FINANCIAL MANAGEMENT

By Sakshi Jain

Meaning of financial management :

Financial management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprises. It means applying general management principles to financial resources of the enterprise.

Definitions :

Finance management J.F. Bradlery :-

“Financial management is the area of business management devoted to a judicious use of capital and a careful selection of sources of capital in order to enable a business firm to move in the direction of reaching its goals”

Business finance Guthmann and dougall :-

”business finance can be broadly defined as the activity concerned with the planning, raising, controlling and administering the funds used in the business”.

Financial management is application of principles of management to the subject called finance , it involves planning, controlling decision making with respect to finance activity of the business.

NATURE OF FINANCIAL MANAGEMENT:

·        FM is an area of decision making in finance function of the business.

·        It is descriptive/ theoretical/statistical/ historical and analytical in nature.

·        It involves application of management principles to the finance function.

·        It is applicable to every organization irrespective of its size, nature, and place.

·        It deals with accumulation and utilization of financial resources (business resources).

·        It is directed towards achieving business objectives.

Objectives of financial management:

The objectives or goals of financial management are- (a) Profit maximization, (b) Return maximization, and (c) Wealth maximization. We shall explain these three goals of financial management as under: 

1)     Goal of Profit maximization: 

Maximization of profits is generally regarded as the main objective of a business enterprise. Each company collects its finance by way of issue of shares to the public. Investors in shares purchase these shares in the hope of getting medium profits from the company as dividend It is possible only when the company's goal is to earn maximum profits out of its available resources. If company fails to distribute higher dividend, the people will not be keen to invest their money in such firm and persons who have already invested will like to sell their stocks. On the other hand, higher profits are the barometer of its efficiency on all fronts, i.e., production, sales and management. A few replace the goal of 'maximization of profits' to 'fair profits'. 'Fair Profits' means general rate of profit earned by similar organization in a particular area. 

2)    Goal of Return Maximization:

The second goal of financial management is to safeguard the economic interest of the persons who are directly or indirectly connected with the company, i.e., shareholders, creditors and employees. The all such interested parties must get the maximum return for their contributions. But this is possible only when the company earns higher profits or sufficient profits to discharge its obligations to them. Therefore, the goals of maximization of returns are inter-related. 

3)    Goal of Wealth Maximization: 

Frequently, Maximization of profits is regarded as the proper objective of the firm but it is not as inclusive a goal as that of maximizing its value to its shareholders. Value is represented by the market price of the ordinary share of the company over the long run which is certainly a reflection of company's investment and financing decisions. The log run means a considerably long period in order to work out a normalized market price. The management can make decision to maximize the value of its shares on the basis of day-today fluctuations in the market price in order t raise the market price of shares over the short run at the expense of the long fun by temporarily diverting some of its funds to some other accounts or by cutting some of its expenditure to the minimum at the cost of future profits. This does not reflect the true worth of the share because it will result in the fall of the share price in the market in the long run. It is, therefore, the goal of the financial management to ensure its shareholders that the value of their shares will be maximized in the long-run. In fact, the performances of the company can well be evaluated by the value of its share.

Sources of finance:

The 12 best sources according to Dr. Dileep Rao are:

1. Bootstrapping: Many billion-dollar entrepreneurs find a way to grow without external financing so that financiers don't control their destinies or grab a disproportionate slice of the wealth pie. For more on the sound strategic thinking you'll need in order to live on your own cash flow.

2. Internal Revenue Service: No, the IRS does not lend money. But it does allow you to deduct expenses. If you are paying a heap in taxes, evaluate whether you can use your profits to expand your business--and reduce your tax bill.

3. Tax Increment Financing: TIF subsidies are geared toward real estate development in targeted areas. Depending on the state, the subsidies can be as large as 20% to 30% of the cost of the project. Better yet, you may even be able to borrow against this subsidized value. If your own community does not offer a TIF program, look at communities that do. You may end up a little farther from your home or office, but it could be worth your while.

4. Small Business Innovation Research (SBIR) grants: Getting past the paper-intensive application process and SBIR grants can be a great way to turn your intellectual property into mailbox money.

5. Friends and family members: If you're lucky, friends and family members might be the most lenient investors of the bunch. They don't tend to make you pledge your house, and they might even agree to sell their interest in your company back to you for a nominal return.

6. Vendors: Dick Schulze built Best Buy  ( BBY- news-people) with financing from large consumer electronics firms--in other words, his suppliers. This way, your financiers do not control your growth; you do. Just be sure not to enslave yourself to a handful of powerful suppliers in the process.

7. Customers: Advance payments from customers--assuming the terms aren't too onerous--can give you the cash you need, at a relatively low cost, to keep your business growing. Advances also demonstrate a level of commitment by that customer to your operation. About half of the world-beating entrepreneurs in my book, Bootstrap to Billions , were funded by their customers. This strategy allowed them to grow faster and with limited resources, and to operate with relative impunity with respect to their investors.

8. Local and state economic development organizations: Economic-development organizations can charge tantalizingly low interest rates when lending alongside a bank.

Say you need to raise $200,000 for a building. A bank may offer $150,000 on a first mortgage at a variable interest rate of prime, now 3.25%, plus 200 basis points, for a total of 5.25%. The local development entity might lend you another $30,000 on a second mortgage at a fixed-interest rate of 4%, without seeking equity shares or warrants. (Without the development corporation's contributions, you would have to scare up $50,000 in equity--expensive.) If you don't have the cash flow to cover the interest, the development organization may offer extended terms. Some loans are interest-only for the first year or two, and even the interest payments can be accrued for a certain time period.

Development groups may not agree to finance an entire operation, but they make snagging the remainder from other private sources a lot easier. Talk to your local chamber of commerce to find these programs.

9. SBA 7(a) loans: Of all the federally sponsored debt-financing programs, this is the most popular, and perhaps the best. It loosens the flow of credit by guaranteeing the lender against a portion of any loss incurred on the loan. Not to say that banks aren't careful when making 7(a) loans: They are required to keep the non-guaranteed portion on their books.

The interest rate can vary based on the size of the loan, with smaller amounts costing a little more. Shop around. Some banks reap servicing fees and nice profits by selling the guaranteed portion of the loan to insurance companies and pension funds; in those cases, a lender may be willing to offer you a better rate.

10. Bank loans: Banks are like the supermarket of debt financing. They provide short-, mid- or long-term financing, and they finance all asset needs, including working capital, equipment and real estate. This assumes, of course, that you can generate enough cash flow to cover the interest payments (which are tax deductible) and return the principal.

Banks want assurance of repayment by requiring personal guarantees and even a secured interest (such as a mortgage) on personal assets. Unlike other financing relationships, banks offer some flexibility: You can pay off your loan early and terminate the agreement. VCs and other institutional investors may not be so amenable.

11. Smart leases: Leasing fixed assets conserves cash for working capital (to cover inventory), which is generally tougher to finance, especially for an unproven business. Warning: Don't put so much money down that you end up spending the same amount of cash as you would have had you bought the asset with a down payment. The cost of a lease may be slightly higher than bank financing (see source No. 10), but the cost of the down payment you did not have to make is likely to be less painful than the dilution you suffer from giving away equity.

12. Angel equity: If you must sell an ownership stake to get your company off the ground, start by finding a respected industry executive who is willing to invest a reasonable amount and give your venture credibility with other investors. The advice and networking--without all the heavy-handed demands of a VC--come in handy, too.