What is Financial Management?
Financial Management is the planning, organising, directing and controlling of the procurement and utilization of funds and safe disposal of profit to the end that individual, organizational and social objectives are accomplished.
Production, marketing and finance are three important line functions of an organisation but finance is the most important function which is treated as the life blood of any organisation. Without effective utilization of finance, no business can survive long.
Table of Contents
- 1 What is Financial Management?
- 2 Financial Management
- 3 Definition of Financial Management
- 4 Nature of Financial Management
- 5 Objectives of Financial Management
- 6 Function of Financial Management
- 7 Importance of Financial Management
- 8 Limitations of Financial Management
Meaning of Financial Management can be best described by the words ‘Effective Utilization of Funds. Financial Management is mainly a part of general management which utilizes available financial funds in optimum way for smooth functioning of business. It starts with planning, administration and control of funds.
Finance is required till business is running and without proper management of funds survival becomes a difficulty. Long run business requires huge capital fund for their business and without proper discipline it becomes difficult to procure and allocate funds.
Anything to do with cost, finance, money, capital are all covered under the ‘financial management’. By implementing proper system of financial management business can invest in profitable avenues which yields high returns.
Financial management also takes into account the future requirement of funds and keeps proper arrangements in present for the same. Hence the financial management is the study of income, expenses, capital investments, capital issues etc.
Definition of Financial Management
Nature of Financial Management
With the help of the following points we can understand the nature of financial management
- Financial Management is a broader concept: It is not justabout accounting of finance. It starts with procurement of funds as per the requirement and their best allocation. Financial planning is required till the business survive. It is an essential part of the business.
- It is the integral part of management: Financial planning is the part of top level Management. Financial policies are drafted by top level mangers and then it is executed by other levels.
- Effective financial management helps in maximizing profits: Financial management helps in selecting the best alternate available. Funds are raised in a perfect combination of debt and equity which bears less cost of capital and are invested in best profitable avenues for higher returns.
- It is scientific and analytical as it starts right from the beginning of business and continues till its survival: Financial management works on certain basic principles. It helps in selecting the best method of financing with less risk and higher returns. It helps in understanding the behavior and pattern of finance.
- Financial Management is different from accounting: In accounting only collection of financial and related data is done whereas in financial management, analysis and decision making are main functions.
- Financial Management is useful in every organisation whether it is sole proprietorship or corporate, manufacturing or service: It is applicable in non – profit organisation also.
- Financial Management is helpful for top management in decision making.
Objectives of Financial Management
Objectives may be expressed as goals, purpose, targets, aims to be attained over a period of time. They also provide the standards to be judged or evaluate the performance of a business.
The main purpose of financial management is to help the firm in achievement of its predetermined objectives.
The objectives of financial management can be explained with the help of following figure:
Only basic objectives are being explained as under:
Earning profit is the main objective of any business.It can be achieved by maximizing profits.Profit is the reward for risk.It also motivates for better performance. Survival of any business mainly depends upon its capacity of earning profits. Efficient and effective utilization of financial funds helps in achieving this goal. This objective was supported under the traditional approach of the financial management. Profit maximization as an objective of financial management can be justified on the following grounds:
- Earning more profit indicates the economic efficiency of a business wheras loss indicates economic inefficiency.
- Profit earning objective provide basis for strategic and tactical decisions. Profit is a premium for staying in business.
- Maximum social welfare activities like more wages, better quality of products at cheaper rate to customers, timely payment to creditors, more employment to society can be attain through earning more and more profits.
- Profits can be said as major source of incentives in a business. If there is no profit incentives in a business, then there will be no competition and thus all the development process will be zero.
- The objective of profit maximization seems rational because it is a device which stimulates mankind into channels of useful services.
But like traditional approach it has been also criticized on some grounds which are as follows:
- It is narrow concept. It gives stress only on generating higher profits. It is not clear under this concept as which profit should be focused like gross profit, net profit, profit before tax or profit after tax.
- Earning profits give benefits only to its owners. It does not add much benefit to the society. Social responsibility is not fulfilled under this concept.
- Decisions taken for earning profits sometimes endangers the stability of the long run of business.
- The biggest disadvantage of this objective is that it ignores time value of money. Profits generated today do not have the same value as it is today. Rupee earned today has more value than its value after one or two years.
- This concept registers progress in monetary terms only. It completely ignores qualitative aspect. Contribution of humans is ignored under this.
- The objective of profit maximisation ignores the time value of money. Because profit received today is not same as it received after 1 or 2 years.
- It is vague term as it do not clear that profit increase in short term or long term.
- Earning more and more profit may be immoral and leads to corrupt practices.
- Profit maximisation objective sometimes degrades human ethical values.
- The objective of profit maximisation ignores social responsibility of a business.
The profit maximisation objective is not only a vague term but it also ignores risk and time value of money. Therefore, the wealth maximisation objective is considered as basic objective rather than profit maximisation. According to Ezra Soloman, the ultimate objective of financial management should be maximisation of wealth. It is modern approach of Financial Management. It is also known as ‘Value maximizing’ or ‘Net worth Maximizing’. Financial Management helps in effective utilisation of its assets which is viewed in terms of benefits it can produce.Wealth maximisation objective means maximizing the wealth of the shareholders, by increasing the value of the firm. Increasing value of the firm means increasing the market price of a company’s share. The value of the firm is affected by many ways i.e. the firm’s growth, risk acceptable to the investors, efficiency and effectiveness of the firm, dividend policy etc.
A firm must consider following points to increase market value of shares.
- Customer should be managed properly.
- Maintain satisfactory dividend policy.
- Increase employees satisfaction level.
- Enhance information system.
- Improve quality of the products.
- Increase the market share by launching new products.
Wealth maximizing policy advocates following objectives:
- It ensures long run survival and growth of the business.
- It increases the value of shares as high dividends are distributed under this.
- Dividend policy is designed in such a way to satisfy shareholders.
- A perfect combination of debt and equity mix is carried out.
- It reduces risk as projects having positive net present value are selected after careful and detailed investigation.
- Stakeholders are also satisfied as they feel connected with business.
Function of Financial Management
Financial management includes performance of finance function which is divided into three main functions for the sake of convenience of study
- Primary function
- Subsidiary function
- Incidental function.
These functions are divided on the basis, type and nature of function and duties they involve. Various activities like decision making, activities of non-recurring nature, strategic nature etc. are involved in these functions.
Details of these various functions are as below:
Primary Or Executive Function
As the name itself speaks, this function is of executive nature and requires lot of skills and expert advice. It generally perform activities like preparation of financial plans, acquiring and allocation of funds, making arrangements for short term and long term requirements and controlling financial activities. Let us study each activity performed in detail.
- Financial Planning: This is the basic function under this. As financial plans is of primary nature and form base for other departments. Finance manager has to draft financial plans for the enterprise. If the business is new, a sound financial plan should be formulated keeping in mind the present and future financial requirements. If the enterprise is on going old plans must be reviewed.
These plans should be flexible enough to be changed according to the dynamic environment. After analyzing need for finance, finance manger plans as to which source should be opted for acquisition of funds. How much should be borrowed from outside financial institutions and how much from internal sources.
A perfect combination of debt and equity mix is carried out by financial manager which bears less cost of capital. Financial plans are to be reviewed from time to time according to the market situation and need of the business.
- Acquisition of Funds: This is the crucial stage of financial planning. Funds are acquired from various sources which were decided in the primary function. All the formalities of acquiring funds are one under this. Every source has its own cost which is to be looked upon.
- Allocating Funds: After acquiring funds, they are allocated to various assets, activities, projects etc. This is very important function because only after allocating funds project work will get started. Improper allocation may cause wastage of funds. Financial manager should ensure that none activity get more funds than they need otherwise resources will not be utilized in optimum way.
- Financial Control: Financial control over various financial activities is necessary for smooth execution of activities. It is very important function of financial management. Finance manager make records, store information and make reports of various activities. This enables to make comparative statements with past performances and finance manager can take corrective functions if he feels so.
After performing primary functions, come subsidiary functions. Details are as follows:
- Maintaining Liquidity: Liquidity means firms financial position to meet its current liability. This is the subsidiary function to maintain adequate liquidity of the business. Business should be strong enough to meet its short term liabilities. Cash inflows and outflows should be balanced properly to maintain liquidity.
- Review of Financial Function: Financial performance should be reviewed and presented in front of the board. This activity helps in taking corrective measures if require. Such reports made base for comparison with past performances like inter-firm comparison, trend analysis, ratio analysis, and cost-volume profit analysis.
- Co-Ordination with Other Departments: Finance is required in each and every activity. Hence, finance function is related with every other department. It is the duty of the finance manager to make a balance between activities of every department. Additional finance required by other departments is also looked by finance department.
Incidental or Routine Function
Finance is also required in day to day routine business. These functions are necessary or supplementary to other primary or subsidiary functions. Commonly performed incidental functions are:
- Maintaining cash receipts, payments and checking cash balances.
- Maintaining accounts and keeping records
- Conducting internal audit
- Making public relation
- Keeping in mind the present governmental regulations.
John J. Hampton has written about the following functions in Handbook for financial decision makers:
- Managing funds,
- Managing assets,
- Liquidity functions
- Forecasting cash flows
- Raising of funds
- Managing the flow of internal funds
- Profitability functions
- Cost control
- Forecasting future profits
- Measuring cost of capital
Importance of Financial Management
Maximum utilization of financial resources to earn maximum profit is the main aim of financial management. The success of every business depends upon sufficient finance as per its requirement.
The study of financial management is indispensible for both profit earning and non – profit earning organisations. Even the industrial progress of the country depends upon effective financial management.
In the words of Ezra Soloman, “Financial Management is properly viewed as an integral part of overall management rather than as a staff specially concerned with fund raising operations. In addition to raising funds, financial management is directly concerned with production, marketing and other functions within an enterprise whether decisions are made about the acquisitions or distribution of assets.”
The same views have also been expressed by Irwin Friend who said, “a firm’s success and even survival, its ability and willingness to maintain production and to invest in the fixed or working capital are to a very considerable extent, determined by its financial policies, both past and present.”
Not only finance officers are related with financial management but every activity of business planning and control has become very significant.
As Husband and Dockery have said, “something must direct the flow of economic activity that facilitates its smooth operations. Finance is the agent that produces this results.
Significance of financial management is being discussed under the following points:
- Reduces Chances of Failure: Implementation of proper system of financial management brings financial discipline in the organization. Every project is overlooked and carried out by detailed investigation which reduces chances of failure. Strong financial position ensures smooth functioning of the business.
- Maximization of Returns: Good financial planning maximizes returns on investment as financial management is of scientific and analytical nature. Under modern approach of financial management, main objective is of wealth maximization. These keep shareholders and other stakeholders satisfy.
- Broader Concept: Study of financial management has its applicability to each type of business from sole proprietorship to large business enterprises. It covers each and every financial activity in the business.
- Makes Base for Planning and Control: Financial planning forms base for planning of other departments. As it is noted that each departments depends upon financial department to starts their functioning. Various budget plans are drafted on the basis of financial availability.
- Optimum and Effective Utilization of Resources: Financial planning ensures optimum utilization of financial resources. Each and every stage is carefully planned under this beginning from generating funds to allocation and disposal of profits. Higher returns are expected for smooth functioning and survival of the business which can be only achieved by properly managing funds.
- Useful for Stakeholders: Various stakeholders like business managers, investors, financial institutions, economist, politicians etc. are always interested in knownig financial position of the company as they maintain financial relation with business in some way.
Limitations of Financial Management
Besides its above importance, it has some limitations which are as follows
- Sometimes it becomes difficult to compute the effect of financial decisions on various other departments. It is very complex procedure which requires careful analysis.
- It requires deep knowledge of finance to perform various finance functions. No professional can be expert in each and every aspect of finance behavior which limits its skills.
- In India, financial management is still in its developing stage. We lack in expertise knowledge which limits the full use of the subject.
- Sometimes financial decisions may get affected by the personal point of view of the finance officer. It is human nature which sometimes gets biased which may sometimes adversely affect the financial decision.
- Proper implementation of financial management is of expensive nature. It is not possible for the small enterprise to appoint and get services of experts nor they implement proper system of financial management