Introduction to Finance and Financial Management
1. What do you mean by finance? Finance is the art of managing large amounts of money. It involves the management of money matters for businesses or business entities.
2. What do you mean by business finance? Business finance is the activity or process concerned with the acquisition, use, and distribution of profits by a business firm. It typically deals with financial planning, acquisition of funds, allocation of funds, and financial controls.
3. What is corporate finance? Corporate finance is the process of raising, providing, and administering all money/funds used in a corporate (business) enterprise.
4. Define financial management. Financial management is the part of management activity concerned with planning and controlling a firm’s financial resources. It deals with finding various sources of raising funds economically and aims to utilize funds profitably for efficient operations to achieve business objectives.
5. What is Financial Planning? Financial planning is deciding in advance the financial requirements of a business, the sources from which they will be met, and the effective utilization of the funds collected. It involves formulating an ideal capital structure that fulfills the organization’s objectives.
6. Differentiate between Financial Management and Financial Accounting.
- Decision-making: Financial Accounting focuses on collecting and presenting data, while Financial Management’s primary responsibility relates to financial planning, controlling, and decision-making.
- Treatment of funds: Financial Accounting measures funds based on the accrual principle, while Financial Management uses cash flows. Revenues are recognized when cash is received (inflow), and expenses are recognized upon payment (outflow).
7. What do you mean by Profit Maximization? Profit earning is the main aim of every business to cover costs, survive, and provide funds for growth. Profit measures a business enterprise’s efficiency and serves as protection against uninsured risks. Accumulated profits enable a business to face risks like price drops, competition, and adverse government policies.
8. Wealth Maximization The wealth maximization objective of an enterprise means maximizing shareholder wealth measured by EPS, DPS, NPV, EVA, and MVA through better and efficient Financial Management. The main aim of Financial management is to maximize the value of shares and stock by managing the sources and application of funds economically, efficiently, and effectively.
SCOPE OF FINANCIAL MANAGEMENT
1. Estimating Financial Requirements: A financial manager’s first task is to estimate the short-term and long-term financial requirements of the business. This involves preparing a financial plan for the present and future.
2. Deciding Capital Structure: The capital structure refers to the kind, quantum, and proportion of different securities for raising funds. Deciding the type and proportion of securities is crucial as it impacts the cost of raising funds and influences financial planning.
3. Selecting a Source of Finance: The need, purpose, object, and cost involved are factors influencing the selection of a suitable financing source. Short-term needs may be met by banks, public deposits, and financial institutions, while long-term needs may require share capital and debentures.
4. Selecting a Pattern of Investment: The selection of an investment pattern relates to the use of funds, applying techniques like Capital Budgeting and Opportunity Cost Analysis.
5. Proper Cash Management: Cash management involves assessing cash needs at different times and making arrangements for arranging cash. Effective cash management ensures neither a shortage nor an excess of idle cash.
6. Implementing Financial Controls: An efficient financial management system requires various control devices like Return on Investment, Budgetary Control, Break-Even Analysis, Cost Control, Ratio Analysis, and Cost and Internal Audit.
7. Proper Use of Surpluses: Utilizing profits or surpluses is essential for expansion, diversification, and protecting shareholder interests. While plowing back profits is a good financing policy, it may sometimes conflict with shareholder interests.
Explain the objectives of financial management: Financial management is crucial for any organization, involving planning, organizing, directing, and controlling financial activities. Here are the primary objectives:
- Profit Maximization: Ensuring the company earns the highest possible profit by managing costs and increasing revenue.
- Wealth Maximization: Increasing the value of the business for its shareholders by making strategic investment decisions.
- Ensuring Liquidity: Maintaining sufficient cash flow to meet obligations and avoid insolvency.
- Efficient Utilization of Funds: Making sure funds are used effectively and efficiently to maximize returns.
- Financial Discipline: Creating a structured financial environment to ensure compliance with regulations and effective financial planning.
What are sources of Short-term financing of Working Capital?
(1) INDIGENOUS BANKERS: Private money lenders are called indigenous bankers. Businesses may obtain loans from them to meet their working capital requirements.
(2) CUSTOMERS’ ADVANCE: Companies may take advance payments from customers to meet short-term financial requirements.
(3) TRADE CREDIT: This is credit granted by a seller to a buyer for a short period, typically based on the buyer’s financial reputation and creditworthiness.
(4) BANK CREDIT: Commercial banks provide short-term finance to businesses through various means:
- Advancing loans
- Cash credit
- Overdraft
- Discounting and purchase of bills of exchange, promissory notes, and hundies
(a) Cash Credit: An arrangement where a customer can borrow money up to a certain limit. The bank opens a separate account and credits the sanctioned loan, charging interest on the actual amount utilized.
(b) Overdraft: A temporary loan given against an existing current account, allowing the account holder to withdraw more than the credit balance. Interest is charged on the actual amount withdrawn.
What is Capital Budgeting? It is the process of making investment decisions in capital expenditure. It involves evaluating and selecting long-term investments consistent with the goal of maximizing shareholder wealth.
Methods of Studying Capital Budgeting Techniques:
Net Present Value (NPV): The difference between the present value of cash inflows and the present value of cash outflows over time. Used to assess the profitability of a project.
Internal Rate of Return (IRR): The discount rate that makes the NPV of a project zero. Represents the expected annual rate of return from a project.
Payback Period: The time required to recover the initial investment in a project. Used as a simple measure of risk.
Discounted Payback Period: Similar to the payback period but accounts for the time value of money by discounting cash flows.
Profitability Index (PI): The ratio of the present value of future expected cash flows to the initial investment. Indicates the relative profitability of a project.
Accounting Rate of Return (ARR): The ratio of average annual accounting profit to the initial investment. Provides a quick estimate of profitability based on accounting information.
What is leverage? Leverage is the analysis of the relative change in income due to changes in sales or capital structure.
What is operating leverage? Operating leverage signifies the relationship between changes in sales volume and operating income (EBIT). It exists when a firm has fixed costs regardless of output or sales volume.
What is financial leverage? Financial leverage is the tendency of residual net income to vary disproportionately with operating profit. It indicates the change in taxable income due to changes in operating income.
What is composite leverage? Composite leverage combines operating and financial leverages, reflecting a firm’s capacity to meet its fixed costs.
What is working capital? Working capital refers to the capital required for the day-to-day operations of a business. It is represented by the excess of current assets over current liabilities.
What is net working capital? Net working capital is the excess of current assets over current liabilities.
What is seasonal working capital? Working capital required during a particular season for seasonal products, such as in the sugar industry, which produces primarily between December and April.