FINANCE ???

As Blood is to Body
Regular and adequate

Finance is to business as blood is to body. It is an enabling function and enables business to perform other business functions such as production, marketing, human resource management. It is the art and science of money. Knowledge of finance is essential for different functional managers.

Career opportunities in finance are available in two major areas namely:

Finance Manager in a company Jobs in Financial Services including banks, investment management, real estate, insurance, mutual funds, etc.

What is Financial Management???

Financial management is concerned with managing the finances of a firm. Managing finances involves Acquisition of assets Sourcing funds (financing) Management of assets According to Solomon, Financial management is concerned with the efficient use of an important economic resource namely capital funds. Thus, financial management is primarily concerned with investment, financing and management decisions.

Basic objective is maintenance of liquid assets and maximisation of profitability of the firm. Maintenance of liquid assets means that the firm has adequate cash in hand to meet its obligations at all times. Ensuring a fair return to shareholders. Maintaining reserves for future growth and expansion. Efficient utilisation of finances and ensuring maximum operational efficiency.

For rational decision making it is necessary to define objectives. The objective of financial management cant be different from the objectives of a firm. Thus, the primary objective of financial management is to help in the achievement of the objectives of a firm.

Two perspective for defining the goal of firm are:

Profit

maximization Maximization of Shareholders Wealth Value creation occurs when we maximize the share price for current shareholders.

A business firm is a profit seeking organisation. Hence profit maximisation should be the goal of a firm. However profit maximisation goal has come under severe criticism: It does not clarify which profits are to be maximised-short run profits or long run profits, rate of profit or amount of profit It ignores time value of money. It does not help in making choices between projects giving benefits spread over a period of time. It overlooks quality aspects of future activities. Business is not run only on the objective to earn high profits. Some companies wishes to concentrate on stability of sales and so they are willing to accept low profits. Some firms use some part of their profits for contribution to society.

Adoption of wealth maximisation is the best criterion for making investment and financing decisions because share prices incorporate both the time value of money, rate of profit and also stability of earnings. Any financial action which creates more wealth than it consumes (or which has net present value above zero) is desirable and should be taken. In case of mutually exclusive projects that project should be taken which creates more wealth or has greater net present value. Now this objective is consistent with the objective of maximising earning per share . The value of share depends on its networth of the company which itself depend on EPS. Thus financial manager should try to increase EPS in long run as this will automatically lead to maximisation of value.
High EPS High Networth High Price of share High shareholders wealth

There are two approaches to scope and functions of financial management: Traditional approach Modern approach

According to traditional approach financial management refers to arranging funds for the activities of a firm. So the scope of financial management was limited to meeting the financing needs by raising funds from external sources. This approach focused the attention of finance manager on financial instruments, financial markets and financial regulation. This approach emphasied more on procurement of funds and its allocation was ignored. Internal decision making such as optimal utilization of financial resources was relatively ignored. Day to day financial problems was ignored. This approach focused more on long term financing needs. Financing of working capital was also ignored.

This approach provides a framework for financial decision making. It covers both acquisition of funds and their allocations. Three broad categories in which financial management can be broken as functions of finance according to modern approach are: investment decisions, financing decisions and dividend policy decisions

This decision relates to selection of assets in which funds will be invested by firm. The assets which can be acquired fall in two categories long term assets which yield return over a period of time and short term assets or current assets assets which in normal course of business are convertible into cash. Decisions relating to acquisition of long term assets are known as capital budgeting decisions. Financial decision making with reference to current assets is termed as working capital management.

This is the most crucial financial decision of a firm. It relates to the selection of assets whose benefits are likely to be available in future over the lifetime of the project. The first aspect is the choice of new assets out of the alternatives available or the reallocation of capital when the existing asset fails to justify the funds invested. An asset fails to justify the funds committed to it if the returns(benefits) are not adequate to compensate for the cost of the funds invested.

The second element of capital budgeting decision is analysis of risk associated with the realization of the benefits /returns from the asset. The third element of capital budgeting is determining the benchmarks against which long term projects are to be evaluated. Benchmarks may relate to the returns that are expected from business. For example cost of capital may be a benchmark rate of return against which all investment proposal will be evaluated.

This is concerned with management of current assets. It is important and integral part of financial management as short term survival is prerequisite for long term success. One aspect here is the trade off between profitability and risk(liquidity). There is a conflict between profitability and liquidity. If a firm does not have adequate working capital that is it doesnt invest sufficient funds in current assets it may become illiquid and consequently may not have the ability to meet its current obligations. If current assets are too large profitability is adversely affected. Another aspect is to manage individual assets efficiently so that neither inadequate or unnecessary funds are locked up.

The concern for financing decision is with the financing mix or capital structure. Capital structure refers to the proportion of debt and equity capital. Financing decision relates to choice of proportion of these sources to finance the investment requirements. A capital structure with reasonable proportion of debt and equity is called optimum capital structure.

Two alternatives available in dealing with profits of a firm are:

They can be distributed to shareholders in the form of dividends. They can be retained in the business itself.

The final decision will depend upon the preference of the shareholders and investment opportunities available with the firm.

Ensuring supply of funds to all units of the organisation as per requirement. Transforming financial data into a form that can be used to monitor and evaluate financial condition/performance. This is done through accounting. Evaluating the need for increased or reduced productive capacity. Monitoring behaviour of share prices. Determining additional /reduced financing requirement Decision regarding the best fixed assets to acquire and when existing fixed assets needs to modified/replaced/liquidated. He has to decide the most appropriate mix of short term and long term financing. To negotiate with bankers, financial institutions and other suppliers of credit.

There has been always a conflict between liquidity and profitability. Liquidity means firm has adequate cash to pay off its bills, to make large purchases, and has cash reserve to meet any emergencies at all times. Profitability means effective utilisation funds so as to yield highest return. Both these are inversely related to each other. If one increase the other will decrease. If a firm does not have adequate working capital that is it doesnt invest sufficient funds in current assets it may become illiquid and consequently may not have the ability to meet its current obligations. If current assets are too large profitability is adversely affected.

There is a direct relationship between Risk and Return. Higher the risk, higher is the return and vice versa High risk will endanger liquidity and high return will increase profitability A company may increase profitability by increasing debt equity ratio. But then its commitments to pay off debts at fixed time will also increase and hence liquidity will be reduced. So an efficient manager tries to maintain a balance between risk and return.

Effective financial management requires use of appropriate methods or tools of analysis. These tools help in Measuring the effectiveness of firms actions and decisions. Evaluating the alternative proposals and selecting the best alternative.

Ratio Analysis ABC Analysis Cash Management Models Financial Leverage and Trading on Equity Cost of Capital and Capital Structure Funds Flow Analysis and Cash Flow Analysis

So a finance manager uses these tools to measure effectiveness of decisions and evaluate alternatives.

Financial Management and Cost Accounting Financial Management and Marketing Financial Management and Assets Management Financial Management and Personnel Management Financial Management and Financial Accounting Financial Management and Strategic Management

Finance manager is concerned with optimum utilisation of resources and he is therefore concerned with the operational cost of the firm. So the information provided by cost accounting is of utmost important as it helps finance manager to keep cost in control

Success or failure of any firm depends on Marketing to a great extent. Deciding upon the price i.e. the pricing policy for the product is of importance to both marketing and finance manager and therefore this should be the joint decision of both the managers. The marketing manager provides with information as to how different pricing policy will affect the firms competitive position. While finance manager provides information such as change in cost at different levels of production and profit margins required to carry on the business. Thus the financial manager contributes substantially towards formulation of the pricing policies of the firm.

Finance manager is concerned with both acquisition and utilization of firms assets. Finance manager and other concerned managers together make joint decision with regard to composition of assets for achieving firms objectives.

Decisions with regard to recruitment, training and placement of staff is responsibility of the Personnel Department. But all this requires finances. Thus these decisions cant be taken by Personnel Department in isolation.

Financial Accounting is a data collection process dealing with accurate recording and reporting while financial management is concerned with management of funds. The main objective of financial accounting is to keep systematic record of all the transactions. The end product of accounting constitutes financial statements such as balance sheets, income statement and cash flow statement. The information contained in these statements help finance managers in assessing the past performance and future directions of the firm and meeting legal obligations. Such information helps in taking financial decisions. Thus, accounting and finance are closely related.

The theory of finance assumes that : Objective of the firm is to maximize wealth of shareholders. Capital markets are perfect ( investors are free to buy/sell, full knowledge available to all the investors, no transaction costs, no restrictions on borrowing fund against security) But in practice capital markets are not perfect and shareholders are not only the stakeholders of the company. Recognizing the imperfection in the markets ( capital, labour, product) companies draw business strategies to manage business in uncertain and imperfect market conditions.

Strategy is a pattern of deployment of resources and environmental interactions in order to achieve objectives of the firm. Strategic Management considers markets as imperfect and designs strategies that aim at achieving the goals for different stakeholders including shareholders. Financial policies must therefore align with corporate strategies. Thus Financial management and strategic management are related.

The three basic decisions of financial management are inter-related. Objectives of each of the three decisions is to maximize shareholders wealth Investment plans are influenced by financing decisions as financing decision determine the cost of capital. One cannot accept any investment proposal where the rate of return is lower than the cost of capital. Thus, investment decisions are taken keeping in mind the financing decision and the cost of financing

Dividend decision are influenced by investment decision. If enough investment opportunities are not available, company may decide to distribute the entire profit as dividend and thus higher dividend may be paid out. Similarly, dividend may be reduced in order to meet the financing requirements of a past investment decision. Current dividends are influenced by the past investment decisions, as earnings from the past investments determine the current profits.

Board of Directors President

V.P. Marketing Controller

V.P. Production

V.P. Finance

V.P. Personnel Treasurer

Planning and General Internal Tax Budgeting Accounting Control Administration

Investment Appraisal and Reporting

Banking Credit and Provision and Collection Custody of Finance

The controller is concerned with management and control of firms assets. Functions of controller are:

Planning and Control- This involves profit planning, plans of capital investment and financing. Also does sales and expense forecasting. Reporting and Interpreting- This involves comparing actual performance with the planned/budgeted performance and interpreting these comparisons in terms of their implications for business. Tax Planning- To establish procedures for tax compliance and develop plans for managing tax liabilities.

Govt. Reporting- To supervise preparation of necessary reports to be submitted to the govt agencies. Protection of Assets- To ensure that business assets are protected against misuse, theft, natural calamities or other risks with the help of internal control, internal audit and insurance. Economic Appraisal- To assess the implications of the economic policies of the govt and social forces that may concern the business( change in import/export policies etc).

The treasurer is primarily concerned with managing the funds (short term assets i.e cash, B/R, debtors, short term investments like t-bills etc) of the company. Functions of treasurer are as follows: Provision of finance- Providing finance for all budgeted activities. Investor Relations- To maintain good relations with investors by providing timely information so that investors have confidence in the company and they provide funds at low cost.

Short term financing- To maintain adequate sources of current borrowings. Banking and custody- To maintain proper banking arrangements and also safe custody of companys funds and securities as well as documents relating to real estate transactions. Credit and Collection- To draw out a credit policy and ensure timely collection of accounts receivables. Investments- To invest companys funds in short term securities so that funds are not idle even for a short period. Insurance- To provide insurance cover as and when required.

What are the major types of financial management decision that business firm make. Describe briefly each one of them and highlight the inter-relationship among these decisions. The traditional role of financial management was wider than the modern role of the financial management Comment and explain. Examine the inter-relationship among the investment, financing and dividend decision. State true or false:
Finance managers objective is to maximize profits Money has no time value Working capital deals with short term liquidity of the firm