Question 1. Suppose if you are a Financial Executive or Manager of your company or any other company what kind of decisions you would have to take about the company and its activities? How does these decisions differ from those decisions which investors, regulatory agencies and others make about the same company? Is the same kind of information needed by groups from within and outside the company? If so, what is that information? If not, what are the essential differences?
Answer. A financial manager is a person who is responsible in a significant way to carry out the finance functions. The finance manager is responsible for shaping the fortunes of an enterprise, and is involved in the most vital decisions of the allocation of capital. The duties of financial managers vary with their specific titles, which include controller, treasurer or finance officer, credit manager, cash manager, and risk and insurance manager. Controllers direct the preparation of financial reports that summarize and forecast the organization’s financial position, such as income statements, balance sheets, and analyses of future earnings or expenses. Controllers also are in charge of preparing special reports required by regulatory authorities. Often, controllers oversee the accounting, audit, and budget departments. Treasurers and finance officers direct the organization’s financial goals, objectives, and budgets. They oversee the investment of funds and manage associated risks, supervise cash management activities, execute capital-raising strategies to support a firm’s expansion, and deal with mergers and acquisitions. Credit managers oversee the firm’s issuance of credit. They establish credit-rating criteria, determine credit ceilings, and monitor the collections of past-due accounts. Managers specializing in international finance develop financial and accounting systems for the banking transactions of multinational organizations.
Cash managers monitor and control the flow of cash receipts and disbursements to meet the business and investment needs of the firm. For example, cash flow projections are needed to determine whether loans must be obtained to meet cash requirements or whether surplus cash should be invested in interest-bearing instruments. Risk and insurance managers oversee programs to minimize risks and losses that might arise from financial transactions and business operations undertaken by the institution. They also manage the organization’s insurance budget.
All financial managers perform tasks unique to their organization or industry. For example, government financial managers must be experts on the government appropriations and budgeting processes, whereas healthcare financial managers must be knowledgeable about issues surrounding healthcare financing. Moreover, financial managers must be aware of special tax laws and regulations that affect their industry.
Financial managers play an increasingly important role in mergers and consolidations, and in global expansion and related financing. These areas require extensive, specialized knowledge on the part of the financial manager to reduce risks and maximize profit. Financial managers increasingly are hired on a temporary basis to advise senior managers on these and other matters. In fact, some small firms contract out all accounting and financial functions to companies that provide these services.
The role of the financial manager, particularly in business, is changing in response to technological advances that have significantly reduced the amount of time it takes to produce financial reports. Financial managers now perform more data analysis and use it to offer senior managers ideas on how to maximize profits. They often work on teams, acting as business advisors to top management. Financial managers need to keep abreast of the latest computer technology in order to increase the efficiency of their firm’s financial operations.
Finance functions or decisions of a finance manger are:
· Investment decisions: Investment or capital budgeting involves the decision of allocation of capital or commitment of funds to long term assets that would yield benefits in the future. Two important aspects of the investment decision are: (a) the evaluation of the prospective profitability of new investments, and (b) the measurement of a cut-off rate against that the prospective return of the new investment could be compared. Investment proposals are evaluated in terms of both expected return and risk. Besides the decision to commit funds in new investment proposals, capital budgeting also involves decision of recommitting funds when an asset becomes less productive or non-profitable.
· Financing Decision: This is the second important function to be performed by the financial manager. Broadly, he or she must decide when, where and how to acquire funds to meet the firm's investment needs. The central issue before him or her is to determine the proportion of equity and debt. The mix of debt and equity is known as the firm's capital structure. The financial manager must strive to obtain the best financing mix or the optimum capital structure for his or her firm. The firm's capital structure is considered to be optimum when the market value of shares is maximized. The use of debt affects the return and risk of shareholders; it may increase the return on equity funds but it always increases risk. A proper balance will have to be struck between return and risk. When the shareholders' return is maximized with minimum risk, the market value per share will be maximized and the firm's capital structure would be considered optimum. Once the financial manager is able to determine the best combination of debt and equity, he or she must raise the appropriate' amount through the best available sources. In practice, a firm considers many other factors such as control, flexibility, loan convenants, legal aspects etc. in deciding its capital structure.
· Dividend Decision: Dividend decision is the third major financial decision. The financial manager must decide whether the firm should distribute all profits, or retain them, or distribute a portion and retain the balance. Like the debt policy, the dividend policy should be determined in terms of its impact on the shareholders' value. The optimum dividend policy is one that maximizes the market value of the firm's shares. Thus, if shareholders are not indifferent to the firm's dividend policy, the financial manager must determine the optimum dividend-payout ratio. The payout ratio is equal to the percentage of dividends to earnings available to shareholders. The financial manager should also consider the questions of dividend stability, bonus shares and cash dividends in practice. Most profitable companies pay cash dividends regularly. Periodically, additional shares, called bonus shares (or stock dividend): are also issued to the existing shareholders in addition to the cash dividend.
· Liquidity Decision: Current assets management that affects a firm’s liquidity is yet another important finance function, in addition to the management of long-term assets. Current assets should be managed efficiently for safeguarding the firm against the dangers of illiquidity and insolvency. Investment in current assets affects the firm’s profitability, liquidity and risk. A conflict exists between profitability and liquidity while managing current assets. If the firm does not invest sufficient funds in current assets, it may become illiquid. But it would lose profitability, as idle current assets would not earn anything. Thus, a proper trade-off must, be achieved between profitability and liquidity. In order to ensure that neither insufficient nor unnecessary funds are invested in current assets, the financial manager should develop sound techniques of managing current assets. He or she should estimate firm's needs for current assets and make sure that funds would be made available when needed. The function of financial management is to review and control decisions to commit or recommit funds to new or ongoing uses. Thus, in addition to raising funds, financial management is directly concerned with production, marketing and other functions
· Financial procedures and Systems: For the effective execution of the finance functions, certain other functions have to be routinely performed. They concern procedures and systems and involve a lot of paper work and time. Some of the important routine finance functions are: (a) supervision of cash receipts and payments and safeguarding of cash balance, (b) custody and safeguarding of securities, insurance policies and other valuable papers, (c) taking care of the mechanical details of new outside financing, (d) record keeping and reporting.
The finance manager in the modern enterprises is mainly involved in the managerial finance functions; the routine functions are carried out by executives at lower levels. Financial manager’s involvement in the routine functions is confined to setting up of rules of procedures, selecting forms to be used, establishing standards for the employment of competent personnel and to check up the performance to see that the rules are observed and that the forms are properly used.
The finance manager in the modern enterprises is mainly involved in the managerial finance functions; the routine functions are carried out by executives at lower levels. Financial manager’s involvement in the routine functions is confined to setting up of rules of procedures, selecting forms to be used, establishing standards for the employment of competent personnel and to check up the performance to see that the rules are observed and that the forms are properly used.
EXTERNAL AND INTERNAL USERS AND THE INFORMATION REQUIRED BY THEM
There are several entities outside the business, which are interested in its operations because of their business dealings with the enterprise. There are individuals or organizations who have economic transactions with the business, e.g. suppliers of goods and services on credit. banks or financial institutions lending money either for a short or a long period, buyers of goods and services produced by the enterprise on the basis of stipulated targets, contractors who have undertaken to build plants and buildings and other facilities for the business. They are all interested, in varying degrees, in the operations of the business with which they deal in order to determine whether the enterprise is credit-worthy and the terms under which credit can be extended, i.e., the amount of goods or services that can be sold on credit (or the loans that can be advanced), the period of such credit and the likelihood that the debt arising out of the transactions would be repaid in time.
Regulatory agencies, i.e., government departments or other agencies who are charged with the responsibility for regulating general business activity or particular types of business are also naturally interested in the operations of the business. The interest of the regulatory agencies is essentially to ensure that the enterprise:
(a) complies with the requirements of the law relating to financial transactions; e.g. it pays the required amount of tax, does not overtrade on its capital, pays dividends to its shareholders out of the profits, provides depreciation according to prescribed norms, etc.;
(b) discloses its capital, retained earnings, profits, sales and costs to the public at large so as to submit its activities to public scrutiny,
(c) provides data relating to its borrowings so that future lenders are provided with the required information regarding the ,present level of borrowings and the state of the security provided by the assets etc.;
The third category of external users consists of those who have neither any economic transactions nor are concerned with regulation of business activities but are interested in the operations of the business on behalf of constituents which they represent, i.e. as representatives of external interests. In this category can be included labour unions, stock brokers, chamber of commerce, trade associations, export agencies, etc.
Lastly, the external group would include, on the one hand the auditor of the business who is required by law to certify the accounts and, on the other, the prospective shareholders who wish to subscribe for shares of a business enterprise or want to buy an already-issued share from another shareholder.
Internal Users of Accounting Information
The owners are proprietary in proprietary concerns and the partners in partnership business, while in the case of a company, the legal owners of the company are the shareholders. The owners would like to know:
(a) whether the enterprise made any profit during the period reported and if so, what the dividend prospects are;
(b) whether the financial condition of the enterprises sound as reflected in its capital to retained earnings ratio, current assets to current liabilities ratio, funds flow statement, etc.
(c) whether these operations are profitable in terms of return on funds invested or return on assets, profits per rupee of sales, gross margin per unit .of sales, etc.;
(d) whether the growth of its sales are in line with the expectations of the shareholders;
(e) whether its costs are in line with the volume of sales and norms of costs in similar efnterprises elsewhere.
The average shareholder would expect to find answers to the questions set out above in "the balance sheet and the income statement prepared by the enterprise for purposes .of external reporting.
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