INTRODUCTION:

Finance is called “The science of money”. It studies the principles

and the methods of obtaining control of money from those who
have saved it, and of administering it by those into whose control
it passes. Finance is a branch of Economics till 1890. Economics is
defined as study of the efficient use of scarce resources. The
decisions made by business firm in production, marketing, finance
and personnel matters form the subject matters of economics.
Finance is the process of conversion of accumulated funds to
productive use. It is so intermingled with other economic forces
that there is difficulty in appreciating the role it plays.

MEANING AND DEFINITION OF FINANCE:

Howard and Uptron in his book introduction to Business Finance
defined, “as that administrative area or set of administrative
function in an organization which relate with the arrangement of
cash and credit so that the organization may have the means to
carry out its objectives as satisfactorily as possible” In simple
terms finance is defined as the activity concerned with the
planning, raising, controlling and administering of the funds used
in the business. Thus, finance is the activity concerned with the
raising and administering of funds used in business.

MEANING AND DEFINITION OF FINANCIAL

MANAGEMENT:
Financial management is managerial activity which is concerned
with the planning and controlling of the firm’s financial resources.

Definitions
Howard and Uptron define financial management “as an
application of general managerial principles to the area of
financial decision-making”.
Weston and Brighem define financial management “as an area of
financial decision making, harmonizing individual motives and
enterprise goal”.
“Financial management is concerned with the efficient use of an
important economic resource, namely capital funds” - Solomon
Ezra & J. John Pringle.
“Financial management is the operational activity of a business
that is responsible for obtaining and effectively utilizing the funds
necessary for efficient business operations”- J.L. Massie.
“Financial Management is concerned with managerial
decisions that result in the acquisition and financing of long-term
and short-term credits of the firm. As such it deals with the
situations that require selection of specific assets, the selection of
specific liability as well as the problem of size and growth of an
enterprise. The analysis of these decisions is based on the
expected inflows and outflows of funds and their effects upon
managerial objectives”- Phillippatus.
Nature of Financial Management

The nature of financial management refers to its relationship with

related disciplines like economics and accounting and other
subject matters.
The area of financial management has undergone tremendous
changes over time as regards its scope and functions. The finance
function assumes a lot of significance in the modern days in view
of the increased size of business operations and the growing
complexities associated there to.

FINANCE AND OTHER RELATED DISCIPLINES:

Financial management is an integral part of the over all
management, on other disciplines and fields of study like
economics, accounting, production, marketing, personnel and
quantitative methods. The relationship of financial management
with other fields of study is explained as under:
Finance and Economics
Finance is a branch of economics. Economics deals with supply
and demand, costs and profits, production and consumption and
so on. The relevance of economics to financial management can
be described in two broad areas of economics i.e., micro
economics and macro economics.
Micro economics deals with the economic decisions of individuals
and firms. It concerns itself with the determination of optimal
operating strategies of a business firm. These strategies include
profit maximization strategies, product pricing strategies,
strategies for valuation of firm and assets etc. The basic principle
of micro economics that applies in financial management
is marginal analysis. Most of the financial decisions should be
made taken into account the marginal revenue and marginal cost.
So, every financial manager must be familiar with the basic
concepts of micro economics.
Macro economics deals with the aggregates of the economy in
which the firm operates. Macro economics is concerned with the
institutional structure of the banking system, money and capital
markets, monetary, credit and fiscal policies etc. So, the financial
manager must be aware of the broad economic environment and
their impact on the decision making areas of the business firm.

Finance and Accounting

Accounting and finance are closely related. Accounting is an
important input in financial decision making process. Accounting
is concerned with recording of business transactions. It generates
information relating to business transactions and reporting them
to the concerned parties. The end product of accounting is
financial statements namely profit and loss account, balance
sheet and the statements of changes in financial position. The
information contained in these statements assists the financial
managers in evaluating the past performance and future direction
of the firm (decisions) in meeting certain obligations like payment
of taxes and so on. Thus, accounting and finance are closely
related.

Finance and Production

Finance and production are also functionally related. Any changes
in production process may necessitate additional funds which the
financial managers must evaluate and finance. Thus, the
production processes, capacity of the firm are closely related to
finance.

Finance and Marketing

Marketing and finance are functionally related. New product

development, sales promotion plans, new channels of distribution,
advertising campaign etc. in the area of marketing will require
additional funds and have an impact on the expected cash flows
of the business firm. Thus, the financial manager must be familiar
with the basic concept of ideas of marketing.

Finance and Quantitative Methods

Financial management and Quantitative methods are closely
related such as linear programming, probability, discounting
techniques, present value techniques etc. are useful in analyzing
complex financial management problems. Thus, the financial
manager should be familiar with the tools of quantitative
methods. In other way, the quantitative methods are indirectly
related to the day-to-day decision making by financial managers.

Finance and Costing

Cost efficiency is a major strategic advantage to a firm, and will
greatly contribute towards its competitiveness, sustainability and
profitability. A finance manager has to understand, plan and
manage cost, through appropriate tools and techniques including
Budgeting and Activity Based Costing.

Finance and Law

A sound knowledge of legal environment, corporate laws,
business laws, Import Export guidelines, international laws, trade
and patent laws, commercial contracts, etc. are again important
for a finance executive in a globalized business scenario. For
example The guidelines of Securities and Exchange Board of India
[SEBI] for raising money from the capital markets. Similarly, now
many Indian corporate are sourcing from international capital
markets and get their shares listed in the international
exchanges. This calls for sound knowledge of Securities Exchange
Commission guidelines, dealing in the listing requirements of
various international
stock exchanges operating in different countries.

Finance and Taxation

A sound knowledge in taxation, both direct and indirect, is
expected of a finance manager, as all financial decisions are likely
to have tax implications. Tax planning is an important function of
a finance manager. Some of the major business decisions are
based on the economics of taxation. A finance manager should be
able to assess the tax benefits before committing funds. Present
value of the tax shield is the yardstick always applied by a finance
manager in investment decisions.
Finance and Treasury Management
Treasury has become an important function and discipline, not
only in banks, but in every organization. Every finance manager
should be well grounded in treasury operations, which is
considered as a profit center. It deals with optimal management
of cash flows, judiciously investing surplus cash in the most
appropriate investment avenues, anticipating and meeting
emerging cash requirements and maximizing the overall returns,
it helps in judicial asset liability
management. It also includes, wherever necessary, managing the
price and exchange rate risk through derivative instruments. In
banks, it includes design of new financial products from existing
products.

Finance and Banking

Banking has completely undergone a change in today’s context.
The type of financial assistance provided to corporate has
become very customized and innovative. During the early and
late 80’s, commercial banks mainly used to provide working
capital loans based on certain
norms and development financial institutions like ICICI, IDBI, and
IFCI used to provide long
term loans for project finance. But, in today’s context, these
distinctions no longer exist. Moreover, the concept of
development financial institutions also does not exist any longer.
The same bank provides both long term and short term finance,
besides a number of innovative corporate and retail banking
products, which enable corporate to choose between them and
reduce their cost of borrowings. It is imperative for every finance
manager to be up-to date on the changes in services & products
offered by banking sector including several foreign players in the
field.

Finance and Insurance

Evaluating and determining the commercial insurance
requirements, choice of products and insurers, analyzing their
applicability to the needs and cost effectiveness, techniques,
ensuring appropriate and optimum coverage, claims handling,
etc. fall within the ambit of a finance manager’s scope of work &
responsibilities.

International Finance
Capital markets have become globally integrated. Indian
companies raise equity and debt funds from international
markets, in the form of Global Depository Receipts (GDRs),
American Depository Receipts (ADRs) or External Commercial
Borrowings (ECBs) and a number of hybrid instruments like the
convertible bonds, participatory notes etc., Access to international
markets, both debt and equity, has enabled Indian companies to
lower the cost of capital. For example, Tata Motors raised debt as
less than 1% from the international capital markets recently by
issuing convertible bonds. Finance managers are expected to
have a thorough knowledge on international sources of finance,
merger implications with foreign companies, Leveraged Buy Outs
(LBOs), acquisitions abroad and international transfer pricing. The
implications of exchange rate movements on new project viability
have to be factored in the project cost and projected profitability
and cash flow estimates. This is an essential aspect of finance
manager’s expertise. Similarly, protecting the value of foreign
exchange earned, through instruments like derivatives, is vital for
a finance manager as the volatility in exchange rate
movements can erode in no time, all the profits earned over a
period of time.

Finance and Information Technology

Information technology is the order of the day and is now driving
all businesses. It is all pervading. A finance manager needs to
know how to integrate finance and costing with operations
through software packages including ERP. The finance manager
takes an active part in assessment of various available options,
identifying the right one and in the implementation of such
packages to suit the requirement.

Types of Finance

Business Finance
 The term ‘business finance’ is very comprehensive. It implies finances of
business activities. The term, ‘business’ can be categorized into three groups:
commerce, industry and service. It is a process of raising, providing and managing
of all the money to be used in connection with business activities.
It encompasses finance of sole proprietary organizations, partnership firms
and corporate organizations. No doubt, the aforesaid organizations have different
characteristics, features, distinct regulations and rules. And financial problems
faced by them vary depending upon the nature of business and scale of operations.
However, it should be remembered that the same principles of finance are
applicable to large and small organizations, proprietary and nonproprietary
organizations.
According to Guthmann & Dougall, business finance can be broadly
defined as the activity concerned with planning, raising, controlling and
administering of funds used in the business. Business finance deals with a broad
spectrum of the financial activities of a business firm. It refers to the raising and
procurement of funds and their appropriate utilization. It includes within its scope
commercial finance, industrial finance, proprietary finance corporation finance and
even agricultural finance. The subject of business finance is much wider than that
of corporation finance. However, since corporation finance forms the lion's share
in the business activity, it is considered almost inter-changeable with business
finance.
Business finance, apart from the financial environment and strategies of financial
planning, covers detailed problems of company promotion, growth and pattern.
These problems of the corporate sector go a long way in widening the horizon of
business finance. The finance manager has to assume the new responsibility of
managing the total funds committed to total assets and allocating funds to
individual assets in consonance with the overall objectives of the business
enterprise.
Direct Finance
The term 'direct', as applied to the financial organization, signifies that savings are
affected directly from the saving-surplus units without the intervention of financial
institutions such as investment companies, insurance companies, unit trusts, and so
on.
Indirect Finance
The term 'indirect finance' refers to the flow of savings from the savers to the
entrepreneurs through intermediary financial institutions such as investment
companies, unit trusts and insurance companies, and so on.
The scope of finance is vast and determined by the financial needs of the business
enterprise, which have to be identified before any corporate plan is formulated.
This eventually means that financial data must be obtained and scrutinized. The
main purpose behind such scrutiny is to determine how to maintain financial
stability.
Public Finance
It is the study of principles and practices pertaining to acquisition of funds for
meeting the requirements of government bodies and administration of these funds
by the government.
Private Finance
It is concerned with procuring money for private organization and management of
the money by individuals, voluntary associations and corporations. It seeks to
analyze the principles and practices of managing one’s own daily affairs. The
finance of non-profit organization deals with the practices, procedures and
problems involved in the financial management of educational chartable and
religions and the like organizations.
Corporation Finance
Corporation finance deals with the financial problems of a corporate enterprise.
These problems include the financial aspects of the promotion of new enterprises
and their administration during their early period the accounting problems
connected with the distinction between capital and income, the administrative
problems arising out of growth and expansion, and, finally, the financial'
adjustments which are necessary to bolster up to rehabilitate a corporation which
has run into financial difficulties.
The term ‘corporation finance’ includes, apart from the financial
environment, the different strategies of financial planning. It includes problems of
public deposits, inter-company loans and investments, organized markets such as
the stock exchange, the capital market, the money market and the bill market.
Corporation finance also covers capital formation and foreign capital and
collaborations.
Objective & Scope of Financial Management
Financial management is that managerial activity which is
concerned with the planning and controlling of the firm’s financial
resources. The funds raised from the capital market needs to be
procured at minimum cost and effectively utilized to maximize
returns on investments. There is a necessity to make the proper
balancing of the risk-return trade off.

Objectives of Financial Management

Financial management is an academic discipline which is
concerned with
decision-making. This decision is concerned with the size and
composition of
assets and the level and structure of financing. In order to make
right decision, it
is necessary to have a clear understanding of the objectives. Such
an objective
provides a framework for right kind of financial decision making.
The objectives
are concerned with designing a method of operating the Internal
Investment and
financing of a firm. There are two widely applied approaches, viz.

(a) Profit maximization

(b) Wealth maximization.

The term 'objective' is used in the sense of an object, a goal
or decision
criterion. The three decisions - Investment decision, financing
decision and
dividend policy decision are guided by the objective. Therefore,
what is relevant -
is not the over-all objective but an operationally useful criterion: It
should also be
noted that the term objective provides a normative framework.
Therefore, a firm
should try to achieve and on policies which should be followed so
that certain
goals are to be achieved. It should be noted that the firms do not
necessarily
follow them.
Profit Maximization as a Decision Criterion
Profit maximization is considered as the goal of financial
management. In this
approach, actions that Increase profits should be undertaken and
the actions that
decrease the profits are avoided. Thus, the Investment, financing
and dividend
also be noted that the term objective provides a normative
framework decisions
should be oriented to the maximization of profits. The term 'profit'
is used in two
senses. In one sense it is used as an owner-oriented. In this
concept it refers to
the amount and share of national Income that is paid to the
owners of business.
The second way is an operational concept i.e. profitability. This
concept signifies
economic efficiency. It means profitability refers to a situation
where output
exceeds Input. It means, the value created by the use of
resources is greater that
the Input resources. Thus in all the decisions, one test is used I.e.
select asset,
projects and decisions that are profitable and reject those which
are not
profitable.
The profit maximization criterion is criticized on several grounds.
Firstly, the
reasons for the opposition that are based on misapprehensions
about the
workability and fairness of the private enterprise itself. Secondly,
profit
maximization suffers from the difficulty of applying this criterion
in the actual real-world situations. The term and not the overall
business operations. We shall now discuss the limitations of profit
maximization objective of financial management. 'objective'
refers to an explicit operational guide for the internal investment
and financing of a firm
1) Ambiguity:
The term 'profit maximization' as a criterion for financial decision
is vague and
ambiguous concept. It lacks precise connotation. The term 'profit'
is amenable to
different interpretations by different people. For example, profit
may be long-term
or short-term. It may be total profit or rate of profit. It may be net
profit before tax
or net profit after tax. It may be return on total capital employed
or total assets or
shareholders equity and so on.
2) Timing of Benefits:
Another technical objection to the profit maximization criterion is
that It Ignores
the differences in the time pattern of the benefits received from
Investment
proposals or courses of action. When the profitability is worked
out the bigger the better principle is adopted as the decision is
based on the total benefits received over the working life of the
asset, Irrespective of when they were received. The following
table can be considered to explain this limitation
3) Quality of Benefits
Another Important technical limitation of profit maximization
criterion is that it
ignores the quality aspects of benefits which are associated with the
financial
course of action. The term 'quality' means the degree of certainty
associated with
which benefits can be expected. Therefore, the more certain the
expected return,
the higher the quality of benefits. As against this, the more
uncertain or
fluctuating the expected benefits, the lower the quality of benefits.
The profit maximization criterion is not appropriate and suitable as
an operational
objective. It is unsuitable and inappropriate as an operational
objective of
Investment financing and dividend decisions of a firm. It is vague
and ambiguous.
It ignores important dimensions of financial analysis viz. risk and
time value of
money. An appropriate operational decision criterion for financial
management should possess the following quality.
a) It should be precise and exact.
b) It should be based on bigger the better principle.
c) It should consider both quantity and quality dimensions of
benefits.
d) It should recognize time value of money.

Wealth Maximization Decision Criterion

Wealth maximization decision criterion is also known as Value
Maximization or
Net Present-Worth maximization. In the current academic
literature value
maximization is widely accepted as an appropriate operational
decision criterion
for financial management decision. It removes the technical
limitations of the
profit maximization criterion. It posses the three requirements of
a suitable
operational objective of financial courses of action. These three
features are
exactness, quality of benefits and the time value of money.
i) Exactness:
The value of an asset should be determined In terms of returns it
can produce. Thus, the worth of a course of action should be
valued In terms of
the returns less the cost of undertaking the particular course of
action. Important
element in computing the value of a financial course of action is
the exactness in
computing the benefits associated with the course of action. The
wealth
maximization criterion is based on cash flows generated and not
on accounting
profit. The computation of cash inflows and cash outflows is
precise. As against
this the computation of accounting is not exact.
ii) Quality and Quantity and Benefit and Time Value of
Money:
The second feature of wealth maximization criterion is that. It
considers both the quality and quantity dimensions of benefits.
Moreover, it also
incorporates the time value of money. As stated earlier the
quality of benefits
refers to certainty with which benefits are received In future. The
more certain the
expected cash in flows the better the quality of benefits and
higher the value. On
the contrary the less certain the flows the lower the quality and
hence, value of
benefits. It should also be noted that money has time value. It
should also be
noted that benefits received in earlier years should be valued
highly than benefits
received later.
The operational implication of the uncertainty and timing
dimensions of the
benefits associated with a financial decision is that adjustments
need to be made
in the cash flow pattern. It should be made to incorporate risk and
to make an
allowance for differences in the timing of benefits. Net present
value
maximization is superior to the profit maximization as an
operational objective. It
involves a comparison of value of cost. The action that has a
discounted value
reflecting both time and risk that exceeds cost is said to create
value. Such actions are to be undertaken. Contrary to this actions
with less value than cost,
reduce wealth should be rejected. It is for these reasons that the
Net Present
Value Maximization is superior to the profit maximization as an
operational
objective.

PROFIT MAXIMIZATION VS WEALTH MAXIMIZATION

PROFIT MAXIMISATION
It is one of the basic objectives of financial management. Profit
maximization aims at improving profitability, maintaining the
stability and reducing losses and inefficiencies.
Normally profit is linked with efficiency and so it is the test of
efficiency.
However this concept has certain limitations like ambiguity i.e.
the term is not
clear as it is nowhere defined, it changes from person to person.
Quality of profit - normally profit is counted in terms of rupees.
Normally amount earned is called as profit but it ignores certain
basic ideas like wastage, efficiency, employee skill, employee’s
turnover, product mix, manufacturing process, administrative
setup.
Timing of benefit / time value of profit - in inflationary conditions
the value of profit will decrease and hence the profits may not be
comparable over a longer period span.
Some economists argue that profit maximization is sometimes
leads to unhealthy trends and is harmful to the society and may
result into exploitation, unhealthy competition and taking undue
advantage of the position.

WEALTH MAXIMISATION
It is one of the traditional approaches of financial management ,
by wealth maximization we mean the accumulation and creation
of wealth , property and assets over a period of time thus if profit
maximization is aimed after taking care , of its limitations it will
lead to wealth maximization in real sense, it is a long term
concept based on the cash flows rather than profits an hence
there can be a situation where a business makes losses every
year but there are cash profits because of heavy depreciation
which indirectly suggests heavy investment in fixed assets and
that is the real wealth and it takes into account the time value of
money and so is universally accepted.

SCOPE OF FINANCIAL MANAGEMENT:

Financial Management today covers the entire gamut of activities
and functions given below.
The head of finance is considered to be important ally of the CEO
in most organizations and performs a strategic role. His
responsibilities include:
a. Estimating the total requirements of funds for a given period.
b. Raising funds through various sources, both national and
international, keeping in mind the cost effectiveness;
c. Investing the funds in both long term as well as short term
capital needs;
d. Funding day-to-day working capital requirements of business;
e. Collecting on time from debtors and paying to creditors on
time;
f. Managing funds and treasury operations;
g. Ensuring a satisfactory return to all the stake holders;
h. Paying interest on borrowings;
i. Repaying lenders on due dates;
j. Maximizing the wealth of the shareholders over the long term.
k. Interfacing with the capital markets;
l. Awareness to all the latest developments in the financial
markets;
m. Increasing the firm’s competitive financial strength in the
market &
n. Adhering to the requirements of corporate governance.

ROLE OF FINANCIAL MANAGEMENT :

_ To participate in the process of putting funds to work within the
business and to control their productivity; and
_ 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 analyzed 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 company’s
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 forecast 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 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:
_ 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;
_ 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.

FUNCTIONS OF FINANCIAL MANAGEMENT :

The modern approach to the financial management is concerned
with the solution of major problems like investment financing and
dividend decisions of the financial operations of a business
enterprise. Thus, the functions of financial management can be
broadly classified into three major decisions, namely:

(a) Investment decisions,

(b) Financing decisions,
(c) Dividend decisions.
The functions of financial management are briefly discussed as
under:
1. Investment Decision
The investment decision is concerned with the selection of assets
in which funds will be invested by a firm. The assets of a business
firm include long term assets (fixed assets) and short term assets
(current assets). Long term assets will yield a return over a period
of time in future whereas short term assets are those assets
which are easily convertible into cash within an accounting period
i.e. a year. The long term investment decision is known as capital
budgeting and the short term investment decision is identified as
working capital management.
Capital Budgeting may be defined as long – term planning for
making and financing proposed capital outlay. In other words
Capital Budgeting means the long-range planning of allocation of
funds among the various investment proposals. Another
important element of capital budgeting decision is the analysis of
risk and uncertainty. Since, the return on the investment
proposals can be derived for a longer time in future, the capital
budgeting decision should be evaluated in relation to the risk
associated with it.
On the other hand, the financial manager is also responsible
for the efficient management of current assets i.e. working capital
management. Working capital constitutes an integral part of
financial management. The financial manager has to determine
the degree of liquidity that a firm should possess. There is a
conflict between profitability and liquidity of a firm.
Working capital management refers to a Trade – off between
liquidity (Risk) and Profitability.
Insufficiency of funds in current assets results liquidity and
possessing of excessive funds in current assets reduces profits.
Hence, the finance manager must achieve a proper trade – off
between liquidity and profitability. In order to achieve this
objective, the financial manager must equip himself with sound
techniques of managing the current assets like cash, receivables
and inventories etc.
2. Financing Decision
The second important decision is financing decision. The financing
decision is concerned with capital – mix, (financing – mix) or
capital structure of a firm. The term capital structure refers to the
proportion of debt capital and equity share capital. Financing
decision of a firm relates to the financing – mix. This must be
decided taking into account the cost of capital, risk and return to
the shareholders. Employment of debt capital implies a higher
return to the share holders and also the financial risk. There is a
conflict between return and risk in the financing
decisions of a firm. So, the financial manager has to bring a trade
– off between risk and return by maintaining a proper balance
between debt capital and equity share capital. On the other hand,
it is also the responsibility of the financial manager to determine
an appropriate capital structure.
3. Dividend Decision
The third major decision is the dividend policy decision. Dividend
policy decisions are concerned with the distribution of profits of a
firm to the shareholders. How much of the profits should be paid
as dividend i.e. dividend payout ratio. The decision will depend
upon the preferences of the shareholder, investment
opportunities available within the firm and the opportunities for
future expansion of the firm. The dividend pay out ratio is to be
determined in the light of the objectives of maximizing the market
value of the share. The dividend decisions
must be analyzed in relation to the financing decisions of the firm
to determine the portion of retained earnings as a means of direct
financing for the future expansions of the firm.

IMPORTANT FUNCTIONS OF THE FINANCIAL MANAGER:

The important function of the financial manager in a modern
business consists of the following:

1. Provision of capital: To establish and execute programmes

for theprovision of capital required by the business.

2. Investor relations: to establish and maintain an adequate

market for the company securities and to maintain adequate
liaison with investment bankers, financial analysis and share
holders.

3. Short term financing: To maintain adequate sources for

company’s current borrowing from commercial banks and
other lending institutions.

4. Banking and Custody: To maintain banking arrangement,

to receive, has custody of accounts.

5. Credit and collections: to direct the granting of credit and

the collection
of accounts due to the company including the supervision of
required
arrangements for financing sales such as time payment and
leasing
plans.

6. Investments: to achieve the company’s funds as required

and to
establish and co-ordinate policies for investment in pension
and other
similar trusts.

7. Insurance: to provide insurance coverage as required.

8. Planning for control: To establish, co-ordinate and
administer an adequate plan for the control of operations.

9. Reporting and interpreting: To compare information with

operating plans and standards and to report and interpret
the results of operations to all levels of management and to
the owners of the business.

10. Evaluating and consulting: To consult with all the

segments of
management responsible for policy or action concerning any
phase of
the operation of the business as it relates to the attainment
of
objectives and the effectiveness of policies, organization
structure an procedures.

11.Tax administration: to establish and administer tax

policies and procedures.

12. Government reporting: To supervise or co-ordinate the

preparation of reports to government agencies.

13. Protection of assets: To ensure protection of assets for

the business
through internal control, internal auditing and proper
 insurance
coverage.

Financial management Science or Art?

Financial management is neither a pure science nor an art. It

deals with various methods and techniques which can be
adopted, depending on the situation of business and the purpose
of the decision. As a science It uses various statistical and
mathematical models and computer applications for solving the
financial problems relating to the firm, for example, capital
investment apraisal, capital allocation and rationing, optimizing,
capital structure mix, portfolio management along with the above,
a finance manager is required to apply his analytical skills in
decision making, hence, financial management is both a science
as well as an art.

Financial System - Illustrated

Below you see the 5 step system of accountancy. If you are able to
manage this you will get a financially well managed company.
Step 1

Make sure that you get an invoice for all financial transaction you make in
your company. When you buy goods, get a receipt. When you sell goods,
issue an invoice. When you pay out salary, make a salary statement.

Step 2
Every evening you organize the invoices, receipts, salary statements and
other financial documentation. File them in date order in a ring binder. If
necessary write a text that explains the content of the invoice if it is unclear.
This make you remember the content of the invoice when you have to do
the bookkeeping.

Step 3
At regular intervals the invoices must be entered in bookkeeping software.
If you have many invoices you may have to do it every day. If you only
have five invoices in a week, you can do it once a month. If you purchase a
PC bookkeeping software you can do it yourself. You can also outsource
the bookkeeping work. Maybe to an accountant or to your wife, husband or
to another family member.

Step 4

All the invoices are now entered in the PC book keeping programme. The
programme can now generate reports. Reports about the financial situation
in the company.

Step 5

Use the different reports to look critically at your company. Does it perform
well? What can you do better? When you are doing this and acting on it,
you are performing financial management.
Financial Statement

A Financial Statement is a report which tells how the financial situation in

the company is at a specific time. It is usually made once a year. But you
can also make a financial statement every three month.

There are two main subjects in the report:

1. Profit & Loss Statement

The Profit and Loss statement tells about the earnings and spending of the
company during the year. This means how much income has the company
had from the daily running of activities and how much has the company
spent on the same activities. This part of the report tells whether the
activities have been running as a profitable business in the period or not. It
is called the Profit & Loss Statement.

2. Balance Statement

The other main statement in the report is the Balance Statement which
shows the actual value of the company as such. This means how much
money is present in the company in total when the value of buildings, tools,
stock, money in the bank account and in the cash box etc. is added. It also
shows how much the company owes to others. A company normally owes
money to suppliers, the bank and to the owner of the company.

Where does the statement come from:

The statement reports are generated by your PC bookkeeping software or

your accountant's software. The statement is generated from the vouchers
entered in the bookkeeping software.

If you have entered all your vouchers correctly during the year, the
statements will give a true financial picture of your business. To be able to
read the statement you must know the elements in it.

Financial Statement
A Financial Statement is a report which tells how the financial situation in the company is at a
specific time. It is usually made once a year. But you can also make a financial statement every
three month.

There are two main subjects in the report:

1. Profit & Loss Statement

The Profit and Loss statement tells about the earnings and spending of the company during the
year. This means how much income has the company had from the daily running of activities
and how much has the company spent on the same activities. This part of the report tells
whether the activities have been running as a profitable business in the period or not. It is called
the Profit & Loss Statement.

2. Balance Statement

The other main statement in the report is the Balance Statement which shows the actual value
of the company as such. This means how much money is present in the company in total when the
value of buildings, tools, stock, money in the bank account and in the cash box etc. is added. It

also shows how much the company owes to others. A company normally owes money to
suppliers, the bank and to the owner of the company.

The statement come from

The statement reports are generated by your PC bookkeeping programme or your

accountant's programme. The statement is generated from the vouchers entered in the
bookkeeping programme. If you have entered all your vouchers correctly during the year, the

statements will give a true financial picture of your business. To be able to read the statement
you must know the elements in it.

The Profit and Loss Statement

Profit & Loss Statement for a commercial company usually follow this structure:

Sale / Turnover

- Variable Costs / Used Goods

= Gross Profit

- Fixed Costs

- Depreciation

- Interest

= Profit

Sale / Turnover
Sale / turnover is the ”the money you receive from the customers” when they have purchased a
product or service from you.

• If you sell 10 pairs of shoes at 100 $ your sale / turnover will be 1.000 $

• If you sell 5 hours of consultancy service at 75 $ per hour your sale /turnover will be 375 $.

Any sales tax will not be a part of the budget. Sales tax will be accounted

for separately.

Variable Costs / Used Goods

In the second line of the Profit & Loss Statement all expenses directly connected with the sale
are deducted. The more you sell the higher variable costs.

• If you expect to sell 10 pairs of shoes you have to buy 10 pairs of shoes.

• If you expect to sell 7.000 pairs of shoes you have to buy 7.000 pairs of shoes.

The buying of shoes is directly connected with the selling of shoes (used goods).
If you produce leather shoes you have to buy leather (raw material). The purchase of leather will
show as variable costs / used goods in the budget.

Consultants rarely have expenses concerning the “variable costs / used goods”. For instance an
accountant has few direct expenses in producing the yearly accounts for a client. Maybe 20
sheets of paper.

Gross Profit

The difference between Sales and Variable Cost is called Gross profit. It shows how much
money you have got left to pay for instance your rent, telephone, internet access, marketing and
your own pay.

Fixed Costs

Fixed costs will usually not be higher if you sell more. And not lower when you sell less. The
rent of the shoe shop will be the same whether you sell 10 pairs of shoes or 150 pairs of shoes.

The staff might be able to sell 150 pairs of shoes. But they only sell 10 pairs. It takes time to lay
off staff so Staff expenses is considered a Fixed cost.

Fixed costs can be variable - like a telephone bill. It is because the telephone bill does not
necessary vary with sales volume. The variation is due to other circumstances than the sales
volume.

Write Of / Depreciation

You invest in a new building for your business. Or you purchase a 10 thousand dollar machine.
You can not deduct such big investments in the accounts the first year. The investment must be
spread out over several years.

One way to do it is to depreciate / deduct / write of 30 % of the value every year. An example:

• A machine cost 10.000 $.

Year 1 you can deduct 3.000 $ in the operating budget

(30 % of 10.000).

Year 2 you can deduct 2.100 $

(10.000 - 3.000 = 7.000. 30 % of 7.000 = 2.100)

For specific rules in your country contact an accountant or the relevant

authorities.

Interest

If you borrow money in a bank you will see the interest deducted as an expense in the Profit and
Loss Statement. Also the different charges to the bank can be deducted. Interest for money
borrowed from family or other sources can usually not be deducted.

For specific rules in your country contact an accountant or the relevant authorities.

Profit / Net income

Also referred to as profit/loss or proprietor´s salary. Net income is the proceeds a proprietor
makes from running his/her business. Net income does not always exist in terms of cash. It can
be partly or fully tied-up in stocks or balance due from customers.

The Balance Statement

The Balance Statement shows the Assets and the Liabilities in the company.

• The Liabilities indicate the sources of money which have been available to the company. You
could also say: “Where did the money come from”

• The Assets show how the money which has been made available to the company was
placed. You could also say: “What did we do with the money”

The Balance Statement only tells how the company stands on one particular day, for instance
the 31st December.

The Balance Statement is usually made by the accountant but it is in your interest to understand
it.

The Assets

The Balance Statement is divided into assets and liabilities. The Assets can also be divided into
two types: the Current Assets and the

Fixed Assets.
A third type of Assets which is a kind of "in between" the other two is the value of the stock.

Current Assets

The Current Assets are the values which are fairly easy to get access to in

case you need money.

The Current Assets are the following:

• Cash

• Bank account

• Staff debtors - money which staff members owe to the company

• Other debtors - money which other people/businesses owe to the company

• Stock – goods that you are able to sell

Stock

If you have a production company or a shop you add the value of all the items in stock together
in the balance statement. The stock is in your possession so you are the owes who own it.

Maybe you have not paid for all the stock yet, but then your debts to the stock will be shown
under the “liabilities” in the Balance Statement.

The value of the stock is the value which was counted in the shop or at the production plant
when closing of the accounts for the year.

The Liabilities

The Balance Statement shows the Assets and the Liabilities in the company.

The Liabilities can be divided into two different types:

 Money that the company has accumulated during the years

 Money that the company has borrowed or owes to creditors

At least at the end of every financial year a company will calculate the two types of liabilities.
Together they make the sum of money which is available to the company at the end of a
financial year. For instance at 31st December 2005.

Accumulated funds
The part of the liabilities which is the money that the company owns is usually registered on the
following accounts:

 Owner´s Equity

 Donations

The Owner´s Equity is the company´s accumulated funds. It consists of money which was
given to the company when it started. Probably the money came from the owner himself and/or
his investors.

Money which the company itself has generated from its activities prior to the financial period will
be registered here. For instance the profit generated in the company in 2005 will be transferred
to Owner´s Equity.

If one year you lose money the amount will be deducted from Owner´s

Equity.

If the company is a development project or a socially oriented organization it will now and then
be granted funds. These donations will be registered on the Donation account.

Creditors

The money that the company owes to creditors could be registered on the following accounts:

 Bank loans – money borrowed from a financial institution

 Suppliers – goods received but not paid for

 Sales tax – tax owed to the government

 Staff tax – tax owed to the government

 Other Creditors – others the company owes money