Financial management notes @ mba bk

1. Financial Management
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2. UNIT – 1
Financial Management
Nature of Scope of Financial Management
During the past three decades role and responsibilities of finance manager have undergone a marked
transformation ever witnessed earlier. The finance manager has now become an integral part of the
business enterprise and is involved in all the activities that take place in the enterprise. Until recently,
finance executive was considered as keeper of books of accounts and provider of funds needed by the
firm. But today his responsibility is not limited ot procurement of funds but extends beyond it to ensure is
optimal utilization. He plays pivotal role in planning quantum and pattern of fund requirements, procuring
the desired amount of funds. Since all the business activities like marketing, purchase and production
involve cash planning and utilization or generation of funds, the finance manager must take cognizance of
his involvement in all the activities of the firm. He must also have clear conception of the overall objective
of his firm as he has to act in conformity lea with the objective. Furthermore, he has to evaluate the
effectiveness of financial decisions in the light of some standard objectives of the firm.
OBJECTIVE OF THE FIRM
Objectives are long-term purpose and mission, which state the reason for existence of the firm and declare
what it wants to achieve in the long run. They represent desired results, the firm wishes to attain by its
existence arid operations. They indicate specific sphere of aims, activities and accomplishment.
Being profit seeking organization, the management is supposed to set profit maximization as the objectives
and accomplishment.
PROFIT MAXIMIZATION OBJECTIVES
Profitability objective may be stated in terms of profits, return on investment, or profit-to sales ratios.
According to this objectives, all such actions as increase income and cut down costs should be undertaken
and those that are likely to have adverse impact on profitability of the enterprise should be avoided.
Advocates of the profit maximization objective are of the view that this objectives is simple and has the
inbuilt advantage of judging economic performance of the enterprise. Further, it will direct the resources in
those channels that promise maximum return. Since the finance manager is responsible for the efficient
utilization of capital, it is plausible to pursue profitability maximization as the operational standard to test
the effectiveness of financial decisions.
However, profit maximization objective suffers from several drawbacks, rendering it as an ineffective
decisional criterion. These drawbacks are:
(1) It is vague
Ambiguity of the term profit as used in the profit maximization objective is its first weakness.
It is not clear in what sense the term profit has been used. It may be total profit before tax or after tax or
profitability rate. Rate of profitability may again be in relation to share capital, owner’s funds, total capital
employed or sales. Which of these variants of profit maximization objective to be considered remains
vague? Furthermore, the word profit does not speak anything about short-term and long-term profit. A firm
can maximize its short-term profit by avoiding current expenditures on maintenance of a machine. But
owing to this neglect, the machine being put to use may no longer be capable of operating after some time
with the result that the firm will have to defray huge investment outlay to replace the machine. Thus, profit
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3. maximization suffers in the long run for the sake of maximizing short-term profit. Obviously, long-term
consideration of profit cannot be neglected in favour of short-term profit.
(2) It ignores times value factor
Profit maximization objective fails to provide any idea regarding timing of expected cash earnings. For
instance, it there are two investment projects and suppose one is likely to produce streams of earnings of
Rs. 90,000 in sixth year from not and the other is likely to produce annual benefits of Rs. 15,000 in each of
he ensuring six years both the projects cannot be treated as equally useful ones although total benefits of
both the projects are identical because of differences in value of benefits received today and those
received a year or two years after. Choice of more worthy projects lies in the study of time value of future
inflows of cash earnings. The interest of the firm and its owners is affected by the time value factor. Profit
maximization objective does not take cognizance of this vital factor and treats all benefits, irrespective of
the timing, as equally valuable.
(3) It ignores risk factor
Another serious shortcoming of the profit maximization objective is that it overbooks risk factor. Future
earnings of different projects are related with risks of varying degrees. Hence, different projects may have
different values even though their earnings capacity is the same. A project with fluctuating earnings is
considered more riskier thatn the one with certainty of earnings. Naturally in investor would provide less
value to the former than to the latter. Risk element of project is also dependent on the financing mix of the
project. Project largely financed by way of debt is generally more riskier than the one predominantly
financed by means of share capital.It view of the above, the profit maximization objective is inappropriate
and unsuitable as an operational objective of the firm. Suitable and operationally feasible objective of the
firm should be precise and clear cut and should give weightage to time value and risk factors. All these
factors are well taken care of by wealth maximization objective, which we shall discuss, in the following
paragraphs.
WEALTH MAXIMIZATION OBJECTIVE
Wealth maximization objective is a widely recognized criterion with which the performance of a business
enterprise is evaluated. The word wealth refers to the net present worth of the firm. Therefore, wealth
maximization is also stated as net present worth. Net present worth is the difference between gross
present worth and amount of Capital investment required to achieve the benefits. Gross present worth
represents the presents value of expected cash benefits discounted at a rate which their certainly or
uncertainly. Thus, wealth maximization objective as decisional criterion suggests that any financial action
which creates wealth or which has a net present value above zero is desirable one and should be accepted
and that which does not satisfy this test should be rejected.
Algebraically, net present value or worth can be expressed as follows, using Ezra Solomon’s symbols and
models
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4. Where W = net present worth
A1, A2 ..... An = the stream of benefits expected to occur from a course of action over a period of time.
K = appropriate discount rate to measure risk and timing
C = initial outlay required to acquire the asset
The objective of wealth maximization as pointed out above has the advantage of exactness and
unambiguity and takes care of time value and risk factors.
The wealth maximization objective when used as decisional criterion serves as a very useful guideline in
taking investment decision. This is because the concept of wealth is very clear. It represents present value
of the benefits minus the cost of the investment. The concept of cash flow is more precise in connotation
than that of accounting profit. Thus, measuring benefits in terms of cash flows generated avoids ambiguity.
The wealth maximization objective considers time value of money. It recognizes that cash benefits
emerging from a project in different years are not identical in value. this is why annual cash benefits of a
project are discounted at a discount rate to calculate total value of these cash benefits. At the same time, it
also gives due weightage to risk factor by making necessary adjustments in the discount rate. Thus, cash
benefits of a project with higher risk exposure is discounted at higher discount rate (cot of capital), while
lower discount rate is applied to discount expected cash benefits of a less risky project. In this way,
discount expected cash benefits of a less risky project. In this way, discount rate used to determine present
value of future streams of cash earnings reflects both the time and risk.
In view of the above reasons, wealth maximization objective is considered superior to profit maximization
objective. It may be noted here that value maximization objective is simply the extension of profit
maximization to real life situations. Where the time period is short and magnitude of uncertainly is not gear,
value maximization and profit maximization amount to almost the same thing.
GOAL OF FINANCIAL MANAGEMENT
Goals of financial management should be so articulated as to help achieve the objective of wealth
maximization. Financial goals may be stated as maximizing long-term as well as short-term profits and
minimizing risks. These goals imply that the finance manager should take financial decisions in such way
as to ensure high level of profits. He should also seek courses of action that avoid unnecessary risks and
anticipate problem areas and ways of overcoming difficulties.
In the pursuit of the above goals, finance manager should recognize the interrelationship between profit
and risk. In fact, value of a firm is influenced jointly by return and risk. In real world, the relationship
between the two is inverse. Investments promising high profits will be more riskier than their counterparts.
It is, therefore, the prime responsibility of the finance manager to strike judicious balance between return
and risk in order to maximize value of the firm. To assure maximum profits to the firm, the finance manager
must monitor the cash inflows and outflows of the business and thereby ensure effective utilization of
resources. He should also endeavour to build in sufficient flexibility in the financial operations of the
enterprise so as to deal with uncertainty. He has to gain flexibility by identifying strategic alternatives both
in regard to investment outlets and acquisition of funds.
Another major financial goal of a firm is imparting sufficient liquidity and profitability of the enterprise. Thus,
a finance manger while managing funds has to ensure that the firm has adequate liquid resources on hand
to satisfy its obligation at all times and in addition it has a certain level above its expected needs to act as a
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5. reserve to meet emergencies. But if the firm carries large amount of funds in cash, it losses opportunity
cost of the funds and therefore, goal of high level of profit suffers. A firm to improve its return must ensure
optimum utilization of resources. Thus, the finance manager is in dilemma. The dilemma is high profitability
means low liquidity and, vice-versa. He must, therefore, strike satisfactory trade off between profitability
and liquidity.
MANAGEMENT vs OWNERS
The management of an enterprise is supposed to pursue the objective set for the firm. Although they may
not act in the best interests of the owners and pursue its goal to fulfill their ambitions of perpetuating their
control over the enterprise, the possibility of pursuing its personal goals exclusively is remote and limited
because of the constant evaluation of the managerial performance in the light of the overall goal. The
management acting against this goal will not be allowed to continue. Furthermore, in a competitive world, a
company must undertake actions which are reasonably consistent with wealth maximization goal.
However, on certain occasions the interest of the management may clash with that of the owners. Thus, an
entrenched management plays the role of a ‘satisficer’ rather than of a ‘maximiser’. The term satisficer here
means a person willing to settle for something less. An entrenched management desirous of perpetuating
its existence for years to come may like to play safe and seek in acceptable level of growth rather than take
the risks to maximize the wealth of stockholders.
It is cumbersome task to determine when a particular management is playing the role of a satisficer and
when it is acting as maximiser. For instance, when a risky venture is rejected because its potential benefits
fall short of its potential costs, how it can be ascertained that decision to reject the venture was motivated
by satisficing factor.
In sum, it can be observed that the management may have other goals but the goal of ‘maximising owners’
interest is the dominant goal which the management has to persue because more and more firms now-a-
days are tying their compensation to the firm’s performance. Even the existence of the management is
linked to the maximization goal.
SOCIAL OBJECTIVE
The modern firm has another objectives – to assume social responsibility. Being a socio-economic organ, a
business enterprise has a responsibility towards various sections of the society. This is necessary not only
because society provides environment conductive to the operation of business enterprise put also for their
survival. No organization can exist any longer without its social acceptance.
A socially responsible enterprise has to conduct its business in a manner that earns recognition as a
constructive and honourable corporate citizen in its relation, designed to be mutually profitable with
stockholder, employees, customers, suppliers, community and government.
It is usually contended that pursuit of social objective interferes with the economic objectives of an
enterprise because social activities will raise costs and risks. Assumption of social obligations by business
is ; therefore ; likely to weaken its economic vitality of the firm and pose threat to its existence.
The above line of argument emerges from those who ardently believe that economic objects and social
objectives are militant to each other. Social obligations increase cost of operations and therefore,
profitability of the enterprise may be adversely affected in the short run but in the long run economic
objectives and social responsibility of business are compatible to each other ; in fact, they reinforce each
other. As economic organs of society, business enterprises are socially responsible to pursue their profit
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6. making objectives to the optimum extent by meeting the material needs of society. In fact, the major social
responsibility of a company is to operate profitability and utilize efficiently the resources at its disposal.
Society does not gain but loss if business performance suffers.
A business enterprise can serve society only when it operates successfully. Profit is essential to the
survival of a firm and also to the support of all non-economic activities. Unless a business is able to make a
profit, the question of coping with social responsibilities voluntarily is largely academic. Economic
objectives are, in fact, means to the social ends of welfare and public interest.
There would not be any reason to suppose that a socially responsible business will earn less, pay fewer
dividends and achieve appreciation of share price than the one who are only as responsible as the law
requires. Social activities of a firm may arise cost of business immediately but in the long run it will be
counter balanced by the increased earnings resulting from its social action. Thus, if management decides
to pay higher wages to workers, ensures job security and improves working conditions, cost of operations
may go up immediately but increased productivity due to highly motivated workers will reduce per unit cost
of operations. In the same view, a firm can raise funds from investors at cheaper rate if it has been able to
ensure fair rate of dividends of its owners. Supply of quality goods at reasonable price will help the firm in
augmenting its sales and improving its earnings because of customers satisfaction.
Even contribution by business organizations to general welfare programmes have several economic spin-
offs to business. For example, charitable contributions to social causes tend to enhance the image of the
business enterprise in public mind and are likely to improve its market standing.
Thus, in the long run profit objectives and social objectives do not conflict. Much depends on top
management personal values, social concern and capability. Management with high social sensitiveness
and strong feeling of personal obligation, considerable drive and skill can turn social ills into a business
opportunity.
EVOLUTION OF BUSINESS FINANCE
To have a clear understanding of the role and responsibilities of finance manager, it would be worthwhile to
study changing contents of business finance as an academic discipline.
Before the turn of the present century finance was studied as a part of economics. Study of finance as a
separate discipline began only in the early part of the present century when massive consolidation
movement took place. Formation of large sized undertakings by consolidating the smaller ones brought
before the management the problem of financing these gaint enterprises. Accordingly, overwhelming
emphasis was placed to the study of sources and forms of financing the new industrial giants. Authorities
on finance, like Meade, Dewing and Lyon dealt with, in a scholarly fashion, the problems of capitalisation,
choice of capital structure, promotions, sale of securities, nature and terms of financial contracts and
similar other matters related to source of raising of funds. Thus, the study of business finance remained
descriptive one.
Emphasis on study of potentially of different securities as a source of procuring funds from outside world
and the role and functions of institutional agencies including investment bankers continue to exist during
1929’s since this decade witnessed a burst of new industries, like radio, chemical, steel and automobile
upon the economic scene of the USA, the emergence of national advertising and improved distribution
practices and the euphoria of high profit margins.
1930’s was a period of grave economic recession which created formidable problem of liquidity.
Businessmen found it difficult ot acquire funds from banks and other institutions to meet their day-to-day
requirements. They had to liquidate their inventory holdings to meet their financial needs. But owing to
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7. precipitate fall in price level the inventory liquidation did not provide sufficient funds to meet the
requirements. The impact of these developments upon financial management was manifested by improved
methods of planning and control, great concern for liquidity and greater interest in sound financial structure
of the firm. Writers on business finance opined vehemently that finance manager would have to play
defensive role to protect the firm from dangers of bankruptcy and liquidation. Thus, as in the past during
this decade too literature on business finance placed considerable emphasis on major financial episodes in
the life cycle of he firm.
Problem of financing assumed new dimension in the post world war II, Reorganization of industries to cope
with the peace time requirements of the economy posed serious problem before the business community
to raise substantially large amount of capital form the market. Accordingly, in 40’s financial experts
continued to be concerned with the necessity for selecting financial structures that would be able to
withstand the stresses and strains of he post war adjustments.
Thus, the approach to business finance, popularly known as traditional approach, which was evolved in the
beginning of the present century and which analysis the firm from an outsider’s points of view instead of
emphasizing the decision making aspects within the firm, remained popular until the early 50’s.
In the early 50’s the U.S. economy witnessed vigorous spurt of the business activity on the one hand and
despondent stock market and tightening money market conditions, on the other. In view of this, emphasis
shifted from profitability analysis to cash flow generation with a resultant deemphasis of the previously
favoured financial ratio analysis. The finance manager was assigned the responsibility of managing the
cash flows in such a manner that the organisation will have the means to carry out its objectives as
satisfactory as possible and at the same time its obligations as they become due. There was thus observed
a market shift away from the institutional and external financing aspects to the primary emphasis on day-to-
day financial operations of the firm. Cash budget technique occupied a place of pride in writing on business
finance. Matters like cash budget forecasting, aging receivables, analysis of purchases and application of
inventory controls received greater emphasis.
The change in approach to business finance noticed in the early 50’s was reaffirmed in the subsequent
years. Limited range of profit opportunities for mature industries and relatively tight money market
conditions which were the characteristic features of these years impelled the necessity for allocation of
capital resources to most profitable investment outlets. Accordingly, capital budgeting as a tool of efficient
allocation of funds within the firm received dramatic premiums. The finance manager had to assume the
new responsibility of managing the total funds committed to total assets and allocating funds to individual
assets in consonance with the overall objectives of the business enterprise.
Consequent upon a series of heated debates regarding cost of capital, optimal capital structure and effects
of capital structure upon the cost of capital and the market value of the firm that the profession went
through, a number of sophisticated valuation models were introduced and advanced techniques like
portfolio selection, mathematical programming and simulations were developed which improved the
practice of financial management.
The period between the mid 1960’s and the early 1970’s was marked as a very fruitful and exciting era for
a number of interesting developments. The brief but ominous recession in the share market spurred a large
number of diverstitures, reorganizations and bankruptcies and renewed concern for liquidity and profit
margins. The analytical and empirical frontiers of the discipline were also at the same time redefined and
redesigned. The Finance manager started rethinking such important issues as aggregate stock prices, the
empirical efficiency of business sales, the profitability of institutional investors and the analytical efficiencies
of various portfolio selection criteria on a new line.
Thus, the dimension of business finance which was earlier limited to periodic or episodic financial events
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8. has in recent years broadened to include the study of day-to-day operations of the financial management
alongside the periodic financial events. The case study is not being increasingly used as an aid in learning
how to analyze and solve typical and recurring problems of financial management. The interest in case
study this stemmed from a desire for a more analytical approach.
MEANING OF BUSINESS FINANCE
Literally speaking, the term ‘business finance’ contents finances of business activities. Thus, to develop the
meaning of business finance appreciation of the meaning of business and finance is necessary.
In common paralance the word ‘Business’ is used to denote merchandising, the operation of some sort of a
shop or store, a large or small. It is, however, giving too narrow a meaning to the word. “Business must be
understood to embrace every human activity (usually activated by the hope of profits, whereby man’s
wants are supplied. Lumbering, merchandising and many other activities are business that helps to supply
material wants. The practices of law, medicine, dentistry, teaching, accounting, nursing, entertaining
represents a few of the types of business activities that supply desired services.” Thus, business can be
categorized into three groups : Commerce, Industry and Service.
Commerce is concerned with the transfer of commodities through numerous channels from the producer to
the ultimate consumers. It includes collecting, grading, warehousing, transporting and insuring of
commodities. Industrial activity, on the other hand, is concerned with the sale of goods produced by
manufacturers. Thus, industrial businesses are those that actually produce commodities either by
manufacture or by some definite treatment of materials or that produce and supply the raw materials, which
may be used in their original form or form which marketable commodities can be manufactured. In addition,
there are certain business activities that do not deal in tangible commodities, instead they render services
for making profit. Such activates are classified under the category ‘Services’. Railroad and steam
companies, doctors, lawyers and bankers, brokers, accountants, teachers, actors, musicians and other
who do not deal with the commodities are the concrete example of services class of business activity.
Having explained the meaning of business we now proceed finance ahead to define the term. Finance,
refers to the application of skills or care in the manipulation, use and control of money. This is as far as the
dictionary goes. It would, however, not be in fitness of things to place too heavy reliance on the dictionary
meaning of finance because the word finance has a marvelous ability to evoke different concepts in the
minds of different persons. We have, therefore, to turn from dictionary to observe what is being
contemplated in actual world about finance.
The word finance in real world has been interpreted differently by different authorities. More significantly,
as noticed in the preceding paragraphs, the concept of finance has changed markedly with change in times
and circumstances. For the convenience of analysis, different viewpoints on finance have been categorized
into three major groups.
(i) The first category incorporates the views of all those who contend that finance concerns with
acquiring funds on reasonable terms and conditions to pay bill promptly. This approach covers
study of financial institutions and instruments from which funds can be secured, the types and
duration of obligations to be issued, the timing of the borrowings or sales of stocks, the amounts
required, urgency of the need and the cost. This approach has the virtue of shedding light on
the very heart of the finance function. However, the approach is too restrictive. It lays stress on
only one aspect of finance and ignores the other aspect which is very vital.
(ii) The second approach holds that finance is concerned with cash. Since almost all business
transactions are expressed ultimately in terms of cash, every activity within the firm is the
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9. concern of the finance manager. Thus, according to this approach finance manager is required
to go into details of every business activity be it concerned with purchasing, production,
marketing, personnel administration, research and other associated activities. Obviously, such a
definition is too broad to be meaningful.
(iii) A less third approach to finance looks on finance as being concerned with acquisitions of funds
and wise application of these funds. Protagonists of this approach opine that responsibility of a
finance manager is not only limited to procurement of adequate cash to meet business
requirements but extends beyond this to optimal utilization of funds. Since money involves cost,
central task of the finance manager, while allocating resources is to match the advantages of
potential uses against the costs of alternative sources so as to maximize the value of the firm.
This is the managerial approach which is also known as problem-centred approach, since it
emphasizes that the finance manager is his endeavour to maximize the value of the firm has to
deal with vital problems of the firm viz., what capital expenditure should the firm make? What
volume of funds should the firm invest? How should the desired funds be financed? How can
the firm maximize its profitability from existing and proposed commitments?
Diagrammatic of the management approach to finance give below will help appreciate the approach.
Fig. 1.1.
MANAGEMENT APPROACH TO FINANCE
Activities (Core Idea)
Funds Sources Funds Uses
I. Internal Cash Flows from I. Asset Expenditures
operations and special A. Current
transactions.
B. Fixed
II. External Debts or equity funds II. Non-asset expenditure
supplied by:
A. Labour
A. Individuals
B. Interest and debt service Charges
B. Financial Institutions
C. Other business firms
D. Government
III. Distributions to owners and / or
losses
The management approach to finance is balanced one having given equal weightage to both procurement
and utilization aspects of finance and hence has received wider recognition in the modern world.
Thus, business finance may be defined as the process of raising, providing and managing of all the money
to be used in connection with business activities. The similar view is also held by the modern scholars as
would be clear from perusal of some of the following definitions.
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10. “Business Finance can be broadly defined as the activity concerned with planning, raising, controlling and
administering of funds used in the business”
Guthmann & Dougall
“The finance function is the process of acquiring and utilizing funds by a business”.
R. C. Osborn
“Finance consists in the raising, providing, managing of all the money, capital, or funds of any kind to be
used in connection with the business”.
Bonneville and Dewey
“Business Finance deals primarily with raising, administrating and disbursing funds by privately owned
business units operating in nonfinancial fields of industry”.
Prather and Wert
NATURE OF FINANCE
Financial management is an integral part of overall management and not a staff function. It is not only
confirmed to fund raising operations but extends beyond it to cover utilization of funds and monitoring its
uses. These functions influence the operations of other crucial functional areas of the firms such as
production, marketing and personnel. In view of this, overall survival of the firm is influenced by its financial
operations.
The heart of the financial management lies in decision making in the areas of investment, finance and
dividend. In investment decision a finance manager has to decide about total amount of assets to be held
in the enterprise and kinds of the assets – the proportion of fixed assets and current assets. The basic
problems facing the finance manager concerning investments are:
(i) How should the firm invest?
(ii) In which specific projects should the firm invest?
In financing decision the finance manager has to decide as to how much funds the firm should raise to fund
its operations and in what form-debt, equity shares, preferences shares and after sources. While deciding
about the debt-equity mix the finance manager’s endeavour should be to evolve such a pattern as may be
helpful in maximizing earnings per share and also market value of the firm.
The finance manager while making dividend decision decides as to how the firm’s should be allocated
between dividend and retention. He has to formulate such a dividend policy as may provide sufficient funds
to finance the firm’s growth requirements and at the same time ensure reasonable dividends to the
stockholders.
The above decisions are intimately related. Thus, the proportion in which fixed assets and current assets
are mixed determines the risk complexion of the firm. Costs of various methods of financing are affected by
this risk. Likewise, dividend decisions influence financing decisions and themselves influenced by
investment decisions.
Since finance functions are intimately connected with other business functions, the finance manager
should call upon the advise of other functional executives of the firm while making decisions particularly in
regard to investment. Decisions in regard to kinds of fixed assets to be acquired for the firm, level of
inventories to be kept in hand, type of customers to be granted credit facilities, terms of credit, etc., should
be made after consulting production and marketing executives. However, the determination of dividend
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11. policies is almost exclusive finance functions and the finance manager need not consult other functional
mangers.
Finally, imperativeness, of the continuous review of the financial decisions explains generic nature of the
financial management. As a matter of fact, financial decision making is a c continuous dynamic process
that goes on throughout the corporate life. An enterprise to survive has constantly to interact with various
environmental forces and adapt and adjust alive to changes in internal as well as external environment and
bring about necessary adjustments in goals, strategies, policies and procedures with a view to seizing
potential opportunities and minimizing impending threats. A one time financial plan not subjected to
periodic review and modification in the light of changed conditions will be a fiasco because conditions
change to such as extent that the plan is no longer relevant and acts as a hindrance.
SCOPE OF BUSINESS FINANCE
In order to understand more clearly the meaning of business finance it is worthwhile to highlight the scope
of business finance. At the outset it may be pointed out that business finance is concerned with finances of
profit seeking organizations only and is important segment of private finance.
Finance, as such is but one facet of broader economic activity of mobilizing savings and directing them in
investments. Finance, includes both public and private finance. Publich finance is the study of principles
and practices relating to acquisition of funds for meeting the requirements of government bodies and
administration of these funds by the government. Contrary to this, private finance concerns with procuring
money for private organisation and management of the money by individuals, voluntary association and
corporations. Private finance therefore comprises personal finance, business finance and the finance of
non-profit organizations. Personal finance seeks to analyze the principles and practices of managing one’s
own daily affairs. Study of practices, procedures and problems concerning the financial management of
profit making organizations in the field of industry, trade and commerce and service and mining is
undertaken in business finance. The finance of non-profit organization deals with the practices, procedures
and problems involved in the financial management of educational, charitable and religious and the like
organizations.
Business finance is further split into three categories – finances of sole trading organisatoins, partnership
firms and corporate organizations. In the study of business finance emphasis is given to financial problems
and practices of incorporated enterprises because business activities are predominantly carried on by
company form of organisation. That is why subject of business finance is also studied as corporation
finance. It should be remembered that the same principle of finance apply to large and small and
proprietary and non-proprietary organizations nevertheless there are sufficient differences of a specific
operating nature justifying separate consideration of each of these organizations.
The field of corporation finance encompasses the study of financial operations of a business enterprise
right from its very inception to its growth and expansion and in some cases to its winding up also. However,
special attention is devoted to the analysis of the problems and practices involved in raising and utilization
of funds. It should be noted that problems of purchase, production and marketing are outside the purview
of business finance although their problems are so intimately linked to problems of finance that in actual
practice it is difficult to discern them.
FINANCE FUNCTIONS
As hinted in the preceding paragraphs, views of traditional and modern scholars regarding finance function
differ markedly. It would, therefore, be germane to give a brief idea about their views.
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12. TRADITIONAL CONCEPT OF FINANCE FUNCTION
Traditional writers contended that primary responsibility of a finance manager is to raise necessary funds to
meet operating requirements of the business. He has to take decision with respect to the choice of
optimum source from which the funds would have to be secured, timing of the borrowing or sale of stock
and cost and other terms and conditions of acquiring these funds. Planning quantum and pattern of fund
requirements and allocation of funds as among different assets, sais traditional scholars, is the concern of
non-financial executives.
Traditional approach to finance function has been bitterly criticized by modern scholars on various cogent
grounds. One such ground is that the traditional approach is too narrow. It viewed finance as a staff
specially. According to them, it would be mistaken to argue that responsibility of the financial executive is
limited to acquisition of sufficient funds for the enterprise and he has little concern as to how such funds
would be allocated.
Another criticism of traditional approach is that it over emphasized episodic and non-recurring problems
like, incorporation, consolidation, reorganization, recapitalization and liquidation and gave little attention to
day-to-day financial problems of on going concerns.
Another shortcoming of the traditional approach is that it gave concentrated attention to problems of
corporation finance while problems of unincorporated organizations like sole trading concerns and
partnership firms were altogether ignored.
Finally, modern authorities charged that the traditional approach laid relatively more stress on problems of
long-term financing as if business enterprises do not have to encounter any financial trouble in the short
run. As a matter of fact, problem of working capital management is very crucial problem which has to be
dealt with efficiently by the finance manager if an enterprise has to reach the goal of wealth maximization.
MODERN CONCEPT OF FINANCE FUNCTION
Modern Scholars viewed finance as an integral part of the over-all management rather than as a staff
speciality concerned with fund raising operations. Accordingly, finance manager has been assigned wider
responsibilities. According to them, it is not sufficient for the finance manager to see that firm has sufficient
funds to carry out its plans but at the same time he has to ensure wide application of funds in the
productive process. Thus, to carry out his responsibilities it is the bounden responsibility of the finance
executive to make a rational matching of the benefits of potential uses against tht costs of alternative
potential sources so as to help the management to accomplish its broad goal. The finance manager is,
therefore, concerned with all financial activities of planning, raising, allocating, and controlling and not with
just any one of them. Aside from this, he has to handle such financial problems as are encountered by a
firm at the time of incorporation, liquidation, consolidation, reorganization and the like situations that occur
infrequently.
Thus, finance functions, according to modern experts, can be categorized into two broad group “ Recurring
finance function and Non-recurring finance function. We shall now discuss in detail each of these functions
separately.
A. RECURRING FINANCE FUNCTION
Recurring finance function encompasses all such financial activities as are carried out regularly for the
efficient conduct of firm. Planning for an raising of funds, allocating of funds and income and controlling the
uses of funds are contents of recurring finance functions. We shall now discuss in brief, each of these
functions.
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13. (1) Planning For Funds
Initial task of the finance manger is a new or going concern is to formulate financial plan for the form.
Financial plan is the act of deciding in advance the quantum of funds requirements and its duration and the
makeup of the requirements to achieve the primary goal of the enterprise. While planning for fund
requirements the finance manager has to aim at synchronizing the cash inflows with cash outflows so that
the firm does not have any resources lying unutilized. Since in actual practice with a synchronization is not
possible, the finance manager must maintain some amount of working capital in reserve so as to ensure
solvency of the firm. The magnitude of this reserve is the function of the amount of risk that the firm can
safely assumes in a given economic and business conditions.
Keeping in view the ling-term goals of the company the finance manager has to determine the total fund
requirements, duration of such requirements and the forms in which the required funds will be obtained.
Decision with respect to fund requirements is reflected in capitalisation. While determining fund
requirements for the enterprise, the finance manger must keep in mind the various considerations, viz.,
purpose of the business, economic and business conditions, management attitude towards risks,
magnitude of future investment programmes, state regulation, etc.
Broadly speaking, there are two methods of estimating funds requirements: Balance sheet method and
Cash budget method. In balance sheet method total capital requirements are determined by totaling the
estimated amount of current, fixed and intangible assets requirements. In contrast, a forecast of cash
inflows and cash outflows in made month-wise and cash deficiencies are calculated to find out the financial
needs under the cash budget method. With the help of cash budget amount of fund requirements at
different time intervals can be calculated.
Having estimated total funds requirements the financial executive decides as to how these requirements
will be met, viz., forms of financing funds requirements. Such decisions are taken under capital structure.
While there may be various pattern of capital structure, the finance manager should decide upon the most
suitable pattern of capital structure for the enterprise.
In order to enable the finance department to perform the aforesaid functions effectively and to achieve the
firm’s objectives successfully, finance manager must establish suitable policies that act as guides to the
executives of the finance department. Major policy guidelines in this respect are:
a) Policies regarding quantum of funds requirements of the firm.
b) Policies regarding debt – equity mix.
c) Policies regarding choice of funds
These policies must be reviewed from time to time keeping in view the changing needs of the firm and
environmental changes.
(2) Raising of Funds
The second responsibility of the finance manager is procuring the requisite capital to satisfy the business
requirements. If the company decides to raise the needed funds by means of security issues, the financial
manger has to arrange the issue of prospectus for the flotation of issue. In order to ensure quick sale of
securities generally the stock brokers, who deal in securities in the stock market and who are in constant
touch with their clients, are approached.
Even after the issues are floated in the stock market there is no certainty that the security issues will bring
in the desired amount of capital because public response to security is difficult to estimate. If a business
enterprise, fails to assemble the desired amount of funds through security issues, the enterprise is plunged
into grave financial trouble. So as to hamstring this problem the finance manager has to make such
BSPATIL 13

14. arrangements as may protect the issue against its failure. For that matter, he has to approach underwriting
firms whose main job is to provide the guarantee of buying the shares placed before the public in the event
of non-subscription of the shares. For these services, they charge underwriting commission. Thus, if an
underwriter is satisfied with the issuing company, an underwriting agreement is entered into between the
company and the issuing company. The obligation of the underwriter as per the agreement arises only
when the event of non-subscription of issues by the public takes places.
Where the company decides to borrow money from financial institutions including commercial banks and
special financial corporations, the finance manger has to negotiate with the authorities. He has to prepare
the project for which the loan is sought and discuss it with the executives of the financial institutions along
with the prospects of repayment of the loan. If the institution is satisfied with the desirability of the proposal,
an agreement is entered into by the finance executive on behalf of the company.
(3) Allocation of Funds
The third major responsibility of the finance manager is to allocate funds among different assets. In
allocating the funds, consideration must be given to the factors such as competing uses, immediate
requirements, and management of assets, profit prospects and overall management plans. However, he
has to acquaint the production executive who is primarily seized with the task of acquiring fixed assets with
fundamentals of capital expenditure projects and also about the availability of capital in the firm. But the
efficient administration of financial aspects of cash, receivables and inventories is the prime responsibility
of the finance managers.
The finance executive has also to see that only that much of assets are acquired that could meet the
current as well as the increased demand of the company’s product. But the efficient administration of
financial aspects of cash, receivables and inventories is the prime responsibility of the finance manager.
The finance executive has also to see that only that much of fixed assets are acquired that could meet the
current as well as the increased demand of the company’s product. But at the same time he should take
steps to minimize the level of buffer stock of fixed assets that the company is required to carry for the
whole year to satisfy the expanded demands. While managing cash, the finance manger should prudently
strike a golden mean between these two conflicting goals to profitability and liquidity of the corporation. He
has to set minimum level of cash so that the company’s liquidity is not jeopardized and at the same time its
profitability is maximized. Besides, the finance manager has to ensure proper utilization of cash funds by
taking steps which help in speeding up the cash inflows on the some hand and showing cash outflows, on
the other.
In managing receivables the finance manager should endeavour to minimize the level of receivables
without adversely affecting sales. For that matter, suitable credit policies should be laid down and suitable
collection procedures should be designed.
The operating responsibility of managing inventories in a corporation is outside the province of the finance
manger and well within the realm of production manager and chief purchase officer. However, the financial
manger is responsible for supplying the necessary funds to support the company’s investments in
inventories. In order to ensure that funds are allocated efficiently in inventories, the finance manager must
familiarize himself with various techniques by which efficient management of inventories can be achieved.
The problem that the finance manager faces is to determine the optimal magnitude of investment in
inventories. With the help of the E.O.Q. (Economic Order Quantity) model suitable level of inventories is
decided.
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15. (4) Allocation of Income
Allocation of annual earnings of the company as between different uses is the exclusive responsibility of
the finance manger. Income may be retained for financing expansion of business or it may be distributed to
the owners as dividend as a return of capital. decision in this respect is taken in the light of financial
position of the company, present and future cash requirements of the firm, shareholders, preferences and
the like.
(5) Control of Funds
A finance manger is also responsible for controlling the uses of funds committed in the enterprise. This will
enable him to ensure that fund are being utilized as per the plan. Control function involves development of
standards. Establishing standards is an essential task of the finance manger which requires high degree of
dexterity and skill and the use of sophisticated forecasting techniques. These standards serve as a
concrete basis for evaluation of current performance. Comparison of actual with predetermined standards
provides opportunity to the management to ascertain immediately the discrepancies that have occurred
and take remedial steps before deviations go out of control. If the assessment of the performance reveals
that the actual operations have not conformed to the standards, the reason for this discrepancy may be
traced either in the inadequacy of the firm’s policies or ineffectiveness of the employees. if the policies are
found to be effective, the finance manager must identify those policies that have not been effective and
suitable and them change such policies so that the firm can accomplish its objectives.
Evaluation work should be performed continuously in view of constantly changing environmental forces.
Whenever and wherever necessary policies should be changed.
B. NON-RECURRING FINANCE FUNCTION
Non-recurring finance function refers to those financial activities that a financial executive has to perform
very infrequently. Preparation of financial plan at the time of promotion of the enterprise, financial
readjustment in times of liquidity crises, valuation of the firm at the time of merger reorganization of the
form and similar other activities are of episodic character. Successful handing of such problems requires
financial skills and understanding of principles and techniques of finance peculiar to non-recurring
situations.
ORGANIZATIONAL FRAMEWORK FOR FINANCIAL MANAGEMENT
Functions of financial management stated above are, by and large, the same in almost all types of
business concerns. However, organisatoin of these functions is not standardized one. It varies from
enterprise to enterprise depending essentially on the characteristics of firm, size, nature convention, etc.
Thus, in similar companies where operations are relatively simple and less complicated and little
delegation of management functions exists, no separate executive is appointed to handle finance
functions. In fact, it is the proprietor who handles all these activities himself. He prepares cash budget for
his firm to assess the requirements and arranges finance to meet these requirements. He himself looks
after receivables and disbursement work, extends credit, collects accounts receivables, manages cash
accounts and arranges additional funds, in collects accounts receivables, managers cash accounts and
arranges additional funds, in such concerns, finance function is not properly defined and finance function is
combined with production and marketing functions. Financial planning is hardly given important place.
Proprietors have seldom any training in such activities.
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16. With growth in the size of the organisation degrees of specialization of finance function increases. In
medium sized undertakings financial activities are handled by senior management executive who is
designated as treasurer, finance director, finance controller, vice-president in charge of finance. He is
generally given the charge of credit and collection departments and accounting department, investment
department and auditing department. He is also responsible for preparing annual financial reports. He
reports directly to the president and board of directors. His vice in decision making depends in part on his
ability and whether or not his firm is one that is closely held.
In large concerns the finance manager is a top management executive who participates in various decision
making functions, for example, those involving dividend policy, the acquisition of other firms, the
refinancing of maturing debt, introducing a major new product, discarding an old one, adding a plant or
changing locations, floating a bond or a stock issue, entering into sale and lease back arrangements. In
most of the cases the finance manger holds the rank of vice-presidentship reporting directly to the
president and Board of Directors. Place of finance in management hierarchy in large enterprise has been
diagrammatically portrayed in figure 1.2. It appears that a large organisation has finance committee
consisting of some members of Board and a finance manager. The committee makes recommendations for
the final approved of the Board.
Figure 1.2
In larger concerns, for handling financial matters controller and Treasurer are appointed. Finance controller
is responsible for financial planning and control, preparation of annual financial reports and for carrying on
capital expenditure activities whereas treasure’s responsibility is limited to raising additional resources for
business purposes, management of working capital and security investment and tax and insurance affairs.
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17. ROLE OF FINANCE MANAGER IN AN ENTERPRISE
Finance manager is an integral part of corporate management of an enterprise and is involved in almost all
the crucial decision making affairs because every problem and every decision entails financial implications.
Finance manager plays significant role in helping the business entrepreneurs and management in
overcoming their business problems and accomplishing their wealth maximization objective. One of the
prime problems facing Corporate management is in the area of capital investments. How much capital
expenditures should the enterprise commit, what volume of funds should be committed and how should
funds be allocated as among different investment outlets are the critical issues which have to be handled
with utmost care failing which the enterprise may land in grave financial crises. The finance manager with
his expertise knowledge management in choosing the most viable project promising maximum results
coupled with minimum risks.
The Central management also faces formidable problem of allocation of funds and they have to strike trade
off between two conflicting but equally important goals of the business i.e. profits vs wealth maximization
Higher the relative share of liquid assets, lesser will be the possibility of cash drain, other things being
equal. However profitability in the case will be less. On the contrary, if a smaller share of funds is held in
liquid form, risk of insolvency will be high but profitability will also be higher. The management is, thus, in
dilemma which the finance manager endeavors to resolve by making use of principles and techniques of
finance.
Another problem plaguing the managemnet pertains to designing such pattern of capitalisation as may be
helpful in maximizing earnings per share and so also the market value of shares. This involves examination
in depth of some of the important issues such as form what sources are funds available, to what extent are
funds available from what sources, what is expected cost of future financing, what sources of funds should
be tapped and to what extent, what financial instruments should be employed to raise funds and at what
time?, which financial institutions should be approached for garnering funds? The finance manager with his
knowledge of finance, capital and Money markets, investors psychology, etc. offers solutions to these
problems.
Once the business is set up and earns profit, the corporate management has to decide about allocation of
earnings between payments to shareholders and rationed earnings. Here again the management is in
dilemma a trade off between growth and dividends, the two equally desirable but conflicting goals of the
enterprise. A satisfactory compromise between the two has to be struck in such a way that shareholder’s
wealth in the enterprise is maximized. The central management calls upon the expertise of the finance
manager in striking such compromise and helps the management in prudent allocations of income.
Besides handling day – to – day problems, finance manger also helps the corporate management in
dealing with episodic problems including reorganization, merger, consolidation and liquidation.
Thus, finance manger plays a very significant role in optimal utilization of financial resources in the firm and
thereby ensures the successful survival and growth of the latter.
DEFINITION OF FINANCE FUNCTION
A. Task of Providing Funds – According to these following definitions, the finance function is simply
the task of providing funds needed by the enterprises on suitable terms.
1. “In a modern money – using economy, finance may be defined as the provision of money at the
time it is wanted”.
- F.W. Paish
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18. 2. “In an organism composed of a myriad of separate enterprises, each working for its own ends
but simultaneously making a contribution to the system as a whole, some force is necessary to
bring about direction and co-ordination. Something must direct the flow of economic actively
and facilitate its smooth operation. Finance is the agent that produces this result”
– Husband and Dockery
3. “The financing function includes the day-to-day concern for the use and control of funds as well
as long range planning which is involved with determining future requirements for funds and
optimum uses to which they mat be put. The financial policies of the firm are exemplified in its
basic decisions about methods of financing growth, dividend distribution policy, relations with
lending institutions, economic evaluation of alternative investments in plant and equipment and
other activities which involves uses or sources of funds”.
- L.A. and C.E. Gubellini
4. “Business finance may be broadly defined as the activity concerned with planning, raising,
controlling and administering of funds used in the business”.
- H. Guthman and H. Douggal
Above mentioned definitions of finance highlight the central core of finance function, i.e., procurement of
funds for the business, but to confine it to this aspect only is a narrow view. It is broader function than that
of funds supply only. It includes the financing decisions, investment decisions as well as dividend
decisions. Financial management is deeply concerned with the economic and effective use of funds.
Therefore, this view cannot be accepted.
B. Management of cash and liquidity – According to the following definition finance function is the
management of cash and maintaining the liquidity of funds.
“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. The task of working capital management is not over-all responsibility of financial
management. It is also a narrow concept ant the functions of a financial executive extend to
financial planning, funds raising and administration of funds, etc. If we entrust the financial function
completely to the accountant, it will be a very limited view of finance function. It may be summed up
as the ‘custodian function of finance’ in the sense that it involves only the proper custody and
authorized utilization of the available funds.
C. Financial decision making – Following definitions are concerned with the financial decision –
making.
1. “Finance may be defined as the administrative area or set of administrative functions in an
organisation which relate with the arrangement of cash and credit so that the organization may
have the means to carry out its objectives as satisfactorily as possible”.
- Howard and Upton
2. “The Finance function is vitally concerned with the use of funds within the business not just the
supply of funds to the business”.
- Hunt, William and Donaldson
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19. In this way finance function covers not only financial planning, financial forecasting, finance raising bout
optimum use of funds as well as the financial control
ROLE AND SCOPE OF FINANCIAL FUNCTION
Financial function seeks to carry out production and marketing functions profitably. These need funds for
investment in fixed assets and current assets. Following are the main financial functions.
MAIN FINANCE FUNCTIONS
1. To estimate the Requirements of Funds – Long – term as well as Short-term-funds requirement,
the investments in fixed assets and those in various current assets etc. should be estimated
through the techniques of budgetary control and long-range planning. This requires proper forecast
of the physical activities of the organization.
2. To take Finance Decisions or Capital Structure Decisions – Each source of funds involves
different considerations regarding cost, risk and control. Keeping these in mind, a proper mix of the
various sources has to be worked out. Long-term funds investments are to provide for the needs of
the core working capital. funds should be procured at optimum costs with the least risk and the
least dilution of control of the present owners. These decisions come under the broad term ‘the
financing decision’.
3. To take Investment Decision – Long-term funds should be invested in various projects only after
an in depth analysis has been carried out through capital budgeting techniques and uncertainly
analysis. Asset management policies are to be laid down regarding various items of current assets
also. These include policies relating to management of inventories, book debts, cash, trade
creditors etc.
4. To take Dividend Decision – From the economic point of view, the amount to be retained or to be
paid to the shareholders would depend on whether the company or the shareholders can make a
more profitable use of the funds. In practice, a large number of other considerations like the trend of
earnings, the trend of share market prices, the requirement of funds for future growth, the cash flow
situation, restrictions under the Companies Act., the tax position of the shareholders etc. are also
kept in mind.
SUBSIDIARY FINANCE FUNCTIONS
1. Supply of funds to all parts of the organization
2. Evaluation of financial performance
3. Financial negotiations with bankers, financial institutions and other suppliers of credit.
4. Keeping track of stock exchange, quotation and behaviour of stock market prices.
5. Financial Control
6. Keeping the records of all assets.
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20. DEFINITION OF FINANCIAL MANAGEMENT
1. “It the application of general managerial principles to the area of financial decision making”.
- Howard and Upton
2. “Financial Management is an area of financial decision making, harmonizing individual motives and
enterprise goals”.
- Weston and Brigham
3. “Financial Management is the operational activity of a business that is responsible for obtaining and
effectively utilizing the funds necessary for efficient operations”.
- Joseph and Massie
4. “In an organism composed of a number of separate activities, each working for its own end out
simultaneously making a contribution to the system as a whole, some force is necessary to bring
about direction and coordination of economic activity and facilitate its smooth operation. Financial
management is the agent that produces this result”.
- Husband and Docker
5. “Financial management is concerned with the managerial decisions that result in the acquisition
and financing of long-term and short-term credits for the firm. As such it deals with the situations
that require selection of specific assets (or combination of assets), the selection of specific liability
(or combination of liability) as well the problems of size and growth of an enterprise. The analysis of
these decisions is based on the expected inflows and outflows of funds and their effects upon
managerial objectives”.
- Philippatus
6. “Financial Management is the area of business management devoted to a judicious use of capital
and a careful selection of sources of capital in order to enable a business firm to more in the
direction of reaching its goals”.
- J.F. Bradley
CHARACTERISTICS OF FINANCIAL MANAGEMENT
1. Investment decisions – These include decisions as regards utilization of funds in one activity or
the other.
2. Financing decisions – These include decisions as regards how the total funds required by the firm
are to be raised, namely, by issue of shares, by raising of loans, or by retaining of profits.
3. Dividend decisions – These include decisions as regards what part of the profits earned by the
BSPATIL 20

21. firm is to be distributed among the shareholders in the form of cash dividend, and how much of the
profit are to be retained for utilization by the firm (ploughing back), and
4. Enforcing Financial decision – This is done through control and coordination of business
activities.
Thus financial management is an operational function in involving financial planning, financial forecasting
and provision of financial as well as the formulation of financial policies. Hunt, William and Donaldson have
called it ‘Resource Management’. In a large organization, the financial manager is the member of the firm’s
top management charged with the responsibility of planning, organizing, performing and controlling the
financial affairs of the enterprise.
FUNCTIONS OF FINANCIAL MANAGEMENT
The finance functions include Executive or Managerial Functions as Routine Functions. While Executive
functions require skilled planning and execution of financial activities, routine finance functions are chiefly
clerical and are identical to the effective handling of the managerial functions.
1. Executive or Managerial Functions
(i) Financial forecasting: The financial management arranges that an adequate supply of
cash in available at the proper time for smooth flow of firm’s activities. As cash-inflow and
cash outflow both are closely related to the volume of sales, it requires financial
forecasting. The estimation of the prospective inflow and outflow of cash in the next
quarter or year is necessary to maintain the liquidity in the funds.
(ii) Investment Decisions – This is the most important executive function of financial executive.
It involves the allocation of capital to various investment proposals in order of their
profitability. The financial manager has little or not operating responsibility for fixed assets,
because these decisions are made by top management. He is however instrumental in
allocating capital to these assets due to his involvement in capital budgeting. As each
investment decision involves risk, a financial manager assets in evaluating the various
proposals in the processes of capital budgeting.
(iii) Management of Corporate Asset Structure – The fixed and current assets of the firm must
be managed efficiently to ensure success. The financial manager is charged with varying
degrees of operating responsibility over existing assets. He is rather concerned with the
management of current assets than with fixed assets. In the management of current
assets his discretion is not an exclusive one. Other area manages also participate in the
formation of policies regarding the level of investment in various current assets like
inventories etc.
(iv) Management of Income – It is a major function of financial executive. It includes the
allocation of net earnings after payment of taxes among shareholders and rationed earning
for employees. the shareholders are generally more interested in current cash dividends.
In order to provide for future contingencies, the top management wants to retain earnings
to the maximum possible extent. The financial manager attempts to arrive at an optimal
dividend – pay out ratio that maximize shareholder’s worth in the long run.
BSPATIL 21

22. (v) Management of Cash – The cash must be managed for the benefit of the owners. The
financial manager has two objectives (a) how can managers choose the best among the
alternative uses of funds, and (b) how can they ascertain that this is a better use than
stock-holders could find outside the company? “Therefore, the financial manager must
select the most desirable temporary investment for the excess cash and near cash
resources of the firm.
(vi) Decision about New Sources of Finance – A business firm is always in need of funds. On
the basis of forecast of the volume of operations the financial manager should decide upon
the needs and prepare the detailed financial plan both short-term and long-term for the
procurement of funds. He should evaluate the prospective cost of funds as against the
anticipated profits from the use of these funds by the operating units to which they are to
be allocated.
(vii) Contact and carry Negotiations for New Financing – The Financial manger has to contract
the source, carry on the negotiations and finalize the terms and conditions of the contract.
In short term, credit is arranged from a bank, lines of credit are to be opened and financial
executive negotiates with bank authorities in this connection. If long-term funds are
needed additional shares should be issued for it. This requires a number of arrangements
to be made by him.
(viii) Analysis and Appraisal Financial Performance – Proper analysis, checking and appraisal
of financial performance is essential to carry out finance function smoothly. Various
financial statements are prepared analyzed and then necessary guide-lines are set for
future. Analysis of what has happened is of great value in improving the standards,
techniques and procedure of financial control.
(ix) To Advise the Top Management – The financial manager advises the top management in
respect of financial matters and suggests various alternative solutions for any financial
difficulty. He makes steady efforts to increase the profitability of capital invested in the firm.
2. Incidental or Routine Functions
Following are routine functions performed by low level assistants like accountants, assistants, accounts
assistants, etc.
1. Record keeping and reporting
2. Preparation of various financial statements
3. Cash management
4. Credit management
5. Custody and safeguarding the different financial securities etc.
6. Providing top management with information on current and prospective financial conditions of the
business as a basis for policy decision on purchases, marketing and pricing.
IMPORTANCE OF FINANCIAL MANAGEMENT
1. Successful Business Promotion – Defective financial plan is one of the most important reasons
of failures of business promotion. It the plan fails to provide sufficient capital to meet the
requirements of fixed and fluctuating capital and to assume the obligations by the corporation, the
BSPATIL 22

23. business cannot be carried on successfully. Hence sound financial plan is very necessary for the
success of business enterprise. In the words of Hoagland, “Unwarranted optimism and lack of
information are more often the cause of faulty financial plans, optimism about the possibilities of an
untried enterprise, and lack of information about the specific needs and limitations”. Selection of
sound financial plan requires a serious consideration over factors like profitability, risk and controls
of various alternative plans. This is not possible in the absence of a sound financial management.
2. Smooth Running of Enterprise – Sound financial planning is necessary for the smooth running of
an enterprise. As finance is required in promotions, incorporation, development, expansion and
administration of day-to-day working etc. its proper administration is very necessary. This means
the study, analysis and evaluation of all financial problems to be faced by the management and to
take proper decision with reference to these present circumstances in regard to the procurement
and utilization of funds.
3. Coordination of Functional Functions – Financial administration provides co-ordination between
various functional areas such as marketing, production etc. If financial management is defective,
the efficiency of all other departments cannot be maintained. If finance department fails in its
obligations, the production and the sales will suffer. Consequently, the income of the concern and
the rate of profit on investment will also suffer. Thus, financial administration controls and co-
ordinates all other activities in the concern.
4. Help in Decision Making – Every decision in business is taken in the light of its profitability.
Among a number of alternatives to carryout the decision the management has to select only the
best in terms of its profitability. Financial administration provides scientific analysis of facts and
figures through various financial tools, such as different financial statements, budgets ratio analysis,
cost-profit-volume analysis etc. These help in evaluating the profitability of the plan in the given
circumstances, so that a proper decision may be taken to minimize the risk involved in the plan.
5. Determination of Business Success – The financial managers plan a very important role in the
success of the business organization by advising the top management and presenting important
facts and figures regarding financial position and the performance of various functions of the
company in a given period before the top management in such a way so as to make it easier for the
top management to evaluate the progress of the company and to amend suitably the principles and
policies of the company. By suggesting the best possible alternative out of the various alternatives
of the problem available, the financial managers assist the top management in its decisions making
process.
6. Measure of Performance – As J.F. Weston and E.F. Brigham have said, “Financial decisions
affect both the size of earnings stream or profitability and the riskiness of the firm. Policy decision
affect risk and profitability and there two factors jointly determine the value of the firm”.
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24. UNIT II
ORGANIZATION OF FINANCIAL MANAGEMENT
Organisation of financial department is the division and the classification of various functions which are to
be performed by the finance department. Finance is one of the important functions of the management.
Financial decisions affect wage policy, inventory policy, labour policy and every other area of decision
making and the reverse is also true. Management decisions are made at every level of business
organisation from president to foreman and nearly management decision involved the finance of the
company.
As finance affects the very existence of a concern, the finance function cannot be decentralized like other
management functions such as personnel, marketing etc. The control and administration of finance should
be given to the top management. Controlling and administrative powers may vest in the Board of Directors
or in the Finance Committee.
The place of finance department in the organization chart depends on the size and the nature of the
business. In a very small business having one man as the proprietor he may make all the management
decision including financial policies. However, in large businesses, a division of responsibility and the
compartmentalization of management are necessary to handle the large volume of work. As finance is one
of the most important functions of management requiring skill and technical expertise, a separate
department for the purpose is established under the charge of an expert in financial matters known as
Finance Manager or Finance Controller or Director of Finance. The Chart No. 2.1 shows an ideal form of
organization for a big business corporation.
FINANCE COMMITTEE
The shareholders, the owners of the corporation control the conduct of the company by electing the Board
of Directors, to whom the management is responsible. Company policies are executed with the help of the
managing director who manages the affairs of the company as per directions of the board. As the
managing director is not an expert of all the matter-labour, market, finance, production etc. relating to the
business, a committee for each function-repairing expert knowledge is constituted for proper guidance and
advice. Thus a finance committee may be constituted to advise the managing director regarding matters
relating to finance of the concern. This may include one or tow directors from the board of directors, the
departmental heads and the chief financial mangers with managing director as the chairman of the
committee. The committee guides and advises the board of directors the control and administration of the
finance.
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25. STATUS OF FINANCE MANGER
The finance manger is located on the same scalar level as the managers of production department or
marketing department etc. He is full-fledged head of finance department and reports directly to the chief
Directors. He is appointed to look after the activities of the finance department. The controller of finance
and the treasurer are the two officers subordinate to the financial manager. The treasurer’s responsibility is
to look after the day to day working such as custody of cash and bank accounts, investment portfolio of the
corporation, collection of loans, payments of premiums etc. Cash receipts and disbursements include such
names as Accounts Receivable, Accounts Payable, General Ledger, Internal Audit, Pay-roll, Tax, Credits
and Collections, budget etc. To prevent unauthorized payments made by the treasurer, it must be
approved by the controller. Controller is responsible to the finance committee.
A detailed organisation for finance department can be drawn it the enterprise is to be managed by one
financial officer:
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26. Fig. 2.2 Organisation of Finance Department
As there is a very wide range of organizational practices the organization structure may change according
to the size and nature of the business. It is also effected by the external factors such as state intervention
in the industrial finance, corporate tax policies etc. Fig. 2.2 shows organization of finance department.
FUNCTIONS OF FINANCIAL MANAGEMENT
The three important activities of a business firm are finance, production and marketing. Through finance
activity the firm secures capital which sis employed through production and marketing activities. This a
business firm engages in activities to perform the functions of finance, production and marketing. It
acquires funds from the sources called investors. When invested, funds are called investments. The firm
expects to receive returns on investments over time. It periodically distributed returns to investors. These
processes are simultaneous and continuous. These are called the finance functions of the firm. These are
as follows:
1. To Raise Funds – Funds are two types: equity funds and borrowed funds
(i) Equity Funds – A firms sells shares to acquire equity funds. These represent ownership
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27. rights of shareholders. They invest their money in the shares of a company in the
expectation of returns on their invested capital in the form of dividend. Shares may be of two
types : common and preference. Preference shareholders receive dividends at a fixed rate
and have a priority over common shareholders in receiving dividends. The dividends rate for
common shareholders is not fixed. It varies from year to year depending on the decision of
the board of directors. The payment of dividends to shareholders is an absolute discretion of
the board of directors.
(ii) Borrowed Funds – An important source of securing capital is creditors or lenders who are
not owners of the company. They supply money to the firm on leading basis and retain title
to the funds lent. Loans are furnished for a specific period at a fixed rate of interest. The
return on loans or borrowed funds is called interest. Payment of interest is a legal obligation
of the firm. Creditors includes banks, financial institutions, debenture holders and others.
2. To Retain Earnings – When company secures funds by retaining a portion of the returns available
for shareholders, this method of acquiring funds is called retaining earnings. As the retained
earnings are undistributed returns on equity capital, they are a part of equity capital. The retention
of earnings can be considered as a form or raising new capital. If a company distributes all earnings
to shareholders, then, it can require new capital from the same sources by issuing new shares.
3. To plan investment project – The funds raised by a company are invested in the available
investment opportunities called investment project or project. These involve use of funds in the
expectation of future benefits. The company may also have on-going projects which involve outlays
of cash to maintain or to increase their profitabilities. Generation of revenue is possible only when
funds are invested in projects.
4. To carryout all the business activities – There is an inseparable relationship between the finance
function and the production, marketing and all kinds of business activities. Directly or indirectly
these involve e the acquisition and use of money. However, it need not necessarily limit or
constraint the general running of the business. A company in a tight financial position will give more
weight to financial considerations.
THE ROLE OF FINANCIAL MANAGER
TRADITIONAL APPROACH
Traditional the scope of financial management and the role of the financial manger were considered
confined to the raising of funds. He was called upon to raise funds during the major events, such as
promotion, reorganization, expansion etc. His only significant duty was to see that the firm has enough
cash to meet its obligations. Till the mid – 1950’s the finance books covered discussion of the instruments,
institutions and practices through which funds are obtained. These books contained detailed descriptions
of the major events like mergers, consolidations, reorganizations, recapitalizations etc. The traditional view
on financial management was based on the assumption that the financial manager has not concern with
the decisions of allocating firm’s funds, he is only required to raise the needed funds from the combination
of various resources.
The basic contents of the traditional approach, which also form its limitations, may be summarized as
follows. According to Prof. Solomon.:
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28. 1. To Raise Funds – The emphasis in the traditional approach was on raising of funds. The subject of
finance was treated from the investors’ point of view. The point of view of the financial decision –
maker was given no importance. The traditional view, thus, was the outsider – looking – in
approach.
2. Episodic Function – The traditional approach was circumscribed to the episodic financing
function. It placed overemphasis on topics of securities and its markets, promotion, incorporation,
merger etc.
3. Solution of Long-Term problems – The traditional approach placed great emphasis on the long-
term problems. It ignored the importance of the working capital management.
4. Problem of Non-corporate enterprises – The traditional approach used to give significant
attention to the financing problems of noncorporate enterprises.
CRITICISM OF TRADITIONAL VIEW
1. Lack of information of controls and regulations – As controls and regulations over firms were
imposed all over the world the management of the firms improved. It started disclosing the financial
information for the purpose of analysis and comparison of performance.
2. Wrong treatment of various problems – The traditional approach has been criticized due to its
failure to consider the day-to-day managerial problems relating to finance of the firm.
3. The outsider’s point of view – The traditional approach concentrated itself to looking into the
problems form lender’s the outsider’s point of view, instead of looking into the problems from
management’s the insider’s point of view.
4. Over emphasis on long term planning – The traditional approach over emphasized long-term
financing, lacked in analytical content and placed heavy emphasis on descriptive material.
5. Conceptual Omissions – The traditional approach neglected the consideration of the question of
the allocation of capital to different assets and the question of optimum combination of finances.
Thus, it omitted discussion on two important matters.
(i) Financing – mix – The traditional approach used to give no consideration to the
relationship between financing – mix and the cost of capital. it failed to deal with the
question of the optimum combination of finances at which the cost of capital is minimized.
(ii) Relationship between the valuation of the firm and the cots of capital – A theory of
valuation must be used as a basis for computing the cost of capital. the cost of capital is at
the root of allocating the firm’s funds most efficiently. The traditional approach failed on their
count.
Modern changes in the role of financial manager
1. Shift in emphasis - The traditional approach, outlived its utility in the changed business situation
since the mid-1950’s. Increasing pace of industrialization, technological innovations and inventions,
intense competition, increasing intervention of government on account of management inefficiency
and failure, population growth and widened markets etc., during and after mid-1950’s required
efficient and effective utilization of the firm’s resources, including financial resources. As the
development of a number of management skills and decision-making techniques facilitated to
implement a system of optimum allocation of the firm’s resources, the approach and scope of
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29. financial management changed. The emphasis shifted from episodic financing to the managerial
financial problems, from raising of funds to efficient and effective use of funds.
2. Analytic approach – The modern approach is an analytical way of looking into the financial
problems of the firm. The central problem of financial policy is the wise use of funds. The central
Process involved is a rational matching of advantages of potential uses against the cost of
alternative potential sources so as to achieve the broad financial goals which an enterprise sets for
itself. The basic finance function is to decide about the expenditure decisions and to determine the
demand for capital for these expenditures.
In his new role, the financial manager, is concerned with the efficient allocation of funds.
The three broad decision areas of modern financial manger are investment financing and dividend
decisions. He makes these decisions in the most rational way so that the funds of the firm are used
optimally.
Besides his traditional function of raising money, the financial manager today determines the size and
technology, sets the pace and direction of growth and shapes the profitability and risk complexion of the
firm by selecting the best asset mix and by obtaining the optimum financing mix. He has to look after profit-
planning which means operating decisions in the areas of pricing, volume of output and the firm’s selecting
of product lines.
ORGANISATION OF THE FINANCE FUNCTION IN LARGE FIRMS
As explained in fig. 2.2, In a large organization, the finance function is divided between a treasurer and
controller who, in addition to his usual duties as the chief accounting officer of the firm, is assigned some
staff function relating to finance such as financial forecasting, financial control and financial evaluation of
results. In many large concerns both the treasure and the controller of finance report to a chief financial
officer who often has the title, Vice-President-Finance. The division of finance function between controller
and treasurer is scientific, sound and efficient. The division of finance function between controller and
treasurer is scientific, sound and efficient. While the controller performs and their analysis, etc, the
treasurer is concerned with the routine functions such as recording of inflow and outflow of cash, credit
management, collection of credit sales etc. The vice-president for finance is in close touch with every
important facet of the operations of his department. He is usually on of the senior officers of the firm
reporting directly to the president of the firm. A survey by J.F. Weston in U.S.A. in the year of 1954
revealed that in most of the firms the finance officer reported to the president or the board of directors. In
other cases where he was not a member of the board, he usually attended board meetings in order to
advice and be consulted on financial affairs of the organization. In the year 1962 a survey conducted by
American Management Association revealed that while a majority of the companies have a vice president
of finance, the middle sized companies have both a treasurer and a controller. Smaller companies have
only treasurer. Finance committee is in some large organisation which directly report to the board directors.
STATUS AND DUTIES OF FINANCE EXECUTIVE
The nature of the organization for financial management differs from firm to firm depending on various
factors such as the size of the firm, nature of the business, kinds of financing operations, capabilities of the
firm’s financial officers and most importantly, on the financial philosophy of the firm.
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30. 1. Financial Manager – The designation of the financial officer differs from firm to firm and sometimes
he is known as the financial manager, while at other times he is known president of finance or the
director of finance or the financial controller. Treasurer and Controller may be appointed to assist
him. There may be a vice-president of director of finance, usually with both the controller and the
treasurer reporting to him.
2. Chief Financial Officer – The title, vice-president of finance or the finance manger is usually used
for the chief financial officer who has to report diretly to the managing director or the board of
directors or the chief manger of the firm. A firm may have a finance committee consisting of
members of top management with the chief financial officer as a member. The chief financial officer
has both line and staff responsibilities. Concerned with the financial planning and control, he is a
member of top management. Associated with the formulating of policies and making decisions for
the firm, he guides the treasurer and controller and others in the effective working of the financing
department.
3. Treasurer – Following are the functions of a treasurer:
(i) To provide finance – The treasurer has to establish and execute programmes for the
provision of the finance required by the business, including negotiating its procurement and
maintaining the required financial arrangements.
(ii) To Improve Investor relations – The treasurer has to establish and maintain an adequate
market for the company’s securities and to maintain adequate contact with the investment
community.
(iii) To Arrange short-term financing – The treasurer has to maintain adequate sources for
the company’s current borrowings from the money market.
(iv) To maintain Banking and custody – The treasurer has to maintain banking arrangement,
to receive and have custody of financial aspects of real estate transactions.
(v) To direct Credit and Collections – The treasurer has to direct the granting of credit and
the collection of accounts to the company.
(vi) To plan Investment – The Treasurer has to invest the company’s funds as required and to
establish and coordinate policies for investment in pension and other similar trusts.
(vii) To provide Insurances – The treasure has to provide insurance coverage as may be
required.
4. Financial controller – Following are the functions of Controller of finance
(i) To Plan and to control – The controller has to establish, coordinate and administer, as part
of management, a plan for the control of operations. This plan would provide, to the extent
required in the business, profit planning, programmes for capital investing and for financing,
sales forecasts and expense budgets.
(ii) To Report and to Interpert – The controller ahs to compare actual performance with
operating plans and standards, and to report and interpret the results of operations to all
levels of management and to the owners of business. To consult with all management about
the financial implications of its actions.
(iii) To Administer Tax – The controller has to establish and administer tax policies and
procedures.
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