Financial Objectives; Impact of Financial and Economical Environment on Financial Management
Finance is the life line for all kinds of businesses. Today, we are experiencing the liquidity crunch all over the world, which in turn has slowed down the economic activities across the all line of businesses. It is equally true money makes money, when it is rightly managed. Therefore, the success of every business depends on how efficiently its finances are managed.
Business finance can be defined as the activities related with planning, raising, controlling and administering of funds used in the business.
FM means the whole efforts of management towards the managing of finance- both its sources and uses of the firm. Thus FM is concerned with proper management of funds. The financial manager must strike a proper balance between the cost and risk, while raising funds and utilisation of funds.
Soloman, said FM is concerned with efficient use of an important resource, namely capital funds. FM is concerned with managerial decision that deals in acquisition and financing of long term and short term credits for the firm.
- Basic objective was to maintain liquid assets and maximisation of profits. All business firms seek profit and it was considered to be sole criteria to test the efficiency of a business. But it has been criticised in recent times on the following grounds:
- It is hazy: which profit to be maximised short term or long term, rate of profit or amount of profit, NP or GP, OP or PAT.
- It ignores timing: time value of money is ignored.
- It overlooks quality aspects of future activities: emphasize on growth of sales to gain stability provided by higher sales volume. At the cost of social and moral obligations.
- Besides the above basic objectives, following are the other objectives of FM:
- Ensuring a fair return to share holders.
- Building reserves and surplus for growth and expansion.
- Ensuring maximum operational efficiency by efficient and effective utilisation of finances.
- Ensuring financial discipline in the organisation.
- In conclusion the operating objective of the FM is to maximise the wealth or net present worth. So, wealth maximisation is considered to be the main objective of FM.
FINANCE AND ECONOMICS
Microeconomics deals with the economic decisions of individuals and organizations. It deals with effective operations of a firm. In other the theories of microeconomics by way of effective operations allow the firm to achieve the success and goal. The concepts and theories of microeconomics relevant to FM are supply and demand relationships, profit maximisation strategies, product mix, optimal sales level and product pricing strategies, risk and value and rationale for depreciating assets. Marginal analysis, which suggests that financial decisions should be made on basis of comparison of marginal revenue and marginal cost, where added revenues exceeds added costs.
FINANCE AND ACCOUNTING
These are closely related to each other and accounting information is an important input for financial management to take the financial decisions. In spite there are key differences between them. Accounting is a sub function of finance. Accounting end results i.e. financial statements provide the help for assessing the past performance and indication for future directions to the firm and comply with the legal obligations such as taxes. The finance (Treasurer) and accounting (Controller) activities are under the control of VP finance/CFO, these functions are closely related and generally overlapping. The two key differences between finance and accounting relates to the treatment of funds and the second relate to the decision making.
The Treatment of Funds in accounting is based on accrual method, whereas in finance view it is base on cash flows.
Decision making: Accounting process is meant for collection and presentation of financial data. The financial manager uses such data for financial decision making. It does not mean that financial manager never collects data and accountant never make decisions. But the primary focus of accountant is to collect and presentation while Financial manager’s responsibility to financial planning, controlling and decision making. Thus, in a sense finance begins where accounting ends.
SCOPE OF FM
As a academic discipline, FM has undergone significant changes over the years. So as the role of financial manager has been changed over the period of time. To understand well, it is better to study both the approaches i.e. traditional and modern approach.
- The term corporation finance was used in place of FM as of now. The symptoms were recorded in 1897 in the book written by Thomas Greene, further emphasized by Edward Meade in 1910. In the year 1919, Arthur Dewing by the book ‘The Financial Policy of Corporation’ dominated around three decades i.e. from 1920 to 1950 and later, it was criticized on the following grounds: the traditional approach covered the arrangement of funds from Financial Institutions and financial instruments and legal and accounting matters.
- Outsider looking in its approach: Since this approach deals in only for raising and administering of funds, which is provided by outsiders.
- Ignores routine financial problems like at the time of incorporation and mergers & acquisition. It also ignored non corporate enterprises.
- Ignored working capital financing needs and the no emphasize on allocation of funds was given. This approach confined to only raising of funds and did not pay any attention on allocation of funds.
- In the mid of 1950, the traditional approach outlived its utility due to changed business environment, new technology and enhanced global business. The introduction of computers in 1960 made the decision of financial manager easy and efficient. All these factors put pressure on the financial manager to think and make optimum use of financial resources. The introduction of techniques of capital budgeting increased the scope of FM and led to allocation of funds. During the 1960 to 1980 many pricing, valuation models and investment portfolio theories were developed. In the 1980’s inflation rose sharply and interest rates went up so high, so raising loan on efficient terms and utilising the funds wisely became the art of the time. The arranging and using the funds became equally important. This enhanced the scope of FM.
- Thus the modern approach is an analytical way of looking at the financial problems of a firm. It includes the following:
- What is the total volume of funds a firm should commit?
- What specific assets should an enterprise acquire?
- How the funds required should be financed?
- So under the scope of FM, there are three major decisions of financing decision, investment decision and dividend decision.
Liquidity V/S Profitability
This is very common problem in front of financial manager, he has to strike a balance between the two. First of all here liquidity means that firm has sufficient funds/ adequate cash to meet its current liabilities, unexpected large purchases and meet emergencies.
On the other hand profitability means that the funds of firm are to be so used as to yield the highest return. These two terms are closely related in a inverse manner, when one increases the other decreases. For e.g. stocking higher inventory keeping in anticipation that prices of RM will increase the profitability but decrease the liquidity. Same way by following a liberal credit policy sales and profitability will increase but liquidity will suffer. There is positive relationship between risk and return, so he has to choose between risk and return. Trade off between risk and return is done to maximise the wealth of the shareholders.