current assets management. If this is done, the aggregate value of the common stock will be maximized. DIMENSIONS OF FINANCIAL MANAGEMENT Anticipating Financial Needs: The financial manager has to forecast expected events in
business and note their financial implications. Financial Manager anticipates financial needs by consulting an array of documents such as the cash budget, the pro-forma income statement, the pro-forma balance sheet, the statement of the sources and uses of funds, etc. Financial needs can be anticipated by forecasting expected funds in a business and their financial implications.

Acquiring Financial Resources: This implies knowing when, where and how to obtain
the funds which a business needs. Funds should be acquired well before the need for them is actually felt. The financial manager should know how to tap the different sources of funds. He may require short-term and long-term funds. The terms and conditions of the different financial sources may vary significantly at a given point of time. Much will also depend upon the size and strength of the borrowing firm. The financial image of a corporation has to be improved in appropriate financial circles which are primarily responsible for supplying finance.

Allocating Funds in Business: Allocating funds in a business means investing

them in the best plans of assets. Assets are balanced by weighing their profitability against their liquidity. Profitability refers to the earning of profits

and liquidity means closeness to money. The financial manager should steer a prudent course between over-financing and under-financing. He should preserve a proper balance among the various assets. He may adopt the famous marginal principle which states that the last rupee invested in each kind of an asset should have the same usefulness as the last rupee invested in any other kind of an asset. He should, moreover, allocate funds according to their profitability, liquidity and leverage. So, while the primary financial responsibility from the owners viewpoint may be to maximize value, the financial executives primary managerial responsibility is to preserve the continuity of the flow of funds so that no essential decision of the top management is frustrated for lack of corporate purchasing power.

Administering the Allocation of Funds: Once the funds are allocated to

various investment opportunities it is the basic responsibility of the finance manager to watch the performance of each rupee that has been invested. He has to adopt close supervision and marking of flow of funds. This will ensure continuous flow of funds as per the requirements of the organisation. This helps the management to increase efficiency by reducing the cost of operations & earn fair amount of profits out of investments. Analysing the performance of finance: Once the funds are administered, it is very comfortable for the finance manager to take decisions. Through the budgeting, he will be able to compare the actuals with standards. The returns on the investments must be continuous and consistent. The cost of each financial decision and returns of each investment must be analysed. Where ever the deviations are found, necessary steps or strategies are to be adopted to overcome such events. This helps in achieving Liquidity of a business unit. Accounting and Reporting to Management: Now, the role of the finance manager is changing. The department of finance has gained substantial recognition. He not only acts as line executive but also as staff. He has to advise and supply information about the performance of finance to top management. He is also responsible for maintaining upto date records of the peformance of financial decisions. If need arises, he has to offer his suggestion to improve the overall functioning of the organisation. The financial manager will have to keep the assets intact, which enable a firm to conduct its business. Asset management has assumed an important role in Financial Management. It is also necessary for the finance manager to ensure that sufficient funds are available for smooth conduct of the business. In this connection, it may be pointed out that management of funds has both liquidity and profitability aspects. Financial Management is concered with the many responsibilities which are the main thrust of a business enterprise

Role and Functions of the Financial Manager The financial manager performs important activities in connection with each of the general functions of the management. He groups activities in such a way that areas of responsibility and accountability are cleared defined. The profit centre is a technique by which activities are decentralised for the development of strategic control points. The determination of the nature and extent of staffing is aided by financial budget programme. Direction is based, to a considerable extent, on instruments of financial reporting. Planning involves heavy reliance on financial tools and analysis. Control requires the use of the techniques of financial ratios and standards. Briefly, an informed and enlightened use of financial information is necessary for the purpose of coordinating the activities of an enterprise. Every business, irrespective of its size, should, therefore, have a financial manager who has to take key decisions on the allocation and use of money by various departments. Specifically the financial manager should anticipate financial needs; acquire financial resources; and allocate funds to various departments of the business. If the financial manager handles each of these tasks well, his firm is on the road to good financial health. The financial managers concern is to: v Determine the total amount of funds to be employed by a firm; v Allocate these funds efficiently to various assets; v Obtain the best mix of financing in relation to the overall evaluation of the firm. Since the financial manager is an integral part of the top management, he should so shape his decisions and recommendations as to contribute to the overall progress of the business, on which depends the value of the firing. That is his primary objective is to maximise the value of the firm to its stockholders. Although, decisions are the end product of the financial managers task, his day-to-day work consists of more than just decision-making. A great deal of his time is spent on financial planning, which may be described as the co-ordination of a series of inter-dependent decisions over an extended period. Of the many environments in which the firm operates, the one closest to the financial manager is the financial market, which ultimately determines whether a firms

policies are a success or a failure. In a fundamental sense, financial management is nothing more or less than a continuing two-way interaction between a firm and its financial environment. It has been explained earlier that financial management is related to the environment, which is external to a firm. This environment is the macro-economic environment, which includes the study of the financial market. The logic here is very simple. A firm is a part of the entire business activity, which is reflected in the financial market. The financial market is sensitive to the reactions of firms to the supply of, and demand for, its securities. No firm can, therefore, exempt itself from undertaking a study of the financial market. It is in this sense that financial management makes a kind of an integrated approach to the external environment. The financial manager should: Supervise the overall working of an organization instead of confining himself to technical matters as a top management executive Make sure that funds have been acquired in sufficient, but not excessive amounts Ensure that disbursements do not create shortage of funds Analyse, plan and control the use of funds Maintain liquidity while retaining the acceptable level of profits Economise on the acquisition of funds and hold down their cost Make allowances for uncertainties that exist in the business world Administer effectively cash, receivables, inventory and other components of working capital Analyse financial aspects of external growth Develop the means to rejuvenate and revitalise the enterprise or to assist in liquidity and distribution of its assets to the various claimants.

A financial manager is often up against a dilemma. He has to choose between profitability and liquidity. Although both are desirable, sometimes one has to be sacrificed for the other. Since cash earns no return, a firm increases its liquidity at the cost of its profitability. The financial manager does something more than co-ordinate business activities in a mechanical way. His central role requires that he understands the nature of problems so that he may take proper decisions. In several situations, he faces a challenge: should he choose profitability or liquidity? Despite the knowledge that a particular investment is quite profitable, he is forced to sacrifice this option, if the investment is going to lock up funds for an unreasonable period; the longer the period, the greater is the risk. Most financial managers are, therefore, tempted to compromise between profitability and liquidity, and select projects which are reasonably profitable and, at the same time, sound from the liquidity point of view. Scope and Functions of Financial Management A priori definition of the scope of financial management fall into three groups. One view is that finance is concerned with cash. At the other extreme is the relatively narrow definition that financial management is concerned with raising and administering of funds to an enterprise. The third approach is that it is an integral part of overall management rather than a staff specialty concerned with fundraising operations. In this connection. Financial Management plays two significant roles: v To participate in the process of putting funds to work within the business and to control their productivity; and v To identify the need for funds and select sources from which they may be obtained. The functions of financial management may be classified on the basis of liquidity, profitability and management. (1) Liquidity: Liquidity is ascertained on the basis of three important considerations: (a) Forecasting cash flows, that is, matching the inflows against cash outflows;

(b) Raising funds, that is, financial management will have to ascertain the sources from which funds may be raised and the time when these funds are needed; (c) Managing the flow of internal funds, that is, keeping its accounts, with a number of banks to ensure a high degree of liquidity with minimum external borrowing. (2) Profitability: While ascertaining profitability, the following factors are taken into account: (a) Cost Control: Expenditure in the different operational areas of an enterprise can be analysed with the help of an appropriate cost accounting system to enable the financial manager to bring costs under control. (b) Pricing: Pricing is of great significance in the companys marketing effort, image and sales level. The formulation of pricing policies should lead to profitability, keeping, of course, the image of the organization intact. (c) Forecasting Future Profits: Expected profits are determined and evaluated. Profit levels have to be forecasted from time to time in order to strengthen the organization. (d) Measuring Cost of Capital: Each source of funds has a different cost of capital which must be measured because cost of capital is linked with profitability of an enterprise. (3) Management: The financial manager will have to keep assets intact, for assets are resources which enable a firm to conduct its business. Asset management has assumed an important role in financial management. It is also necessary for the financial manager to ensure that sufficient funds are available for smooth conduct of the business. In this connection, it may be pointed out that management of funds has both liquidity and profitability aspects. Financial management is concerned with the many responsibilities which are thrust on it by a business enterprise. Although a business failure may not always be the result of financial failures, financial failures do positively lead to business failures. The responsibility of financial management is enhanced because of this peculiar situation. Financial management may be divided into two broad areas of responsibilities, which are not by any means independent of each other. Each, however, may be regarded

as a different kind of responsibility; and each necessitates very different considerations. These two areas are: v The management of long-term funds, which is associated with plans for development and expansion, and which involves land, buildings, machinery, equipment, transport facilities, research project, and so on; v The management of short-term funds, which is associated with the overall cycle of activities of an enterprise. These are the needs which may be described, as working capital needs. One of the functions of financial management is co-ordination of different activities of a business house. A business depends upon availability of funds which, in turn, depends upon the extent to which a firm is able to effect cash sales. Financial management must offer a solution for decisions in areas of capital structure, investment, dividend distribution, and retention of surplus inter-alia. The investment decision involves current cash outlay in anticipation of benefits to be realised in the future. The uncertain nature of future benefits necessitates evaluation of investment proposals in relation to their expected rate of return and risk. Once the investment proposals are evaluated and combined into a capital expenditure programme or planned capital budget, the next decision involves finalisation of sources for a given capital outlay. In other words, the financing decision involves the determination of the ideal financing mix or capital structure. For deciding the dividend policy, the percentage of earnings paid to shareholders becomes an important consideration. It is obvious that the percentage of dividend policy paid affects the quantum of retained earnings. The dividend policy is thus instrumental for changes in market price of shares in the capital market. A prudent financial management policy calls for an optimal mix of different decisions in line with organizational objectives. Today, financial management extends itself to the broad subject of international money management which refers to the problem of collecting, utilising and protecting the financial assets of internationally involved companies. This includes both operating responsibilities of a multi-national corporation and providing the array of techniques and tools available to co-ordinate that task. This task is already difficult in domestic companies. But the task becomes more onerous on account of grated structural and environmental

impediments confronting multi-national companies. New problems in managing and administering finances of companies have emerged following the increasing international financing of domestic companies and the entry of foreign collaborations, problems of dealings between parents and subsidiaries speaking in multiple languages, heavy reliance on communication environments, following diverse legal practices, different tax umbrellas and exchange, control system among others. It has become imperative to have reporting systems and optimal use of financial institutions attempting to forecast liquidity and foreign exchange risks of companies. International cash management deals with more mechanical areas of cash collection, holding and disbursement. International cash management involves longer distances, exchange controls different currency units and multiple financial institutions. A variety of instruments exist for effecting international transfer of funds. There may be payment instructions in written or documentary form incorporating some form of credit. The standard method of transferring funds internationally is by mail payment order, which is a lengthy process. Cable transfers reduce remittance time appreciably. Other international modes of payment include bank drafts, cheques and trade bills. Sight and time drafts, acceptances and letters of credit are termed as documentary credits. The international liquidity management is regulated by exchange control and other barriers which usually prohibit the flow of funds in desired directions. Funds held by individual subsidiaries in different countries cannot be considered fungible and there is little or no chance of international pooling of funds. Even intra-country liquidity management may be affected by weak capital markets which offer few investment media or banking systems which delay transfers. This area is also affected by impediments in banking and mail systems. PROFITABILITY VERSUS LIQUIDITY A firm is required to maintain a balance between liquidity and profitability while conducting its day to day operations. Investments in current assets are inevitable to ensure delivery of goods or services to the ultimate customers. A proper management of the same could result in the desired impact on either profitability or liquidity.1

Liquidity is a precondition to ensure that firms are able to meet its short-term obligations.1 The 'liquidity position' in a company is measured based on the 'current ratio' and the 'quick ratio'. The current ratio establishes the relationship between current assets and current liabilities. Normally, a high current ratio is considered to be an indicator of the firm's ability to promptly meet its short term liabilities. 1 The quick ratio establishes a relationship between quick or liquid assets and current liabilities. An asset is liquid if it can be converted into cash immediately or reasonably soon without a loss of value.1
Consequences of low liquidity

a) A company that cannot pay its creditors on time and continues not to honor its obligations to the suppliers of credit, services and goods could result in losses on account of non-availability of supplies and lead to possible sickness or insolvency.2 Also, the inability to meet the short term liabilities could affect the company's operations and in many cases it may affect its reputation as well.2 Lack of cash or liquid assets on hand may force a company to miss the incentives given by the suppliers of credit, services, and goods as well. Loss of such incentives may result in higher cost of goods which in turn affects the profitability of the business.2 b) Every stakeholder has interest in the liquidity position of a company. Suppliers of goods will check the liquidity of the company before selling goods on credit. Employees should also be concerned about the company's liquidity to know whether the company can meet its employee related obligations--salary, pension, provident fund, etc. Thus, a company needs to maintain adequate liquidity.2 Profitability is a measure of the amount by which a company's revenues exceeds its relevant expenses.4 Profitability ratios are used to evaluate the management's ability to create earnings from revenue-generating bases within the organization.7 The 'profitability position' of a company is measured using the 'gross profit margin' and the 'net profit margin'. The gross profit margin is an indicator of the profit a business makes on its cost of sales, or cost of goods sold. It is the profit earned before any administration costs; selling costs and so on are removed.5 The net profit margin is an indicator of the amount of net profit per rupee of turnover a business has earned. That is, after taking account of the cost of sales, the administration costs, the selling and distributions costs and all other costs, the net profit is the profit that is left, out of which the company will have to pay interest, tax, dividends and so on.5 Consequences of low profitability A profit ratio indicates how effectively management can wring profits from sales. It also indicates how much room a company has to withstand a downturn, fend off competition and make mistakes.6 Potential investors are interested in dividends and appreciation in market price of stock, so they focus on profitability ratios. Managers, on the other hand, are interested in measuring the operating performance in terms of profitability. Hence, a low profit margin would suggest ineffective management and investors would be hesitant to invest in the company.

Thus, a financial manager has to ensure on one hand that the firm has adequate cash to pay for its bills, has sufficient cash to make unexpected large purchases and cash reserve to meet emergencies, while on the other hand, he has to ensure that the funds of the firm are used so as to yield the highest return. The liquidity and profitability goals conflict in most decisions which the finance manager makes. For example, if higher inventories are kept in anticipation of increase in prices of raw materials, profitability goal is approached, but the liquidity of the firm is endangered. Similarly, the firm by following a liberal credit policy, may be in a position to push up its sales, but its liquidity decreases.8 Similarly, there is a direct relationship between higher risk and higher return. A company taking higher risk could endanger its liquidity position.8 However, if a company has a higher return it will increase its profitability. RISK RETURN TRADE-OFF Deciding what amount of risk you can take while remaining comfortable with your investments is very important. In the investing world, the dictionary definition of risk is the chance that an investment's actual return will be different than expected. Technically, this is measured in statistics by standard deviation. Practically, risk means you have the possibility of losing some or even all of your original investment. Low risks are associated with low potential returns. High risks are associated with high potential returns. The risk return tradeoff is an effort to achieve a balance between the desire for the lowest possible risk and the highest possible return. The risk return tradeoff theory is aptly demonstrated graphically in the chart below. A higher standard deviation means a higher risk and therefore a higher possible return. A common misconception is that higher risk equals greater return. The risk return tradeoff tells us that the higher risk gives us the possibility of higher returns. There are no guarantees. Just as risk means higher potential returns, it also means higher potential losses. On the lower end of the risk scale is a measure called the risk-free rate of return. It is represented by the return on 10 year Government of India Securities because their chance of default (i.e. not being able to repay principal and interest) is next to nothing. This risk free rate is used as a reference for equity markets whereas the overnight repo rate is used as a reference for debt markets. If the risk-free rate is currently 6 per cent, this means, with virtually no risk, we can earn 6 per cent per year on our money. The common question arises: who wants 6 per cent when index funds average 13 per cent per year over the long run (last five years)? The answer to this is that even the entire market (represented by the index fund) carries risk. The return on index funds is not 13 per cent every

year, but rather -5 per cent one year, 25 per cent the next year, and so on. An investor still faces substantially greater risk and volatility to get an overall return that is higher than a predictable government security. We call this additional return, the risk premium, which in this case is 7 per cent (13 per cent - 6 per cent). How do you know what risk level is most appropriate for you? This isn't an easy question to answer. Risk tolerance differs from person to person. It depends on goals, income, personal situation, etc. Hence, an individual investor needs to arrive at his own individual risk return tradeoff based on his investment objectives, his life-stage and his risk appetite.

The level of net working capital (NWC) has a bearing on profitability as well as risk. The termRISK is defined as the probability that a firm will become technically insolvent so that it will be not able to meet its obligations when they become due for payment. The greater the NWC, the more liquid is the firm and, therefore, the less likely it is to become technically insolvent. Conversely, lower levels of NWC and liquidity will be increased levels of risk. The relationship between liquidity, NWC and risk is such that if either NWC or liquidity increases, the firms risk decreases. In evaluating the profitability-risk related to the levels of NWC, three basic assumptions, which are generally true, are:

That we are dealing with a manufacturing firm That current assets are less profitable than fixed assets That short term funds are less expensive than long term funds

I. Effect of the level of Current Assets on the Profitability-Risk

It can be shown, using the ratio of current assets to total assets. This ratio indicates the percentage of total assets that are in the form of current assets. A change in the ratio will reflect a change in the amount of current assets. It may either increase or decrease. a. Effect of higher ratio An increase in the ratio of current assets to total assets will lead to a decline in profitability because current assets are assumed to be less profitable than fixed assets. A second effect of the increase in the ratio will be that the risk of technical insolvency would also decrease because the increase in current assets, assuming no change in current liabilities, will increase NWC. b. Effect of lower ratio A decrease in the ratio of current assets to total assets will result in an increase in profitability as well as risk. The increase in profitability will primarily be due to the corresponding increase in the fixed assets which are likely to generate higher returns. Since the current assets decrease without a corresponding reduction in current liabilities, the amount of NWC will decrease, thereby increasing risk. II. Effect of change in Current Liabilities on Profitability- Risk The current liabilities to total assets ratio will indicate the percentage of total assets financed by current liabilities. a. Effect of higher ratio One effect of an increase in the ratio of current liabilities to total assets would be that profitability would increase. The reason for the increased profitability lies in the fact that current liabilities, which are a short term source of finance, will increase, whereas the long term sources of finance will be reduced. As short term sources of finance are less expensive than the long run sources, increase in the ratio will, in effect , mean substituting less expensive sources for more expensive sources of financing. There will, therefore, be a decline in cost and a corresponding rise in profitability. The increased ratio will also increase the risk. Any increase in the current liabilities, assuming no change in current assets, would adversely affect the NWC. A decrease in NWC leads to an increase in risk. Thus, as current liabilities-total assets ratio increases, profitability and risk increases. b. Effect of lower ratio The consequences of a decrease in the ratio are exactly opposite to the results of an increase.i.e. it will lead to a decrease in profitability as well as risk. The use of more long term funds which, by definition are more expensive will increase the cost; by implications, profits will also decline. Similarly, risk will decrease because of the lower level of current liabilities on the assumption that current assets remain unchanged. III. Combined effect of changes in Current Assets and Current Liabilities on ProfitabilityRisk

The combined effect of these changes, should logically be to increase overall profitability as also risk and at the same time decreases NWC. FINANCIAL MARKET any marketplace where buyers and sellers participate in the trade of assets such as equities, bonds, currencies and derivatives. Financial markets are typically defined by having transparent pricing, basic regulations on trading, costs and fees and market forces determining the prices of securities that trade. A financial market is a market in which people and entities can trade financial securities, commodities, and other fungible items of value at low transaction costs and at prices that reflect supply and demand. Securities include stocks and bonds, and commodities include precious metals or agricultural goods. There are both general markets (where many commodities are traded) and specialized markets (where only one commodity is traded). Markets work by placing many interested buyers and sellers, including households, firms, and government agencies, in one "place", thus making it easier for them to find each other. An economy which relies primarily on interactions between buyers and sellers to allocate resources is known as a market economy in contrast either to a command economy or to a non-market economy such as a gift economy. In finance, financial markets facilitate:

The raising of capital (in the capital markets) The transfer of risk (in the derivatives markets) Price discovery Global transactions with integration of financial markets The transfer of liquidity (in the money markets) International trade (in the currency markets)

and are used to match those who want capital to those who have it. Typically a borrower issues a receipt to the lender promising to pay back the capital. These receipts are securities which may be freely bought or sold. In return for lending money to the borrower, the lender will expect some compensation in the form of interest or dividends. This return on investment is a necessary part of markets to ensure that funds are supplied to them

Basis of Financial Market Basis of Financial Markets are the Borrowers and Lenders.

Borrowers of the Financial Market can be individual persons, private companies, public corporations, government and other local authorities like municipalities. Individual persons generally take short term or long term mortgage loans from banks to buy any property. Private Companies take short term or long term loans for expansion of business or for improvement of the business infrastructure. Public Corporations like railway companies and postal services also borrow from Financial Market to collect required money. Government also borrows from Financial Market to bridge the gap between govt. revenue and govt. spending. Local authorities like municipalities sometimes borrow in their own name and sometimes govt. borrows in behalf of them from the Financial Market.

Lenders in the Financial Market are actually the investors. Their invested money is used to finance the requirements of borrowers. So, there are various types of investments which generate lending activities. Some of these types of investments are depositing money in savings bank account, paying premiums to Insurance Companies, investing in shares of different companies, investing in govt. bonds and investing in pension funds and mutual funds.

Financial Market is nothing but a tool which is used to raise capital. Just like any other tool, it can be beneficial and can be harmful too. So, the ultimate outcome solely lies in the hands of the people who use it to serve their purpose.

TYPES OF FINANCIAL MARKET:

Financial market can be divided into the following categories a)Money Market: A segment of the financial market in which financial instruments with high
liquidity and very short maturities are traded. The money market is used by participants as a means for borrowing and lending in the short term, from several days to just under a year. Money market securities consist of negotiable certificates of deposit (CDs), bankers acceptances, U.S. Treasury bills, commercial paper, municipal notes, federal funds and repurchase agreements (repos).

b) CAPITAL MARKET:

Broadly speaking the capital market is a market for financial assets which have a long or indefinite maturity. Unlike money market instruments the capital market instruments become mature for the period above one year. It is an institutional arrangement to borrow and lend money for a longer period of time. It consists of financial institutions like IDBI, ICICI, UTI, LIC, etc. These institutions play the role of lenders in the capital market. Business

units and corporate are the borrowers in the capital market. Capital market involves various instruments which can be used for financial transactions. Capital market provides long term debt and equity finance for the government and the corporate sector. Capital market can be classified into primary and secondary markets. The primary market is a market for new shares, where as in the secondary market the existing securities are traded. Capital market institutions provide rupee loans, foreign exchange loans, consultancy services and underwriting. Important functions include Mobilization of Savings : Capital market is an important source for mobilizing idle
savings from the economy. It mobilizes funds from people for further investments in the productive channels of an economy. In that sense it activate the ideal monetary resources and puts them in proper investments.

Capital Formation : Capital market helps in capital formation. Capital formation is

net addition to the existing stock of capital in the economy. Through mobilization of ideal resources it generates savings; the mobilized savings are made available to various segments such as agriculture, industry, etc. This helps in increasing capital formation.

Provision of Investment Avenue : Capital market raises resources for longer

periods of time. Thus it provides an investment avenue for people who wish to invest resources for a long period of time. It provides suitable interest rate returns also to investors. Instruments such as bonds, equities, units of mutual funds, insurance policies, etc. definitely provides diverse investment avenue for the public.

Speed up Economic Growth and Development : Capital market enhances

production and productivity in the national economy. As it makes funds available for long period of time, the financial requirements of business houses are met by the capital market. It helps in research and development. This helps in, increasing production and productivity in economy by generation of employment and development of infrastructure.

Proper Regulation of Funds : Capital markets not only helps in fund mobilization,
but it also helps in proper allocation of these resources. It can have regulation over the resources so that it can direct funds in a qualitative manner.

Service Provision : As an important financial set up capital market provides various

types of services. It includes long term and medium term loans to industry, underwriting services, consultancy services, export finance, etc. These services help the manufacturing sector in a large spectrum.

Continuous Availability of Funds : Capital market is place where the investment

avenue is continuously available for long term investment. This is a liquid market as

it makes fund available on continues basis. Both buyers and seller can easily buy and sell securities as they are continuously available. Basically capital market transactions are related to the stock exchanges. Thus marketability in the capital market becomes easy. 3)GOVERNMENT SECURITES MARKET: The government securities market is at the core of financial markets in most countries. It deals with tardeable debt instruments issued by Government for meeting its financing requirements. The development of the primary segment of this market enables the managers of public debt to raise resources from the market in a cost effective manner with due recognition to associated risks. A vibrant secondary segment of the government securities market helps in the effective operation of monetary policy through application of indirect instruments such as open market operations, for which government securities act as collateral. The government securities market is also regarded as the backbone of fixed i n c o m e s e c u r i t i e s m a r k e t s a s i t p r o v i d e s t he benchmark yield and imparts liquidity to other financial markets. The existence of an efficient government securities market is seen as an essential precursor, in particular, for development of the corporate debt mark t . Furthermore, the g over nment securities market acts as a channel for integration of various segments of the domestic financial market and helps in establishing inter-linkages between the domestic and external financial markets.

4)Foreign Exchange Market: The foreign exchange market (forex, FX, or currency market) is
a global, worldwide-decentralized financial market for trading currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative values of different currencies. The foreign exchange market assists international trade and investment, by enabling currency conversion. For example, it permits a business in theUnited States to import goods from the European Union member states especially Eurozone members and pay Euros, even though its income is in United States dollars. It also supports direct speculation in the value of currencies, and the carry trade, speculation on the change in interest rates in two currencies. In a typical foreign exchange transaction, a party purchases a quantity of one currency by paying a quantity of another currency. The modern foreign exchange market began forming during the 1970s after three decades of government restrictions on foreign exchange transactions (the Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states after World War II), when countries gradually switched to floating exchange rates from the previous exchange rate regime, which remained fixed as per the Bretton Woods system. The foreign exchange market is unique because of its huge trading volume representing the largest asset class in the world leading to high liquidity; its geographical dispersion;

its continuous operation: 24 hours a day except weekends, i.e. trading from 20:15 GMT on Sunday until 22:00 GMT Friday; the variety of factors that affect exchange rates; the low margins of relative profit compared with other markets of fixed income; and the use of leverage to enhance profit and loss margins and with respect to account size.

DECISION AREAS: INVESTMENT DECISION: Investment decision is concerned with deciding the asset composition of any firm. Here the finance manager is required to take decision about amount of fund to be invested in fixed assets and current assets. Both these investments have to done with great precision because of their respective crucial roles in the organizations functioning.Investment decision can be further sub classified as a)Capital Budgeting: Capital budgeting decisions are most crucial; for they have long-term implications. They relate to judicious allocation of capital. Current funds have to be invested in long-term activities in anticipation of an expected flow of future benefits spread over a long period of time. Capital budgeting forecasts returns on proposed long-term investments and compares profitability of different investments and their cost of capital. It results in capital expenditure investments. The various proposal assets ranked on the basis of such criteria as urgency, liquidity, profitability and risk sensitivity. The financial analyser should be thoroughly familiar with such financial techniques as pay back, internal rate of return, discounted cash flow and net present value among others because risk increases when investment is stretched over a long period of time. The financial analyst should be able to blend risk with returns so as to get current evaluation of potential investments. b)Working Capital Management: Working capital is rightly an adjunct of fixed capital investment. It is a financial lubricant which keeps business operations going. It is the life-blood of a firm. Cash, accounts receivable and inventory are the important components of working capital, which is rotating in its nature. Cash is the central reservoir of a firm that ensures liquidity. Accounts receivables and inventory form the principal of production and sales; they also represent liquid funds in the ultimate analysis. The financial manager should weigh the

advantage of customer trade credit, such as increase in volume of sales, against limitations of costs and risks involved therein. He should match inventory trends with level of sales. The uncertainties of inventory planning should be dealt within a rational manner. There are several costs and risks which are related to inventory management. The risks are there when inventory is inadequate or in excess of requirements. The former may hold up production, while the latter would result in an unjustified locking up of funds and increase the cost of capital. Inventory management entails decisions about the timing and size of purchases purely on a cost basis. The financial manager should determine the economic order quantities after considering the relationships of different cost elements involved in purchases. Firms cannot avoid making investments in inventory because production and deliveries involve time lags and discontinuities. Moreover, the demand for sales may vary substantially. In the circumstances, safety levels of stocks should be maintained. Inventory management thus includes purchase management and material management as well as financial management. Its close association with financial management primarily arises out of the fact that it is a simple cash asset. Financing Decisions: Financing decision is concerned with identification of various sources of funds. Funds are available through primary market, financial institution and through the commercial banks. Cost associated with each of the instrument or source is different. The overall cost of that capital composition must be kept at minimum proper debt. Equity ratio should be maintained to maximize the returns to the shareholders. This decision will be made by considering the different factors. viz., inflation, size of the organisation, government policies, etc. . It is to decide, where from and how to acquire funds to meet the firms investment needs. The central issue here is to determine the appropriate proportion of equity and debt. The mix of debt and equity is known as the firms capital structure. The firms capital structure is considered optimum when the market value of shares is maximized. Tools used for taking such decisions are EBIT- EPS Analysis, Capital Structure Theories and Leverage Analysis.

DIVIDEND DECISION: Dividend decisions are an important aspect of corporate financial

policy since they can have an effect on the availability as well as the cost of capital. The Lintner proposition which asserts that the corporate management maintains a constant target payout ratio has been the most influential. However, the concept of primary of dividend decisions as well as the reasons for it are not unambiguously defined. There is a variety of theories which attempt to rationalize the observed secular constancy of the dividend payout ratio. These studies examine the factors underlying the

structure of the management, the nature of the product and financial markets, as well as the influence of the shareholders in their attempt to explain the Lintner proposition. However, in the case of any one firm, the following two pertinent questions need to be examined on an empirical basis to provide substance to the notion of primary of dividend decisions. (a) What are dividend decisions primary for?, and (b) for whom are they primary? An attempt has been made to develop a theoretical framework to approach these questions and identify the appropriate concept of primary and determine empirically the relationship of the primary notion with the objectives of the share holders and the management. The modeling framework postulates that (a) the dividend decisions may be primary to the management of the firm and /or the shareholder, and (b) each of the decision makers can have a short run and /or long run objective when they evaluate dividend decisions. Share price increases have been postulated as the basic short run objective of both the groups of decision makers. Similarly, both the share holders and the management are viewed as net worth maximizes over the long run.The fundamental hypothesis for the short run models is that the management increases the dividend per share whenever the share price down, and that the share holder responds, to these in such a way as to increase the share price. This result is expected if dividend decisions are primary for both the groups.In the long run context, it was felt that a progressive management would increase the networth the firm by investments in fixed assets or through building the reserve base. Dividends would be a primary decision if the internal financing of investment is constrained by the necessity to pay dividends at a constant rate.