UNIT 1
MEANING OF FINANCE
Finance may be defined as the art and science of managing money. It includes
financial service and financial instruments. Finance also is referred as the
provision of money at the time when it is needed. Finance function is the
procurement of funds and their effective utilization in business concerns
Definition:
According to GUTHMANN and DOUGALL, business finance may be broadly
defined as “the activity concerned with the planning, raising, controlling and
administering the funds used in the business.”
Financial decisions refer to decisions concerning financial matters of a business
firm. There are many kinds of financial management decisions that the firm
makers in pursuit of maximizing shareholder‟s wealth, viz., kind of assets to be
acquired, pattern of capitalization, distribution of firm‟s income etc. We can
classify these decisions into three major groups:
Investment decisions
Financing decision.
Dividend decisions.
Working capital decisions.
NATURE OF FINANCE FUNCTION:
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 form 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. Finance
makes use of economic tools. From Micro economics it uses theories and
assumptions. From Macro economics it uses forecasting models. Even
though MRCET MBA
, finance is concerned with individual firm and economics is concerned with
forecasting of an industry.
SCOPE OF FINANCIAL MANAGEMENT:
The main objective of financial management is to arrange sufficient finance for meeting short
term and long term needs. A financial manager will have to concentrate on the following areas of
finance function.
1. Estimating financial requirements:
The first task of a financial manager is to estimate short term and long term financial
requirements of his business. The amount required for purchasing fixed assets as well as needs
for working capital will have to be ascertained.
2. Deciding capital structure:
Capital structure refers to kind and proportion of different securities for raising funds. After
deciding the quantum of funds required it should be decided which type of securities should be
raised. A decision about various sources for funds should be linked to the cost of raising funds.
3. Selecting a source of finance: An appropriate source of finance is selected after preparing a
capital structure which includes share capital, debentures, financial institutions, public deposits
etc. If finance is needed for short term periods then banks, public deposits and financial
institutions may be the appropriate. On the other hand, if long term finance is required then share
capital and debentures may be the useful.
4. Selecting a pattern of investment: When funds have been procured then a decision about
investment pattern is to be taken. 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 and for other requirements.
5. Proper cash management: Cash management is an important task of finance manager. He
has to assess various cash needs at different times and then make arrangements for arranging
cash. Cash may be required to purchase of raw materials, make payments to creditors, meet wage
bills and meet day to day expenses. The idle cash with the business will mean that it is not
properly used.
6. Implementing financial controls: An efficient system of financial management necessitates
the use of various control devices. They are ROI, break even analysis, cost control, ratio
analysis, cost and internal audit. ROI is the best control device in order to evaluate the
performance of various financial policies.
7. Proper use of surpluses: The utilization of profits or surpluses is also an important factor in
financial management. A judicious use of surpluses is essential for expansion and diversification
plans and also in protecting the interests of share holders. A balance should be struck in using
funds for paying dividend and retaining earnings for financing expansion plans.
MRCET MBA
,EVOLUTION OF FINANCE FUNCTION:
Financial management came into existence as a separate field of study from finance function in
the early stages of 20th century. The evolution of financial management can be separated into
three stages:
1. Traditional stage (Finance up to 1940): The traditional stage of financial management
continued till four decades. Some of the important characteristics of this stage are:
i) In this stage, financial management mainly focuses on specific events like formation
expansion, merger and liquidation of the firm.
ii) The techniques and methods used in financial management are mainly illustrated and
in an organized manner.
iii) The essence of financial management was based on principles and policies used in
capital market, equipments of financing and lawful matters of financial events.
iv) Financial management was observed mainly from the prospective of investment
bankers, lenders and others.
2. Transactional stage (After 1940): The transactional stage started in the beginning years of
1940‟s and continued till the beginning of 1950‟s. The features of this stage were similar to the
traditional stage. But this stage mainly focused on the routine problems of financial managers in
the field of funds analysis, planning and control. In this stage, the essence of financial
management was transferred to working capital management.
3. Modern stage (After 1950): The modern stage started in the middle of 1950‟s and observed
tremendous change in the development of financial management with the ideas from economic
theory and implementation of quantitative methods of analysis. Some unique characteristics of
modern stage are:
i) The main focus of financial management was on proper utilization of funds so that
wealth of current share holders can be maximized.
ii) The techniques and methods used in modern stage of financial management were
analytical and quantitative.
Since the starting of modern stage of financial management many important
developments took place. Some of them are in the fields of capital budgeting, valuation models,
dividend policy, option pricing theory, behavioral finance etc.
ROLE OF FINANCIAL MANAGEMENT IN CONTEMPORARY SCENARIO:
MRCET MBA
, GOALS OF FINANCE FUNCTION
Effective procurement and efficient use of finance lead to proper utilization of the finance by the
business concern. It is the essential part of the financial manager. Hence, the financial manager
must determine the basic objectives of the financial management. Objectives of Financial
Management may be broadly divided into two parts such as:
1. Profit maximization
2. Wealth maximization.
1 .Profit Maximization
Main aim of any kind of economic activity is earning profit. Profit is the measuring techniques to
understand the business efficiency of the concern. Profit maximization is also the traditional and
narrow approach, which aims at, maximizing the profit of the concern. Profit maximization
consists of the following important features.
1. Profit maximization is also called as cashing per share maximization. It leads to
maximize the business operation for profit maximization.
2. Ultimate aim of the business concern is earning profit, hence, it considers all the possible
ways to increase the profitability of the concern.
3. Profit is the parameter of measuring the efficiency of the business concern. So it shows
the entire position of the business concern.
4. Profit maximization objectives help to reduce the risk of the business.
Unfavorable Arguments and Drawbacks for Profit Maximization
The following important points are against the objectives of profit maximization:
(i) Profit maximization leads to exploiting workers and consumers.
(ii) Profit maximization creates immoral practices such as corrupt practice, unfair trade
practice, etc.
(iii) Profit maximization objectives leads to inequalities among the stake holders such as
customers, suppliers, public shareholders, etc.
Profit maximization objective consists of certain drawback also:
MRCET MBA
MEANING OF FINANCE
Finance may be defined as the art and science of managing money. It includes
financial service and financial instruments. Finance also is referred as the
provision of money at the time when it is needed. Finance function is the
procurement of funds and their effective utilization in business concerns
Definition:
According to GUTHMANN and DOUGALL, business finance may be broadly
defined as “the activity concerned with the planning, raising, controlling and
administering the funds used in the business.”
Financial decisions refer to decisions concerning financial matters of a business
firm. There are many kinds of financial management decisions that the firm
makers in pursuit of maximizing shareholder‟s wealth, viz., kind of assets to be
acquired, pattern of capitalization, distribution of firm‟s income etc. We can
classify these decisions into three major groups:
Investment decisions
Financing decision.
Dividend decisions.
Working capital decisions.
NATURE OF FINANCE FUNCTION:
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 form 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. Finance
makes use of economic tools. From Micro economics it uses theories and
assumptions. From Macro economics it uses forecasting models. Even
though MRCET MBA
, finance is concerned with individual firm and economics is concerned with
forecasting of an industry.
SCOPE OF FINANCIAL MANAGEMENT:
The main objective of financial management is to arrange sufficient finance for meeting short
term and long term needs. A financial manager will have to concentrate on the following areas of
finance function.
1. Estimating financial requirements:
The first task of a financial manager is to estimate short term and long term financial
requirements of his business. The amount required for purchasing fixed assets as well as needs
for working capital will have to be ascertained.
2. Deciding capital structure:
Capital structure refers to kind and proportion of different securities for raising funds. After
deciding the quantum of funds required it should be decided which type of securities should be
raised. A decision about various sources for funds should be linked to the cost of raising funds.
3. Selecting a source of finance: An appropriate source of finance is selected after preparing a
capital structure which includes share capital, debentures, financial institutions, public deposits
etc. If finance is needed for short term periods then banks, public deposits and financial
institutions may be the appropriate. On the other hand, if long term finance is required then share
capital and debentures may be the useful.
4. Selecting a pattern of investment: When funds have been procured then a decision about
investment pattern is to be taken. 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 and for other requirements.
5. Proper cash management: Cash management is an important task of finance manager. He
has to assess various cash needs at different times and then make arrangements for arranging
cash. Cash may be required to purchase of raw materials, make payments to creditors, meet wage
bills and meet day to day expenses. The idle cash with the business will mean that it is not
properly used.
6. Implementing financial controls: An efficient system of financial management necessitates
the use of various control devices. They are ROI, break even analysis, cost control, ratio
analysis, cost and internal audit. ROI is the best control device in order to evaluate the
performance of various financial policies.
7. Proper use of surpluses: The utilization of profits or surpluses is also an important factor in
financial management. A judicious use of surpluses is essential for expansion and diversification
plans and also in protecting the interests of share holders. A balance should be struck in using
funds for paying dividend and retaining earnings for financing expansion plans.
MRCET MBA
,EVOLUTION OF FINANCE FUNCTION:
Financial management came into existence as a separate field of study from finance function in
the early stages of 20th century. The evolution of financial management can be separated into
three stages:
1. Traditional stage (Finance up to 1940): The traditional stage of financial management
continued till four decades. Some of the important characteristics of this stage are:
i) In this stage, financial management mainly focuses on specific events like formation
expansion, merger and liquidation of the firm.
ii) The techniques and methods used in financial management are mainly illustrated and
in an organized manner.
iii) The essence of financial management was based on principles and policies used in
capital market, equipments of financing and lawful matters of financial events.
iv) Financial management was observed mainly from the prospective of investment
bankers, lenders and others.
2. Transactional stage (After 1940): The transactional stage started in the beginning years of
1940‟s and continued till the beginning of 1950‟s. The features of this stage were similar to the
traditional stage. But this stage mainly focused on the routine problems of financial managers in
the field of funds analysis, planning and control. In this stage, the essence of financial
management was transferred to working capital management.
3. Modern stage (After 1950): The modern stage started in the middle of 1950‟s and observed
tremendous change in the development of financial management with the ideas from economic
theory and implementation of quantitative methods of analysis. Some unique characteristics of
modern stage are:
i) The main focus of financial management was on proper utilization of funds so that
wealth of current share holders can be maximized.
ii) The techniques and methods used in modern stage of financial management were
analytical and quantitative.
Since the starting of modern stage of financial management many important
developments took place. Some of them are in the fields of capital budgeting, valuation models,
dividend policy, option pricing theory, behavioral finance etc.
ROLE OF FINANCIAL MANAGEMENT IN CONTEMPORARY SCENARIO:
MRCET MBA
, GOALS OF FINANCE FUNCTION
Effective procurement and efficient use of finance lead to proper utilization of the finance by the
business concern. It is the essential part of the financial manager. Hence, the financial manager
must determine the basic objectives of the financial management. Objectives of Financial
Management may be broadly divided into two parts such as:
1. Profit maximization
2. Wealth maximization.
1 .Profit Maximization
Main aim of any kind of economic activity is earning profit. Profit is the measuring techniques to
understand the business efficiency of the concern. Profit maximization is also the traditional and
narrow approach, which aims at, maximizing the profit of the concern. Profit maximization
consists of the following important features.
1. Profit maximization is also called as cashing per share maximization. It leads to
maximize the business operation for profit maximization.
2. Ultimate aim of the business concern is earning profit, hence, it considers all the possible
ways to increase the profitability of the concern.
3. Profit is the parameter of measuring the efficiency of the business concern. So it shows
the entire position of the business concern.
4. Profit maximization objectives help to reduce the risk of the business.
Unfavorable Arguments and Drawbacks for Profit Maximization
The following important points are against the objectives of profit maximization:
(i) Profit maximization leads to exploiting workers and consumers.
(ii) Profit maximization creates immoral practices such as corrupt practice, unfair trade
practice, etc.
(iii) Profit maximization objectives leads to inequalities among the stake holders such as
customers, suppliers, public shareholders, etc.
Profit maximization objective consists of certain drawback also:
MRCET MBA
