Financial Management

Meaning of Financial Management

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.

Definitions of financial managementAccording to Solomon, Financial management is concerned with the efficient use of an important economic resource, namely, capital funds. According to Weston & Brigham, Financial management is an area of financial decision making harmonizing individual motives & enterprise goals.

Definitions of financial management:Financial Management can be defined as The management of the finances of a business / organization in order to achieve financial objectives

Financial management is that managerial activity which is concerned with the planning and controlling of the firms financial resources

Introduction

FM may be defined as the art & science of managing money. Relationship of financial management and other supportive disciplines is:Shareholder wealth maximizationSupportSupportResulting inFinancial Decision AreasInvestment analysisWorking Capital ManagementSources and cost of fundsDetermination of capital structureDividend PolicyAnalysis of risk and returnsPrimary DisciplinesAccountingMacroeconomicsMicroeconomicsOther Related DisciplinesMarketing ProductionQuantitative methods

Scope of financial management

Investment decisions includes investment in fixed assets (called as capital budgeting). Investment in current assets are also a part of investment decisions called as working capital decisions. Financial decisions - They relate to the raising of finance from various resources which will depend upon decision on type of source, period of financing, cost of financing and the returns thereby. Dividend decision - The finance manager has to take decision with regards to the net profit distribution. Net profits are generally divided into two: Dividend for shareholders- Dividend and the rate of it has to be decided. Retained profits- Amount of retained profits has to be finalized which will depend upon expansion and diversification plans of the enterprise.

Objectives (or) Goals of Financial ManagementThe main objective of a business is to maximize the owners economic welfare. This objective can be achieved by;

Profit maximization

Wealth maximization

1. Profit Maximization.Profit earning is the main aim of every economic activity. A business being an economic institution must earn profit to cover its costs and provide funds for growth. No business can survive without earning profit. Profit is a measure of efficiency of a business enterprise.Profits also serve as a protection against risks which cannot be ensured. The accumulated profits enable a business to face risks like fall in prices, competition from other units, adverse government policies etc. Thus, profit maximization is considered as the main objective of business.

The following arguments are advanced in favour of profit maximization as the objective of business:1. When profit-earning is the aim of business then profit maximization should be the obvious objective.2. Profitability is a barometer for measuring efficiency and economic prosperity of a business enterprise3. Economic and business conditions do not remain same at all times. There may be adverse business conditions like recession, depression, severe competition etc. A business will be able to survive under unfavorable situation, only if it has some past earnings to rely upon. Therefore, a business should try to earn more and more when situation is favorable.4. Profits are the main sources of finance for the growth of a business. So, a business should aim at maximization of profits for enabling its growth and development.

5. Profitability is essential for fulfilling social goals also. A firm by pursuing the objective of profit maximization also maximizes socio-economic welfare. However, profit maximization objective has been criticized on many grounds. They are: A firm pursuing the objective of profit maximization starts exploiting workers and the consumers. Hence, it is immoral and leads to a number of corrupt practices.It is also argued that profit maximization should be the objective in the conditions of perfect competition and in the wake of imperfect competition today, it cannot be the legitimate objective of a firmOne has to reconcile the conflicting interests of all the parties connected with the firm. Thus, profit maximization as an objective of financial management has been considered inadequate. Even as an operational criterion for maximizing owners economic welfare

Profit maximization has been rejected because of the following drawbacks;1. The term profit is vague and it cannot be precisely defined. It means different things for different people. Should we consider short-term profits or long-term profits? Does it mean total profits or earnings per share? Even if, we take the meaning of profits as earnings per share and maximize the earnings per share, it does not necessarily mean increase in the market value of share and the owners economic welfare.2. Profit maximization objective ignores the time value of money and does not consider the magnitude and timing of earnings. It treats all earnings as equal when they occur in different periods. It ignores the fact that cash received today is more important than the same amount of cash received after, three years.3. It does not take into consideration the risk of the prospective earnings stream. Some projects are more risky than other.4. The effect of dividend policy on the market price of shares is also not considered in the objective of profit maximization.

2. Wealth Maximization. Wealth maximization is the appropriate objective of an enterprise. When the firm maximizes the stockholder's wealth, the individual stockholder can use this wealth to maximize his individual utility. It means that by maximizing stockholder's wealth the firm is operating consistently towards maximizing stockholder's utility.

A stockholder's current wealth in the firm is the product of the number of shares owned, multiplied with the current stock price per share.This objective helps in increasing the value of shares in the market. The share's market price serves as a performance index or report card of its progress. It also indicates how well management is doing on behalf of the shareholder.However, the maximization of the market price of the shares should be in the long run. Every financial decision should be based on cost-benefit analysis. If the benefit is more than the cost, the decision will help in maximizing the wealth.

Implications of Wealth maximization. There is a rationale in applying wealth maximizing policy as an operating financial management policy. It serves the interests of suppliers of loaned capital, employees, management and society. Besides shareholders, there are short-term and long-term suppliers of funds who have financial interests in the concern. Wealth maximization objective not only serves shareholders interests by increasing the value of holdings but ensures security to lenders also. The economic interest of society is served if various resources are put to economical and efficient use.

Criticism of Wealth Maximization. The wealth maximization objective has also been criticized by certain financial theorists mainly on following accounts;1. It is a prescriptive idea. The objective is not descriptive of what the firms actually do.2. The objective of wealth maximization is not necessarily socially desirable.3. There is some controversy as to whether the objective is to maximize the stockholders wealth or the wealth of the firm which includes other financial claimholders such as debenture holders, preferred stockholders, etc.,

4. The objective of wealth maximization may also face difficulties when ownership and management are separated as is the case in most of the large corporate form of organizations.In spite of all the criticism, we are of the opinion that wealth maximization is the most appropriate objective of a firm and the side costs in the form of conflicts between the stockholders and debenture holders, firm and society and stock holders and managers can be minimized

Other Objectives of Financial Management

To ensure regular and adequate supply of funds to the concern.

To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price of the share, expectations of the shareholders.

To ensure optimum funds utilization. Once the funds are procured, they should be utilized in maximum possible way at least cost.

To ensure safety on investment, i.e., funds should be invested in safe ventures so that adequate rate of return can be achieved.

To plan a sound capital structure-There should be sound and fair composition of capital so that a balance is maintained between debt and equity capital.

Functions of Financial Management

Estimation of capital requirementsDetermination of capital compositionChoice of sources of fundsInvestment of fundsDisposal of surplusManagement of cashFinancial controls

Functions of Financial Management

Estimation of capital requirements: A finance manager has to make estimation with regards to capital requirements of the company. This will depend upon expected costs and profits and future programmes and policies of a concern. Estimations have to be made in an adequate manner which increases earning capacity of enterprise. Determination of capital composition: Once the estimation have been made, the capital structure have to be decided. This involves short- term and long- term debt equity analysis. This will depend upon the proportion of equity capital a company is possessing and additional funds which have to be raised from outside parties.

Functions of Financial Management (conti)Choice of sources of funds: For additional funds to be procured, a company has many choices like- Issue of shares and debentures Loans to be taken from banks and financial institutions Public deposits to be drawn like in form of bonds. Choice of factor will depend on relative merits and demerits of each source and period of financing. Investment of funds: The finance manager has to decide to allocate funds into profitable ventures so that there is safety on investment and regular returns is possible.

Functions of Financial Management (conti)Disposal of surplus: The net profits decision have to be made by the finance manager. This can be done in two ways: Dividend declaration - It includes identifying the rate of dividends and other benefits like bonus. Retained profits - The volume has to be decided which will depend upon expansion, innovational, diversification plans of the company. Management of cash: Finance manager has to make decisions with regards to cash management. Cash is required for many purposes like payment of wages and salaries, payment of electricity and water bills, payment to creditors, meeting current liabilities, maintenance of enough stock, purchase of raw materials, etc. Financial controls: The finance manager has not only to plan, procure and utilize the funds but he also has to exercise control over finances. This can be done through many techniques like ratio analysis, financial forecasting, cost and profit control, etc.

Finance Functions

Investment DecisionEvaluation of new investment in terms of profitability Comparison of cut off rate against new investment and prevailing investment. Financial DecisionDividend DecisionLiquidity Decision

Role of a Financial Manager A financial manger is a person who takes care of all the important financial functions of an organization. The person in charge 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.Role of financial manager:Raising of FundsAllocation of FundsProfit PlanningUnderstanding Capital Markets