Scope of Financial Management: An Overview

Financial management is an important activity in any organization. It is the process of planning, organizing, controlling, and monitoring the financial resources with a view to attain organizational goals and objectives. It is the best approach for controlling the financial activities of an organization such as procurement of funds, utilization of funds, accounting, payment, risk assessment, and everything that is related to money management. Read the article below to know the objectives and scope of financial management.

Objectives of Financial Management

The foremost aim of financial management is to manage the finances of an organization so that businesses are compliant with necessary rules and regulations and are successful in their field. This  process involves extensive planning and its proper execution. When done precisely, businesses flourish  and profitability increases. This is the primary reason why the finance department, along with finance or revenue managers, plays a significant role in any organization. Accordingly, the  basic objective of financial management are:

• Ensuring a regular and suitable supply of funds for the organisation.

• To ensure optimum use of funds. Once the funds are procured, they should be used in the maximum possible way at minimum cost.

• Creation of a stable capital structure. The capital distribution should strike a steady balance between debt and equity. 

• Ensuring the safety of investments. The funds should be invested in safe ventures to guarantee adequate returns.

• Ensuring adequate returns for the organisation and the shareholders.

Scope of Financial Management

Financial management helps a particular organisation to utilise their finances most profitably. This is achieved via the following two conducts.

The scope of financial management is divided into two categories:

• Traditional Approach

• Modern Approach

Let us discuss the two approaches in brief.

Traditional Approach

According to this approach,the scope of financial function is restricted to procurement of funds by the corporate organizations to meet their financial needs.

The term procurement here refers to raising of funds externally as well as the interdependent aspects of raising funds.

Following Three Things are used for the Procurement of Finance

• Institutional source of finance

• Issuance of financial instruments to collect necessary funds from the capital market.

• Legal and accounting relationship between the business and the source of finance.

According to this approach, finance is not required for the routine events but for the sporadic events like promotion, reorganization, liquidation, expansion, etc. Managing funds for these things is considered as the most important feature of financial management. The financial manager in this approach is not concerned with internal financing rather he has to maintain relationships with outside parties and financial institutions.

According to this approach, the financial manager is not responsible for the efficient use of funds whereas he is responsible to get necessary funds on fair terms from the outside parties. The traditional approach continued till the fifth decade of the 20th century.

What are the Limitation of Traditional Approach

The traditional approach of finance can be considered somewhat narrow because of several reasons. Following are the primary drawbacks and this approach.

One-sided Approach

This traditional approach gives more attention to the system of procurement and the problems that might arise during that scenario. It does not offer a system for efficient utilisation of procured funds. This approach considers the viewpoint of outside parties (like banks, financial institutions, investors) who provide funds to the business but ignores the internal parties who are responsible to take financing decisions. Therefore, a one-sided approach is also termed as an outsider-looking approach.

• More Focus On the Financial Issues of Corporate Enterprise:

This approach focuses only on the financial problem of corporate enterprises but the financial problems of non corporate entities like partnership firms, and sole trade are ignored.

• More Emphasis On Sporadic Events:

Traditional approach considers fund allocation as on the contingencies for sporadic incidents like business reorganization, incorporations, mergers, consolidation, etc. ignoring This approach ignores everyday financial problems that a business enterprise might face. Working capital financing decisions are also kept outside the scope of a traditional approach.

Modern Approach

By the end of the 1950 technology up-gradation, development of strong corporate structure and increasing competition made it necessary for the management to make optimum use of available natural resources.

According to this approach, the financial manager considers the broader and analytical point of view. According to the modern approach, financial management is concerned with both acquisition of funds and optimum use of available resources. The arrangement of funds is an important component of the whole finance function.

In this approach, not only sporadic events are considered but also the long term and short term financial problems are considered. The main components of financial management include financial planning, evaluation of alternative use of funds, capital budgeting, determination of cost of capital, determination of the financial standard for the success of the business, management of income, etc. Therefore, according to this approach, three important decisions are taken by the finance manager. The three decisions are:

• Investment Decision

• Financing Decision

• Dividend Decision

Let us discuss the three decisions in brief

Investment Decision

This decision is related to the selection of assets in which finds will be invested by the firms. The asset that is acquired by a firm may be a long term asset or short term asset. 

The decision taken to invest the funds in long term assets is known as capital budgeting decision. Hence, capital budgeting is the process of selecting assets or an investment proposal that yields return for a long term.

The decision taken to invest the funds in short term assets or current assets is known as working capital management. The working capital management deals with the management of current assets that are highly liquid in nature.

Financing Decision

This scope of financial management indicates the possible sources of raising finances from various resources. They are of 2 different types – Financial planning decisions attempt to estimate the sources and possible application of accumulated funds. A proper financial planning decision is crucial to ensure the availability of funds whenever required.Capital structure decisions involve identifying various sources of funds. It facilitates the selection of the best external sources for short or long-term financial requirements. The financing decision is related to the procurement of funds required at the right time. After the decision related to the fund requirement is made then the financial manager has to select the various options for financing and select the best and cost effective method for financing so that the business runs smoothly without any unnecessary obstacles such as inadequate funds.

Dividend Decision

It involves decisions taken with regards to net profit distribution. It is divided into two categories – 

• Dividend for the shareholders.

• Retained profits (usually depends on a particular company’s expansion and diversification plans).

The dividend decision is concerned with determining the percentage of profit earned to be paid to the shareholders as dividend. Here the financial manager makes the decision regarding how much dividend is to be paid out or how much to retain as retained earnings. Dividend payout decisions are critical to make so that shareholders and investors are happy and even the firm has enough funds for the business expansion.