Finance Functions

The following explanation will help in understanding each finance function in detail

Investment Decision
One of the most important finance functions is to intelligently allocate capital to long term assets. This
activity is also known as capital budgeting. It is important to allocate capital in those long term assets so
as to get maximum yield in future. Following are the two aspects of investment decision

a. Evaluation of new investment in terms of profitability

b. Comparison of cut off rate against new investment and prevailing investment.

Since the future is uncertain therefore there are difficulties in calculation of expected return. Along with
uncertainty comes the risk factor which has to be taken into consideration. This risk factor plays a very
significant role in calculating the expected return of the prospective investment. Therefore while
considering investment proposal it is important to take into consideration both expected return and the
risk involved.

Investment decision not only involves allocating capital to long term assets but also involves decisions of
using funds which are obtained by selling those assets which become less profitable and less productive.
It wise decisions to decompose depreciated assets which are not adding value and utilize those funds in
securing other beneficial assets. An opportunity cost of capital needs to be calculating while dissolving
such assets. The correct cut off rate is calculated by using this opportunity cost of the required rate of
return (RRR)

Financial Decision
Financial decision is yet another important function which a financial manger must perform. It is important
to make wise decisions about when, where and how should a business acquire funds. Funds can be
acquired through many ways and channels. Broadly speaking a correct ratio of an equity and debt has to
be maintained. This mix of equity capital and debt is known as a firms capital structure.

A firm tends to benefit most when the market value of a companys share maximizes this not only is a
sign of growth for the firm but also maximizes shareholders wealth. On the other hand the use of debt
affects the risk and return of a shareholder. It is more risky though it may increase the return on equity
funds.

A sound financial structure is said to be one which aims at maximizing shareholders return with minimum
risk. In such a scenario the market value of the firm will maximize and hence an optimum capital structure
would be achieved. Other than equity and debt there are several other tools which are used in deciding a
firm capital structure.

Dividend Decision
Earning profit or a positive return is a common aim of all the businesses. But the key function a financial
manger performs in case of profitability is to decide whether to distribute all the profits to the shareholder
or retain all the profits or distribute part of the profits to the shareholder and retain the other half in the
business.

Its the financial managers responsibility to decide a optimum dividend policy which maximizes the
market value of the firm. Hence an optimum dividend payout ratio is calculated. It is a common practice to
pay regular dividends in case of profitability Another way is to issue bonus shares to existing
shareholders.

Liquidity Decision
It is very important to maintain a liquidity position of a firm to avoid insolvency. Firms profitability, liquidity
and risk all are associated with the investment in current assets. In order to maintain a tradeoff between
profitability and liquidity it is important to invest sufficient funds in current assets. But since current assets
do not earn anything for business therefore a proper calculation must be done before investing in current
assets.

Current assets should properly be valued and disposed of from time to time once they become non
profitable. Currents assets must be used in times of liquidity problems and times of insolvency.

Functions in Finance

Finance is the process of creating, moving and using money, enabling the flow of money
through a company in much the same way it facilitates global money flow. Money is created by
the sales force when they sell the goods or services the company produces; it then flows into
production where it is spent to manufacture more products to sell. What remains is used to pay
salaries and fund the administrative expenses of the company.

Benefits

The flow of finance starts on Wall Street with the creation of capital used to fund business
through the issuance of common stock to provide capital, bonds to lend capital and derivatives
(packaged groups of securities that help to hedge against financial risk and replace the money
banks lend out to borrowers). Public companies and municipalities use this capital to help fund
their operations, and banks use it to lend to companies, municipalities and individuals to finance
the purchase of goods and services.

Five Concepts of Finance

There are some concepts in finance that every small business owner should
get their heads around before making too many plans to start-up a small
business.
Greater Return Requires Greater Risk

This is one of the oldest financial concepts in the books. It is a simple relation
between risk and return. Risk and return is one of the most correlated
relationships in finance. For return to increase, you absolutely must take on
more risk. If there are securities where this isn't true, then the one with the
better risk return relationship will be bought, and the other will not.

Efficient Markets

This is also known as the "good deals disappear fast" phenomenon. Chances
are that if you think you see a good deal because of a news release, it has
already been bid up to reflect the news. Other items include arbitrage
opportunities. Arbitrage is when an investor can perform a series of
transactions and receive a profit without any risk.

Risk free arbitrage sometimes happens because of market inefficiencies.

However, once these opportunities are identified by analysts, they are quickly
taken advantage of until they disappear.

Time Value of Money

Money is more valuable the earlier in time you receive the payment. Every
moment you wait to receive payment could have been spent investing that
money into the market and earning a return. This applies to small businesses
negotiating payment schedules and other cash flow arrangements.

Getting the money sooner is always a better option than receiving it later.
Receiving the money also alleviates the risk that the paying party will not
come through on their side of the contract. Delinquency of accounts can really
add some costs to a small business, so make sure you receive your payments
as soon as possible.

Cash is King

Cash is the king in finance. Net income, revenue and other forms of
measurement for businesses are not nearly as important as the operating
cash flows of a firm. Cash cannot be manipulated by accounting procedures,
and represents an unbiased benchmark for where the firm stands.

Cash is also the most liquid form of payment and represents only inflation and
depreciation risk. Other forms of payment can possess delinquency risks
among other things. When dealing with schedules, remember that cash is the
best option for your firm when accepting payment.

Don't forget that some other forms of payment are easier for customers, so
don't sacrifice customer service just to get cash payments.

Asymmetric Information

Someone out there knows more than you about whatever you are looking into
investing in. This is the basic theory of asymmetric information. There is a
difference in knowledge for every security out there.

Insider trading, industry expertise and experience generally lend themselves

to a greater wealth of knowledge for analysts. If you think a deal is too good to
be true, it generally is. There is no such thing as a free lunch in these markets,
so be careful how much you buy into seemingly incredible deals.

Goals of Financial Management

Financial management is a process that enables a business to plan, direct, organize,
monitor and control its current and future financial resources and events. It involves
applying the basic principles of management in financial activities such as purchases,
sales, capital expansion, inventory valuation, financial reporting, and profit distribution.
A business organization is organic in nature, and its successful growth depends on the
financial efficiencies of operations and strategies. Therefore, the primary goals of
financial management dwell on both short-term and long-term activities that seek to
maximize value creation from scarce financial resources.
Disseminating

Timely dissemination of monthly, quarterly and annual financial information to internal and external
stakeholders is a significant goal of financial management. It ensures that financial information is
prepared in accordance with accounting principles and International Financial Reporting Standards. This
provides internal stakeholders -- that is, owners and employees -- with reliable information on the
performance and profitability of the business. The financial reports furnish suppliers with the information
they require to determine the stability of the business, and enable the government to examine the tax
obligations of the business.

Planning

Financial plans and forecasts aim at facilitating efficiency in the current and future activities of the
business. The planning process seeks to match the organizations operational and investment activities to
its overall cash flow capabilities. Current and future cash flow projections determine the scope of short-
term and long-term plans of the business. This goal ensures sufficient funds are sourced in good time and
allocated to different business activities. Financial planning also ensures the business engages in
profitable long-term investments. For example, capital budgeting analyzes the financial viability and
profitability of long-term assets prior to procuring such assets.

Managing Risks

Risk management is a very important goal because it touches on one of the soft underbellies of the
business enterprise. Financial management prescribes the appropriate contingency measures for both
operational and strategic risks. Insurance and automated financial management systems help business
owners and employees to prevent or reduce the risks from theft, fraud and embezzlement. Internal and
external auditing processes also enhance the detection of fraud and other forms of financial malpractices.

Exerting Controls

The financial management function exerts internal controls over financial resources with the objective of
ensuring efficient resource utilization. These controls enhance scrutiny of financial transactions to prevent
business owners or employees from violating financial principles or undermining transparency. The goal
of enhancing internal financial controls is pursued through oversight by the senior financial management
staff and internal auditors. Failure to exert internal financial controls could spell unprecedented
consequences for the business, as was the case of financial reporting scandals by Enron, Tyco and
WorldCom in the early 2000s.

Goals & Objectives for a Finance Department

Small businesses might not have multi-employee finance departments, but the goals and
objectives for the accounting function of any entrepreneur should go beyond just
accurate record keeping. Even if youre not a CPA, using a variety of basic finance
techniques can help you avoid money problems, spot opportunities and manage your
cash flow to maximize your productivity.
Strategic Budgeting

One of the main goals for your finance department should be to create and monitor not only your overall
company budget, but a variety of functional or departmental budgets, as well. Budgeting requires research
to estimate accurate revenue levels based on demand forecasting. Using annual budget projections, your
accounting staff can help you set targets for profit goals and for overhead and production spending levels.
Overhead includes costs such as phones, rent and marketing, while production costs are those related to
making your product. Create monthly or quarterly budget variance analyses to see if youre on track with
your revenues and spending or if you need to make changes before expenses get out of hand.

Cost Containment

To ensure you get the best quality at the lowest price for materials, supplies and services, make
purchasing management one of the duties of your finance department. Require that employees get
multiple bids or present some justification for large purchases, and have your vendors, suppliers and
contractors rebid their contracts each year. Look for trends in spending levels to determine where you can
cut costs without sacrificing quality.

Cash Flow Management

Knowing when your bills are due and when you can expect payment from customers youve billed or
other sales revenues is critical for any small business. Its not enough to show a profit on paper, and your
finance function should help you manage your working capital and credit to ensure you have enough to
pay your bills at all times. Make receivables management a key role for your finance department.

Debt Service

Letting your debt get out of control can have serious long-term impacts on your business. Keep an eye on
your credit use, including interest amounts youre generating, the scheduling of your payments and the
status of your credit report and scores.

Tax Planning

Dont wait until the end of the year to find out what your income tax liability is. Use proactive strategies
to lower your tax burden, such as depreciating assets and offering voluntary benefits to employees that
help you lower payroll taxes.

Accurate Record Keeping

The most important objective of any finance department is to keep accurate financial records. This
includes helping you meet your legal requirements and ensuring you dont spend more than you have by
accident. Consider external audits to prevent fraud, and institute policies and procedures for controlling
contracts and payments.