DEFINITION OF CORPORATION FINANCE / FINANCIAL MANAGEMENT

Wheeler defines business finance as “that business activity which is concerned

with the acquisition and conservation of capital funds in meeting the financial needs and
overall objectives of business enterprise.”

According to Guthmann and Dougall; Business finance can be broadly defined as

the activity concerned with the planning, raising, controlling and administering the funds
used in the business.”

Financial Management refers to that part of the management activity which is

concerned with the planning and controlling of firm’s financial resources. It deals with
finding out various sources for raising funds for the firm. The sources must be suitable
and economical for the needs of the business. The most appropriate use of such funds
also forms a part of financial management. As a separate managerial activity, it has a
recent origin.

EVOLUTION OF CORPORATION FINANCE / FINANCIAL MANAGEMENT

Corporation finance emerged as a distinct field of study only in the early part of
this century as a result of consolidation movement and formation of large sized business
undertakings.
In the initial stages of the evolution of corporation finance, emphasis was placed
on the study of sources and forms of financing the large sized business enterprises. The
grave economic recession of 1930’s rendered difficulties in raising finance from banks
and other financial institutions. Thus, emphasis was laid upon improved methods of
planning and control, sound financial structure of the firm and more concern for liquidity.
The ways and means of evaluating the credit worthiness of firms were developed.

The post World War II era necessitated reorganization of industries and the need
for selecting sound financial structure. In the early 50’s the emphasis shifted from the
profitability to liquidity and from institutional finance to day to day operations of the
firm. Thus, the scope of financial management widened to include the process of
decision-making within the firm.

The modern phase began in mid-fifties and the discipline of corporation finance
or financial management has now become more analytical and quantitative. 1960’s
witnessed phenomenal advances in the theory of ‘portfolio analysis’ by Microwitz,
Sharpe, Lintner etc. Capital Asset Pricing Model (CAPM) was developed in 1970’s. The
CAPM suggested that some of the risks in investments can be neutralized by holding of
diversified portfolio of securities. The ‘Option Pricing Theory’ was also developed in the
form of the Binomial Model and the Block-Scholes Model during this period. The role of
taxation in personal and corporate finance was emphasized in 80’s. Further, newer
avenues of raising finance with the introduction of new capital market instrument such as
PCD’s, FCD’S, etc. were also introduced. Globalisation of markets has witnessed the
emergence of ‘Financial Engineering’ which involves the design, development and

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implementation of innovative financial instruments and the formulation of creative
optimal solutions to problems in finance. The techniques of models, mathematical
programming and simulations are presently being used in corporation finance and it has
achieved the prime place of importance. We may conclude that financial management
has evolved from a branch of economics to a distinct subject of detailed study of its own.

IMPORTANCE OF CORRORATION FINANCE / FINANCIAL MANAGEMENT

Finance is the life blood and nerve centre of a business, just as circulation of
blood is essential in the human body for maintaining life, finance is very essential to
smooth running of the business.

The Present day business activities are predominantly carried on company or

corporate form of organization. The advent of corporate enterprises has resulted into:

(i) the increase in size and influence of the business enterprises,

(ii) wide distribution of corporate ownership, and
(iii) Separation of ownership and management.

The above three factors have further increased the importance of corporation
finance. As the owners (shareholders) in a corporate enterprise are widely scattered and
the management is separated from the ownership, the management has to ensure the
maximization of owner’s economic welfare. The success and growth of a firm depends
upon adequate return on its investment. The investors or shareholders can be attracted
by a firm only by maximization of their wealth through the application of principles and
procedures.

The knowledge of the Finance is important not only to the managers, but also to
investors, lenders, bankers, creditors, etc., as there is always a scope for the management
to manipulate and ‘window dress’ the financial statements.
In the present day capitalistic regime, the size of the business enterprises is
increasing resulting into corporate empires empowered with a lot of social and political
influence. This makes corporation finance all the more important.
This subject is important and useful for all types of ownership organizations.
Where there is a use of finance, financial management is helpful. Every management
aims to utilize its funds in a best possible and profitable way. So this subject is acquiring
a universal applicability.

It is indispensable in any organization as it helps in:

(i) Financial planning and successful promotion of an enterprise;
(ii) Acquisition of funds as and when required at the minimum possible cost;
(iii) Proper use and allocation of funds;
(iv) Taking sound financial decisions;
(v) Improving the profitability through financial controls;
(vi) Increasing the wealth of the investors and the nation; and
(vii) Promoting and mobilizing individual and corporate savings.

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AIMS OF FINANCE FUNCTION

The primary aim of finance function is to arrange as much funds for the business
as required from time to time. This function has the following aims:

1. Acquiring Sufficient Funds. The main aim of finance function is to assess the
financial needs of an enterprise and then finding out suitable sources for raising them.
The sources should be suitable with the needs of the business. If funds are needed for
longer periods then long-term sources like share capital, debentures, term loans may be
explored. A concern with longer gestation period should rely more on owner’s funds
instead of interest-bearing securities because profits may not be there for some years.
2. Proper Utilization of Funds. Though raising of funds is important but their
effective utilization is more important. The funds should be used in such a way that
maximum benefit is derived from them. The returns from their use should be more than
their cost. It should be ensured that funds do not remain idle at any point of time. The
funds committed to various operations should be effectively utilized.
3. Increasing Profitability. The firm’s ability to earn profit must be increased.
There must be higher profit measured in terms of ROI. The management practices must
be so designed to increase its profitability.
4. Maximising Firm’s Value. Finance function also aims at maximizing the
value of the firm. It is generally said that a concern’s value is linked with its profitability.
Even though profitability influences a firm’s value but it is not all. Besides profits, the
type of sources used for raising funds, the cost of funds, the condition of money market,
the demand for products are some other considerations which also influence a firm’s
value.

SCOPE OR CONTENT OF FINANCIAL MANAGEMENT

The main objective of financial management is to arrange sufficient finances for

meeting short-term and long-term needs. These funds are procured at minimum costs so
that profitability of the business is maximized. With these things in mind, a Financial
Manager will have to concentrate on the following areas of finance function.

1. Estimating Financial Requirements. The first task of a financial manager is

to estimate short-term and long-term financial requirements of his business. For this
purpose, he will prepare a financial plan for present as well as for future. The amount
required for purchasing fixed assets as well as needs of funds for working capital will
have to be ascertained. The estimations should be based on sound financial principles
so that neither there are inadequate nor excess funds with the concern. The inadequacy of
funds will adversely affect the day-to-day working of the concern whereas excess funds
may tempt a management to indulge in extravagant spending or speculative activities.
2. Deciding Capital Structure. The capital structure refers to the kind and
proportion of different securities for raising funds. After deciding about the quantum
of funds required it should be decided which type of securities should be raised. It may
be wise to finance fixed assets through long-term debts. If gestation period is longer,

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then share capital may be most suitable. Long-term funds should be employed to finance
working capital also partially. A decision about various sources for funds should be
linked to the cost of raising funds.
3. Selecting a Source of Finance. After preparing a capital structure, an
appropriate source of finance is selected. Various sources, from which finance may be
raised, include; share capital, debentures, financial institutions, commercial banks,
public deposits, etc. If finances are needed for short periods then banks, public deposits
and financial institutions may be appropriate; on the other hand, if long-term finances are
required then share capital and debentures may be useful. The need, purpose, object and
cost involved may be the factors influencing the selection of a suitable source of
financing.
4. Selecting a Pattern of Investment. When funds have been procured then a
decision about investment pattern is to be taken. The selection of an investment pattern is
related to the use of funds. The decision-making techniques such as Capital Budgeting,
Opportunity Cost Analysis etc. may be applied in making decisions about capital
expenditures. One may not like to invest on a project which may be risky even though
there may be more profits.
5. Proper Cash Management. Cash management is also an important task of
finance manger. He has to assess various cash needs at different times and then make
arrangements for arranging cash. Cash may be required to (a) purchase raw materials, (b)
make payments to creditors, (c) meet wage bills; (d) meet day-to-day expenses. The cash
management should be such that neither there is a shortage of it and nor it is idle. It will
be better if Cash Flow Statement is regularly prepared so that one is able to find out
various sources and applications.
6. Implementing Financial Controls. An efficient system of financial
management necessitates the use of various control devices. Financial control devices
generally used are,; (a) Return on investment, (b) Budgetary Control, (c) Break
Even Analysis., (d) Cost Control, (e) Ratio Analysis (f) cost and Internal Audit. The
use of various control techniques by the finance manager will help him in evaluating the
performance in various areas and take corrective measures whenever needed.
7. Proper Use of Surpluses. The utilisation of profits or surpluses is also an
important factor in financial management. A judicious use of surpluses is essential for
expansion and diversification plans and also in protecting the interests of shareholders.
The ploughing back of profits is the best policy of further financing. A finance manager
should consider the influence of various factors, such as; (a) trend of earnings of the
enterprise, (b) expected earnings in future, (c) market value of shares, (d) need for funds
for financing expansion, etc. A judicious policy for distributing surpluses will be essential
for maintaining proper growth of the unit.

8. Financial Analysis and Interpretation. The analysis and interpretation of

financial statements is an important task of a finance manager. He is expected to know
about the profitability, liquidity position, short-term and long-term financial position of
the concern. For this purpose, a number of ratios have to be calculated. The
interpretation of various ratios is also essential to reach certain conclusions. Financial
analysis and interpretation has become an important area of financial management.

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 9. Cost-Volume-Profit Analysis. Cost-volume-profit analysis is an important
tool of profit planning. It answers questions like, what is the behavior of cost and volume.
At what point of production a firm will be able to recover its costs? How much a firm
should produce to earn a desired profit?
The first concern of a finance manager will be to recover all costs. It will aspire to
achieve break-even point at the earliest. It is a point of no-profit no-loss. Any production
beyond break-even point will bring profits to the concern. This analysis is very helpful in
deciding the volume of output or sales. The knowledge of cost-volume profit analysis is
essential for taking important decisions about production and profits.

10. Capital Budgeting. Capital budgeting is the process of making investment

decisions in capital expenditure. It is an expenditure the benefits of which are expected to
be received over a period of time exceeding one year. It is an expenditure incurred for
acquiring or improving the fixed assets, the benefits of which are expected to be received
over a number of years in future. Capital budgeting decisions are vital to any
organization. An unsound investment decision may prove to be fatal for the very
existence of the concern.

11. Working Capital Management. No business can run successfully without an

adequate amount of working capital. Working capital refers to that part of the firm’s
capital which is required for financing short-term or current assets such as cash,
receivables and inventories. Proper management of working capital is an important area
of financial management.

12. Profit Planning and Control. Profit planning and control is an important
responsibility of the financial manager. Profit is determined by the volume of revenue
and expenditure. The excess of revenue over expenditure determines the amount of profit.
Profit planning and control directly influence the declaration of dividend, creation of
surpluses, taxation etc. Break-even analysis and cost-volume-profit relationship are some
of the tools used in profit planning and control.

13. Dividend Policy. Dividend is the reward of the shareholders for investments
made by them in the shares of the company. The company should distribute a reasonable
amount as dividends to its members and retain the rest for its growth and survival.
Dividend policy is an important area of financial management because the interests of the
share holders and the needs of the company are directly related to it.

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OBJECTIVES OF FINANCIAL MANAGEMENT OR GOALS OF BUSINESS
FINANCE

Financial management is concerned with procurement and use of funds. Its main
aim is to use business funds in such a way that the firm’s value / earnings are maximized.
Financial management provides a frame work for selecting a proper course of action and
deciding a viable commercial strategy. The main objective of a business is to maximize
the owner’s economic welfare. This objective can be achieved by;

1. Profit Maximization, and

2. Wealth Maximization.

1. Profit Maximisation. Profit earning is the main aim of every economic

activity. A business being an economic institution must earn profit to cover its costs and
provide funds for growth. No business can survive without earning profit. Profit is a
measure of efficiency of a business enterprise. Profits also serve as a protection against
risks which cannot be ensured. The accumulated profits enable a business to face risks
like fall in prices, competition from other units, adverse government policies etc. Thus,
profit maximization is considered as the main objective of business. The following
arguments are advanced in favour of profit maximization as the objective of business:

(i) When profit-earning is the aim of business then profit maximization

should be the obvious objective.
(ii) Profitability is a barometer for measuring efficiency and economic
prosperity of a business enterprise
(iii) Economic and business conditions do not remain same at all times. There
may be adverse business conditions like recession, depression, severe
competition etc. A business will be able to survive under unfavorable
situation, only if it has some past earnings to rely upon. Therefore, a
business should try to earn more and more when situation is favorable.
(iv) Profits are the main sources of finance for the growth of a business. So, a
business should aim at maximization of profits for enabling its growth and
development.
(v) Profitability is essential for fulfilling social goals also. A firm by pursuing
the objective of profit maximization also maximizes socio-economic
welfare.

However, profit maximization objective has been criticized on many grounds.

They are:
a. A firm pursuing the objective of profit maximization starts exploiting workers
and the consumers. Hence, it is immoral and leads to a number of corrupt practices.
b. It is also argued that profit maximization should be the objective in the
conditions of perfect competition and in the wake of imperfect competition today, it
cannot be the legitimate objective of a firm
c. One has to reconcile the conflicting interests of all the parties connected with
the firm. Thus, profit maximization as an objective of financial management has been

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considered inadequate. Even as an operational criterion for maximizing owner’s
economic welfare, profit maximization has been rejected because of the following
drawbacks;

(i) The term ‘profit’ is vague and it cannot be precisely defined. It means
different things for different people. Should we consider short-term profits or long-term
profits? Does it mean total profits or earnings per share?
Even if, we take the meaning of profits as earnings per share and maximize the
earnings per share, it does not necessarily mean increase in the market value of share and
the owner’s economic welfare.
(ii) Profit maximization objective ignores the time value of money and does not
consider the magnitude and timing of earnings. It treats all earnings as equal when they
occur in different periods. It ignores the fact that cash received today is more important
than the same amount of cash received after, three years.
(iii)It does not take into consideration the risk of the prospective earnings stream.
Some projects are more risky than other.
(iv) The effect of dividend policy on the market price of shares is also not
considered in the objective of profit maximization.

2. Wealth Maximization. Wealth maximization is the appropriate objective of an

enterprise. When the firm maximizes the stockholder’s wealth, the individual stockholder
can use this wealth to maximize his individual utility. It means that by maximizing
stockholder’s wealth the firm is operating consistently towards maximizing stockholder’s
utility.
A stockholder’s current wealth in the firm is the product of the number of shares
owned, multiplied with the current stock price per share.

Stockholder’s current =(Number of shares) x (Current stock)

wealth in a firm (owned) (price per share)

Symbolically, Wo = N x Po

This objective helps in increasing the value of shares in the market. The share’s
market price serves as a performance index or report card of its progress. It also indicates
how well management is doing on behalf of the shareholder. We can conclude that:

refers to refers to
Maximum Utility Maximum stockholder’s wealth Maximum current
Stock price per share

However, the maximization of the market price of the shares should be in the long
run. Every financial decision should be based on cost-benefit analysis. If the benefit is
more than the cost, the decision will help in maximizing the wealth.

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 Implications of Wealth maximization. There is a rationale in applying wealth
maximizing policy as an operating financial management policy. It serves the interests of
suppliers of loaned capital, employees, management and society. Besides shareholders,
there are short-term and long-term suppliers of funds who have financial interests in the
concern. Short-term lenders are primarily interested in liquidity position so that they get
their payments in time. The long-term lenders get a fixed rate of interest from the
earnings and also have a priority over shareholders in return of their funds.
Wealth maximization objective not only serves shareholder’s interests by
increasing the value of holdings but ensures security to lenders also. The economic
interest of society is served if various resources are put to economical and efficient use.

Criticism of Wealth Maximization. The wealth maximization objective has also

been criticized by certain financial theorists mainly on following accounts;
(i) It is a prescriptive idea. The objective is not descriptive of what the
firms actually do.
(ii) The objective of wealth maximization is not necessarily socially
desirable.
(iii) There is some controversy as to whether the objective is to maximize
the stockholders wealth or the wealth of the firm which includes other
financial claimholders such as debenture holders, preferred
stockholders, etc.,
(iv) The objective of wealth maximization may also face difficulties when
ownership and management are separated as is the case in most of the
large corporate form of organizations.

In spite of all the criticism, we are of the opinion that wealth maximization is the
most appropriate objective of a firm and the side costs in the form of conflicts between
the stockholders and debenture holders, firm and society and stock holders and managers
can be minimized.

FINANCIAL DECISIONS
We can classify these decisions into three major groups:
1. Investment decisions.
2. Financing decisions.
3. Dividend decisions.

1. Investment Decisions. Investment Decision relates to the determination of total

amount of assets to be held in the firm, the composition of these assets and the business
risk complexions of the firm as perceived by its investors
Capital budgeting is the process of making investment decisions in capital
expenditure. These are expenditure, the benefits of which are expected to be received
over a long period of time exceeding one year. The finance manager has to assess the
profitability of various projects before committing the funds. The investment proposals
should be evaluated in terms of expected profitability, costs involved and the risks
associated with the projects. The investment decision is important not only for the setting
up of new units but also for the expansion of present units, replacement of permanent

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assets, research and development project costs, and reallocation of funds, in case,
investments made earlier do not fetch result as anticipated earlier.

Short-term investment decision, on the other hand, relates to the allocation of

funds as among cash and equivalents, receivables and inventories. A sound short-term
investment decision or working capital management policy is one which ensures higher
profitability and proper liquidity..

2. Financing Decisions. Once the firm has taken the investment decision and
committed itself to new investment, it must decide the best means of financing these
commitments. It is concerned with the best overall mix of financing for the firm.
A finance manager has to select such sources of funds which will make optimum
capital structure. The financial manager has to strike a balance between various sources
so that the overall profitability of the concern improves. If the capital structure is able to
minimize the risk and raise the profitability then the market prices of the shares will go
up maximizing the wealth of shareholders.

3. Dividend Decision. The third major financial decision relates to the

disbursement of profits back to investors who supplied capital to the firm. The term
dividend refers to that part of profits of a company which is distributed by it among its
shareholders. It is the reward of shareholders for investments made by them in the share
capital of the company. The dividend decision is concerned with the quantum of profits
to be distributed and the way of distribution among shareholders.

ORGANISATION OF THE FINANCE FUNCTION

The finance function is very vital for every type of business enterprise. There is a
need to set up a sound and efficient organization to achieve its goals. However,
organization of finance function is not standardized one. It varies from enterprise to
enterprise, depending upon its nature, size and other requirements. In a small concern,
whose operations are simple and there is little delegation of authority no separate
executive is appointed to handle finance function. It is the owner who performs all these
function himself. But in medium and large scale concerns, a separate department to
organize all financial activities may be created at top level under the direct supervision of
Board of Directors or a highly placed official. This function may be headed by a
committee or a top management executive. All important financial decisions are taken by
the committee or the executive but routine decisions are left to the lower levels of
management.
The finance function is centralized because of its importance. The financial
decisions are crucial for the survival of the concern. Any bad decision on financial
aspects will adversely affect the reputation of the concern. The centralization of finance
function will result in certain economies in raising funds, purchasing of fixed assets, etc.
In large concerns, for organizing finance functions, the Controller and Treasurer
are appointed. The organization of finance function may be diagrammatically Shown as
below:

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 Board of Directors

Managing Director

Finance Committee

Vice President Production Vice President Finance Vice President Sales

Financial Controller Treasurer

Planning Annual Budgeting Profit Analysis Accounting

And Control Reports and Payroll

Additional Cash Receivables Audit Protect Funds Relations with

Funds Management Management and Securities Banks &
Financial
Institutions

The Controller vs Treasurer.

The table below lists some of the important functions of the treasurer and the
control:
Treasurer Controller
1. Provision of capital (both long-term & 1. Accounting.
short-term)
2. Relations with banks & financial 2. Preparation of financial reports.
institutions
3. Cash Management. 3. Reporting and interpreting.

4. Receivables management. 4. Planning and control.

5. Protect funds and securities 5. Internal audit

(insurance)
6. Investor relations. 6. Tax administration.

7. Audit 7. Economic appraisal &reporting to

Government.

A large number of companies in India appoint finance managers to discharge the

duties of the treasurer or both of the controller and treasurer. Some big companies even
appoint the chief financial officer (CFO) to supervise the functions of these two financial
executives.

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