Financial Management

Ans 1 What Is Finance?

Finance is a term for matters regarding the management, creation, and study of money and investments. It involves the use of credit and debt, securities, and investment to finance current projects using future income flows. Because of this temporal aspect, finance is closely linked to the time value of money, interest rates, and other related topics.

Finance can be broadly divided into three categories:

Public finance

Corporate finance

Personal finance

There are many other specific categories, such as behavioral finance, which seeks to identify the cognitive (e.g., emotional, social, and psychological) reasons behind financial decisions.

Meaning of Business Finance

Business finance is the cornerstone of every organization. It refers to the corpus of funds and credit employed in a business. Business finance is required for purchasing assets, goods, raw materials and for performing all other economic activities. Precisely, it is required for running all the business operations.

To understand what business finance is, we must know that business finance includes activities concerning the acquisition and conservation of capital funds for meeting an organization’s financial needs and objectives. The importance of business finance is evident from the fact that business finance is required to undertake every business operation successfully.

The amount of capital that is pooled by a business owner into their company is often not enough to meet the financial needs of a company. Herein, the importance of business finance and its management rises even more. Consequently, business owners along with their teams look out for various other ways to generate funds.

A business may require additional funds for anything ranging from buying plant or apparatus, raw materials or further development. Different types of business finance are:

Fixed Capital

Working Capital

Diversification

Technology upgrading

Ans 2 Types of Finance

Presently entrepreneur, startups, businesses must be aware of all types of finance available in the market. Also it’s their primary due to analyze it like, what they can do, which type of financing technique is better to another, and where required funding can be found. So here you can gain enough knowledge about it. What are the two main types of finance? Let us understand in detail:

Debt Financing

Debt financing is essentially cash that you obtain to run or maintain your business. Debt financing does not give the moneylender ownership control, but rather the principal amount must be repaid along with the interest percentage agreed upon.

Interest percentage is mostly determined based on duration, inflation rate, amount of loan and the purpose for which specified type of finance is been used. You can consider debt financing as being divided into three types of finance they are: short-term finance, medium-term finance and long-term finance.

Short-Term Types of Finance

Loans usually for more than 1 to 180 days of period is known as short-term types of finance. This are made to cover occasional or temporary requirements and shortage of funds. Short-term financing most commonly applies to cash required for the everyday activities of the business. Example of short-term types of finance: obtaining raw materials or paying wages to their staff members. The amount to get a short-term credit is mostly dependably on the other source of income for repayment. Most common type of short-term finance is line of credit from their suppliers. Following are some of the types of short-term finance:

Credit Cards.

Trade Credit.

Bank Overdraft.

Bill Discounting.

Small Business Loans.

Working Capital Loans.

Advances from customers.

Short-term loans from Retail Banks.

Medium-Term Types of Finance

Loans usually required for more than 180 to 365 days of period is known as medium-term types of finance. It mostly depends on business how the funds are utilized. The business will mostly repay from the cash-flow source of the business. Mostly such type of finance are chosen by business to buy fixed assets, equipment’s and so forth.

Many times it is been observed that such types of financing are frequently used by startups or small business owners to fulfill the rotation of funds. As new businesses have to pay upfront to suppliers for all the required goods. Example of medium-term types of finance: buying machinery, equipment, inventories etc. Following are some of the types of medium-term finance:

Lease Finance.

Hire Purchase Finance.

Issue of Debenture / Bonds.

Medium-term loans from Commercial Banks.

Long-Term Types of Finance

Loans usually required for more than 365 days of period is known as long-term type of finance. Such financing for the most part is required for buying land, plant, restructuring buildings or offices, etc. for your business.

Normally long-term types of financing options have better rate of interest when compare to short-term financing. Such type of finance are usually having repayment duration of 5, 10 or 20 years of period. Example of long-term type of finance: Home loans or Car loans are categories as types long-term of finance. Following are some of the types of long-term finance:

Issue of Equity Shares.

Issue of Preference Shares.

Issue of Debenture / Bonds.

Venture Funding or Finance from Investors.

Long-Term Loans from Government, Investment Banks or Financial Services Institutions.

Equity Financing

Equity financing is a typical route for businesses to raise capital by offering or issues shares of their company. This is a major difference of equity financing from debt financing. Equity financing option is ordinarily used for seed funding for new business and start-ups. Whereas raising additional capital for a business to expand for well-known companies.

Equity financing is commonly raised by offering equity stocks of the business. Typically, each stock is a unit of ownership for that particular organization.

Example of equity type of financing: if the organization has offered 100,000 equity stocks to public investors. You being the investor buy 10,000 equity stocks of that company, which means that you hold 10% of ownership in that company.

For example:

A company can decide to offer equity stocks as an ownership along with dividend and voting rights.

A company can also offer equity stocks as an ownership with neither dividend nor voting rights.

A company can offer preferred stocks as an ownership with no voting rights but they will get dividend on stocks.

Seed Investors (Angel Investors)

In most cases, the amount of money invested by such investors is less than $0.5 million. This kind of equity financing consists of investors who are typically family members or close friends of the business’s founders or owners.

IPOs (Initial public offerings)

An initial public offering (IPO) is a method of raising capital for companies that are more established (IPO). The initial public offering (IPO) allows businesses to raise cash by selling their stock to the general public for trading on the stock exchanges.

Ans 3 Objectives of Financial Management

A financial manager is responsible for making the decisions to bring effective financial management to the organization. His/her decisions should be gainful for the shareholders as well as the company. So the decisions which increase the value of the share in the market are considered to be good and fruitful. Increased value of shares fulfills many other objectives also but it does not mean that the manager should use manipulative activities to raise the prices of the shares. This boom must come with the growth of the organization, with the increase in profits, and with the satisfaction of all the parties which are directly or indirectly associated with the firm.

Some of the prime objectives of financial management are as follows:

1. Profit Maximization

A business is set up with the main aim of earning huge profits. Hence, it is the most important objective of financial management. The finance manager is responsible to achieve optimal profit in the short run and long run of the business. The manager must be focused on earning more and more profit. For this purpose, he/she should properly use various methods and tools available.

2. Wealth Maximization

Shareholders are the actual owners of the company. Hence, the company must focus on maximizing the value or wealth of shareholders. The finance manager should try to distribute maximum dividends among the shareholders to keep them happy and to improve the goodwill of the company in the financial market. The declaration

of dividend and payout policy is decided with the help of financial management. A proper dividend policy related to the declaration of dividends or retaining the company's profit for future growth and development is part of dividend decisions. But this is based on the performance of the company and the amount of profit earned. Better performance means a higher value of shares in the financial market. In nutshell, the finance manager focuses on maximizing the value of shareholders.

3. Maintenance of Liquidity

With the help of proper financial management, the manager can easily monitor the regular supply of liquidity in the company. But it is not as easy as it sounds. To maintain the proper cash flow, the manager must keep an eye over all the inflows and outflows of money to reduce the risk of underflow and overflow of cash. The finance manager is responsible to maintain an optimal level of liquidity in the organization. Healthy cash flow means a higher possibility of survival and success of the business. Because it helps the business to deal with uncertainty, timely payment of dues, getting cash discounts, making day-to-day payments without delays, etc.

4. Proper Estimation of Financial Requirements

Financial management also helps the finance manager in estimating the proper financial needs of the company. This means the estimations related to the requirement of capital to start or run a business, the need for fixed and working capital of the company, etc., can be done with effective management of finance. If this management will not be present in the company, then there will be a higher possibility of having a shortage or surplus of finance. For this estimation, a financial manager checks various factors like the technology used by the organization, the number of employees working, the scale of operations, and the legal requirements of the company to run its business.

5. Proper Mobilization

Financial management helps in the effective utilization of sources of finance. It means without wasting them and getting the maximum benefit from the available resources. The finance manager is responsible for managing the different sources of funds such as shares, debentures, bonds, loans, etc. So, after estimating the financial requirements, the manager must decide which source of the funds he/she should use to avail the maximum benefit.

6. Proper Utilization of Financial Resources

With proper financial management, the organization can make optimum utilization of financial resources. To achieve this, a financial manager has various tools that he/she can use. They include managing receivables, better management of inventory, and effective payment policy in hand. This will not only save the finance of the organization but will also reduce the wastage of other resources.

Ans 5 Scope of Financial Management

To understand the financial management scope, first, it is essential to understand the approaches that are divided into two sections.

Traditional Approach

Modern Approach

1: Traditional Approach to Finance Function

During the 20th century, the traditional approach was also known as corporate finance. This approach was initiated to procure and manage funds for the company. For studying financial management, the following three points were used

(i) Institutional sources of finance.

(ii) Issue of financial devices to collect refunds from the capital market.

(iii) Accounting and legal relationship l between the source of finance and business.

In this approach, finance was required not for regular business operations but occasional events like reorganization, promotion, liquidation, expansion, etc. It was considered essential to have funds for such events and regarded as one of the crucial functions of a financial manager.

Though he was not accountable for the effective utilization of funds, however, his responsibility was to get the required funds from external partners on a fair term. The traditional approach of finance management stayed until the 5th decade of the 20th century. The traditional approach only emphasized on the fund’s procurement only by corporations. Hence, this approach is regarded as narrow and defective.

2: Modern Approach to Finance Function

With technological improvement, increase competition, and the development of strong corporate, it was important for Management to use the available financial resources in its best possible way. Therefore, the traditional approach became inefficient in a growing business environment.

The modern approach had a more comprehensive analytical viewpoint with a focus on the procurement of funds and its active and optimum use. The fund arrangement is an essential feature of the entire finance function.

The main elements of this approach are an evaluation of alternative utilisation of funds, capital budgeting, financial planning, ascertainment of financial standards for the business success, determination of cost of capital, working capital management, Management of income, etc. The three critical decisions taken under this approach are.

(i) Investment Decision

(ii) Financing Decision

(iii) Dividend Decision.

Ans 6 Role of a Financial Manager

Financial activities of a firm is one of the most important and complex activities of a firm. Therefore in order to take care of these activities a financial manager performs all the requisite financial activities.

A financial manger is a person who takes care of all the important financial functions of an organization. The person in charge should maintain a far sightedness in order to ensure that the funds are utilized in the most efficient manner.

Following are the main functions of a Financial Manager:

Raising of Funds

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

Allocation of Funds

Once the funds are raised through different channels the next important function is to allocate the funds. The funds should be allocated in such a manner that they are optimally used. In order to allocate funds in the best possible manner the following point must be considered

The size of the firm and its growth capability

Status of assets whether they are long-term or short-term

Mode by which the funds are raised

These financial decisions directly and indirectly influence other managerial activities. Hence formation of a good asset mix and proper allocation of funds is one of the most important activity

Profit Planning

Profit earning is one of the prime functions of any business organization. Profit earning is important for survival and sustenance of any organization. Profit planning refers to proper usage of the profit generated by the firm.

Profit arises due to many factors such as pricing, industry competition, state of the economy, mechanism of demand and supply, cost and output. A healthy mix of variable and fixed factors of production can lead to an increase in the profitability of the firm.

Fixed costs are incurred by the use of fixed factors of production such as land and machinery. In order to maintain a tandem it is important to continuously value the depreciation cost of fixed cost of production. An opportunity cost must be calculated in order to replace those factors of production which has gone thrown wear and tear. If this is not noted then these fixed cost can cause huge fluctuations in profit.

Understanding Capital Markets

Shares of a company are traded on stock exchange and there is a continuous sale and purchase of securities. Hence a clear understanding of capital market is an important function of a financial manager. When securities are traded on stock market there involves a huge amount of risk involved. Therefore a financial manger understands and calculates the risk involved in this trading of shares and debentures.

Its on the discretion of a financial manager as to how to distribute the profits. Many investors do not like the firm to distribute the profits amongst share holders as dividend instead invest in the business itself to enhance growth. The practices of a financial manager directly impact the operation in capital market.