Business finance is a term that encompasses a wide range of activities and disciplines revolving around

the management of money and other valuable assets. Business finance programs in universities
familiarize students with accounting methodologies, investing strategies and effective debt
management.

Role of a Financial Manager

Financial activities of a firm is one of the most important and complex activities of a firm. Therefore in
order to take care of these activities a financial manager performs all the requisite financial activities.

A financial manger is a person who takes care of all the important financial functions of an organization.
The person in charge should maintain a far sightedness in order to ensure that the funds are utilized in
the most efficient manner. His actions directly affect the Profitability, growth and goodwill of the firm.

Following are the main functions of a Financial Manager:

Raising of Funds

In order to meet the obligation of the business it is important to have enough cash and liquidity. A firm
can raise funds by the way of equity and debt. It is the responsibility of a financial manager to decide the
ratio between debt and equity. It is important to maintain a good balance between equity and debt.

Allocation of Funds

Once the funds are raised through different channels the next important function is to allocate the
funds. The funds should be allocated in such a manner that they are optimally used. In order to allocate
funds in the best possible manner the following point must be considered

The size of the firm and its growth capability

Status of assets whether they are long-term or short-term

Mode by which the funds are raised

These financial decisions directly and indirectly influence other managerial activities. Hence formation of
a good asset mix and proper allocation of funds is one of the most important activity
Profit Planning

Profit earning is one of the prime functions of any business organization. Profit earning is important for
survival and sustenance of any organization. Profit planning refers to proper usage of the profit
generated by the firm.

Profit arises due to many factors such as pricing, industry competition, state of the economy,
mechanism of demand and supply, cost and output. A healthy mix of variable and fixed factors of
production can lead to an increase in the profitability of the firm.

Fixed costs are incurred by the use of fixed factors of production such as land and machinery. In order to
maintain a tandem it is important to continuously value the depreciation cost of fixed cost of
production. An opportunity cost must be calculated in order to replace those factors of production
which has gone thrown wear and tear. If this is not noted then these fixed cost can cause huge
fluctuations in profit.

Understanding Capital Markets

Shares of a company are traded on stock exchange and there is a continuous sale and purchase of
securities. Hence a clear understanding of capital market is an important function of a financial
manager. When securities are traded on stock market there involves a huge amount of risk involved.
Therefore a financial manger understands and calculates the risk involved in this trading of shares and
debentures.

Its on the discretion of a financial manager as to how to distribute the profits. Many investors do not like
the firm to distribute the profits amongst share holders as dividend instead invest in the business itself
to enhance growth. The practices of a financial manager directly impact the operation in capital market.

Objectives of Financial Management:

Financial management is one of the functional areas of business. Therefore, its objectives must be
consistent with the overall objectives of business. The overall objective of financial management is to
provide maximum return to the owners on their investment in the long- term.

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This is known as wealth maximisation. Maximisation of owners wealth is possible when the capital
invested initially increases over a period of time. Wealth maximisation means maximising the market
value of investment in shares of the company.

Wealth of shareholders = Number of shares held Market price per share.

In order to maximise wealth, financial management must achieve the following specific objectives:

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(a) To ensure availability of sufficient funds at reasonable cost (liquidity).

(b) To ensure effective utilisation of funds (financial control).

(c) To ensure safety of funds by creating reserves, re-investing profits, etc. (minimisation of risk).

(d) To ensure adequate return on investment (profitability).

(e) To generate and build-up surplus for expansion and growth (growth).

(f) To minimise cost of capital by developing a sound and economical combination of corporate
securities (economy).
(g) To coordinate the activities of the finance department with the activities of other departments of the
firm (cooperation).

Profit Maximisation:

Very often maximisation of profits is considered to be the main objective of financial management.
Profitability is an operational concept that signifies economic efficiency. Some writers on finance believe
that it leads to efficient allocation of resources and optimum use of capital.

It is said that profit maximisation is a simple and straightforward objective. It also ensures the survival
and growth of a business firm. But modern authors on financial management have criticised the goal of
profit maximisation.

Ezra Solomon has raised the following objections against the profit maximisation objective:

Objections against the Profit Maximisation Objectives:

(i) The concept is ambiguous or vague. It is amenable to different interpretations, e.g., long run profits,
short run profits, volume of profits, rate of profit, etc.

(ii) It ignores the timing of returns. It is based on the assumption of bigger the better and does not take
into account the time value of money. The value of benefits received today and those received a year
later are not the same.

(iii) It ignores the quality of the expected benefits or the risk involved in prospective earnings stream.
The streams of benefits may have varying degrees of uncertainty. Two projects may have same total
expected earnings but if the earnings of one fluctuate less widely than those of the other it will be less
risky and more preferable. More uncertain or fluctuating the expected earnings, lower is their quality.
(iv) It does not consider the effect of dividend policy on the market price of the share. The goal of profit
maximisation implies maximising earnings per share which is not necessarily the same as maximising
market-price share. According to Solomon, to the extent payment of dividends can affect the market
price of the stock (or share), the maximisation of earnings per share will not be a satisfactory objective
by itself.

(v) Profit maximisation objective does not take into consideration the social responsibilities of business.
It ignores the interests of workers, consumers, government and the public in general. The exclusive
attention on profit maximisation may misguide managers to the point where they may endanger the
survival of the firm by ignoring research, executive development and other intangible investments.

Wealth Maximisation:

Prof. Ezra Solomon has advocated wealth maximisation as the goal of financial decision-making. Wealth
maximisation or net present worth maximisation is defined as follows: The gross present worth of a
course of action is equal to the capitalised value of the flow of future expected benefits, discounted (or
as capitalised) at a rate which reflects their certainty or uncertainty.

Wealth or net present worth is the difference between gross present worth and the amount of capital
investment required to achieve the benefits being discussed. Any financial action which creates wealth
or which has a net present worth above zero is a desirable one and should be undertaken.

Any financial action which does not meet this test should be rejected. If two or more desirable courses
of action are mutually exclusive (i.e., if only one can be undertaken), then the decision should be to do
that which creates most wealth or shows the greatest amount of net present worth. In short, the
operating objective for financial management is to maximise wealth or net present worth.

Wealth maximisation is more operationally viable and valid criterion because of the following reasons:

(a) It is a precise and unambiguous concept. The wealth maximisation means maximising the market
value of shares.
(b) It takes into account both the quantity and quality of the expected steam of future benefits.
Adjustments are made for risk (uncertainty of expected returns) and timing (time value of money) by
discounting the cash flows,

(c) As a decision criterion, wealth maximisation involves a comparison of value of cost. It is a long-term
strategy emphasising the use of resources to yield economic values higher than joint values of inputs.

(d) Wealth maximisation is not in conflict with the other motives like maximisation of sales or market
share. It rather helps in the achievement of these other objectives. In fact, achievement of wealth
maximisation also maximises the achievement of the other objectives. Therefore, maximisation of
wealth is the operating objective by which financial decisions should be guided.

The above description reveals that wealth maximisation is more useful if objective than profit
maximisation. It views profits from the long-term perspective. The true index of the value of a firm is the
market price of its shares as it reflects the influence of all such factors as earnings per share, timing of
earnings, risk involved, etc.

Thus, the wealth maximisation objective implies that the objective of financial management should be
to maximise the market price of the companys shares in the long-term. It is a true indicator of the
companys progress and the shareholders wealth.

However, profit maximisation can be part of a wealth maximisation strategy. Quite often the two
objectives can be pursued simultaneously but the maximisation of profits should never be permitted to
overshadow the broader objectives of wealth maximisation.

Objectives of Financial Management

1 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.
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. The Ultimate aim of the business concern is
earning profit, hence, it considers all the possible ways to increase the profitability of the concern.
Profit is the parameter of measuring the efficiency of the business concern.So it shows the entire
position of the business concern. and hence Profit maximization objectives help to reduce the risk of
the business.
Favourable Arguments for Profit Maximization
The following important points are in support of the profit maximization objectives of the business
concern:
(i) Main aim is earning profit.
(ii) Profit is the parameter of the business operation.
(iii) Profit reduces risk of the business concern.
(iv) Profit is the main source of finance.
(v) Profitability meets the social needs also.
Unfavourable Arguments for Profit Maximization
The following important points are against the objectives of profit maximization:
(i) Profit maximization leads to exploiting workers and consumers.
(ii) Profit maximization creates immoral practices such as corrupt practice, unfair
trade practice, etc.
(iii) 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:
(i) 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.
(ii) 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.
(iii) 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.
Favourable Arguments for Wealth Maximization
(i) 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.
(ii) 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.
(iii) Wealth maximization considers both time and risk of the business concern.
(iv) Wealth maximization provides efficient allocation of resources.
(v) It ensures the economic interest of the society.
Unfavourable Arguments for Wealth Maximization
(1) The ultimate aim of the wealth maximization objectives is to maximize the profit.
(2) Wealth maximization can be activated only with the help of the profitable position of the business
concern.So The goal of maximizing the value of the stock avoids the problems associated with the
different goals we discussed above.in a simple language a good financial decisions increase the
market value of the owners equity and poor financial decisions decrease it. Finally, our goal does
not imply that the financial manager should take illegal or unethical actions in the hope of increasing
the value of the equity in the firm. What we mean is that the financial manager best serves the
owners of the business by identifying goods and services that add value to the firm because they are
desired and valued in the free marketplace.

Major Areas of Decision-Making | Financial Management

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This article throws light upon the three major decision-making areas in
financial management. The areas are: 1. Investment
Decision 2. Financing Decision 3. Dividend Decision.
Decision-Making: Area # 1. Investment Decision:
It is the decision for creation of assets to earn income. Selection of assets in
which investment is to be made is the investment decision. It has to be
decided how the funds realized will be utilized on various investments.

Generally, the assets of a company are of two types those which yield
income spreading over a year or so and assets which are easily convertible
into cash within a short time. The first type of investment decision is capital
budgeting and the second one is the working capital management.

Capital budgeting is the allocation of funds on a new asset or reallocation of

capital when an old asset becomes non-profitable. The worthiness of different
investment proposals forms a vital part of capital budgeting exercise.

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Risks of investment are there, so the management has to consider it with

sufficient caution and prudence. Capital budgeting decision has another im-
portant aspect. It is to determine the norm or standard against which benefits
are to be judged. This is known as cut-off rate, hurdle rate, minimum rate of
return etc. This is actually cost of capital.

Working capital management relates to management of the current assets. To

meet current obligations, sufficient working capital may be necessary. This
can be termed as liquidity. In case proper amount of working capital cannot be
estimated, there may revenue lying idle or there may be dearth of capital.
Neither is desirable. In case working capital remains in excess which could
otherwise be utilized in the long term productive assets, profit earning would
suffer a setback. The very significant point here to note is that in working
capital management there is the trade-off between liquidity and profitability.

Decision-Making: Area # 2. Financing Decision:

This decision relates to how, when and where funds are to be acquired to
meet investment needs. It is related to the capital structure or financial
leverage. This is debt-equity ratio. If more recourse is taken to debt capital,
shareholders risk is lessened and the prospects of their dividend earning are
reduced. So, in financing decision, the crucial point is the trade-off between
returned risks.

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The financing decision unlike investment decision relates to the

determination of the capital structure the proper balance between debt and
equity.

Financing decision has two important dimensions:

(1) Is there an optimum capital structure, and

(2) In what proportion should funds be raised to maximize the return to the
shareholders? Once the best debt-equity mix is determined, the finance
manager will be on the lookout for appropriate sources for raising loans and
selling shares.
Decision-Making: Area # 3. Dividend Decision:
The profit of a company can be dealt with in two alternative ways to
distribute them as dividends to shareholders or to retain them in the business.
If sufficient dividend is not paid, shareholders will not be satisfied, the market
value of shares will come down and there may be financial crisis.

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If the profits, on the other hand, are distributed to the maximum extent, the
company will lose on important source of self financing. So a judicious
decision is a must. There should be a good combination of distribution and
retention.

The dividend decision boils down to the determination of net profits to be paid
out to shareholders as dividends. Here the management is to consider two
major factors preference of the shareholders and the investment
opportunities in the company.

The functions of financial management can be discussed from different angles

but the fact remains that finance plays the pivotal role in the whole
organization. Whatever has to be done needs money and that money
procurement is the financial managers function.

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How to use the money, how much to use and where to use are also matters of
consultation with the finance management. Even the top management
personnel cannot bypass the financial management to decide matters relating
to finance which is so vital to keep the organization in sound health.

Financial planning, investment of funds procured, financial control and the

future financial policy all are within the preview of financial management.