Role and Objectives of Financial Management
We all know that finance is essential for running a business. Business enterprises require careful financial planning and understanding of the resultant capital structure, risks, and profitability that they may have. All these have an effect on shareholders as well as the employees. They require an understanding of business finance, major financial decision areas, financial risk, and the business’s working capital requirements. The success of a business depends on how well finance is invested in assets and operations and how timely and cheaply the finance is arranged from different sources.
Meaning of Business Finance
The money required for carrying out business activities is known as Business Finance. Every business activities require some finance. It is concerned with the acquisition of funds, use of funds, and distribution of projects.
Need for business finance
Business finance is needed to start a business. The need for business finance are as follows:
- To run the day-to-day activities of a business, such as the purchase of raw materials, payment of salary, etc.
- To moderate and expand the business
- To purchase assets like machinery, land, building, patents, etc.
Thus, the availability of finance is very crucial for the survival and growth of the business.
Financial Management is concerned with the management of the flow of funds and involves decisions related to the acquisition and application of funds in long-term and short-term assets. It is concerned with two aspects: procurement of funds as well as usage of finance.
Procurement of funds
For optimum procurement, there are different sources available for finance. They are identified and compared by their cost and risk applied. The fund procured is to be used as a profitable investment. This means returns from the investment must be more than the cost at which funds have been procured.
Usage of finance
As financial management aims at ensuring the availability of enough funds whenever required. It also looks that the development of funds is effective. The funds invested should yield good returns for the business.
Role of Financial Management
Financial management influences the financial health of a business. The financial statements such as the Balance Sheet and Profit and Loss account show the firm’s financial position and health. Most of the items in the financial statements are affected directly or indirectly by some financial management decisions. The prominent examples of the aspects, which are affected by financial management are:
- Size as well as the composition of fixed assets: Financial management plays a significant role in determining the size and composition of fixed assets of a business. Such as the decision of investing rupees 80 crores in fixed assets by capital budgeting will realize the fixed assets by the same amount.
- Quantum of current assets: Financial management decisions can influence the quantum of current assets. The quantum of current assets has to determine the amount of current investment, as well as its breakup into cash inventories and receivables.
- Amount of long-term and short-term finance: Financial management takes decisions regarding the proportion of long-term and short-term finance. An organization raises more for the long-term basis if it wants to remain more liquid. But long-term debts adversely affect the profitability of the business because debts are costly as compared to short-term debts.
- Breakup of long-term finance into debt of equity: Financial management decisions also help in fixing the ratio between debt and equity in long-term finance. As for the amount of debt, equity share capital and preference share capital are affected by the financial financing decision.
- All items in the profit and loss account: Financial management decisions also affect the items in the profit and loss account of the business. For example, the use of more debts means higher interest expense and the use of more equity means higher dividend payments.
Objectives of Financial Management
The primary and most important objective of financial management is to maximize the wealth of equity shareholders, which means maximizing the market price of equity shares. This is because the company’s fund belongs to the shareholder. Market price of equity shares increases if the benefits derived from a decision exceed the cost involved. So, all the financial decisions are made to make some profit. So that the market price of equity shares is maximized.
For example, financial management not only makes decisions about investing in new machines, but also takes care of the fact that the benefits from the investment exceed the cost. Therefore, there might be a few projects for the improvement of the market price of the share. Further, when finance is acquired, the management focuses on diminishing the cost, so that the value addition is even greater.
Profit Maximisation Vs Wealth Maximisation
One of the most important objectives of financial management is Profit maximization. The objective of profit maximization measures the performance of a company by looking at its total profit. In this process of profit maximization, the risk performed by the firm is not considered. Though profit maximization is criticized, as it ignores the timing of returns, it ignored the interest of consumers, workers, and society, it ignores the effect of dividend policy on the market value of shares, it does not consider uncertainty or future earnings and it does not differentiate between short-term and long-term profits.
On the other hand, the wealth maximization objective is to consider all the future cash flows, dividends, earnings per share, risk of a decision, etc. The objective of wealth maximization is not possible without ensuring the availability of sufficient funds at a reasonable cost with effective utilization of funds and ensuring the safety of funds by creating reserves, re-investment of profits, etc. This objective also helps in achieving other objectives of financial management.
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