Financial Management

Financial Management
Introduction to Financial Management
Budget & Budgeting

FinancialManagement Lecture # 10
 Any kind of business activity depends on the finance.
So, it is called as lifeblood of business organization.
 Finance may be defined as the art and science of
managing money. It includes financial service and
financial instruments.
 Finance also is referred as the provision of money at
the time when it is needed.
 The concept of finance includes capital, funds,
money, and amount. But each word is having unique
meaning.
Meaning of Finance 02

Definition of Finance
 According to Khan and Jain ─ ‘Finance is the art and science
of managing money’.
 According to Oxford dictionary ─ ‘management of money’.
 Webster’s Dictionary defines ─ finance is the science on study
of the management of funds as the system that includes
the circulation of money, the granting of credit, the
making of investments, and the provision of banking
facilities.
Finance can be classified into two major parts:
1. Private finance, which includes the individual, firms,
business or corporate financial activities to meet the
requirements.
2. Public finance, which concerns with revenue and
distribution of government such as Central government,
State government and Semi-government financial matters.
03

Finance consists of three interrelated areas:
1. money and capital markets, which deals with
securities markets and financial institutions;
2. investments, which focuses on the decisions made
by both individual and institutional investors
based on investment portfolios;
3. financial management, or ‘business finance’,
which involves decisions within firms.
 Financial managers must have a knowledge of all
three areas if they are to do their jobs well.
Construction of Finance 04

What is Financial Management?
 Financial management is the application of planning
and control functions to the area of finance.
 Financial managing is providing and controlling the
flow of funds in an organization.
Howard and Upton : Financial management “as an
application of general managerial principles to the
area of financial decision-making’’.
Solomon defined — It is concerned with the efficient
use of an important economic resource namely,
capital funds.
Definitions of Financial Management 05

Joshep & Massie defines, Financial management “is the
operational activity of a business that is responsible
for obtaining and effectively utilizing the funds
necessary for efficient operations.
Weston & Brigham defines the Financial management
“is an area of financial decision-making, harmonizing
individual motives and enterprise goals”.
The most popular and acceptable definition by Kuchal is
— Financial management deals with procurement of
funds and their effective utilization in the business.
Definitions of Financial Management 06

Objectives of FM broadly divided into two parts such as:
1. Profit maximization
2. Wealth maximization.
Objectives of FM
• Profit is the measuring techniques to
understand the business efficiency of
the concern. It is also called as
cashing per share maximization.
• Profit maximization is also the traditional and
narrow approach, which aims at, maximizes
the profit of the concern.
Profit
maxn:
07

Profit maximization consists of the following important
features.
 Ultimate aim of the business concern is earning
profit, hence, it considers all the possible ways to
increase the profitability of the concern.
 Profit is the parameter of measuring the efficiency
of the business concern. So it shows the entire
position of the business concern.
 Profit maximization objectives help to reduce the
risk of the business.
Profit Maximization 08

 It is vague: In this objective, profit is not defined
precisely or correctly. It creates some unnecessary
opinion regarding earning habits of the business
concern.
 It ignores the time value of money: PM does not
consider the time value of money or the net present
value of the cash inflow.
It leads certain differences between the actual cash inflow
and net present cash flow during a particular period.
 It ignores risk: PM does not consider risk of the
business concern.
Risks may be internal or external which will affect the
overall operation of the business concern.
Profit Maximization
Drawbacks of profit maximization
09

 Wealth means shareholder wealth or the wealth of the
persons those who are involved in the business.
 WM is one of the modern approaches, which involves
latest innovations and improvements in the field of the
business concern.
Wealth Maximization 10
Unfavorable arguments for wealth maximization:
 WM is nothing, it is also profit maximization, it is
the indirect name of the profit maximization.
 WM creates ownership-management controversy.
 Management alone enjoy certain benefits, and the
ultimate aim of the wealth maximization.
 WM can be activated only with the help of the
profitable position of the business concern.

Finance manager must have entire knowledge in the area
of accounting, finance, economics and management.
 His position is highly critical and analytical to solve
various problems related to finance. A person who
deals finance related activities may be called
Finance Manager.
Finance manager performs the following major functions:
 Forecasting financial requirements - is the primary
function of the Finance Manager.
He estimate, how much finances required to acquire
fixed assets and forecast the amount needed to
meet the working capital requirements in future.
Function of Financial Manager 11

 Acquiring necessary capital – he should concentrate
how the finance is mobilized and where it will be
available.
 Investment decision- he must carefully select best
investment alternatives and consider the reasonable
and stable return from the investment.
 The finance manager must concentrate to principles
of safety, liquidity and profitability while investing
capital.
 Cash management- for effective utilization of cash and
to meet the short-term liquidity position of concern.
 Interrelation with other departments - deals with
various departments such as marketing, production,
personnel, system, research, development, etc.
Function of F Manager 12

 What should be the goal of a corporation?
• Maximize profit?
• Minimize costs?
• Maximize market share?
• Maximize the current value of the company’s
stock?
• Does this mean organization should do anything
and everything to maximize owner wealth?
• Follow the governmental laws and act.
Financial Manager’s Goal 13

Goods
Services
Raw materials Natural resources
Conversion process
Human resources Capital
Production Process for Goods and Services
Cost accounting provides the detailed cost information that
management needs to control current operations and plan
for the future.
Financial management uses this information to decide how
to allocate resources to the most efﬁcient and proﬁtable
areas of the business.
Cost Accounting 14

All types of business, manufacturing, merchandising, and
service businesses require cost accounting information
systems to track their activities.
 Manufacturers convert purchased raw materials
into finished goods by using labor, technology, and
facilities.
 Merchandisers purchase finished goods for resale.
They may be retailers, who sell products to
individuals, or wholesalers, who purchase goods
from manufacturers and sell to retailers.
 For-profit service businesses, such as health clubs,
accounting firms, and basketball teams, sell
services rather than products.
Cost Accounting 15

Use of Cost Accounting
Principles of cost accounting have been
developed to enable manufacturers to process
the many different costs associated with
manufacturing and to provide built-in control
features.
The information produced by a cost accounting system
provides a basis for
 Determining product costs and pricing
• determining product costs, and
• Determining the selling prices,
 Planning and control
• helps management to plan & control operations.
16

Cost accounting procedures must be designed to
permit the determination of unit costs as well as total
product costs.
Unit cost is also useful in the decisions such as:
• Determining the selling price of a product.
• Meeting competition.
o estimate undersold,
o reducing the selling price,
o reducing manufacturing and selling
expenses, and combination
• Bidding on contracts.
o submit competitive bids in work order
• Analyzing proﬁtability.
o to determine the amount of proﬁt
o allocating the company’s scarce resources
Use of Cost Accounting
 Determining product costs and pricing
17

 Planning and Control
‘Planning’ is the process of establishing objectives or goals
for the ﬁrm and determining the means by which they
will be met.
These objectives may be expressed in terms of the
number of units to be produced, the desired quality,
the estimated unit cost, the delivery schedules, and
the desired inventory levels.
The word ‘control’ is used for monitoring the company’s
operations and determining whether the objectives
identiﬁed in the planning process are being
accomplished.
Use of Cost Accounting 18

Budget is defined as "a plan quantified in
monetary terms prepared and approved prior to
a defined period of time usually showing
planned income to be generated and/ or
expenditure to be incurred during that period
and the capital to be employed to attain a given
objective".
Budgeting is the process of identifying,
gathering, summarizing, and communicating
financial and nonfinancial information about an
organization’s future activities.
Budget and Budgeting ? 19

An analysis of the definition will bring out the following
features of a budget:
Features of Budget
 It is a plan expressed in monetary terms; but it also
contains physical units;
 It is prepared prior to the period during which it will
operate;
 It is approved by the management for
implementation;
 It is related to a definite future period;
 It indicates planned income and expenditure
including capital expenditure during the period, and
 It is prepared for the purpose of implementing the
policy formulated by the management, and the
objective to be achieved during the period.
20

Budgeting is advantageous for organizations, because:
1. Budgets foster organizational communication.
2. Budgets ensure a focus both on future events and
on resolving day-to-day issues.
3. Budgets assign resources and the responsibility to
use them wisely to managers who are held
accountable for their results.
4. Budgets can identify potential constraints before
they become problems.
5. Budgets facilitate congruence between
organizational and personal goals.
6. Budgets define organizational goals and
objectives numerically, against which actual
performance results can be evaluated.
Advantages of Budgeting 21

A more common approach is to start with last year’s
budget and revise it for actual results and expected
changes for the coming year.
Two major budgets using this approach are:
1. the static budget, and
2. the flexible budget.
Types of Budgets
A static budget shows the expected results
of a responsibility center for only one
activity level.
Once the budget has been determined, it is
not changed, even if the activity changes.
Static
Budget
22

Static budgeting is used by many service companies
and for some functions of manufacturing companies,
such as purchasing, engineering, and accounting.
Static Budget
A disadvantage of static budgets is that they do not
adjust for changes in activity levels.
23

Flexible
Budget
Flexible budgets show the expected results of a
responsibility center for several activity levels.
A flexible budget is, in effect, a series of static
budgets for different levels of activity.
Step 1. Identify the
relevant activity
levels.
Step 2. Identify the
fixed and variable cost
components.
Step 3. Prepare the
budget for each
activity level by
multiplying the
variable costs.
24

The master budget is an integrated set of operating,
investing, and financing budgets for a period of time.
 Most companies prepare the master budget on a
yearly basis.
 For a manufacturing company, the master budget
consists of the following integrated budgets:
Master Budget
25

A basic budget is based on a long term plan and is
used as a basis for developing current budgets.
It may be fixed or flexible. The basic data are not
updated whenever there are changes in conditions,
such as, increase in material price or wage rates.
Types of Budgets 26
Basic budget
Fixed Budget
Flexible Budget
Master Budget
Current budget
Current budget is established for use over a short
period of time, usually one year but sometimes less.
Already
discussed
in
previous
slides

 Keep in mind, because procedures for preparing
budgets vary from organization to organization, there is
no standard format for budget preparation.
 The only universal requirement is that budgets
communicate the appropriate information to the reader
in a clear and understandable manner.
 By keeping that in mind and using the following
guidelines, managers can improve the quality of
budgets in any type of organization:
1. Know the purpose of the budget, and clearly
identify who is responsible for carrying out the
activities in the budget.
Budget Procedure 27

2. Identify the user group and its information needs.
3. Identify sources of accurate, meaningful budget
information. Such information may be gathered
from documents or from interviews with
employees, suppliers, or managers who work in
the related areas.
4. Establish a clear format for the budget. A budget
should begin with a clearly stated heading that
includes the organization’s name, the type of
budget, and the accounting period under
consideration.
The budget’s components should be clearly
labeled, and the unit and financial data
should be listed in an orderly manner.
28

5. Use appropriate formulas and
calculations in deriving the
quantitative information.
6. Revise the budget until it includes all
planning decisions.
7. Several revisions may be required
before the final version is ready for
distribution.
29

Illustration:
Budget output - 8000 units per month
Budget fixed overheads - Tk. 40000 per month
Budget variable cost - Tk. 5 per unit
Budget total overheads - Tk. 80000 per month
Actual for June, 2016, Output - 7000 units
Solution :
Hence, allowed cost for June 2016 will be Tk. 40000
+ (7000 x 5) = Tk. 75000.
Actual expense will be compared against allowed cost
of Tk.75000.
Expressed as a formula,
Allowed cost = Fixed cost + (Actual units of output ×
Variable cost per unit).
Flexible Budget 30

The Multi-activity method involves the preparation of a
budget for all major levels of activity.
When the actual output is known at the end of the budget
period,
• the allowed costs are computed by either
adopting the budget of the given level, or
• next higher level of activity or by interpolating
between the budgets of the activity levels on
either side of the actual level of activity.
For example, if the budget amounts for the following
levels are given, at 70% – Tk. 24,000; 80% – Tk. 28,000;
90% – Tk. 30,000, and actual level of activity attained is
75%, then the allowed cost will be either (a) Tk. 28000, (b)
by interpolation method,
Tk. 24000 + (28000 - 24000) x 5/ 10 = Tk. 26000
Flexible Budget cont… 31

Illustration:
X Ltd. produces a standard product, the estimated
cost of which is given below :
Raw-materials – Rs. 10 per unit
Direct wages – Rs. 8 per unit
Direct expenses – Rs. 2 per unit
Variable overheads – Rs. 3 per unit.
Semi-variable overheads at 100% activity level
(10000 units) are expected to be Rs. 40000, and
these overheads vary in steps of Rs. 2000 for each
change of output of 1000 units. Fixed overheads are
estimated at Rs. 50000. Selling price per unit is
expected to be Rs. 40. Prepare a flexible budget at
50%, 70% and 90% levels of activity.
32

33

Note:
Semi-variable overheads are segregated into variable
and fixed parts such as:
Variable cost per unit = Rs. 2000 divided by 1000
= Rs. 2 per unit.
Fixed cost = Rs. 40000 - (10000 units @ 2/-)
= Rs. 20,000.
Hence, total variable overheads
= Rs. 3 + Rs. 2 = Rs. 5 per unit, and
total fixed overheads = Rs. 50000 + 20000 = Rs. 70000.
34

Financial Management

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