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INTRODUCTION TO FINANCIAL MANAGEMENT 1.1 Meaning , Scope and Importance 1.2 Functions of Financial Management – Long term & Short term 1.3 Role & Functions of Finance Manager 1.4 Goals of a Firm – Profit Maximisation & Wealth Maximisation.

1.1 Meaning , Scope and Importance Meaning: 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. Scope: The scope and functions of financial management is classified in two categories: Traditional approach Modern approach.

According to Traditional approach, the scope of the finance function is restricted to procurement of funds by corporate enterprise to meet their financial needs. The term ‘procurement’ refers to raising of funds externally as well as the interrelated aspects of raising funds. The interrelated aspects are the institutional arrangement for finance, financial instruments through which funds are raised and legal and accounting aspects between the firm and its sources of funds. Modern approach is an analytical way of looking into financial problems of the firm. According to this approach, the finance function covers both acquisition of funds as well as the allocation of funds to various uses..

This approach answers following questions: How large should an enterprise be and how far it should grow? In what form should it hold its assets? How should the funds required be raised? Importance: A company may go awry and incur losses without sound financial management. The following points highlight its importance: It helps a business to organise its finances and acquire the necessary capital. It is crucial for efficient and effective use of borrowed money. Businesses need financial management to make financial decisions..

4. It is essential for executing plans considering up-to-date financial reports and data on relevant Key Performance Indicators (KPIs). 5. It ensures that the company is adhering to all the legal requirements on financial aspects. 6. It ensures that each department operates within budget and in alignment with strategy..

1.3 Role & Functions of Finance Manager A financial manger plays an important role in the firm. He is a person who takes care of all the important financial functions of an organization. As a person in charge, he should maintain a far sightedness in order to ensure that the funds are utilized in the most efficient manner. His actions directly affect the Profitability, growth and goodwill of the firm. 1. Raising of Funds In order to meet the obligation of the business it is important to have enough cash and liquidity. A firm can raise funds by the way of equity and debt. It is the responsibility of a financial manager to decide the ratio between debt and equity. It is important to maintain a good balance between equity and debt..

2. Allocation of Funds Once the funds are raised through different channels, the next important function is to allocate the funds. The funds should be allocated in such a manner that they are optimally used. The Size of the firm and its growth capability, Status of assets whether they are long-term or short-term & Mode by which the funds are raised must be considered. These financial decisions directly and indirectly influence other managerial activities. Hence formation of a good asset mix and proper allocation of funds is one of the most important activity..

3. Profit Planning Profit earning is one of the prime functions of any business organization. Profit earning is important for survival and sustenance of any organization. Profit planning refers to proper usage of the profit generated by the firm. Profit arises due to many factors such as pricing, industry competition, state of the economy, mechanism of demand and supply, cost and output. A healthy mix of variable and fixed factors of production can lead to an increase in the profitability of the firm..

4. Understanding Capital Markets Shares of a company are traded on stock exchange and there is a continuous sale and purchase of securities. Hence a clear understanding of capital market is an important function of a financial manager. When securities are traded on stock market there involves a huge amount of risk involved. Therefore a financial manger understands and calculates the risk involved in this trading of shares and debentures..

It is the discretion of a financial manager as to how to distribute the profits. Many investors do not like the firm to distribute the profits amongst share holders as dividend instead invest in the business itself to enhance growth. The practices of a financial manager directly impact the operation in capital market..

1.2 Functions of Financial Management – Long term & Short term Finance function is difficult to separate from production, marketing and other functions. Yet these functions can be readily identified. Finance functions or decisions can be divided as follows: Finance functions/decisions Long term Finance decisions Short term Finance decisions Investment Decision 1. Liquidity decision Financing Decision Dividend Decision.

Long term Finance Decisions: These decisions have a longer time horizon, generally greater than on year. These decisions affect the firm’s performance in the long run. They are related to the firm’s strategy and thus senior management is involved in taking final decisions. Investment decisions: These are also called as Long term asset – mix decisions. They involve capital expenditures. They are thus, also called as capital budgeting decisions. This decision involves decision regarding allocation of capital towards long term assets that yield benefits (cash flows) in the future..

Two important aspects of investment decisions are: Evaluation of prospective/future profitability of new investment, and Measurement of a cut – off rate against which the prospective return on rate could be compared. As future is rather risky and uncertain, it is very difficult to predict and measure the future benefits. Investment decisions are therefore evaluated in terms of expected returns and risks..

b. Financing Decisions: This is also called as Capital – mix decision. This decision is the second most important to be performed by the finance manager. He/she must decide when, from where and how to acquire funds to meet the firm’s investment needs. The central issue addressed is to determine the appropriate proportion of Equity and Debt. The mix of debt & equity is known as the firm’s Capital Structure. The finance manager must make every effort to determine the optimum capital structure for his or her firm. The firm’s capital structure is considered optimum when the market value of shares is maximised..

If there is no debt in the capital , shareholders’ return is the firm’s return. But debt capital can be used to increase the shareholders’ return. Thus a proper balance must be achieved by the finance manager while deciding the sources of funds. c. Dividend decisions: This is also called as Profit allocation decision. This is the third major financial function/decision. Here the finance manager must decide whether to distribute profits as dividend to shareholders or to retain them for future use. The proportion of profits distributed as dividends is called as the Dividend – payout ratio and the retained portion of profits is known as Retention Ratio. Thus an optimum dividend policy must be framed by the finance manager which will result in increase in the market value of the firm’s shares..

Short term Finance Decisions: These decisions involve a period of less than one year. These decisions are needed for managing the day to day fund requirement. They are generally related to management of current assets and current liabilities, short term borrowings and investment of surplus cash for short periods. Liquidity decisions: Investment in current assets affects the firm’s profitability and liquidity. Current assets require proper management to safeguard the firm against the risk of illiquidity i.e., lack of cash. Current assets must not be kept idle but need to be invested appropriately to avoid the risk of poor liquidity. Thus the finance manager should develop sound techniques of current asset management..

1.4 Goals of a Firm – Profit Maximisation & Wealth Maximisation a. Profit Maximization – Profits earned by businesses are shown in their Annual Report. Hence it is one of the leading goals for all firms. Profit is the surplus made by over costs of carrying business activities in an accounting period. Profit maximisation means the firm maximizes its Earnings or Profit after Tax ( EAT/ PAT). Profit maximisation implies that a firm either produces maximum output from a given amount of inputs, or uses minimum input for producing a given output. Thus a most efficient firm will be able to maximise profits..

Profit Maximization causes the efficient allocation of resources under the competitive market conditions and profit is considered as the most appropriate measure of a firm’s performance. However in the long run, profit maximisation fails to serve as an operational criterion for maximising the owners’ economic welfare. This term suffers from following limitations: It is vague, It ignores time value of money and, It ignores risk..

b. Wealth Maximization – Also called as Value Maximisation means maximising the value of investments made by the shareholders, enhancing the earnings to shareholders by maximising earnings per share, dividend payments and capital gain by increasing the market price of the shares. Thus, Wealth maximisation principle implies that the fundamental objective of a firm is to maximise the market value of its shares. Wealth maximisation creates goodwill of the company in the market..