MEANING OF FINANCE
• Finance may be defined as the art and science
of managing money.
• It includes financial service and financial
• Finance also is referred as the provision of
money at the time when it is needed. Finance
function is the procurement of funds and their
effective utilization in business concerns.
What is Financial Management?
Financial Management is that managerial activity
which is concerned with the planning and controlling
of the firm’s financial resources.
It encompasses the procurement of the funds in the
most economic and prudent manner and employment
of these funds in the most optimum way to maximize
the return to the owner.
• Financial Management means planning,
organizing, directing and controlling the
financial activities such as procurement and
utilization of funds of the enterprise.
Definitions Of Financial management
According to Ezra Solamn “Financial management is concerned with the efficient use of an
important economic resources viz capital funds”.
Howard and Upton : Financial management “as an application of general managerial
principles to the area of financial decision-making.
Weston and Brigham : Financial management “is an area of financial decision-making,
harmonizing individual motives and enterprise goals”.
Joshep and Massie : Financial management “is the operational activity of a business that
is responsible for obtaining and effectively utilizing the funds necessary for efficient
Thus, Financial Management is mainly concerned with the effective funds management in the
business. In simple words, Financial Management as practiced by business firms can be
called as Corporation Finance or Business Finance.
The Traditional Approach
(i) Estimation of requirements of finance,
(ii) Arrangement of funds from financial institutions,
(iii) Arrangement of funds through financial instruments such as shares, debentures, bonds and
(iv) Looking after the accounting and legal work connected with the raising of funds.
The traditional approach was evolved during the 1920s and 1930s period and continued till 1950.
The approach had been discarded due to the following limitations:
(i) No Involvement in Application of Funds: The finance manager had not been involved in
decision-making in allocation of funds. He had been treated as an outsider. He had been
ignored in internal decision making process and considered as an outsider.
(ii) No Involvement in day to day Management: The focus was on providing long-term funds
from a combination of sources. This process was more of one time happening. The finance
manager was not involved in day to day administration of working capital management.
Smooth functioning depends on working capital management, where the finance manager
was not involved and allowed to play any role.
(iii) Not Associated in Decision-Making Allocation of Funds: The issue of allocation of funds was
kept outside his functioning. He had not been involved in decision- making for its judicious
The Modern Approach
The modern phase began in the mid fifties and has
witnessed an accelerated Pace of development with the
infusion of ideas from economic theory and Application
of quantitative methods of analysis.
Significant contribution to the development of modern theory of Financial Management
Theory of Portfolio Management developed by Harry Markowitz in 1950
The Theory of Leverage and Valuation of Firm developed by Modigliani &
Miller in 1958
The Presentation of Option Valuation Model by Black and Scholes in 1970
The trust of financial decision making is on
Procurement of funds and their optimal
Utilisation through investment, financing,
dividends and working capital decision.
The scope of financial management extends to 3
key decisions areas:
1. Investment Decision
Investment decisions pertain to selection of the most productive
avenues with a view to maximise the returns on investment and
consequently the shareholders wealth.
Investment decisions which are alternatively referred to as capital
Budgeting decisions are crucial for survival and growth of any
Firm as they involve large capital outlay.
Acquisition of Fixed Assets
Long term Assets
(What & When to Buy)
• Short Term
• Working Capital Decision
•Nature of the Business
•Price Level Change
•Market Competitions etc…..
Long Term Investment
Factors Affecting Investment Decisions
Capital Budgeting Decision
•Cash Flow of the Project
•Cost of Capital
•Investment criteria involved
Financing Decisions are concerned with the procurement of the
required amount of Funds on most convenient terms as and
Financing Decision relates to the composition of relative proportion
Of various sources of finance. It involves deciding the proportion of
Equity and debt in Capital Structure.
Capital Structure Decision Cost of Capital
From which Source Equity should be raised- whether by issue of Equity
shares or through Preference share.
What should be the proportion of equity and debt in the Capital structure?
From which source Debt should be raised – whether by issue of debenture
Or raising long term loans.
Factor affecting Financing Decisions
Cash Flow Ability
3. Dividend Decision
Dividend decision involves deciding whether to distribute the profits
as dividend to shareholders or to retain profits and reinvest in
The main objective of dividend decision is to divide net earnings in an
Optimum manner so as to pay dividend to the shareholders and to
Retain earnings for reinvestments with the objective of maximizing
The wealth of shareholders
How much earnings should be retained for reinvestment opportunities?
How much earnings should be distributed as dividend to shareholders?
• There is a interrelation between investment
decision and financing decision, without
knowing the amount of funds required and
types of funds (short-term & long-term) it is
not possible to raise funds.
• These two are dependent on each other.
Financing decisions influences and is
influenced by dividend decision, since
retention of profits for financing selected
projects reduces the profit available to
ordinary shareholders, there by reducing
dividend payout ratio.
Hence, there is an interrelation between
financing decision and dividend decision.
Dividend decision and investment decisions
are interrelated because retention of profits
for financing the selected assets depends on
the rate of return of proposed investment and
the opportunity cost.
Profits are retained when return on
investment is higher than the opportunity
cost of retained profits and vice-versa.
Estimating Financial Requirements,
Deciding Capital Structure,
Selecting a Sources of Finance,
Selecting a pattern of Investment.
Proper Cash management
Proper use of surplus
Financial Management and Economics
Financial Management and Accounting
Financial Management and Mathematics
Financial Management and Production
Financial Management and Marketing
Financial Management and HRM
It is a term which denotes the maximum profit to
be earned by an organization in a given period of
The profit maximization goal implies that the
Investment, Financing and Dividend decisions of
the enterprise should be oriented to profit
The following important points are in support of the
profit maximization objectives of the business
(i) Main aim is earning profit.
(ii) Profit is the parameter of the business operation.
(iii) Profit reduces risk of the business concern.
(iv) Profit is the main source of finance.
(v) Profitability meets the social needs also.
The following important points are against the
objectives of profit maximization:
(i) Profit maximization leads to exploiting workers
(ii) Profit maximization creates immoral practices
such as corrupt practice, unfair trade practice, etc.
(iii) Profit maximization objectives leads to
inequalities among the stake holders such as
customers, suppliers, public shareholders, etc.
Profit maximization objective consists of certain
(i) It is vague: In this objective, profit is not defined
precisely or correctly. It creates some unnecessary
opinion regarding earning habits of the business
(ii) It ignores the time value of money: Profit
maximization does not consider the time value of
money or the net present value of the cash inflow. It
leads certain differences between the actual cash inflow
and net present cash flow during a particular period.
(iii) It ignores risk: Profit maximization does not consider
risk of the business concern. Risks may be internal or
external which will affect the overall operation of the
business concern. 01-04-2023 26
Fundamental objective of wealth maximization is
to maximize the market value of the firm’s shares.
Maximizes the net present value of a course of
action to the shareholders.
Benefits are measured in terms of cash flows.
(i) Wealth maximization is superior to the profit
maximization because the main aim of the business
concern under this concept is to improve the value or
wealth of the shareholders.
(ii) Wealth maximization considers the comparison of
the value to cost associated with the business
concern. Total value detected from the total cost
incurred for the business operation. It provides
extract value of the business concern.
(iii) Wealth maximization considers both time and risk
of the business concern.
(iv) Wealth maximization provides efficient allocation of
(v) It ensures the economic interest of the society.
(i) Wealth maximization leads to prescriptive idea of the
business concern but it may not be suitable to present day
(ii) Wealth maximization is nothing, it is also profit
maximization, it is the indirect name of the profit
(iii) Wealth maximization creates ownership-management
(iv) Management alone enjoy certain benefits.
(v) The ultimate aim of the wealth maximization objectives is
to maximize the profit.
(vi) Wealth maximization can be activated only with the help
of the profitable position of the business concern.
It focuses on the long term.
It takes into account the time value of money.
It considers risk.
It maintains market price of the shares of the
It recognizes the value of regular dividend
Profit Maximization Wealth Maximization
Its main objective is to earn
large amount of profits.
It emphasizes short term
It ignores time value of
It ignores risk and
It ignores timing of return
Its main objective is to
achieve highest market value
of common stock.
It emphasizes long term
It considers time value of
It recognizes risk and
It recognizes the timings of
Financial Forecasting and Planning
Acquisition of Fund
Investment of funds
Maintain Proper Liquidity
Acquisition of Funds
Proper Use of Funds
Increase the Value of the Firm