24495170 Financial Management Nature and Scope

Nature of Financial Management

Introduction:

The term ‘nature’ as applied to financial management refers to its relationship with the closely- related fields of economics and accounting, its functions and scope.

The objective of this chapter is to describe the evolving functions and scope of financial management.

Definitions of the Financial Management Different authors have given different definitions of

the financial management which are as follows:1) The ways and means of managing money.

This statement can be further expanded to define F.M. the determination, acquisition, allocation and utilisation of the financial resources with the aim of achieving the goals and objectives of the orgnisation.

1) According to Archer and Ambrosia:“Financial management is the

application of the planning and control functions to the finance functions”.

Scope of the financial management

To understand the scope of the financial management, we must examine the traditional as well as the modern approach of the financial management.

The traditional approach to the financial management is restricted to raising to funds from various sources and completion of the legal formalities required to do the same.

The modern approach to the financial management says that there are three important functions which are expected to be performed by the financial management.

These functions are as follows:

I) How much amount of funds will be required by the firm?

II) How to raise the amount required by the firm? III) How to invest the amount raised so that the

objectives of the financial management as well as the firm will be achieved?

Financing Decision:

As mentioned above ,a finance manager has to perform three important functions:

I) Estimating the requirements of the funds.

II) Raising the funds

III) Investing the funds.

Raising of finance:

A crucial decision that is to be taken by a finance manager is regarding raising of funds. In raising of the funds, a careful consideration is to be given to the mix of owned funds and borrowed funds. The aim should be to achieve a right combination of debt and equity for enhancing the value of the firm.

I) Requirements of funds during long- term and short-term.

II) Deciding about optimum combination of owned funds and borrowed funds for raising the funds.

II) Investing of funds:

After raising the funds , the next important decision that is to be taken is investing of these funds. Investments of funds should be in a well planned manner. Funds raised from various sources are invested in:

Fixed assets, and Working capital.

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Investment in the fixed assets.

Investments in the fixed assets are made with long-term perspective with a objective to enhance the earning capacity.

such investments are generally irreversible and involve heavy amount.

So that this decision regarding the investment in the fixed assets are taken after the proper of cost benefit study.

Investment in working capital

Working capital funds are necessary for day-to-day requirements of the orgnisation.

In every business orgnisation there is a operating cycle; working capital funds are recovered back after some period.

There should not be excessive amount invested in the working capital otherwise the funds will be remain idle.

Dividend Decision.

It is one more important area which requires careful consideration regarding the dividends.

How much amount of profits should be distributed amongst the shareholders and how much amount should be retained for investing in the business will have to be decided by the management.

Several factors are taken into consideration before a dividend decision is to be taken.

Continued...

The following aspects need to be in depth consideration in determining the dividend policy.

(a) Assessing the shareholders expectations.

(b) Determination of dividend payout ratio and retention policy.

(c) Projecting the requirement of the funds for expansion and diversification

proposals.

(d) Considering the impact of the legal constraints on dividend decision.

Functions of the financial management:Functions of the financial management:

The following are the some of the areas in which financial management assumes importance and their functions are as follows:

i) Fund raising:

Raising the right type of funds at the right time and right cost.

ii) Increasing the productivity of the funds;

The preparation of the information for operating executives which will enable them to increase their earning rate on the funds employed.

Functions of the financial management:

To conserve the funds:

To conserve the funds of the orgnisation through such measures as stock or inventory control ,control of credit and debtors balances to minimises the losses that would otherwise occur.

Functions of the financial management:

To plan and evaluate:

To plan and evaluate is in relation to budget for future operations in short- term and long term and in the assessment of the proposed capital expenditure projects.

Continued..

As already explained above, one of the main functions of the financial management is to provide sufficient funds at a reasonable cost, to ensure their profitable use and disposal of surplus in such a manner so as to maximise the wealth of the shareholders.

The nature and structure of a finance department mainly depends upon a number of factors, such as size of the orgnisation, the nature of the business, financing operations, caliber of the finance personnel etc.

Continued.. The Board of Directors decides the financial

decisions . Financial policies are approved by the Board of the Directors. The operational and functional areas are left to the Chief Financial Officer who reports to the Board.

The Board of Directors have the responsibility of ensuring that the overall goals and objectives are achieved and the expectations of the shareholders are fulfilled.

As a general practice, especially in a large concerns, the finance functions are grouped into operational areas of finance and functional areas of the finance.

Continued…

The operational areas of the finance are entrusted to finance executives reporting to treasurer and functional areas of finance are entrusted to the another group of finance officers reporting to the controller.

Both the controller and the treasurer who are responsible for the respective functions report to the Chief Finance Officer or Vice President (Finance) or Head of Finance.

Continued… Thus, the finance functions are broadly classified into

two types:

a) Treasuring functions

b) Control functions

The treasurer is responsible for

The procurement and management of funds, cash management, collection of accounts, credit administration, investment of surplus funds, Short-term financing.

Continued…

The controller is responsible for management and control of assets, and his responsibilities include

--accounting, preparation of financial reports, internal auditing, internal control systems, taxation matters, protection of assets including insurance coverage,etc.

Board of Directors

Managing Directors

Treasurer

Managers

Investment Credit collection

Credit administration

Controller

Managers

Accounting Auditing Protection of the assets

Finance (Director)/C.F.O./Vice-President

Agency problem:

A characteristic feature of the corporate enterprise is the separation between ownership and management as a corollary of which management enjoys substantial autonomy in regard to the affairs of the firm.

Shareholders are the owners of the orgnisation and they have the right to change the management.

The conflicting goals of the management objective of survival and maximising owners wealth can be harmonised.

Agency problem: In order to ensure that management would take

optimal decisions compatible with the shareholders interest of the value maximisation and minimises the agency problems in terms of conflict of interests two remedial measures commend themselves.

i) Provision of appropriate incentives

ii) Monitoring of agents/ managers.

Incentives to the agents;

Incentives to the agents:

The incentives given to the agents/managers are of different types.

some of them are as follows:

i) Stock options:

In this incentives , management having the right to acquire the shares of the enterprise at a concessional price.

ii) Cash bonus:

It is linked to the performance target.

Incentives to the agents;

Perquisites:

Perquisites such as company car, expensive offices and other fringe benefits.

These incentives promote the congruence between the personal goals of management and the interests of the owners/ shareholders.

ii) Monitoring of Agents:

There is a greater need for the monitoring the Agents by the Shareholders. Monitoring can be done by:

i) Auditing the financial statements and limiting decision making by the management.

ii) Bonding the agents.

Implications of various forms of the business orgnisation: Forms of business orgnisation:

i) Sole proprietorship:

This form of the business orgnisation is owned by the single person. A sole proprietorship business and its owner are treated as one and the same and there is no separate existence for the owner from the business. The owner himself is responsible for the losses and at the same time, he himself is entitled for the profits. This form of business orgnisation has the following benefits.

Continued…

A) The owner can start the business with very little legal formalities.

B) The owner can take the decisions connected with the business himself which results into very fast decision-making.

C) The running of the firm can be very smooth as there is no possibility of differences opinion among different persons because of the single owner.

Limitations of the proprietorship business

The personal liability of the owner is unlimited, which means that if assets of the firm are not sufficient to pay off the business liabilities, personal assets of the owner are utilised for the payment of the business debts.

The sole proprietorship firm has no separate status from that of the owner. This means that the business will cease to exist if there is the death of the owner.

The incidence of taxation is very high because personal income and firm’s income are treated separately.

Partnership Firms

A partnership firm is a business by two or more persons. The partnership comes into existence according to the provision of the Indian Partnership Act,1932. The rights, duties and obligations of the partners are also governed by the Partnership Act,1932.

The main advantages of the partnership firm are as follows:

a) Like the sole proprietorship, it is easy for formation and comparatively free form government regulations.

Continued… The partners are coming from the various

backgrounds and therefore, the benefit of their experiences is available for the firm.

However there are certain limitations which are:

a) Unlimited liability of the partners prevents the firm from taking the risk.

b) The firm do not have any perpetual succession and, therefore ,the death, insolvency or retirement of the partner may threaten the very existence of the firm.

Limited Company: A limited company registered under Companies

Act,1956.Limited Companies has some unique features

such as,a) Perceptual succession:

A limited company has perpetual succession which implies that a company has a separate existence from its owners i.e. shareholders.Even though the shareholders are keep changing the existence of the firm is not threatened.

Continued…

b) Limited liability:

The liability of the shareholders are limited .

c) Transferability of the shares:

Subject to the limitations mentioned in the Article of Association, the shares of a limited freely transferable.

A limited company has divides into private and Public Company.

Private company:

A private company is that company which satisfies the following criteria.

i) Minimum number of members are two and maximum numbers of the members are fifty.

ii) No public invitation is allowed for the subscription of shares and debentures.

Public Company:

a) A public limited company is a form of orgnisation that has a minimum of seven

members while there is no restriction on maximum number of members.

b) A public company is allowed to invite the public for subscription to its shares and debentures.

c) There is no any restriction on the transfer of the shares.

Significance of the Financial Management: