Finance Function – Managerial & Routine Finance Functions

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Finance Function - Managerial & Routine Finance Functions

Finance Function – Managerial & Routine Finance Functions

Finance functions

Finance functions are carried on to achieve the objectives of the firm. Finance functions are mainly viewed from two approaches: ‘rasing of funds’ and ‘raising and allocation of funds’. The first approach confines the finance functions to the procurement of funds only and ignores the use of the funds. It was the major finance function at the early stage of the development of finance. The second approach is a comprehensive and universally accepted approach. We follow the second approach to this topic. Alternatively, finance functions may be viewed on the basis of the level of managerial attention required to get them performed. On this basis, finance functions may be classified as managerial finance functions and routine finance functions. 

Managerial finance functions

Managerial finance functions, also known as executive functions, require managerial skills in their planning, execution, and control. Therefore, they are carried out at the managerial level. The managerial finance functions are described as follows: 

Investment Decision

The investment decision, also known as capital budgeting decision, is the managerial decision regarding investment in long-term investment proposals. It includes the decisions concerned with the acquisition, modification, and replacement of long-term assets like plant, machinery, equipment, land, and buildings. Long-term assets require a huge amount of capital outlay at the beginning but the benefits are derived over several periods in the future. Because the future benefits are not known with certainty, long-term investment proposals involve risks. The financial manager should at first estimate the expected risk and return of the long-term investment and then should evaluate the investment proposals in terms of both expected return and risk. The financial manager accepts the log-term investment proposal only if the investment maximizes the shareholder’s wealth. Shareholder wealth is maximized only if the present value of benefits from the investment proposal exceeds the present value of cost. 

Financing Decision

Financing Decision, also known as capital structure decision, is concerned with determining the sources of funds and deciding upon the proportionate mix of funds from different sources. It calls for raising funds from different sources maintaining an appropriate mix of capital. 
Under the financing decisions, the financial manager should assess what amount of capital is needed and which sources could be relied upon. The funds can be collected from various short-term and long-term sources. However, the financing decision is generally concerned with determining the proportionate mix of long-term sources of financing. The sources of long-term funds include equity capital and debt capital. The use of debt in the capital structure is beneficial because the interest expense on debt capital is tax-deductible and the effective cost of debt capital is lower than other sources. However, the use of excess debt reduces the bankruptcy protection of the firm and increases the level of financial risk perceived by shareholders. If so, the use of debt capital increases the overall cost of capital instead of reducing it. 
A particular combination of debt and equity capital may be more beneficial to the firm than any others. Therefore, the financial manager should decide on an optimal structure of debt and equity capital. In doing so, a proper balance between risk and return has to be maintained that reduces the cost of capital and maximizes shareholder’s wealth or the market price of shares of the corporation. 

Dividend decision

Dividend Decision is concerned with deciding the portion of earning to be allocated to common shareholders. The net income after paying the preference dividend belongs to common shareholders. Dividends could be paid in the form of cash or in the form of a share of stock. However, there is no legal obligation to pay dividends to the common stockholders. The financial manager has three alternatives regarding dividend decision: 
  • Pay all earnings as dividends.
  • Retain all earnings for reinvestment.
  • Pay certain percentage of earnings and retain the rest for reinvestment.
The financial manager must choose among the above alternatives. The choice should be optimum in the sense that it should maximize the shareholder’s wealth. While making dividend decisions, the financial manager should consider the preference of shareholders as well as the investment opportunities available to the firm. Dividend decisions must be analyzed in relation to the financing decision because the amount of dividend paid reduces the amount available from the internal sources. 
The financial manager should consider the existing practice of the company, attitude of the shareholders, legal requirements, etc. while deciding the dividend payout ratio (dividend paid/income available to common shareholders). Further, s/he should decide whether the dividend should be paid in cash or in stock or in cash and stock both. 

Working Capital Decision

Working Capital Decision refers to the current asset’s investment and financing decision. Investment in current assets affects a firm’s profitability and liquidity. More investment in current assets enhances liquidity. Liquidity refers to the capacity to meet the short-term obligation of the firm. At the same time, more investment in current assets negatively affects profitability because idle current assets earn nothing. Even if they earn, they earn much less than their cost of capital. Similarly less investment in current assets negatively affects the firm’s liquidity and the firm may lose its profitable opportunities. So, a financial manager should achieve a proper trade-off between liquidity and profitability. This requires maintaining optimal investment in current assets. 
Once the level of current assets investment is decided, the financial manager should consider the financing pattern of current assets. The financial manager could use both long-and short-term funds to satisfy the financing need of current assets. However, it also requires addressing liquidity versus profitability tradeoff. The cost of short-term funds to some extent enhances the profitability of the firm because short-term fund costs less than long-term funds. But excess use of short-term funds may lead the firm into technical insolvency because it reduces the liquidity. Therefore, a proper trade-off between the use of short-term and long-term funds is required. 

Routine finance functions

Routine finance functions generally do not require managerial involvement to carry out them. These functions are performed for the effective execution of managerial finance functions and are carried out by the people at lower levels. A few examples of routine functions are: 
  • Supervision of cash receipts and cash payment.
  • Custody and safeguarding cash balances and valuable papers (such as securities, insurance policies, certificates of property, contract paper, etc)
  • Taking care of mechanical details regarding all-new outside financing employed by the firm,
  • Maintaining records of the firm’s activities which have financial implications; and
  • Timely reporting to facilitate financial decisions.
The financial manager’s involvement in these functions is only limited to the extent of setting up rules and procedures, establishing standards for the employment of personnel, and evaluating the performance to ensure that rules are properly followed.


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