Finance is the art and science of
managing money. Finance includes the following:
is traditionally classified as:
· Private Finance
Public Finance: It deals with the
requirements, receipts and disbursements of funds in government institutions
like state, local self-government and central government.
Private Finance: It is concerned with
requirements, receipts and disbursements of funds in case of an individual, a
profit seeking business organization and a non-profit organization. Thus it
is classified into three types:
· Business Finance
· Personal Finance
· Finance of non-profit organisations.
1. Business Finance: The study of principles, practices, procedures, and problems concerning
financial management of profit making organisations engaged in the field of
industry, trade and commerce is undertaken under the discipline of business
2. Personal Finance: It deals with the analysis of principles and practices involved in
managing one’s own daily need of funds.
3. Finance of non-profit organisations: This is concerned with the practices, procedures and
problems involved in financial management of charitable, religious,
educational, social and other similar organisations.
Business finance can be classified into three categories, which are:
Sole-Proprietary Finance: In
this form of organisation, a single individual promotes, finances controls and
manages the business enterprise. He also bears the whole risk of the business.
Partnership Firm Finance:
A partnership is an association of two or more persons to carry on as co-owners of a business and to share its
profits and losses. The liability of the partners is unlimited and they
collectively share the risks of the business.
Corporation or Company Finance: It
is an association of many persons who contribute money or money’s worth to a
common stock and employ it in some trade or business who share profit and loss
Therefore the principles
of business finance can be applied to both small (proprietary) and large
(corporation) forms of business enterprises.
There are three main approaches to
first approach views finance as to providing of funds needed by a business on
most suitable terms. This approach confines finance to the raising of funds and
to the study of financial institutions and instruments from where funds can be
second approach relates finance to cash.
third approach views finance as being concerned with raising of funds and their
FUNCTIONS OF FINANCE
Finance function is the most important of all business
functions. It remains a focus of all activities. It is not possible to
substitute this function because the business will close down in the absence of
finance. The need for money is simultaneous starting with setting up of an
enterprise and remains at all times. The development and expansion of business
needs more commitment for funds. The funds will be raised from various sources
depending on the relation to the implications attached with them.
The management should have an idea of using the money
profitably. It may be easy to raise funds but it may be difficult to repay
The inflows and outflows of funds should be properly
APRROACHES TO FINANCE FUNCTION
There are two approaches to the finance function:
1. The Traditional Approach: According to
this approach the scope of finance function was confined to only procurement of
funds needed by a business on most suitable terms. The utilisation of funds was
considered beyond the purview of finance function. It felt that the decisions
regarding the application of funds are taken somewhere else the organisation.
The scope of the finance function revolves around the study of rapidly growing
capital market institutions, instruments and practices involved in raising of external
2. The Modern Approach: The modern
approach vies finance function in a broader sense. It includes both raising of
funds as well as their effective utilisation under the purview of finance. The finance
function does not stop only by finding the sources of raising enough funds;
their proper utilisation is also to be considered. The cost of raising funds
and returns from their use should be compared. The utilisation of funds require
decision making. Finance has to be considered as an integral part of overall
AIMS OF FINANCE FUNCTION
1. Acquiring sufficient funds: The main
aim of the finance function is to assess the financial needs of an enterprise
and then finding out suitable sources for raising them. If funds are needed for
longer periods then long-term sources like share capital, debentures, term
loans may be used.
2. Proper utilisation of funds: Though
raising funds is important but their effective utilisation is more important.
The funds should be used in such a way that maximum benefit is derived by them.
Should be ensured that the funds do not remain idle at
any point of time. The funds committed to various operations should be
The planning and control of the finance function aims at increasing
profitability of the concern. To
increase profitability, sufficient funds will have to be invested.
A proper control should be exercised so that scarce
resources are not frittered away on uneconomical operations.
The cost of acquiring funds also influences
profitability of the business. If the cost of raising funds is more, the
profitability will go down.
It also requires matching of cost and returns from
4. Maximising Firm’s
value: Finance function also aims at maximising the value of the firm. The
firm’s value is linked to its profitability.
Besides profits, the type of sources used for raising funds,
the cost of funds, the condition of money market, the demand for products are
some other considerations which also influence the firm’s value.
SCOPE OF THE FINANCE
The main objective of finance
function is to arrange sufficient finances for meeting short term and long term
needs. These funds are procured at minimum costs so that profitability of the
business is maximised. A financial manager will have to concentrate on the
following areas of the function.
1. Estimating Financial Requirements: The
first task of a financial manager is to estimate short-term and long term
financial requirements of the business. For this purpose, it is necessary to
prepare a financial plan for the present as well as the future. The amount
required for purchasing fixed assets as well as for working capital will have
to be ascertained. The inadadequacy of funds will adversely affect the day-to-day
working of the concern whereas excess funds may tempt a management to indulge
in extravagant spending or speculative activities.
2. Deciding capital structure: The capital
structure refers to the kind and proportion of different securities for raising
funds. After deciding about the quantum of funds required it should be decided
which type of securities should be raised. Long term funds should be employed
to finance working capital if not wholly then partially. A decision about
various sources of funds should be linked to the cost of raising funds. If cost
of raising funds is very high then such sources may not be useful. A decision
about the kind of securities to be employed and the proportion in which these
should be used is an important decision which influences the short-term and
long-term financial planning of an enterprise.
3. Selecting a source of finance: After
preparing a capital structure, an appropriate source of finance is selected
from which finance may be raised. These include: share capital, debentures,
financial institutions, commercial banks, public deposits etc. If finances are
needed for short periods then banks, public deposits and financial institutions
may be appropriate; on the other hand if the finances are required for a longer
period then share capital and debentures may be useful. The need,purpose,object
and cost involved are the factors influencing the selection of a suitable
source of financing.
4. Selecting a pattern of investment: When
funds have been procured then a decision about investment pattern is to be
taken. The selection of an investment pattern is related to the use of funds. The
funds will have to be spent on fixed assets first and then an appropriate
portion will be retained for working capital. The decision making techniques
such as capital budgeting, opportunity cost analysis may be applied in making
decisions about capital expenditures. While spending on various assets, the
principles of safety, profitability and liquidity should not be ignored.
5. Proper cash management: Cash management
is also an important task for a finance manager. He has to assess various cash
needs at different times and then make arrangements for arranging cash. Cash may be required to (a)purchase raw materials (b) make payments
to creditors (c) meet wage bills (d) meet day-to-day expenses. The sources of
cash may be (a) cash sales (b) collection of debts (c) short-term arrangements
with banks. Any shortage of cash will damage the creditworthiness of the
enterprise. A proper idea on sources of cash inflow may also enable to assess
the utility of various sources.
6. Implementing financial controls: An
effective system of financial management necessitates the use of various
control devices. Financial control devices generally used are : (a) return on investment (b) budgetary
control (c) Break even analysis (d) cost
control (e) Ratio analysis (f) cost and internal audit. Return on
investment is the best control device to evaluate the performance of various
financial policies. The use of various control techniques by the finance
manager will help him in evaluating the performance in various areas and take
corrective measures whenever needed.
7. Proper use of surpluses: The utilisation
of profits or surpluses is also an important factor in financial management. A
judicious use of surpluses is essential for expansion and diversification plans
and also in protecting the interests of shareholders. The ploughing back of
profits is the best policy of further financing but it clashes with the
interests of shareholders. The market value of shares will also be influenced
by the declaration of dividend and expected profitability in future. The
factors that influence the expansion of finance are as follows: (a) trend of earning of the enterprise (b)
expected earning in future (c) market value of shares (d) need for funds. A
judicious policy for distributing surpluses will be essential for maintaining
proper growth of the unit.
SOURCES OF FINANCE
1. Bank Loans and Advances:
The term ‘loan’
refers to the amount borrowed by one person from another. The amount is in the
nature of loan and refers to the sum paid to the borrower. Thus. from the view
point of borrower, it is ‘borrowing’ and from the view point of bank, it is
‘lending’. Loan may be regarded as ‘credit’ granted where the money is
disbursed and its recovery is made on a later date. It is a debt for the
borrower. While granting loans, credit is given for a definite purpose and for
a predetermined period. Interest is charged on the loan at agreed rate and
intervals of payment. ‘Advance’ on the other hand, is a ‘credit facility’
granted by the bank. Banks grant advances largely for short-term purposes, such
as purchase of goods traded in and meeting other short-term trading
liabilities. There is a sense of debt in loan, whereas an advance is a facility
being availed of by the borrower.
2. Retained earnings: This refers to accumulation of profits by a
company to finance its developmental activities or repay debt. It increases the
goodwill of the business and future contingencies can be easily met. It is less
costly as it does not involve any flotation cost. It is highly useful for
expansion and development activities. At the same time it might be misused by
the management to cover their inefficiency in managing the affairs of the
3. Venture capital: Venture capital is money invested in
businesses that are small; or exist only on paper as a concept, but have the
potential to grow and become immense. The people who invest this money are
called venture capitalists or, simply, VCs. The businesses VCs choose to invest
in are; typically, privately owned, their shares are not listed on the stock
exchange and also carry restrictions regarding their transfers. The venture
capital investment is made when a VC buys shares of such a company and becomes
a financial partner in the business.
4. Issue of shares: The share capital forms part of the
proprietary or ownership funds and it is used for financing the long term
requirements, the fixed capital and the fixed part of the regular working capital. It need not be
repaid during the lifetime of the company.
There are two types of shares:
· Preference shares: Preference shares are those which carry
preferential rights in the receipt of dividend. It has also got a preferential
right for the repayment of capital, when the company winds up. The rate of
dividend is fixed.
· Equity shares:
Equity shares are those which are not preference shares. The dividend on
these shares is paid after the dividend on preference shares is paid. The
holders of these shares are entitled to dividend at such rate recommended by
5. Debentures: A company raises
funds by issuing and selling document called debentures. A debenture is an
acknowledgement of a debt by the company. Debentures carry a particular rate of
interest. If a person purchases debentures he is called debenture holder. He
gets interest for the company for the loan given.
TYPES OF DEBENTURES
· Registered debentures
· Bearer debentures
· Secured debentures
· Unsecured debentures
· Redeemable debentures
· Irredeemable debentures
· Equitable debentures
· Legal debentures
· Preferred debentures
· Second debentures
· Convertible debentures
· Non- convertible debentures
6. Bonds: Bonds refers to the financial debt instruments issued
by the government, companies, and other business entities to raise funds in
order to finance their operations. The instruments promises to pay the interest
at regular intervals and principal after the maturity date to the holder of a
bond. The bonds are usually issued for long term for a minimum of five years to
a maximum of 20 years.
TYPES OF BONDS
· Government bonds
· Corporate bonds
· Tax savings bonds
· Fixed rate bonds
· Floating rate bonds
7. Public deposits: When companies accept deposits from the
public, it is called public deposits. Members of the public, deposit their
money for periods varying from six months to three years. They receive interest
from the company for the deposits made by them. This system is popular in the
textile industries in Bombay, Ahmadabad, and Coimbatore etc. Usually a
depositor can withdraw money whenever he needs it. People usually prefer to
deposit their money with the mill owners who enjoy their confidence instead of
depositing it with banks.
8. Loans from commercial banks: The banks lend funds by means of
loans, overdrafts, cash credits, discounting of bills.
· Loans: It is a financial accommodation under which bank grants
an advance on a separate account called loan account.
· Overdraft: It
is a financial accommodation under which a current account holder is permitted
to overdraw his account up to an agreed limit. Interest is charged on the exact
amount of overdrawn by the customer.
· Cash credit: It
is a financial accommodation under which an advance is granted on a separate
account called a cash credit account up to a specified limit.
· Discounting of bills: It is a financial accommodation under which a customer holding a bill
of exchange can get a loan equivalent to the value of the bill less discount.
9. Loans from financial institutions: A large number of financial institutions have been set
up by the country after independence to meet the specific term financial needs
of industrial enterprises.
Industrial finance corporation of India(IFCI)
· State financial corporation of India (SFC)
· Industrial development bank of India (IDBI)
· EXIM bank
10. Mutual Funds: A
mutual fund is an association of trust of public members who wish to make
investments in corporate securities for their mutual benefit. The fund collects
the savings of these members and invests the same in a diversified portfolio of
A number of banking
companies and some financial institutions have by forming separate subsidiaries
started mutual funds. Such a mutual fund company