Financial Management Bangalore university | III Sem B.Com| Bangalore university
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Unit 1:
INTRODUCTION FINANCIAL MANAGEMENT
Meaning of finance
Finance is needed for starting and establishing a business, to run it, to modernise it, to expand, or diversify it. It is required for buying a variety of assets, which may be tangible like machinery, factories, buildings, offices or intangible such as trademarks, patents, etc
Finance is defined as the management of money and includes activities such as investing, borrowing, lending, budgeting, saving, and forecasting.
The easiest way to define finance is by providing examples of the activities it includes like investing of personal money in stocks or bonds, or borrowing money from investors by issuing bonds , or lending money to people for buying a house, saving personal money in a savings account, developing a forecast for government spending and revenue collection etc.
Science and society 2019 solved paper
Science and society 2018 solved paper
Unit-1 Important MCQ Science and Society
- Also, finance is essential for running the day-to-day operations of business, like buying raw material, paying bills, paying salaries for employees, collecting cash from customers, etc. which are needed at every stage in the life of a business entity. Money required for carrying out business activities is called business finance.
Finance function is a part of financial management.In business, it involves the acquiring and utilisation of funds necessary for efficient operations.It is concerned with the functions of procuring funds,investing them into profitable projects, and distributing the returns earned from this investment.
Aims of finance function
1.Raising sufficient funds
The main aim of finance function is to assess the financial needs of an enterprise and then finding out suitable sources for raising them. The amount of capital needed by an organisation has to be raised by the finance manager from different internal and external sources like loans, shares, debentures, short term loans,term loans retained earnings from the organisations etc.
2.Funds allocation/utilisation of funds
The raised fund should be used in proper manner for profitability of the organisation.The best profitable project must be selected.
3.Project selection and risk return trade off
Whatever finance is raised it must be invested in highly profitable projects with risk -return trade off in order to provide a balance between risk and returns which is denoted by risk return trade off
4.Dividend payout
Dividend is the distribution of profit made by the company to its share holders.Equity shareholders expect returns for their investment in the company.The company has to decide whether it should give the entire profit as dividend or a part of the profit as dividend.It depends on the finance policies of the company and is one of the chief aims of the finance function.
5.Maintaining liquidity and solvency
There should sufficient liquidity of finance in order to maintain the daily requirements of the business.There must be circulation of funds in the business continuously which means there must be assets which have high liquidity(easily convertible to cash) and there are also fixed assets with less liquidity.In what ratio these assets must be available or maintained in the company is also one of the aims of finance function as both the types of assets are important for proper finance maintenance of the company.Solvency is the maintenance of debts in the company that is to see whether the company is in a position to mange its loans or debts
6.Reporting and auditing
Day to day financial activities such as how much fund ,is available, how much is allocated funds for different projects, status of the present projects, and the ongoing projects, whether they have given the estimated returns , all these must be reported to the stakeholders
7.Budgeting and controlling
The plans of finance are prepared in advance,like how much finance is required for the company for a future period say six months or one year is budgeted and this allows proper control and maintenance of the finance.
8. EPS maximisation
Earnings per share (EPS) maximisation which is improving the wealth position of an organisation which in turn is increasing the share holders wealth are share holders are the actual owners of the company.The finance manager must make sure that the EPS must be increasing for the benefit of the shareholders.So giving them maximum returns for their investment is one of the major aims of finance function
9.Maintaining efficiency and sustainability
Maintaining the efficiency of the company is also important aim of finance function as how efficiently a raised fund or capital is used by the company so that it runs profitably will decide the profitability and hence growth of the company which in the long run leads to sustainability.
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Financial Management
The objectives of financial management can be classified into two types
i)Specific objective
ii)General Objectives
i)Specific objective
Specific Objectives can be further divided into
1.Profit maximization-Ultimate aim of the business concern is earning profit.Any business would be making the use of economic and human resources available to generate profits. Cost of these resources is required to be met from the revenue generated from the use of these resources and the surplus remaining would be needed for the growth and expansion of the company.
It is only an efficiently run business which can afford to meet the cost of resources and generate profits. Therefore, the survival and growth of any business depends upon its ability in earnings profits and is one of the primary goals of the organization
2. Wealth maximization.-The term wealth means shareholder wealth or the wealth of the persons those who are involved in the business concern. Maximization of the wealth of the shareholders means maximizing the net worth of the company for its shareholders. This reflected in the market price of the shares held by them. Therefore, wealth maximization means creation of maximum value for company’s shareholders which mean maximizing the market price of the share. Wealth maximization refers to the gradual increase in value of the net assets of the organization.
ii)General Objectives
These include
1)Balanced Asset structure-The goal of financial management is to maintain a balanced asset structure for the company which involves balancing the size of fixed assets and current assets.
2)Liquidity-The liquidity objective of the company will help in the positive growth of the company as it helps to meet the short term as well as long term obligations of the company.
3)Judicious planning of funds-A company must be able to judiciously plan its funds, to achieve wealth or profit maximization. This can be achieved if it is able to reduce the cost of operations.
4)Efficiency-A finance manager must be vigilant to increase the efficiency of the company in a competitive environment.To be successful the company must be innovative, and efficient.
Role of a Financial Manager
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 farsightedness in order to ensure that the funds are utilised in the most efficient manner. His actions directly affect the Profitability, growth and goodwill of the firm.
Financial managers perform data analysis and advise senior managers on profit-maximising ideas. Financial managers are responsible for the financial health of an organization. They produce financial reports, direct investment activities, and develop strategies and plans for the long-term financial goals of their organization. Financial managers typically:
- Prepare financial statements, reports regarding business activities, and forecasts,
- Constantly keep watch on financial details to ensure that legal requirements are met
- Supervise employees who do financial reporting and budgeting
- controls how much has to be paid as dividends to share holders
- Review company financial reports and seek ways to reduce costs
- Analyse current and future market trends to find opportunities for expansion
- Helping the management to make proper financial decisions.
Following are the main functions of a Financial Manager:
1.Financial forecasting and planning
It is the job of a financial manager to plan the financial needs of a concern in terms of, for what purpose the finance is required, how much of finance is required and when exactly they are required.
The finance manager has to foresee the requirement of funds for the short term as well as long term well in advance and also for any future events demanding more money than in actual plan, while preparing the financial forecast. Care must be taken to see that the business does not get impacted negatively due to fluctuations in the flow of money into business.
2.Acquisition of funds
After making the finance forecasting and planning, the next step will be to acquire funds. The finance executive must find out the various sources available for acquiring funds. These sources may be long-term or short-term.
The long-term sources available are issue of shares, debentures, long-term loans from financial institutions, etc. The various short-term sources are bank credit i.e., short-term loans, cash credit, overdraft facilities, discounting of bills of exchange, lease finance, etc.
3.Investment of funds
Investment decision refers to planning the deployment of available capital for the purpose of maximisation of the long-term profitability of the firm. It is the firm’s decision to invest its current funds most efficiently in long-term activities in anticipation of flow of future benefits over a series of year.
Capital budgeting decisions are the most crucial and critical business decisions because the success or failure of a concern based on these decisions.
4.Helping in valuation decisions
A number of mergers and consolidations take place in the present competitive industrial world. A finance manager is supposed to assist management in making valuation etc. For this purpose, he should understand various methods of valuing shares and other assets so that correct values are arrived at.
5.Maintain proper liquidity
Every concern is required to maintain some liquidity for meeting day- to-day needs. Cash is the best source for maintaining liquidity. It is required to purchase raw materials, pay workers, meet other expenses, etc. A finance manager is required to determine the need for liquid assets and then arrange liquid assets in such a way that there is no scarcity of funds.
6.Distribution of surplus funds
Any surplus generated through funds invested over a period of time need to be utilized carefully. A portion could be distributed to shareholders in the form of dividends.
7.Performance evaluation
The finance manager compares the actual cost with the budgeted cost .In the initial financial forecasting and planning stage ,the financial manager had calculated a budget.So the finance manager will see whether the actual cost is in comparison with the budgeted/calculated cost.In the same way he will compare the actual revenue with the budgeted/predicted revenue and further he will compare the actual profit with the calculated or predicted profit.From this the finance manager is to able to study how much deviation has occurred in actual case of cost,revenue and profit and will be able to make regulations or corrections in the future accordingly.
Financial Planning
Financial planning is essentially the preparation of a financial blueprint of an organisation’s future operations. The objective of financial planning is to ensure that enough funds are available at right time .Financial planning on the other hand aims at smooth operations by focusing on fund requirements and their availability in the light of financial decisions.Financial planning process tries to forecast all the items which are likely to undergo changes. It enables the management to foresee the fund requirements both the quantum as well as the timing. Likely shortage and surpluses are forecast so that necessary activities are taken in advance to meet those situations.
(1) Laying Down Financial Objectives:
In order to make an effective financial plan, first of all the financial objective of the corporation should be laid down. The financial objectives including short-term and long-term objectives of a business help in determining policies and procedures.
Short-term objectives should be determined in a manner that they help in the achievement of long-term objectives. The objectives should be clear and definite so that they can be used as guidelines by the executives and the activities of the organisation could be performed in an organised and coordinated manner.
The long-term financial objective of business should stress the maximum and economical use of the financial resources so that value of assets could be maximised. The liquidity of funds is maintained only when the adequate cash for each transaction is maintained. For this purpose, there is a need for effective management of working capital.
(2) Formulating Financial Policies:
The formulation of policies is the second step in financial planning. They act as guidelines for the procurement of funds, their utilisation and control which helps in achieving the financial goals. Policies should be based on predetermined objectives and practicable so that they can be implemented easily and effectively.
The policies should be determined at the top level of management. These policies can relate to determination of capital structure, capitalisation, sources of funds, realisation of debt, management of capital as well as working capital, distribution of profit etc.
(3) Developing Financial Procedures:
To implement the policies, detailed financial procedures must be determined which explain all rules and sub-rules. This will help the subordinates to know what work they have to do and how to do it. Performance can be determined effectively.This helps to effectively determine the performance and will increase the efficiency of the employees and their tasks can be coordinated.
For implementing the predetermined objectives, policies and programmes and to control the deviations, a budgetary control and cost control system is adopted. Under it, standards are determined for financial performance. Actual performance is compared with the standards to find out how much deviation has occurred and due to what reasons. Efforts are made to prevent the deviations.
(4) Preparation of Financial Plan:
Under this process, total capital requirement is determined. It is called capitalisation. To determine the capitalisation, fixed assets, current assets, preliminary expenses, and other expenses are determined to make the correct estimate of necessary funds.
After determining the total fund requirements, it is determined in what proportion the funds will be raised from different sources. It is called capital structure.
(5) Reviewing of Financial Planning:
Financial planning is a continuous process of business. The financial objectives, policies, procedures, capitalisation and capital structure should be modified according to the changing internal and external circumstances.
Principles of sound financial planning
1. 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 be 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 be such that dependence on such funds may be reduced in due course of time.
4. Flexibility:
The financial plan should not be rigid and should allow scope for adjustments as and when new situations which demand changes 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 bearing securities. Flexibility in a plan will be helpful in coping with the demands of the future.
5. Long-term View/Foresight
A financial plan should take a foresight or long-term view. Foresight means besides the needs of ‘today’, the requirements of ‘tomorrow’ should also be kept in view.The needs for funds in the near future and over a longer period should be considered while selecting the pattern of financing.
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.
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 be 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 be ensured by a proper debt-equity mix.
Factors influencing a sound financial plan
Before drafting financial plans,it is important for the finance managers to understand the aspects of business environment to discover the opportunities and threats that are evolving and that need to be addressed by the enterprise.
The external and internal factors provide managers with the base to create a budget, which works in sequence with financial planning. The following are the key factors that influence a financial plan.
1. Nature of Business
The nature of an organisation’s business directly influences its fund requirements, Depending on what type of business the organisation is into, say ,for example manufacturing business unit requires large investments in plant, machinery, warehouses etc whereas trading concerns need relatively lesser investment in such assets.
2. Risk Appetite
The level of risk that an organization is willing to undertake in its normal course of business is referred to as risk appetite.
When deciding on its risk appetite for each category of risk in its financial plan, the board of directors should consider the risk capacity of the company.This includes the amount and type of risk the company is able to support while pursuing its business objectives.For this company's capital structure and access to financial markets should be taken into account.
3. Position of the Firm
Position of the firm implies its present market share, goodwill, reputation of the management and financial performance of the business enterprise.
A company in a good position can easily raise funds from various sources, further it can also avail credit facilities from various suppliers at ease. Therefore a finance manager has to assess the position of the company before formulating a financial plan.
4. Study of Financial Markets
Businesses often need to raise capital in order to fund its fixed and working capital requirements, therefore a comparative study should be undertaken to study various sources of finance critically.
Funds can be obtained through financial markets, which offer a variety of financing to meet the requirements of the organization. Therefore study of the financial market is necessary to strike out a balance between cost and risk involved in financing decisions and its impact on profitability.
5. Economic Conditions
Economic condition means the state of the economy which can be sound or positive when an economy is expanding, and can be adverse or negative when an economy is contracting.It is determined by numerous macroeconomic and micro economic factors which influence the working of a business enterprise.Therefore a financial plan should be designed keeping in mind these factors.
Macroeconomic and micro economic factors includes monetary and fiscal policy, the state of the global economy, unemployment levels, productivity, exchange rates, inflation, business cycles and so on as an economy goes through expansion and contraction.
6. Future Plans
Majority of the organizations have ambitious plans of expansion, capturing wider market share and also going international. Whatever be the plan,if it fails to assume the obligations by the corporations without establishing earning power, the business cannot be carried on successfully. Hence assumption of future plans which financial planning is very necessary for the success of all future endeavours of the organization.
7. Government Policies and Control
To protect the rights and interests of general public, government create the rules and frameworks in which businesses operate. The government will change these rules and frameworks from time to time . While preparing financial plans the financial managers should take into consideration these policies .This forces the businesses to change the way they operate
For example the financial managers should take into consideration changes made by RBI and SEBI which are government regulatory bodies .They periodically frame regulations pertaining to issue of debentures, shares, payment of dividend, mergers and acquisitions and rate of interest etc. Therefore while preparing financial plans these policies should be taken into consideration.
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