Unit 12. Financial management a. Text finance function

Any business – whether large or small, profit-seeking or not-for-profit – has important financial concerns:

How to get the funds needed to run the business on favourable terms and how to make sure that the funds are used effectively?

In this connection modern businesses have financial managers to look after these problems, whose major objective is to maximize the value of the firm for its owners, i.e. to maximize the shareholders' wealth, which is represented by the market price of a firm's common stock.

Managers daily face questions like the following:

• What assets to acquire?

• Will a particular investment be profitable?

• Where will the funds come from to finance the investment?

• How much to maintain as equity capital?

• Does the firm have adequate cash or access to cash – through bank borrowing agreements, for example, to meet its daily operating needs?

• Which customers should be offered credit and how much should they be offered?

• How much inventory should be held?

• Is the merger or acquisition advisable?

• How should profits be used or distributed? What is the optimal dividend policy?

• How should the firm behave in the situation of exchange rate variations and interest rate changes?

• How should risk to which the firm is exposed and return be balanced?

Financial managers are primarily concerned with the management of fixed assets, working capital management, including management of current assets and current liabilities, cash management, receivables management and inventory management; they are responsible for designing capital structure, choosing long- and short-term financing techniques.

The financial manager has to take these decisions with reference to the objectives of the firm.

To have a better understanding of how managers go about all these concerns one should know what resources managers typically have at their disposal. The position of an enterprise, its assets and capital are best illustrated by its financial statements – the balance sheet and the income statement.

The first major component of the balance sheet of an enterprise is its assets, which are the resources owned by the enterprise. The standard classification of assets divides them into: 1) fixed assets, 2) current assets, 3) investments and 4) other assets.

Fixed assets are assets purchased for use in the business on a permanent basis, e.g. land and buildings, plant and machinery, furniture, motor vehicles, etc.

Current assets are short-term in nature. They are also known as liquid assets and include cash, marketable securities, accounts receivable (debtors), notes/bills receivable and inventory, including finished goods or work in process.

Investments represent investment of funds in the securities of another company, the purpose of which is either to earn a return or/and to control another company.

The second major component of the balance sheet is liabilities of the enterprise, which represent the amount that the enterprise owes to other enterprises, or the outside sources which the enterprise uses to finance its assets. They are: long-term liabilities (obligations payable after the accounting period) – debentures, bonds, mortgages, secured loans – and current liabilities (obligations usually repayable within the accounting period) – accounts payable, bills/notes payable, accrued expenses, deferred income and short-term bank credit.

The third major component of a balance sheet is the owners' equity-part of the resources of a firm which are supplied by its owners – shareholders. The owners' equity may consist of two elements: paid-up capital (the initial amount of funds contributed by the shareholders) and retained earnings (part of the profits of the shareholders which is not paid out to them as dividends but ploughed back in the business).

Capital is the store of accumulated wealth contributed to the firm by its proprietors – it is the net worth of the business to the owners. Fixed capital is capital tied up in fixed assets. Working capital is the capital available for working the business. When an enterprise has bought fixed assets it still needs further capital to buy raw materials, etc., or money to pay wages.

The finance function in a firm is usually headed by a chief financial officer (CFO), who reports to the firm's president.

The chief financial officer distributes the financial management responsibilities between the controller and the treasurer.