Author: indiafreenotes

In these other discipline, we can include production and its department, marketing and its department and personnel and its department. Relationship shows balanced behavior of officers of finance department and other department’s officers. They should concentrate on one target of company and many other things, they should know for creating good relation.

Relationship of finance with other discipline can be explained in following way:

(i) Finance and Accounting

The two are embedded with different disciplines. The finance is the discipline which is mainly based on the cash basis of operations but the accounting is totally governed by the accrual system.

Accounting is mainly vested with the collection and presentation of data, but the finance is closely connected with the decision making of the organization.

Till this moment, the differences are discussed only to know the role of finance over the accounting of any organization. The following is the major relationship which lies in between the finance and accounting as follows “Finance begins where accounting ends”

(ii) Relationship of Finance with Production

Production department’s main duty is to produce the goods. For producing goods, it needs raw material, labor and other expenses. For paying all expenses, production department needs money and fund which will be fulfilled by finance department. Finance department checks the budget of production department and allow funds for production department. With this view, we can understand that production department is dependent on finance department’s decision. Now, if production department performs his duty honestly and products are produced and sold on time, it will be helpful for increase sale and profitability and it will again recycle the fund with high profit in finance department. So, we can say both are dependent on each other. Both are players of business team. Both should be adopt co-operative view for each other. After this, business team can succeed in business.

(iii) Relationship of Finance with Marketing

Marketing department’s main duty is to sell maximum goods and satisfy the consumers. Its product’s input cost will decrease if all products are sold by marketers of company. For developing the product, promotion activities and distribution activities of marketing department need some money for paying salesmen, advertising budget and other promotional expenses. For this marketing department makes his marketing budget and it is cleared by finance department, but sometime finance department will not all specific marketing expenses but marketing department need that type of expenses for promotion of sales. This will create confliction. Good relations will be helpful for both departments. If both department does meeting and show behavior like good relative, the problem can easily solve. Both departments should think that both are the part of company’s organization and co-ordination between them is must. Sometime, marketing department obtains big order for supplying the goods, at that time finance department should help marketing department for arrangement of money for buying raw material and supplying fastly without any delay.

(iv) Relationship of Finance with Personnel

Personnel are that science which manages the employees of company and finance is that science which manages the money. If personnel department and finance department work together with co-operation, both departments can satisfy the objectives of company. It is the objective of company to satisfy employee by fulfilling their financial needs. It is also objective of company to reduce the misuse of fund by paying excess salary that required cost of doing work by employee. So, both department should understand each other’s objective and should help other department for fulfilling the objectives. One more thing, financial decisions are also very necessary in human resource area. Corporate are moving to the development of employees. They are human resource capital of company. Now, investment in training of employees, incentive schemes and retirement schemes etc. should be calculated like other investment and both departments should take maximum advantages from this asset.

(v) Relationship of Finance with Economics

There are two areas of economics with which the financial manager must be familiar: micro-economics and macroeconomics. Microeconomics deals with the economic decisions of individuals, households, and firms, whereas macroeconomics looks at the economy as a whole.

The typical firm is heavily influenced by the overall performance of the economy and is dependent upon the money and capital markets for investment funds. Thus, financial managers should recognize and understand how monetary policies affect the cost of funds and the availability of credit. Financial managers should also be versed in fiscal policy and how it affects the economy. What the economy can be expected to do in the future is a crucial factor in generating sales forecasts as well as other types of forecasts.

The financial manager uses microeconomics when developing decision models that are likely to lead to the most efficient and successful modes of operation within the firm. Specifically, financial managers use the microeconomic concept of setting marginal cost equal to marginal revenue when making long-term investment decisions (capital budgeting) and when managing cash, inventories, and accounts receivable (working capital management).

Business financing is just it what it sounds like: the activity of funding the many aspects of a business, whether the funding be for starting a business, running it, or expanding it. Regardless of the size or type of business, there are fundamental questions involving financing that must be addressed.

For example, most businesses purchase a variety of items, such as buildings, machinery, or office furniture and equipment that are intended to be useful for a long time. Such items are called long-term investments. Any business making long-term investments must carefully consider what those investments will be, how much they will cost, and how much they will hold their value over time. Just as important is the question of where to get the money needed to pay for them.

When a business is just starting, it typically borrows money from banks or other financial institutions, or it brings in additional individuals or institutions (that is, investors) to share ownership in the business in order to procure the initial capital it needs to cover the costs of building a new business. Capital is the term given to the money or other things of worth that are needed to produce goods or services. Capital can take the form of human beings, physical goods, or some means of financial exchange. Examples of capital are skilled labor, factories, office space, tools, machinery, and money.

When a businesses is up and running and managing the everyday financial operations, it may likewise turn to banks and investors for financing, but it typically relies on its customers for generating the money needed to finance the business. If the business is profitable and the company saves some of the money it makes from commercial activity, it may use that money to make new investments that will further expand its business. There are many different methods businesses use to acquire the financing they need to fund large projects and to improve their profitability.

Recorded instances of business financing date back to ancient times when wealthy Greeks arranged loans to shipping concerns that needed financing to transport freight. Greek lenders also funded miners and erectors of public buildings. In the Middle Ages Jewish merchants living in Italy loaned money to Christian Italian farmers. This practice established merchants in Europe as the main source of loans for farms and businesses and originated the concept of the “merchant bank.”

In 1781 the first commercial bank was established in the United States. Named the Bank of North America, it extended short-term loans to merchants who then passed them on to wholesalers of imported goods. The wholesalers, in turn, extended loans to retailers, often country stores and independent peddlers.

Another step in the development of business financing in the United States was taken in 1904, when the American banker A.P. Giannini (1870–1949; later to be nicknamed “America’s banker,”) opened the Bank of Italy in San Francisco in 1904. Immigrants who sought to borrow money to start businesses but had been turned down because they had no established wealth were supported by the Bank of Italy, which became the Bank of America in 1930. California industry and agriculture and Hollywood filmmaking were among the many interests supported by Giannini’s financing enterprise.

The Small Business Investment Act of 1958 established ways to make venture capital (funds from investors seeking to share ownership in new businesses) and long-term loans available to small, independent businesses in the United States. This program was the first to give small American businesses the financing they needed to start, maintain, and expand their operations.

Aspects of Business Financing

As businesses grow, their financing needs evolve and typically become more complex. In the case of a small business, the owner generally makes the financial decisions for the firm. In the case of a large company, the owner or owners (who in some cases are the stockholders) do not get involved in financial decisions. Instead, they hire managers who take on the financial responsibilities. In large companies, this person is known as the chief financial officer (CFO) or vice-president of finance.

The process of planning and managing the long-term investments of a business is known as capital budgeting. Usually this process involves seeking those business opportunities that will earn the company more than they will cost the company. For each type of business, these opportunities are distinct. For example, for a commercial airline the decision about whether to begin regular service to a new city would be an important capital budgeting decision. For a large discount retailer the decision about whether to introduce a new line of gardening products would be one. Other types of capital budgeting opportunities (for example, investments in computer systems or human labor) are common to almost all businesses.

When a company’s financial manager reviews a proposed capital budgeting decision, he or she must respond to several issues concerning the flow of cash associated with an investment. Primary considerations are the amount of cash the company is likely to make from an investment, when the company can collect the cash, and how high is the risk of the investment (that is, the chance of losing money in it). Basically, all capital investments must be evaluated for their size, timing, and risk. In the example of the airline’s beginning a new route, mentioned above, the financial manager must estimate how much money the company will make once the route is established, when it will earn the money, and how reliable the new market will be.

When a company makes a long-term investment, as it does when it decides to develop a new product or open a new division, it must know from where the needed money will come: from outside the company, from within the company, or some combination of the two. Long-term investments require what is called long-term financing. The financial structure (sometimes called the capital structure) of a company is the particular mix of long-term borrowing and the equity that it can use to pay for its operations and new investments. The company, for example, may have a certain amount of long-term debt incurred from borrowing money for its startup or to make new investments. The equity is the market value of the business’s property held by the owners and shareholders. Financial managers constantly weigh the levels of debt and equity. Equity allows a company to keep growing and gives it its value. Debts must be kept under control because they represent the level of financial risk a company takes upon itself; the greater its debts, the greater it risks financial instability.

The term “working capital” refers to the short-term investments a business can draw upon. A business’s short-term investments may be the inventory of goods it has produced. A business also may have short-term debts in the form of money it owes to the suppliers who provide materials to the business. The owners or the financial manager of the business must manage these short-term investments and debts of the firm on a daily basis so that the firm does not lose track of its costs, run out of ready cash, or interrupt its operations.

Recent Trends in Business Financing

An area of business finance that has grown steadily in the late twentieth and early twenty-first centuries is the practice of extending small loans to poor entrepreneurs who live in developing countries. The practice is known as microlending, and the loan is often called microcredit. The purpose of microlending is to assist individuals in creating income for themselves (for instance, by farming, weaving, or making crafts) and therefore to improve their living standards. Usually the individuals borrowing money have no existing property to use as collateral and no credit history and so would not qualify for a traditional bank loan.

Microcredit is generally issued for a short time period (one year or less), and the terms mandate that it be paid back on a weekly basis. Interest rates on the loans generally are high (in some places 40-50 percent) because costs of running the programs are high. The loan programs also generally seek to improve the education and health care of those enrolled. Microcredit is extended to women more often than men, and usually it is arranged as a community program, which cultivates responsibility to repay the loans because the whole community takes on the risk involved in improving the financial situation of its constituents.

The stock market refers to the collection of markets and exchanges where regular activities of buying, selling, and issuance of shares of publicly-held companies take place. Such financial activities are conducted through institutionalized formal exchanges or over-the-counter (OTC) marketplaces which operate under a defined set of regulations. There can be multiple stock trading venues in a country or a region which allow transactions in stocks and other forms of securities.

While both terms – stock market and stock exchange – are used interchangeably, the latter term is generally a subset of the former. If one says that she trades in the stock market, it means that she buys and sells shares/equities on one (or more) of the stock exchange(s) that are part of the overall stock market. The leading stock exchanges in the U.S. include the New York Stock Exchange (NYSE), Nasdaq, and the Chicago Board Options Exchange (CBOE). These leading national exchanges, along with several other exchanges operating in the country, form the stock market of the U.S.

In a nutshell, stock markets provide a secure and regulated environment where market participants can transact in shares and other eligible financial instruments with confidence with zero- to low-operational risk. Operating under the defined rules as stated by the regulator, the stock markets act as primary markets and as secondary markets.

As a primary market, the stock market allows companies to issue and sell their shares to the common public for the first time through the process of initial public offerings (IPO). This activity helps companies raise necessary capital from investors. It essentially means that a company divides itself into a number of shares (say, 20 million shares) and sells a part of those shares (say, 5 million shares) to common public at a price (say, $10 per share).

To facilitate this process, a company needs a marketplace where these shares can be sold. This marketplace is provided by the stock market. If everything goes as per the plans, the company will successfully sell the 5 million shares at a price of $10 per share and collect $50 million worth of funds. Investors will get the company shares which they can expect to hold for their preferred duration, in anticipation of rising in share price and any potential income in the form of dividend payments. The stock exchange acts as a facilitator for this capital raising process and receives a fee for its services from the company and its financial partners.

Following the first-time share issuance IPO exercise called the listing process, the stock exchange also serves as the trading platform that facilitates regular buying and selling of the listed shares. This constitutes the secondary market. The stock exchange earns a fee for every trade that occurs on its platform during the secondary market activity.

The stock exchange shoulders the responsibility of ensuring price transparency, liquidity, price discovery and fair dealings in such trading activities. As almost all major stock markets across the globe now operate electronically, the exchange maintains trading systems that efficiently manage the buy and sell orders from various market participants. They perform the price matching function to facilitate trade execution at a price fair to both buyers and sellers.

A listed company may also offer new, additional shares through other offerings at a later stage, like through rights issue or through follow-on offers. They may even buyback or delist their shares. The stock exchange facilitates such transactions.

The stock exchange often creates and maintains various market-level and sector-specific indicators, like the S&P 500 index or Nasdaq 100 index, which provide a measure to track the movement of the overall market. Other methods include the Stochastic Oscillator and Stochastic Momentum Index.

The stock exchanges also maintain all company news, announcements, and financial reporting, which can be usually accessed on their official websites. A stock exchange also supports various other corporate-level, transaction-related activities. For instance, profitable companies may reward investors by paying dividends which usually comes from a part of the company’s earnings. The exchange maintains all such information and may support its processing to a certain extent.

Functions of a Stock Market

A stock market primarily serves the following functions:

1. Fair Dealing in Securities Transactions

Depending on the standard rules of demand and supply, the stock exchange needs to ensure that all interested market participants have instant access to data for all buy and sell orders thereby helping in the fair and transparent pricing of securities. Additionally, it should also perform efficient matching of appropriate buy and sell orders.

For example, there may be three buyers who have placed orders for buying Microsoft shares at $100, $105 and $110, and there may be four sellers who are willing to sell Microsoft shares at $110, $112, $115 and $120. The exchange (through their computer operated automated trading systems) needs to ensure that the best buy and best sell are matched, which in this case is at $110 for the given quantity of trade.

2. Efficient Price Discovery

Stock markets need to support an efficient mechanism for price discovery, which refers to the act of deciding the proper price of a security and is usually performed by assessing market supply and demand and other factors associated with the transactions.

Say, a U.S.-based software company is trading at a price of $100 and has a market capitalization of $5 billion. A news item comes in that the EU regulator has imposed a fine of $2 billion on the company which essentially means that 40 percent of the company’s value may be wiped out. While the stock market may have imposed a trading price range of $90 and $110 on the company’s share price, it should efficiently change the permissible trading price limit to accommodate for the possible changes in the share price, else shareholders may struggle to trade at a fair price.

3. Liquidity Maintenance

While getting the number of buyers and sellers for a particular financial security are out of control for the stock market, it needs to ensure that whosoever is qualified and willing to trade gets instant access to place orders which should get executed at the fair price.

4. Security and Validity of Transactions

While more participants are important for efficient working of a market, the same market needs to ensure that all participants are verified and remain compliant with the necessary rules and regulations, leaving no room for default by any of the parties. Additionally, it should ensure that all associated entities operating in the market must also adhere to the rules, and work within the legal framework given by the regulator.

5. Support All Eligible Types of Participants

A marketplace is made by a variety of participants, which include market makers, investors, traders, speculators, and hedgers. All these participants operate in the stock market with different roles and functions. For instance, an investor may buy stocks and hold them for long term spanning many years, while a trader may enter and exit a position within seconds. A market maker provides necessary liquidity in the market, while a hedger may like to trade in derivatives for mitigating the risk involved in investments. The stock market should ensure that all such participants are able to operate seamlessly fulfilling their desired roles to ensure the market continues to operate efficiently.

6. Investor Protection

Along with wealthy and institutional investors, a very large number of small investors are also served by the stock market for their small amount of investments. These investors may have limited financial knowledge, and may not be fully aware of the pitfalls of investing in stocks and other listed instruments. The stock exchange must implement necessary measures to offer the necessary protection to such investors to shield them from financial loss and ensure customer trust.

For instance, a stock exchange may categorize stocks in various segments depending on their risk profiles and allow limited or no trading by common investors in high-risk stocks. Exchanges often impose restrictions to prevent individuals with limited income and knowledge from getting into risky bets of derivatives.

7. Balanced Regulation

Listed companies are largely regulated and their dealings are monitored by market regulators, like the Securities and Exchange Commission (SEC) of the U.S. Additionally, exchanges also mandate certain requirements – like, timely filing of quarterly financial reports and instant reporting of any relevant developments – to ensure all market participants become aware of corporate happenings. Failure to adhere to the regulations can lead to suspension of trading by the exchanges and other disciplinary measures.

Stock Market Participants

Along with long-term investors and short term traders, there are many different types of players associated with the stock market. Each has a unique role, but many of the roles are intertwined and depend on each other to make the market run effectively.

1. Stockbrokers

Stockbrokers, also known as registered representatives in the U.S., are the licensed professionals who buy and sell securities on behalf of investors. The brokers act as intermediaries between the stock exchanges and the investors by buying and selling stocks on the investors’ behalf. An account with a retail broker is needed to gain access to the markets.

2. Portfolio Managers

 Portfolio managers are professionals who invest portfolios, or collections of securities, for clients. These managers get recommendations from analysts and make the buy or sell decisions for the portfolio. Mutual fund companies, hedge funds, and pension plans use portfolio managers to make decisions and set the investment strategies for the money they hold.

3. Investment Bankers

Investment bankers represent companies in various capacities, such as private companies that want to go public via an IPO or companies that are involved in pending mergers and acquisitions. They take care of the listing process in compliance with the regulatory requirements of the stock market.

4. Custodian and depot service providers

Custodian and depot service providers, which are institution holding customers’ securities for safekeeping so as to minimize the risk of their theft or loss, also operate in sync with the exchange to transfer shares to/from the respective accounts of transacting parties based on trading on the stock market.

5. Market Maker

A market maker is a broker-dealer who facilitates the trading of shares by posting bid and ask prices along with maintaining an inventory of shares. He ensures sufficient liquidity in the market for a particular (set of) share(s), and profits from the difference between the bid and the ask price he quotes.

Stock exchanges operate as for-profit institutes and charge a fee for their services. The primary source of income for these stock exchanges are the revenues from the transaction fees that are charged for each trade carried out on its platform. Additionally, exchanges earn revenue from the listing fee charged to companies during the IPO process and other follow-on offerings.

The exchange also earns from selling market data generated on its platform like real-time data, historical data, summary data, and reference data which is vital for equity research and other uses. Many exchanges will also sell technology products, like a trading terminal and dedicated network connection to the exchange, to the interested parties for a suitable fee.

The exchange may offer privileged services like high-frequency trading to larger clients like mutual funds and asset management companies (AMC), and earn money accordingly. There are provisions for regulatory fee and registration fee for different profiles of market participants, like the market maker and broker, which form other sources of income for the stock exchanges.

The exchange also makes profits by licensing their indexes (and their methodology) which are commonly used as a benchmark for launching various products like mutual funds and ETFs by AMCs.

Many exchanges also provide courses and certification on various financial topics to industry participants and earn revenues from such subscriptions.

Competition for Stock Markets

While individual stock exchanges compete against each other to get maximum transaction volume, they are facing threat on two fronts.

1. Dark Pools

Dark pools, which are private exchanges or forums for securities trading and operate within private groups, are posing a challenge to public stock markets. Though their legal validity is subject to local regulations, they are gaining popularity as participants save big on transaction fees.

2. Blockchain Ventures

Amid rising popularity of blockchains, many crypto exchanges have emerged. Such exchanges are venues for trading cryptocurrencies and derivatives associated with that asset class. Though their popularity remains limited, they pose a threat to the traditional stock market model by automating a bulk of the work done by various stock market participants and by offering zero- to low-cost services.

Examples of Stock Markets

The first stock market in the world was the London stock exchange. It was started in a coffeehouse, where traders used to meet to exchange shares, in 1773. The first stock exchange in the United States of America was started in Philadelphia in 1790. The Buttonwood agreement, so named because it was signed under a buttonwood tree, marked the beginnings of New York’s Wall Street in 1792. The agreement was signed by 24 traders and was the first American organization of its kind to trade in securities. The traders renamed their venture as New York Stock and Exchange Board in 1817.

• Stock markets are vital components of a free-market economy because they enable democratized access to trading and exchange of capital for investors of all kinds.
• They perform several functions in markets, including efficient price discovery and efficient dealing.

Financial forecasting is the processing, estimating, or predicting how a business will perform in the future. The most common type of financial forecast is an income statement, however, in a complete financial model, all three statements are forecasted. In this guide on how to build a financial forecast, we will complete the income statement model from revenue to operating profit or EBIT.

Financial forecasting is concerned with the projection of future financial performance, condition, flows, and requirements.

It enables the firm to protest the financial feasibility of various policies and actions, it facilitates the raising of funds by enhancing the confidence of lenders in the management of the firm, it provides a basis of control and improves the utilization of resources.

Major Components of Financial Forecasting

1. Projected Income statement

The projected income statement also referred to as the profit plan or operating budget, shows the expected revenues and expenses for the budget period, usually, one year, and the net financial results of the operations.

The profit plan of the firm is based on several budgets, Sales budget, production budget, materials and purchases budget, labour cost budget, manufacturing overhead budget, and budget for non-manufacturing costs.

2. Cash budget

The cash budget reflects the cash inflows and outflows expected In the future. The major sources of cash Inflow are: Cash sales, collection of accounts receivable, disposal of assets, short-term borrowing, long-term debt and equity capital.

The important cash outflows relate to: Cash purchases, payment of accounts payable, wages, salaries, rent, interest, taxes, dividends, capital expenditures and repayment of loans and debentures. The cash budget should not include non­cash expense items like depreciation.

The projected surpluses/deficits in the cash budget provide the basis for investment (where there is a surplus beyond the target cash balance the firm wishes to maintain) and financing (when the projected cash balance falls below the target cash balance).

3. Projected Balance Sheet

The projected balance sheet shows the projected assets, liabilities and owners equity at the end of the period. The inputs required for its preparation are the initial balance sheet, the profit plan, the capital expenditure budget, the cash budget, and the investment and financing plan.

4. Projected sources and uses of funds statement

The projected sources and uses of funds statement shows the sources of funds and uses of funds in the planning period (funds are usually defined as working capital). The inputs required for its preparation are the initial balance sheet, the projected balance sheet and the projected income statement.

The projected sources of funds are:

• Operations (profit before tax plus depreciation),
• Issue of additional share capital
• Decrease in fixed assets, and
• Increase in long-term liabilities

The projected uses of funds are:

• Tax payment,
• Dividend payment
• Decrease in long-term liabilities
• Gross increase in fixed assets, and
• Net change in working capital

Methods of Financial Forecasting

1. Qualitative Techniques of Financial Forecasting

(i) Executive Opinions

In this method, the expert opinions of key personnel of various departments, such as production, sales, purchasing and operations, are gathered to arrive at future predictions. The management team makes revisions in the resulting forecast, based on their expectations.

(ii) Reference Class Forecasting

This method involves predicting the outcome of a planned action based on similar scenarios in other times or places. This is used to defy predictions that are arrived at based only on human judgment.

(iii) Delphi Technique

Here, a series of questionnaires are prepared and answered by a group of experts, who are kept separate from each other. Once the results of the first questionnaire are compiled, a second questionnaire is prepared based on the results of the first. This second document is again presented to the experts, who are then asked to reevaluate their responses to the first questionnaire. This process continues until the researchers have a narrow shortlist of opinions.

(iv) Sales Force Polling

Some companies believe that salespersons have close contact with the consumers and could provide significant insights regarding customer behavior. In this method of forecasting, the estimates are derived based on the average of sales force polling.

(v) Consumer Surveys

Businesses often conduct market surveys of consumers. The data is collected via telephonic conversations, personal interviews or survey questionnaires, and extensive statistical analysis is conducted to generate forecasts.

(vi) Scenario Writing

In this method, the forecaster generates different outcomes based on diverse starting criteria. The management team decides on the most likely outcome from the numerous scenarios presented.

2. Quantitative Techniques of Financial Forecasting

(i) Proforma Financial Statements

Proforma statements use sales figures and costs from the previous two to three years after excluding certain one-time costs. This method is mainly used in mergers and acquisitions, as well as in cases where a new company is forming and statements are needed to request capital from investors.

(ii) Time-Series Forecasting

Time-series forecasting is a popular quantitative forecasting technique, in which data is gathered over a period of time to identify trends. Time-series methods are one of the simplest methods to deploy and can be quite accurate, particularly over the short term. Some techniques that fall within this method are simple averaging and exponential smoothing.

(iii) Cause-Effect Method

Here, the forecaster examines the cause-and-effect relationships of the variable with other relevant variables such as changes in consumers’ disposable incomes, the interest rate, the level of consumer confidence, and unemployment levels.  This method uses past time series on many relevant variables to produce the forecast for the variable of interest.

Financial forecasting is tough and selection of the appropriate forecasting method is crucial to achieve the desired results. One needs to remember that the chosen method for one program may differ for another. While complex techniques may give accurate predictions in special cases, simpler techniques tend to perform just as well. Whatever may be the case, financial forecasting always helps to predict future performance and aids decision makers.

Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprise. It means applying general management principles to financial resources of the enterprise.

In simple terms objective of Financial Management is to maximize the value of firm, however it is much more complex than that. The management of the firm involves many stakeholders, including owners, creditors, and various participants in the financial market.

For any business, it is important that the finance it procures is invested in a manner that the returns from the investment are higher than the cost of finance. In a nutshell, financial management:

• Endeavors to reduce the cost of finance
• Ensures sufficient availability of funds
• Deals with the planning, organizing, and controlling of financial activities like the procurement and utilization of funds

“Financial management is the activity concerned with planning, raising, controlling and administering of funds used in the business.” :Guthman and Dougal

“Financial management is that area of business management devoted to a judicious use of capital and a careful selection of the source of capital in order to enable a spending unit to move in the direction of reaching the goals.” :J.F. Brandley

“Financial management is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations.”- Massie

Objective of Financial Management

The objectives of financial management are given below:

1. Profit maximization

Main aim of any kind of economic activity is earning profit. A business concern is also functioning mainly for the purpose of earning profit. Profit is the measuring techniques to understand the business efficiency of the concern.

The finance manager tries to earn maximum profits for the company in the short-term and the long-term. He cannot guarantee profits in the long term because of business uncertainties. However, a company can earn maximum profits even in the long-term, if:

• The Finance manager takes proper financial decisions
• He uses the finance of the company properly

2. Wealth maximization

Wealth maximization (shareholders’ value maximization) is also a main objective of financial management. Wealth maximization means to earn maximum wealth for the shareholders. So, the finance manager tries to give a maximum dividend to the shareholders. He also tries to increase the market value of the shares. The market value of the shares is directly related to the performance of the company. Better the performance, higher is the market value of shares and vice-versa. So, the finance manager must try to maximize shareholder’s value

3. Proper estimation of total financial requirements

Proper estimation of total financial requirements is a very important objective of financial management. The finance manager must estimate the total financial requirements of the company. He must find out how much finance is required to start and run the company. He must find out the fixed capital and working capital requirements of the company. His estimation must be correct. If not, there will be shortage or surplus of finance. Estimating the financial requirements is a very difficult job. The finance manager must consider many factors, such as the type of technology used by company, number of employees employed, scale of operations, legal requirements, etc.

4. Proper mobilization

Mobilization (collection) of finance is an important objective of financial management. After estimating the financial requirements, the finance manager must decide about the sources of finance. He can collect finance from many sources such as shares, debentures, bank loans, etc. There must be a proper balance between owned finance and borrowed finance. The company must borrow money at a low rate of interest.

5. Proper utilization of finance

Proper utilization of finance is an important objective of financial management. The finance manager must make optimum utilization of finance. He must use the finance profitable. He must not waste the finance of the company. He must not invest the company’s finance in unprofitable projects. He must not block the company’s finance in inventories. He must have a short credit period.

6. Maintaining proper cash flow

Maintaining proper cash flow is a short-term objective of financial management. The company must have a proper cash flow to pay the day-to-day expenses such as purchase of raw materials, payment of wages and salaries, rent, electricity bills, etc. If the company has a good cash flow, it can take advantage of many opportunities such as getting cash discounts on purchases, large-scale purchasing, giving credit to customers, etc. A healthy cash flow improves the chances of survival and success of the company.

7. Survival of company

Survival is the most important objective of financial management. The company must survive in this competitive business world. The finance manager must be very careful while making financial decisions. One wrong decision can make the company sick, and it will close down.

8. Creating reserves

One of the objectives of financial management is to create reserves. The company must not distribute the full profit as a dividend to the shareholders. It must keep a part of it profit as reserves. Reserves can be used for future growth and expansion. It can also be used to face contingencies in the future.

9. Proper coordination

Financial management must try to have proper coordination between the finance department and other departments of the company.

10. Create goodwill

Financial management must try to create goodwill for the company. It must improve the image and reputation of the company. Goodwill helps the company to survive in the short-term and succeed in the long-term. It also helps the company during bad times.

11. Increase efficiency

Financial management also tries to increase the efficiency of all the departments of the company. Proper distribution of finance to all the departments will increase the efficiency of the entire company.

12. Financial discipline

Financial management also tries to create a financial discipline. Financial discipline means:

• To invest finance only in productive areas. This will bring high returns (profits) to the company.
• To avoid wastage and misuse of finance.

13. Reduce cost of capital

Financial management tries to reduce the cost of capital. That is, it tries to borrow money at a low rate of interest. The finance manager must plan the capital structure in such a way that the cost of capital it minimized.

14. Reduce operating risks

Financial management also tries to reduce the operating risks. There are many risks and uncertainties in a business. The finance manager must take steps to reduce these risks. He must avoid high-risk projects. He must also take proper insurance.

15. Prepare capital structure

Financial management also prepares the capital structure. It decides the ratio between owned finance and borrowed finance. It brings a proper balance between the different sources of capital. This balance is necessary for liquidity, economy, flexibility and stability.

1. Investment Decision

The investment decision involves the evaluation of risk, measurement of cost of capital and estimation of expected benefits from a project. Capital budgeting and liquidity are the two major components of investment decision. Capital budgeting is concerned with the allocation of capital and commitment of funds in permanent assets which would yield earnings in future.

Capital budgeting also involves decisions with respect to replacement and renovation of old assets. The finance manager must maintain an appropriate balance between fixed and current assets in order to maximise profitability and to maintain desired liquidity in the firm.

Capital budgeting is a very important decision as it affects the long-term success and growth of a firm. At the same time it is a very difficult decision because it involves the estimation of costs and benefits which are uncertain and unknown.

2. Financing Decision

While the investment decision involves decision with respect to composition or mix of assets, financing decision is concerned with the financing mix or financial structure of the firm. The raising of funds requires decisions regarding the methods and sources of finance, relative proportion and choice between alternative sources, time of floatation of securities, etc. In order to meet its investment needs, a firm can raise funds from various sources.

The finance manager must develop the best finance mix or optimum capital structure for the enterprise so as to maximize the long- term market price of the company’s shares. A proper balance between debt and equity is required so that the return to equity shareholders is high and their risk is low.

Use of debt or financial leverage effects both the return and risk to the equity shareholders. The market value per share is maximized when risk and return are properly matched. The finance department has also to decide the appropriate time to raise the funds and the method of issuing securities.

3. Dividend Decision

In order to achieve the wealth maximization objective, an appropriate dividend policy must be developed. One aspect of dividend policy is to decide whether to distribute all the profits in the form of dividends or to distribute a part of the profits and retain the balance. While deciding the optimum dividend payout ratio (proportion of net profits to be paid out to shareholders).

The finance manager should consider the investment opportunities available to the firm, plans for expansion and growth, etc. Decisions must also be made with respect to dividend stability, form of dividends, i.e., cash dividends or stock dividends, etc.

4. Working Capital Decision

Working capital decision is related to the investment in current assets and current liabilities. Current assets include cash, receivables, inventory, short-term securities, etc. Current liabilities consist of creditors, bills payable, outstanding expenses, bank overdraft, etc. Current assets are those assets which are convertible into cash within a year. Similarly, current liabilities are those liabilities, which are likely to mature for payment within an accounting year.

5. Preparation of Annual Financial Statements

This is the sixth scope of financial management and it means, financial statements includes Profit & Loss A/C and Balance Sheet. These two main aspects are shows the financial reputation or condition of the company during a working period usually a financial year. It shows the income and expenditure of the company also.

Financial Statements are designed by always keeps finance manager and its started from 1st April to 31st March (1 Year).

6. Estimation of Financial Performance

This is the seventh scope of financial management and it means an annually and time-to-time evaluation of performance is the very crucial task for financial management and financial manager. For doing the evaluation, there are various turnover variables like ratio analysis, trend analysis, net profit, cost per unit, and Return on Investment plays a very crucial role to judge the performance of a firm of past and current years.

7. Evaluating the Impact of New Financing

This is the eighth scope of financial management and it means, nature of modern management is becoming future-oriented and follow the objectivity. In this case, time-to-time growth and development are very important for doing a specific business because it helps the business to build a huge empire.

Now it’s the turn of finance, in this function finance plays an essential role to make a successful business for the purpose of development and growth.

8. Miscellaneous Functions

This is the ninth scope of financial management and it means, the finance area is a very broad concept and it includes a bulk amount of scope or functions for determining the financial management. The number of functions includes tax-planning, management of the provident fund, gratuity, safety of securities, social insurance funds and so on.

1. Determining Financial Needs

A finance manager is supposed to meet financial needs of the enterprise. For this purpose, he should determine financial needs of the concern. Funds are needed to meet promotional expenses, fixed and working capital needs. The requirement of fixed assets is related to the type of industry. A manufacturing concern will require more investments in fixed assets than a trading concern. The working capital needs depend upon the scale of operations, larger the scale of operations, the higher will be the needs for working capital. A wrong assessment of financial needs may jeopardies the survival of a concern.

2. Selecting the Sources of Funds

A number of sources may be available for raising funds. A concern may resort to issue of share capital and debentures. Financial institutions may be requested to provide long-term funds. The working capital needs may be met by getting cash credit or overdraft facilities from commercial banks. A finance manager has to be very careful and cautious in approaching different sources. The terms and conditions of banks may not be favourable to the concern. A small concern may find difficulties in raising funds for want of adequate securities or due to its reputation. The selection of a suitable source of funds will influence the profitability of the concern. This selection should be made with great caution.

3. Financial Analysis and Interpretation

The analysis and interpretation of financial statements is an important task of a finance manager. He is expected to know about the profitability, liquidity position, short-term and long-term financial position of the concern. For this purpose, a number of ratios have to be calculated. The interpretation of various ratios is also essential to reach certain conclusions. Financial analysis and interpretation has become an important area of financial management.

4. Cost-Volume-Profit Analysis

Cost-volume-profit analysis is an important tool of profit planning. It answers questions like, what is the behaviour of cost and volume? At what point of production a firm will be able to recover its costs? How much a firm should produce to earn a desired profit? To understand cost-volume-profit relationship, one should know the behaviour of costs. The costs may be subdivided as: fixed costs, variable costs and semi-variable costs. Fixed costs remain constant irrespective of changes in production.

An increase or decrease in volume of production will not influence fixed costs. Variable costs, on the other hand, vary in direct proportion to change in production. Semi-variable costs remain constant for a period and then become variable for a short period. These costs change with the change in output but not in the same proportion.

The first concern of a finance manager will be to recover all costs. He will aspire to achieve break-even point at the earliest. It is a point of no-profit no-loss. Any production beyond break-even point will bring profits to the concern. The volume of sales, to earn a desired profit, can also be ascertained. This analysis is very helpful in deciding the volume of output or sales. The knowledge of cost-volume profit analysis is essential for taking important decisions about production and profits.

5. Capital Budgeting

Capital budgeting is the process of making investment decisions in capital expenditures. It is an expenditure the benefits of which are expected to be received over a period of time exceeding one year. It is an expenditure incurred for acquiring or improving the fixed assets, the benefits of which are expected to be received over a number of years in future. Capital budgeting decisions are vital to any organization. An unsound investment decision may prove to be fatal for the very existence of the concern.

The crux of capital budgeting is the allocation of available resources to various proposals. The crucial factor which influences the capital budgeting decision is the profitability of the prospective investment. For making correct capital budgeting decisions, the knowledge of its techniques is essential. A number of methods like payback period method, rate of return method, net present value method, internal rate of return method and profitability index method may be used for making capital budgeting decisions.

6. Working Capital Management

Working capital is the life blood and nerve centre of a business. Just as circulation of blood is essential in the human body for maintaining life, working capital is essential to maintain the smooth running of business. No business can run successfully without an adequate amount of working capital. Working capital refers to that part of the firm’s capital which is required for financing short-term or current assets such as cash, receivables and inventories. It is essential to maintain a proper level of these assets. Finance manager is required to determine the quantum of such assets. Cash is required to meet day-to-day needs and purchase inventories etc.

The scarcity of cash may adversely affect the reputation of a concern. The receivables management is related to the volume of production and sales. For increasing sales, there may be a need to give more credit facilities. Though sales may go up but the risk of bad debts and cost involved in it may have to be weighed against the benefits. Inventory control is also an important factor in working capital management. The inadequacy of inventory may cause delays or stoppages of work. Excess inventory, on the other hand, may result in blocking of money in stocks, more costs in stock maintaining etc. Proper management of working capital is an important area of financial management.

7. Profit Planning and Control

Profit planning and control is an important responsibility of the financial manager. Profit maximization is, generally, considered to be an important objective of a business. Profit is also used as a tool for evaluating the performance of management. Profit is determined by the volume of revenue and expenditure. Revenue may accrue from sales, investments in outside securities or income from other sources. The expenditures may include manufacturing costs, trading expenses, office and administrative expenses, selling and distribution expenses and financial costs.

The excess of revenue over expenditure determines the amount of profit. Profit planning and control directly influence the declaration of dividend creation of surpluses, taxation etc. Break even analysis and cost-volume profit relationship are some of the tools used in profit planning and control.

8. Dividend Policy

Dividend is the reward of the shareholders for investments made by them in the shares of the company. The investors are interested in earning the maximum return on their investments whereas management wants to retain profits for further financing. These contradictory aims will have to be reconciled and in the interests of shareholders and the company. The company should distribute a reasonable amount as dividends to its members and retain the rest for its growth and survival.

A dividend policy is influenced by number of factors such as magnitude and trend of earnings, desire and type of shareholders, future requirements of the company, government’s economic policy, taxation policy, etc. Dividend policy is an important area of financial management because the interests of the shareholders and the needs of the company are directly related to it.

The Financing Decision is yet another crucial decision made by the financial manager relating to the financing-mix of an organization. It is concerned with the borrowing and allocation of funds required for the investment decisions.

The financing decision involves two sources from where the funds can be raised: using a company’s own money, such as share capital, retained earnings or borrowing funds from the outside in the form debenture, loan, bond, etc. The objective of financial decision is to maintain an optimum capital structure, i.e. a proper mix of debt and equity, to ensure the trade-off between the risk and return to the shareholders.

The Debt-Equity Ratio helps in determining the effectiveness of the financing decision made by the company. While taking the financial decisions, the finance manager has to take the following points into consideration:

• The Risk involved in raising the funds. The risk is higher in the case of debt as compared to the equity.
• The Cost involved in raising the funds. The manager chose the source with minimum cost.
• The Level of Control, the shareholders, want in the organization also determines the composition of capital structure. They usually prefer the borrowed funds since it does not dilute the ownership.
• The Cash Flow from the operations of the business also determines the source from where the funds shall be raised. High cash flow enables to borrow debt as interest can be easily paid.
• The Floatation Cost such as broker’s commission, underwriters fee, involved in raising the securities also determines the source of fund. Thus, securities with minimum cost must be chosen.

Thus, a company should make a judicious decision regarding from where, when, how the funds shall be raised, since, more use of equity will result in the dilution of ownership and whereas, higher debt results in higher risk, as fixed cost in the form of interest is to be paid on the borrowed funds.

Types of Financial Decisions

1. Investment Decision

A financial decision which is concerned with how the firm’s funds are invested in different assets is known as investment decision. Investment decision can be long-term or short-term.

A long term investment decision is called capital budgeting decisions which involve huge amounts of long term investments and are irreversible except at a huge cost. Short-term investment decisions are called working capital decisions, which affect day to day working of a business. It includes the decisions about the levels of cash, inventory and receivables.

A bad capital budgeting decision normally has the capacity to severely damage the financial fortune of a business.

A bad working capital decision affects the liquidity and profitability of a business.

Factors Affecting Investment Decisions / Capital Budgeting Decisions

(i) Cash flows of the project: The series of cash receipts and payments over the life of an investment proposal should be considered and analyzed for selecting the best proposal.

(ii) Rate of return: The expected returns from each proposal and risk involved in them should be taken into account to select the best proposal.

(iii) Investment criteria involved: The various investment proposals are evaluated on the basis of capital budgeting techniques. Which involve calculation regarding investment amount, interest rate, cash flows, rate of return etc. It is to be considered which technique to use for evaluation of projects.

2. Financing Decision

A financial decision which is concerned with the amount of finance to be raised from various long term sources of funds like, equity shares, preference shares, debentures, bank loans etc. Is called financing decision. In other words, it is a decision on the ‘capital structure’ of the company.

Capital Structure Owner’s Fund + Borrowed Fund

Financial Risk: The risk of default on payment of periodical interest and repayment of capital on ‘borrowed funds’ is called financial risk.

Factors Affecting Financing Decision

(i) Cost: The cost of raising funds from different sources is different. The cost of equity is more than the cost of debts. The cheapest source should be selected prudently.

(ii) Risk: The risk associated with different sources is different. More risk is associated with borrowed funds as compared to owner’s fund as interest is paid on it and it is also repaid after a fixed period of time or on expiry of its tenure.

(iii) Flotation cost: The cost involved in issuing securities such as broker’s commission, underwriter’s fees, expenses on prospectus etc. Is called flotation cost. Higher the flotation cost, less attractive is the source of finance.

(iv) Cash flow position of the business: In case the cash flow position of a company is good enough then it can easily use borrowed funds.

(v) Control considerations: In case the existing shareholders want to retain the complete control of business then finance can be raised through borrowed funds but when they are ready for dilution of control over business, equity shares can be used for raising finance.

(vi) State of capital markets: During boom period, finance can easily be raised by issuing shares but during depression period, raising finance by means of debt is easy.

3. Dividend Decision

A financial decision which is concerned with deciding how much of the profit earned by the company should be distributed among shareholders (dividend) and how much should be retained for the future contingencies (retained earnings) is called dividend decision.

Dividend refers to that part of the profit which is distributed to shareholders. The decision regarding dividend should be taken keeping in view the overall objective of maximizing shareholder s wealth.

Factors affecting Dividend Decision

(i) Earnings: Company having high and stable earning could declare high rate of dividends as dividends are paid out of current and past earnings.

(ii) Stability of dividends: Companies generally follow the policy of stable dividend. The dividend per share is not altered in case earning changes by small proportion or increase in earnings is temporary in nature.

(iii) Growth prospects: In case there are growth prospects for the company in the near future then, it will retain its earnings and thus, no or less dividend will be declared.

(iv) Cash flow positions: Dividends involve an outflow of cash and thus, availability of adequate cash is foremost requirement for declaration of dividends.

(v) Preference of shareholders: While deciding about dividend the preference of shareholders is also taken into account. In case shareholders desire for dividend then company may go for declaring the same. In such case the amount of dividend depends upon the degree of expectations of shareholders.

(vi) Taxation policy: A company is required to pay tax on dividend declared by it. If tax on dividend is higher, company will prefer to pay less by way of dividends whereas if tax rates are lower, then more dividends can be declared by the company.

A chief financial officer (CFO) is the senior executive responsible for managing the financial actions of a company. The CFO’s duties include tracking cash flow and financial planning as well as analyzing the company’s financial strengths and weaknesses and proposing corrective actions.

The CFO is similar to a treasurer or controller because they are responsible for managing the finance and accounting divisions and for ensuring that the company’s financial reports are accurate and completed in a timely manner. Many have a CMA designation.

The CFO reports to the chief executive officer (CEO) but has significant input in the company’s investments, capital structure and how the company manages its income and expenses. The CFO works with other senior managers and plays a key role in a company’s overall success, especially in the long run.

For example, when the marketing department wants to launch a new campaign, the CFO may help to ensure the campaign is feasible or give input on the funds available for the campaign.

 In the financial industry, a CFO is the highest-ranking financial position within a company.

The CFO may assist the CEO with forecasting, cost-benefit analysis and obtaining funding for various initiatives. In the financial industry, a CFO is the highest-ranking position, and in other industries, it is usually the third-highest position in a company. A CFO can become a CEO, chief operating officer or president of a company.

The Benefits of Being a CFO

The CFO role has emerged from focusing on compliance and quality control to business planning and process changes, and they are a strategic partner to the CEO. The CFO plays a vital role in influencing company strategy.

The United States is an international financial hub and global economic growth increases employment growth in the U.S. financial industry. Companies continue to increase profits leading to a demand for CFOs. The U.S. Bureau of Labor Statistics predicts the job outlook for financial managers to grow 7% between 2014 and 2024.

Role of Chief Financial Officer (CFO)

1. The Strategist CFO

The first role of the CFO is to be a strategist to the CEO. The traditional definition of success for a chief financial officer was reporting the numbers, managing the financial function, and being reactive to events as they unfold. But in today’s fast paced business environment, producing financial reports and information is no longer enough.

CFO’s in the twenty-first century must be able to “peak around corners”. Therefore, they must be able to apply critical thinking skills, along with financial acumen, to the long term goals of the organization.

2. The CFO as a Leader

The second role of the CFO hand in hand with the first one. That is one of a leader implementing the strategies of the company. As a result, it is no longer sufficient for a CFO to sit back and analyze the effort of others. The chief financial officer (CFO) of today must take ownership of the financial results of both the organization and senior management team.

The chief financial officer of today must be responsible for providing leadership to other senior management team members, including the CEO. The CFO’s role can sometimes force them to make the tough calls that others in the organization don’t or can’t make. Occasionally, this can mean the difference between success and failure.

3. The CFO as a Team Leader

The third role of the CFO is that of a team leader to other employees both inside and outside of the financial function. Not only will a coach call plays for a team, but they are also responsible for getting the highest results out of the talent on their team.

An aspiring and successful coach will produce superior results by finding the strengths of their team members and obtaining a higher level of performance than the individuals might achieve on their own. The role of the CFO (Chief Financial Officer) is to bring together a diverse group of talented individuals to achieve superior financial performance.

4. The CFO with Third Parties

Last, but not least, the role of the CFO is that of a diplomat to third parties. People outside of the company look to senior management team for inspiration and confidence in the company’s ability to perform. In almost every case the financial viability of the company is vouched for by the CFO.

The CFO’s role becomes that of the “face” of the company’s sustainability to customers, vendors and bankers. Often these third parties look to the CFO for the unvarnished truth regarding the financial viability of the company to deliver on it’s brand promise.

5. Today’s Role of the CFO

In today’s fast paced environment the role of the CFO is extremely fluid. One day the CFO might be developing a compensation plan for employees. Then the next day taking their bankers on a tour of the facilities. Consequently, to be a successful CFO in the future you must be a more multi-functional executive with financial skills.