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Finance

Your gateway to a successful future…

by Prasad Kulkarni
CA, CPA
What is Finance
Finance is a term describing the study and system of money, investments, and other financial instruments. Some
people prefer to divide finance into three distinct categories: public finance, corporate finance, and personal finance.
There is also the recently emerging area of social finance. Behavioral finance seeks to identify the cognitive (e.g.
emotional, social, and psychological) reasons behind financial decisions.

Banking

Leverage

Credit

Capital Markets

Money

Investments

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Finance…

• Finance is the lifeline of any business.

• However, finances, like most other resources, are always limited.

• On the other hand, wants are always unlimited.

• Therefore, it is important for a business to manage its finances efficiently.

• As an introduction to financial management, Let’s look at the nature, scope, and significance of
financial management, along with financial decisions and planning.

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Finance…

• Let’s define financial management as the first part of the introduction to financial management.

• For any business, it is important that the finance it procures is invested in a manner that the
returns from the investment are higher than the cost of finance.

• In a nutshell, financial management –

• Endeavors to reduce the cost of finance

• Ensures sufficient availability of funds

• Deals with the planning, organizing, and controlling of financial activities like the
procurement and utilization of funds.

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Finance…Some Definations…

• “Financial management is the activity concerned with planning, raising, controlling and
administering of funds used in the business.” – Guthman and Dougal

• “Financial management is that area of business management devoted to a judicious use of


capital and a careful selection of the source of capital in order to enable a spending unit to
move in the direction of reaching the goals.” – J.F. Brandley

• “Financial management is the operational activity of a business that is responsible for


obtaining and effectively utilizing the funds necessary for efficient operations.”- Massie

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Finance…Nature, Significance and Scope of FM…

• Financial management is an organic function of any business. Any organization needs finances to obtain physical
resources, carry out the production activities and other business operations, pay compensation to the suppliers, etc.
There are many theories around financial management:

1. Some believe that financial management is all about providing funds needed by a business on terms that are most
favorable, keeping its objectives in mind. Therefore, this approach concerns primarily with the procurement of funds
which may include instruments, institutions, and practices to raise funds. It also takes care of the legal and accounting
relationship between an enterprise and its source of funds.

2. Another set of experts believe that finance is all about cash. Since all business transactions involve cash, directly or
indirectly, finance is concerned with everything done by the business.

3. The third and more widely accepted point of view is that financial management includes the procurement of funds and
their effective utilization. For example, in the case of a manufacturing company, financial management must ensure
that funds are available for installing the production plant and machinery. Further, it must also ensure that the profits
adequately compensate the costs and risks borne by the business.
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Finance…Scope of FM…

• The introduction to financial management also requires you to understand the scope of financial management.

• It is extremely important that financial decisions take care of the shareholders interests.

• Further, they are upheld by the maximization of the wealth of the shareholders, which depends on the increase in net
worth, capital invested in the business, and ploughed-back profits for the growth and prosperity of the organization.

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Finance…Scope of FM…

• Furthermore 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.

• Financial Management and Economics

• Financial Management and Accounting

• Financial Management and Mathematics

• Financial Management and Production Management

• Financial Management and Marketing

• Financial Management and Human Resource

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Core Financial Management Decisions
• Investment Decisions: Managers need to decide on the amount of investment available out of the existing finance,
on a long-term and short-term basis. They are of two types:

1. Long-term investment decisions or Capital Budgeting mean committing funds for a long period of time like fixed
assets. These decisions are irreversible and usually include the ones pertaining to investing in a building and/or land,
acquiring new plants/machinery or replacing the old ones, etc. These decisions determine the financial pursuits and
performance of a business.

2. Short-term investment decisions or Working Capital Management means committing funds for a short period of
time like current assets. These involve decisions pertaining to the investment of funds in the inventory, cash, bank
deposits, and other short-term investments. They directly affect the liquidity and performance of the business.

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Core Financial Management Decisions
• Financing Decisions: Managers also make decisions pertaining to raising finance from long-term sources (called
Capital Structure) and short-term sources (called Working Capital). They are of two types:

1. Financial Planning decisions which relate to estimating the sources and application of funds. It means pre-
estimating financial needs of an organization to ensure availability of adequate finance. The primary objective of
financial planning is to plan and ensure that the funds are available as and when required.

2. Capital Structure decisions which involve identifying sources of funds. They also involve decisions with respect to
choosing external sources like issuing shares, bonds, borrowing from banks or internal sources like retained earnings
for raising funds.

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Core Financial Management Decisions
• Dividend Decisions: These involve decisions related to the portion of profits that will be distributed as dividend.
Shareholders always demand a higher dividend, while the management would want to retain profits for business
needs. Hence, this is a complex managerial decision.

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Approaches to FM

• 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.

1. Traditional Approach

2. Modern Approach

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Approaches to FM

Traditional Approach
• The traditional approach to the finance function relates to the initial stages of its evolution during 1920s and 1930s when the
term ‘corporation finance’ was used to describe what is known in the academic world today as the ‘financial management’.

• According to this approach, the scope, of finance function was confined to only procurement of funds needed by a business
on most suitable terms.

The traditional approach to the scope and functions of finance has now been discarded as it suffers from many serious
limitations:

a. It is outsider-looking in approach that completely ignores internal decision making as to the proper utilisation of funds.

b. The focus of traditional approach was on procurement of long-term funds. Thus, it ignored the important issue of working
capital finance and management.

c. The issue of allocation of funds, which is so important today, is completely ignored.

d. It does not lay focus on day to day financial problems of an organisation.


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Approaches to FM
Modern Approach

The modern approach views finance function in broader sense.

• It includes both raising of funds as well as their effective utilisation under the purview of finance.

• The finance function does not stop only by finding out sources of raising enough funds; their proper utilisation is also to be considered.

• The cost of raising funds and the returns from their use should be compared.

• The funds raised should be able to give more returns than the costs involved in procuring them.

• The utilisation of funds requires decision making.

• Finance has to be considered as an integral part of overall management. So finance functions, according to this approach, covers
financial planning, rising of funds, allocation of funds, financial control etc.

The new approach is an analytical way of dealing with financial problems of a firm. The techniques of models, mathematical programming,
simulations and financial engineering are used in financial management to solve complex problems of present day finance.

The modern approach considers the three basic management decisions, i.e., investment decisions, financing decisions and dividend
decisions within the scope of finance function.
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FUNCTIONS OF FINANCE MANAGER

• Finance function is one of the major parts of business organization, which involves the
permanent, and continuous process of the business concern.

• Finance is one of the interrelated functions which deal with personal function, marketing
function, production function and research and development activities of the business concern.

• Finance manager is one of the important role players in the field of finance function. He must
have entire knowledge in the area of accounting, finance, economics and management. His
position is highly critical and analytical to solve various problems related to finance. A person
who deals finance related activities may be called finance manager.

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Finance manager - major functions:

• Forecasting Financial Requirements

• Acquiring Necessary Capital

• Investment Decision

• Cash Management

• Interrelation with Other Departments

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Finance manager - major functions:

• 1. What is finance? Define business finance.

• 2. Explain the types of finance?

• 3. Discuss the objectives of financial management?

• 4. Critically evaluate various approaches to the financial management?

• 5. Explain the scope of financial management?

• 6. Discuss the role of financial manager?

• 7. Explain the importance of financial management?

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