Lecture notes Financial management

lecture notes advanced financial management and financial institutions. what is financial management discuss its nature and scope pdf free download
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PAPER – VI : FINANCIAL MANAGEMENT UNIT – I LESSON – 1 FINANCE – AN INTRODUCTION LESSON OUTLINE  Significance  Definition of Finance  Functions of Finance  Types of Finance  Business Finance  Direct Finance  Indirect Finance  Public Finance  Private Finance  Corporation Finance  Finance in Relation to other Allied Disciplines LEARNING OBJECTIVES After reading this lesson you should be able to  Understand the significance and definition of finance  Know the functions of finance  Identify the different types of finance  Describe this relationship between finance with other allied disciplines 1 Significance Finance is the life blood of business. Before discussing the nature and scope of financial management, the meaning of ‘finance’ has to be explained. In fact, the term, finance has to be understood clearly as it has different meaning and interpretation in various context. The time and extent of the availability of finance in any organization indicates the health of a concern. Every organization, may it be a company, firm, college, school, bank or university requires finance for running day to day affairs. As every organization previews stiff competition, it requires finance not only for survival but also for strengthening themselves. Finance is said to be the circulatory system of the economy body, making possible the required cooperation between the innumerable units of activity. Definition of Finance According to F.W.Paish, Finance may be defined as the position of money at the time it is wanted. In the words of John J. Hampton, the term finance can be defined as the management of the flows of money through an organization, whether it will be a corporation, school, bank or government agency. According to Howard and Upton, “finance may be defined as that administrative area or set of administrative functions in an organization which relates with the arrangement of each and credit so that the organization may have the means to carry out the objectives as satisfactorily as possible. 2 In the words of Bonneville and Dewey, Financing consists in the raising, providing, managing of all the money, capital or funds of any kind to be used in connection with the business. As put forth by Hurband and Dockery in his book ‘Modern Corporation Finance’, finance is defined as “an organism composed of a myriad of separate enterprise, each working for its own ends but simultaneously making a contribution to the system as a whole, some force is necessary to bring about direction and co-ordination. Something must direct the flow of economic activity and facilitate its smooth operation. Finance is the agent that produces this result”. The Encyclopedia Britannica defines finance as "the act of providing the means of payment." It is thus the financial aspect of corporate planning which may be described as the management of money. An analysis of the aforesaid definition, makes it clear that finance directs the flow of economic activity and facilitates the smooth operation. Finance provides the required stimulus for continued business operations of all categories. Finance is essential for expansion, diversification, modernization, establishment, of new projects and so on. The financial policy of any organization to a greater extent, determines not only its existence, and survival but also the performance and success of that organization. Finance is required for investment, purposes as well as to meet substantial capital expenditure projects. Functions of Finance According to Paul G. Hasings, "finance" is the management of the monetary affairs of a company. It includes determining what has to be paid for and when, raising the money on the best terms available, and devoting the available funds 3to the best uses. Kenneth Midgley and Ronald Burns state: "Financing is the process of organising the flow of funds so that a business can carry out its objectives in the most efficient manner and meet its obligations as they fall due." Finance squeezes the most out of every available rupee. To get the best out of the available funds is the major task of finance, and the finance manager performs this task most effectively if he is to be successful. In the words of Mr.A.L.Kingshott, "Finance is the common denominator for a vast range of corporate objectives, and the major part of any corporate plan must be expressed in financial terms." The description of finance may be applied to money management provided that the following three objectives are properly noted : Many activities associated with finance such as saving, payment of things, giving or getting credit, do not necessarily require the use of money. In the first place, the conduct of international trade has been facilitated. The development of the pecuniary unit in the various commercial nations has given rise to an international denominator of values. The pecuniary unit makes possible a fairly accurate directing of capital to those parts of the world where it will be most productive. Within any given country, the flow of capital from one region to another is guided in a similar manner. The term ‘finance’ refers to the financial system in a rudimentary or traditional economy, that is, an economy in which the per capita output is low and declining over a period of time. The financial organisation in rudimentary finance is characterized by the absence of any financial instruments of the saving deficit units of their own which they can issue and attract savings. There will not be any inducement for higher savings by offering different kinds of financial assets to suit the varied interests and preferences of the investing 4public. The other characteristic of such a financial system is that there are no markets where firms can compete for private savings. Types of Finance Business Finance: The term ‘business finance’ is very comprehensive. It implies finances of business activities. The term, ‘business’ can be categorized into three groups: commerce, industry and service. It is a process of raising, providing and managing of all the money to be used in connection with business activities. It encompasses finance of sole proprietary organizations, partnership firms and corporate organizations. No doubt, the aforesaid organizations have different characteristics, features, distinct regulations and rules. And financial problems faced by them vary depending upon the nature of business and scale of operations. However, it should be remembered that the same principles of finance are applicable to large and small organizations, proprietary and non- proprietary organizations. According to Guthmann & Dougall, business finance can be broadly defined as the activity concerned with planning, raising, controlling and administering of funds used in the business. Business finance deals with a broad spectrum of the financial activities of a business firm. It refers to the raising and procurement of funds and their appropriate utilisation. It includes within its scope commercial finance, industrial finance, proprietary finance corporation finance and even agricultural finance. The subject of business finance is much wider than that of corporation finance. However, since corporation finance forms the lion's share in the business activity, it is considered almost inter-changeable with business finance. 5Business finance, apart from the financial environment and strategies of financial planning, covers detailed problems of company promotion, growth and pattern. These problems of the corporate sector go a long way in widening the horizon of business finance. The finance manager has to assume the new responsibility of managing the total funds committed to total assets and allocating funds to individual assets in consonance with the overall objectives of the business enterprise. Direct Finance The term 'direct', as applied to the financial organisation, signifies that savings are effected directly from the saving-surplus units without the intervention of financial institutions such as investment companies, insurance companies, unit trusts, and so on. Indirect Finance The term 'indirect finance' refers to the flow of savings from the savers to the entrepreneurs through intermediary financial institutions such as investment companies, unit trusts and insurance companies, and so on. Finance administers economic activities. The scope of finance is vast and determined by the financial needs of the business enterprise, which have to be identified before any corporate plan is formulated. This eventually means that financial data must be obtained and scrutinised. The main purpose behind such scrutiny is to determine how to maintain financial stability. Public Finance It is the study of principles and practices pertaining to acquisition of funds for meeting the requirements of government bodies and administration of these funds by the government. 6 Private Finance It is concerned with procuring money for private organization and management of the money by individuals, voluntary associations and corporations. It seeks to analyse the principles and practices of managing one’s own daily affairs. The finance of non-profit organization deals with the practices, procedures and problems involved in the financial management of educational chartable and religions and the like organizations. Corporation Finance: Corporation finance deals with the financial problems of a corporate enterprise. These problems include the financial aspects of the promotion of new enterprises and their administration during their early period ; the accounting problems connected with the distinction between capital and income, the administrative problems arising out of growth and expansion, and, finally, the financial' adjustments which are necessary to bolster up to rehabilitate a corporation which has run into financial difficulties. The term ‘corporation finance’ includes, apart from the financial environment, the different strategies of financial planning. It includes problems of public deposits, inter-company loans and investments, organised markets such as the stock exchange, the capital market, the money market and the bill market. Corporation finance also covers capital formation and foreign capital and collaborations. Finance in Relation to Other Allied Disciplines: The finance function cannot work effectively unless it draws on the-disciplines which are closely associated with it. Management is heavily dependent on accounting for operating facts. Accounting' has been described by Richard M. Lynch and Robert W. Williamson as "the - measurement and communication of financial 7and economical data. In fact, accounting information relates to the production, sales, expenses, investments, losses and gains of the business. Accounting has three branches namely, financial accounting, cost accounting and management accounting. Relationships between Finance and other Disciplines Primary Disciplines Finance Decisions Supports 1. Accounting 2. Economics Investment, 3. Taxation Working capital, Other Disciplines 1. Operations Leverage Research Supports 2. Production Dividend policy Financial Accounting: It is concerned with the preparation of reports which provide information to users outside the firm. The most common reports are the financial statements included in the annual reports of stock-holders and potential investors. The main objective of these-reports is to inform stockholders, creditors and other investors how assets are controlled by a firm. In the light of the financial statements and certain other information, the accountant prepares funds film statement, cash flow statement and budgets. A master plan (Budget) of the organization includes and coordinates the plans of every department in financial terms. According to Guthmann and Dougall, “Problems of finance are intimately connected while problems of purchasing, production and marketing”. Cost Accounting: It deals primarily with cost data. It is the process of classifying, recording, allocating and reporting the various costs incurred in the operation of an enterprise. It includes a detailed system of control for material, labour and overheads. Budgetary control and standard casting are integral part of 8cost accounting. The purpose of cost accounting is to provide information to the management for decision making, planning and control. It facilitates cost reduction and cost control. It involves reporting of cost data to the management. Management Accounting: It refers to accounting for the management. It provides necessary information to assist the management in the creation of policy and in the day to day operations. It enables the management to discharge all its functions, namely, planning, organizing, staffing, direction and control efficiently with the help of accounting information. Functions of management accounting include all activities connected with collecting, processing, interpreting and presenting information to the management. According to J. Batty, ‘management accounting’ is the term used to describe the accounting methods, systems and technique which coupled with special knowledge and ability, assist management in its task of maximizing profits or minimizing losses. Management accounting is related to the establishment of cost centres, preparation of budgets, preparation of cost control accounts and fixing of responsibility for different functions. SUMMARY Finance is the life blood of business. Before discussing the nature and scope of financial management, the meaning of ‘finance’ has to be explained. In fact, the term, finance has to be understood clearly as it has different meaning and interpretation in various contexts. The time and extent of the availability of finance in any organization indicates the health of a concern. Finance may be defined as the position of money at the time it is wanted. Financing consists in the raising, providing, managing of all the money, capital or funds of any kind to be used in connection with the business. 9 The term ‘business finance’ is very comprehensive. It implies finances of business activities. The term, ‘business’ can be categorized into three groups: commerce, industry and service. It is a process of raising, providing and managing of all the money to be used in connection with business activities. The term ‘corporation finance’ includes, apart from the financial environment, the different strategies of financial planning. It includes problems of public deposits, inter-company loans and investments, organised markets such as the stock exchange, the capital market, the money market and the bill market. The finance function cannot work effectively unless it draws on the- disciplines which are closely associated with it. Management is heavily dependent on Accounting, Economics, Taxation, Operations research, Production and Marketing. 10KEYWORDS Finance : It is defined as the position of money at the time it is wanted. Business Finance : According to Guthmann & Dougall, business finance can be broadly defined as the activity concerned with planning, raising, controlling and administering of funds used in the business. Corporation Finance : The term ‘corporation finance’ includes, apart from the financial environment, the different strategies of financial planning. It includes problems of public deposits, inter-company loans and investments, organised markets such as the stock exchange, the capital market, the money market and the bill market. Accounting : It relates to the production, sales, expenses, investments, losses and gains of the business. Financial Accounting : The most common reports are the financial statements included in the annual reports of stock-holders and potential investors. Cost Accounting : It deals primarily with cost data. It is the process of classifying, recording, allocating and reporting the various costs incurred in the operation of an enterprise. It includes a detailed system of control for material, labour and overheads. Management Accounting : It refers to accounting for the management. It provides necessary information to assist the management in the creation of policy and in the day to day operations. It enables the management to discharge all its functions, namely, planning, organizing, staffing, direction and control efficiently with the help of accounting information. Management : Process of attainment of predetermined goals by directing activities of a group of persons and employing other resources. 11 REVIEW QUESTIONS 1. Explain fully the concept of finance. 2. Bring out the importance of finance. 3. It is often said that financial activities hinge on the money management. Do you agree with this point of view? 4. “Financial accounting is essentially of a stewardship nature." Comment. 5. What is business finance? Explain its significance. 6. How can you classify finance? 7. How is finance related to other disciplines? 12LESSON 2 FINANCE FUNCTION LESSON OUTLINE  Nature of Finance Function  Content of Finance Function  Finance Function - Objectives  Changing Concept of Finance  Scope of Finance Function  Organisation of the Finance Function  Meaning of the Finance Function  Finance Function - A New Perspective LEARNING OBJECTIVES After reading this lesson, you should be able to  Understand the nature of finance function  Analyse the content of finance function  Know the objectives of finance function  Understand the changing concept of finance.  Discuss the scope of the finance function  Describe the organization of finance function  Know the meaning of controller and treasure  Understand the new perspective of finance function 13Nature of Finance Function 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 like of business, size of firm, type of equipment used, use of debt, liquidity position. These policy decisions determine the size of the profitability and riskiness of the business of the firm. Prof. K.M.Upadhyay has outlined the nature of finance function as follows: i) In most of the organizations, financial operations are centralized. This results in economies. ii) Finance functions are performed in all business firms, irrespective of their sizes / legal forms of organization. iii) They contribute to the survival and growth of the firm. iv) Finance function is primarily involved with the data analysis for use in decision making. v) Finance functions are concerned with the basic business activities of a firm, in addition to external environmental factors which affect basic business activities, namely, production and marketing. vi) Finance functions comprise control functions also vii) The central focus of finance function is valuation of the firm. Content of Finance Functions The areas of responsibility covered by finance functions may be regarded as the content of finance function. These areas are specific functions of finance. Famous authors of financial management have enumerated the contents of finance function, as outlined, below: 14 Name of the Author Content of Finance Functions 1) James C. Van Horne  Investment Decision  Financing Decision  Dividend Decisions 2) Earnest W. Walker  Financial Planning  Financial Co-ordination  Financial Control 3) J. Fred Weston and Eugene F. Brigham  Financial Planning and Control  Management of Working Capital  Investment in Fixed Assets  Capital Structure Decisions  Individual Financing Episodes It is clear from the above, that, finance functions can be grouped as outlined below: i) Financial planning ii) Financial control iii) Financing decisions iv) Investment decision v) Management of income and dividend decision vi) Incidental functions 15Finance Function – Objectives 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 then finding out suitable sources for raising them. The sources should be commensurate with the needs of the business. If funds are needed for longer periods then long-term sources like share capital, debentures, term loans may be explored. 2. Proper Utilisation of Funds : Though raising of funds is important but their effective utilisation is more important. The funds should be used in such a way that maximum benefit is derived from them. The returns from their use should be more than their cost. It should be ensured that funds do not remain idle at any point of time. The funds committed to various operations should be effectively utilised. Those projects should be preferred which are beneficial to the business. 3. Increasing Profitability. The planning and control of finance function aims at increasing profitability of the concern. It is true that money generates money. To increase profitability, sufficient funds will have to be invested. Finance function should be so planned that the concern neither suffers from inadequacy of funds nor wastes more funds than required. A proper control should also be exercised so that scarce resources are not frittered away on uneconomical operations. The cost of acquiring funds also influences profitability of the business. 164. Maximising Value of Firm. Finance function also aims at maximizing the value of the firm. It is generally said that a concern's value is linked with its profitability. The changing concept of finance According to Ezra Solomon, the changing concept of finance can be analysed by dividing the entire process into three broad groupings. First Approach This approach just emphasizes only on the liquidity and financing of the enterprise. Traditional Approach This approach is concerned with raising of funds used in an organization. It compasses a) instruments, institutions and practice through which funds are augmented. b) the legal and accounting relationship between a company and its source of funds. Modern approach This approach is concerned not only with the raising of funds, but their administration also. This approach encompasses a) determination of the sum total amount of funds to employ in the firm. b) Allocation of resources efficiently to various assets. 17c) Procuring the best mix of financing – i.e. the type and amount of corporate securities. An analysis of the aforesaid approaches unfold that modern approach involving an integrated approach to finance has considered not only determination of total amount of funds but also allocation of resources efficiently to various assets of the firm. Thus one can easily decipher that the concept of finance has undergone a perceptible change. This is evident from the views expressed by one of the financial experts, namely, James C Van Horne and the same are reproduced below: Finance concept (function or scope) has changed from a primarily descriptive study to one that encompasses regions analysis and normative theory; from a field that was concerned primarily with the procurement of funds to one that includes the management of assets, the allocation of capital and the valuation of the firm as a whole; and from a field that emphasized external analysis to the firm to one that stresses decision making within the firm. Finance, today, is best characterized as ever changing with new ideas and techniques. The role of financial manager is considerably different from what it was a few years ago and from what it will no doubt be in another coming years. Academicians and financial mangers must grow to accept the changing environment and master its challenge. Scope of Finance Function The scope of finance function is very wide. While accounting is concerned with the routine type of work, finance function is concerned with financial planning, policy formulation and control. Earnest W. Walker and William are of the opinion that the financial function has always been important in business management. The financial organiastion depends upon the nature of the 18organization – whether it is a proprietary organsation, a partnership firm or corporate body. The significance of the finance function depends on the nature and size of a business firm. The role of various finance officers must be clearly defined to avoid conflicts and the overlapping of responsibilities. The operational functions of finance include : Financial planning Deciding the capital structure Selection of source of finance Selection of pattern of investment i) Financial Planning. The first task of a financial manager is to estimate short- term and long-term financial requirements of his business. For this purpose, he will prepare a financial plan for present as well as for future. The amount required for purchasing fixed assets as well as needs of funds for working capital will have to be ascertained. The estimations should be based on sound financial principles so that neither there are inadequate nor excess funds with the concern. The inadequacy of funds will adversely affect the day-to-day operations of the concern whereas excess funds may tempt a management to indulge in extravagant spending or speculative activities. ii) Deciding Capital Structure. The Capital structure refers to the kind and proportion of different securities for raising funds. After deciding about the quantum of funds required it should be decided which type of securities should be raised. It may be wise to finance fixed assets through long-term debts. Even if gestation period is longer, then share capital may be most suitable. Long-term funds should be raised. It may be wise to finance fixed assets through long-term debts. Even here if gestation period is longer, then share capital may be most 19suitable. Long-term funds should be employed to finance working capital also, if not wholly then partially. Entirely depending upon overdrafts and cash creditors for meeting working capital needs may not be suitable. A decision about various sources for funds should be linked to the cost of raising funds. If cost of raising funds is very high then such sources may not be useful for long. iii) Selection of Source of Finance. After preparing a capital structure, an appropriate source of finance is selected. Various sources from which finance may be raised, include: share capital, debentures, financial institutions, commercial banks, public deposits, etc. If finances are needed for short periods then banks, public deposits and financial institutions may be appropriate; on the other hand, if long-term finances are required then share capital and debentures may be useful. If the concern does not want to tie down assets as securities then public deposits may be a suitable source. If management does not want to dilute ownership then debentures should be issued in preference to share. iv) Selection of Pattern of Investment. When funds have been procured then a decision about investment pattern is to be taken. The selection of an investment pattern is related to the use of funds. A decision will have. to be taken as to which assets are to be purchased ? The funds will have to be spent first on fixed assets and then an appropriate portion will be retained for Working Capital. The decision-making techniques such as Capital Budgeting, Opportunity Cost Analysis, etc. may be applied in making decisions about capital expenditures. While spending on various assets, the principles of safety, profitability and liquidity should not he ignored. A balance should be struck even in these principles. 20

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