What is Financial Management?
Financial management refers to the effective planning, organising, and controlling of monetary resources. Financial management primarily includes decisions and considerations regarding the size of investments, sources and range of use for capital, and the extent of profit earned from the same. It generally involves applying different management techniques to an enterprise’s financial resources to maximise profits.
Scope of Financial Management
Financial management helps a particular organisation to utilise their finances most profitably. This is achieved via the following three conducts.
Investment decision – Investment decision depicts investing in a fixed asset; it is also referred to as capital budgeting. Investment decisions can be of either long-term or short-term basis.
Long-term investment decisions allow committing funds towards resources like fixed assets. Long-term investment decisions determine the performance of a business and its ability to achieve financial goals over time.
Short-term investment decisions or working capital financing decisions mean committing funds towards resources like current assets. It occupies funds for a shorter period, including investments in inventory, liquid cash, etc. Short-term investment decisions directly affect the liquidity and performance of an organisation.
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.
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).
Objectives of Financial Management
Financial management definition indicates its primary objectives as procurement, allocation, and control of the financial resources of an organisation. The primary objectives are often defined as –
Ensuring a regular and suitable supply of funds for the organisation.
Allowing for optimum utilisation of funds.
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.
Features of Financial Management
The unique characteristics of financial management offer two different approaches to its functions.
Traditional approach –
Developed during the twentieth century, the traditional approach encourages the use of financial management only to secure financial assistance for that particular organisation. The utilisation of those funds was not on the cards.
Financial management is considered as corporate finance under this approach. Traditional approach depicts that funding is required only for infrequent events like liquidation, reorganisation, etc.
The following aspects were studied for the procurement of finance –
Institutional sources of finance.
The process of issuing financial instruments to collect funds.
Legal and accounting relationship between businesses and sources of finance.
Limitations of the traditional approach
The traditional approach of finance can be considered somewhat narrow because of several reasons. Following are the primary drawbacks of this approach.
One-sided approach –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.
More emphasis on large scale enterprises –The primary focus of the traditional approach is toward corporate entities. Non-corporate entities, i.e. partnership firms, remain outside its scope.
Emphasis on sporadic events –Traditional approach considers fund allocation as contingencies for sporadic incidents, ignoring 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 –
The traditional approach became less effective in the changing business environment of the late ‘50s. A new approach was developed, keeping in mind a broad analytical viewpoint. It involved both acquisition of funds and their optimum utilisation.
The importance of financial management in a modern way considers both long and short-term financial shortcomings that an organisation might face. The modern approach also creates provision for various sporadic events as well. The primary components of this approach include -
Perpetual functioning and proper capital budgeting evaluation.
Provision to manage working capital in an optimal manner.
A broad scope and capability to measure a company’s performance.
Thus, the modern approach helps set a financial standard for the success of the business.
The above mentioned details about the scope of financial management offer an insight into the concept and the important details that Commerce students should be aware of to ace the exams. To learn more, check the official website of Vedantu.
1. What are the Scope and Objectives of Financial Management?
Ans. – The primary objective of financial management includes procurement, allocation, and control of funds for an organisation. Proper financial management also allows an adequate utilisation of funds, ensuring best returns as well as investment’s safety.
2. Explain the Scope of Finance Functions.
Ans. – Finance functions primarily involve activities like raising funds and investing them in a company’s various assets. Another scope of financial function is to balance the inflow and outflow of cash. Finance function primarily includes 3 decisions – investment decision, financing decisions, and dividend decisions. Liquidity decisions can also be considered as a financial function.
3. What is Financial Management and Example?
Ans. – Financial management can be defined as a process that deals with, and analyses a company’s investments and availability of funds (including working capital). Financial management also helps make suitable business decisions to Maximise profits for an organisation. An example of financial management can be referred to as the work handled by the accounting department of an organisation.
4. What are the Different Types of Financial Management?
Ans. – There are two primary types of financial management, the traditional approach, and a modern approach. Traditional approach relies primarily on institutional sources of finance, which is utilised for infrequent events like liquidation, reorganisation, etc. The modern approach relies on an analytical viewpoint. Arrangement of funds is an essential feature of the modern approach, whereas it also analyses capital budgeting, financial planning, and working capital management for better wealth utilisation.