Nature and Scope of Finance PDF

1 Outline – Nature and Scope of Finance  2 Key learning point – At the end of this module, students should be able to:  Give the meaning of finance/ financial management and its scope.  Describe the evolution of financial management. ...

1 Outline – Nature and Scope of Finance  2 Key learning point – At the end of this module, students should be able to:  Give the meaning of finance/ financial management and its scope.  Describe the evolution of financial management.  Discuss the scope of financial management.  State and explain the various disciplines related to financial management.  Describe how the finance department is organised.  State the duties of a finance manager.  State and explain the environmental factors affecting financial management.  3 Some Preliminaries.  Course Title - Introduction to Finance  Lecturer – Dr. Fredrick Ikpesu  CA - Tests, Assign, Group Work - 30%  Participation - Active participation is important - 5%  Exam - 65%.  Cheating - Carries penalty plus no score.  Contact - Department of Accounting & Finance, (SMSS).  Email - [email protected]  Office - Rm T.Y 250 Danjuma Academic complex  Mobile - 07033975732  4 Meaning of Finance Finance is simply the provision of money when and where needed. It deals with the acquisition and utilisation of fund. Finance is the study and management of money, investments, and other financial instruments. It encompasses the processes of acquiring funds, allocating resources, managing assets, and making decisions that affect an organization’s financial health.  5 Finance can be broadly divided into three categories: 1. Personal Finance: Managing individual or household financial activities, such as budgeting, saving, investing, and planning for retirement. 2. Corporate Finance: Involves the financial activities of businesses, including funding, capital structure, and investment decisions aimed at maximizing shareholder value. 3. Public Finance: Focuses on the financial activities of governments and public entities, dealing with revenue generation, public expenditure, and budgeting.  6 Meaning of Financial Management The term financial management is coined from two words: FINANCE MANAGEMENT  7  Financial management refers to the sourcing of funds and the effective and efficient utilisation of such funds to meet the financial need of the firm.  Financial management is a subset of finance that involves planning, organizing, directing, and controlling financial activities within an organization.  It aims to manage the company’s finances in a way that maximizes its value and ensures long-term sustainability.  The person in charge of managing the firm’s financial resources is usually referred to as the finance manager/finance director/chief finance officer.  8 Key components of financial management 1. Budgeting: Creating a financial plan that outlines expected revenues and expenses over a specific period. 2. Forecasting: Predicting future financial outcomes based on historical data and market analysis. 3. Capital Structure: Determining the optimal mix of debt and equity financing to fund the company's operations and growth. 4. Investment Analysis: Evaluating potential investment opportunities to determine their profitability and risk. 5. Risk Management: Identifying and mitigating financial risks that could adversely affect the organization. Overall, financial management is critical for making informed decisions that align with the organization’s strategic goals and enhance its overall financial performance.  9 TRADITIONAL PHASE TRANSITIONAL PHASE EVOLUTI ON OF MODERN FINANCE PHASE  1 0 Traditional Phase Key Characteristics:  The focus of financial management was predominantly on sourcing of funds.  This period viewed financial management from the perspective of external stakeholders, primarily the providers of capital.  Emphasis on fund sourcing over fund allocation. It viewed financial management primarily from the perspective of external stakeholders, particularly fund providers  Use of financial instruments such as bonds, shares, options, debentures, etc; to raise funds Limitations:  Little attention paid to the working capital problems faced by finance managers.  This phase has been criticized for its external viewpoint i.e., external stakeholders  Neglect of routine financial management issues  Lack of focus on the allocation of funds.  1 1 Transitional Phase Key Characteristics:  The Transitional Phase commenced in the early 1940s  During this period, financial management began to shift focus, addressing some of the shortcomings of the Traditional Phase.  Greater emphasis was placed on the working capital challenges encountered by finance managers.  This phase saw the development and advancement of capital budgeting techniques, marking a significant evolution in financial management practices.  The phase also saw the introduction of finance courses in the Universities.  Overall, the early 1940s marked a crucial period for the formalization and development of finance as a key area of study.  1 2 Modern Phase The Modern Phase marked a period of substantial transformation in financial management. The primary concern during this phase was the optimal allocation of funds to maximise shareholders wealth. This era integrated concepts from economics and statistics, rendering financial management more quantitative and analytical. Key Characteristics:  Advanced Financial Theories: The introduction of theories such as Modern Portfolio Theory (MPT), Capital Asset Pricing Model (CAPM), Cost of capital, Dividend policy, Risk/return relationships, Portfolio management, Working capital management etc.  Technological Integration: The rise of financial technology (fintech) has revolutionized how financial services are delivered, making transactions faster and more accessible.  Globalization: Increased cross-border investment and the integration of global financial markets have expanded opportunities and complexity in finance.  Regulatory Environment: More sophisticated regulatory frameworks have  1 3 Scope of Financial Management… Cont’d Modern scope of financial management Investment decision Scope of Dividend Financial Liquidity decision managem decision ent Financing decision  1 4 Financial Management and Its Link to Other Disciplines i. Accounting ii. Law iii. Economics iv. Quantitative method v. Behavioural science  1 5 Financial management as a discipline draws on related subjects such as accounting, law, economics, behavioural science, and quantitative method. i. Accounting: Accounting involves recording and reporting the financial transactions of a business. Financial management utilises these reports to make decisions on investment, financing, dividends, and liquidity. Additionally, the financial statements prepared by accountants are often considered indicators of effective financial management, as a robust financial statement reflects sound financial practices. ii. Law: The activities of a finance manager are typically governed by legal frameworks. This includes aspects such as dividend payments, taxation, and raising funds in the stock market. Therefore, the finance manager must have a thorough understanding of the relevant laws and ensure that the organisation complies with them to avoid fines and penalties. iii. Economics: Financial management is closely linked with economics, applying principles of both microeconomics and macroeconomics. A strong grasp of economic theories and government policies enables the finance manager to understand the broader business environment and how various economic factors impact the firm's operations. iv. Behavioural science: Behavioural science, which examines human actions and societal behaviour patterns, provides valuable insights for financial management. By applying principles of behavioural science, finance managers can better understand and predict investor behaviours and market trends. Quantitative method: Quantitative methods involve the use of statistical tools for collecting and analysing data. Financial management relies on these methods for financial planning, budgeting, and the management and control of the firm’s financial resources. Quantitative techniques enable finance managers to forecast and analyse risks and returns effectively  1 6 Organisation of the Finance Department The finance department is usually headed by the vice president finance/finance director/chief financial officer.  1 7 Organisation of the Finance Department…cont’d  1 8 Duties of a Finance Manager The finance manager anticipates (forecasts or estimates) the financial needs of the firm. The finance manager determines the capital structure of the firm. The finance manager source funds from the providers of finance (banks, financial institutions, non-financial institutions, etc.) to meet the financial needs of the firm. The finance manager allocates funds obtained from the various sources of finance to meet the organisational goal.  1 9 Duties of a Finance Manager…cont’d The finance manager appropriates the firm’s profits among various shareholders and debenture holders and retains some as reserves for future investment. The finance manager control all the financial activities (including cash and credit management) of the firm to ensure that the overall aim of the organisation is being achieved.  2 0 Financial Management Environment i. Financial environment The financial environment comprises the regulators, financial market, financial instruments, and financial intermediaries. ii. Business environnent The business environment refers to the internal and external factors that affect or influence an organisation’s activity.  2 1 Group activities Duties of a finance manager o Develop and manage financial forecasts, budgets, and long-term financial plans. o Analyze financial data to identify trends and provide insights for strategic decision-making. o Prepare annual budgets and monitor performance against budgeted figures. o Identify variances and implement corrective actions as needed o Monitor cash flow to ensure liquidity for day-to-day operations. o Develop strategies to optimize cash flow and manage working capital effectively. o Evaluate potential investment opportunities and conduct cost-benefit analyses. o Assess risks associated with investments and make recommendations to senior management. o Identify financial risks and develop strategies to mitigate them. o Ensure adequate insurance coverage and compliance with regulatory requirements. o Analyze the company's capital structure and recommend changes to optimize funding sources. o Manage relationships with financial institutions and investors.  2 2 Answer: 1. Financial Planning and Analysis: o Develop and manage financial forecasts, budgets, and long-term financial plans. o Analyze financial data to identify trends and provide insights for strategic decision- making. 2. Budget Management: o Prepare annual budgets and monitor performance against budgeted figures. o Identify variances and implement corrective actions as needed. 3. Liquidity Management: o Monitor cash flow to ensure liquidity for day-to-day operations. o Develop strategies to optimize cash flow and manage working capital effectively. 4. Investment Analysis: o Evaluate potential investment opportunities and conduct cost-benefit analyses. o Assess risks associated with investments and make recommendations to senior management. 5. Capital Structure Management/Financing: o Analyze the company's capital structure and recommend changes to optimize funding sources. o Manage relationships with financial institutions and investors. 6. Risk Management: o Identify financial risks and develop strategies to mitigate them.  2 3 Recommended readings Fundamentals of Financial Management: A Simplified Approach: by Fredrick Ikpesu and Olusegun Vincent