Discussing the Subsidiary Functions are follow – Decision making, Innovation, Representation, Reporting, Budgeting, and Forecasting. After that discussing the Functions of a Finance Manager. The functions are – 1) Financial Forecasting and Planning, 2) Acquisition of Funds, 3) Investment of Funds, 4) Helping in Valuating Decisions, and 5) Maintain Proper Liquidity.Also learned, The Features of Directing Function of Management! Discuss the Subsidiary Functions of Management!
Learn and Study, Discuss the Subsidiary Functions of Management!
Besides the primary functions of management, below are some of the important subsidiary functions:
#Decision making:
Joseph L. Massie regards decision-making as the first important separate function of management. An important job of a manager is decision-making. Every day he has to decide about doing or not doing specific work. Decision-making is the process of choosing the best from among alternatives courses- of action, evaluation of alternatives and choosing the best. However, it may be. Appropriate to cover the function of decision-making under the planning function of management.
#Innovation:
Ernest Dale has given innovation as a separate function of- management. According to him, management involves the introduction of new systems, procedures, methods, techniques, products, and services. However, it is not right to regard innovation as a separate function of management. Because innovation is very much a part of planning function.
#Representation:
Ernest Dale has regarded representation also as a separate function of management. According to him, a manager has to represent his organization to outsiders, financial institutions, government, and others. He has to keep good relations with these agencies with a view to attaining the enterprise objectives. However, this function falls under organizing and directing functions of management.
#Reporting:
Luther Gulick has suggested reporting as a separate function of management. The process of giving information to the management/shareholders is considered as reporting. The reports are regularly sent to various levels of management for judging the effectiveness of different responsibility centers. These reports also become a base for taking corrective actions, if necessary. However, it may not be appropriate to consider reporting as a separate function. Because it is very much a part of controlling function of management.
#Budgeting:
Luther Gulick has also given budgeting as a separate function of management. A budget is a future plan represented in a numerical form. Budgeting is preparing various budgeted figures for the enterprise for the future period. Then comparing the actual results with the budgeted and taking corrective action in the future so as to achieve the optimum results. Nowadays, budgeting has become a very important function of management but it is only a technique of planning and controlling.
#Forecasting:
Lyndall Urwick regards forecasting as a separate function of management. According to him, forecasting is involved to some extent in every business decision. The management has to forecast while preparing plans for the future. According to Henry Fayol, the entire plan is made of a series of separate plans called forecasts. Forecasting provides a logical basis for preparing the plans. However, it will be proper to cover forecasting under the planning function of management.
#The Functions of a Finance Manager:
Now Explain it:
#Financial Forecasting and Planning:
A financial manager has to estimate the financial needs of a business. How much money will be required for acquiring various assets? The amount will be needed for purchasing fixed assets and meeting working capital needs. He has to plan the funds needed in the future. How these funds will be acquired and applied is an important function of a finance manager.
#Acquisition of Funds:
After making financial planning, the next step will be to acquire funds. There are a number of sources available for supplying funds. These sources may be shares, debentures, financial institutions, commercial banks, etc. The selection of an appropriate source is a delicate task. The choice of a wrong source for funds may create difficulties at a later stage. The pros and cons of various sources should be analyzed before making a final decision.
#Investment of Funds:
The funds should be used in the best possible way. The cost of acquiring them and the returns should be compared. The channels which generate higher returns should be preferred. The technique of capital budgeting may be helpful in selecting a project. The objective of maximizing profits will be achieved only when funds are efficiently used and they do not remain idle at any time. A financial manager has to keep in mind the principles of safety, liquidity, and soundness while investing funds.
#Helping in Valuating Decisions:
A number of mergers and consolidations take place in the present competitive industrial world. A finance manager is supposed to assist management in making valuation etc. For this purpose, he should understand various methods of valuing shares and other assets so that correct values are arrived at.
#Maintain Proper Liquidity:
Every concern is required to maintain some liquidity for meeting day-to-day needs. Cash is the best source for maintaining liquidity. It is required to purchase raw materials, pay workers, meet other expenses, etc. A finance manager is required to determine the need for liquid assets and then arrange liquid assets in such a way that there is no scarcity of funds.
Learn and Understand, Factors Affecting the Major Types of Financial Decisions!
Definition: The Financing Decision is yet another crucial decision made by the financial manager relating to the financing-mix of an organization. It is concerning the borrowing and allocation of funds required for the investment decisions. Types of Decisions: i. Investment decision ii. Financing decision iii. Dividend decision iv. Liquidity Decision. Also learn, Simple Types of Financial Decisions, Factors Affecting the Major Types of Financial Decisions!
Some of the important functions which every finance manager has to take are as follows:
A. Investment decision.
B. Financing decision.
C. Dividend decision, and.
D. Liquidity Decision.
The following decision is explained below:
A. Investment Decision (Also Know, Capital Budgeting Decision):
This decision relates to the careful selection of assets in which funds will be invested by the firms. A firm has many options to invest their funds but the firm has to select the most appropriate investment which will bring maximum benefit to the firm and decide or selecting most appropriate proposal is investment decision.
The firm invests its funds in acquiring fixed assets as well as current assets. When decision regarding fixed assets is taken it is also called capital budgeting decision.
Whenever a company is investing huge funds in an investment proposal it expects some regular amount of cash flow to meet day to day requirement. The amount of cash flow an investment proposal will be able to generate must assess properly before investing in the proposal.
2. Return on Investment:
The most important criteria to decide the investment proposal is the rate of return it will be able to bring back for the company in the form of income for, e.g., if project A is bringing 10% return and project В is bringing 15% return then we should prefer project B.
3. Risk Involved:
With every investment proposal, there is some degree of risk is also involved. The company must try to calculate the risk involved in every proposal and should prefer the investment proposal with the moderate degree of risk only.
4. Investment Criteria:
Along with return, risk, cash flow there are various other criteria which help in selecting an investment proposal such as availability of labor, technologies, input, machinery, etc.
The finance manager must compare all the available alternatives very carefully and then only decide where to invest the most scarce resources of the firm, i.e., finance.
Investment decisions are considered very important decisions because of following reasons:
(i) They are long-term decisions and therefore are irreversible; means once taken cannot change.
(ii) Involve huge amount of funds.
(iii) Affect the future earning capacity of the company.
Importance or Scope of Capital Budgeting Decision:
Capital budgeting decisions can turn the fortune of a company. The capital budgeting decisions are considered very important because of the following reasons:
1. Long-Term Growth:
The capital budgeting decisions affect the long-term growth of the company. As funds invested in long-term assets bring the return in future and future prospects and growth of the company depend upon these decisions only.
2. Large Amount of Funds Involved:
Investment in long-term projects or buying of fixed assets involves the huge amount of funds and if the wrong proposal is selected it may result in wastage of huge amount of funds that is why capital budgeting decisions are taken after considering various factors and planning.
3. Risk Involved:
The fixed capital decisions involve huge funds and also the big risk because the return comes in long run and company has to bear the risk for a long period of time till the returns start coming.
4. Irreversible Decision:
Capital budgeting decisions cannot reverse or change overnight. As these decisions involve huge funds and heavy cost and going back or reversing the decision may result in heavy loss and wastage of funds. So these decisions must take after careful planning and evaluation of all the effects of that decision because adverse consequences may be very heavy.
B. Financing Decision:
The second important decision which finance manager has to take is deciding source of finance. A company can raise finance from various sources such as by issue of shares, debentures or by taking loan and advances. Deciding how much to raise from which source is the concern of financing decision.
Mainly sources of finance can divide into two categories:
Owners fund.
Borrowed fund.
Share capital and retained earnings constitute owners’ fund and debentures, loans, bonds, etc. constitute borrowed fund.
The main concern of finance manager is to decide how much to raise from owners’ fund and how much to raise from a borrowed fund.
While taking this decision the finance manager compares the advantages and disadvantages of different sources of finance. The borrowed funds have to pay back and involve some degree of risk whereas in owners’ fund there is no fixing commitment of repayment and there is no risk involved. But finance manager prefers a mix of both types. Under financing, decision finance manager fixes a ratio of owner fund and borrowed fund in the capital structure of the company.
Factors Affecting Financing Decisions:
While taking financing decisions the finance manager keeps in mind the following factors:
1. Cost:
The cost of raising finance from various sources is different and finance managers always prefer the source with minimum cost.
2. Risk:
More risk is associated with the borrowed fund as compared to owner’s fund securities. Finance manager compares the risk with the cost involved and prefers securities with the moderate risk factor.
3. Cash Flow Position:
The cash flow position of the company also helps in selecting the securities. With smooth and steady cash flow companies can easily afford borrowed fund securities but when companies have a shortage of cash flow, then they must go for owner’s fund securities only.
4. Control Considerations:
If existing shareholders want to retain the complete control of business then they prefer borrowed fund securities to raise further fund. On the other hand, if they do not mind to lose the control then they may go for owner’s fund securities.
5. Floatation Cost:
It refers to the cost involved in the issue of securities such as broker’s commission, underwriters fees, expenses on the prospectus, etc. The firm prefers securities which involve least floatation cost.
6. Fixed Operating Cost:
If a company is having high fixed operating cost then they must prefer owner’s fund because due to high fixed operational cost, the company may not be able to pay interest on debt securities which can cause serious troubles for the company.
7. State of Capital Market:
The conditions in capital market also help in deciding the type of securities to raise. During boom period it is easy to sell equity shares as people are ready to take risk whereas during depression period there is more demand for debt securities in the capital market.
C. Dividend Decision:
This decision is concerned with the distribution of surplus funds. The profit of the firm is distributed among various parties such as creditors, employees, debenture holders, shareholders, etc.
Payment of interest to creditors, debenture holders, etc. is a fixed liability of the company, so what company or finance manager has to decide is what to do with the residual or left over the profit of the company.
The surplus profit is either distributed to equity shareholders in the form of the dividend or kept aside in the form of retained earnings. Under dividend decision, the finance manager decides how much to distribute in the form of dividend and how much to keep aside as retained earnings.
To take this decision finance manager keeps in mind the growth plans and investment opportunities.
If more investment opportunities are available and company has growth plans then more is kept aside as retained earnings and less is given in the form of dividend, but if company wants to satisfy its shareholders and has fewer growth plans, then more is given in the form of dividend and less is kept aside as retained earnings.
This decision is also called residual decision because it is concerned with the distribution of residual or leftover income. Generally new and upcoming companies keep aside more of retain earning and distribute less dividend whereas established companies prefer to give more dividend and keep aside less profit.
Factors Affecting Dividend Decision:
The finance manager analyses following factors before dividing the net earnings between dividend and retained earnings:
1. Earning:
Dividends are paid out of current and previous year’s earnings. If there are more earnings then company declares the high rate of dividend whereas during the low earning period the rate of dividend is also low.
2. Stability of Earnings:
Companies having stable or smooth earnings prefer to give the high rate of dividend whereas companies with unstable earnings prefer to give the low rate of earnings.
3. Cash Flow Position:
Paying dividend means outflow of cash. Companies declare the high rate of dividend only when they have surplus cash. In the situation of shortage of cash, companies declare no or very low dividend.
4. Growth Opportunities:
If a company has a number of investment plans then it should reinvest the earnings of the company. As to invest in investment projects, the company has two options: one to raise additional capital or invest its retained earnings. The retained earnings are the cheaper source as they do not involve floatation cost and any legal formalities.
If companies have no investment or growth plans then it would be better to distribute more in the form of the dividend. Generally, mature companies declare more dividends whereas growing companies keep aside more retained earnings.
5. Stability of Dividend:
Some companies follow a stable dividend policy as it has the better impact on shareholder and improves the reputation of the company in the share market. The stable dividend policy satisfies the investor. Even big companies and financial institutions prefer to invest in a company with regular and stable dividend policy.
There are three types of stable dividend policies which a company may follow:
(i) Constant dividend per share:
In this case, the company decides a fixed rate of dividend and declares the same rate every year, e.g., 10% dividend on investment.
(ii) Constant payout ratio:
Under this system, the company fixes up a fixed percentage of dividends on profit and not on investment, e.g., 10% on profit so dividend keeps on changing with the change in profit rate.
(iii) Constant dividend per share and extra dividend:
Under this scheme, a fixed rate of dividend on investment is given and if profit or earnings increase then some extra dividend in the form of bonus or interim dividend is also given.
6. Preference of Shareholders:
Another important factor affecting dividend policy is expectation and preference of shareholders as their expectations cannot ignore the company. Generally, it is observed that retired shareholders expect the regular and stable amount of dividend whereas young shareholders prefer capital gain by reinvesting the income of the company.
They are ready to sacrifice present-day income dividend for future gain which they will get with growth and expansion of the company.
Secondly poor and middle-class investors also prefer the regular and stable amount of dividend whereas wealthy and rich class prefers capital gains.
So if a company is having a large number of retired and middle-class shareholders then it will declare more dividend and keep aside less in the form of retained earnings whereas if company is having a large number of young and wealthy shareholders then it will prefer to keep aside more in the form of retained earnings and declare low rate of dividend.
7. Taxation Policy:
The rate of dividend also depends upon the taxation policy of the government. Under present taxation system dividend income is tax-free income for shareholders whereas. The company has to pay tax on dividend given to shareholders. If the tax rate is higher, the company prefers to pay less in the form of dividend whereas. If the tax rate is low then the company may declare the higher dividend.
8. Access to Capital Market Consideration:
Whenever company requires more capital it can either arrange it by the issue of shares or debentures in the stock market or by using its retained earnings. Rising of funds from the capital market depends upon the reputation of the company.
If capital market can easily access or approach and there is enough demand for securities of the company then company can give more dividend and raise capital by approaching capital market, but if it is difficult for company to approach and access capital market then companies declare low rate of dividend and use reserves or retained earnings for reinvestment.
9. Legal Restrictions:
Companies’ Act has given certain provisions regarding the payment of dividends that can pay only out of current year profit or past year profit after providing depreciation fund. In case the company is not earning the profit then it cannot declare the dividend.
Apart from the Companies’ Act, there are certain internal provisions of the company that is whether the company has enough flow of cash to pay the dividend. The payment of dividend should not affect the liquidity of the company.
10. Contractual Constraints:
When companies take a long-term loan then financier may put some restrictions or constraints on the distribution of dividend and companies have to abide by these constraints.
11. Stock Market Reaction:
The declaration of the dividend has an impact on the stock market as an increase in dividend is taken as a good news in the stock market and prices of security rise. Whereas a decrease in dividend may have the negative impact on the share price in the stock market. So possible impact of dividend policy on the equity share price also affects dividend decision.
D. Liquidity Decision:
It is very important to maintain a liquidity position of a firm to avoid insolvency. Firm’s profitability, liquidity, and risk all are associated with the investment in current assets. In order to maintain a tradeoff between profitability and liquidity. It is important to invest sufficient funds in current assets. But since current assets do not earn anything for business, therefore, a proper calculation must do before investing in current assets.
Current assets should properly value and dispose of from time to time once they become non-profitable. Currents assets must use in times of liquidity problems and times of insolvency.
Learn and Understand, What are the Major Types of Financial Decisions?
Financial decision is yet another important function which a financial manager must perform. It is important to make wise decisions about when, where and how should a business acquire funds. Funds can acquire through many ways and channels. The types are 1. Investment decisions, 2. Financing decisions, 3. Dividend decisions, and 4. Liquidity decisions. Broadly speaking a correct ratio of an equity and debt has to maintain. This mix of equity capital and debt is known as a firm’s capital structure. Also learn, Concept of Financial Decisions, What are the Major Types of Financial Decisions?
A firm tends to benefit most when the market value of a company’s share maximizes this not only is a sign of growth for the firm but also maximizes shareholders wealth. On the other hand, the use of debt affects the risk and return of a shareholder. It is riskier though it may increase the return on equity funds.
A sound financial structure is said to be one which aims at maximizing shareholders return with minimum risk. In such a scenario the market value of the firm will maximize and hence an optimum capital structure would achieve. Other than equity and debt there are several other tools which are used in deciding a firm capital structure.
Some of the important functions which every finance manager has to take are as follows:
i. Investment decision.
ii. Financing decision.
iii. Dividend decision, and.
iv. Liquidity Decision.
The Following types are explained below:
1. Investment Decisions:
Investment Decision relates to the determination of total amount of assets to hold in the firm, the composition of these assets and the business risk complexions of the firm as perceived by its investors. It is the most important financial decision. Since funds involve cost and are available in a limited quantity, its proper utilization is very necessary to achieve the goal of wealth maximization.
The investment decisions can classify into two broad groups:
(i) Long-term investment decision and
(ii) Short-term investment decision.
The long-term investment decision is referring to as the capital budgeting and the short-term investment decision as working capital management.
Capital budgeting is the process of making investment decisions in capital expenditure. These are expenditures, the benefits of which are expecting to receive over a long period of time exceeding one year. The finance manager has to assess the profitability of various projects before committing the funds.
The investment proposals should evaluate in terms of expecting profitability, costs involving and the risks associated with the projects.
The investment decision is important not only for the setting up of new units but also for the expansion of present units, replacement of permanent assets, research and development project costs, and reallocation of funds, in case, investments made earlier do not fetch result as anticipated earlier.
Short-term investment decision, on the other hand, relates to the allocation of funds as among cash and equivalents, receivables and inventories. Such a decision is influencing the tradeoff between liquidity and profitability.
The reason is that the more liquid the asset, the less it is likely to yield and the more profitable an asset, the more illiquid it is. A sound short-term investment decision or working capital management policy is one which ensures higher profitability, proper liquidity and sound structural health of the organization.
2. Financing Decisions:
Once the firm has taken the investment decision and committed itself to new investment, it must decide the best means of financing these commitments. Since firms regularly make new investments; the needs for financing and financial decisions are ongoing.
Hence, a firm will be continuously planning for new financial needs. The financing decision is not only concerned with how best to finance new assets but also concerned with the best overall mix of financing for the firm.
A finance manager has to select such sources of funds which will make the optimum capital structure. The important thing to decide here is the proportion of various sources in the overall capital mix of the firm. The debt-equity ratio should fix in such a way that it helps in maximizing the profitability of the concern.
The raising of more debts will involve fixed interest liability and dependence upon outsiders. It may help in increasing the return on equity but will also enhance the risk.
The raising of funds through equity will bring permanent funds to the business but the shareholders will expect higher rates of earnings. The financial manager has to strike a balance between various sources so that the overall profitability of the concern improves.
If the capital structure is able to minimize the risk and raise the profitability then the market prices of the shares will go up maximizing the wealth of shareholders. Also learn, What is the Definition of Price Perception?
3. Dividend Decisions:
The third major financial decision relates to the disbursement of profits back to investors who supplied capital to the firm. The term dividend refers to that part of profits of a company which is distributing it among its shareholders.
It is the reward of shareholders for investments made by them in the share capital of the company. The dividend decision is concerning with the quantum of profits to distribute among shareholders.
A decision has to take whether all the profits are to distribute, to retain all the profits in business or to keep a part of profits in the business and distribute others among shareholders. The higher rate of the dividend may raise the market price of shares and thus, maximize the wealth of shareholders. The firm should also consider the question of dividend stability, stock dividend (bonus shares) and cash dividend.
4. Liquidity Decisions:
It is very important to maintain a liquidity position of a firm to avoid insolvency. Firm’s profitability, liquidity, and risk all are associating with the investment in current assets. In order to maintain a tradeoff between profitability and liquidity, it is important to invest sufficient funds in current assets. But since current assets do not earn anything for business, therefore, a proper calculation must do before investing in current assets.
Current assets should properly value dispose of from time to time once they become not profitable. Currents assets must use in times of liquidity problems and times of insolvency.
Learn, What is the Concept of Financial Decisions?
Decisions concerning the liabilities and stockholders’ equity side of the firm’s balance sheet, such as a decision to issue bonds. Decisions that involve: (1) determining the proper amount of funds to employ in a firm. (2) selecting projects and capital expenditure analysis. (3) raising funds on the most favorable terms possible, and. (4) managing working capital such as inventory and accounts receivable. Also learn, Financial Management, What is the Concept of Financial Decisions?
Definition of Financing Decision:
The Financing Decision is yet another crucial decision made by the financial manager relating to the financing-mix of an organization. It is concerned with the borrowing and allocation of funds required for the investment decisions.
The financing decision involves two sources from where the funds can raise: using a company’s own money. Such as share capital, retained earnings or borrowing funds from the outside in the form debenture, loan, bond, etc. The objective of financial decision is to maintain an optimum capital structure, i.e. a proper mix of debt and equity, to ensure the trade-off between the risk and return to the shareholders.
The Debt-Equity Ratio helps in determining the effectiveness of the financing decision made by the company. While taking the financial decisions, the finance manager has to take the following points into consideration:
The Risk involved in raising the funds. The risk is higher in the case of debt as compared to the equity.
The Cost involved in raising the funds. The manager chose the source with minimum cost.
The Level of Control, the shareholders, want in the organization also determines the composition of capital structure. They usually prefer the borrowed funds since it does not dilute the ownership.
The Cash Flow from the operations of the business also determines the source from where the funds shall raise. High cash flow enables to borrow debt as interest can easily pay.
The Floatation Cost such as broker’s commission, underwriters fee, involved in raising the securities also determines the source of fund. Thus, securities with minimum cost must choose.
Thus, a company should make a judicious decision regarding from where, when, how the funds shall raise. Since, more use of equity will result in the dilution of ownership and whereas, higher debt results in higher risk. As the fixed cost in the form of interest is to pay on the borrowed funds.
The Concept of Financial Decisions:
Financial decisions refer to decisions concerning financial matters to a business concern. Decisions regarding the magnitude of funds to invest to enable a firm to accomplish its ultimate goal, kind of assets to acquire. The pattern of capitalization, the pattern of distribution of firm’s income and similar other matters are including in financial decisions.
These decisions are crucial for the well-being of a firm because they determine the firm’s ability to obtain plant and equipment. When needed to carry the required amount of inventories and receivables, to avoid burdensome fixed charges when profits and sales decline and to avoid losing control of the company.
Financial decisions are taking by a finance manager alone or in conjunction with his other executive colleagues of the enterprise. In principle, finance manager is held responsible to handle all such problems as involve money matters.
But in actual practice, he has to call on the expertise of those in other functional areas: marketing, production, accounting, and personnel to carry out his responsibilities wisely. For instance, the decision to acquire a capital asset is based on the expected net return from its use and on the associated risk.
These cannot give values to finance manager alone. Instead, he must call on the expertise of those in charge of production and marketing. Similarly, the decision regarding allocation of funds as between different types of current assets cannot take by a finance manager in the vacuum.
The policy decision in respect of receivables—whether to sell for credit, to what extent and on what terms is essentially financial matter and has to hand by a finance manager. But at the operating level of carrying out the policies. Sales may also involve in decisions to tighten up or relax collection procedures may have repercussion on sales.
Similarly, in respect of inventory, while determining, types of goods to carry in stock and their size are a basic part of the sales function. The decision regarding the quantum of funds to invest in inventory is the primary responsibility of the finance manager since funds must supply to finance inventory.
As against the above, the decision relating to the acquisition of funds for financing business activities is primarily a finance function. Likewise, finance manager has to take the decision regarding the disposition of business income without consulting. Other executives since various factors involving in the decision affect ability of a firm to raise funds.
