Nature and scope of Financial Management PDF

Preview

Summary

Learn about the nature and scope of Financial Management...

Description

Financial Management:    

Finance is the lifeline of any business. However, finances, like most other resources, are always limited. On the other hand, wants are always unlimited. Therefore, it is important for a business to manage its finances efficiently.

Introduction to Financial Management:   

Let’s define financial management as the first part of the introduction to financial management. For any business, it is important that the finance it procures is invested in a manner that the returns from the investment are higher than the cost of finance. In a nutshell, financial management –

-

Endeavors to reduce the cost of finance Ensures sufficient availability of funds Deals with the planning, organizing, and controlling of financial activities like the procurement and utilization of funds

Some Definitions “Financial management is the activity concerned with planning, raising, controlling and administering of funds used in the business.” – Guthman and Dougal

“Financial management is that area of business management devoted to a judicious use of capital and a careful selection of the source of capital in order to enable a spending unit to move in the direction of reaching the goals.” – J.F. Brandley

“Financial management is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations.”- Massie

Nature, Significance, and Scope of Financial Management   

Financial management is an organic function of any business. Any organization needs finances to obtain physical resources, carry out the production activities and other business operations, pay compensation to the suppliers, etc. There are many theories around financial management:

1. Some experts believe that financial management is all about providing funds needed by a business on terms that are most favorable, keeping its objectives in mind. 2. Therefore, this approach concerns primarily with the procurement of funds which may include instruments, institutions, and practices to raise funds. 3. It also takes care of the legal and accounting relationship between an enterprise and its source of funds. 4. Another set of experts believe that finance is all about cash. 5. Since all business transactions involve cash, directly or indirectly, finance is concerned with everything done by the business. 6. The third and more widely accepted point of view is that financial management includes the procurement of funds and their effective utilization. 7. For example, in the case of a manufacturing company, financial management must ensure that funds are available for installing the production plant and machinery. Further, it must also ensure that the profits adequately compensate the costs and risks borne by the business.

  

In a developed market, most businesses can raise capital easily. However, the real problem is the efficient utilization of the capital through effective financial planning and control. Further, the business must ensure that it deals with tasks like ensuring the availability of funds, allocating them, managing them, investing them, controlling costs, forecasting financial requirements, planning profits and estimating returns on investment, assessing working capital, etc.

The scope of Financial Management:   

The introduction to financial management also requires you to understand the scope of financial management. It is important that financial decisions take care of the shareholders ‘interests. Further, they are upheld by the maximization of the wealth of the shareholders, which depends on the increase in net worth, capital invested in the business, and plowed-back profits for the growth and prosperity of the organization.



The scope of financial management is explained in the diagram below:



You can understand the nature of financial management by studying the nature of investment, financing, and dividend decisions.

Core Financial Management Decisions:



In organizations, managers in an effort to minimize the costs of procuring finance and using it in the most profitable manner, take the following decisions:

Investment Decisions: Managers need to decide on the amount of investment available out of the existing finance, on a long-term and short-term basis. They are of two types:

-

-

Long-term investment decisions or Capital Budgeting mean committing funds for a long period of time like fixed assets.  These decisions are irreversible and usually include the ones pertaining to investing in a building and/or land, acquiring new plants/machinery or replacing the old ones, etc.  These decisions determine the financial pursuits and performance of a business. Short-term investment decisions or Working Capital Management means committing funds for a short period of time like current assets.  These involve decisions pertaining to the investment of funds in the inventory, cash, bank deposits, and other short-term investments.  They directly affect the liquidity and performance of the business.

Financing Decisions: Managers also make decisions pertaining to raising finance from long-term sources (called Capital Structure) and short-term sources (called Working Capital). They are of two types:

-

-

Financial Planning decisions which relate to estimating the sources and application of funds.  It means pre-estimating financial needs of an organization to ensure the availability of adequate finance.  The primary objective of financial planning is to plan and ensure that the funds are available as and when required. Capital Structure decisions which involve identifying sources of funds.  They also involve decisions with respect to choosing external sources like issuing shares, bonds, borrowing from banks or internal sources like retained earnings for raising funds.

Dividend Decisions: These involve decisions related to the portion of profits that will be distributed as dividend.  

Shareholders always demand a higher dividend, while the management would want to retain profits for business needs. Hence, this is a complex managerial decision.

What is Financial Management:        

Financial Management means applying management principles to manage the financial resources of an organization. It simply involves planning, organizing, directing, and controlling financial operations to manage the finance of an organization efficiently. Financial Management is a methodology that a business implements to monitor and govern its revenue, expenses, and assets in order to maximize profitability and ensure sustainability. Management of finance is a vital part of every business. Finance is termed as the backbone of every business and is required for carrying out each and every activity. Financial management is concerned with efficiently planning the procurement of funds and the utilization of these funds in the business. The finance manager is required to decide the proper capital structure of an organization deciding the optimum mix of debt and equity for raising required funds. Financial management concept ensures that an adequate amount of funds is always available in business from different sources and also it earns the best return on its investments.

Scope of Financial Management:

Investment Decision   

Financial management is involved in managing all investment decisions of an organization. Investment decisions involve risk evaluation, measuring the cost of capital, and estimating benefits expected out of a particular project. Managers are responsible for deciding how available funds should be invested in fixed or current assets to earn optimum returns.

Working Capital Decision    

Taking working capital decisions properly is another important scope of financial management. These decisions are concerned with investment in current assets or current liabilities. Working capital decisions revolve around working capital and short-term financing. Current assets include cash, inventories, receivables, short-term securities, etc. whereas current liabilities include creditors, bank overdraft, bills payable.

Financing Decision   

Financing decisions involves deciding how the required funds should be raised from available long term or short term sources. A financial manager is required to form a proper finance mix or optimum capital structure of the company to raise its value. They are required to maintain a proper balance between equity and debt to provide maximum return to shareholders.

Dividend Decision    

Financial management involves taking all dividend decisions of the company. These decisions involve developing a proper dividend policy regarding the distribution or retaining of company profits. The finance manager should decide an optimum dividend payout ratio out of available profit. He should consider all expansion and growth opportunities available to the organization and should avail them by retaining a proper amount of profit.

Ensures Liquidity   

Maintaining proper liquidity in an organization is another important role played by financial management. The finance manager ensures that there is a regular supply of funds in an organization. He monitors all cash-inflows and cash-outflows and avoids any underflow or overflow like situations.



Ensuring the optimum level of liquidity in an organization is one of the important scopes of financial management.

Profit Management   

Financial management aims at increasing the profit of the company. It works towards reducing the cost of various activities through proper monitoring and setting up proper price policy. The finance manager measures the cost of capital and chooses cheap sources of capital by properly analyzing different sources available.

Nature of Financial Management: Estimates Capital Requirements   

Financial management helps in anticipation of funds required for running the business. It estimates working and fixed capital requirements for carrying out all business activities. The finance manager prepares a budget of all expenses and revenues for a particular time period on the basis of which capital requirements are determined.

Decides Capital Structure   

Deciding optimum capital structure for an organization is a must for attaining efficiency and earning better profits. It involves deciding the proper portion of different securities like common equity, preferred equity, and debt. The proper balance between debt and equity should be attained which minimizes the cost of capital.

Select Sources of Fund   

Choosing the source of funds is one of the crucial decisions for every organization. There are various sources available for raising funds like shares, bonds, debentures, venture capital, financial institutions, retained earnings, owner investment, etc. Every business should properly analyze different sources of funds available and choose one which is cheapest and involves minimal risk.

Selects Investment Pattern

  

Once funds are procured it is important to allocate them among profitable investment avenues. The investment proposal should be properly analyzed regarding its safety, profitability, and liquidity. Before investing any amount in it all risk and return associated with it should be properly evaluated.

Raises Shareholders Value   

Financial management works towards raising the overall value of shareholders. It aims at increasing the amount of return to shareholders by reducing the cost of operations and increasing the profits. The finance manager focuses on raising cheap funds from different sources and invest them in the most profitable avenues.

Management of Cash   

Financial management monitors all funds movement in an organization. Finance managers supervise all cash movements through proper accounting of all cash inflows and outflows. They ensure that there is no situation like deficiency or surplus of cash in an organization.

Apply Financial Controls   

Implying financial controls in business is a beneficial role played by financial management. It helps in keeping the company actual cost of operation within the limit and earning the expected profits. There are various processes involved in this like developing certain standards for business in advance, comparing the actual cost or performance with pre-established standards, and taking all required remedial measures.

Conclusion of Financial Management:    

Applying management principles to manage the financial resources Finance is termed as the backbone of every business It involves planning, organizing, directing and controlling of financial operations to Manage Covers the Fundamentals of Strategic Financial Management...