Financial Management UNIT-1

Financial Management UNIT-1 Notes (Chapter 1)

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To get completely into the syllabus of this subject Financial Management lovably called as just FM, please come here 👉💌

Unit-1 of financial management has three chapters 

Chapter 1: Introduction to Business Finance Chapter 2: Time value of money & Chapter 3: Investment Decisions





Introduction to Business Finance

Finance is the backbone of any business. Finance is generally the art and science of managing all the monetary resources of a business and it is extremely crucial for the survival of any business enterprise.

Finance helps in the procurement of various resources as well as ensures the smooth flow of business operations.

Basically, "the term finance is considered as the management of money or financial resources of a business enterprise."

Business Finance is also known as finance function or Corporation function.
It deals with assessment, procurement and management of funds.

Nature of Business Finance

  • Includes all category of funds (owners fund or borrowed fund)
  • Required in all type of businesses
  • Dependent on size and nature of operations(complex in MNCs whereas simpler in small businesses)
  • Requirement of finance varies from time to time 
  • It involves estimation
  • It has continuous requirement

Significance of Business Finance

Business Finance is majorly important:
  1. For acquiring fixed assets
  2. For purchasing raw materials or other goods
  3. For hiring labour/workforce
  4. For paying operating expenses
  5. For adopting latest technology
  6. For meeting the contingencies

Objectives of Business Finance

  1. Analysing the financial requirement
  2. Proper utilisation of funds
  3. Increasing Profitability
  4. Maximizing value of firm

Scope of Business Finance

  • Estimating financial requirements
  • Deciding the capital structure
  • Selecting a source of finance
  • Selecting the pattern of investment
  • Cash management
  • Proper uses of surplus
  • Implementing financial control

The board of directors is the ultimate body responsible for managing the finance function. The finance function is majorly managed by the Chief financial offices (CFO) who takes all the important financial decisions of a company.
Functions of CFO as a treasurer
Cash management function
Credit Management function
Financial planning function
Securities flotation function
Functions of CFO as a controller
To maintain and examine the books of account, financial statements, Internal auditing, etc which helps in formulating the best financial strategies.

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Concept of Financial Management

To understand the concept of Financial Management let's understand both of these terms separately.
"Financial" denotes the process of identifying, obtaining and allocating sources of money for any business and on the other hand "Management" is the process of planning, organising, coordinating and controlling various resources for attaining organisational goals.

Thus, "the management concerned with the planning, organising, coordinating and controlling of financial resources is known as financial management."

Approaches to financial management

1. Traditional school of thought/approach

Under this school of thought, the scope of financial management was only limited to the procurement of funds and the finance manager was supposed to provide funds as and when required by the organisation.
Limitations
  • It looked at financial management from the outsider point of view and did not considered financial management as the core function.
  • It only focuses on major Investments and overlooks the regular issues of financial management.
  • Ignores fund allocation.
  • Overlooks working capital financing.

2. Modern school of thought/approach

Model School of approach viewed financial management in a broader sense and derived its 4 major function as investing decision, financing decision, dividend policy decision and liquidity decision.
It caters all the limitations of traditional school of thought for financial management.

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Functions of financial management

1. Investing decision

It is concerned with the identification of assets that require investment. It can be long term assets, short term assets/current assets.
Investment decision can be broadly classified into two main categories:
1. Capital budgeting decisions which determine the long term financial health of a firm.

2. Working capital decisions which are short term in nature and determine the management of current assets to remain profitable and liquidifiable.

2. Financing decision

This function of Financial Management is concerned with determining the financing mix or capital structure of a firm.
Capital structure is sometimes defined as the ratio of debt and equity capital of a firm.

3. Dividend policy decision

This function of Financial Management is concerned with deciding that whether to retain the profit or to distribute the profit among the stakeholders.

4. Liquidity decision

It is closely related to working capital decision. This decision is concerned with proper administration of current assets which assures that a firm is completing its commitment on regular basis.

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Significance of financial management

Financial Management is significant because of its following roles:
  • Finance is itself a controling function
  • It aids to managerial decisions
  • Results in wealth maximization
  • Financial Management is an analytical tool
  • It is administrative in nature
  • Finance function is centralised

Functional areas of financial management

"Finance being the blood of any business, financial management becomes the core of any business."
It works in harmony with the other management departments and functional areas of a business such as Economics, accounting Mathematics, production management, marketing as well as Human Resource Departments.

Financial Management and all the above mentioned functional areas are completely, directly or indirectly dependent on each other for smoothly running a business.

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Objectives of financial management

In a broader sense there are two main objectives of financial management.

1. Profit maximization

Profit maximization is the traditional and narrow approach as it considers that maximization of profit is the sole objective of any business 
Features of profit maximization
  • Related to maximization of earnings per share.
  • Increasing profitability is the foremost concern.
  • Profit is the benchmark of business survival and well-being.
  • Maximization of profit minimises risk and uncertainty.
Limitations of profit maximization
  • Ambiguity
As the term profit is an unlear and confusing concept because there are endless types of profit, for example, profit after tax, profit before tax, short term profit, long term profit, etc.
  • Timing of benefits
Profit maximization does not considers the time value of money (you will read about it in detail in Chapter 2).
  • Quality of benefits
Ignores the qualitative aspect of benefits and returns.
  • Impacts the social welfare
  • Results in increased cut throat competition

2.Wealth maximization

Wealth maximization is also known as value maximization or net present worth maximization.
Wealth maximization is free from all the limitations of profit maximization as it considers timing benefits as well as qualitative aspects of returns.
Wealth maximization is concerned with the holistic development of any business.
Features of wealth maximization
  • Simple to understand
  • Important for investment decisions
  • Considers time value of money and risk factors
  • Eliminates limitation of profit maximization
Limitations
  • Incorrect assumptions
  • Speculations 
"Wealth maximization is superior to profit maximization"
●Due to uncertainty of future, it is not possible to determine the profit in advance, so maximizing unknown profit is not a feasible at all.
●In fact, the definition of profit is vague and there is no clear meaning to it.
●Predictions of future returns is also not possible to be made by the decision-maker & hence, no efforts are made to maximize it.
●The objective of profit maximization is narrowly defined and it does not considers the time value of money.
Whereas
Wealth maximization says that the organisation should make efforts towards "satisfying" in place of "maximizing" and hence, it is superior to profit maximization in these aspects.

Finance manager

"The person solely responsible for carrying out the finance functions of accompany who is a part of top management team and extremely efficient in solving complicated fund management issues is known as finance manager."

The person also acts are the financial advisor to the top management.
Role of a financial manager
Raising funds of a company Finance by estimating short term and long term requirements.
Taking maximum benefits from leverages(financial and operating Assets of a company).
Making International Financial decisions and always updating himself/herself with the latest developments taking place in the international market.
Making sound investment decisions
Efficient risk management
Risks can never be avoided in a business but identification and efficient management of risk is the responsibility of a financial manager.


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To get in depth knowledge of these topics you can also look into it 👉👻



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