Introduction to Financial Management: Concept of Financial Management, Finance functions, Objectives

Financial Management involves planning, organizing, directing, and controlling financial activities to achieve an organization’s objectives. It focuses on the efficient procurement and utilization of funds while balancing risk and profitability. Key aspects include capital budgeting, determining financial structure, managing working capital, and ensuring liquidity. It aims to maximize shareholder wealth by optimizing resource allocation and minimizing costs. Effective financial management supports decision-making related to investments, financing, and dividends, ensuring sustainable growth. It also involves analyzing financial risks and returns, maintaining financial stability, and complying with legal and regulatory requirements.

Finance functions:

Finance functions refer to the key activities involved in managing an organization’s financial resources efficiently to achieve its objectives. These functions can be broadly categorized into Investment decisions, Financing decisions, and Dividend decisions, along with managing day-to-day financial operations.

1. Investment Decisions

Investment decisions involve determining where to allocate the firm’s resources for long-term and short-term benefits. This function is crucial for wealth maximization and can be divided into two types:

• Capital Budgeting: This focuses on evaluating potential investment opportunities in fixed assets such as machinery, buildings, or new projects. Tools like Net Present Value (NPV), Internal Rate of Return (IRR), and Payback Period are used for analysis.
• Working Capital Management: This deals with managing current assets and liabilities to ensure liquidity and smooth operations. It involves maintaining an optimal balance between inventory, accounts receivable, and cash.

2. Financing Decisions

Financing decisions revolve around determining the best mix of debt, equity, and internal funds to finance the organization’s activities.

• Capital Structure: It involves deciding the proportion of debt and equity in the company’s financial structure to optimize cost and risk.
• Sources of Funds: The finance team must decide whether to raise funds through equity (issuing shares), debt (loans or bonds), or retained earnings. Factors such as cost of capital, risk, and control considerations influence these decisions.

3. Dividend Decisions

Dividend decisions determine the distribution of profits to shareholders.

• Dividend Payout Ratio: The organization must decide what portion of profits to distribute as dividends and what to retain for reinvestment.
• Form of Dividend: Dividends can be in cash, stock, or other forms. A stable dividend policy enhances shareholder confidence.

4. Risk Management

Financial risk management is an integral part of finance functions. It involves identifying, analyzing, and mitigating risks such as credit risk, market risk, and operational risk. Techniques like diversification, hedging, and insurance are employed.

5. Financial Control

This function ensures that the company’s financial activities align with its strategic goals. It involves budget preparation, financial reporting, variance analysis, and adherence to regulatory requirements.

Objective of Financial Management

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.