CHAPTER 1

AN OVERVIEW OF FINANCIAL MANAGEMENT

1.1. Introduction
Definition of Financial Management is an integral part of overall management. It is concerned
with the duties of the financial managers in the business firm. The term financial management
has been defined by Solomon, “It is concerned with the efficient use of an important economic
resource namely, capital funds”. The most popular and acceptable definition of financial
management as given by S.C. Kuchal is that “Financial Management deals with procurement of
funds and their effective utilization in the business”. Financial management “as an application of
general managerial principles to the area of financial decision-making. Weston and Brigham:
Financial management “is an area of financial decision-making, harmonizing individual motives
and enterprise goals”. Joshep and Massie: Financial management “is the operational activity of a
business that is responsible for obtaining and effectively utilizing the funds necessary for
efficient operations. Thus, Financial Management is mainly concerned with the effective funds
management in the business. In simple words, Financial Management as practiced by business
firms can be called as Corporation Finance or Business Finance.

1.1.1. Meaning of finance

defines finance as “the Science on study of the management of funds’ and the management of
fund as the system that includes the circulation of money, the granting of credit, the making of
investments, and the provision of banking facilities. “Business finance is the business activity
which concerns with the acquisition and conversation of capital funds in meeting financial needs
and overall objectives of a business enterprise”. Business finance can broadly be defined as the
activity concerned with planning, raising, controlling, administering of the funds used in the
business”. Corporate finance is concerned with budgeting, financial forecasting, cash
management, credit administration, investment analysis and fund procurement of the business
concern and the business concern needs to adopt modern technology and application suitable to
the global environment. “Corporation finance deals with the financial problems of corporate
enterprises. These problems include the financial aspects of the promotion of new enterprises and

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their administration during early development, the accounting problems connected with the
distinction between capital and income, the administrative questions created by growth and
expansion, and finally, the financial adjustments required for the bolstering up or rehabilitation
of a corporation which has come into financial difficulties”.

1.1.2. Classification of finance

Finance is one of the important and integral part of business concerns, hence, it plays a major
role in every part of the business activities. It is used in all the area of the activities under the
different names. Finance can be classified into two major parts:

Private finance and public finance

Private Finance, which includes the Individual, Firms, Business or Corporate Financial
activities to meet the requirements. Public Finance which concerns with revenue and
disbursement of Government such as Central Government, State Government and Semi-
Government Financial matters.

1.1.3. Evolution of finance

The evolution of financial management may be divided into three broad phases:

i) The traditional phase

ii) The transitional phase
iii) The modern phase.
 In the traditional phase the focus of financial management was on certain events which
required funds e.g., major expansion, merger, reorganization etc. The traditional phase was
also characterized by heavy emphasis on legal and procedural aspects as at that point of time
the functioning of companies was regulated by a plethora of legislation. Another striking
characteristic of the traditional phase was that, a financial management was designed and
practiced from the outsider’s point of view mainly those of investment bankers, lenders,
regulatory agencies and other outside interests.
 During the transitional phase the nature of financial management was the same but more
emphasis was laid on problems faced by finance managers in the areas of fund analysis
planning and control.

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 The modern phase is characterized by the application of economic theories and the
application of quantitative methods of analysis.
The distinctive features of the modern phase are:
 Changes in macro-economic situation that has broadened the scope of financial
management. The core focus is how on the rational matching of funds to their uses in the
light of the decision criteria.
 The advances in mathematics and statistics have been applied to financial management
especially in the areas of financial modeling, demand forecasting and risk analysis.
1.1.4. Sources of finance.

Sources of finance mean the ways for mobilizing various terms of finance to the industrial
concern. Sources of finance state that, how the companies are mobilizing finance for their
requirements. The companies belong to the existing or the new which need sum amount of
finance to meet the long-term and short-term requirements such as purchasing of fixed assets,
construction of office building, purchase of raw materials and day-to-day expenses. Sources of
finance may be classified in to two these are

 Long-term sources
 Short-term sources
. Long-term sources: Finance may be mobilized by long-term or short-term. When the finance
mobilized with large amount and the repayable over the period will be more than five years, it
may be considered as long-term sources. Share capital, issue of debenture, long-term loans from
financial institutions and commercial banks come under this kind of source of finance. Long-
term source of finance needs to meet the capital expenditure of the firms such as purchase of
fixed assets, land and buildings, etc. Long-term sources of finance include:

 Equity Shares
 Preference Shares
 Debenture
 Long-term Loans
 Fixed Deposits
Short-term sources: firms can generate finance with the help of short-term sources like loans
and advances from commercial banks, moneylenders, etc. Short-term source of finance needs

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to meet the operational expenditure of the business concern. Short-term source of finance
include:

 Bank Credit
 Customer Advances
 Trade Credit
 Factoring
 Public Deposits
 Money Market Instruments
1.2. The nature and scope of financial management

The following are the important scope of financial management.

1. Financial Management and Economics

Concepts like micro and macroeconomics are directly applied with the financial management
approaches. Investment decisions, micro and macro environmental factors are closely associated
with the functions of financial manager. Financial management also uses the economic equations
like money value discount factor, economic order quantity etc. Financial economics is one of the
emerging area, which provides immense opportunities to finance, and economical areas.

2. Financial Management and Accounting

Accounting records includes the financial information of the business concern. Hence, we can
easily understand the relationship between the financial management and accounting. In the
older periods, both financial management and accounting are treated as a same discipline and
then it has been merged as Management Accounting because this part is very much helpful to
finance manager to take decisions. But nowadays financial management and accounting
discipline are separate and interrelated.

3. Financial Management or Mathematics

Modern approaches of the financial management applied large number of mathematical and
statistical tools and techniques. They are also called as econometrics. Economic order quantity,
discount factor, time value of money, present value of money, cost of capital, capital structure

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theories, dividend theories, ratio analysis and working capital analysis are used as mathematical
and statistical tools and techniques in the field of financial management.

4. Financial Management and Production

Production management is the operational part of the business concern, which helps to multiple
the money into profit. Profit of the concern depends upon the production performance.
Production performance needs finance, because production department requires raw material,
machinery, wages, operating expenses etc. These expenditures are decided and estimated by the
financial department and the finance manager allocates the appropriate finance to production
department. The financial manager must be aware of the operational process and finance
required for each process of production activities.

5. Financial Management and Marketing

Produced goods are sold in the market with innovative and modern approaches. For this, the
marketing department needs finance to meet their requirements. The financial manager or
finance department is responsible to allocate the adequate finance to the marketing department.
Hence, marketing and financial management are interrelated and depends on each other.

6. Financial Management and Human Resource

Financial management is also related with human resource department, which provides
manpower to all the functional areas of the management. Financial manager should carefully
evaluate the requirement of manpower to each department and allocate the finance to the human
resource department as wages, salary, remuneration, commission, bonus, pension and other
monetary benefits to the human resource department. Hence, financial management is directly
related with human resource management.

The goal of a firm in financial management

Effective procurement and efficient use of finance lead to proper utilization of the finance by
the business concern. It is the essential part of the financial manager. Hence, the financial
manager must determine the basic objectives of the financial management. Objectives of
Financial Management may be broadly divided into two parts such as:

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 1. Profit maximization
Profit Maximization Main aim of any kind of economic activity is earning profit. A business
concern is also functioning mainly for the purpose of earning profit. Profit is the measuring
techniques to understand the business efficiency of the concern. Profit maximization is also the
traditional and narrow approach, which aims at, maximizes the profit of the concern. Profit
maximization consists of the following important features.

1. Profit maximization is also called as cashing per share maximization. It leads to

maximize the business operation for profit maximization.

2. Ultimate aim of the business concern is earning profit; hence, it considers all the possible
ways to increase the profitability of the concern.

3. Profit is the parameter of measuring the efficiency of the business concern. So it shows
the entire position of the business concern.

4. Profit maximization objectives help to reduce the risk of the business.

Favourable Arguments for Profit Maximization

The following important points are in support of the profit maximization objectives of the
business concern:

(i) Main aim is earning profit.

(ii) Profit is the parameter of the business operation.
(iii) Profit reduces risk of the business concern.
(iv) Profit is the main source of finance.
(v) Profitability meets the social needs also.
Unfavourable Arguments for Profit Maximization

The following important points are against the objectives of profit maximization:

(i) Profit maximization leads to exploiting workers and consumers.

(ii) Profit maximization creates immoral practices such as corrupt practice, unfair trade
practice, etc.

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 (iii) Profit maximization objectives leads to inequalities among the sake holders such as
customers, suppliers, public shareholders, etc.
2. Wealth maximization.
Wealth maximization is one of the modern approaches, which involves latest innovations
and improvements in the field of the business concern. The term wealth means shareholder
wealth or the wealth of the persons those who are involved in the business concern. Wealth
maximization is also known as value maximization or net present worth maximization. This
objective is an universally accepted concept in the field of business.

Favorable Arguments for Wealth Maximization

(i) Wealth maximization is superior to the profit maximization because the main aim of
the business concern under this concept is to improve the value or wealth of the
shareholders.
(ii) Wealth maximization considers the comparison of the value to cost associated with
the business concern. Total value detected from the total cost incurred for the
business operation. It provides extract value of the business concern.
(iii) Wealth maximization considers both time and risk of the business concern.
(iv) Wealth maximization provides efficient allocation of resources.
(v) It ensures the economic interest of the society.
Unfavourable Arguments for Wealth Maximization

(i) Wealth maximization leads to prescriptive idea of the business concern but it may
not be suitable to present day business activities.
(ii) Wealth maximization is nothing, it is also profit maximization, it is the indirect
name of the profit maximization.
(iii) Wealth maximization creates ownership-management controversy.
(iv) Management alone enjoys certain benefits.
(v) The ultimate aim of the wealth maximization objectives is to maximize the profit.
(vi) Wealth maximization can be activated only with the help of the profitable position
of the business concern.

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 CHAPTER 2
FINANCIAL ANALYSES AND PLANNING

2. INTRODUCTION

2.1. Financial Analysis

Financial analysis is the process of evaluating businesses, projects, budgets, and other finance-
related transactions to determine their performance and suitability. Typically, financial analysis
is used to analyze whether an entity is stable, solvent, liquid, or profitable enough to warrant a
monetary investment.

2.1.1. The need for financial analysis

A financial analysis helps business owners determine their company's performance,
sustainability, and growth by reviewing various financial statements like their income
statement, balance sheet, and cash flow statement.

A financial analysis will not only help you understand your company's financial condition,
helping you determine its creditworthiness, profitability and ability to generate wealth, but will
also provide you with a more in-depth look at how well it operates internally.

Why Is Financial Analysis Useful?

The financial analysis aims to analyze whether an entity is stable, liquid, solvent, or profitable
enough to warrant a monetary investment. It is used to evaluate economic trends, set financial
policies, build long-term plans for business activity, and identify projects or companies for
investment.

2.1.2. Source of financial data

The three main sources of data for financial analysis are a company's

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  Balance sheet: summary of the assets, liabilities (debt) and equity of a
business at the end of an accounting period and a report of the company’s
financial worth in terms of book value.
 Income statement, a detailed account of a company’s revenue earning (also
known as the profit and loss statement). and
 Cash flow statement: provides data on how much cash or cash equivalent
circulates the company via various inflows and outflows, spanning ongoing
operational activities, external investment sources and cash from financing.
2.1.2. Approaches to financial analysis and interpretation
There are five common place approaches to financial statement analysis:

 horizontal analysis,
 vertical analysis,
 ratio analysis,
 trend analysis and
 Cost-volume profit analysis.
1. Horizontal Analysis
Horizontal analysis compares historical data (such as ratios and line items) and is usually
depicted as a percentage growth over the same line item in the base year. This allows
financiers to easily spot trends and growth patterns and forecast future projections. This type
of analysis also lends insight into the operational results of an organization and whether it is
operating efficiently and profitably, and makes it easier to compare growth rates amongst
sector competitors.

2. Vertical Analysis
Vertical analysis is the proportional analysis of a financial statement, where each line item on
a financial statement is listed as a percentage of another item. For example, every line item
on an income statement is stated as a percentage of gross sales, while every line item on a
balance sheet is stated as a percentage of total assets. This gives analysts an understanding of
overall performance in terms of revenue and expenses.

3. Ratio Analysis

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 Ratio analysis allows for meaningful comparison between the different elements of a
financial statement and is used to reveal a general upward or downward trend. It’s a quick
method to obtain an overview of a company’s financial health, but also more granular
relationships between data, such as debt and equity or price versus earnings, in addition to
liability areas such as staff turnover. Once a ratio has been calculated, it can be compared
against the previous period, which is crucial for setting performance targets.

4. Trend Analysis

Trend analysis uses historical data (such as price movements and trade volume) to forecast
the long-term direction of market sentiment. It’s based on the idea that what has transpired in
the past will occur again in the future, which helps a business to better predict and prepare for
upward trends and reversals within particular market segments. Trend analysis is a useful
technique as moving with trends (and not against them) will result in profit for an investor.

5. Cost Volume Profit Analysis

This analysis technique helps businesses better understand the relationship between sales,
costs, and business profit. It examines the fixed cost and variable cost and establishes the
relationship between sales and variable cost to help business leader’s better plan and project
profit.

2.2. Financial planning (forecasting)

A financial plan is a strategic approach to finances that marks out a road-map to follow into the
future. A financial forecast is an estimate of future outcomes arrived at using one of several
methods, including statistical models to make projections.

Financial Plan vs. Financial Forecast

A financial forecast
 is an estimation, or projection, of likely future income or revenue and expenses.
 Financial forecasts are commonly reviewed and revised annually as new information
regarding assets and costs becomes available.
 The new data enables an individual or business to make more accurate financial
projections.

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  It is easier for established companies that generate steady revenues to make accurate
financial forecasts than it is for new businesses or companies whose revenue is subject to
significant seasonal or cyclical fluctuations. While a
Financial plan
 Lays out the necessary steps to generate future income and cover future expenses.
 Alternatively, a financial plan can be looked at as what an individual or company plans to
do with income or revenue received.
 A financial plan is a process a company lays out, typically broken down into a step-by-
step format, for utilizing its available capital and other assets to meet its goals for growth
or profit based on a reasonable financial forecast.
 A financial plan can be considered synonymous with a business plan in that it lays out
what a company plans to do in terms of putting resources to work to generate maximum
possible revenues.

2.3. The planning process

Planning Process: 7 Vital Steps of Planning
Planning is ascertaining prior to what to do and how to do. It is one of the primary managerial
duties. Before doing something, the manager must form an opinion on how to work on a specific
job. Hence, planning is firmly correlated with discovery and creativity. But the manager would
first have to set goals. Planning is an essential step what managers at all levels take. It requires
making decisions since it includes selecting a choice from alternative ways of performance.

Planning Process
As planning is an activity, there are certain reasonable measures for every manager
to follow:
(1) Setting Objectives
 This is the primary step in the process of planning which specifies the objective of an
organization, i.e. what an organization wants to achieve.
 The planning process begins with the setting of objectives.
 Objectives are end results which the management wants to achieve by its operations.
 Objectives are specific and are measurable in terms of units.

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  Objectives are set for the organization as a whole for all departments, and then
departments set their own objectives within the framework of organizational objectives.
Example:
A mobile phone company sets the objective to sell 2,00,000 units next year, which
is double the current sales.
(2) Developing Planning Premises
 Planning is essentially focused on the future, and there are certain events which are
expected to affect the policy formation.
 Such events are external in nature and affect the planning adversely if ignored.
 Their understanding and fair assessment are necessary for effective planning.
 Such events are the assumptions on the basis of which plans are drawn and are known as
planning premises.
Example:
The mobile phone company has set the objective of 200,000 units sale on the basis of forecast
done on the premises of favorable Government policies towards digitization of transactions.

(3) Identifying Alternative Courses of Action

 Once objectives are set, assumptions are made.
 Then the next step is to act upon them.
 There may be many ways to act and achieve objectives.
 All the alternative courses of action should be identified.
Example:
The mobile company has many alternatives like reducing price, increasing
advertising and promotion, after sale service etc.
(4) Evaluating Alternative Course of Action
 In this step, the positive and negative aspects of each alternative need to be evaluated in
the light of objectives to be achieved.
 Every alternative is evaluated in terms of lower cost, lower risks, and higher returns,
within the planning premises and within the availability of capital.
Example:
The mobile phone company will evaluate all the alternatives and check its pros
and cons.

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 (5) Selecting One Best Alternative
The best plan, which is the most profitable plan and with minimum negative effects, is
adopted and implemented.
In such cases, the manager’s experience and judgment play an important role in selecting
the best alternative.
Example:
Mobile phone company selects more T.V advertisements and online marketing with
great after sales service.
(6) Implementing the Plan
 This is the step where other managerial functions come into the picture.
 This step is concerned with “Doing What Is Required”.
 In this step, managers communicate the plan to the employees clearly to help convert the
plans into action.
 This step involves allocating the resources, organizing for labour and purchase of
machinery.
Example:
Mobile Phone Company hires salesmen on a large scale, creates T.V
advertisement, starts online marketing activities and sets up service workshops.
(7) Follow up Action
 Monitoring the plan constantly and taking feedback at regular intervals is called follow-
up.
 Monitoring of plans is very important to ensure that the plans are being implemented
according to the schedule.
 Regular checks and comparisons of the results with set standards are done to ensure that
objectives are achieved.
Example:
A proper feedback mechanism was developed by the mobile phone company
throughout its branches so that the actual customer response, revenue collection,
employee response, etc. could be known.
2.4. The importance of sales forecasting
What is sales forecasting?

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Sales forecasting is the process of estimating future sales or revenue for a business based on
historical sales data, market trends, and other relevant factors. It involves analyzing past sales
data to identify patterns and trends that can be used to make predictions about future sales
performance.

Why is forecasting important?

Sales forecasting enables businesses to plan and make informed decisions about future
operations, marketing, and resource allocation. Accurate sales forecasting can help businesses
anticipate future demand, identify potential problems or opportunities, and adjust their strategies
accordingly. It can also help businesses optimize their inventory levels, production schedules,
and staffing requirements.

Forecasting future sales has several important applications. The firm can use this information to:

Plan future production levels. The questions how many products should be manufactured and
how much raw materials should be purchased need to be answered. This will allow for a more
efficient use of the firm’s resources, in particular labor which is normally a firm’s highest cost. It
will identify recruitment and training needs, or depressingly the requirement for redundancies.

Improve Cash Flow and Working Capital. Being able to accurately predict future sales aids
Cash Flow management as it helps to calculate liquidity and workforce planning as it helps with
deciding how much workers will be needed in the future. Examining variations in sales and
predicting future sales can help the firm plan for its liquidity and evaluate the need for additional
sources of finance. Lenders will be more likely to supply additional funds if they can see that the
firm will be able to repay on time.

Improve stock control. Accurate sales forecasts will underpin stock ordering and ensure that
production has the raw materials when required. Stock represents is tied up cash, so maintaining
the correct level of stock will also help liquidity. This knowledge how much to produce and
waste less will contribute towards increasing efficiency.

Drive marketing campaigns. The identification of key periods for company sales will allow the
firm to plan effective marketing including distribution, pricing and promotion.

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 2.5. Techniques of determining external financial requirements.
External financing in business refers to the money borrowed from banks or investors. It is
essentially external because it is not generated from within the business but instead comes from
an outside source. When it comes to the overall finances of a company, external financing is
important as it can help a company grow.

The business must calculate the external financing needed to understand exactly how much
money is needed from external sources. External financing needed can be calculated using the
formula:

External Financing Needed = Increase in Assets - Increase in Liabilities - Retained Earnings

For example, if a business is looking to expand its physical property, it will need to consider the
amount of external financing needed. If it is expanding the property by about 25%, it may also
calculate the expenses by this amount. So, if its assets are $200,000 and liabilities at $100,000,
the increase of 25% would be $50,000 and $25,000 respectively. If, for example, the retained
earnings are projected at $15,000, then the formula would be written as:

External Financing Needed = Increase in Assets - Increase in Liabilities - Retained Earnings

= $50,000 - $25,000 - $15,000

=$10,000

It's important to note that the EFN formula assumes all costs are fixed, which means they do not
fluctuate or alter in different periods. If the business expects changes in these costs, they must be
adjusted within the equation.

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