Unit –
I: Introduction to Financial Management
Meaning
and Definitions of Financial Management/Business Finance/ Finance Functions
Financial management is management principles and practices
applied to finance. General management functions include planning, execution
and control. Financial decision making includes decisions as to size of
investment, sources of capital, extent of use of different sources of capital
and extent of retention of profit or dividend payout ratio. Financial
management, is therefore, planning, execution and control of investment of
money resources, raising of such resources and retention of profit/payment of
dividend.
Howard and Upton define financial management as "that
administrative area or set of administrative functions in an organisation which
have to do with the management of the flow of cash so that the organisation
will have the means to carry out its objectives as satisfactorily as possible
and at the same time meets its obligations as they become due.”
According to Guthamann and Dougall,” Business finance can be
broadly defined as the activity concerned with the planning, raising,
controlling and administering the funds used in the business.”
Bonneville and Dewey interpret that financing consists in the
raising, providing and managing all the money, capital or funds of any kind to
be used in connection with the business.
Osbon defines financial management as the "process of
acquiring and utilizing funds by a business”.
Considering all these views, financial management may be defined
as that part of management which is concerned mainly with raising funds in the
most economic and suitable manner, using these funds as profitably as possible.
Nature or Features or
Characteristics of Financial Management
Nature of financial management is concerned with its functions,
its goals, trade-off with conflicting goals, its indispensability, its systems,
its relation with other subsystems in the firm, its environment, its
relationship with other disciplines, the procedural aspects and its equation
with other divisions within the organisation.
1) Financial
Management is an integral part of overall management. Financial considerations
are involved in all business decisions. So financial management is pervasive
throughout the organisation.
2) The
central focus of financial management is valuation of the firm. That is
financial decisions are directed at increasing/maximization/ optimizing the
value of the firm.
3) Financial
management essentially involves risk-return trade-off Decisions on investment
involve choosing of types of assets which generate returns accompanied by
risks. Generally higher the risk, returns might be higher and vice versa. So,
the financial manager has to decide the level of risk the firm can assume and
satisfy with the accompanying return.
4) Financial
management affects the survival, growth and vitality of the firm. Finance is
said to be the life blood of business. It is to business, what blood is to us.
The amount, type, sources, conditions and cost of finance squarely influence
the functioning of the unit.
5) Finance
functions, i.e., investment, rising of capital, distribution of profit, are
performed in all firms - business or non-business, big or small, proprietary or
corporate undertakings. Yes, financial management is a concern of every
concern.
6) Financial
management is a sub-system of the business system which has other subsystems like
production, marketing, etc. In systems arrangement financial sub-system is to
be well-coordinated with others and other sub-systems well matched with the
financial subsystem.
7) Financial
management of a business is influenced by the external legal and economic
environment. The investor preferences, stock market conditions, legal
constraint or using a particular type of funds or on investing in a particular
type of activity, etc., affect financial decisions, of the business. Financial
management is, therefore, highly influenced/constrained by external
environment.
8) Financial
management is related to other disciplines like accounting, economics, taxation
operations research, mathematics, statistics etc., It draws heavily from these
disciplines.
MEANING OF FINANCE FUNCTION
Finance function is the most important of all
business functions. It means a focus of all activities. It is not possible to
substitute or eliminate this function because the business will close down in
the absence of finance. The need for money is continuous. It starts with the
setting up of an enterprise and remains at all times. The development and
expansion of business rather needs more commitment for funds. The funds will
have to be raised from various sources. The sources will be selected in
relation to the implications attached with them. The receiving of money is not
enough, its utilization is more important. The money once received will have to
be returned also. It its use is proper then its return will be easy otherwise
it will create difficulties for repayment. The management should have an idea
of using the money profitably. It may be easy to raise funds but it may be
difficult to repay them. The inflows and outflows of funds should be properly
matched.
APPROACHES
TO FINANCE FUNCTION: A number of approaches are associated with finance
function but for the sake of convenience, various approaches are divided into
two broad categories:
1. The
Traditional Approach: The traditional approach to the finance function
relates to the initial stages of its evolution during 1920s and 1930s when the
term ‘corporation finance’ was used to describe what is known in the academic
world today as the ‘financial management’. According to this approach, the
scope, of finance function was confined to only procurement of funds needed by
a business on most suitable terms. The utilization of funds was considered
beyond the purview of finance function. It was felt that decisions regarding the
application of funds are taken somewhere else in the organization. However,
institutions and instruments for raising funds were considered to be a part of
finance function. The scope of the finance function thus, revolved around the
study of rapidly growing capital market institutions, instruments and practices
involved in raising of external funds.
The traditional approach to the scope and
functions of finance has now been discarded as it suffers from many serious
limitations:
a)
It is outsider-looking in approach that
completely ignores internal decision making as to the proper utilization of
funds.
b)
The focus of traditional approach was on
procurement of long-term funds. Thus, it ignored the important issue of working
capital finance and management.
c)
The issue of allocation of funds, which is
so important today, is completely ignored.
d)
It does not lay focus on day to day
financial problems of an organization.
2. The
Modern Approach: The modern approach views finance function in broader
sense. It includes both raising of funds as well as their effective utilization
under the purview of finance. The finance function does not stop only by
finding out sources of raising enough funds, their proper utilization is also
to be considered. The cost of raising funds and the returns from their use
should be compared. The funds raised should be able to give more returns than
the costs involved in procuring them. The utilization of funds requires
decision making. Finance has to be considered as an integral part of overall
management. So finance functions, according to this approach, covers financial
planning, raising of funds, allocation of funds, financial control etc. The new
approach is an analytical way of dealing with financial problems of a firm. The
techniques of models, mathematical programming, simulation and financial
engineering are used in financial management to solve complex problems of
present day finance. The modern approach considers the three basic management
decisions i.e., investment decisions, financing decisions and dividend
decisions within the scope of finance function.
Finance
Functions (Scope of Financial Management)/ Types of Decisions to be taken under
financial management
The finance function encompasses the
activities of raising funds, investing them in assets and distributing returns
earned from assets to shareholders. While doing these activities, a firm
attempts to balance cash inflow and outflow. It is evident that the finance
function involves the four decisions viz., financing decision, investment
decision, dividend decision and liquidity decision. Thus the finance function
includes:
a) Investment
decision
b) Financing
decision
c) Dividend
decision
d) Liquidity
decision
1. Investment Decision: The investment
decision, also known as capital budgeting, is concerned with the selection of
an investment proposal/ proposals and the investment of funds in the selected
proposal. A capital budgeting decision involves the decision of allocation of
funds to long-term assets that would yield cash flows in the future. Two
important aspects of investment decisions are:
(a) The evaluation of the prospective
profitability of new investments, and
(b) The measurement of a cut-off rate against
that the prospective return of new investments could be compared.
Future benefits of investments are difficult
to measure and cannot be predicted with certainty. Risk in investment arises
because of the uncertain returns. Investment proposals should, therefore, be
evaluated in terms of both expected return and risk. Besides the decision to
commit funds in new investment proposals, capital budgeting also involves
replacement decision, that is decision of recommitting funds when an asset
become less productive or non-profitable. The
computation of the risk-adjusted return and the required rate of return,
selection of the project on these bases, form the subject-matter of the
investment decision.
Long-term investment decisions may be both
internal and external. In the former, the finance manager has to determine
which capital expenditure projects have to be undertaken, the amount of funds
to be committed and the ways in which the funds are to be allocated among
different investment outlets. In the latter case, the finance manager is
concerned with the investment of funds outside the business for merger with, or
acquisition of, another firm.
2. Financing Decision: Financing decision is
the second important function to be performed by the financial manager.
Broadly, he or she must decide when, from where and how to acquire funds to
meet the firm’s investment needs. The central issue before him or her is to
determine the appropriate proportion of equity and debt. The mix of debt and
equity is known as the firm’s capital structure. The financial manager must
strive to obtain the best financing mix or the optimum capital structure for
his or her firm. The firm’s capital structure is considered optimum when the
market value of shares is maximized.
The use of debt affects the return and risk of
shareholders; it may increase the return on equity funds, but it always
increases risk as well. The change in the shareholders’ return caused by the
change in the profit is called the financial leverage. A proper balance will
have to be struck between return and risk. When the shareholders’ return is maximized
with given risk, the market value per share will be maximized and the firm’s
capital structure would be considered optimum. Once the financial manager is
able to determine the best combination of debt and equity, he or she must raise
the appropriate amount through the best available sources. In practice, a firm
considers many other factors such as control, flexibility, loan covenants,
legal aspects etc. in deciding its capital structure.
3. Dividend Decision: Dividend decision is the
third major financial decision. The financial manager must decide whether the
firm should distribute all profits, or retain them, or distribute a portion and
return the balance. The proportion of profits distributed as dividends is
called the dividend-payout ratio and the retained portion of profits is known
as the retention ratio. Like the debt policy, the dividend policy should be
determined in terms of its impact on the shareholders’ value. The optimum
dividend policy is one that maximizes the market value of the firm’s shares.
Thus, if shareholders are not indifferent to the firm’s dividend policy, the
financial manager must determine the optimum dividend-payout ratio. Dividends
are generally paid in cash. But a firm may issue bonus shares. Bonus shares are
shares issued to the existing shareholders without any charge. The financial
manager should consider the questions of dividend stability, bonus shares and
cash dividends in practice.
4. Liquidity Decision: Investment in current
assets affects the firm’s profitability and liquidity. Current assets should be
managed efficiently for safeguarding the firm against the risk of illiquidity.
Lack of liquidity in extreme situations can lead to the firm’s insolvency. A
conflict exists between profitability and liquidity while managing current
assets. If the firm does not invest sufficient funds in current assets, it may
become illiquid and therefore, risky. But if the firm invests heavily in the
current assets, then it would lose interest as idle current assets would not
earn anything. Thus, a proper trade-off must be achieved between profitability
and liquidity. The profitability-liquidity trade-off requires that the
financial manager should develop sound techniques of managing current assets
and make sure that funds would be made available when needed.
Objectives of Financial Management
The firm’s investment and
financing decision are unavoidable and continuous. In order to make them
rational, the firm must have a goal. Two financial objectives predominate
amongst many objectives. These are:
1. Profit maximization
2. Shareholders’ Wealth
Maximization (SWM)
Profit maximization refers to
the rupee income while wealth maximization refers to the maximization of the
market value of the firm’s shares. Although
profit maximization has been traditionally considered as the main objective of
the firm, it has faced criticism. Wealth maximization is regarded as
operationally and managerially the better objective.
1. Profit maximization:
Profit maximization implies that either a firm produces maximum output for a
given input or uses minimum input for a given level of output. Profit
maximization causes the efficient allocation of resources in competitive market
condition and profit is considered as the most important measure of firm
performance. The underlying logic of profit maximization is efficiency.
In a market economy, prices
are driven by competitive forces and firms are expected to produce goods and
services desired by society as efficiently as possible. Demand for goods and
services leads price. Goods and services which are in great demand can command
higher prices. This leads to higher profits for the firm. This in turn attracts
other firms to produce such goods and services. Competition grows and
intensifies leading to a match in demand and supply. Thus, an equilibrium price
is reached. On the other hand, goods and services not in demand fetches low
price which forces producers to stop producing such goods and services and go
for goods and services in demand. This shows that the price system directs the
managerial effort towards more profitable goods and services. Competitive
forces direct price movement and guides the allocation of resources for various
productive activities.
Objections to Profit Maximization:
Certain objections have been raised against
the goal of profit maximization which strengthens the case for wealth
maximization as the goal of business enterprise. The objections are:
(a) Profit cannot be ascertained well in
advance to express the probability of return as future is uncertain. It is not
at all possible to maximize what cannot be known. Moreover, the return profit
vague and has not been explained clearly what it means. It may be total profit
before tax and after tax of profitability tax. Profitability rate, again is
ambiguous as it may be in relation to capital employed, share capital, owner’s
fund or sales. This vagueness is not present in wealth maximisation goal as the
concept of wealth is very clear. It represents value of benefits minus the cost
of investment.
(b) The executive or the decision maker may
not have enough confidence in the estimates of future returns so that he does
not attempt further to maximize. It is argued that firm’s goal cannot be to
maximize profits but to attain a certain level or rate of profit holding
certain share of the market or certain level of sales. Firms should try to
‘satisfy’ rather than to ‘maximise’.
(c)There must be a balance between expected
return and risk. The possibility of higher expected yields are associated with
greater risk to recognize such a balance and wealth maximisation 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 maximisation.
(d) The goal of maximisation of profits is
considered to be a narrow outlook. Evidently when profit maximisation becomes
the basis of financial decision of the concern, it ignores the interests of the
community on the one hand and that of the government, workers and other
concerned persons in the enterprise on the other hand.
(e) The criterion of profit maximisation
ignores time value factor. It considers the total benefits or profits in to
account while considering a project where as the length of time in earning that
profit is not considered at all. Whereas the wealth maximization concept fully
endorses the time value factor in evaluating cash flows. 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 maximisation and not
the profit maximisation.
(f) To make a distinction between profits and
profitability. Maximisation of profits with a view to maximizing the wealth of
share holders is clearly an unreal motive. On the other hand, profitability
maximisation with a view to using resources to yield economic values higher
than the joint values of inputs required is a useful goal. Thus, the proper
goal of financial management is wealth maximisation.
2. Shareholders’ Wealth
Maximization: Shareholders’ wealth maximization means maximizing the net
present value of a course of action to shareholders. Net Present Value (NPV) of
a course of action is the difference between the present value of its benefits
and the present value of its costs. A financial action that has a positive NPV
creates wealth for shareholders and therefore, is desirable. A financial action
resulting in negative NPV destroys shareholders’ wealth and is, therefore undesirable.
Between mutually exclusive projects, the one with the highest NPV should be
adopted. NPVs of a firm’s projects are additive in nature. That is
NPV(A) + NPV(B) = NPV(A+B)
The objective of Shareholders
Wealth Maximization (SWM) considers timing and risk of expected benefits.
Benefits are measured in terms of cash flows. One should understand that in
investment and financing decisions, it is the flow of cash that is important,
not the accounting profits. SWM as an objective of financial management is appropriate
and operationally feasible criterion to choose among the alternative financial
actions.
Maximizing the shareholders’
economic welfare is equivalent to maximizing the utility of their consumption
over time. The wealth created by a company through its actions is reflected in
the market value of the company’s shares. Therefore, this principle implies
that the fundamental objective of a firm is to maximize the market value of its
shares. The market price, which represents the value of a company’s shares,
reflects shareholders’ perception about the quality of the company’s financial
decisions. Thus, the market price serves as the company’s performance
indicator.
In such a case, the financial
manager must know or at least assume the factors that influence the market
price of shares. Innumerable factors influence the price of a share and these
factors change frequently. Moreover, the factors vary across companies. Thus,
it is challenging for the manager to determine these factors.
WEALTH
MAXIMIZATION AS PRIMARY OBJECTIVE OF FINANCIAL MANAGEMENT
The primary objective of financial management
is wealth maximization. The concept of wealth in the context of wealth
maximization objective refers to the shareholders’ wealth as reflected by the
price of their shares in the share market. Therefore, wealth maximization means
maximization of the market price of the equity shares of the company. However,
this maximization of the price of company’s equity shares should be in the long
run by making efficient decisions which are desirable for the growth of a
company and are valued positively by the investors at large and not by
manipulating the share prices in the short run. The long run implies a period
which is long enough to reflect the normal market price of the shares
irrespective of short-term fluctuations. The long run price of an equity share
is a function of two basic factors:
a)
The likely rate of earnings or earnings per
share (EPS) of the company; and
b)
The capitalization rate reflecting the
liking of the investors of a company.
The financial manager must identify those
avenues of investment; modes of financing, ways of handling various components
of working capital which ultimately will lead to an increase in the price of
equity share. If shareholders are gaining, it implies that all other claimants
are also gaining because the equity share holders are paid only after the
claims of all other claimants (such as creditors, employees, lenders) have been
duly paid.
The
following arguments are advanced in favour of wealth maximization as the goal
of financial management:
a) It
serves the interests of owners, (shareholders) as well as other stakeholders in
the firm; i.e. suppliers of loaned capital, employees, creditors and society.
b) It
is consistent with the objective of owners’ economic welfare.
c) The
objective of wealth maximization implies long-run survival and growth of the
firm.
d) It
takes into consideration the risk factor and the time value of money as the
current present value of any particular course of action is measured.
e) The
effect of dividend policy on market price of shares is also considered as the
decisions are taken to increase the market value of the shares.
f) The
goal of wealth maximization leads towards maximizing stockholder’s utility or
value maximization of equity shareholders through increase in stock price per
share.
Criticism
of Wealth Maximization: The wealth maximization objective has been
criticized by certain financial theorists mainly on following accounts:
a) It
is prescriptive idea. The objective is not descriptive of what the firms
actually do.
b) The
objective of wealth maximization is not necessarily socially desirable.
c) There
is some controversy as to whether the objective is to maximize the stockholders
wealth or the wealth of the firm which includes other financial claimholders
such as debenture holders, preferred stockholders, etc.
d) The
objective of wealth maximization may also face difficulties when ownership and
management are separated as is the case in most of the large corporate form of
organization. When managers act as agents of the real owners (equity
shareholders), there is a possibility for a conflict of interest between
shareholders and the managerial interests. The managers may act in such a
manner which maximizes the managerial utility but not the wealth of
stockholders or the firm.
Differences between profit maximization and
wealth maximization are:
1) The process through which the company is
capable of increasing is earning capacity is known as Profit Maximization. On
the other hand, the ability of the company in increasing the value of its
stock in the market is known as wealth maximization.
2) Profit maximization is a short term objective
of the firm while long term objective is Wealth Maximization.
3) Profit Maximization ignores risk and
uncertainty. Unlike Wealth Maximization, which considers both.
4) Profit Maximization avoids time value of
money, but Wealth Maximization recognizes it.
5) Profit Maximization is necessary for the
survival and growth of the enterprise. Conversely, Wealth Maximization
accelerates the growth rate of the enterprise and aims at attaining
maximum market share of the economy.
Need of Business Finance
Business finance is required for the
establishment and existence of every business organization. Finance is required
not only to start the business but also to operate it, it expand for modernize
its operations and to secure stable growth. The importance of business finance
arises basically to bridge the time gap. Manufacturers require business finance
to bridge the time gap between the purchase of raw material and other supplies
for production and recovery of sales. Traders require finance to bridge the
time gap between the purchase of goods and recovery of sales. The need for
business finance arises for the following purposes:
1. To acquire Fixed Assets: Every business
organization whether manufacturing or trading needs finance to acquire some
fixed assets. Manufacturers need finance to acquire land & building, plant
& machinery, furniture etc. Traders need finance to acquire shops for sale
of goods, godown for storage of goods and vehicles for distribution of goods.
2. To purchase raw materials/goods:
Manufacturers need finance to acquire raw-materials and consumable stores for
production. Traders need finance to acquire goods for distribution.
3. To acquire service of human being:
Manufacturers need finance to pay their workers, supervisors, managers and
other staff employed by them. Traders need finance to pay their staff employed
by them.
4. To meet other operating expenses: Every
organization needs finance to meet day to day other operating expenses like
payment for electricity bills, water bills, telephone bills, travelling &
conveyance of staff, postage & telegram expenses & so on.
5. To adopt Modern Technology: With fast
changing technology, business organizations need finance to modernize their
plans & machineries, production methods and distribution methods. An
enterprise may decide to replace outdated and obsolete assets with new assets
to operate more economically.
6. To meet contingencies: Every
organization needs finance to meet the ups and downs of business and unforeseen
problems.
7. To expand existing operations: Every
organization needs finance to expand its existing operations. For example, a
company manufacturing Pen Drives at a rate of 10,000 per day needs finance to
increase its plant capacity to manufacture 20,000 Pen Drives per day.
8. To diversity: Every organization which
decides to diversify needs finance to add new products to the existing line.
For example, the company manufacturing Pen Drive needs finance to add new
products say Ganga Water.
9. To avail of business opportunities:
Finance is required to avail of business opportunities. For example, where
raw-materials are available at heavy cash discounts, the enterprises need
finance to avail of this opportunity.
Finance is said to be life
blood of business. It is required not only at the time of setting up of business
but at every stage during the existence of business. It must be available at
the time when it is needed. It must also be adequate for the purpose for which
it is needed. Thus, finance is required to bring a business into existence, to
keep it alive and to see it growing. Men, materials, machinery and managers can
be brought together and engaged in business when adequate finance is available.
Many business firms are known to have failed mainly due to shortage of finance.
The importance of finance has increased in modern times for two reasons viz.,
(i) the business activities are now undertaken on a much larger scale than in
the past, and (ii) the manufacturing process has become more complex than it
used to be. With the growth in size and volume of business and with the
increasing complexity of production and trade there is growing need for
finance.
Significance
of financial management in the present day business world
The scope and significance of financial
management can be discussed from the following angles:
1) Importance
to Organizations
a) Business
organizations: Financial management is important to all types of business
organization i.e. Small size, medium size or a large size organization. As the
size grows, financial decisions become more and more complex as the amount
involves also is large.
b) Charitable
organization / Non-profit organization / Trust: In all those organizations,
finance is a crucial aspect to be managed. A finance manager has to concentrate
more on collection of donations/ revenues etc and has to ensure that every
rupee spent is justified and is towards achieving Goals of organization.
c) Government
/ Govt. or public sector undertaking: In central/ state Govt, finance is a key/
important portfolio generally given to most capable or competent person.
Preparation of budget, monitoring capital /revenue receipt and expenditure are
key functions to be performed by the person in charge of finance. Similarly, in
a Govt or public sector organization, financial controller or Chief finance
officer has to play a key role in performing/ taking all three financial
decisions i.e. raising of funds, investment of funds and distributing funds.
d) Other
organizations: In all other organizations or even in a family finance is a key area
to be looked in to seriously by a competent person so that things do not go out
of gear.
2)
Importance to all Stake holders
a) Share holders: Share holders are interested
in getting optimum dividend and maximizing their wealth which is basic
objective of financial management.
b) Investors / creditors: these stake holders
are interested in safety of their funds, timely repayment of the principal
amount as well as interest on the same. All these aspect are to be ensured by
the person managing funds/ finance.
c) Employees: They are interested in getting
timely payment of their salary/ wages, bonus, incentives and their retirement
benefits which are possible only if funds are managed properly and organization
is working in profit.
d) Customers: They are interested in quality
products at reasonable rates which is possible only through efficient
management of organization including management of funds.
e) Public: Public at large is interested in
general public welfare activities under corporate social responsibility and
this aspect is possible only when organization earns adequate profit.
f) Government: Govt is interested in timely
payment of taxes and other revenues from business world where again efficient
finance manager has a definite role to play.
g) Management: Management is interested in
overall image building, increase in the market share, optimizing share holders
wealth and profit and all these aspect greatly depends upon efficient
management of financial resources.
3) Importance
to other departments of an organization
A large size company, besides finance dept.,
has many departments like
a) Production
Dept
b) Marketing
Dept
c) Personnel
Dept
d) Material/
Inventory Dept
All these departments look for availability of
adequate funds so that they could manage their individual responsibilities in
an efficient manner. Lot of funds are required in production/manufacturing dept
for ongoing / completing the production process as well as maintaining adequate
stock to make available goods for the marketing dept for sale. Hence, finance
department through efficient management of funds has to ensure that adequate
funds are made available to all department and these departments at no stage
starve for want of funds. Hence, efficient financial management is of utmost
importance to all other department of the organization.
Role
and Functions of Finance Manager
In the modern enterprise, a finance manager
occupies a key position, he being one of the dynamic member of corporate
managerial team. His role, is becoming more and more pervasive and significant
in solving complex managerial problems. Traditionally, the role of a finance
manager was confined to raising funds from a number of sources, but due to
recent developments in the socio-economic and political scenario throughout the
world, he is placed in a central position in the organisation. He is
responsible for shaping the fortunes of the enterprise and is involved in the
most vital decision of allocation of capital like mergers, acquisitions, etc. A
finance manager, as other members of the corporate team cannot be averse to the
fast developments, around him and has to take note of the changes in order to
take relevant steps in view of the dynamic changes in circumstances.
The nature of job of an accountant and finance
manager is different, an accountant's job is primarily to record the business
transactions, prepare financial statements showing results of the organisation
for a given period and its financial condition at a given point of time. He is
to record various happenings in monetary terms to ensure that assets,
liabilities, incomes and expenses are properly grouped, classified and
disclosed in the financial statements. Accountant is not concerned with
management of funds that is a specialised task and in modern times a complex
one. The finance manager or controller has a task entirely different from that
of an accountant, he is to manage funds. Some of the important decisions as
regards finance are as follows:
1)
Estimating the requirements of funds: A
business requires funds for long term purposes i.e. investment in fixed assets
and so on. A careful estimate of such funds is required to be made. An
assessment has to be made regarding requirements of working capital involving,
estimation of amount of funds blocked in current assets and that likely to be
generated for short periods through current liabilities. Forecasting the
requirements of funds is done by use of techniques of budgetary control and
long range planning.
2)
Decision regarding capital structure: Once
the requirements of funds is estimated, a decision regarding various sources
from where the funds would be raised is to be taken. A proper mix of the
various sources is to be worked out, each source of funds involves different
issues for consideration. The finance manager has to carefully look into the
existing capital structure and see how the various proposals of raising funds
will affect it. He is to maintain a proper balance between long and short term
funds.
3)
Investment decision: Funds procured
from different sources have to be invested in various kinds of assets. Long
term funds are used in a project for fixed and also current assets. The
investment of funds in a project is to be made after careful assessment of
various projects through capital budgeting. A part of long term funds is also
to be kept for financing working capital requirements. Asset management
policies are to be laid down regarding various items of current assets,
inventory policy is to be determined by the production and finance manager,
while keeping in mind the requirement of production and future price estimates
of raw materials and availability of funds.
4)
Dividend decision: The finance
manager is concerned with the decision to pay or declare dividend. He is to
assist the top management in deciding as to what amount of dividend should be
paid to the shareholders and what amount be retained by the company, it
involves a large number of considerations. The principal function of a finance
manager relates to decisions regarding procurement, investment and
dividends.
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)
Management
of Cash, Receivables and Inventory: Finance manager is required to
determine the quantum and manage the various components of working capital such
as cash, receivables and inventories. On the one hand, he has to ensure
sufficient availability of such assets as and when required, and on the other
there should be no surplus or idle investment.
7)
Disposal
of Surplus: A finance manager is also expected to make proper utilization
of surplus funds. He has to make a decision as to how much earnings are to be
retained for future expansion and growth and how much to be distributed among
the shareholders.
8)
Evaluating financial performance: Management
control systems are usually based on financial analysis, e.g. ROI (return
on investment) system of divisional control. A finance manager has to
constantly review the financial performance of various units of the
organisation. Analysis of the financial performance helps the management for
assessing how the funds are utilised in various divisions and what can be done
to improve it.
9)
Financial negotiations: Finance
manager's major time is utilised in carrying out negotiations with financial
institutions, banks and public depositors. He has to furnish a lot of
information to these institutions and persons in order to ensure that raising
of funds is within the statutes. Negotiations for outside financing often
require specialised skills.
10)
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.
Financial forecasting and planning
Financial Forecasting uses a set of
techniques to determine the amount of additional financing a company will, or
may, require in the future. It can also be a useful approach for assessing a
new venture's profitability. Methods employed include, but are not limited to,
assumptions, expectations, scenarios, sales percentage, and in addition there
are more mathematical analytic methodologies, such as financial ratio based or
regression analysis based forecasting. The concept explains the
structured methodology that allows organisations to evaluate future financial
needs. It also reviews how this technique is used to assess the amount of cash
the company requires if a project develops more quickly or slowly than
expected.
Sweat
equity shares
Sweat equity shares refers to equity shares
given to the company’s employees on favourable terms, in recognition of their
work. It is one of the modes of making share based payments to employees of the
company. The issue of sweat equity allows the company to retain the employees
by rewarding them for their services. Sweat equity rewards the beneficiaries by
giving them incentives in lieu of their contribution towards the development of
the company. Further, it enables greater employee stake and interest in the
growth of an organization as it encourages the employees to contribute more
towards the company in which they feel they have a stake.
