FINANCIAL MANAGEMENT

Chapter – 1 SCOPE AND OBJECTIVES OF FINANCIAL MANAGEMENT

Meaning of Financial Management

Financial management is the managerial activity which is concerned with planning and controlling of the firm’s
financial resources. In other words it is concerned with acquiring, financing and managing assets to accomplish
the overall goal of a business enterprise, that is, to maximise the shareholder’s wealth).

Financial Management is the Art and Science of Managing Money

Definition:
Financial management comprises the forecasting, planning, organizing, directing, coordinating and controlling
of all activities relating to acquisition and application of the financial resources of an undertaking in keeping with
its financial objective.

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Financial Management deals with the procurement of funds and their effective utilization in the business. The
first basic function of financial management is procurement of funds and the other is their effective utilization.
Procurement of funds:
1) Funds can be procured from different sources. Some of them are owners’ funds and others are borrowed
funds. Various sources for funds for a business enterprise are:-
(a) Owners Funds
(b) Loans from Banks and Financial Institutions
(c) Debentures and Bonds
(d) Hire purchases and Leasing
(e) Angel Funding
(f) Venture Capital
2) Procurement of funds is a complex problem for business concerns. Funds procured from different sources
have different characteristics in terms of risk, cost and control.
i) The funds raised by issuing equity share poses no risk to the company. The funds raised are quite
expensive. The issue of new shares may dilute the control of existing shareholders.
ii) Debenture is relatively cheaper source of funds, but involves high risk as they are to be repaid in
accordance with the terms of agreement. Also interest payment has to be made under any
circumstances. Thus there are risk, cost and control considerations, which must be taken into account
before raising funds.
iii) Funds can also be procured from banks and financial institutions subject to certain restrictions.
iv) Instruments like commercial paper, deep discount bonds, etc also enable to raise funds.
v) Foreign direct investment (FDI) and Foreign Institutional Investors (FII) are two major routes for
raising funds from international sources, besides ADR’s and GDR’s.
Effective utilisation of funds:
1) Since all the funds are procured at a certain cost, therefore it is necessary for the finance manager to take
appropriate and timely actions so that the funds do not remain idle.
2) If these funds are not utilised in the manner so that they generate an income higher than the cost of
procuring them then there is no point in running the business.

IMPORTANCE OF FINANCIAL MANAGEMENT

Financial Management is the key to successful business operations. Financial management is all about planning
the investment, funding the investment, managing returns from the investments and monitoring expenses
against budget. Financial management means management of all matters related to an organization’s finances.
The importance of Financial Management can be described through the following functions.
1) Not to over-invest or under-invest in fixed assets
2) Balancing cash-outflow with cash-inflows
3) Ensuring that there is a sufficient level of working capital
4) Setting sales revenue targets that will deliver growth
5) Increasing gross profit by setting the correct pricing for products or services
6) Controlling the level of general and administrative expenses by finding more cost-efficient ways of running
the day-to-day business operations,
7) Tax planning that will minimize the taxes a business has to pay.
8) To take key decisions relating to the business which enhance the wealth of owners.

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SCOPE OF FINANCIAL MANAGEMENT
Financial management is mainly concerned with acquisition and use of funds by an organization. The scope of
financial management includes;
a) Determination of size of the enterprise and determination of rate of growth.
b) Determining the composition of assets of the enterprise.
c) Determining the mix of enterprise’s financing i.e. consideration of level of debt to equity,
d) Analysis, Planning and control of financial affairs of the enterprise

The given figure depicts the overview of the scope and functions of financial management. It also gives the
interrelation between the market value, financial decisions and risk return trade off. The finance manager, in a
bid to maximize shareholders’ wealth, should strive to maximize returns in relation to the given risk; he should
seek courses of actions that avoid unnecessary risks. To ensure maximum return, funds flowing in and out of
the firm should be constantly monitored to assure that they are safeguarded and properly utilized.

OBJECTIVES OF FINANCIAL MANAGEMENT

A firm’s financial management may often have the following as their objectives:
(i) The maximisation of firm’s profit.
(ii) The maximisation of firm’s value / wealth.
Profit Maximisation:
The primary objective of any business is to earn profit. In this sense, it is the objective of Financial Management
also to maximize the profits of the firm. This implies that the finance manager has to make his decisions in a
manner so that the profits of the concern are maximised.
Profit in simple terms is the excess of revenue over expenditure. Firm earns profits when the products / services
are sold at a price which is more than the total cost of products / services.
However, profit maximisation cannot be the sole objective of a company. Profit maximization has certain
limitations as described below:
a. The term profit is vague. It cannot be determined easily.
b. Profit maximisation ignores the risk involved in the business.
c. Profit maximisation as an objective does not take into account the time pattern of returns.
d. Profit maximisation ignores social responsibility, ethical values and morals of the business.
Due to these limitations, wealth maximization is a better goal to be pursued compared to Profit maximization.

Wealth / Value Maximisation:

The shareholder value maximization model holds that the primary goal of the firm is to maximize its market
value and implies that business decisions should seek to increase the net present value of the economic profits
of the firm.
Thus, it can be observed that the value/wealth maximization decision takes into consideration time value
of money and uncertainty of risk. And hence, Wealth maximization is to be considered over profit
maximization.
As a normal tendency the management may pursue its own personal goals (profit maximization). But in an
organization where there is a significant outside participation (shareholding, lenders etc.), the management
may not be able to exclusively pursue its personal goals due to the constant supervision of the various
stakeholders of the company employees, creditors, customers, government, etc.

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The wealth maximization objective is generally in accord with the interests of the various groups such as
owners, employees, creditors and society, and thus, it may be consistent with the management objective of
survival.
The table below highlights some of the advantages and disadvantages of both profit maximization and wealth
maximization goals:-
Particulars Profit maximization Wealth maximization

Meaning Profit maximization refers to maximizing The term wealth maximization refers to maximizing the
the profits of the firm. The focus is on short wealth or value of shareholders. The focus is on long term
term gains. wealth creation instead of short term profits.

Advantages I) Easy to calculate profits I) Emphasizes the long term gains

II) Easy to determine the link between II) Recognises risk or uncertainty
financial decisions and profits.
III) Recognises the timing of returns
IV) Considers shareholders’ return.

Limitations I) Emphasizes the short term gains I) Offers no clear relationship between financial decisions and
II) Ignores risk or uncertainty share price.
III) Ignores the timing of returns II) Can lead to management anxiety and frustration
IV) Requires immediate resources.

DECISIONS OF FINANCE MANAGER:

Focus of financial management is to address three major financial decisions. They are,
1. Financing Decisions
2. Investment Decisions
3. Dividend Decisions.
To achieve wealth maximization, the finance manager has to take careful decision in respect of:
1) Financing decisions:
These decisions relate to acquiring the finance to meet financial objectives. The financial manager needs
to possess a good knowledge of the sources of available funds and their respective costs and needs to
ensure that the company has a sound capital structure, i.e. a proper balance between equity capital and
debt.
2) Investment decisions:
These decisions relate to the selection of assets in which funds will be invested by a firm. The investment
of funds in a project has to be made after careful assessment of the various projects through capital
budgeting. A part of long term funds is also to be kept for financing the working capital requirements.
3) Dividend decisions:
These decisions relate to the determination as to how much and how frequently cash can be paid out of the
profits of an organisation as income for its owners/shareholders. The owner of any profit-making
organization looks for reward for his investment in two ways, the growth of the capital invested and the
cash paid out as income; for a sole trader this income would be termed as drawings and for a limited
liability company the term is dividends.
The dividend decision thus has two elements – the amount to be paid out and the amount to be retained to
support the growth of the organisation, the latter being also a financing decision; the level and regular
growth of dividends represent a significant factor in determining a profit-making company’s market value,
i.e. the value placed on its shares by the stock market.

Role of Chief Financial Officer (CFO)

The Chief Financial Officer of an organisation plays an important role in the company’s goals, policies, and
financial success. His responsibilities include:

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1) Financial analysis and planning: Determining the proper amount of funds to employ in the firm, i.e.
designating the size of the firm and its rate of growth.
2) Investment decisions: The efficient allocation of funds to specific assets.
3) Financing and capital structure decisions: Raising funds on favourable terms as possible i.e. determining
the composition of liabilities.
4) Management of financial resources (such as working capital).
5) Risk management: Protecting assets.
The Role of CFO in information age
1) The information age has given a fresh perspective on the role of financial management and finance
managers.
2) The Chief Finance Officer must transform himself to a front-end organiser and leader who spend more
time in networking, analysing the external environment, making strategic decisions, managing and
protecting cash flows.
3) In due course of time, the role of Chief Finance Officer has shifted from an operational to a strategic level.
4) However, on an operational level the Chief Finance Officer cannot be excused from his traditional duties.
5) The knowledge requirements for the evolution of a Chief Finance Officer will extend from being aware
about capital productivity and cost of capital to human resources initiatives and competitive environment
analysis.
6) He has to develop general management skills for a wider focus encompassing all aspects of business that
depend on or dictate finance.

Functions of a Chief Financial Officer

The twin aspects viz procurement and effective utilization of funds are the crucial tasks, which the CFO faces.
The Chief Finance Officer is required to look into financial implications of any decision in the firm. Thus all
decisions involving management of funds comes under the purview of finance manager. These are namely
Estimating requirement of funds
Capital structure or financing decisions
Investment decisions
Dividend decision
Cash management
Evaluating financial performance
Financial negotiation
Monitoring stock exchange quotations and observing the behaviour of market price per share in the stock
market.
Functions of Finance Manager:
The Finance Manager’s main objective is to manage funds in such a way so as to ensure their optimum
utilisation and their procurement in a manner that the risk, cost and control considerations are properly balanced
in a given situation. To achieve these objectives the Finance Manager performs the following functions:
1) Estimating the requirement of Funds:
This includes forecasting the funds required for both long-term purposes i.e. investment in fixed assets and
for short-term i.e. for working capital. Forecasting the requirements of funds involves the use of techniques
of budgetary control and long range planning.
2) Decision regarding Capital Structure:
Once the requirement of funds has been estimated, a decision regarding various sources from which these
funds would be raised has to be taken. A proper balance has to be made between the loan funds and own

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funds. He has to ensure that he raises sufficient long term funds to finance fixed assets and other long term
investments and to provide for the needs of working capital.
3) Investment Decision:
The investment of funds, in a project has to be made after careful assessment of various projects through
capital budgeting. Assets management policies are to be laid down regarding various items of current
assets. It involves coordination with other department heads. For example, receivable are to be planned in
coordination with sales manager and inventory in coordination with production manager.
4) Dividend decision:
The finance manager is concerned with the decision as to how much to retain and what portion to pay as
dividend depending on the company’s policy. Trend of earnings, trend of share market prices, requirement
of funds for future growth, cash flow situation etc., are to be considered.
5) Evaluating financial performance:
A finance manager has to constantly review the financial performance of the various units of organisation
generally in terms of ROI Such a review helps the management in seeing how the funds have been utilised
in various divisions and what can be done to improve it.

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