3rd Revised Edition

FINANCIAL MANAGEMENT [Theory, Problems and Solutions] For B.Com., B.Com.(CA), BBA, BBM, BBA(CA)., M.Com., M.Com.(CA), MBA., MCA. Courses of Periyar University, and Commerce, Management Courses of all Indian Universities

Dr. V.R. PALANIVELU MBA., M.Com., M.Phil, Ph.D., D. Litt. Professor Periyar Institute of Management Studies (PRIMS) Periyar University Tamil Nadu, India

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First Edition 2010 Second Revised and Enlarged Edition 2012 Reprint 2016 Third Edition 2018

ISBN: 978-93-528-3327-6

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FOREWORD I have great pleasure to write this foreword for the Second revised edition of the book entitled as “FINANCIAL MANAGEMENT” authored by Dr. V.R. Palanivelu, Reader Periyar Institute of Management Studies, Periyar University Salem-11. I appreciate his painstaking effort in bringing out the Second Revised Edition. I observed that this Second Revised Edition is prepared carefully and incorporating the latest developments in the field of Financial Management and also include certain modifications suggested by the readers of first edition of this book. The Unique features of this book are : For the past two decades have witnessed a dramatic changes in the Indian business and financial Sectors due to this changes Financial Manager occupy key positions in top management areas for solving Complicated Management problems. The Primary thrust of this revised edition is to show how financial theory can be applied to solve real and day-to-day problems. An attempt has been made to relate theory to practice. The coverage of this book is very comprehensive, and I am sure that it will serve as concise guide to a wide range of areas that are relevant to the Finance field. The book contain 25 chapters and also number of real life financial problems in the Indian context in addition to the illustrative problems. This book is written keeping in view, the needs of practitioners, Academicians, Students and Researchers and it will be helpful in improving financial effectiveness and in acquiring new knowledge. I hope that this book which is more suited to the commerce and Management Courses of all Indian Universities. My congratulations to Dr. V.R. Palanivelu on his thoughtful endeavour and his contribution to the field of Financial Management.

PREFACE TO THE THIRD EDITION The Third Edition of Accounting for Management and Second Edition of my Financial Management book received excellent response from the readers, faculties of different discipline and students of different segmentation from all over the country. I really proud about this excellent response I am very grateful to all the readers. I received feedback from various sources and various categories of readers some of the mistakes they observed and also some of the modifications are suggested. Based on the feedback and suggestion this (Third) Edition is thoroughly revised and substantially expanded. All the Chapters have been updated and expanded. Financial Management is a difficult and controversial subject. In order to overcome this difficulty an appropriative examples have been incorporated throughout the book for better understanding of the topics discussed. As per the request and feedback of the readers two new chapters have been added Viz. Chapter No: 2 Legal Framework of the business Chapter No: 25 Industrial Sicknesses Apart from the above the whole texts have been completely revised and incorporating number of solved and unsolved problems for the benefit of student’s community. I have employed various technique to remove the errors notified by the readers in the second edition. I shall be very happy any of the mistakes, defectives are notified by the readers. I look forward to your valuable comments and feedback for improving the best quality of the book in the next edition. Any criticisms or suggestions for further improvement of the book will be greatly acknowledged and appreciated. Salem MAY 2011

Prof. Dr. V.R. PALANIVELU

Disclaimer : While the author of this book has made every effort to avoid any mistake or omission and has used his skill, expertise and knowledge to the best of his capacity to provide accurate and updated information. The author and S. Chand do not give any representation or warranty with respect to the accuracy or completeness of the contents of this publication and are selling this publication on the condition and understanding that he will not be made liable in any manner whatsoever. S.Chand and the author expressly disclaim all and any liability/responsibility to any person, whether a purchaser or reader of this publication or not, in respect of anything and everything forming part of the contents of this publication. S. Chand shall not be responsible for any errors, omissions or damages arising out of the use of the information contained in this publication. Further, the appearance of the personal name, location, place and incidence, if any; in the illustrations used herein is purely coincidental and work of imagination. Thus the same should in no manner be termed as defamatory to any individual.

PREFACE TO THE FIRST EDITION I have great pleasure in bringing out the book Financial Management (Theory, Problems and Solutions). I feel it is a great opportunity to place on record of my thanks to esteemed readers, professor and beloved students of various colleges for their overwhelming support to our book on Accounting for Management. Before implementation of Globalization Policy in India scope of financial management was confined only to raising of funds and little significance way attached to the analytical thinking in the financial decision making and problem solving. After the implementation of Globalization Policy and reforms in the Financial sector, the subject of Financial Management accords for a greater importance to organization in decision making and execution of policy. At present the Financial Managers play a dynamic role in solving most of the management problems. They are now responsible for not only shaping enterprises but also involved in most of the management decision especially for borrowing of fund and effective utilization of funds etc. In order to overcome this changes the descriptive treatment of the subject of financial management is being replaced by applying analytical treatment with strong theoretical background. Generally Commerce and Management Students feel Financial Management is a controversial subject. But the readers of this book will realize that is not so. And at the same time I do not claim any originally but I have taken much effort to present this subject in simple and systematic manner. This book contain 16 chapters. All the sixteen chapters are presented in clear cut theoretical explanation, procedure for work out problems, test questions and solved problems. For the benefit of the students all the problems are collected from the various University Examination Question papers, and it should be solved with the detailed working notes. I have made serious effort to remove the printing mistakes of the book. I will be very happy in receiving any suggestions, omission/errors for improving the quality of presentation and standard of the book in the next edition.

TIRUCHENGODE

Dr. V. R. PALANIVELU

ACKNOWLEDGEMENT I would like to extend my gratitude to my parent Institution: Periyar Institute of Management Studies (PRIMS), Periyar University, Salem. Providing great academic and infrastructure support. I wish to express my sincere and whole hearted thanks to several exemplary personalities who have been a source of inspiration and support personally and professionally including Dr.M.Manivannan, Registrar, Periyar University, Salem, Dr. N.Rajendhiran, Professor-Cum-DirectorPRIMS, Dean of Arts, Periyar University, Salem, Prof. Dr.M.Karunanami, Chairman & secretary, Vivekandha Educational Institutions, Tiruchengodu, Dr. P. Vikkraman, Director i/c, Anna University, Regional Campus, Coimbatore, Dr. M. Ravichandran, Anna University, Regional Campus, Tiruchirappalli, Dr. A. Jayakumar, Professor, (former), Periyar University, Salem, Dr.R.Usha, University of Madras, Dr.Rupa Gunaseelan, & Dr. G. Barani, Bharathiar University, Dr. N. Thamaraiselvan, National Institute of Technology (NIT), Tiruchirappall, Dr.A.A.Ananth, Annamalai University, Dr.C.Muthuvelayatham, Anna University, Regional campus, Madurai, I would like to thank my colleagues, Faculty members, Research scholar, and countless students from various institutions for their contribution to completing this task. I record my special word of thanks is also due to my research scholars D.Manikandan, A.Apdhulkathar for their support and hard work. Preparation and completion of third revised edition of the book is not easy task without emotional and psychological encouragement from my wife Sasikala, daughter Kavina and son Kowranth. Several thanks for their support. I would like to thank my beloved parents G. Rangasamy, Pappayee and family members Ravindran, Balasundran, Senna Krishnan their moral support for completion of this work. I am very proud to bring out the throughly revised edition of the book Financial Management is more useful to the students and faculty members for studying Financial Management Subject. S.Chand & Company Pvt Ltd especially Mr. Himanshu Gupta (MD), SH. K.M. Thomas Business Head, Shi Naval Shukla Executive Vice President and Editorial Team-special Projects, DTP staff, Sales Executive and all other forces that kept on prodding me to revise this edition. My Sincere thanks to all of them for rendering dedicated job for completing this task and ensuring this book reached in the hands of the beloved student’s community and esteemed professors in time. Salem NOV. 2017

Prof. Dr. V.R. PALANIVELU

CONTENTS 1. FINANCIAL MANAGEMENT NATURE AND SCOPE Finance - Meaning- Definition of finance- Importance of finance- Theories of finance -Traditional theory of finance - modern theory of finance - Business finance meaning -Definition- characteristics of business finance- Scope and significance of business finance-Relationship of finance with other related Discipline - Financial Management- Introduction-Meaning- Definition- Scope of financial Management Basic principles of Financial Decisions-Importance of Financial ManagementFunctions of Financial Management - Objectives of Financial Management- Test Questions.

1–8

2. LEGAL FRAMEWORK OF THE BUSINESS 9–14 Forms of business organization- sole proprietorship- salient feature of sole proprietorship-Advantages of sole proprietorship- Disadvantages of sole proprietorship-Partnership fiim- salient features of the Partnership firm- Formation of Partnership- contents of the Partnership deed- Advantages - Disadvantages of Partnership- Joint stock company salient features- Advantages of Public limited company- Disadvantages of Public limited company- Co-operative societyCharacteristics features- Merits- Demerits- Joint Hindu family Business-Main featureslimitations- State owned Enterprises - Defects of Departmental Management - Public Corporation. 3. TIME VALUE OF MONEY 15–30 Introduction, Concept of time value of money, Reason for time preference for money, Techniques of time of money, Compounding techniques, Discounting or present value techniques, Doubling period, Test questions, Problems and solutions. 4. VALUATION OF SECURITIES 31–46 Introduction, Concepts of value, Salient features of bonds, Valuation of securities, Test questions, Problem and solutions. 5. FINANCIAL STATEMENT ANALYSIS Financial statements Introduction- Meaning- Definition-Nature of financial statementsObjectives of financial statements-Importance of financial statements –Limitations of financial statements meaning and concept of financial analysis- Types of financial Analysis: External Analysis, Internal Analysis, Steps involved in financial statements analysis, procedure for financial statement analysis- Tools of financial analysis, common size income statements problem and solutions, Trend percentage analysis, Fund flow analysis, Cash flow analysis, Ratio analysis, Cost volume Profit analysisTest Questions.

47–57

6. FUND FLOW STATEMENT

58–71

Introduction – Fund Flow Statement-Meaning of Funds- Meaning and Concept of Flow of Funds- Fund Flow Statement- Different names of fund flow statements –Uses and importance of fund flow statement-Limitations of fund flow statement - Procedure for preparing fund flow statements-Steps in preparing of fund flow statement list Noncurrent or permanent liabilities -Non current or permanent assets-Fund flow statement specimen –Necessity Treatment of provision for Taxation - proposed dividend –Test Questions- Problems and solutions- Problems. 7. CASH FLOW STATEMENT

72–81

Introduction –Meaning of cash flow statement-Managerial uses of cash flow statement- Limitation of cash flow statement- Difference between Fund Flow statement and cash Flow statement– Procedure for preparation of Cash Flow Statement-Steps in Preparation of Cash Flow Statement under Excising Format–Test Questions- Problems and solutions- Problems. 8. RATIO ANALYSIS

82–105

Introduction –Meaning of Ratio-Steps involved in the Ratio Analysis-Importance or Advantages of Ratio Analysis-Limitations of Ratio Analysis- Classifications of Ratios: Liquidity Ratios, Long term Solvency Ratios, Profitability Ratios, Efficiency or Activity or Turnover Ratios, Leverage or capital structure Ratios–Test Questions- Problems and solutions- Problems. 9. MARGINAL COSTING AND COST VOLUME PROFIT ANALYSIS

106–126

Introduction- Definition of Marginal cost- Definition of marginal costing- Assumption of marginal costing-Advantages of marginal costing-Disadvantages of Marginal costing –Absorption costing-Contribution- Advantages of Contribution –Cost Profit Volume Analysis– Objectives of cost Volume Profit Analysis- profit volume ratioMarginal cost Equation-Break Even Point-Break even Analysis- Break even ChartAngle of Incidence-Assumptions underlying Break Even Charts-Advantages or Managerial uses of Break Even Analysis and Chart-Limitations or Disadvantages of Break Even Analysis and Chart-Decision Making: Cost Associate with decision Making- Managerial applications of Marginal Costing- Areas of Decision Making – Test Questions- Problems and solutions- Problems. 10. BUDGETS AND BUDGETORY CONTROL

127–139

Introduction –Meaning of budget-Meaning of control, meaning of Budgetory control, Budget, Budgeting and Budgeting control- Process of Budgetory control- Objectives of Budgetory control-Disadvantages of Budgetory control- Installation of Budgetory control system- Essentials of sound Budgetory control system –Objectives of Budgeting- Classification of Budgets: Classification According to time, Classification on the basis of function ,Classification According to flexibility –Other Budgets: Zero base Budgeting, Zero base budgeting Definition- Performance budgeting- Test Questions- Problem and solutions- Problems. 11. CAPITAL STRUCTURE 140–172 Introduction, Capitalization: Meaning, Capital structure: Meaning, Definition, Patterns of capital structure, Theories of capital structure, Net income approach, Net operating income approach, Modigani-Miller approach, Arbitrage process, Leveled firm, Unleveled firm-Assumption, Criticism of MM approach, The traditional approach, Determination of capital structure, Point of indifference, Capital gearing, Capital

structure planning, Essential feature of sound capital structure, Computation of valuation of firms, Computation of point of indifference, Test questions, Problems and solutions. 12. COST OF CAPITAL 173–210 Introduction, Meaning, Definition of cost capital, Importance of cost of capital in decision making, Features of cost of capital, Classification of cost with related to cost of capital, Determination of cost of capital, Computational of cost of capital, Computation of cost of each specific sources of Finance, Computation of Weighted average cost of capital, Zero coupon bonds, Inflation adjusted cost of Debt, Marginal cost of capital, Test questions, Problems and Solutions. 13. LEVERAGES 211–222 Meaning, Definition, Types of leverages, Operating leverages, Financial leverages, Significance of financial leverage, Limitation of financial leverage, Degree of financial leverage, Composite leverage, Computation of leverage, Working capital leverage, Test questions, Problems and solutions. 14. SOURCES OF FINANCE 223–238 Introduction, Types of capital, Sources of funds, Loan financing, Short term sources financing, Long term sources of financing, Sources of term loans, Security financing, Shares; meaning, Preference shares, Kinds-Equity shares, Meaning, Kinds-Debenture, Meaning-Kinds-Significance of debentures in corporate finance, Internal Financing, Innovative sources of financing, Venture capital, Importance feature of venture capital, Functions of venture capital, Venture capital funds in India, Indian capital markets, Evolution and Growth, Constituents of Indian capital market, The gilt edge markets, Industrial securities market, Primary market, Issues of prospectus, Important Concepts of prospectus, Offer for sale, Private placement, Initial public offer, Right issues, Bonus issues, Book building, Project Finance, Capital investment subsidy, Product subsidy, Bridge Finance, Role of financial institutions in project financing, Test questions. 15. WORKING CAPITAL 239–267 Introduction, Types of capital, Fixed capital, Working capital, Definition of working capital, Gross working capital, Net working capital, Types of working capital, Permanent working capital, Temporary working capital, Need for working capital, Operating cycle, Factors determining the working capital requirements, Techniques of working capital, Advantages and Disadvantages of working capital, Procedure for workout the problems, Test questions, Problems and Solutions. 16. WORKING CAPITAL FINANCE 268–273 Introduction, Sources of working capital, Commercial paper, Conditions, Use and maturity, Cost of the commercial paper, Factors-Meaning, Definition, Benefits of factoring services to its client, Functions of factoring services, Types of factoring, Cost of factoring, Unsuitability of factoring services, Test questions, Problems and Solutions. 17. CASH MANAGEMENT 274–292 Introduction, Motive for holding cash, Objective of cash management, Basic problems of cash management, Managing of cash inflows and outflows, Techniques involved in accelerating cash inflows, Cash outflows, Cash management models, William J. Baumols model, Assumption of Baumol model, Test questions, Problems and Solutions.

18. RECEIVABLE MANAGEMENT 293–307 Introduction, Meaning of receivables, Receivables management, Meaning-Cost of maintaining receivables, Factors influencing the size of receivables, Dimensions of receivables management, Management of accounts payable, Test questions, Problem and Solutions. 19. INVENTORY MANAGEMENT 308–323 Introduction, Kinds of inventories, Objectives of inventory Management, Tools and Techniques of inventory Management, Methods of inventory valuation, Test questions, Problem and Solutions. 20. DIVIDEND POLICY 324–340 Meaning, Dividend policy, Determinants of Dividend policy, Forms of dividend policy, Theories of dividend, Relevance concept of dividend, Irrelevance concept of dividend, Welter’s model, Assumption of Water model, Criticism of Walters model, Gordon’s models, Test questions, Problems and Solutions. 21. CAPITAL BUDGETING 341–398 Introduction Concept of Capital expenditure, Concept of capital budgeting, Need and Importance of Capital budgeting, Kinds of capital expenditure, Objectives of capital budgeting, Limitation of capital budgeting, Kinds of capital investment proposals, Pay back period method, Accounting or average rate of return method, Discounted cash flow techniques, Decision procedure, Profitability index methods, Terminal value method, Internal rate of return, Procedure for computation of trail and error methods, Factors influencing the capital budgeting decision, Control of capital expenditure, Factors influencing the estimation of future cash flow, Capital rationing, Procedure for applying capital budgeting evaluation techniques, Test questions, Problems and Solutions. 22. RISK ANALYSIS IN CAPITAL BUDGETING 399–407 Introduction, Meaning of risk and uncertainty, Methods of Risk analysis, Modern methods, Modern quantitative techniques, Conservation methods, Test questions, Problem and solutions. 23. LEASE FINANCING AND HIRE PURCHASING 408–413 Introduction, Meaning, Steps involved leasing transaction, Types of leasing, Advantages of leasing, Disadvantages of leasing, Choice of lessor, Hire purchase, Defination, Characteristics feature of hire purchase agreement, Difference between the leasing and hire purchasing, Financial evaluation of leasing, Methods of Computing lease rentals, Test Questions. 24. CORPORATE RESTRUCTURING

414–416

Introduction- Aims and objectives of Corporate Restructuring: Important forms corporate Restructuring: Mergers, Amalgamations and Acquisitions, Spinning off or demergers- Test Questions. 25. INDUSTRIAL SICKNESS 417–420 Meaning - Definition - Process of Industrial Sickness- Signals or symptoms of Industrial Sickness- consequences of Industrial Sickness- Rehabilitation of a sick unit- problem in Rehabilitation of sick units- Remedies or preventive measures for Industrial Sickness- causes of Industrial Sickness- Government of India and the Remedies for Industrial Sickness. University Question Papers Appendix

421–441 442–445

1 CHAPTER

Financial Management– Nature and Scope Finance: Meaning Generally speaking finance means money. In other words, we explain it is the provision of money at the time when it is required to meet an obligation. Finance is said to be life blood of all the business organizations. Finance is otherwise called money. Each and every human being ultimate aim is to earn money. Because the modern economic world is completely depend on the money. Finance is required not only at the time of establishment of new business but also at each and every stage during the existence of business. It must be essential as and when it is need arise. Without adequate finance no organisation can survive and without efficient financial management no business organisation can earn profit. We have rightly pointed out that business organisation always need money to make more money. It is possible only when the organisation to utilize in an effective manner. Definition of Finance Finance may be defined as the art and Science of managing money. Importance of Finance The scope and importance of finance has increased in modern economic and business world due to the following reasons. 1. The economic and business activities are undertaken in a large scale manner. 2. Complicated Manufacturing process. 3. Technological development 4. Heavy competition. 5. Industrial Development 6. Financial Growth 7. Social Development 8. Life style changes of the people Due to that reasons there is an growing need of finance. Theories of finance Theories of fiancee divided into two categories. A. Traditional theory of finance. B. Modern theory of finance. 1

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Financial Management

A. Traditional theory of finance Traditional theory of finance otherwise called as traditional approach.lt was very popular at early part of the century. It represent the financial management role was limited to procurements of the funds of the organisation. And also to establish the effective administering the funds, which was needed by the organisation. An important area of traditional theory of finance is as follows. (i) To mobilize the funds through various financial instruments, (ii) To mobilization of funds from various financial institutions, (iii) To ensure legal and accounting relationship. B. Modern theory of finance Modern theory of finance otherwise called as modern approach. Due to expanding of business operation, technological development, strong corporate and healthy business competition, the subject of finance is considered as a separate discipline and wider perspective. Simply says the modern approach of the financial management has become an integral part of the entire organization. In other words due to modern approach the financial management is concerned with not only for the acquisition of funds but also their allocation and effective utilization of funds. The elements of modern approach are listed below. (i) Fund requirement decision. (ii) Financing decision, (iii) Investment decision, (iv) Dividend decision. (v) Liquidity decision, (vi) Working capital management decision. Business Finance - Meaning Business finance means money and credit employed by the business organization. In other words it is expressed the fund may be procured and effectively utilized for the business purposes. In the real sense of the world any activity whether economic or non economic, it requires money to complete the particular task. Business Finance - Definition Guthmar & Dougallin his book business finance, “Business finance can be broadly define as the activity concerned with planning, raising, controlling and administering of the funds used in the business”. Wheeler defines business finance as “Business finance is that business activity which is concerned with the acquisition and conservation of capital funds in meeting financial needs and overall objectives of business enterprises. Characteristics of Business finance (i) Owners fund, Borrowers fund and any other type of funds used in the business as business finance, (ii) Business finance is required large, medium and small size of the organisation whether it is manufacturing, trading or servicing. (iii) The quantum of business Finance may varies from time to time, (iv) Business finance is required on regular basis during the life time of the business organisation.

Financial Management – Nature and Scope

3

Scope and significance of business finance Generally business finance arises basically to bridge the time gap. Business finance is also more useful to manufactures, traders and business man. The purpose of business finance is as follows (i) To purchase of raw material, consumer stores and goods. (ii) To employ updated technology. (iii) To meet out daily operating expenses. (iv) To acquire capital assets. (v) To meet out the services of human being. (vi) To meet out contingencies and also to meet any of the emergencies, (vii) To expand its existing operation, (viii) To take capital expenditure decision - acquire fixed assets. Relationship of finance with other related Disciplines (i) Finance and Accounting (ii) Finance and Economics (iii) Finance and Mathematics (iv) Finance and statistics & Quantitative Techniques (v) Finance and Marketing Management (vi) Finance and Production (vii) Finance and Personnel Management Financial Management - Introduction Financial Management is more important and at the same time it is an controversial subject because certain areas has no unanimous solution for solving the problem. Corporate executives’ and practicing mangers are very much interested in this subject because it should provide in-depth, conceptual and analytical insight to formulate crucial financial decisions of the firm. The subject of Financial Management is of recent origin. It was the branch of economics till 1890. Financial Management- Meaning Financial Management is concerned with the duties of the financial managers in the business firm. Financial management involves acquisition and management of financial resources for the organisation to maximize the stock holders’ wealth or claims. Financial Management- Definitions “Financial Management is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operation”- Joseph and Massie. “ Financial Management is the area of business management devoted to a judicious use of capital and a careful selection of sources of capital in order to enable a business firm to move in the direction of reaching its goals”- J.F Bradley. “Financial Management is an area of financial decision making, harmonizing individual motives and enterprises goals”- Weston and Brigham. Generally speaking Financial Management is directly related to the general management func-

4

Financial Management

tions, specifically in the area of financial decision making, i.e. Fund requirement, Investment, financing, dividend and working capital. Apart from this the company has to maximize the wealth of the shareholders. In any respect financial management answers the following basic questions (i) How much amount required for the particular business or project? i.e. Fund requirement decision. (ii) Where to invest? i.e. Investment decision. (iii) Whom to supplying the finance or where to raise the funds i.e. financing decision. (iv) What percentage of profit is distributed and retained? i.e. dividend decision, (v) How to obtain and manage working capital? i.e. working capital management decision, (vi) How to maintain minimum cash balance or liquid assets i.e. liquidity decision. Scope of Financial Management The modern concept of the financial management is to focus on the acquisition of funds as well their proper allocation. In this respect the organization has to critically examine financial problems of a firm. The important content of the new approach relates to various important financial decisions. These decisions can be expressed as the scope of finance management. Which are listed below: (i) Fund requirement Decision (ii) Financing Decision (iii) Investment Decision (iv) Dividend Decision (v) Liquidity Decision Fund Requirement Decision The first and foremost decision of the finance manager in any organization has to carefully estimate the total funds required by the organization. It includes both working capital and fixed capital. Financing Decision This second important decision of the finance manager, after estimation of the total fund requirement by the finance manager has to clearly identify the sources from which the funds can be raised. And also the finance manager tries to obtain best finance mix or optimum capital structure of the firm. Investment Decision Under this aspect the finance manager has to concentrate investment decision in both capital assets and current assets. But any how the finance manager gives special attention to capital budgeting decisions. Capital budgeting is the long term planning for the proposed capital outlay. It involves huge amount of capital that it would give benefits in some definite future period. In simple investment decision otherwise known as capital budgeting decisions. Dividend Decision The formulation of sound dividend policy is another important decision of the finance manager. He must very clearly decide, whether the firm should distribute all the earned profits to its shareholders or retain certain portion and distribute the balance amount. In this respect he assess the dividend payout ratio i.e. proportion of profits distributed as dividend and retention percentage.

Financial Management – Nature and Scope

5

Liquidity Decision Huge funds invested in current assets affect the organizations profitability and liquidity. So thereby the finance manager must appropriate investment decision in current assets. Investment in current assets should be managed effectively in order to protect the firm from the risk of liquidity. Suppose the firm invests insufficient fund in current assets, it may become illiquid and more risky and may lose profitability. And at the same time excess fund invested in current assets create idle current assets which no vid earn anything. To overcome this difficulties a proper trade-off must be achieved between profitability and liquidity. Finance Function Finance function is always have its impact with other functional activities of the organization. The function of raising funds, investing them in assets and distributing profits to the shareholders are respectively known as financing decision, investment decision, dividend decisions. For successful performce of these functions an organization has to maintain a balance between cash inflows and outflows. This is otherwise called as liquidity decision of the organization. Some of the finance functions are listed below. (i) Investment decision or long term asset mix decision (ii) Financing decision or capital mix decision (iii) Dividend decision or profit allocation decision (iv) Liquidity decision or short term asset mix decision. Basic principles of Financial Decisions Basic principles of financial decisions are common for all categories of financial decisions. Major principles of financial decisions are:(i) Risk Return trade off: It indicates that in any financial decision risk must commensurate with expected return. (ii) Maximization of wealth: This principle indicates that all the functional decisions should be taken in such a way as to maximize the shareholders wealth. (iii) Time value of money: This principle says that since money has time value, construction of each and every financial decision on the basis of the discounted cash flow of investment proposal. (iv) Balance between liquidity and profitability: According to this principle an organization has to maintain sufficient funds for its obligation and at the same time to maximize its profitability. (v) Suitability: According to this principle short term assets should be financed by short term funds and vice versa. (vi) Diversification: In order to minimize risk and maximize its profits the organization has to invest its funds on different investment proposals. Importance of Financial Management Proper and sufficient finance is most important for any business operations. It is not only essential for the success of the business but also for its expansion and long run survival of the firm. The following points expressed the importance of financial management (i) Acquiring financial resources: It involves the organization to decide on where to obtain fund for their business needs, It is tapping the potential sources of funds and raising then at low cost for both short term as well long term financial needs of the company. (ii) Anticipation of financial needs: Finance manager of an organization has to estimate financial needs with help of the cash flow statements, cash budgets and other related tools.