ROLE AND SIGNIFICANCE OF FINANCE IN OTHER FUNCTIONAL AREAS

Submitted to : R.D. Purkayasthya Assistant Professor DBA-JNSMS

Submitted by :

Biswajit Bhattacharjee

Student, DBA-JNSMS

Roll No. 19

INTRODUCTION

Finance is the lifeblood of business organisations, without finance the formation, establishment, production, functioning or operating of big, medium or small business enterprise is not possible. Finance may be defined as the art and science of managing money. The major areas of finance are :

1) financial services and

2) financial management

Financial Services is concerned with the design and delivery of products to individuals, business and government within the areas of financial institutions, personal financial planning, investments, real estate, and so on.

Financial management is concerned with the duties of the financial mangers in the business firm.

The subject of finance is traditionally classified into two classes

1) Public Finance and

2) Private Finance.

Public finance deals with the requirements, receipts, and disbursement of funds

in the government institutions like states, local self-governments and central

governments.

Whereas the private finance deals with the requirements, receipts and

disbursement of funds by the individual, a business organisation and non-business

organisation. The private finance from the above we can once again classified into

personal finance and business finance and finance of non-business organisation.

MEANING OF BUSINESS FINANCE

To understand the meaning of business finance there is a need to understand the

concepts business and finance. Business may be understood as the organised

efforts of enterprises to supply consumers with goods and services for satisfying

these needs and wants and in the process. All businesses share the same purpose

that is to earn profits. Broadly speaking, the term business includes industry,

trade and commerce.

Finance refers to provisioning of money at the time when it is required. Here

finance refers to management of flows of money through an organisation. Hence

Business Finance concerned with acquisition of funds, use of funds and

distribution of profits by a business firm.

The business finance can be further classified in to sole proprietary finance,

partnership finance and company or corporate finance. The principle of business

finance can be applied to any of the forms of business organisations. But since the

business in an economy in terms of value in companies is more hence the

emphasis to the financial practices and problems of the incorporated enterprises

are studied much in business finance. So most of the authors use corporate

finance interchangeably with business finance.

DEFINITIONS OF FINANCIAL MANAGEMENT

Financial management refers to that part of the management activity which is

concerned with the planning and controlling of firm's financial resources. It deals

with finding out various sources for raising funds for the firm.

Accoding to Soloman, 'Financial Management is concerned with the efficient use

of important economic resource, manely, Capital Funds.'

According to Prather & Wert, "Business finance deals primarily with raising

administering and disbursing funds by privately owned business units operating in

non-financial fields of industry."

Wheeler defines Business Finance as "that business activity which is concerned

with the acquisition and conservation of capital funds in meeting the financial

needs and administering the funds used in the business."

According to Guthmann and Dougall, business finance can be broadly defined as

the activity concerned the planning, raising, controlling and administering the

funds used in the business.

According to James C. Van Horne 'Financial Management is concerned with the

acquisition, financing, and management of assets with some overall goal in mind.'

ROLE AND SIGNIFICANCE OF FINANCE IN OTHER FUNCTIONAL AREAS

Various functional areas of management are:

Production management

Marketing management

Financial management

Personal management

Production management:

Production means creation of utilities by converting raw material in to final

product by various scientific methods and regulations. It is very important field of

management. Various sub-areas of the production department are as follows.

Plant lay out and location

Production planning

Material management

Research and Development

Quality Control

Marketing management:

Marketing management involves distribution of the product to the buyers. It may

need number of steps. Sub areas are as follows

Advertising

Sales management

Market research

Finance and accounting management :

Financial and accounting management deals with managerial activities related to

procurement and utilization of fund for business purpose. Its sub areas are as

follows

Financial accounting

Management accounting

Taxation

Costing

Personnel Management :

Personnel management is the phase of management which deals with effective

use and control of manpower. Following are the sub areas of Personnel

management

Personnel planning

Recruitment and selection

Training and development

Wage administration

Industrial relation

Relationship of Finance with other Functional areas

Relationship with production management

The production department is responsible for the development and

manufacturing of the product. It is also responsible for the quality control. The

inventory manager acts as the bridge between the sales department and

production department. The inventory manager develops the inventory policy

considering the requirement of both production department and the marketing

department. Similarly, the capital budgeting manager works in coordination with

the sales department and production department in order to decide whether an

investment proposal is to be made or not. The capital budgeting manager uses

the revenue forecast from the sales department and production volume and costs

from the production department in order to analyze an investment alternative.

Thus, there is close relationship between production management and financial

management.

Relationship with marketing management

The financial manager closely work with the marketing manager. The marketing

manager involves in product survey, demand analysis and forecasting of the sales

volume for the given price. The marketing manager also involves in new product

development, expanding marketing territory, pricing of the products etc. These

functions of the marketing manager have financial implications. The financial

manger closely works with marketing manager in these issues in order to analyze

develops the promotion and pricing strategies. In this regard, the credit manager,

inventory manager and the capital budgeting manager work together with the

credit policies. Similarly, the inventory manager suggests the best inventory

policy. The capital budgeting manager analyses the feasibility of the project.

Relationship with human resource management

Human resource management involves in the recruitment and selection of the

employees. It definitely involves cost. The costs of human resource are analyzed

in capital budgeting decision by the capital budgeting manager. Similarly, the

treasure works closely with human resource department regarding the pension

fund management and different incentive policies to the employees.

ROLE AND SIGNIFICANCE OF FINANCE IN OTHER FUNCTIONAL AREAS

Business finance is required for the establishment of every business

organisation. With the growth in activities, financial needs also grow. Funds

are required for the purchase of land and building, machinery and other

fixed assets. Besides this, money is also needed to meet day-to- day

expenses e.g. purchase of raw material, payment of wages and salaries,

electricity bills, telephone bills etc. We are aware that production continues

in anticipation of demand. Expenses continue to be incurred until the goods

are sold and money is recovered. Money is required to bridge the time gap

between production and sales. Besides producers, may be necessary to

change the office set up in order to install computers. Renovation of

facilities can be taken up only when adequate funds are available.

To meet contingencies

Funds are always required to meet the ups and downs of business and

unforeseen problems. Suppose, some manufacturer anticipates shortage of raw

materials after a period. Obviously he would like to stock raw materials. But he

will be able to do so only when money would be available.

To promote sales

In this era of competition, lot of money is required to be spent on activities for

promoting sales like advertisement, personal selling, home delivery of goods etc.

To avail of business opportunities

Funds are also required to avail of business opportunities. Suppose a company

wants to submit a tender but some minimum amount is required to be deposited

along with the application. In the case of non-availability of funds it would not be

possible for the company to apply.

AREAS OF DECISION MAKING IN FINANCIAL MANAGEMENT

Therefore the decision function of financial management can be broken down

into three major areas: the investment, financing, and asset management

decisions.

Investment Decision

The investment decision is the most important of the firm's three major decisions

when it comes to the value creation. Investment decision relates to the

determination of total amount of assets to be held in the firm, the composition of

these assets like the amount of fixed assets, current assets and the extent of

business risk involved by the investors.

The investment decisions can be classified in to two groups: (1) Long-term

investment decision or capital budgeting and (2) Short-term decision or Working

capital decision.

Financing Decision

Financing decision follows the Investment decision. The Finance manager now has

to decided how much of finance is required to meet the long-term and short-term

investment decisions, what are the sources of financing these investment

decisions, what is the composition of these finance and what should be the

financial mix and so on.

Asset Management Decision

The third important decision of the firm is the asset management decision. Once

assets have been acquired and appropriate financing provided, these assets must

still be managed efficiently. The finance manager has more responsibility in

managing the current assets than fixed assets. A large share of the responsibility

of managing the fixed assets would reside in the hands of operating managers of

the company.

SCOPE OF FINANCIAL MANAGEMENT

Financial management is concerned with acquisition, proper utilisation or

allocation of these funds. It is an activity concerned with the planning, raising,

controlling and administering the funds used in the business. Hence the finance

manager have to concentrate on the following areas of finance function.

Estimating Financial Requirements. The finance manager has to estimate what

would be the short term and long-term financial requirement of his business. For

this he has to prepare financial plan for present as well as for future. He should

make correct estimate of finance for purchasing of fixed assets and current assets.

The estimate should be accurate other wise it leads to either excess of funds or

inadequacy both these situations will have adverse impact on the profitability of

an organisation.

Deciding Capital Structure. The capital structure refers the composition and

proportion of different securities for raising funds. After deciding the estimate of

financial requirements for fixed and current assets of his business the finance

manager must decide what should be composition of long-term funds like capital

and debt ratio. Then he has to plan what should be its proportion by taking in to

consideration the cost of funds. Similarly for short-term funds.

Selecting a Source of Finance. After selecting the capital structure the finance

manager must select the sources of finance by considering the cost of capital and

availability of funds in the market.

Selecting a pattern of investment. After procurement of funds, he has to decide

the pattern of investment. He should decide about which assets should be

purchased among fixed assets and which is the method of selecting the fixed

assets or capital budgeting techniques to be used and cost analysis etc.,

Proper Cash Management. Proper cash management is another important

function of finance manager. He has to asses the cash needs of the organisation

like for purchasing of raw materials, making payment to the creditors, wages, rent

and other day-today expenses. He must identify the sources of raising cash like

from cash sales, collection of debts, short-term loans from banks and so on. The

cash in an organisation neither excess nor shortage. Excess cash will increase the

idle funds in the organisation, whereas shortage of funds or cash will affect the

creditworthiness of the company, hence it should be adequate.

Implementing Financial Controls. Efficient financial management requires

implementation of some financial controls like ratio analysis, return on capital

employed, return on assets, budgetary control, break-even analysis, return of

investment, internal audit etc., to evaluate the performance of various financial

policies of the organisation.

Proper use of surpluses. Proper use of profits or surpluses is also essential for the

expansion and diversification plans and also protecting the interests of

shareholders. Issue of bonus shares or ploughing back of capital etc., will increase

the value of the shares of the company hence judicious utilisation of these

surpluses is very important.

OBJECTIVES OR GOALS OF FINANCIAL MANAGEMENT

Financial management is concerned with procurement and use of funds. Its main

aim is to use business funds is such a way that value or earnings of the firm's are

maximised. There are various alternative ways of using business funds. The

organisation should go through the pros and cons of each alternative way of using

these business funds before final selection. The financial management provides a

framework for selecting a proper course of action and deciding a viable

commercial strategy.

The following are the objectives of financial management.

Profit Maximisation

Wealth Maximisation, and

Other objectives.

PROFIT MAXIMISATION

The main objective of a business firm is profit maximisation because the business

firm is a profit-seeking organisation. Hence the objective of the financial

management of business organisation is profit maximisation. There are some

arguments in favour of this objective of business. They are.

a) When profit earning is the aim of business then profit maximisation should be

the obvious objective.

b) Profitability is a barometer for measuring efficiency and economic prosperity

of a business enterprise, therefore, profit maximisation is justified on the

grounds of rationality.

c) The economic and business conditions do not remain same at all the times like

recession, depression, cut throat competition and so on. Hence the business

organisations should earn more and more profits when the situations are

favourable.

d) Since profit is the main source finance for growth and development of a

business organisation hence, keeping profit maximisation of profit, as an

objective of the business is justifiable.

e) Through maximisation of profitability of a business it is possible to contribute

more and more funds for social activities to meet social goals.

However, the concept of profit maximisation has been criticised and rejected as

the objective of financial management of a business organissation on account of

the following reasons:

a) It is vague. The term 'profit' is vague and it cannot be precisely defined. It

means the term profits if different to different people. Which profits are to be

maximised, short term or long term profit, profits before tax or after tax, or

total profits or profit per share and the like.

b) It ignores timings. Profit maximisation objective ignores the time value of

money and does not consider the magnitude and timing of earnings.

1. It overlooks quality aspects of future activities. The business is not solely run

with the objective of earning maximum profits. Some organisations give more

emphasis to sales growth, by increasing its volume of sales by decreasing the

profits or gain margin. Some organisations make more profits and contribute

more amounts to the development of the society.

WEALTH MAXIMISATION

Wealth or net worth is the difference between gross present worth and the

amount of capital investment required to achieve the benefits. Any financial

action which creates wealth or which has a net present worth above zero is a

desirable one and should be undertaken. The operating objective for financial

management is to maximise wealth or net present worth. Wealth maximisation is,

therefore, considered to be the main objective of financial management. The

objective of wealth maximisation is to maximise the economic welfare of the

shareholders of a company. The value of a company's shares depends largely on

its new worth which itself depends on earning per share (EPS). A stockholder's

current wealth in the firm is the product of the number of shares owned,

multiplied with the current stock price per share.

Stockholder's current wealth in the firm = (Number of shares owned) x (current

stock price per share)

It is symbolically represented

W o = NP o

Thus the business organisation should strive for the increase in the current stock

price per share or EPS, so that the current wealth of a firm will increases. This in

turn depends upon the proper financial management.

CRITICISM OF WEALTH MAXIMISATION

The wealth maximisation objective has been criticised by certain financial theorists mainly on the following grounds.

a) It is a prescriptive rather than descriptive. The objective should tell what the

firm should actually do.

b) The objective of wealth maximisation is not necessarily socially desirable.

c) There is controversy as to whether the objective of a firm is maximise the

stockholders wealth or wealth of the firm, since the firm includes

stockholders, debenture-holders, preference shareholders etc.

d) Since the management and ownership are separated in large corporate form

of organisations, the managers will act in such a manner, which maximises the

managerial utility rather than the wealth maximisation of stockholders of the

firm. This is a controversial argument.

In spite of all the criticism, we are of the opinion that wealth maximisation is the

most appropriate objective of a firm.

OTHER OBJECTIVES

Besides the above basic objectives, the following are the other objectives of

financial management.

(a) Ensuring fair return to shareholders.

(b) Building up reserves for growth and expansion.

(c) Ensuring maximum operational efficiency by efficient and effective utilisation

of finances.

(d) Ensuring financial discipline in the organisation.