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UNIT 1

Environment of Business Finance


1.1 Business Finance 1.2 Financial Management 1.3 Functions of Finance Manager

Introduction
Business needs finance to meet their requirements in the economic world.
Any kind of business activity depends on finance. Hence, it is called as lifeblood of business organisation. Finance, in a real sense, is the cornerstone of the enterprise system good. It is vitally important to the economic health business firms, and hence to the nation and the world. All of this makes finance stimulating and exciting but also challenging and

sometimes confusing. Thus study of finance will helps for better understanding
of our financial system.

1.1 business finance


A) Meaning :

Finance is an art and science of managing money. It includes financial service and financial instruments. Finance is also referred as the provision of money at the time when it is needed.
B) 1) Definitions : Wheeler : Business finance is that business activity which concerns with the acquisition and conversation of capital funds in meeting financial needs and overall objectives of a business enterprise. 2) Bonneville and Deway : Business finance consists of the raising, providing, managing of all the money, capital or funds of any kind to be used in connection with the finance.

1.1 business finance


C) 1) Nature of Finance : The nature of finance is as follows: Life-Blood of Business : Finance is the foundation stone of Scarce and Limited every business. It is life blood of every corporate. Scarce and Limited : The financial resources are always Life-Blood of Business scarce and limited. It needs proper planning and control in order to achieve the best result out of the complex situation of risk and uncertainty prevailing in the business world.
Concern with Cash Important Function of Business

2)

Nature of Finance

Procurement and Utilisation of Funds

1.1 business finance


3) Concern with Cash :

Finance is concerned with cash as every business transaction involves cash directly or indirectly, finance is concerned with everything that takes place in the conduct of business.
4) Important Function of Business : Finance is an important function of any corporate, as money is required to purchase raw material, to pay wages and salary and so on. Proper planning is necessary, which may provide ways and means of ensuring that finance is readily available as and when need so arise. 6) Procurement and Utilisation of Funds :

Finance function is the task of procurement and utilisation of funds. It covers financial planning, forecasting of cash receipt and raising of funds, use and allocation of funds and financial control.

1.1 business finance


D) Important Aspects of Finance : In the light of this broader scope of the finance function, it includes the following aspects: 1) 2) 3) 4) 5) 6) 7) Estimating Financial Requirements Determining the Structure of Capitalisation Determining the Optimum Sources of Capital Management of Earnings Cash Flow Assets Debt

1.1 business finance


E) Finance and Other Related Disciplines : The relationship of financial management with other fields of study is explained as under:
Finance and Economics Finance and Accounting Finance and Mathematics Finance and Production Finance and Marketing Finance and Human Resource Finance and Quantitative Methods Finance and Costing Finance and Law Finance and Taxation Finance and Treasury Management Finance and Banking Finance and Insurance Finance and Information Technology

1.2 FINANCIAL MANAGEMENT


A) Meaning : Management means planning, organising, directing and controlling the financial activities such as procurement and utilisation of funds of the enterprise. It means applying general management principles to financial resources of the enterprise. B) Definitions : 1) Dr. S. N. Maheshwari : "Financial management is concerned with raising financial resources and their effective utilisation towards achieving the organisational goals." 2) Richard A. Brealey : "Financial management is the process of putting the available funds to the best advantage from the long term point of view of business objectives. 3) Howard and Uptron : Financial management is an application of general managerial principles to the area of financial decision- making.

1.2 FINANCIAL MANAGEMENT


C) Goals of Financial Management : The financial objectives of the firm can be grouped in two parts : 1) Short-term Goals / Objectives : a) Financial Discipline: The basic objective of financial management is to create financial discipline among employees in the organisation and to minimise the chances of misuse of funds. b) Procedure and Practice : To develop some procedure and practice, for systematic payments to outside parties and the procedure as to appropriate handling of cash balances, cash receipts every day. c) Proper Accounting :

Another short-term objective of financial management may be proper accounting of receipts and payments of cash and payments in the form of cheques.

1.2 FINANCIAL MANAGEMENT


2) Long-term Goals/Objectives:
a) Profit Maximisation : According to this approach the actions which increases profits should be undertaken and those which decrease the profits should he avoided

b) Wealth Maximisation : Wealth maximisation means maximising the net present value of a course of action. c) Regulation and Control : Regulation and control in respect of use of funds may be regarded as long-term objective of financial management d) Proper Estimation of Total Financial Requirements Proper estimation of total financial requirements is a very important objective of financial management. e) Proper Mobilisation of Funds : Mobilisation (collection) of finance is an important objective of financial management. f) Proper Utilisation of Finance : Proper utilisation of finance is an important objective of financial management.

1.2 FINANCIAL MANAGEMENT


g) Maintaining Proper Cash Flow : Maintaining proper cash flow is a short-term objective of financial management. h) Survival of Company : Survival is the most important objective of financial management i) Creating Reserves : One of the objectives of financial management is to create reserves j) Proper Coordination : Financial management must try to have proper co-ordination between the finance department and other departments of the company. k) Create Goodwill : Financial management must try to create goodwill for the company. l) Increase Efficiency : Financial management also tries to increase the efficiency of all the departments of the company. m) Financial Discipline : Financial management also tries to create a financial discipline

1.2 FINANCIAL MANAGEMENT


D) Elements of Finanacial Management : There are four key elements to the process of financial management: 1) Financial Planning : Financia Management need to ensure that enough funding is available l Planning at the right time to meet the needs of the business. 2) Financial Control : Financia Elements of Financial control is a critically important activity to l Finanacial DecisionManagement help the business ensure that the business is making meeting its objectives. 3) Organizing and Directing : Organizing and Directing When organizing, the financial manager decides how to use the resources of the organization to most effectively carry out the plans that have been established. 4) Financial Decision-making : The key aspects of financial decision-making relate to investment, financing and dividends.

Financial Control

1.2 FINANCIAL MANAGEMENT


E) Functions of Finanacial Management : The functions of financial management can be broadly classified into three major decisions, namely:] Investment Financing Dividend 1) Investment Decision : Decision Decision Decision The investment decision is concerned with Capital Shareholders Dividend Budgeting Fund Policy the selection of assets in which funds will Working Borrowing Retained Capital From Outside Earnings be invested by a firm. Management Agencies a) Capital Budgeting : Capital budgeting is the long term planning for making and financing proposed capital outlay. b) Working Capital Management : The financial manager is also responsible for the efficient management of current assets i.e. working capital management. 2) Financing Decision : The financing decision is concerned with capital mix, financing mix or capital structure of a firm. The sources could be: a) Shareholders Fund: Equity Share Capital, Preference share capital, Accumulated profits.

1.2 FINANCIAL MANAGEMENT


b) Borrowing From Outside Agencies : Debentures, Loans from Financial Institutions. A demand for raising funds generates a new capital structure since a decision has to be made as to the quantity and forms of financing. Dividend Decision : The third major decision area of financial management is the decision relating to the dividend policy. The dividend decision should be analysed in relation to the financing decision of a firm. They can be distributed to the shareholders in the form of dividends or they can be retained in the business itself.

3)

a)

Dividend Policy : The decision as to which course should be followed depends largely on a significant element in the dividend decision, the dividend-payout ratio, that is, what proportion of net profits should be paid out to the shareholders. b) Retained Earnings : The second major aspect of the dividend decision is the factors determining dividend policy of a firm in practice

1.2 FINANCIAL MANAGEMENT


F) Approaches to Financial Management : Theoretical points of view, financial management approach may be broadly divided into two major parts. 1) Traditional Approach : The traditional approach to the scope of financial management refers to its subject matter, in academic literature in the initial stages of its evolution, as a separate branch of academic study. the field of study dealing with finance was treated as encompassing three interrelated aspects of raising and administering resources from outside: a) Institutional Arrangement : The institutional arrangement in the form of financial institutions, which comprise the organisation of the capital market; b) Fund Raising through Financial Instruments : The financial instruments through which funds are raised from the capital markets and the related aspects of practices and the procedural, aspects of capital markets; and

1.2 FINANCIAL MANAGEMENT


c) Legal and Accounting Relationships : The legal and accounting relationships between a firm and its sources of funds, the coverage of corporation finance was, therefore, conceived to describe the rapidly evolving complex of capital market institutions, instruments and practices. Modern Approach : According to this approach, financial management is concerned with both acquisition of funds and their effective and optimum utilisation. Therefore, according to this approach, three important decisions are taken under financial management. Investment Decisions : This is concerned with the allocation of capital. The investment decision relates to the selection of assets in which funds will be invested by a firm. The assets which can be acquired fall into two broad groups: Long-term Assets or Fixed Assets Short-Term Assets or Current Assets

2)

a)

1.2 FINANCIAL MANAGEMENT


b) Financial Decisions : This decision is concerned with the mobilization of finance for investment. There are two aspects of financing decision. A proper balance between debt and equity to ensure a tradeoff between risk and return to shareholders is necessary. A capital structure with a reasonable proportion of debt and equity is called the optimum capital structure. Aspect is the determination of an appropriate capital structure. Once the financial manager is able to determine the best combination of debt and equity, he must raise the appropriate amount through the best available sources. Dividend Decision : The dividend decision involves the determination of the percentage of profit earned by the enterprise which is paid to the shareholders. The dividend payout ratio must be evaluated in the light of the objective of maximizing shareholders wealth. Thus, the dividend decision has become a vital aspect of financial decision.

c)

1.2 FINANCIAL MANAGEMENT


G) Key Strategies of Financial Management : The areas of key strategies are identified by financial management to achieve the objectives of an organisation in the context of an intelligent and knowledgeable anticipation of changes in the environment. The key strategies of financial management are as follows:
Cost-VolumeProfit Analysis Profit Planning and Control

Optimal Capital Structure

Fixed Assets Management

Financial Analysis

Project Planning and Evaluation

Determining Sources of Funds

Capital Budgeting

Determining Financial Needs

Key Strategies of Financial Management

Working Capital Management

1.2 FINANCIAL MANAGEMENT


1) Determining Financial Needs : One of the most important functions of the financial manager is to ensure availability of adequate financing. 2) Determining Sources of Funds : The financial manager has to choose sources of funds. 3) Financial Analysis : It is the evaluation and interpretation of a firms financial position and operations, and involves a comparison and interpretation of accounting data. 4) Optimal Capital Structure : The financial manager has to establish an optimum capital structure and ensure the maximum rate of return on investment. 5) Cost-Volume-Profit Analysis : This is popularly known as the CVP relationship. For this purpose, fixed costs, variable costs and semi-variable costs have to be analysed.

1.2 FINANCIAL MANAGEMENT


6) Profit Planning and Control : Profit planning and control have assumed great importance in the financial activities of modern business 7) Fixed Assets Management : A firms fixed assets are land, building, machinery and equipment, furniture and such intangibles as patents, copyrights, goodwill, and so on. The acquisition of fixed assets involves capital expenditure decisions and long-term commitments of funds. 8) Project Planning and Evaluation : A substantial portion of the initial capital is sunk in long-term assets of a firm. The error of judgment in project planning and evaluation should be minimized. 9) Capital Budgeting : Capital budgeting decisions are most crucial; for they have long-term implications. They relate to judicious allocation of capital. 10) Working Capital Management : Working capital is rightly an adjunct of fixed capital investment. It is a financial lubricant which keeps business operations going. It is the life-blood of a firm.

1.3 Functions of financial manager


Finance manager is one of the department managers and he performs his role at the middle management level. For the sake of convenience, his functions may be subdivided in to two parts:
Executive Finance Functions Incidental Finance Functions

Financial Forecasting

Safety of Cash Balances

Making Financing Decisions

Safe Custody of Documents

Investment Policy Decisions

Mechanical Details of the Machines

Dividend Policy Decision

Record and Report Keeping

Cash Flows and Requirements

Good Relations

1.3 Functions of financial manager


1) a) Executive Finance Functions : Financial Forecasting : Finance managers important function in the initial stages is to forecast exactly the financial needs of the concern. Making Financing Decisions : After deciding the financial requirement, the finance manager should concentrate on how the finance is mobilized and where it will be available. Investment Policy Decisions : A finance manager will be required to decide how much cash will be invested in the procurement of fixed assets and current assets, also to decide upon the kind of insurance for the protection of assets. Dividend Policy Decision : It is another challenging task before financial manager, how to allocate the net profits of a business unit. Cash Flows and Requirements : The main responsibility of the financial manager is to see that cash is always available in companys office.

b)

c)

d)

e)

1.3 Functions of financial manager


2) Incidental Finance Functions : The important incidental or supplementary functions are as follows : a) Safety of Cash Balances : The Finance manager should cheek cash receipt and its application and balance in the end. b) Safe Custody of Documents : It is one of the routine functions of the finance manager to see the proper safety of valuable papers, securities and insurance policies. c) Mechanical Details of the Machines : It is the duty of finance manager to take proper care of all machinery, required for calculation of depreciation. d) Record and Report Keeping: It is the duty of Finance manager to have a proper record of all financial transactions and report to the concerned parties as and when needed e) Good Relations: The Finance manager has to maintain good relationship with banks and financial institutions for financial negotiations.