Tuesday, February 18, 2014



Financial management is concerned with management of fund. It may be defined as “acquisition of fund at optimum cost and its utilization with minimum financial risk.”


Finance function has three broad categories:

1.    Financial planning followed by implementation of financial decisions
    Financing decision

Investment decision
Dividend decision

2.    Financial Analysis

3.    Financial Control

Financial Planning

l     Planning means deciding in advance. Thus financial planning is the act of deciding in advance the activities related to financial decisions necessary to achieve the objectives of financial management.

l     In other words, financial planning is the process of determining the financial objectives, procedures and strategies, programmes and policies and budgets to deal with the activities related to financial decisions of an organization.

l     Thus financial planning provides framework within which financial decisions take place.

l     Financial decisions refer to financing decision (procurement of fund), investment decision (utilization of fund) and dividend decision (distribution of fund).

l     Financial planning i.e. planning for financing, investment and dividend decision must confront with (i.e. take into account) external environment (industry level and country level factors) and internal environment (organizational level factors). Factors like risk or uncertainty, inflation, liquidity, taxation etc. are some examples in this regard.

l     Capitalization, financial forecasting and budgeting are important tools for financial planning which helps in planning financing and investment decisions.

l     Capitalization refers to planning of financing decision, which means estimation of total fund requirement to run the concerned organization.

l     Financial forecasting includes preparation of projected income statement, projected balance sheet, projected fund flow statement etc.

l     Budgeting includes preparation of budgets and installation of proper budgetary control system.

l     Financial planning leads to implementation of financial decisions viz. financing decision, investment decision and dividend decision.

Financial Decisions

Business decisions are of two types viz. short-term decision, also known as working capital decision and long-term decision, also known as capital budgeting decision/project decision capital expenditure decision and therefore financing decision and investment must be viewed in the light of these decisions.

Following is a brief description of financial decisions viz. Financing decision, Investment decision and Dividend decision:

q Financing decision: (procurement of fund)

Financing decision is categorized into two parts:

Working Capital (WC) financing

Project financing i.e. financing for long-

i.e. financing of CA components

term investment decision/capital

structure decision.

Both category of financing decision require following three key points to take into consideration: (i) Sources

(ii) Sources mix

(iii) Cost and other consequences

Sources: A finance manager has to identify the various sources available to him through which he can raise the fund. It is the financial system which facilitates financing decision in identifying/ procuring short-term as well as long-term sources of finance (for details refer to Financial Market/Financial System).

Sources mix: He has to decide the composition of each source in total capital.

Cost and other consequences: A finance manager while raising fund must take into consideration the cost and other consequences associated with each source.

Investment decision is also categorized into two parts:

Working capital investment i.e.

Long-term investment i.e. investment

investment in current asset

in project decision


Both categories of investment decision require following three key points to take into consideration: (i) Assets

(ii) Assets mix

(iii) Profitability

Assets: Assets means resources to the organization. A finance manager has to identify what are the various assets required to maintain for smooth functioning of concerned organization.

Assets mix: He has to decide the composition of each asset in total assets.

Profitability: A finance manager while investing fund must take into consideration the profitability associated with each asset. Profitability means ability to earn profit.

Financing of Investment Decision

Sources of finance

Investment decision

Long-term sources: e.g.
Finance to

Capital budgeting


(Project) decision /

Long-term debt

long-term investment

Reserve & surplus

Finance to

Short-term sources: e.g.

Working capital

Short-term securities

Trade creditors


Finance to

Short-term loan/Bank


Dividend decision: (Distribution of fund)

A finance manager has to decide what percentage of profit he has to distribute as dividend among shareholders and how much to retain for further requirement. This aspect of financial management is dealt under dividend policy.

Financial Analysis

l     Financial analysis refers to study of financial health from different interested groups’ (management, employee, government, suppliers, lenders, investors etc.) point of view.

l     Financial health means ability to serve above-mentioned groups.

l     Ratio Analysis, Cost-Volume-Profit (CVP), Fund Flow/Cash Flow Analysis are popular tools for financial analysis which in turn further helps in financial planning for subsequent periods.

3.  Financial Control

l     Financial control refers to comparison of actual activities related to financial decisions with planned activities.

l     In other words, it is reviewing financial performances as per planning schedule in order to meet the set financial objective.

l     Budgetary control system, variance analysis are some popular tools, which help in controlling activities related to financial decisions.

Apart from above-mentioned categories of finance function, finance department is also responsible for support services. They are,

l     Finance department has to make available the fund to other functional departments whenever they need money in time.

l     Finance department under financing activity has to negotiate with the lenders to acquire the fund at optimum cost.

l     Finance department keeps an eye on stock market as stock market prices reflects performance of the concerned organization.