INTRODUCTION TO FINANCIAL MANAGEMENT

Finance is the blood of business. Without finance, the heart and brain of business cannot function implying thereby its death. It is without adequate finance no business can survive and without efficient financial mgt no business can prosper and grow.

Definition
Finance may be defined as the position of money at the time it is wanted. F.W. Paish The term finance can be defined as the management of the flows of money through an organization, whether it will be a corporation, school, bank or government agency. John J.Hampton

Classification of finance
Public finance:-Public finance deals with the requirements, receipts and disbursements of funds in the government institutions like states, local self-governments and central government. Private finance:-Private finance is concerned with requirements, receipts and disbursements of funds in case of an individual, a profit seeking business organization and a

non-profit organization. Thus , private finance can be classified into: i Personal finance:- It deals with the analysis of principles and practices involved in managing ones own daily need of funds. ii Business finance:- The study of principles, practices, procedures, and problems concerning financial management of profit making organizations engaged in the field of industry, trade, and commerce is undertaken under the discipline of business finance. iii Finance of non-profit organizations:- The finance of nonprofit organization is concerned with the practices, procedures and problems involved in financial management of charitable, religious, educational, social and the other similar organizations. Institutional finance:- In the economic set up of a country there are many financial institutions such as banks, insurance companies, financial corporations, units trusts, etc. International finance: - This area of finance focuses attention on flow of funds beyond national boundaries. Many governments put restrictions on the exchange of currency and these may affect business transactions.

Evolution of Financial management

The term financial management refers to corporation finance. In the earlier days its evolution was broadly analyzed into: Traditional phase:- Traditional phase lasted for about four decades. As its features, it referred to certan episodic events

in the life cycle of the firm, particularly about the formation of the company. It also focuses on the issue of capital, its broad expansion programme and highlighted on mergers, reorganization an liquidation. Transitional phase:-Transitional phase began around fourties and continued upto the fifties. This was more or less similar to the traditional phase but with the current problematic views of the managers of finance in the areas of finds analysis, planning and control. Modern phase:- The modern phase started in mid-fifties, and has witnessed an accelerated pace of development. Economic theories have incorporated these finance ideas and attempted to develop quantitative techniques in explaining these ideas.

The brief overview of the evolution of financial management shows that it has developed form a descriptive discipline to an analytical and prescriptive one. It now deals with rigorous analysis of the totality of the finance function, and provides practical guidelines to decision-makers.

Financial management
Meaning of financial management Financial means procuring sources of money supply and allocation of these source on basis of forecasting monetary requirements of the business. Thus , financial management is that part of business management which is concerned with the planning and controlling of firms financial resources.

Definition of financial management

Financial management is the application of the application of the planning & control functions of the finance functions. Howard & Upton Financial management is an area of financial decision making harmonizing individual motive & enterprise goals. Weston & Bringhan

Scope of financial management

Traditional approach:-procurement of funds:-Procurement of funds, Modern approach:-effective utilization of funds:- Effective utilization of funds.

Traditional approach
Under this approach financial management was considered as corporation finance. The following three things were to be studied for procurement of finances: 1. Institutional sources of finance. 2. Issue of financial instrument to collect necessary fund from capital market. 3. Legal and accounting relationship between business & source of finance.

Limitations of traditional approach

One sided approach:-this approach gives more attention to procurement of funds and the problems attached to their administration but ignore efficient utilization of funds. More emphasis on financial problem of corporation:-this approach focused attention only on financial problem of corporate enterprises but non corporate enterprises but non corporate enterprises remain outside purview of its scope. More emphasis to long term funds:-working capital financing are kept outside scope of finance function.

Modern approach
The finance functions or financial decisions into four major groups: Investment decision:-it is relate to selection of assets in which funds are to be investment by the firm. Investment alternatives are numerous. Resources are scarce and limited. The effort is to find out the projects, which are acceptable. i. Long-term investment decisions:-the long-term capital decisions are referred to as capital budgeting decisions, which relate to fixed assets. Short-term investment decisions:-the short investment decisions are referred to as working capital management. Finance decision:- finance decision is concerned with the mix or composition of the sources of raising the funds required by the firm. it is related to the pattern of financing. Liquidity decision:-liquidity decision is concerned with the management of current assets. Basically , this is working capital management. working capital management is concerned with the management of current assets. Dividend decision:- dividend decision is concerned with the amount of profits to be distributed and retained in the firm. The term dividend relates to the portion of profit, which is distributed to shareholder of a company.

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Functions of financial management

Executive finance functions:- it include all those financial decisions of importance which require specialized administrative skill. i. Financial forecasting:- The first and foremost function of financial management is to forecast the financial needs of the concern. In the initial stage, it is done by promoters but in a going concern, it is generally performed by the executive chief or by the officer in charge of the finance-department in a large scale enterprise. Investment policy decisions or establishing assetmanagement policies:- In order to estimate and arrange for cash requirements of an enterprise, it is very necessary to decide now much cash will be invested in fixed (non-cash) assets and how much in short-term or current assets which are normally convertible into cash within a year. Dividend policy decision or allocation of net profit:- For paying dividends to the shareholders of the company as a return upon this investment. For distributing bonus to the employees and companys contribution to other profit sharing plans; and retention of profits for the expansion of business. Cash flows and requirements:- It is the prime responsibility of the financial manager to see that an adequate supply of cash is available at proper time for the smooth running of the business. A good financial cash originates in scales and cash outflows or cash requirements are closely related to volume of sales.

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Deciding upon borrowing policy:- Every organization plans for the expansion of the business for which it requires additional resources. Personal resources being limited, the cash must be arranged by borrowing money, either from commercial banks, and other financial institutions or by floating new debentures or by issuing, new shares. Negotiations for new outside financing:- Finance functions do not stop with the decision to undertake outside financing; it extends towards carrying on negotiations from the outside financing agencies to arrange for it. Checking upon financial performance:-The financial manager is under an obligation to check the financial performance of the funds invested in the business. It requires retrospective analysis of the operating period to evaluate the efficiency of financial planning.

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Incidental finance functions:- Incidental finance functions are those functions of clerical or routine nature which are necessary for the execution of decisions taken by the executives. Some of the important incidental finance functions are: I. II. III. Supervision of cash receipts and disbursements and safeguarding of cash balance. Taking care of all mechanical details of financing. Record keeping and reporting.

Objectives of financial management

Profit maximization:- 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. The following arguments are advanced in favour of profit maximization as the objective of business. I. Profit is the test of economic efficiency:- It is a measuring rod by which the economic performance of the company can be judged. II. Efficient allocation of fund:- Profits leads to efficient allocation of resources tend to be directed to uses which in terms of profitability are the most desirable. III. 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 to society and maximization of capital to be the owners. IV. Internal resources for expansion:- Retained profits can be used for expansion and modernization. V. Reduction in risk and uncertainty:- The gross present value of a course of action is found out by discounting or capital sating it benefits at a rate which reflects their timing and uncertainty. VI. More competitive:- More and more profit enhances the competitive spirits thus, under such conditions firms having more profits can survive.

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Desire for controls:- More and more profits do not add new shareholders as internal resources are used for expansion and modernization. Basis of decision-making:- In all business profit earning capacity is the sound basis of decision-making.

Favourable Arguments for Profit Maximization

The following important points are in support of the profit maximization objectives of the business concern: (i) Main aim is earning profit. (ii) Profit is the parameter of the business operation. (iii) Profit reduces risk of the business concern. (iv) Profit is the main source of finance. (v) Profitability meets the social needs also.

Unfavourable Arguments for Profit Maximization

The following important points are against the objectives of profit maximization: (i) Profit maximization leads to exploiting workers and consumers. (ii) Profit maximization creates immoral practices such as corrupt practice, unfair trade practice, etc. (iii) Profit maximization objectives leads to inequalities among the sake holders such as customers, suppliers, public shareholders,etc.

Limitations of Profit Maximization

1. Quality of benefits:- Profit maximization approach ignores the quality aspects of benefits associated with a financial course of action. 2. Ambiguity-vague:- The term profit is vague and has different interpretations. It means different things to different people.

3. Timing and value of money-ignored:- The concept of profit maximization does not help in making a choice between projects, giving different benefits, spread over a period of time. 4. Ignores financing and dividend aspects:- The profit maximization concepts concentrates on profitability aspect alone and impact of financing and dividend decisions on the market value of shares are, totally, ignored. Wealth maximization:- This is also known as value maximization or net present worth maximization approach, it takes into consideration the time value of money. Its operational features satisfy all the three requirements of a suitable operational objective of financial courses of action i.e quality of benefits, timing of benefits and exactness.

Favourable Arguments for Wealth Maximization

(i) Wealth maximization is superior to the profit maximization because the main aim of the business concern under this concept is to improve the value or wealth of the shareholders. (ii) Wealth maximization considers the comparison of the value to cost associated with the business concern. Total value detected from the total cost incurred for the business operation. It provides extract value of the business concern. (iii) Wealth maximization considers both time and risk of the business concern. (iv) Wealth maximization provides efficient allocation of resources. (v) It ensures the economic interest of the society.

Unfavourable Arguments for Wealth Maximization

(i) Wealth maximization leads to prescriptive idea of the business concern but it may not be suitable to present day business activities. (ii) Wealth maximization is nothing, it is also profit maximization, it is the indirect name of the profit maximization. (iii) Wealth maximization creates ownership-management controversy. (iv) Management alone enjoy certain benefits. (v) The ultimate aim of the wealth maximization objectives is to maximize the profit. (vi) Wealth maximization can be activated only with the help of the profitable position of the business concern.

Limitations of wealth maximization

1. The objective of wealth maximization is not, necessarily, socially desirable. 2. There is some controversy whether the objective of maximization of wealth is of firm or stockholders. 3. In corporate sector, ownership and management are separate unlike in a sole proprietorship.

Functional areas of financial management

1. Determining financial needs:- A finance manager is supposed to meet financial needs of the enterprise. For this purpose, he should determine financial needs of the concern. 2. Financial analysis and interpretation:- The analysis & interpretation of financial statements is an important task of a finance manager. He is expected about the

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profitability, liquidity position, short term and long -term financial position, short varying sales volumes. Choosing the sources of funds:- A number of sources may be available for raising funds. A concern may be resort to issue of share capital and debentures. Cost-volume profit analysis:- This is popularly known as cvp relationship. For this purpose, fixed costs, variable costs and semi variable costs have to be analysed. Capital budgeting:- Capital budgeting is the process of making investment decisions in capital expenditures. Working capital management:- Working capital refers to that part of firms capital which is required for financing short-term or current assets such as cash, receivables and inventories.

FUNCTIONS OF FINANCE MANAGER

Finance function is one of the major parts of business organization, which involves the permanent, and continuous process of the business concern. Finance is one of the interrelated functions which deal with personal function, marketing function, production function and research and development activities of the business concern. At present, every business concern concentrates more on the field of finance because, it is a very emerging part which reflects the entire operational and profit ability position of the concern. Deciding the proper financial function is the essential and ultimate goal of the business organization. Finance manager is one of the important role players in the field of finance function. He must have entire knowledge in the area of accounting, finance, economics and management. His position is highly critical and analytical to solve various problems related to finance. A person who deals finance related activities may be called finance manager. Finance manager performs the following major functions:

1. Forecasting Financial Requirements:-It is the primary function of the Finance Manager. He is responsible to estimate the financial requirement of the business concern. He should estimate, how much finances required to acquire fixed assets and forecast the amount needed to meet the working capital requirements in future. 2. Acquiring Necessary Capital:-After deciding the financial requirement, the finance manager should concentrate how the finance is mobilized and where it will be available. It is also highly critical in nature. 3. Investment Decision:-The finance manager must carefully select best investment alternatives and consider the reasonable and stable return from the investment. He must be well versed in the field of capital budgeting techniques to determine the effective utilization of investment. The finance manager must concentrate to principles of safety, liquidity and profitability while investing capital. 4. Cash Management:-Present days cash management plays a major role in the area of finance because proper cash management is not only essential for effective utilization of cash but it also helps to meet the short-term liquidity position of the concern. 5. Interrelation with Other Departments:-Finance manager deals with various functional departments such as marketing, production, personel, system, research, development, etc. Finance manager should have sound knowledge not only in finance related area but also well versed in other areas. He must maintain a good relationship with all the functional departments of the business organization.

IMPORTANCE OF FINANCIAL MANAGEMENT

Finance is the lifeblood of business organization. It needs to meet the requirement of the business concern. Each and every business concern must maintain adequate amount of finance for their

smooth running of the business concern and also maintain the business carefully to achieve the goal of the business concern. The business goal can be achieved only with the help of effective management of finance. We cant neglect the importance of finance at any time at and at any situation. Some of the importance of the financial management is as follows: 1. Financial Planning:-Financial management helps to determine the financial requirement of the business concern and leads to take financial planning of the concern. Financial planning is an important part of the business concern, which helps to promotion of an enterprise. 2. Acquisition of Funds:-Financial management involves the acquisition of required finance to the business concern. Acquiring needed funds play a major part of the financial management, which involve possible source of finance at minimum cost. 3. Proper Use of Funds:-Proper use and allocation of funds leads to improve the operational efficiency of the business concern. When the finance manager uses the funds properly, they can reduce the cost of capital and increase the value of the firm. 4. Financial Decision:-Financial management helps to take sound financial decision in the business concern. Financial decision will affect the entire business operation of the concern. Because there is a direct relationship with various department functions such as marketing, production personnel, etc. 5. Improve Profitability:-Profitability of the concern purely depends on the effectiveness and proper utilization of funds by the business concern. Financial management helps to improve the profitability position of the concern with the help of strong financial control devices such as budgetary control, ratio analysis and cost volume profit analysis. 6. Increase the Value of the Firm:-Financial management is very important in the field of increasing the wealth of the investors and the business concern. Ultimate aim of any business concern will achieve the maximum profit and higher

profitability leads to maximize the wealth of the investors as well as the nation. 7. Promoting Savings:-Savings are possible only when the business concern earns higher profitability and maximizing wealth. Effective financial management helps to promoting and mobilizing individual and corporate savings. Nowadays financial management is also popularly known as business finance or corporate finances. The business concern or corporate sectors cannot function without the importance of the financial management.

Interface of Financial Management with other Functional Areas Marketing-Finance Interface There are many decisions, which the Marketing Manager takes which have a significant impact on the profitability impact on the profitability of the firm. For example, he should have a clear understanding of the impact the creditext ended to the customers is going to have on the profits of the company. Otherwise in his eagerness to meet the sales targets he is liable to extend liberal terms of credit, which is likely to put the profit plans out of gear. S i milarly, h e shou ld weigh the b en efits of k eepin g a larg e invento ry of finished goods in anticipation of sales against the costs of maintaining thatin v ento ry. Production-Finance Interface As we all know in any manufacturing firm, the Production Manager controlsa major part of the investment in the form of equipment, materials and men. He should so organize his department that the equipments under his control are used most productively, the inventory of work-in- process or unfinishedg o o d s a n d s t o r e s a n d s p a r e s i s o p t i m i z e d a n d t h e i d l e t i m e a n d w o r k stoppages are minimized. If the production manager can achieve this, he would be holding the cost of the output under control and thereby help in maximizing profits. He has to appreciate the fact that whereas the price at which the output can be sold is largely determined by factors external to the firm like competition, government

regulations, etc. the cost of production is more amenable to his control. Similarly, he would have to make decisions regarding make or buy, buy or lease etc. for which he has to evaluate the financial implications before arriving at a decision. Top Management-Finance Interface The top management, which is interested in ensuring that the firm's long-term goals are met, finds it convenient to use the financial statements as am e a n s f o r k e e p i n g i t s e l f i n f o r m e d o f t h e o v e r a l l e f f e c t i v e n e s s o f t h e organization. We have so far briefly reviewed the interface of finance with the non-finance functional disciplines like production, marketing etc.Besides these, t he fi nan ce f uncti on al so has a st rong li nkage wit h t hef un cti ons of the t op man agemen t. St rat egi c pl anni ng and management con t rol are t wo i mp orta n t f uncti ons of the t op managemen t. Fi nancefunction provides the basic inputs needed for undertaking these activities Economics - Finance Interface The field of finance is closely related to economics. Financial managers must understand the economic framework and be alert to the consequences of varying levels of economic activity and changes in economic policy. They must also be abl e t o use econo mi c theori es as guideli ne s f or effi ci entbusine ss op erati on. The pri mary economic pri ncipl e used i n man age rialfinance is marginal analysis, the principle that financial decisions should be made and actions taken only when the added benefit s ex ceed t he added costs. Nearly all-financial decisions ultimately come down to an assessment of their marginal benefits and marginal costs. Accounting Finance Interface The fi rm's fi nan ce (t rea surer) and accounti ng (cont roll ed) acti viti e s are typically within the control of the financial vice president (CFO). Thesef un ct ions are cl osel y relat ed and generall y overl ap

; ind eed , manageri al finance and accounting are often not easily distinguishable. In small firms the controller often carries out the finance function, and in large firms manyaccountants are closely involved in various finance activi ties. However,there are two basic differences between finance and accounting; one relatesto the emphasis on cash flows and the other to decision making. Complex and diverse responsibilities.

Agency problem
A conflict arising when people (the agents) entrusted to look after the interests of others (the principals) use the authority or power for their own benefit instead. It is a pervasive problem and exists in practically every organization whether a business, church, club, or government. Organizations try to solve it by instituting measures such as tough screening processes, incentives for good behavior and punishments for bad behavior, watchdog bodies, and so on but no organization can remedy it completely because the costs of doing so sooner or later outweigh the worth of the results. Also called principal-agent problem or principal-agency problem

Agency risk
Probability of loss due to an agent's pursuance of his or her own interests instead of those of the principal. Also called agency cost.

Agency security
One issued by government agencies (such as municipalities) and which are usually exempt from

most or all taxes.

Agency shop
A working environment where employees are required t o pay union fees, even if they are not union members. The agency shop typically requires such payments to cover the relevant union's services in contract negotiations, settlement of grievances and general adm inistrative procedures.

Agency shop clause

Provision in a collective bargaining agreement that all employees of the firm (whether or not members of the union) pay a fixed monthly sum to the union as a condition of employment. This arrangement (where it is legal) serves as a compromise between the union's objective to eliminate free riders, and management's objective to make union membership a voluntary decision of each employee.

Agency theory
A way of studying the way that a broker and a client work together. This theory will help in determining the best incentives for both individuals in enacting a successful transaction, as well as seeking to reduce the expenses that are related to any potential disagreements between the broker and the client.

Resolving the agency problem

1. Market forces:-market forces act to prevent/minimize agency problems in two ways: I. Behaviour of security market participants:- The security market participants in general and large institutional investors like mutual funds, insurance organisations, financial institutions and so on which hold large blocks of shares of corporate, in particular, actively participate in management. II. Hostile takeovers:-another market forces has in recent years threatened corporate management to perform in the best interest of the owners/shareholders is the possibility of a hostile takeover, i.e acquisition of the (target) firm by another firm/group (i.e, acquirer) that is not supported by management. 2. Agency costs:- To respond to potential market forces by preventing/maximizing agency problems and contributing to the maximization of owners wealth /value. I. Monitoring expenditures II. Bonding expenditures III. Opportunity costs IV. Structuring expenditure a. Incentive plans b. Performance plans