3. Financial Management means
planning, organizing, directing and
controlling the financial activities such as
procurement and utilization of funds of the
enterprise. It means applying general
management principles to financial
resources of the enterprise.
4. Scope/Elements
1. Investment decisions includes investment in fixed
assets (called as capital budgeting). Investments in
current assets are also a part of investment
decisions called as working capital decisions.
2. Financial decisions - They relate to the raising of
finance from various resources which will depend
upon decision on type of source, period of
financing, cost of financing and the returns thereby.
5. 3. Dividend decision - The finance manager has to
take decision with regards to the net profit
distribution. Net profits are generally divided into
two:
a. Dividend for shareholders- Dividend and the
rate of it has to be decided.
b. Retained profits- Amount of retained profits
has to be finalized which will depend upon
expansion and diversification plans of the
enterprise.
6. Objectives of Financial Management
The financial management is generally concerned with
procurement, allocation and control of financial resources of a
concern. The objectives can be1. To ensure regular and adequate supply of funds to the concern.
2. To ensure adequate returns to the shareholders which will
depend upon the earning capacity, market price of the
share, expectations of the shareholders?
3. To ensure optimum funds utilization. Once the funds are
procured, they should be utilized in maximum possible way at least
cost.
4. To ensure safety on investment, i.e, funds should be invested in
safe ventures so that adequate rate of return can be achieved.
5. To plan a sound capital structure-There should be sound and fair
composition of capital so that a balance is maintained between
debt and equity capital.
7. 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 have 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.
8. 3. Choice of sources of funds: For additional funds to
be procured, a company has many choices likeIssue 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.
9. 5. Disposal of surplus: The net profits decision
has 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, innovation, diversification plans of
the company.
10. 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.
11. FINANCE FUNCTIONS/DECISIONS
The following explanation will help in understanding
each finance function in detail –
Investment Decision
One of the most important finance functions is to
intelligently allocate capital to long term assets. This
activity is also known as capital budgeting. It is
important to allocate capital in those long term assets
so as to get maximum yield in future. Following are the
two aspects of investment decision
A. Evaluation of new investment in terms of
profitability
B. Comparison of cut off rate against new investment
and prevailing investment.
12. Financial Decision
Financial decision is yet another important
function which a financial manger must
perform. It is important to make wise decisions
about when, where and how should a business
acquire funds. Funds can be acquired through
many ways and channels. Broadly speaking a
correct ratio of an equity and debt has to be
maintained. This mix of equity capital and debt
is known as a firm’s capital structure.
13. Dividend Decision
Earning profit or a positive return is a common
aim of all the businesses. But the key function a
financial manger performs in case of profitability
is to decide whether to distribute all the profits
to the shareholder or retain all the profits or
distribute part of the profits to the shareholder
and retain the other half in the business. It’s the
financial manager’s responsibility to decide a
optimum dividend policy which maximizes the
market value of the firm.
14. Liquidity Decision
It is very important to maintain a liquidity
position of a firm to avoid insolvency. Firm’s
profitability, liquidity and risk all are associated
with the investment in current assets. In order
to maintain a trade-off between profitability and
liquidity it is important to invest sufficient funds
in current assets. But since current assets do not
earn anything for business therefore a proper
calculation must be done before investing in
current assets.
15. PROJECT APPRAISAL
Definition - Systematic and comprehensive
review of the
economic, environmental, financial, social, techn
ical and other such aspects of a project to
determine if it will meet its objectives.
16. The following are the points through which a project
has to be appraised –
1. Technical – consideration of a project’s supplies
(inputs) and its production (output), focusing on
technical relations and aspects such as climatic
features and attributes, soils, water, spatial
considerations, etc.
2. Institutional/organizational – concerns for the
administration and management of projects. Here the
focus is on the institutional factors and setting (e.g.
laws and regulations), communication
networks, structures of authority and
responsibility, etc.
17. 3. Social – consideration of the project’s impact
on and implications for particular groups and
regions, gender implications, wider effects on
the health, culture, quality of life, etc. of those
affected by it directly and indirectly.
4. Commercial – covering all the commercial
considerations and arrangements for
procurement of supplies and the marketing of
output.
18. 5. Financial – budgeting considerations such as
operating expenses and investment funds
required for various participating agencies;
credit terms to be arranged, etc.
6. Economic – this addresses the project’s
impact and it’s worthwhileness from the
viewpoint of the whole society. It is different
from financial analysis in that it goes beyond the
concerns of participating agents alone.
19. Tools of Financial Decision Making
1. NPV Method
2. IRR Method
3. Pay-back Period Method
4. Profitability Index Method-NPV /initial
investment
5. Accounting Rate of Return Method-avg. acc
profit/initial investment
21. Capital required for a business can be classified
under two main categories, viz,
1. Fixed Capital, and
2. Working Capital
Every business needs funds for two purposes-for
its establishment and to carry out in day-to-day
operation.
22. Long-term funds are required to create
production facilities through purchase of fixed
assets such as Plant and
Machinery, Land, Building, Furniture, etc.
investments in those assets represent that part
of firm’s capital which is blocked on a
permanent or fixed basis and Fixed Capital.
23. Funds are also needed for short-term purposes
for the purchase of raw materials, payment of
wages and other day-to-day expenses etc. These
funds are known as Working Capital. In simple
words, working capital refers to that part of the
firm’s capital which is required for financing
current assets.
24. THE NEED OR OBJECTS OF WORKING CAPITAL
The need for working capital arises due to the
time gap between production and realization of
cash from. There is an operating cycles involved
in the sales and realization of cash. There are
time gaps in purchases of raw materials and
production; Production and sales; and sales and
realization of cash.
25. Thus, Working Capital is needed for the following
purposes:
i. For the purchase of raw materials, components and
spares.
ii. To pay wages and salaries.
iii. To incur day-to-day expenses and overhead costs
such as fuel, power and office expenses, etc.
iv. To meet the selling costs as
packing, advertising, etc.
v. To provide credit facilities to the customers.
vi. To maintain the inventories of raw material, workin-progress, stores and spares and finished stock.
26. KINDS OF WORKING CAPITAL
• On the basis of concept
• On the basis of time
On the basis of Concept: Working capital is
classified as gross working capital and net
working capital.
27. 1. Gross Working Capital: The term working
capital refers to the gross working capital and
represents the amount of funds invested in
current assets. Thus, the gross working capital is
that capital invested in total current assets of
the enterprise.
2. Net Working Capital: The excess of total
current asset over total current liabilities is
known as Net working Capital.
Net Working Capital = Current Assets – Current
Liabilities
28. On the basis of Time: Working capital may be
classified as:
1. Permanent or Fixed Working capital:
Permanent or fixed working capital to the
minimum amount which is required to ensure
effective utilization of fixed facilities and for
maintaining the circulation of current assets.
This minimum level of working capital is called
as Permanent Working Capital as this part of
capital is permanently blocked in current assets.
29. The permanent working capital can further be
classifies as:
i. Regular Working Capital
ii. Reserved Working Capital
2. Temporary or variable working Capital: It is
the amount of working capital which is required
to meet the seasonal demands and some special
exigencies. Variable working capital further be
classifies asi. Seasonal Working Capital
ii. Special Working Capital
30. FACTORS DETERMINING THE WORKING
CAPITAL REQUIREMENTS
The working capital requirements of a concern
depend upon a large number of factors such as
nature and size of business, the character of
their operations, and the length of production
cycles.
31. The following are important factors generally
influencing the working capital requirements:
1. Nature of Business - The working capital
requirements of a firm basically depend upon the
nature of its business. Public utility undertakings like
Electricity, Water Supply and Railways need very limited
working capital because they offer cash sales only and
supply services, not products, and as such no funds are
ties up in inventories and receivables. On the other
hand trading and financial firms require less investment
in fixed assets but have to invest large amounts in
current assets like inventories, receivables and cash; as
such they need large amount of working capital.
32. 2. Size of Business or Scale of Operations - The
working capital requirements of a concern are
directly influenced by the size of its business
which may be measured in terms of scale of
operations. Greater the size of business
unit, generally larger will be the requirements of
working capital.
33. 3. Production Policy - In certain industries the
demand is subject to wide fluctuations due to
seasonal variations. The requirements of
working capital, in such cases, depend upon the
production policy.
34. 4. Manufacturing Process/Length of Production
Cycle - In manufacturing business, the
requirements of working capital increase in
direct proportion to length of manufacturing
process. Longer the process period of
manufacture, larger is the amount of working
capital required.
35. 5. Seasonal Variations - In certain industries raw
material is not available throughout the year.
They have to buy raw materials in bulk during
the season to ensure an uninterrupted flow and
process them during the entire year. A huge
amount is blocked in the form of material during
such season, which gives rise to more working
capital requirements.
36. 6. Credit Policy - The credit policy of a concern
in its dealings with debtors and creditors
influence considerably the requirements of
working capital. A concern that purchases its
requirements on credit and sells its
products/services on cash requires lesser
amount of working capital. On the other hand a
concern buying its requirements for cash and
allowing credit to its customers.
37. 7. Rate of Growth of Business - The working
capital requirements of a concern increase with
the growth and expansion of its business
activities.
8. Earning Capacity and Dividend Policy - Some
firms have more earning capacity than others
due to quality of their products, monopoly
conditions, etc. Such firms with high earning
capacity may generate cash profits from
operations and contribute to their working
capital.
38. 9. Price Level Changes - Changes in the price
level also affect the working capital
requirements. Generally, the rising prices will
require the firm to maintain larger amount of
working capital as more funds will be require to
maintain the same current assets. The effect of
rising prices may be different for different firms.
Some firms may be affected much while some
others may not be affected at all by the rise in
prices.
39. Advantages of having adequate WC
1. Solvency of Business
2. Goodwill
3. Easy Loans
4. Supply of Raw Materials
5. Payment of wages, salaries, etc.
6. Ability to face financial crisis.
40. Financing WC
1. Permanent sources like
shares, debentures, public deposits and loans
from financial institutions.
2. Temporary sources like commercial
banks, trade credits, advances and account
receivables.
