FINANCIAL MANAGEMENT

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1 FINANCIAL MANAGEMENT Question 1: What is financial management? Explain the functions of financial management. (May 13, Nov 11) (Mark 7) Answer: Financial management is that specialized activity which is responsible for obtaining and affectively utilizing the funds for the efficient functioning of the business and, therefore, it includes financial planning, financial administration and financial control. The following are the functions of Financial Management: 1. 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. 2. Determination of capital composition: Once the estimation has 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. 3. 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. 4. 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. 5. 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. 6. 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. 7. 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. Question 2: Describe the role of financial manager. (May 13, Nov 11) (Mark 7) Answer: The financial manager plays an important role in the functional areas of finance. The assignments of finance functions to the financial manager depend upon size of the business enterprise. The larger the business enterprise- the greater degree of specialization of tasks is needed. The financial manager is the key persons in any business enterprise.

2 The following are the role / functions of a Financial Manager: 1. FINANCING AND INVESTING: The financial manager performs the financing and investing function of an enterprise. He supervises the cash and other holding of the firm. He arranges for raising additional funds as per the requirement of the enterprise. 2. FINANCIAL ANALYSIS: Financial manager makes analysis of financial condition of the firm. Financial analysis ensures the effective and smooth functioning of any enterprise. Financial analysis is made to judge the propriety of the trend of share market prices, etc. 3. DIVIDEND DECISIONS: The financial manager takes dividend decision. For taking decisions in respect of dividend, the following factors are considered-availability of cash, tax position of the share-holders, trend of earnings, etc. 4. ACCOUNTING AND CONTROL: The financial manager arranges for the maintenance of financial records. He controls the financial activities of the enterprise. He identifies deviations from planned and efficient financial activities. 5. FORECASTING AND LONG-RUN PLANNING: The finance manager forecasts costs and technological changes. He studies the market conditions and forecasts the funds needed for investment. He calculated the estimated returns on proposed investment project and forecasts about the demand for the products of the enterprise. 6. CASH MANAGEMENT: The financial manager arranges for cash management of the enterprise. Through cash management, he ensures the supply of funds to the different dept. of the enterprise. The financial manager arranges for the adequate supply of cash to all sections of the enterprise for its smooth flow of operations. 7. DECISION REGARDING CAPITAL STRUCTURE: The financial manager takes decision regarding capital structure of the firm. Capital structure indicates the proper mix of different sources of capital. He tries to maintain proper balances between the long-run funds and shorts-run funds. 8. EVALUATION OF FINANCIAL PERFORMANCE: The financial manager evaluates the financial performance for the analysis of financial performance of the enterprise. The financial manager constantly reviews the financial performance to assess the financial health of the business enterprise. The financial manager helps the management to take different decision on the result of the evaluation of the financial performances. Question 3: What are the objectives of financial management? (May 13) (Mark 7) Answer: The main financial objective of the managers of a business is to maximise its value to its owners. To ensure that they have the right balance, managers set objectives in a number of areas, that affect the value of the business: Maximization of Profit: Profit maximization is a term which denotes profit to be earned by the organization in a given time period. The term profit can be used in two senses once is the owner oriented concept and other as the operational concept. Profit in the owner oriented concept refers to the amount of net profit which goes in the form of dividend to the shareholders. Profit in the operational concept means profitability which is an indicator of economic efficiency of the enterprise.

3 Wealth Maximization: Wealth Maximization is also called Value Maximization The wealth or net present worth of course of action is the difference between gross present worth and the amount of capital investment required to achieve the benefits. Gross present worth represents the present value of expected cash benefits.. In simple Wealth Maximization means maximizing the present value of a course of action(npv=gpv OF BENEFITS INVESTMENT).The significance of Wealth Maximization is that along with the share holders it takes care of Lenders or Creditors, Workers or Employees, Public or Society, Management or Employer. Other objectives are: 1. Liquidity Is the ability of an organisation to pay its short-term obligations as they fall due. A business must have sufficient cash flow to meet financial obligations or convert current assets into cash quickly. Planning cash flow is essential in this goal. 2. Profitability Is the ability of an organisation to maximise its profits. Profits satisfy owners and shareholders and are important for long term sustainability. 3. Efficiency Is the ability of an organisation to minimise its costs and manage its assets so that maximum profit is achieved with the lowest possible level of assets. Control measures are essential here 4. Growth An important aspect of profit maximisation is the ability of an organisation to maintain profits in the longer term. To do this growth is essential, and growth is the ability of the organisation to increase its size in the longer term. 5. Return on Capital Is the amount of profit returned to owners or shareholders as a percentage of their capital contribution. Owners have expectation profits will be maximised such that they can receive a share of them. Managers will set different objectives on the return on capital for different projects depending on the risk associated. Question 4: Define financial management and explain scope of financial management. (Nov 11) (Mark 7) Answer: We already saw financial management. The scopes of Financial Management are: 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. 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.

4 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. 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. 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. Financial Controls 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. Question 5: What are the sources of finance for any organization? (Nov 11) (Mark 7) Answer: Sources of financing a business are classified based on the time period for which the money is required. Time period are commonly classified into following three: Long Term Sources of Finance: Long term financing means capital requirements for a period of more than 5 years to 10, 15, 20 years or may be more depending on other factors. Capital expenditures in fixed assets like plant and machinery, land and building etc of a business are funded using long term sources of finance. Part of working capital which permanently stays with the business is also financed with long term sources of finance. Long term financing sources can be in form of any of them: Share Capital or Equity Shares Preference Capital or Preference Shares Retained Earnings or Internal Accruals Debenture / Bonds

5 Term Loans from Financial Institutes, Government, and Commercial Banks Venture Funding Asset Securitization International Financing by way of Euro Issue, Foreign Currency Loans, ADR, GDR etc. Medium Term Sources of Finance: Medium term financing means financing for a period between 3 to 5 years. Medium term financing is used generally for two reasons. One, when long term capital is not available for the time being and second, when deferred revenue expenditures like advertisements are made which are to be written off over a period of 3 to 5 years. Medium term financing sources can in the form of one of them: Preference Capital or Preference Shares Debenture / Bonds Medium Term Loans from Financial Institutes Government, and Commercial Banks Lease Finance Hire Purchase Finance Short Term Sources of Finance: Short term financing means financing for period of less than 1 year. Need for short term finance arises to finance the current assets of a business like inventory of raw material and finished goods, debtors, minimum cash and bank balance etc. Short term financing is also named as working capital financing. Short term finances are available in the form of: Trade Credit Short Term Loans like Working Capital Loans from Commercial Banks Fixed Deposits for a period of 1 year or less Advances received from customers Creditors Payables Factoring Services Bill Discounting etc. Question 6: What is the significance of Financial Planning? (Nov 11) (Mark 7) Answer: Financial Planning is process of framing objectives, policies, procedures, programmes and budgets regarding the financial activities of a concern. This ensures effective and adequate financial and investment policies. The importance can be outlined as- 1. Adequate funds have to be ensured. 2. Financial Planning helps in ensuring a reasonable balance between outflow and inflow of funds so that stability is maintained. 3. Financial Planning ensures that the suppliers of funds are easily investing in companies which exercise financial planning. 4. Financial Planning helps in making growth and expansion programmes which helps in long-run survival of the company. 5. Financial Planning reduces uncertainties with regards to changing market trends which can be faced easily through enough funds. 6. Financial Planning helps in reducing the uncertainties which can be a hindrance to growth of the company. This helps in ensuring stability and profitability in concern.

INTRODUCTION TO FINANCIAL MANAGEMENT

INTRODUCTION TO 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