Meaning, Objective & Scope Financial Management.
Meaning of Financial Management
As we know finance is the lifeblood of every business, its management requires special attention. Financial management is that activity of management which is concerned with the planning, procuring and controlling of the firm’s financial resources.
The scope and coverage of financial management have undergone fundamental changes over the last half a century. During 1930s and 1940s, it was concerned of raising adequate funds and maintaining liquidity and sound financial structure. This is known as the ‘Traditional Approach’ to procurement and utilization of funds required by a firm. Thus, it was regarded as an art and science of raising and spending of funds. In the words of Paisco, “In a modern money using economy, finance may be defined as the provision of money at the time it is wanted.” The traditional approach emphasized the acquisition of funds and ignored efficient allocation and constructive use of funds. It does not give sufficient attention to the management of working capital.
During 1950s, the need for most profitable allocation of scarce capital resources was recognized. During 1960s and 1970s many analytical tools and concepts like funds flow statement, ratio analysis, cost of capital, earning per share, optimum capital structure, portfolio theory etc. were emphasized. As a result, a broader concept of finance began to be used. Thus, the modern approach to finance emphasizes the proper allocation and utilization of funds in addition to their economical procurement. Thus, business finance, in the words of Authman and Dongall, may broadly be defined as ” the activity concerned with the planning, raising, controlling and administering of funds used in the business.” Modern business finance includes – (i) determining the capital requirements of the firm. (ii) raisin of sufficient funds to make an ideal or optimum capital structure, (iii) allocating the funds among various types of assets and (iv) financial control so as to ensure efficient use of funds.
The most important area of business finance is the corporation finance because the big business firms require a huge capital which is procured from the market/public. So, an efficient use of funds is very essential. Huge business houses employ expertise to raise and utilize finance from various sources. The corporation finance refers to the planning, raising, administrating and controlling. Thus, it refers to planning, raising, administrating and financing of expansion of business and the financial adjustments.
Objectives of Finance Function
For optimum financial decisions, the objectives of financial management shall be clearly defined. They should be so laid down that they contribute directly towards the achievement of overall business objectives. Objectives provide a normative framework within which a firm is to take decisions. Financing is the functional area of objective of the business and contribute directly towards it. The main objectives of a business are survival and growth. In order to survive ups and downs in the business, the business must earn sufficient profits and it should also maintain proper relations with shareholders, customers, suppliers and other social groups. The financial management of an organisation must seek to achieve the following objectives:
- To ensure adequate and regular supply of funds.
- To provide a fair rate of return to the suppliers of capital viz. shareholders.
- To ensure effective utilization of funds by maintaining proper balance between profitability, liquidity and safety.
- to generate and build up sufficient surplus for expansion and growth through ploughing back of profits.
- To minimize cost of capital by developing a sound capital between various securities issued by the company.
- To coordinate the activities of the finance department with the activities of other departments in the organisation.
Scope of Functions of Financial Management
The finance department of an enterprise performs several functions in order to achieve the above objectives. The scope of finance function is very wide. It consists of the following activities:
Estimating the Requirement of Funds
The finance department must estimate the capital requirements of the firm accurately for long term and short term needs. In estimating the capital requirements of the business, the finance department must take help of the budgets of various activities of the business e.g. sales budget, production budget, expenses budget etc. prepared by the concerned departments. In the initial stage, the estimate is done by promoters but in a growing concern, it is done by the finance department. Unless the financial forecast is correct, business is likely to run into difficulties due to excess or shortage of funds. Correct estimates ensure the availability of funds as and when they are needed. In estimating the requirement of funds, nature and size of the business, modernization and expansion plan should be given due consideration.
Determining the Capital Structure
By capital structure we mean the kind and proportion of different securities for raising the required funds. Once the total requirement of funds is determined, a decision regarding the type of securities to be issued and the relative proportion between them is to be taken. The finance department must determine the proper mix of debt and equity. It should also decide the ratio between long term and short term debts. In determining these ratios, cost of raising finance from different sources, period for which funds are required and several other factors should be considered. A proper balance between risk and returns should be maintained.
Choice of Sources of Finance
A company can raise funds from different sources e.g. shareholders, debenture holders, banks, financial institutions, public deposits etc. Before raising the funds, it has to decide the source from which the funds are to be raised. The choice of the source of finance should be made very carefully by taking a number of factors into account such as cost of raising funds, conditions attached, charge on assets, burden of fixed charges, dilution of ownership and control etc. For example, if the company does not want to dilute the ownership, it will depend on any source of finance other than investment in shares.
Investment of Funds
The funds raised from different sources should be prudently invested in various assets -short term as well as long term to optimize the return on investment. In taking decisions for the investment of long term funds, a careful assessment of various alternatives should be made through capital budgeting, opportunity cost analysis and many other techniques used to evaluate the investment proposals. A part of the long term funds should be invested in working capital of the company. While taking decision for the investment of funds in long term assets, management should be guided by three basic principles, viz. safety, profitability and liquidity. In taking decisions for the investment of funds in working capital, the finance manager must seek cooperation of marketing and production departments in estimating the funds which are to be involved in carrying of inventories in finished product and credit policy of the marketing department and in raw material and factory supplies of the production department.
Management of Cash
It is the prime responsibility of the finance manager to see that an adequate supply of cash is available at proper time for the smooth running of the business. Cash is needed to purchase raw materials, pay off creditors, to pay to workers and to meet the day to day expenses of the business. Availability of cash is necessary to maintain liquidity and credit- worthiness of the business. Excess cash must be avoided as it costs money. It there is any cash in excess, it should be invested in near cash assets such as investments etc. which may be converted into cash within no time. A cash flow statement should be prepared by the department to know the correct need of cash is essential to achieve the goal of profitability and liquidity. The finance manager should decide in advance how much cash he should retain to meet current obligations of the company.
Disposal of Surplus
One of the prime function of the finance department is to allocate the surplus. After paying all taxes, the available surplus of the business can be allocated for three purposes -(a) for paying dividend to the shareholders as a return on their investment, (b) for distributing bonus to workmen and company’s contribution to other profit sharing plans, and (c) for ploughing back of profits for the expansion of business. As far as the second alternative is concerned, the amount to be paid to workers is generally fixed either by statute or by agreement and therefore, there is no problem in allocating surplus for this purpose. But a considerable, attention is to be paid in so far as first and third alternatives are concerned i.e., how much to be paid to shareholders as dividend and how much to be retained in the business. For this purpose factors like the trend of the earning of the company, trend of the market price of its shares; the requirement of funds for the purpose of expansion and future prospects should be considered.
The financial manager is under an obligation to check the financial performance of the funds invested in the business. There are a number of techniques to evaluate the performance viz. Return on Investment (ROI), budgetary control, cost control, internal audit, ratio analysis and break-even point analysis. The financial manager must lay emphasis on financial planning as well.