MCM606_Financial Management-converted

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MASTER OF COMMERCE SEMESTER-II FINANCIAL MANAGEMENTMCM60 2

CHANDIGARH UNIVERSITY Institute of Distance and Online Learning Course Development Committee Prof. (Dr.) R.S.Bawa Pro Chancellor, Chandigarh University, Gharuan, Punjab Advisors Prof. (Dr.) Bharat Bhushan, Director – IGNOU Prof. (Dr.) Majulika Srivastava, Director – CIQA, IGNOU Programme Coordinators & Editing Team Master of Business Administration (MBA) Bachelor of Business Administration (BBA) Coordinator – Dr. Rupali Arora Coordinator – Dr. Simran Jewandah Master of Computer Applications (MCA) Bachelor of Computer Applications (BCA) Coordinator – Dr. Raju Kumar Coordinator – Dr. Manisha Malhotra Master of Commerce (M.Com.) Bachelor of Commerce (B.Com.) Coordinator – Dr. Aman Jindal Coordinator – Dr. Minakshi Garg Master of Arts (Psychology) Bachelor of Science (Travel &Tourism Management) Coordinator – Dr. Samerjeet Kaur Coordinator – Dr. Shikha Sharma Master of Arts (English) Bachelor of Arts (General) Coordinator – Dr. Ashita Chadha Coordinator – Ms. Neeraj Gohlan Academic and Administrative Management Prof. (Dr.) R. M. Bhagat Prof. (Dr.) S.S. Sehgal Executive Director – Sciences Registrar Prof. (Dr.) Manaswini Acharya Prof. (Dr.) Gurpreet Singh Executive Director – Liberal Arts Director – IDOL © No part of this publication should be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording and/or otherwise without the prior written permission of the authors and the publisher. SLM SPECIALLY PREPARED FOR CU IDOL STUDENTS Printed and Published by: TeamLease Edtech Limited www.teamleaseedtech.com CONTACT NO:- 01133002345 For: CHANDIGARH UNIVERSITY 3 Institute of Distance and Online Learning

First Published in 2020 All rights reserved. No Part of this book may be reproduced or transmitted, in any form or by any means, without permission in writing from Chandigarh University. Any person who does any unauthorized act in relation to this book may be liable to criminal prosecution and civil claims for damages. This book is meant for educational and learning purpose. The authors of the book has/have taken all reasonable care to ensure that the contents of the book do not violate any existing copyright or other intellectual property rights of any person in any manner whatsoever. In the even the Authors has/ have been unable to track any source and if any copyright has been inadvertently infringed, please notify the publisher in writing for corrective action. 4

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CONTENT Unit -1 Introduction To Financial Management...................................................................4 Unit-2 Financial Management Objectives .......................................................................... 13 Unit-3 Finance Function........................................................................................................ 26 Unit -4 Financial Decisions.................................................................................................. 36 Unit -5 Time Value Of Money............................................................................................... 50 Unit-6 Capital Investment Decisions................................................................................. 63 Unit-7 Techniques Of Capital Budgeting .......................................................................... 75 Unit-8 Working Capital Management And Finance .......................................................... 98 Unit-9 Methods Of Working Capital ................................................................................. 114 Unit-10 Working Capital Management And Finance Ii................................................... 130 Unit-11 Inventory Management ......................................................................................... 152 Unit-12 Leverage .................................................................................................................. 165 3 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT -1 INTRODUCTION TO FINANCIAL MANAGEMENT Structure Introduction Learning Objectives Introduction of Financial Management Meaning Evolution of Financial Management Importance of Financial Management Summary Keywords Learning Activity Unit end Questions References LEARNING OBJECTIVES After studying this unit, you will be able to: • Highlight the basic concepts of Financial Management • Explain evolution of financial statement • State importance of financial statement INTRODUCTION Finance is regarded as the life blood of the business enterprise and an integral part of the overall management which is concerned with the financial decision making. Finance is the art and science of managing money. The discipline of finance is concerned with the procurement, allocation, application and disbursement of money to maximize the return on invested capital. Financial management is the management of funds and use of important economic resources. Financial decisions are important as it results in procurement of funds and their effective utilization in the business. Financial Management deals with the two aspects of financial activities one is inflow of cash and the other is outflow of cash. These inflow and outflow of cash are performed through types of activities as a) operating activities b) investing activities and c) financing activities. Financial Management helps in increasing the intrinsic value of the firm by controlling inflows and outflows of cash properly. The Finance managers helps in actively managing the affairs of the business and perform various tasks of budgeting, financial forecasting, cash management, credit administration, investment analysis and fund management. So Finance is needed to carry on the business operations and achieve its objectives by providing funds to the business enterprise in terms of its need. Hence Financial 4 CU IDOL SELF LEARNING MATERIAL (SLM)

Management is concerned with the entire gamut of managerial decisions which results in acquisition and financing of long term and short-term credits of the firm. MEANING Financial Management is a systematic process that provides the necessary financial information to help a business to produce and distribute the goods and services in a way that will help to make the most profit. It is a managerial activity that is associated with planning and controlling of the company’s financial resources are scarce and limited which needs proper planning and control for achieving the best result out of the complex situation of risk and uncertainty and it is regarded as specialized function of general management for achievement of common goal of the organization. “It can be defined as the activity concerned with the planning, raising, controlling and administering of funds used in the business” Financing Decisions If carefully reviewed what constitutes a business, we will come to the conclusion that there are two things that matter, money and decision Without money, a company won’t survive and without decisions, money can’t survive. An administration has to take countless decisions in the lifetime of the company. Thus, the most important ones are related to money. The decisions related to money are called ‘Financing Decisions.’ Investment Decision These are also known as Capital Budgeting Decisions. A company’s assets and resources are rare and must be put to their utmost utilization. A firm should pick where to invest in order to gain the highest conceivable returns. This decision relates to the careful selection of assets in which funds will be invested by the firms. The firm puts its funds in procuring fixed assets and current assets. When choice with respect to a fixed asset is taken it is known as capital budgeting decision. Financing Decision Financial decision is important to make wise decisions about when, where and how should a business acquire fund. Because a firm tends to profit most when the market estimation of an organization’s share expands and this is not only a sign of development for the firm but also it boosts investor’s wealth. Consequently, this relates to the composition of various securities in the capital structure of the company. EVOLUTION OF FINANCIAL MANAGEMENT In 1900 Finance Management emerged as a separate field of accounting and the enterprises became big and complex with technological growth and evolution as creation of certain industries resulted in funds, thus promoting investment, liquidity and financing of the firms. 5 CU IDOL SELF LEARNING MATERIAL (SLM)

The process of evolution of financial management was divided into many phases: T T First Phase till 1890: Till 1890 Financial Management was a branch of economics and under this phase the basic responsibility was of the financial managers for the procurement of funds W and so the scope of financial management was limited. Its evolution may be divided into H three broad phases (though the demarcating lines between these phases are somewhat arbitrary): the traditional phase, the transitional phase, and the modern phase. A. The traditional phase lasted for about four decades. The following were its important features: • he focus of financial management was mainly on certain episodic events like formation, issuance of capital, major expansion, merger, reorganization, and liquidation in the life cycle of the firm. • he approach was mainly descriptive and institutional. The instruments of financing, the institutions and procedures used in capital markets, and the legal aspects of financial events formed the core of financial management. B. The transitional phase commenced around 1940 and continued till early 1950 where the general problems related to the fund analysis, planning and control were highlighted. C. Modern Phase: It began in mid-fifties of the last century and under this phase the scope of financial management extended as it covered three issues •I n what form should a firm hold its assets? • hat should be the composition of the liabilities of the firm? • ow large a firm should grow? In order to solve these problems, the financial management has to take three decisions and financial management has evolved from a branch of economics. IMPORTANCE OF FINANCIAL MANAGEMENT Financial management is one of the most integral responsibilities of business owners and managers. One need to consider all the potential consequences of your management decisions on profits, cash flow, and the financial health of the company Corporate/ business finance is an important and inevitable function in any business and 6 CU IDOL SELF LEARNING MATERIAL (SLM)

efficient financial management is crucial for success and sustenance since it involves the management of financial resources and financial activities of the organization. As Collin Brooks has remarked “Bad Production Management and bad sales management have slain in hundreds, but faulty financial management has slain in thousands.” Financial management helps in ascertaining about the performance of the company in future. It helps in indicating whether the firm will generate sufficient funds to meet its various obligations like repayment of the various instalments due on loans, redemption of other liabilities, etc. So sound financial management encompasses different activities and is indispensable for any organization, as it in helps in profit planning, capital spending, measurement of costs and thus helps in optimizing the output from a given input of funds. Financial management provides pathways to attain goals and objectives in an organisation. The main duty of a financial manager is to measure organisational efficiency through proper allocation, acquisition and management. The importance of financial management is explained below − • It provides guidance in financial planning. • It assists in acquiring funds from different sources. • It helps in investing an appropriate amount of funds. • It increases organisational efficiency. • It reduces delay production. • It cut down financial costs. • It reduces cost of fund. • It ensures proper use of fund. • It helps business firm to take financial decisions. • It prepares guideline for earning maximum profits with minimum cost. • It increases shareholders’ wealth. • It can control the financial aspects of the business. • It provides information through financial reporting. • It makes the employees aware of saving funds. Finance is the lifeblood of business organization. It needs to meet the requirement of the business concern. Each and every business concern must maintain adequate amount of finance for their smooth running of the business concern and also maintain the business carefully to achieve the goal of the business concern. The business goal can be achieved only with the help of effective management of finance. We can’t neglect the importance of finance 7 CU IDOL SELF LEARNING MATERIAL (SLM)

at any time at and at any situation. Some of the importance of the financial management is as follows: Financial Planning. Financial management helps to determine the financial requirement of the business concern and leads to take financial planning of the concern. Financial planning is an important part of the business concern, which helps to promotion of an enterprise Acquisition of Funds. Financial management involves the acquisition of required finance to the business concern. Acquiring needed funds play a major part of the financial management, which involve possible source of finance at minimum cost. Proper Use of Funds. Proper use and allocation of funds leads to improve the operational efficiency of the business concern. When the finance manager uses the funds properly, they can reduce the cost of capital and increase the value of the firm. Financial Decision. Financial management helps to take sound financial decision in the business concern. Financial decision will affect the entire business operation of the concern. Because there is a direct relationship with various department functions such as marketing, production personnel, etc. Improve Profitability. Profitability of the concern purely depends on the effectiveness and proper utilization of funds by the business concern. Financial management helps to improve the profitability position of the concern with the help of strong financial control devices such as budgetary control, ratio analysis and cost volume profit analysis. Increase the Value of the Firm. Financial management is very important in the field of increasing the wealth of the investors and the business concern. Ultimate aim of any business concern will achieve the maximum 8 CU IDOL SELF LEARNING MATERIAL (SLM)

profit and higher profitability leads to maximize the wealth of the investors as well as the nation. Promoting Savings. Savings are possible only when the business concern earns higher profitability and T maximizing wealth. Effective financial management helps to promoting and mobilizing individual and corporate savings. F Now days financial management is also popularly known as business finance or corporate T finances. The business concern or corporate sectors cannot function without the importance H of the financial management. A H SUMMARY A • his chapter focusses the nature of financial management in terms of its relationship with its scope and objectives and the organization of its finance functions. The importance of financial management is an integral part of the management of the firm and it depends on the size of the firm as financial management and managerial finance is concerned with the duties of the finance manager in the business firm. • inancial management is one of the most important aspects in business. In order to start up or even run a successful business, you will need excellent knowledge in financial management. So what exactly is this form of management and why is it important? Read on to find out more. • his form of management is important for various reasons. Take a look at some of these reasons: • elps organizations in financial planning; • ssists organizations in the planning and acquisition of funds; • elps organizations in effectively utilizing and allocating the funds received or acquired; • ssists organizations in making critical financial decisions; 9 CU IDOL SELF LEARNING MATERIAL (SLM)

• H elps in improving the profitability of organizations; P •I E ncreases the overall value of the firms or organizations; F • T rovides economic stability; T T • ncourages employees to save money, which helps them in personal financial planning. F F • inancial management has emerged as a distinct field of study, only in the early part of F this century, as a result of consolidation movement and formation of large enterprises. B Its evolution may be divided into three phases (somewhat arbitrary) viz., • he Traditional phase, • he Transitional phase and • he Modern phase. KEYWORDS / ABBREVIATIONS • inance: It is defined as the management of money and includes activities such as investing, borrowing, lending, budgeting, saving, and forecasting. • inancial Management: Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprise. It means applying general management principles to financial resources of the enterprise. • inancial Modeling: is the task of building an abstract representation (a model) of a real world financial situation. • usiness Valuation models: - A business valuation is a general process of determining the economic value of a whole business or company unit. Business valuation can be used to determine the fair value of a business for a variety of reasons, including sale value, establishing partner ownership, taxation, and even divorce proceedings. 10 CU IDOL SELF LEARNING MATERIAL (SLM)

LEARNING ACTIVITY E E 1. xplain the role of finance in a public limited company. 2. xplain how financial management is of help in any organization UNIT END QUESTIONS A. Descriptive Types Questions: 1. Identify the decision taken in financial management which affects the liquidity as well as the profitability of business. 2. What are the phases needs to be implemented in financial management to be successful. 3. State and explain the role of finance in any organization. 4. Explain the importance of financial management in success of any organization. 5. Evaluate briefly the term financial management. B. Multiple Choice Questions 1. Financial management is mainly concerned with a. Arrangement of funds b. All aspects of acquiring and utilizing the financial resources for the firm’s activities c. efficient management of business 2. Basic objective of Financial Management is a. Making Profit b. Maximization of shareholder’s wealth c. Ensuring financial discipline in the organization 3. Financial Management helps in: a. The estimation of total requirement of funds b. Long-term planning of company’s activities c. Profit planning of the organization 11 CU IDOL SELF LEARNING MATERIAL (SLM)

4. The finance manager is responsible for a. Arrangement and efficient utilization of funds b. Arrangement of financial resource c. Acquiring capital assets for the organization 5. The concept of financial management is. a. Profit maximization b. All features of obtaining and using financial resources for company operations c. Organization of funds d. Effective Management of every company Answer: 1. b), 2. b), 3. a), 4. b), 5. b) REFERENCES • Chandra, P. (2012). Financial Management. New Delhi: Tata McGraw Hill. • James, C. (2014). Financial Management. New Delhi: Prentice-Hall. • Khan, M.Y. & Jain, P.K. (2012). Financial Management. New Delhi: Tata McGraw Hill. • Pandey, I.M (2009). Financial Management. New Delhi: Vikas Publishing House. • Maheshwari S.N. (2014). Principles of Financial Management. New Delhi: Sultan Chand & Sons. • Kulkarni P.V. (2014). Financial Management. Mumbai: Himalaya Publishing House. • Brigham and Ehrhardt, Financial Management: Theory & Practice, Thomson ONE, 2010 • Brigham and Houston, Fundamentals of Financial Management, Thomson ONE, 2009. 12 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT-2 FINANCIAL MANAGEMENT OBJECTIVES Structure Learning Objectives Introduction Wealth Maximization Profit Maximization and Wealth Maximization Profit Maximization Vs. Wealth Maximization Comparison of profit maximization and wealth maximization Scope of Financial Management Summary Keywords Unit End Questions References LEARNING OBJECTIVES After studying this unit you will be able to • Discuss the basic concept of profit maximization • Explain wealth maximization • Outline scope of financial management INTRODUCTION Financial Management is a critical topic in business. The reason is that a company cannot function without the proper use of funds. It might even suffer stunted growth. To understand and apply the right management practices in the handling and use of funds, one has to know how valuable financial management is to a business. Profit Earning is the primary aim of the business enterprise as it is an important economic activity and the business firm must earn profit to cover its cost and provide the funds for growth. Financial Management is concerned with the proper utilization of funds in such a manner that it will increase the value plus earnings of the firm. Wherever funds are involved, financial management is there. There are two paramount objectives of the Financial Management: Profit Maximization and Wealth Maximization. Profit Maximization as its name signifies refers that the profit of the firm should be increased while Wealth Maximization, aims at accelerating the worth of the entity. No business can survive in the long run without earning profit and it is a measure of efficiency of the business enterprise as profits serve as a protection against the risks of the 13 CU IDOL SELF LEARNING MATERIAL (SLM)

business. The accumulated profit helps the business to face all risks with fall in prices, R advertisements, competition from other units, advertisements. So the basic idea behind profit S maximization approach is to earn maximum profit by optimum use of resources as profit is the yardstick of measurement of efficiency and the financial activities are managed in such a way to ensure that sufficient profit is earned by use of efficient resources like capital .In spite of its advantages the concept of profit maximization has been criticized o the following grounds: •I ndistinct concept of profit: The main idea behind profit maximization was to maximize profit but it varies with the short term and long term profit. •I gnoring the time value of money: Time value of money is not considered in the theory of profit maximization as different amount of cash inflows occurs at different times and the approach considers only the total value of money without considering the times of inflows. • isk and Uncertainty: This aspect has been ignored in the profit maximization criterion as the future earnings of the different projects are subject to the different types of risks and as the earning capacities of different projects are same , so the value of the earnings are never identical. WEALTH MAXIMIZATION According to Prof .Solomon Ezra, the primary goal of the financial management should be the maximization of the owner’s wealth ad according to him the maximization of the profit is the half and unreal motive because the proper goal of financial management is wealth maximization of the equity shareholders as it is expressly concerned with the relationship of profitability. Wealth maximization is the concept of increasing the value of a business in order to increase the value of the shares held by its stockholders. The concept requires a company's management team to continually search for the highest possible returns on funds invested in the business, while mitigating any associated risk of loss. This calls for a detailed analysis of the cash flows associated with each prospective investment, as well as constant attention to the strategic direction of the organization. It is the versatile goal of the company and highly recommended criterion for evaluating the performance of a business organization. This will help the firm to increase their share in the market, attain leadership, and maintain consumer satisfaction and many other benefits are also there. To maximize wealth to the shareholders, a firm must: • 14 CU IDOL SELF LEARNING MATERIAL (SLM)

trike a balance between debt and equity in financing A M • E void a high level of risk, when the projects with positive or maximum net present value are accepted as the value of the firm is maximized. M P • P anage customers properly P • nhanced information system and employee’s capabilities •I ncrease the market share by new products and process developments and by improving the quality of the products. PROFIT MAXIMIZATION AND WEALTH MAXIMIZATION Profit maximization is the primary objective of the concern because of profit act as the measure of efficiency. On the other hand, wealth maximization aims at increasing the value of the stakeholders. The following important points are in support of the profit maximization objectives of the business concern: • ain aim is earning profit. • rofit is the parameter of the business operation. It indicates efficiency and economic prosperity of a business. • rofit reduces risk of the business concern. • rofit is the main source of finance Profitability meets the social needs also. It helps in safeguarding the interests of different stakeholders. So, profit is essential for satisfying social objectives also. A firm, by pursuing the objective of profit maximization, also maximizes social welfare. The following important points are against the objectives of profit maximization (i) I t is argued that profit maximization is a consequence of perfect competition, and in the face of imperfect modern markets, it cannot be a legitimate objective of the 15 CU IDOL SELF LEARNING MATERIAL (SLM)

firm. P (ii) rofit maximization leads to exploiting workers and consumers. This concept was developed in the early of 19th century, when the businesses were mostly in the form of sole-proprietorship businesses. The only aim was to enhance his individual wealth and personal power, which could easily be satisfied by the profit maximization objective. However, in the present day business world the concept of limited liability has been introduced which has separated ownership and management. Nowadays a business is financed not only by its shareholders but also by its creditors, different financial institutions etc. and is run by a group of professional managers. All these stakeholders have conflicting interests in the same organization. So, in the modern business environment profit maximization is regarded as unrealistic and difficult. Profit maximization creates immoral practices such as corrupt practice, unfair trade practice, etc. Profit maximization objectives leads to inequalities among the stake holders such as customers, suppliers, public shareholders, etc. Drawbacks of Profit Maximization Profit maximization objective consists of certain drawback also: •I t is vague: In this objective, profit is not defined precisely or correctly. It creates some unnecessary opinion regarding earning habits of the business concern. •I t ignores the time value of money: Profit maximization does not consider the time value of money or the net present value of the cash inflow. It leads certain differences between the actual cash inflow and net present cash flow during a particular period. •I t ignores risk: Profit maximization does not consider risk of the business concern. Risks may be internal or external which will affect the overall operation of the business. Profit concept is not clear in the profit maximization criterion whereas wealth maximization criteria, wealth refers to the net present value of the project. In profit maximization the aspects of risks and uncertainty are ignored which are considered in wealth maximization. Also, the value of money is not considered whereas it is considered in this criterion. 16 CU IDOL SELF LEARNING MATERIAL (SLM)

PROFIT VS WEALTH MAXIMIZATION R The objective of profit maximization is to measure the performance of the firm by looking at its total profit as it does not consider the risk which the firm may undertake in maximization of its profits and it does not consider the effect of earnings per share, dividend paid or any other return to the shareholders on the wealth of the shareholders. The objective of maximization of shareholder’s wealth considers all the future cash flows, dividends, earnings per share, risk of decision and the objective of maximization of the shareholder’s wealth is operational in approach. The firm that wishes to maximize the profits may opt to pay no dividend and to reinvest the retained earnings but the firm that wishes to maximize the shareholder’s wealth may pay regular dividends. So the profit maximization can be considered as a part of the wealth maximization strategy and the objective of the maximization of the shareholder’s wealth is taken as the primary goal of financial decision making. Comparison of profit maximization and wealth maximization Profit maximization is basically a single-period or, at the most, a short-term goal. It is usually interpreted to mean the maximization of profits within a given period of time. A firm may maximize its short-term profits at the expense of its long-term profitability and still realize this goal. In contrast, shareholder wealth maximization is a long-term goal, shareholders, are interested in future as well as present profits. Wealth maximization is generally preferred because it considers (1) wealth for the long term, (2) risk or uncertainty. (3) the timing of returns, and (4) the shareholders' return.: Point of Differences between Profit Maximization and Wealth Maximization Concept: Profit maximization involves maximization of difference between revenue and cost. Wealth or value maximization involves maximization of net present value, i.e. the difference between present value of cash flows and cost incurred. Objective: Profit maximization considers profit as the most appropriate performance of a business. In the wealth maximization objective, the shareholders’ wealth is used as the most appropriate indicator for measuring the performance of the company Approach It is a quantitative approach as risk and uncertainty are not It is a quantitative as well as qualitative approach because it considered. Considers the degree of certainty with which the value may be generated. Market the existence of perfect competition in the product is assumed in case of profit maximization objective the existence of an efficient capital market is assumed at the time of recognizing wealth maximization as the objective of financial management. Profit maximization ignores the differences in the time pattern of the profit earned. This approach considers the time dimension in measuring wealth of the organization. • 17 CU IDOL SELF LEARNING MATERIAL (SLM)

isk: The profit maximization objective does not consider the risk associated with the prospective earnings stream. Wealth maximization objective takes into account the risk associated with the future stream of benefits. • A cceptability: This approach is not acceptable to all interest groups as it promotes inequality between various groups. This approach is intensively accepted by various groups as maximization of wealth also maximizes financial interest of all the groups. BASIS FOR PROFIT MAXIMIZATION WEALTH MAXIMIZATION COMPARISON Concept The main objective of a concern The ultimate goal of the concern is is to earn a larger amount of to improve the market value of its profit. shares. Emphasizes on Achieving short term objectives. Achieving long term objectives. Consideration of Risks No Yes and Uncertainty Advantage Acts as a yardstick for computing Gaining a large market share. the operational efficiency of the entity. Recognition of Time No Yes Pattern of Returns The essential difference between the maximization of profits and the maximization of wealth is that the profits focus is on short-term earnings, while the wealth focus is on increasing the overall value of the business entity over time. These differences are substantial, as noted below: Planning duration. Under profit maximization, the immediate increase of profits is paramount, so management may elect not to pay for discretionary expenses, such as advertising, research, and maintenance. Under wealth maximization, management always pays for these discretionary expenditures. 18 CU IDOL SELF LEARNING MATERIAL (SLM)

Risk management. Under profit maximization, management minimizes expenditures, so it is less likely to pay for hedges that could reduce the organization's risk profile. A wealth- focused company would work on risk mitigation, so its risk of loss is reduced. Pricing strategy. When management wants to maximize profits, it prices products as high as possible in order to increase margins. A wealth-oriented company could do the reverse, electing to reduce prices in order to build market share over the long term. Capacity planning. A profit-oriented business will spend just enough on its productive capacity to handle the existing sales level and perhaps the short-term sales forecast. A wealth- oriented business will spend more heavily on capacity in order to meet its long-term sales projections. It should be apparent from the preceding discussion that profit maximization is a strictly short-term approach to managing a business, which could be damaging over the long term. Wealth maximization focuses attention on the long term, requiring a larger investment and lower short-term profits, but with a long-term payoff that increases the value of the business. SCOPE OF FINANCIAL MANAGEMENT As Financial Management is an integral part of the overall business management, so the scope of financial management is also limited. The introduction to financial management also requires you to understand the scope of financial management. It is important that financial decisions take care of the shareholders ‘interests. Further, they are upheld by the maximization of the wealth of the shareholders, which depends on the increase in net worth, capital invested in the business, and plowed-back profits for the growth and prosperity of the organization. The scope of financial management is explained in the diagram below: Figure 2.1 Scope of Financial Management 19 The scope of financial management is discussed below: CU IDOL SELF LEARNING MATERIAL (SLM)

Traditional Approach: According to this approach the scope of financial management was limited for raising and administering funds which was required by the business enterprises for meeting the financial requirements and according to this concept the financial management had to consider three aspects---a) Collection of funds from the sale of shares and debentures b) Collection of funds from various financial institutions c) looking after the legal and accounting relationship between the sources of funds and the business. The concept of financial management was criticized for its limited scope. Firstly, the subject of finance was considered from the view point of the external suppliers of funds as investors, bankers and financial institutions but it ignored the internal financing decisions. Secondly, it highlighted the importance only to the financial problems rising due to the incorporation, amalgamation and reconstruction of the firm and in traditional approach the importance was given only to the long term capital. Thirdly under this concept the activity of financial management was limited by the collection of capital but it had not given importance for the appropriation of capital. Lastly under the traditional approach the scope of financial management was so narrow that it S failed to answer the following questions: A H • hould the firm commit capital funds for certain purposes. D F • D re the expected returns enough to compensate the cost and risk attached the and capital employed? E • ow does the cost of capital vary with the mixture of financing the methods used? According to the modern approach, the financial problem has three aspects • etermination of the necessary amount of finance for investment • ixation of the amount of investment in various classes of assets • ividend Policy. On the basis of these three aspects of financial management, the scope can be explained under different heads: • 20 CU IDOL SELF LEARNING MATERIAL (SLM)

stimation of financial requirements: The financial management estimates with D regards to the amount of fixed capital and working capital is required on the basis C of the volume of the business P D • M etermination of optimum capital structure: Capital Structure refers to the proportion of equity capital and debt capital in the total capita of the firm and it is P said to be optimum when the market price of the equity shares is maximum and the Determination of optimum capital structure financial management is needed to determine the capital structure for maximizing the market price of the equity shares. • hoice of source of financing: As every business activity requires funds and the required funds can be obtained from different sources as sale of shares, sale of debentures, taking public deposits and the financial managers evaluate the various sources of funds and choose the best source. • roper utilization of collected funds: If it is possible to meet the financial requirement of the business by the collection of the funds and maximizing the return obtainable from the investment, it is to be noted that the collected funds have been properly utilized. • etermination of Dividend Policy: The financial managers determine the dividend policy keeping in mind the legal requirements and the portion of the divisible profits which will be distributed as dividend amongst the shareholders and which portion will be reinvested into the business as retained earnings. • anagement of cash flows: The financial managers are needed to manage the cash in such a way for maintaining consistency between inflow and outflow of cash. The financial managers are needed to manage the cash in such a way for maintaining consistency between inflow and outflow of cash. So, it can be said that the scope of financial management is not limited to collection of money. SUMMARY • rofit maximization is a strictly short-term approach to managing a business, which can be damaging over the long term. It is the capability of the firm in producing maximum 21 CU IDOL SELF LEARNING MATERIAL (SLM)

output with limited input. O • T T n the other hand, Wealth maximization, which focuses attention on the long term, M increases the value of the business and eventually pays-off better. It is the ability of the company to increase the stock over time. The scope of financial management P helps one to know and understand the financial decisions take care of the shareholders’ interests. Further, they are upheld by the maximization of the wealth of the shareholders, which depends on the increase in net worth, capital invested in the business, and plowed-back profits for the growth and prosperity of the organization. • o understand the financial management scope, first, it is essential to understand the approaches that are divided into two sections. • raditional Approach • odern Approach • Wealth maximization (shareholders' value maximization) is also a main objective of financial management. Wealth maximization means to earn maximum wealth for the shareholders. So, the finance manager tries to give a maximum dividend to the shareholders. He also tries to increase the market value of the shares. The market value of the shares is directly related to the performance of the company. Better the performance, higher is the market value of shares and vice-versa. So, the finance manager must try to maximize shareholder's value. • No business can exist without having good financial management. This could fall within the responsibilities of the owner or a chief financial officer. • It has become essential for the financial manager to adopt a more comprehensive and foresighted approach. His decisions affect the size, growth and expansion, profitability and risk of business. But he had not always been considered an important person in making such decisions. However, today he is considered an important functionary. KEY WORDS/ ABBREVIATIONS • rofit Maximization: It is one of the objectives of the firm to earn higher returns on its resources, which means higher dividends to the investors. It is nothing but a criterion for economic efficiency as profits provide a yardstick by which economic performances can be judged under condition of perfect competition. 22 CU IDOL SELF LEARNING MATERIAL (SLM)

• W ealth Maximization: It is the most widely accepted objective of the firm for its E owners, which states that the management should seek to maximize the present S value of the expected returns of the firm. W • conomic interest: An institutional unit is said to have a center of economic interest within a country when there exists some location within the economic territory of the country on, or from, which it engages, and intends to continue to engage, in economic activities and transactions on a significant scale, either indefinitely or over a finite but long period of time. • hareholder’s Wealth: Shareholder wealth is defined as the present value of the expected future returns to the owners (that is, shareholders) of the firm. These returns can take the form of periodic dividend payments and/or proceeds from the sale of the stock. LEARNING ACTIVITY 1. hat is the implication of profit maximization for a small firm, as ABC Co. Limited and why should the firm follow the principle of profit maximization? 2. H ow can maximization of the shareholder’s wealth affect the activities of a big firm? UNIT END QUESTIONS (MCQ AND DESCRIPTIVE) A. Descriptive Types Questions 1. Explain the meaning of profit maximizing in a hotel with the available resources? 2. Mr. A has a salary of Rs. 50,000 and monthly expenses of Rs. 35,000. How can he maximize his wealth by keeping remaining money in bank? 3. Outline the differences between Profit Maximization and Wealth Maximization in respect to organization’s success 4. Analyze the importance of profit maximization in financial management with respect to retail store 23 CU IDOL SELF LEARNING MATERIAL (SLM)

5. Evaluate the importance of Wealth Maximization with regards to shareholders wealth B. Multiple Choice Question 1. The only feasible purpose of financial management is a. Wealth Maximization b. Sales Maximization c. Profit Maximization d. Assets maximization 2. Financial management process deals with a. Investments b. Financing decisions c. Both a and b d. none of the above 3. The objective of wealth maximization takes into account a. Amount of returns expected b. Timing of anticipated returns c. Risk associated with uncertainty of returns d. All of the above 4. Maximization of is the goal of financial management a. Shareholder’s Wealth b. Owner’s Wealth c. Profit d. None of the above 5. Shareholder’s wealth in a firm is represented by: a. The number of people employed in the firm b. The book value of the firm ‘s assets less the book value of its liabilities c. The amount of salary paid to its employees d. The market price per share of the firm’s common stock. Answers 1. a), 2. b), 3. d) , 4. a), 5. d) REFERENCES • Chandra, P. (2012). Financial Management. New Delhi: Tata McGraw Hill. • James, C. (2014). Financial Management. New Delhi: Prentice-Hall. 24 CU IDOL SELF LEARNING MATERIAL (SLM)

• Khan, M.Y. & Jain, P.K. (2012). Financial Management. New Delhi: Tata McGraw Hill. • Pandey, I.M (2009). Financial Management. New Delhi: Vikas Publishing House. • Maheshwari S.N. (2014). Principles of Financial Management. New Delhi: Sultan Chand & Sons. • Kulkarni P.V. (2014). Financial Management. Mumbai: Himalaya Publishing House. • Van Horne: Fundamentals of Financial Management, Prentice Hall, 2008 • Jeff Madura, International Financial Management, South-Western College Pub., 2010 25 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT-3 FINANCE FUNCTION L I Structure I O 3.0 S earning Objectives A S 3.1 K ntroduction L U 3.2 ntroduction to Finance Function 3.3 bjectives and scope of Finance Function 3.4 cope of Finance function and its approaches 3.5 pproaches of Finance function 3.6 ummary 3.7 eywords 3.8 earning Activity 3.9 nit End Questions 3.10 References LEARNING OBJECTIVES After studying this unit you will be able to • Apply the concept of finance function in learning financial management • State the objectives of finance function • Describe approaches of finance function INTRODUCTION Finance functions can be viewed from two different approaches; traditional approach and modern approach. Under the traditional approach finance, functions are based on only to the procurement of fund to the organization or finance function means obtaining fund to the organization or finance means funds for business enterprise. Contemporary organizations need to practice cost control if they are to survive the 26 CU IDOL SELF LEARNING MATERIAL (SLM)

recessionary times. Given the fact that many top tier companies are currently mired in low growth and less activity situations, it is imperative that they control their costs as much as possible. This can happen only when the finance function in these companies is diligent and has a hawk eye towards the costs being incurred. Apart from this, companies also have to introduce efficiencies in the way their processes operate and this is another role for the finance function in modern day organizations. There must be synergies between the various processes and this is where the finance function can play a critical role. Lest one thinks that the finance function, which is essentially a support function, has to do this all by themselves, it is useful to note that, many contemporary organizations have dedicated project office teams for each division, which perform this function. INTRODUCTION TO FINANCE FUNCTION Finance function is solely concerned with the acquisition (or procurement) of short- term and long-term funds. According to R. C Osborn “Finance Function is the process of utilizing and acquiring funds of the business “ According to “Bonneville and Dewey “Financing consists of raising, providing and managing of all the money capital or funds of any kind to be used in connection with the business. The Finance Function is a part of financial management. Financial Management is the activity concerned with the control and planning of financial resources. In business, the finance function involves the acquiring and utilization of funds necessary for efficient operations. Finance is the lifeblood of business, without its things wouldn’t run smoothly. It is the source to run any organization, it provides the money, it acquires the money. There are three ways of defining the finance function. Firstly, the finance function can simply be taken as the task of providing funds needed by an enterprise on favorable terms, keeping in view the objectives of the firm. This means that the finance function is solely concerned with the acquisition (or procurement) of short- term and long-term funds. Another extreme view is that finance is concerned with cash. This definition is much too broad and thus is not really meaningful. The third view — based on a compromise between the two — is more useful for practical purposes. This definition treats the finance function as the procurement of funds and their effective utilization in business. The finance manager takes all decisions that relate to funds which can be obtained as also the best way of financing an investment such as the installation of a new machinery inside the factory-or office building. 27 CU IDOL SELF LEARNING MATERIAL (SLM)

The cost of the machinery may be financed by making a public issue of 8% cumulative preference shares. At the same time, he has to consider whether the additional return (cash flow) expected from the new machinery is sufficient to cover the cost of capital in terms of interest to be paid over a period of time. In this case, the finance decision is based on an analysis of the alternative sources and uses of funds. To start with the finance manager has to draw a plan outlining the company’s need for funds. Such financial plan is based on forecasts of financial needs of the company. Such forecasts are based on sales forecasts. OBJECTIVES OF FINANCE FUNCTION 1.I nvestment Decisions– This is where the finance manager decides where to put the company funds. Investment decisions relating to the management of working capital, capital budgeting decisions, management of mergers, buying or leasing of assets. Investment decisions should create revenue, profits and save costs 2. F inancing Decisions– Here a company decides where to raise funds from. They are two D main sources to consider mainly equity and borrowed. From the two a decision on the L appropriate mix of short and long-term financing should be made. The sources of T financing best at a given time should also be agreed upon D 3. ividend Decisions– These are decisions as to how much, how frequent and in what form to return cash to owners. A balance between profits retained and the amount paid out as dividends should be decided here 4. iquidity Decisions– Liquidity means that a firm has enough money to pay its bills when they are due and have sufficient cash reserves to meet unforeseen emergencies. This decision involves the management of the current assets so you don’t become insolvent or fail to make payments. 5. decisions: he finance function is concerned with three types of Financing decisions are the decisions regarding the process of raising funds 6.I nvestment decisions are the decisions regarding the investment of funds. 7. ividend Policy decisions are strategic financial decisions and they are based on the profits 28 CU IDOL SELF LEARNING MATERIAL (SLM)

earned by the organization. As the shareholders are the owners of the organization thus they are entitled to receive profits in the form of dividend. SCOPE OF FINANCE FUNCTION The scope of finance function is very wide. While accounting is concerned with the routine F type of work, finance function is concerned with financial planning, policy formulation and D control. Earnest W. Walker and William are of the opinion that the financial function has S always been important in business management. The financial organization depends upon the S nature of the organization – whether it is a proprietary organization, a partnership firm or F corporate body. The significance of the finance function depends on the nature and size of a business firm. The role of various finance officers must be clearly defined to avoid conflicts D and the overlapping of responsibilities. The operational functions of finance include: • inancial planning • eciding the capital structure • election of source of finance • election of pattern of investment 1. inancial Planning The first task of a financial manager is to estimate short-term and long-term financial requirements of his business. For this purpose, he will prepare a financial plan for present as well as for future. The estimation of fund is essential to purchase fixed assets as well as for the rotation of working capital. The estimations should be based on sound financial principles so that neither there are inadequate nor excess funds with the concern. The inadequacy of funds will adversely affect the day-to-day operations of the concern whereas excess funds may tempt a management to indulge in extravagant spending or speculative activities. 2. eciding Capital Structure The Capital structure refers to the kind and proportion of different securities for raising funds. After deciding about the quantum of funds required it should be decided which type of securities should be raised. It may be wise to finance fixed assets through long-term debts. Even if gestation period is longer, then share capital may be most suitable. Long-term funds should be raised. It may be wise to finance fixed assets through long-term debts. Even here if 29 CU IDOL SELF LEARNING MATERIAL (SLM)

gestation period is longer, then share capital may be most suitable. Long-term funds should S be employed to finance working capital also, if not wholly then partially. Entirely depending upon overdrafts and cash creditors for meeting working capital needs may not be suitable. A F decision about various sources for funds should be linked to the cost of raising funds. If cost D of raising funds is very high then such sources may not be useful for long. 3. election of Source of Finance After preparing a capital structure, an appropriate source of finance is selected. Various sources, from which finance may be raised, include share capital, debentures, financial institutions, commercial banks, public deposits, etc. If finances are needed for short periods then banks, public deposits and financial institutions may be appropriate; on the other hand, if long-term finances are required then share capital and debentures may be useful. If the concern does not want to tie down assets as securities then public deposits may be a suitable source. If management does not want to dilute ownership then debentures should be issued in preference to a share. When funds have been procured then a decision about investment pattern is to be taken. The selection of an investment pattern is related to the use of funds. A decision will have to be taken as to which assets are to be purchased? The funds will have to be spent first on fixed assets and then an appropriate portion will be retained for Working Capital. The decision- making techniques such as Capital Budgeting, Opportunity Cost Analysis, etc. may be applied in making decisions about capital expenditures. While spending on various assets, the principles of safety, profitability and liquidity should not be ignored. A balance should be struck even in these principles. IMPORTANCE OF FINANCE FUNCTION 1.I nvestment Decisions– This is where the finance manager decides where to put the company funds. Investment decisions relating to the management of working capital, capital budgeting decisions, management of mergers, buying or leasing of assets. Investment decisions should create revenue, profits and save costs. 2. inancing Decisions– Here a company decides where to raise funds from. They are two main sources to consider mainly equity and borrowed. From the two a decision on the appropriate mix of short and long-term financing should be made. The sources of financing best at a given time should also be agreed upon. 3. ividend Decisions– These are decisions as to how much, how frequent and in what form 30 CU IDOL SELF LEARNING MATERIAL (SLM)

to return cash to owners. A balance between profits retained and the amount paid out as L dividends should be decided here. T T 4. iquidity Decisions– Liquidity means that a firm has enough money to pay its bills when T they are due and have sufficient cash reserves to meet unforeseen emergencies. This T decision involves the management of the current assets so you don’t become insolvent or fail to make payments APPROACHES TO FINANCE FUNCTION: A number of approaches are associated with finance function but for the sake of convenience, various approaches are divided into two broad categories: 1. he Traditional Approach 2. he Modern Approach The traditional approach to the finance function relates to the initial stages of its evolution during 1920s and 1930s when the term ‘corporation finance’ was used to describe what is known in the academic world today as the ‘financial management’. According to this approach, the scope, of finance function was confined to only procurement of funds needed by a business on most suitable terms. The utilization of funds was considered beyond the purview of finance function. It was felt that decisions regarding the application of funds are taken somewhere else in the organization. However, institutions and instruments for raising funds were considered to be a part of finance function. The scope of the finance function, thus, revolved around the study of rapidly growing capital market institutions, instruments and practices involved in raising of external funds. The traditional approach to the scope and functions of finance has now been discarded as it suffers from many serious limitations: (i) I t is outsider-looking in approach that completely ignores internal decision making as to the proper utilization of funds. (ii) he focus of traditional approach was on procurement of long-term funds. Thus, it ignored the important issue of working capital finance and management. (iii) 31 CU IDOL SELF LEARNING MATERIAL (SLM)

he issue of allocation of funds, which is so important today, is completely ignored. (iv) I t does not lay focus on day to day financial problems of an organization. The Modern Approach: The modern approach views finance function in broader sense. It includes both rising of funds as well as their effective utilization under the purview of finance. The finance function does not stop only by finding out sources of raising enough funds; their proper utilization is also to be considered. The cost of raising funds and the returns from their use should be compared. The funds raised should be able to give more returns than the costs involved in procuring them. The utilization of funds requires decision making. Finance has to be considered as an integral part of overall management. So finance functions, according to this approach, covers financial planning, rising of funds, allocation of funds, financial control etc. The new approach is an analytical way of dealing with financial problems of a firm. The techniques of models, mathematical programming, simulations and financial engineering are used in financial management to solve complex problems of present day finance. The modern approach considers the three basic management decisions, i.e., investment decisions, financing decisions and dividend decisions of Finance Function Identify the Need of Finance -To commence a business you need to know how much is required to open it. So, the finance function helps you know how much the initial capital is, how much of it you have and how much you need to raise. Identify Sources of Finance Once you know what needs to be raised you look at areas you can raise these funds from. You can borrow or get from various shareholders. Comparison of the various sources of finance After identifying various fund sources compare the cost and risk involved. Then choose the best source of financing that suits your business needs SUMMARY • T he Finance function deals with the profit planning and other major activities of finance including the sources of finance. The Finance Function is a part of financial management. 32 CU IDOL SELF LEARNING MATERIAL (SLM)

• F inancial Management is the activity concerned with the control and planning of financial resources. In business, the finance function involves the acquiring and T utilization of funds necessary for efficient operations. The finance function can simply A be taken as the task of providing funds needed by an enterprise on favorable terms, T keeping in view the objectives of the firm. T T • his means that the finance function is solely concerned with the acquisition (or T procurement) of short- term and long-term funds. T • number of approaches are associated with finance function but for the sake of F convenience, various approaches are divided into two broad categories: F 1. he Traditional Approach 2. he Modern Approach • he traditional approach to the finance function relates to the initial stages of its evolution during 1920s and 1930s when the term ‘corporation finance’ was used to describe what is known in the academic world today as the ‘financial management’. According to this approach, the scope, of finance function was confined to only procurement of funds needed by a business on most suitable terms. • he utilization of funds was considered beyond the purview of finance function. It was felt that decisions regarding the application of funds are taken somewhere else in the organization. However, institutions and instruments for raising funds were considered to be a part of finance function. • he scope of the finance function, thus, revolved around the study of rapidly growing capital market institutions, instruments and practices involved in raising of external funds. KEY WORDS/ABBREVIATIONS • inance: The management of large amounts of money especially the government of large companies. • inance Function: s, the finance function involves the acquiring and utilization of 33 CU IDOL SELF LEARNING MATERIAL (SLM)

funds necessary for efficient operations. E W LEARNING ACTIVITY 1. stablish the concept of finance function for any organization. 2. hat role does finance manager play in an organization? UNIT END QUESTIONS (MCQ AND DESCRIPTIVE) D 2.I A. Descriptive Type Questions 1. A escribe is the role of financial manager in an organization? E E nterpret the features of finance function to increase profitability in an organization T 3. T nalyze the concept of finance function in chose of your medium size organization T T 4. xplain the objectives of finance function to improve performance of an organization 5. xplain the scope of finance function in construction industry B. Multiple Choice Questions 1. What should be the long term focal point of financial management in a firm? a. he number and types of products and services b. he creation of value for shareholders c. he minimization of the amount of taxes paid by the firm d. 34 CU IDOL SELF LEARNING MATERIAL (SLM)

he profits earned by the firm. 2. Finance Function comprises S E a. P afe custody of funds only P b. E xpenditure of funds only B A c. A rocurement of finance only E d. E rocurement & effective use of funds A P 3. Financial management mainly focuses on a. fficient management of every business b. rand dimension c. rrangement of funds d. ll elements of acquiring and using means of financial resources for financial activities. 4. The finance manager is accountable for. 35 a. arning capital assets of the company b. ffective management of a fund c. rrangement of financial resources d. roper utilization of funds CU IDOL SELF LEARNING MATERIAL (SLM)

5. What is the primary goal of financial management? T T a. T o minimize the risk T b. 5. b) o maximize the return c. o maximize the owner’s wealth d. o raise profit Answer 1. b) 2. d) 3. c) 4. c) REFERENCES • Chandra, P. (2012). Financial Management. New Delhi: Tata McGraw Hill. • James, C. (2014). Financial Management. New Delhi: Prentice-Hall. • Khan, M.Y. & Jain, P.K. (2012). Financial Management. New Delhi: Tata McGraw Hill. • Pandey, I.M (2009). Financial Management. New Delhi: Vikas Publishing House. • Maheshwari S.N. (2014). Principles of Financial Management. New Delhi: Sultan Chand & Sons. • Kulkarni P.V. (2014). Financial Management. Mumbai: Himalaya Publishing House. • Jeff Madura, International Financial Management, South-Western College Pub., 2010 • Prasanna Chandra, Financial Management, McGraw Hill, 2008. UNIT -4 FINANCIAL DECISIONS Structure Learning Objectives Introduction Investment Decisions Financing Decision Factors affecting Financing Decisions Dividend Decisions Factors Affecting Dividend Decisions Investment Decision , Financing Decision and Dividend Decision by Financial Manager 36 CU IDOL SELF LEARNING MATERIAL (SLM)

Roles and Responsibilities of Financial Manager Summary Keywords Learning Activity Unit End Questions References LEARNING OBJECTIVES After studying this unit you will be able to • Explain the basic concepts of financial decisions • State Investment decisions • Describe dividend decision INTRODUCTION Financial decision is a process which is responsible for all the decisions related with liabilities and stockholder's equity of the company as well as the issuance of bonds. . The Financing Decision is yet another crucial decision made by the financial manager relating to the financing-mix of an organization. It is concerned with the borrowing and allocation of funds required for the investment decisions... Financing Decision. Definition: The Financing Decision is yet another crucial decision made by the financial manager relating to the financing-mix of an organization. The Financing Decision is yet another crucial decision made by the financial manager relating to the financing-mix of an organization. It is concerned with the borrowing and allocation of funds required for the investment decisions. The financing decision involves two sources from where the funds can be raised: using a company’s own money, such as share capital, retained earnings or borrowing funds from the outside in the form debenture, loan, bond, etc. The objective of financial decision is to maintain an optimum capital structure, i.e. a proper mix of debt and equity, to ensure the trade-off between the risk and return to the shareholders. INVESTMENT DECISIONS: A firm’s resources are scarce in comparison to the uses to which they can be put. Thus, a firm has to choose where to invest these resources. This is so that they are able to earn the highest possible return for their investors. To survive and grow, all organizations have to be innovative. Investment decision relates to as how the funds of a firm are to be invested into different assets, so that the firm is able to earn highest possible return for the investors. Investment decision can be long-term, also known as capital budgeting where the funds are committed into long-term basis. Short-term investment decision also known as working capital decision and it is concerned with the levels of cash, inventories and debtors. 37 CU IDOL SELF LEARNING MATERIAL (SLM)

Investment decision can be long-term and short-term. Innovation demands managerial proactive actions and proactive organizations search for innovative ways of performing the activities of the organization. Investment decisions deals with the following: Thus, a firm has to choose where to invest these resources. This is so that they are able to earn the highest possible return for their investors. To survive and grow, all organizations have to be innovative. Investment decision relates to as how the funds of a firm are to be invested into different assets, so that the firm is able to earn highest possible return for the investors. Investment decision can be long-term, also known as capital budgeting where the funds are committed into long-term basis. Short-term investment decision also known as working capital decision and it is concerned with the levels of cash, inventories and debtors. Investment decision can be long-term and short-term. Innovation demands managerial proactive actions and proactive organizations search for E innovative ways of performing the activities of the organization. Investment decisions deals A with the following: P A • R xpansion through entering into new markets C • M dding new product to its product mix B • erforming value added activities to enhance customer satisfaction • dopting new technology that would drastically reduce the cost of production • endering services or mass production at low cost or restructuring the organization to improve the productivity. •I t relates to the management of working capital • apital budgeting decisions • anagement of mergers , reorganizations and disinvestment • uy or lease 38 CU IDOL SELF LEARNING MATERIAL (SLM)

• S ecurities analysts and portfolio management S • C o investment decision which is taken as to what should be the amount of R investment in different assets in order to get benefits in the future. C C FINANCING DECISION The financing decision involves two sources from where the funds can be raised: using a company’s own money, such as share capital, retained earnings or borrowing funds from the outside in the form debenture, loan, bond, etc. The objective of financial decision is to maintain an optimum capital structure, i.e. a proper mix of debt and equity, to ensure the trade-off between the risk and return to the shareholders. It is concerned with the borrowing and allocation of funds required for the investment decisions. The financing decision is mainly concerned with the identification of the sources of finance, determining financing mix and cultivating sources of funds and raising funds. The cost of funds, determination of debt equity mix, impact of tax, depreciation, consideration of control and financial strain, interest rate and inflation are some of the factors affecting financing decision. Financial decision is important to make wise decisions about when, where and how should a business acquire fund. Because a firm tends to profit most when the market estimation of an organization’s share expands and this is not only a sign of development for the firm but also it boosts investor’s wealth. Consequently, this relates to the composition of various securities in the capital structure of the company. Factors affecting Financing Decisions 1. ost: Financing decisions are all about allocation of funds and cost-cutting. The cost of raising funds from various sources differs a lot. The most cost-efficient source should be selected. 2. isk: The dangers of starting a venture with the funds from various sources differ. Larger risk is linked with the funds which are borrowed, than the equity funds. This risk assessment is one of the main aspects of financing decisions. 3. ash flow position: Cash flow is the regular day-to-day earnings of the company. Good or bad cash flow position gives confidence or discourages the investors to invest funds in the company. 4. 39 CU IDOL SELF LEARNING MATERIAL (SLM)

ontrol: In the situation where existing investors need to hold control of the C business then finance can be raised through borrowing money, however, when they are prepared for diluting control of the business, equity can be utilized for raising funds. How much control to give up is one of the main financing decisions. 5. ondition of the market: The condition of the market matter a lot for the financing decisions. During boom period issue of equity is in majority but during a depression, a firm will have to use debt. These decisions are an important part of financing decisions. DIVIDEND DECISION Dividends decisions relate to the distribution of profits earned by the organization. The major alternatives are whether to retain the earnings profit or to distribute to the shareholders. Retained earnings being source of funding, dividend decision is concerned as part of the financing decision of the firm. The impact of the levels of the dividends and retention of earnings on market value of share and future earnings of the firm, funds required for future expansion, impact of legal and cash flow constraints and the future boom or recession are some of the factors that affect the decision. Dividends may be paid in the form of bonus shares. 4.4.1 Factors Affecting Dividend Decisions Earnings: Returns to investors are paid out of the present and past income. Consequently, earning is a noteworthy determinant of the dividend. Dependability in Earnings: An organization having higher and stable earnings can announce higher dividend than an organization with lower income. Balancing Dividends: For the most part, organizations attempt to balance out dividends per share. A consistent dividend is given every year. A change is made, if the organization’s income potential has gone up and not only the income of the present year. Development Opportunity: Organizations having great development openings if they hold more cash out of their income to fund their required investment. The dividend announced in growing organizations is smaller than that in the non-development companies. Other Factors 1. Cash flow: Dividends are an outflow of funds. To give the dividends, the organization must have enough to provide them, which comes from regular cash flow. 2. Shareholders’ Choices: While announcing dividends, the administration must remember the choices of the investors. Some shareholders want at least a specific sum to be paid as dividends. The organizations ought to consider the preferences of such 40 CU IDOL SELF LEARNING MATERIAL (SLM)

investors. 3. Taxes: Compare tax rate on dividend with the capital gain tax rate that is applicable to increase in market price of shares. If the tax rate on dividends is lower, shareholders will prefer more dividends and vice versa. 4. Stock market: For the most part, an expansion in dividends positively affects the stock market, though, a lessening or no increment may negatively affect the stock market. Consequently, while deciding dividends, this ought to be remembered. 5. Access to Capital Market: Huge and organizations with a good reputation, for the most part, have simple access to the capital market and, consequently, may depend less on retained earnings to finance their development. These organizations tend to pay higher dividends than the smaller organizations. 6. Contractual and Legal Constraints: While giving credits to an organization, once in a while, the lending party may force certain terms and conditions on the payback of dividends in future. The organizations are required to guarantee that the profit payout does not abuse the terms of the loan understanding in any manner. The third major financial decision relates to the disbursement of profits back to investors who supplied capital to the firm. The term dividend refers to that part of profits of a company which is distributed by it among its shareholders. It is the reward of shareholders for investments made by them in the share capital of the company. The dividend decision is concerned with the quantum of profits to be distributed among shareholders. It is the reward of shareholders for investments made by them in the share capital of the company. The dividend decision is concerned with the quantum of profits to be distributed among shareholders. INVESTMENT DECISION, FINANCING DECISION AND DIVIDEND DECISION BY FINANCIAL MANAGER The Financial Manager of a company must have the proper ability and training to address key financial management decisions. The main aspects of the financial decision-making process relate to investments, financing dividends and asset management. According to the Inter-American Investment Corporation (IIC), the role of the Financial Managers in the decision-making process can be divided into four main areas: 1. Investments: in the investments area, the Financial Manager is responsible for defining the optimal size of the company. In this regard, it is important to have a market study in place and be clear on the objectives that the company needs to meet. It is important to have properly studied the demand, technology and equipment, financing methods and human resources available. In second place, the director must 41 CU IDOL SELF LEARNING MATERIAL (SLM)

analyze whether the resources adapt to the optimal size desired for the company. If they don’t, it is necessary to define the types of assets that the company must acquire, or otherwise sell or get rid of, in order to achieve efficient management. 2. Financing: defining a financing strategy is essential to the continuity of the business over the long term. Access to financing is closely related with maintaining a constant inflow of capital since the savings margin will not allow operations to continue for much longer without the support of additional liquidity. The Financial Manager must define several aspects of the financing strategy. For example, study the sources willing to offer credit to the organization, and define the best financing options for operations. The Financial Manager can also design a mixed financing strategy for efficient financial management: this is called the company’s “financing mix”. Sometimes the company can benefit from a combination of short and long term financing to meet investment and financial strategy objectives. 3. Asset management: asset management is one of the main aspects for a company to adequately meet its obligations and in turn to position itself to meet the objectives or growth targets that have been laid out. In other words, the Financial Manager must stipulate and assure that the existing assets are managed in the most efficient way possible. Generally, this manager must prioritize current asset management before fixed asset management. Current assets are those that will become effective in the near future, such as accounts receivable or inventories. By contrast, fixed assets lack liquidity since they are needed for permanent operations. This includes offices, warehouses, machinery, vehicles, etc. 4. Dividend Policy: one of the most important financial decisions that a Financial Manager must make is related to the company’s dividend policy. It concerns how much of the company’s earnings will be paid out to shareholders. Specifically, it is necessary to determine if generated earnings will be reinvested in the company to improve operations or if they will be distributed among shareholders. It is also possible to choose a mixed policy in this regard, distributing a part among shareholders and investing the rest in the company. However, if the dividends distributed are too high, the company may encounter limitations to expand or improve the management of its operations. It is important to consider that in order to have growth perspectives over the long term, short term reinvestments are necessary. ROLES AND RESPONSIBILITIES OF FINANCIAL MANAGER Financial activities of a firm is one of the most important and complex activities of a firm. Therefore in order to take care of these activities a financial manager performs all the requisite financial activities. A financial manager is a person who takes care of all the important financial functions of an organization. The person in charge should maintain a far sightedness in order to ensure that 42 CU IDOL SELF LEARNING MATERIAL (SLM)

the funds are utilized in the most efficient manner. His actions directly affect the Profitability, growth and goodwill of the firm. Following are the main functions of a Financial Manager: 1. Raising of Funds In order to meet the obligation of the business it is important to have enough cash and liquidity. A firm can raise funds by the way of equity and debt. It is the responsibility of a financial manager to decide the ratio between debt and equity. It is important to maintain a good balance between equity and debt. 2. Allocation of Funds Once the funds are raised through different channels the next important function is to allocate the funds. The funds should be allocated in such a manner that they are optimally used. In order to allocate funds in the best possible manner the following point must be considered 3. The size of the firm and its growth capability A successful firm usually has rapid growth in sales, which requires investments in plant, equipment and inventory. It is the task of the financial manager to help determine the optimal sales growth rate, and he (she) must help decide what specific assets to acquire and the best way to finance those assets. For example, should the firm finance with debt, equity, or some combination of the two, and if debt is used, how much should be long term and how much should be short term? 4. Mode by which the funds are raised These financial decisions directly and indirectly influence other managerial activities. Hence formation of a good asset mix and proper allocation of funds is one of the most important activity. 5. Profit Planning Profit earning is one of the prime functions of any business organization. Profit earning is important for survival and sustenance of any organization. Profit planning refers to proper usage of the profit generated by the firm. Profit arises due to many factors such as pricing, industry competition, state of the economy, mechanism of demand and supply, cost and output. A healthy mix of variable and fixed factors of production can lead to an increase in the profitability of the firm. Fixed costs are incurred by the use of fixed factors of production such as land and machinery. In order to maintain a tandem it is important to continuously value the depreciation cost of fixed cost of production. An opportunity cost must be calculated in order to replace those factors of production which has gone thrown wear and tear. If this is not noted then these fixed cost can cause huge fluctuations in profit. 43 CU IDOL SELF LEARNING MATERIAL (SLM)

6. Understanding Capital Markets Shares of a company are traded on stock exchange and there is a continuous sale and purchase of securities. Hence a clear understanding of capital market is an important function of a financial manager. When securities are traded on stock market there involves a huge amount of risk involved. Therefore a financial manger understands and calculates the risk involved in this trading of shares and debentures. It’s on the discretion of a financial manager as to how to distribute the profits. Many investors do not like the firm to distribute the profits amongst shareholders as dividend instead invest in the business itself to enhance growth. The practices of a financial manager directly impact the operation in capital market. SUMMARY •I T f carefully reviewed what constitutes a business, we will come to the conclusion that R there are two things that matter, money and decision Without money, a company T won’t survive and without decisions, money can’t survive. An administration has to take countless decisions in the lifetime of the company. Thus, the most important ones are related to money. The decisions related to money are called ‘Financing Decisions.’ Financial decision is a process which is responsible for all the decisions related with liabilities and stockholder’s equity of the company as well as the issuance of bonds. Financial decisions refer to decisions concerning financial matters to a business concern. Decisions regarding the magnitude of funds to invest to enable a firm to accomplish its ultimate goal, kind of assets to acquire. The pattern of capitalization, the pattern of distribution of firm’s income and similar other matters are including in financial decisions. • hese decisions are crucial for the well-being of a firm because they determine the firm’s ability to obtain plant and equipment. When needed to carry the required amount of inventories and receivables, to avoid burdensome fixed charges when profits and sales decline and to avoid losing control of the company. • eflecting the emerging economic and financial environment in the post liberalization era, the role job of financial managers in India has become more important and demanding. The decisions relating to dividend, investment and finance plays an important role. • he investment decisions made by a firm will determine the future potential dividends and future earnings, whereas dividend decisions influence the 44 CU IDOL SELF LEARNING MATERIAL (SLM)

amount of equity capital in a firm's capital structure, thus, influences the cost of O capital which is the financing decision. H •I T nvestment Decision relates to the determination of total amount of assets to be held in the firm, the composition of these assets and the business risk complexions of the firm A as perceived by its investors. It is the most important financial decision. Since funds A involve cost and are available in a limited quantity, its proper utilization is very F necessary to achieve the goal of wealth maximization. • nce the firm has taken the investment decision and committed itself to new investment, it must decide the best means of financing these commitments. Since, firms regularly make new investments; the needs for financing and financial decisions are ongoing. • ence, a firm will be continuously planning for new financial needs. The financing decision is not only concerned with how best to finance new assets, but also concerned with the best overall mix of financing for the firm. • he third major financial decision relates to the disbursement of profits back to investors who supplied capital to the firm. The term dividend refers to that part of profits of a company which is distributed by it among its shareholders. •I t is the reward of shareholders for investments made by them in the share capital of the company. The dividend decision is concerned with the quantum of profits to be distributed among shareholders. • decision has to be taken whether all the profits are to be distributed, to retain all the profits in business or to keep a part of profits in the business and distribute others among shareholders. The higher rate of dividend may raise the market price of shares and thus, maximize the wealth of shareholders. The firm should also consider the question of dividend stability, stock dividend (bonus shares) and cash dividend. • financial manager plays a critical role in providing financial guidance and support to a company. Also known as a finance manager or finance lead, they can make a real difference to a business’ success. Discover whether the role of a financial manager is for you, with expert tips on how to progress through the ranks of finance officer to assistant finance manager, and beyond. • inancial activities of a firm is one of the most important and complex activities of a firm. Therefore in order to take care of these activities a financial manager performs 45 CU IDOL SELF LEARNING MATERIAL (SLM)

all the requisite financial activities. A • F financial manger is a person who takes care of all the important financial functions of D an organization. The person in charge should maintain a far sightedness in order to S ensure that the funds are utilized in the most efficient manner. His actions directly A affect the Profitability, growth and goodwill of the firm. KEY WORDS/ABBREVIATIONS • inancial Decision: Financial decisions refer to decisions concerning financial matters to a business concern. •I nvestment Decision: Investment decisions are made by investors and investment managers. Investors commonly perform investment analysis by making use of fundamental analysis, technical analysis and gut feel. Investment decisions are often supported by decision tools • ividend decision: The Dividend Decision is one of the crucial decisions made by the finance manager relating to the payouts to the shareholders • hareholder’s Wealth: Shareholder wealth is defined as the present value of the expected future returns to the owners (that is, shareholders) of the firm. These returns can take the form of periodic dividend payments and/or proceeds from the sale of the stock. LEARNING ACTIVITY 1. newly formed company which aims to develop its business should follow which type of financial decision 2. E numerate the financial decision to be implemented by a manufacturing concern with suitable examples. 46 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT END QUESTIONS (DESCRIPTIVE AND MCQ) A. Descriptive Questions 1. Analyze briefly the concept of financial decisions which can leads to sustainable success 2. Evaluate the importance of financial decisions in pharmaceutical industry 3. How investment decision plays an important role in the success of an organization? 4. Explain what is dividend decision for a dividend paying company? 5. Explain the difference between dividend decision and investment decision in Tata Motors B. Multiple choice Questions. 1. The sale of financial assets is also referred to as the a. Capital decision b. CFO decision c. Financing decision d. Investment decision 2. The construction of new manufacturing plant is also referred to as the a. Capital decision b. CFO decision c. Financing decision d. Investment decision 3. Financial decisions are concerned with which of the following M a. 47 CU IDOL SELF LEARNING MATERIAL (SLM)