Monday, 26 March 2012

Financial Management

Financial Management

Management of funds is an important aspect of financial management.


By Financial Management we mean-

-         Efficient use of economic resources namely capital funds.

-         According to Phillippatus, "Financial management is concerned with the managerial decisions that result in the acquisition and financing of short term and long term credits for the firm".

-         Here it deals with the situations that require selection of specific assets (or combination of assets), the selection of specific problem of size and growth of an enterprise.

-         Here the analysis deals with the expected inflows and outflows of funds and their effect on managerial objectives.

-         So the analysis simply states two main aspects of financial management like procurement of funds and an effective use of funds to achieve business objectives.

Procurement of funds:

-         As funds can be obtained from different sources so procurement of funds is   considered as an important problem of business concerns.

-         Funds procured from different sources have different characteristics in terms of risk, cost and control.

-         Funds issued by the issue of equity shares are the best from risk point of view for the company as there is no question of repayment of equity capital except when the company is under liquidation.

-         From the cost point of view equity capital is most expensive source of funds as dividend expectations of shareholders are normally higher than prevalent interest rates.

-         Financial management constitutes risk, cost and control. The cost of funds should be at minimum for a proper balancing of risk and control.

-         In the Globalised competitive scenario mobilization of funds plays a very significant role.

-         Funds can be raised either through domestic market or from abroad. Foreign Direct Investment (FDI) as well as Foreign Institutional Investors (FII) is two major sources of raising funds. The mechanism of procurement of funds has to be modified in the light of requirements of foreigninvestors

Utilization of Funds:

1.      Effective utilization of funds as an important aspect of financial management avoids the situations where funds are either kept idle or proper uses are not being made.

2.      Funds procured involve a certain cost and risk.

3.      If the funds are not used properly then running business will be too difficult.

4.       In case of dividend decisions we also consider this. So it is crucial to employ the funds properly and profitably.

Scope In Financial Management

- A sound financial management is essential in all types of organizations whether it may be profit or non-profit.

-         Financial management is essential in a planned Economy as well as in a capitalist set-up as it involves efficient use of the resources.

-         From time to time it is seen that many firms have been liquidated not because their technology was obsolete or because their products were not in demand or their Labour was not skilled and motivated but there was a complete mismanagement of financial affairs.

-         Even in a boom period, when a company make high profits there is also a fear of liquidation because of bad financial management.

-         Financial management optimizes the output from the given input of funds.

-         In the country like India where resources are scarce and the demand for funds are many, the need of proper financial management is required.

-         In case of newly started companies with a high growth rate it is more important to have sound financial management since finance alone guarantees their survival.

-         Financial management is very important in case of non-profit organizations, which do not pay adequate attentions to financial management.

-         How ever a sound system of financial management has to be cultivated among bureaucrats, administrators, engineers, educationalists and public at a large.

Financial Management In India

- In the country like India there is a changing scenario of financial management.
-         As the economy is opening up and global participation is increasing very fast, the opportunities have no limits.
-         Presently financial management passes through an era of experimentation as a larger part of finance activities are carried out.
Highlights Context:
  • Interest rates are free from regulations.
  • Rupee is fully convertible in current account.
  • Optimum debt equity mix is possible.
  • Maintaining share prices are also crucial. In liberalized scenario the capital market is an important avenue of funds for business.
  • Ensuring management control is vital especially in the light of foreign participation.

Financial Management Objectives

1) Profit Maximization:

-         Objective of financial management is same as the objective of a company  
      that is to earn profit.

-         But profit maximization cannot the sole objective of a company. It is a limited objective.

-         If profits are given undue Importance then problems may arise as discussed below.
  • The term profit is vague and it involves much more contradictions.
  • Profit maximization has to be attempted with a realization of risks involved. A positive relationship exists between risk and profits. So both risk and profit objectives should be balanced.
  • Profit Maximization does not take into account the time pattern of returns.
  • Profit maximization fails to take into account the social considerations

2) Wealth Maximization:

      - It is commonly agreed that the objective of a firm is to maximize value or

      -  Value of a firm is represented by the market price of the company's
          common stock.

-         The market price of a firm's stock represents the focal judgement of all market participants as to what the value of the particular firm is.

-         It takes in to account present and prospective future earnings per share, the timing and risk of these earning, the dividend policy of the firm and many other factors that bear upon the market price of the stock. Market price acts as the performance index or report card of the firm's progress.


- Prices in the share markets are largely affected by many factors like general economic outlook, outlook of particular company, technical factors and even mass psychology.

-         Normally this value is a function of two factors as given below,
  • The anticipated rate of earnings per share of the company
  • The capitalization rate.
-         The likely rate of earnings per shares (EPS) depends upon the assessment
      as to how profitably a company is growing to operate in the future.

 -    The capitalization rate reflects the liking of the investors for the company.

Methods of Financial Management:

-         In the field of financing there are various methods to procure funds. Funds may be obtained from long-term sources as well as from short-term sources.

-         Long-term funds may be availed by owners that are shareholders, lenders by issuing debentures, from financial institutions, banks and public at large.

-         Short-term funds may be availed from commercial banks, public deposits, etc. Financial leverage or trading on equity is an important method by which a finance manager may increase the return to common shareholders.

-         At the time of evaluating capital expenditure projects methods like average rate of return, pay back, internal rate of returns, net present value and profitability index are used.

-         A firm can increase its profitability without affecting its liquidity by an efficient utilization of the current resources at the disposal of the firm.

-         A firm can increase its profitability without affecting its liquidity by an efficient management of working capital.

-         Similarly for the evaluation of a firm's performance there are different methods.

-         Ratio analysis is a popular technique to evaluate different aspects of a firm.

-         An investor takes in to account various ratios to know weather investment in a particular company will be profitable or not.

-         These ratios enable him to judge the profitability, solvency, liquidity and growth aspect of the firm.


-         Is defined as ability of the business to meet short-term obligations.

-         It shows the quickness with which a business/company can convert its assets into cash to pay what it owes in the near future.

-         It measures a company’s ability to meet expected as well as unexpected requirements of cash to expand its assets, reduce its liabilities and cover up any operating losses.

-         Liquidity is assessed through the use of ratio analysis. liquidity ratio provides an insight into the present cash solvency of a firm and its ability to remain solvent in the event of calamities.

-         Liquidity of receivables is assessed through Average collection period(ACP) it tells us the average number of days receivables are outstanding i.e., the average time a bill takes to convert into cash.

-         The ratio, reveals the following:

-         Too low an ACP may suggest excessively restricted credit policy of a company.

-         Too high an ACP may indicate too liberal a credit policy. A large number of receivables may remain due and outstanding, resulting in less profits and more chances of bad debts.


-         It becomes essential for a company to examine profit per unit of sale then it is done by estimating profitability per rupee sales. It is used to measure of comparison and standard of performance.

-         Profitability to sales ratio reflects the company’s ability to generate profits per unit of sales.


-         In managing business risk, the firm has to cope with the variability of the demand for its products, their prices, etc.

-         It has also to keep a tab on fixed costs.

-         As regards financial risk, high proportion of debt in the capital structure entails a high level of interest payments.

-         If cash inflow is inadequate, the firm will face difficulties in payment of interest and repayment of principal.

-         If the situation continues long enough, a time will come when the firm would face pressure from creditors.

-         Failure of sales can also cause difficulties in carrying out production operations.

-         The firm would find itself in a tight spot.

-         Investors would not invest further. Creditors would recall their loans. Capital market would heavily discount its securities.

-         Thus, the firm would find itself in a situation called distress.

-         When the sale proceeds is inadequate to meet outside liabilities, the firm is said to have failed or become bankrupt or (after due processes of law are gone through) insolvent.


-         Forecasting of cash flow
-         Raising funds
-         Managing the flow of internal funds
-         To facilitate cost control
-         To facilitate pricing of product lines and services
-         Forecasting profits
-         Measuring required return
-         Managing assets
-         Managing funds


Following key areas of reforms:

-         Reforms of structure of financial systems

-         Policies and regulations to deal with insolvency and liquidity of financial intermediaries

-         The development of markets for short and long term financial instruments

-         The role of institutional elements in development of financial systems

-         The link between financial sector and the real sectors, particularly in the case of restructuring financial and industrial institutions or enterprises

-         The dynamics of financial systems management in terms of stabilization and adjustment, and

-         Access to international markets.

The financial sector reforms in India seeks to achieve the following:

-         Suitable modifications in the policy framework
-         Improvement in the financial health and competitive capabilities
-         Building financial infrastructure
-         Upgradation of the level of managerial competence and the quality of human resource of banks by reviewing to recruitment, training, and placement.