An individual, business firm, and government do have goals to realize. They implement a number of programs, such as manufacturing trading or services, to attain their goods. Implementing programs requires resources such as natural resources (raw materials), human resources (skilled manpower), and financial resources (funds). Effective management of financial resources is the key to the optimum use of natural and human resources. In the case of an individual, the management of financial resources is called by personal finance. The same is called public finance in government organizations.
Financial management is used to refer to the management of funds in the context of a business firm. Thus, broadly, finance as a discipline is categorized into three domains: public finance, financial management, and personal finance. Public finance is the management of funds (revenue and expenditure) for governments: both local government units and central government. Personal finance refers to the management of funds of an individual. In this topic, we deal with various aspects of financial management and exclude public finance and personal finance from its scope.
Nowadays, financial management, business finance, corporate finance, and managerial finance are used as synonyms for each other. But we use financial management throughout this topic. At the early stage of the development of finance as a separate discipline, academics and practitioners used the term business finance. And later on, they used corporate finance instead of business finance. The rationale behind the use of corporate finance was the dominance of the corporate form of business organizations in the business world.
Traditionally, business finance used to focus only on the procurement of funds required to set up a corporation (company) and the expansion of its activities. Accordingly, the responsibility of the financial manager was limited only to estimate the financial requirements and raise the funds to meet the projected financial requirement of a corporation.
However, with the passage of time, the scope of finance widened. Now it is not limited to the fundraising activities; it has widened to cover the acquisition, financing, and management aspects of a corporation’s assets. This approach to the concept of financial management is known as a modern concept.
Let us take an example to illustrate the modern concept of financial management. Assume you along with some of your friends wish to start an ice-cream factory. Obviously, the goal of doing an ice-cream business will be to enhance owners’ wealth. You require fixed assets like a machine, freezers, delivery van, etc. and current assets like inventory, receivables, and some amount of cash to initiate the ice-cream business. Therefore, first, you will have to assess how much investment will be required to invest in these assets, how much benefits will it brings, and how risky is the ice-cream business.
In the language of finance, deciding on all these aspects of business is known as an investment decision. Next, if you decide the ice-cream project is worth investing in, you have to manage the fund for financing the project. You have to decide on the proportion of equity capital your team will invest and the debt you will borrow. Deciding on the sources of funds is known as a financing decision. A significant amount is invested in current assets that require special attention. Keeping all components of current assets at an optimal level is known as current assets management.
Finally, the decision relating to how much of the earning to hold in the business for future growth and expansion and how much to distribute to shareholders as dividends are known as dividend decisions. Thus, investment decision, financing decision, current assets management decision, and dividend decision belongs to the purview of financial management. In other words, we can define financial management as the decision-making process relating to investment, financing, dividend, and current assets management decisions of a corporation.
Tips: Financial management is concerned with the procurement of funds from the least costly sources of financing and their effective allocation into productive use.