OMTEX CLASSES: Meaning of Financial Management

Meaning of Financial 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.

Definition :
Financial Management is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations”. – Joseph & Massie

·       Investment decisions
·       Financial decisions  
·       Dividend decision  


The financial management is generally concerned with procurement, allocation and control of financial resources of a concern. The objectives can be-
v To ensure regular and adequate supply of funds to the concern.
v To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price of the share, expectations of the shareholders.
v To ensure optimum funds utilization. Once the funds are procured, they should be utilized in maximum possible way at least cost.
v To ensure safety on investment, i.e, funds should be invested in safe ventures so that adequate rate of return can be achieved.
v To plan a sound capital structure-There should be sound and fair composition of capital so that a balance is maintained between debt and equity capital. 


Ø  Estimation of capital requirements: A finance manager has to make estimation with regards to capital requirements of the company. This will depend upon expected costs and profits and future programmes and policies of a concern. Estimations have to be made in an adequate manner which increases earning capacity of enterprise.
Ø  Determination of capital composition: Once the estimation have been made, the capital structure have to be decided. This involves short- term and long- term debt equity analysis. This will depend upon the proportion of equity capital a company is possessing and additional funds which have to be raised from outside parties.
Ø  Choice of sources of funds: For additional funds to be procured, a company has many choices like-
o   Issue of shares and debentures
o   Loans to be taken from banks and financial institutions
o   Public deposits to be drawn like in form of bonds.
Ø  Investment of funds: The finance manager has to decide to allocate funds into profitable ventures so that there is safety on investment and regular returns is possible.
Ø  Disposal of surplus: The net profits decision have to be made by the finance manager. This can be done in two ways:
o   Dividend declaration - It includes identifying the rate of dividends and other benefits like bonus.
o   Retained profits - The volume has to be decided which will depend upon expansional, innovational, diversification plans of the company.
Ø  Management of cash: Finance manager has to make decisions with regards to cash management. Cash is required for many purposes like payment of wages and salaries, payment of electricity and water bills, payment to creditors, meeting current liabilities, maintainance of enough stock, purchase of raw materials, etc.
Ø  Financial controls: The finance manager has not only to plan, procure and utilize the funds but he also has to exercise control over finances. This can be done through many techniques like ratio analysis, financial forecasting, cost and profit control, etc. 

The relationship between risk and return is a fundamental financial relationship that affects expected rates of return on every existing asset investment.
 The Risk-Return relationship is characterized as being a "positive" or "direct" relationship meaning that if there are expectations of higher levels of risk associated with a particular investment then greater returns are required as compensation for that higher expected risk.  Alternatively, if an investment has relatively lower levels of expected risk then investors are satisfied with relatively lower returns.
·       The variability of the actual return from the expected return which is associated with the investment /asset known as risk of the investment.
·       Variability of return means that the Deviation in between actual return and expected return which is in other words as variance i.e., the measure of statistics.
·       Greater the variability means that Riskier the security/ investment.
·       Lesser the variability means that More certain the returns, nothing but Least risky e.g. Treasury Bills, Savings Deposit.
The risk can be further classified into six different categories
v Interest rate risk
v Inflation risk
v Financial risk
v Market risk
v Business risk and
v  Liquidity risk

Interest Rate Risk
-        It is risk – variability in a security's return resulting from the changes in the level of interest rates.
-        Security prices - inverse relationship with
Market Risk
It refers to variability of returns due to fluctuations in the securities market which is more particularly to equities market due to the effect from the wars, depressions etc.

Inflation Risk
-        Rise in inflation leads to Reduction in the purchasing power which influences only few people to invest due to
-        Interest Rate Risk which is nothing but the variability of return of the investment due to oscillation of interest rates due to deflationary and inflationary pressures.
Business Risk
Risk of doing business in a particular industry / environment is known as business risk. Business risk is nothing but Operational risk which arises only due to the presence of the fixed cost of operations. The Higher the fixed cost of operations requires the firm to have Greater BEP to avoid the firm to incur losses. It is normally transferred to the investors who invest in the business or company, the major reason is that EBIT of the firm is subject to the fixed cost of operations.
Financial Risk
Connected with the raising of fixed charge of funds viz Debt finance & Preference share capital. More the application of fixed charge of financial will lead to Greater the financial Risk which is nothing but the Trading on Equity.
Liquidity Risk
This is the risk pertaining to the secondary Market, in which the securities can be Bought and sold quickly and without any concession in the price.