Nature of Financial Management

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Chapter 3 - NATURE OF FINANCIAL MANAGEMENT

What is finance

Finance can be defined as he art and science of managing money. Virtually all individuals and organizations earn or raise money and spend or invest money. Finance is concerned with the process, institutions, markets and instruments involved in the transfer of money among individuals, business and governments.

Nature of Financial Management

Financial Management as an academic discipline has undergone fundamental changes as regard its scope and coverage. In the earlier years, it was treated synonymously with the raising of funds. In the later years, its broader scope, included in addition to procurement of funds, efficient use of resources.

Scope of Financial Management

Financial is broadly concerned with the acquisition and use of funds by a business firm. The important tasks of financial management, as related to the above, may be categorized as follows: -

A. Financial Analysis, Planning and Control
• Analysis of financial condition and preference
• Profit Planning
• Financial forecasting
• Financial Control
B. Investing
• Management of current assets (cash, marketable securities, receivables and inventories) • Capital Budgeting (identification, selection and implementation of capital projects) • Managing of mergers, reorganizations and divestments

C. Financing
• Identification of sources of finance and determination of financing mix • Cultivating sources of funds and raising funds
• Allocation of profits between dividends and retained earnings

Important Topics in Financial Management

Table 1.1 Balance Sheet and Topics in Financial Management

Share Capital
EquityCapital Structure and Cost of Capital
Preference

Reserves and Surplus
Debentures

Unsecured Loan
Current Liabilities & ProvisionsWorking Capital
Trade CreditorsFinancing Policy
Provisions

Fixed Assets (Net)Capital Budgeting
Gross Block
Less Depreciation

InvestmentSecurity Analysis

Current Assets, Loans and Advances
Cash and bank balancesCash Management

ReceivablesReceivables Management

InventoriesInventory Policy
Loans and Advances
Miscellaneous Expenditure and Losses

Table 1.2 Income statement and Topics in Financial Management

Net SalesRevenue risk

Cost of goods Sold
Materials and stocks
Wages and Salaries
Other Manufacturing Expenses

Gross ProfitGross profit margin

Operating Expenses
Selling and Administration Expenses
DepreciationDepreciation Policy

Operating Profit

Non operating surplus / deficit

Earnings before interest and taxBusiness risk

InterestFinancial risk

Profit before tax
TaxTax planning

Profit after taxReturn on equity

DividendsDividend policy

Retained Earnings

Goals / Objectives of Financial Management-

Traditional Approach –

It has been traditionally been argued that the objective of a company is to earn profit. This means that the finance manager has to make decision in a manner that the profit is maximised. Each alternative, therefore, is to be seen as to whether or not it gives maximum profit.

Profit maximization objective gives rise to a number of problems as below: -

i) Profit maximization concept should be considered in relation to risks involved. There is a direct relationship between risk and profit. Many risky propositions yield high profit. Higher the risk, higher is the possibility of profits. If profit maximization is the only goal, then risk factor is altogether ignored....
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