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.

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:

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

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

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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.

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.

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.

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

   1. Issue of shares and debentures

   2. Loans to be taken from banks and financial institutions

   3. 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:

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

   2. 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.

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Principles of Financial Management

Financial management is a broad topic which encompasses a wide range of actions taken by corporations in order to maximize their financial value of the firm. These actions are generally guided by the policies being followed in the organization. These policies in turn are guided by some of the fundamental principles related to financial management.

The details related to the seven fundamental principles of financial management are as follows:

1. Consistency: It is important for the actions and financial policies of the company to be consistent over time. Of course, the organization cannot be stagnant and must change with the external environment. However, it is important to be consistent regarding the core financial management principles being followed. Lack of consistency is considered as one of the first signs of financial trouble by external stakeholders.

2. Accountability: The organization allocates financial resources to different stakeholders in order to achieve certain objectives. All stakeholders who receive such resources are accountable to all other stakeholder groups. They have a legal as well as moral obligation to ensure that the resources of the organization are being judiciously used.

   Financial management programs must ensure that the stakeholders are aware of this accountability. It is important to have periodic appraisals and feedback process in order to ensure accountability is maintained.

3. Transparency: It is important for the financial management processes in any company to be transparent. Transparency means that accurate and up to date financial reports must be easily accessible to all stakeholder groups who have a need to know such information.

4. Viability: The financial management plans of a company must take into account the long-term viability of the overall business. It is important for the organization to ensure that the ability of the business to sustain itself is not compromised because of the financial policies being implemented.

5. Integrity: It is important for the company to ensure that none of their key stakeholders have a conflict of interest. In the context of financial management, integrity means that the financial objectives of the stakeholders must be aligned with that of the organization in general. Most organizations have a zero-tolerance policy with regards to integrity. This is because undetected unethical behaviour can severely compromise the financial health of the company.

6. Stewardship: Stewardship generally means being vigilant and taking good care of something. Financial stewardship involves the protection of long-term assets of the company via proper decision making. Decisions should be analysed on the grounds of morality, ethics as well as financial prudence before they are implemented.

7. Accounting Standards: The principle of accounting standards mandates that the accounts of the organization be created in accordance with the widely followed and accepted accounting standards. This is done to ensure that the financial data collected by the organization can be compared across periods of time as well as with competing firms.

It is important for each organization to either adopt some of these principles or create their own principles with regards to financial management.

Financial Management Strategies

It is important to understand that financial management is not an exact science. There is no “one size fits all” approach which can be used with regards to financial management. Instead, companies may have to choose between different approaches.

Over the years, companies have realized that they need to choose amongst two or three commonly used financial management strategies and align their actions to the same. The purpose of the strategy is to clearly communicate to all stakeholders about what the firm is trying to achieve. The objectives must be clear, measurable and quantifiable.

Some of the strategies which are commonly used in financial management are as follows.

1. Profit Maximization: The profit maximization strategy, as the name suggests, revolves around maximizing the profits of the company. It must be understood that profits are calculated from a profit and loss statement i.e. quarterly, half yearly or annually.

   Hence, a profit maximization strategy for financial management is inherently focused on the short term. This means that the financial resources of the company need to be deployed to meet short term goals. Such a strategy may be useful for startups who need to show short term profitability in order to keep investor funds flowing.

2. Wealth Maximization: Wealth maximization is quite different from the profit maximization strategy of financial management. Wealth maximization focuses on deploying the financial assets of the company in order to generate the highest possible shareholder wealth in the long run. It might seem like that the goal of short-term profits and long-term wealth will always be aligned but this is not the case.

   There are many well known companies across the world which spend a lot of their financial resources on research and development. In the short run, this goes against the principles of profit maximization. However, in the long run, financial resources spent on research enables companies to produce better products, gain market share and increase their wealth. The same principles of financial management can be applied to companies who deploy their financial resources in branding, customer services and such other intangible assets.

   The wealth maximization strategy of financial management is more important for mature companies or companies trying to disrupt their marketplace with technological innovation.

3. Risk Mitigation: Financial management, at its core, is about assisting the company in making financial investments in order to achieve their strategic goals. Now, anyone who is well versed with the concept of investments is aware that any kind of investment entails risk taking. Most organizations can generally choose to deploy their capital in different projects, each of which may carry different risks.

   The level of risk which an organization is willing to bear must be carefully thought through. It is important for financial managers to clearly define the level of risk their willing to take in order to meet their financial objectives.

   In the absence of a clearly defined risk measurement and mitigation strategy, the company may not be able to meet its strategic objectives using financial management tools and techniques.