Introduction to Financial Management - Accountancy and Financial Management | Accountancy and Financial Management - B Com PDF Download

Introduction

• Financial Management: This is about making money decisions within a company, like figuring out how much cash to keep on hand, deciding whether to merge with another company or choosing how to raise funds.
• Investments: This part looks at how financial markets work and how to decide on the prices of financial stuff like stocks and bonds.
• Financial Institutions: These are banks and other places that help connect people who have money to spare with those who need money. There are different types, like banks and markets.

Financial management is mainly about how a company gets and uses its money. It's evolved over time, but its main concerns are:
~ How big should a company be, and how quickly should it grow?
~ What stuff should a company own?
~ How should a company pay for things?
~ How does a company keep track of its money and make plans?
Over the past couple of decades, things have changed a lot in the world of business. Some countries have opened up to new opportunities, while others have slowed down. This means companies have had to explore new markets to keep growing.

Finance

• Finance may be defined as the art and science of managing money. It includes financial services and financial instruments. Finance also is referred to as the provision of money at the time when it is needed. The finance function is the procurement of funds and their effective utilization in business concerns.
• The concept of finance includes capital, funds, money, and amount. But each word has a unique meaning. Studying and understanding the concept of finance has become an important part of the business concern.
• According to Khan and Jain, “Finance is the art and science of managing money”.
• According to the Oxford dictionary, the word ‘finance’ connotes ‘management of money'. Webster’s Ninth New Collegiate Dictionary defines finance as “the Science on the study of the management of funds" and the management of funds the system that includes the circulation of money, the granting of credit, the making of investments, and the provision of banking facilities.

Types of Finance

• Finance is one of the important and integral parts of business concerns, hence, it plays a major role in every part of the business activities. It is used in all the areas of the activities under different names.
• Finance can be classified into two major parts:
  (i) Private Finance, which includes the Individual, Firms, Business or Corporate Financial activities to meet the requirements.
  (ii) Public Finance which concerns with revenue and disbursement of Government such as Central Government, State Government and Semi-Government Financial matters.

Financial Management

• Financial management is an integral part of overall management. It is concerned with the duties of the financial managers in the business firm.
• The term financial management has been defined by Solomon, “It is concerned with the efficient use of an important economic resource namely, capital funds”.
• The most popular and acceptable definition of financial management as given by S.C. Kuchal is that “Financial Management deals with procurement of funds and their effective utilization in the business”.
• Howard and Upton: Financial management “as an application of general managerial principles to the area of financial decision-making. Weston and Brigham: Financial management “is an area of financial decision-making, harmonizing individual motives and enterprise goals”.
• Joshep and Massie: Financial management “is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations.

Thus, Financial Management is mainly concerned with effective fund's management in the business. In simple words, Financial Management as practiced by business firms can be called Corporation Finance or Business Finance.

Scope of Financial Management

Financial management is one of the important parts of overall management, which is directly related to various functional departments like personnel, marketing, and production. Financial management covers a wide area with multi-dimensional approaches. 

The important scope of financial management:

1. Financial Management and Economics; Economic concepts like micro and macroeconomics are directly applied to the financial management approaches. Investment decisions, micro, and macro-environmental factors are closely associated with the functions of a financial manager.
   Financial management also uses economic equations like money value discount factor, economic order quantity, etc. Financial economics is one of the emerging areas, which provides immense opportunities to finance, and economic areas.
2. Financial Management and Accounting: Accounting records include the financial information of the business concern. Hence, we can easily understand the relationship between financial management and accounting.
   In the olden periods, both financial management and accounting were treated as the same discipline, and then it has been merged as Management Accounting because this part is very helpful to finance managers to make decisions. But nowadays financial management and accounting discipline are separate and interrelated.
3. Financial Management or Mathematics: Modern approaches to financial management apply a large number of mathematical and statistical tools and techniques. They are also called Econo metrics.
   Economic order quantity, discount factor, time value of money, the present value of money, cost of capital, capital structure theories, dividend theories, ratio analysis and working capital analysis are used as mathematical and statistical tools and techniques in the field of financial management.
4. Financial Management and Production Management: Production management is the operational part of the business concern, which helps to multiply the money into profit. The profit of the concern depends upon the production performance. Production performance needs finance because the production department requires raw materials, machinery, wages, operating expenses etc. These expenditures are decided and estimated by the financial department and the finance manager locates the appropriate finance to the production department. The financial manager must be aware of the operational process and finance required for each process of production activities.
5. Financial Management and Marketing: Produced goods are sold in the market with innovative and modern approaches. For this, the marketing department needs finance to meet their requirements.
   The financial manager or finance department is responsible for allocating adequate finance to the marketing department. Hence, marketing and financial management are interrelated and depend on each other.
6. Financial Management and Human Resources: Financial management is also related to the human resource department, which provides manpower to all the functional areas of the management. The financial manager should carefully evaluate the requirement of manpower to each department and allocate the finance to the human resource department as wages, salary, remuneration, commission, bonus, pension, and other monetary benefits to the human resource department. Hence, financial management is directly related to human resource management.

Evolution of Financial Management 

Financial management has changed over time in three main phases: traditional, transitional, and modern.

• Traditional Phase: Back then, financial management mainly dealt with big events like expansions or mergers. It also focused heavily on following rules and regulations. Companies mostly looked at finance from the outside perspective, like what investors or regulators thought.
• Transitional Phase: In this phase, the focus was still on the same things, but finance managers started paying more attention to problems they faced, like analyzing funds and planning better.
• Modern Phase: Nowadays, financial management uses economic theories and fancy math to make decisions. It's all about matching money with where it's needed most efficiently, considering things like economic changes and risks. Math and stats play a big role, especially in things like financial modelling and predicting demand.

Significance of Financial Management 

Financial management is all about using resources wisely to make as much profit as possible. Over the past few decades, industries have grown rapidly thanks to globalization and liberalization policies. The way companies handle money is crucial for their success or failure. As Irwin Friend put it, a company's ability to survive and thrive depends a lot on its financial strategies. In today's world, where ownership of companies is spread out and companies care about social responsibility, financial management is more than just planning and controlling money.

Here's why financial management is so important:

• Determining Business Success: Good financial management helps companies use their resources well, which is essential for success. Companies that fail often do so because they mismanage their money. Financial management helps companies plan for growth, expansion, and other important moves.
• Optimizing Resource Use: Financial managers are responsible for making sure resources are used efficiently. The problem isn't usually a lack of money, but rather not using what's available wisely. In places like India where money is scarce, using resources effectively is crucial.
• Decision-Making Hub: Financial management provides tools and techniques for making smart money decisions. Things like comparing financial statements, making budgets, and analyzing ratios help companies figure out if a project will be profitable.
• Measuring Performance: A company's success is judged by its financial results. The value of a company depends on how much money it makes and how risky those earnings are. Making decisions that increase profits and reduce risks boosts a company's value.
• Basis of Planning, Coordination, and Control: Every part of a company needs money, and the finance department is in charge of that. They help plan activities and coordinate between different departments. Since everything is measured in money, finance is crucial for monitoring and controlling activities.
• Advisory Role: Finance managers play a big part in guiding a company to success.
• Providing Information to Stakeholders: In today's world, where companies are responsible to the public, it's important for them to share information about how they're doing. Financial management ensures that stakeholders get the right information at the right time.

Principles of Financial Management 

The main principles of corporate finance can be broken down into four parts:

1. Investment Decision: This is about choosing where to put the company's money. Should it go into projects that will make more money, like building new facilities or reducing costs? Financial managers compare the potential returns of these investments to a minimum acceptable rate. If the returns are higher, they go ahead with the project. The minimum rate depends on how risky the project is. It's like comparing how much you could earn from different investments.
2. Financing Decision: This is all about figuring out how to get the money needed for investments. There are lots of ways to raise funds, like through stocks, bonds, or loans. Financial managers need to find the right mix of debt and equity (ownership) for the company. Using debt can boost returns for shareholders, but it also adds risk. This is called financial leverage.
3. Dividend Decision: Once the company makes money, it needs to decide what to do with it. Should it give some of it back to shareholders as dividends, or keep it to reinvest in the business? The goal is to maximize the value of the company's shares. The decision depends on factors like investment opportunities and what shareholders expect. Dividends are usually paid in cash, but sometimes companies give out bonus shares to existing shareholders for free.
4. Liquidity Decision: A company needs to make sure it always has enough money to pay its bills. That means keeping a good balance of liquid assets, like cash or easily sellable investments. Financial managers need to make sure that the money coming in matches the money going out. But there's a trade-off between profitability and liquidity. Too much cash sitting around means missed opportunities to invest, but too little can lead to financial trouble.

Objectives of Financial Management 

The main goals of financial management need to align with the overall goals of a business, which are usually survival and growth. To achieve these goals, financial management focuses on several objectives:

• Ensuring Adequate Funding: Making sure the company always has enough money to operate smoothly.
• Providing Fair Returns to Investors: Giving investors a decent return on their investment.
• Efficient Use of Funds: Using money wisely to make sure it's making a profit while also being safe and available when needed.
• Creating a Clear System for Investments and Financing: Setting up a plan for how the company will invest in itself and where it will get the money to do so.
• Minimizing Costs of Capital: Finding the most cost-effective mix of debt and equity to fund the company's operations.
• Coordinating with Other Departments: Working closely with other parts of the company to make sure everyone's goals are aligned.

The main financial objective of a company is usually to maximize the economic welfare of its owners. 

Profit Maximization

The main aim of any kind of economic activity is earning profit. A business concern is also functioning mainly for the purpose of earning profit. Profit is the measuring technique to understand the business efficiency of the concern. Profit maximization is also the traditional and narrow approach, which aims, to maximise the profit of the concern. Profit maximization consists of the following important features.

1. Profit maximization is also called cash-per-share maximization. It leads to maximising the business operation for profit maximization.
2. The ultimate aim of the business concern is earning a profit, hence, it considers all the possible ways to increase the profitability of the concern.
3. Profit is the parameter for measuring the efficiency of the business concern. So it shows the entire position of the business concern.
4. Profit maximization objectives help to reduce the risk of the business.

Favourable Arguments for Profit Maximization
The following important points are in support of the profit maximization objectives of the business concern:
(i) The main aim is earning profit.
(ii) Profit is the parameter of the business operation.
(iii) Profit reduces the risk of the business concern.
(iv) Profit is the main source of finance.
(v) Profitability meets the social needs also

Unfavourable Arguments for Profit Maximization
The following important points are against the objectives of profit maximization:
(i) Profit maximization leads to exploiting workers and consumers.
(ii) Profit maximization creates immoral practices such as corrupt practices, unfair trade practices, etc.
(iii) Profit maximization objectives lead to inequalities among the sake holders such as customers, suppliers, public shareholders, etc.

Drawbacks of Profit Maximization
The profit maximization objective consists of certain drawbacks also:
(i) It is vague: In this objective, profit is not defined precisely or correctly. It creates some unnecessary opinions regarding the earning habits of the business concern.
(ii) It ignores the time value of money: Profit maximization does not consider the time value of money or the net present value of the cash inflow. It leads to certain differences between the actual cash inflow and net present cash flow during a particular period.
(iii) It ignores risk: Profit maximization does not consider the risk of the business concern. Risks may be internal or external which will affect the overall operation of the business concern.

Wealth Maximization

Wealth maximization is one of the modern approaches, which involves the latest innovations and improvements in the field of business concern. The term wealth means shareholder wealth or the wealth of the persons who are involved in the business concern.

Wealth maximization is also known as value maximization or net present worth maximization. This objective is a universally accepted concept in the field of business.

Favourable Arguments for Wealth Maximization

(i) Wealth maximization is superior to profit maximization because the main aim of the business concern under this concept is to improve the value or wealth of the shareholders.
(ii) Wealth maximization considers the comparison of the value to cost associated with the business concern. Total value detected from the total cost incurred for the business operation. It provides extract value of the business concern.
(iii) Wealth maximization considers both time and risk of the business concern.
(iv) Wealth maximization provides efficient allocation of resources.
(v) It ensures the economic interest of the society.

Unfavourable Arguments for Wealth Maximization
(i) Wealth maximization leads to a prescriptive idea of the business concern but it may not be suitable to present-day business activities.
(ii) Wealth maximization is nothing, it is also profit maximization, it is the indirect name of the profit maximization.
(iii) Wealth maximization creates ownership-management controversy.
(iv) Management alone enjoys certain benefits.
(v) The ultimate aim of the wealth maximization objectives is to maximize profit.
(vi) Wealth maximization can be activated only with the help of the profitable position of the business concern.

Maximizing EPS

• Earnings per share (EPS) is the portion of a company's profit that is assigned to each outstanding share of common stock. It's a key indicator of how profitable a company is and is widely used to gauge its financial health. Comparing EPS with that of similar companies gives an idea of their relative profitability, and tracking EPS over time shows if a company's earning power is improving or declining. Investors typically prefer companies with a consistent increase in EPS.
• EPS growth is crucial as it reflects how much money the company is generating for its shareholders, considering changes in profit and the impact of issuing new shares, especially through acquisitions. However, solely focusing on maximizing EPS may not ensure the best economic outcome for shareholders, as it overlooks factors like timing and risk.
• Maximizing profits or EPS alone as financial objectives may not fully benefit shareholders because they don't consider the timing and uncertainty of returns. A better approach is wealth maximization, which takes these factors into account and aims to maximize the overall economic welfare of shareholders.

Importance of Financial Management

1. Financial Planning
   Financial management helps to determine the financial requirement of the business concern and leads to financial planning of the concern. Financial planning is an important part of the business concern, which helps to promote an enterprise.
2. Acquisition of Funds
   Financial management involves the acquisition of required finance to the business concern. Acquiring needed funds plays a major part in financial management, which involves possible sources of finance at minimum cost.
3. Proper Use of Funds
   Proper use and allocation of funds leads to improving the operational efficiency of the business concern. When the finance manager uses the funds properly, they can reduce the cost of capital and increase the value of the firm.
4. Financial Decision
   Financial management helps to make sound financial decisions in the business concern. Financial decisions will affect the entire business operation of the concern, because there is a direct relationship with various department functions such as marketing, production personnel, etc.
5. Improve Profitability
   The profitability of the concern purely depends on the effectiveness and proper utilization of funds by the business concern. Financial management helps to improve the profitability position of the concern with the help of strong financial control devices such as budgetary control, ratio analysis and cost volume profit analysis.
6. Increase the Value of the Firm
   Financial management is very important in the field of increasing the wealth of the investors and the business concern. The ultimate aim of any business concern is to achieve the maximum profit and higher profitability leads to maximising the wealth of the investors as well as the nation.
7. Promoting Savings
   Savings are possible only when the business concerned earns higher profitability and maximises wealth. Effective financial management helps to promote and mobilise individual and corporate savings.

Economic Profit VS Accounting Profit 

Economic Value Added (EVA) is a way to measure how well a company is doing financially. It involves:

• Finding the company's operating profit.
• Figuring out the cost of using capital.
• Comparing the operating profit to the cost of capital.

Market Value Added (MVA) is another measure that looks at how much a company's worth compared to what it's invested. This involves:

• Calculating the market value of the company's assets.
• Finding out how much capital has been invested.
• Comparing the market value of assets to the invested capital.

Basically, financial decisions involve deciding what assets to buy or sell and how to use funds effectively. These decisions affect things like the company's size, growth, profits, and risk, ultimately determining its overall value.

Agency Relationship 

As businesses grow larger and more complex, they often transition from sole proprietorships or partnerships to public limited companies, where decision-making becomes more decentralized. Owners or partners can't handle all aspects of the business anymore, so they delegate decision-making authority to managers, who act on behalf of the owners or shareholders. This relationship between managers (agents) and owners (principals) is known as an agency relationship.

Problems with Agency Relationship:

• Agents are supposed to act in the best interest of the principals, but sometimes they act in their own self-interest instead.
• This can lead to issues like financial misappropriation or using company funds for personal gain.
• Managers might prioritize short-term gains over long-term growth, like overselling products or neglecting market expansion.

Costs of the Agency Relationship:

• Monitoring Costs: Principals incur costs to monitor and control the actions of agents, like preparing financial statements or checking up on activities. This can also involve missing out on potential profits when restricting agent decision-making.
• Bonding Costs: Agents incur costs to assure principals that they'll act in their best interest. This might involve implementing internal controls or hiring independent auditors.
• Residual Costs: These are the remaining costs after factoring in monitoring and bonding costs, reflecting any ongoing inefficiencies or conflicts in the agency relationship.

Tasks and Responsibilities of a Modern Financial Manager 

The tasks and responsibilities of finance managers vary from organisation to organisation depending upon the nature and size of the business, but in spite of these variations the main tasks and responsibilities of a finance manager can be classified as follows: 

1. Compliance with Policies and Regulations:

• Finance managers must adhere to the policies and procedures established by the company's Board of Directors.
• They also ensure compliance with various legal regulations governing financial activities.

2. Information Generation for Stakeholders:

• Finance managers generate and provide financial information to stakeholders such as investors, shareholders, regulators, and internal management.
• This involves preparing financial reports, statements, and forecasts to communicate the company's financial health and performance.

3. Funds Management:

• Acquiring Funds: Finance managers are responsible for ensuring the company has access to adequate funds from appropriate sources and at the right cost and time.
• Allocating Funds: They allocate funds to various projects and activities based on the priorities set by the Board of Directors and the company's strategic objectives.
• Utilizing Funds: They oversee the efficient utilization of funds by making sound investment decisions, managing working capital effectively, and maintaining proper control over assets.

4. Dividend Decision:

• Finance managers determine the amount of dividend to be paid to shareholders, considering factors such as the company's future funding needs for expansion and the prevailing tax policies.

5. Maximization of Shareholder Wealth:

• Finance managers aim to maximize shareholder wealth by making decisions that increase the value of the company's shares.
• They focus on strategies and policies that enhance the company's earnings and future growth prospects.

6. Interpretation and Reporting:

• Finance managers analyze financial data to identify trends, variances, and areas of concern.
• They interpret the financial performance of the company and provide insights to management through reports and presentations.
• They assess the financial impact of variances from established standards and recommend corrective actions as needed.

7. Legal Obligations:

• Finance managers ensure the company complies with all legal and regulatory requirements related to financial reporting, taxation, corporate governance, and accounting practices.
• They oversee the preparation of accurate financial statements and timely submission of tax returns and other regulatory filings.

Overall, finance managers play a critical role in managing the company's financial resources, optimizing profitability, and ensuring compliance with legal and regulatory standards to support the organization's long-term success.