ICAI Notes: Scope and Objectives of Financial Management | Financial Management & Strategic Management for CA Intermediate PDF Download

 Page 1


a
    
 
 
CHAPTER 
1 
 
 
 
 
 
 
SCOPE AND 
OBJECTIVES OF  
FINANCIAL 
  MANAGEMENT  
 
 
 
After studying this chapter, you would be able to - 
? State the meaning, importance and scope of Financial Management in 
an entity.  
? Discuss Financing decision/functions. 
? Discuss the objectives of Financial Management; Profit maximisation 
vis-a-vis Wealth maximisation. 
? Discuss Shareholders value maximising approach. 
? Examine the role and functions of Finance executives in an entity. 
? Discuss Financial Distress and Insolvency. 
? Discuss Agency Cost and its Mitigation.  
? Discuss Agency Problem and Agency Cost. 
 
LEARNING OUTCOMES 
© The Institute of Chartered Accountants of India
Page 2


a
    
 
 
CHAPTER 
1 
 
 
 
 
 
 
SCOPE AND 
OBJECTIVES OF  
FINANCIAL 
  MANAGEMENT  
 
 
 
After studying this chapter, you would be able to - 
? State the meaning, importance and scope of Financial Management in 
an entity.  
? Discuss Financing decision/functions. 
? Discuss the objectives of Financial Management; Profit maximisation 
vis-a-vis Wealth maximisation. 
? Discuss Shareholders value maximising approach. 
? Examine the role and functions of Finance executives in an entity. 
? Discuss Financial Distress and Insolvency. 
? Discuss Agency Cost and its Mitigation.  
? Discuss Agency Problem and Agency Cost. 
 
LEARNING OUTCOMES 
© The Institute of Chartered Accountants of India
a
 
  
 
FINANCIAL MANAGEMENT  
1.2 
 
 
 
 1. INTRODUCTION 
We will like to explain Financial Management by giving a very simple scenario. For 
the purpose of starting any new business/venture, an entrepreneur goes through 
the following stages of decision making:- 
Stage 1 Stage 2 Stage 3 Stage 4 
Decide which 
assets 
(premises, 
machinery, 
equipment 
etc.) to buy. 
Determining 
what is total 
investment 
(since assets 
cost money) 
required for 
buying 
assets. 
Apart from buying 
assets the 
entrepreneur would 
also need to 
determine how 
much cash he would 
need to run the daily 
operations (payment 
for raw material, 
salaries, wages etc.). 
In other words this 
is also defined as 
Working Capital 
requirement. 
The next stage is to 
decide what all sources, 
does the entrepreneur 
need to tap to finance 
the total investment 
(assets and working 
capital). The sources 
could be Share Capital 
(Including 
Entrepreneur’s own 
funds) or Borrowing 
from Banks or 
Investment from 
Financial Institutions etc. 
FINANCIAL MANAGEMENT 
Scope and Objectives of 
Financial Management 
Role and functions of 
Chief Finance Officer 
(CFO) 
Profit Maximisation  
vis-à-vis Wealth 
Maximisation 
Relationship of Financial 
Management with other 
disciplines of 
accounting. 
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
Page 3


a
    
 
 
CHAPTER 
1 
 
 
 
 
 
 
SCOPE AND 
OBJECTIVES OF  
FINANCIAL 
  MANAGEMENT  
 
 
 
After studying this chapter, you would be able to - 
? State the meaning, importance and scope of Financial Management in 
an entity.  
? Discuss Financing decision/functions. 
? Discuss the objectives of Financial Management; Profit maximisation 
vis-a-vis Wealth maximisation. 
? Discuss Shareholders value maximising approach. 
? Examine the role and functions of Finance executives in an entity. 
? Discuss Financial Distress and Insolvency. 
? Discuss Agency Cost and its Mitigation.  
? Discuss Agency Problem and Agency Cost. 
 
LEARNING OUTCOMES 
© The Institute of Chartered Accountants of India
a
 
  
 
FINANCIAL MANAGEMENT  
1.2 
 
 
 
 1. INTRODUCTION 
We will like to explain Financial Management by giving a very simple scenario. For 
the purpose of starting any new business/venture, an entrepreneur goes through 
the following stages of decision making:- 
Stage 1 Stage 2 Stage 3 Stage 4 
Decide which 
assets 
(premises, 
machinery, 
equipment 
etc.) to buy. 
Determining 
what is total 
investment 
(since assets 
cost money) 
required for 
buying 
assets. 
Apart from buying 
assets the 
entrepreneur would 
also need to 
determine how 
much cash he would 
need to run the daily 
operations (payment 
for raw material, 
salaries, wages etc.). 
In other words this 
is also defined as 
Working Capital 
requirement. 
The next stage is to 
decide what all sources, 
does the entrepreneur 
need to tap to finance 
the total investment 
(assets and working 
capital). The sources 
could be Share Capital 
(Including 
Entrepreneur’s own 
funds) or Borrowing 
from Banks or 
Investment from 
Financial Institutions etc. 
FINANCIAL MANAGEMENT 
Scope and Objectives of 
Financial Management 
Role and functions of 
Chief Finance Officer 
(CFO) 
Profit Maximisation  
vis-à-vis Wealth 
Maximisation 
Relationship of Financial 
Management with other 
disciplines of 
accounting. 
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
 
 
 
1.3 
SCOPE AND OBJECTIVES OF FINANCIAL 
 MANAGEMENT 
a
    
 
1.3 
 
While deciding how much to take from each source, the entrepreneur would keep 
in mind the cost of capital for each source (Interest/Dividend etc.). As an 
entrepreneur he would like to keep the cost of capital low.  
Thus, financial management is concerned with efficient acquisition (financing) 
and allocation (investment in assets, working capital etc.) of funds with an 
objective to make profit (dividend) for owners. In other words, focus of financial 
management is to address three major financial decision areas namely, 
investment, financing and dividend decisions. 
Any business enterprise requiring money and the 3 key questions being enquired 
into 
1. Where to get the money from? (Financing Decision) 
2. Where to invest the money? (Investment Decision) 
3. How much to distribute amongst shareholders to keep them satisfied? 
(Dividend Decision) 
 2. MEANING OF FINANCIAL MANAGEMENT 
Financial management is that managerial activity which is concerned with 
planning and controlling of the firm’s financial resources. In other words it is 
concerned with acquiring, financing and managing assets to accomplish the 
overall goal of a business enterprise (mainly to maximise the shareholder’s 
wealth).  
In today’s world where positive cash flow is more important than book profit, 
Financial Management can also be defined as planning for the future of a 
business enterprise to ensure a positive cash flow. Some experts also refer to 
financial management as the science of money management. It can be defined as:  
“Financial Management comprises of forecasting, planning, organizing, directing, 
co-ordinating and controlling of all activities relating to acquisition and application 
of the financial resources of an undertaking in keeping with its financial objective. 
© The Institute of Chartered Accountants of India
Page 4


a
    
 
 
CHAPTER 
1 
 
 
 
 
 
 
SCOPE AND 
OBJECTIVES OF  
FINANCIAL 
  MANAGEMENT  
 
 
 
After studying this chapter, you would be able to - 
? State the meaning, importance and scope of Financial Management in 
an entity.  
? Discuss Financing decision/functions. 
? Discuss the objectives of Financial Management; Profit maximisation 
vis-a-vis Wealth maximisation. 
? Discuss Shareholders value maximising approach. 
? Examine the role and functions of Finance executives in an entity. 
? Discuss Financial Distress and Insolvency. 
? Discuss Agency Cost and its Mitigation.  
? Discuss Agency Problem and Agency Cost. 
 
LEARNING OUTCOMES 
© The Institute of Chartered Accountants of India
a
 
  
 
FINANCIAL MANAGEMENT  
1.2 
 
 
 
 1. INTRODUCTION 
We will like to explain Financial Management by giving a very simple scenario. For 
the purpose of starting any new business/venture, an entrepreneur goes through 
the following stages of decision making:- 
Stage 1 Stage 2 Stage 3 Stage 4 
Decide which 
assets 
(premises, 
machinery, 
equipment 
etc.) to buy. 
Determining 
what is total 
investment 
(since assets 
cost money) 
required for 
buying 
assets. 
Apart from buying 
assets the 
entrepreneur would 
also need to 
determine how 
much cash he would 
need to run the daily 
operations (payment 
for raw material, 
salaries, wages etc.). 
In other words this 
is also defined as 
Working Capital 
requirement. 
The next stage is to 
decide what all sources, 
does the entrepreneur 
need to tap to finance 
the total investment 
(assets and working 
capital). The sources 
could be Share Capital 
(Including 
Entrepreneur’s own 
funds) or Borrowing 
from Banks or 
Investment from 
Financial Institutions etc. 
FINANCIAL MANAGEMENT 
Scope and Objectives of 
Financial Management 
Role and functions of 
Chief Finance Officer 
(CFO) 
Profit Maximisation  
vis-à-vis Wealth 
Maximisation 
Relationship of Financial 
Management with other 
disciplines of 
accounting. 
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
 
 
 
1.3 
SCOPE AND OBJECTIVES OF FINANCIAL 
 MANAGEMENT 
a
    
 
1.3 
 
While deciding how much to take from each source, the entrepreneur would keep 
in mind the cost of capital for each source (Interest/Dividend etc.). As an 
entrepreneur he would like to keep the cost of capital low.  
Thus, financial management is concerned with efficient acquisition (financing) 
and allocation (investment in assets, working capital etc.) of funds with an 
objective to make profit (dividend) for owners. In other words, focus of financial 
management is to address three major financial decision areas namely, 
investment, financing and dividend decisions. 
Any business enterprise requiring money and the 3 key questions being enquired 
into 
1. Where to get the money from? (Financing Decision) 
2. Where to invest the money? (Investment Decision) 
3. How much to distribute amongst shareholders to keep them satisfied? 
(Dividend Decision) 
 2. MEANING OF FINANCIAL MANAGEMENT 
Financial management is that managerial activity which is concerned with 
planning and controlling of the firm’s financial resources. In other words it is 
concerned with acquiring, financing and managing assets to accomplish the 
overall goal of a business enterprise (mainly to maximise the shareholder’s 
wealth).  
In today’s world where positive cash flow is more important than book profit, 
Financial Management can also be defined as planning for the future of a 
business enterprise to ensure a positive cash flow. Some experts also refer to 
financial management as the science of money management. It can be defined as:  
“Financial Management comprises of forecasting, planning, organizing, directing, 
co-ordinating and controlling of all activities relating to acquisition and application 
of the financial resources of an undertaking in keeping with its financial objective. 
© The Institute of Chartered Accountants of India
a
 
  
 
FINANCIAL MANAGEMENT  
1.4 
Another very elaborate definition given by Phillippatus is: 
“Financial Management is concerned with the managerial decisions that result in 
the acquisition and financing of short term and long term credits for the firm.”  
As such it deals with the situations that require selection of specific assets (or 
combination of assets), the selection of specific problem of size and growth of an 
enterprise. The analysis of these decisions is based on the expected inflows and 
outflows of funds and their effect on managerial objectives. 
There are two basic aspects of financial management viz., procurement of funds 
and an effective use of these funds to achieve business objectives. 
 
2.1 Procurement of Funds 
Since funds can be obtained from different sources therefore their procurement is 
always considered as a complex problem by business concerns.  Some of the 
sources for funds for a business enterprise are: 
 
Aspects of Financial 
Management
Procurement of Funds
Utilization of Funds
Debentures and 
Bonds
Angel Financing
Venture Capital
Commercial Banks 
(Short, Medium & 
Long-term Fund)
Owner's Funds
© The Institute of Chartered Accountants of India
Page 5


a
    
 
 
CHAPTER 
1 
 
 
 
 
 
 
SCOPE AND 
OBJECTIVES OF  
FINANCIAL 
  MANAGEMENT  
 
 
 
After studying this chapter, you would be able to - 
? State the meaning, importance and scope of Financial Management in 
an entity.  
? Discuss Financing decision/functions. 
? Discuss the objectives of Financial Management; Profit maximisation 
vis-a-vis Wealth maximisation. 
? Discuss Shareholders value maximising approach. 
? Examine the role and functions of Finance executives in an entity. 
? Discuss Financial Distress and Insolvency. 
? Discuss Agency Cost and its Mitigation.  
? Discuss Agency Problem and Agency Cost. 
 
LEARNING OUTCOMES 
© The Institute of Chartered Accountants of India
a
 
  
 
FINANCIAL MANAGEMENT  
1.2 
 
 
 
 1. INTRODUCTION 
We will like to explain Financial Management by giving a very simple scenario. For 
the purpose of starting any new business/venture, an entrepreneur goes through 
the following stages of decision making:- 
Stage 1 Stage 2 Stage 3 Stage 4 
Decide which 
assets 
(premises, 
machinery, 
equipment 
etc.) to buy. 
Determining 
what is total 
investment 
(since assets 
cost money) 
required for 
buying 
assets. 
Apart from buying 
assets the 
entrepreneur would 
also need to 
determine how 
much cash he would 
need to run the daily 
operations (payment 
for raw material, 
salaries, wages etc.). 
In other words this 
is also defined as 
Working Capital 
requirement. 
The next stage is to 
decide what all sources, 
does the entrepreneur 
need to tap to finance 
the total investment 
(assets and working 
capital). The sources 
could be Share Capital 
(Including 
Entrepreneur’s own 
funds) or Borrowing 
from Banks or 
Investment from 
Financial Institutions etc. 
FINANCIAL MANAGEMENT 
Scope and Objectives of 
Financial Management 
Role and functions of 
Chief Finance Officer 
(CFO) 
Profit Maximisation  
vis-à-vis Wealth 
Maximisation 
Relationship of Financial 
Management with other 
disciplines of 
accounting. 
CHAPTER OVERVIEW 
© The Institute of Chartered Accountants of India
 
 
 
1.3 
SCOPE AND OBJECTIVES OF FINANCIAL 
 MANAGEMENT 
a
    
 
1.3 
 
While deciding how much to take from each source, the entrepreneur would keep 
in mind the cost of capital for each source (Interest/Dividend etc.). As an 
entrepreneur he would like to keep the cost of capital low.  
Thus, financial management is concerned with efficient acquisition (financing) 
and allocation (investment in assets, working capital etc.) of funds with an 
objective to make profit (dividend) for owners. In other words, focus of financial 
management is to address three major financial decision areas namely, 
investment, financing and dividend decisions. 
Any business enterprise requiring money and the 3 key questions being enquired 
into 
1. Where to get the money from? (Financing Decision) 
2. Where to invest the money? (Investment Decision) 
3. How much to distribute amongst shareholders to keep them satisfied? 
(Dividend Decision) 
 2. MEANING OF FINANCIAL MANAGEMENT 
Financial management is that managerial activity which is concerned with 
planning and controlling of the firm’s financial resources. In other words it is 
concerned with acquiring, financing and managing assets to accomplish the 
overall goal of a business enterprise (mainly to maximise the shareholder’s 
wealth).  
In today’s world where positive cash flow is more important than book profit, 
Financial Management can also be defined as planning for the future of a 
business enterprise to ensure a positive cash flow. Some experts also refer to 
financial management as the science of money management. It can be defined as:  
“Financial Management comprises of forecasting, planning, organizing, directing, 
co-ordinating and controlling of all activities relating to acquisition and application 
of the financial resources of an undertaking in keeping with its financial objective. 
© The Institute of Chartered Accountants of India
a
 
  
 
FINANCIAL MANAGEMENT  
1.4 
Another very elaborate definition given by Phillippatus is: 
“Financial Management is concerned with the managerial decisions that result in 
the acquisition and financing of short term and long term credits for the firm.”  
As such it deals with the situations that require selection of specific assets (or 
combination of assets), the selection of specific problem of size and growth of an 
enterprise. The analysis of these decisions is based on the expected inflows and 
outflows of funds and their effect on managerial objectives. 
There are two basic aspects of financial management viz., procurement of funds 
and an effective use of these funds to achieve business objectives. 
 
2.1 Procurement of Funds 
Since funds can be obtained from different sources therefore their procurement is 
always considered as a complex problem by business concerns.  Some of the 
sources for funds for a business enterprise are: 
 
Aspects of Financial 
Management
Procurement of Funds
Utilization of Funds
Debentures and 
Bonds
Angel Financing
Venture Capital
Commercial Banks 
(Short, Medium & 
Long-term Fund)
Owner's Funds
© The Institute of Chartered Accountants of India
 
 
 
1.5 
SCOPE AND OBJECTIVES OF FINANCIAL 
 MANAGEMENT 
a
    
 
1.5 
 
In a global competitive scenario, it is not enough to depend on the available ways 
of raising finance but resource mobilization has to be undertaken through 
innovative ways on financial products which may meet the needs of investors.  We 
are constantly seeing new and creative sources of funds which are helping the 
modern businesses to grow faster. For example: trading in Carbon Credits is 
turning out to be another source of funding.  
Funds procured from different sources have different characteristics in terms of 
risk, cost and control. The cost of funds should be at the minimum level for that a 
proper balancing of risk and control factors must be carried out.  
Another key consideration in choosing the source of new business finance is to 
strike a balance between equity and debt to ensure the funding structure suits the 
business. 
Let us discuss some of the sources of funds (discussed in detail in later chapters): 
(a) Equity: The funds raised by the issue of equity shares are the best from the 
risk point of view for the firm, since there is no question of repayment of 
equity capital except when the firm is under liquidation. From the cost point 
of view, however, equity capital is usually the most expensive source of 
funds. This is because the dividend expectations of shareholders are 
normally higher than prevalent interest rate and also because dividends are 
an appropriation of profit, not allowed as an expense under the Income Tax 
Act. Also the issue of new shares to public may dilute the control of the 
existing shareholders. 
(b) Debentures: Debentures as a source of funds are comparatively cheaper 
than the shares because of their tax advantage. The interest the company 
pays on a debenture is free of tax, unlike a dividend payment which is made 
from the taxed profits. However, even when times are hard, interest on 
debenture loans must be paid whereas dividends need not be.  However, 
debentures entail a high degree of risk since they have to be repaid as per 
the terms of agreement. Also, the interest payment has to be made whether 
or not the company makes profits. 
© The Institute of Chartered Accountants of India