Finance Function Meaning
Among various functions of business, financial functions are one of the most significant functions. It is all the business activities. This function of a business cannot be ignored, substituted or the lack of finance may prove to be disastrous for a business enterprise and may lead to its closure. The demand for flance is ongoing and uninterrupted during the entire lifetime of a company.
There are three basic approaches regarding the concept of financial function in a business, which are as follows:
1) According to the first approach, the finance function is restricted to providing finance required by the company on favourable terms and conditions keeping in view its objectives. The underlying presumption of this approach are:
i) Demand for finance is created separately out of expenditure decisions taken within a business, and
ii) The finance manager’s job is to procure finances at optimum level and with the lowest cost.
2) Under the second approach, the basic premise is that the finance function is broad-based and related to every activity taking place in a business. However, the above premise appears to be misplaced as the finance function is not as broad-based as is made to appear under this approach.
3) The third approach (which is a balanced one and more acceptable) considers the finance function as raising the funds and their effective application in the business. The responsible officials of a company bear a threefold responsibility, namely:
i) Deciding on the best option available for raising funds,
ii) Placing the funds so raised to their optimal use efficiently, and
iii) Forecasting an appropriate level of the company’s fund requirements.
What is Finance Function?
Finance is the backbone of any business. Finance is an indispensable component for the smooth functioning of any business. Without adequate financial resources, a company may face challenges and even decline. Finance is the art and science of managing the monetary resources of a business concern and is extremely crucial for the survival of a business entity. It plays an important role throughout the entire lifecycle of a business, from its inception and day-to-day operations to its eventual liquidation. Finance aids in the procurement of various resources such as raw materials, machinery and equipment, human resources etc., and helps to maintain a smooth flow of business operations. Therefore, an organization needs to establish a healthy and sound financial management system.
The term finance has been defined in many ways by various schools of thought. The term finance primarily includes the effective management of financial or monetary resources within a business enterprise. The discipline of finance is concerned with the sources, allocation, application and usage of money by a business ety for maximising its returns and stakeholder satisfaction.
Finance Function Definition
According to Howard and Upton, “Finance may be defined as that administrative area or set of administrative functions in an organisation which relates with the arrangement of each and credit so that the organisation may have the means to carry out the objectives as satisfactorily as possible”.
As per F.W. Paish, “Finance may be defined as the position of money at the time it is wanted”.
According to John J. Hampton, “The term finance can be defined as the management of the flows of money through an organisation, whether it will be a corporation, school, bank or government agency”
Nature of Finance Function
Finance can be broadly classified into three decision areas, namely investment decision, financing decision, and dividend decision. Investment decision mostly relates to the efficient allocation and utilisation of company funds to invest in selected investment proposals after proper appraisal, depending upon the nature, type and scale of business, to maximise the company’s profitability and returns in the long term. The financing decision revolves around the acquisition of funds from various sources of finances available to the company. Whereas, dividend decision relates to the company’s dividend policy to maximise shareholders’ wealth. Thus, the finance function revolves around all other functions and activities of an organisation.
A few salient features of the finance function are mentioned below:
1) The Finance function is mostly integrated and centralised in every business organisation, as it brings forth cost advantages to the company.
2) Irrespective of size, nature, and legal status, every organisation has a finance function, as it puts across certain amount of control on other activities and functions of the organisation.
3) Finance and its related activities play a very significant role in the long-term growth and survival of the organisation.
4) Finance functions help in managerial decision-making, through analysis and interpretation of financial data.
5) Finance function interrelated to other primary functions of business as well, such as marketing production planning, human resources, etc. These functions are very much dependent on finance and are affected by external factors of the environment.
6) Basically, “Valuation of a Firm” is one of the important aspects of the finance function.
- nature of business meaning
- nature of international business
- scope of international marketing
- determinants of economic development
- nature of capital budgeting
- nature of international marketing
Scope of Finance Function
The finance function of a company has an extensive scope, which is discussed as follows:
1) Estimating Financial Requirements
It is of paramount importance for a company to as its long-term as well as short-term capital needs in a precise manner. While making such an assessment, the Department of the company needs to coordinate with other departments like purchase, production, marketing, sales, etc. take into account the assessments of budgets prepared by them and only thereafter arrive at the final assessment. In the formative stage of a company, such coordination may not be necessary as the promoters have an overall idea of the funds requirement of their company.
However, with the growth of the company in size and complexity, it becomes the responsibility of the ‘Finance department’ to make an overall assessment of the company’s fund requirements in consultation with other departments. The projection about capital requirements should be accurate or otherwise, the business may run into trouble either due to a shortage of funds or its excess.
An accurate assessment of fund requirements would result in the availability of funds (long-term as well as short-term) at the time of their requirements. Some of the factors like the nature and size of the business, its planning about modernisation, expansion diversification, etc., needed to be considered at the time of estimation of the fund’s process.
2) Deciding Capital Structure
After evaluating the overall funding needs of a business, the next step is to decide the capital structure of the company. This refers to the proportionate distribution of different capital components within the organization. The determination of an appropriate mix of various components of capital is a crucial decision that can significantly impact a company’s performance in the long run.
The ratio in which :
(i) long-term and short-term funds,
(ii) debt, equity, hybrid funds, and
(iii) borrowed funds, that need to be raised may be decided carefully by the finance department of the company.
The following factors may be taken into account in the matter:
i) Cost of raising funds from various sources.
ii) Period for which the funds are required.
iii) Risks and returns involved in each source of investment (a suitable balance between the two needs to be maintained).
3) Selecting a Source of Finance
There are several sources from where funds can be raised by a company, eg., the issue of equities/debentures/bonds, borrowing from banks/financial institutions, public deposits, etc. Selection of the source of funds may be done with utmost care and the following factors may be taken into consideration:
i) Cost of funds and conditions attached therewith,
ii) Charge on assets,
iii) Potential Implications of Ownership and Control Dilution, etc.
iv) Burden of fixed charges.
If a company is extremely particular about preserving its ownership and control, it may choose to completely avoid raising funds through equity.
4) Selecting a Pattern of Investment
Once the funds have been raised, the next important decision to be taken is the appropriate application of funds. The decision regarding investment patterns may be taken based on well-established scientific techniques, like ‘Capital Budgeting’, ‘Opportunity Cost Analysis’, etc. Three cardinal principles, namely safety, profitability, and liquidity, should never be disregarded when allocating funds to different assets.
5) Proper Cash Management
Availability of an adequate supply of cash at the appropriate time for the hassle-free conduct of the business may be ensured through proper cash management by the Finance Department. Cash requirements generally arise to meet expenses relating to
i) Purchase of raw materials,
ii) Payments to the creditors,
iii) Payment of salaries/wages,
iv) Miscellaneous day-to-day business expenses, etc.
Cash availability needs to be just enough, i.e., neither in excess nor in short supply. Shortage of cash may lead to a payment Crisis and a reputational Risk for the company, whereas maintenance of excess cash will need a loss of money and hence should be avoided. If for any reason excess cash is noticed at any point in time, the same may be promptly invested in highly liquid instruments (so that it may be converted into cash without any delay). A cash flow statement is very handy to ascertain the exact level of cash requirement over a given time horizon. The Finance Manager must prepare the cash flow statement to achieve the dual objectives of profitability and liquidity, which are crucial for running a successful business.
6) Proper Uses of Surpluses
After the payment of all statutory dues (taxes), the balance of profit earned is referred to as the ‘Surplus of the business. The allocation of resources serves three distinct purposes:
i) Bonus distribution to the workmen and the company’s contribution to other profit-sharing plans.
ii) One effective strategy for business growth, expansion, and diversification is reinvesting the remaining profits back into the company, and
iii) The distribution of dividends to shareholders serves as a return on their investment in the company’s shares.
As regards the first purpose, the amount is typically determined either by law or through agreement. Therefore, there is no issue involved in allocating funds for this specific purpose. However, subjectivity and flexibility are important in second and third purposes and as such proper attention needs to be given to them. The decision as to how much is to be distributed as dividend and how much is to be retained in the business requires careful consideration by the management keeping in view the following factors:
i) Trend noticed in the earning pattern of the company.
ii) Trend in the market price of the company’s shares.
iii) Expansion, diversification and growth plans of the company.
7) Implementing Financial Controls
Monitoring the financial performance of funds raised and invested by a company in the business is an important function of the finance department. For this purpose, various analytical tools and techniques such as Budgetary Control, Cost Control, Internal Audit, Ratio Analysis, and Break-even Point Analysis. These tools must be utilized and implemented by every organization. Besides the above, financial planning also plays an important role, and therefore needs to be given proper attention.