Functions of Financial Management

Objectives of Financial Management

It is useful to define the objectives of financial management before venturing to identify its functions. What are the goals that a financial manager should seek? A quick impulse will indicate that profit maximisation is the first goal. Business enterprise aims at earning profit and hence it may be argued that profit maximisation is the directing goal of the enterprise, which in turn is the responsibility of financial management. The finance manager makes available need-based funds at a competitive cost, and oversees its effective deployment. The commercial firm is thereby enabled a smooth and unhindered operations yielding optimum business results. Profit earning is the purpose of the business. Earning profit sustains its continued existence. The destination of financial management centers therefore towards the goal of earning profit or earning maximum profit.

However a blind pursuit of profit maximisation though may providing positive results in the short run, could prove to be counter-productive ultimately. Profit maximisation is vague. Last year the firm might have shown Rs.50 Lacs profit on a turn over of Rs.500 Lacs (Rs.5 Crores). This year the turn over is Rs.10 Crores, and the profit generated is Rs.75 Lacs. Though in absolute terms the profit has increased, the profit as a percentage of sales turnover has diminished from 10% last year to 7.5% this year. Similarly profit earned per product could also have come down. Business involves risk factor, and highly speculative decisions may in the initial stages return very attractive profits. However such a practice is prone to bring detrimental results in due course, and may even wipe away all past gains.

An individual also craves to earn income or wealth. But he will not go after wealth neglecting his own health or well being of his family members. He also gives importance for his social responsibilities, cultural pursuits etc. In short he aims for his welfare and looks to wealth as an essential and necessary part of providing such welfare.

Profit maximisation may benefit the shareholders, but the business thrives successfully only when different stakeholders are made happy with its policies and functions. They are the employees, the customers, and the credit institutions. Others to be taken care of are rating agencies, the stock exchanges, the Government etc. The business enterprise has also specific social obligations to the society at large. Profit maximisation at the cost of social and ethical standards is a shortsighted policy. The objective of profit maximisation cannot be achieved if any one of the other stakeholders withdraws or even reduces the level of support. Similarly certain steps like periodical shutdown of the plant for maintenance are required in the interest of their better upkeep. Impetuous pursuit of profit maximisation may turn a blind eye to the plant-upkeep consideration and overuse these facilities leading to their quicker decay and mal-functioning. Similarly a firm should not minimise expenditure on such items like product advertisement and publicity; vendor development; customer-care; employee-training and development. Good public relations with influential stake holders like bankers, suppliers, government officials; etc. are equally important to promote the all round progress of the firm

A better objective is to accept "wealth maximisation" of the business enterprise as the goal of financial management, which is reflected in the earnings per share of the firm and the market price of its shares. If the shares of the firm are traded in stock exchange, a good performance of the firm results in the price at which the shares are traded. When the firms shares attracts a good price, the owners or shareholders are better of, because the market value of their investment appreciates. According to Van Horne "Value of a firm is represented by the market price of the company's stock...The market price of a stock represents the focal judgement of all market participants, as to what the value of the particular firm is. It takes into account the present and prospective future earnings per share, the timing and risk of these earnings, the dividend policy of the firm and many other factors that bear on the market price of the stock. The market price serves as a performance index or report card of the firm's progress. It indicates how well management is doing on behalf of the stake holders. The modern thinking on management goes further and consider wealth as consisting not only physical or tangible assets, but also intangible assets, like human capital, knowledge capital and relations capital.

Obviously the functions of a finance manager are oriented towards realisation of the objectives set above. These can be summarised as under:

1. Mobilization of needed funds for the business.

2. Deployment of the funds as per budget allocation

3. Investment decision

4. Dividend decision

5. Control over proper use of the Funds

6. Risk-return Trade off

7. Financial negotiations

8. Interface with other functions To Management like Production, Personal, Marketing etc.

In addition to the above other challenges before the Finance Manager are Treasury Operations i.e. short-term productive investment of surplus funds in the money market; operations in the forex market, where the business of the firm involves considerable exports and/or imports; tax-planning. i.e. bonafide steps to avail all measures provided under the Acts for minimising tax-liability; maintenance of the share price; protecting management from hostile take-over etc. We shall now dwell in greater detail about the development of functions of financial services.

Mobilisation of funds involves estimating the cost of the project and to arrive at the means of finance. The finance required is then planned for raising at different mix by way of equity, debentures, Bank-credit for Term Loans and working capital, unsecured loans etc. Careful calculations are to be made for the funds needed for long-term use and that for working capital. This is termed as "planning the capital structure".

After mobilizing funds, its proper use has to be attended, and day-today problems with regards to finance matters to be dealt with.

However these are the traditional functions identified decades back. Let us study the recent development of thought with reference to functions of the finance manager, i.e both the traditional functions and the modern conceptions of the functions of a Chief Financial Manager (CFO).

Managerial approach to finance evolved with the recognition of Corporate Finance as a distinct field of study at the turn of the 20th century. Its evolution may be divided into two broad phases, i.e. traditional phase and modern phase. A transitional phase in between the two is also sometimes recognised.

The traditional phase lasted for about four decades. The following were its important features:

• The focus of corporate finance was mainly on certain episodic events in the life cycle of the firm; formation, issuance of capital, major expansion, merger, reorganization, and liquidation.

• The approach was mainly descriptive and institutional (and not analytical). The instruments of financing, the institutions and procedures used in capital markets, and legal aspects of financial events formed the core of corporate finance.

• The outsider's point of view was dominant. Corporate finance was viewed mainly from the point of view of the investment bankers, lenders, and other outside interests.

A typical work of the traditional phase is the book The Financial Policy of Corporations by Arthur S.Dewing, professor of finance at the Harvard University. This book discusses at length the types of securities, procedures used in issuing these securities, bankruptcy, reorganization, mergers, consolidations, and combinations. The treatment of these topics is essentially descriptive, institutional and legalistic.

In a brief transitional phase started during the early forties, and continued through the early fifties, the basic approach of the traditional phase was elaborated by greater emphasis on the day-to-day problems faced by financial managers in the area of funds analysis, planning and control. A limited analytical framework characterised this period.

The modern phase began in mid-fifties and has witnessed an accelerated pace of development with the infusion of ideas from economic theory and application of quantitative methods of analysis. The distinctive features of the modern phase are:

• The scope of financial management has broadened. The central concern of financing management is considered to be a rational matching of funds to their uses in the light of appropriate decision criteria.

• The approach of financial management has become more analytical and quantitative.

• The point of view of managerial decision-maker has become dominant

Since the beginning of the modern phase many significant and seminal developments have occurred in the fields of capital budgeting, capital structure theory, efficient market theory, option pricing theory, agency theory, arbitrage pricing theory, valuation models, dividend policy, working capital management and financial modeling. As the Managerial approach to Finance is has turned into a subject of growing complexity, many more exciting developments are in the offing making finance a fascinating and challenging field.

The modern approach views the term financials management in a broad sense and provides a conceptual and analytical framework for financial decision-making. According to it the finance function covers both acquisition of funds as swell as the efficient and wise allocation of funds to various uses. It is an integral part of overall management. Its scope may be defined in terms of the following questions:

• How large should the firm be and how fast should it grow?

• What should be the composition of the firm's assets?

• What should be the mix of the firm's financing?

• How should the firm analyse, plan, and control its financial affairs?

The first three questions cover Ezra Solomon's conception of financial management as discussed in his classic work, The Theory of Financial management, while the fourth one represents an addition based on the responsibilities shouldered by financial managers in practice.

The important tasks of financials management, as related to the central concerns noted above, may be cataloged as follows:

1. financial Analysis, Planning and Control

   • Analysis of financial condition and performance - That is, assessing the financial performance and condition of the firm.

   • Profit Planning - Forecasting and planning the future of the firm.

   • Financial forecasting - Estimating the future needs of the firm

   • Financial Control - Instituting appropriate systems of control to ensure that the actions of managers are congruent with the goals of the firm.

2. Investing

   • Management of current assets

   • Capital budgeting

   • Management of mergers, reorganizations, and divestments

3. Financing

   • Identification of sources of finance and determination of financing mix

   • Cultivating sources of funds and raising funds

   • Disposition of profits between dividends and retained earnings.

Recent Developments since the last decade of the Nineties, coinciding with the onset of Economic Reforms have changed the scope of he functions of the Financial Manager in India. The emergence of financial services sector and SEBI as a watchdog for investor protection and regulating body of capital market is contributing towards the prominence of finance manager's job. The innovative tools of fund raising like zero coupon bonds, flexible bonds are some of the examples of developments during the recent years having a direct impact on the corporate financial policies.

In earlier years financial managers used to function in an environment, where sellers' market prevailed. Nearly monopoly was the state of Indian business. Finance was coming from traditional sources, i.e. Banks and Financial Institutions. The satisfaction of shareholders' was not the concern of the promoters, since most companies were closely held. But the situations is totally changed today. Because of opening of the economy and dismantling of tariff walls, the competition is hotting up. Markets are becoming buyers' market at a rapid rate. The development of Internet in the field of Information Technology has brought new challenges before Indian managers. Now the Indian concerns have not only to compete domestically, but also internationally.