Financial Management Meaning and Scope

HML2305
A presentation by: Inder Singh
FINANCIAL MANAGEMENT
MEANING AND SCOPE 1
1

A presentation by: Inder Singh2

Meaning
 Financial Management means planning,
organizing, directing and controlling the financial
activities such as procurement and utilization of
funds of the enterprise. It means applying general
management principles to financial resources of
the enterprise.
3

SCOPE/ ELEMENTS
 1. Investment decisions- includes investment in fixed
assets (called as capital budgeting). Investment in
current assets are also a part of investment decisions
called as working capital decisions.
 2. Financial decisions – They relate to the raising of
finance from various resources which will depend upon
decision on type of source, period of financing, cost of
financing and the returns thereby.
 3. Dividend decision – The finance manager has to take
decision with regards to the net profit distribution. Net
profits are generally divided into two:
(i) Dividend for shareholders - Dividend and the rate of it
has to be decided.
(ii) Retained profits - Amount of retained profits has to be
finalized which will depend upon expansion and
diversification plans of the enterprise.
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OBJECTIVES OF FINANCIAL
MANAGEMENT
 The financial management is generally concerned with
procurement, allocation and control of financial resources
of a concern. The objectives can be-
 To ensure regular and adequate supply of funds to the
concern.
 To ensure adequate returns to the shareholders this will
depend upon the earning capacity, market price of the
share, expectations of the shareholders.
 To ensure optimum funds utilization. Once the funds are
procured, they should be utilized in maximum possible way
at least cost.
 To ensure safety on investment, i.e, funds should be
invested in safe ventures so that adequate rate of return
can be achieved.
 To plan a sound capital structure-There should be sound
and fair composition of capital so that a balance is
maintained between debt and equity capital.5

FUNCTIONS OF FINANCIAL
MANAGEMENT
 1. Estimation of capital requirements: A finance manager has to make
estimation with regards to capital requirements of the company. This will depend
upon expected costs and profits and future programmes and policies of a
concern. Estimations have to be made in an adequate manner which increases
earning capacity of enterprise.
 2. Determination of capital composition: Once the estimation has been made,
the capital structure has to be decided. This involves short- term and long- term
debt equity analysis. This will depend upon the proportion of equity capital a
company is possessing and additional funds which have to be raised from
outside parties.
 3. Choice of sources of funds: For additional funds to be procured, a company
has many choices like-
a) Issue of shares and debentures
b) Loans to be taken from banks and financial institutions
c) Public deposits to be drawn like in form of bonds.
Choice of factor will depend on relative merits and demerits of each source and
period of financing.
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FUNCTIONS OF FINANCIAL
MANAGEMENT
 4. Investment of funds: The finance manager has to decide to allocate funds
into profitable ventures so that there is safety on investment and regular returns
is possible.

 5. Disposal of surplus: The net profits decision has to be made by the finance
manager. This can be done in two ways:

 a) Dividend declaration – It includes identifying the rate of dividends and other
benefits like bonus.
 b) Retained profits – The volume has to be decided which will depend upon
expansional, innovate, diversification plans of the company.

 6. Management of cash: Finance manager has to make decisions with regards
to cash management. Cash is required for many purposes like payment of wages
and salaries, payment of electricity and water bills, payment to creditors, meeting
current liabilities, maintenance of enough stock, purchase of raw materials, etc.

 7. Financial controls: The finance manager has not only to plan, procure and
utilize the funds but he also has to exercise control over finances. This can be
done through many techniques like ratio analysis, financial forecasting, cost and
profit control, etc.
8

FINANCIAL STATEMENT & ITS
TYPES
2

Financial Statements
 Financial Statements represent a formal record of the
financial activities of an entity. These are written reports
that quantify the financial strength, performance and
liquidity of a company. Financial Statements reflect the
financial effects of business transactions and events on the
entity.
 Financial statements are written records that convey the
financial activities and conditions of a business or entity
and consist of four major components. Financial
statements are meant to present the financial information
of the entity in question as clearly and concisely as
possible for both the entity and for readers. Financial
statements for businesses usually include income
statements, balance sheets, statements of retained
earnings and cash flows but may also require additional
detailed disclosures depending on the relevant accounting
framework. Financial statements are often audited by
government agencies, accountants, firms, etc. to ensure
accuracy and for tax, financing or investing purposes.A presentation by: Inder Singh11

TYPES OF FINANCIAL
STATEMENTS
 1. Statement of Financial Position
 Statement of Financial Position, also known as the
Balance Sheet, presents the financial position of an
entity at a given date. It is comprised of the following
three elements:

 Assets: Something a business owns or controls
(e.g. cash, inventory, plant and machinery, etc)
 Liabilities: Something a business owes to
someone (e.g. creditors, bank loans, etc)
 Equity: What the business owes to its owners. This
represents the amount of capital that remains in the
business after its assets are used to pay off its
outstanding liabilities. Equity therefore represents the
difference between the assets and liabilities.

TYPES OF FINANCIAL
STATEMENTS
 2. Income Statement
 Income Statement, also known as the Profit and
Loss Statement, reports the company’s financial
performance in terms of net profit or loss over a
specified period. Income Statement is composed
of the following two elements:
 Income: What the business has earned over a
period (e.g. sales revenue, dividend income, etc)
 Expense: The cost incurred by the business
over a period (e.g. salaries and wages,
depreciation, rental charges, etc)
 Net profit or loss is arrived by deducting
expenses from income.A presentation by: Inder Singh13

TYPES OF FINANCIAL
STATEMENTS
 Cash Flow Statement
 Cash Flow Statement, presents the movement in
cash and bank balances over a period. The
movement in cash flows is classified into the following
segments:
 Operating Activities: Represents the cash flow
from primary activities of a business.
 Investing Activities: Represents cash flow from
the purchase and sale of assets other than
inventories (e.g. purchase of a factory plant)
 Financing Activities: Represents cash flow
generated or spent on raising and repaying share
capital and debt together with the payments of
interest and dividends.A presentation by: Inder Singh14

TYPES OF FINANCIAL
STATEMENTS
 4. Statement of Changes in Equity
 Statement of Changes in Equity, also known as the
Statement of Retained Earnings, details the
movement in owners’ equity over a period. The
movement in owners’ equity is derived from the
following components:
 Net Profit or loss during the period as reported in the
income statement
 Share capital issued or repaid during the period
 Dividend payments
 Gains or losses recognized directly in equity (e.g.
revaluation surpluses)
 Effects of a change in accounting policy or correction
of accounting error

TECHNIQUES OF FINANCIAL
ANALYSIS

Financial Analysis is defined as being the process of identifying financial
strength and weakness of a business by establishing relationship between
the elements of balance sheet and income statement. The information
pertaining to the financial statements is of great importance through which
interpretation and analysis is made. It is through the process of financial
analysis that the key performance indicators, such as, liquidity solvency,
profitability as well as the efficiency of operations of a business entity may
be ascertained, while short term and long-term prospects of a business
may be evaluated. Thus, identifying the weakness, the intent is to arrive at
recommendations as well as forecasts for the future of a business entity.

The income statement
 The income statement, having been termed as
profit and loss account is the most useful financial
statement to enlighten what has happened to the
business between the specified time intervals
while showing, revenues, expenses gains and
losses.

Balance sheet
 Balance sheet is a statement which shows the
financial position of a business at certain point of
time. The distinction between income statement
and the balance sheet is that the former is for a
period and the latter indicates the financial
position on a particular date. However, on the
basis of financial statements, the objective of
financial analysis is to draw information to
facilitate decision making, to evaluate the
strength and the weakness of a business, to
determine the earning capacity, to provide
insights on liquidity, solvency and profitability and
to decide the future prospects of a business

LIMITATIONS OF FINANCIAL
ANALYSIS
 1. Mislead the user
 The accuracy of financial information largely depends
on how accurately financial statements are prepared.
If their preparation is wrong, the information obtained
from their analysis will also be wrong which may
mislead the user in making decisions.
 2. Not useful for planning
 Since financial statements are prepared by using
historical financial data, therefore, the information
derived from such statements may not be effective in
corporate planning, if the previous situation does not
prevail.

ANALYSIS
3. Qualitative aspects
 Then financial statement analysis provides only
quantitative information about the company’s financial
affairs. However, it fails to provide qualitative
information such as management labour relation,
customer’s satisfaction, and management’s skills and
so on which are also equally important for decision
making.
 4. Comparison not possible
 The financial statements are based on historical data.
Therefore, comparative analysis of financial
statements of different years cannot be done as
inflation distorts the view presented by the statements
of different years.

ANALYSIS
5. Wrong judgement
 The skills used in the analysis without adequate
knowledge of the subject matter may lead to
negative direction. Similarly, biased attitude of the
analyst may also lead to wrong judgement and
conclusion.
 The limitations mentioned above about financial
statement analysis make it clear that the analysis
is a means to an end and not an end to itself. The
users and analysts must understand the
limitations before analyzing the financial
statements of the company.

RATIO ANALYSIS
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RATIO ANALYSIS
 Ratio analysis involves the construction of ratios
using specific elements from the financial
statements in ways that help identify the
strengths and weaknesses of the firm. Ratios
help measure the relative performance of different
financial measures that characterize the firm’s
financial health. We could just look at the dollar
value of each financial measure and draw
conclusions about performance; however, using
ratios often provides a standardized measure
which is easier to interpret.

CLASSIFICATION OF RATIOS
 1. Liquidity Ratios: These ratios measure the
ability of a company to meet its current
obligations, and indicate the short-term financial
stability of the company. The parties interested in
the liquid ratio would be employees, bankers and
short-term creditors.

LIQUIDITY RATIO
 Current ratio=current assets/ current liabilities
 Quick ratio= Current assets- inventories- prepaid
expenses/ current liabilities
 Cash ratio= cash+ Marketable securities/ current
liabilities
 Net working capital ratio= working capital/Net
assets
Working capital= CA-CL

 2. Profitability Ratios: These measure the
overall effectiveness in terms of returns
generated, with profits being related to sales and
adequacy of such profits as to sales or
investment. The profitability ratios are important
to internal management, to bankers, to investors
and to the owners.

 3. Leverage Ratios: These measure the extent to
which the company has been financed through
borrowing (debt financing whether short or long-
term). Those interested would be bankers,
owners and investors.

 4. Activity Ratios: These measure the extent to
which the company has been financed through
borrowing (debt financing whether short or long-
term). Those interested would be bankers,
owners and investors.

 5. Solvency Ratios: These ratios would give a
picture of the company so that an early
forewarning is available for remedial action in
time
 6. Financial Ratios: These enable quick spotting
of over or under-capitalization of a business, so
that a proper, balance is achieved between
owner’s funds, borrowed funds and shareholder’s
funds.

Advantages/ Uses
 Ratio analysis is a useful tool for users of
financial statements. It has following advantages:
 1) It simplifies the financial statements.
 2) It helps in comparing companies of different
size with each other.
 3) It helps in trend analysis which involves
comparing a single company over a period.
 4) It highlights important information in a simpler
form quickly. A user can judge a company’s
financial position and profitability by just looking
at few ratios instead of reading the whole
financial statements.

Limitations
 Despite advantages, ratio analysis has some
disadvantages. Some key demerits of financial ratio
analysis are:
 1) Different companies operate in different industries,
each having different environmental conditions such as
regulation, market structure, etc. Such factors are so
significant that a comparison of two companies from
different industries might be misleading.
 2) Financial accounting information is affected by
estimates and assumptions. Accounting standards allow
different accounting policies, which impairs comparability
and hence ratio analysis is less useful in such situations.
 3) Ratio analysis explains relationships between past
information while users are more concerned about current
and future information.
 4) There may be window dressing of financial statements
by the management of the company which may lead to
misleading information.

FUND FLOW STATEMENT
 Flow of funds refers to change in fund. Increase
of funds of any transaction is a source and
decrease of funds in any transaction is
application or users of funds. Fund being working
capital; funds flow refers to the flow of working
capital between two points of time. It involves
information relating to various transformations
undergone by working capital (i.e., the changes
that have taken place in working capital) during
the period involved between the two points of
time.

Advantages/ Uses
 Ratio analysis is a useful tool for users of
financial statements. It has following advantages:
 1) It simplifies the financial statements.
 2) It helps in comparing companies of different
size with each other.
 3) It helps in trend analysis which involves
comparing a single company over a period.
 4) It highlights important information in a simpler
form quickly. A user can judge a company’s
financial position and profitability by just looking
at few ratios instead of reading the whole
financial statements.

Limitations
 Despite advantages, ratio analysis has some
disadvantages. Some key demerits of financial ratio
analysis are:
 1) Different companies operate in different industries,
each having different environmental conditions such as
regulation, market structure, etc. Such factors are so
significant that a comparison of two companies from
different industries might be misleading.
 2) Financial accounting information is affected by
estimates and assumptions. Accounting standards allow
different accounting policies, which impairs comparability
and hence ratio analysis is less useful in such situations.
 3) Ratio analysis explains relationships between past
information while users are more concerned about current
and future information.
 4) There may be window dressing of financial statements
by the management of the company which may lead to
misleading information.

FUND FLOW STATEMENT
 Flow of funds refers to change in fund. Increase
of funds of any transaction is a source and
decrease of funds in any transaction is
application or users of funds. Fund being working
capital; funds flow refers to the flow of working
capital between two points of time. It involves
information relating to various transformations
undergone by working capital (i.e., the changes
that have taken place in working capital) during
the period involved between the two points of
time.

FUND FLOW STATEMENT
 Funds flow statement is a statement which
depicts the sources from which funds were
obtained and the uses to which they have been
put. It speaks about the changes in financial
items of balance sheets prepared at two different
dates. Therefore, the funds flow analysis studies
the movement of funds (inflows and outflows of
funds) during a given period, generally a year.
Thus, it exhibits the movements of funds in both
the directions – inside and outside the business.

SIGNIFICANCE OF FUNDS
FLOW
 Helps shareholders, creditors and others to evaluate
the users of funds by the enterprise.
 Assists of analysis of past the trends and thus aid
future expansion decisions.
 Guides the management in deciding about the
dividend and retention policies.
 Enables planning for long-term purposes.
 Facilitates proper allocation of resources and funds
 Indicates the sources from which the company has
obtained its funds.
 Helps in ascertaining the factors resulting in change in
working capital.

ADVANTAGES OF FUNDS FLOW
STATEMENT
 In addition to the balance sheet, it serves as an
additional reference for many interested parties like
creditors, suppliers, government etc. to look into
financial position of the company.
 It shows how the fund were raised from various
sources and also how also how those funds were put
to use in the business, therefore it is a great tool for
management when it wants to know about where and
from funds were raised and also how those funds got
utilized into the business.
 . It reveals the causes of the changes in liabilities and
assets between the two balance sheet dates therefore
providing a detailed analysis of the balance sheet of
the company.
 Funds flow statement helps the management in
deciding its future course of plans and also it acts as
a control tool for the management.

LIMITATIONS OF FUNDS FLOW
STATEMENT
 Funds flow statement has to be used along with balance
sheet and profit and loss account; it cannot be used alone.
 It does not reveal the cash position of the company, and
that is why company has to prepare cash flow statement in
addition to funds flow statement.
 Funds flow statement merely rearranges the data which is
there in the books of account and therefore it lacks
originally. In simple words it presents the data in the
financial statements in systematic way and therefore many
companies tend to avoid preparing funds flow statements.
 Funds flow statement is basically historic in nature, that it
indicates what happened in the past and it does not
communicate anything about the future, only estimates can
be made based on the past data and therefore it cannot be
used the management for taking decision related to future.

Cash Flow Statement

Introduction to Cash flow Statement
 Cash plays a very important role in the economic
life of a business. A firm needs cash to make
payment to its suppliers, to incur day-to-day
expenses and to pay salaries, wages, interest
and dividends etc.
 In fact, what blood is to a human body, cash is to
a business enterprise. Thus, it is very essential
for a business to maintain an adequate balance
of cash.

Meaning of Cash Flow Statement
Cash Flow Statement deals with flow of cash
which includes cash equivalents as well as cash.
This statement is an additional information to the
users of Financial Statements.
The statement shows the incoming and outgoing
of cash. The statement assesses the capability of
the enterprise to generate cash and utilize it.

Definition of Cash Flow
Statement
 Cash-Flow statement may be defined as a
summary of receipts and disbursements of cash
for a particular period of time. It also explains
reasons for the changes in cash position of the
firm.
 Cash flows are cash inflows and outflows.
 Transactions which increase the cash position of
the entity are called as inflows of cash and those
which decrease the cash position as outflows of
cash.

Objectives of CFS
To Help the Management in Making Future
Financial Policies
Helpful in Declaring Dividends etc.
Helps in planning the repayment of loan
Helps to ascertain the liquid position of the firm in
a better manner.
Cash Flow Statement based on AS-3 (revised)
presents separately cash generated and used in
operating, investing and financing activities.

Difference between CFS and FFS

Cash and relevant terms as per
AS-3 (revised)

Cash and relevant terms as per AS-3 (revised)

Classification of Cash inflows and Cash Outflows
Activities

Financial Management Meaning and Scope

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