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Financial Management — Business Studies STD 12 Commerce — Question

CBSE BoardEnglish MediumSTD 12 CommerceBusiness StudiesFinancial Management6 Marks
Question
Explain the role of financial management.
✓

Answer

Financial management has an important role to play in a business organisation. Decisions taken by the financial management have a direct bearing on the Financial Statements, e.g., Trading and Profit and Loss Account and Balance Sheet. They are the statements which reflect the progress of the business. For the determination of various items of the financial statements, the financial management has the following role to play:
  1. Determination of Fixed Assets: Fixed assets have an important contribution in the profits of a business organisation. Under the financial management, the total investment in the fixed assets and every separate fixed asset is determined. This is done through capital budgeting. For example, if it has been decided in the capital budgeting to invest rupees 500 crore, there will be an increase of rupees 500 crore in the fixed assets.
  2. Determination of Current Assets: Current assets are needed in the day to day transactions of business. Under the financial management, the total investment in current assets and every separate current asset is determined. For example, if the investment in current assets is rupees 100 crore, it will then be determined how much should be invested in cash, stock, debtors, etc.
  3. Determination of Proportion of Long-term and Short-term Finance: All the financial needs of business are fulfilled through long-term and short-term sources. Under financial management, a proportion of both the financial sources is determined. Long-term sources provide capital for business for a long time. Therefore, their use increases liquidity (meaning thereby that the business has the capacity to make quick payments in respect of daily payments). At the same time, the cost of long-term sources is higher than the cost of shortterm sources. Therefore, if there is more liquidity is required in business, more cost shall have to be borne, and vice-versa. Under financial management, the proportion of both these sources is determined on the basis of liquidity and cost analysis.
  4. Determination of Proportion of Various Sources of Long-term Finance: Long-term financial sources include primarily equity share capital, preference share capital, retained earning, debenture, long-term loan, etc. Under financial management, the proportion of various long-term financial sources is determined. All the sources have their merits and demerits. After making an analysis of their merits and demerits, a balanced decision is taken.
  5. Determination of Various Items of Profit and Loss Account: Various items included in the profit and loss get influenced or affected by different financial decisions. For example, interest is related to the amount of debt, depreciation is related to the amount of long-term assets, discount is related to the position of liquidity (which means that if the position of liquidity is good, discount can be earned by making timely payments) etc.

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