Nature, Scope, and Objectives of Financial Management | Commerce & Accountancy Optional Notes for UPSC PDF Download

What Is Financial Management?

Financial management is a vital function within any organization, involving the systematic planning, organizing, controlling, and monitoring of financial resources to achieve organizational goals. It serves as the optimal method for overseeing various financial activities, including fund procurement, fund utilization, accounting, payments, risk assessment, and all aspects related to the effective management of money. 

Objectives of Financial Management

The primary goal of financial management is to effectively handle an organization's finances, ensuring compliance with essential rules and regulations and fostering success in their respective industries. This involves thorough planning and precise execution, leading to enhanced business performance and increased profitability. This underscores the pivotal role played by the finance department and financial managers in any organization.
Consequently, the fundamental objectives of financial management include:

• Securing a consistent and appropriate supply of funds for the organization.
• Ensuring optimal utilization of funds, maximizing their use while minimizing costs.
• Establishing a stable capital structure that maintains a balanced distribution between debt and equity.
• Safeguarding investments by directing funds towards secure ventures to guarantee satisfactory returns.
• Ensuring sufficient returns for both the organization and its shareholders.

Scope of Financial Management

Financial management helps a particular organisation to utilise their finances most profitably. This is achieved via the following two conducts.
The scope of financial management is divided into two categories:

1. Traditional Approach
2. Modern Approach

Let us discuss the two approaches in brief:

Traditional Approach

• The Traditional Approach confines the financial function to the acquisition of funds by corporate organizations to address their financial requirements. The term "procurement" encompasses both external fund-raising and the associated aspects of securing funds.
• Three key elements are utilized for the procurement of finance under this approach:
  • Institutional sources of finance.
  • Issuance of financial instruments to gather necessary funds from the capital market.
  • Legal and accounting relationships between the business and the source of finance.
• In this perspective, finance is deemed necessary not for routine events but for sporadic occurrences such as promotion, reorganization, liquidation, and expansion. Managing funds for these events is considered the most crucial aspect of financial management. In the Traditional Approach, the financial manager is more concerned with maintaining relationships with external parties and financial institutions than with internal financing.
• In this approach, the financial manager is not tasked with ensuring the efficient use of funds but rather with obtaining necessary funds on fair terms from external parties. The Traditional Approach persisted until the fifth decade of the 20th century.

Limitations of the Traditional Approach include:

• One-sided Approach: This approach overly prioritizes the system of procurement and potential issues arising during that process. It lacks a framework for the efficient utilization of procured funds, focusing on external parties and neglecting internal decision-makers. It is often termed an outsider-looking approach.
• Focus on Corporate Enterprise Financial Issues: The Traditional Approach concentrates solely on the financial problems of corporate enterprises, sidelining financial concerns of non-corporate entities like partnership firms and sole traders.
• Emphasis on Sporadic Events: This approach places more importance on fund allocation for sporadic incidents such as business reorganization, incorporations, mergers, consolidation, while neglecting everyday financial issues and working capital financing decisions.

Modern Approach

• By the end of the 1950s, technological advancements, the development of robust corporate structures, and increasing competition necessitated management to optimize the utilization of available natural resources.
• In this modern approach, the financial manager adopts a broader and analytical perspective. Financial management, according to this approach, encompasses both fund acquisition and the efficient utilization of available resources. Fund arrangement is a vital component within the broader scope of the finance function.
• Unlike the traditional approach, the modern approach considers not only sporadic events but also addresses long-term and short-term financial issues. Key components of financial management under this approach include financial planning, evaluating alternative uses of funds, capital budgeting, determining the cost of capital, establishing financial standards for business success, and managing income. Consequently, the finance manager is responsible for three pivotal decisions:
  1. Investment Decision
  2. Financing Decision
  3. Dividend Decision

Let us discuss the three decisions in brief:

Investment Decision

• This decision involves selecting the assets in which funds will be invested by a firm. The acquired assets may be either long-term or short-term.
• The decision to invest funds in long-term assets is referred to as the capital budgeting decision. Capital budgeting is the process of choosing assets or investment proposals that yield returns over the long term.
• On the other hand, the decision to invest funds in short-term assets or current assets is termed working capital management. Working capital management focuses on the administration of current assets, which are highly liquid in nature.

Financing Decision

The financing decision in financial management pertains to identifying potential sources for raising funds from various channels.
There are two main types of financing decisions:

• Financial Planning Decisions: Financial planning decisions aim to estimate the sources and potential applications of accumulated funds. It is crucial to ensure the availability of funds whenever needed. Proper financial planning decisions are essential for effective fund management.
• Capital Structure Decisions: Capital structure decisions involve identifying diverse sources of funds. This process facilitates the selection of optimal external sources for short or long-term financial requirements. The financing decision is directly related to procuring funds at the right time. Once the decision regarding fund requirements is made, the financial manager then evaluates various options for financing, selecting the most cost-effective method to ensure the smooth operation of the business without unnecessary obstacles such as inadequate funds.

Dividend Decision
The dividend decision involves decisions related to the distribution of net profits and is categorized into two components:

• Dividend for Shareholders: This aspect focuses on determining the percentage of the profit earned that will be distributed to the shareholders as dividends. The financial manager plays a crucial role in deciding the amount of dividend to be paid out to shareholders.
• Retained Profits: Retained profits depend on a particular company's expansion and diversification plans. This decision involves determining the portion of profits to be retained within the company for future use, contributing to its growth and development.

The dividend decision is vital as it requires the financial manager to strike a balance between satisfying shareholders and investors by paying out dividends and ensuring the company retains enough funds for future business expansion.