Financial Management Theory

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BY :SUMIT JAIN
EMAIL:vaibhav4u38@rediffmail.com

CHAPTER ONE  
FINANCIAL MANAGEMENT : AN OVERVIEW
 
 
|Question : What do you mean by financial management ? |

 
Answer :
Meaning of Financial Management :
              The primary task of a Chartered Accountant is to deal with funds, 'Management of Funds' is an important aspect of financial management in a business undertaking or any other institution like hospital, art society, and so on. The term 'Financial Management' has been defined differently by different authors.              According to Solomon "Financial Management is concerned with the efficient use of an important economic resource, namely capital funds."  Phillippatus has given a more elaborate definition of the term, as , "Financial Management, is concerned with the managerial decisions that results in the  acquisition and financing of short  and long term credits for the firm."  Thus, it deals with the situations that require selection of specific problem of size and growth of an enterprise. The analysis of these decisions is based on the expected inflows and outflows of funds and their effect on managerial objectives. The most acceptable definition of financial management is that given by S.C.Kuchhal as, "Financial management deals with procurement of funds and their effective utilisation in the business." Thus, there are 2 basic aspects of financial management :  

1) procurement of funds :
            As funds can be obtained from different sources thus, their procurement is always considered as a complex problem by business concerns. These funds procured from different sources have different characteristics in terms of risk, cost and control that a manager must consider while procuring funds.  The funds should be procured at minimum cost, at a balanced risk and control factors.             Funds raised by issue of equity shares are the best from risk point of view for the company, as it has no repayment liability except on winding up of the company, but from cost point of view, it is most expensive, as dividend expectations of shareholders are higher than prevailing interest rates and dividends are appropriation of profits and not allowed as expense under the income tax act. The issue of new equity shares may dilute the control of the existing shareholders.             Debentures are comparatively cheaper since the interest is paid out of profits before tax. But, they entail a high degree of risk since they have to be repaid as per the terms of agreement; also, the interest payment has to be made whether or not the company makes profits.             Funds can also be procured from banks and financial institutions, they provide funds subject to certain restrictive covenants. These covenants restrict freedom of the borrower to raise loans from other sources. The reform process is also moving in direction of a closer monitoring of 'end use' of resources mobilised through capital markets. Such restrictions are essential for the safety of funds provided by institutions and investors. There are other financial instruments used for raising finance  e.g. commercial paper, deep discount bonds, etc. The finance manager has to balance the availability of funds and the restrictive provisions tied with such funds resulting in lack of flexibility.             In the globalised competitive scenario, it is not enough to depend on available ways of finance but resource mobilisation is to be undertaken through innovative ways or financial products that may meet the needs of investors. Multiple option convertible bonds can be sighted as an example, funds can be raised indigenously as also from abroad. Foreign Direct Investment (FDI) and Foreign Institutional Investors (FII) are two major sources of finance from abroad along with American Depository Receipts (ADR's) and Global...
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