Académique Documents
Professionnel Documents
Culture Documents
Financial Management:
The Finance Function:
Concept: The finance function is the process of acquiring and utilizing funds
of a business . Finance functions are related to overall management of an
organization. Finance function is concerned with the policy decisions such as
1. Kind of business
2. Size of firm
3. Type of equipment used
4. Use of debt
5. Liquidity positions
All these determine the size and the profitability and risk of the business of
the firm. Prof. K.M. Upadhyay has outlined the concept of finance function as
follows.
1. In most of the organizations, financial operations are centralized. This
results in economies.
2. Finance functions are performed in all business firms, irrespective of
their sizes legal forms of organizations.
3. They contribute to the survival and growth of the firm.
4. Finance function is primarily involved with the date analysis and used
for decisions makings.
5. Finance functions are concerned with the basic business activities of a
firm in addition to external environmental factors which affect basic
business activates, and also production and marketing.
6. Finance functions comprise control functions also.
7. The central focus of finance function is valuation of the firm.
The areas of responsibility covered by finance functions may be regarded as
the content and concept of finance function. These areas are specific
functions of finance. Famous authors of financial management have
explained the concept and contents of finance function as under.
1. James. C. Van Horne has opined the concept and content of financial
function as a. Investment Decision b. Financing Decision c. Dividend
Decisions.
2. Earnest W. Walker has opined the concept and content of the financial
function as a financial Planning b. Financial Co-ordination C. Financial
Control.
1|Page
3. J. Fred Weston and Eugene F. Brigham has opined the concept and
content of financial function as consisting of a. Financial Planning and
control. B. Management of working Capital. C. Investment in Fixed
Assets. D. Capital Structure Decisions. E. Individual Financial Episodes.
The Concept and the content of finance functions can be grouped as under.
1. Financial Planning.
2. Financial Control.
3. Financing Decisions.
4. Investment decisions.
5. Management of income and dividend decisions.
6. Incidental functions.
OBJECTIVES OF FINANCE FUNCTION:
The objective of finance function is to arrange as much funds for the
business as are required from time to time. This function has the following
objectives.
1. ASSESSING THE FINANCIAL REQUIREMENTS.
The main objective of finance function is to assess the financial needs of an
organization and finding out suitable sources for raising them. The sources
should be commensurate with the needs of the business. If funds are
needed for longer period then long term sources like share capital,
debentures, tem loans may be explored.
2.
It is
Market standing.
Innovation
Productivity
Economical use of physical and financial resources.
Increasing the profitability
Improved performance
Development of workers performance and co-operatives
Public responsibility
At
(1+ K)t
C0
their wealth. These same prices provide important signals to manage firm in
their selection of investment projects and financing.
6. Dealing with incentive problem
When one party to a transaction has information that the other does not
have informational asymmetry exists. This leads to the problems of moral
hazards and adverse selection which are broadly referred to as agency
problem. The nature of these problems may be illustrated with reference to
insurance. A person who has taken a fire insurance policy is likely to become
somewhat negligent. This is moral hazard faced by the insurance company. A
person who is more likely to experience fire losses will be inclined to take fire
insurance. This is adverse selection problem faced by the insurance
company.
Financial intermediaries like banks and venture capital organizations can
solve the problem of informational asymmetry by handling sensitive
information discreetly and developing a reputation for profitable activity.
Financial Markets
A financial market is a market and exchange of financial asset. If you buy or
sell financial assets you will participate in financial market in some way or
other.
Functions of financial markets:
Financial markets play a very pivotal role in allocating recourses in an
economy by performing three important functions and thereby play a very
important role in allocating resources.
1. Financial markets facilitate price discovery: The continuous
interaction among numerous buyers and sellers who throng financial
markets helps in establishing or discovering the prices of financial
assets. Well organized V markets say; if you want to know what value
of financial assets is simply look at its price in the financial markets.
2. Financial markets provide liquidity to financial assets: Investors
can readily sell their financial assets through the mechanism of
financial markets. In the absence of financial markets which provides
such liquidity, the motivation of investor to hold financial assets will be
considerably diminished. Thanks to negotiability and transferability of
securities through the financial markets, it is possible for companies
(and other entities) to raise long term funds from investors with short
term and medium term horizons. While investor is substituted by
another when a security is transacted the company is assured of long
term availability of funds.
3. Financial markets considerably reduce the cost of transacting: The
two major costs associated with transacting are search cost and
information cost. Search cost comprise explicit costs such as expense
incurred on advertising when one wants to buy or sell an assets and
7|Page
implicit cost such as time and effort one has to put in to locate a
customer. Information cost refers to costs incurred in evaluating the
investment merits of financial assets.
Classification of financial markets: There are different ways of classifying
financial markets.
One way is to classify financial markets by the type of financial claim. The
debt market is the financial market for fixed claims (debt instrument) and the
equity market is the financial market for residual and varying claims (equity
instrument).
A second way is classifying financial market by the maturity of claims. The
market for short financial claims is refers to as money market and market for
long term financial claims is called capital market. Traditionally the cut off
between short term and long term has been one year- though this dividing
line is arbitrary, it is widely accepted. Since short term financial claims are
almost invariably debt claims, the money market is the market for short term
debt instruments. The capital market is the market for long term debt
instruments and equity instruments.
A third way to classify financial markets is based on whether the claims
represent new issue or outstanding issue. The market where issuer
sells new claim is referred to as the primary market and the market where
investor trade outstanding securities is called the secondary market.
A forth way to classify financial markets is by the timing of delivery. A
cash or spot market is one where the delivery occurs immediately and
forward or future market is one where delivery occurs at predetermined time
in future.
The Fifth way to classify financial markets is by the nature of its
organizational structure. An Exchange traded market is characterized by
a centralized organization with standardized procedures. An over the counter
market is a decentralized with different procedures suitable for different
people/party.
The exhibit presents a summary of the classification of financial markets:
Seasoning of Claims
Timing of Deliver
Organizational Structure
organized/centralized
1.
Exchange
Traded
Market
(well
Organization/standardized procedure )
2. Over the counter
Market (decentralized
organization/
Customized procedure)
Rise of Formal Financial Markets: The role of formal financial markets
has expanded rapidly in recent years. The key factors which have
contributed to this are as follows:
1. Robust mechanism for ensuring that traders are completed according
to agreed terms.
2. Adequate legal procedure to settle dispute
3. Low transaction cost
4. Transparent availability of information on trade and prices
5. Adequate protection tp investors
6. High liquidity
Forces of Changes: Financial markets have undergone significant
transformation since the mid-1980s, thanks to following factors:
1. Technological advances in computing and telecommunications.
2. The wave of deregulation and liberalization that has been sweeping the
world.
3. Consolidation and globalization in the wake of heightened competition
9|Page
11 | P a g e
Financial institutions
Since independent a number of financial institutions have been set up to
cater to the long term financing needs of the industrial sector and meet
specialized financing requirements. An elaborate structure of financial
institutions consisting of all India term-lending institutions like IFCI, ICICI and
IDBI. (The last two have transformed themselves into banks.) State financial
Corporations and State Industrial Development Corporations has come into
being.
There are many specialized financial institutions like Small Industries
Development Bank of India (SIDBI), Export-Import Bank (EXIM bank), National
Bank for Agriculture and Rural development (NABARD), Shipping credit and
Investment Corporation of India (SICCI), Power Finance Corporation (PFC),
Rural Electrification Corporation (REC), Infrastructure Development Finance
Corporation (IDFC) and National Housing Bank (NHB).
Insurance Companies
Till recently there were just two insurance companies in India: the Life
Insurance Corporation of India (LIC) and the General Insurance Corporation of
India(GIC), the latter being a holding company with four fully owned
subsidiary companies in its fold. With the liberalization of the insurance
sector, many private sector players like ICICI-Prudential, Tata-AIG, Bajaj
Allianz, Birla Sunlife and HDFC Standard have set up insurance business in
India. Insurance companies LIC in particular have massive resources at their
command because insurance policies usually have a substantial element of
saving and insurance premiums are payable in advance.
Mutual Funds
A mutual fund is a collective investment vehicle .It mobilizes resources from
investors in various types of securities. While there was only one mutual fund
in India viz. The Unit Trust of India, till 1986, presently there are a number of
mutual funds in public and private sector. In last decade or so, private
mutual funds like ICICI-Prudential Mutual Fund, Reliance Mutual Fund, HFDC
Mutual Fund and Templeton Mutual Fund have grown impressively.
Non-Banking Financial Companies
From Mid-1980s many non-banking financial companies have come into
being in the public sector as well as private sector. Some of the well-known
name are HDFC, Sundaram Finance, Kotak Mahindra Finance, Industrial
Development and Financial Corporation(IDFC), ICICI ventures, Infrastructure
Leasing and Finance and SBI Factors. These companies engage in a variety of
activities like leasing finance , hire purchase finance, housing finance,
infrastructure finance , venture capital finance factoring and investment
securities.
12 | P a g e
13 | P a g e
Profit
Maximization
Maximization
versus
Shareholder
Wealth
Profit Maximization is basically a single period or, at the most, a short term
goal. It is usually interpreted to mean the maximization of profits within a
given period of time. A firm may maximize its short term profits at the
expense of its long term profitability and still realize the goal. In contrast
shareholder wealth maximization is a long term shareholders are interested
in future as well as present profits. Wealth maximization is generally
preferred because it considers
1.
2.
3.
4.
the
advantages
and
Shareholde
r
wealth
maximizati
on
Objective
Large
amount
profits
Advantages
Disadvantages
Easy to calculate Emphasize short term
of profits.
Ignores
risk
or
Easy to determine uncertainty
the link between
financial decisions Ignores the timing of
and profits
returns
Highest
market value
of common
stock
Requires
immediate
resources
Emphasize
long Offers
no
clear
term
relationship
between
financial decisions and
Recognizes risk or stock price
uncertainty
Can lead to management
Recognizes
the anxiety and frustration
timing of returns
Considers return
14 | P a g e
15 | P a g e