Financial Management Practices in India

Sandeep Goel

• Publisher: Routledge India
• Year: 2016
• ISBN:
  9781317332411
• Edition: 1
• Topic: Business
• Subtopic: Corporate Finance
• Index: Business

Efficient financial management is the essence of business. This book analyses and evaluates core financial management practices of corporate enterprises in India across diverse sectors including realty, FMCG, pharmaceutical, automobile, IT, chemical and BPO sectors. It emphasizes the importance of the integrated process of capital investments, financing policy, working capital management and dividend distribution for shareholders for a developing economy as India. It further highlights the need for financial viability both in totality and segmental performance. The volume also offers a comparative study of the practices of the companies in different sectors to allow a better appreciation of the issues and challenges regarding management of finances.

Rich in case studies, this book will be an indispensable resource for scholars, teachers and students of financial management, business economics as also corporate practitioners.

Part I
Introduction

1
Nature of Financial Management

Introduction

Almost everything in life eventually boils down to the rupee sign. Money, and therefore, finance, is an integral part of life.¹ It is equally applicable to a business organisation. The success of business depends on the efficient financial management. All functions of business revolve around finance. Therefore, every business enterprise needs to be efficient in managing its finance. They need to ensure that enough funding is available at the right time and invested into the right projects.

What is financial management?

Financial management is the process of acquiring and disbursement of funds. It includes all the activities relating to planning, organising, directing and controlling the funds of the enterprise.

Elements

1. Investment decision: It implies the allocation of funds in various assets. The investment in fixed assets is called capital budgeting decision. The investment in current assets is called working capital decision.
2. Financing decision: It refers to the process of raising funds from various sources depending on factors, such as the cost of funds, control, liquidity and so forth.
3. Dividend decision: It is the decision about distributing net profit. The finance manager decides what percentage of profits would be distributed as dividend to shareholders and how much profits would be kept aside as reserves for future contingencies.

Objectives of financial management

The main objectives of financial management are as follows:

1. Profit maximisation: It is the primary objective of financial management. Every business enterprise tries to earn maximum profit, both short term and long term.
2. Wealth maximisation: Shareholders’ value maximisation is the key objective of financial management and is preferred over profit maximisation on account of market interest. Wealth maximisation is a combination of regular return to shareholders in the form of dividend and appreciating market returns.
3. Liquidity: Liquidity maintenance is one of the most important objectives of financial management. The firm must have a sound cash position for meeting day-to-day expenses; otherwise, there might be a threat to the survival of the firm.
4. Solvency: Long-term soundness is a key objective of financial management. The company must be solvent to pay interest and repay loans at regular intervals. Lack of solvency can be a big blow to the firm in this competitive scenario.

Functions of financial management

Following are the main functions of financial management:

1. Estimating financial requirements: Proper estimation of financial requirements is an important function of financial management. The finance manager must determine accurately how much finance is required for business operations, keeping in view the long-term and short-term requirements.
2. Mobilisation of funds: Funds acquisition is another important function of financial management. After estimating the financial requirements, the finance manager must decide on raising the funds from various sources of finance, such as shares, debentures, bank loans and the like. There must be a proper balance between owned funds and debt funds.
3. Proper utilisation of finance: The next task of finance manager is to utilise these funds efficiently. Long-term funds should be invested in fixed assets and short-term funds should be used for current assets. The finance manager should not invest the company’s funds in unprofitable projects.
4. Distribution of profits: The distribution of net profit has to be decided by the finance manager regarding dividend and reinvestment of earnings. The finance manager must consider the requirements of shareholders and expansion plans of the company.
5. Cash management: Finance manager must ensure enough liquidity and should plan out the cash required for various requirements of the firm, such as payment of salaries, bills, meeting current liabilities and the like.
6. Financial control: Sound financial control is the prerequisite for the growth of business. The finance manager must exercise proper control with the help of techniques, such as budgetary control, cost analysis, financial forecasting and the like.

Financial management scene in India

Traditionally, a single manager would manage the entire operations of a business. With business going global, the finance function has become a specialised function. There are finance specialists now to manage your operations.

Since liberalisation in 1991, the face of Indian corporate has changed tremendously, making finance as the essence of every business. Today every company has specialist set of people shouldering the responsibility of finance managers in their organisation, called Director-Finance, Chief Finance Officer and Financial Controller and the like.

The finance manager is not merely concerned with maintaining accounts of the business. He or she has to perform multi-tasks, including fund raising to procurement of assets to distribution of profits to ensuring safety of the financial assets of the company. He or she has to plan the operations of a business in such a manner so that there is a positive cash flow and the firm keeps on growing. He or she is expected to generate maximum profits for the company and keep shareholders satisfied.

Financial management is continuously progressing. A good finance manager must see all updates, changes in the fields of financial management. He or she should be interested to know what new sources of funds are developed at international level. What new projects are in current period? What amendments are done by government in tax laws? A good finance manager must be aware of what is happening around.

Following are the main changes which have tuned the field of financial management in India during past few decades:

• Interest rates. Interest rates are controlled by the Reserve Bank of India (RBI) and other commercial banks’ rates are affected from RBI’s action. To ascertain cost of debt, one should know this.
• Value of shares. Value of shares now can be determined at premium or discount freely. One should determine its shares value at optimum level because it directly affects the earnings per share (EPS).
• Mergers and acquisitions. As good finance manager, one should keep one’s eye on who is taking over which company. To merge with other company may be sometime profitable than going alone.

In conclusion, financial management has changed with the changing times and has become very scientific with the latest principles and practices of management around.

Financial management problems

Some of the problems relating to the financial management faced by corporate enterprises are discussed below:

1. Due to poor planning, the enterprises do not maintain a desirable combination of sources of funds. This leads to shortage of equity and then they depend too much on borrowed capital. Hence, sound financial planning is required for an optimal financial structure.
2. Inadequate combination of assets results in the problem of either underinvestment or overinvestment in total assets. This is more pertinent to current assets, such as inventories and receivables. For a manufacturing undertaking, these problems need an immediate check by adopting appropriate inventory controlling techniques and sound credit and collection policies.
3. Inaccurate projection of revenues and costs results in improper investment in inventories, receivables and plant capacity. These factors ultimately result in poor earnings of the enterprises. So, there should be an efficient and effective profit planning for better utilisation of resources and enhanced earnings.
4. The enterprises lack a definite and stable dividend policy. There should be an adequate balance between payment of dividends and retention of earnings. Dividend payments should be more regular and consistent in proportion to the paid-up capital.
5. The enterprises should be managed by only professionally competent, qualified and experienced personnel for better result orientation.

Discussion questions

1. Define financial management. Explain its elements.
2. What are the objectives of financial management?
3. ‘Shareholders’ wealth maximisation is the key objective of financial management’. Justify.
4. Discuss the function of financial management.
5. ‘The financial management scenario in India has undergone a sea change of late’. Elaborate.
6. What are the various financial management problems faced by the corporate enterprise? Discuss with solutions.

Note

1 Douglas R. Emery, John D. Finnerty, and John D. Stowe, Principles of Financial Management, Upper Saddle River, NJ: Prentice Hall, 1998, p. 2.

Part II
Investment Decision

Capital budgeting

2
Capital Budgeting

Nature and scope

Introduction

Capital budgeting decision is the decision of investment in long-term assets. The major criterion for selection of a capital investment project is its financial viability in terms of expected cash inflows over initial cash outflows. They should meet a target benchmark. Capital budgeting techniques are applied in order to determine which projects will yield the maximum return over a given period of time.

The various types of capital investment decisions are:

• replacement of an asset;
• expansion of the production capacity;
• diversification of business;
• modernisation of existing facilities; and
• research and development (R&D) activities.

Capital budgeting process

The capital budgeting process includes the following steps:

1. Identifying investment needs: The first step is to identify the need or opportunity for a capital investment. This involve...