CONCEPT OF FINANCIAL MANAGEMENT

The activities of organisations whether business or non-business, have finance as their centrepiece. The role of finance however reflects the objectives of an organisation. Therefore, financial management is a reflection of the nature and objectives of the organisation.  Financial management is thus a very important aspect of finance although it is not easy to separate financial management from the rest of other finance activities (Myres, 1976). However, an attempt to limit the areas of financial management can be made if one agrees with the fact that financial management itself requires the simultaneous consideration of three key financial decisions (Christy and Roden, 1973), namely:  

i) anticipation of financial needs of the organisation;

ii) acquisition of financial resources for the organisation;  

 
iii) allocation of financial resources within the organisation.

These three key financial decisions provide the basis for periodic financial analysis and interpretation of historical financial practices. The control measures which may be  contemplated by management or re-orientation of management strategies in turn depend on the analysis and interpretation of historical financial data.  

Financial management is, therefore, a dynamic and evolving art of making daily financial decisions and control in households, businesses, non-business organisations and government. It is a managerial activity which is concerned with planning, providing and controlling the financial resources at the disposal of an organisation. Thus, a financial manager continues to answer some basic questions like:   

√ What specific assets should the organisation    acquire?  

√ How much of funds should the organisation commit?   

√ How can such funds be acquired?  

Financial management system is, therefore, very important for adaptation in government, business and other organisations as it provides the theoretical concepts and analytical models and insights for making skillful financial decisions. However, the definition of financial management is influenced by its objectives. It can however, in general, be defined as the use of accounting knowledge, financial models, mathematical rules and some aspects of systems analysis and behavioural science for the specific purpose of assisting management in its function of financial planning, implementation and control.

The role of financial management in a simplified form is the synchronisation of receipts and payments flows. Thus, payments must be planned against receipts in order that the firm may remain liquid to the extent desired by management. In other words, financial management involves the management of funds inflows and outflows efficiently and effectively in order to guarantee the firm adequate liquidity. This implies effective management of financial resources in order to achieve a firm’s two most important objectives, namely: the maximisation of profits or maximisation of shareholder’s wealth and the maintenance of adequate liquidity level.

Functions of a Financial Manager

The financial manager assumes different names depending on the nature, size and organisational structure of the business. In some organisations, he is known as Finance Director or Director of Finance, in others, he is known as Finance Controller or General Manager (Finance).  Here, it will be assumed that the financial manager refers to the person in charge of the finance department of an organisation, whatever name he may be called. The financial manager is usually a member of the Board of Directors and he normally enlightens the board on financial implications of a firm’s decisions since most members of the Board are not usually adequately versed in financial terms and practices.

The functions of a financial manager pervade all the departments of an organisation in that he has to make key decisions affecting the operations of these departments as far as finances are concerned. And some of the functions are as follows,

1 Anticipation of the Financial Needs of an Organisation

Anticipation of the financial needs of an organisation involves the determination of how much the organisation would need within a certain period to run its activities.  This in essence is a forecasting activity. In other words, the financial manager has the responsibility of deciding how much funds his organisation would need within the short term, medium term and long term periods.  The short-term needs for funds are usually determined by considering series of cash inflows and outflows.  The financial manager can make a forecast of the firm’s financial requirements for a period of one month, one year or many years ahead. Forecasts are normally made in the form of budgets.

Forecast of the financial needs of an organisation should normally depend on the long term growth and profit plan of the organisation. By this, the financial manager will be able to determine the nature of funds needed by his organisation. This is because funds could be needed for expansion, in which case, such funds are of long-term nature.

2 Acquisition of Financial Resources  

Acquisition of financial resources is another important responsibility of the financial manager. This is based on the nature of funds needed by the organisation. The financial manager has to determine the time at which such funds could be acquired in order to make them available to his organisation when it most needs them. Thus, timing of funds acquisition is very important in financial management. Timing can equally help to reduce the cost of borrowing if the financial manager knows when to raise such funds from the market. The most important thing for the financial manager to do in terms of funds acquisition is to decide on where he is going to acquire such funds.

The nature and source of funds will determine the cost of borrowing. Funds could be raised from a bank, a non-bank financial  institution or from the capital market. The ability of a financial manager to raise funds from any of the sources would be determined by the size as well as the level of credit worthiness of the business organisation. The financial manager has to make the basic decision of whether funds should come from external or internal sources.  In the case of internal sources, he has to help in the formulation of appropriate dividend policy which will help him to achieve his objectives.

3 Allocation of Financial Resources  

Allocation of financial resources is the third important responsibility of the financial manager. Since the objectives of most businesses are profitability and liquidity, the financial manager has to allocate funds to assets that would help in the achievement of these objectives. The allocation of funds is normally done in a way that would minimise or eliminate over investment in fixed assets, or stock piling of inventory. In allocation of funds, the financial manager is normally conscious of maturity transformation in order to guarantee the firm its needed liquidity level.

4 Funds Management  

Funds management is highly related to allocation of funds. The financial manager can invest temporary surplus funds in securities to earn interest income for the company. He should know when to invest and when to divest. It is also the responsibility of the financial manager to prepare periodic reports on the finances of the organisation for the information of Management, Board of Directors, shareholders and the general public who may be interested in the affairs of the organisation.

5 Financial Analysis and Interpretation

The financial manager can also undertake the analysis of the historical financial data of the company in order to advise management on appropriate corporate and management strategies to adopt. An appropriate interpretation of financial analysis can always afford him to do this.  By his close association with the financial markets, the financial manager is in a position to determine the anticipated influence of fiscal and monetary policies on his company’s operations. It is his responsibility to pass informed judgement to management in order to adopt appropriate management strategies which can minimise such effects on the company’s operations.

6 Financial Planning and Control

The responsibility of the financial manager includes participation in product pricing. The determination of unit cost of production is done by accounting method and is under the control of the financial manager. Thus, pricing of products also attracts his attention since his objective is to maximise the difference between revenues and costs. Long-range planning, financial planning and control and budget preparation are very closely related.

Security For Bank Advances/Lending

                           

A security is an interest or a right in property given to the creditor to convert it into cash in case the debtor fails to meet the principal and interest on loan . It is an insurance against unforeseen development and the last avenue through which the bank can get its money recouped should things turn sour. It provides bankers with succour if every other things fails. Apparently, good security does not guarantee that loans will not be bad and neither does its absence impair the chance of success of the investment.

Bankers hold various kinds of securities as a cover of advances to their customers. The securities offered to the banks vary in rating.Securities which can be converted into cash without loss of value are ranked higher than that whose value fluctuate widely and tends to become frozen under adverse economic conditions . The main types of security offered against the loans are stocks and shares, title deeds, life policies, bills of exchange, bills of sale, and promissory notes. The banks also sometimes extend credit to their trusted customers on their personal securities or on the guarantees of responsible parties. The guiding principles of accepting securities are that they should be adequate, stable easily realizable e. t. c

Virtues of a good banking security

A good banking securities therefore must have the following essential attributes, viz,

1. Sufficiency
A good security must be adequate to cover the bank's entire exposure. To be on a safer side, the value of the pledge security should be 100% or more of the loan seek.

2. Objective and Stable value
A good banking security must be capable of being valued in a relatively objective rather than sentimental way. And apart from this,  its value must not be volatile but stable in the market.

3. Easily realizable
This attribute has to do with high marketability of the security. This implies that the pledged assets must be in high demand and easy to be sold off without loss in value.

4. Ease of assignment
The security must be capable of having its title legally passed to the bank with little problem. It must also be easy for the bank to re-transfer it back to the customer on liquidation of the debt.

5. Not Onerous
The security must not pose undue liabilities or inconvenience on the bank. For example, a basket of tomatoes.

6. Prime Asset
At best, security must be the borrower's prime asset  i. e an asset that the borrower hold in high esteem and would not like to lose. Borrowers normally have psychological attachment to their prime assets hence they will have the urge to liquidate their debt and take back the asset.

7. Legal binding
The security must be legally water tight so as to make it legally binding and enforceable.

8.Good Title
A good security must have unquestionable title. Registered land without encroachment and encumbrances obviously have good title.

What are Financial Assets ?

The financial assets are the financial instruments that are traded in the financial markets such as money market and capital market. These financial assets constitute the documentary evidence of the funds raised from the investors and savers who have surplus to part with for the use of corporate entities and government. The financial assets are inherently products of transactions in both the money market and the capital market. Such markets are well established in some economies while they are just being entrenched in some other economies.

The financial assets as products of transactions in the financial markets can be denominated in various currencies particularly the local currencies of various economies around the world. There are those financial instruments that are traded across international boundaries in some countries especially in highly developed capital markets in US, UK, Japan, France, and South Africa, just to mention but a few. Such financial assets are usually denominated mainly in American dollars and any other international money that is acceptable around the world.

Financial assets are normally issued in units such that the number of subscribers can be in threshold of thousands. For instance, a State Government Bond can be a total sum of N30 billion but in the denomination of N1,000 per unit of subscription. Therefore, the total amount of the amount has to be subscribed by many if not numerous investors at the end of the subscription period. This arrangement of raising funds through the financial markets is applicable to all financial instruments (e.g., Federal Government Loan Stock, shares, debentures, treasury bills, treasury certificates, etc) being used in such markets.

TYPES OF FINANCIAL ASSETS
The financial assets can be grouped into two main categories such as debt instruments and equity instruments. These are explained below.

i) Debt Instruments 
These are the financial instruments that are normally used by corporate entities and government to raise funds on the basis of debt obligations. This implies that such financial instruments are repayable by the organizations issuing them for raising funds from the financial markets from their operations.   The holders, therefore, are entitled to the funds at maturity dates in addition to the regular income accruing to them on them on the basis of interest payments by the corporate entities and government. Some of such instruments can be redeemed before their maturity dates as agreed to by the parties involved in the transactions. Such financial assets or instruments are also negotiable, being capable of being traded for cash before their maturity date. The various debt instruments being used for financial transactions in money market include the following:


> Treasury Bills;
> Treasury Certificates;
> Trade Bills; Commercial Papers; and
> Certificate of Deposits.

The above list is not exhaustive since there are new ones which are being developed and there are various ones that are peculiar to some specific economies that may not be available in some other economies.  The various debt instruments being used for financial transactions in capital market include the following:

> Development Loan Stocks;
> Debenture Stocks;
> Bonds;
> Mortgage Loan Stocks;
> Leases;
> Preference Shares; and
> Hire Purchase Contracts.

The above list is not exhaustive since there are variations in various world economies while there are new ones that are being developed. There are various ones that are peculiar to some specific economies that may not be available in some other economies.

ii) Equity Instruments
There are some financial instruments that are being used in the financial markets to raise equity funds by corporate entities. Such financial instruments are essentially Ordinary or Common Shares being used to raise funds to enhance the capital base of corporate organizations.

What are the characteristics of financial assets ?

There are peculiar characteristics that are inherent in financial assets that are normally used partly to determine their pricing in the financial markets. These characteristics are identified and discussed below.

1 Moneyness
The moneyness of the financial assets implies that they are easily convertible to cash within a defined time and determinable value. The cost of transactions involved in securing funds from them before the maturity date can be likened to agency cost besides the cost of discounting some of them, which reduces their face value.  Therefore, these financial instruments are regarded as near money because of the ease with which they can be traded for cash. Examples are Treasury bills, Treasury certificates, Trade bills, Commercial papers, and Certificate of Deposits, among others.

2 Divisibility & Denomination
The financial assets are usually made out in denominations depending on the face value that the corporate organizations and institutions that are using them to raise funds from the financial markets. The divisibility of such near money refers to the minimum monetary value in which a financial asst can be liquidated or exchanged for money by the holder.

Divisibility for financial assets is imperative so as to enable both suppliers and borrowers to understand the magnitude of funds involved in each of them; the borrowers have certain amount to source and the suppliers will like to know the amount that is required of him to part with for the transaction. It is also necessary so that a limit cab set for the minimum amount of subscription for each instrument and the overall amount of subscription that may accrue to a particular investor. For instance, many bonds can denominated like N1,000 denomination while that of certificate of deposits are denominated form N500,000.  

3 Reversibility
The financial assets are highly reversible in the sense that they are like deposits in accounts of customers with the banks. This implies that the cost of investing in the financial assets and getting them back into cash is negligible. Hence reversibility of financial assets is often regarded as turnaround cost or roundtrip cost.

The most relevant part of the roundtrip cost as associated with financial assets constitutes what is known as the ‘bid-ask spread’ in which commissions cost of delivery an asset is entrenched. In the well-organized financial market there are market makers who take responsibility of assuming risk in associated with the financial assets while making the market or carrying inventory of financial assets.

Therefore, the spread being charged by the market makers varies in line with financial assets that are traded.  Some financial assets carry less risk than others; for instance, marketable securities that can easily be converted into liquid cash with little or no hassles because they are more liquid than other financial assets. The risk involved in marketable securities or mortgage loan stock cannot be comparable with risk inherent in bond issue of a fledgling company.

The risk involved in market making is related to market forces that are twofold such as: Variability of the price; and Thickness of the market.

a) Variability of Price of financial asset 
 This is determined by some measure of dispersion in the price. It implies that the greater the variability in price, the greater the probability that the market maker may loose in the bargain. For instance, a speculative stock such as shares will be fraught with much larger short-run variations. On the other hand, Treasury bills, which government securities (or gilt-edged securities) exhibit stable price with less short-run variation.        

b) Thickness of the Market for financial asset 
The thickness of the market implies the frequency of transactions on a given financial asset. A thin market reflects a financial asset that has few trades on a regular or continuous basis, hence the greater the order flows on it the shorter the time that the asset will be held in the inventory of market makers. Therefore, such financial asset will exhibit smaller probability of an unfavourable price movement while it is in the inventory of market makers.    A thick market is associated with market where frequent transaction on financial assets is being exhibited and this varies from market to market. Hence a particular market for a financial asset such as shares may be thick while in another such financial asset may be thin. For instance, the shares of blue-chip firms will exhibit thickness in transactions while the shares of small companies may exhibit thinness in transactions in a given market situation.


4 Cash
Flow This refers to the return that an investor will derive from holding a financial asset, which invariably depends on all the cash distributions that the asset will pay holders. This is expressed in terms of the dividend on shares or coupon yield payments that are associated with bonds.
The return on investment in a financial asset is also affected by the repayment of the principal amount for a debt instrument and any expected price variation of the stock. In calculation of expected returns on a financial asset, factors that should be considered include non-cash payments in form of stock dividend yield and options to purchase additional stock or the distribution of other securities that must be factored in the  consideration. The issue of inflation implies that there is difference between normal effective return and real effective return on financial assets.  Therefore, the net real return on financial assets is the amount of cash returns that are accruable after adjusting the nominal returns against inflation.  

5 Maturity Period 
In financial parlance, the maturity period refers to the length of time within which the corporate entity or institution that employs a financial instrument to raise funds will use the funds before its payment back to the holders of such instrument. For instance, a bond can be held by a corporate entity for a period of thirty (30) years while that of government can extend to a period of ninety-nine (99) years before their repayment to the holders.  

There are some financial instruments being traded in the financial markets that may not reach the stated maturity dates before they are terminated by the corporate entities that use them to raise funds. There are reasons that may be responsible for such situation which include the following:

Bankruptcy:- a situation in which the company is being unable to meet its external financial obligations  and therefore, declared bankrupt;

Reorganization:- a situation in which the company is restructuring its ownership structure and operations; and

Call Provision:- the financial instrument being associated with call provision.

The case of call provision implies that the company as the debtor or user of the funds takes responsibility of setting aside sinking funds with which to redeem the instruments eventually.
The sinking fund is normally made as one of the contractual obligations that are established in the agreement or indenture regulating the usage of the funds from the financial instrument.

 6 Convertibility
This characteristic implies that a financial asset or instrument can be converted into another class of asset which will still be held by the corporate entity has original used to raise funds for its operations. The conversion can take a form of bond being converted to bond, preference shares being converted to equity shares, and a company bond being converted into equity shares of the company.

 The opportunity for convertibility of financial instruments into another financial assets has to be entrenched in the covenant which has been written to guide the contractual agreement on the instrument or to regulate the behaviour of the company using the funds from the instruments. Nevertheless, such a provision can be negotiated in the course of the usage of the funds by a company especially when the holders discover that the company is manipulating its operational and financial records to shortchange them.  

7 Currency 
Financial assets are normally denominated in currencies of the various countries around the world. This implies financial assets of the Nigerian financial system are denominated in Naira such as Federal Government Loan Stock, Treasury Bills, Treasury Certificate, Shares and Corporate and State Government Bonds. Those financial assets in Japan are denominated in Yen, those in the United States of America are in Dollars, those in United Kingdom are in Pounds Sterling while those in China are in Yuan, etc.

You have also learned from the initial section of this study unit that financial assets as products of transactions in the financial markets can be denominated in various currencies particularly the local currencies of various economies around the world. Nevertheless, there are those financial instruments that are traded across international boundaries in some countries especially in highly developed capital markets in US, UK, Japan, France, and South Africa, just to mention but a few. Such financial assets are usually denominated mainly in American dollars and any other international money that is acceptable around the world.

Furthermore, it is important for investors to know the currency in which certain financial assets are denominated when buy them. For instance, the recent ECO Bank shares were denominated in US dollars when they were offered to the public for subscription. These shares were floated across international boundaries many countries in Africa. Therefore, the use of an international currency such as the US dollars made it easier for the bank to handle the transactions in the stock seamlessly. Nevertheless, subscribers were made to pay the equivalent of their total amount of subscription in their local currencies. The dividends for these shares are also being paid in US dollars.

Dual currency securities may be issued in some instances. For instance, the EURO Bonds are issued in dual currencies for ease of transactions by multiple subscriptions by various investors around the world. Therefore, it is the policy on EURO Bonds to pay interest in one currency while the principal repayment is effected in another currency.

8 Liquidity
You have learned from above that one of the main characteristics of financial assets is the moneyness of such instruments which implies that they are easily convertible to cash within a defined time and determinable value. The cost of transactions involved in securing funds from them before the maturity date can be likened to agency cost besides the cost of discounting some of them, which reduces their face value. Hence, these financial instruments are regarded as near money because they are highly liquid in terms of the ease with which they can be traded for cash. Good examples of highly liquid financial instruments include Treasury bills, Treasury certificates, Certificate of Deposits, Bills of Exchange, and shares of blue chip companies, e.g., Shares of Cadbury, First Bank, Guaranty Trust Bank, etc.

However, there are some financial instruments that cannot be easily converted to cash whenever the holders need money. Therefore, they are illiquid because the holders may have to retain them till they are matured; alternatively they can only trade them for very insignificant value in capital markets where there are jobbers that may be willing to carry them in their stock of securities. Presently there are no jobbers operating in the Nigerian Stock Exchange, and hence the stock brokers in the Exchange are usually not willing to trade in financial instruments of weak corporate entities.

 9 Predictable Returns 
The return on financial assets must be predictable for the purpose of their being patronized by investors. For instance, the investors should be able to know the percentage of interest that are attached to certain debt instruments before they will be prepared to stake their funds on them. This is because performance of a company cannot be taken for granted due to the mere fact that top management and the boards of directors are known to be manipulating the accounting records of their companies these days.  This is more reason why investors are always very skeptical in patronizing financial instruments of some corporate entities due to their antecedents in manipulating their accounting records. The cases of Cadbury in Nigeria and Enron in the US are classical testimonies to the unwholesome accounting practices in the operations of companies around the world.

However, the returns on bonds, development loan stocks, and preference shares are determinable so that the investors are aware about the expected returns on their investment. There other government securities such as Treasury bills and Treasury certificates which are traded in money market that command fixed returns. The apex bank has the responsibility in their issuance and also their repayment as well as the payment of their returns to the subscribers. Therefore, State government bonds, Federal Government development loan stocks, Treasury bills and Treasury certificates are regarded as gilt-edged securities because their returns as well as principal amount of investment in these securities must be paid as at when due for settlement.  

The issue of unpredictability of future returns on some securities such as equity shares results from volatility in earnings by the companies in their operations. However, the unpredictability to future returns can be measured on how it relates to the level of volatility of a given financial asset. The returns on equity shares like dividends are the residual payments from the earnings of corporations. Nevertheless, the attraction in these shares is the possibility of capital appreciation in their value but subject to the performance of their corporations and capital market operational forces.

10 Tax Status of Returns 
The returns on various financial assets are subject to tax status because they are taxable earnings. The tax authorities are interested in collection of taxes on earnings from financial assets as securities which are regarded as incomes for investors. However, the tax status on financial assets varies from one economy to another.

The rate of such taxes on financial assets is also subject to variation from time to time depending on the interest of the government which must be adhered to by the tax authorities. The tax status on financial assets also differs from one type of security to another depending on the nature of the issuing companies or institutions such as Federal, State, or local government.