Unit - 1

Finance – A concept
• Henry ford remarked once, “Money is an arm or a leg.
You either use it or lose it.”
• Finance is one of the basic foundations of all kinds of
economic activities, it is the master key which
provides access to all the sources for being employed
in manufacturing and merchandising activities.
• Business finance is that business activity which is
concerned with the acquisition and conservation of
capital funds in meeting financial needs and overall
objectives of business enterprises.
 Financial management
• Financial management mainly involves rising
of funds and their effective utilization with the
objective of maximising shareholders’ wealth.
• According to Joseph & Massie, “Financial
management is the operational activity of a
business that is responsible for obtaining and
effectively utilising funds necessary for
efficient operations”.
 3 A’s of Financial Management

• Financial manager has to forecast expected events in

business such as
1. Anticipating financial needs (estimation of funds
required for investment in fixed assets and current
assets).
2. Acquiring financial resources (where and how to obtain
the funds to finance the anticipated financial needs)
3. Allocating funds in business (allocation of available
funds among the best plans of assets, which are able to
maximize shareholders’ wealth.
Thus, the decisions of FM can be divided into –
investment, financing and dividend decision.
Decisions of Financial Management

Investment

Financial
Financing
decisions

Dividend
 Investment decisions
• It relates to the selection of assets, that a firm will invest
funds.
i. Long-term funds (fixed assets: Plant & machinery, Land &
building, etc.) which involve huge investment and yield a
return over a period of time in future. Investment in long-
term funds is popularly known as “Capital budgeting”.
ii. Short-term funds (Current assets: raw materials, work in
process, finished goods, debtors, cash etc.). That can be
converted into cash within a financial year. Investment in
current assets is known as ‘Working Capital
Management’.
 Financing decisions
• It is related to the financing mix or capital
structure and to determine the proportion of
debt and equity. There should be an optimum
finance mix, which maximizes shareholders’
wealth.
 Dividend decisions
• Third financial decisions, which relates to
dividend policy. Dividend is a part of profits,
that are available for distribution to equity
shareholders. There are two options available
in dealing with the net profits i.e., distribution
of profits as dividends to the shareholders’
with no retention of earnings or they can
retained in the firm for business expansion.
 Importance of financial management

1. Successful promotion – successful promotion

of a business concern depends on efficient
financial management. If the plan adopted,
fails to provide adequate capital to meet the
requirements of fixed and working capital,
then firm cannot carry on its business
successfully. Therefore, sound financial
planning is quite essential for the success of a
firm.
2. Smooth running – Since finance is required at every
stage of the business such as promotion, expansion,
management of day to day expenses, etc. proper
financial administration becomes necessary for the
smooth running of a business enterprises.
3. Decision Making – FM provides scientific analysis of
all facts and figures through various financial tools
such as ratio analysis, variance analysis, budget etc.,
such an analysis helps the management to evaluate
the profitability of the plan, so that a proper
decision can be taken to minimize the risk.
• 4. Solutions to financial problems – Efficient
FM helps the top management by providing
solutions to the various financial problems
faced by it.
• 5. Measure of performance – Financial
management is considered as a yard stick to
measure the performance of the firm.
 Scope of Financial Management
• Changes that takes place over the years is known as
‘Scope of financial management’. Hence, it is necessary
to divide the scope in two approaches.
• 1. Traditional approach- the scope was limited to
raising and administering of funds needed by the firm
to meet their financial needs. It deals with following
aspects –
i. Arrangement of funds from financial institutions.
ii. Arrangement of funds through financial instruments
like shares, bonds etc.
• Finance manger had a limited role to perform. He
was expected to keep accurate financial records,
prepare reports on firm’s status and performance
and manage cash in a way that the firm was in a
position to pay its obligations (liabilities) on time.
Due to some limitations in traditional approach
such as finance taken up from the view point of
suppliers of funds (bankers, investors), ignored
internal financing decisions, ignored working
capital financing (day to day financial activities)
etc.
2. Modern approach – this approach provides a
conceptual and analytical framework for
financing decision-making. In this approach,
finance function covers both acquisition and
allocation of funds. Hence, the decision in
financial management can be divided into –
i. The investment decision
ii. The financing decision
iii. The dividend decision
iv. The funds requirement decision
Functions of financial management
• 1. Liquidity – ascertained on 3 important
consideration-:
i. forecasting cash flows – matching inflows
against cash outflows.
ii. Raising funds – financial manager has to
ascertain the sources from which funds may be
raised and the time when these funds may be
needed.
iii. Managing the flow of internal funds.
2. Profitability – following factors are taken into
consideration –
i. Cost control
ii. Pricing
iii. Forecasting future profits
iv. Measuring cost of capital
3. Management – it includes
v. The management of long term funds
vi. The management of short term funds
 Objectives of Financial Management
1. Basic objectives
i. Maintenance of liquid assets – firm must be able to meet its
obligations at all times. However, investment in liquid assets has
to be adequate – neither too low nor too excessive. There must
be a balance between profitability and liquidity.
ii. Maximization of Profits – ‘profit maximization’ goal implies that
the investment, financing and dividend policy decision of the firm
should be oriented to profit maximization.
iii. Wealth maximization- also called ‘Value maximization’. It means
maximizing the present value of a course of action. It takes care
of – lenders/creditors, workers/employees, public/society,
management/employer.
2. Other objectives can be –
i. Ensuring a fair return to shareholders
ii. Building up reserves for growth & expansion
iii. Effective and efficient utilization of finance
iv. Ensuring financial discipline in management.