Financial Management

Theoretical Questions

Unit – 1 Introductions.

Q. Define Financial Management. Explain its objectives and its functions.

A - 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.

The Skopes/elements of the financial management are as follows.

1. Investment decisions includes investment in fixed assets (called as capital budgeting).

Investment in current assets are also a part of investment decisions called as working capital
decisions.

2. Financial decisions - They relate to the raising of finance from various resources which will depend
upon decision on type of source, period of financing,

cost of financing and the returns thereby.

3. Dividend decision - The finance manager has to take decision with regards to the net profit
distribution. Net profits are generally divided into two:

a. Dividend for shareholders- Dividend and the rate of it has to be decided.

b. Retained profits- Amount of retained profits has to be finalized which will depend upon expansion
and diversification plans of the enterprise.

The financial management is generally concerned with procurement, allocation and control of
financial resources of a concern. The objectives can be-

1. To ensure regular and adequate supply of funds to the concern.

2. To ensure adequate returns to the shareholders which will depend upon the earning capacity, market
price of the share, expectations of the shareholders.

3. To ensure optimum funds utilization. Once the funds are procured, they should be utilized in
maximum possible way at least cost.

4. To ensure safety on investment, i.e, funds should be invested in safe ventures so that adequate rate
of return can be achieved.
5. 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.

The important functions of financial management that should be followed by the financial
manager are as follows.

1. 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.

2. 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.

3. Choice of sources of funds: For additional funds to be procured, a company has many choices like-

a. Issue of shares and debentures

b. Loans to be taken from banks and financial institutions

c. Public deposits to be drawn like in form of bonds.

Choice of factor will depend on relative merits and demerits of each source and period of financing.

4. 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.

5. Disposal of surplus: The net profits decision have to be made by the finance manager. This can be
done in two ways:

a. Dividend declaration - It includes identifying the rate of dividends and other benefits like bonus.

b. Retained profits - The volume has to be decided which will depend upon expansional, innovational,
diversification plans of the company.

6. 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.

7. 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.

Q. What are the main objectives of the firm? Differentiate between Profit Maximization
& Wealth Maximization.

A- The firm has mainly two objectives that is maximizing their profits and their wealth. The meaning of
these two objectives are as follows.

Profit Maximization is the capability of the firm in producing maximum output with the limited
input, or it uses minimum input for producing stated output. It is termed as the foremost objective of
the company. It has been traditionally recommended that the apparent motive of any business
organisation is to earn a profit, it is essential for the success, survival, and growth of the company.

Profit is a long term objective, but it has a short-term perspective i.e. one financial year. Profit can be
calculated by deducting total cost from total revenue. Through profit maximization, a firm can be able to
ascertain the input-output levels, which gives the highest amount of profit. Therefore, the finance
officer of an organisation should take his decision in the direction of maximizing profit although it is not
the only objective of the company.

Wealth maximization is the ability of a company to increase the market value of its common
stock over time. The market value of the firm is based on many factors like their goodwill, sales, services,
quality of products, etc. It is the versatile goal of the company and highly recommended criterion for
evaluating the performance of a business organisation. This will help the firm to increase their share in
the market, attain leadership, maintain consumer satisfaction and many other benefits are also there.

It has been universally accepted that the fundamental goal of the business enterprise is to increase the
wealth of its shareholders, as they are the owners of the undertaking, and they buy the shares of the
company with the expectation that it will give some return after a period. This states that the financial
decisions of the firm should be taken in such a manner that will increase the Net Present Worth of the
company’s profit. The value is based on two factors:

1. Rate of Earning per share.

2. Capitalization Rate.

The main differences between these two objectives of the firm are as follows.

Basis Profit Maximization Wealth Maximization

1. Concept The ultimate goal of the concern The ultimate goal of the concern
is to improve the market value of is to improve the market value of
its shares.  its shares. 
2. Emphasizes on Achieving short term objectives. Achieving long term objectives. 
3. Consideration of Risks There is no risk and uncertainty. There is high risk and
and Uncertainty uncertainty.
4. Advantage Acts as a yardstick for computing Gaining a large market share. 
the operational efficiency of the
 entity.
5. Recognition of Time Pattern of The time patern of returns Time patern of return may be
Returns cannot be recognized. recognized.

The fundamental differences between profit maximization and wealth maximization is explained in
points below:

1. The process through which the company is capable of increasing earning capacity known as Profit
Maximization. On the other hand, the ability of the company in increasing the value of its stock in the
market is known as wealth maximization.

2. Profit maximization is a short term objective of the firm while the long-term objective is Wealth
Maximization.

3. Profit Maximization ignores risk and uncertainty. Unlike Wealth Maximization, which considers both.

4. Profit Maximization avoids time value of money, but Wealth Maximization recognises it.

5. Profit Maximization is necessary for the survival and growth of the enterprise. Conversely, Wealth
Maximization accelerates the growth rate of the enterprise and aims at attaining the maximum market
share of the economy.

Q. What are the main roles that are played by the Cheaf Financial Officer’s(CFO’S)?

A- Financial activities of a firm is one of the most important and complex activities of a firm. Therefore in
order to take care of these activities a financial officer performs all the requisite financial activities.

A financial officer is a person who takes care of all the important financial functions of an organization.
The person in charge should maintain a far sightedness

in order to ensure that the funds are utilized in the most efficient manner. His actions directly affect the
Profitability, growth and goodwill of the firm.

Following are the main functions of a Financial Manager:

1. Raising of Funds: In order to meet the obligation of the business it is important to have enough cash
and liquidity. A firm can raise funds by the way of equity and debt. It is the responsibility of a financial
officer to decide the ratio between debt and equity. It is important to maintain a good balance between
equity and debt.

2. Allocation of Funds: Once the funds are raised through different channels the next important function
is to allocate the funds. The funds should be allocated in such a manner that they are optimally used. In
order to allocate funds in the best possible manner the following point must be considered

■ The size of the firm and its growth capability

■ Status of assets whether they are long-term or short-term

■ Mode by which the funds are raised

financial decisions directly and indirectly influence other managerial activities. Hence formation of a
good asset mix and proper allocation of funds is one of the most important activity

3. Profit Planning: Profit earning is one of the prime functions of any business organization. Profit
earning is important for survival and sustenance of any organization. Profit planning refers to proper
usage of the profit generated by the firm. Profit arises due to many factors such as pricing, industry
competition, state of the economy, mechanism of demand and supply, cost and output. A healthy mix of
variable and fixed factors of production can lead to an increase in the profitability of the firm. Fixed
costs are incurred by the use of fixed factors of production such as land and machinery. In order to
maintain a tandem it is important to continuously value the depreciation cost of fixed cost of
production. An opportunity cost must be calculated in order to replace those factors of production
which has gone thrown wear and tear. If this is not noted then these fixed cost can cause huge
fluctuations in profit.

4. Understanding Capital Markets: Shares of a company are traded on stock exchange and there is a
continuous sale and purchase of securities. Hence a clear understanding of capital market is an
important function of a financial manager. When securities are traded on stock market there involves a
huge amount of risk involved. Therefore a financial officer’s understands and calculates the risk
involved in this trading of shares and debentures. Its on the discretion of a financial officer’s as to how
to distribute the profits. Many investors do not like the firm to distribute the profits amongst share
holders as dividend instead invest in the business itself to enhance growth. The practices of a financial
officer’s directly impact the operation in capital market.