Unit 1: Introduction

Content: Finance: meaning, scope; financial management: objectives, merits, criticism,

functions of financial management, factors influencing financial decisions, Role of finance
manager, functions of financial manager, and recent trends in Financial Management

Introduction and meaning

Finance is called “The science of money”. It studies the principles and the methods of obtaining
control of money from those who have saved it, and of administering it by those into whose
control it passes.
Economics is defined as study of the efficient use of scarce resources. The decisions made by
business firm in production, marketing, finance and personnel matters form the subject matters
of economics. Finance is the process of conversion of accumulated funds to productive use.
In simple terms finance is defined as the activity concerned with the planning, raising,
controlling and administering of the funds used in the business. Thus, finance is the activity
concerned with the raising and administering of funds used in business

Definition of Financial Management

Financial Management is managerial activity which is concerned with the planning and
controlling of the firm’s financial resources.
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
“Financial management is the application of the planning & control functions of the finance
function.”- Howard & Upton
“Financial management is province of financial decision-making, harmonizing individual
motives and enterprise goals”. - Weston and Brigham

Features of Financial Management

1. Financial Management is an integral part of overall management. Financial considerations
are involved in all business decisions. So financial management is pervasive throughout the
organization.

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2. The central focus of financial management is valuation of the firm. That is financial decisions
are directed at increasing/maximization/ optimizing the value of the firm.
3. Financial management essentially involves risk-return trade-off Decisions on investment
involve choosing of types of assets which generate returns accompanied by risks.
4. Financial management affects the survival, growth and vitality of the firm. Finance is said
to be the life blood of business. It is to business, what blood is to us.
5. Financial management is a sub-system of the business system which has other subsystems
like production, marketing, etc.
6. Nature of financial management is multi-disciplinary. Financial management depends upon
various other factors like accounting, banking, inflation, economy, etc. for the better utilization
of finances.
7. An approach to financial management is no limit to business functions but it is a backbone
of commerce, economic and industry.
8. The finance manager is often called the Controller; and the financial management function
is given name of controllership function.
9. No production, purchases or marketing are possible without being duly supported by
requisite finances.
10. Hence, Financial Management commands a higher status vis-a-vis all other functional areas
of general management.

Scope of Financial Management

Some of the major scope of financial management is as follows:
1. Investment Decision: Where to invest?
2. Financing Decision: Sources of money for investment.
3. Dividend Decision: Distributing profit to stakeholders.
4. Working Capital Decision: Day to day activities.

1. Investment Decision: The investment decision involves the evaluation of risk,

measurement of cost of capital and estimation of expected benefits from a
project. Capital budgeting and liquidity are the two major components of investment
decision. Capital budgeting is concerned with the allocation of capital and commitment
of funds in permanent assets which would yield earnings in future. Capital
budgeting also involves decisions with respect to replacement and renovation of old
assets. The finance manager must maintain an appropriate balance between fixed and
current assets in order to maximize profitability and to maintain desired liquidity in the
firm.

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2. Financing Decision: While the investment decision involves decision with respect to
composition or mix of assets, financing decision is concerned with the financing mix
or financial structure of the firm. The raising of funds requires decisions regarding the
methods and sources of finance, relative proportion and choice between alternative
sources, time of flotation of securities, etc. In order to meet its investment needs, a firm
can raise funds from various sources. The finance manager must develop the best
finance mix or optimum capital structure for the enterprise so as to maximize the long-
term market price of the company’s shares. A proper balance between debt and equity
is required so that the return to equity shareholders is high and their risk is low.

3. Dividend Decision: In order to achieve the wealth maximization objective, an

appropriate dividend policy must be developed. One aspect of dividend policy is to
decide whether to distribute all the profits in the form of dividends or to distribute a
part of the profits and retain the balance. While deciding the optimum dividend payout
ratio (proportion of net profits to be paid out to shareholders). The finance manager
should consider the investment opportunities available to the firm, plans for expansion
and growth, etc. Decisions must also be made with respect to dividend stability, form
of dividends, i.e., cash dividends or stock dividends, etc.

4. Working Capital Decision: Working capital decision is related to the investment in

current assets and current liabilities. Current assets include cash, receivables, inventory,
short-term securities, etc. Current liabilities consist of creditors, bills payable,
outstanding expenses, bank overdraft, etc. Current assets are those assets which are
convertible into a cash within a year. Similarly, current liabilities are those liabilities,
which are likely to mature for payment within an accounting year.

Objectives of Financial Management

The major objectives of financial management is as follows:
 Profit maximization
 Wealth maximization
 Proper estimation of total financial requirements
 Proper mobilization
 Proper utilization of finance
 Maintaining proper cash flow
 Survival of company
 Creating reserves
 Proper coordination
 Create goodwill

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1. Profit maximization: Profit Maximization is the main objective of business because:
(i) Profit acts as a measure of efficiency and (ii) It serves as a protection against risk.
Arguments in favour of Profit Maximization
(i) When profit earning is the main aim of business the ultimate objective should be profit
maximization.
(ii) Future is uncertain. A firm should earn more and more profit to meet the future
contingencies.
(iii) The main source of finance for growth of a business is profit. Hence, profit
maximization is required.
(iv) Profit maximization is justified on the grounds of rationality as profits act as a measure
of efficiency and economic prosperity.
Arguments against Profit Maximization
(i) It leads to exploitation of workers and consumers.
(ii) It Ignores the risk factors associated with profit.
(iii) Profit in itself is a vague concept and means differently to different people.
(iv) It is narrow concept at the cost of social and moral obligations.
Thus, profit maximization as an objective of Financial Management has been considered
inadequate.

2. Wealth Maximization: Wealth Maximization is considered as the appropriate objective of

an enterprise. When the firms maximizes the stock holder’s wealth, the individual stockholder
can use this wealth to maximize his individual utility. Wealth Maximization is the single
substitute for a stock holder’s utility.
A Stock holder’s wealth is shown by
Stock holder’s wealth = No. of shares owned x Current stock price per share

Higher the stock price per share, the greater will be the stock holder’s wealth
Arguments in favour of Wealth Maximization
(i) Due to wealth maximization, the short term money lenders get their payments in time.
(ii) The long time lenders too get a fixed rate of interest on their investments.
(iii) The employees share in the wealth gets increased.
(iv) The various resources are put to economical and efficient use.

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Argument against Wealth Maximization
(i) It is socially undesirable.
(ii) It is not a descriptive idea.
(iii) Only stock holders’ wealth maximization does not lead to firm’s wealth maximization.
(iv) The objective of wealth maximization is endangered when ownership and management
are separated.
Inspite of the arguments against wealth maximization, it is the most appropriative objective of
a firm.

Functions of Financial Management

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 Cost: Financing decisions are based on the allocation of funds and cost-cutting. The
cost of fundraising from different sources differs a lot and the most cost-efficient source
should be chosen.
 Risk: Borrowed funds have a larger risk compared to equity funds.
 Cash flow position: Cash flow is the daily earnings of the company. A good cash flow
position gives confidence to the investors to invest funds in the company.
 Control: The issue of more equity shares may lead to a dilution of management control
over the business. Debt financing has no such implication. Companies that are afraid of
taking over will prefer debt. It means if existing shareholders want to retain complete
control of the company, then the debt should be preferred. However, if they don’t mind
the loss of control, then the company may go for equity. So we can say that equity
dilutes control, whereas debt doesn’t affect control.
 Condition of the market: The condition of the stock market also helps in making the
source of finance. In the case when the stock market is rising, during this period it is
also easy to raise funds for the issue of shares because people are interested to invest in
equity shares. But in case of a depressed market, company may face difficulties for
issue equity shares. The condition of the market plays a major role in financing
decisions. Issuance of equity is in majority during the boom period, but debt of a firm
is used during a depression.
 Floatation Cost: Floatation cost refers to the cost, which is involved in the issue of
securities. In the case of equity, floatation cost is low, and in the case of debt,
floatation cost is high. Some of the examples are underwriting commission, broken
range stamp duty, etc. The firm prefers securities with the least floatation cost.
 Level of Fixed Operating Costs: Owner’s fund is preferred by firms with a higher
level of operating costs, like rent, salaries, insurance premiums, etc., because interests

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 payment on debt will further add to the cost burden. And in case of moderate or low
fixed operating costs, firms can go for borrowed funds.

ADVANTAGES OF FINANCIAL MANAGEMENT:

1. Guide for Future Activities: Financial control provides the base for future financial
activities. It provides guidance to finance manager about how to perform a financial
activity.
2. Controlling Finance: Financial control not only provides the base for future financial
activities but also provides tools for checking actual performance with standard performance
and to take appropriate measures in case of deviations.
3. Increases Managerial Efficiency: Financial control ensures proper financial discipline in
an organization. It also ensures optimal utilization of resources. These two lead to production
of goods and services at cheaper price thereby increasing the earnings of the concern. This
ensures that the overall efficiency of all the staff increases.
4. Ascertaining Adequate Capital: Financial control helps ascertain adequate amount of
capital and thus the problems associated with under-capitalization and over-capitalization can
be avoided.
5. Maintenance of Financial Stability: Financial control increases productivity and efficiency
of the concern. Productivity and efficiency increases the earnings of the concern and the
increase in earnings increases the financial strength of the concern.

DISADVANTAGES OF FINANCIAL MANAGEMENT:

1. Setting of Standards: One of the important tasks of financial control is to compare the
actual performance with the standard performance; but determination of standard performance
for a job or an activity is a difficult task.
2. Rigidity: Standard is fixed by taking into account certain parameters but when the actual
job is performed, conditions may not remain the same as set at the time of fixing the standards.
Therefore, proper evaluation of actual and standard performance cannot be done due to rigidity
of standards.
3. Difficulty in Implementation of Control Measures: Financial control measures can be
implemented at the beginning of a process. It is difficult to implement a control measures when
the process is in operation.
4. Difficulty in Identification of Deviation: It is not always possible to identify the actual
reasons for deviation in actual performance; as a result, the benefit of control cannot be
enjoyed.
5. High Costs: Implementation of financial control tools in an organization requires a lot of
money. Thus, financial control is a costly affair.

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Functions of Finance Manager
1. Estimating the Amount of Capital Required: This is the foremost function of the financial
manager. Business firms require capital for:
• Purchase of fixed assets,
• Meeting working capital requirements, and
• Modernization and expansion of business.
The financial manager makes estimates of funds required for both short-term and long term.

2. Determining Capital Structure: Once the requirement of capital funds has been
determined, a decision regarding the kind and proportion of various sources of funds has to be
taken. For this, financial manager has to determine the proper mix of equity and debt and short-
term and long-term debt ratio. This is done to achieve minimum cost of capital and maximize
shareholders wealth.

3. Choice of Sources of Funds: Before the actual procurement of funds, the finance manager
has to decide the sources from which the funds are to be raised. The management can raise
finance from various sources like equity shareholders, preference shareholders, debenture-
holders, and banks and other financial institutions, public deposits, etc.

4. Procurement of Funds: The financial manager takes steps to procure the funds required for
the business. It might require negotiation with creditors and financial institutions, issue of
prospectus, etc. The procurement of funds is dependent not only upon cost of raising funds but
also on other factors like general market conditions, choice of investors, government policy,
etc.

5. Utilization of Funds: The funds procured by the financial manager are to be prudently
invested in various assets so as to maximize the return on investment: While taking investment
decisions, management should be guided by three important principles, viz., safety,
profitability, and liquidity.

6. Disposal of Profits or Surplus: The financial manager has to decide how much to retain for
ploughing back and how much to distribute as dividend to shareholders out of the profits of the
company. The factors which influence these decisions include the trend of earnings of the
company, the trend of the market price of its shares, the requirements of funds for self-
financing the future programmes and so on.

7. Management of Cash: Management of cash and other current assets is an important task of
financial manager. It involves forecasting the cash inflows and outflows to ensure that there is
neither shortage nor surplus of cash with the firm. Sufficient funds must be available for
purchase of materials, payment of wages and meeting day-to-day expenses.

8. Financial Control: Evaluation of financial performance is also an important function of

financial manager. The overall measure of evaluation is Return on Investment (ROI). The
other techniques of financial control and evaluation include budgetary control, cost control,
internal audit, break-even analysis and ratio analysis. The financial manager must lay
emphasis on financial planning as well.

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Major Financial Management Trends of 2023

1. Emphasis on Data Analytics: With more firms utilizing technology to improve internal
operations and gain insights with more firms using technology to improve internal operations
and gain insights into their consumers, data analytics is becoming further significant in the field
of finance. Financial management professionals will rely on data analytics to make informed
financial decisions. They will use data to create financial models and forecasts, analyze market
trends, and identify potential risks and opportunities.

2. Financial management also undergo a digital transformation: Technological

advancements are changing financial management. Financial management will undergo a
digital transformation, with more businesses using cloud-based accounting software,
automation tools, and other digital solutions to manage their finances. Accuracy,
effectiveness, and decision-making are all improved. Financial management is changing as
a result of digital transformation, and companies that adopt it will gain a competitive edge.

3. Personal Finance Apps: Consumers will increasingly rely on personal finance apps to
manage their finances, track their spending, and invest their money. The number of people
using personal finance apps like Mint, Prism, and Every Dollar increased by nearly 90%
during the pandemic. These apps provide investment opportunities in equities and
cryptocurrency, in addition to helping individuals manage their finances. The ease of
utilizing their smartphones to manage their financial matters remotely draws people in.

4. Blockchain technology: Blockchain technology will be used more and more in financial
management for efficient, safe, and transparent financial transactions. This technology has
long been linked to cryptocurrencies, but it is now anticipated to become more integrated
with traditional financial systems. By utilizing Blockchain technology, banks can perform
transactions more affordably and securely. Furthermore, peer-to-peer lending, which is
anticipated to reach $150 billion by 2025, can be made possible by technology. In 2023, as
more banks switch to cloud-based banking, Blockchain is anticipated to be a key
component of this shift.

Important Questions
1. Define financial management and its Scope
2. State the objectives of financial management
3. Elucidate the scope of financial management
4. Explain the concept of Profit maximization and wealth maximization
5. State the factors affecting financial decisions
6. Who is financial manager? Explain his role in the context of financial management

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