Financial Management Unit 1 Introduction

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Financial Management Unit 1 Introduction

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Financial Management Unit 1 Introduction Notes cover all the exercise questions in UGC Syllabus. Financial Management Unit 1 Introduction provided here ensures a smooth and easy understanding of all the concepts. Understand the concepts behind every Unit and score well in the board exams.

Introduction

FINANCIAL MANAGEMENT

A. State whether each of the following statements is True and False:

1. Corporation finance is a wider term in business finance.

Ans: False.

2. Corporation finance deals with the company form of organisation.

Ans: True.

3. In the present days corporation finance is also referred to as business finance and financial management.

Aus: True.

4. Corporation finance is a part of public finance.

Ans: False.

5. Corporation finance emerged as a distinct field of study in the beginning of eighteenth century.

Ans: False.

6. The Principles of corporation finance can be applied to every type of organisation.

Aus: True.

7. Traditional approach confines finance function only to raising of funds.

Ans: True.

8. The main aim of finance function is to maximise the profit.

Ans: False.

9. Finance function is one of the most important function of business management.

Ans: True.

10. Cash management is an important task of the finance manager.

Ans: True.

11. Investment decisions are outside the purview of financial decisions.

Ans: False.

B. Select the most appropriate answer:

1. The appropriate objective of an enterprise is-

(i) Maximisation of sales.

(ii) Maximisation of owner’s wealth.

(iii) Maximisation of profit. 

Ans: (i) Maximisation of sales.

2. The job of a finance manager is confined to —

(i) Raising of funds.

(ii) Management of cash.

(iii) Raising of funds and their effective utilisation.

Ans: (iii) Raising of funds and their effective utilisation. 

3. Financial decision involve –

(i) Investment, financing and dividend decision.

(ii) Investment, financing and sale decisions.

(iii) Financing, dividend and cash decisions.

Ans: (i) Investment, financing and dividend decisions.

C. Fill up the blanks:

1. Financial management is the application of ______ Principles to a particular financial position. 

Ans: General management.

2. Financial management is something of which _____ is a part.

Ans: Accounting.

3. The function of financial management may be classified on the basis of ____ and ____.

Ans: Liquidity, profitability acquiring financial resources.

4. Traditional treatment of financial management places too much emphasis on _______.

Ans: Corporate finance.

5. Finance function provides the ____ required by the business enterprise.

Ans: Fund.

6. There is a number of _____ factors underlying the finance function. 

Ans: Basic.

SHORT TYPE QUESTIONS & ANSWERS

1. What do you understand by Financial Management? Mention five nature of Financial Management.

Ans: Financial management is concerned with those managerial decisions which result in the acquisition and financing of long term and short-term assets of a firm. It, there fore, deals with the situations which call selection of specific assets and specific liabilities, as also with the problems of size and growth of an enterprise. An analysis of these decisions is based upon expected inflows and outflows of funds and their effects on the stated managerial objectives.

Raymond Schultz and Robert Schultz have said that the subject of financial management is extremely broad and complex. The difficulty is compounded by the fact that it can be approached in a variety of ways in a descriptive, theoretical, analytical and applicative wary.

Five nature of financial management are: 

(i) An indispensable organ of business management.

(ii) Continuous process.

(iii) Less descriptive and more analytical.

(iv) Different from accounting function.

(v) Centralised nature of finance function.

2. Briefly mention the scope of Financial Management. Write three functions of Financial Management. 

Ans: A priori definitions of the scope of financial manage fall into three groups. One view is that finance is Concerned with cash. At the other extreme is the relatively narrow definition that financial management is concerned with sailing administering funds for an enterprise. The third approach is that it is an integrate part of overall management part of overall management rather than a staff specially can corned with fund raising operations. In this connection, Ezra Solomon says that in this broader view, the central issue of financial policy is the wise use of funds. One apparently straight forward approach is to define the scope of financial management as something which embraces those areas in which the finance officer or treasurer operators.

Three functions of financial management are:

(i) Recurring Finance Functions.

(ii) Non-Recurring Finance Functions.

(iii) Routine Functions.

3. Mention five roles of Finance Manager.

Ans: Five Roles of Finance Manager are:

(i) Estimating financial requirements.

(ii) Preparation of financial plan.

(iii) Balanced Capital structure.

(iv) Liquidity of the firm.

(v) Profitability of the firm.

4. Mention five importance of Financial Management. Write five limitation of Financial Management.

Ans: Five importance of financial management are:

(i) Basis of success of the enterprise.

(ii) Optimum allocation and utilisation of resources.

(iii) Central focal point of decision-making.

(iv) Measurement of performance and efficiency.

(v) Basis of planning, Coordination and control.

Five limitation of Financial Management are:

(i) It is difficult to know the financial effects of various managerial decisions.

(ii) Based on financial records.

(iii) Lack of knowledge of related subjects.

(iv) Lack of objectivity.

(v) Developing subject.

5. Write the Objectives of Financial Management.

Ans: The financial management is generally concerned with procurement, allocation and control of financial resources of a concern.

The objectives can be:

(i) To ensure regular and adequate supply of funds to the concern.

(ii) To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price of the share, expectations of the shareholders. 

(iii) To ensure optimum funds utilisation. Once the funds are procured, they should be utilised in maximum possible way at least cost.

(iv) To ensure safety on investment, i.e, funds should be invested in safe ventures so that adequate rate of return can be achieved.

(v) 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.

6. Mention five suitability of Profit Maximization Concept.

Ans: Five suitability of profit maximisation concept are:

(i) Profit maximisation is justified on the ground of rationality.

(ii) Indicator of economic efficiency.

(iii) Efficient allocation and utilisation of resources.

(iv) Measurement of success of business decisions.

(v) Source of incentive.

7. Mention five advantages of wealth Maximization Concept.

Ans: The five advantage of wealth maximisation concept are:

(i) It considers the cash flows rather than accounting profits. 

(ii) It considers both the quantity and quality of benefits.

(iii) It incorporates the time value of money.

(iv) It has got universal acceptance because it watches interest of all the sections of society.

(v) It gives due direction of the management for clear dividend policy

8. What is finance? What are the Different Types of Finance?

Ans: According to Oxford Dictionary, the word ‘finance’ connotes’ management of money’. It emphasises on securing of money rather than application of money raised.

Howard and Lipton defined as, “That administrative area or set of administrative functions in an organisation which relate with the arrangement of cash and credit so that the organisation may have the means to carry out its objectives as satisfactorily as possible.”

Finance is usually divided into two categories such as:

(i) Public Finance: The study of public finance is to analyse how do the different public authorities arrange their finance. Public finance is concerned with acquiring money for the conduct of government administration like government institutions, states, local self government, central government. The public finance also includes the public debt.

(ii) Private Finance: Private finance is concerned with the requirements, collection and allocation of funds in case of an individual or business organisation. Thus in private finance, we study how different persons and private institutions obtain their income and how they spend the income for the fulfilment of their objectives.

Private finance can be classified into:

(a) Personal finance: It is concerned with the management of money in the daily life.

(b) Business finance: It is concerned with the arrangement of finance in business firms for the purpose of earning profit.

Business finance can be further divided into:

(i) Proprietary finance. 

(ii) Partnership finance. 

(iii) Company or corporation finance.

9. Definition of Profit Maximization.

Ans: Profit Maximization is the capability of the firm in producing maximum output with the limited input, or it uses minimum input for producing stated output. It is termed as the foremost objective of the company. It has been traditionally recommended that the apparent motive of any business organisation is to earn a profit, it is essential for the success, survival, and growth of the company. Profit is a long term objective, but it has a short-term perspective i.e. one financial year. Profit can be calculated by deducting total cost from total revenue. Through profit maximisation, a firm can be able to ascertain the input-output levels, which gives the highest amount of profit. Therefore, the finance officer of an organisation should take his decision in the direction of maximising profit although it is not the only objective of the company.

10. Definition of Wealth Maximization.

Ans: Wealth maximisation is the ability of a company to increase the market value of its common stock over time. The market value of the firm is based on many factors like their goodwill, sales, services, quality  of products, etc. It is the versatile goal of the company and highly recommended criterion for evaluating the performance of a business organisation. This will help the firm to increase its share in the market, attain leadership, maintain consumer satisfaction and many other benefits are also there.

11. What Does a Financial Manager Do?

Ans: Regardless of their mission, all organisations can benefit from the work that a financial manager does. Financial managers generally overseè the financial health of an organisation and help ensure its continued viability. They supervise important functions, such as monitoring cash flow, determining profitability, managing expenses and producing accurate financial information. Whether charged with oversight of an entire financial operation or a specific aspect of finance, such as credit or risk management, financial managers are key to organisational success. Pursuing an online master’s degree in accountancy is one way to obtain the knowledge and skills to prepare for a career in financial management.

12. What are the Features of Profit Maximization?

Ans: Profit Maximization consists of the following features:

(i) Profit Maximization is also known as cash per share maximisation. It helps in achieving the objects to maximise the business operation for profit maximisation.

(ii) The ultimate objective of any business is to earn a huge amount of return in terms of profit. Thus, this objective of financial management considers all the possible ways to increase the profitability of the business concern.

(iii) Profit earning capacity is kind of a parameter for measuring the efficiency of a particular business. Thus, it shows the entire position of business along with the measures to improve and increase profitability.

(iv) Profit Maximization is an objective that helps in reducing risk.

LONG TYPE QUESTIONS & ANSWERS

1. What are the primary objectives of financial management? Explain the limitations of Financial Management.

Ans: Financial managers need to determine financial management objectives for efficient procurement, use of resources and minimising costs. Here are the most important financial management objectives that businesses across industries need to prioritize:

(i) Profit Maximization: The basic objective of financial management is to achieve optimal profit, both in the short and long run. It even includes wealth maximization, where every shareholder’s value or hold over dividends should increase. These outcomes are related to business performance, which means that the better a business performs, the higher its market value of its shares will be.

(ii) Proper Mobilization: Effective mobilization is one of the most important objectives of financial function. It means that managers need to make decisions regarding the allocation and utilization of various funds. Whether it’s shares or debentures, finance managers need to estimate an organization’s requirements and make financial decisions accordingly.

(iii) Improved Efficiency: Proper utilization of finance also encourages proper distribution. From creating inventories to investing in profitable businesses, mobilization and utilization of finances lead to better business decisions. This also allows managers to dedicate resources and distribute them among departments, increasing the overall efficiency of an organization.

(iv) Business Survival: The primary goal of financial management is ensuring an organization’s survival. As the term suggests, businesses need to survive the competitive market and the best way to do so is to manage their financial resources. Managers need to make big decisions after due diligence. They may consult with external members or agencies if needed. Every decision makes a difference as it impacts the business.

(v) Balanced Structure: As financial managers prepare capital structure, it creates balance among different sources of capital. This balance is essential for liquidity, flexibility and stability. This further decides the ratio between owned capital and borrowed capital.

(vi) To Ensure Availability of Funds: The sound financial condition of business is a must for any business to survive. The availability of funds at the proper time of need is an important objective of business. The organization will not be able to function without funds, and activities will come to a halt.

(vii) Effective Utilisation of Funds: Business not only needs a large number of funds but also skills to handle such large amounts. To cut down unnecessary costs and to save funds from wasting in useless assets is crucial for business. An example of such misuse of funds would be investing in extra raw material, in quantities not required.

(viii) Ensuring the Safety of Funds: The vital objective of financial management is to ensure the security of its funds through the creation of reserves. The chances of risk in investment should be minimum possible. Some of the reserves created for this purpose are Sinking Funds, General Reserves etc.

The role of financial management is increasing continuously and is a part of top management. But it has some limitations which are as follows:

(i) Based on financial records: Certain techniques of financial analysis and performance measurement are based on accounting records. As the financial accounts are concerned with the past, the decisions based on those records may be faulty.

(ii) Lack of objectivity: There is a lack of objectivity in financial management. The decisions of financial management are affected by the personal views and feelings of the personal managers and when the effect is more it can lead to bad results.

(iii) Lack of knowledge of related subjects: The objectives of financial management can be fulfilled only when the financial managers have knowledge about management, management accounting, statistics, economics etc. If they do not have adequate knowledge, they cannot take right decisions.

(iv) Expensive: It is quite expensive to build an effective financial management. So, the small business organisation are not able to bear the burden.

(v) Developing subject: It is not a fully developed subject and development is still going on. The specialists are not agreeing on certain views and theories. The standards of financial analysis are also changing.

2. What do you mean by cost of capital? What are the components of cost of capital?

Ans: Cost of capital is the rate of return that a firm must earn on its project investments to maintain its market value and attract funds. Cost of capital is the required rate of return on its investments which belongs to equity, debt and retained earnings. If a firm fails to earn return at the expected rate, the market value of the shares will fall and it will result in the reduction of overall wealth of the shareholders.

According to the definition of John J. Hampton “ Cost of capital is the rate of return the firm required from investment in order to increase the value of the firm in the market place”.

According to the definition of Solomon Ezra, “Cost of capital is the minimum required rate of earnings or the cut-off rate of capital expenditure”.

Various components of cost of capital:

Capital structure of a company mainly consists of debt and equity. Debt includes debentures, loans and bonds and equity include both equity and preference shares and retained earnings. The individual cost of each source of financing is called component of cost of capital. The component of cost of capital is also known as the specific cost of capital which includes the individual cost of debt, preference shares, ordinary shares and retained earnings. Such components of cost of capital have been presented below:

(i) Cost of debt.

(a) Cost of irredeemable debt.

(b) Cost of redeemable debt (before tax and after tax).

(c) Cost of debt redeemable in installments.

(d) Cost of existing debt.

(e) Cost of zero coupon bonds.

(ii) Cost of Preference Share.

(a) Cost of irredeemable preference Share.

(b) Cost of redeemable preference Share.

(iii) Cost of ordinary/equity shares or common stock.

(iv) Cost of retained earning.

3. Discuss the difference between Business Finance and Corporation Finance.

Ans: Business activity is concerned with the acquisition and conservation of capital funds in meeting the financial needs and overall objectives of business enterprises. Finance when applied to corporate form of organisation is termed as corporate finance. Corporate finance, usually deals with financial planning, acquisition of funds, use and allocation of funds, and financial controls.

Business finance involves an analysis of the various means of securing money for private business enterprises and the administration of this money by individuals, voluntary associations and corporations. The present day business activities are predominantly carried on by company or corporate form of organisation. That is why, some authorities do not make any distinction between business finance and corporation finance. Further the principles of business finance can be applied both to small (proprietary) and large (corporation) forms of business.

However, the following distinctions can be drawn between business finance and corporation finance:

4. Discuss relationship of finance with other Functional Areas.  

Ans: The relationship between finance and other business functions of an enterprise is discussed below:

(i) Finance and purchase function: Finance is closely linked with purchase function. Finance manager plays a key role in providing finance for purchase of materials. He also appliės material management techniques such as economic order quantity, perpetual inventory etc. and even exercise maximum control over stock. Timely and adequate purchase needs financial approvals. The task of the finance manager is to arrange the availability of cash when the bills for purchase become due.

(ii) Finance and accounting function: Finance is also connected with accounting function. The efficiency of the whole organisation can be greatly improved with correct recording of financial data. All the accounting tools and control devices, necessary for appraisal of financial policy can be correctly formulated if the accounting data are properly recorded. Thus sound financial management is the result of good accounting.

(iii) Finance and marketing function: Finance is intimately related  with marketing. While formulating credit and collection policies for the  firm, both finance and marketing managers consult each other because  such policies directly affect the volume of sales and funds. The marketing manager can provide information as to how different prices affect the demand for the company’s product in the market. Similarly, the financial manager can supply information about costs, profit margins etc.

(iv) Finance and production function: The production department is headed by a production manager. He is responsible for decisions concerning the level of fixed assets and current assets. The finance manager exercises tight control on the investment in the productive assets. The acquisition and maintenance of assets also involve finance. The finance manager is responsible for supplying funds to the production manager.

(v) Finance and personnel function: The recruitment, training and placement of staff is the responsibility of personnel department. A sound personnel policy includes proper wage structure, incentives schemes, promotional opportunity, human resource development and other fringe benefits provided to the employees. All these matters affect finance. Therefore the relation between the finance and personnel department should be intimate.

Thus finance can be seen as closely linked with all other areas of management.

5. Define Financial Management. What are the characteristics of Financial Management?

Ans: Financial management is mainly concerned with the proper management of funds:

According to Ezra Soloman: “Financial Management is concerned with the efficient use of an important economic resource, namely capital fund”

According to Howard and Lipton: “Financial Management is the application of planning and control function to the finance function”.

According to modern approach, the finance function plays an important role in business management. So the role of finance manager becomes quite important.

The following are the characteristics of financial management:

(i) An indispensable organ of business management: In modern approach the financial management is an important part of business management and the finance manager is an active member of group of high level of management. As finance is linked to all business activities, financial management plays an important role in business decisions.

(ii) Continuous process: In modern days financial management has become a continuous process and for the successful running of business, the role of finance manager is quite important.

(iii) Different from accounting function: Many people consider the finance function to be same as accounting function because many terms and records are same, but finance function is different from accounting  function. In accounting function the collection of financial and related  statistics is done while in finance function these are used for the analysis and decision making.

(iv) Wide scope: The scope of financial management is quite wide. The function of financial management is to find the sources for short- term and long-term requirements, their distribution and optimum use. Financial management is responsible for Accounts, Audit, Cost Accounts, Business Budget, Management of Materials, Cash and Credit.

(v) Helpful in decisions of top-management: According to modern theory the financial manager helps the top management in decision making. The finance manager presents the reports to the high level of management on financial performance of the enterprise.

(vi) Measurement of performance: In the modern times the business performance is measured on the basis of financial results. The finance manager has to manage the liquidity and profitability functions and for this he has to divide the profit and risk property. Then he can get the desired level of performance.

(vii) Coordination with other departments: The finance manager cannot do his work effectively without coordination with other departments of the enterprise. The work of every department affects the financial results, so the non-cooperation of any department disturbs the expected results.

(viii) Applicable to all types of organisation: Financial Management is applicable in all organisations whether it is manufacturing organisation or service organisation, small or big organisation. It is also applicable to non-profit organisations.

6. Explain the objectives of financial management in the modern era.

Ans: The objectives of financial management in the modern era are:

(i) Ensuring a regular and suitable supply of funds for the organisation.

(ii) To ensure optimum use of funds. Once the funds are procured, they should be used in the maximum possible way at minimum cost.

(iii) Creation of a stable capital structure. The capital distribution should strike a steady balance between debt and equity. 

(iv) Ensuring the safety of investments. The funds should be invested in safe ventures to guarantee adequate returns.

(v) Ensuring adequate returns for the organisation and the shareholders.

Here are ways in which financial management courses can help modern businesses: 

(i) Boosting Efficiency:  An efficient business is a profitable business. Financial management professionals help businesses boost efficiency by reducing unnecessary expenditure, inculcating time-saving processes, and enhancing financial processes. Regularly monitor and review the quality of the data, identify and address data issues promptly, and establish data cleansing procedures if necessary. Businesses benefit from reduced turn-around time, more transparent decision making, and overall modern solutions to modern problems. 

(ii) Ensuring Liquidity: One way to ensure liquidity is to maintain large cash balances or arrange necessary borrowing facilities but neither approach results in optimal profitability. Liquidity in terms of cash flow is necessary for day-to-day operations of a business. Funds are necessary for employee salaries, pay vendors, advertise, and implement processes to enhance business functions. 

(iii) Maximising Profits: The aim of any business is to ensure profitability. Financial managers utilise their skills and knowledge to help businesses attain this goal. Businesses have a responsibility towards their stakeholders, investors, and employees to maximise profits and utilise a portion of those profits to ensure continued and successful advancement of the business. Profits also help businesses survive in difficult times such as a pandemic. Profit maximization is when a business achieves its highest revenue or profit. The profit maximization theory assumes that the goal of a company is to make the highest profits possible.

(iv) Monetary Security: Financial managers make sure that funds are invested in a secure manner. Astute financial managers ensure that the funds of a business are invested in profitable ventures, and in implementing profitable processes to ensure further growth of the business. Financial managers study the market, assess risks, and then invest in ventures that are profitable without being too risky. 

(v) Stabilising Capital Structure: A business derives capital from a variety of different sources. Bank loans and market capital are two of the most common forms of securing capital to grow. Financial managers have to assess the cost of capital from different sources before securing funds. Such decisions help businesses create a healthy balance of a company’s capital structure. 

7. Briefly describe the goals of Financial Management.

Ans: The goal of financial management should be to achieve the objectives of the business owners i.e. share holders. It is generally argued that the goal of finance function should be maximisation of profits. However, there is disagreement over this goal.

There are two basic goals in business to be achieved through finance function.

They are:

(i) Profit Maximisation.

(ii) Wealth Maximisation.

(i) Profit Maximisation: Profit earning is the main aim of every economic activity. Traditionally, the business has been considered as an economic institution and profit has been accepted as the valid criterion of measuring its efficiency. Therefore this is a natural objective that the profit should be maximised.

The following reasons are being given for the suitability of profit maximisation:

(a) Profit maximisation is justified on the ground of rationality: If a person does some economic activities with patience then his ultimate objective is to maximise his utility. Utility can easily be measured in terms of profit. So on the basis of rationality it is considered right to maximise profit.

(b) Indicator of economic efficiency: The profit is an indicator of economic efficiency of the enterprise whereas the loss is an indicator of economic inefficiency.

(c) Efficient allocation and utilisation of resources: The efficient allocation and utilisation of resources is done on the basis of profit. The financial management puts the less profitable utilisation into more profitable utilisation which increases the efficiency of the enterprise.

(d) Source of incentive: The profit is a major source of incentive in business. For earning of more profit, one firm tries to become more profitable than the other firm.

(e) Maximisation of social benefit: Profitability is essential for fulfilling social goals also. A firm by pursuing the objective of profit maximisation also maximises socio-economic welfare.

However, profit maximisation objective has been criticised on many grounds because of its limitations:

(a) It is a vague concept: The term ‘profit’ is vague as it does not clarify what exactly does it mean. For example, which profit are to be maximised — short run or long run, rate of profit or the amount of profit, profit before tax or after tax or distributable profit.

(b) It is a short-run concept: The profit concept ignores the long run going concern concept and concentrates on the short-run view. Some capital expenditures which are not profitable today may yield revenues in future. But this is ignored by profit concept.

(c) It ignores the time value of money: The profit concept ignores the timing of return. A return on investment or cash received today is better than at the end of a period of time because the time value of money decreases along with the passage of time. 

For example:

Time pattern of benefits:

It can be seen from the table that the total profits associated with both the alternatives are identical under profit maximisation concept both the alternatives are ranked equal. But alternative A provides higher return in the earlier period while return from B is larger in the later period. Thus, the basis principle of finance ‘the earlier is the better’ is ignored by the profit maximisation concept.

(d) It ignores risk: Risk factor is totally ignored by the profit maximisation concept. Some projects are more risky than others. More uncertain the expected benefits. The lower the quality of benefits and vice versa.

For example:

Uncertainty about expected benefits.

It can be seen from the table that the total returns from both the alternatives are identical in normal situations. But the variation is very wide in case of alternative B, while it is narrow in case of alternative A. From uncertainty point of view, alternative A is better as B is more uncertain or risky. Profit maximisation criteria ignores it.

(ii) Wealth maximisation: Wealth maximisation is the appropriate objective of an enterprise. Financial theory asserts that wealth maximisation is the single substitute for a stockholder’s utility.

Wealth of the firm is reflected in the maximisation of the present value of the firm. The term ‘wealth’ is reflected in the earning per share (EPS) and the market price of shares (MPS). The wealth of shareholders increases only when there is increase in the price of shares in the market. The market value of shares is indication of prosperity and efficiency of the enterprise. So the objective of financial management is to increase the wealth of the firm. Wealth maximisation is a long-term strategy.

It has the following advantages:

(a) It considers the cash flows rather than accounting profits.

(b) It considers both the quantity and quality of benefits.

(c) It corporates the time value of money.

(d) It has got universal acceptance because it watches interest of all the sections of society.

(e) It gives due direction to the management for clear dividend policy.

The wealth maximisation objective has been criticised on following grounds:

(i) It is a prescriptive idea. The objective is not descriptive of what the firms actually do.

(ii) The objective of wealth maximisation is not necessary socially desirable.

(iii) There is some controversy as to whether the objective is to maximise the stockholders wealth or the wealth of the firm which includes other financial claim holders such as debenture holders, preference shareholders etc.

(iv) This objective may also face difficulties when ownership and management are separated as in the case of corporate form of organisations. The managers may act in such a manner which maximises the managerial utility but not the wealth of stockholders or the firm. 

In spite of all the criticism, we are of the opinion that wealth maximisation is the most appropriate objective of a firm and the side costs in the form of conflicts between the stockholders and debenture holders, firm and society and stockholders and managers can be minimised.

8. Discuss the functions of Financial Management.What are the importance of Financial Management?

Or

Discuss the scope/elements/areas of finance function. What are the importance of Financial Management?

Ans: The finance manager in a big enterprise has to perform such important functions which are known to be Finance Functions.

According to the modern scholars the contents of finance functions can be discussed under three broad groups as under:

A. Recurring finance functions.

B. Non-recurring finance functions.

C. Routine functions.

A. Recurring finance functions: It means all such financial activities that are carried out regularly or frequently for the efficient conduct of a firm.

The contents of recurring finance functions are as follows:

(a) Planning for funds: The initial task of the finance manager in a new or going concern is to formulate plans for the company.

Planning for funds involve two activities:

(i) Estimation of fund requirements: The finance manager has to estimate the quantum of fund requirements and its duration. While determining fund requirements the finance manager must keep in aind various considerations like the purpose of the business, economic and business conditions, future investment programmes, state regulations etc.

(ii) Determination of sources: After estimating total fund requirements, the finance manager decides as to how these requirements will be met. The finance manager has to decide the various sources where from the required funds are to be raised.

(b) Organizing of funds: The next important function of the finance manager is the organisation or administration of funds.

Three activities are involved in it:

(i) Raising of funds: The finance manager has to arrange the issue of prospectus for the security issues, in case of public limited companies. In order to ensure quick sale of securities, he may approach the brokers or underwriters, who deal in securities. If the company decides to borrow fund from financial institutions the finance manager has to negotiate with the appropriate authorities.

(ii) Allocation of funds: The finance manager should take into consideration some factors while allocating funds such as immediate requirements, overall management plans, profit prospects etc. The finance manager has to strike a balance in allocating funds among fixed assets and current assets.

(iii) Allocation of income: Allocation of income is the exclusive responsibility of the finance manager. He must be very careful in deciding what portion of earnings should be distributed as dividend and how much to retain for future growth or expansion.

(iv) Controlling of funds: The finance manager has to control the usage of funds in business. He is to see whether the funds are raised or utilised as per plans and budgets or if there is any deviation. He can apply various tools or techniques to control the usage of funds such as budgetary control, ratio analysis, break even analysis etc.

B. Non-Recurring Finance Functions: Non-recurring finance functions refers to these financial activities that are performed by a financial manager very infrequently. These functions are not found in the ordinary routine of the financial manager. 

Some non-recurring finance functions are:

(i) Preparation of financial plan at the time of promotion of the company.

(ii) Financial readjustments at the time of financial crisis or liquidation of a company.

(iii) Valuation of the firm at the time of merger, or amalgamation of two or more companies.

C. Routine functions: In this category these functions are included which are of routine in nature. These are performed by lower level employees like accountant, cashier and typist.

Ordinarily these functions include:

(i) Supervision of receipt of cash and its disbursement.

(ii) Keeping the cash balances properly and safely.

(iii) Keeping record of every transaction and the accounts safely.

(iv) Management of credit transactions.

(v) Safety of securities and important documents.

(vi) Administration of pension and welfare schemes.

(vii) Providing information to top management.

(viii) Obeying government rules and regulations.

The modern finance manager is also required to advise the operating executives on important operational and strategic matters such as pricing, diversification, expansion, acquisition etc.

The importance of financial management has increased day by day in the business world due to three important reasons:

(i) Increase in size and number of corporation.

(ii) Wide distribution of corporate ownership.

(iii) Divorce between ownership and management.

The importance of financial management can be discussed under the following heads:

(i) Basis of planning, coordination and control: The financial management gives the basis of planning, coordination and control in the enterprise. The financial planning is done on the basis of financial forecasting. In this case coordination among various departments and budgetary control are essential.

(ii) Basis of the success of the enterprise: The success of an enterprise depends wholly on effective financial management. The effective financial management can turn an enterprise which is running in loss into a profit making organisation.

(iii) Central focal point of decision-making: In the past, the business managers used to make the decisions on the basis of intuition. But, today most of the decisions are taken on the basis of financial analysis and comparison.

(iv) Measurement of performance and efficiency: Whatever work is done in the enterprise, its measurement of efficiency is done on the basis of finance. For this work, certain new techniques have been developed in financial management.

(v) National importance: The per capita national income can be increased by effectiveness of financial management. Inefficient management of public investment is a big reason for slow economic development.

(vi) Optimum allocation and utilisation of resources: A good finance manager can make possible the optimum allocation and utilisation of resources and through this works they help in increasing the wealth of the firm.

(vii) Useful for various groups: The financial management is quite useful for business managers, shareholders, financial institutions, politicians, etc. Even economists, sociologists, students of commerce and management, all have been benefitted from this subject.

9. Discuss the role or responsibilities of Finance Manager. What are the Financial Manager Responsibility?

Ans: Finance manager is the person responsible for the overall financial health of the firm.

He takes care of the finance functions by discharging the following responsibilities:

(i) Preparation of financial plan: It is the responsibility of the financial manager to adopt a sound, simple and flexible financial plan.

(ii) Profitability: Profitability indicates the rate of return from investments (ROI). The financial manager must approve only these projects for investments which can yield adequate rate of return.

(iii) Liquidity of the firm: Liquidity means the ability of the firm to meet its current obligations. The financial manager must ensure that the liquidity position of the company is not affected by its investment policy.

(iv) Sound capital structure: The financial manager must ensure that appropriate ratios and proportions are maintained among various sources of capital. The capital structure should ensure maximum revenues at a minimum cost.

(v) Maximisation of wealth: All the activities of the finance manager must be directed towards the maximisation of the wealth of the firm. Wealth will be maximised if the cost of capital is the minimum and market price of shares and earning per share are the maximum.

(vi) Estimating financial requirements: The financial manager must estimate the financial requirements of the firm so that it can carry out its operations without inadequacy of funds.

(vii) Controlling financial resources: The finance manager has to develop the standards, procedures and practices for the use of finance so that the misuse of finance is stopped. If there is control on costs then there is reduction in cost.

(viii) Dividend policy: The finance manager must ensure that stable dividend policy is followed year after year for the benefit of the firm as well as share holders.

The responsibility of Financial Manager are:

(i) Forecasting and Planning: The financial manager must interact with other executives as they look ahead and lay the plans which will shape the firm’s future.

(ii) Major Investment and Financing Decisions: A successful firm usually has rapid growth in sales, which requires investments in plant, equipment and inventory. It is the task of the financial manager to help determine the optimal sales growth rate, and he (she) must help decide what specific assets to acquire and the best way to finance those assets. For example, should the firm finance with debt, equity, or some combination of the two, and if debt is used, how much should be long term and how much should be short term?

(iii) Coordination and Control: The financial manager must interact with other executives to ensure that the firm is operated as efficiently as possible. All business decisions have financial implications, and all managers financial and otherwise need to take this into account. For example, marketing decisions affect sales growth, which, in turn, influences investment requirements. Thus, marketing decision makers must take account of how their actions affect (and are affected by) such factors as the availability of funds, inventory policies and plant capacity utilisation.

(iv) Dealing with the Financial Markets: The financial manager must deal with the money and capital markets. Each firm affects and is affected by the general financial markets where funds are raised, where the firm’s shares and debentures are traded, and where its investors either make or lose money.

(v) Risk Management: All business face risks, including natural disasters such as fires and floods, uncertainties in commodity and share prices, changing interest rates and fluctuating foreign exchange rates. However, many of these risks can be reduced by purchasing insurance or by hedging. The financial manager is usually responsible for the firm’s overall risk management programmes, including identifying the risks that should be hedged and then hedging them in the most efficient manner. 

10. Discuss the nature of Financial Management. Discuss the scope of Financial Management.

Ans: According to modern approach, the finance function plays an important role in business management. So the role of finance manager becomes quite important.

According to modern approach the following are the characteristics of financial management:

(a) An indispensable organ of Business management: When the traditional approach was in use, the finance manager was considered quite unimportant in the management of business but in modern approach the financial management is an important port of business management and the finance manager is an active member of group of high level of management. The question of finance is attached to all business activities, therefore, finance manager plays an important role in business decisions.

(b) Continuous process: The process of financial management was not a continuous process in traditional approach, rather this process was used only on occupancy of special events and when the problem was solved, it again became slow, But in modern approach it is a continuous process and for the successful renaming of business, the role of finance manager is quite important.

(c) Less descriptive and more analytical: The traditional financial management was more descriptive and less analytical while the modern financial management is more analytical and less descriptive. To day the statistical and mathematical models have been developed by which the best alternative can be easily chosen under given internal and external conditions.

(d) Different from accounting functions: many people consider the finance function to be same as accounting function because many terms and records are same, but finance function is different from accounting function. In accounting function the collection of financial and related statistics is done while in finance function these are used for the analysis and decision – making.

(e) Centralized nature of finance function: In different areas of modern business management, the finance function is centralized Decentralization of production distribution and management of works is possible but in finance function this is not possible on practical ground.

(f) Wide scope: The scope of financial management is quite wide. The function of financial management is to find the sources for short – term and long term requirements, their distribution and optimum use, optimum use. Financial management is responsible for Accounts, Audit, Cost Accounts, Business Budget, management of Materials, Cash and Credit.

(g) Helpful in decisions of top management: According to modern theory the finance management helps the top management in decision making. The finance manager presents the reports to the high level of management on financial performance of the enterprise.

(h) Measurement of performance: In the modern times the business performance is measured on the basis of financial results. The finance manager has to manage the liquidity and profitability functions and fir this he has to divide the profit and risk property. Then he can get the desired level of performance.

(i) Co-Ordination with other departments of the enterprise: The Finance manager Cannot do his work effectively. Without co-ordination with other department of the enterprise. The work of every department affects the financial results so the non-cooperation of any department disturbs the expected results.

(j) Financial planning control and follow up: According to modern approach the following are included in financial management like obtaining of resources and planning of their use, control according to the budgets, search of deviations and improvement of work by feedback.

(k) Applicable to all types of organizations: Financial management is applicable in all organizations whether it is manufacturing organization  or service organization or sole proprietorship organization. It is also applicable in non-profit organizations.

Scope of financial management means the various decisions to be taken by a financial manager in a corporate enterprise for achievement  of business Objectives. The decisions taken by a financial manager may be discussed under two broad groups:

(a) Long-term Financial Decisions: Such decisions have long term effects on the value of the enterprise. It is, therefore, necessary to consider the likely cost and benefits of the various decisions. Long-term financial decisions may be of four types:

(b) Fund Requirement Decision: This is the most important function performed or delusion taken by the finance manager. A careful estimate has to be made about the total funds required by the enterprise, taking into account both the fixed and working capital requirements. This is done by forecasting the physical activities of the enterprise.

(c) Capital Budgeting Decision: It is concerned with the allocation of a given amount of capital to fixed assets of the business. It is also known as capital expenditure decision. In making the capital budgeting decision selection of projects should be carefully done. Certain methods are employed to judge the profitability of the decision e.g. pay back method, average rate of return method, internal rate of return method etc.

(d) Capital structure Decision: The financial manager in a corporate enterprise must decide the proportion of equity capital and debt capital i.e., the Debt-Equity Ratio. He must obtain an optimal or balanced capital structure where overall. Cost of capital is the minimum and the value of firm is maximum.

(e) Dividend Decision: The next crucial financial decision is the dividend decision. This decision is involved with two policies, i.e. dividend policy and reserve policy. The dividend pay out ratio-determines the amount of earnings retained in the business. The dividend policy must be such that it increases the market value of shares.

(f) Short-term Financial Decision: The job of the financial manager is not just limited to the long term financial decision. He should take short-term financial decisions which includes investment decisions on current assets such as cash, inventories, debtors, receivables etc. The investment in current assets will depend on the credit and inventory policies perused by the enterprise. Investment in current assists affects the firms profitability, liquidity and solvency.

11. Describe the evolution of Financial Management.

Ans: Before the start of 20th century, the study of finance was included under economies, but after the start of 20th century due to merging of small industries to form big industries led to the problem of arrangement of finance in front of business managers. Because of special contribution of finance in solving of these problems, it began to be studied as a separate subject. Mostly big undertakings were organized on they corporation from, due to which books on corporation finance were published. In Corporation finance books, we find a detailed description of capital structure, classification of securities and conditions of financial contracts. That is why the Business finance was descriptive subject. The names of Green, Mede, Darling and Lion are better Known as developers of the subject. 

Before the recession of thirties great importance was given for obtaining of finance through different type of securities and from different financial institutions. In the 1930’s development of radio, chemical, steel and motor car industries took place rapidly and the importance of national advertisement, new distribution system and high profits increased.

Due to recession of thirties, the liquidity problem arise in many business enterprises. The businessmen have problem in obtaining of finance from banks and other financial institutions for their day to day requirements. Therefore, in order to fulfill their demand of liquidity they had to sell the manufactured stock quickly and in more quantity but due to decrease in prices, the finance available was not adequate. Thus changes took place in financial management of a firm. More importance was given to financial planning and control. The protective policy was developed for business institutions by finance managers in order to protect them from closing of business and declaring themselves insolvent. More attention was paid to the problems arising out of financial crisis in the life of the business firms.

In 1950’s after the second world war, the reorganization of industries led to different problems in procuring of money from capital markets for the peaceful requirements. In the fifth decade of 20th century the financial experts had give importance to the selection of such a financial structure that could bear the burden of post was pressures and adjustments.

The traditional approach of Business finance, which originated in 1920, was extremely popular till 1950, After 1950 certain changes took place due to which the importance of traditional approach declined and the new approach of business finance developed.

In the sixth decade of 20th century, on the one hand there was increase in business activities in America and on the other hand frustrated stock exchanged and money market conditions were there In these circumstances, cash analysis was given more importance than profit analysis. The financial exports were given the responsibility to control the cash flow in such a way that the firm could achieve its objectives an due dates. Now the financial arrangement of day-to-day activities of the firm was given more importance than institutional and external finance. Cash forecast, Cash Budget, Receivables management, Purchase Analysis and Inventory control were given special place in financial management.

In sixth decade of this century, the change in approach towards business finance became more fast. After 1960 the problem of falling profit in established classical industries and availability of easy money led to problem of investment of capital in such areas where profit could be maximize profit. For the fulfillment of this objective capital Budget, Project Evaluation and control Expenditure and such other new techniques were developed. Now Business Finance is not a descriptive subject but analytical and the name of subject is changed to Financial Management.

12. Explain in brief the Arguments in the favor of Profit Maximization and criticism of profit maximisation.

Ans: Arguments in the favour of Profit Maximization:1

(i) When earning the profit is the only motive of doing the business, the objectives to achieve those targets should be considered feasible; therefore, profit maximization should be the obvious objectives.

(ii) Profit earning capacity is the barometer for measuring efficiency and economic prosperity of business concern, thus this objective is justified based on rationality.

(iii) Economic and business situations don’t go the same all the time. There are at times adverse business conditions like recession, depression, severe competition, etc. During these situations earned profit works as a savior. Thus, a business should earn more and more profit at the time of a favorable situation. A business entity will be able to survive under unfavorable situations only if it has certain funds in the form of past accumulated earnings that it can rely upon.

(iv) The main source of income and funds for the business is the amount of profit earned. Thus, a business should aim to maximize its profit for enabling its growth and development.

(v) The fulfilment of social goals is also achieved by earning the expected amount of profit. A business concern by pursuing the objects of maximizing the profit also maximizes socio-economic welfare.

Arguments in the Criticism of Profit Maximization:

(i) A firm pursuing its objective of profit maximization usually starts exploiting its workers as well as its customers.

(ii) To earn maximum profits business usually engaged in immoral and number of corrupt practices such as unfair trade practices, corrupt practices, etc.

(iii) It affects the ideal social system by leading to colossal inequalities amongst stakeholders such as customers, suppliers and public shareholders, etc. and lowers the human values.

(iv) In today’s era of imperfect competition, profit maximization cannot be the legitimate objective. Thus, it is more suitable in the conditions of perfect competition.

13. Write the Key Differences Between Profit Maximization and Wealth Maximization.

Ans: The fundamental differences between profit maximization and wealth maximization is explained in points below:

(i) The process through which the company is capable of increasing earning capacity known as Profit Maximization. On the other hand, the ability of the company in increasing the value of its stock in the market is known as wealth maximization.

(ii) Profit maximization is a short term objective of the firm while the long-term objective is Wealth Maximization.

(iii) Profit Maximization ignores risk and uncertainty. Unlike Wealth Maximization, which considers both.

(iv) Profit Maximization avoids time value of money, but Wealth Maximization recognises it.

(v) Profit Maximization is necessary for the survival and growth of the enterprise. Conversely, Wealth Maximization accelerates the growth rate of the enterprise and aims at attaining the maximum market share of the economy.

(vi) Under profit maximization, the immediate increase of profits is paramount, so management may elect not to pay for discretionary expenses, such as advertising, research, and maintenance. Under wealth maximization, management always pays for these discretionary expenditures.

(vii) Under profit maximization, management minimizes expenditures, so it is less likely to pay for hedges that could reduce the organization’s risk profile. A wealth-focused company would work on risk mitigation, so its risk of loss is reduced.

(viii) When management wants to maximize profits, it prices products as high as possible in order to increase margins. A wealth-oriented company could do the reverse, electing to reduce prices in order to build market share over the long term.

(ix) A profit-oriented business will spend just enough on its productive capacity to handle the existing sales level and perhaps the short-term sales forecast. A wealth-oriented business will spend more heavily on capacity in order to meet its long-term sales projections.

14. Write short notes:

(i) Difference between profit maximization and wealth maximization.

Ans: 

(ii) Significance of cost of capital.

Ans: computation of cost of capital is a very important part of the financial management to decide the capital structure of the business concern.

(a) Important to capital budgeting decisions: capital budget decision largely depends on the cost of capital of each source. According to net present value method, present value of cash inflow must be more than the present value of cash outflow. Hence, cost of capital is used to capital budgeting decisions.

(b) importance to structure decision: Capital structure is the mix or proportion of the different kinds of long term Securities. A firm uses particular types of sources if the cost of capital is suitable. Hence, cost of capital helps to take decision regarding structure.

(c) Importance to evolution of financial performance:cost of capital is one of the important determine which affects the capital budgetings, capital structure and value of the firm. Hence, it helps to evaluate the financial performance of the firm.

(d) Importance to other financial decisions: Apart from the above points, cost of capital is also used in some other areas such as, market value of share, earning capacity of securities etc. hence, it pays a major part in the financial management.

(iii) Argument in favour of wealth maximization as the goal of financial management.

Ans: The following arguments are advanced in favour of wealth maximization as the goal of financial management:

(a) It serves the interests of owners, as well as other stakeholders in the firm; i.e. suppliers of loaned capital, employees, creditors and society.

(b) It is consistent with the objective of owners’ economic welfare.

(c) Main aim is earning profit.

(d) The objective of wealth maximization implies long-run survival and growth of the firm.

(e) It takes into consideration the risk factor and the time value of money as the current present value of any particular course of action is measured.

(f) The effect of dividend policy on market price of shares is also considered as the decisions are taken to increase the market value of the shares.

(g) Profit is the parameter of the business operation.

(h) The goal of wealth maximization leads towards maximizing stockholder’s utility or value maximization of equity shareholders through increase in stock price per share.

Favourable Arguments for Profit Maximization

(i) Profit reduces risk of the business concern.

15. Discuss the significance of financial management in the present day business world?

Ans: The significance of financial management can be discussed from the following angles:

(i) Importance to Organizations:

(a) Business organizations: Financial management is important to all types of business organization i.e. Small size, medium size or a large size organization. As the size grows, financial decisions become more and more complex as the amount involves also is large.

(b) Charitable organization / Non-profit organization / Trust: In all those organizations, finance is a crucial aspect to be managed. A finance manager has to concentrate more on collection of donations/ revenues etc. and has to ensure that every rupee spent is justified and is towards achieving Goals of organization.

(c) Government / Govt. or public sector undertaking: In central/ state Govt, finance is a key/ important portfolio generally given to most capable or competent person. Preparation of budget, monitoring capital /revenue receipt and expenditure are key functions to be performed by the person in charge of finance. Similarly, in a Govt or public sector organization, financial controller or Chief finance officer has to play a key role in performing/ taking all three financial decisions i.e. raising of funds, investment of funds and distributing funds.

(d) Other organizations: In all other organizations or even in a family finance is a key area to be looked in to seriously by a competent person so that things do not go out of gear.

(ii) Importance to all Stake holders:

(a) Shareholders: Shareholders are interested in getting optimum dividend and maximizing their wealth which is basic objective of financial management.

(b) Investors / creditors: these stake holders are interested in safety of their funds, timely repayment of the principal amount as well as interest on the same. All these aspect are to be ensured by the person managing funds/ finance.

(c) Employees: They are interested in getting timely payment of their salary/ wages, bonus, incentives and their retirement benefits which are possible only if funds are managed properly and organization is working in profit.

(d) Customers: They are interested in quality products at reasonable rates which are possible only through efficient management of organization including management of funds.

(e) Public: Public at large is interested in general public welfare activities under corporate social responsibility and this aspect is possible only when organization earns adequate profit.

(f) Government: Govt is interested in timely payment of taxes and other revenues from business world where again efficient finance manager has a definite role to play.

(g) Management: Management is interested in overall image building, increase in the market share, optimizing shareholders wealth and profit and all these aspect greatly depends upon efficient management of financial resources.

(iii) Importance to other departments of an organization A large size company, besides finance dept., has many departments like

(a) Production Dept.

(b) Marketing Dept.

(c) Personnel Dept.

(d) Material/ Inventory Dept.

All these departments look for availability of adequate funds so that they could manage their individual responsibilities in an efficient manner. Lot of funds are required in production / manufacturing dept. for ongoing / completing the production process as well as maintaining adequate stock to make available goods for the marketing dept. for sale. Hence, finance department through efficient management of funds has to ensure that adequate funds are made available to all department and these departments at no stage starve for want of funds. Hence, efficient financial management is of utmost importance to all other department of the organization.