17-01-2011, 03:10 PM
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Introduction
Every business enterprise in this world irrespective of its nature and scale of operations needs finance to carry out its activities and accomplish its goals.
Money is a continuous necessity in running any organization and without it very few opportunities can be taken advantage of.
Financial management basically deals with the procurement of funds needed for business and its efficient utilization.
In other words management of finance is the anticipation of financial needs, acquiring financial resources and allocating funds to different departments.
Financial management plays a key role in any business and in fact, will be a difference between success and failure.
The important objectives of any organization are profitability, growth and survival.
The attainment of these objectives largely depend upon the efficient management of finance.
In today’s scenario following external factors are also influencing on the financial managers.
Technological change
Increased corporate competition
Fluctuating and volatile interest rates
Worldwide economic uncertainity
Fluctuating exchange rates
Tax law changes etc.
Objectives of financial management
To maximize profits and minimize losses
To determine the financial needs of the company
To raise funds for both fixed and working capital needs
To pay salaries and wages to the employees
To control all financial activities of the company through standard costing, budgetary control, financial analysis, Break-Even analysis.
To prepare financial statements like profit and loss accounts and balance sheet.
To forecast the economic trends of the market well in advance.
Scope of finance
What is finance? What are the financial activities of a firm? How are they related to the firm’s other activities? Firms establish manufacturing facilities for production of goods while some provide services to customers.
They sell their goods or services to earn profit.
They raise funds to acquire production and other various facilities.
Thus, the three most important activities of a business firm are:
i) Production
ii) Marketing
iii)Finance
The broad objective of any firm would be to raise the finance it needs and employ it in production and marketing activities in order to generate returns on the invested capital.
Therefore, there exists an inseperable relationship between finance on one hand and production and marketing on the other hand.
A regular supply of finance in any firm ensures efficient production and marketing activities, which in turn helps returns, which again improves the flow of finance.
A company in a tight financial position may compromise on production and marketing activities which in turn leads to poor returns and poorer flow of funds.
Sources of Finance
All business enterprise have to raise funds from various sources in order to invest in their business and earn profits out of them. Funds raised are used for purchasing fixed assets and for working capital.
Fixed assets are those like land, building, machinery, office equipment, furniture etc. which have to be bought even before beginning the operations of the company.
Working capital is that which is required to meet the expenditure for day-to-day working of the business. It includes the cost of maintenance and service activities, cost of sales activities etc.
Following are the different methods of raising capital:
1.Internal sources
1.Retained equity earnings
This is the earnings of the shareholders retained for internal investment. However, care should be taken to protect the interest of shareholders.
2. Depreciation provisions
A depreciation account should be maintained to replace the existing machinery when it becomes uneconomical to use.A depreciation reserve can be maintained for this purpose.
3.Personal funds saved or Inherited
It is very essential that the owner of the company has assets of his own to win the confidence of external financiers.
4.Deferred taxation
This refers to the fund available due to deferred taxation which can be utilized.
2.External Sources
1.Permanent or long term sources of finance
i) Savings- This refers to the money saved by people and subsequently used to purchase life insurance, buy stocks or bonds, buy shares or deposit in a bank. This money can be utilized by the business enterprise. Majority of capital for investment in business comes from savings of people.
2.Loans
Money can be borrowed either to start a business or to expand the existing one. The sources may be friends or relatives, money lending institutions, commercial or other banks etc. However money borrowed also has its own obligation of paying interest in time and date.
3. Shares
These are the funds generated by issuing shares to public. Based on the capital to be collected by issuing shares, the number of authorized shares and value of each share is decided. Shares can be floated in the market either to start a new venture or to expand the existing one.
4. Corporate bonds
Corporate bonds may be of two types unsecured bonds or debentures and secured bonds.
a debenture is a formal document raised by business corporations having good earning records, favourable expansion prospects etc…to raise funds. Debenture is a certificate of indebtness issued by an organization. Company pays a fixed rate of interest on the deposit and repays the amount after stated number of years. A debenture holder is only a creditor with no control over the company affairs.
5.Public deposits
Public can be encouraged to directly invest money for a fixed long/short period ranging from half an year to seven years.
6. Taking partners
By taking partners who are ready to invest in the firm.
2.Medium Term Sources of finance
1.Bank loans
Short term loans can be arranged from banks at reasonable interest rates.
2. Hire purchase
Machines, goods etc… can be arranged (hired) by depositing some amount and subsequently pay money periodically in instalments. When all the instalments are paid, possession of the goods passes to the hirer.
3.Sale and lease back
In this case, the company sells some of its property to an investment company with the agreement of getting the same property leased back at an agreed rent.
4.Equipment leasing
This usually happens with fixed assets like, land, machines, equipment etc which can be obtained on lease for a number of years on rental basis.
5.Profit plow back
In this case portion of the whole profit is retained in the business, rather distributing it to the share holders in the form of dividends. This money is utilized for expansion and growth of the company.
3.Short term sources of finance
1.Credit facilities
Goods and services can be obtained on credit.
2.It is the financial assistance available from other firms with whom business has dealings.
Ex: Inventory suppliers
4.Specialist Institutions
i) Industrial financial corporation
ii) State financial corporation
iii) Industrial development corporation
iv) Insurance companies.
Finance functions
The most important work of a finance manager in a company is to raise money from various sources, allocate them wisely, and distribute the returns to all the shareholders appropriately. These are known as finance functions.
Types
1.Investment or long term asset-mix decision
Investment decision involves the decision of allocation of funds to long term assets that would yield benefits in the future.
Two important aspects of the investment decision are:
i)the evaluation of prospective profitability of new investments
ii)the measurement of a cut-off rate against which the prospective returns of new investments could be completed.
2.Financing decision
This is the second most important function to be performed by the finance manager. A finance manager should broadly determine when, where, why, and how much of funds to acquire in order to meet the firms investment needs.
The most important issue in front of a finance manager is to determine the proportion of equity and debt. The mix of debt and equity is known as the firm’s Capital structure.
3. Dividend decision
This is the third major financial decision. The finance manager must decide, in conjunction with the top management, whether to distribute all profits or retain them, or distribute a portion and retain the balance.
4.Liquidity decision: This is the fourth important financial decision. Liquidity generally refers to the ability of a firm to meet its financial obligation in the short run, usually one year.
Liquidity literally mean flow of cash. A business which deals only in cash ie sells in cash and buys in cash, is said to be having high liquidity.
But it might lose profitability because idle current assets (or cash) would not earn anything against being invested.
Types of shares
Preference shares
These are the shares which have some preferred rights over other types of shares. They are entitled to a fixed dividend out of the profit. Further, dividends are first paid to the preference share and then to ordinary shares. When the company faces financial crisis and is unable to pay the dividends, the preference share holders may exert their powers and take over control from ordinary share holders.
Preference shares may by further classified as,
Cumulative preference shares
These shares get a fixed annual dividend. If it is not possible to pay the full dividend in an year, the balance may be paid from the profit of next subsequent years.
Non Cumulative preference shares
These shares get a fixed annual dividend, but the share holders can not ask for arrears from future profits if in any years the company fails to make enough profits to pay fixed dividends for that year.
© Participating preference shares
These shares get a fixed annual dividend and some surplus left after paying dividend to ordinary shareholders.
2. Ordinary shares
Dividend to ordinary share holders is higher than that of preference share holders. However these shares are subject to risk in market. Ordinary shareholders are entitled to dividend which has no specific limit, but get the dividend only after paying dividend to preference shares.It is possible that shareholders may get high dividend in one year when company makes high profit and no dividend at all in another year when company makes high profit and no dividend at all in another year when company is under loss. The ordinary shares are also known as equity shares or equities.
3.Deferred shares
These shares are issued to founders or promoters of the business concern. Dividend to deferred share holders is given in the end. Ie only after paying dividend to ordinary and preference share holders.
4.Debentures
These are formal documents issued by business corporations having good transaction to raise funds for business expansion. A fixed interest is given to the debentures for a specified period and the amount is repaid at the end of that period.
Accounting process
Any business usually involves a large number of transactions. Buying, selling, paying and receiving are very frequent. It is humanly impossible to remember all transactions. Hence it becomes necessary for us to record all the transactions in a note-book.
Accounting is the art of recording, classifying, summarizing and reporting all business transactions.
Objectives of Accounting
1.To maintain systematic records- Accounting is used to maintain systematic records of all financial transactions like purchase and sale of goods, cash receipts and cash payments
2.To ascertain net profit or net loss of the business.
3.To ascertain the financial position of the business.
4.To provide accounting information to interested parties.
Limitations of accountancy
1.Accounting does not reflect non-financial factors.
- location, quality of human resources, patents, licenses etc.
2.Data is historical in nature.
3. Estimation and personal judgments are utilized.
4.Insufficient data
