DAF1307: FINANCIAL MANAGEMENT
LESSON ONE
NATURE AND SCOPE OF FINANCIAL MANAGEMENT
Introduction
Financial management is that managerial activity which is concerned with the planning and
controlling of the firm’s financial resources. It involves the decision of the three decisions of the
firm i.e.
a) Investment decision
b) Financial decision
c) Dividend decision
Together they determine the value of the firm to its shareholders. The finance manager makes
use of certain analytical tools in the analysis, planning and control activities associated with the
major decisions of the firm.
Role of the Finance Manager
A financial manager is a person who is responsible in a significant way to carry out the finance
functions:
a) Interaction with the financial markets
In order to raise finance knowledge is needed of the financial markets and the way in which they
operate.
b) Investment
Decisions have to be made concerning how much to invest in real assets and which specific
projects to undertake (capital budgeting decisions).
c) Treasury management
Many firms have large sums of cash which need to be managed properly too obtain a high return
for shareholders. Other areas of responsibility might include inventory control, creditor
management and issues of solvency and liquidity.
d) Risk management
Exposures to interest rates changes and commodity price fluctuations can be reduced by using
hedging techniques. These often employ instruments such as futures, options, swaps, and
forward agreements.
e) Strategy
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Managers need to formulate and implement long term plans to maximize shareholders wealth.
This means selecting markets and activities in which the firm given its resources has a
competitive edge.
Functions of a Finance Manager
Financial manager is concerned with
a) Investment decision or long-term asset mix
A firm’s investment decisions involve capital expenditures; therefore referred to as capital
budgeting decisions. It involves the decision of allocation of capital or commitment of funds to
long-term asset that would yield benefit (cash flows) in the future.
b) Financing decision
The mix of debt and equity is known as the firm’s capital structure. The finance manager must
strive to obtain the best financing mix or the optimum capital structure for his/ her firm. Broadly
he/ she must decide when, where from and how to acquire funds to meet the firm’s investment
needs.
c) Dividend decision
The finance manager must decide whether the firm should distribute all profits, or retain them, or
distribute a portion and retain the balance. The proportion of profits distributed as dividend is
called the dividend payout ratio and the retained portion is known as the retention ratio.
d) Liquidity decision
Investment in current assets affects the firm’s profitability and liquidity. Current assets should be
managed efficiently for safeguarding the firm against the risk of illiquidity. The profitability
liquidity trade off requires that the financial manager should develop sound techniques of
managing current assets.
Objectives of a Firm
I. Profit maximization
A company is an entity, which invests its resources so as to gain maximum profit-this is a
traditional objective of business or cardinal objective. The business must make profits:
To give a return to its owners(shareholders)
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The return must be satisfactory i.e. higher than the bank rate on savings account. The owners
may pull out of the company if it is making losses.
It must give a reasonable reward to employees –good salaries and benefits.
The company must make profits some of which should contribute to social causes. Nevertheless
this objective cannot be fully achieved under perfect competition as a number of firms will
compete for a limited number of customers; also maximization of profits must not be done at the
expense of customer welfare i.e. the firm should not achieve this objective by exploiting its
customers as it owes them a duty of care.
II. Wealth maximization/maximization of the net worthiness of a business
This is achieved through retention of earnings and subsequent reinvestment of these earnings in
the business or other viable ventures .this will boost the value of the company’s share as
shareholders or owners will receive better returns from such ventures. In this case, the net worth
should be taken to be the total assets less its liabilities.
III. Social Responsibility
i.) Maximization of the welfare of its employees
Happy (contented) body of employees will boost the company’s production thus sales and
profits. The company must provide its employees with
Reasonable salaries commensurate with the employees’ qualification, competence,
experience and nature of the job
Transport facilities for those people performing sensitive jobs i.e. jobs which can hold
others e.g. cashiers, accountants, storekeepers, etc.
Medical facilities for employees and their families (To the employee such facilities will
facilitate a healthy employee who can work better and avoid absences). To their families
this is an incentive for the employees.
Assurance of terminal benefits e.g. pension schemes or other retirement benefits- to
ensure steady employees and boost their morale towards the company.
Recreation facilities e.g. playgrounds, clubs- lower grade employees enjoy mixing with
management, which facilitates unity and harmony in the company and facilitates
attainment of the company’s goals.
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ii.) Interest of customers
A business must be mindful of its customers and must seek to retain them and for this reason, a
business should
Provide quality products
Fair prices for the goods purchased i.e. customers should get a good value for their
money.
Have an honest dealing with customers i.e. to avoid bouncing them/ill treatments of
customers should be avoided as these contribute to the company’s profitability.
iii.)Welfare of the society
A business owes a social responsibility to the society in such forms as
Maintaining sound industrial relations with the society around it
Avoiding harmful production processes e.g. avoiding pollution of environment.
The company should contribute to the social cause e.g. in form of Harambee donations,
building public clinics, recreational centers, schools etc.
The company must identify itself with the society in as much as it must understand the
problems of the society around it e.g. be aware of the society’s development needs and
contribute to its attainment
iv.) Fair dealing with suppliers of goods and finance
The company must
Meet its obligations as and when they fall due
Avoid dishonor of any obligation and also double dealings in procurement of goods
The creditors also need assurance of the company’s ability not only to service the current
obligations but also to be able to raise more internal equity to back their finances.
v.) Duty to the government
The company must
Pay corporation taxes as and when they fall due
Operate within the government development plans e.g. banks and financial institutions
which should operate within boundaries required by the central bank so as to facilitate
development
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Operate within legal system i.e. adhere to industrial requirements and ensure safety
standards to its employees
End
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