IMPORTANCE OF FINANCE
Finance is the elixir that assists in the formation of new businesses, and allows businesses to take advantage of opportunities to grow, employ local workers and in turn support other businesses and local, state and federal government through the remittance of income taxes.
MEANING OF BUSINESS FINANCE
It refers to the corpus of funds and credit employed in a business. Business finance is required for purchasing assets, goods, raw materials and for performing all other economic activities. Precisely, it is required for running all the business operations.
MEANING OF FINANCIAL MANAGEMENT
In simple terms, financial management is the business function that deals with investing the available financial resources in a way that greater business success and return-on-investment (ROI) is achieved. Financial management professionals plan, organize and control all transactions in a business.
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-
1. To ensure regular and adequate supply of funds to the concern.
2. To ensure adequate returns to the shareholders which will depend upon the earning capacity, market price of the share, expectations of the shareholders.
3. To ensure optimum funds utilization. Once the funds are procured, they should be utilized in the maximum possible way at least cost.
4. To ensure safety of investment, i.e, funds should be invested in safe ventures so that adequate rate of return can be achieved.
5. 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.
Functions of Financial Management
1. Estimation of capital requirements: A finance manager has to make estimation with regard to capital requirements of the company. This will depend upon expected costs and profits and future programmers 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 have 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 has 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.
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 are possible.
5. Disposal of surplus: The net profits decision have 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 expansion, innovational, diversification plans of the company.
6. Management of cash: Finance manager has to make decisions with regard 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 fund, 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.
OBJECTIVES OF FINANCIAL MANAGEMENT
1) PROFIT MAXIMIZATION
2) MAXIMIZATION OF WEALTH
1. Profit Maximization
A business is set up with the main aim of earning huge profits. Hence, it is the most important objective of financial management. The finance manager is responsible to achieve optimal profit in the short run and long run of the business. The manager must be focused on earning more and more profit. For this purpose, he/she should properly use various methods and tools available.
2. Wealth Maximization
Shareholders are the actual owners of the company. Hence, the company must focus on maximizing the value or wealth of shareholders. The finance manager should try to distribute maximum dividends among the shareholders to keep them happy and to improve the goodwill of the company in the financial market. The declaration of dividend and payout policy is decided with the help of financial management. A proper dividend policy related to the declaration of dividends or retaining the company's profit for future growth and development is part of dividend decisions. But this is based on the performance of the company and the amount of profit earned. Better performance means a higher value of shares in the financial market. In nutshell, the finance manager focuses on maximizing the value of shareholders.
FUNCTIONS OF FINANCIAL MARKETS
The important functions performed by Financial Markets are as follows:
1. Facilitation of Price Discovery
The price of anything depends upon two factors: its demand and supply in the market. Hence, the demand and supply of financial securities and assets help decide the price of different financial securities.
2. Mobilization of Savings and Channelizing the Savings into the most Productive Uses
As the financial markets act as a link between the savers and investors, it transfers savers’ savings to the most productive and appropriate investment opportunities.
3. Providing Liquidity to Financial Assets
Financial Markets provides the savers and investors with a platform to convert the securities into cash, as they easily sell and buy the financial securities in this market.
4. Reduction of the Cost of Transaction
Investors and companies have to collect information regarding financial securities before investing in them, which can be very time-consuming. The financial markets help these investors and companies by providing them with all information regarding financial securities including its price, availability, and cost.
Classification of Financial Market
The Financial Market is divided into two broad categories; viz., Capital Market and Money Market.
Capital Market
A marketer including all institutions, organizations, and instruments providing medium and long-term funds is known as a Capital Market. A capital market does not include institutions and instruments providing finance for a short term, i.e., up to one year. Some of the common instruments of a capital market are debentures, shares, bonds, public deposits, mutual funds, etc. An ideal capital market is one which allocates capital productively, provides sufficient information to the investors, facilitates economic growth, where finance is available to the traders at a reasonable cost, and where the market operations are fair, free, competitive, and transparent.
A capital market is of two types, namely, Primary Market and Secondary Market
• Primary Market: A market in which the securities are sold for the first time is known as a Primary Market. It means that under the primary market, new securities are issued from the company. Another name for the primary market is New Issue Market. This market contributes directly to the capital formation of a company, as the company directly goes to investors and uses the funds for investment in machines, land, building, equipment, etc.
• Secondary Market: A market in which the sale and purchase of newly issued securities and second-hand securities are made is known as a Secondary Market. In this market, a company does not directly issue its securities to the investors. Instead, the existing investors of the company sell the securities to other investors. The investor who wants to sell the securities and the one who wants to purchase meet each other in the secondary market, and exchange the securities for cash takes place with the help of an intermediary called a broker.
Money Market
A market for short-term funds that are meant to use for a period of up to one year is known as Money Market. In the general case, the money market is the source of funds or finance for working capital. The transactions held in the money market involve lending and borrowing of cash for a short term and also consist of the sale and purchase of securities with one year term or securities which get paid back (redeemed) within one year. Some of the common instruments of the money market are Call Money, Commercial Bills, T. Bills, Commercial Paper, Certificates of Deposits, etc.
Some of the features of a Money Market are as follows:
1. It is a market for the short term.
2. There is no fixed geographical location of a money market.
3. Some of the common instruments of the money market are Call Money, Commercial Bills, Certificates of Deposits, etc.
4. Some of the major institutions involved in the money market are LIC, GIG, RBI, Commercial Banks, etc.
Some of the Instruments of Money Market are as follows:
1. Call Money: The money borrowed or lent on demand for a short period of time (generally one day) is known as Call Money. The term of the call money does not include Sundays and other holidays. It is used mostly by banks. It means that when one bank faces a temporary shortage of cash, then the bank with surplus cash lends the former bank with money for one or two days. It is also known as Interbank Call Money Market.
2. Treasury Bills (T. Bills): On behalf of the Government of India, Treasury Bills are issued by the Reserve Bank of India (RBI). With the help of T. Bills, the Government of India can get short-term borrowings as they are sold to the general "public" and banks. The Treasury Bills are freely transferable and negotiable instruments and are issued at a discount. As Treasury Bills are issued by the Reserve Bank of India, they are considered the safest investments. The maturity period of the Treasury Bills varies from 14 days to 364 days.
3. Commercial Bills: Commercial Bills also known as Trade Bills or Accommodation Bills are the bills drawn by one organization on another. Commercial Bills are the common instruments of the money market which are used to credit sales and purchases. The maturity period of commercial bills is for short-term, generally of 90 days. However, one can get the commercial bills discounted with the bank before the maturity period. The Trade Bills are negotiable and easily transferable instruments.
4. Commercial Paper: An unsecured promissory note issued by private or public sector companies with a fixed maturity period, varying from 15 days to one year, is known as a Commercial Paper. It was for the first time introduced in India in 1990. As this instrument is unsecured, it can be issued by companies with creditworthiness and good reputation. The main investors of commercial papers are commercial banks and mutual funds.
5. Certificate of Deposits: A time or deposit that can be sold in the secondary market is known as a Certificate of Deposits (C.D.). It can be issued by a bank only and is a bearer certificate of Deposits (C.D.). It can be issued by a bank only and is a bearer certificate or document of title. A Certificate of Deposits is a negotiable and easily transferable instrument. The banks issue the Certificate of Deposits against the deposit kept by the institutions and companies. The time period of a Certificate of Deposits ranges from 91 days to one year. The C.D.’s can be issued to companies, corporations, and individuals during a period of tight liquidity. It is that time when the bank’s deposit growth is slow, but the credit demand is high.
Classification of Financial Markets
Introduction to Classification of Financial Markets
The term “financial market” refers to a business place where different types of financial securities take place. These financial securities include equity shares, derivatives, bonds, etc. In a capitalistic economy, financial markets play the key role of intermediaries between the collectors and investors that ensure the economy’s smooth functioning. In other words, the financial markets mobilize the flow of capital between those who have excess funds and those who require business funds. As a result, there are various types of financial market instruments. This article will provide you a brief understanding of the most common categories of products. To this topic; we will see a different way of classification of financial markets.
Classification of Financial Markets
The financial markets can be broadly classified on the basis of the following:
• Issuance of securities
• Maturity Period
• Types of financial instruments
Based on Issuance of Securities
Primary Market
In the primary market, the financial securities are directly issued to the buyers. In this type of market, the investors get the first crack at the newly issued securities. The issuing companies receive the cash proceeds from the sale and utilize it either to fund existing operations or fuel business expansion. Finally, the newly issued securities are purchased by the buyers in the form of:
• Initial Public Offering (IPO): In an IPO, the investors are issued shares of a company when it is in the process of getting listed on an exchange, which means that a private company is going public.
• Follow-on Public Offer (FPO): In an FPO, the investors are issued shares of an already publicly listed company.
• Rights Issue: In this type of share issuance, the company’s existing shareholders are offered an option to buy its new shares at a pre-decided price. The number of the newly issued share would be proportionate to the existing shareholding of the investors.
Secondary Market
In the secondary market, the financial securities that are issued in the primary market are traded over the counter or through an exchange. For instance, ABC Inc. issued new shares in the primary market through an IPO, and David purchased 100 shares of the company. Now, David decided to sell off 50 of these shares and book some profit. However, since he can’t sell these shares back to the issuer (ABC Inc.), he will have to go to the secondary market and find an investor interested in buying ABC Inc.’s shares. This is how a secondary market works.
Essentially, the secondary market provides an exit option to the existing investors of the securities. Thus, it brings together the existing investors who are willing to sell and the prospective investors who are willing to buy. In this way, the secondary market also helps in the discovery of the market price of the securities based on their demand and supply in the market
CONCLUSION
Financial management practices is a field which deals with financial decisions including short and long goals of the organization and ensures that there is a high return on the invested capital without necessarily taking excess finance risk.
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