Financial management

Define financial management Involves the planning, directing, monitoring, organizing, and controlling of the monetary resources of an organization.

Discuss the functions and scope of financial management 1st. Scope of financial management

1.Estimating the financial requirement: on the basis of their forecast of the volume of business operations of the company, the finance executives have to estimate the amount of fixed capital and working capital required in a given period of time

2. Determining the structure of capitalization: after estimating the requirement of capital, the finance executives have to decide about the composition of capital. They have to determine the relative proportion of owner’s risk, capital and borrowed capital. These decisions have to be taken in the light of cost of raising form different resources, period for which funds are needed and several others factors.

3. Investment decision: the funds raised from different resources are to be intelligently invested in various assets so as to optimize their return of investment. While making investment decision, management should be guided by three important principles-safety, liquidity and profitability.

4. Management of cash flows: - Cash is needed to pay off creditors, for purchase of materials, pay labor and to meet everyday expenses. These should not be shortage of cash at any time as it will damage credit- worthiness of the company. These should not be access cash them required because money has time value.

5. Management of earnings: - The finance executive has to decide about the allocation of earnings among several competitive needs. A certain amount of total earnings may be kept as reserve or a portion of earnings may be distributed among and ordinary and preference share holders, yet another portion may be ploughed back or re-invested. The finance executives must consider the merits and de-merits of alternative schemes of utilizing the funds generating from the companies own earnings.

6. Choice of sources of finance: - The management can raise finance from various sources like share holders, banks and others financial distributors finance executives has to evaluate each source over method of finance and choose the best source. Financial management is the new branch of accounting that deals with the acquisition of financial resources & management of them.

2nd. Functions of financial management

First. Investment Decisions: To survive and grow, all organizations must be innovative. Innovation demands managerial proactive actions. Proactive organization’s continuously search for innovative ways of performing the activities of the organization. Innovation is wider in nature. It could be expansion through entering into new markets, adding new products to its product mix, performing value added activities to enhance the customer satisfaction, or adopting new technology that would drastically reduce the cost of production or rendering services or mass production at low cost or restructuring the organization to improve productivity. All these will change the profile of an organization. These decisions are strategic because, they are risky but if executed successfully with a clear plan of action, they generate super normal growth to the organization. If the management errs in any phase of taking these decisions and executing them, the firm may become bankrupt. Therefore, such decisions will have to be taken after taking into account all facts affecting the decisions and their execution. Two critical issues to be considered in these decisions are: 1.Evaluation of expected profitability of the new investments. 2. Rate of return required on the project. The rate of return required by investor is normally known by hurdle rate or cutoff rate or opportunity cost of capital. After a firm takes a decision to enter into any business or expand it’s existing business, plans to invest in buildings, machineries etc. are conceived and executed. The process involved is called Capital Budgeting. Capital Budgeting decisions demand considerable time, attention and energy of the management. They are strategic in nature as the success or failure of an organization is directly attributable to the execution of capital budgeting decisions taken. Investment decisions are also known as Capital Budgeting Decisions. Capital Budgeting decisions lead to investment in real assets Dividends are payouts to shareholders. Dividends are paid to keep the shareholders happy. Dividend policy formulation requires the decision of the management as to how much of the profits earned will be paid as dividend. A growing firm may retain a large portion of profits as retained earnings to meet its needs of financing capital projects. Here, the finance manager has to strike a balance between the expectation of shareholders on dividend payment and the need to provide for funds out of the profits to meet the organization’s growth. Second. Financing Decisions: Financing decisions relate to the acquisition of funds at the least cost. Here cost has two dimensions viz explicit cost and implicit cost. Explicit cost refers to the cost in the form of coupon rate, cost of floating and issuing the securities etc. Implicit cost is not a visible cost but it may seriously affect the company’s operations especially when it is exposed to business and financial risk. For example, implicit cost is the failure of theorganization to pay to its lenders or debenture holders loan installments on due date on account of fluctuations in cash flow attributable to the firms business risk. A company which employs debt as a means of financing normally faces this risk especially when its operations are exposed to high degree of business risk. In all financing decisions a firm has to determine the proportion of equity and debt. The composition of debt and equity is called the capital structure of the firm. Debt is cheap because interest payable on loan is allowed as deductions in computing taxable income on which the company is liable to pay income tax Another thing notable in this connection is that the firm cannot avoid its obligation to pay interest and loan installments to its lenders and debentures. On the other hand, a company does not have any obligation to pay dividend to its shareholders. A company enjoys absolute freedom not to declare dividend even if its profitability and cash positions are comfortable. However, shareholders are one of the stakeholders of the company. They are in reality the owners of the company. Therefore well managed companies cannot ignore the claim of shareholders for dividend. Dividend yield is an important determinant for stock prices. Dividend yield refers to dividend paid with reference to the market price of the shares of the company. An investor in company’s shares has two objectives for investing: 1. Income from Capital appreciation (i.e. Capital gains on sale of shares at market price) 2. Income from dividends. It is the ability of the company to give both these incomes to its shareholders that determines the market price of the company’s shares. The most important goal of financial management is maximisation of net wealth of the shareholders. Therefore, management of every company should strive hard to ensure that its shareholders enjoy both dividend income and capital gains as per the expectation of the market. Third. . Dividend Decisions Dividend yield is an important determinant of an investor’s attitude towards the security (stock) in his portfolio management decisions. But dividend yield is the result of dividend decision. Dividend decision is a major decision made by a finance manager. It is the decision on formulation of dividend policy. Since the goal of financial management is maximisation of wealth of shareholders, dividend policy formulation demands the managerial attention on the impact of its policy on dividend on the market value of the shares. Optimum dividend policy requires decision on dividend payment rates so as to maximize the market value of shares. The payout ratio means what portion of earnings per share is given to the shareholders in the form of cash dividend. In the formulation of dividend policy, management of a company must consider the relevance of its policy on bonus shares. Dividend policy influences the dividend yield on shares. Since company’s ratings in the Capital market have a major impact on its ability to procure funds by issuing securities in the capital markets, dividend policy, a determinant of dividend yield has to be formulated having regard to all the crucial elements in building up the corporate image. The following need adequate consideration in deciding on dividend policy: 1. Preferences of share holders Do they want cash dividend or Capital gains? 2. Current financial requirements of the company 3. Legal constraints on paying dividends. 4. Striking an optimum balance between desires of share holders and the company’s funds requirements. Fourth. Liquidity Decision Liquidity decisions are concerned with Working Capital Management. It is concerned with the day to day financial operations that involve current assets and current liabilities. The important element of liquidity decisions are: 1) Formulation of inventory policy 2) Policies on receivable management. 3) Formulation of cash management strategies 4) Policies on utilization of spontaneous finance effectively. Fifth. Organization Of Finance Function Financial decisions are strategic in character and therefore, an efficient organizational structure is required to administer the same In all organizations CFOs play an important role in ensuring proper reporting based on substance to the stake holders of the company. Because of the crucial role these functions play, finance functions are organized directly under the control of Board of Directors. For the survival of the firm, there is a need to ensure both long term and short term financial solvency. Failure to achieve this will have its impact on all other activities of the firm. Weak functional performance by financial department will weaken production, marketing and HR activities of the company. The result would be the organization becoming anemic. Once anemic, unless crucial and effective remedial measures are taken up it will pave way for corporate bankruptcy..