Understand Financial Management in detail for BCA, MCA, BBA, MBA
Finance Functions
These are the different tasks or activities that financial managers perform to manage the money of a business. They include decisions about investing, financing, dividend distribution, and managing liquidity.
1. Investment Decision:
This is the process of deciding where to invest the money of a business. For example, a company might decide to invest in new equipment or expand its operations to earn more profits in the future.
2. Financing Decision:
This is the decision about how to finance or pay for the investments. It involves choosing between using the company's own money (equity) or borrowing money (debt) from others.
3. Dividend Decision:
This is the decision about how much of the company's profits to distribute to shareholders as dividends. It involves balancing the interests of shareholders who want higher dividends and the need to reinvest profits back into the business for growth.
4. Liquidity Decision:
This refers to the decision about how to manage the company's short-term cash needs and obligations. It involves maintaining enough cash or liquid assets to meet immediate financial obligations, such as paying employees or suppliers.
These concepts are important because they help businesses make sound financial decisions to ensure long-term success and profitability.
Interface between Finances and Other Functions
This means how money matters connect with different parts of your business. For example, if you want to buy more lemons for your stand, you need to check if you have enough money. Finances also link with things like how much you sell and how much profit you make.
1. Marketing Finance Interface:
Marketing is how you tell people about your lemonade. The money you spend on marketing should bring in more money from selling lemonade. For instance, if you spend money on a signboard advertising your stand, you hope more people will see it and buy your lemonade, making your money back and more.
2. Production Finance Interface:
This is about how you make your lemonade. To make more lemonade, you need more lemons, sugar, and water. So, you need to buy these things with your money. But you also need to make sure you're not spending more than you're making from selling the lemonade.
3. Top Management Finance Interface:
This involves the big decisions about money. As the owner of the lemonade stand, you need to decide how much to save, how much to spend on ingredients, and how much to charge for your lemonade. You also need to think about expanding your business, like opening another stand, and how much that will cost.
Understanding how finances work with different parts of your business is crucial for running a successful lemonade stand, or any business for that matter!
Financial Goals
Financial goals are the things you want to achieve with your money. Here are three common financial goals explained in simple terms:
1. Product Maximization:
This means trying to make the most money possible from selling a product. For example, if you have a lemonade stand, your goal might be to sell as many cups of lemonade as you can to make the most profit.
2. Wealth Maximization:
This is about growing your overall wealth or money over time. It's like planting a money tree that keeps growing. For instance, if you save a portion of your allowance each week and put it in a piggy bank, over time, you'll have more money saved up.
3. Other Objectives:
These are additional goals you might have with your money. For example, you might want to save money to buy a new bike or to help your parents with household expenses.
These goals help you plan how to use your money wisely and achieve the things you want in the future.
Corporate Finance
Definition: Corporate finance deals with how companies raise and manage money, as well as how they make investment decisions.
Example: Imagine you and your friends want to start a lemonade stand. You need to decide how much money each of you will put in (capital structure), how much of the profit you'll keep versus giving back to investors (dividend policy), and how you'll use any extra money to grow the business (financial planning for growth).
1. Capital Structure:
Definition: Capital structure refers to the way a company finances its operations and growth by using different sources of funds, such as debt and equity.
Layman Example: Imagine you want to start a small business selling homemade snacks. You can use your own savings (equity) or borrow money from a bank (debt) to buy ingredients and equipment. Your decision on how much to borrow and how much of your own money to use determines your capital structure.
Details:
- Companies aim for an optimal capital structure that minimizes the cost of capital and maximizes shareholder wealth.
- The capital structure includes equity (money invested by owners/shareholders) and debt (borrowed money).
- Too much debt can be risky because you have to pay it back with interest, while too much equity means giving away ownership of your business.
2. Dividend Policy:
Definition: Dividend policy refers to how a company decides to distribute profits to its shareholders.
Layman Example: Imagine you and your friends start a small company selling handmade crafts. At the end of the year, after paying for materials and other expenses, you have some profit left. You can decide to either distribute this profit among yourselves as dividends or reinvest it in the business to buy more materials and grow the company.
Types of Dividend Policies: There are different dividend policies:
- Regular dividend: Paying a fixed amount of dividends regularly.
- Special dividend: Paying extra dividends during good years.
- No dividend: Reinvesting all profits back into the business.
Details:
- Dividends are typically paid in cash, but they can also be paid in the form of additional shares.
- Companies need to balance dividend payments with retaining earnings for future growth opportunities.
- Dividend policies can vary; some companies pay dividends regularly, while others may pay them occasionally or not at all.
3. Financial Planning for Growth and Expansion:
Definition: Financial planning for growth and expansion involves making financial decisions to support the company's growth objectives.
Layman Example: Let's say your snack business is doing well, and you want to expand by opening a second store. You would need to plan how much money you need to set up the new store, how to finance it (using your own money or borrowing), and how much profit you expect to make from the new store.
Details:
- Financial planning for growth includes budgeting for new projects, measuring financial risks, and ensuring the company has enough capital to fund expansion.
- It involves forecasting future financial needs based on expected growth rates and market conditions.
- Financial planning also includes evaluating investment opportunities to ensure they align with the company's growth strategy and financial goals.
These concepts are crucial for businesses to manage their finances effectively and achieve long-term success.
Financial Markets and Instruments
Financial Markets:
Financial markets are where buyers and sellers meet to trade financial assets, like stocks, bonds, and derivatives. There are two main types of financial markets: the money market and the capital market.
1. Money Market:
- The money market deals with short-term debt securities, which are financial instruments that mature in less than one year.
- Example: Imagine you lend ₹100 to a friend, and they promise to pay you back ₹110 in three months. This transaction is like a money market deal.
2. Capital Market:
- The capital market deals with long-term securities, like stocks and bonds, which mature in more than one year.
- Example: Buying shares of a company's stock is a capital market transaction. You become a part-owner of the company and can make money if the company does well.
Financial Instruments:
Financial instruments are tradable assets that represent a legal agreement or a right to future payment of money. Some common financial instruments include stocks, bonds, and derivatives.
1. Stocks (Equities):
- Stocks represent ownership in a company. When you buy a stock, you become a shareholder and own a part of the company.
- Example: If you buy 10 shares of a company's stock at ₹50 per share, you own a small part of that company.
2. Bonds:
- Bonds are debt securities issued by companies or governments to raise money. When you buy a bond, you are lending money to the issuer in exchange for periodic interest payments and the return of the bond's face value when it matures.
- Example: Buying a bond issued by the government is like lending money to the government. In return, the government pays you interest every six months and returns the bond's face value when it matures.
3. Derivatives:
- Derivatives are financial contracts whose value is derived from the value of an underlying asset, index, or rate.
- Example: Futures and options are types of derivatives. For instance, a futures contract on gold allows you to buy or sell a certain amount of gold at a specified price on a future date.
