CHAPTER – 1

INTRODUCTION

1.1 FINANCIAL MANAGEMENT

1.2 FINANCE FUNCTIONS
1.3 ESSENCE OF FINANCIAL DECISIONS

1
 CHAPTER – 1

INTRODUCTION
1.1 FINANCIAL MANAGEMENT :
Financial management is broadly concerned with the acquisition
and use of funds by a business firm. It is also concerned with the
acquisition, financing and the management of assets, which are financed
by the funds employed, with some overall goal in mind. The matters
involved in financial management would cover the issues like : (1) How
large should the firm be and how fast should it grow ? (2) What should be
the composition of the firm’s assets ? (3) What should be the mix of the
firm’s financing ? (4) How should the firm analyse, plan and control its
financial affairs ?1 In other words, financial management is concerned
with the determination, acquisition, allocation and utilization of financial
resources usually with the aim of achieving some particular goals and
objectives
More specifically, financial management is about: analyzing
financial situations, making financial decisions, setting financial
objectives, formulating financial plans to attain those objectives and
providing effective systems of financial control to ensure plans progress
towards the set objectives.2 In essence, financial management is
concerned with composition and financing of various assets required for
doing the business, the composition and mix of this assets which will
affect the mix of financing also, the start up and growth objectives and
plans of the firm and last but not the least, plans, policies, and practices
which will guide and control the financial affairs of the firm.

2
 Business firm needs financial resources at various stages of its
existence. The framework of its initial financing, periodic infusion of new
financial resources, sources, cost of finance, nature of security and the
type of finance, tax implications of financing, employment of finance in
short term and long term uses, prudent allocation of funds to various
activities, ideal use of available financial resources etc. has a bearing on
financial and business success or otherwise of the firm. The funds are
required to possess various assets which are needed for running the
business most profitably. The variety, number and composition of these
assets will decide the funds required. The uneconomical assets or the
assets which are not required may be discarded or replaced. Financing
aspect of these assets would be concerned with own sources or debt
sources and another issue of short term and long term of finance.
Dividend policy of the company is also an important issue related with
this. The management of fixed assets and current assets would also have
bearing on the working and yield of the activities.
Business finance can be defined as the activity concerned with the
raising and administering of the funds used in the business. Since today
the business property is held largely by the impersonal units known as
corporations, the emphasis in the study of business finance is often given
to corporation finance and the matters of policy that are involved in the
financial management of these larger organizations. It should be noted,
however, that the same principles of finance apply to large and small,
incorporated and unincorporated concerns. It is only the greater
complexity and the larger public interest in the affairs of the corporation
that justify special attention to its financial problems.3.

3
 Another way to consider the role of financial Management covers the
activities like Business investments, arrangement of short term and long term
finance for various needs of the firm and management of assets. Investment
decision begins with determination of the total amount of assets needed to be
held by the firm. All the assets appear on the right side of the Balance sheet
which is the probable amount needed to fund the enterprise. This is to be kept
in mind by the finance manager of the firm. With this, the composition of
assets also needs to be decided. Financial management in this area will cover
replacement, elimination and disposing off decisions too. Another major area
is financing decision. Here the finance manager is concerned with the makeup
of the left hand side of the balance sheet. This covers owners’ funds and debt
funds for long term and short term needs of the firm. The mix of financing
makes difference. The dividend policy is also an integral part of the firm’s
financing decision. The dividend-payout ratio determines the amount of
earnings that can be retained in the firm. Retaining a greater amount of
current earnings means lesser amount of fund available for current dividend
payment. The value of the dividends paid to shareholders must therefore be
balanced against the opportunity cost of retained earnings earmarked as a
means of equity financing. Together with the decision about the mix of
financing, another question is how best to physically acquire the needed
funds. This will cover the issues like issue of Shares, Bonds, leasing
agreements, short-term loans etc. Next important are is Asset management.
This encompasses efficient utilization of the assets after they have been
acquired. The finance manager is more concerned with management of
current assets. However, the finance executive is concerned with replacement
and retirement of certain fixed assets. A large share of the responsibility for

4
the management of fixed assets would fall on the operating managers who
employ these assets.4
Another way of approach for exposition is having two broad
categories for referring to the scope and functions of financial
management. Traditional approach refers to the academic subject matter
for which the term was Corporation finance. This was later on known as
financial management. As the name suggests, the concern of corporation
finance was with the financing of corporate enterprises. In other words,
the scope of the finance function was treated by the traditional approach
in the narrow sense of procurement of funds by corporate enterprise to
meet their financial needs. The term procurement was used in a broad
sense so as to include the whole gamut of raising funds externally.
1.2 FINANCE FUNCTIONS :
The scope of financial management can be viewed as a part of
whole management process. This involves several key stages of functions
which can be logically analysed in a sequential manner. In fact the
process is continuous and dynamic, with some activities overlapping and
being carried out simultaneously.
With reference to above approach, it is pertinent to view financial
management as a dynamic decision making process which involves a
series of interrelated activities, like :
1. financial analysis.
2. financial decision making.
3. financial planning.
4. financial control.

5
 In all the business enterprises reliable and relevant financial
information is crucial. Financial management involves making strategic
financing and investment decisions which are critical to the survival and
success of the enterprise. Therefore, the quality of the financial
information used will ultimately affect the quality of the decisions made,
plans implemented and the value of the firm. The provision of reliable
and relevant financial information and the professional advice based on
such information is a key responsibility of the finance manager who in
turn should ensure that reliable financial information systems exist in the
organization.
(1) Financial analysis :
This includes analysis and review to determine the current financial
performance and condition of the business, identification of any particular
financial problems, risks, constraints and an assessment of financial
strengths, weaknesses, opportunities and threats.
(2) Financial decision making :
On the basis of the analysis, financial decisions and choices will have
to be made. This includes strategic investment decisions, for example
acquiring the competitor company, and strategic financing decisions, such as
floating new long term loans. The review will lead to various strategic
options for the management. Here, the finance manager will be ultimately
concerned in the financial evaluation and assessment of the options
available, in determining their respective costs, benefits and risks.
The decision making phase involves determination of the firm’s
financial objectives. The Financial objectives will be related to (a)
Profitability : that is the firm’s investment decisions should yield a rate of

6
return commensurate with the risks involved. The management usually
seek to improve profitability for survival and growth. Many a times this is
linked with the rewards the executives get.
(b) liquidity : it is required that sufficient cash is available to pay off the
current liabilities, when the become due. (c) capital structure : which
refers to the relationship between debt and equity finance in its long term
funding arrangements.
The finance executive has to ensure that the firm maintains a
healthy balance between the proportion of debt and equity finance in its
capital structure, subject to specific conditions of the individual firm.
(3) Financial planning :
Financial objectives set out what has to be achieved, and the
financial plans will detail how the financial objectives are to be achieved.
Financial plans will have a timeframe, short, medium or long term and
will essentially provide the road maps detailing how the firm’s objectives
are to be achieved. The essence of financial planning is to ensure that the
right amount of funds is available at the right time and at the right cost for
the level of risks involved to enable the firm’s objectives to be achieved.
(4) Financial control :
The process will require effective management reporting and
control systems to be operative throughout the organization. This is to
ensure that plans are properly implemented, that progress is continually
reported to management, and that any deviations from plans are clearly
identified. Control will inevitably lead to a review and analysis of
financial performance, which in turn lead to new decisions being made,

7
objectives and plans being modified as warranted, suitable remedial
actions, and so forth, thus continuing the dynamic management cycle. 5
Practically, the finance function can be viewed as attempting to
balance cash inflows and cash outflows. The finance activity, activities
which a finance controller of a business firm ( that is a joint stock
Company ) performs, involves financing and investment decisions.
Periodically the return earned is to be distributed to the shareholders,
which is called dividend decision. We can summarise the finance
functions as under :
1) Investment or long – term asset – mix decision.
2) Financing or capital – mix decision.
3) Dividend or profit allocation decision.
4) Liquidity or short – term asset – mix decision.
A business firm performs finance functions simultaneously and
continuously in the normal course of business. They do not necessarily
occur in sequence. Finance functions call for skillful planning, control
and execution of a firm’s activities. 6
(1) Investment Decision :
Investment decision involves allocation of long term capital
funds to long term assets that earn for the firm. The crucial aspects
of investment decision are (a) evaluation of the prospective
profitability of new investment, and (b) the measurement of
acceptable rate against which the prospective return of new
investments could be compared. The evaluation should be with
reference to risks and return.

8
(2) Financing Decision :
This requires the finance executive to decide when, where
and how to acquire the funds to meet the firm’s investment needs.
The major issue will be mix of equity and debt. This is the capital
structure of the Company. The use of debt has impact on the risk
and return to the shareholders. Best possible proportion of equity
and debt will maximize firm’s value, subject to the earning of the
Company. According to such mix, the finance executive has to
raise appropriate funds through best available sources. Practically,
in Companies, factors like flexibility, legal aspects, tax
implications, terms & conditions of the loans, management control
etc. also form important aspects of the decision.
(3) Dividend Decision :
Every year end, the finance executive is concerned with an
issue whether the firm (company) should distribute all profits, or
retain them, or distribute a portion and retain the balance. The
ultimate idea is its impact on the shareholders’ value. For an
optimum dividend policy, the issues like cash dividend, dividend
stability and bonus shares is to be considered.
(4) Liquidity Decision :
Current assets management which affects a firm’s liquidity is
also another important finance function. Current assets should be
managed efficiently for safeguarding the firm against the dangers of
illiquidity and insolvency. In order to ensure that neither insufficient
nor unnecessary funds are invested in current assets, the finance
executive has to develop useful techniques of managing current assets.

9
 Ultimately, the financial decisions directly concern the firm’s
decision to acquire or dispose off assets and require commitment or
recommitment of funds on a continuous basis.
To quote Ezra Solomon : “… The function of financial
management is to review and control decisions to commit or recommit
funds to new or ongoing uses. Thus in addition to raising funds, financial
management is directly concerned with production, marketing and other
functions, within an enterprise whenever decisions are made about the
acquisition or distribution of assets”. 7
Another important and relevant aspect which is emphasized by
Prof. I M Pandey is worth noting. There is a reference to the procedures
and systems which are required for effective execution of the finance
function. These are the issues of routine, however, very much
indispensable and part of the finance function. The Finance Manager in
the modern enterprises is mainly involved in the managerial finance
functions, the routine functions are carried out by executives at lower
levels. In recent times the scope of finance function is widened and the
role of the finance manager has changed a lot. His role covers :
1) Raising of Funds : In the day-to-day activities, his role is to
ensure that the firm has enough cash to meet its obligations.
However, the major and crucial involvement is with
reference to reorganizations, mergers, expansion,
diversifications, recapitalisation etc.
2) Allocation of Funds : A number of factors such as fast
industrialization, technological innovations, intense
competition, government intervention and controls,

10
 demographic changes and widening of customers and
markets necessitated efficient and effective utilization of all
the resources of the firm, particularly financial resources.
The development and use of a number of management skills
and decision-making techniques facilitated the
implementation of a system of optimum allocation and use
of the firm’s resources. The concern of the Finance Manager
will be on determining the size and technology of the firm,
in setting the pace and direction of growth and in shaping the
profitability and risk complexion of the firm by selecting
best asset mix and by obtaining the optimum financing mix.
3) Profit Planning : This refers to decisions in the areas of
costs, pricing, volume of output and selection of product
lines. These issues are preconditions for framing ideal
investment and financing decisions. The cost structure, that
is the mix of fixed and variable costs has significant
influence on firm’s profitability. Profit planning helps to
anticipate the relationships among volume, costs and profits
and develop action plans to safeguard against any
unexpected results.
4) Capital Markets : Finance Manager has to fully understand
the operations and technicalities of capital markets. High
dependence on debt may be viewed adversely by the
investors in the market. At the same time distributing all the
profit by a profitable growing firm may not be liked by
majority of investors, who opine that the funds should be

11
 reinvested for augmenting future profitability and making
capital gains. Thus, through their operations in capital
markets the investors evaluate the actions and performance
of the Finance Manager.8
In the market economy, the individual firms are using productive
resources of the society for supplying the goods and services needed by
the society. Through price system the scarce resources are allocated for
production. The ultimate mechanism of demand, supply and market
forces brings equilibrium of prices customers pay and profit earning
opportunities for producers. In this process there is an adjustment about
price as well as quantity of goods produced. The prices of goods which
manufacturers (firms) get and the quantities as well as type of goods have
a bearing on profit earning of the firm, which is ultimately the finance
function. Economists also have confirmed that profit maximizing
behaviour of various firms ultimately lead to efficient utilization of scarce
resources of the ecomomy.9
In terms of economic wisdom, the firms tend to function in a way
that increases firm’s profit and avoid the functioning which decreases the
profit. For this goal, the firm has to maximize output with reference to
inputs, as also minimize the production and other costs. This can be
termed as efficiency of the firm. Therefore, one can say that profit
maximization is the yardstick of economic efficiency. Thus, in the
competitive economy, profitability is the measure of performance.
The financial management has two way reference to efficient use
of resources. For profit maximization, it is required that there should be
the most economical use of all the resources held by the firm. This has a

12
direct bearing on the cost of performance, and hence the profitability.
Secondly, the firm is employing and using an important resource of
Capital, i.e. financial resources. Capital is the most important scarce
resource in the society. Therefore, profit maximization can be a logical
criterion for various decisions where the finance executive is involved.
Here, the finance executive should be adept to understand implications of
economic realities of timing of costs and income as well as the problems
of uncertainty.
Another measure of performance is value maximization. This is the
value an asset can produce in relation to a particular time. The benefits of
investment should be judged with reference to magnitude of returns as
well as the certainty of flows of returns. Such value creation is to be
evaluated against costs involved. The finance executive is defining this
value from investors’ point of view, since they supply the capital funds.
This return is to be capitalized which reflect time and risk parameters
from investors point of view. This is optimization with respect to owner
interests. In joint stock companies, particularly professional firms, there is
a separation of management from the ownership, where this concept fits
perfectly. In such firms, there is a real test of the finance executive, who
in turn will strive to maximize the value for owner investors.
The explanation of “Financial Management” falls into three broad
groups. Firstly, finance function in a business encompasses the task of
providing funds needed by the enterprise on terms that are most
favourable in the light of its objectives. This approach is concerned
almost exclusively with the procurements of funds. It is widened to cover
a discussion of the instruments, institutions and practices through which

13
funds are obtained. It also covers the legal and accounting relationships
between a company and its sources of funds. Another view considers that
finance is concerned with cash, and that since nearly every business
transaction involves cash directly or indirectly. Finance is concerned with
everything that takes place in the conduct of a business. The third
approach envisages finance function as procurement of funds and their
effective utilization in the business. This approach entails a decision
making after analyzing the alternative uses and sources of funds. The
finance manager has to play a major role in planning a business concern’s
need of funds : raising the necessary funds, and then putting them to
effective use. In this sense, financial management covers financial
planning, forecasting of cash receipts and disbursements, the realizing of
funds, use and allocation of funds, and financial control. Through budgets
and other devices of financial control, the finance executive attempts to
bring performance closer to the targets. 10
In broader scope, financial management includes judgments about
whether a company should hold, reduce or increase investments in
various assets. This requires to answer the following three questions.
1) What specific assets should a company acquire ?
2) What total volume of funds should a company commit ?
3) How should the funds required be raised ?
Illustrative list of executive finance functions is :
1. Establishing asset management policies : This involves policy
making about fixed and current assets and involving other
functional executives in the attainment of overall corporate goals.

14
2. Determining the allocation of net profits : This involves strategic
decision making about distribution of dividend and retaining the
earnings for the growth of the company.
3. Estimating and controlling cash flows and disbursements : This
involves short term as well as long term receipts and payments of
funds. For instance, recovery from debtors, repayment of long term
loan etc.
4. Deciding upon needs and sources of new outside financing :
This involves assessing and evaluating the real need of finance for
business activities as well as decisions about best possible
economical use of the funds.
5. Carrying on negotiations for new outside financing : This
involves negotiations and deciding about availing short term
(working capital ) and long term (term loans, debentures etc.) funds
for business needs.
6. Checking upon financial performance : This involves
retrospective analysis of operating period for the purpose of
evaluating the wisdom and efficiency of financial planning.
Analysis of what has happened should be of great value in
improving the standards, techniques and procedures of financial
control involved in carrying out finance function. 11
Together with explanation of finance function, another relevant and
crucial aspect is about the Goals of Financial Management. One of the
objective of a Company is to maximize its value to its shareholders.
Value is represented by market price of the ordinary shares of the
company over the long run, which is a reflection of the company’s

15
investment and financing decisions. The long run means a period long
enough so that a normalized market price can be worked out. Any
decision to curtail the expenses in the short run can raise the shares price
in the short run. However, saving of cost in the short run for crucial
activities like research, product development, exports etc. will reduce
future profits of the firm and resultant drop in the value of the firm and
market price of shares. Profit maximization has an implication of timing
of expected returns. The volume and time pattern of returns are relevant
factors. With this, the financial aspect involved is risk and uncertainty of
prospective earnings stream.
Another relevant dimension is about the controversy regarding the
goals of financial decision making as profit maximization or wealth
maximization. Certain objections have been raised against profit
maximization as the goal of the business enterprise. First, it relates to the
problem of uncertainty as future cannot be known well enough to express
the probability of possible return. It is not possible to maximize what
cannot be known. Secondly, most decisions involve a balancing between
expected return and risk. Opportunities promising the possibility of
higher expected yields are associated with greater risk to recognize such a
balancing and wealth maximization is brought into the analysis. If greater
expected returns are associated with higher risks, a higher capitalization
rate should be applied to opportunities that involve greater risk. The
combination of expected returns with risk variations and related
capitalization rate cannot be considered in the concept of profit
maximization. Thirdly, the decision maker may not have enough
confidence in estimates of future returns so that he does not attempt

16
further to maximize. It is argued that the firm’s goals cannot be to
maximize profits but to attain a certain level of rate of profit, holding a
certain share of the market or a certain level of sales. Firms try to
sacrifice rather than to maximize. The satisfying goal is appropriate for a
behavioural theory of the firm and is perfectly manageable. Satisfying is
primarily a short run search strategy and relates to the cost of search. If
information and search costs are low, additional efforts will be made to
maximize. Where information and search costs are high, additional
efforts to seek to maximize promises little additional net gains. So the
decision maker may be said to satisfies. Thus, when information and
search costs are taken into account, the differences between satisfying
and maximizing may be insignificant or non-existent. Lastly, the
objective to profit maximization indicates that it is too narrowly centered.
Such maximization criteria fail to take into consideration the interests of
government, workers and other persons in the enterprise.
Prof. Ezra Solomon argues that it is useful to distinguish between
profits and profitability. Maximisation of profit in the sense of
maximizing the wealth accruing to shareholders is clearly an unreal
motive. On the other hand, profitability maximization in the sense of
using resources to yield economic values higher than the joint values of
inputs required is a useful goal. The goal of the profitability achieved in
terms of greater outputs than input values involves a different set of
considerations. Thus the proper goal of financial management is wealth
maximization. Even if the management has other motives, such as
maximizing sales or size, growth or market share, or their own survival or
peace of mind, these operating goals do not necessarily conflict with

17
operating goal of wealth maximization. This means that wealth
maximization also maximizes the achievement of these other objectives.
Maximisation of wealth provides a useful and meaningful objective as
basic guideline by which financial decisions should be evaluated. 12
Recent developments in economics and finance have placed the
finance executive in a central position in the business firm. Finance has to
consider a broad range of business decisions with reference to funds flow
implications. In addition, it involves the evaluation of resource allocation
choices. Thus, financial management is concerned with wide range of
issues like : size of the firm, rate of growth, asset mix, product mix,
project evaluation, financial analysis, financing mix, fixed versus variable
costs, make or buy decisions and so on.
The field of finance is a subset of behavioural sciences, and derives
its analytical foundations from the economic theory of the firm. The field
of finance is enriched by the behavioural characteristics of all market
participants – management, shareholders, lenders and consumers.
Similarly, it is constrained by the institutional and legal environmental
factors of government, markets and so on. One is interested in the efforts
of all participants to optimize their own welfare through the pursuance of
specific goals, within the accepted modes of behaviour.
The nature, objectives and scope of financial management can be
analysed further with a different perspective. Finance, as applied in the
area of Business, is management of flows of money in the organization.
Financial Management is the applied field of Business Administration.
The principles developed in the field of financial management heavily
rely on the disciplines of accounting and economics. Accounting is

18
concerned with identification, recording, measuring and reporting of
monetary/financial transactions of a business firm. Financial management
is very much concerned with the monetory resources. The data generated
by accounting system has varied utility in the business, which employ
huge financial resources for earning profit and maximizing value.
Economics is concerned with analyzing the allocation of resources in the
economy. The study is two fold, in the sense that on one part it analyses
the transactions of individuals/consumers with exchange of money, and
another part which is broad in magnitude analyses issues like demand,
supply, costs and profit, and production and consumption. Another
approach to analyse this is the concepts of Microeconomics and
Macroeconomics. These theories study issues like pricing and production,
economic resources, gross national product and level of economic activity
in the economy as a whole. The science of financial management is also
concerned with such issues of resources, costs, profit, levels of
production, use of financial and other resources for attaining ultimate
goals of profit maximization and value maximization.
John Hampton analyses the nature and scope of financial
management as under. 13
The ultimate objectives rightly defined and understood are the key
to successfully moving the firm to a healthy future. As the business firms
are profit – seeking organizations, their objectives are usually expressed
in terms of money. The primary objectives are: (1) maximization of
profits, and (2) maximization of wealth. These signify the essence, scope
and goals of financial management.

19
 Maximisation of profit as such is a simple and a rational goal of all
businessmen. This implies holding down the costs, so that the margin is
maintained. If losses are continuing, it reduces the value of the firm and
there will be erosion of Capital. Earning profit is also a basic requirement
for survival and growth of any economic entity, particularly a business
firm.
Maximisation of wealth implies maximizing value of the firm over
the long run. This is maximizing the net present worth of the firm. As
against focusing on the profits, this goal emphasizes the impact of profits
on the current market value of the firm’s securities. If the firm is highly
valuable for the foreseeable future, it commands a high current value. The
reverse is also true. The objective of maximisation of wealth is linked to
the long term profits of the firm. In addition, other important issues are
firm’s growth, amount of risk for investors, price of the shares of the
company and the trend of dividend payment. For maximizing the value,
the firm should avoid high level of risks, have healthy dividend policy,
maintain steady growth and monitor the market price of its shares.
The scope of financial management can further be analysed with
reference to the Goals of financial management. In pursuit of maximum
profits and wealth, financial management interprets the primary goal in
to specific financial goals. One can refer to the following basic approach
for this analysis :
(1) Profit-Risk approach : This approach recognizes that finance
deals with creating proper framework to maximize profit and value
at a given level of business risks. In pursuing this balance, the firm
has to develop controls over flows of funds while allowing

20
 sufficient flexibility to respond to changes in the operating
environment. This classification method identifies following goals:
a) Maximise profit : Finance should strive for a high level of
primarily long term and secondary short term corporate goals.
b) Minimise Risk : Finance should always seek courses of action
that avoid unnecessary risks and anticipate problem areas and
ways of overcoming difficulties.
c) Maintain Control : Funds flowing in and out of the firm must
be constantly monitored to assure that they are safeguarded and
properly utilized. The financial reporting system must be
designed to provide timely and accurate pictures of the firm’s
activities. Errors or weaknesses should be located and corrected
so that risky situations can be controlled.
d) Achieve flexibility : The firm should always be prepared to
deal with an uncertain future. Flexibility is attained by careful
management of funds and activities. If the firm has located
sufficient sources of funds in advance of needs, it will be
flexible when money is required. If it identifies and analyses a
variety of potential projects, it will have flexibility in
determining its courses of action. Finance attempts to be as
flexible as possible in providing the funds or data needed to
support the production and marketing functions of the firm.
2) Liquidity Profitability approach : This approach recognizes that
the finance manager has two goals to achieve. The first is liquidity,
which means that the firm has adequate cash on hand to meet its
obligations at all times. In other words, the firm can pay all its bills

21
 and have sufficient cash to take advantage of large purchases with
discounts. The comfortable position should also be able to meet
emergencies. The second goal is profitability. This aspect focuses
on the firm’s operations to yield a long term profit for the
shareholders as part of the overall goal of maximizing the present
value of the Shares of the Company.
Together with the above approach, one can analyse the functions
of financial management which will address to the scope of financial
management.
A) Functions relating to liquidity :
For achieving liquidity, the finance manager performs the functions
such as :
(1) Forecasting cash flows : Efficient day to day operations
require the firm to be able to pay its obligations promptly. As
such this is a matter of matching cash inflows against outflows.
The firm must be able to forecast the sources and timing of
inflows from customers and other sources and use them to pay
its creditors and other financial obligations.
(2) Raising funds : The firm receives its financing from a variety
of sources. With reference to the position of the firm and the
position of funds market at particular times, specific sources
would be more desirable than others. At a given time, a possible
source of funds may not have sufficient funds available to meet
the firm’s needs, or the funds may be expensive. The finance
executive has to identify the amount of funds available from
each source and the periods when the funds will be needed, then

22
 the manager must take steps to ensure that the funds will
actually be available and committed to the firm.
(3) Managing the flow of internal funds : A large firm has a
number of different bank accounts for various operating
divisions or for special purposes. The money that flows among
these internal accounts should be carefully monitored.
Frequently, a firm has excess cash in one bank account when it
has a need for cash elsewhere in the firm. By continuously
checking on the cash levels in the headquarters and each
operating division’s accounts, the manager can achieve a high
degree of liquidity with minimum external borrowing.
Shortages and the costs associated with short term borrowing
are reasons to control the use and distribution of the firm’s
money.
B) Functions relating to profitability :
With respect to profitability, some of the specific functions would
cover :
(1) Cost control : Most of the large Companies have
comprehensive cost accounting systems to monitor expenditure
in the operational areas like production and marketing. The
system generates data and various reports which the finance
executive is supervising. His involvement in this important area
allows him to monitor and measure the money committed or
spent by the company.
(2) Pricing : Some of the important and strategic decisions made

by the firm involve the prices established for its products,

23
 product lines and services. The philosophy and approach to the
pricing policy are critical elements in the company’s marketing
effort, image and sales level. Prices have an interface with
marketing function. The finance executive can supply important
information about costs, changes in costs at varying levels of
production and the profit margins needed to carry on the
business successfully. Ultimately, finance provides tools to
analyse profit requirements in pricing decisions and contributes
to the formulation of pricing policies.
(3) Profit forecasts : The finance executive is usually responsible

for gathering and analyzing the relevant data and making

forecasts of profit levels. To estimate profits from future sales,
the firm must be aware of current costs, likely increase in costs
and likely changes in the ability of the firm to sell its products
at established or planned selling prices. Basic variables of
purchase and production costs and sales inputs are to be
analised. Once costs and sales are forecasted, the data arranged
in financial formats will depict the expected profit. Similarly,
before funds are committed to new projects, the expected
profits must be determined and evaluated.
(4) Measuring required return : Whenever the funds are

invested, the firm has to make a risk-return decision. The

adequacy of return is to be evaluated with reference to the
investments and risks. The required return is the rate of return
that must be expected from a proposal before it can be
accepted. It is also called the cost of capital. The finance

24
 manager has to determine and evaluate the required return or
the cost of capital. 14
The nature of Financial Management can also be analysed with
reference to the scope, functions and objectives of the subject of
financial management. Financial Management as an academic
discipline, was initially treated simply as raising of funds. In terms
of the crucial importance of finance in business and industry as
also with current reference, the broader scope of efficient use of
financial resources is also universally recognized. The scope and
objectives thus include the importance of basic financial concepts,
techniques of financial analyses, current assets management, long
term investment decisions, financing decisions and other related
important issues like dividend policy, plough back of earnings, tax
implications of business and long term business strategy.15
As per another authority on the subject, the term ‘finance’ in real
world has been interpreted variably by different finance scholars. More
significantly, the concept of finance has changed markedly with change
in times and circumstances. For convenience of analysis different
viewpoints on finance can be categorized into three major groups :
(1) The first category incorporates the views of all those who contend
that finance concerns with acquiring funds on reasonable terms and
conditions to pay bills promptly. This approach covers study of
financial institutions and instruments from which funds can be
secured, the types and duration of obligations to be issued, the
timing of the borrowing or sale of stocks, the amount required,
urgency of the need and cost. The approach has the virtue of

25
 shedding light on the very heart of finance function. However, the
approach is too restrictive. It lays stress on only one aspect of
finance. This approach of finance is held by the traditional
scholars.
(2) The second approach holds that finance is concerned with cash.
Since almost all business transactions are expressed ultimately in
terms of cash, every activity within the enterprise is the primary
concern of the financial manager. Thus, according to this approach,
the financial manager is required to go into details of every
business activity be it concerned with purchasing, production,
marketing, personnel, administration research and other associated
activities. Obviously, such a definition is too broad to be
meaningful.
(3) A third approach to finance, held by modern scholars, looks on
finance as being concerned with procurement of funds and wise
application of these funds. Protagonists of this approach opine that
responsibility of the financial manager is not only limited to
acquisition of adequate cash to satisfy business requirements but
extends beyond this to optimal utilization of funds. Since money
involves cost, the central task of the financial manager while
allocating resources is to match the benefits of potential uses
against the cost of alternative sources so as to maximize value of
the enterprise. This is the managerial approach of finance which is
also known as problem-centered approach, since it emphasizes that
the financial manager in his endeavour to maximize value of the
enterprise has to deal with vital problems of the enterprise, viz.,

26
 what capital expenditure should the enterprise make ? What
volume of the funds should the enterprise invest ? How should the
desired funds be obtained ? How can the enterprise maximize its
profitability from existing prepared commitments ?
The management approach to finance is balanced one having given
equal weightage to both procurement and utilization aspects of finance
and has received wider recognition in modern world. Thus, finance may
appropriately be defined as the process of raising, providing and
managing of all the money to be used in connection with business
activities. Finance when applied to corporate form of organization is
termed as corporation finance. 16
Certain relevant definitions are :
Business finance can be broadly defined as the activity concerned
with planning, raising, controlling and administering of funds used in
business. (Guthmann & Dougall).
The finance function is the process of acquiring and utilizing funds
by a business. (R C Osborn).
Business finance deals primarily with raising, administering and
disbursing funds by privately owned business units operating in non-
financial fields of industry. (Prather & Wert).
Functions of Financial Management :
The views of traditional and modern scholars regarding finance
function differ markedly. Therefore, it would be germane to give a brief
idea about their views.
Traditional writers contended that primary responsibility of the
financial manager is to raise necessary funds to meet operating

27
requirements of the business. He has to take decisions with respect to the
choice of optimum source from which the funds would have to be
secured, timing of the borrowing or sale of stock and cost and other terms
and conditions of acquiring these funds. Planning quantum and pattern of
fund requirements and allocation of funds as among different assets,
according to the traditional scholars, is the primary concern of non-
financial executives. Traditional approach to finance function has been
bitterly criticized by modern scholars on various cogent grounds. One
such ground is that the traditional ground approach is too narrow. It
viewed finance as a staff specialty. According to them, it would be
mistaken to argue that responsibility of the financial executive is limited
to acquisition of sufficient funds for the enterprise and he has little
concern as to how such funds would be allocated. The approach of
traditional experts is also criticized on the ground that it overemphasized
episodic and non-recurring problems like incorporation, consolidation,
reorganization, recapitalization and liquidation and gave little attention to
day-to-day financial problems of ongoing concerns. Another shortcoming
of the traditional approach is that it gave concentrated attention to
problems of the corporation finance while problems of unincorporated
organizations like sole trading concerns and partnership firms were
altogether ignored. Modern authorities also argued that the traditional
approach laid relatively more stress on problems of long term financing
as if business enterprises do not have to encounter any financial trouble in
the short run. As a matter of fact, problem of working capital
management is very crucial problem which has to be dealt with

28
efficiently by the financial manager if an enterprise has to reach the goal
of wealth maximization.
Modern scholars have viewed finance as an integral part of the
overall management rather than as a staff specialist concerned with the
fund raising operations. Accordingly, the financial manager has been
assigned wider responsibilities. According to them, it is not sufficient for
the financial manager to see that the company has sufficient funds to
carry out its plans but at the same time he has to ensure wise application
of funds in the productive process. Thus, to carry out his responsibilities
effectively it is the bounden responsibility of the financial executive to
make a rational matching of the benefits of potential uses against the
costs of alternative potential sources so as to help the management to
accomplish its broad goal. The financial manager is, therefore, concerned
with all financial activities of planning, raising, allocating and controlling
and not with just any one of them. Aside from this, he has to handle such
financial problems as are encountered by a firm at the time of
incorporation, liquidation, consolidation, reorganization and the like
situations that occur infrequently.
Contents of Modern Finance function :
As per this approach, the finance functions can be categorized into
two broad groups : Recurring finance function and non-recurring finance
function.
Recurring finance function :
Recurring finance function encompasses all such financial
activities as are carried out regularly for the efficient conduct of a firm.
Planning for and raising of funds, allocation of funds and income and

29
controlling the uses of funds are the contents of recurring finance
function.
(1) Planning for funds : The prime task of the finance manager in a
new or growing concern is to formulate finance plan for the
company.Finance plan is the act of deciding in advance the
quantum of fund requirements and its duration and the make-up of
such investments to achieve the primary goal of the enterprise.
While planning for fund requirements, the finance manager has to
aim at synchronizing the cash inflows with cash outflows so that
the firm does not have any resources lying unutilized. Since in
actual practice such a synchronization is not possible the finance
manager must maintain some amount of working capital in reserve
so as to ensure solvency of the firm. The magnitude of this reserve
is the function of the amount of risk that the firm can safely assume
in given economic and business conditions.
Keeping in view the long term goals of the company, the
finance manager has to determine the total funds requirements,
duration of such requirements and the forms in which the required
funds will be obtained. Decision with respect to funds requirements
is reflected in capitalization. While determining funds requirements
for the enterprise the finance manager should keep in mind the
various considerations, viz., purpose of the business, state of
economic and business conditions, the management attitude
towards risks, magnitude of future investment programmes, state
regulations etc. Broadly speaking, there are two methods of
estimating funds requirements : Balance Sheet Method and Cash

30
 Budget Method. In the Balance Sheet Method total capital
requirements are arrived at after totaling the estimates of current,
fixed and intangible assets. In contrast with this, a forecast of cash
inflows and cash outflows is made monthwise and cash
deficiencies are calculated to find out the financial needs. With the
help of cash budget amount of funds requirements at different time
intervals can be calculated. Having estimated total funds
requirements the financial executive decides as to how these
requirements will be met, viz. forms of financing funds
requirements. Such decisions are taken under “ Capital structure.”
While there may be various patterns of capital structure, the
finance manager must select the one that best suits the enterprise.
Bearing in mind the cardinal principles of cost, risk, control,
flexibility and timing, the finance manager should decide upon the
most suitable pattern of capital structure for the enterprise.
(2) Raising of Funds : Second responsibility of the finance manager is
that of procuring the necessary capital to meet the business
requirements. If company decides to raise the needed funds by
means of security issues, the finance manager has to arrange the
issue of prospectus for the flotation of issues. In order to ensure
quick sale of securities generally the stock brokers, who deal in
securities in the stock market and who are in constant touch with
their clients, are approached. Even after the issues are floated in the
stock market there is no certainty that the security issues will bring
in desired amount of capital because public response to security
issues is difficult to estimate. If a business entrepreneur fail to

31
 assemble desired amount of fund through security issues, the
enterprise is plunged into grave financial trouble. In order to
hamstring this problem the finance manager has to make such an
arrangement as may protect the issue against its failure. For that
matter, he has to approach underwriting firms whose main job is to
provide the guarantee of buying the shares placed before the public
in the event of non-subscription of the shares. For this service, they
charge underwriting commission. Thus, if an underwriter is
satisfied with the issuing company, an underwriting agreement is
entered into between the company and the issuing company. The
obligation of the underwriter as per the agreement arises only when
the event of non-subscription of issues by the public takes place.
Where size of the security issue is too large to be handled by a
single underwriter, the issuing company may enter into agreement
with a number of underwriting firms. Where a company decides to
borrow money from financial institutions including commercial
banks and special financial corporations, the finance manager has
to negotiate with the authorities. He has to prepare the project
report for which the loan is to be sought and discuss it with the
executives of the financial institutions along with the prospects of
repayment of the loan. If the institution is satisfied with the
desirability of the proposal an agreement is entered into by the
finance executive on behalf of the company.
(3) Allocation of Funds : Third major responsibility of the finance
manager is to allocate funds among different assets. In allocating
the funds consideration must be given to the factors such as

32
competing uses, immediate requirements, management of assets,
profit prospects and overall management plans. It is true that
management of fixed assets is not the direct responsibility of the
finance manager. However, he has to acquaint production
executive who is primarily seized with the task of acquiring fixed
assets with fundamentals of capital expenditure projects and also
about the availability of capital in the firm. But the efficient
administration of financial aspects of cash receivables and
inventories is the prime responsibility of finance executive. The
finance executive has also to see that only that much of fixed assets
is acquired that could meet current as well as increased demand of
company’s product. But at the same time he should take steps to
minimize level of buffer stock of fixed assets that the company is
required to carry for the whole year to satisfy the expanded
demands. While managing cash the finance executive should
prudently strike a golden mean between these two conflicting goals
of profitability and liquidity of the business firm. He has to set
minimum level of cash so that the company’s liquidity is not
jeopardized and at the same time its profitability is maximized.
Alongside this, the finance executive has to ensure proper
utilization of cash funds by taking such steps as to help in speeding
up the cash inflows, on the one hand and slowing cash outflows, on
the other.
In managing receivables the finance manager should
endeavour to minimize the level of receivables without adversely

33
 affecting sales. For that matter, suitable credit policy should be laid
down and suitable collection procedures would be designed.
Regarding management of inventories, operating responsibility
of managing inventories in a company is outside the province of the
finance executive and well within the realm of production manager
and purchase manager. However, the finance executive is responsible
for supplying necessary funds to support the company’s investment in
inventories. In order to ensure that funds are allocated efficiently in
inventories, the finance executive must familiarize himself with
various methods by which efficient management of inventories can
be achieved. The problem that the finance executive faces is to
determine the optimal magnitude of investment in inventories with
the help of the EOQ model suitable level of inventories is decided.
(4) Allocation of Income : Allocation of annual income of the
company as between different uses is the exclusive responsibility
of the finance executive. Income may be retained for financing
expansion of business or it may be utilized for retiring outstanding
debt or it may be distributed to the owners as dividend as a return
on capital. Decision in this regard is taken in the light of financial
position of the enterprise, its present and future cash requirements,
shareholders’ preferences and the like.
(5) Control of Funds : Last but not the least responsibility of the
finance executive is to control the use of funds committed in the
company’s business so as to ensure that cash is flowing as per the
plan and if there is a deviation between actuals and estimates, the
same is dealt with in a manner compatible with the continued

34
financial health of the business. Similarly, the finance executive
has to evaluate performance of receivable management in order to
judge how far credit and collection policies laid down by the
enterprise are being carried out effectively by the credit
department. For that purpose, credit and collection practices will
have to be examined minutely. If analysis of receivable turnover,
age of each account, percentage of collections, ratio of bad debts to
sales and ratio of delinquent accounts to sales indicates that the
performance is not satisfactory, the finance executive must
determine whether credit and collection policies are inadequate and
need revision or there is laxity in the credit and collection
department in implementing the policies.
While controlling inventories the finance executive must
ascertain whether the capital tide in inventories corresponds with the
predetermined standards. In the event of deviation, the finance
executive should analyse the situation to detect the cause. There may
be two principal reasons for the variations. In the first instance,
economic conditions may have changed since the determination of
budget limits making the standards wrong. Actual investment in
inventories may have, therefore, been proper under the changed
circumstances nevertheless it varies from the predetermined
standards. In such a situation the only remedy left with the finance
executive is to revise budgetary programme in the light of new
developments. Another factor attributable to deviation is failure of the
personnel to execute the policies and programmes of action. In this
case, besides correcting the error, the finance executive should detect

35
 individuals who are at fault and take necessary action to ensure that
such deviations do not recur in future.
Certain important tools that are employed to control the uses
of funds are Budgetary reports, Projected financial statements and
Actual financial statements, Ratio Analysis, Funds flow statement
and Break even Analysis.
Non-recurring Finance functions :
This refers to those financial activities that the finance executive has to
perform very infrequently. Preparation of financial Plan at the time of
promotion of the enterprise, financial adjustment in times of illiquidity crisis,
valuation of the enterprise at the time of merger or reorganization of the
enterprise and similar other activities are of episodic character. Successful
handling of such problems requires financial skills and understanding of
principles and techniques of finance peculiar to non-recurring situations.
Nature of Financial Decision :
The functions of financial management elaborated above, leads to
an unmistakable conclusion that the finance manager is an executive
endowed with decision making powers. The function of asset
management recognizes the decision making role of the finance manager.
The finance executive in conjunction with other executive officers of the
enterprise participates in making decisions affecting the current and fuller
utilization of the company’s resources. These executives may discuss the
total amount of assets needed by the company to carry out its operations.
They will determine the mix of assets that will help the company in
achieving its goals. They will identify ways to more effectively use
existing assets and reduce waste and unneeded expenses.

36
 In the management of funds the finance executive acts as a
specialized staff officer to the chief executive of the company. He is
responsible for having sufficient funds for the organization to conduct its
business and to pay its bills. He must locate funds to finance receivables
and inventories make arrangements for the purchase of assets and identify
sources of long term financing. Cash must be available to pay dividends
declared by the Board of Directors.
In managing income the finance executive has to take decisions
regarding allocation of income as between distribution and retention. The
determination of dividend policies is almost exclusively a finance
function. The finance executives have final say in decisions on dividends
than in asset management decisions.
In sum, the finance executive is charged with the responsibility of
taking financial decisions : decisions concerning financial matters of a
business concern. Thus decisions regarding magnitude of funds to be
invested to enable an enterprise to accomplish its ultimate goal, kind of
assets to be acquired, pattern of capitalization, pattern of distribution of
company’s income and similar other matters are included in the financial
decisions.
Financial decisions are looked on as cutting across functional even
disciplinary boundaries. It is such an environment that the finance
executive works as a part of total management. In principle, the finance
executive is held responsible to handle all such problems as involve
money matters. But in actual practice he has to call on the expertise of
those in other functional areas, viz. marketing, production, accounting,
purchase, personnel and other executives to carry out his responsibilities.

37
Major Financial Decision areas :
In a business enterprise three type of financial decisions, viz.
investment decision, financing decision and dividend decision are taken.
The nature and contents of each of these decisions are as follows :
Investment Decision :
Investment decision is the vital financial decision. Since funds
involve cost and are available in limited quantity, its proper utilization is
necessary to help the company to attain the ultimate goal of maximization
of wealth. This, therefore, calls for prudent investment decision on the
part of the finance manager. Investment decision determines total amount
of assets to be held in the enterprise, makeup of these assets and business
risk complexion of the enterprise as perceived by the investors.
Broadly speaking, investment decision can be categorized in two
groups : long term investment decision and short term investment
decision. Long term investment decision decides about the allocation of
capital to investment projects whose benefits accrue in the long run. Such
decision may take the form of internal decision and external decision. In
internal investment decision the finance executive has to decide what
capital expenditure projects the company should take, what volume of
funds should be committed and how funds should be allocated as among
different investment outlets. Before committing funds in the business the
finance executive has to select the most economically viable projects. A
company may have a number of profitable investment proposals in hand
but owing to paucity of funds it may find it difficult to take up all the
projects simultaneously. The finance manager will in such circumstances
be called upon to decide which investment proposal should be taken so

38
that the company realizes maximum results. For that matter, economic
viability of the projects will have to be judged in terms of expected
return, cost involved and the risk associated with projects. Sometimes
investment made earlier do not fetch results as anticipated. In that case
the finance executive has to decide about reallocation of funds.
In the external investment decision the finance executive has to
decide about issues concerning investment of funds outside the business.
Broadly speaking, external decision concerns with merger of the
company with other company and portfolio management. With respect to
merger, the finance executive has to decide whether the company should
be merged with other company or not. This decision is based on the
exchange ratio. With this ratio parties to the merger can evaluate the
efficacy of the merger. Factors that influence this important aspect of a
merger scheme are current earnings and its future growth rate, dividend,
market value, book value and net current assets.
In portfolio management the finance executive has to select a
bundle of securities that will provide the investing organization a
maximum yield for a given level of risk or alternatively minimum risk for
a given level of return. With the help of a number of quantitative
techniques the finance executive evaluates the merits of an investment
portfolio and thereby select the most efficient portfolio which will
provide best trade off between risk and return.
Short run decision decides about allocation of funds as among cash
and equivalents, receivables and inventories. Such a decision is
influenced by trade off between liquidity and profitability. Higher the
relative share of liquid assets, lesser will be the possibility of cash drain,

39
other things being equal. However, profitability in that case will be less.
On the contrary, if a smaller proportion of funds is held in liquid form,
risk of insolvency will be high but profitability will also be high.
Compromise between conflicting goals of profitability and liquidity with
respect to these decisions usually rests on the risk preferences of the
management. Hopefully, these preferences are strongly influenced by the
goal of maximizing shareholders’ wealth.
Financing Decision :
In financing decision the finance executive has to decide about the
optimal financing mix or make up of capitalization. While deciding about
the debt-equity mix his endeavour is to have such pattern as may be
helpful in maximizing earning per share and so also market value of
shares. This involves examination in depth of some of the following
important issues :
(a) From what sources are funds available ?
(b) To what extent are funds available from these sources ?
(c) What is the cost of funds presently used ?
(d) What is the expected cost of future financing ?
(e) Given sources of funds and their cost, what sources should
be tapped and to what extent ?
(f) What instruments should be employed to raise funds and at
what time ?
(g) Should the company approach financial institutions for
securing funds ? If yes, on what terms and conditions ?
(h) Will the enterprise make underwriting arrangements ? If yes,
on what terms ?

40
 Acceptable answers to the above questions are hard to derive
without some knowledge of money and capital markets, financial
institutions, risk and uncertainty, investor’s psychology and economies.
Dividend Decision :
Dividend decision decides about allocation of business earnings
between payments to shareholders and retained earnings. Retained
earnings constitute one of the most potent sources of funds for financing
corporate growth, but dividends constitute the cash flows that accrue to
equity investors. Although both growth and dividends are desirable, these
two goals are conflicting : a higher dividend rate means less retained
earnings and consequently, a slower rate of growth in earnings and stock
prices. The finance executive has to strike a satisfactory compromise
between the two in such a way that shareholders’ wealth in the company
is maximized, prudent finance executive takes dividend decision in the
light of investors’ preferences, liquidity position of the company, stability
of earnings of the company, need to repay debt, restrictions in debt
contracts, access to capital markets, control and similar other factors.
1.3 ESSENCE OF FINANCIAL DECISIONS :
The essence of financial decisions refers to basic principles which
serve as guidelines to the finance executive in decision making. The
principles are common to all financial decision areas. A brief outline of
some of the fundamental principles of financial decisions is as follows.
(a) Risk-return Trade off : According to this principle, in any financial
decision the risk must be commensurate with the expected return.
While taking investing decisions the finance executive should be
concerned with weather return on assets justifies the risk of acquiring

41
 them. Similarly, in making financial decisions the finance executive
chooses suitable source of financing in the light of risk return
relationship.
(b) Time value of Money : Principle of time value of money is key to
the financial decisions. It is widely recognized that money has a
time value. This is why the financial decisions are made on the
basis of discounted cash flow value which is determined by using
an interest factor.
(c) Maximisation of wealth : All financial decisions are taken in such
wise manner as to maximize the stockholders’ wealth. Prudent
investment decision is one which maximizes share values of the
enterprise. Likewise, in deciding upon sources of financing the
finance executive should strike compromise as among conflicting
considerations of cost, risk and control so as to maximizing the share
values of the enterprise. Similarly, maximization of stockholders’
wealth should be central consideration in making decisions regarding
pattern of income distribution and kinds of dividend.
(d) Suitability : This principle implies that funds should be employed
in assets for the period for which funds were procured from the
market. Short term assets should be financed by short term sources
of funds and long term funds should be utilized for acquiring long
term assets. If this principle is not followed, profitability of the
enterprise will suffer and sometimes the enterprise may lend in
financial predicament.
(e) Liquidity Vs Profitability : In taking any financial decision the
finance executive should see that the cash is on hand to pay bills

42
 and the company makes maximum profits on its investment. As
cash inflows and cash outflows seldom synchronise, cash balance
is kept in the company to protect it against hazards of liquidity.
However, keeping any excess stock of cash is considered waste of
resources because it is a non-earning asset and the same could be
invested elsewhere to earn some income. This means the company
will be failing to maximize its earnings at the expense of high
liquidity. If, more and more cash is put to profitable use, the
company’s liquidity will be impaired causing the company to lose
benefits of cash discount, liberal loans from banks and above all
business image in the market. Thus, the finance executive is in
dilemma to trade off between liquidity and profitability and
prudent finance executive is one who strikes golden mean between
these conflicting but important goals in making financial decisions.
(f) Leverage : Financial leverage refers to employment of funds
obtained at a fixed charge in the hope of increasing return to the
owners of the organization. The use of leverage is like a double
edged weapon which magnifies both profits and losses. This
principle implies that financial leverage should be employed as
long as it is favourable i.e. magnifies return. The principle of
leverage is applied where financing decisions are involved. Where
the finance executive is seized of the problem of deciding whether
to take recourse to debt financing and if yes, to what extent,
leverage principle acts as useful guideline.
(g) Diversification : Diversification is venerable rule of investment
policy of a business concern. It implies holding of an assortment of

43
 securities by an investor rather than a limited number of issues.
Diversification may take the form of unit, industry, maturity,
geography, type of security and management. Though
diversification of investments management can reduce investment
risks if it could not be avoided altogether. However, it should be
remembered that too much or too little of any asset can be
detrimental. Middle course should be allowed while building
investment portfolio.
Now, the role of the person who takes care of finance
function in industries
( Chief Financial Officer) has changed as shown below :
Then Now
1 Support function, reporting Strategic role, partnering with CEO
to CEO
2 Extended focus on Bankers, Focus on stakeholder value, regulatory
capital raising compliance
3 Past orientation : budgets, Future orientation : Forecasting, rolling
bookkeeping, MIS budgets
4 Risk mitigation, cost control Optimising and balancing risk against
returns
5 Transaction processing, data Financial Analysis, decision support
management systems
6 Stewardship of financial and Focus on intangible assets
physical assets
7 Passive investor in technology Enterprise wide integrator of technology
8 Allocation of resources in Monitoring/management of business
Business portfolio
9 All financial activities done Outsourcing/in sourcing of non-core
in-house finance activity

44
 The drivers of change in business management, and particularly in
the area of finance are : (1) Aggressive regulatory environment after the
instances like Enron, Worldcom etc. (2) Technology (3) Growing
internationalization of business and sensitivity to capital markets.
Now, the CFOs, and not the CEOs, are asked to play a strategic
role. This is because of (a) CFOs fundamental familiarity with cost of
capital and numbers. (b) Finance roles tend to have different linkages
with the business. 17
Latest trends in the corporate world contemplate the following
additional finance functions with which a financial executive is ultimately
concerned.
a. Present value of financial resources, time and risk. Business firms
ultimately involve financial resources in different forms, for
current period as well as medium and long term period. This has
direct implications of value of resources, periodic value with future
economic uncertainties and financial/business risks affecting the
performance of the firm.
b. The implications of off-balance sheet items on the business
performance.
c. The controversy about dividend. Many companies declare
exorbitant amount of dividend. At the same time, so many
companies either do not declare dividend or declare very low rate
of dividend. Some people opine that dividend is irrelevant.
Different type of research is an ongoing activity. One has to
understand as to what decides the payout policy and how that
policy affects firm value.

45
d. The question of what and how much risks a firm should take. There
are various types of financial and non-financial risks in business.
This has a bearing on the performance, success and value of the
firm.
e. Existence of different type of organizations for carrying out
business activity and choice of various types of financial
architecture all over the world. The size and legal forms of the
firms are different all over the world. The financial architecture is
also different in different countries. There exists various types of
securities, debt and equity mixture, varying type of financial
involvement of owners and outsiders in the firm. One has to
understand as to which arrangements are most efficient. 18

46
References :
1. Prasanna Chandra, Fundamentals of Financial Management , P.I., Tata
McGraw Hill ,New Delhi, 1993.
2. Jim Mcnamin , Financial Management , P.9. ,Oxford University Press,
2000
3. H. Guthman & HE Dougall,Corporate, Financial Policy, P-I, Prantice
Hall, 1956.
4. JC VanHorne & Jim Wachowiz, Fundamentals of Financial Management,
P-3, 1998.
5. Jim Ncnamin, Financial Management, P. 19.
6. IM Pandey, Financial Management , P.5, Vikas Publications Pvt. Ltd.,
New Delhi, 1999.
7. Ezra Soloman, The Theory of Financial Management , P.3, Columbia
University Press, 1969.
8. IM Pandey, Financial Management, Vikas Publications Pvt. Ltd., New
Delhi, Pg.7-11,1999.
9. Ezra Soloman & John Pingle , An Introduction To Financial Management,
P.7, Prantice Hall of India, New Delhi, 1978.
10. SC Kuchhal, Financial Management , P.2, Chaitanya Publishing House,
Allahabad.
11. SC Kuchhal , Financial Management, P. 5 Chaitanya Publishing House,
Allahabad.
12. SC Kuchhal , Financial Management, P. 8 & 9, Chaitanya Publishing
House, Allahabad.
13. John Hampton, Financial Decision Making, Pg. 9-10, Prentice Hall of
India, New Delhi,1983.
14. John Hampton, Financial Decision Making, Pg. 14-16, Prentice Hall of
India, New Delhi,1983.

47
15. M.Y. Khan & P. K. Jain, Financial Management, P. 1.3, Tata

McGraw Hill Publishing Co. Ltd, New Delhi.

16. R M Srivastav , Financial Decision Making, Sterling Publishers
Pvt. Ltd., New Delhi, Pg. 9-11.
17. ICFAI, Journal of Applied Finance : June, 2004.
18. Richard Brealey and Stewart Myers. Principles of Corporate
Finance. P. 998 – 1004, Tata McGrath Hill Publishing Co. Ltd,
New Delhi, 2003.

48