Financial Management means planning, organizing,
directing and controlling the financial activities such as procurement and
utilization of funds of the enterprise. It means applying general management
principles to financial resources of the enterprise.
Definition
:
“Financial
Management is the operational activity of a business that is responsible for
obtaining and effectively utilizing the funds necessary for efficient
operations”. – Joseph & Massie
Scope/Elements
· Investment
decisions
· Financial
decisions
· Dividend
decision
OBJECTIVES
OF FINANCIAL MANAGEMENT
The
financial management is generally concerned with procurement, allocation and
control of financial resources of a concern. The objectives can be-
v To
ensure regular and adequate supply of funds to the concern.
v To
ensure adequate returns to the shareholders which will depend upon the earning
capacity, market price of the share, expectations of the shareholders.
v To
ensure optimum funds utilization. Once the funds are procured, they should be
utilized in maximum possible way at least cost.
v To
ensure safety on investment, i.e, funds should be invested in safe ventures so
that adequate rate of return can be achieved.
v To
plan a sound capital structure-There should be sound and fair composition of
capital so that a balance is maintained between debt and equity capital.
FUNCTIONS
OF FINANCIAL MANAGEMENT
Ø Estimation
of capital requirements: A finance manager has to make
estimation with regards to capital requirements of the company. This will
depend upon expected costs and profits and future programmes and policies of a
concern. Estimations have to be made in an adequate manner which increases
earning capacity of enterprise.
Ø Determination
of capital composition: Once the estimation have been
made, the capital structure have to be decided. This involves short- term and
long- term debt equity analysis. This will depend upon the proportion of equity
capital a company is possessing and additional funds which have to be raised
from outside parties.
Ø Choice
of sources of funds: For additional funds to be procured, a
company has many choices like-
o
Issue of shares and debentures
o
Loans to be taken from banks and
financial institutions
o
Public deposits to be drawn like in form
of bonds.
Ø Investment
of funds: The finance manager has to decide to allocate funds
into profitable ventures so that there is safety on investment and regular
returns is possible.
Ø Disposal
of surplus: The net profits decision have to be
made by the finance manager. This can be done in two ways:
o
Dividend declaration - It includes
identifying the rate of dividends and other benefits like bonus.
o
Retained profits - The volume has to be
decided which will depend upon expansional, innovational, diversification plans
of the company.
Ø Management
of cash: Finance manager has to make decisions with regards
to cash management. Cash is required for many purposes like payment of wages
and salaries, payment of electricity and water bills, payment to creditors,
meeting current liabilities, maintainance of enough stock, purchase of raw
materials, etc.
Ø Financial
controls: The finance manager has not only to plan, procure
and utilize the funds but he also has to exercise control over finances. This
can be done through many techniques like ratio analysis, financial forecasting,
cost and profit control, etc.
RISK-RETURN RELATIONSHIP
The relationship between risk and
return is a fundamental financial relationship that affects expected rates of
return on every existing asset investment.
The Risk-Return relationship is characterized
as being a "positive" or "direct" relationship meaning that
if there are expectations of higher levels of risk associated with a particular
investment then greater returns are required as compensation for that higher
expected risk. Alternatively, if an
investment has relatively lower levels of expected risk then investors are
satisfied with relatively lower returns.
CONCEPT AND
TYPES OF RISK
·
The variability of the actual return
from the expected return which is associated with the investment /asset known
as risk of the investment.
·
Variability of return means that the
Deviation in between actual return and expected return which is in other words
as variance i.e., the measure of statistics.
·
Greater the variability means that
Riskier the security/ investment.
·
Lesser the variability means that More
certain the returns, nothing but Least risky e.g. Treasury Bills, Savings
Deposit.
The risk can be
further classified into six different categories
v Interest
rate risk
v Inflation
risk
v Financial
risk
v Market
risk
v Business
risk and
v Liquidity risk
Interest
Rate Risk
-
It is risk – variability in a security's
return resulting from the changes in the level of interest rates.
-
Security prices - inverse relationship
with
Market
Risk
It refers to
variability of returns due to fluctuations in the securities market which is
more particularly to equities market due to the effect from the wars,
depressions etc.
Inflation
Risk
-
Rise in inflation leads to Reduction in
the purchasing power which influences only few people to invest due to
-
Interest Rate Risk which is nothing but
the variability of return of the investment due to oscillation of interest
rates due to deflationary and inflationary pressures.
Business
Risk
Risk of doing
business in a particular industry / environment is known as business risk.
Business risk is nothing but Operational risk which arises only due to the
presence of the fixed cost of operations. The Higher the fixed cost of
operations requires the firm to have Greater BEP to avoid the firm to incur
losses. It is normally transferred to the investors who invest in the business
or company, the major reason is that EBIT of the firm is subject to the fixed
cost of operations.
Financial
Risk
Connected with
the raising of fixed charge of funds viz Debt finance & Preference share
capital. More the application of fixed charge of financial will lead to Greater
the financial Risk which is nothing but the Trading on Equity.
Liquidity
Risk
This is the risk
pertaining to the secondary Market, in which the securities can be Bought and
sold quickly and without any concession in the price.