Understanding Finance and Financial Management: Definitions and Objectives, Slides of Financial Management

Download Understanding Finance and Financial Management: Definitions and Objectives and more Slides Financial Management in PDF only on Docsity! •Financial Management •An Introduction Business concern needs finance to meet their requirements .Any kind of business activity depends on the finance. Whether the business concerns are big or small, they need finance to fulfill their business activities. FINANCE DEFINITION OF FINANCE • According to Khan and Jain, “Finance is the art and science of managing money”. • According to Oxford dictionary, the word ‘finance’ connotes ‘management of money’. • Webster’s Ninth New Collegiate Dictionary defines finance as “the Science on study of the management of funds’ and the management of fund as the system that includes the circulation of money, the granting of credit, the making of investments, and the provision of banking facilities. BUSINESS FINANCE • According to the Wheeler, “Business finance is that business activity which concerns with the acquisition and allocation of capital funds in meeting financial needs and overall objectives of a business enterprise”. • According to the Guthumann and Dougall, “Business finance can broadly be defined as the activity concerned with planning, raising, controlling, administering of the funds used in the business”. Corporate finance is concerned with budgeting, financial forecasting, cash management, credit administration, investment analysis and fund procurement of the business concern and the business concern needs to adopt modern technology and application suitable to the global environment.  Joshep and Massie : Financial management “is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations.  Thus, Financial Management is mainly concerned with the effective funds management in the business.  In simple words, Financial Management as practiced by business firms can be called as Corporation Finance or Business Finance.  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. NATURE AND SCOPE OF FINANCIAL MANAGEMENT The nature of financial decisions would be clear when we try to understand the operation of a firm. At the very outset, the promoters makes an appraisal of various investment proposals and selects one or more of them ,depending upon the net benefits derived from each as well as on the availability of funds. Financial Management and Production Management Production management is the operational part of the business concern. Profit of the concern depends upon the production performance. Production performance needs finance, because production department requires raw material, machinery, wages, operating expenses etc. These expenditures are decided and estimated by the financial department and the finance manager allocates the appropriate finance to production department. The financial manager must be aware of the operational process and finance required for each process of production activities. Financial Management and Marketing Produced goods can be sold in the market with innovative and modern approaches. For this, the marketing department needs finance. The finance manager or finance department is responsible to allocate the adequate finance to the marketing department. Hence, marketing and financial management are interrelated and depends on each other. Financial Management and Human Resource Financial management is also related with human resource department, which provides manpower to all the functional areas of organization. Finance manager should carefully evaluate the requirement of manpower to each department and allocate the finance to the human resource department as wages, salary, remuneration, commission, bonus, pension and other monetary benefits to the human resource department. Hence, financial management is directly related with human resource management.  The success or failure of any firm is mainly linked with the quality of financial decisions. The focus of Financial management is on efficient and judicious use of resources to attain the desired objective of the firm.  The basic objectives of Financial management centers around (a) the procurement funds from various sources like equity share capital, preference share capital, debentures, term loans, working capital finance, and (b) effective utilization of funds to maximize the profitability of the firm and the wealth of its owners.  The responsibilities of the Finance managers are linked to the goals of ensuring liquidity, profitability or both and are also related to the management of assets and funds of any business enterprise.  The traditional view of financial management looks into the following functions, that a Finance manager of a business firm will perform:  (a) Arrangement of short term and long-term funds from financial institutions.  (b) Mobilization of funds through financial instruments like equity shares, preference shares, debentures, bonds etc.  (c) Orientation of finance function with the accounting function and compliance of legal provisions relating to funds procurement, use and distribution.  Globalization has caused to integrate the national economy with the world economy and it has created a new financial environment which brings new opportunities and challenges to the individual business concern. This has led to total reformation of the finance function and its responsibilities in the organization. Financial management in India has changed substantially in scope and complexity in view of recent Government policy. Today’s Finance managers are seized with problems of financial distress and are trying to overcome it by innovative means. In the current economic scenario, financial management has assumed much greater significance.  It is now a question of survival of entities in the total spectrum of economic activity, with pragmatic readjustment of financial management. The information age has given a fresh perspective on the role of financial management and Finance managers. With the shift in paradigm it is imperative that the role of Chief Finance Officer (CFO) changes from Controller to a Facilitator.  Investment decision or capital budgeting involves the decision of allocation of capital or commitment of funds to long-term assets that would yield benefits in the future. Two important aspects of the investment decision are: (a) the evaluation of the prospective profitability of new investments, and (b) the measurement of a cut-off rate against that the prospective return of new investments could be compared.  Future benefits of investments are difficult to measure and cannot be predicted with certainty. Because of the uncertain future, investment decisions involve risk. Investment proposals should, therefore, be evaluated in terms of both expected return and risk.  Besides the decision for investment managers do see where to commit funds when an asset becomes less productive or non-profitable. There is a broad agreement that the correct cut-off rate is the required rate of return or the opportunity cost of capital.  However, there are problems in computing the opportunity cost of capital in practice from the available data and information.  A decision maker should be aware of capital in practice from the available data and information. A decision maker should be aware of these problems.  A proper balance will have to be struck between return and risk.  When the shareholders’ return is maximized with minimum risk, the market value per share will be maximized and the firm’s capital structure would be considered optimum.  Once the financial manager is able to determine the best combination of debt and equity, he or she must raise the appropriate amount through the best available sources.  In practice, a firm considers many other factors such as control, flexibility loan convenience, legal aspects etc. in deciding its capital structure. liquidity  Current assets management that affects a firm’s liquidity is yet another important finances function, in addition to the management of long-term assets.  Current assets should be managed efficiently for safeguarding the firm against the dangers of illiquidity and insolvency.  Investment in current assets affects the firm’s profitability,Liquidity and risk.  SCOPE OF FINANCIAL MANAGEMENT The main objective of financial management is to arrange sufficient finance and its effective utilisation. A finance manager will have to concentrate on the following areas of finance function.  1. Estimating financial requirements: The first task of a financial manager is to estimate short term and long term financial requirements of his business. For that, he will prepare a financial plan for present as well as for future. The amount required for purchasing fixed assets as well as needs for working capital will have to be ascertained.  2. Deciding capital structure: Capital structure refers to kind and proportion of different securities for raising funds. After deciding the quantum of funds required it should be decided which type of securities should be raised. It may be wise to finance fixed assets through long term debts. A decision about various sources for funds should be linked to the cost of raising funds.  5. Proper cash management: Cash management is an important task of finance manager. He has to assess various cash needs at different times and then make arrangements for arranging cash. Cash may be required to purchase of raw materials, make payments to creditors, meet wage bills and meet day to day expenses. The idle cash with the business will mean that it is not properly used.  6. Implementing financial controls: An efficient system of financial management necessitates the use of various control devices. They are ROI, break even analysis, cost control, ratio analysis, cost and internal audit. ROI is the best control device in order to evaluate the performance of various financial policies.  7. Proper use of surpluses: The utilization of profits or surpluses is also an important factor in financial management. A judicious use of surpluses is essential for expansion and diversification plans and also in protecting the interests of share holders. The ploughing back of profits is the best policy of further financing but it clashes with the interests of share holders. A balance should be struck in using funds for paying dividend and retaining earnings for financing expansion plans  Objectives of Financial Management may be broadly divided into two parts such as: 1. Profit maximization 2. Wealth maximization. Maximization of profits Profit earning is the main aim of every economic activity. Profit maximization simply means maximizing the income of the firm . Economist are of the view that profits can be maximized when the difference of total revenue over total cost is maximum, or in other words total revenue is greater than the total cost. 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. 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 sake holders such as customers, suppliers, public shareholders, etc. Drawbacks of Profit Maximization (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. 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 exact 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. Unfavorable Arguments for Wealth Maximization (i) Wealth maximization leads to prescriptive idea of the business concern but it may not be suitable to present day business activities. (ii) Wealth maximization is nothing, it is also profit maximization, it is the indirect name of the profit maximization. •More likely, when stockholders are dissatisfied they will simply sell their stock shares. •This action by stockholders will cause the market price of the company’s stock to fall. •When stock price falls relative to the rest of the market (or relative to the rest of the industry) ... •Management is failing in their job to increase the welfare (or wealth) of the stockholders (the owners). •Conversely, when stock price is rising relative to the rest of the market (or industry), ... •Management is accomplishing their goal of increasing the welfare (or wealth) of the stockholders (the owners). •Why is market value more important than book value? • Book values are often based on dated values. They consist of the original cost of the asset from some past time, minus accumulated depreciation (which may not represent the actual decline in the assets’ value). • Maximization of market value of the stockholders’ shares is the goal of the firm. Why is cash flow more important than accounting income? • Cash flow to stockholders (in the form of dividends) is the only basis for valuation of the common stock shares. Since the goal is to maximize stock price, cash flow is more directly related than accounting income. • Accounting methods recognize income at times other than when cash is actually received or spent. •One more reason that cash flow is important: • When cash is actually received is important, because it determines when cash can be invested to earn a return. [Also: When cash must be paid determines when we need to start paying interest on money borrowed.] •Definitions: Operating income vs. operating cash flow • Operating income = earnings before interest and taxes (EBIT). This is the total income that the company earned by operating during the period. It is income available to pay interest to creditors, taxes to the government, and dividends to stockholders. •Operating cash flow: • Operating cash flow = EBIT + Depreciation - Taxes. This definition recognizes that depreciation expense is subtracted in computing EBIT, though it is not a cash outlay. • It also recognizes that taxes paid is a cash outlay. me HeCDS7//wy WaNoseltelniDOoresoulinea com/linreny Aviasy/ccivicleinelsplte so tsbinelelc/7 3935 25)0) eo AO Pcritrei/necrelies—O0 O2s-cnienn| = http://schools.aglasem.com/18834