A business is an activity which is carried on with the intention of earning the profits. If the operations of a typical manufacturing organization are considered, it involves the purchasing of raw material, processing the same with the help of various factors of production like labour and machinery, manufacturing the final product and selling the finished product in the market to earn the profits.
Thus production, marketing and 100 business financing are the key operational areas in case of any business organization, out of which finance is the most crucial one. This is so as the functions of production and marketing are related with the function of finance. If the decisions relating to money and funds fail, it may result into the failure of the business organization as a whole. Hence, it is utmost important to take the proper financial decisions and that too at a proper point of time. In practical situations, in order to overcome temporary financial problems, the organizations tend to take the hasty decisions which may prove to be fatal over a longer span of time.
According to the modern approach, the function of finance is concerned with the following three types of decisions -
a) Financing decisions
b) Investment decisions
c) Dividend policy decisions
100 business financing decisions are the decisions regarding the process of raising the funds. This function of finance is concerned with providing the answers to the various questions like,
a) What should the amount of funds to be raised In simple words, the amount of funds to be raised by the organization should not be more or less than what is required as both the situations involve the adverse consequences.
b) What are the various sources available to the organization for raising the required amount of funds For the purpose of raising the funds, the organization can go for internal sources as well as external sources.
c) What should be the proportion in which the internal and external sources should be used by the organization
d) If the organization, particularly the corporate form of organization, wants to raise the funds from different sources, it is required to comply with various legal and procedural formalities.
e) During the last decade of twentieth century, lots of changes have taken place in the capital market, which refers to the market available to the companies to raise the long term requirement of funds. The question arises what is the nature of capital market operations What kinds of changes have taken place recently affecting the capital market in the country
Investment decisions are the decisions regarding the application of funds raised by the organization. The investment decisions relate to the selection of the assets in which the funds should be invested.
a) Fixed assets: Fixed assets indicate the infrastructural facilities and properties required by the organization. Fixed assets are the assets which bring the returns to the organization over a longer span of time. The investment decisions in these types of assets are technically referred to as Capital Budgeting Decisions. Capital Budgeting decisions are concerned with the answers to the questions like,
1. How the fixed assets or proposals or projects should be selected to make the investment in What are the various methods available to evaluate the investment proposals in the fixed assets
2. How the decisions regarding the investment in fixed assets or proposals or projects should be made in the situations of risk and uncertainty
b) Current assets:
Current assets are the assets which get generated during the course of operations and are capable of getting converted in the form of cash or getting utilized within a short span of time of one year. Current assets keep on hanging the form and shape very frequently. The investment decisions in these types of assets are technically referred to as working capital management. Working capital management decisions are concerned with the answers to the questions like
1. What is the meaning of Working Capital Management What are the objectives of working capital management
2. Why the need for working capital management
3. What are the factors affecting the requirement of working capital
4. How to quantify the requirement of working capital
5. What are the sources available for financing the requirement of working capital
6. Working capital management is concerned with the management of current assets on overall basis as well as individual basis. In practical situations, current assets may be found in the form of cash and bank balances and inventory. Working capital management is concerned with the management of these particular components of current assets as well.
Profits earned by the organizations belong to the owner of the organization. In case of the corporate form of organization, shareholders are the owners and they are entitled to receive the profits in the form of dividend. However, there is no specific law or statute which specifies as to how much amount of profits should be distributed by way dividend and how much amount of profits should be distributed by way of dividend and how much amount of profits should be retained in the business. The alternatives available to the organization i.e. to distribute the profits in the form of dividend on one hand and retention of profit in the business have reciprocal relationship with each other. If the dividends paid are higher, retained profits are less and vise versa. I f the organization pays higher dividend, shareholders are very happy as the get more recurring income and the company may be able to gain the confidence of the shareholders. However, the organization can be in the financial problems as payment of dividend results in to withdrawal of profits from the business. On the other hand, if the organization pays less dividends, the organization may be in the favorable situation. However, the shareholders are likely to be offended. As such, the organization is required to take the decisions regarding the payment of dividend in such a way that neither the shareholders are offended nor the organization is in financial problems. As such, dividend policy decisions are the strategic financial decisions and are concerned with the answers to the questions like-
a. What are the forms in which the dividends can be paid to the shareholders
b. What are the legal and procedural formalities to be completed while paying the dividend in different forms
As a basic principle any business activity aims at earning the profits. According to this principle, all the functions of the business will have the profit as the main objective. Similarly, the finance function will also have the profit as the main objective. But this was only a traditional belief. Now, profit cannot be the sole and only goal or objective of the finance function, due to the following problems connected with this objective.
a. The term profit is an ambiguous concept which isnt having precise connotation. E.g. Profits can be long term and short term. Profits can be before task or after task and so on. Which type of profits should be maximized if profit maximization is accepted as the goal of finance function, is the other question that arises.
b. The profit always goes hand in hand with risks. The more profitable ventures necessarily include more amount of risk. The owners of the business will not like to earn more and more profits by accepting more risk. If the profit maximization is accepted as the goal of finance function, it totally ignores the risks factor.
c. Profit maximization as the goal of financial function ignores the time pattern of returns.
d. Profit maximization as the objective doesnt take into consideration the social considerations as well as the obligations to various interests of workers, consumers, society and the ethical trade practices. If these factors are ignored, the organization cant survive for long. Profit maximization at the cost of social and moral obligations is a short-sighted policy.
As such, profit maximization cant be a prime objective of the finance function. The objective has to be one having broad a base, which is more precise, which considers risk factor and time value of money and which consideration to social and ethical elements also. The alternative is in the form of wealth maximization as the objective of the finance function.
Due to the limitations attached with the profit maximization as an objective of the 100 business financing function, it is no more accepted s the basic objective. As against it, it is now accepted that the objective of the business should be to maximize its wealth and value of shares of the company. The object can also be stated as maximization of the value.
The value of an asset is judged not in terms of its cost but in terms of the benefit it produces. Similarly the value of a course of action is judged in terms of benefits it produces less the cost of undertaking it. The benefits can be measured in terms of stream of future expected cash flows, but they must take into consideration not only their magnitude but also the extent of uncertainty.
Thus, wealth maximization goal as decision criteria suggests that any financial action which creates wealth or which has discounted stream of future benefits exceeding its cost, is desirable and should be accepted and that which does not satisfy this test should be rejected.
The goal of wealth maximization is supposed to be superior to the goal of profit maximization due to the following reasons:
a) It uses the concept of future expected cash flows rather than the ambiguous term of profits. As such measurement of benefits in terms of cash flows avoids ambiguity.
b) It considers time value of money. It recognizes that the cash flows generated earlier are more valuable than those generated earlier. That is why while computing value of total benefits; the cash flows are discounted at a certain discounting rate. At the same time, it recognizes the concept of risk also, by making necessary adjustments in discounting rate. As such, cash flows of a project involving higher risk are discounted at a higher discounting rate and vise versa.
Thus, the discounting rate used to discount future cash flows reflects the concepts of both time and risk.
Due to the above reasons, the wealth maximization is considered to be superior to profit maximization as an objective or goal of finance function. However, it should be noted that wealth maximization goal is only an extension of profit maximization goal. Both wealth maximization and profit maximization will mean the same thing if the time period is too short and risk element is minimum.
Getting Finance in relation with other functions in a business organization
Other than getting finance, every business generally operates in three main functional areas, such as Production, Marketing and Personnel. All these functions are closely related to finance function due to the simplest reason that for executing these functions, funds are required which is the area covered by finance function.
E.g. To produce good quality of finished goods, the business needs good infrastructural facilities like building, machineries etc, a regular flow of production facilities like quality, raw material, work in progress, consumable stores, quality control equipments, good maintenance facilities, etc. All these activities need the investment to be made either in terms of fixed capital and / or working capital which is the area of finance. To market the finished goods properly in market, the business has to have proper investment in the finished goods to guarantee regular flow of goods in the market; it may be required to have good distribution systems which may call for investment in terms of fixed assets or labour force. All these activities need the investments to be made either in terms of fixed capital and / or working capital which is the area of finance function. The personnel department deals with the availability of proper kinds of laborers at proper time, their proper training and their job responsibilities. All these activities need funds e.g. to pay salaries, wages and other facilities to workers, funds are needed, to provide training facilities to workers, it may be necessary to invest in some fixed assets like building or equipment etc.
To conclude, it may be stated that all the functions or activities of a business are ultimately related to 100 business financing. The success of a business depends on how best all these functions can be coordinated.
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