CHAPTER 13: OBJECTIVES AND SCOPE OF FINANCIAL MANAGEMENT

Nature, Purpose and Scope of Financial Management

Financial Management - is an area of financial decision-making, harmonizing individual

motives and enterprise goals. It is mainly concerned with the funds in business. Financial
Management deals with procurement of funds and their effective utilization in the agreement as
an application of general managerial principles in the area of business decision making.

Thus, financial management is the operational activity of a business that is responsible for
obtaining and effectively utilizing the funds necessary is efficient operations.

Finance - the art and science of managing money. It is basically the study of how to make good
decisions that involve money, eg, what assets to buy, how to pay for the assets, or how much
cash should be maintained. Almost everything in finance revolves around the concepts of RISK
and RETURN

Functions of Finance
1. Analysis
2. Decision making

Areas of Finance

1. Corporate (or Business or Managerial) Finance-how a fem should make good financial
decisions
2 Personal Finance - how an individual should make good financial decisions
3. Investments and Portfolio Management-how we should make good decisions involving
financial investments like common stocks, preferred stocks, bonds, etc. It involves the selecting
of these investments and how to combine them into a portfolio that has attractive risk and return
characteristics.
4. Financial Market and Institutions a broad area that overlaps with Macroeconomics. It is
about how the financial markets should be organized and how financial institutions should be
managed in such a way that they provide the most benefit for an economy.
5. Public Finance - it is about taxes, spending balatong the budget and financing public debt

Importance of Financial Management

1. Financial planning
2. Acquisition of funds
3. Proper use of funds Financial management leads to the Improvement of operational efficiency
of the business.
4. Financial decision Financial management helps to make sound financial decision in the
business.
5. Improve profitability Financial management helps to improve the profitability position with
the help of strong financial control devices such as budgetary control, ratio analysis and cost-
volume-prof analysis.
6. Increase the value of the firm - The aim of any business firm is to achieve the maximum profit
and higher profitability leads to maximize the wealth of the investors as well as the nation.
7. Promoting savings - Effective financial management helps to promote and mobilize individual
and corporate savings

Scope of Financial Management

Financial Management covers a wide area with multi-dimensional approaches:

1. Economics financial economics is one of the emerging area which provides immense
opportunity to finance and economical areas
2. Accounting-accounting records includes the financial information of the business.
3. Mathematics modern approaches of the financial management applied large number of
mathematical and statistical toot and techniques. They are also called as econometrics.
4. Production Management it is the operational part of the business which helps to multiply the
money into profit.
5. Marketing-produced goods are sold in the market with innovative and modern approaches.
For this, the marketing department needs finance to meet their requirements
6. Human Resource-financial management is also related to human resource department which
provides manpower to all the functional areas of the management

Inter-relation among financial decisions

All the major functions or decisions are inter-related and Inter-connected. They are inter-related
because the goal of all functions is the same. Their ultimate objective is the achievement of
maximization of the Shareholders wealth or maximizing the market value of the shares. All
decisions are also interconnected or inter-dependent of the shares. superior. All the functions are
important. The importance depends on the situation of the firm.

Nature of Financial Management

It is the relationship with economics and accounting; its functions and its scope. The modern
approach to financial management is to find out how much money is required by the company
and then to source at least that amount. When raising finance, a financial management team
should ensure a balance to owned and borrowed funds. An important decision of financial
management is how much to pay the shareholders and how much is to retain as working capital
for the business

Functional areas of modern financial management

1. Determining financial needs - a finance manager is supposed to meet the financial needs of
the enterprise. For this purpose, he should determine the financial needs of the business.
2. Choosing the sources of funds-several sources may be available for raising funds. A concern
may be resorted to the issue of share capital and debentures. Financial institutions may be
requested to provide long term funds.
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, quidity,
short term and long-term financial position of the business
4 Cost-Volume-Profit Analysis Fixed costs, variable costs and semi-variable costs have to be
analyzed.
5. Working capital management-it refers to that part of the firm's capital which is required for
financing short-term assets such as cash, receivables and inventories. It is essential to maintain
proper level of these assets
6. Dividend policy-it is an important area of financial management because the interest of the
shareholders and the needs of the company are directly related to it
7. Capital budgeting - capital budgeting decisions are vital to my organization. Any unsound
investment decision may prove to be fatal to the very existence of the business

Organization of the Finance Functions. Finance functions can be divided into three major
decisions.
1. Investment decision - it relates to the selection of assets in which funds are invested by the
firm. Assets fall into two categories:
● Long-term assets - will yield a return over a period of time In the future
● Short-term assets - convertible into cash course of business, usually within a year. in the
normal
The asset selection decision of a firm is of two types:

 Capital budgeting - it is the most crucial financial decision of the firm which relates to
the selection of an investment proposal whose benefits are likely to arise in the future
over the life of the project.
 Liquidity - it is concerned with the management of the current assets which is a pre-
requisite to long-term success of any business firm. The main objective of the current
asset's management is the trade-off between profitability and liquidity.

2. Financing decision- decisions as to how to raise the funds to pa for investment in assets. It
determines the best financing mix of the firm. It covers two interrelated aspects:
● Capital structure theory
● Capital structure decision
Financing decisions involve raising optimum finance at minimum cost to meet the objectives of
the firm. It involves:
● Deciding the appropriate mix of short term and long-term financing
● Deciding which individual short term or long-term sources of financing are best at a
given point of time.

3. Dividend decision - decisions as to how much, how frequently and in what form to return
cash to owners. It should be taken in terms of its impact to the shareholders' wealth. The
optimum dividend policy is one that maximizes the market value of the shares.
Objectives of Financial Management.

It may be broadly divided into two parts:

1. PROFIT MAXIMIZATION
● It aims at maximizing the profit of the business. The aim of the business is earning profit.
It shows the entire position of the business. It helps to reduce the risk of the business.
● To achieve the objective of profit maximization, the financial manager takes only those
actions that are expected to contribute to the firm's overall profits.
● Maximizing EPS is often advocated as an improved version of "Profit Maximization",
● Profit maximization consists of certain drawbacks.
○ It ignores the time value of money or the timing of returns
■ The firm can earn a return on funds it receives. Thus, the receipt of funds
sooner rather than later is preferred.
○ It ignores risk.
■ E.g., Two projects may have the same cumulative EPS but if one is riskier
than the other, the market price per share would fall if the risky project is
undertaken.
○ It is vague and it ignores cash flows available to stockholders
■ Higher EPS...
● Does not necessarily mean higher dividends for the stockholders;
● Could have been obtained by cutting down necessary expenditures;
● Could have been obtained by retaining and reinvesting at any
positive rate of return without considering shareholders' required
rate of return
○ Profit manipulation
■ Profit can be manipulated through the creative use of elective accounting
practices.

FAVORABLE ARGUMENTS UNFAVORABLE ARGUMENTS

The main aim is earning profit. Profit maximization leads to exploiting workers
and consumers

Profit is the parameter of the business operation. It creates immoral practices such as corrupt
practice, unfair trade practice, etc.

Profit reduces risk of the business concern. Its objectives lead to inequalities among the
stakeholders such as customers, suppliers,
shareholders, etc. public
 Profit is the main source of finance

Profitability meets the social needs.

2. WEALTH MAXIMIZATION
● One of the modern approaches which involve the latest innovations and improvements in
the business. It is abo known as value maximization or net present wort maximization
● To achieve the objective of shareholders' wean maximization, financial managers should
accept only those actions that are expected to increase shareholders' wealth.

FAVORABLE ARGUMENTS UNFAVORABLE ARGUMENTS

It is superior to the profit maximization It leads to prescriptive idea of the business

because the main aim of the business concern concem, but it may not be suitable to present
under this concept is to improve the value or day business activities.
wealth of the shareholders.

It considers the comparison of the value to It is the indirect name of the profit
cost associated with the business concern. maximization.

It considers both time and risk of the business It creates ownership management controversy
concern

It provides efficient allocation of resources. Management alone enjoys certain benefits.

It ensures the economic Interest of the society. The ultimate aim of the wealth maximization
objectives is to maximize the profit

It can be activated only with the help of the

profitable position of the business

Role of Financial Managers in Investment, Operating and Financing Decisions

The role of financial managers is to act as an intermediary between financial markets and the
firm. To have an overview of the role of a financial manager, refer to the diagram below
 The Finance Manager, being faced with the issue of needing
funds for the investment in fixed assets and current assets
raises funds from Finance Markets thru capital markets and
money markets which in tum obtains funds from the different
sources of finance such as commercial banks, merchant banks,
insurance firms, other firms, etc.

The investment in fixed assets and current assets would of

course result to positive net cash flows which will be used by
the Finance Manager for reinvestments OR for repayment to
the financial markets in the form of principal payments,
interest or dividends.

Financial Management vs. Financial Accounting and Management Accounting

● Financial Management vs. Financial Accounting

Financial management is forward looking and based on cash flows and this differentiates it from
financial accounting, which is historic in nature and focuses on profit rather than cash.

● Financial Management vs. Management Accounting

Financial management is concerned with raising funds and providing a return to investors, and
this differentiates it from management accounting, which is primarily concerned with the
provision of information for management to assist it in making decisions within the company.