Topic Financial Management

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Financial management

Topic Financial management

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Contents

Meaning of Finance

Definition of finance

Types of finance

Financial management

Definition of financial management

The goals of financial management

The nature of the financial management

The scope of the financial management

Objectives of financial management

Approaches of financial management

Characteristics of financial program

Importance of financial management

Financial decision making

Advantages and disadvantages of financial management

Journals

References

MEANING OF FINANCE:

Finance may be defined as the art and science of managing money. It includes financial service and financial instruments. Finance also is referred as the provision of money at the time when it is needed. Finance function is the procurement of funds and their effective utilization in business concern.

The concept of finance includes capital, funds, money, and amount. But each word is having unique meaning.

DEFINITION OF FINANCE

According to Khan and Jain:

“Finance is the art and science of managing money”

TYPES OF FINANCE

Finance is one of the important and integral part of business concerns, hence, it plays a major role in every part of the business activities. It is used in all the area of the activities under the different names.

Finance can be classified into two major parts:

Private finance

Public finance

Private finance:

Private Finance, which includes the Individual, Firms, Business or Corporate Financial activities to meet the requirements.

Public finance:

Public Finance which concerns with revenue and disbursement of Government such as Central Government, State Government and Semi-Government Financial matters.

Financial Management

According to Oxford dictionary:

The word ‘finance’ connotes ‘management of money’. Webster’s Ninth New Collegiate Dictionary defines finance as

“The Science on study of the management of funds’ and the management of fund as the system that includes the circulation of money, the granting of credit, the making of investments, and the provision of banking facilities.

DEFINITION OF FINANCIAL MANAGEMENT

Financial management is an integral part of overall management. It is concerned with the duties of the financial managers in the business firm.

According to Solomon:

“It is concerned with the efficient use of an important economic resource namely, capital funds”.

According to S.C. Kuchal :

“Financial Management deals with procurement of funds and their effective utilization in the business”.

Financial management is concerned with the acquisition, financing and management of assets with some overall goal in mind.

Types of financial management

Thus the decision function of financial management can be broken down into three major areas: the investment, financing, and assets management decisions.

Investment decision:

The investment decision is the most important of the firm’s three major decisions. It begins with a determination of the total amount of assets needed to be held the firm’s.

Financing decision:

The second major decision of the firm is the financial decision. Here the financial manager is concern with the make-up of the right – hand side of the balance sheet.

Dividend policy must be viewed as an integral part of the firm’s financing decision. The dividend –payout ratio determines the amount of earnings that can be retain in the firm.

Asset management decision

The third important decision of the firm is the assets management decision. Once assets have been acquired and appropriate financing provided, these assets must still be managed efficiently. The financial manager is charged with varying degrees of operating responsibility over existing assets. These responsibilities require that the financial manager be more concerned with the management of current assets than with that of fixed assets.

The goals of the financial management

Efficient financial management requires the existence of some objectives or goals because judgment as to whether or not a financial decision is efficient must be made in light of some standard. The goal of the firm is to maximize the wealth of the firm’s present owners. The economic efficiency goal for both businesses and public enterprises is not an end in itself. Those things which enterprises seek to do reflect the personal goals of individuals and the collective goals of private and public institutions. These personal, social and political goals are themselves continuing to change and to evolve; at times the changes appear to be dramatic, if not revolutionary. The goal of economic efficiency itself is being challenged and may undergo changes. However, as long as goods are scarce, efficient use of resources is necessary in order to achieve individuals and group, political and social, national and international, and industrial and cultural goals of our society.

THE NATURE OF FINANCIAL MANAGEMENT

Financial management is that part of total management which is concerned primarily with the financial affairs of an organization and the translation of actions, both past and proposed, into meaningful and relevant information for use in the management process. It includes the functions of budgeting, accounting, reporting, and the analysis and interpretation of the financial significance of past events and future plans. It sometimes also includes other related functions such as internal auditing, management analysis, and others. It is not primarily concerned with the technical procedures and methodology of those individual functions. Rather, it is characterized by the coordination and correlation of those functions into an effective and broad system of financial control that will assure that they, collectively more than individually, become an integral part of the management of the organization.

Financial management involves the art of interrelating data to obtain a perspective of the total financial situation that will assist managers1 in program planning and decision-making. A very simple operating program2 may require only a minimum of financial management, and this, in some cases, can be provided by the manager himself. However, many Federal agencies with complex programs have a need for broad financial advice and know-how -- advice that can only be furnished following a synthesis, analysis, and interrelating of meaningful financial data with programming and planning information by an organization and officials particularly adept and capable in financial matters.

More fully, financial management may be described as --

Designing, establishing, and maintaining an integrated financial management system, including at least budgeting, accounting, and managerial-financial reporting, which will furnish timely data that are used in the direction, evaluation, and control of operations at the various levels of management. Such a system must be compatible with the requirements of the Bureau of the Budget, the General Accounting Office, and the Treasury Department, and should provide accountability for agency funds and assets and full disclosure of the financial results of agency operations. This involves responsibility for proper and economic management of all financial resources under jurisdiction of the agency, in accordance with a wide variety of laws and regulations. To accomplish this, a suitable financial management organization must be established and maintained, and must be staffed with appropriate, competent personnel. Rather than being limited to supervision of separate entities such as the budgetary system, the accounting system, the financial reporting system, etc., financial management consists of the integration and coordination of those operations into a comprehensive financial system that is compatible with management needs.

SCOPE OF FINANCIAL MANAGEMENT

Financial management is one of the important parts of overall management, which is directly related with various functional departments like personnel, marketing and production. Financial management covers wide area with multidimensional approaches. The following are the important scope of financial management:

1. Financial Management and Economics

Economic concepts like micro and macroeconomics are directly applied with the financial management approaches. Investment decisions, micro and macro environmental factors are closely associated with the functions of financial manager. Financial management also uses the economic equations like money value discount factor, economic order quantity etc. Financial economics is one of the emerging area, which provides immense opportunities to finance, and economical areas.

1. Financial Management and Accounting

Accounting records includes the financial information of the business concern. Hence, we can easily understand the relationship between the financial management and accounting. In the olden periods, both financial management and accounting are treated as a same discipline and then it has been merged as Management Accounting because this part is very much helpful to finance manager to take decisions. But nowadays financial management and accounting discipline are separate and interrelated.

1. Financial Management or Mathematics

Modern approaches of the financial management applied large number of mathematical and statistical tools and techniques. They are also called as econometrics. Economic order quantity, discount factor, time value of money, present value of money, cost of capital, capital structure theories, dividend theories, ratio analysis and working capital analysis are used as mathematical and statistical tools and techniques in the field of financial management.

1. Financial Management and Production Management

Production management is the operational part of the business concern, which helps to multiple the money into profit. Profit of the concern depends upon the production performance. Production performance needs finance, because production department requires raw material, machinery, wages, operating expenses etc. These expenditures are decided and estimated by the financial department and the finance manager allocates the appropriate finance to production department. The financial manager must be aware of the operational process and finance required for each process of production activities.

1. Financial Management and Marketing

Produced goods are sold in the market with innovative and modern approaches. For this, the marketing department needs finance to meet their requirements.

The financial manager or finance department is responsible to allocate the adequate finance to the marketing department. Hence, marketing and financial management are interrelated and depends on each other.

1. Financial Management and Human Resource

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

OBJECTIVES OF FINANCIAL MANAGEMENT

Effective procurement and efficient use of finance lead to proper utilization of the finance by the business concern. It is the essential part of the financial manager. Hence, the financial manager must determine the basic objectives of the financial management. Objectives of Financial Management may be broadly divided into two parts such as:

1. Profit maximization

2. Wealth maximization

(i)Profit Maximization

Main aim of any kind of economic activity is earning profit. A business concern is also functioning mainly for the purpose of earning profit. Profit is the measuring techniques to understand the business efficiency of the concern. Profit maximization is also the traditional and narrow approach, which aims at, maximizes the profit of the concern. Profit maximization consists of the following important features.

1. Profit maximization is also called as cashing per share maximization. It leads to maximize the business operation for profit maximization.

2. Ultimate aim of the business concern is earning profit, hence, it considers all the possible ways to increase the profitability of the concern.

3. Profit is the parameter of measuring the efficiency of the business concern. So it shows the entire position of the business concern.

4. Profit maximization objectives help to reduce the risk of the business.

Favorable Arguments for Profit Maximization

The following important points are in support of the profit maximization objectives of the business concern:

Main aim is earning profit.

Profit is the parameter of the business operation.

Profit reduces risk of the business concern.

Profit is the main source of finance.

Profitability meets the social needs also.

Unfavorable Arguments for Profit Maximization

The following important points are against the objectives of profit maximization:

Profit maximization leads to exploiting workers and consumers.

Profit maximization creates immoral practices such as corrupt practice, unfair trade practice, etc.

Profit maximization objectives leads to inequalities among the stake holders such as customers, suppliers, public shareholders, etc.

Drawbacks of Profit Maximization

Profit maximization objective consists of certain drawback also:

It is vague: In this objective, profit is not defined precisely or correctly. It creates some unnecessary opinion regarding earning habits of the business concern.

It ignores the time value of money: Profit maximization does not consider the time value of money or the net present value of the cash inflow. It leads certain differences between the actual cash inflow and net present cash flow during a particular period.

It ignores risk: Profit maximization does not consider risk of the business concern. Risks may be internal or external which will affect the overall operation of the business concern.

Wealth Maximization

Wealth maximization is one of the modern approaches, which involves latest innovations and improvements in the field of the business concern. The term wealth means shareholder wealth or the wealth of the persons those who are involved in the business concern.

Wealth maximization is also known as value maximization or net present worth maximization. This objective is a universally accepted concept in the field of business.

Favorable Arguments for Wealth Maximization

Wealth maximization is superior to the profit maximization because the main aim of the business concern under this concept is to improve the value or wealth of the shareholders.

Wealth maximization considers the comparison of the value to cost associated with the business concern. Total value detected from the total cost incurred for the business operation. It provides extract value of the business concern.

1. Wealth maximization considers both time and risk of the business concern.
2. Wealth maximization provides efficient allocation of resources.
3. It ensures the economic interest of the society.

Unfavorable Arguments for Wealth Maximization

1. Wealth maximization leads to prescriptive idea of the business concern but it may not be suitable to present day business activities.
2. Wealth maximization is nothing, it is also profit maximization, and it is the indirect name of the profit maximization.
3. Wealth maximization creates ownership-management controversy.
4. Management alone enjoy certain benefits.
5. The ultimate aim of the wealth maximization objectives is to maximize the profit.
6. Wealth maximization can be activated only with the help of the profitable position of the business concern.

APPROACHES TO FINANCIAL MANAGEMENT

Financial management approach measures the scope of the financial management in various fields, which include the essential part of the finance. Financial management is not a revolutionary concept but an evolutionary. The definition and scope of financial management has been changed from one period to another period and applied various innovations. Theoretical points of view, financial management approach may be broadly divided into two major parts:

(i)Traditional Approach to financial management

Traditional approach is the initial stage of financial management, which was followed, in the early part of during the year 1920 to 1950. This approach is based on the past experience and the traditionally accepted methods. Main part of the traditional approach is rising of funds for the business concern.

(ii)MODERN APPROACH TO FINANCIAL MANAGEMENT

Henry Ford has once remarked:

“Money is an arm or a leg; you either use it or lose it”.

Though the above statement looks simple but it is quite meaningful.

According to the modern approach the term financial management provides a conceptual and analytical framework for financial decision making. That means, the finance function covers both acquisition of funds as well as their allocation. This new approach views the term financial management in a broader sense. It is viewed as an integral part of overall management.
The modern approach of financial Management can be divided into four major decisions as function of finance:
- The investment decision
- The financial decision
- The dividend policy decision
- The funds requirement decision

INVESTMENT DECISIONS

This is concerned with the allocation of capital. It has to show the funds can be invested in assets which would yield benefit in future. This is a decision based on risk and uncertainty. Finance Manager has to evaluate the investment in relation to their expected results and risk to determine whether the investment is feasible or not.

FINANCIAL DECISIONS

This decision is concerned with the mobilization of finance for investment. The Finance Manager has to take the decisions regarding the acquisition of finance. Whether entire capital required should be raised in the form of equity capital or the amount should be borrowed totally or a balance should be struck between equity and borrowed capital has to be decided. Even the timing of acquisition of capital should also be perfectly made.

DIVIDEND DECISION
The dividend decision involves the determination of the percentage of profit earned by the enterprise which is paid to the shareholders. The dividend payout ratio must be evaluated in the light of the objective of maximizing shareholder’s wealth. Thus, the dividend decision has become a vital aspect of financial decision.

CURRENT ASSETS MANAGEMENT
The Finance Manager should also manage the current assets to have liquidity in the business. Investment of funds in current assets reduces the profitability of the firm. However the finance manager should also equally look after the current financial needs of the firm to maintain optimum production. While investing in current assets, he should see that proper trade off is maintained between the profitability and liquidity.