Financial Management

Unit.I
Introduction to finance - Introduction to Financial Management -
Importance of Financial Management - Merits and Demerits of Financial
Management - Nature of Finance - scope of Finance - functions of Finance -
objectives of Financial Management - Approaches in Financial Management -
Profit Maximization - Wealth Maximization - Functions of financial manager -
Role of a financial manager - Allocation of Funds - Raising of funds - Profit
Planning - Understanding Capital Markets - Sources of finance - Introduction to
Financial planning - Importance of Financial planning - Objectives of Financial
Planning - Limitations of Financial Planning - Introduction to financial
forecasting - Problems in financial forecasting.
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Meaning of Finance
According to Khan and Jain “Finance is the art and science managing
money. It includes financial services and financial instruments”.
The concept of finance includes capital , funds, money and amount. But
each word having unique function
Finance may be defined as the provision of adequate amount of money when it
is required. ‘
`Guthumann and Dougall “Business finance may be defined as the activity
concerned with planning, raising, controlling and administering of the funds used
in the business”.

Definitions of financial management

According to Howard & Upton, “Financial management is the application of the

planning and control functions to the finance function.”

According to Solomon, “Financial management is concerned with the efficient

use of an important economic resource, namely, capital funds.”

According to J. L. Massie, “Financial management is the operational activity of

a business that is responsible for obtaining and effectively utilizing the funds
necessary for efficient operation.”
According to Weston & Brigham, “Financial management is an area of financial
decision making harmonizing individual motives & enterprise goals.”

According to J. F. Bradley, “Financial management is the area of business

management devoted to the judicious use of capital & careful selection of sources
of capital in order to enable a spending unit to move in the direction of reaching
its goals.”

“Financial Management is concerned with the managerial decisions that results

in the acquisition and financing of short and long term credits for the
organizations.”

IMPORTANCE OF FINANCIAL MANAGEMENT

Finance is the lifeblood of business organization. It needs to meet the
requirement of the business concern. Each and every business concern must
maintain adequate amount of finance for their smooth running of the business
concern and also maintain the business carefully to achieve the goal of the
business concern. The business goal can be achieved only with the help of
effective management of finance. We can’t neglect the importance of finance at
any time at and at any situation. Some of the importance of the financial
management is as follows:
1.Financial Planning
Financial management helps to determine the financial requirement of the
business concern and leads to take financial planning of the concern. Financial
planning is an important part of the business concern, which helps to promotion
of an enterprise.
2.Acquisition of Funds
Financial management involves the acquisition of required finance to the business
concern. Acquiring needed funds play a major part of the financial management,
which involve possible source of finance at minimum cost.
3.Proper Use of Funds
Proper use and allocation of funds leads to improve the operational
efficiency of the business concern. When the finance manager uses the funds
properly, they can reduce the cost of capital and increase the value of the firm.
4.Financial Decision
Financial management helps to take sound financial decision in the
business concern. Financial decision will affect the entire business operation of
the concern. Because there is a direct relationship with various department
functions such as marketing, production personnel, etc.
5.Improve Profitability
Profitability of the concern purely depends on the effectiveness and proper
utilization of funds by the business concern. Financial management helps to
improve the profitability position of the concern with the help of strong financial
control devices such as budgetary control, ratio analysis and cost volume profit
analysis.
6. Increase the Value of the Firm
Financial management is very important in the field of increasing the wealth of
the investors and the business concern. Ultimate aim of any business concern will
achieve the maximum profit and higher profitability leads to maximize the wealth
of the investors as well as the nation.
7. Promoting Savings
Savings are possible only when the business concern earns higher profitability
and maximizing wealth. Effective financial management helps to promoting and
mobilizing individual and corporate savings.

Merits and Demerits of Financial Management

Merits of Financial Management

1.Better Decision Making

Financial management facilitates better decision making. It collects and
provides all financial information regarding the organization. Easy availability
and accessibility of all information help managers in taking decisions efficiently
on the bases of facts and figures.
2.Transparency Of Information
Financial management leads to the transparency of all information
in business. It records all information systematically and made it available to all
business users. Better transparency helps in developing proper understanding
within and outside the organization and avoids any confusion or errors.

3.Finance Control
Controlling the finance of an organization is one of the better advantages
offered by financial management. It supervises and manages all activities of the
business to exercise financial control. Finance managers ensure that all activities
of business go in accordance with the estimated cost and should not go above the
pre-set budgets.
4. Enhances Managerial Efficiency
Financial management is responsible for maintaining proper financial
discipline in an organization. It ensures that all financial resources are efficiently
utilized and there is no wastage. Financial managers supervise the activities of all
employees and work at deriving better results out of them.
5. Profit Maximization And Wealth Maximization
Financial management aims at raising the profit of organization and wealth
of shareholders. It aims at earning high profits by reducing the cost of operation
and efficiently utilizing all resources. Higher the profit the company earns, the
higher would be the dividend declared by the company for its shareholders. This
way it will increase their wealth.

6. Determines Adequate Capital

Estimation of an adequate amount of capital that a business requires to start
and continue its activities is an important task. Financial management estimates
the right amount of funds required by the business so that it can be acquired
timely.
7. Avoids Debts
Financial management helps in avoiding and taking any unnecessary debt
by the company. It aims at the proper and efficient application of all funds and
aims at reducing the overall cost. This leads to avoiding any need for additional
funds requirements by the business.

Demerits of Financial Management

1.Costly
Practicing Financial management is a costly activity for business
organizations. For controlling and measuring the cost, financial management
implies various financial control tools. These tools are costly to use and are time-
consuming.
2.Rigidity
Financial management leads to rigidity by setting certain standards for
measuring performance. All the standards are set in accordance with certain
parameters. However, conditions may differ while performing the actual task
from those conditions which were considered while framing standards. Therefore
due to standards rigidity, actual and standard performance cannot be properly
evaluated.
3.Determination Of Standards
Financial management requires determination of standards for measuring
actual performance which is a very difficult task. There are no proper setup
criteria for setting up standards and there may be chances to set improper
standards.
4.Difficulty In Applying Control Measures
Applying various financial control measures faces several difficulties.
These financial controls can be easily applied at the starting of the process but its
implication becomes difficult during operation of the process.
5.Problems In Recognizing Deviation
 The identification of real reasons for deviation in an actual performance is
not always possible. Financial management can work toward managing or
avoiding deviations if and only real reasons for such deviations are found out,
otherwise, it is ineffective.

Nature of finance
Finance is one of the very suitable sectors of a business that can make or
break entrepreneurs. Ideally, all companies need finances for daily operations,
and this is what makes the concept of finance very important as an area for al
organizations to cover. Below are some of the reasons finance matters to business
organizations

1.Profit Creation
A popular phrase, money is for making money , explains why finance
management in business organisation requires the utmost attention. For a business
to keep running successfully, the amounts of profit coming in must keep
increasing. This means that the initial capital investment must be well managed,
with a thin line between debt and equity financing. The profit planning for the
finance ream should look a lot like determining the profitability of individual
products and services that the business offers while weeding out the losers and
promoting the winners .
2.Operational expenses
Meeting the operational needs of an organisation is what keeps a business
going . Finance for most companies .some operational costs such as remunerative
payments for staff members, raw materials, inventor, interest payments, to
mention a few . A proper financial plan provides a form of stability in managing
the profit that are coming into the organisation, in relation to the operational
expenses that need to be met frequently.
3. Assets Creation
The primary long -term agenda for company owners is to scale up
production by increasing the asset of the business. The finance sector allows
companies to have a sold saving plan that is not dependent on short- term finances
to meet this need. Investing in items such as, land, equipment and machinery will
definitely boost the production scale, but will only happen with intelligent
financial management. For the most part, the matter of asset creation goes as far
and wide as keeping up with technological advancement that will mean well for
the success of the business.
4.New products and markets:
The chase for new products and markets is vivid for all business. For
example you can engage in mystery shopping so that you find out what
commodities are available in the market, and what customers are interested in.
Without a proper financial structure , you may not have the financial muscle to
get new spaces and approach a different market with newer solutions or products.
5.Cashflow Management
Any business big or small anticipates a large sum of cash flowing in and
out of the company. These money transactions are necessary to keep a business
going , but without a proper system in place, they can be a great source of
problems, particularly, legal issues. A business organization needs a strong
financial team to handle the cash flow of the company, with existing records as a
testament to eh different transactions. This help to check out that all necessary
expenses are met, including taxations to the government.

6.Financial Goals.
Among other necessary goals for a business set-up every organization has
a set of financial goals. While most involve hitting a certain profit margin over a
specified period, financial goals go as fr as catering for the overall economic
demands and requirements of the nation..

7.Management of Unavoidable risks

Running any company is all about taking risks. Even so, it is not enough to
think of your business set up as a risk. Natural phenomena along with human
errors can by far be the leading reasons you suffering significant loss in your
business. Before that time comes, your financial management techniques will
help pull out a contingency plan that will prepare your company to manage
unavoidable risks.

Scope of Business Finance

Scope means the research or study that is covered by a subject. The scope of
Business Finance is hence the broad concept. Business finance studies, analyses and
examines wide aspects related to the acquisition of funds for business and allocates
those funds. There are various fields covered by business finance and some of them
are:
1. Financial planning
A business firm must manage and make their financial analysis and planning. To
make these planning’s and management, the financial manager should have
the knowledge about the financial situation of the firm. On this basis of information,
he/she regulates the plans and managing strategies for a future financial situation of
the firm within a different economic scenario.
2. Financial control The financial budget serves as the basis of control over
financial plans. The firms on the basis of budget find out the deviation between the
plan and the performance and try to correct them. Hence, business finance consists
of financial planning and control.

3 Financial Statement Analysis

One of the scopes of business finance is to analyze the financial statements. It also
analyses the financial situations and problems that arise in the promotion of the
business firm. This statement consists of the financial aspect related to the
promotion of new business, administrative difficulties in the way of expansion,
necessary adjustments for the rehabilitation of the firm in difficulties.

4. Working capital Budget

The financial decision making that relates to current assets or short-term assets is
known as working capital management. Short-term survival is a requirement for
long-term success and this is the important factor in a business. Therefore, the
current assets should be efficiently managed so that the business won’t suffer any
inadequate or unnecessary funds locked up in the future. This aspect implies that
the individual current assets such as cash, receivables, and inventory should be very
efficiently managed.
Functions of Finance
There are different classifications for finance functions, and it varies with
organization types. The finance department functions like bookkeeping, budgeting,
forecasting, and management of taxes, and the finance manager functions like
financial report preparations contribute to the overall financial wellbeing of an
entity. Let’s look into some of the popular classifications.
Finance functions are divided into two broad functions − Long-term
decisions and Short-term decisions. Long-term decisions are applicable to a
tenure of more than one year, while short-term decisions are meant for one year or
less.

I. Long-term Decisions
Long-term Decisions include: Investment Decision, Financing Decision, and
Dividend Decision.
1.Investment Decision
A company's investment decision must consider long-term budgeting or capital
expenditure. This decision, therefore, is known as a capital budgeting decision.
Capital budgeting consists of allocating the funds and investment decisions in
general for future profits. The two major aspects of capital budgeting are 1. The
probable return on investments in the future and 2. A cut of rate against which the
future returns could be compared.
Although often given much importance, capital budgeting is not a perfect decision,
as it is hard to interpret the future of investments.

2.Financing Decisions
The managers of an organization must know when, how, and form where to raise
money for the company to run smoothly. The assets to be raised comprises debt and
equity. The mix of debt and equity of a firm is known as capital structure. Capital
structure varies from one company to the other but every organization looks for the
best productivity out of the capital structure. This is known as optimum capital
structuring. Apart from the mix of debt and equity, the firm must consider some
other factors, such as control, loan covenants, and flexibility.
3.Dividend Decisions
A company must know and decide how to distribute the funds or profits of the
company to its shareholders. These are known as dividend decisions. The amount
of dividend paid to the shareholders is known as the dividend pay out ratio and it is
important for the company. The companies usually follow an optimum dividend
policy for the best result.
II. Short-term Decisions
1. Liquidity Decisions − The perfect mix of debt and liquidity is important for
a company's overall health. Lack of liquidity may lead to a firm's insolvency.
Moreover, the firm must have current assets in its possession for having less
risk.

Too much liquidity means more danger. Hence, liquidity decisions must consider
the right amount of liquidity mix in order to the firm to perform at its best. For this,
right amount of current assets must be held by a company

Functions of Finance
There are different classifications for finance functions, and it varies with
organization types. The finance department functions like bookkeeping,
budgeting, forecasting, and management of taxes, and the finance manager
functions like financial report preparations contribute to the overall financial
wellbeing of an entity. Let’s look into some of the popular classifications.
 Finance functions are divided into two broad functions − Long-term
decisions and Short-term decisions. Long-term decisions are applicable to a
tenure of more than one year, while short-term decisions are meant for one year
or less.

I. Long-term Decisions

Long-term Decisions include: Investment Decision, Financing Decision,

and Dividend Decision.

1.Investment Decision
A company's investment decision must consider long-term budgeting or
capital expenditure. This decision, therefore, is known as a capital budgeting
decision. Capital budgeting consists of allocating the funds and investment
decisions in general for future profits. The two major aspects of capital budgeting
are 1. The probable return on investments in the future and 2. A cut of rate against
which the future returns could be compared.

Although often given much importance, capital budgeting is not a perfect

decision, as it is hard to interpret the future of investments.

2.Financing Decisions
The managers of an organization must know when, how, and form where
to raise money for the company to run smoothly. The assets to be raised comprises
debt and equity. The mix of debt and equity of a firm is known as capital structure.
Capital structure varies from one company to the other but every organization
looks for the best productivity out of the capital structure. This is known as
optimum capital structuring. Apart from the mix of debt and equity, the firm must
consider some other factors, such as control, loan covenants, and flexibility.

3.Dividend Decisions
A company must know and decide how to distribute the funds or profits of
the company to its shareholders. These are known as dividend decisions. The
amount of dividend paid to the shareholders is known as the dividend payout ratio
and it is important for the company. The companies usually follow an optimum
dividend policy for the best result.

II.Short-term Decisions

1.Liquidity Decisions: − The perfect mix of debt and liquidity is important for
a company's overall health. Lack of liquidity may lead to a firm's insolvency.
Moreover, the firm must have current assets in its possession for having less risk.
 Too much liquidity means more danger. Hence, liquidity decisions must
consider the right amount of liquidity mix in order to the firm to perform at its
best. For this, right amount of current assets must be held by a company.

Objectives of Financial Management

There are two main objectives of Financial management. They are
1.Profit Maximisation and
2.Wealth Maximisation
I.. Profit Maximisation:
Profit maximisation refers to the maximisation of income or earnings of the
firm. The argument in favour of profit maximisation as the objectives of
financial management are
Favourable:
1. Natural goal : Profit is the aim of any business. Naturally, the goal of
financial management should be profit maximisation.
2. Measure efficiency: Profit is a measure of efficiency. Higher profits
imply greater efficiency. Hence the objective of profit maximisation
is quite rational.

3. Internal generation of funds: Profit lead to internal generation of

funds. It helps to finance the growth of the business.

4. Protection Against risks : Profits provide protection against risks.

When a company is faced with unfavourable conditions (such as fall
in prices, increase in costs and severe competition) , accumulated
profits serve as a cushion to absorb the stocks

5. Fulfilment of social obligation: Profits are essential for fulfilling

social obligation of the business. The goal of profit maximisation
helps to maximise social welfare.
Unfavourable
The arguments against the objectives of profit maximisation are
1. Vague: The term profit is vague. It has different meanings. For
instance, profit may refer to long term profits or short term profits. It
may refer to profit before tax or profit after tax or even operating profit.
 2. Neglects Time Value of Money: The objective of profit maximisation
neglects time value of money. Profits or today are more valuable that
profits to be earned after taxes five years. But profit maximisation
objective treats all profits as equal, irrespective of the timing.

3. Ignores Risk Factor : Some projects are more risky than the others
through the expected earnings may be equal but, the risk factor is not
considered by the profit maximisation gaol.

4. Trait of Immorality: Profit maximisation implies exploitation of

consumers, workers and the society , Hence it is regarded as immoral.

5. Invalid: Profit maximisation may be a valid objective under conditions

of perfect competition. As the markets are not perfect. It can not be a
valid objective.

6. Inadequate: In company formal of organisation, there is separation of

ownership and control. Shareholders are the owners, but control is in
the hands of professional managers. Creditors m financial institutions,
workers , consumers and the society are concerned with the company’s
operations. The management has to reconcile the conflicting interest of
the these stakeholders. Profit maximisation goal is inadequate for the
purpose
II. Wealth Maximisation:
Wealth Maximisation refers to the maximation of the wealth of the shareholders.
It involves maximisation of the present value of an investment. Net present value
(NPV) of an investment is the difference between present value of its inflows
(benefits) and outflows (costs)
Favourable:
The advantage of wealth maximisation objective are:
1. Clarity: It takes into account the time value of money, by discounting the
future cash inflows.
2. Time value of Money: I takes into account the time value of money, by
discounting the future cash inflows.
3. Recognise Risk Factors : The risk factor is also recognised. For
proposals with a greater degree of risk, a high discount rate (cost of
capital) is used and vice versa
 4. Universal Acceptance: The concept of wealth maximisation is
universally accepted. It takes care of the interest of shareholders, financial
institutions, employees and the society.

Financial Decision

Financial decision are decisions concerning the financial matters of a firm.

To accomplish the goal of wealth maximisation, a finance manager has to take
decision such as the amount of investment, kinds of assets to be acquired,
financing of the investment and distribution of profits. The decisions are
grouped into there categories

1.Investment decision
2. Financing decision
3.Dividend decision

1. Investment decision
Investment decision is the most important financial decision. It is concerned
with deciding the total amount of assets tot be held in the firm and their
composition
a) Long-term Investment decision:
Long term investment decision refers to the capital expenditure
decision. I is also known as capital budgeting. It involves evaluation
of various capital expenditure proposals to terms of their cost,
revenue, profit and risks. Pau-back period , Accounting rate of
return, Net present value, Net present Value Index and Internal Rate
of Return are widely used for evaluation of investment proposals

b) Short -term investment Decision:

Short term investment decision is concerned with the management
of working capital. It is also known as liquidity and profitability firm
invest too much in current assets it would lose profit as idel current
asset do not earn anything.

2. Financing Decision:
Once the investment is made, the finance manager has to decide the sources
of finance for financing the investment. Debt and equity are tow major sources
of long term finance. Use of the debt helps to enhance the earrings of the
shareholders , But excessive debt increases the risk.

3. Dividend Decision :
 Dividend decision is concerned with deciding the quantum of profits to be
distributed to share holders . The finance manage has to decide whether the
firm should distribute all the profits, retain all the profits or distribute a portion
and retain the balance.T he fiancé manger should generally aim at an optimum
dividend pay out, which maximises the value of the firm.

Approaches or scope of Financial management

Approaches of financial management can be discussed under two major heads .
1.Traditional Approach
2. Modern Approach
1.Traditional Approach:
The traditional approach was popular during the early stages of evolution
of financial management. It was introduced by Thomas Green Finance. Under the
traditional approach , the scope of financial management was limited to the
procurement of funds on the most suitable terms. The utilization of funds was not
regarded as a function of financial management.
It broadly dcovered the following three aspects
1.Arrangement of funds from financial institutions
2. Arrangement of funds through financial instrument viz share ,bonds etc.
3.Relationship between a corporation and its sources of funds

Limitations of Traditional Approach

1.One-sided approach- It is more considerate towards the fund procurement

and the issues related to their administration, however, it pays no attention to
the effective utilization of funds.

2.Gives importance to the Financial Problems of Corporations- It only

focuses on the financial problems of corporate enterprises, so it narrows the
opportunity of the finance function.

3.Attention to Irregular Events- It provides funds to irregular events like

consolidation, incorporation, reorganization, and mergers, etc. and does not
give attention to everyday business operations.

4.More Emphasis on Long Term Funds- It deals with the issues of long-
term financing.
 5. Fails to deal with financing mix : The traditional approach fail to deal with
the financing mix. It gives no consideration to the relationship between
financing mix and cost of capital

2.Modern Approach
Since the mid 1950,s business conditions have changed , factors like rapid
industrialization ,technological improvements an severe competition
arrangement of funds have made business more complex. They also necessitated
the efficient utilization of financial resources. In response to the changes, the
approache to financial management has also changed.
The main contents of Mew approach
1.Total volume of funds
2.Specfic assets an enterprise acquire
3.Funds requires be financed

Features of Modern Approach

The following are the main features of a modern approach.

 More Emphasis on Financial Decisions- This approach is more analytic

and less descriptive as the right decisions for a business can be taken only
on the base of accounting and statistical data.
 Continuous Function- The modern approach is a constant activity where
the financial manager makes different financing decisions unlike the
traditional method,
 Broader View- It gives importance not only to optimum use of finance
also abut the fund’s procurement. Similarly, it also incorporates features
relating to the cost of capital, capital budgeting, and financial planning, etc.
 The measure of Performance- Performance of a firm is also affected by
the financial decision taken by the Management or finance manager.
Therefore, to maximize revenue, the modern approach keeps a balance
between liquidity and profitability.
The other scope of financial management also includes the acquisition of funds,
gathering funds for the company from different sources, assessment and
evaluation of financial plans and policies, allocation of funds, use of funds to buy
fixed and current assets, appropriation of funds, dividing and distribution of
profits, and the anticipation of funds along with estimation of financial needs of
the company.
Functions of Financial Management
1.Estimating Financial needs
An important function of the finance manage is to provide adequate and
timely fiancé. Finance maybe needed for different purposes. A form may need
money for purchase of fixed assets or investment on current assets. Therefore it
is necessary to estimate the fixed as well as working capital requirements in
advance.
2.Indenfification of Sources of Funds
In order to meet varied financial needs, financial management has to
identify the various sources of finance. The sources of long term as will as short
term finance , their cost and other terms have to be ascertained.
Many sources are available for raising fund. Equity shares, preference
shares, institutional loans, debentures are the popular sources of long term funds.
The company may also use retained earnings for financings its needs . Cash credit
and bank overdraft are important sources of short term funds.
3.Developing an optimum capital structure
Capital structure decision is very important. It involves deciding the
proportion of debt and equity as the sources of finance. Use of debt helps to
increase the earnings of shareholder. But excessive debt increases the risk and
reduces the market value of shares. Therefore the function of financial
management is to design and develop an optimum capital structure which
maximizes the value of the firm or minimizes the cost of capital.
4.Capital Budgeting
Capital expenditure decision relates to effective utilization of capital. They
commit funds in long term -asset and influence the firm’s wealth, determine its
size and affect its risks. Hence there decisions are crucial. Capital budgeting is a
process by which investment proposals are evaluated. It helps to assess the
profitability of projects or investment.
5.Working Capital Management
Working capital refers to the funds required for financing the day-to-day
operations. The firm should have sufficient liquidity to meet its current
obligation. The function of financial management is to endure adequacy of
working capital. Working capita management includes cash management,
receivables management, and inventory management.
6. Dividend Policy
An important function of financial management is to formulate the
dividend policy of the company. Shareholders may prefer high dividends . But
retention of profits strengthens the internal generation of funds. For firms with
profitable opportunities, retention is ideal. On the other hand , for declining firms,
distribution of profits as dividends is desirable. The finance manager has to decide
the proportion of earnings to eb paid out as dividends taking these factors into
consideration.
7.Mergers and Acquisitions (M&A)
Acquisition refers to the purchase of a business. Mergers is a process by
which one company is merged into the other, Mergers and Acquisitions are rare
or episodic events in the life of a company. But, they are of great importance
from the point of view of financial management. These events involve
commitment of huge funds for long periods and influence the prospects and
profitability significantly.
8.Financial Analysis
Analysis of financial performance isa an integral part of financial
management. It helps in the assessment of strength and weaknesses of the of
the company in respect of liquidity, solvency, profitability, operating efficiency
etc. It is also useful in analysing the capital structure , its effect on earnings of
shareholders, and the dividend behaviour of a company. Financial analysis is very
useful in financial planning and control.
9. Cost Volume Profit Analysis
Cost, volume and profit are closely related. In fact, profit depends on the efficient
management of costs which in turn, depend on the volume of output. Analysis of
the relationship is known as Cost, volume and profit analysis. It divides the cost
into fixed and variable. The Cost, volume and profit is a very significant function
of financial management. It is quite useful in financial decision making.
10. Financial control
Financial control is the control function of financial management. It
objects is to measure that the performance is according plans. Financial control
involves application of control devices such as return on investment, budgetary
control and Break Even analysis, ratio analysis etc.
 Role of a Financial Manager in Financial Management
Financial activities of a firm is one of the most important and complex
activities of a firm. Therefore in order to take care of these activities a financial
manager performs all the requisite financial activities.

A financial manger is a person who takes care of all the important financial
functions of an organization. The person in charge should maintain a far
sightedness in order to ensure that the funds are utilized in the most efficient
manner. His actions directly affect the Profitability, growth and goodwill of the
firm.

1.Forecasting Financial Requirements

The first function of finance manager is to forecast the required funds in the
firm. Certain funds are required for long purposes. i,e investment in fixed assets
etc. A careful estimate of such funds, and of the exact timing, when such funds
are required must be made. Also an assessment has to be made regarding
requirements of working capital which involves estimating the amount of funds
blocked in various current assets and the amount of funds likely to be generated
for short period through current liabilities.

2.Financing Decision

Once the requirement of funds has been estimated, the finance manager has to
take decision regarding various sources from where these funds would he raised.
A proper mix of various sources has to he worked out. Each source of funds
involves different issues for consideration. In this context, the finance manager
has to carefully look into the existing capital structure and see how the various
proposals of raising funds will affect it. He has to maintain a proper balance'
between long term funds and short term funds. He has to ensure that he raises
sufficient long term funds in order to finance fixed assets and other long term
investments and to provide for the permanent needs of working capital.

3.Raising of Funds

In order to meet the obligation of the business it is important to have enough

cash and liquidity. A firm can raise funds by the way of equity and debt. It is the
responsibility of a financial manager to decide the ratio between debt and equity.
It is important to maintain a good balance between equity and debt.
 4.Allocation of Funds

Once the funds are raised through different channels the next important
function is to allocate the funds. The funds should be allocated in such a manner
that they are optimally used. In order to allocate funds in the best possible manner
the following point must be considered

The size of the firm and its growth capability

Status of assets whether they are long-term or short-term

Mode by which the funds are raised

These financial decisions directly and indirectly influence other managerial

activities. Hence formation of a good asset mix and proper allocation of funds is
one of the most important activity

5.Investment Decision

After having procured the funds from different sources, the finance manager
has to take investment decisions. Investment decisions relate to selection of assets
in which funds are to he invested by the firm. Investment alternatives art
numerous. Resources are scarce and limited, They have to rationed . and
discretely used. Investment decisions• allocate and ration the resources among
the competing investment alternatives or opportunities. The effort is to find out
the projects, which are acceptable.

The investment decisions result in purchase of assets. Assets can be classified

under two broad categories:

Long term investment decisions — Long term assets.

Short term investment decisions Short term assets

6.Profit Planning

Profit earning is one of the prime functions of any business organization. Profit
earning is important for survival and sustenance of any organization. Profit
planning refers to proper usage of the profit generated by the firm.

Profit arises due to many factors such as pricing, industry competition, state
of the economy, mechanism of demand and supply, cost and output. A healthy
mix of variable and fixed factors of production can lead to an increase in the
profitability of the firm.

Fixed costs are incurred by the use of fixed factors of production such as land
and machinery. In order to maintain a tandem it is important to continuously value
the depreciation cost of fixed cost of production. An opportunity cost must be
calculated in order to replace those factors of production which has gone thrown
wear and tear. If this is not noted then these fixed cost can cause huge fluctuations
in profit.

7.Understanding Capital Markets

Shares of a company are traded on stock exchange and there is a continuous

sale and purchase of securities. Hence a clear understanding of capital market is
an important function of a financial manager. When securities are traded on stock
market there involves a huge amount of risk involved. Therefore a financial
manger understands and calculates the risk involved in this trading of shares and
debentures.

Its on the discretion of a financial manager as to how to distribute the profits.

Many investors do not like the firm to distribute the profits amongst share holders
as dividend instead invest in the business itself to enhance growth. The practices
of a financial manager directly impact the operation in capital market.

8.Evaluating financial performance

Management control systems are often based upon financial analysis. One
prominent example is the ROI (Return on Investment) system of divisional
control. The finance manager has to constantly review the financial performance
of the various units of the organization. The ROI chart is extremely useful in
this regard. Analysis of the financial performance helps the management for
assessing how the funds have been utilized in various divisions and what can he
done to in improve it.

9.Financial negotiation

A major portion of the time of the Finance manager is utilized in carrying

negotiations with the financial institutions, banks and public depositors. has to
furnish a lot of information to these institutions and persons and have to ensure
that raising of funds is within the statutes like Companies Act etc. Negotiations
for outside financing often require specialized skills

10.Deciding overall objectives

The finance manager needs to be guided by mane objectives. As a head or

finance department,. The finance manager, therefore has to determine the overall
goals of -finance department. The goals help in of planning and decision making.

Sources of Finance
I. According to Period :
a)Short term sources: Bank credit, customer advances, trade credit, factoring,
accruals , commercial papers etc.
b) Medium term source: Issue of preference shares, Debentures, Bank loan,
Public deposits or fixed deposits etc.

c) Long term sources: Issue of shares , debentures, ploughing Back of profits,

loans from specialized financial institutions etc.

II. According to ownership:

a) Owned capital: Share capital, retained earnings, profits and surplus etc.

b) Borrowed capital: Such as debentures , bonds, public deposits, loans

etc.
III. According to source of finance
a) Internal sources: such as ploughing back of profis, retained earnings,
profits, surplus, depreciation funds etc.

b) External sources: shares Debentures, public deposits, loans etc.

IV. According to mode of financing:
a) Security or External financing: Financing through raising of corporate
securities such as shares debentures etc.
b) Internal financing: Financing through retained earnings, capitalization of
profits and depreciation of funds etc.
c) Loan financing: Raising of long term and short term loans.
Long term source of finance
1.Issue of share:
Maximum amount of permanent capital is generally provided out
of issue of shares, Both the types of shares ie equity share as well as
preference shares may be sided for this purpose
2. Issue of Debentures :
A debentures is a debt acknowledged by a company to its holder.
It is also an important source of long term.. Issue of debentures is
helpful for a company to trade on equity , retention of control and tax
benefits.
3.Ploughing back of profits:
The surplus earnings of a firm can be reinvested it its business A
portion of profit may be ploughed back to meet its capital needs .

4.Long term loan:

Long- term fund are also obtained through various types of loan
provided by the financial institutions like IBDI, ICICI and commercial
banks.
Short term Financing:
a) Internal sources:
1)Depreciation funds:
Depreciation is cost free source of funds for capital. The amount
provided as depreciation cab be retained in the business.
 2. Provision for taxation:
Provision for taxation can also be used by a firm as a source of
working capital by postponing tax payment to the extent possible.
3Accrued Expenses:
The expenses due for a period may be postponed for short period.
This also cab be source capital provided the method is used
judiciously.

b) External sources:
1) Trade credit:
The most important source of short term finance is the trade
credit extended by one business concern to another on the
purchase and sale of goods . The terms depend on negotiation
strength of the parties
2. Credit Papers:
The term-credit papers refers to bills of exchange and promissory
note of shorter duration. These papers cab be discounted with banks.
3.Bank credit
Commercial banks also provide short term in the form of
overdraft, cash credit, short term loams etc
4. Customers’ credit:
Customers are asked to make advance payment on contracts entered
into by the firm.
5. Government finance
Central and state Governments sometimes proved short term loans
on easy terms.
Financial Planning

Financial planning indicates a firms growth, performance , investments and

requirements of funds during a given period of time, usually three to five years. It
involves the preparation of projected or proforma profit and loss account , balance
sheet and funds flow statements.

A financial plan should be formulated in the light of present as well as future

developments. The requirements for purchasing fixed assets and working capital
needs should first be estimated. The needs for funds in the future for financing
expansion and diversification should also be taken into consideration. A decision
about the type of securities to be issued is also an important aspect of financial
planning.

A financial plan is a statement estimating the amount of capital and

determining its composition. The quantum of funds needed will depend upon the
asset’s requirements of the business. The time at which funds will be needed should
he carefully decided so that finances arc raised at a time when these are needed. The
next aspect of a financial plan is to determine the pattern of financing. There are a
number of ways for raising funds. The selection of various securities should be done
carefully

Importance of Financial Planning

A Financial manager should consider the following factors while finalising a
financial plan :
I. Simplicity. A financial plan should be so simple that it may be easily
understood even by a layman. A complicated financial structure creates complications
and confusion.
2.Based on Clear—cut Objectives. Financial planning should be done by
keeping in view the overall objectives of the company. It should aim to procure funds
at the lowest cost so that profitability of the business is improved.
3.Less Dependence on Outside Sources. A long—term financial planning should
aim to reduce dependence on outside sources. This can he possible by retaining a part
of profits for ploughing back. The generation of own funds is the way of financial
operations. In the beginning, outside funds may be a necessity but financial planning
should he such that dependence on such funds may he reduced in due course of time.

4. Flexibility. The financial plan should not he rigid. It should allow a scope for adjustments
as and when new situations emerge. There may be a scope for raising additional
funds if fresh opportunities occur. Similarly, idle funds, if any, may be invested in
short—term and low—risk hearing securities. Flexibility in a plan will be helpful in
coping with the demands of the future.

5. Solvency and Liquidity : Financial planning should ensure solvency and

liquidity of the enterprise. Solvency requires that short-term and long-term
payments should be made on dates when these are due. This will ensure credit
worthiness and goodwill to the concern. Solvency will be possible when liquidity
of assets is maintained. There should be sufficient funds whenever payments are
to be made . Proper forecasting of future payments will be helpful in planning
liquidity.
6. Cost.: The cost of raising capital is an important consideration in selecting a
financial plan. The selection of various sources should be such that the cost burden
should be minimum. As and when possible interest bearing securities should be
returned so that this burden is reduced.
7.Profitability.: A financial plan should adjust various securities in such a way
that profitability of the enterprise is not adversely affected. The interest-bearing
securities and other liabilities should be so adjusted that business is able to improve
its profitability.

Objectives of Financial Planning

A financial plan has the following main objectives:
1. Adequate Funds. A financial plan would ensure the availability of sufficient
funds to achieve enterprise goals.
2.Balancing of Costs and Risks. There should be a balancing of costs and risks
so as to protect the investors.
3.Flexibility. A financial plan should ensure flexibility so as to adjust as per the
requirements. It should be adjustable as per the changing conditions.
4. Simplicity. The financial structure should not be complicated by issuing a
variety of securities. The number of securities should he less so that it is easily
understood.
5.Long—term View. A financial plan should take a long—term view. The needs
for funds in the near future and over a longer period should he considered while
selecting the pattern of financing.
6.Liquidity.The liquidity of funds should always he kept in mind while preparing
a financial plan. During periods of depression, it is the liquidity which can keep a
concern going.
7.Optimum use. A financial plan should ensure sufficient funds for genuine needs.
Neither the plans should suffer due to shortage of funds nor there should be
wasteful use of them. The funds should he put to their optimum use.
8.Economy. The cost of raising the funds should be minimum. It should not
impose disproportionate burden on the company. It can been ensured by a proper
debt—equity mix.

Limitations of Financial Planning

There are few limitations of financial planning which you should be aware of.
1. Expensive Process
Planning is actually the top process so it is extremely time-consuming and funds
consuming. It may delay certain cases that expenses regarding planning is directly
proportional to your time invested during planning stage. It’s a major limitations of
financial planning for small business owners. In case you reserve and maintain your
finances according, then consequences might vary in many matters.

2.No Availability of Data

It’s a leading limitations of financial planning in every organization. Where you’ll
not see the genuine data what a person desire. planning loses considering those
values in their absence. Secondly, you can perhaps not effort too-much of cost
expenditure to get correct and sufficient insight information.
3.Lack of Communication
If there is an insufficient communication and improper co-ordination anywhere
between different officers, departments associated with a company, even the
excellent financial strategy will never exercise effectively and is assured in order to
fail. This type of limitations of financial planning most observed in large
companies.
4.Change in Environment, Rules, Policies
Abrupt changes in the government guidelines or the economic environment may
adversely impact your finance plan. In the event that financial strategy cannot adjust
for corrections based on the changing government rules, policies as well as financial
environment, an efficient financial plan probably also be inefficient for the
insufficient required adjustments.
5.Lack of Financial Forecasting
As financial methods depend on presumptions, which, financial forecasting, truth
be told there continues to be a scope for the mistaken predictions. Therefore, the
program must be evaluated from time for you time and some must adjustments must
be created with respect to the business environment.
6.Failure to Plan
Planning is a always a forward looking process. If a founder, owner or management
possesses to follow instead of leading then he can never make a good financial
plans. Therefore, this limitations of financial planning can be avoided by hiring a
best financial planner.
7.Over Ambitious Projection
Sometimes professionals and business owners put through over ambitious
projections then the realistic once. Always describe the best clear vision. Business
planning should-be based on realistic vision and mission.
8.Rigid Planning
It involves your determination of the course of action ahead of time. It may lead to
inflexibility, internal as well as procedural rigidity. For example: utilizing at the
planning a business may succeed some objectives. Then again this way planning
may build rigidity or even locks business into some goals. To overcome this
disadvantages of financial planning you should have dynamic planning with
involvement of others.
9.Less Accurate
Planning and also forecasting of future efforts may be a terrible work for someone.
There are times when, business planning is carried out by fast, simple with easy
strategies. Ineffective techniques of information gathering followed by financial
planners can lead of problem of accurate data.
10.External Factors
One of the limitation of financial planning is external aspects, as they are extremely
tough to predict. a few external factors for example: war, natural calamities, stock
market crisis and so forth. All can make implementation of plan difficult. To
overcome such limitation of financial planning model, you should protect yourself
with sufficient insurance policies.

Financial Forecasting
Financial forecasting is an integral part of financial planning. Forecasting uses past
data to estimate the future financial requirements. A simple approach to financial
forecasting is to relate the items of profit and loss account and balance sheet to sales.
Problems in Financial Forecasting

1.Forecasting Time Period

Shorter the period, the more accurate financial forecasting. Longer the period, the
less accurate and difficult financial forecasting. Mostly, less difficulty comes for a
short span and more difficulty comes for a long span.
Let’s take an instant that preparing forecasting for future 5 years, using past 5 years
data is less difficult as compared to predicting for next 10 years. Even there might
be variations in market shares or the business economic conditions.

2.Data Collections
It is really a big task. Collecting and gathering all the business finance data to
proceed further can never be easy. This task can take a week to weeks to gather all
the information to build the cash flow projection and revenue forecast. Collecting
these data for forecasting is one of the huge financial forecasting problems.

3.Problems with the Input data

Forecasts using linear analysis can be common, but this type of forecasting fails to
account for the uncertainty in the future. In statistics, the assumption of linearity is
necessary when certain assumptions are made about the future. However, there is
no assurance that a relationship between two variables will continue in the future.
In essence, noisy data can create a correlation where none truly exists.
4.Unforeseeable Events
Another financial forecasting problem is unforeseeable. Though the businesses
achieve the quantitative and qualitative forecasting techniques to make their
prediction accurate, unforeseeable can never be achieved. These components can
vary inherently, and reach the risks of forecasting. For example, let us take a retail
shop that opens the store with the pillar financial growth.

5. Accuracy of past data

Financial forecasting is performed based on past business data to predict the future.
Take an instant that your business average growth as 10% as a stable one for the
past 4 years, you could predict your business finance for the next 4 years as 10%.
While you use this kind of system wider, then you are on the way to financial
forecasting problems.

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