Financial Management

Unit – I Meaning – Objective and Importance of Finance – Source of Finance – Function

of Financial Management – Role of Financial Manager in Financial Management.

Meaning of Finance: -
Finance means arising and allocation of funds or money. It is an art and science of
managing money. It often defined simply as the management of Money. It is considered
as the life blood of the business.

Allocation Finance
Arising of
Money of Money

Management of Money

What is Finance?
Finance is the science of funds management. It includes savings money and often
includes lending money. The field of finance deals with the concepts of time, money and
risk and how they are interrelated. It also deals with how money is spent and budgeted.
What is meant by Financial Management?
It means to Plan and control the finance of the company. It is done to achieve the
objectives of the company. It is concerned with raising financial resources and their
effective utilization towards achieving the organizational goals. It refers to the
management of flow of funds in the firm.

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Definition of Financial Management.

Solomon: Financial Management is concerned with the efficient use of an importance
economic resource, namely capital funds.
J. L. Massie: Financial Management is the operational activity of a business that is
responsible for obtaining effectively utilizing the funds necessary for efficient operations.
Archer and Ambrosio: Financial Management is the application of the planning and
control function to the finance function.
Objectives of Financial Management: -
• Profit Maximization: Earning profit is the ultimate aim of any economic activity.
Business decision should enhance the profit of the business. Business decision such
as merger, financial collaboration entry into new areas and raising of capital should
be analyzed for profit.
• Wealth Maximization: It is more effective term representing the goal of financial
management. The concept of shareholder wealth is considered to be broader than
profit. Shareholders wealth can be calculated by the following formula:
Shareholders wealth = No. of shares held x Market price of shares.
Finance Manager is required to take all the decisions that lead to increase in
the market value of the shares. Shareholders wealth increase with all such
decisions that create positive NPV (Net Present Value).
• Proper estimation of total financial requirements: Proper estimation of total
financial requirements is a very important objective of financial management. The
finance manager must estimate the total financial requirements of the company. He
must find out how much finance is required to start and run the company. He must
find out the fixed capital and working capital requirements of the company. His
estimation must be correct. If not, there will be shortage or surplus of finance.
Estimating the financial requirements is a very difficult job. The finance manager
must consider many factors, such as the type of technology used by company,
number of employees employed, scale of operations, legal requirements, etc.
• Proper mobilization: Mobilization (collection) of finance is an important objective
of financial management. After estimating the financial requirements, the finance
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manager must decide about the sources of finance. He can collect finance from
many sources such as shares, debentures, bank loans, etc. There must be a proper
balance between owned finance and borrowed finance. The company must borrow
money at a low rate of interest.
• Proper utilization of finance: Proper utilization of finance is an important objective
of financial management. The finance manager must make optimum utilization of
finance. He must use the finance profitable. He must not waste the finance of the
company. He must not invest the company's finance in unprofitable projects. He
must not block the company's finance in inventories. He must have a short credit
period.
• Maintaining proper cash flow: Maintaining proper cash flow is a short-term
objective of financial management. The company must have a proper cash flow to
pay the day-to-day expenses such as purchase of raw materials, payment of wages
and salaries, rent, electricity bills, etc. If the company has a good cash flow, it can
take advantage of many opportunities such as getting cash discounts on purchases,
large-scale purchasing, giving credit to customers, etc. A healthy cash flow
improves the chances of survival and success of the company.
• Survival of company: Survival is the most important objective of financial
management. The company must survive in this competitive business world. The
finance manager must be very careful while making financial decisions. One wrong
decision can make the company sick, and it will close down.
• Creating reserves: One of the objectives of financial management is to create
reserves. The company must not distribute the full profit as a dividend to the
shareholders. It must keep a part of it profit as reserves. Reserves can be used for
future growth and expansion. It can also be used to face contingencies in the future.
• Proper coordination: Financial management must try to have proper coordination
between the finance department and other departments of the company.
• Create goodwill: Financial management must try to create goodwill for the
company. It must improve the image and reputation of the company. Goodwill
helps the company to survive in the short-term and succeed in the long-term. It also
helps the company during bad times.

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• Increase efficiency: Financial management also tries to increase the efficiency of all
the departments of the company. Proper distribution of finance to all the
departments will increase the efficiency of the entire company.
• Financial discipline: Financial management also tries to create a financial discipline.
Financial discipline means: -

To invest finance only in productive areas. This will bring high returns (profits)
to the company.

To avoid wastage and misuse of finance.

• Reduce cost of capital: Financial management tries to reduce the cost of capital.
That is, it tries to borrow money at a low rate of interest. The finance manager must
plan the capital structure in such a way that the cost of capital it minimized.
• Reduce operating risks: Financial management also tries to reduce the operating
risks. There are many risks and uncertainties in a business. The finance manager
must take steps to reduce these risks. He must avoid high-risk projects. He must
also take proper insurance.
• Prepare capital structure: Financial management also prepares the capital
structure. It decides the ratio between owned finance and borrowed finance. It
brings a proper balance between the different sources of. capital. This balance is
necessary for liquidity, economy, flexibility and stability.

Importance of Financial Management: -

• Financial Planning: Financial management helps to determine the financial
requirement of the business concern and leads to take financial planning of the
concern. Financial planning is an important part of the business concern, which
helps to promotion of an enterprise
• Acquisition of Funds: Financial management involves the acquisition of required
finance to the business concern. Acquiring needed funds play a major part of the
financial management, which involve possible source of finance at minimum cost.
• Proper Use of Funds: Proper use and allocation of funds leads to improve the
operational efficiency of the business concern. When the finance manager uses the

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funds properly, they can reduce the cost of capital and increase the value of the
firm.
• Financial Decision: Financial management helps to take sound financial decision in
the business concern. Financial decision will affect the entire business operation of
the concern. Because there is a direct relationship with various department
functions such as marketing, production personnel, etc.
• Improve Profitability: Profitability of the concern purely depends on the
effectiveness and proper utilization of funds by the business concern. Financial
management helps to improve the profitability position of the concern with the
help of strong financial control devices such as budgetary control, ratio analysis
and cost volume profit analysis.
• Increase the Value of the Firm: Financial management is very important in the field
of increasing the wealth of the investors and the business concern. Ultimate aim of
any business concern will achieve the maximum profit and higher profitability
leads to maximize the wealth of the investors as well as the nation.
• Promoting Savings: Savings are possible only when the business concern earns
higher profitability and maximizing wealth. Effective financial management helps
to promoting and mobilizing individual and corporate savings.
Source of Funds: -

Source of Funds

Short Term Finance Long Term Finance

1. Trade Credit 1. Shares

2. Bank Credit 2. Retained Earnings

3. Customers Advances 3. Debeentures

4. Instalment Credit 4. Public Deposits
5.Commercial Paper 5. Loan from Financial Instituttions

6. Depreciation Fund 6. Lease Financing

7. Provision for Taxation 7. Venture Capital Financing
8. Outstanding Expenses 8. Hire Purchase Financing
9. Debt Securitsartion
10. Interenational Financing

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Introduction
Finance is the life blood of firm. The firm cannot have smooth sailing unless it has
sufficient financed funds to meet its working capital and fixed capital requirements.
Funds that are required for a period of one year or less than one year to meet working
capital needs are known as short term funds. Funds which are needed for a period of
more than one year to meet fixed capital requirements are known as long term funds.
They are sometimes, classified as (i) Medium term funds and (ii) Long term funds. The
former category includes funds required for a period between one to five years, while
the latter category includes funds required for a period exceeding five years. In this let
us discuss the various sources of finance/funds that are available to the firm.
Short term Finance
After establishment of the firm, funds are required to meet its day-to-day expenses. For
example, raw materials must be purchased at regular intervals, workers must be paid
wages regularly; water and power charges have to be paid regularly. Thus, there is a
continuous necessity of liquid cash to be available for meeting these expenses. For
financing such requirements, short term funds are needed. The availability of short-term
funds is essential. Inadequacy of short-term funds may even lead to closure of firm.
Purpose of Short-term Finance
Short term Finance serves following purposes:
(a) It facilitates the smooth running of business operations by meeting day to day
financial requirements
(b) It enables firms to hold stock of raw materials and finished product.

(C) With the availability of short-term finance, goods can be sold on credit. Sales are for
a certain period and collection of money from debtors takes time. During this time gap,
production continues and money will be needed to finance various operations of the
business.
(d) Short term finance becomes more essential when it is necessary to increase the volume
of production at a short notice.

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(e) Short term funds are also required to allow flow of cash during the operating cycle.
Operating cycle, as explained earlier, refers to the time gap between commencement of
production and realization of the sales.
Sources of Short-term Finance
Following are the major sources of short-term finance available to the firm:
1. Trade Credit

2. Bank Credit
3. Customers' Advances
4. Instalment Credit
5. Commercial Paper
6. Depreciation Fund
7. Provision for Taxation
8. Outstanding Expenses
1. Trade Credit: Trade credit represents credit extended by the suppliers of goods in the
normal course of business. The usual duration of credit is 15 to 90 days. It is granted to
the firm on 'Open accounts' without any security except that of the goodwill and financial
standing of purchaser. No interest is expressly charged for this. Only the price is a little
higher than the cash price.
Advantages
(a) It is more advantageous to purchase goods on an open- book account in comparison
with the payment of cash at the time of making purchases viz, at the time of taking
delivery.

(b) It is a 'Spontaneous' source of financing compared to other sources of financing

because in other cases, there is a lead time to arrange the funds and that is why it is a
more flexible means of financing.

(c) It is advantageous to small firms that have difficulty in getting credit elsewhere or
cannot get at all.
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(d) There is no need of creating any sort of charge against firm's assets for getting the
trade credit.
Disadvantages
(a) The cost of trade credit may be necessarily very high when all factors are considered.
While determining the selling price of product to be sold, the seller takes into account the
interest, the risk and the inconvenience attached with supplying goods on credit. As a
matter of fact, many firms like to go in for other sources of short-term finance in order to
enable them to avail the benefit of cash discount.
(b) The trade credit facility may induce a firm to overtrading which may later prove to
be disastrous for the firm.
2. Bank Credit: Commercial banks grant short term finance to business firms which is
known as bank credit. When bank credit is granted, the borrower gets a right to draw the
amount of credit at one time or in instalments as and when needed. Bank credit may be
granted by way of loans, cash credit, overdraft and discounting of bills.
(i) Loans: When a certain amount is advanced by a bank repayable after a specified
period, it is known as bank loan. Such advance is credited to a separate loan account and
the borrower has to pay interest on the whole amount of loan irrespective of the amount
of loan actually drawn. Usually loans are granted against security of assets.

(ii) Cash credit: This is an advance given to customer on the security of Inventory. It is an
arrangement whereby banks allow the borrower to withdraw money upto a specified
limit subject to margin prescribed by R.B.I. This limit is known as cash credit limit.
Initially this limit is granted for one year. This limit can be extended after review for
another year. However, if the firm still desires to continue the limit, it must be renewed
after three years. Rate of interest varies depending upon the amount of limit. Banks ask
for stock details for the grant of cash credit. In this arrangement, the borrower can draw,
repay and again draw the amount within the sanctioned limit. Interest is charged only
on the amount actually withdrawn and not on the sanctioned amount
(iii) Overdraft: When a bank allows its depositor or account holder to withdraw money
in excess of the balance in his account upto a specified limit, it is known as overdraft
facility. This limit is granted purely on the basis of credit worthiness of the borrower.
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Interest is charged only on the overdrawn money. Rate of interest in case of overdraft is
less than the rate charged under cash credit.

(iv) Discounting of Bills: Banks also advance money by discounting bills of exchange,
promissory notes and hundis. When these documents are presented before the bank for
discounting, banks credit the amount to customer's account after deducting discount.
The amount of discount is equal to the amount of interest for the period of bill. The
advantages and disadvantages of getting finance from this source are listed below:
Advantages of Bill Discounting
(a) Immediate availability of cash: By discounting the bill, the drawer get cash
immediately. He does not have to wait for the payment unit the expiry of credit period
stated on the bill.
(b) No extra security to be offered: Banks generally do not ask for any other security while
making payment against the bill discounted.
(c) Nature of liability for repayment: Repayment of money advanced against discounted
bill is the responsibility of the drawee of bill of exchange. Banks, therefore, approach the
drawee, who is generally the acceptor of the bill for payment after the due date on the
bill. In case, the drawee does not pay or refuses to pay, the drawer or the person who got
payment after discounting the bill is held responsible for payment.
Disadvantages of Bills Discounting
(a) Payment of interest in advance: While discounting a bill, bank deducts the discount
and the balance is credited in customer's account. This discount is equal to the amount
of interest for the remaining period of payment against the bill. Thus, a person receiving
money through discounting the bill has to offer advance interest on the amount of the
bill.
(b) Facility is subjected to the credit worthiness of parties involved: Bankers generally
extend this facility after being satisfied with the credit worthiness of different parties
involved. In case of doubt, the bank may ask for some security. Thus, it is not a very
easily available facility

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(e) Additional burden in case of non-payment: Bills not paid upon maturity are to be
certified by notary public and a certain amount in the form of noting charges is paid.
Thus, it becomes an additional burden.
Difference between Bank overdraft and Bank loan
(a) Charge of interest: Interest is charged only on the overdrawn amount in the case of
bank overdraft, but in the case of bank loan, interest is charged on the entire amount of
loan.

(b) Amount of borrowing: The amount of borrowing is limited in case of bank overdraft,
but bank loan may be for any amount depending upon the securities offered by the
borrower against the loan
(c) Renewal procedure: The renewal procedure is simple in the case overdraft. Banks
require positive balance to be shown in the customer’s account on the last Friday of every
month. But loans are to be paid back after the expiry of credit period. For renewal, fresh
negotiation is to be made.
(d) Security: Overdraft facility is generally granted by banks purely on the basis of credit
worthiness of the customer but for bank loan, security of tangible assets is an essential
requirement besides the personal security of the borrower.
(e) Rate of interest: Rate of interest is generally higher in case of bank loan.
(f) Flexibility: Bank overdraft is more flexible than bank loan. Money can be withdrawn,
deposited and again withdrawn within the limits. But in case of bank loan, the amount
sanctioned is fixed.
(g) Economical: Bank overdraft is more economical because interest is paid only on the
amount drawn in excess of the balance. However, in case of bank loan, interest is paid on
the whole amount of loan, whether it is withdrawn or not.
(h) Repayment: Bank overdraft can be repaid conveniently by the customer. But the
amount of entire bank loan has to be repaid on the expiry of credit period. It appears to
be more burdensome.
Difference between Bank overdraft and Cash credit

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(a) Cash credit is a separate arrangement of credit granted by a bank to a firm on the basic
of inventory. Overdraft is granted to an account holder purely on the basis of his credit
worthiness. Credit worthiness is decided by the financial soundness of past dealings of
the customer with the bank.
(b) In the case of cash credit, the amount of credit is placed in a separate account of the
borrower. Overdraft limit is generally granted to its existing account of the customer.
(c) The amount of credit in case of cash credit depends upon the value of inventory
offered as security. But overdraft limit is decided on the average balance of the customer
in his account.
(d) Overdraft is granted without the security of tangible assets. But for cash credit,
security of tangible assets is an essential requirement.
3. Customers ‘Advance: Firms engaged in manufacturing or constructing costly goods
involving considerable length of manufacturing or construction time usually demand
advance money from their customers at the time of accepting their orders for executing
their contracts or supplying the goods. The customers' advance is a cost-free source of
short-term finance.
Advantages:
(a) Interest free: Amount offered as advance is interest free. Hence funds are available
without involving financial burden.
(b) No tangible security: The seller is not required to deposit any tangible security while
seeking advance from the customer. Thus, assets remain free of charge.
(c) No repayment obligation: Money received as advance is not to be refunded. Hence
there are no repayment obligations.
Disadvantages
(a) Limited amount: The amount advanced by the customers is subject to the value of
the order. Borrowers' need may be more than the amount of advance.

(b) Limited period: The period of customers' advance is only upto the delivery of goods.
It cannot be reviewed or renewed.

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(c) Penalty in case of non- delivery of goods: Generally, advances are subject to the
condition that in case goods are not delivered on time, the order would be cancelled and
the advance would have to refunded along with interest.
4. Instalment Credit: Instalment credit is a system under which a small payment is made
at the time of taking possession of the goods and the remaining amount is paid in
instalment. Instalment amount is inclusive of interest. The instalment credit is a popular
source of finance for consumer goods like T.V. refrigerators as well as for industrial
goods.
Advantages
(a) Immediate possession of assets: Delivery of assets is assured immediately on payment
of initial instalment (down payment).
(b) Convenient payment for assets and equipment’s: Costly assets and equipment’s
which cannot be purchased due to inadequacy of long-term funds can be conveniently
purchased on payment by instalments.
(c) Saving of one-time investment: If the value of asset or equipment is very high, funds
of the business are likely to be blocked if lump sum payment is made. Instalment credit
leads to saving of one-time investment.
(d) Facilitates expansion and modernization of business and office: Business firms can
afford to buy necessary equipment’s and machines when the facility of payment in
instalments is available. Thus, expansion and modernization of business and office are
facilitated by instalment credit.
Disadvantages
(a) Committed Expenditure: Payment of instalment is a commitment to pay irrespective
of profit or loss in the business.
(b) Obligation to pay interest: Under Instalment credit system, payment of interest is
obligatory, Generally, Sellers charge a high rate of interest.
(c) Additional burden in case of default: Seller sometimes imposes stringent conditions
in the form of penalty or additional interest, if the buyer fails to pay the installment
amount.
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(d) Cash does not flow: Like trade credit, instalment credit facilitates the purchase of
asset or equipment. It does not make cash available which can be utilized for all needful
purposes.
5. Commercial Paper: Commercial paper (CP) is a "Usance Promissory note" issued by
a firm, approved by RBI, negotiable by endorsement and delivery, issued at such
discount on the face value as may be determined by the issuing firm. Each CP will bear
a certificate from the banker verifying signature of the executants. These are issued by a
firm to raise funds for a short period, generally varying from a few days to few months.
The CP may be issued in multiples of Rs. 5 lakhs.
Eligibility: The following conditions are to be fulfilled by the firm for issuing CP:
(a) The issuing firm should have a tangible net worth of not less than Rs. 4 crores as per
the latest balance sheet.

(b) The firm should have working capital limit of not less than Rs. 4 crores.
(c)The current ratio should be minimum 1.33 as per the latest balance sheet.
(d) The firm should have minimum P2/A2 rating from CRISILICRA/CARE or any other
credit rating agency for the purpose. The rating should not be more than two months old
from the date of issue of the CP.
c) The borrowal account of the firm is classified as standard asset by financing banking
company/companies.
No CP can be issued for a period less than 15 days from the date of its issue. There is no
grace period for payment of CPs. The RBI has increased the maturity period of the CPs
from a maximum of 6 months to a maximum of less than 1-year period from the date of
its issue.
There is, however, reluctance on the part of investors, especially banks to invest in less
than 1-year CP because of the absence of a secondary market.
CP may be issued to any person including individuals, banks and other corporate bodies
registered/ incorporated in India and unincorporated bodies, it cannot, however, be
issued to NRIs.

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A firm issuing CP may request the banker to provide standby facility for an amount not
exceeding the amount of issue for meeting the liability of CP on maturity. The financing
banker shall correspondingly reduce the working capital limits of every firm issuing the
CP.
Issuing Norms
As per the guidelines issued by RBI, a firm will issue CP's through same
bank/consortium of bank from whom it has a line of credit. In other words, instead of
making loans and advances, the bank will deal in the issue.
Another underlying issue is the time dimension. The firms applying for lese of CP to RBI
have to obtain credit rating which should not be more than two months old. This implies
that firm intending to issue CP has to obtain a fresh rating if time lapses.
Besides, once the RBI approves a firm's application, it has to make arrangements within
15 days for placing the CP privately.
Advantages
The advantages of commercial papers lie in its simplicity involving hardly any
documentation between the issuer and the investor and its flexibility will regard to short-
term maturity. A well rated firm can diversify its sources of finance from banks to the
short-term money markets at a somewhat cheaper cost, especially in a situation of easy
money market. The CP provides investors with higher returns than they could obtain
from the banking system. They have to pay off their debts semi-annually i.e., for instance,
eight instalments over a period of years.
6. Depreciation Fund: The depreciation funds created out of firm's profit provide a
reliable source of short-term finance so long as they are not invested in assets or
distributed as dividends.
7. Provision for Taxation: There remains a time lag between creating provision for taxes
and their actual payment. Thus, the funds appropriated for taxation can be used for the
short-term working capital requirements of the firm during the intermittent period

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8. Outstanding Expenses: Sometimes, the firm postpones the payment of certain

expenses due on the date of finalization of accounts. Outstanding expenses like unpaid
wages, salaries rent, etc. also constitute an important source of short-term finance.
Long Term Finance
Funds which are required in the firm for a period of more than one year and used for
purchase of fixed assets such as land, building, machinery, furniture, etc., are termed as
fixed capital. A part of working capital is also of a permanent nature. Funds required for
this part of the working capital and for fixed capital is known as long term Finance.
Purpose of Long-term Finance
Long term finance is required for the following purposes:
i) To finance fixed assets: Firm requires fixed assets like land, building, furniture etc.
Finance required to buy these assets is for a long period because such assets can be used
for a long period and are not for
ii) To finance the permanent part of working capital: Business is a continuing activity. It
must have a certain amount of working capital which would be needed again and again.
This part of working capital is of a fixed or permanent nature. This requirement is also
met from long term funds.
iii) To finance growth and expansion of business: Expansion of business requires
investment of a huge amount of capital permanently or for a long period.
Factors Determining Long Term Financial Requirements
The following factors are to be considered for determining long term financial
requirements of the firm:
(i) Nature of business: The nature and character of a business determines the amount of
fixed capital. A manufacturing firm requires land, building, machines, etc., So it has to
invest a large amount of capital for a long period. But a trading concern dealing in, say
washing machine will require a smaller amount of long-term fund because it does not
have to buy building or machines.

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(ii) Nature of goods purchased: If a firm is engaged in manufacturing small and simple
articles, it will require a smaller amount of fixed capital as compared to one
manufacturing heavy machines or heavy consumer items like cars, refrigerators etc.
which will require more fixed capital.
(iii) Technology used: In heavy industries like steel, the fixed capital requirement is larger
than in the case of a firm producing plastic jars using simple technology or producing
goods using labour intensive technique.
Role of Finance Manager
The finance manager is required to discharge all the functions/activities envisaged by
financial management. The important functions of finance manager are a follow:
(i)Forecasting Financial Requirements: The first function of finance manager is to
forecast the required funds in the firm. Certain funds are required for long term purposes
i.e. investment in fixed assets etc. A careful estimate of such funds, and of the exact
timing, when such funds are required must be made. Also, an assessment has to be made
regarding requirements of working capital which involves estimating the amount of
funds blocked in various current assets and the amount of funds likely to be generated
for short periods through current liabilities. Forecasting the requirements of funds
involves the use of techniques of budgetary control and long-range planning. Estimates
of requirement of funds can be made only if all the physical activities of a firm have been
forecasted. They can then be translated into monetary terms
(ii) Financing Decision: Once the requirement of funds has been estimated, the finance
manager has to take decision regarding various sources from where these funds would
be raised. A proper mix of various sources has to be worked out. Each source of funds
involves different issues for consideration. In this context, the finance manager has to
carefully look into the existing capital structure and see how the various proposals of
raising funds will affect it. He has to maintain a proper balance between long term funds
and short-term funds. He has to ensure that he raises sufficient long-term funds in order
to finance fixed assets and other long-term investments and to provide for the permanent
needs of working capital. Within the total volume of long-term funds, he has to maintain
a proper balance between the loan funds and own funds. Long term funds raised from
outsiders have to be in a certain proportion with the funds procured from the owners.
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There are various options available for procuring outside long term funds also. The
finance manager has to decide the ratio between outside long-term funds and own funds.
He has also to see that the overall capitalization of the firm is such that the firm is able to
procure funds at minimum cost and is able to tolerate shocks of lean periods. All such
kinds of decisions are termed as ‘Financing Decisions’.

(iii) Investment Decision: After having procured the funds from different sources, the
finance manager has to take investment decisions. Investment decisions relate to
selection of assets in which funds are to be invested by the firm. Investment alternatives
are numerous. Resources are scarce and limited. They have to be rationed and discretely
used. Investment decisions allocate and ration the resources among the competing
investment alternatives or opportunities. The effort is to find out the projects, which are
acceptable.
Investment decisions relate to the total amount of assets to be held and their composition
in the form of fixed and current assets. Both the factors influence the risk the firm is
exposed to take. The more important aspect is how the investors perceive the risk
The investment decisions result in purchase of assets. Assets can be classified under two
broad categories:
(a) Long term investment decisions – Long term assets.
(b) Short term investment decisions – Short term assets.
(a) Long term Investment Decisions: The long-term investment decisions, are referred to
as capital budgeting decisions, which relate to fixed assets. The fixed assets are long term
in nature. Basically, fixed assets create earnings to the firm. They give benefits in future.
It is difficult to measure the benefits as future is uncertain.

The investment decision is important not only for setting up new units but also for
expansion of existing units. Decisions related to them are generally, irreversible. Often
reversal of decision result in substantial loss. When a brand-new car is sold, even a day
after its purchase, buyer treats the vehicle as a second hand car. The transaction,
invariably, results in heavy loss for a short period of owning. So, the finance manager
has to evaluate profitability of every investment proposal carefully before funds are
committed to them.
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(b) Short term Investment Decisions: The short-term investment decisions are, generally
referred as working capital management. The finance manager has to allocate among
cash and cash equivalent, receivables and inventories. Though these current assets do
not, directly, contribute to the earnings, their existence is necessary for proper, efficient
and optimum utilization of fixed assets.

(iv) Dividend Decision: The finance manager is also concerned with the decision to pay
or declare a dividend. He has to assist the top management in deciding as to what amount
of dividend should be paid to the shareholders and what amount should be retained in
the business itself. Generally, firms distribute certain amount of profit in the form of
dividend, in a stable manner, to meet the expectations of shareholders and balance is
retained within the firm for expansion. If dividend is not distributed, there would be
great dissatisfaction to the shareholders. Non-declaration of dividend affects the market
price of equity shares severely. One significant element in the dividend decision is,
therefore, the dividend payout ratio i.e. what 'proportion of dividend is to be paid to the
shareholders. The dividend decision depends on the preference of the equity
shareholders and investment opportunities available within the firm. A higher rate of
dividend, beyond the market expectations, increases the market price of shares.
However, it leaves a small amount in the form of retained earnings for expansion. The
business that reinvests less will tend to grow slower. The other alternative is to raise
funds in the market for expansion. It is not a desirable decision to retain all the profit for
expansion, without distributing any amount in the form of dividend.
There is no ready-made answer, how much is to be distributed and what portion is to be
retained. Retention of profit is related to:
(a) Reinvestment opportunities available to the firm.

(b) Alternative rate of return available to equity shareholders, if they invest

themselves.
The principal function of a finance manager relates to decisions regarding procurement,
investment and dividends. However, the finance manager also undertakes the following
subsidiary functions:

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(v) Deciding overall objectives: The finance manager needs to be guided by some
objectives. As a head of finance department, the finance manager, therefore has to
determine the overall goals of finance department. The goals help in effective financial
planning and decision making.
(vi) Supply of funds to all parts of the organization: The finance manager has also to
ensure that all sections i.e. branch, factories, departments and units of the organization
are supplied with adequate funds. Sections which have an excess of funds have to
contribute to the central pool for use in other sections which need funds. An adequate
supply of cash at all points of time is absolutely essential for the smooth flow of business
operations. Even if one of the 200 retail branches do not have sufficient funds, the whole
business may be in danger. Hence the need for laying down cash management and cash
disbursement policies with a view to supplying adequate funds at all times and at all
points in an organization is an important function of finance manager. Cash management
should also ensure that there is no excessive cash.
(vii) Evaluating financial performance: Management control systems are often based
upon financial analysis. One prominent example is the ROI (Return on Investment)
system of divisional control. The finance manager has to constantly review the financial
performance of the various units of the organization. The ROI chart is extremely useful
in this regard. Analysis of the financial performance helps the management for assessing
how the funds have been utilized in various divisions and what can be done to improve
it.
(viii) Financial negotiation: A major portion of the time of the finance manager is utilized
in carrying out negotiations with the financial institutions, banks and public depositors.
He has to furnish a lot of information to these institutions and persons and have to ensure
that raising of funds is within the statutes like Companies Act etc. Negotiations for
outside financing often require specialized skills.
(ix) Keeping touch with stock exchange quotations and behaviour of share prices: This
involves analysis of major trends in the stock market and judging their impact on the
prices of the shares of the firm.

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Functions of Financial Management

1. Estimates the capital requirements of business: A financial manager firstly has to make
the estimation with regards to overall capital requirements of the business. This will
depend on several determinants like probable costs and expected profits and upcoming
programs and policies of the company. Predictions have to be made in an adequate and
concern manner which increases the earning capacity of business and which ensures
proper use of financial resources. Thus, financial management functions guide a financial
manager to estimate organizational capital requirements.
2. Ascertains capital composition: Once the estimation of capital requirement has been
made with the best effort, the capital structure of the enterprise has to be decided. This
involves the analysis of short- term and long- term debt equity. This will depend on the
proportion of possessed equity capital a company and other additional funds which have
to be raised from outside parties through borrowing.
3. Makes the Choice of sources of funds: A financial manager needs to evaluate different
sources of funds. A company has many choices for raising additional funds to be
procured in the business-like loans to be taken from banks and other financial
institutions, issue of company shares and debentures, public deposits to be drawn like in
form of bonds. Choice of a factor depends on the relative advantages and disadvantages
of each source and financing period.
4. Investment of total funds: The finance manager has to decide how to allocate the total
amount of funds into profitable ventures. He has to make sure that there is safety on
investment and positive regular returns are possible. The capital should be invested in a
wisely manner so that there is less possibility of losing funds or experience loses. For that,
the manager can use different investment tools like portfolio analysis, net present value,
internal rate of return, an average rate of return and so on.
5. Disposal of surplus: Financial manager calculates profits of business at the end of an
accounting period. Then the net profits decision has to be taken by the finance manager
of the company. This decision can be made in two ways. He can declare a dividend to
the shareholders of a company where the ordinary shareholders will get the profits in the
form of money or share or retain profits for some purposes like expansion, diversification
or innovation of the business.
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6. Manages of cash flow: Finance manager of a company has to make decisions regarding
cash management. Cash is required for several purposes like payment of wages and
salaries to the workers, payment to the creditors, payment of electricity and water bills,
meeting current liabilities of the business, cost of maintenance of having enough stock,
purchase of raw materials for daily production etc.

7. Controls Finances: The functions of a finance manager are not only to do a financial
plan, procure fund and utilize the funds but he also has to control the finances involving
in the business. This function can be done by many techniques like ratio analysis,
forecasting of financials, cost analysis and control and profit distribution techniques etc.
8. Decisions regarding acquisitions and mergers: A business organization can either be
expanded through acquiring other business or by entering into the business by mergers
with other firms. While acquisition decision denotes a process of purchasing new or
existing companies, the merger is a process where two or more companies join together
in the formation of a new business. During such decision, a financial manager has to deal
with many complex valuations of securities of each company.
9. Tax Planning and protection of Assets: It is the duty of a financial manager to lessen
the tax liability of the business. This task should be performed wisely. It is very important
that a finance executive properly examines various schemes and invest accordingly. He
should also protect the assets engaged in the business to ensure the best use of the
resources.
10. Decision on Capital Budgeting: Long-term decisions involve investing in share or
bond, purchasing new equipment, building new plant etc. These decisions are called
capital budgeting. In this decision making of the company financial managers faces many
complicated situations. As the process requires a huge amount of capital, it is necessary
that a financial manager identifies the investment opportunities and involved challenges.
The efficient use of financial management functions helps a company to maximize
wealth. Financial management is a continuous and interrelated process which involves
identifying the required amount of capital that is needed for running the business
promptly, evaluating and selecting best alternative sources of funds, allocating the funds
according to the need of business area and distributing earned profits.

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