Nature of Financial Management

Introduction:

The term ‘nature’ as applied to

financial management refers to its relationship
with the closely- related fields of economics
and accounting, its functions and scope.
The objective of this chapter is to
describe the evolving functions and scope of
financial management.
Definitions of the Financial Management
 Different authors have given different definitions of the
financial management which are as follows:
1) The ways and means of managing money.
This statement can be further expanded to define F.M.
the determination, acquisition, allocation and utilisation
of the financial resources with the aim of achieving the
goals and objectives of the orgnisation.
1) According to Archer and Ambrosia:
“Financial management is the application of the planning
and control functions to the finance functions”.
 Scope of the financial management

 To understand the scope of the financial management,

we must examine the traditional as well as the modern
approach of the financial management.
 The traditional approach to the financial management
is restricted to raising to funds from various sources
and completion of the legal formalities required to do
the same.
 The modern approach to the financial management
says that there are three important functions which are
expected to be performed by the financial
management.
These functions are as follows:

 I) How much amount of funds will be required by the

firm?
 II) How to raise the amount required by the firm?
 III) How to invest the amount raised so that the
objectives of the financial management as well as the
firm will be achieved?
Financing Decision:

 As mentioned above ,a finance manager has to

perform three important functions:
I) Estimating the requirements of the funds.
II) Raising the funds
III) Investing the funds.
Raising of finance:
 A crucial decision that is to be taken by a finance
manager is regarding raising of funds. In raising of
the funds, a careful consideration is to be given to
the mix of owned funds and borrowed funds. The
aim should be to achieve a right combination of
debt and equity for enhancing the value of the firm.
I) Requirements of funds during long- term and
short-term.
II) Deciding about optimum combination of
owned funds and borrowed funds for raising the
funds.
II) Investing of funds:
 After raising the funds , the next important decision
that is to be taken is investing of these funds.
Investments of funds should be in a well planned
manner. Funds raised from various sources are
invested in:
Fixed assets, and

Working capital.

.
Investment in the fixed assets.

 Investments in the fixed assets are made with long-

term perspective with a objective to enhance the
earning capacity.

such investments are generally irreversible and

involve heavy amount.

So that this decision regarding the investment in

the fixed assets are taken after the proper of cost
benefit study.
Investment in working capital

 Working capital funds are necessary for day-to-day

requirements of the orgnisation.
In every business orgnisation there is a
operating cycle; working capital funds are recovered
back after some period.
There should not be excessive amount
invested in the working capital otherwise the funds
will be remain idle.
 Dividend Decision.

It is one more important area which requires careful

consideration regarding the dividends.
How much amount of profits should be distributed
amongst the shareholders and how much amount
should be retained for investing in the business will
have to be decided by the management.
Several factors are taken into consideration before a
dividend decision is to be taken.
Continued...

 The following aspects need to be in depth consideration in

determining the dividend policy.
(a) Assessing the shareholders expectations.
(b) Determination of dividend payout ratio and
retention policy.
(c) Projecting the requirement of the funds
for expansion and diversification proposals.
(d) Considering the impact of the legal constraints on
dividend decision.
Functions of the financial management:
 The following are the some of the areas in which
financial management assumes importance and their
functions are as follows:
i) Fund raising:
Raising the right type of funds at the
right time and right cost.
ii) Increasing the productivity of the funds;
The preparation of the information
for operating executives which will enable them to
increase their earning rate on the funds employed.
Functions of the financial management:

 To conserve the funds:

To conserve the funds of
the orgnisation through such measures as stock
or inventory control ,control of credit and
debtors balances to minimises the losses that
would otherwise occur.
Functions of the financial management:

 To plan and evaluate:

To plan and evaluate is in relation to
budget for future operations in short- term and long
term and in the assessment of the proposed capital
expenditure projects.
Continued..

 As already explained above, one of the main

functions of the financial management is to provide
sufficient funds at a reasonable cost, to ensure their
profitable use and disposal of surplus in such a
manner so as to maximise the wealth of the
shareholders.
 The nature and structure of a finance department
mainly depends upon a number of factors, such as
size of the orgnisation, the nature of the business,
financing operations, caliber of the finance personnel
etc.
Continued..
 The Board of Directors decides the financial
decisions . Financial policies are approved by the
Board of the Directors. The operational and
functional areas are left to the Chief Financial Officer
who reports to the Board.
The Board of Directors have the responsibility of
ensuring that the overall goals and objectives are
achieved and the expectations of the shareholders are
fulfilled.
As a general practice, especially in a large
concerns, the finance functions are grouped into
operational areas of finance and functional areas of
the finance.
Continued…
 The operational areas of the finance are entrusted to
finance executives reporting to treasurer and
functional areas of finance are entrusted to the
another group of finance officers reporting to the
controller.
 Both the controller and the treasurer who are
responsible for the respective functions report to the
Chief Finance Officer or Vice President (Finance) or
Head of Finance.
Continued…
 Thus, the finance functions are broadly classified into
two types:
a) Treasuring functions
b) Control functions
The treasurer is responsible for
The procurement and management of funds, cash
management, collection of accounts, credit
administration, investment of surplus funds, Short-
term financing.
Continued…

 The controller is responsible for management and

control of assets, and his responsibilities include
--accounting, preparation of
financial reports, internal auditing, internal control
systems, taxation matters, protection of assets
including insurance coverage,etc.
 Board of Directors

Managing Directors
Finance (Director)/C.F.O./Vice-President

Treasurer Controller

Managers Managers

Investment Credit collection Accounting Auditing Protection

of
Credit administration the assets
Agency problem:
A characteristic feature of the corporate enterprise is
the separation between ownership and management
as a corollary of which management enjoys
substantial autonomy in regard to the affairs of the
firm.
Shareholders are the owners of the
orgnisation and they have the right to change the
management.
The conflicting goals of the management
objective of survival and maximising owners
wealth can be harmonised.
Agency problem:
 In order to ensure that management would take
optimal decisions compatible with the shareholders
interest of the value maximisation and minimises the
agency problems in terms of conflict of interests two
remedial measures commend themselves.

i) Provision of appropriate incentives

ii) Monitoring of agents/ managers.

Incentives to the agents;
Incentives to the agents:
The incentives given to the
agents/managers are of different types.
some of them are as follows:
i) Stock options:
In this incentives , management
having the right to acquire the shares of the enterprise
at a concessional price.
ii) Cash bonus:
It is linked to the performance target.
Incentives to the agents;
 Perquisites:

Perquisites such as company car, expensive

offices and other fringe benefits.

These incentives promote the

congruence between the personal goals of
management and the interests of the owners/
shareholders.
ii) Monitoring of Agents:
 There is a greater need for the monitoring the Agents
by the Shareholders. Monitoring can be done by:
i) Auditing the financial statements and
limiting decision making by the management.
ii) Bonding the agents.
Implications of various forms of the business
orgnisation:
 Forms of business orgnisation:
i) Sole proprietorship:
This form of the business
orgnisation is owned by the single person. A sole
proprietorship business and its owner are treated as
one and the same and there is no separate existence
for the owner from the business. The owner himself is
responsible for the losses and at the same time, he
himself is entitled for the profits. This form of
business orgnisation has the following benefits.
Continued…

 A) The owner can start the business with very little

legal formalities.
 B) The owner can take the decisions connected with
the business himself which results into very fast
decision-making.
 C) The running of the firm can be very smooth as there
is no possibility of differences opinion among
different persons because of the single owner.
Limitations of the proprietorship business
 The personal liability of the owner is unlimited,
which means that if assets of the firm are not
sufficient to pay off the business liabilities, personal
assets of the owner are utilised for the payment of the
business debts.
 The sole proprietorship firm has no separate status
from that of the owner. This means that the business
will cease to exist if there is the death of the owner.
 The incidence of taxation is very high because
personal income and firm’s income are treated
separately.
Partnership Firms

A partnership firm is a business by two or more

persons. The partnership comes into existence
according to the provision of the Indian Partnership
Act,1932. The rights, duties and obligations of the
partners are also governed by the Partnership
Act,1932.
The main advantages of the partnership firm are
as follows:
a) Like the sole proprietorship, it is easy for
formation and comparatively free form government
regulations.
Continued…
 The partners are coming from the various
backgrounds and therefore, the benefit of their
experiences is available for the firm.
However there are certain limitations which are:
a) Unlimited liability of the partners prevents the firm
from taking the risk.
b) The firm do not have any perpetual succession and,
therefore ,the death, insolvency or retirement of the
partner may threaten the very existence of the firm.
Limited Company:
A limited company registered under Companies
Act,1956.
Limited Companies has some unique features
such as,
a) Perceptual succession:
A limited company has perpetual
succession which implies that a company has a
separate existence from its owners i.e. shareholders.
Even though the shareholders are keep changing the
existence of the firm is not threatened.
Continued…
b) Limited liability:
The liability of the shareholders are limited
.
c) Transferability of the shares:
Subject to the limitations mentioned in the
Article of Association, the shares of a limited freely
transferable.
A limited company has divides into private and
Public Company.
Private company:

A private company is that company which satisfies

the following criteria.
i) Minimum number of members are two and
maximum numbers of the members are fifty.
ii) No public invitation is allowed for the
subscription of shares and debentures.
Public Company:
a) A public limited company is a form of
orgnisation that has a minimum of seven
members while there is no restriction on maximum
number of members.

b) A public company is allowed to invite the public

for subscription to its shares and debentures.

c) There is no any restriction on the transfer of the

shares.
Significance of the Financial Management: