FINANCE!!!!

IS IT ONLY FINANCE MANGERs CUP OF TEA

Richa looks worried. She is lost in thought. Sitting in her chair, she is shaking her head in sorrow. She is also saying something to herself. At that moment, Diya walks in. Diya and Richa work in the same factory. Both of them get the same salary. While Richa is unhappy, Diya is happy and looks relaxed. Diya realises that something is troubling Richa and decides to find out. Thus goes the conversation : Diya: Ah! Richa, you look worried, what is the matter? Richa: Diya, you and I get the same wages. But you are able to purchase all that you want and also save some money. And I I am unable to save even a Rupee by the end of the month Diya: That means you have not been looking at your finances properly. Richa: Finance! What is finance? What Diya sits next to is Richa and starts finance? explaining .

Diya: In simple terms, finance is money. Finance is keeping an account of money where is money coming from and where is it going, how are we spending, how much are we spending and so on. Richa: I understand what you are saying. But is this actually possible? Diya: Of course it is! See. You earn Rs. 30,000 per month. This is your income. This is where your money is coming from. You have to spend this money on food, clothes, rent, medicines, provisions etc. for yourself and your family. This is your

expenditure. This is where your money is going. Finance is keeping track of the expenditure. This means you must keep checking how the money is being spent.

Out of the Rs. 30,000 that you earn, if your expenditure is only Rs. 29000 per month, then you get to save Rs. 1000 Rupees per month. But, if your expenditure is Rs. 31,000 every month, you will face problems. There will be no savings at all. If the need arises, you may have to borrow money from friends and relatives to meet your expenses. This leads to debts. Richa: Yes. That is what has happened. My expenditure has exceeded my income. Because of this , I am in debt. Now I wonder how I can meet my familys expenses and repay my loans at the same time Diya: First, Richa: But reduce your expenses. how?

Diya: Check your expenses. On which items do you spend most of your money? Do you buy unnecessary or expensive items? Do you buy more than what you need? How Richa does carefully listening finance to Diya as help? continues :

is

she

Diya: We usually buy some goods that are not required immediately. This leads to unnecessary expenditure. Because of this there is no money left to buy necessary items. When we have a limited income, we have to be very careful about how we spend that money. Try to reduce the number of things or the quantity of things you are buying. When we buy items more than requirement, it leads to wasteful expenditure. Try to down such wasteful expenditure. Spend money only on the the cut the

necessary items. This way, you will be able to save some money. Soon you can save enough to pay off your debts. Richa: But how can I decide what expenditure is necessary and what is not? This time both my children have asked for new clothes. How can I say no to them? Diya: Dont Richa: Then say how no will I to them. manage?

Diya: I will give you a solution. Buy clothes this month for your son and next month for your daughter. This is called allocation of resources. You have a limited budget. Therefore, you must first spend the money on necessary household expenses. Only after that, if some money is left, you can buy new clothes for your children. It is good that you take care of your childrens needs. But if you give importance only to their happiness and spend all your money, how will you be able to pay back your debts? Financial management is all about managing expenditure within a limited budget. It is all about allocating money to the necessary items first. If after that, you have some money left, it must be used to pay off the debts. If there is still some money left you can use it as you like. The need to know financial management By now Richa has understood the importance of allocation of resources. But there is still some confusion about financial management. Lets see how her friend clears the confusion for her. Richa: Financial management! That is a big word! Isnt financial management used in big businesses? Diya: Financial management sounds like a big word. But it is

not just the companies who use it. The truth is that all of us use financial management at some point or the other. We calculate our earnings and expenses and also try to save a part of our earnings. Sometimes, it may seem very difficult, but we find ways in which we can manage our finances. If there isnt enough money, we avoid spending on certain items. Financial management means management of all matters related to an organisations finances. This principle is the same whether its an organisation, a family, or even a countrys economy. We must balance expenditure and income. Let us understand this better by taking the example of our own company, ALS Textiles. Our company earns money by selling textiles. Let us assume that it earns Rs. 10 lakhs every month. This is known as revenue.

A company has many expenses. Some of the major expenses of the company can be listed as follows: 1. Wages to workers like us. 2. Raw materials for making the textile. 3. Electricity and water bills. 4. Purchase and repair of machines that are used to manufacture the textile. All these expenses are paid out of the revenues. If the revenues are more than the expenses, then ALS will make profits. But, if the expenses are more than revenues, then it will face losses. Richa: (Smiling) Just like me!

Diya: Exactly! If ABC continues like that, eventually, it will lose all its assets. In other words it will lose its property and all that it owns. In that case, we may even be asked to leave the company. To avoid this situation, ABC has cash inflows (cash coming into to manage the the company)

and outflows (various expenses that the company has to meet). Now you have to start managing your cash inflows and outflows! Richa: I never looked at finance and financial management in this way! I always thought that these terms have something to do with large companies only. But I now realise that I am the finance manager at home! But not a very good one! But tell me one thing Diya, what could be the wasteful expenditure for our company? Diya: Well, I dont know the exact details, but I can give you an example. Suppose we assume that the company sells about 1000 meters of textile every month. So, we need enough raw materials so that we can make about 1000 or 1100 meters of textile a month. But if the company buys large amount of raw materials to manufacture 3000 meters of textile every month, isnt that an unnecessary expenditure? Then the company has to pay a huge bill to the supplier and also pay a rent to the warehouse where the raw materials have to be stored. Moreover, there is bound to be wastage of materials. These may seem to be small matters, but they affect the companys finances very badly.

Richa: Hmm. So, this means that if our company starts spending money like I do, then we would very soon be out of jobs! Diya: (Jokingly) Well, I definitely hope that our financial manager Nikhil does not need any lessons like you! Diya and Richa laugh.

The two friends need not worry. Nikhil is very experienced and knowledgeable about finance and handles it well. Their jobs are safe! Richa and Diya meet in the market. Richa is looking very happy.

Diya: hello Richa. You seem to be in very good spirits today. Richa: Indeed I am. And also very relaxed. All thanks to you! Diya: Me? How?

Richa: It was you who gave me guidance. After you gave me some lessons on managing my finances I thought over it. I began to take steps. I started making budgets. I bargained for provisions and got the same items at lesser price. I postponed whatever expenses I could. I can see a tremendous change! Now after just two months I am a relaxed person. Most of my debts are paid and I am no longer worried about my finances! Diya: Congratulations! That means you have turned into a good Finance Manager. Richa: At least a better one. I now wonder why I did not think of doing all this earlier. Diya: That is because you did not prioritise your expenses before. You spent whatever money you had without thinking about the future. And sometimes, it becomes difficult to manage all the costs. Richa: Yes. I wonder how larger organisations manage their money. The example you gave me about raw materials in our company got me thinking. Nikhil is good at managing the company finances. He has to pay wages and bills, purchase raw materials, all from the amount that comes from selling textiles. Diya: A Finance Manager has many more responsibilities. He has to manage all the incomes and expenses related to the company. He has to see that resources are not wasted anywhere. He has to negotiate with the suppliers. And see that

all departments get the money to meet their expenses. Richa: Please tell me more

Diya: Just as the Purchase Manager needs money to buy the raw materials, the Production Manager also has to maintain his machinery so that the textile production goes on smoothly. This maintenance also requires money. If Nikhil does not give the required funds to either of them, the production will stop. What will ALS sell, if no textile is manufactured? Financial management involves several functions, especially in bigger companies. Richa: How do you know all this?

Diya: Remember I was working as a secretary at Nikhils office till a few months ago? I used to see him discuss all these issues with the various managers. I developed an interest in what these managers do. I learnt some of their duties and functions. That is where I understood that managing the finances of a company requires an understanding of many things. Richa: But our company manages to make enough money to meet all the expenses, doesnt it? It is just a matter of matching the income and expenditure. Diya : But matching the income and expenditure is not the only job. Nikhil has to allocate the cash, but at the same time, he has to see that equipment, workers, supplies, etc. are also being used properly. Wastage of any of these resources will affect the cash balances of ALS. Using resources efficiently will help ABC to reduce the costs of operations. At the same time, if resources are used efficiently, it will generate additional resources for the company. Nikhil also has to analyse ALSs financial performance. If the company is not able to make profits, he has to find out the reasons for it.

Diya then explains to Richa the elements of financial management Diya: See. The financial management process has some basic elements: a. Financial Planning b. Financial Control c. Financial Decision-Making Financial Planning: Financial Planning means that Nikhil has to see that enough funds are available to meet all the business expenses. Also, the company should take advantage of investment opportunities. The expenses and investments could be for short term or for long-term. Shortterm investments would be in equipment and stocks. Short-term expenses include employees wages and salaries and managing goods sold on credit. In case of medium or long-term, the company needs funds to increase its productivity or scale of operations. For example, a company needs funds if it plans to take over or merge with another company. Richa: Then what is financial control?

Diya: Financial control deals with those activities that are necessary to help a business meet its objectives. Thus Nikhil has to see that the business assets are being used efficiently and that these assets are secure. Also, the business activities should be according to the business rules. All activities should be in the interest of the shareholders of the business. Richa: So, financial decision-making means that he has to decide how much money to give to which department. Diya: Not just that. Financial management involves taking some critical business decisions. These decisions are usually on matters relating to investments, financing and dividends. These decisions may have to do with how to arrange for finances for a particular investment what are the

various sources from which the company can get money. Another important decision that the management has to take is whether to distribute the profits made by the company in a financial year, or to reuse these funds for further expansion of the business. A few days later, Richa and Diya go to their friend s home for lunch. Arnav works as a cashier at ALS Textiles Ltd. Tshey get talking about managing finances. Richa: Financial management has always been an important part of every business organisation. Arnav: You know that I have just joined a diploma course in financial management. That is wshere I learnt that financial management was never considered an important part of a business till a few years ago. Richa: Thats a surprise! Arnav: Yes its true. Financial management evolved gradually over the past 50 years. The evolution of financial management is divided into three phases. Financial Management evolved as a separate field of study at the beginning of the century. The three stages of its evolution are: The Traditional Phase: During this phase, financial management was considered necessary only during occasional events such as takeovers, mergers, expansion , liquidation, etc. Also, when taking financial decisions in the organisation, the needs of outsiders to the business were kept in mind. Diya: Who are outsiders?

Arnav: They are investment bankers, people who lend money to the business and other such people. Then came the transitional phase.

The Transitional Phase: During this phase, the day-to-day problems that financial managers faced were given importance. Richa: What kind of problems? Arnav: I am coming to that. The general problems are related to funds analysis, planning and control. These were given more attention in this phase. The Modern Phase: Modern phase is still going on. It is important to carry out financial analysis for a company. This analysis helps in decision-making. It seems during this phase, many theories have been developed. Diya: What are these theories? Arnav: Theories regarding efficient markets, capital budgeting, option pricing, valuation models and several otsher important fields in financial management. Richa: What are all these theories? Arnav: Sorry, that area I dont know much about. Diya: Then I think we must ask Nikhil, or someone who knows these things. Richa: But what is the objective of financial management? Diya: Simple. It is the duty of tshe financial manager to see that the company makes more and more profits. Arnav: No. Actually, the real objective of financial management should be wealth maximisation. Diya: What does wealth maximisation mean?

Wealth

maximisation:

Arnav: Let me explain. You must be aware that many companies sell their shares in the stock market. People buy the shares as an investment. It means that they expect these shares to give them some returns. It is the duty of the finance manager to see that the shareholders get good returns on the shares. Hence, the value of the share should increase in the share market. Richa: How can the finance manager ensure that the share value increases? Arnav: Well, the share value is affected by many things. If a company is able to make good sales and build a good name for itself, in the industry, the companys share value goes up. If the company makes a risky investment, people may lose confidence in the company and the share value will come down. Diya: Yes youre right. My brother trades in shares sometimes. He bought 100 shares of I-Tech Solutions a few years ago. A few months after that, there was some downsizing in the company and the share-value went down. He had to suffer a loss. Arnav: That downsizing was the result of the economic slump in the aftermath of September 11. The company was not able to get enough orders to justify a big staff. A big staff means higher wages, and that means the company has to spend more funds on wages. If the company spends more money on wages, it may not be able to survive. So, it is an important decision. Diya: So, this means that the finance manager has the power to influence decisions regarding finances of the company. The decisions should be such that the share value does not decrease.

Arnav: Yes. You are right. Richa: But is that all? Other goals Arnav: Wealth maximisation is the most important goal of financial management. Of course, there are other goals too.

Achieving a higher growth rate Attaining a larger market share Gaining leadership in the market in terms of products and technology Promoting employee welfare Increasing customer satisfaction

Many companies have several other goals for the welfare of the society, like improving community life, supporting education and research, solving societal problems, etc. But wealth maximisation means that the company is using its resources in a good manner. If the share value is to stay high, the company has to reduce its costs and use the resources properly. If the company follows the goal of wealth maximisation, it means that the company will promote only those policies that will lead to an efficient allocation of resources. Diya: And some of the other goals also support wealth maximisation. A high growth rate, a large market share and leadership in terms of products and technology automatically increase the market value of shares of the company. This leads to wealth maximisation for the equity shareholder. Richa: But I have a doubt. How does the finance manager get the basic information for managing the funds of the company? Diya: When the finance manager prepares the accounts, she gets to know how much money the company has. Then, she has to manage this money. And how well she manages the money will affect the value of the shares.

Arnav: Yes, but please dont mix up accounting and financial management! There are several differences between the two. Differences between financial accounting and financial management Arnav: Financial accounting gives the financial status of the company to people outside the company. It is recording and reporting the activities and events that lead to cash inflow and outflow. But financial management means efficiently managing tshe various resources of the company. Diya: But generally, both these terms are interchangeable.

Arnav: Both of the functions are closely related. But there are clear differences between the two. Let me elaborate: Aim: Financial accounting aims at maintaining a clear record of the financial condition of the firm. Accounting measures the performance of the firm so that the situation of the company can be measured in financial terms. And financial management is concerned with value maximisation. Managements efforts are for increasing the value of the company for the shareholders. This requires investing in projects that are likely to provide positive returns to the company.

Method: The methods are also different. The accountant prepares accounting reports on the basis of accrual method. This means that she records financial transactions as receipts or payments, whether the cash will be paid/received immediately, or in the future. Thus, cash that will be received next month for a sale in this month will be recorded as cash receivable in this month itself.

A finance manager, on the other hand, is concerned about the actual cash flows of the company. Diya: She looks after when and how much cash is going to come into the company and go out of the company. Arnav: Thats right. Also, she has to take care of the risks involved in financial management. Certainty: Accounting is maintenance of financial records. So, it deals with what has already occurred. This makes it more certain. But a finance manager is concerned with what is going to happen in the future. She takes critical decisions that will affect the future of the company. These are based on various calculations and assessments. This is not easy because there are many uncertainties in financial management.