Financial Management

Meaning of Financial Management

Financial

Management

organizing,

directing

and

means

planning,

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.

Definitions of financial management

According to Solomon, Financial
management is concerned with the
efficient use of an important economic
resource, namely, capital funds.
According to Weston & Brigham,
Financial management is an area of
financial decision making harmonizing
individual motives & enterprise goals.

Definitions of financial
management:

Financial Management can be defined

as The management of the finances of
a business / organization in order to
achieve financial objectives
Financial
management
is
that
managerial activity which is concerned
with the planning and controlling of
the firms financial resources

Introduction
FM may be defined as the art & science of
managing money.
Relationship of financial management and other
supportive disciplines is:
Financial Decision Areas
1.
2.
3.
4.
5.
6.

Investment analysis
Working Capital Management
Sources and cost of funds
Determination of capital structure
Dividend Policy
Analysis of risk and returns

Support

Primary Disciplines
1.
2.
3.

Accounting
Macroeconomics
Microeconomics

Support Other Related Disciplines

Resulting in
Shareholder wealth maximization

1.
2.
3.

Marketing
Production
Quantitative methods

Scope of financial management

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.
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.
Dividend decision - The finance manager has to
take decision with regards to the net profit
distribution. Net profits are generally divided into
two:
Dividend for shareholders- Dividend and the rate of it
has to be decided.
Retained profits- Amount of retained profits has to be
finalized which will depend upon expansion and
diversification plans of the enterprise.

Objectives (or) Goals of Financial

Management
The main objective of a business is to maximize the owners
economic welfare. This objective can be achieved by;

Profit maximization

Wealth maximization

1. Profit Maximization.
Profit earning is the main aim of every economic
activity.
A business being an economic institution must earn
profit to cover its costs and provide funds for growth.
No business can survive without earning profit.
Profit is a measure of efficiency of a business
enterprise.
Profits also serve as a protection against risks which
cannot be ensured.
The accumulated profits enable a business to face
risks like fall in prices, competition from other units,
adverse government policies etc.
Thus, profit maximization is considered as the main
objective of business.

The following arguments are advanced in favour of

profit maximization as the objective of business:
1. When profit-earning is the aim of business then profit
maximization should be the obvious objective.
2. Profitability is a barometer for measuring efficiency
and economic prosperity of a business enterprise
3. Economic and business conditions do not remain same
at all times. There may be adverse business conditions
like recession, depression, severe competition etc. A
business will be able to survive under unfavorable
situation, only if it has some past earnings to rely upon.
Therefore, a business should try to earn more and more
when situation is favorable.
4. Profits are the main sources of finance for the growth
of a business. So, a business should aim at
maximization of profits for enabling its growth and
development.

5. Profitability is essential for fulfilling social goals also. A firm by

pursuing the objective of profit maximization also maximizes
socio-economic welfare.
However, profit maximization objective has been criticized on
many grounds. They are: A firm pursuing the objective of profit
maximization starts exploiting workers and the consumers.
Hence, it is immoral and leads to a number of corrupt
practices.

It is also argued that profit maximization should be the

objective in the conditions of perfect competition and
in the wake of imperfect competition today, it cannot
be the legitimate objective of a firm
One has to reconcile the conflicting interests of all the
parties connected with the firm. Thus, profit
maximization as an objective of financial management
has been considered inadequate. Even as an
operational criterion for maximizing owners economic
welfare

 Profit maximization has been rejected because of the following

drawbacks;
1. The term profit is vague and it cannot be precisely
defined. It means different things for different people. Should
we consider short-term profits or long-term profits? Does it
mean total profits or earnings per share? Even if, we take the
meaning of profits as earnings per share and maximize the
earnings per share, it does not necessarily mean increase in
the market value of share and the owners economic welfare.
2. Profit maximization objective ignores the time value of
money and does not consider the magnitude and timing of
earnings. It treats all earnings as equal when they occur in
different periods. It ignores the fact that cash received today is
more important than the same amount of cash received after,
three years.
3. It does not take into consideration the risk of the
prospective earnings stream. Some projects are more risky
than other.
4. The effect of dividend policy on the market price of shares is
also not considered in the objective of profit maximization.

2. Wealth Maximization.
Wealth maximization is the appropriate
objective of an enterprise. When the
firm
maximizes
the
stockholder's
wealth, the individual stockholder can
use this wealth to maximize his
individual utility.
It
means
that
by
maximizing
stockholder's wealth the firm is
operating
consistently
towards
maximizing stockholder's utility.

 A stockholder's current wealth in the firm is the

product of the number of shares owned,
multiplied with the current stock price per share.
This objective helps in increasing the value of
shares in the market. The share's market price
serves as a performance index or report card of
its progress. It also indicates how well
management is doing on behalf of the
shareholder.
However, the maximization of the market price of
the shares should be in the long run. Every
financial decision should be based on costbenefit analysis. If the benefit is more than the
cost, the decision will help in maximizing the
wealth.

 Implications of Wealth maximization. There

is a rationale in applying wealth maximizing
policy as an operating financial management
policy. It serves the interests of suppliers of
loaned capital, employees, management and
society. Besides shareholders, there are shortterm and long-term suppliers of funds who have
financial interests in the concern.
Wealth maximization objective not only serves
shareholders interests by increasing the value
of holdings but ensures security to lenders also.
The economic interest of society is served if
various resources are put to economical and
efficient use.

 Criticism of Wealth Maximization. The

wealth maximization objective has also been
criticized by certain financial theorists mainly
on following accounts;
1. It is a prescriptive idea. The objective is not
descriptive of what the firms actually do.
2. The objective of wealth maximization is not
necessarily socially desirable.
3. There is some controversy as to whether the
objective is to maximize the stockholders
wealth or the wealth of the firm which
includes other financial claimholders such as
debenture holders, preferred stockholders,
etc.,

 4. The objective of wealth maximization

may
also
face
difficulties
when
ownership
and
management
are
separated as is the case in most of the
large corporate form of organizations.
In spite of all the criticism, we are of the
opinion that wealth maximization 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
stock holders and managers can be
minimized

Other Objectives of Financial Management

To ensure regular and adequate supply of
funds to the concern.
To ensure adequate returns to the
shareholders which will depend upon the
earning capacity, market price of the share,
expectations of the shareholders.

To ensure optimum funds utilization. Once the

funds are procured, they should be utilized in
maximum possible way at least cost.
To ensure safety on investment, i.e., funds
should be invested in safe ventures so that
adequate rate of return can be achieved.
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

Estimation of capital requirements
Determination of capital composition
Choice of sources of funds
Investment of funds
Disposal of surplus
Management of cash
Financial controls

Functions of Financial Management

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.
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.

Functions of Financial Management (conti)

Choice of sources of funds: For additional funds to be
procured, a company has many choices like Issue of shares and debentures
Loans to be taken from banks and financial institutions
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.
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.

Functions of Financial Management (conti)

Disposal of surplus: The net profits decision have to be made by the
finance manager. This can be done in two ways:
Dividend declaration - It includes identifying the rate of dividends and
other benefits like bonus.
Retained profits - The volume has to be decided which will depend
upon expansion, innovational, diversification plans of the company.
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, maintenance of enough
stock, purchase of raw materials, etc.
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.

Finance Functions
Investment Decision
Evaluation of new investment in terms of profitability
Comparison of cut off rate against new investment and
prevailing investment.

Financial Decision
Dividend Decision
Liquidity Decision

Role of a Financial
Manager
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.
Role of financial manager:

Raising of Funds
Allocation of Funds
Profit Planning
Understanding Capital Markets