Question

Draw a concept map or paradigm (with discussion) that illustate the concept of:

a. Functions of Financial Management
b. Responsibilities of Financial Managers
c. Agency Relationships

Answer 1

Financial management

Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprise. It means applying general management principles to financial resources of the enterprise.

                                                        according to J.F. Bradley defined as “Financial management is that area of business management devoted to a judicious use of capital and a careful selection of the source of capital in order to enable a spending unit to move in the direction of reaching the goals.”

A. Functions of Financial Management

1. Estimation of capital requirements:

A finance manager has to make estimation with regards to capital requirements of the company. This will depend upon expected costs and profits and future programmers and policies of a concern. Estimations have to be made in an adequate manner which increases earning capacity of enterprise.

2. Determination of capital composition:

Once the estimation have been made, the capital structure have to be decided. This involves short- term and long- term debt equity analysis. This will depend upon the proportion of equity capital a company is possessing and additional funds which have to be raised from outside parties.

3. Choice of sources of funds:

A. Issue of shares and debentures

B. Loans to be taken from banks and financial institutions

C. Public deposits to be drawn like in form of bonds.

Choice of factor will depend on relative merits and demerits of each source and period of financing.

4. Investment of funds:

The finance manager has to decide to allocate funds into profitable ventures so that there is safety on investment and regular returns is possible.

5. Disposal of surplus:

The net profits decision have to be made by the finance manager. This can be done in two ways:

Dividend declaration - It includes identifying the rate of dividends and other benefits like bonus.

Retained profits - The volume has to be decided which will depend upon expansion, innovational, diversification plans of the company.

6. Management of cash:

Finance manager has to make decisions with regards to cash management. Cash is required for many purposes like payment of wages and salaries, payment of electricity and water bills, payment to creditors, meeting current liabilities, maintenance of enough stock, purchase of raw materials, etc.

7. Financial controls:

The finance manager has not only to plan, procure and utilize the funds but he also has to exercise control over finances. This can be done through many techniques like ratio analysis, financial forecasting, cost and profit control, etc.

B. Responsibilities of Financial Managers

Financial managers perform data analysis and advise senior managers on profit-maximizing ideas. Financial managers are responsible for the financial health of an organization. They produce financial reports, direct investment activities, and develop strategies and plans for the long-term financial goals of their organization

a. Prepare financial statements, business activity reports, and forecasts,

b. Monitor financial details to ensure that legal requirements are met,

c. Supervise employees who do financial reporting and budgeting,

d. Review company financial reports and seek ways to reduce costs,

e. Analyze market trends to find opportunities for expansion or for acquiring other companies,

f. Help management make financial decisions.

Financial managers also do tasks that are specific to their organization or industry

1. Estimating the Amount of Capital Required:

This is the foremost function of the financial manager. Business firms require capital for:

(i) purchase of fixed assets,

(ii) meeting working capital requirements, and(iii) modernization and expansion of business.

The financial manager makes estimates of funds required for both short-term and long-term.

2. Determining Capital Structure:

Once the requirement of capital funds has been determined, a decision regarding the kind and proportion of various sources of funds has to be taken. For this, financial manager has to determine the proper mix of equity and debt and short-term and long-term debt ratio. This is done to achieve minimum cost of capital and maximise shareholders wealth.

3. Choice of Sources of Funds:

Before the actual procurement of funds, the finance manager has to decide the sources from which the funds are to be raised. The management can raise finance from various sources like equity shareholders, preference shareholders, debenture- holders, banks and other financial institutions, public deposits, etc.

4. Procurement of Funds:

The financial manager takes steps to procure the funds required for the business. It might require negotiation with creditors and financial institutions, issue of prospectus, etc. The procurement of funds is dependent not only upon cost of raising funds but also on other factors like general market conditions, choice of investors, government policy, etc.

5. Utilization of Funds:

The funds procured by the financial manager are to be prudently invested in various assets so as to maximize the return on investment: While taking investment decisions, management should be guided by three important principles, viz., safety, profitability, and liquidity.

6. Disposal of Profits or Surplus:

The financial manager has to decide how much to retain for sloughing back and how much to distribute as dividend to shareholders out of the profits of the company. The factors which influence these decisions include the trend of earnings of the company, the trend of the market price of its shares, the requirements of funds for self- financing the future programmers and so on.

7. Management of Cash:

Management of cash and other current assets is an important task of financial manager. It involves forecasting the cash inflows and outflows to ensure that there is neither shortage nor surplus of cash with the firm. Sufficient funds must be available for purchase of materials, payment of wages and meeting day-to-day expenses.

8. Financial Control:

Evaluation of financial performance is also an important function of financial manager. The overall measure of evaluation is Return on Investment (ROI). The other techniques of financial control and evaluation include budgetary control, cost control, internal audit, break-even analysis and ratio analysis. The financial manager must lay emphasis on financial planning as well.

C. Agency Relationships

All agency relationships are fiduciary relationships. This means the relationship involves a certain level of trust and confidence. The agent is obligated to act in the best interests of the principal because the agent's actions will create legal obligations for the principal. The agency relationship allows the agent to work on behalf of the principal as if the principal was present and acting alone. The principal-agent relationship is an arrangement in which one entity legally appoints another to act on its behalf. In a principal-agent relationship, the agent acts on behalf of the principal and should not have a conflict of interest in carrying out the act. The relationship between the principal and the agent is called the "agency," and the law of agency establishes guidelines for such a relationship.

A principal appoints an agent to act on their behalf and in their best interest. Examples include an investor picking a fund manager or someone hiring an attorney for legal work.

There should be no conflict of interest between the two, if there is, this creates a principal-agent problem.

The principal-agent relationship is expressed clearly through a written contract or is implied through actions. An agency relationship is a fiduciary relationship, where one person (called the “principal”) allows an agent to act on his or her behalf.

Duties of Principals and Agents

Agents are required to act up to the following duties and standards:

1.    Duty of loyalty: An agent owes his principal a general duty of loyalty. This means that the agent must subordinate his interests to those of the principal if they fall within the agency relationship. An example of a breach of this duty occurred when an employee in charge of determining what to bid on construction projects began working for a different construction company as an independent contractor doing the same type of work. The employee did not tell his current employer and, in fact, submitted bids for both companies on the same jobs. After a bench trial, the trial judge determined that the employee had breached his duty of loyalty

2.    Duty to act in accordance with the express and implied terms of a contract: For example, if the contract provides that the agent, a marketer, will call 5 large clothing companies on behalf of the principal, then that marketer has a duty to make those 5 phone calls and ONLY those 5 phone calls.

3.    Duty of care, competence, and diligence: This requires that the agent behave with the proper amount of care required by the situation.

4.    Duty of good conduct: This requires that the agent act in a way that does not injure the principal’s endeavor. The agent must make a reasonable attempt to provide the principal with relevant facts and information. If the agent has access to the property of the principal, the agent cannot make it appear as if the property is her own and may not commingle the property with anyone else’s. The agent must also keep track of how the principal’s property (money), is being spent.

   Duty to comply with the principal’s lawful instructions

Principals also owe agents a number of duties:

1.    Duty to act in accordance with the express and implied terms of a contract: If the principal breaches this duty, the agent can recover based on a breach of contract claim.[12] In one example, a seller decided to subdivide a large piece of property into separate lots. He hired an agent to plot and map the new development and they agreed to split the profit 50/50. The agent spent time and money starting this new venture, but then the seller changed his mind and terminated the contract. The court held there was a breach of contract and the agent was entitled to whatever benefits he would have received under the agreement

2.   Duty to deal fairly and in good faith with the agent: The principal must refrain from taking actions that could foreseeably result in loss for the agent, when the agent is not at fault.