Functions of Financial Management
Finance functions are carried on to achieve the objective of the firm. There are mainly two approaches to express the "Financial Function". The first approach relates it to the collection of funds. The second approach relates finance functions to the procurements of funds and their effective utilization. The first ignores the uses of funds it was. It was major finance function at the early stage of the development of finance. The second is comprehensive and universally accepted; we are following the Second One.
Executive Finance Function
Routine Finance Function
1) Investment decision
1) Supervision of cash receipts and disbursements
2) Financial Decision
2) Safeguarding of cash balances
3) Dividend Decision
3) Custody and safeguarding of valuable documents
Like securities and policies
4) Working Capital Decision
4) taking care of mechanical details of financing
5) Record keeping of the financial performance of the
6) Reporting the top management
7) supervision of fixed assets and current assets
Executive finance functions are those functions that require managerial skills in their planning, execution and control. Since these functions require greater managerial ability, they are also known as managerial functions.
The executive finance functions are explained here:
1. Investment Decision
It refers to acceptance/ rejection of long-term investment proposal. Proposal related to acquisition, modification and replacement of assets are long-term investment proposal. Long-term refers to the time horizon of more than one year. The long term assets like plants, machines, equipments, land, buildings etc…………
2. Financing Decision
Is concerned with the collection of the fund. The financial manager needs to decide about the appropriate amount and sources of the fund. ………………
3. Dividend Decision
The net income after paying preference dividend belongs to the equity shareholders. However, there is no legal obligation to pay dividend to the equity shareholders. The dividend decision is the allocation of net profit after tax and preference dividend to equity shareholders. ……………….
4. Working Capital Decision
Working capital decision refers to the commitment of funds to current such as inventory, bills receivable, cash balance, prepaid, etc. this decision is known as current assets management also……………..
5. Routine Finance Decision
It is also the incidental finance function, which is performed to execute the executive finance effectively. Routine finance function does not require specialized skills of finance. They are of clerical nature. So they are called clerical finance function too. These function cover procedures and system and involve a lot of paper work and time, some of them are below:
1. Supervision for cash receipts and disbursements
2. Safeguarding of cash balances
3. Custody and safeguarding of valuable documents like securities and insurance policies
4. Taking care of mechanical details of financing
5. Record keeping of the financial performance of the firm
6. Reporting to the top management
7. Superviion of fixed assets and current assets.
Profit Maximization Objective
In the conventional theory of the firm, the principle objective of a business fir is to maximize profits. Under the assumption of given tastes and technology, price and output of a given product under perfect competition are determined with the sole objective of maximization of profit.
Maximization of profit simply refers to the maximization of rupees income of the firm. Under profit maximization objective, business firm attempt to adopt those investments projects, which yield profits, and drop all other unprofitable activities.
In maximizing profit, input-output relationship is crucial, either input is minimized to achieve a given amount of output or the output is maximized with a given amount of input. Thus, this objective of the firm enhances productivity and improves the efficiency of the firm.
The conventional theory of the firm defends profit maximization objective on the following grounds;
a. Only those firms survive in the long-run in a competitive market, which are able to make a reasonable amount of profit. Once they are able to make profit, they will always try to make it large as possible. All other objectives are subjected to this primary objective.
b. Profit maximization assumption is a time-honored objective of a firm and evidence against this objective is not conclusive or unambiguous
c. Profit maximization objective has been found extremely accurate in predicting certain aspect of firm's behavior and trends as such the behavior of most firms are directed with the objective of profit maximization.
d. Though not perfect, profit is the most efficient and reliable measure of the efficiency of a firm
e. Under the condition of competitive market, profit can be used as a performance evaluation criterion, and profit maximization leads to efficient allocation of resources
Wealth Maximization Objective
Wealth refers to the market price of stock. Wealth maximization (shareholders wealth maximization) is almost universally accepted goal/ objective of a firm. According to this goal, the manager should take decision that maximizes the shareholders wealth. In other words, it is to make the shareholders as richer as possible. Shareholders wealth is maximized when a decision generates net present value. The net present value is the difference between present value of the benefits of a project and present value of its costs. A decision that has a positive net present value creates wealth for shareholders and a decision that has a negative net present value destroys wealth of shareholders. Therefore only those projects which have positive net present value should be accepted.
Wealth maximization: A superior Decision Criterion
a. Efficient allocation of resources
b. Separation between ownership and management
c. Residual owners
d. Emphasis on cash flow
e. Recognizes time value of money
Financial markets consist of financial markets, financial institutions, financial instruments, and financial services. Financial markets are the place where transactions of financial instruments and services take place. Financial markets exist in order to bring buyer and seller of securities and financial services together. They are the mechanism that exists in order to facilitate the exchange of financial assets, thus adding to the liquidity of financial assets. Financial markets facilitate the flow of saving generated from one sector of the economy to another, where there is the demand for funds. In financial markets fund suppliers and funds borrowers are brought together with the help of financial intermediaries directly. These intermediaries channel nation's savings into most productive uses.
Division of Financial Markets
1. Primary Market: - When securities are issued for the first time, they are traded in the primary market. All proceeds from the issue in this market go to issuing corporation. It is the market for first issue of securities by corporation, in which the corporation raise new capital. However in issuing the securities, the issuing corporation could take the service of investment bankers and securities dealers, which could cover wide geographical area for distribution of securities by forming underwriting syndicat.
2. Secondary Market: - Secondary market is the market for existing securities. It deals with trading of outstanding securities. Once the securities are issued in primary markets, they become a part of secondary market. A secondary market is the market for already existing securities, where trading between investors to investors take place. The original issuer has no role in secondary markets, and the proceeds from securities transaction do not go to them.
3. Money Market: - money market deals with trading of securities with less than one year of life spam, it is the market for borrowing and lending for relatively short period of time, usually less than one year. Government, corporations and individuals requiring short-term loan are major participants of money market. Government issues Treasury bills to meet its need of short-term funds. Corporation could issue commercial papers or take loan on short-term basis from banks to satisfy their short-term needs of funds. Other money market instruments include bankers' acceptance, certificate of deposits, promissory notes, bills of exchange and any other with less than one year life.
4. Capital Market:-Capital market involves the trading of financial assets having a life spam greater than one year .all long terms securities issued by corporation and government such as common stock, corporate bonds, government bonds are the instruments of capital market. These capital market instruments are also traded in both primary as well as secondary market. Capital market instruments are not as liquid as money market instruments because of longer maturity. However the existence of secondary market adds to the liquidity of these instruments to a greater extent. When there is a change in market interest rates, value of these instruments fluctuate widely tan money market instruments because of longer maturity.
Organizations that issue financial claims against themselves for cash and use the proceeds from this assurance to purchase primarily the financial assets of others. They help in generating the saving from people, business and government which is supplied to the users of funds.
They are specialized firms that facilitate the transfer of funds from savers to borrowers. They offer accounts to the savers and in turn the money deposited are used to buy the financial assets issued by other.
1. Commercial Banks
2. Finance Companies
3. Insurance Companies
4. Mutual Funds
5. Pension Funds
6. Other Financial Institutions
a. Credit Unions
b. Saving and Loan Associations
c. Mutual Saving Banks