Financial Management - Meaning, Objectives and Functions?

Meaning of Financial Management

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.

Scope/Elements

1. Investment decisions includes investment in fixed assets (called as capital budgeting). Investment 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.
3. Dividend decision - The finance manager has to take decision with regards to the net profit distribution. Net profits are generally divided into two:
   1. Dividend for shareholders- Dividend and the rate of it has to be decided.
   2. Retained profits- Amount of retained profits has to be finalized which will depend upon expansion and diversification plans of the enterprise.

Objectives of Financial Management

The financial management is generally concerned with procurement, allocation and control of financial resources of a concern. The objectives can be-

1. 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.

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.
3. Choice of sources of funds: For additional funds to be procured, a company has many choices like-
   1. Issue of shares and debentures
   2. Loans to be taken from banks and financial institutions
   3. 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.
5. Disposal of surplus: The net profits decision have to be made by the finance manager. This can be done in two ways:
   1. Dividend declaration - It includes identifying the rate of dividends and other benefits like bonus.
   2. Retained profits - The volume has to be decided which will depend upon expansional, innovational, diversification plans of the company.
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, maintainance 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.

Financial Planning - Definition, Objectives and Importance

Definition of Financial Planning

Financial Planning is the process of estimating the capital required and determining it’s competition. It is the process of framing financial policies in relation to procurement, investment and administration of funds of an enterprise.

Objectives of Financial Planning

Financial Planning has got many objectives to look forward to:

1. Determining capital requirements- This will depend upon factors like cost of current and fixed assets, promotional expenses and long- range planning. Capital requirements have to be looked with both aspects: short- term and long- term requirements.
2. Determining capital structure- The capital structure is the composition of capital, i.e., the relative kind and proportion of capital required in the business. This includes decisions of debt- equity ratio- both short-term and long- term.
3. Framing financial policies with regards to cash control, lending, borrowings, etc.
4. A finance manager ensures that the scarce financial resources are maximally utilized in the best possible manner at least cost in order to get maximum returns on investment.

Importance of Financial Planning

Financial Planning is process of framing objectives, policies, procedures, programmes and budgets regarding the financial activities of a concern. This ensures effective and adequate financial and investment policies. The importance can be outlined as-

1. Adequate funds have to be ensured.
2. Financial Planning helps in ensuring a reasonable balance between outflow and inflow of funds so that stability is maintained.
3. Financial Planning ensures that the suppliers of funds are easily investing in companies which exercise financial planning.
4. Financial Planning helps in making growth and expansion programmes which helps in long-run survival of the company.
5. Financial Planning reduces uncertainties with regards to changing market trends which can be faced easily through enough funds.
6. Financial Planning helps in reducing the uncertainties which can be a hindrance to growth of the company. This helps in ensuring stability an d profitability in concern.

Finance Functions

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

1. Evaluation of new investment in terms of profitability
2. Comparison of cut off rate against new investment and prevailing investment.

Since the future is uncertain therefore there are difficulties in calculation of expected return. Along with uncertainty comes the risk factor which has to be taken into consideration. This risk factor plays a very significant role in calculating the expected return of the prospective investment. Therefore while considering investment proposal it is important to take into consideration both expected return and the risk involved.
Investment decision not only involves allocating capital to long term assets but also involves decisions of using funds which are obtained by selling those assets which become less profitable and less productive. It wise decisions to decompose depreciated assets which are not adding value and utilize those funds in securing other beneficial assets. An opportunity cost of capital needs to be calculating while dissolving such assets. The correct cut off rate is calculated by using this opportunity cost of the required rate of return (RRR)

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.
A firm tends to benefit most when the market value of a company’s share maximizes this not only is a sign of growth for the firm but also maximizes shareholders wealth. On the other hand the use of debt affects the risk and return of a shareholder. It is more risky though it may increase the return on equity funds.
A sound financial structure is said to be one which aims at maximizing shareholders return with minimum risk. In such a scenario the market value of the firm will maximize and hence an optimum capital structure would be achieved. Other than equity and debt there are several other tools which are used in deciding a firm capital structure.

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. Hence an optimum dividend payout ratio is calculated. It is a common practice to pay regular dividends in case of profitability Another way is to issue bonus shares to existing shareholders.

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 tradeoff 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.
Current assets should properly be valued and disposed of from time to time once they become non profitable. Currents assets must be used in times of liquidity problems and times of insolvency.

The Role of the Finance Function in Organizational Processes

The Finance Function and the Project Office

Contemporary organizations need to practice cost control if they are to survive the recessionary times. Given the fact that many top tier companies are currently mired in low growth and less activity situations, it is imperative that they control their costs as much as possible. This can happen only when the finance function in these companies is diligent and has a hawk eye towards the costs being incurred. Apart from this, companies also have to introduce efficiencies in the way their processes operate and this is another role for the finance function in modern day organizations.
There must be synergies between the various processes and this is where the finance function can play a critical role. Lest one thinks that the finance function, which is essentially a support function, has to do this all by themselves, it is useful to note that, many contemporary organizations have dedicated project office teams for each division, which perform this function.
In other words, whereas the finance function oversees the organizational processes at a macro level, the project office teams indulge in the same at the micro level. This is the reason why finance and project budgeting and cost control have assumed significance because after all, companies exist to make profits and finance is the lifeblood that determines whether organizations are profitable or failures.

The Pension Fund Management and Tax Activities of the Finance Function

The next role of the finance function is in payroll, claims processing, and acting as the repository of pension schemes and gratuity. If the US follow the 401(k) rule and the finance function manages the defined benefit and defined contribution schemes, in India it is the EPF or the Employee Provident Funds that are managed by the finance function. Of course, only large organizations have dedicated EPF trusts to take care of these aspects and the norm in most other organizations is to act as facilitators for the EPF scheme with the local or regional PF (Provident Fund) commissioner.
The third aspect of the role of the finance function is to manage the taxes and their collection at source from the employees. Whereas in the US, TDS or Tax Deduction at Source works differently from other countries, in India and much of the Western world, it is mandatory for organizations to deduct tax at source from the employees commensurate with their pay and benefits.
The finance function also has to coordinate with the tax authorities and hand out the annual tax statements that form the basis of the employee’s tax returns. Often, this is a sensitive and critical process since the tax rules mandate very strict principles for generating the tax statements.

Payroll, Claims Processing, and Automation

We have discussed the pension fund management and the tax deduction. The other role of the finance function is to process payroll and associated benefits in time and in tune with the regulatory requirements.
Claims made by the employees with respect to medical, and transport allowances have to be processed by the finance function. Often, many organizations automate this routine activity wherein the use of ERP (Enterprise Resource Planning) software and financial workflow automation software make the job and the task of claims processing easier. Having said that, it must be remembered that the finance function has to do its due diligence on the claims being submitted to ensure that bogus claims and suspicious activities are found out and stopped. This is the reason why many organizations have experienced chartered accountants and financial professionals in charge of the finance function so that these aspects can be managed professionally and in a trustworthy manner.
The key aspect here is that the finance function must be headed by persons of high integrity and trust that the management reposes in them must not be misused. In conclusion, the finance function though a non-core process in many organizations has come to occupy a place of prominence because of these aspects.

Role of a Financial Manager

Financial activities of a firm is one of the most important and complex activities of a firm. Therefore in order to take care of these activities a financial manager performs all the requisite financial activities.
A financial manger is a person who takes care of all the important financial functions of an organization. The person in charge should maintain a far sightedness in order to ensure that the funds are utilized in the most efficient manner. His actions directly affect the Profitability, growth and goodwill of the firm.
Following are the main functions of a Financial Manager:

1. Raising of Funds

   In order to meet the obligation of the business it is important to have enough cash and liquidity. A firm can raise funds by the way of equity and debt. It is the responsibility of a financial manager to decide the ratio between debt and equity. It is important to maintain a good balance between equity and debt.
   

2. Allocation of Funds

   Once the funds are raised through different channels the next important function is to allocate the funds. The funds should be allocated in such a manner that they are optimally used. In order to allocate funds in the best possible manner the following point must be considered
   
   • The size of the firm and its growth capability
   • Status of assets whether they are long-term or short-term
   • Mode by which the funds are raised
   These financial decisions directly and indirectly influence other managerial activities. Hence formation of a good asset mix and proper allocation of funds is one of the most important activity
   

3. Profit Planning

   Profit earning is one of the prime functions of any business organization. Profit earning is important for survival and sustenance of any organization. Profit planning refers to proper usage of the profit generated by the firm.
   Profit arises due to many factors such as pricing, industry competition, state of the economy, mechanism of demand and supply, cost and output. A healthy mix of variable and fixed factors of production can lead to an increase in the profitability of the firm.
   Fixed costs are incurred by the use of fixed factors of production such as land and machinery. In order to maintain a tandem it is important to continuously value the depreciation cost of fixed cost of production. An opportunity cost must be calculated in order to replace those factors of production which has gone thrown wear and tear. If this is not noted then these fixed cost can cause huge fluctuations in profit.
   

4. Understanding Capital Markets

   Shares of a company are traded on stock exchange and there is a continuous sale and purchase of securities. Hence a clear understanding of capital market is an important function of a financial manager. When securities are traded on stock market there involves a huge amount of risk involved. Therefore a financial manger understands and calculates the risk involved in this trading of shares and debentures.
   Its on the discretion of a financial manager as to how to distribute the profits. Many investors do not like the firm to distribute the profits amongst share holders as dividend instead invest in the business itself to enhance growth. The practices of a financial manager directly impact the operation in capital market.