Notes for 101

Financial Management: Meaning, Scope, Objectives & Functions

Meaning of Financial Management

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.

Scope/Elements of Financial Management

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.

1. 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.
2. 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.

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-

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.

1. To ensure optimum funds utilization. Once the funds are procured, they
should be utilized in maximum possible way at least cost.
2. To ensure safety on investment, i.e, funds should be invested in safe ventures
so that adequate rate of return can be achieved.
3. 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

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.

1. 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.

2. 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.
3. 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.
4. 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.

5. Financial controls: The finance manager has not only to plan, procure and
utilize the funds but he also has to exercise control over finances.
Objectives of Financial Management

1. Assessing Capital Needs

Financial professionals' duties entail them to get a measure of certain attributes.

These attributes include the cost of current fixed assets, the cost of promotions,
the requirement, and measure of buffer capital, long-term expenses, and human
resource operations. As a result, organizations that constantly develop in the
financial domain have predefined their short-term and long-term finances and
conduct their business according to these estimates.

2. Capital Structure

Suppose a company has a solid capital structure. In that case, it means that there
is sustainable groundwork for financial decision-making, like projections of debt-
equity ratio in the short-term and long-term.

3. Business Survival

According to the exceptionally renowned scientist Charles Darwin, the phrase

'survival of the fittest' warrants adapting to one's surroundings to persist through
life. The same goes for business decisions. A company endures and abides by
market conditions with the help of secure financial management.
4. Balanced Structure

Maintaining a balance is crucial to keep running smoothly under any

circumstances. When pertaining to business, the role of financial executives is to
ensure this structure by fabricating a plausible capital strategy. This is possible
after considering all capital sources and assessing the business's liquidity, current
economic conditions, and financial stability.

5. Effective Financial Policies

Apart from making sound financial decisions, it is also essential for the funds'
manager to create profitable financial policies that administer cash flow and
lending and borrowing procedures.

6. Resource Optimization

The best financial management executives have the skill and efficiency to use all
obtainable financial resources and maximize their ratio. This results in little
expense and an exponential rise in cash flow to produce a greater return on
investment.

7. Profit Maximization

Profit maximization is probably one of financial management's most important and

tricky attributes. The company has to frame means to generate profits in the short-
term and long-term. As a result, a financial manager has to focus more on profit
optimization and ensure that all business operations' actions are sustainable and
correct.

8. Proper Mobilization

Mobilizing profits is as critical as maximizing them. One does not simply spend all
their earnings without creating separate criteria for savings. In a business, the
financial management department has to assess and project the allocation and
application of available funds. This is achieved through investment in shares, new
products, or acquiring a portion of small companies. However, there are various
factors to evaluate before coming to these decisions.
9. High Efficiency

The meaning and definition of financial management entail the creation of a stable
work relationship with other company departments. It tries to improve performance
by appropriate allocation of funds to different departments. This distribution is
carried out considering the resources and effort required to amplify the company's
efficiency.

10. Reduce Risks

Along with maintaining the performance, it is also necessary to minimize the risks.
Risks often present themselves in unforeseen circumstances or unexpected
market conditions. Financial managers need to have a foolproof plan against such
situations. In addition, they must calculate potentially risky situations beforehand
with the help of professionals and try to steer clear of those.

What Is Capital Budgeting?

 Capital budgeting is used by companies to evaluate major projects and

investments, such as new plants or equipment.
 The process involves analyzing a project's cash inflows and outflows to
determine whether the expected return meets a set benchmark.
 The major methods of capital budgeting include discounted cash flow,
payback analysis, and throughput analysis.

Capital Budgeting Process

The process of capital budgeting is as follows:

Identifying investment opportunities

An organization needs to first identify an investment opportunity. An investment

opportunity can be anything from a new business line to product expansion to

purchasing a new asset. For example, a company finds two new products that they

can add to their product line.

Evaluating investment proposals

Once an investment opportunity has been recognized an organization needs to

evaluate its options for investment. That is to say, once it is decided that new

product/products should be added to the product line, the next step would be

deciding on how to acquire these products. There might be multiple ways of

acquiring them. Some of these products could be:

 Manufactured In-house

 Manufactured by Outsourcing manufacturing the process, or

 Purchased from the market

Choosing a profitable investment

Once the investment opportunities are identified and all proposals are evaluated an

organization needs to decide the most profitable investment and select it. While

selecting a particular project an organization may have to use the technique of

capital rationing to rank the projects as per returns and select the best option

available. In our example, the company here has to decide what is more profitable

for them. Manufacturing or purchasing one or both of the products or scrapping the
idea of acquiring both.
Capital Budgeting and Apportionment

After the project is selected an organization needs to fund this project. To fund the

project it needs to identify the sources of funds and allocate it accordingly. The

sources of these funds could be reserves, investments, loans or any other available

channel.

Performance Review

The last step in the process of capital budgeting is reviewing the investment. Initially,

the organization had selected a particular investment for a predicted return. So now,

they will compare the investments expected performance to the actual

performance.

In our example, when the screening for the most profitable investment happened, an

expected return would have been worked out. Once the investment is made, the

products are released in the market, the profits earned from its sales should be

compared to the set expected returns. This will help in the performance review.

Unit – 2
What Is Working Capital?
Working capital, also known as net working capital (NWC), is the difference
between a company’s current assets—such as cash, accounts
receivable/customers’ unpaid bills, and inventories of raw materials and finished
goods—and its current liabilities, such as accounts payable and debts. It's a
commonly used measurement to gauge the short-term health of an organization.

Working Capital = Current Assets - Current Liabilities

Components of Working Capital

Current Assets

 Cash and Cash Equivalents: All of the money the company has on hand. This
includes foreign currency and certain types of investments such as money market
accounts with very low risk and very low investment term periods.
 Inventory: All of the unsold goods being stored. This includes raw materials
purchased to manufacture, partially assembled inventory that is in process, and
finished goods that have not yet been sold.
 Accounts Receivable: All of the claims to cash for inventory items sold on credit.
This should be included net of any allowance for doubtful payments.
 Notes Receivable: All of the claims to cash for other agreements, often agreed to
through a physically signed agreement.
 Prepaid Expenses: All of the value for expenses paid in advance. Though it may be
difficult to liquidate these in the event of needing cash, they still carry short-term
value and are included.
 Others: Any other short-term asset. An example is some companies may recognize
a short-term deferred tax asset that reduces a future liability.

Current Liabilities
Current liabilities are simply all debts a company owes or will owe within the next twelve
months. The overarching goal of working capital is to understand whether a company will
be able to cover all of these debts with the short-term assets it already has on hand.

 Accounts Payable: All unpaid invoices to vendors for supplies, raw materials,
utilities, property taxes, rent, or any other operating expense owed to an outside
third party. Credit terms on invoices are often net 30 days, so essentially all invoices
are captured here.
 Wages Payable: All unpaid accrued salary and wages for staff members.
Depending on the timing of the company's payroll, this may only accrue up to one
month's worth of wages (if the company only issues one paycheck per month).
Otherwise, these liabilities are very short-term in nature.
 Current Portion of Long-Term Debt: All short-term payments related to long-term
debt. Imagine a company finances its warehouse and owes monthly debt payments
on the 10-year debt. The next 12 months of payments are considered short-term
debt, while the remaining 9 years of payments are long-term debt. Only 12 months
are included when calculating working capital.
 Accrued Tax Payable: All obligations to government bodies. These may be
accruals for tax obligations for filings not due for months; however, these accruals
are usually always short-term (due within the next 12 months) in nature.
 Dividend Payable: All authorized payments to shareholders. A company may
decide to decline future dividend payments but must fulfill obligations on already
authorized dividends.
 Unearned Revenue: All capital received in advance of having completed work.
Should the company fail to complete the job, it may be forced to return capital back
to the client.
Types of Working Capital
Permanent Working Capital
It is that portion of the working capital that remains permanently tied up in current assets to
undertake business activity uninterruptedly. In other words, permanent working capital is the
least amount of current assets needed to carry out business effortlessly. Thus, it is also
known as fixed working capital
Regular Working Capital
This is defined as the least amount of capital required by a business to fund its day-to-day
operations of a business. Examples include payment of salaries and wages and overhead
expenses for the processing of raw materials.
Reserve Margin Working Capital
Apart from day-to-day activities, a business may need some amount of capital for
unforeseen circumstances. Reserve Margin Working Capital is nothing but the amount of
capital kept aside apart from the regular working capital. These pool of funds are kept
separately for unforeseen circumstances such as strikes, natural calamities, etc

Gross Working Capital

This refers to the aggregate amount of funds invested in the current assets of the business.
In other words, Gross Working Capital is the total of the current assets of the business.
These include:

 Cash
 Accounts Receivable
 Inventory
 Marketable Securities and
 Short-Term Investments

Gross Working Capital used alone neither shows the complete picture of the short-term
financial soundness. Nor does it showcase the operational efficiency of the business.
Current assets should be compared with the current liabilities to get a better understanding
of a business’s operational efficiency. That is, how efficiently a business utilizes its short
term assets to meet its day-to-day cash requirements.
Net Working Capital
Net Working Capital is the amount by which current assets exceed the current liabilities of a
business. Thus, the working capital equation is defined as the difference between current
assets and current liabilities. Where current assets refer to the sum of cash, accounts
receivable, raw material and finished goods inventory. Whereas, current liabilities include
accounts payable.

The amount of working capital in a business is the indicator of liquidity, operational efficiency
and short-term financial soundness of the business. Businesses having adequate working
capital typically have the ability to invest and grow.

On the other hand, businesses having insufficient working capital have higher odds of going
bankrupt. This is because of their inability to pay for their short-term obligations, thus making
it difficult for them to grow.

Factors affecting W.C

Size of Business

Larger businesses usually require more working capital due to their expansive operations,

diverse product lines, and vast customer base. Such entities might need significant funds on

hand to manage their extensive transactions.

Nature of the Business

A manufacturing enterprise might have different working capital needs than a service-based

business. The former often requires funds for inventory, while the latter might need more for

payroll.
Scale of Operations

Companies operating globally typically have more intricate financial needs, warranting higher

working capital. Diverse markets, varied currencies, and differing regulations come into play.
Sales Growth

Rapid sales growth, while positive, can strain resources. As sales volume increases, more

working capital is needed to support production, delivery, and potentially longer receivables

cycles.
Credit Policy

A lenient credit policy might attract more customers, but it can tie up funds in receivables.

The longer the credit terms, the higher the working capital needed to bridge the gap until

payment is received.
Business Cycles

During boom periods, businesses may need more working capital to cater to increased

demand. Conversely, during downturns, they might have excess capital due to reduced

sales.
Government Regulations

Stringent regulations can lead to increased working capital needs. For instance, specific

industries might be required to maintain certain inventory levels, pushing up working capital

requirements.
Creditworthiness

A company with a good credit history can easily obtain short-term credit, reducing the need

for high working capital. Conversely, firms with poorer credit might need to maintain higher

reserves.
Some businesses, especially those in sectors like agriculture or tourism, experience

seasonal sales. They might need more working capital during peak seasons to meet

heightened demand.

Understanding these factors influencing working capital allows businesses to plan better,

ensuring they maintain optimal working capital levels for seamless operations.

What is working capital management?

Working capital management is a business process that helps companies make effective
use of their current assets and optimize cash flow. It’s oriented around ensuring short-term
financial obligations and expenses can be met, while also contributing towards longer-term
business objectives. The goal of working capital management is to maximize operational
efficiency.

Nature of Working Capital:

i. It is used for purchase of raw materials, payment of wages and expenses.

ii. It changes form constantly to keep the wheels of business moving.

iii. Working capital enhances liquidity, solvency, creditworthiness and reputation of the

enterprise.

iv. It generates the elements of cost namely: Materials, wages and expenses.

v. It enables the enterprise to avail the cash discount facilities offered by its suppliers.

vi. It helps improve the morale of business executives and their efficiency reaches at the

highest climax.

vii. It facilitates expansion programmes of the enterprise and helps in maintaining operational

efficiency of fixed assets.

What Is Inventory Management?

Inventory management refers to the process of ordering, storing, using, and selling a
company's inventory. This includes the management of raw materials, components, and
finished products, as well as warehousing and processing of such items. There are different
types of inventory management, each with its pros and cons, depending on a company’s
needs.
objectives of inventory management
The objectives of inventory management are to provide the desired level of customer

service, to allow cost-efficient operations, and to minimize the inventory investment.