Chapter One: An Overview Of Financial Management

1.1. Introduction

Business concern needs finance to meet their requirements in the economic world. Any kind of
business activity depends on the finance. Hence, it is called as lifeblood of business organization.
Whether the business concerns are big or small, they need finance to fulfill their business
activities.
Organization is a group of employees working together consciously towards the organization’s
goal. The goal of traditional organizations is to maximize profit. But the goal of modern
organizations, which are raising funds by issue of equity shares, is to maximize shareholders’
wealth. In other words, the objective is to maximize net present worth by taking right decisions
which help increase share price.
Maximization of shareholders’ wealth is possible only when the organization is able to maximize
net profits. The employees work in the organization under different departments viz., HR,
finance, production, marketing and R & D and now-a-days, IT. All the employees who are in the
decision-making level have to take decisions that help maximize shareholders’ wealth.
1.1.1. Meaning of finance
Finance may be defined as the art and science of managing money. It includes financial service
and financial instruments. It also is referred as the provision of money at the time when it is
needed.
According to Khan and Jain, “Finance is the art and science of managing money”
According to Oxford dictionary, the word ‘finance’ connotes ‘management of money’.
1.1.2. Classification of finance

Finance is one of the important and integral part of business concerns, hence, it plays a major
role in every part of the business activities. It is used in all the area of the activities under the
different names. Finance can be classified into two major parts
A. Private Finance, which includes the Individual, Firms, Business or Corporate Financial
activities to meet the requirements.
B. Public Finance, which concerns with revenue and disbursement of Government such as
Central Government, State Government and Semi-Government Financial matters.
1.1.3. Evolution of finance ----reading assignment
1.1.4. Sources of finance.

A source or sources of finance, refer to where a business gets money from to fund their business
activities. A business can gain finance from either internal or external sources.
A. Internal sources of finance

Internal sources of finance refer to money that comes from within a business. It includes

Owner’s capital refers to money invested by the owner of a business. This source of
finance does not cost the business, as there are no interest charges applied.

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 Retained profit/earning/ is when a business makes a profit, it can leave some or all of
this money in the business and reinvest it in order to expand. This source of finance does
not incur interest charges or require the payment of dividends, which can make it a
desirable source of finance.
Selling assets involves selling products owned by the business. This may be used when
either a business no longer has a use for the product or they need to raise money quickly.
Business assets that can be sold include for example, machinery, equipment, and excess
stock.

B. External sources of finance

External sources of finance refer to money that comes from outside a business. It includes

Family and friends - businesses can obtain a loan or be given money from family or friends
that may not need to be paid back or are paid back with little or no interest charges.
A bank loan is money borrowed from a bank by an individual or business. A bank loan is
paid off with interest over an agreed period of time, often over several years.
Overdrafts - are where a business or person uses more money than they have in a bank
account. This means the balance is in minus figures, so the bank is owed money. Overdrafts
should be used carefully and only in emergencies as they can become expensive due to the
high interest rates charged by banks.
Trade credit- is also an important aspect of external financing. This form of funding usually
applies to a business that gets its goods from wholesale suppliers. Trade credit works by
having the suppliers allow the business to pay for the goods later. This helps the business get
going by driving initial sales and then paying the supplier later.
Leasing - is a way of renting an asset that the business requires, such as a coffee machine.
Monthly payments are made and the leasing company is responsible for the provision and
upkeep of the leased item.
Hire purchase - is used to purchase an asset, such as a delivery van or piece of equipment. A
deposit is paid and the remaining amount for the asset is paid in monthly installments over a
set period of time. The business does not own the item until all payments are made.
Government grants - are a fixed amount of money awarded by the government. Grants are
given to a business on the condition that they meet certain criteria such as providing jobs in
areas of high unemployment. These do not usually need to be paid back.

1.2. The nature and scope of financial management

Definition
Financial management is an integral part of overall management. It is concerned with the duties
of the financial managers in the business firm. It has been defined by Solomon, “It is concerned
with the efficient use of an important economic resource namely, capital funds”.

The most popular and acceptable definition of financial management as given by

 S.C. Kuchal “Financial Management deals with procurement of funds and their effective
utilization in the business”.
 Howard and Upton: Financial management “as an application of general managerial
principles to the area of financial decision-making.

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 Weston and Brigham: Financial management “is an area of financial decision-making,
harmonizing individual motives and enterprise goals”.
 Joshep and Massie: Financial management “is the operational activity of a business that is
responsible for obtaining and effectively utilizing the funds necessary for efficient
operations.
o Thus, Financial Management is mainly concerned with the effective funds
management in the business. In simple words, Financial Management as practiced by
business firms can be called as Corporation Finance or Business Finance.
Financial Management is all about planning, organizing, directing, and controlling the economic
pursuits such as acquisition and utilization of capital of the firm. To put it in other words, it is
applying general management standards to the financial resources of the firm.

Scope of Financial Management

The Scope of financial management is a fundamental part of the day-to-day operations of any
business.
Financial management is one of the important parts of overall management, which is directly
related with various functional departments like personnel, marketing and production.
A. Financial Management and Production Management
Production management is the operational part of the business concern, which helps to multiple
the money into profit. Profit of the concern depends upon the production performance.
Production performance needs finance, because production department requires raw material,
machinery, wages, operating expenses etc. These expenditures are decided and estimated by the
financial department and the finance manager allocates the appropriate finance to production
department.
The financial manager must be aware of the operational process and finance required for each
process of production activities.
B. Financial Management and Marketing
Produced goods are sold in the market with innovative and modern approaches. For this, the
marketing department needs finance to meet their requirements. The financial manager or
finance department is responsible to allocate the adequate finance to the marketing department.
Hence, marketing and financial management are interrelated and depends on each other.

C. Financial Management and Human Resource

Financial management is also related with human resource department, which provides
manpower to all the functional areas of the management. Financial manager should carefully
evaluate the requirement of manpower to each department and allocate the finance to the human
resource department as wages, salary, remuneration, commission, bonus, pension and other
monetary benefits to the human resource department. Hence, financial management is directly
related with human resource management.

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Objectives of Financial Management

Effective procurement and efficient use of finance lead to proper utilization of the finance by the
business concern.
Financial Management focused on
Profit maximization
Wealth maximization
A. Profit Maximization
Main aim of any kind of economic activity is earning profit. A business concern is also
functioning mainly for the purpose of earning profit. Profit is the measuring techniques to
understand the business efficiency of the concern. It has of the following important features.
1. Profit maximization is also called as cashing per share maximization. It leads to
maximize the business operation for profit maximization.
2. Ultimate aim of the business concern is earning profit; hence, it considers all the possible
ways to increase the profitability of the concern.
3. Profit is the parameter of measuring the efficiency of the business concern. So it shows
the entire position of the business concern.
4. Profit maximization objectives help to reduce the risk of the business.
Drawbacks of Profit Maximization
Profit maximization objective consists of certain drawback also:
1. It is vague: In this objective, profit is not defined precisely or correctly. It creates some
unnecessary opinion regarding earning habits of the business concern. The precise
meaning of the profit maximization objective is unclear and ambiguous.
a. Does it mean short or long term profit?
b. Does it mean profit before or after tax?
c. Does it mean total profit or profit per share?
d. Does it mean gross profit or net profit?
Due to these ambiguities, profit fails to serve as an operational and feasible objective of
financial management.
2. It ignores the time value of money: Profit maximization does not consider the time
value of money or the present value of the cash inflow. That is it gives no consideration
to the time value of money and it values benefits received in different periods of time as
the same. It leads certain differences between the actual cash flow and present cash flow
during a particular period.
It does not make an explicit distinction between returns received in different time periods.
3. It ignores risk: Profit maximization does not consider risk of the business concern. Risks
may be internal or external which will affect the overall operation of the business
concern. The streams of benefits may possess different degrees of certainty.

B. Wealth Maximization

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Wealth maximization is also known as value maximization or net present worth maximization.
This objective is a universally accepted concept in the field of business.
Wealth maximization means maximizing the net present value of a course of action to
shareholders. NPV is the difference between the present value of its benefits and the present
value of its costs. Thus, a financial decision that has a positive NPV creates wealth for
shareholders and therefore is desirable.
Important decision function of financial management
1. Investment Decision: This decision is called capital budgeting decision. It begins with a
determination of the total amount of assets needed to be held by the firm. It generally
answers the question that what assets should the firm owns, investment decision or capital
budgeting involves the decision of allocation of capital or commitment of funds to long- term
assets that would yield benefits in the future.
2. Financing Decision: - The second major decision involved in financial management is the
financing decision. The investment decision is broadly concerned with the asset mix or the
composition of the assets of the firm. The concern of the financing decision is with the
financing mix or capital structure, or leverage. The term capital structure refers to the
proportion of debt (fixed – interest source of financing) and equity capital (variable –
dividend securities/ source of funds). The financing decision of a firm relates to the choice of
the proportion of these sources to finance the investment requirements.
3. Dividend Policy Decision: - The third major decision area of financial management is the
decision relating to the dividend policy. It determines the amount of earnings that can be
retained in the firm. The dividend decision should be analyzed in relation to the financing
decision of a firm. Two alternatives are available in dealing with the profits of a firm:
They can be distributed to the shareholders in the form of dividends or
They can be retained in the business itself.
The decision as to which course should be followed depends largely on a significant
element in the dividend decision, the dividend payout ratio that is what portion of net
profits should be paid out to shareholders. The final decision will depend up on the
preference of the shareholders and investment opportunities available within the firm.
The second major aspect of the dividend decision is the factors determining dividend
policy on a firm in practice.
4. Asset Management Decision: After the assets are acquired the need to be managed
effectively. The financial manager is charged with the varying degree of operating
responsibility over existing assets.

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 1.3. The goal of a firm in financial management
Efficient financial management requires the existence of some objective or goal, because
judgment as to whether or not a financial decision is efficient must be made in light of some
standard. Therefore the goal of the firm is to maximize the wealth of the firm’s present
owners, maximizing profit and Corporate Social Responsibility (CSR)

Note: Maximizing shareholder wealth does not mean that management should ignore corporate
social responsibility (CSR), such as protecting the consumer, paying fair wages to employees,
maintaining fair hiring practices and safe working conditions, supporting education, and
becoming involved in such environmental issues as clean air and water. It is appropriate for
management to consider the interests of stakeholders other than shareholders. These stakeholders
include creditors, employees, customers, suppliers, communities in which a company operates,
and others.
1.4. 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. Some of the importance of the financial management is as follows:
A. 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.
B. 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.
C. 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.
D. 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.
E. 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.

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F. 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.
G. 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.

Generally, 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.

THE END