CHAPTER – 1

INTRODUCTION

1.1 FINANCIAL MANAGEMENT

1.2 FINANCE FUNCTIONS

1.3 ESSENCE OF FINANCIAL DECISIONS

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CHAPTER – 1

INTRODUCTION

1.1 FINANCIAL MANAGEMENT :

Financial management is broadly concerned with the acquisition

and use of funds by a business firm. It is also concerned with the

acquisition, financing and the management of assets, which are financed

by the funds employed, with some overall goal in mind. The matters

involved in financial management would cover the issues like : (1) How

large should the firm be and how fast should it grow ? (2) What should be

the composition of the firm’s assets ? (3) What should be the mix of the

firm’s financing ? (4) How should the firm analyse, plan and control its

financial affairs ?1 In other words, financial management is concerned

with the determination, acquisition, allocation and utilization of financial

resources usually with the aim of achieving some particular goals and

objectives

More specifically, financial management is about: analyzing

financial situations, making financial decisions, setting financial

objectives, formulating financial plans to attain those objectives and

providing effective systems of financial control to ensure plans progress

towards the set objectives.2 In essence, financial management is

concerned with composition and financing of various assets required for

doing the business, the composition and mix of this assets which will

affect the mix of financing also, the start up and growth objectives and

plans of the firm and last but not the least, plans, policies, and practices

which will guide and control the financial affairs of the firm.

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Business firm needs financial resources at various stages of its

existence. The framework of its initial financing, periodic infusion of new

financial resources, sources, cost of finance, nature of security and the

type of finance, tax implications of financing, employment of finance in

short term and long term uses, prudent allocation of funds to various

activities, ideal use of available financial resources etc. has a bearing on

financial and business success or otherwise of the firm. The funds are

required to possess various assets which are needed for running the

business most profitably. The variety, number and composition of these

assets will decide the funds required. The uneconomical assets or the

assets which are not required may be discarded or replaced. Financing

aspect of these assets would be concerned with own sources or debt

sources and another issue of short term and long term of finance.

Dividend policy of the company is also an important issue related with

this. The management of fixed assets and current assets would also have

bearing on the working and yield of the activities.

Business finance can be defined as the activity concerned with the

raising and administering of the funds used in the business. Since today

the business property is held largely by the impersonal units known as

corporations, the emphasis in the study of business finance is often given

to corporation finance and the matters of policy that are involved in the

financial management of these larger organizations. It should be noted,

however, that the same principles of finance apply to large and small,

incorporated and unincorporated concerns. It is only the greater

complexity and the larger public interest in the affairs of the corporation

that justify special attention to its financial problems.3.

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Another way to consider the role of financial Management covers the

activities like Business investments, arrangement of short term and long term

finance for various needs of the firm and management of assets. Investment

decision begins with determination of the total amount of assets needed to be

held by the firm. All the assets appear on the right side of the Balance sheet

which is the probable amount needed to fund the enterprise. This is to be kept

in mind by the finance manager of the firm. With this, the composition of

assets also needs to be decided. Financial management in this area will cover

replacement, elimination and disposing off decisions too. Another major area

is financing decision. Here the finance manager is concerned with the makeup

of the left hand side of the balance sheet. This covers owners’ funds and debt

funds for long term and short term needs of the firm. The mix of financing

makes difference. The dividend policy is also an integral part of the firm’s

financing decision. The dividend-payout ratio determines the amount of

earnings that can be retained in the firm. Retaining a greater amount of

current earnings means lesser amount of fund available for current dividend

payment. The value of the dividends paid to shareholders must therefore be

balanced against the opportunity cost of retained earnings earmarked as a

means of equity financing. Together with the decision about the mix of

financing, another question is how best to physically acquire the needed

funds. This will cover the issues like issue of Shares, Bonds, leasing

agreements, short-term loans etc. Next important are is Asset management.

This encompasses efficient utilization of the assets after they have been

acquired. The finance manager is more concerned with management of

current assets. However, the finance executive is concerned with replacement

and retirement of certain fixed assets. A large share of the responsibility for

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the management of fixed assets would fall on the operating managers who

employ these assets.4

Another way of approach for exposition is having two broad

categories for referring to the scope and functions of financial

management. Traditional approach refers to the academic subject matter

for which the term was Corporation finance. This was later on known as

financial management. As the name suggests, the concern of corporation

finance was with the financing of corporate enterprises. In other words,

the scope of the finance function was treated by the traditional approach

in the narrow sense of procurement of funds by corporate enterprise to

meet their financial needs. The term procurement was used in a broad

sense so as to include the whole gamut of raising funds externally.

1.2 FINANCE FUNCTIONS :

The scope of financial management can be viewed as a part of

whole management process. This involves several key stages of functions

which can be logically analysed in a sequential manner. In fact the

process is continuous and dynamic, with some activities overlapping and

being carried out simultaneously.

With reference to above approach, it is pertinent to view financial

management as a dynamic decision making process which involves a

series of interrelated activities, like :

1. financial analysis.

2. financial decision making.

3. financial planning.

4. financial control.

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In all the business enterprises reliable and relevant financial

information is crucial. Financial management involves making strategic

financing and investment decisions which are critical to the survival and

success of the enterprise. Therefore, the quality of the financial

information used will ultimately affect the quality of the decisions made,

plans implemented and the value of the firm. The provision of reliable

and relevant financial information and the professional advice based on

such information is a key responsibility of the finance manager who in

turn should ensure that reliable financial information systems exist in the

organization.

(1) Financial analysis :

This includes analysis and review to determine the current financial

performance and condition of the business, identification of any particular

financial problems, risks, constraints and an assessment of financial

strengths, weaknesses, opportunities and threats.

(2) Financial decision making :

On the basis of the analysis, financial decisions and choices will have

to be made. This includes strategic investment decisions, for example

acquiring the competitor company, and strategic financing decisions, such as

floating new long term loans. The review will lead to various strategic

options for the management. Here, the finance manager will be ultimately

concerned in the financial evaluation and assessment of the options

available, in determining their respective costs, benefits and risks.

The decision making phase involves determination of the firm’s

financial objectives. The Financial objectives will be related to (a)

Profitability : that is the firm’s investment decisions should yield a rate of

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return commensurate with the risks involved. The management usually

seek to improve profitability for survival and growth. Many a times this is

linked with the rewards the executives get.

(b) liquidity : it is required that sufficient cash is available to pay off the

current liabilities, when the become due. (c) capital structure : which

refers to the relationship between debt and equity finance in its long term

funding arrangements.

The finance executive has to ensure that the firm maintains a

healthy balance between the proportion of debt and equity finance in its

capital structure, subject to specific conditions of the individual firm.

(3) Financial planning :

Financial objectives set out what has to be achieved, and the

financial plans will detail how the financial objectives are to be achieved.

Financial plans will have a timeframe, short, medium or long term and

will essentially provide the road maps detailing how the firm’s objectives

are to be achieved. The essence of financial planning is to ensure that the

right amount of funds is available at the right time and at the right cost for

the level of risks involved to enable the firm’s objectives to be achieved.

(4) Financial control :

The process will require effective management reporting and

control systems to be operative throughout the organization. This is to

ensure that plans are properly implemented, that progress is continually

reported to management, and that any deviations from plans are clearly

identified. Control will inevitably lead to a review and analysis of

financial performance, which in turn lead to new decisions being made,

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objectives and plans being modified as warranted, suitable remedial

actions, and so forth, thus continuing the dynamic management cycle. 5

Practically, the finance function can be viewed as attempting to

balance cash inflows and cash outflows. The finance activity, activities

which a finance controller of a business firm ( that is a joint stock

Company ) performs, involves financing and investment decisions.

Periodically the return earned is to be distributed to the shareholders,

which is called dividend decision. We can summarise the finance

functions as under :

1) Investment or long – term asset – mix decision.

2) Financing or capital – mix decision.

3) Dividend or profit allocation decision.

4) Liquidity or short – term asset – mix decision.

A business firm performs finance functions simultaneously and

continuously in the normal course of business. They do not necessarily

occur in sequence. Finance functions call for skillful planning, control

and execution of a firm’s activities. 6

(1) Investment Decision :

Investment decision involves allocation of long term capital

funds to long term assets that earn for the firm. The crucial aspects

of investment decision are (a) evaluation of the prospective

profitability of new investment, and (b) the measurement of

acceptable rate against which the prospective return of new

investments could be compared. The evaluation should be with

reference to risks and return.

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(2) Financing Decision :

This requires the finance executive to decide when, where

and how to acquire the funds to meet the firm’s investment needs.

The major issue will be mix of equity and debt. This is the capital

structure of the Company. The use of debt has impact on the risk

and return to the shareholders. Best possible proportion of equity

and debt will maximize firm’s value, subject to the earning of the

Company. According to such mix, the finance executive has to

raise appropriate funds through best available sources. Practically,

in Companies, factors like flexibility, legal aspects, tax

implications, terms & conditions of the loans, management control

etc. also form important aspects of the decision.

(3) Dividend Decision :

Every year end, the finance executive is concerned with an

issue whether the firm (company) should distribute all profits, or

retain them, or distribute a portion and retain the balance. The

ultimate idea is its impact on the shareholders’ value. For an

optimum dividend policy, the issues like cash dividend, dividend

stability and bonus shares is to be considered.

(4) Liquidity Decision :

Current assets management which affects a firm’s liquidity is

also another important finance function. Current assets should be

managed efficiently for safeguarding the firm against the dangers of

illiquidity and insolvency. In order to ensure that neither insufficient

nor unnecessary funds are invested in current assets, the finance

executive has to develop useful techniques of managing current assets.

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Ultimately, the financial decisions directly concern the firm’s

decision to acquire or dispose off assets and require commitment or

recommitment of funds on a continuous basis.

To quote Ezra Solomon : “… The function of financial

management is to review and control decisions to commit or recommit

funds to new or ongoing uses. Thus in addition to raising funds, financial

management is directly concerned with production, marketing and other

functions, within an enterprise whenever decisions are made about the

acquisition or distribution of assets”. 7

Another important and relevant aspect which is emphasized by

Prof. I M Pandey is worth noting. There is a reference to the procedures

and systems which are required for effective execution of the finance

function. These are the issues of routine, however, very much

indispensable and part of the finance function. The Finance Manager in

the modern enterprises is mainly involved in the managerial finance

functions, the routine functions are carried out by executives at lower

levels. In recent times the scope of finance function is widened and the

role of the finance manager has changed a lot. His role covers :

1) Raising of Funds : In the day-to-day activities, his role is to

ensure that the firm has enough cash to meet its obligations.

However, the major and crucial involvement is with

reference to reorganizations, mergers, expansion,

diversifications, recapitalisation etc.

2) Allocation of Funds : A number of factors such as fast

industrialization, technological innovations, intense

competition, government intervention and controls,

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demographic changes and widening of customers and

markets necessitated efficient and effective utilization of all

the resources of the firm, particularly financial resources.

The development and use of a number of management skills

and decision-making techniques facilitated the

implementation of a system of optimum allocation and use

of the firm’s resources. The concern of the Finance Manager

will be on determining the size and technology of the firm,

in setting the pace and direction of growth and in shaping the

profitability and risk complexion of the firm by selecting

best asset mix and by obtaining the optimum financing mix.

3) Profit Planning : This refers to decisions in the areas of

costs, pricing, volume of output and selection of product

lines. These issues are preconditions for framing ideal

investment and financing decisions. The cost structure, that

is the mix of fixed and variable costs has significant

influence on firm’s profitability. Profit planning helps to

anticipate the relationships among volume, costs and profits

and develop action plans to safeguard against any

unexpected results.

4) Capital Markets : Finance Manager has to fully understand

the operations and technicalities of capital markets. High

dependence on debt may be viewed adversely by the

investors in the market. At the same time distributing all the

profit by a profitable growing firm may not be liked by

majority of investors, who opine that the funds should be

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reinvested for augmenting future profitability and making

capital gains. Thus, through their operations in capital

markets the investors evaluate the actions and performance

of the Finance Manager.8

In the market economy, the individual firms are using productive

resources of the society for supplying the goods and services needed by

the society. Through price system the scarce resources are allocated for

production. The ultimate mechanism of demand, supply and market

forces brings equilibrium of prices customers pay and profit earning

opportunities for producers. In this process there is an adjustment about

price as well as quantity of goods produced. The prices of goods which

manufacturers (firms) get and the quantities as well as type of goods have

a bearing on profit earning of the firm, which is ultimately the finance

function. Economists also have confirmed that profit maximizing

behaviour of various firms ultimately lead to efficient utilization of scarce

resources of the ecomomy.9

In terms of economic wisdom, the firms tend to function in a way

that increases firm’s profit and avoid the functioning which decreases the

profit. For this goal, the firm has to maximize output with reference to

inputs, as also minimize the production and other costs. This can be

termed as efficiency of the firm. Therefore, one can say that profit

maximization is the yardstick of economic efficiency. Thus, in the

competitive economy, profitability is the measure of performance.

The financial management has two way reference to efficient use

of resources. For profit maximization, it is required that there should be

the most economical use of all the resources held by the firm. This has a

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direct bearing on the cost of performance, and hence the profitability.

Secondly, the firm is employing and using an important resource of

Capital, i.e. financial resources. Capital is the most important scarce

resource in the society. Therefore, profit maximization can be a logical

criterion for various decisions where the finance executive is involved.

Here, the finance executive should be adept to understand implications of

economic realities of timing of costs and income as well as the problems

of uncertainty.

Another measure of performance is value maximization. This is the

value an asset can produce in relation to a particular time. The benefits of

investment should be judged with reference to magnitude of returns as

well as the certainty of flows of returns. Such value creation is to be

evaluated against costs involved. The finance executive is defining this

value from investors’ point of view, since they supply the capital funds.

This return is to be capitalized which reflect time and risk parameters

from investors point of view. This is optimization with respect to owner

interests. In joint stock companies, particularly professional firms, there is

a separation of management from the ownership, where this concept fits

perfectly. In such firms, there is a real test of the finance executive, who

in turn will strive to maximize the value for owner investors.

The explanation of “Financial Management” falls into three broad

groups. Firstly, finance function in a business encompasses the task of

providing funds needed by the enterprise on terms that are most

favourable in the light of its objectives. This approach is concerned

almost exclusively with the procurements of funds. It is widened to cover

a discussion of the instruments, institutions and practices through which

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funds are obtained. It also covers the legal and accounting relationships

between a company and its sources of funds. Another view considers that

finance is concerned with cash, and that since nearly every business

transaction involves cash directly or indirectly. Finance is concerned with

everything that takes place in the conduct of a business. The third

approach envisages finance function as procurement of funds and their

effective utilization in the business. This approach entails a decision

making after analyzing the alternative uses and sources of funds. The

finance manager has to play a major role in planning a business concern’s

need of funds : raising the necessary funds, and then putting them to

effective use. In this sense, financial management covers financial

planning, forecasting of cash receipts and disbursements, the realizing of

funds, use and allocation of funds, and financial control. Through budgets

and other devices of financial control, the finance executive attempts to

bring performance closer to the targets. 10

In broader scope, financial management includes judgments about

whether a company should hold, reduce or increase investments in

various assets. This requires to answer the following three questions.

1) What specific assets should a company acquire ?

2) What total volume of funds should a company commit ?

3) How should the funds required be raised ?

Illustrative list of executive finance functions is :

1. Establishing asset management policies : This involves policy

making about fixed and current assets and involving other

functional executives in the attainment of overall corporate goals.

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2. Determining the allocation of net profits : This involves strategic

decision making about distribution of dividend and retaining the

earnings for the growth of the company.

3. Estimating and controlling cash flows and disbursements : This

involves short term as well as long term receipts and payments of

funds. For instance, recovery from debtors, repayment of long term

loan etc.

4. Deciding upon needs and sources of new outside financing :

This involves assessing and evaluating the real need of finance for

business activities as well as decisions about best possible

economical use of the funds.

5. Carrying on negotiations for new outside financing : This

involves negotiations and deciding about availing short term

(working capital ) and long term (term loans, debentures etc.) funds

for business needs.

6. Checking upon financial performance : This involves

retrospective analysis of operating period for the purpose of

evaluating the wisdom and efficiency of financial planning.

Analysis of what has happened should be of great value in

improving the standards, techniques and procedures of financial

control involved in carrying out finance function. 11

Together with explanation of finance function, another relevant and

crucial aspect is about the Goals of Financial Management. One of the

objective of a Company is to maximize its value to its shareholders.

Value is represented by market price of the ordinary shares of the

company over the long run, which is a reflection of the company’s

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investment and financing decisions. The long run means a period long

enough so that a normalized market price can be worked out. Any

decision to curtail the expenses in the short run can raise the shares price

in the short run. However, saving of cost in the short run for crucial

activities like research, product development, exports etc. will reduce

future profits of the firm and resultant drop in the value of the firm and

market price of shares. Profit maximization has an implication of timing

of expected returns. The volume and time pattern of returns are relevant

factors. With this, the financial aspect involved is risk and uncertainty of

prospective earnings stream.

Another relevant dimension is about the controversy regarding the

goals of financial decision making as profit maximization or wealth

maximization. Certain objections have been raised against profit

maximization as the goal of the business enterprise. First, it relates to the

problem of uncertainty as future cannot be known well enough to express

the probability of possible return. It is not possible to maximize what

cannot be known. Secondly, most decisions involve a balancing between

expected return and risk. Opportunities promising the possibility of

higher expected yields are associated with greater risk to recognize such a

balancing and wealth maximization is brought into the analysis. If greater

expected returns are associated with higher risks, a higher capitalization

rate should be applied to opportunities that involve greater risk. The

combination of expected returns with risk variations and related

capitalization rate cannot be considered in the concept of profit

maximization. Thirdly, the decision maker may not have enough

confidence in estimates of future returns so that he does not attempt

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further to maximize. It is argued that the firm’s goals cannot be to

maximize profits but to attain a certain level of rate of profit, holding a

certain share of the market or a certain level of sales. Firms try to

sacrifice rather than to maximize. The satisfying goal is appropriate for a

behavioural theory of the firm and is perfectly manageable. Satisfying is

primarily a short run search strategy and relates to the cost of search. If

information and search costs are low, additional efforts will be made to

maximize. Where information and search costs are high, additional

efforts to seek to maximize promises little additional net gains. So the

decision maker may be said to satisfies. Thus, when information and

search costs are taken into account, the differences between satisfying

and maximizing may be insignificant or non-existent. Lastly, the

objective to profit maximization indicates that it is too narrowly centered.

Such maximization criteria fail to take into consideration the interests of

government, workers and other persons in the enterprise.

Prof. Ezra Solomon argues that it is useful to distinguish between

profits and profitability. Maximisation of profit in the sense of

maximizing the wealth accruing to shareholders is clearly an unreal

motive. On the other hand, profitability maximization in the sense of

using resources to yield economic values higher than the joint values of

inputs required is a useful goal. The goal of the profitability achieved in

terms of greater outputs than input values involves a different set of

considerations. Thus the proper goal of financial management is wealth

maximization. Even if the management has other motives, such as

maximizing sales or size, growth or market share, or their own survival or

peace of mind, these operating goals do not necessarily conflict with

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operating goal of wealth maximization. This means that wealth

maximization also maximizes the achievement of these other objectives.

Maximisation of wealth provides a useful and meaningful objective as

basic guideline by which financial decisions should be evaluated. 12

Recent developments in economics and finance have placed the

finance executive in a central position in the business firm. Finance has to

consider a broad range of business decisions with reference to funds flow

implications. In addition, it involves the evaluation of resource allocation

choices. Thus, financial management is concerned with wide range of

issues like : size of the firm, rate of growth, asset mix, product mix,

project evaluation, financial analysis, financing mix, fixed versus variable

costs, make or buy decisions and so on.

The field of finance is a subset of behavioural sciences, and derives

its analytical foundations from the economic theory of the firm. The field

of finance is enriched by the behavioural characteristics of all market

participants – management, shareholders, lenders and consumers.

Similarly, it is constrained by the institutional and legal environmental

factors of government, markets and so on. One is interested in the efforts

of all participants to optimize their own welfare through the pursuance of

specific goals, within the accepted modes of behaviour.

The nature, objectives and scope of financial management can be

analysed further with a different perspective. Finance, as applied in the

area of Business, is management of flows of money in the organization.

Financial Management is the applied field of Business Administration.

The principles developed in the field of financial management heavily

rely on the disciplines of accounting and economics. Accounting is

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concerned with identification, recording, measuring and reporting of

monetary/financial transactions of a business firm. Financial management

is very much concerned with the monetory resources. The data generated

by accounting system has varied utility in the business, which employ

huge financial resources for earning profit and maximizing value.

Economics is concerned with analyzing the allocation of resources in the

economy. The study is two fold, in the sense that on one part it analyses

the transactions of individuals/consumers with exchange of money, and

another part which is broad in magnitude analyses issues like demand,

supply, costs and profit, and production and consumption. Another

approach to analyse this is the concepts of Microeconomics and

Macroeconomics. These theories study issues like pricing and production,

economic resources, gross national product and level of economic activity

in the economy as a whole. The science of financial management is also

concerned with such issues of resources, costs, profit, levels of

production, use of financial and other resources for attaining ultimate

goals of profit maximization and value maximization.

John Hampton analyses the nature and scope of financial

management as under. 13

The ultimate objectives rightly defined and understood are the key

to successfully moving the firm to a healthy future. As the business firms

are profit – seeking organizations, their objectives are usually expressed

in terms of money. The primary objectives are: (1) maximization of

profits, and (2) maximization of wealth. These signify the essence, scope

and goals of financial management.

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Maximisation of profit as such is a simple and a rational goal of all

businessmen. This implies holding down the costs, so that the margin is

maintained. If losses are continuing, it reduces the value of the firm and

there will be erosion of Capital. Earning profit is also a basic requirement

for survival and growth of any economic entity, particularly a business

firm.

Maximisation of wealth implies maximizing value of the firm over

the long run. This is maximizing the net present worth of the firm. As

against focusing on the profits, this goal emphasizes the impact of profits

on the current market value of the firm’s securities. If the firm is highly

valuable for the foreseeable future, it commands a high current value. The

reverse is also true. The objective of maximisation of wealth is linked to

the long term profits of the firm. In addition, other important issues are

firm’s growth, amount of risk for investors, price of the shares of the

company and the trend of dividend payment. For maximizing the value,

the firm should avoid high level of risks, have healthy dividend policy,

maintain steady growth and monitor the market price of its shares.

The scope of financial management can further be analysed with

reference to the Goals of financial management. In pursuit of maximum

profits and wealth, financial management interprets the primary goal in

to specific financial goals. One can refer to the following basic approach

for this analysis :

(1) Profit-Risk approach : This approach recognizes that finance

deals with creating proper framework to maximize profit and value

at a given level of business risks. In pursuing this balance, the firm

has to develop controls over flows of funds while allowing

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sufficient flexibility to respond to changes in the operating

environment. This classification method identifies following goals:

a) Maximise profit : Finance should strive for a high level of

primarily long term and secondary short term corporate goals.

b) Minimise Risk : Finance should always seek courses of action

that avoid unnecessary risks and anticipate problem areas and

ways of overcoming difficulties.

c) Maintain Control : Funds flowing in and out of the firm must

be constantly monitored to assure that they are safeguarded and

properly utilized. The financial reporting system must be

designed to provide timely and accurate pictures of the firm’s

activities. Errors or weaknesses should be located and corrected

so that risky situations can be controlled.

d) Achieve flexibility : The firm should always be prepared to

deal with an uncertain future. Flexibility is attained by careful

management of funds and activities. If the firm has located

sufficient sources of funds in advance of needs, it will be

flexible when money is required. If it identifies and analyses a

variety of potential projects, it will have flexibility in

determining its courses of action. Finance attempts to be as

flexible as possible in providing the funds or data needed to

support the production and marketing functions of the firm.

2) Liquidity Profitability approach : This approach recognizes that

the finance manager has two goals to achieve. The first is liquidity,

which means that the firm has adequate cash on hand to meet its

obligations at all times. In other words, the firm can pay all its bills

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and have sufficient cash to take advantage of large purchases with

discounts. The comfortable position should also be able to meet

emergencies. The second goal is profitability. This aspect focuses

on the firm’s operations to yield a long term profit for the

shareholders as part of the overall goal of maximizing the present

value of the Shares of the Company.

Together with the above approach, one can analyse the functions

of financial management which will address to the scope of financial

management.

A) Functions relating to liquidity :

For achieving liquidity, the finance manager performs the functions

such as :

(1) Forecasting cash flows : Efficient day to day operations

require the firm to be able to pay its obligations promptly. As

such this is a matter of matching cash inflows against outflows.

The firm must be able to forecast the sources and timing of

inflows from customers and other sources and use them to pay

its creditors and other financial obligations.

(2) Raising funds : The firm receives its financing from a variety

of sources. With reference to the position of the firm and the

position of funds market at particular times, specific sources

would be more desirable than others. At a given time, a possible

source of funds may not have sufficient funds available to meet

the firm’s needs, or the funds may be expensive. The finance

executive has to identify the amount of funds available from

each source and the periods when the funds will be needed, then

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the manager must take steps to ensure that the funds will

actually be available and committed to the firm.

(3) Managing the flow of internal funds : A large firm has a

number of different bank accounts for various operating

divisions or for special purposes. The money that flows among

these internal accounts should be carefully monitored.

Frequently, a firm has excess cash in one bank account when it

has a need for cash elsewhere in the firm. By continuously

checking on the cash levels in the headquarters and each

operating division’s accounts, the manager can achieve a high

degree of liquidity with minimum external borrowing.

Shortages and the costs associated with short term borrowing

are reasons to control the use and distribution of the firm’s

money.

B) Functions relating to profitability :

With respect to profitability, some of the specific functions would

cover :

(1) Cost control : Most of the large Companies have

comprehensive cost accounting systems to monitor expenditure

in the operational areas like production and marketing. The

system generates data and various reports which the finance

executive is supervising. His involvement in this important area

allows him to monitor and measure the money committed or

spent by the company.

(2) Pricing : Some of the important and strategic decisions made

by the firm involve the prices established for its products,

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product lines and services. The philosophy and approach to the

pricing policy are critical elements in the company’s marketing

effort, image and sales level. Prices have an interface with

marketing function. The finance executive can supply important

information about costs, changes in costs at varying levels of

production and the profit margins needed to carry on the

business successfully. Ultimately, finance provides tools to

analyse profit requirements in pricing decisions and contributes

to the formulation of pricing policies.

(3) Profit forecasts : The finance executive is usually responsible

for gathering and analyzing the relevant data and making

forecasts of profit levels. To estimate profits from future sales,

the firm must be aware of current costs, likely increase in costs

and likely changes in the ability of the firm to sell its products

at established or planned selling prices. Basic variables of

purchase and production costs and sales inputs are to be

analised. Once costs and sales are forecasted, the data arranged

in financial formats will depict the expected profit. Similarly,

before funds are committed to new projects, the expected

profits must be determined and evaluated.

(4) Measuring required return : Whenever the funds are

invested, the firm has to make a risk-return decision. The

adequacy of return is to be evaluated with reference to the

investments and risks. The required return is the rate of return

that must be expected from a proposal before it can be

accepted. It is also called the cost of capital. The finance

24

manager has to determine and evaluate the required return or

the cost of capital. 14

The nature of Financial Management can also be analysed with

reference to the scope, functions and objectives of the subject of

financial management. Financial Management as an academic

discipline, was initially treated simply as raising of funds. In terms

of the crucial importance of finance in business and industry as

also with current reference, the broader scope of efficient use of

financial resources is also universally recognized. The scope and

objectives thus include the importance of basic financial concepts,

techniques of financial analyses, current assets management, long

term investment decisions, financing decisions and other related

important issues like dividend policy, plough back of earnings, tax

implications of business and long term business strategy.15

As per another authority on the subject, the term ‘finance’ in real

world has been interpreted variably by different finance scholars. More

significantly, the concept of finance has changed markedly with change

in times and circumstances. For convenience of analysis different

viewpoints on finance can be categorized into three major groups :

(1) The first category incorporates the views of all those who contend

that finance concerns with acquiring funds on reasonable terms and

conditions to pay bills promptly. This approach covers study of

financial institutions and instruments from which funds can be

secured, the types and duration of obligations to be issued, the

timing of the borrowing or sale of stocks, the amount required,

urgency of the need and cost. The approach has the virtue of

25

shedding light on the very heart of finance function. However, the

approach is too restrictive. It lays stress on only one aspect of

finance. This approach of finance is held by the traditional

scholars.

(2) The second approach holds that finance is concerned with cash.

Since almost all business transactions are expressed ultimately in

terms of cash, every activity within the enterprise is the primary

concern of the financial manager. Thus, according to this approach,

the financial manager is required to go into details of every

business activity be it concerned with purchasing, production,

marketing, personnel, administration research and other associated

activities. Obviously, such a definition is too broad to be

meaningful.

(3) A third approach to finance, held by modern scholars, looks on

finance as being concerned with procurement of funds and wise

application of these funds. Protagonists of this approach opine that

responsibility of the financial manager is not only limited to

acquisition of adequate cash to satisfy business requirements but

extends beyond this to optimal utilization of funds. Since money

involves cost, the central task of the financial manager while

allocating resources is to match the benefits of potential uses

against the cost of alternative sources so as to maximize value of

the enterprise. This is the managerial approach of finance which is

also known as problem-centered approach, since it emphasizes that

the financial manager in his endeavour to maximize value of the

enterprise has to deal with vital problems of the enterprise, viz.,

26

what capital expenditure should the enterprise make ? What

volume of the funds should the enterprise invest ? How should the

desired funds be obtained ? How can the enterprise maximize its

profitability from existing prepared commitments ?

The management approach to finance is balanced one having given

equal weightage to both procurement and utilization aspects of finance

and has received wider recognition in modern world. Thus, finance may

appropriately be defined as the process of raising, providing and

managing of all the money to be used in connection with business

activities. Finance when applied to corporate form of organization is

termed as corporation finance. 16

Certain relevant definitions are :

Business finance can be broadly defined as the activity concerned

with planning, raising, controlling and administering of funds used in

business. (Guthmann & Dougall).

The finance function is the process of acquiring and utilizing funds

by a business. (R C Osborn).

Business finance deals primarily with raising, administering and

disbursing funds by privately owned business units operating in non-

financial fields of industry. (Prather & Wert).

Functions of Financial Management :

The views of traditional and modern scholars regarding finance

function differ markedly. Therefore, it would be germane to give a brief

idea about their views.

Traditional writers contended that primary responsibility of the

financial manager is to raise necessary funds to meet operating

27

requirements of the business. He has to take decisions with respect to the

choice of optimum source from which the funds would have to be

secured, timing of the borrowing or sale of stock and cost and other terms

and conditions of acquiring these funds. Planning quantum and pattern of

fund requirements and allocation of funds as among different assets,

according to the traditional scholars, is the primary concern of non-

financial executives. Traditional approach to finance function has been

bitterly criticized by modern scholars on various cogent grounds. One

such ground is that the traditional ground approach is too narrow. It

viewed finance as a staff specialty. According to them, it would be

mistaken to argue that responsibility of the financial executive is limited

to acquisition of sufficient funds for the enterprise and he has little

concern as to how such funds would be allocated. The approach of

traditional experts is also criticized on the ground that it overemphasized

episodic and non-recurring problems like incorporation, consolidation,

reorganization, recapitalization and liquidation and gave little attention to

day-to-day financial problems of ongoing concerns. Another shortcoming

of the traditional approach is that it gave concentrated attention to

problems of the corporation finance while problems of unincorporated

organizations like sole trading concerns and partnership firms were

altogether ignored. Modern authorities also argued that the traditional

approach laid relatively more stress on problems of long term financing

as if business enterprises do not have to encounter any financial trouble in

the short run. As a matter of fact, problem of working capital

management is very crucial problem which has to be dealt with

28

efficiently by the financial manager if an enterprise has to reach the goal

of wealth maximization.

Modern scholars have viewed finance as an integral part of the

overall management rather than as a staff specialist concerned with the

fund raising operations. Accordingly, the financial manager has been

assigned wider responsibilities. According to them, it is not sufficient for

the financial manager to see that the company has sufficient funds to

carry out its plans but at the same time he has to ensure wise application

of funds in the productive process. Thus, to carry out his responsibilities

effectively it is the bounden responsibility of the financial executive to

make a rational matching of the benefits of potential uses against the

costs of alternative potential sources so as to help the management to

accomplish its broad goal. The financial manager is, therefore, concerned

with all financial activities of planning, raising, allocating and controlling

and not with just any one of them. Aside from this, he has to handle such

financial problems as are encountered by a firm at the time of

incorporation, liquidation, consolidation, reorganization and the like

situations that occur infrequently.

Contents of Modern Finance function :

As per this approach, the finance functions can be categorized into

two broad groups : Recurring finance function and non-recurring finance

function.

Recurring finance function :

Recurring finance function encompasses all such financial

activities as are carried out regularly for the efficient conduct of a firm.

Planning for and raising of funds, allocation of funds and income and

29

controlling the uses of funds are the contents of recurring finance

function.

(1) Planning for funds : The prime task of the finance manager in a

new or growing concern is to formulate finance plan for the

company.Finance plan is the act of deciding in advance the

quantum of fund requirements and its duration and the make-up of

such investments to achieve the primary goal of the enterprise.

While planning for fund requirements, the finance manager has to

aim at synchronizing the cash inflows with cash outflows so that

the firm does not have any resources lying unutilized. Since in

actual practice such a synchronization is not possible the finance

manager must maintain some amount of working capital in reserve

so as to ensure solvency of the firm. The magnitude of this reserve

is the function of the amount of risk that the firm can safely assume

in given economic and business conditions.

Keeping in view the long term goals of the company, the

finance manager has to determine the total funds requirements,

duration of such requirements and the forms in which the required

funds will be obtained. Decision with respect to funds requirements

is reflected in capitalization. While determining funds requirements

for the enterprise the finance manager should keep in mind the

various considerations, viz., purpose of the business, state of

economic and business conditions, the management attitude

towards risks, magnitude of future investment programmes, state

regulations etc. Broadly speaking, there are two methods of

estimating funds requirements : Balance Sheet Method and Cash

30

Budget Method. In the Balance Sheet Method total capital

requirements are arrived at after totaling the estimates of current,

fixed and intangible assets. In contrast with this, a forecast of cash

inflows and cash outflows is made monthwise and cash

deficiencies are calculated to find out the financial needs. With the

help of cash budget amount of funds requirements at different time

intervals can be calculated. Having estimated total funds

requirements the financial executive decides as to how these

requirements will be met, viz. forms of financing funds

requirements. Such decisions are taken under “ Capital structure.”

While there may be various patterns of capital structure, the

finance manager must select the one that best suits the enterprise.

Bearing in mind the cardinal principles of cost, risk, control,

flexibility and timing, the finance manager should decide upon the

most suitable pattern of capital structure for the enterprise.

(2) Raising of Funds : Second responsibility of the finance manager is

that of procuring the necessary capital to meet the business

requirements. If company decides to raise the needed funds by

means of security issues, the finance manager has to arrange the

issue of prospectus for the flotation of issues. In order to ensure

quick sale of securities generally the stock brokers, who deal in

securities in the stock market and who are in constant touch with

their clients, are approached. Even after the issues are floated in the

stock market there is no certainty that the security issues will bring

in desired amount of capital because public response to security

issues is difficult to estimate. If a business entrepreneur fail to

31

assemble desired amount of fund through security issues, the

enterprise is plunged into grave financial trouble. In order to

hamstring this problem the finance manager has to make such an

arrangement as may protect the issue against its failure. For that

matter, he has to approach underwriting firms whose main job is to

provide the guarantee of buying the shares placed before the public

in the event of non-subscription of the shares. For this service, they

charge underwriting commission. Thus, if an underwriter is

satisfied with the issuing company, an underwriting agreement is

entered into between the company and the issuing company. The

obligation of the underwriter as per the agreement arises only when

the event of non-subscription of issues by the public takes place.

Where size of the security issue is too large to be handled by a

single underwriter, the issuing company may enter into agreement

with a number of underwriting firms. Where a company decides to

borrow money from financial institutions including commercial

banks and special financial corporations, the finance manager has

to negotiate with the authorities. He has to prepare the project

report for which the loan is to be sought and discuss it with the

executives of the financial institutions along with the prospects of

repayment of the loan. If the institution is satisfied with the

desirability of the proposal an agreement is entered into by the

finance executive on behalf of the company.

(3) Allocation of Funds : Third major responsibility of the finance

manager is to allocate funds among different assets. In allocating

the funds consideration must be given to the factors such as

32

competing uses, immediate requirements, management of assets,

profit prospects and overall management plans. It is true that

management of fixed assets is not the direct responsibility of the

finance manager. However, he has to acquaint production

executive who is primarily seized with the task of acquiring fixed

assets with fundamentals of capital expenditure projects and also

about the availability of capital in the firm. But the efficient

administration of financial aspects of cash receivables and

inventories is the prime responsibility of finance executive. The

finance executive has also to see that only that much of fixed assets

is acquired that could meet current as well as increased demand of

company’s product. But at the same time he should take steps to

minimize level of buffer stock of fixed assets that the company is

required to carry for the whole year to satisfy the expanded

demands. While managing cash the finance executive should

prudently strike a golden mean between these two conflicting goals

of profitability and liquidity of the business firm. He has to set

minimum level of cash so that the company’s liquidity is not

jeopardized and at the same time its profitability is maximized.

Alongside this, the finance executive has to ensure proper

utilization of cash funds by taking such steps as to help in speeding

up the cash inflows, on the one hand and slowing cash outflows, on

the other.

In managing receivables the finance manager should

endeavour to minimize the level of receivables without adversely

33

affecting sales. For that matter, suitable credit policy should be laid

down and suitable collection procedures would be designed.

Regarding management of inventories, operating responsibility

of managing inventories in a company is outside the province of the

finance executive and well within the realm of production manager

and purchase manager. However, the finance executive is responsible

for supplying necessary funds to support the company’s investment in

inventories. In order to ensure that funds are allocated efficiently in

inventories, the finance executive must familiarize himself with

various methods by which efficient management of inventories can

be achieved. The problem that the finance executive faces is to

determine the optimal magnitude of investment in inventories with

the help of the EOQ model suitable level of inventories is decided.

(4) Allocation of Income : Allocation of annual income of the

company as between different uses is the exclusive responsibility

of the finance executive. Income may be retained for financing

expansion of business or it may be utilized for retiring outstanding

debt or it may be distributed to the owners as dividend as a return

on capital. Decision in this regard is taken in the light of financial

position of the enterprise, its present and future cash requirements,

shareholders’ preferences and the like.

(5) Control of Funds : Last but not the least responsibility of the

finance executive is to control the use of funds committed in the

company’s business so as to ensure that cash is flowing as per the

plan and if there is a deviation between actuals and estimates, the

same is dealt with in a manner compatible with the continued

34

financial health of the business. Similarly, the finance executive

has to evaluate performance of receivable management in order to

judge how far credit and collection policies laid down by the

enterprise are being carried out effectively by the credit

department. For that purpose, credit and collection practices will

have to be examined minutely. If analysis of receivable turnover,

age of each account, percentage of collections, ratio of bad debts to

sales and ratio of delinquent accounts to sales indicates that the

performance is not satisfactory, the finance executive must

determine whether credit and collection policies are inadequate and

need revision or there is laxity in the credit and collection

department in implementing the policies.

While controlling inventories the finance executive must

ascertain whether the capital tide in inventories corresponds with the

predetermined standards. In the event of deviation, the finance

executive should analyse the situation to detect the cause. There may

be two principal reasons for the variations. In the first instance,

economic conditions may have changed since the determination of

budget limits making the standards wrong. Actual investment in

inventories may have, therefore, been proper under the changed

circumstances nevertheless it varies from the predetermined

standards. In such a situation the only remedy left with the finance

executive is to revise budgetary programme in the light of new

developments. Another factor attributable to deviation is failure of the

personnel to execute the policies and programmes of action. In this

case, besides correcting the error, the finance executive should detect

35

individuals who are at fault and take necessary action to ensure that

such deviations do not recur in future.

Certain important tools that are employed to control the uses

of funds are Budgetary reports, Projected financial statements and

Actual financial statements, Ratio Analysis, Funds flow statement

and Break even Analysis.

Non-recurring Finance functions :

This refers to those financial activities that the finance executive has to

perform very infrequently. Preparation of financial Plan at the time of

promotion of the enterprise, financial adjustment in times of illiquidity crisis,

valuation of the enterprise at the time of merger or reorganization of the

enterprise and similar other activities are of episodic character. Successful

handling of such problems requires financial skills and understanding of

principles and techniques of finance peculiar to non-recurring situations.

Nature of Financial Decision :

The functions of financial management elaborated above, leads to

an unmistakable conclusion that the finance manager is an executive

endowed with decision making powers. The function of asset

management recognizes the decision making role of the finance manager.

The finance executive in conjunction with other executive officers of the

enterprise participates in making decisions affecting the current and fuller

utilization of the company’s resources. These executives may discuss the

total amount of assets needed by the company to carry out its operations.

They will determine the mix of assets that will help the company in

achieving its goals. They will identify ways to more effectively use

existing assets and reduce waste and unneeded expenses.

36

In the management of funds the finance executive acts as a

specialized staff officer to the chief executive of the company. He is

responsible for having sufficient funds for the organization to conduct its

business and to pay its bills. He must locate funds to finance receivables

and inventories make arrangements for the purchase of assets and identify

sources of long term financing. Cash must be available to pay dividends

declared by the Board of Directors.

In managing income the finance executive has to take decisions

regarding allocation of income as between distribution and retention. The

determination of dividend policies is almost exclusively a finance

function. The finance executives have final say in decisions on dividends

than in asset management decisions.

In sum, the finance executive is charged with the responsibility of

taking financial decisions : decisions concerning financial matters of a

business concern. Thus decisions regarding magnitude of funds to be

invested to enable an enterprise to accomplish its ultimate goal, kind of

assets to be acquired, pattern of capitalization, pattern of distribution of

company’s income and similar other matters are included in the financial

decisions.

Financial decisions are looked on as cutting across functional even

disciplinary boundaries. It is such an environment that the finance

executive works as a part of total management. In principle, the finance

executive is held responsible to handle all such problems as involve

money matters. But in actual practice he has to call on the expertise of

those in other functional areas, viz. marketing, production, accounting,

purchase, personnel and other executives to carry out his responsibilities.

37

Major Financial Decision areas :

In a business enterprise three type of financial decisions, viz.

investment decision, financing decision and dividend decision are taken.

The nature and contents of each of these decisions are as follows :

Investment Decision :

Investment decision is the vital financial decision. Since funds

involve cost and are available in limited quantity, its proper utilization is

necessary to help the company to attain the ultimate goal of maximization

of wealth. This, therefore, calls for prudent investment decision on the

part of the finance manager. Investment decision determines total amount

of assets to be held in the enterprise, makeup of these assets and business

risk complexion of the enterprise as perceived by the investors.

Broadly speaking, investment decision can be categorized in two

groups : long term investment decision and short term investment

decision. Long term investment decision decides about the allocation of

capital to investment projects whose benefits accrue in the long run. Such

decision may take the form of internal decision and external decision. In

internal investment decision the finance executive has to decide what

capital expenditure projects the company should take, what volume of

funds should be committed and how funds should be allocated as among

different investment outlets. Before committing funds in the business the

finance executive has to select the most economically viable projects. A

company may have a number of profitable investment proposals in hand

but owing to paucity of funds it may find it difficult to take up all the

projects simultaneously. The finance manager will in such circumstances

be called upon to decide which investment proposal should be taken so

38

that the company realizes maximum results. For that matter, economic

viability of the projects will have to be judged in terms of expected

return, cost involved and the risk associated with projects. Sometimes

investment made earlier do not fetch results as anticipated. In that case

the finance executive has to decide about reallocation of funds.

In the external investment decision the finance executive has to

decide about issues concerning investment of funds outside the business.

Broadly speaking, external decision concerns with merger of the

company with other company and portfolio management. With respect to

merger, the finance executive has to decide whether the company should

be merged with other company or not. This decision is based on the

exchange ratio. With this ratio parties to the merger can evaluate the

efficacy of the merger. Factors that influence this important aspect of a

merger scheme are current earnings and its future growth rate, dividend,

market value, book value and net current assets.

In portfolio management the finance executive has to select a

bundle of securities that will provide the investing organization a

maximum yield for a given level of risk or alternatively minimum risk for

a given level of return. With the help of a number of quantitative

techniques the finance executive evaluates the merits of an investment

portfolio and thereby select the most efficient portfolio which will

provide best trade off between risk and return.

Short run decision decides about allocation of funds as among cash

and equivalents, receivables and inventories. Such a decision is

influenced by trade off between liquidity and profitability. Higher the

relative share of liquid assets, lesser will be the possibility of cash drain,

39

other things being equal. However, profitability in that case will be less.

On the contrary, if a smaller proportion of funds is held in liquid form,

risk of insolvency will be high but profitability will also be high.

Compromise between conflicting goals of profitability and liquidity with

respect to these decisions usually rests on the risk preferences of the

management. Hopefully, these preferences are strongly influenced by the

goal of maximizing shareholders’ wealth.

Financing Decision :

In financing decision the finance executive has to decide about the

optimal financing mix or make up of capitalization. While deciding about

the debt-equity mix his endeavour is to have such pattern as may be

helpful in maximizing earning per share and so also market value of

shares. This involves examination in depth of some of the following

important issues :

(a) From what sources are funds available ?

(b) To what extent are funds available from these sources ?

(c) What is the cost of funds presently used ?

(d) What is the expected cost of future financing ?

(e) Given sources of funds and their cost, what sources should

be tapped and to what extent ?

(f) What instruments should be employed to raise funds and at

what time ?

(g) Should the company approach financial institutions for

securing funds ? If yes, on what terms and conditions ?

(h) Will the enterprise make underwriting arrangements ? If yes,

on what terms ?

40

Acceptable answers to the above questions are hard to derive

without some knowledge of money and capital markets, financial

institutions, risk and uncertainty, investor’s psychology and economies.

Dividend Decision :

Dividend decision decides about allocation of business earnings

between payments to shareholders and retained earnings. Retained

earnings constitute one of the most potent sources of funds for financing

corporate growth, but dividends constitute the cash flows that accrue to

equity investors. Although both growth and dividends are desirable, these

two goals are conflicting : a higher dividend rate means less retained

earnings and consequently, a slower rate of growth in earnings and stock

prices. The finance executive has to strike a satisfactory compromise

between the two in such a way that shareholders’ wealth in the company

is maximized, prudent finance executive takes dividend decision in the

light of investors’ preferences, liquidity position of the company, stability

of earnings of the company, need to repay debt, restrictions in debt

contracts, access to capital markets, control and similar other factors.

1.3 ESSENCE OF FINANCIAL DECISIONS :

The essence of financial decisions refers to basic principles which

serve as guidelines to the finance executive in decision making. The

principles are common to all financial decision areas. A brief outline of

some of the fundamental principles of financial decisions is as follows.

(a) Risk-return Trade off : According to this principle, in any financial

decision the risk must be commensurate with the expected return.

While taking investing decisions the finance executive should be

concerned with weather return on assets justifies the risk of acquiring

41

them. Similarly, in making financial decisions the finance executive

chooses suitable source of financing in the light of risk return

relationship.

(b) Time value of Money : Principle of time value of money is key to

the financial decisions. It is widely recognized that money has a

time value. This is why the financial decisions are made on the

basis of discounted cash flow value which is determined by using

an interest factor.

(c) Maximisation of wealth : All financial decisions are taken in such

wise manner as to maximize the stockholders’ wealth. Prudent

investment decision is one which maximizes share values of the

enterprise. Likewise, in deciding upon sources of financing the

finance executive should strike compromise as among conflicting

considerations of cost, risk and control so as to maximizing the share

values of the enterprise. Similarly, maximization of stockholders’

wealth should be central consideration in making decisions regarding

pattern of income distribution and kinds of dividend.

(d) Suitability : This principle implies that funds should be employed

in assets for the period for which funds were procured from the

market. Short term assets should be financed by short term sources

of funds and long term funds should be utilized for acquiring long

term assets. If this principle is not followed, profitability of the

enterprise will suffer and sometimes the enterprise may lend in

financial predicament.

(e) Liquidity Vs Profitability : In taking any financial decision the

finance executive should see that the cash is on hand to pay bills

42

and the company makes maximum profits on its investment. As

cash inflows and cash outflows seldom synchronise, cash balance

is kept in the company to protect it against hazards of liquidity.

However, keeping any excess stock of cash is considered waste of

resources because it is a non-earning asset and the same could be

invested elsewhere to earn some income. This means the company

will be failing to maximize its earnings at the expense of high

liquidity. If, more and more cash is put to profitable use, the

company’s liquidity will be impaired causing the company to lose

benefits of cash discount, liberal loans from banks and above all

business image in the market. Thus, the finance executive is in

dilemma to trade off between liquidity and profitability and

prudent finance executive is one who strikes golden mean between

these conflicting but important goals in making financial decisions.

(f) Leverage : Financial leverage refers to employment of funds

obtained at a fixed charge in the hope of increasing return to the

owners of the organization. The use of leverage is like a double

edged weapon which magnifies both profits and losses. This

principle implies that financial leverage should be employed as

long as it is favourable i.e. magnifies return. The principle of

leverage is applied where financing decisions are involved. Where

the finance executive is seized of the problem of deciding whether

to take recourse to debt financing and if yes, to what extent,

leverage principle acts as useful guideline.

(g) Diversification : Diversification is venerable rule of investment

policy of a business concern. It implies holding of an assortment of

43

securities by an investor rather than a limited number of issues.

Diversification may take the form of unit, industry, maturity,

geography, type of security and management. Though

diversification of investments management can reduce investment

risks if it could not be avoided altogether. However, it should be

remembered that too much or too little of any asset can be

detrimental. Middle course should be allowed while building

investment portfolio.

Now, the role of the person who takes care of finance

function in industries

( Chief Financial Officer) has changed as shown below :

Then Now

1 Support function, reporting to CEO

Strategic role, partnering with CEO

2 Extended focus on Bankers, capital raising

Focus on stakeholder value, regulatory compliance

3 Past orientation : budgets, bookkeeping, MIS

Future orientation : Forecasting, rolling budgets

4 Risk mitigation, cost control Optimising and balancing risk against returns

5 Transaction processing, data management

Financial Analysis, decision support systems

6 Stewardship of financial and physical assets

Focus on intangible assets

7 Passive investor in technology Enterprise wide integrator of technology8 Allocation of resources in

Business Monitoring/management of business portfolio

9 All financial activities done in-house

Outsourcing/in sourcing of non-core finance activity

44

The drivers of change in business management, and particularly in

the area of finance are : (1) Aggressive regulatory environment after the

instances like Enron, Worldcom etc. (2) Technology (3) Growing

internationalization of business and sensitivity to capital markets.

Now, the CFOs, and not the CEOs, are asked to play a strategic

role. This is because of (a) CFOs fundamental familiarity with cost of

capital and numbers. (b) Finance roles tend to have different linkages

with the business. 17

Latest trends in the corporate world contemplate the following

additional finance functions with which a financial executive is ultimately

concerned.

a. Present value of financial resources, time and risk. Business firms

ultimately involve financial resources in different forms, for

current period as well as medium and long term period. This has

direct implications of value of resources, periodic value with future

economic uncertainties and financial/business risks affecting the

performance of the firm.

b. The implications of off-balance sheet items on the business

performance.

c. The controversy about dividend. Many companies declare

exorbitant amount of dividend. At the same time, so many

companies either do not declare dividend or declare very low rate

of dividend. Some people opine that dividend is irrelevant.

Different type of research is an ongoing activity. One has to

understand as to what decides the payout policy and how that

policy affects firm value.

45

d. The question of what and how much risks a firm should take. There

are various types of financial and non-financial risks in business.

This has a bearing on the performance, success and value of the

firm.

e. Existence of different type of organizations for carrying out

business activity and choice of various types of financial

architecture all over the world. The size and legal forms of the

firms are different all over the world. The financial architecture is

also different in different countries. There exists various types of

securities, debt and equity mixture, varying type of financial

involvement of owners and outsiders in the firm. One has to

understand as to which arrangements are most efficient. 18

46

References : 1. Prasanna Chandra, Fundamentals of Financial Management , P.I., Tata

McGraw Hill ,New Delhi, 1993.

2. Jim Mcnamin , Financial Management , P.9. ,Oxford University Press,

2000

3. H. Guthman & HE Dougall,Corporate, Financial Policy, P-I, Prantice

Hall, 1956.

4. JC VanHorne & Jim Wachowiz, Fundamentals of Financial Management,

P-3, 1998.

5. Jim Ncnamin, Financial Management, P. 19.

6. IM Pandey, Financial Management , P.5, Vikas Publications Pvt. Ltd.,

New Delhi, 1999.

7. Ezra Soloman, The Theory of Financial Management , P.3, Columbia

University Press, 1969.

8. IM Pandey, Financial Management, Vikas Publications Pvt. Ltd., New

Delhi, Pg.7-11,1999.

9. Ezra Soloman & John Pingle , An Introduction To Financial Management,

P.7, Prantice Hall of India, New Delhi, 1978.

10. SC Kuchhal, Financial Management , P.2, Chaitanya Publishing House,

Allahabad.

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