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Financial Management:
The Finance Function:
Concept: The finance function is the process of acquiring and utilizing funds
of a business . Finance functions are related to overall management of an
organization. Finance function is concerned with the policy decisions such as
1. Kind of business
2. Size of firm
3. Type of equipment used
4. Use of debt
5. Liquidity positions
All these determine the size and the profitability and risk of the business of
the firm. Prof. K.M. Upadhyay has outlined the concept of finance function as
follows.
1. In most of the organizations, financial operations are centralized. This
results in economies.
2. Finance functions are performed in all business firms, irrespective of
their sizes legal forms of organizations.
3. They contribute to the survival and growth of the firm.
4. Finance function is primarily involved with the date analysis and used
for decisions makings.
5. Finance functions are concerned with the basic business activities of a
firm in addition to external environmental factors which affect basic
business activates, and also production and marketing.
6. Finance functions comprise control functions also.
7. The central focus of finance function is valuation of the firm.
The areas of responsibility covered by finance functions may be regarded as
the content and concept of finance function. These areas are specific
functions of finance. Famous authors of financial management have
explained the concept and contents of finance function as under.
1. James. C. Van Horne has opined the concept and content of financial
function as a. Investment Decision b. Financing Decision c. Dividend
Decisions.
2. Earnest W. Walker has opined the concept and content of the financial
function as a financial Planning b. Financial Co-ordination C. Financial
Control.
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3. J. Fred Weston and Eugene F. Brigham has opined the concept and
content of financial function as consisting of a. Financial Planning and
control. B. Management of working Capital. C. Investment in Fixed
Assets. D. Capital Structure Decisions. E. Individual Financial Episodes.
The Concept and the content of finance functions can be grouped as under.
1. Financial Planning.
2. Financial Control.
3. Financing Decisions.
4. Investment decisions.
5. Management of income and dividend decisions.
6. Incidental functions.
OBJECTIVES OF FINANCE FUNCTION:
The objective of finance function is to arrange as much funds for the
business as are required from time to time. This function has the following
objectives.
1. ASSESSING THE FINANCIAL REQUIREMENTS.
The main objective of finance function is to assess the financial needs of an
organization and finding out suitable sources for raising them. The sources
should be commensurate with the needs of the business. If funds are
needed for longer period then long term sources like share capital,
debentures, tem loans may be explored.
2.
It is
Market standing.
Innovation
Productivity
Economical use of physical and financial resources.
Increasing the profitability
Improved performance
Development of workers performance and co-operatives
Public responsibility
community at large. The goal for the maximum present values is generally
justified on the following grounds.
1. It is consistent with the object of maximizing owners economic
welfare.
2. It focuses on the long run picture.
3. It considers risk.
4. It recognizes the values of regular dividend payments.
5. It maintains market price of its shares
6. It seeks growth is sales and earnings.
Maximizing the shareholders economic welfare is equivalent to maximizing
the utility of the consumption every time. With their wealth maximized,
shareholders can afford their cash flows in such a way as to optimize their
consumption. From the shareholders point of view, the wealth created by a
company through the actions is reflected in the market values of the
companys shares.
6. It helps in dealing with the incentive problem when one party has an
informational advantage.
The above functions are described in brief hereunder:
1. Payment System
Depository financial intermediaries such as banks are the pivot of the
payment system. Credit card companies play as supplementary role. To
realize the importance of the payment system one should look at the
hardship and inconvenience caused when the payment system breaks down.
2. Pooling of Funds
Modern business enterprise requires large investment which is often beyond
the means of an individual or even of hundreds of individuals. Mechanisms
like financial market, financial intermediaries, financial institutions which are
an integral ape of the financial system facilitate the cooling of household
savings for financing business. The financial system thus enables household
to participate in large indivisible enterprises.
3. Transfer of Resources
The financial system facilitates the transfer of economic resources across
time and space. As Rober Merton says, a well-developed , smooth
functioning financial system facilitate the efficient life cycle allocations of
household consumption and efficient allocation of physical capital to its most
productive use in the business sector.
A well developed, smooth functioning capital market also makes possible the
efficient separation of ownership from management of the firm. This in turn
makes feasible efficient specialization in production according to the
principle of comparative advantage.
4. Risk Management
A well-developed financial system offers a variety of instrument that
enables economic agents to pool, price and exchange risk. It provides
opportunity for risk pooling and risk sharing for both household and business
firm.
The three basic methods for managing risk are i) Hedging ii) Diversification
and iii) Insurance.
5. Price Information and Decentralized Decision Making
Apart from the manifest function of facilitating individuals and businesses to
trade in financial assets, financial markets served an important latent
function as well. They provide information that helps in coordinating
decentralized decision making. Rober Merton puts it thus; interest rates and
security prices are used by household or their agents in making their
consumption- savings decisions and in choosing the portfolio allocations of
their wealth. These same prices provide important signals to manage firm in
their selection of investment projects and financing.
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Maturity of Claim
Seasoning of Claims
Timing of Deliver
Organizational Structure
organized/centralized
1.
Exchange
Traded
Market
(well
Organization/standardized procedure )
2. Over the counter
Market (decentralized
organization/
Customized procedure)
Rise of Formal Financial Markets: The role of formal financial markets
has expanded rapidly in recent years. The key factors which have
contributed to this are as follows:
1. Robust mechanism for ensuring that traders are completed according
to agreed terms.
2. Adequate legal procedure to settle dispute
3. Low transaction cost
4. Transparent availability of information on trade and prices
5. Adequate protection tp investors
6. High liquidity
Forces of Changes: Financial markets have undergone significant
transformation since the mid-1980s, thanks to following factors:
1. Technological advances in computing and telecommunications.
2. The wave of deregulation and liberalization that has been sweeping the
world.
3. Consolidation and globalization in the wake of heightened competition
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Financial institutions
Since independent a number of financial institutions have been set up to
cater to the long term financing needs of the industrial sector and meet
specialized financing requirements. An elaborate structure of financial
institutions consisting of all India term-lending institutions like IFCI, ICICI and
IDBI. (The last two have transformed themselves into banks.) State financial
Corporations and State Industrial Development Corporations has come into
being.
There are many specialized financial institutions like Small Industries
Development Bank of India (SIDBI), Export-Import Bank (EXIM bank), National
Bank for Agriculture and Rural development (NABARD), Shipping credit and
Investment Corporation of India (SICCI), Power Finance Corporation (PFC),
Rural Electrification Corporation (REC), Infrastructure Development Finance
Corporation (IDFC) and National Housing Bank (NHB).
Insurance Companies
Till recently there were just two insurance companies in India: the Life
Insurance Corporation of India (LIC) and the General Insurance Corporation of
India(GIC), the latter being a holding company with four fully owned
subsidiary companies in its fold. With the liberalization of the insurance
sector, many private sector players like ICICI-Prudential, Tata-AIG, Bajaj
Allianz, Birla Sunlife and HDFC Standard have set up insurance business in
India. Insurance companies LIC in particular have massive resources at their
command because insurance policies usually have a substantial element of
saving and insurance premiums are payable in advance.
Mutual Funds
A mutual fund is a collective investment vehicle .It mobilizes resources from
investors in various types of securities. While there was only one mutual fund
in India viz. The Unit Trust of India, till 1986, presently there are a number of
mutual funds in public and private sector. In last decade or so, private
mutual funds like ICICI-Prudential Mutual Fund, Reliance Mutual Fund, HFDC
Mutual Fund and Templeton Mutual Fund have grown impressively.
Non-Banking Financial Companies
From Mid-1980s many non-banking financial companies have come into
being in the public sector as well as private sector. Some of the well-known
name are HDFC, Sundaram Finance, Kotak Mahindra Finance, Industrial
Development and Financial Corporation(IDFC), ICICI ventures, Infrastructure
Leasing and Finance and SBI Factors. These companies engage in a variety of
activities like leasing finance , hire purchase finance, housing finance,
infrastructure finance , venture capital finance factoring and investment
securities.
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