What is Financial Management?
Financial Management is all about planning, organizing, directing, and controlling the economic pursuits such as acquisition and utilization of capital of the firm. To put it in other words, it is applying general management standards to the financial resources of the firm.
Scope of Financial Management
To understand the financial management scope, first, it is essential to understand the approaches that are divided into two sections.
- Traditional Approach
- Modern Approach
Approach 1: Traditional Approach to Finance Function
During the 20th century, the traditional approach was also known as corporate finance. This approach was initiated to procure and manage funds for the company. To study the procurement of financial Management the following three points were used
(i) Institutional sources of finance.
(ii) Issue of financial devices to collect refunds from the capital market.
(iii) Accounting and legal relationship l between the source of finance and business.
In this approach, finance was required not for regular business operations but occasional events like reorganization, promotion, liquidation, expansion, etc. It was considered essential to have funds for such events and regarded as one of the crucial functions of a financial manager.
Though he was not accountable for the effective utilization of funds, however, his responsibility was to get the required funds from external partners on a fair term. The traditional approach of finance management stayed until the 5th decade of the 20th century. The traditional approach only emphasized on the fund’s procurement only by corporations. Hence, this approach is regarded as narrow and defective.
Also Read: Types of Financial Statements
Limitations of Traditional Approach
- One-sided approach- It is more considerate towards the fund procurement and the issues related to their administration, however, it pays no attention to the effective utilization of funds.
- Gives importance to the Financial Problems of Corporations- It only focuses on the financial problems of corporate enterprises, so it narrows the opportunity of the finance function.
- Attention to Irregular Events- It provides funds to irregular events like consolidation, incorporation, reorganization, and mergers, etc. and does not give attention to everyday business operations.
- More Emphasis on Long Term Funds- It deals with the issues of long-term financing.
Approach 2: Modern Approach to Finance Function
With technological improvement, increase competition, and the development of strong corporate, it was important for Management to use the available financial resources in its best possible way. Therefore, the traditional approach became inefficient in a growing business environment.
The modern approach had a more comprehensive analytical viewpoint with a focus on the procurement of funds and its active and optimum use. The fund arrangement is an essential feature of the entire finance function.
The main element of this approach are an evaluation of alternative utilization of funds, capital budgeting, financial planning, ascertainment of financial standards for the business success, determination of cost of capital, working capital management, Management of income, etc. The three critical decisions taken under this approach are.
(i) Investment Decision
(ii) Financing Decision
(iii) Dividend Decision
Features of Modern Approach
The following are the main features of a modern approach.
- More Emphasis on Financial Decisions- This approach is more analytic and less descriptive as the right decisions for a business can be taken only on the base of accounting and statistical data.
- Continuous Function- The modern approach is a constant activity where the financial manager makes different financing decisions unlike the traditional method,
- Broader View- It gives importance not only to optimum use of finance also abut the fund’s procurement. Similarly, it also incorporates features relating to the cost of capital, capital budgeting, and financial planning, etc.
- The measure of Performance- Performance of a firm is also affected by the financial decision taken by the Management or finance manager. Therefore, to maximize revenue, the modern approach keeps a balance between liquidity and profitability.
The other scope of financial management also includes acquisition of funds-gathering funds for the company from different sources, assessment- evaluation of financial plans and policies, allocation of funds- use of funds to buy fixed and current assets, appropriation of funds- dividing and distribution of profits, and the anticipation of funds- estimation of financial needs of the company.
Roles of Financial Management:
- Taking part in utilizing the funds and controlling the productivity.
- Recognizing the requisites of capital (funds) and picking up the sources for that capital.
- Investment accords incorporate investment in fixed assets known as capital budgeting. Investing in current assets are a part and parcel of investment decisions known as working capital decisions.
- Financial decisions associated with the finance raised from different sources which would rely upon the accord on – the kind of resource, when is the financing done, cost incurred and the returns as well.
- In the case of dividend decision, the finance manager is the who is responsible for the accord that is taken by him or her; regarding the net profit distribution (NPD). However, Net profits are classified into 2 types:
- Dividend for shareholders: The rate of dividend and the amount of dividend has to be decided
- Retained profits: The amount of contained (retained) gains has to be ascertained which would rely upon the development and variety of strategies of the trading concern
Also Check: Important Roles of Financial Management
The above mentioned is the concept, that is elucidated in detail about ‘Scope of Financial Management’ for the Commerce students. To know more, stay tuned to BYJU’S.