Chapter 1

1. Introduction:
Finance is the lifeblood of any business unit. No business unit can survive or
grow without proper financial management. Not only in the business sector,
but in the national and international sectors, proper financial management is
indispensable for the progress of the nation.
The field of financial management i.e. the concept of finance is constantly
changing. Until 1950, finance was considered to be only the work of getting
money for business. Financial management mainly deals with different
instruments of raising money, financial institutions, documents related to
money etc. Efficient use of money also financial. It is now accepted for the last
40-50 years is for that occupies the position of finance minister in the modern
economy. Getting enough money at the right time and using it profitably is one
of the most important tasks of top management. That itself can be called
financial management. All the management functions are delegated to other
officers, but the decision regarding financial matters is reserved to the top
managers, indicating the importance of financial management Money is the
lifeblood of industry. The industry needs money to buy dust collectors. So, day
to day money is needed to buy raw materials, pay labour, pay for factory as
well as other administrative expenses. Also, if there is to be development, if
modernization is to be planned, then more and more money will be needed.
Thus, finance is the lifeblood of the industry. Authors Husband and Dockery
explain the importance of money and write: “Money is the circulatory system
of the economic body, the system of activity.
It makes the necessary cooperation between different units possible." Let us
clarify another point at this stage. Thus, there are many forms of business
organization like sole trader, partnership firm, joint stock company, cooperative
society etc. It is not an exaggeration to say that the stock company is the
ultimate form of business finance. Of course, the questions we will study about
finance are also applicable to some extent.
2. Meaning of Finance Management:
financial management means getting the money needed for the business,
getting it at the right time and using it effectively in the business. In short, the
job of financial management is to solve the financial problems of the business.
Financial management can include issues related to the cost of setting up a
company, raising permanent capital required to purchase properties for the
business, raising current capital for day-to-day expenses, sharing income, and
raising money needed for development and modernization. Here are some of
the definitions given by different scholars:
(1) Mr. Hoagland writes, “How a business corporation acquires capital and uses
it primarily concerned with financial management."
(2) In the opinion of Mr. Raymond Chambers, “To facilitate the implementation
of decisions on financial matters; Taking action and observing it is financial
management.”
(3) Mr. Pais states, "Financial management in a modern economy based on the
use of money means making provision for the availability of money when it is
needed."
(4) According to Mr. Ezra Solomon, “In addition to raising funds, financial
management and business ventures involve production, marketing and other
functions when decisions have to be made regarding the acquisition or
distribution of ownership.
Importance of Financial Management:
No business can be successful without adequate financial management. There
is no need to repeat that now. Pay money to buy raw materials. It is not difficult
to imagine the mental state of a manager who is facing financial difficulties to
pay wages to workers and other employees on time. No business can succeed
without the necessary funds to take advantage of the opportunity. The
importance of financial management in business will be clearer from the
following points:
(1) Basis of success of company operation: Whether the company will be
successful or not will come from the strategic plan made by its founder. If this
plan is flawed, there will not be enough money to buy permanent assets and
the constant shortage of working capital will be a source of mental anguish for
the managers. An over-optimistic financial plan can lead to over-capitalization,
if the business raises more capital than it can absorb, it may not earn enough
and may not be able to return on capital at the right rate. Such attempts are
bound to fail
(2) Smooth operation of the business: Finance is required at several stages in
the operation of the business, especially the need for working capital is on a
day-to-day basis. Money is needed at the right time to purchase machinery
required for production, to purchase raw materials frequently and to pay
labour and salaries. The need for money in sales cannot be underestimated.
Money is needed for advertising, paying salesmen's salaries and many other
activities related to sales promotion. If the financial system is flawed then the
managers will be suffering due to the collapse.
(3) Sufficient Finance for Development: Naturally, any business needs finance
for development, expansion and modernization. How to meet this requirement
is a question of financial management. Wise canal management will gradually
build up sufficient reserves from the bath, raising capital at the least possible
cost under the circumstances.
(4) Essential for Cash Planning: Liquidity in business is more important than
any other factor affecting success. A manager who pumps without realizing the
cash situation may be imagining a rosy picture of the financial position of his
business, but his chances of failure are manifold.
4. Scope of Financial Management:
Thus, financial management includes both obtaining money and using it
effectively. Apart from that, the decision regarding distribution of income i.e.
dividend policy also comes under the purview of financial management. To get
money it is very important to first determine how much money is needed and
from where and by what means it can be raised. This can be called
capitalization planning. Financial management is also the function of deciding
which activities require money and whether they are profitable or not. For
example, this includes capital projects that require substantial investment as
well as plans to obtain working capital for ongoing ventures. Financial
management cannot be thought of without how to calculate the profit made in
the business (for example, how much to keep in reserve, how much to keep
depreciation fund etc.) and how much and how to distribute it. Three things
become important in financial management: (1) decision about investment, (2)
decision about how and how much money to raise, and (3) decision about
dividend policy.
A detailed consideration of financial management functions may include the
following:
(1) Planning of Finance: Requirement of finance for many things at the start-up
stage of the business and in the ongoing business It has to be estimated.
Several types of establishment expenses have to be estimated, such as site
investigation, purchase of properties, purchase of machinery, preliminary
contracts, solicitor's fees, founders' remuneration etc. The task of formulating
capital expenditure plans for ongoing business is a function of financial
management. How much money will be required in capital expenditure plans,
how much cash income will be generated from that investment and how much
return on capital will be obtained requires expert calculation. Investing money
without it is like taking a plunge in the dark. Creating a cash flow budget at the
beginning of the year is obviously a financial management task. Business
managers without an idea of the estimated cash inflows and outflows each
month and each week lead rich people down the road to bankruptcy.
2) Receipt of money: The financial manager has to do the work of getting the
estimated money efficiently and easily. Efficiency of officials lies in getting
money at minimum cost. A short-term requirement and a long-term
requirement cannot be met from the same type of equipment. He should make
a comparative study of the different attainments of these two. Just as it is
useless to create unnecessary burdens by raising more money than needed,
less money than needed cripples the business. For this, different types of
shares, debentures, financial institutions
(3) Use of money: Using money in such a way that the objectives of the pump
can be achieved is important for financial management. Doing so can protect
the interest of the owner who has invested money in the business. However,
the use of funds should be the focus of financial management in such a way
that the interests of the debenture holders and other creditors of the company
are preserved and their interests are aligned with those of the owners.
(4) Distribution of income: Equally important as the receipt of money is the
right distribution of the income earned for the success of the business. First,
determining the distributable income is a question that requires intelligence
and insight. Added to that is the daunting task of distributing it. Also, after
determining the net profit, the decisions of how much to keep the reserve fund
for which purpose, how much to reinvest the profit in the business and how
much to distribute as dividend etc. have a significant impact on the viability of
the business. Dividend policy affects the interest of shareholders, creditors,
employees etc. in the long run.
(5) Determining the financial policy: The financial manager also has to do the
work of formulating the policy regarding the policy to be adopted by each
account when the question arises about the income and expenditure of money.
He has to decide the policy regarding the use of money in production,
purchase, sale etc. For example, the guiding policy as to whom to sell up to
whom and under what conditions should rest with the financial manager.
(6) Financial control: Plans and policies regarding financial matters have no
meaning if they are not monitored to ensure that the work is being done
according to the plans and policies laid down. For this internal audit system,
return on investment, ratio analysis, breakeven analysis, budgetary control etc.
provide useful guidance. Controlling past and ongoing operations, ensuring
that cash flows are generated as planned and taking action on any
discrepancies that arise so as to ensure that the financial position is viable etc.
are the areas of financial management.
Objectives of Financial Management:
A financial manager has to make three types of decisions: investment decision,
raising money decision and dividend distribution decision. While making these
decisions, he has to keep some goal or purpose in mind and take decisions in
such a way that it is achieved.
(a) profit maximization and (b) wealth maximization.
(a) Profit Maximisation:
Economists have long regarded bath maximization as a welcome norm. It is
considered as a guarantee of business efficiency. According to this theory,
actions or decisions that increase profits should be welcomed and those that
decrease the firm's profits should be avoided. A firm must be efficient in the
use of these economic tools to maximize profit, produce the maximum with
the given tools and do it at the least cost.
(1) The concept of profit maximization is a result of perfect competition, but
perfect competition is now rare. Imperfect competition prevails everywhere in
the market. In those circumstances it is no longer reasonable to accept it as a
standard of financial judgment.
(2) Solomon and Pringle state, "A system based on private ownership and profit
maximization may be efficient, but it results in inequality of income and wealth
between different classes of society." Of course, there are arguments against it.
That under these circumstances’ resources are allocated efficiently and society
becomes richer.
(3) Concept of profit is vague. It can have different meanings. Profit means
profit before tax or after tax; neither short-term nor long-term profit; gross
profit or net profit; Profit is used in many senses like rate of profit on total
assets or rate of return on shareholders' capital. Thus, the concept of profit
itself is not clear, so it is not appropriate to take it as a basis for decision.
4) Time factor is ignored in this concept. The goal of maximizing profit is not
taking into account when and how much profit is made, so the time value of
money is ignored. Invest in two different schemes and the total income from
both is same, but different at different times.
* An Introduction to Financial Management Soloman and Pringle Above we
saw that the goal of profit maximization is not appropriate as a criterion for
maximizing the economic welfare of the business owner. Hence wealth
maximization is presented as a reasonable standard for that. The time element
is neglected in profit maximization. It is not taken into account here that a
scheme may have maximum profit but its value varies at different times. Also, it
does not take into account that the element of uncertainty is also different in
different schemes. So, wealth maximization is accepted as the cornerstone of
financial decision making. Financial decisions of a business unit are taken in
such a way as to maximize the value of the business. For this, the total present
value of the investment decisions taken should be more than the investment
made in it. Only then the wealth of the unit is maximised.
(B) Maximization of Wealth:
Above we saw that the goal of profit maximization is not appropriate as a
criterion for maximizing the economic welfare of the business owner. Hence
wealth maximization is presented as a reasonable standard for that. The time
element is neglected in profit maximization. It is not taken into account here
that a scheme may have maximum profit but its value varies at different times.
Also, it does not take into account that the element of uncertainty is also
different in different schemes. So, wealth maximization is accepted as the
cornerstone of financial decision making. Financial decisions of a business unit
are taken in such a way as to maximize the value of the business. For this, the
total present value of the investment decisions taken should be more than the
investment made in it. Only then the wealth of the unit is maximised.
net present value = present value of cash flows received - investment
Introduction to Financial Management
As the value of the unit increases based on the maximization of wealth, the
interest of other parties involved besides the owner of the business is
preserved. E.g., creditors, workers, government, society etc. If the value of the
unit increases, its financial viability increases annually and its earnings increase.
So that both the interest and principal can be paid to the creditor and the
maximum economic welfare of the society can be achieved due to optimal
distribution of snakes. Thus, the purpose of social responsibility can also be
fulfilled.
Of course, from the above discussion it is clear that wealth maximization
should be the main objective of financial management, but in practice it is
possible. The actual situation is that the owners or shareholders of the
business entrust the management of the business to the directors.
Shareholders themselves do not take any decisions, but directors do. They do
not always strive for wealth maximization for the sake of security. They only
strive to get a satisfactory return on investment. Thus, in practice there is more
tendency towards satisfaction rather than maximization.
6. Basic objectives of managing financial instruments
(Underlying Objectives of Resource Management)":
Above we have examined the two basic purposes of financial management. Let
us see how the same thing is presented differently in the syllabus.
The basic purpose of existence of a business entity is to create maximum value
for its owners. Of course, a business unit also has its employees, customers and
society associated with it and the business has responsibilities towards them,
but the fundamental responsibility of managers is to maximize the benefits of
its owners. For this one has to focus on two things: one, raising funds properly
and secondly using those funds or financial instruments wisely.
If the financial instruments or funds are to be used wisely and increase the net
worth of the owners then the maximum return on the invested funds should
be achieved i.e. the rate of return on investment should be focused. Thus, not
the total profit, but the percentage of profit on investment needs to be taken
higher. This is the basic purpose of managing financial instruments.
1 Satisfactory rate of return on investment:
Thus, the ultimate goal of a business is to add value to the business owners.
The goal of maximizing return on investment is now widely accepted as one of
its means. The concept of rate of return on investment has been accepted as a
'primary measure' of directors to measure how they have managed the money
entrusted to them, i.e. their performance.
There are several reasons for this:
(1) It accepts that capital has value and also that capital is not available in
unlimited quantities.
(2) It lays emphasis on economical use of capital in business.
(3) If this measure is adopted for performance evaluation, it becomes a guide
for improvement of performance.
(4) The concept is simple and can be understood by every person working in
the management system
Risk return:
And since interest has to be paid on it, the rate of return on total investment is
reduced, but the rate of return on proprietary investment is very high, because
of the benefit of trading on equity. In other words, the rate of return on equity
investment will be higher if outside money can be obtained at a lower interest
rate than the return on total investment in the business. So is the risk of
borrowing money against that benefit. If the interest cannot be paid on time,
the creditors may drive the business into bankruptcy. Hence this risk has to be
taken into consideration while using external debt, i.e. maintaining the right
proportion of both equity capital and external equity can maximize return on
equity investment
9.3 Du-Pont Chart:
the following charts the return on investment over the years to measure the
performance of the managers of an American company named Du-Pont
Uses:
This chart shows that many factors affect the return on investment affects the
final rate of return. Similarly, even if there is a change in current assets, rate of
return on investment is used to measure the performance of any business unit.
Not only this method is also used to evaluate each option if a new investment
plan is to be implemented. These rates of return have to be consistent if they
are to be used for comparison purposes. Only income from properties included
in the denominator should be included in the profit shown in the numerator.
the cure
Effective use of assets in a business can result in a higher rate of return on
investment, thus, business success requires that business assets remain
operational and put to productive use. Every business has some constraints
against the effective use of property. In every business and especially in highly
profitable business there is a tendency to invest more and more. Everyone likes
to work with modern and best tools. Some businessmen have a tendency to
over invest to show that they are superior to others. Other people's money is
invested in companies.
Some managers always have a tendency to maximize return on investment and
make optimal use of resources are:
(1) Even there the departmental managers try to make their department more
efficient by investing more and more. For example, a production manager may
demand that better machinery and equipment be purchased to increase
production or reduce labour costs. Sometimes, if the factory is shut down due
to shortage of raw material, the production manager may demand that more
stock of raw material be kept so that such a situation does not arise.
(2) The sales manager may demand that the sales policy be liberalized in order
to increase sales (but therefore increase investment in debtors) or to keep a
more varied stock (so that the year of cash in stock). All these propositions lead
to increased return on investment, say departmental managers.
(3) But they do not take into account the additional expenses incurred by over-
investment in properties and the funds required for additional capital
expenditure. For example, a sales manager demanding an increase in stock
forgets that more space is needed to store the additional stock; Godowns have
to pay more taxes and insurance premiums and the goods do not spoil
(4) Keeping cash in hand for a long time also reduces its value due to inflation.
(5) If additional investment is made in the properties in this way, the additional
net income and the additional expenses, depreciation and interest etc. should
be compared against it. Investment should be made only if the return on such
additional investment in properties is greater than the cost of such additional
investment. The concept of return on investment is also useful in this regard.
6) Another question arises that although the return on additional investment is
high, it is not easy for small firms to obtain additional funds. So the question of
the effort required to get additional capital against the return from additional
investment should also be considered. The function of finance officer becomes
important here.
(7) Efforts should be made to obtain additional funds in this way only if the
property can be put to effective use; Otherwise, the best way is not to make
any further investment efforts.
7. Finance Function:
The English word for money is 'Finance', which is derived from the French
language. The meaning of this word has changed from time to time. Originally
it meant, "Ransom". Later it came to mean 'revenue of the state'. Around 1721
it came to mean 'borrowing of money at interest'. Today finance means
'administration of money'. ' is done. The word money is coined. This word can
be interpreted as "the use of skill or care in the management, use and control
of money". However, in actual situation the meaning of finance is reduced in
different ways. Different authors have defined finance in different ways. This is
why Anderson and other writers equate finance with beauty and that in the
eyes of the viewer.
It has been stated that Each business unit has different functions. If it is a
manufacturing unit, then the functions of purchase, production, sales,
personnel management, accounting, etc. are done in it, whereas in a trading
unit, functions other than production work are done. Irrespective of the type of
unit, there is a need for financial instruments. The task of obtaining financial
resources is very essential for the other functions of the unit to be carried out
successfully. What can the purchasing department do without adequate
financial resources? Sufficient to meet the expenses till the product is sold and
the money invested is recovered
How can the unit function without provision of financial instruments? Thus, of
financial instruments in a business unit
Provision and arrangement become imperative. Finance deals with such
provision and arrangement.
Finance is a dynamic concept. As time and circumstances change, the concept
of finance also changes. Finance has been defined in different ways by different
authors. It has changed over time. It is difficult to give an agreed definition of
finance. Finance has been variously defined as follows:
The point of view about what finance is called or what finance involves is
changing from time to time. Three approaches are prevalent in this regard:
(a) Traditional approach
(b) Transitional approach
(c) Modern approach.
Traditional Approach:
Until the 1950s, the approach to finance was narrow. According to that
approach, obtaining money for Pampa was considered a financial function.
That's why Paish gave the meaning of finance and said that "Financial
management in a modern economy that depends on the use of money means
making provision that money is available when it is needed."
Due to such a narrow approach, the scope of financial management included
only the following matters related to finance: (1) Study of financial institutions
i.e. study of capital market. E.g., stock market, merchant banks, specialized
institutions, investment banking etc. (2) Study of financial documents was
expected. In which different types of shares, debentures and other documents
through which capital can be obtained. (3) Legal and accounting relationship
between the firm and its financiers. According to this approach, there is a need
to raise money at certain events. E.g., formation of company, registration,
restructuring, amalgamation, merger, dissolution etc. A study of such
phenomena was expected in the study of financial management. Also, the
financial management of companies was his subject. That is why the subject
kept in the syllabus was also called 'Corporation Finance' and the books were
also written with that name.
(1) According to this way of thinking only getting money is emphasized for the
business. In the concept of receiving money for Pampa, it is forgotten that the
insiders who manage the money on a day-to-day basis also have to do with
managing the money. It only considers investors, creditors, banks, insurance
companies etc. who provide finance. All of these individuals are outsiders to
the business, so this perspective represents an “outsider's point of view”.
(2) The traditional view focuses only on the financial management of joint stock
companies. It is also narrow in that sense, as it only targets companies that are
part of the business world. The fact that sole traders, partnership firms, co-
operative societies etc. also have their own financial functions is ignored here.
(3) It is objective point of view. It only discusses the need for money and its
receipt in case of events occurring during the life of the company. E.g.,
formation, registration, dissolution, reorganization etc. of a company. Thus, the
whole point of view is only episodic. Now, such incidents are not frequent or
daily occurrences during the lifetime of the company, whereas the
management of finances is an everyday question.
(4) It emphasizes only the long-term financial need of the business. That is why
short-term requirements i.e. working capital needs of money are ignored. The
reality is that day-to-day financial requirements are the main concern of
managers in running a business. Of course, short-term capital requirements
arise due to long-term investment plans, but long-term requirements arise
once or twice a year, while short-term requirements have to be attended to by
managers on a day-to-day basis.
Transitional Approach:
This approach makes finance as its name implies. Accordingly, it includes all
transactions involving cash. If we adopt this approach, the entire business
management becomes financial management. Because almost every business
function involves cash transactions. Credit sales are also recovered in cash.
Thus, all important aspects of a business-like sales, production, purchase etc.
are included in finance. Hence this approach is not practical for discussing
finance
Modern Approach:
It is a practical approach and its development is seen in writings after 1950.
According to this approach finance is concerned with the acquisition of money
and its proper use. Here both things are given importance: one, the acquisition
of money and second, the proper use of money. Mr. Pandey writes. "The
approach to financial management and its scope changed. Emphasis shifted
from objective financial management to managerial financial issues, from
raising funds to efficient and effective use of funds."
Here are the views of some writers:
(1) Mr. Hoagland writes, "Financial management is primarily concerned with
how a business corporation acquires and uses capital."
(2) In the words of Mr. van Horn, “Financial management is concerned with -
(1) the efficient allocation of funds to the enterprise and (2) the raising of funds
on as favourable terms as possible.
(3) According to Weston, "The area of business finance includes the operations
of a business firm that relate to obtaining capital and investing it in various
types of assets."
The modern approach suggests that financial management is concerned with
two things: (1) getting money when the business needs it at the least cost, and
(2) making the best investment of the money received, so as to get the
maximum return on investment. That is, according to this approach it is not
only the acquisition of money that is important, but also its efficient and wise
allocation between different uses.
An analysis of this approach suggests the following:
(1) Financing: present and future financing requirements of the unit are
estimated. Then it is considered how to raise money to meet those needs.
Every type of finance incurs a cost and it is the job of the finance manager to
raise money in such a way as to keep those costs to a minimum. This work is
accepted in both traditional and modern approaches.
(2) Investment: The financial manager has to decide in which properties to
invest the money in the business. For this he has to compare both the cost of
obtaining capital and the return on investment. If there are more than one
investment scheme, the most profitable scheme is invested.
(3) Revenue Management: Apart from these two, the financial manager also
has to consider the question of distribution of the revenue received. This
decision is a dividend decision. It is important to decide how much of the
business income to distribute as dividend and how much to keep as business.
Thus, the modern approach emphasizes three types of financial manager's
work: (1) investment decision, (2) financing decision, and (3) dividend policy
decision.
The modern approach is called problem-oriented approach. In this approach,
the manager generally has the following considerations: (1) What costs should
the firm incur? (2) How much funds the firm should invest. (3) How the
necessary funds should be obtained. (4) Unit own profitability from current and
proposed investments
Funding instruments
(1) Transactions and Specials
Cash flow from transactions
(2) Equity or Debts
(i) Persons
(II) Financial institutions
(iii) Other business establishments
Use of funds
(1) Unexpected expenses:
(i) Continued
(ii) Permanent.
(2) Unexpected expenses:
(I) Interest and Debt Expenses.
(ii) Govt.
(iii) Allocation or deficit among owners.
Difference between traditional and modern approaches:
T (1) Finance in this approach means only the function of receiving money i.e.
the function of obtaining money from the right source when the business
needs it. It does not involve using money efficiently.
M (1) According to the modern approach, finance means money collection and
efficient use of money. including both. That is, the job of the financial manager
is to decide how to invest the money in the properties.
T (2) The classical approach considers only the financial arrangements relating
to the company. It does not consider unincorporated business units.
M (2) The modern approach considers the financial problems of all types of
business units. It prescribes the same principles and procedures. In addition to
the company, it also brings in sole traders = partner firms and co-operative
societies.
T (3) It considers only sources of long-term capital. He believes that there are
no working capital issues for managers.
M (3) This approach addresses both types of finance issues. gives Working
mood in addition to long-term capital Management also includes finance.
T (4) From the point of view of a person of wealth who observes the financial
affairs. E.g., investors, creditors, financing persons or institutions. While
insiders, financial managers who have to deal with day-to-day financial issues
are not considered.
M (4) It examines the finances from the point of view of both the parties. The
financial question of insiders is given as much attention as that of outsiders.
That is to say, along with raising money, the issue of using money is also
considered.
T (5) It is a case-oriented approach, in which raising money to meet the need of
money arising on the occasion of setting up, restructuring, dissolution etc. of
the company is considered to be the only financial function.
M (5) It is a holistic approach, i.e. it includes management of day-to-day
financial needs in addition to critical events.
T (6) It presents a narrow concept of finance.
M (6) It shows practical approach to finance. It considers the entire function of
financial management.
8. Classification of Financial Function
Types are:
(A)Executive Finance Functions:
The functions related to the three financial decisions we discussed above
(investment decision, financing decision, dividend decision) are administrative
functions. Such functions can be presented in detail as follows:
(1) The administrative finance function that arises from the investment
decision is the function of deciding in which assets to invest i.e. the function of
determining asset-management policy.
(2) The tasks that arise from the financing decision are (i) determining the need
for financing and determining new external sources of financing (ii) negotiating
to obtain funds from such external sources.
(3) The function relating to the decision of dividend policy means the function
of distribution of net profit.
(4) Control is one of the important functions of managers, whatever their field.
Accordingly, the finance manager also needs to (I) control the financial
operations. Also, (ii) Planning and controlling the inflow and outflow of cash is
also a part of control. Thus, presented in detail, the financial functions can be
presented as follows:
(1) Financial planning: Planning is the first task of a manager in any field. An
important administrative function of a finance manager is money
management. For this he has to plan every year for investment and working
capital for next year. As part of working capital planning, cash budgets have to
be prepared in great detail. Apart from this, long-term planning is also to be
considered by the financial manager. Planning of finances in accordance with
the development and expansion plan prepared by the top management of the
company in collaboration with the production manager and sales manager
(2) Determining Asset-Management Policy: Determining in which and how
assets to invest money - stock prices are a very delicate task. Business
profitability is based on it. Decisions have to be made about how much to
invest in fixed assets and how much to invest in current assets. Capital
budgeting decisions to invest in fixed assets are cash available. The amount of
investment in current assets also depends on the decision of the capital
budget. Also, daily cash flow income. Both are to decide how much investment
in current assets is required based on the detail of the outgoings. Thus, as any
financial manager, important asset-management decisions have to be made. Of
course, these decisions are not for him to make independently. comes higher
management. And sales managers, product managers etc. also have a
significant impact on these decisions. E.g., how much to invest in stocks. The
sales manager's opinion is important in deciding how much to invest in
debtors, i.e. in debt, based on credit policy. Accuracy in decisions about how
much to invest in machinery and equipment in the factory, how much to invest
in stock of raw materials etc.
(3) Determining the need for financing and external sources of financing: The
function of the finance manager is to determine the need for financing based
on the activities that have been decided for the next year. He has to make
arrangements to get the cash inflows and outflows by calculating when the
need for additional money will arise. When, how much money to get from
banks, how much money to get from other financial institutions, debentures
issued for recording this Owner To make decisions about the extent to which it
is necessary and desirable to raise money, issue additional shares and raise
money It includes things like deciding whether there is a need or not. Based on
all these calculations were external When, how much money will be raised and
how much will be spent from receivables and from what instruments it can be
repaid Matters have to be decided in advance by the finance manager.
(4) Negotiating for Funding: After deciding how much money to raise from
external sources, it is the job of the finance manager to negotiate and
complete the formalities necessary to implement it. Short-term requirements
have to be arranged with the bank. Bank arrangements are usually for one year.
Therefore, the financial manager has to do the necessary negotiations and
procedures to continue the overdraft or cash credit arrangement every year. If
finance is to be obtained for a long-term plan, it has to issue shares or
debentures or obtain long-term loans from specialized financial institutions.
For this, it is the job of the finance manager to negotiate with them, approve
the loan. Raising money by issuing shares or debentures goes through a lot of
formalities and takes a long time to prepare. In such circumstances, advance
planning is necessary well in advance.
(5) Distribution of Net Profit: The function of distribution of the profit after tax
made in the business during the year is of great importance. A mistake made in
it affects the financial condition of the business in the long run. What are the
two main uses of such net profit? One is to distribute the dividend to the
shareholders and the other is to retain some of it in the business, so that it can
be used for the growth and expansion of the business. Apart from this,
sometimes there is a practice of giving profit share to the employees in a party
other than the owner, but the opinion of the financial manager is not
important in this matter, but with the labour contract done.
It is given as per the agreement made. So the manager has only two questions
to consider: how much dividend to distribute and how much profit to keep for
future growth in the business. The decision taken on both these issues has a
significant impact on the company's share prices and the company's
reputation. So, the opinion of top management becomes important in this
matter.
(6) Estimation and control of cash inflows and outflows: It is the responsibility
of the finance manager to see that there is sufficient cash on hand when the
current liabilities are due. That is why he should make a detailed estimate of
both cash inflows and cash outflows for the coming year. Both of these are
dependent on the sales volume; hence the price forecast can be taken as its
basis. Along with this, the credit policy of the company has to be taken into
consideration, so that one gets an idea of when the above sales will be
realized.
Estimating and controlling cash flow is a delicate task. Naturally, a financial
manager will want to have enough cash on hand when short-term debt needs
to be paid. But his predictions are not always correct. So, the money manager
has to keep more cash on hand than required. But if too much cash is kept on
hand, more money is unnecessarily sitting idle. Thus, the financial manager has
a difficult task to maintain a balance between profitability and liquidity.
(7) Control over financial performance: It is important for the financial
manager to check that the financial performance is being done according to
the planned and established policies. For this, ratio analysis, break even
analysis, rate of return on investment, control system through budget etc. are
useful tools. The performance is compared with the standards set by these
tools. In particular, it is ascertained whether cash inflows and outflows are as
determined, investments in fixed assets and working capital are as per
prescribed standards. If significant differences are found, corrective action is
taken. Besides, such verification may sometimes reveal that the prescribed
standards are not suitable, so they can be amended.
(B) Incidental Finance Functions:
Ancillary finance functions may be briefly presented as follows: (1) Supervising
cash receipts and disbursements (2) Maintenance of cash balances (3) Custody
and custody of securities, insurance policies and other valuable documents (4)
Taking care of administrative matters relating to finances (5) keeping notes and
(6) preparing reports. These tasks are mainly clerical in nature and do not
require any skill or judgment.
Let us present these matters in detail:
(1) Monitoring of cash income: The main source of cash income is sales. In
particular, it is the job of the finance department to take care whether the up-
selling invoices come in time or not. The function of dealing with timely receipt
of other cash receipts is also a subsidiary function of the Finance Department.
(2) Payment of cash: It is also the responsibility of the finance department to
see that the payment of cash is done on time, i.e. not earlier than required and
not delayed in such a way that it does not affect the reputation of the business.
The finance department is tasked with taking care of the timeliness of
payments especially to business creditors and loan creditors.
(3) Keeping Cash Accounts: of It is important that cash receipts and
disbursements accounts are maintained so that they can be controlled. So, this
department sees to it that cash accounts are properly prepared as per rules.
(4) Receiving cash and bank balances: This department supervises the matters
such as keeping control of cash balances and correct bank balance notes, bank
transactions are carried out as per rules, etc. Time to time Bank Reconciliation -
Ensures reconciliation
(5) Monitoring of bills of exchange: Bills receivable & bills payable affect cash
inflows and outflows. Therefore, keeping track of both types of bills of
exchange and seeing that their money is received and paid on time is the
responsibility of the finance department.
(6) Documentation: Proper maintenance of securities (e.g., shares, debentures,
loans, etc.) in respect of which surplus business money has been held in any
security, interest and dividends on the same in due course. It is the
responsibility of the finance department to see that it is received etc.
(7) Insurance Policy: The finance department has to do the work of making
arrangements to insure different properties and maintaining the policies,
presenting claims and getting money accordingly as the need arises.
(8) Filing: The Finance Department undertakes the proper filing of all papers
relating to decisions taken, correspondence or other action taken on matters
relating to finance. This filing should be done in such a manner that the
prescribed action can be taken.
(9) Preparation of reports: Finance department prepares reports related to
financial matters and presents them to the managers. By doing this, the
managers get an idea of the financial performance. Especially cash account,
loss account. Balance sheet, cash flow statement etc. are prepared and
presented to the management from time to time.
Basic Principles of Financial Management:
The basic principles of financial management include the following six
principles:
(1) Cash flow should be preferred over accounting profit.
(2) Time value of money should be considered.
(3) The risk-return trade-off should be considered, as the additional risk is
compensated by the additional profit.
(4) Taxes should be considered.
(5) Decisions should be made keeping in mind the financial market.
(6) Excess cash flow should be preferred over total cash flow.
10. The trade-off between risk-reward in financial decisions
(Risk-Return Farmwork for Financial Decision Making)
A modern approach to financial management sees many financial decision
options. Financial decision mainly includes investment decisions, financing
decisions and dividend decisions. Financial decisions in financial management
are largely concerned with the trade-off between risk and return.
The trade-off between risk and return shows the intrinsic relationship between
investments and money. Every financial business decision involves risk. For
example, a company expects to earn 10% return on its investments, but in 10%
return cannot be obtained due to risk.
The trade-off between risk-return states that the potential return increases
with an increase in risk. A of this principal business owner’s lower uncertainty
with lower potential returns and higher with higher potential returns A fair or
probable return is realized only if there is uncertainty or risk.
Risk-Return Trade Off:
In it Lower the risk, lower the gain, and higher the risk, the higher the gain.
Financial management is always about balancing risk and reward and managing
money with risk and future benefit in mind. A financial manager undertakes
any project with high risk and high return. Then the expected rate of return will
also be higher and the cash flows will result in a lower present value, in
contrast to the case of a low-return project with lower risks, the expected rate
of return will be lower and this lower rate of return will be offset by a lower
return on the lower cash flows which will also result in a lower present value.
So, the financial manager has to find the risk-return point that maximizes the
present value and maintains the risk-return. called the risk-return trade off.
11. Agency Theory:
Agency theory is a managerial and economic theory that elaborates on the
various relationships and spheres of interest in firms. Agency theory describes
the relationship between principals and agents as well as the delegation of
control.
agency theory deals with how best to structure a relationship in which one
party, called the agent, makes decisions or makes decisions on behalf of the
principal.
Agency theory is the optimal arrangement of relationships in which one party
decides the work! Is when the other also works that. P. According to
management, agency theory is a useful framework for designing governance
and control in organizations. This theory helps in evaluating the strengths and
weaknesses of a company.
12. Agency problem:
An agency problem is a conflict of interest inherent in any relationship, where
one party is expected to act in the best interest of the other. In corporate
finance, the agency problem usually refers to the conflicts of interest between
the company's management and the company's shareholders, as well as the
cynic agents' attempts to maximize (increase) those shareholders' wealth. An
agency problem does not exist without a relationship between the principal
(owner) and the agent. In this case the agent acts on behalf of the owner.
Agents are usually hired by owners due to different skill levels, different job
positions, and time as well as price restrictions. That is why agency problem
arises if there is no consistency in any work. The agency problem mainly arises
from the distribution of work and payment of money to the agent by the
owner. For example, in the plumbing business, a plumber is hired by an agent
to earn three times as much. So doing agency there can be a problem.
The agency problem is common in fiduciary relationships in general; As
between trustees and beneficiaries, between board members and
shareholders, between lawyers and clients (clients), it has long been recognized
that the division of ownership and control in the modern corporation results in
potential conflicts between owners and agents or managers. In particular,
management's objectives may differ from those of shareholders.
Often the stock grows so widely that the shareholders do not even know their
purpose because of little control, and thus, this separation of ownership from
management creates a situation in which the management of the entire
company may act in their own interest rather than that of the shareholders.
Jensen and Meckling have shown the theory of agency arrangement, that if the
agents (management) are given the right incentives, they will make the right
decision and it will increase the wealth of the shareholder-shareholder as well
as provide incentives to the outside shareholders. Also, the objectives in the
agency theory problem may be different.
Three problems mainly arise in professional firms as follows:
* Conflict between controlling and minority shareholders – problem.
* Conflict between shareholders and bondholders – problem.
* Conflict between owners and agents – problem.
13. Agency Pending (Expenses):
Any cost incurred in trying to reduce the potential for conflict between
management's interest and agent's interest is known as agency cost or agency
cost.
Agency costs are mainly of three types:
(1) Monitoring costs
(2) Bonding costs
(3) Residual damages - Residual loss
(1) Monitoring Costs: Monitoring costs are the costs incurred by the owner in
limiting or monitoring the agent's actions.
(2) Bonding cost: Bonding expenses are expenses incurred by agents in the
best or proper interest of the owners.
(3) Residual damages– Residual Losses: Even when monitoring and bonding
costs are used, the difference in interest of owners and agents arises which is
known as residual loss is the implicit cost of the venture.
Jensen and Meckling developed the theory of agency costs, stating who bears
the costs of monitoring. Regardless, the price is ultimately set by the
shareholders. Ex. Debtors, expected monitoring costs, more interest paid.
14. Stakeholder's Wealth Maximization:
The main objective of a business owner is to protect the interest of the
business person, every section of the society who is connected with the
business internally or externally.
According to J.C. Van Horn, the objective can be achieved only by taking care of
the various stakeholders involved in the company in order to achieve the
objective of maximizing the shareholder value of the company.
The managers of the company should maintain a harmonious relationship with
the interests of the employees, government, creditors, customers etc. and with
the owners. So that the wealth of the stakeholders is preserved through the
proper functioning of the company without compromising the objective of
maximizing the wealth of the shareholders who are the managers and owners
of the company. Stakeholders include company owners, creditors, employees,
government, customers, traders etc. A company cannot form its operations
without stakeholders. So, the company formulates its appropriate work-
oriented procedures in association with or with these stakeholders. So that the
company can also increase the profitability with the aim of doing more work.
The company's priority is the shareholders. So, the primary objective of the
company is to maximize the wealth of the shareholders, but at the same time
the company prioritizes the maximization of the wealth of its stakeholders by
giving priority to the maximization of their wealth.
A company aims to maximize shareholder wealth as well as to maximize
stakeholder wealth Responsibilities are also provided as stated in the
Companies Act, 2013. So that the interest of every stakeholder is protected as
well Their wealth is also maximized. Generally speaking, a company can do well
to maximize the wealth of its shareholders while keeping the main objective of
protecting the interests of the stakeholders.
Role of a Financial Manager:
A chief financial officer is called a financial manager in a large business. He is
directly responsible to the Managing Director and is an officer of the level of
another departmental head or it may be said that the higher management
team is a member. And he is known as the Vice-President of Finance. He has
been playing a very important role in business management for the past two-
three decades. It is concerned with the importance of efficient allocation of
funds in business decisions. His actions have far-reaching effects on the
company's growth, profitability, size and its bottom line happens on But it is
important to remember that its role was not important a few years ago. He
himself was the most important officer in the business unit. Its function was to
receive funds only when the business required them and that too on important
occasions; This role was attributed to the customary or systematic approach to
finance. Mr. Pandey writes, “This traditional approach dominated the field of
financial management and limited the role of financial management in the
early stages. According to this approach, the field of financial management and
the role of the financial manager were considered to be limited to raising funds
and that too during the life of the firm, the financial manager was told to raise
funds only during major events like operations, restructuring and expansion.
His main duty in his day-to-day activities was simply to see that the firm had
sufficient cash to meet its obligations. But the role of financial manager has
changed over the last three decades. Now his work is not only limited to raising
funds, but also includes wise allocation of firm's funds. Now as a member of
the finance management team, the top management has to make important
decisions about investment, revenue sharing and financing. In his new role he
has to provide logical answers to the following three questions:
(1) To what extent and how fast to allow the unit to grow.
(2) In what form he should assume his properties.
(3) What should be the components of his liabilities or debts.
Since the financial manager is responsible for making these important financial
decisions, he is now an important member of the business unit has and its role
has changed significantly.
To perform this role, the financial manager has to perform the following
functions:
(1) It has to raise sufficient funds, but not so much that it is not costly to the
firm
(2) These funds are to be raised in such a manner as to minimize their
expenditure.
(3) It has to maintain sufficient liquidity in the business and also profitability to
be maintained.
(4) Funds are to be allocated wisely.
(5) To perform the functions of analysing, planning and controlling the
utilization of funds
(6) Working capital is to be managed so that its components like cash, payables
and stock are effectively managed.
7) He has analysed the impact of external factors on the financial position of
the business and the mitigating measures to be taken by him.
(8) Allocation of profits is to maintain a balance between distribution of
dividends and retention in the business, so that the shareholders are satisfied
and at the same time sufficient funds are available for the development of the
business.
(9) It is the duty of the Finance Manager to inform the higher management of
important events relating to financial matters.
Two Assistant Officers to assist the Finance Director —
(1) Treasurer
(2) controller.
If we consider the functions of both the officers, the main function of the
treasurer is related to the duties related to cash, credit and investments, while
the main functions of the director include preparing accounts, budgeting,
preparing and presenting reports, etc.
In detail these functions are as follows:
Functions of Treasurer:
(1) Financing: To plan and implement the program of obtaining the necessary
finance for the business. This includes negotiating and arranging financial
arrangements.
(2) Relations with Investors: To establish and develop a suitable market for the
company's securities and to maintain adequate contact with the investors.
(3) Short Term Finance: To maintain adequate receivables from the money
market for the company in terms of short-term financing.
(4) Banking and Occupancy: Maintaining arrangements with banks. To receive,
hold and pay the money and securities of the company and to assume
responsibility for the financial aspect of the fixed assets transactions.
(5) Credit and Debt Collection: Giving instructions regarding who to give credit
and collection of debts of the company.
(6) Investments: To invest the funds of the company as required and to
establish pension and other trusts and coordinate its policy.
(7) Insurance: To arrange insurance as required.
Functions of the Controller:
(1) Planning and Control: Determining, coordinating and administering the
control plan of operations as a part of management. The plan will include, as
necessary, profit planning, investment program and financing and sales
forecasting and cost budgeting.
(2) Reporting and Interpretation: Comparing actual performance with
performance plans and standards and reporting and interpreting performance
results to all levels of management and business owners Discussing with all
managers the financial implications of their actions.
(3) Taxation Administration: Determining and implementing taxation policies
and procedures.
(4) Presentation of report to Government: Appears on preparation of reports
to be presented to Government institutions Maintain and coordinate.
(5) Protection of Assets: Ensuring protection of business assets through
internal controls and internal audit and by obtaining adequate insurance
protection.
(6) Economic Evaluation: Evaluating economic and social factors and the effects
of government policies and interpreting those effects on business.