FM 101: FINANCIAL MANAGEMENT

CHAPTER 2: NATURE, PURPOSE & SCOPE OF FINANCIAL MANAGEMENT

Objectives :

●​ Describe the Concept of Financial Management

Any company's financial health is crucial. Finances, like most other resources, are, however, finite. Wants,
on the other hand, are often limitless. As a result, it is important for a company to effectively control its
finances.

It is important for any company to invest the funds it receives in such a way that the investment yields a
higher return than the cost of capital. Financial management, in a nutshell –
●​ Endeavours to reduce the cost of finance
●​ Ensures sufficient availability of funds
●​ Deals with the planning, organizing, and controlling of financial activities like the procurement and
utilization of funds

Definitions of Financial Management

“Financial management is the activity concerned with planning, raising, controlling and administering of
funds used in the business.” – Guthman and Dougal

“Financial management is that area of business management devoted to a judicious use of capital and a
careful selection of the source of capital in order to enable a spending unit to move in the direction of
reaching the goals.” – J.F. Brandley

“Financial management is the operational activity of a business that is responsible for obtaining and
effectively utilizing the funds necessary for efficient operations.”- Massie
Nature, Significance, and Scope of Financial Management

1.​ Some experts believe that Financial management is all about getting a company the money it
needs on the most attractive terms possible while keeping its goals in mind. As a result, this
strategy is mainly concerned with the acquisition of assets, which can include instruments,
institutions, and fundraising activities. It also looks after the legal and accounting aspects of a
company's relationship with its funding source.
2.​ Another group of experts believes that money is all in finance. Since all business transactions,
whether directly or indirectly, include cash, finance is concerned with everything the company
does.
3.​ The third and most commonly held viewpoint is that financial management encompasses both the
acquisition and effective use of funds. In the case of a manufacturing company, for example,
financial managers must ensure that funds are sufficient for the installation of the manufacturing
plant and machinery. It must also ensure that earnings are sufficient to cover the costs and risks
faced by the company.

Many companies can easily raise capital in a developed market. The real issue, however, is maximizing
capital use through successful financial planning and control.
 FM 101: FINANCIAL MANAGEMENT
Furthermore, the company must ensure that it handles activities such as allocating funds, handling them,
investing them, controlling expenses, predicting financial needs, preparing income and calculating returns
on investment, evaluating working capital, and so on.

The Scope of Financial Management

Core Financial Management Decisions

Managers of companies make the following decisions in order to reduce the costs of obtaining finance and
to use it in the most efficient way possible:

●​ Investment Decisions
●​ Financing Decisions
●​ Dividend Decisions

Investment Decisions: Managers must determine the amount of investment available from existing funds,
both long- and short-term.

There are two kinds of them:

➢​ Capital Budgeting, also known as Long-term investment decisions, imply committing funds
for a long time, similar to fixed assets. These decisions are normally irreversible and involve those
involving the purchase of a building and/or property, the acquisition of new plants/machinery or
the replacement of old ones, and so on. These choices influence a company's financial goals and
results.
➢​ Working capital management, also known as short-term investment decisions, refers to
committing funds for a short period of time, such as current assets. These decisions include cash,
bank deposits, and other short-term investments, as well as inventory investment. They have a
direct impact on a company's liquidity and profitability.

Financing Decisions: Managers must also make decisions on raising funds from long-term (Capital
Structure) and short-term sources (called Working Capital). There are two kinds of them:

➢​ Financial Planning Decisions that include estimating the origins and applications of funds. It
entails anticipating a company's financial needs in order to ensure that sufficient funds are
available. The primary goal of financial planning is to prepare ahead of time to ensure that funds
are available when needed.
➢​ Capital Structure Decisions that include locating funding sources. They also include decisions
on whether to raise funds from external sources such as selling shares, bonds, or borrowing from
banks, or from internal sources such as retained earnings.

Dividend Decisions: These are decisions over how much of a company's earnings will be paid as
dividends. Shareholders often seek a higher dividend, while management prefers to keep income for
operational purposes. As a result, this is a difficult managerial decision.