Financial Management

Chapter No.: 1 Financial Management Meaning & Scope

1.1 Meaning of Business Finance
According to B.O. Wheeler Meaning of Business Finance includes those business activities
that are concerned with the acquisition and conservation of capital funds in meeting the
financial needs and overall objectives of a business enterprise.”
Business is identified with the generation and circulation of products and services for
fulfilling of needs of society. For successfully doing any operation, business requires money
which is known as business finance. Therefore, funds are known as the lifeblood of any
business. A business would not function unless there is adequate money accessible for use.
The capital contributed by the businessman to establish the business isn’t adequate to meet
the financial needs of the business. Consequently, the businessman needs to search for an
option to generate funds. A research of the financial needs and options to fulfil those needs
must be done with a specific end goal to arrive at effective financial management to
maintain the business.
The fundamental necessities of business would be to buy a plant or apparatus, or it could be
to buy raw materials, development of a business that prompts more enrolments, paying
wages and so on. The money related necessities of a business can be classified as follows:
Fixed Capital Requirement: In order to begin a business, money is required to buy fixed
assets like land, building, plant and machinery. This is called the Fixed Capital Requirement.
Working Capital Requirement: A business needs funds for its day to day activities. This is
known as Working Capital Requirements. Working capital is required for the purchase of
raw materials, paid salaries, wages, rent, and taxes.
Diversification: A company needs more funds to diversify its activities to become a multi-
product company e.g. ITC.
Technology upgrading: Finances are needed to adopt the latest technology for example use
of particular software and the latest computers in business.

1.2 Meaning of Financial Management

Meaning:
Financial statements are plain statements based on historical records, facts and figures.
They are uncompromising in their objectives, nature and truthfulness. They reflect a
judicious combination of recorded facts, accounting principles, concepts and conventions,
personal judgements and sometimes estimates.
Financial statements consist of ‘Revenue Account’ and ‘Balance Sheet’.
1. Revenue Account / Income Statement:
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Revenue Account refers to ‘Profit and Loss Account’ or ‘Income and Expenditure Account’ or
simply ‘Income Statement’. Revenue Account may be split up or divided into ‘Manufacturing
Account’, ’Trading Account’, ’Profit and Loss Account’ and ‘Profit and Loss Appropriation
Account’, Revenue Account is prepared for a period, covering one year. This statement
shows the expenses incurred on production and distribution of the product and sales and
other business incomes. The final result of this statement may be profit of loss for a
particular period.

2. Balance Sheet:
Balance sheet shows the financial position of a business as on a particular date. It represents
the assets owned by the business and the claims of the owners and creditors against the
assets in the form of liabilities as on the date of the statement.

3. Funds Flow Statement –

It describes the sources from which the additional funds were derived and the use of these
funds. Funds flow statement helps to understand the changes in the distribution of
resources between two balance sheet periods. The statement reveals the sources of funds
and their application for different purposes.

4. Cash flow Statement:

A cash flow statement shows the changes in cash position from one period to another. It
shows the inflow and outflow of cash and helps the management in making plans for
immediate future. An estimated cash flow statement enables the management to ascertain
the availability of cash to meet business obligations. This statement is useful for short term
planning by the management.

5. Schedules:
Schedule explains the items given in income statement and balance sheet. Schedules are a
part of financial statements which give detailed information about the financial position of a
business organization.

1.3 Objectives of Financial Statements

The main object of financial statements is to provide information about the financial
position, performance and changes taken place in an enterprise. Financial statements are
prepared to meet the common needs of most users. The important objectives of financial
statements are given below:
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1. Providing information for taking Economic decisions:

The economic decisions that are taken by users of financial statements require an
evaluation of the ability of an enterprise to generate cash and cash equivalents and of the
timing and certainty of their generation. This ability ultimately determines the capacity of an
enterprise to pay its employees and suppliers meet interest payments, repay loans and
make distributions to its owners.

2. Providing information about financial position:

The financial position of an enterprise is effected by the economic resources it controls, its
financial structures its liquidity and solvency and its capacity to adapt to changes in the
environment in which it operates. Information about financial structure is useful in
predicting future borrowing needs and how future profits and cash flows will be distributed
among those with an interest in the enterprise. This information is useful in predicting how
successful the enterprise is likely to be in raising further finance. Information about liquidity
and solvency is useful to predicting the ability of the enterprise to meet the financial
commitments as fall due.

3. Providing information about performance (working results) of an enterprise:

Another important objective of the financial statements is that it provides information
about the performance and in particular its profitability, which requires in order assessing
potential changes in the economic resources that are likely to control in future. Information
about performance is useful in predicting the capacity of the enterprise to generate cash
inflows from its existing resource base as well in forming judgment about the effectiveness
with which the enterprises might employ additional resources.

4. Providing Information about changes in financial position:

The financial statements provide information concerning changes in the financial position of
an enterprise, which is useful in order to assess its investing, financing and operating
activities during the reporting periods. This information is useful in providing the user with a
basis to assess the ability of the enterprise to generate cash and cash equipment’s and the
needs of the enterprise to utilize those cash flows.
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1.4 Financial Statement Analysis and Interpretation

1.4.1 Meaning and Types of Financial Statements

Financial Statements

Financial statements are the statements that present an actual view of the financial
performance of an organisation at the end of a financial year. It represents a formal record
of financial transactions taking place in an organisation. These statements help the users of
the information in determining the financial position, liquidity and performance of the
organisation.

Financial statements reflect the impact of financial effects of the transactions on the
organisation. Preparation of financial statements is done by both profit and non-profit
organisations. It forms a crucial part of the annual report of any organisation.

Financial statements are used by different stakeholders of an organisation which includes

shareholders, staff, customers, investors, suppliers, stock exchanges, government authority
and other related stakeholders.

1.4.2 Techniques of Financial Analysis

As in balance sheet, so in the revenue statement, as shown above, ready figures can be
obtained for the purpose of further analysis. For instance, gross profit, net profit, materials
consumed, prime cost, works cost, cost of goods sold, etc. are readily available. This would
facilitate the calculation of ratios.

As the information provided in the financial statements is not an end in itself as no

meaningful conclusions can be drawn from these statements alone. However, the
information provided in the financial statements is of immense use in making decisions
through analysis and interpretation of financial statements. To overcome from the
limitations, it becomes necessary to analyse the financial statements. The analytical tools
generally available to an analyst for this purpose are:

1. Comparative financial and operating Statements

2. Common-size statement

3. Trend ration and trend analysis

4. Average Analysis
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5. change in working capital

6. Fund-flow and cost-flow analysis

7. Ratio analysis

1. Comparative Financial and Operating Statement:

Here the Balance Sheet and Income Statement are prepared in a Comparative from as the
impact of the conduct of business is brought to bear in the Balance Sheet, Comparative
statement are made to show –

a. Increases and decreases in absolute data in term of money values.

b. Increases or decreases in absolute data in term of percentage.

c. Comparisons expressed in ration.

d. Percentage of total.

Comparative financial statements are very useful to the analyst as they provide information
necessary for the study of financial and operating trend over a period of years. They indicate
the duration of the movement with respect to the financial position and operating results.
Financial data become more meaningful when compared with similar data for a previous
period or a number of prior periods. The comparative profit and loss account presents a
review of operating activities of the business. The comparative balance sheet shows the
effect of operations on the assets and liability and changes in the financial position during
the period under consideration.

2. Common size Statement:

Comparative statement showing only the vertical percentage or ration for financial data
without giving any rupee value are known as common size statement.

3. Trend Analysis:

This is an important and useful technique of analysis and interpretation of financial

statement. In this technique the ration of different items for various periods are calculate
over a definite period of time say three to five years and then we can analysis trend
highlighted by this ratio. Trend analysis can be done in three following way:

(i) Trend percentage,

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(ii) Trend ratio,

(iii) Graphic and diagrammatic representation.

Here the percentage column is more relevant than the figure.

4. Average Analysis:

It is an improvement over trend analysis method. Here the trend can be presented on the
graph paper also in the shape of curve. In this from the analysis and comparison become
more comprehensive and impressive.

5. Statement of changes in Working Capital:

This statement is prepared to know an increase or decrease in working capital over a period
of time. The statement gives an accurate summary of the events that effects on the amount
of working capital.

6. Funds flow and Cash flow Analysis:

Funds flow analysis is a valuable aid for the financial executive and creditor for the
evaluation of the use of funds by the firm and determining how the funds for the uses are
generated. A Funds flow statement indicates the sources of funds and the application of
during the period under review.

7. Ratio Analysis:

An absolute figure does not convey much meaning. Ration means the relationships
expressed in mathematical terms between two figures which are connected with each other
in some manner

1.4.3 Limitation of Financial Statement

Following are the limitations of financial statements:
1. The information being of historical nature does not reflect the future.
2. It is the outcome of accounting concept, convention combined with personal judgement.
3. The statement portrays the position in monetary term. The profit or loss position
excludes from their purview things which cannot be expressed or recorded in term of
money.
To overcome from the limitations, it becomes necessary to analyse the financial statements.