Functions of Financial Management

Financial management performs different function for the effective management of funds of any
organization. Financial management is concerned with the supervision of the capital invested in the
business enterprise,
allocation of finance to resources and overall increase in the value of business.
Jim Mc Menamin proposes the following interrelated activities of financial management-Financial
analysis, financial decision making, financial planning, and financial control. The function of financial
management include the following1. Resource mobilization from the economy
2. Resource development
3. Resource generation and distribution for growth and risk comparison

Now we will discuss the finance related functions of financial management. Basically these decisions
are divided under three broad categories. These are financial decision, investment decision and
dividend decisions. We will discuss them one by one.
Financial Decision- Financing decision of an enterprise includes decision for short term capital and
long term capital requirement. Financing decision include decision upon the needs and source of new
outside financing and caring on negotiations for new outside financing. Financing means procurement
of finance at most convenient and economic rates.
Investment Decisions- Funds acquired from different sources are to be invested in profitable
projects so that maximum profit can be earned and the value of the wealth becomes maximum. Long
term funds are invested for the acquisition of fixed assets and current assets also. The investment of
funds in different projects should be made carefully so that the funds can be utilized in the maximum
possible ways. Capital budgeting techniques is used or making investment decisions. Investment
decision considers the management of current assets such as cash, marketable securities, etc.
Capital budgeting which includes identification, selection, implementation of capital projects, etc. and
management of mergers, reorganization, disinvestment, etc.
Dividend Decisions- The financial managers takes dividend decisions. For taking decision in respect
of dividend, the factor to be consider include- availability of cash, tax position of the shareholders,
trend of earnings, requirements of funds for the future, etc. Dividend decision considers the allocation
of net profit. Dividend decision gives emphasis on the checking on financial performance. The
financial manager takes initiatives to take proper dividend decisions as to the amount of dividend to
be paid and the time of payment of dividend. He tries to set balance between dividend retention and
distribution. Dividend decisions are taken considering the overall liquidity and profitability of the
enterprise. Dividend decisions are taken taking into account the disposition of profits between
dividend and retained earnings.

What is Financial Management?

Financial management is the planning of the requirement of capital investment with the objective of
earning higher return incurring the least cost and efficient management of the financial management
of the financial affairs of any business enterprise.
According to the J.J Hampton "Financial management is an applied field of business
administration."

Financial management may be defined as, "Financial management is the integral part of general
management engaged in raising of finance, allocation and utilization of finances or funds and other
managerial function for the overall growth of the enterprise."
Financial management has some basic features. Financial management is an applied form of general
management. It concerned with the procurement and conversation of capital funds to meet the
financial needs of the business enterprise and to achieve the overall objectives of the firm.
Procurement of Funds- Financial management concerned with the collection of funds from different
sources. The collection of fund includes- identification of sources of funds, raising of funds,
consideration of cost of capital.
Effective Use Of Funds- Financial management concerned with the effective use of funds collected
from various sources. Effective utilization of funds ensures safety, liquidity and profitability of funds
collected from different sources.
Flexibility- Financial management is flexible in articulating the changes in the economic activities
within the enterprise and outside the enterprise.
Managerial Decision Making- Financial management takes different types of decision in respect of
financial activities of a firm. It takes the following decision- INVESTMENT, FINANCINING, and
DIVIDEND.
Financial Planning- Financial management frames financial planning which includes-determination
of capital requirement, methods of raising funds, etc.
Financial Analysis- Financial management makes financial analysis of the performance of any
enterprise to access the effectiveness of the financial activities.
Financial Control- Financial management implements control over the financial activities of the
business enterprise. Financial control ensures effective use of funds in a planned way.
Credit Management- Financial management arranges for credit management. Credit management
ensures the flow of cash in the business enterprise.

Objectives of Financial Management

Financial management is the integral part of general management having the objective of
maximization of wealth of the business enterprise. Another objective of financial management is to
achieve adequate return on investment. For this purpose, investment of funds is to be made in
profitable schemes.
RISING OF FUNDS: Rising of finance is the main objectives of financial management. It aims to
procure required finance from different sources at the most convenient and economical rates.
ALLOCATION OF FINANCE: Financial management aims at the proper allocation of finance raised
or collected from the different sources. Proper allocation of funds ensures security, liquidity and
profitability of funds. It uses the funds in most productive way.

PROPER INVESTMENT DECISION: It aims at the proper investment of funds collected from different
sources. Proper investment of funds helps to increase the profitability of the enterprise.
MAXIMIZATION OF WEALTH: It aims at the wealth maximization of the business enterprise. It aims
to the improvement of the market value of shares through wealth maximization.
EARNING OF REASONABLE PROFIT: It aims at the earning of reasonable amount of return by
investing the capital funds collected. Profit can be earned by increasing return on investment of funds.
COORDINATION: It aims to establish coordination between the finance dept. and other dept. of the
business enterprise in respect of financial activities.
PRESERVATION OF CAPITAL FUNDS: It aims to preserve the amount of capital invested by
adopting proper financial policy.
PROPER TAX PLANNING: It aims to make proper tax planning considering the previsions of Income
Tax Act, Value Added Tax(VAT) and other related tax laws and accounting standards.

Profit Maximization or Wealth Maximization

We know that the goals of financial management are profit maximization and wealth maximization.
These are the important objectives of business firms. Now the question arises of the choices,
i.e. which should be the goal of decision making be profit maximization or which strengthen the case
for wealth maximization as the goal of the business enterprise.
Argument and Counter Argument:
Profits cannot be ascertained well in advance to express the profitability of return as future is
uncertain. It is not at possible to maximize what cannot be known.
The executive or the decision maker may not have enough confidence in the estimates of future
returns so that he does not attempt future to maximize. It is argued that firm's goal cannot be
maximize profits but attain a certain level of profit holding certain shares of the market or certain level
of sales.
There must be a balance between the expected return and risk. The possibility of higher expected
yields are associated with greater risk to recognize such
a balance and wealth maximization is brought in to the analysis. In such cases, higher capitalization
rate involves. Such combination of expected returns with risk variations and related capitalization rate
cannot be considered in the concept of profit maximization.
The goal of profit maximization is consider being a narrow outlook. Evidently when profit
maximization becomes the basis of financial decision of the concern, it ignores the interest of the
community on one hand and that of the Govt., workers and other concerned persons in the enterprise
on the other hand.
Keeping the above objection in view, most of the thinkers on the subject have come to the
conclusion that the aim of an enterprise should be wealth maximization not the profit maximization.
Prof. Solomon of Stanford University has handled the issue very logically. He argues that it is useful
to make a distinction between profit and profitability maximization of profit with a view to maximizing

the wealth of shares holders is clearly an unreal motive. On the other hand, profitability maximization
with a view to using resources to yield economic value higher than the joint values of inputs required
is useful goal.
Thus the proper goal of financial management is wealth maximization.

Scope of Financial Management

Finance is not a standalone activity of any organization. The three most important activities of
business firm are: Production, Finance and Marketing.
A firm secures whatever capital it needs and employs it in activities, which generate returns on
investment. Thus the scope of Finance spreads in the following areas
EQUITY AND BORROWED FUNDS: Equity and Debt are the two types of that a firm can raise. A
firm sells shares to primary market to acquire equity funds. Shareholder invests their money in the
shares of a company in the expectation of a return on their investment. Another important source of
raising capital is from creditors. Creditors may be another firm, a financial institution or a bank.
Lenders are not the owners of the company they just make money from the interest that a company
pays because of his loan.
REAL AND FINANCIAL ASSETS: A firm requires real assets to carry on its business. Assets may be
tangible or real assets or intangible assets. Tangible are physical assets that include plant, machinery,
office, building etc. On the other hand know-how, patents, copy rights etc. are called intangible
assets. Financial assets which are also called securities are financial paper or instrument such as
share and bonds or debenture. Financial assets also include lease obligation and borrowing from
banks, financial institutions and other sources.
FINANCE AND MANAGEMENT FUNCTION: As we already see that finance is inter-linked with other
function of the business. Almost all business activities directly or indirectly involve the acquisition and
use of funds. For example recruitment of a worker for a production purpose is a responsibility of
production department but payment of wages involves finance. Similarly all the sales and marketing
activities involve finance. Thus we see that finance and marketing activities are directly linked and
dependent to each other.

Role of Financial Manager

The financial manager plays an important role in the functional areas of finance. The assignments of
finance functions to the financial manager depend upon size of the business enterprise. The larger
the business enterprise the greater degree of
specialization of tasks is needed. The financial manager is the key persons in any business
enterprise. The function of finance manager includes budgeting and investing funds, accounting,
products pricing and forecasting. The financial manager is engaged in the analysis, planning and
control of the financial activities of the enterprise.
FINANCING AND INVESTING: The financial manager performs the financing and investing function
of an enterprise. He supervises the cash and other holding of the firm. He arranges for raising
additional funds as per the requirement of the enterprise.

FINANCIAL ANALYSIS: Financial manager makes analysis of financial condition of the firm.
Financial analysis ensures the effective and smooth functioning of any enterprise. Financial analysis
is made to judge the propriety of the trend of share market prices, etc.
DIVIDEND DECISIONS: The financial manager takes dividend decision. For taking decisions in
respect of dividend, the following factors are considered-availability of cash, tax position of the shareholders, trend of earnings, etc.
ACCOUNTING AND CONTROL: The financial manager arranges for the maintenance of financial
records. He controls the financial activities of the enterprise. He identifies deviations from planned
and efficient financial activities.
FORECASTING AND LONG-RUN PLANNING: The finance manager forecasts costs and
technological changes. He studies the market conditions and forecasts the funds needed for
investment. He calculated the estimated returns on proposed investment project and forecasts about
the demand for the products of the enterprise.
CASH MANAGEMENT: The financial manager arranges for cash management of the enterprise.
Through cash management, he ensures the supply of funds to the different dept. of the enterprise.
The financial manager arranges for the adequate supply of cash to all sections of the enterprise for its
smooth flow of operations.
DECISION REGARDING CAPITAL STRUCTURE: The financial manager takes decision regarding
capital structure of the firm. Capital structure indicates the proper mix of different sources of capital.
He tries to maintain proper balances between the long-run funds and shorts-run funds.
EVALUATION OF FINANCIAL PERFORMANCE: The financial manager evaluates the financial
performance for the analysis of financial performance of the enterprise. The financial manager
constantly reviews the financial performance to assess the financial health of the business enterprise.
The financial manager helps the management to take different decision on the result of the evaluation
of the financial performances.

What Is the Pecking Order Theory?

Also known as the Pecking Order Model, the Pecking Order Theory is an approach to defining the capital structure
of a company, as well as how the business goes about the process of making financial decisions. First developed by
Nicola Majluf and Stewart C. Myers in 1984, the theory seeks to explain how companies prioritize their financing
sources. The general idea is that companies will tend to take the course of least resistance, obtaining financing from
sources that are readily available, and then steadily moving on to sources that may be more difficult to utilize.
While the specifics of the Pecking Order Theory are somewhat involved, the general idea can be explained by using
the example of a local business entity. When it comes to financing the operation, the business is likely to make use
of its internal resources first, such as using funds in a savings or other interest bearing account to manage

operational costs or to order more stock or raw materials for use in the operation. When this first line of financing is
exhausted or not available for some reason, the business will then turn to lenders or investors as a means of
generating the funds needed to keep the company going. When no other options are available, the business may
choose to make use of the equity found in any assets held by the business.
Ad
With this approach, the theory shows that the business chose to take the past of least resistance when it came to
financing. Resources that were readily available were used first, since they did not involve encumbering any of the
company holdings with debt. Next, the business moved on to issuing stock or a bond issue as means to raise
money while still not encumbering company assets. If necessary, the business would then go for unsecured
loans that left the business free to use its assets in any way deemed proper. Finally, the business resorts to
financing methods that do impact company assets directly, such as trading off equity for cash or taking on a
collateralized loan.
While the Pecking Order Theory holds that companies do tend to manage financing using the easiest approaches
first, it does not really imply that one mode of financing is inherently superior to the other. Depending on the
circumstances of a business, it may be prudent to use an asset to acquire a secured loan rather than deplete
interest-bearing accounts in the possession of the business. Business owners may tend to weigh all available
options and then choose the one that is most likely to produce the result that will be in the best interests of the
company over the long-term, rather than simply going with what appears to be the easiest solution at present.