Unit-IV

Financial Management
• Financial management seeks to plan for the future
such that a personal or business entity has a positive
flow of cash.
• It is a branch of economics that deals with planning
and controlling of financial resources of the business
enterprise.
• The term ‘financial management’ has a number of
meanings including the administration and
maintenance of financial assets.
The process of financial management may also
include dentifying and trying to work around the
various risks to which a particular project may be
exposed.
• Some experts refer to financial management as the
science of money management – the primary usage
of the term being in the world of financing business
activities.
However, the process of financial management is
important at all levels of human existence, because
every entity needs to look after its finances.
• Financial Management is management of finances
of an organization in order to achieve its objectives.
• From an organizational standpoint, the process of
financial management is the process associated with
financial planning and financial control. Financial
planning seeks to quantify various financial resources
available and plan the size and timing of
expenditures.
• Various tools of financial management are cost
accounting,, statistics, budgeting and ratio analysis.
• At the corporate level, the main aim of the
process of business organization is to achieve the
various goals a company sets at a given point of
time. Businesses also seek to generate substantial
amounts of profits with the help of a particular
set of financial processes.
• Financial planning aims to boost the levels of
resources at their disposal, while also functioning
on money invested in them from external
investors.
• Another goal companies have is to provide
investors with sufficient amounts of returns on
their investments.
• At the individual level, financial management
 mostly involves tailoring expenses as per the
financial resources the particular individual has.
• Individuals who are in a favorable financial
position, with surplus cash on hand or
• access to funding, plan to either invest their
money for a positive return (which
• normally means that they have made more
money after calculating the double impact
• of tax and inflation) or to spend it on
discretionary items.
• Financial decision-making is also an important
part of the modern day financial
• management process. The particular entities
involved in financial management also
• need to be able to take the financial decisions
that are intended to benefit them in the
• long run and achieve their financial aims, which
is the basic premise of financial management.
 Key Elements of Financial Management:
• Planning
• Reporting
• Management Cycle
• Managing Performance & Resources
• Allocating Resources
Functions of financial management
A. Executive functions
1. Financial forecasting
2. Investment decisions
3. Dividend policy decisions
4. Manage nets of funds flow
5. Cash flow management
6. Borrowing policy decisions
7. Cost control
B. Incidental Functions :
• These are the routine functions of the manager. It
includes:
• Record keeping
• Supervising cash receipts and payments
• Management of credits
• Management of assets
• Short term as well as long term planning for the
business activity

Importance of financial management

• Determination of financial requirements
• Allocation of funds
• Make or buy decisions
• Co-ordination between financial activities
• Profit and wealth maximization
 • Credit and payment decisions
• Purchasing and replacement policies decisions
• Smooth running of the business enterprise
Sources of finance
•In the present days there exists several sources of
finance. Keeping in view the type of requirement the
finance sources are chosen.
1) Long-term Sources of finance :

• Share capital or Equity Share.

• Preference shares.
• Retained earnings.
• Debentures/Bonds of different types.
• Loans from financial institutions.
• Loan from State Financial Corporation.
• Loans from commercial banks.
• Venture capital funding.
 • International
2) Medium-term Sources of finance :
• Preference shares.
• Debentures/Bonds.
• Public deposits/fixed deposits for duration of
three years.
• Commercial banks.
• Financial institutions.
• State financial corporations.
• Lease financing / Hire Purchase financing.
• External commercial borrowings.
• Foreign Currency bonds.
3) Short term Sources of finance:

• Trade credit.
• Commercial banks.
• Fixed deposits for a period of 1 year or less.
 • Advances received from customers.

Capital
• In economics, capital or capital goods or real capital
refers to items of extensive value. The term can also
be applied to the amount of wealtha person controls
or is capable of controlling.
• Capital goods may be acquired with money or
financial capital. In finance and accounting,capital
generally refers to financial wealth,especially that
used to start or maintain abusiness, sometimes
referred to as Cash flow.
Types of capital
1. Fixed capital or blocked capital
Fixed capital is that portion of the total capital that is
invested in fixed assets that stay in the business
almost permanently.
eg.land,buildings,vehicle,Equipment,Tools,
Furniture etc.

2. Working or current capital

The enterprise needs funds to meet its day to day
needs and expenditures which is in the form of cash
is called working capital
Working capital is used for
• Purchase of raw material
• Payment of employee wages
• Storage costs
• Advertisement and selling expenses
• Transportation and shipping expenses
• Expenses for tools and machineries maintenance
Costing
• It is defined as classifying, recording, and
appropriate allocation expenditure for the
determination of the costs of products and services.
• According to Harley," costing is a study of expenses
incurred in manufacturing a product and conducting a
business in such a manner that the expenses are
analyzed and classified so as to enable the actual cost
of any particular process or unit of production to be
determined with a minimum of error.”
 Elements of cost
• Direct material cost: eg: cost of raw and semi
finished materials.
• Direct expenses: eg: cost of drawing, design, cost of
traveling, fees of architect.
• Direct wages: eg: wages paid to labors engaged in
production,construction, conformation, alteration etc.
• Indirect expenses: eg: Rents, insurances, repairs,
medical expenses etc.
• Indirect labor: eg: wages of the labors involved in
job ancillary to the production.
• Indirect materials: eg: cost of oils, grease, lubricant,
stationary etc.
• Overheads:
sum of total of Indirect expense Indirect labor and
Indirect materials
Budgets and budgetary control
a) Budget:
3. A formal statement of the financial resources set
aside for carrying out specific activities in a given
 period of time.
4. A budget is basically a yardstick against which
actual performance is measured and assessed.
5. Control is provided by comparisons of actual
results against budget plan.
6. Departures from budget can then be investigated
and the reasons for the differences can be divided
into controllable and non-controllable factors.
7. Enables remedial action to be taken as variances
emerge.

• Example : advertising budget or sales force budget.

b) Budgetary control:
• A control technique whereby actual results are
compared with budgets.
• Any differences (variances) are made the
responsibility of key individuals who can either
exercise control action or revise the original
budgets.
Advantages of budgeting and budgetary control:
1.Compels management to think about the future,
which is probably the most important feature of a
budgetary planning and control system.
2.Forces management to look ahead, to set out
detailed plans for achieving the targets for each
department, operation and (ideally) each manager, to
anticipate and give the organization purpose and
direction.
3.Promotes coordination and communication.
4.Clearly defines areas of responsibility. Requires
managers of budget centers to be made responsible
for the achievement of budget targets for the
operations under their personal control.
5.Provides a basis for performance appraisal
(variance analysis).

6.Improves the allocation of scarce resources.

Make or buy analysis
• “A business decision that compares the costs and
benefits of manufacturing a product or product
component against purchasing it...”
• Make or buy analysis is a decision making process
which requires an in depth analysis of the pros and
cons in order to determine the strategic benefits to be
gained from, retaining a product/service in-house or
alternatively sourcing from a supplier or service
provider.
• The make or buy decision is one of the most critical
supply chain,strategic decisions. The decision is
important for a number of reasons as it can determine
and define an organization's competencies.
It also affects the level of investment a business
should make internally as well as with suppliers.
• The make or buy decision should be reviewed
periodically, say,every 1 to 3 years.
.

Financial Statements
Balance Sheet
• Shows the status of company’s financial position. It
is actually a snap shot at the instant it is prepared,
what the company owns and owes.
• Ideally, can be calculated every day; however
companies usually calculate on a quarterly basis.
• Shows the sources and applications of funds.
Balance Sheet Structure
Profit and Loss account
 Ratio Analysis

It’s a tool which enables the banker or lender to

arrive at the following factors :
• Liquidity position
• Profitability
• Solvency
• Financial Stability
• Quality of the Management
• Safety & Security of the loans & advances to
be or already been provided
As Percentage - such as 25% or 50% . For
example if net profit is Rs.25,000/- and the sales
is Rs.1,00,000/- then the net profit can be said to
be 25% of the sales.
Types of ratio
1. Current Ratio : It is the relationship between the
current assets and current liabilities of a concern.
Current Ratio = Current Assets/Current Liabilities
If the Current Assets and Current Liabilities of a
concern are Rs.4,00,000 and Rs.2,00,000
respectively, then the Current Ratio
will be : Rs.4,00,000/Rs.2,00,000 = 2 : 1
The ideal Current Ratio preferred by Banks is 1.33 : 1
2. Net Working Capital : This is worked out as
surplus of Long Term Sources over Long Tern Uses,
alternatively it is the difference of
Current Assets and Current Liabilities.
NWC = Current Assets – Current Liabilities
3. ACID TEST or QUICK RATIO : It is the ratio
between Quick Current Assets and Current
Liabilities.
Quick Current Assets : Cash/Bank Balances +
Receivables upto 6 months + Quickly
realizable securities such as Govt. Securities or
quickly marketable/quoted shares and
Bank Fixed Deposits
Acid Test or Quick Ratio = Quick Current
Assets/Current Liabilities
4. DEBT EQUITY RATIO : It is the relationship
between borrower’sfund (Debt) and Owner’s Capital
(Equity).
For instance, if the Firm is having the following :
Capital
= Rs. 200 Lacs
Free Reserves & Surplus
= Rs. 300 Lacs
Long Term Loans/Liabilities = Rs. 800 Lacs
Debt Equity Ratio will be => 800/500 i.e. 1.6 : 1

5. GROSS PROFIT RATIO :

Gross Profit Ratio = (Gross Profit / Net Sales ) x 100
Gross Profit Ratio = [ (Sales – Cost of goods sold)/
Net Sales] x 100
A higher Gross Profit Ratio indicates efficiency in
production of the unit.