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[/b]Introduction to Financial Management[/b]
Meaning of Financial Management
Financial Management means planning, organizing, directing and controlling the firm’s financial resources. It means applying general management principles to financial resources of the enterprise. Financial Management deals with procurement of funds and effective utilization of funds in business. The two basic aspects of Financial Management are (1) Procurement of Funds and (2) Effective Utilization of Funds, to achieve business objectives.
1. Procurement of Funds: [/b]
(a) Funds can be obtained from various sources like Equity, Preference Capital, Debentures, Term Loans, etc. Funds procured from various sources have different characteristics in terms of risk, cost and control.
(b) While procuring funds from different sources, the objective is to minimize the cost of funds obtained. Hence, a proper balancing of risk and control factors becomes essential.
(c) Thus, Procurement of funds involves the following.
· Identification of Sources of Finance.
· Determination of Finance Mix.
· Raising of Funds.
· Division of Profits between dividends and retention of profits i.e. internal fund generation.
2[/b]. [/b]Effective Utilisation of funds: [/b]
(a) Funds are procured at a cost. Hence it is crucial to employ them properly and profitably.
(b) The Finance Manager identifies the areas where funds remain idle and why they are not used properly.
(c) He analyses the financial implications of each decision -to invest in Fixed Assets, the need for adequate Working Capital, etc.
Major consideration / aspects involved in procurement of funds:[/b]
The major considerations in procurement of funds are - (1) Risk (2) Cost and (3) Control. They differ with the type of fund. A comparative analysis of Debt and Equity Funds is given below-
Fund Type[/b]
Risk[/b]
Cost[/b]
Control[/b]
Own Funds (Equity)[/b]
Low Risk -[/b]no question of repayment of Capital except when the Company is under liquidation. Hence best from viewpoint of risk.
Most expensive –[/b] dividend expectations of Shareholders are higher than interest rates. Also, dividends are not tax deductible.
Dilution of control - [/b]Since the capital base might be expanded and new Shareholders / public are involved.
Loan Funds (Debt)[/b]
High Risk -[/b]Capital should be repaid as per agreement, Interest should be paid irrespective of performance of profits
Comparatively cheaper - [/b]prevailing interest rates are considered only to the extent of after tax impact.
No dilution of control - generally there is no voting power, except in special situations, e.g. default etc.
Scope and significance of Financial Management:[/b]
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1. Necessity: [/b]Financial Management is essential wherever funds are involved -in a centrally planned economy and also in a capitalist set-up. It attempts to use funds in the most productive manner, i.e. optimizing the 6 output from the given input of funds:' It focuses on effective Utilisation of the most important resource in any activity, i.e. money.
2. Pervasiveness: [/b]Financial Management is necessary in all types of organizations, whether profit oriented or non-profit oriented. It is a must for private as well as public enterprises, and all type of business forms.
3. Primacy:[/b] The strength of the finance function determines the strength of other functions since production; marketing, etc. are possible only with sound financial management. Hence Financial Management guarantees the survival of a business and constitutes a primary place in managerial attention.
Stages in the evolution of Financial Management: [/b]
The three broad stages in the evolution of Financial Management are:
1. [/b]Traditional Phase:[/b] In this phase, Financial Management was considered necessary only for special, significant and occasional events, e.g. mergers and acquisitions, liquidation, etc. The focus of decision-making was primarily oriented towards Shareholders and Lenders (Loan Creditors).
2. [/b]Transitional Phase:[/b] In this phase, Financial Management was considered to meet the day-to-day decision making requirements of Top Level Managers. The focus of decision-making was towards funds analysis, financial planning and control.
3. [/b]Modern Phase:[/b] Here, Financial Management is viewed as a supportive and facilitative function, not only for Top Management, but for all levels of Managers. Financial Management decisions range from corporate strategies -mergers & takeovers, option pricing, capital budgeting, etc. to regular and procedural aspects of financial discipline and control.
Changing scenario of Financial Management in India:[/b]
1. [/b]Change in Role:[/b] The information age has given a fresh perspective to the role of Finance Management and Finance Managers. With the shift in the paradigm, it is imperative that the role of Chief Financial Officer (CFO) changes from a Controller to a Facilitator.
2. [/b]Organizer/Facilitator:[/b] In his new emergent role, the CFO acts as a catalyst to facilitate changes in an environment where the Company succeeds through self-managed teams in each function e.g. production, marketing, purchase scheduling etc. The CFO must now transform himself to a front-end organizer or a leader, whose role will be in networking the functions of various sub-units or teams
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3. [/b]Strategic Level Role:[/b] The CFO must analyse the external environment and take strategic decisions in order to manage and optimize the Firm's cash flows. Thus the role of the CFO shifts from an operational level to a strategic level. However, the operational level duties (back-end duties) will still have to be carried out.
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4. [/b]Knowledge Manager:[/b] The CFO's knowledge requirements will extend from routine things like capital productivity, cost of capital etc. to specialized aspects like human resources initiatives, competitive mitt etc. environment analysis etc. So, the CFO must develop / sharpen his skills in order to meet the needs of the emergent situation.
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Objectives of Financial Management:[/b]
Primary Objectives[/b]
Other Objectives[/b]
(a) Profit Maximisation.
(b) Value or Wealth Maximization.
(a) Customer Satisfaction, i.e. value for money, quality goods, etc.
(b) Employee Welfare, i.e. good standard of living, giving fair wages, etc.
(c) Maintaining and improving Market Share.
(d) Market Leadership in terms of products, services, technology, management techniques, etc.
(e) Good Corporate Citizenship in terms of tax remittance, maintaining ecological balance, etc.
1. [/b]Profit Maximization:[/b] The basic business motive is Profitability. So, the Finance Manager has to take his decisions in order to maximise the profits of the business. Profit Maximisation is a basic and long-term objective, but has a short-term measurement focus (say a financial year.) Profit Maximisation, as an objective has the following advantages and limitations:
Advantages[/b]
Disadvantages/Limitations[/b]
(a) Must for survival of business, else, Capital is lost.
(b) Essential for growth and development of business.
(c) Impact on society through factor payments.
(d) Profit-making firms only can pursue social obligations.
(a) The term "Profit" is vague.
(b) Higher the profits, higher the risks involved.
(c) It ignores time pattern of returns.
(d) It ignores social and moral obligations of the business
Hence, Profit Maximization is viewed as a limited objective, i.e. essential but not sufficient.
2.[/b] Wealth Maximisation: The second objective of Financial Management is to maximise the Value of Wealth of the Firm. Wealth or Value of a Firm is represented by the market price of its Capital (i.e. Shares and Debentures). This value depends upon-(a) likely rate of earnings of the Company (EBIT) and (b) Capitalisation Rate.