Financial Management Unit I (Theory Only)

BBA Course Notes

Financial management meaning definition objectives importance functions structure of financial management role of a financial manager - sources of finance short-term bank sources long-term shares debentures - preference stock - debt. Financial management is defined as the management of flow of funds in a firm and it deals with financial decision making of the firm. Financial management includes any decision made by an investor that affects his finances. In financial management the emphasis is laid on optimum utilization of funds. Financial management is important to all levels of human existence as every entity has to look after its finances. Financial management is also referred as planning, organizing and controlling the monetary resources of an organization. Financial management helps in improving the allocations of working capital within business operations. Meaning of Financial Management In general, finance may be defined as the provision of money at the time it is wanted. However, as a management function it has a special meaning. Finance function may be defined as the procurement of funds and their effective utilization. Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprise. It means applying general management principles to financial resources of the enterprise. Definition of Financial Management According to Wheeler Business finance is that business activity which is concerned with the acquisition and conservation of capital funds in meeting financial needs and overall objectives of a business enterprises. According to Guthman & Dougall defines Business finance can broadly be defined as the activity concerned with planning raising, controlling and administering of the funds used in the business.

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Financial Management

BBA Course Notes

According to Soloman, Financial management is concerned with the efficient use of important economic resources, namely Capital funds. Financial management is concerned with the managerial decisions that result in the acquisition and financing of long-term and short-term credits for the firm. Thus financial management is mainly concerned with the proper management of funds. The finance manager must see that the funds are procured in a manner that the risk, cost the control considerations are properly balanced in a given situation and there is optimum utilization of funds. Objectives of financial Management The financial management is generally concerned with procurement, allocation and control of financial resources of a concern. The objectives can be1. To ensure regular and adequate supply of funds to the concern.
2. To ensure adequate returns to the shareholders which will depend upon the earning

capacity, market price of the share, expectations of the shareholders? 3. To ensure optimum funds utilization. Once the funds are procured, they should be utilized in maximum possible way at least cost. 4. To ensure safety on investment, i.e, funds should be invested in safe ventures so that adequate rate of return can be achieved. 5. To plan a sound capital structure-There should be sound and fair composition of capital so that a balance is maintained between debt and equity capital. A goal of the firm is the target against which a firms operating performance is measured. The goals serve as the point of reference to a decision maker. The objectives or goals of financial management are: 1. Profit Maximization. 2. Wealth Maximization. 3. Return Maximization. 1. Profit Maximization: The objective of financial management is to earn maximum profits. Various important decisions are taken to maximize the profit of the firm. Profit

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Financial Management

BBA Course Notes

maximization as an objective of financial management results in efficient allocation of resources. Companies collect their finance by issuing shares to the public. Investors also purchase shares in hope of getting good returns from the company in the form of dividend. If the company does not earn good profits and fails to distribute higher dividends, the people would not invest in such a company and people who have already invested will sell their stock. 2. Wealth Maximization: The objective of wealth maximization of shareholders considers all future cash flows, dividends, earning per share, risk of a decision, etc. This goal directly affects the policy decision of the firm about what to invest in and how to finance these investments. Shareholders are always interested in maximization of wealth which depends upon the market price of the shares. Increase in market price lead to appreciation in shareholders wealth and vice versa. So the major goal of financial management is to maximize the market price of the equity shares of the company. 3. Return Maximization: The third objective of financial management says to safeguard the economic interest of all the persons who are directly or indirectly connected with the company whether they are shareholders, creditors or employees. All these parties must also get maximum return on the investment and this can be possible only when the company earns higher profits to discharge its obligations to them. Importance of financial Management 1. Investment decisions includes investment in fixed assets (called as capital budgeting).Investment in current assets are also a part of investment decisions called as working capital decisions. 2. Financial decisions - They relate to the raising of finance from various resources which will depend upon decision on type of source, period of financing, cost of financing and the returns thereby. 3. Dividend decision - The finance manager has to take decision with regards to the net profit distribution. Net profits are generally divided into two: a. Dividend for shareholders- Dividend and the rate of it has to be decided.

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Financial Management

BBA Course Notes

b. Retained profits- Amount of retained profits has to be finalized which will depend upon expansion and diversification plans of the enterprise. Finance is considered to be the life blood of business. Financial management is concerned with procurement and utilisation of funds in a proper way. Therefore, financial management enjoys great importance in an organaisation. Financial management is crucial for the success of a business. Financial management is important because of the following advantages: 1. Financial management helps in obtaining sufficient funds at a minimum cost. 2. Financial management ensures effective utilisation of funds. Financial management tries to invest funds in various assets with a view to maximise the return on shareholders investment. 3. Financial management tries to generate sufficient profits to finance expansion and modernisation of the enterprise and secure stable growth. 4. Financial management ensures safety of funds through creation of reserves, re-investment of profits, etc Financial management is very important or significant because it is related to funds of company. Financial management guides to finance manager to make optimum position of funds. 1. Financial Planning: It is the duty of management to ensure the adequate funds are available to meet the needs of the business. In the short term, funds are required to pay the employers or to invest in stocks. In the middle and long term funds are required to make additions to the productive capacity of the business. 2. Financial Control: Financial control helps the business to ensure that it is meeting its goals. Through financial control the firm decides how much to invest in short term assets and how to raise the required funds.

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Financial Management

BBA Course Notes

3. Financial Decision Making: The three primary aspects of financial decision making are investment, financing and dividends. Investment must be financed in some way for which various alternatives are available. A financing decision is to retain the profits earned by the business or should it should be distributed among the shareholders via dividends.

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Financial Management

BBA Course Notes

Functions of Financial Managers The act of providing money in the form of a loan or capital is known as finance and is something that everyone from governments to the private individual uses. It can also be an expression used by specialists in the field when they look at how money is managed. If you prefer, it can also be a general term which encompasses the entire subject of managing and supplying money in the business and private sector. Management of finance has also developed into a specialized branch within the financial sector and is carried out by finance managers. Simply put these managers arrange money to be lent to businesses or private individuals using either money already available from company accounts or from external lenders. The term optimization is used to explain the procedure whereby finance is maximized by reducing costs and increasing the return. Poor finance management is caused when managers neglect the rules and a deterioration occurs affecting markets around the world. It is for this very reason that finance managers are very careful with finance they agree too and where it is funded from. Finance managers can be very short sighted, only looking at the initial cost involved and not the future return capability of the project. Unlike the sales managers who would like to invest in the future by product development, finance managers are rather skeptical of financing a project whose benefits lie in the future; even though their management governs future outcomes too. When arranging a business loan, many applicants forget that they are not to be used for personal matters; something that is ignored regularly. When money is lent under these circumstances, lenders feel quite aggrieved as they have lost control of where the money is being invested. By stopping business borrowing this way it is hoped they will start to see the importance of maintaining good practices which should help with investment later on. Fortunately, small businesses can always use the more approved methods of friends or relations to help provide finance. The simple trick is for finance managers to arrange loans using outside lenders thereby protecting their own assets whilst maximizing their own profit simultaneously. Banks have a strange attitude regarding lending money; they prefer to only arrange this facility to people that dont actually need money.

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Financial Management

BBA Course Notes

The following are the functional areas of financial managers, but extremely difficult tasks to delineate functions of modern financial management. The subject financial management has been stretched to such a limit that a financial manager today has to be conversant with a large variety of subjects, while the traditional financial management concerned itself with such macroeconomic areas of finance as long term financing, short-term financing, study of financial institutions, capital market, etc., Functional Areas of Financial Management 1. Determining Financial Needs 2. Determining sources of funds 3. Financial Analysis 4. Optimal capital structure 5. Cost volume profit analysis 6. Profit planning and control 7. Fixed assets management 8. Project planning and evaluation 9. Capital budgeting 10. Working capital management 11. Dividend policies 12. Acquisition and mergers 13. Corporate taxation The financial managers need to perform all this above said activities in better manner can successes in financial management. To perform all the above said activities a manager must use modern techniques and where to mobilize source of fianc and how to utilize in an effective manner. Within a short time period how to maximize his profit these are the functions of financial managers. In India, adequate attention has not been devoted to recent techniques of financial management. An analysis of financial data with the help of scientific tools and techniques to

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Financial Management

BBA Course Notes

improve performance of an undertaking better operating results and better quality of results is essential now-a-days. There is lack of data on a marginal efficiency of capital, input-output analysis, technical co-efficiency, etc., which will stimulate our business process when properly employed.

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Financial Management

BBA Course Notes

Structure &Organization of Financial Management A firm should give proper attention to the structure and organization of its finance department. If financial data are missing or inaccurate, the firm may not be in a position to identify the serious problems confronting the firm in time for necessary corrective action. Organization of the finance function differs from company to company depending on their respective needs and the financial philosophy.

Vice President Personnel

Appraisal & Reporting

Vice President Finance

Tax Administration

Treasurer

Banking &

Board of Directors

President

Internal Control

Vice President Production

Controller

General Accounting

Vice President

Marketing

Planning & Budgeting

Provision of Finance
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Investment

Custody

Credit & Collections

Financial Management

BBA Course Notes

Role of Financial Management

1. Estimation of capital requirements: A finance manager has to make estimation with

regards to capital requirements of the company. This will depend upon expected costs and profits and future programmes and policies of a concern. Estimations have to be made in an adequate manner which increases earning capacity of enterprise.
2. Determination of capital composition: Once the estimation have been made, the capital

structure have to be decided. This involves short- term and long- term debt equity analysis. This will depend upon the proportion of equity capital a company is possessing and additional funds which have to be raised from outside parties.
3. Choice of sources of funds: For additional funds to be procured, a company has many

choices likea. Issue of shares and debentures b. Loans to be taken from banks and financial institutions c. Public deposits to be drawn like in form of bonds. Choice of factor will depend on relative merits and demerits of each source and period of financing.
4. Investment of funds: The finance manager has to decide to allocate funds into profitable

ventures so that there is safety on investment and regular returns is possible.

5. Disposal of surplus: The net profits decision have to be made by the finance manager.

This can be done in two ways: a. Dividend declaration - It includes identifying the rate of dividends and other benefits like bonus. b. Retained profits - The volume has to be decided which will depend upon expansional, innovational, diversification plans of the company.
6. Management of cash: Finance manager has to make decisions with regards to cash

management. Cash is required for many purposes like payment of wages and salaries, payment of electricity and water bills, payment to creditors, meeting current liabilities, maintenance of enough stock, purchase of raw materials, etc.

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Financial Management

BBA Course Notes

7. Financial controls: The finance manager has not only to plan, procure and utilize the

funds but he also has to exercise control over finances. This can be done through many techniques like ratio analysis, financial forecasting, cost and profit control, etc. Sources of finance Financial needs of a business: business enterprises need funds to meet their different types of requirements. All the financial needs of a business may be grouped into the following three categories.
1) Long term financial needs a) Requirement of funds which are for a period exceeding 5 10 years. b) All investments in plan, machinery, land buildings etc., are considered as long term

financial needs.
c) Hard core working capital should also be procured from long term resources. 2) Medium term financial needs a) Requirement of funds which are for a period exceeding one year but not exceeding 5

years.
b) Example: extensive publicity and advertisement campaign. 3) Short term financial needs a) Requirement of funds which are for a period less than 1 year. b) Finance in current asset such as stock, debtors, cash etc. investment in these assets is

known as meeting of working capital requirements of the concern. Sources of finance of a business:
1) Long term a) Equity share b) Preference share c) Retained earnings d) Debentures e) Loans from financial institutions, commercial bsnks f) Venture capital funding

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Financial Management
2) Medium term a) Preference share b) Debentures c) Public deposits d) Commercial banks e) Financial institutions 3) Short term a) Trade credit b) Commercial banks c) Fixed deposits d) Advance received from customers

BBA Course Notes

Owners capital or equity capital share

A public limited company may raise funds from promoters or from the investing public

by way of owners capital or equity capital by issuing ordinary equity shares.

Ordinary shareholders are owners of the company and they undertake risk of business. Shareholders elect the directors to run the company and have the optimum control over

the management of the company.

Least risk involved. It is a permanent source of finance.

Preference share capital

These are a special kind of shares; the holders of such shares enjoy priority on payment

of fixed amount of dividend and repayment of capital in winding up of the company.

The rate of dividend on preference share is normally higher than the rate of interest on

debentures, loans etc.

Preference share capital may be redeemed after a specific period. There is no managerial control. Preference share bears a fixed charge.

Debentures

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Financial Management

BBA Course Notes

A debenture is a document that either creates a debt or acknowledges it, and it is a

debt without collateral.

In corporate finance, the term is used for a medium- to long-term debt instrument

used by large companies to borrow money.

A debenture is thus like a certificate of loan or a loan bond evidencing the fact that

the company is liable to pay a specified amount with interest

Debentures are generally freely transferable by the debenture holder. Debenture holders have no rights to vote in the company's general meetings of

shareholders, but they may have separate meetings or votes

Debentures are normally issued in different denominations ranging from Rs. 100 to

Rs. 1000 and carry different rates of interest. Short term sources of finance Trade credit
It represents credit granted by suppliers of goods, etc., as an incident of sale. The usual duration of such credit is 15 to 90 days. Trade credit is preferred as a source of finance because it is without any explicit cost.

Advance from customers

Manufacturer and contractors engaged in producing costly goods demand advance money

from their customers.

This is a cost free source of finance and really useful.

Bank advances Loans

In a loan account, the entire advance is disbursed at one time. It is a single advance. Repayment under the loan account may be the full amounts or by way of schedule of

repayments.

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Financial Management

BBA Course Notes

Securities shares, life insurance policies, fixed deposits receipts.

Overdraft
Customers allowed withdrawing in excess of credit balance standing in their current

deposit account.
A fixed limit granted to the borrower within which the borrower is allowed to overdraw

his account.
Interest is charged on daily balances. Securities shares, debentures, government securities.

Clean overdraft
The bank has to rely upon the personal security of the borrowers. Request for clean advances are entertained only from parties which are financial sound

and reputed for their integrity. Cash credits

Cash credit is an arrangement under which a customer is allowed an advance up to

certain limit against credit granted by bank.

Customer need not borrow the entire advance at one time; he can only draw to the extent

of his requirements and deposit his surplus funds in his account. Advance against goods
Advances provided against goods as securities. Goods are security have certain distinct advantages. They provide a reliable source of repayment. Goods are charged to the bank either by way of pledge or by way of hypothecation.

Bills purchased

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Financial Management

BBA Course Notes

Bills purchased, in trade finance, allows a seller to obtain financing and receive

immediate funds in exchange for a sales document

Bills are sometimes purchased from approved customers in whose favor limits are

sanctioned. Advance against document of title to goods

A document becomes a document of title to goods when its possession is recognized by

law as possession of the goods.

These documents include a bill of lading, dock warehouse keepers certificate.

Advance against supply of bills

Advance against bills for supply of goods to government or semi government

departments against firm orders after acceptance of tender fall under this category.
These bills are clean bills without being accompanied by any document of title to goods.

But they evidence supply of goods directly to governmental agencies.

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