____________________________________________________________________________________________________

Subject Commerce

Paper No and Title Paper No. 8: Financial Management

Module No and Title Module No. 1: Nature and scope of financial management

Module Tag COM_P8_M1

TABLE OF CONTENTS

1. Learning Outcomes

2. Meaning of Financial Management

3. Nature and Scope of Financial Management

4. Evolution of Financial Management

4.1.The Traditional Phase
4.2.The Transitional Phase
4.3.The Modern Phase

SUBJECT PAPER No. : 8

MODULE No. : 1
____________________________________________________________________________________________________

5. Interdisciplinary aspects of Financial Management

5.1.Financial ManagementandEconomics
5.2.Financial Management and Accounting
5.3. Financial Management and Statistics
5.4. Financial Management and Top Management
5.5. Financial Management and Production Management
5.6. Financial Management and Marketing Management
5.7. Financial Management and Human Resource Management

6. Financial System
6.1. Financial Assets or Instruments
6.2. Financial Markets
6.3. Financial Institutions or Intermediaries
6.4. Regulatory Framework in India

7. Summary

1. Learning Outcomes

After studying this module, you will be able to

· Comprehend the meaning of Financial Management.

· Know the nature and scope of Financial Management.
· Learn about the evolution of Financial Management.
· Appreciate the Interdisciplinary aspects of Financial Management.
· Understand the meaning and components of Financial system.

2. Meaning of Financial Management

Financial management is concerned with the acquisition of funds and their optimum utilisation. It
seeks to acquire funds at minimum cost and generate optimum return by its utilization
consumerate with desired level of risk. Funds are acquired to meet financial aspects of business
activity.
According to the Guthumann and Dougall, “Business finance can broadly be defined as the
activity concerned with planning, raising, controlling, administering of the funds used in the
business.”
Howard and Upton defines Financial management “as an application of general managerial
principles to the area of financial decision-making”.
In terms of Joshep and Massie: Financial management “is the operational activity of a business
that is responsible for obtaining and effectively utilizing the funds necessary for efficient
operations.

SUBJECT PAPER No. : 8

MODULE No. : 1
____________________________________________________________________________________________________

3. Nature and Scope of Financial Management

The nature and scope of financial management has evolved over period of time. It has expanded
in its coverage and has seen a large number of new developments and innovations from
academicians, researchers, practioners and regulators.
Traditionally, Financial Management was a part of economics concerned with record keeping,
arranging funds, managing cash etc. and thus was episodic in nature. It was viewed from
outsider’s (suppliers of funds) view point, was focused on long term financing and was more of
descriptive in nature rather than analytical. However, later on with increasing competition,
globalization, growth and complexity in business activities, scope of financial management
widened. It was no more an episodic activity but became as regular in nature as other areas like
productions, marketing. Financial management emerged as a separate discipline. Focus was no
more just on long term financing and record keeping but also on appraisal and comparative
evaluation of long term investment proposals, management of funds required for running day to
day business operations. As sole proprietorship and partnership gave way to corporations as
preferred form of business, dividend policy and corporate governance rose in prominence. The
nature of financial management in modern times is no more just theoretical or conceptual but is
empirical based and analytical.
Today, almost every business decision and activity involve some financial implications and so
financial management is required to evaluate their financial impact. Since decisions in virtually

all areas of management (purchase, production, marketing, operations and logistic, human
resource) have financial payoffs involved, they come within the scope and purview of financial
management. Also, since financial decisions especially those relating to procurement and
utilization of funds are necessary and have significant impact in every aspect of life, the scope of
financial management covers all decision making entities of society viz. individuals, households,
businesses, organizations and government.

4. Evolution of Financial Management

Financial management is evolutionary concept not a revolutionary concept. Its evolution may be
divided broadly in three phases: the Traditional, the Transitional and the Modern phase. The
time frame in demarcating these phases is not exact.

4.1. The Traditional Phase

TheTraditional phase lasted for about four decades till early 1940’s. In this phase, the focus of
financial management was mostly on events of episodic nature like procurement of capital,
engagement with major lenders like banks, issuance of securities, debt servicing, expansion,
merger and compliance with legal aspects. The approach was mainly descriptive.
Financial management was viewed mainly from the viewpoint of the investment bankers, lenders,
and other outsiders.

4.2. The Transitional Phase

SUBJECT PAPER No. : 8

MODULE No. : 1
____________________________________________________________________________________________________

The Transitional phase began around the early 1940’s

continued till early 1950’s. Financial management had almost similar nature and scope during this
phase as during the traditional phase. However, there was an increasing emphasis on planning,
procuring, managing and controlling funds to meet day to day financial needs of the business.
Financial issues began to be analyzed in an analytical framework.

4.3. The Modern Phase

The mid 1950’s marked the beginning of Modern phase in financial management owing to
increasing competition, growth opportunities, globalization, breakthroughs in economic theories
and development of quantitative methods of analysis. This led to development of a more
analytical, empirical approach to decision making. Management or insider’s view point became
central to financial management. Development of Theory of Portfolio Management by Harry
Markowitz in 1950, Theory of Leverage and Valuation of firm by Modigliani and Miller in 1958
and Option Valuation Model by Black and Scholes in 1970’s are regarded as milestones in the
evolutionary journey of modern financial management. Since then, the fields of capital budgeting,
capital structure , efficient market hypothesis, option pricing theory, agency theory, financial
derivatives and risk management, valuation model, dividend policy, working capital management,
financial modeling, financial engineering, international finance and behavioral finance to name a
few, have seen fascinating developments. With the on-going endeavors of various academicians,
researchers, practioners and regulators, we are poised to see many more significant advancements
in these and upcoming areas, which would add further dimensions to financial management.

5. Interdisciplinary Aspects of Financial Management

5.1.Financial Management and Economics

Various economic theories provide guidelines to finance manager for decision making in real
business situations. Finance manager must have understanding of microeconomic economic
concepts like demand and supply analysis, behaviour of costs, pricing theory, marginal analysis
and profit optimization models under different market situations. These are of great relevance to
finance manager in budgeting & forecasting, evaluating alternative investment proposals, profit
planning. For fund raising, finance manager should have good understanding of functioning of
financial institutions and market. Concepts of present value, economic income, opportunity cost,
risk management, behaviour of investors under different market situations and macroeconomic
variables like inflation, employment, per capita income, aggregate demand, and aggregate supply
have great implications for investment decisions.

5.2.Financial Management and Accounting

Financial managers have to take decisions about future. They make extensive use of historical
accounting information for analyzing past performances and forecasting about future profitability,
liquidity and solvency of the firm. So as one of the important users of accounting information
they should be capable of understanding and interpreting financial information. Cost and
Management accounting are specialized areas of accounting which provide accounting
information in a form which facilitates efficient decision making. Finance manager also oversees
preparation of financial statements as per legal & statutory requirements.

SUBJECT PAPER No. : 8

MODULE No. : 1
____________________________________________________________________________________________________

5.3. Financial Management and Statistics

In the modern phase, financial management has become more analytical and empirical. This
requires application of large number of statistical tools and techniques such as measures of central
tendency, measures of dispersion, correlation and regression, sampling and estimation, hypothesis
testing on raw data to derive meaningful interpretation & conclusions. These tools and techniques
are widely applied across all decision areas of financial management such as capital budgeting,
capital structure, dividend and working capital.

5.4. Financial Management and Top Management

Top management formulates and implements strategy to maximize wealth of shareholders and
achieve the stated goals & objective of business. All strategic decisions like strategic alliances,
joint venture, mergers and acquisitions, demerger have significant financial impact on
profitability, liquidity and solvency of firm in the long run. So top management along with chief
finance officer assesses the impact of financial decisions and incorporates them in strategy
formulation.

5.5. Financial Management and Production Management

Production department in a business organization is concerned with arrangement of raw

materials, machinery, technology, manpower, tools and equipment to facilitate efficient and
effective production of goods and services. They aim to complete production targets within time,

minimise cost and ensure optimum utilization of production facilities. To achieve this, they incur
expenditures on raw material, machinery, wages, operating expenses etc. These expenditures are
estimated by production department and then sent for approval to the finance department. Finance
manager after evaluating these estimates may suggest changes and thereafter allocates the
required funds to the production department.

5.6. Financial Management and Marketing Management

Marketing managers make marketing plans, do demand forecasting, take decisions regarding
pricing, product promotion, product mix, market segmenting, targeting and positioning, choice &
length of distributional channels. All of these involve payoffs between benefits generated and
expenditures incurred. Finance managers work with their marketing colleagues to evaluate the
profitability of alternative marketing proposals. Finance manager after due deliberation approves
funding for selected proposals.

5.7. Financial Management and Human ResourceManagement

Human resource department of an organisation takes several decisions that have financial
implications such as manpower planning, recruitment, training and development programs,
employee compensation and benefits which include wages, salary, bonus, commission,
perquisites, allowances. Financial manager discusses benefits and costs of these decisions with
human resource manager and approves funds to implement them.
Concepts from fields of psychology and organisational behaviour which
earlier were used by human resource department are being today used by finance managers to
understand the behaviour of investors. This new area called behavioural finance has grown
SUBJECT PAPER No. : 8
MODULE No. : 1
____________________________________________________________________________________________________

rapidly in past few decades by attracting interest of

academicians and researchers in developing theory and
conceptual framework for the field. Finance managers and practioners have also found it to be
very practical and useful in their work.

6. Financial System

Financial system is the system that channelizes funds from funds surplus units or savers (like
households) to funds deficit units like governments and business organizations. All decisions of
financial management and entire functioning of finance department of any organization is directly
affected by and linked to the surrounding financial system or environment.Financial
Systems consists of closely interrelated financial assets or instruments, financial markets and
financial institutions or intermediaries functioning within a regulatory framework.

6.1. Financial Assets or Instruments

Financial Assets are different from Real or Physical or Tangible assets such as land, buildings,
machinery, equipments. Financial Assets or Instruments represent a financial claim of the holder
or purchaser of the asset over the issuer or seller. It is liability for the issuer and asset for holder.
Currencies, bank deposits, post office savings, shares, bonds, debentures, derivatives, mutual fund
units are some commonly used financial assets.

6.2. Financial Markets

A financial market is a market in which financial assets like shares, bonds are traded. Financial
markets facilitate:
Ø The raising of capital (in the capital markets).
Ø The transfer of risk (in the derivatives markets).
Ø Price discovery of financial assets.
Ø Global transactions with integration of financial markets.
Ø The transfer of liquidity (in the money markets).
Ø International trade (in the currency markets).

Types of Financial Markets

Ø Capital markets are markets for long term financial assets like shares, bonds.
Capital markets can be further divided into primary and secondary markets. Newly
formed (issued) securities are bought or sold in primary markets. Secondary markets
allow investors to buy and sell existing securities.
Ø Money market is market for short term debt financing and investment.
Ø Foreign exchange marketsfacilitate the trading of foreign currencies.

6.3. Financial Institutions or Intermediaries

Financial intermediary are institutions which connect or establish linkages between fund surplus
and fund deficit units allowing transfer of funds from savers to borrowers. Commercial banks,

SUBJECT PAPER No. : 8

MODULE No. : 1
____________________________________________________________________________________________________

insurance companies, mutual funds, non-banking financial

companies, investment bankers, merchant bankers, brokerage
houses, central or state government established financial institutions are major financial
intermediaries.

6.4. Regulatory Framework in India

Financial system in India is monitored and controlled by several regulators and regulations.
Main regulators are Reserve bank of India (RBI); Securities Exchange Board of India (SEBI);
Insurance Regulatory and Development Authority (IRDA); Ministry of Finance; Ministry of
Corporate Affairs.Major legislations governing and influencing financial system in India are
Companies Act, 2012; Securities Contract Regulation Act, 1956; Banking Regulation Act, 1949;
Income Tax Act, 1961 andNegotiable Instruments Act, 1881.

7. Summary

Ø Financial management is concerned with the acquisition of funds and their optimum
utilization. It seeks to acquire funds at minimum cost and generate optimum return by its
utilization consumerate with desired level of risk.

Ø The nature and scope of financial management has evolved over period of time. It has
expanded in its coverage and has seen a large number of new developments and
innovations from academicians, researchers, practioners and regulators.

Ø Financial management is evolutionary concept. Its evolution may be divided broadly in

three phases: the Traditional, the Transitional and the Modern phase.

Ø Financial management is related to other disciplines such as economics, accounting,

statistics and other areas of management viz. top management, production management,
marketing management, and human resource management.

Ø Financial system is the system that channelizes funds from funds surplus units or savers
(like households) to funds deficit units like governments and business organizations.

Ø Financial Systems consists of closely interrelated financial assets or instruments,financial

markets and financial institutions or intermediaries functioning within a regulatory
framework.

SUBJECT PAPER No. : 8

MODULE No. : 1