Financial Management - Financial Management - Key Areas - Notes - Finance, Study notes of Business Administration

Download Financial Management - Financial Management - Key Areas - Notes - Finance and more Study notes Business Administration in PDF only on Docsity! Financial Management – Key Areas The key areas of financial management are discussed in the following paragraphs. (i) Estimating the Capital requirements of the concern. The Financial Manager should exercise maximum care in estimating the financial requirement of his firm. To do this most effectively, he will have to use long-range planning techniques. This is because, every business enterprise requires funds not only for long-term purposes for investment in fixed assets, but also for short term so as to have sufficient working capital. He can do his job properly if he can prepare budgets of various activities for estimating the financial requirements of his enterprise. Carelessness in this regard is sure to result in either deficiency or surplus of funds. If his concern is suffering because of insufficient capital, it cannot successfully meet its commitments in time, whereas if it has acquired excess capital, the task of managing such excess capital may not only prove very costly but also tempt the management to spend extravagantly. (ii) Determining the Capital Structure of the Enterprise. The Capital Structure of an enterprise refers to the kind and proportion of different securities. The Financial Manager can decide the kind and proportion of various sources of capital only after the requirement of Capital Funds has been decided. The decisions regarding an ideal mix of equity and debt as well as short- term and long-term debt ratio will have to be taken in the light of the cost of raising finance from various sources, the period for which the funds are required and so on. Care should be taken to raise sufficient long-term capital in order to finance the fixed assets as well as the extension programme of the enterprise in such a 34 wise manner as to strike an ideal balance between the own funds and the loan funds of the enterprise. (iii) Finalising the choice as to the sources of finance. The capital structure finalised by the management decides the final choice between the various sources of finance. The important sources are share-holders, debenture-holders, banks and other financial institutions, public deposits and so on. The final choice actually depends upon a careful evaluation of the costs and other conditions involved in these sources. For instance, although public deposits carry higher rate of interest than on debentures, certain enterprises prefer them to debentures as they do not involve the creation of any charge on any of the company's assets. Likewise, companies that are not willing to dilute ownership, may prefer other sources instead of investors in its share capital. (iv) Deciding the pattern of investment of funds. The Financial Manager must prudently invest the funds procured, in various assets in such a judicious manner as to optimise the return on investment without jeopardising the long-term survival of the enterprise. Two important techniques— (i) Capital Budgeting; and (ii) Opportunity Cost Analysis—can guide him in finalising the investment of long-term funds by helping him in making a careful assessment of various alternatives. A portion of the long-term funds of the enterprise should be earmarked for investment in the company's working capital also. He can take proper decisions regarding the investment of funds only when he succeeds in striking an ideal balance between the conflicting principles of safety, profitability and liquidity. He should not attach all the importance only to the canon of profitability. This is particularly because of the fact that the company's 35 business. This will ensure that liquidity position of the company is maintained intact with the minimum amount of external borrowings. 4) To Facilitate Cost Control: The Financial Manager is generally the first person to recognise when the costs for the supplies or production processes are exceeding the standard costs/budgeted figures. Consequently, he can make recommendations to the top management for controlling the costs. 5) To Facilitate Pricing of Product, Product Lines and Services: The Financial Manager can supply important information about cost changes and cost at varying levels of production and the profit margins needed to carry on the business successfully. In fact, financial manager provides tools of analysis of information in pricing decisions and contribute to the formulation of pricing policies jointly with the marketing manager. 6) Forecasting Profits: The Financial manager is usually responsible for collecting the relevant data to make forecasts of profit levels in future. 7) Measuring Required Return: The acceptance or rejection of an investment proposal depends on whether the expected return from the proposed investment is equal to or more than the required return. An investment project is accepted if the expected return is equal or more than the required return. Determination of required rate of return is the responsibility of the financial manager and is a part of the financing decision. 8) Managing Assets: The function of asset management focuses on the decision-making role of the financial manager. Finance personnel meet with other officers of the firm and participate in making decisions affecting the current and future utilization of the firm's resources. As an example, managers may discuss the total amount of assets needed by the 38 firm to carry out its operations. They will determine the composition or a mix of assets that will help the firm best achieve its goals. They will identify ways to use existing assets more effectively and reduce waste and unwarranted expenses. The decision-making role crosses liquidity and profitability lines. Converting the idle equipment into cash improves liquidity. Reducing costs improves profitability. 9) Managing Funds: In the management of funds, the financial manager acts as a specialised staff officer to the Chief Executive of the company. The manager is responsible for having sufficient funds for the firm to conduct its business and to pay its bills. Money must be located to finance receivables and inventories, 10 make arrangements for the purchase of assets, and to identify the sources of long-term financing. Cash must be available to pay dividends declared by the board of directors. The management of funds has therefore, both liquidity and profitability aspects. Financial Management as Science or Art Financial management is both a science and an art. Its nature is nearer to applied sciences as it envisages use of classified and tested knowledge as a help in practical affairs and solving business. Theory of financial management is based on certain systematic principles, some of which can be tested in mathematical equations like the law of physics and chemistry. Financial management contains a much larger body of rules or tendencies that hold true in genera! and on the average. The use of computers, operations research, statistical techniques and econometric models find wide application in financial management as tools for solving corporate 39 financial problems like budgeting, choice of investments, acquisition or mergers etc. This takes the financial management nearer to treatment as a subject of science. Most practical problems of finance have no hard and fast answers that can be worked out mathematically or programmed on a computer. They must be solved by judgment, intuition and the "feel" of experience. Thus, despite its frequent acceptance as an applied science, finance remains largely an art. Because, according to George A. Christy and Feyton Foster Roden (Finance: Environment and Decisions) knowledge of facts, principles and concepts is necessary for making decisions but personal involvement of the manager through his intuitive capacities and power of judgment becomes essential. As the application of human judgement and skills is also required for effective financial management, financial management is also an art. In the entire study of financial management whether it is related to investment decisions, financing decisions i.e. deciding about the sources of financing, or dividend decisions, there is a mixture of science as well as art. When techniques for analytical purposes are used, it is science and when choice is application of the results it is an art. Summary Financial management is the application of planning and control to the finance function. It helps in profit planning, measuring costs, controlling inventories, accounts receivables. It also helps in monitoring the effective deployment of funds in fixed assets and in working capital. It aims at ensuring that adequate cash is on hand to meet the required current and capital expenditure. It facilitates ensuring that significant capital is procured at the minimum cost to maintain adequate cash on hand to meet any exigencies that may arise in the course of 40