Financial management: meaning, scope and objectives

1. Meaning

Financial management is the planning, raising, use and control of the funds of a business. It asks three questions: in which assets should the firm invest, how should it pay for them, and what should it do with the profit it earns. Solomon described it as the efficient use of an important economic resource, namely capital funds. Older writers saw it as mere fund-raising (the traditional approach: arranging funds from banks and the capital market, chiefly at times of promotion, expansion or reorganisation). The modern approach, associated with Ezra Solomon and Van Horne, treats finance as part of every management decision: it covers the use of funds as well as their supply.

2. Scope: the decisions

1. Investment decision (capital budgeting): which long-term assets or projects to take up, judged by expected return against risk. Payback, ARR, NPV, IRR and PI are its tools.
2. Financing decision (capital structure): the mix of equity, preference capital, debentures and loans; the cost of each source and the risk that debt adds.
3. Dividend decision: how much of the profit to pay out and how much to retain; Walter, Gordon and Modigliani–Miller models.
4. Liquidity (working capital) decision: how much to hold in stock, debtors and cash, and how to finance it, balancing liquidity against profitability.

The decisions are linked. A new project needs funds (financing), funds retained reduce dividends (dividend), and every project needs its own working capital (liquidity).

3. Objectives

Wealth (value) maximisation is accepted as the proper objective. Ezra Solomon put it as maximising the net present worth of the firm to its shareholders. It is qualified by the interests of creditors, employees, customers and the State (the stakeholder view), and in India by the duties of directors under section 166 of the Companies Act, 2013, which require a director to act in good faith for the benefit of the members as a whole and in the best interests of the company, its employees, the shareholders, the community and the protection of the environment.

4. Functions of the finance manager

• estimating the amount of capital needed, long-term and short-term;
• deciding the capital structure and choosing the sources of funds;
• evaluating investment proposals;
• managing cash, receivables and inventory;
• deciding the dividend and retention policy;
• financial planning, budgeting and control; dealing with banks, investors and the stock market.

5. Time value of money

A rupee today is worth more than a rupee tomorrow, because it can be invested to earn a return, because of inflation, and because the future is uncertain. Every long-term decision therefore brings cash flows of different years to a common point of time.

Compounding (future value): FV = PV × (1 + r)ⁿ. Rs. 1,000 at 10% for 3 years grows to 1,000 × 1.331 = Rs. 1,331.

Discounting (present value): PV = FV ÷ (1 + r)ⁿ. The factor 1/(1.10)ⁿ gives the table the papers print:

Annuity: an equal sum each year. Its present value is the sum multiplied by the cumulative factor: Rs. 10,000 a year for 5 years at 10% is worth 10,000 × 3.790 = Rs. 37,900 today. A perpetuity (an equal sum for ever) is worth the sum divided by the rate: Rs. 10,000 ÷ 0.10 = Rs. 1,00,000. The perpetuity formula is the basis of the cost of irredeemable debt and of the dividend models.

How this is examined

The definition-and-scope question (August 2024, 6 marks) is answered by sections 1, 2 and 4; add the profit-versus-wealth table when the question says “objectives”. The time value of money is rarely asked alone, but section 5 and its table are needed for the NPV, PI and IRR problems in Unit IV and the Modigliani–Miller dividend problem in Unit II.