Finance Function: Meaning and Approaches

This article provides a study note on Finance Function:- 1. Meaning of Finance Function 2. Approaches to Finance Function 3. Aims.

Meaning of Finance Function:

Finance function is the most important of all business functions. It remains a focus of all activities. It is not possible to substitute or eliminate this function because the business will close down in the absence of finance. The need for money is continuous.

It starts with the setting up of an enterprise and remains at all times. The development and expansion of business rather needs more commitment for funds. The funds will have to be raised from various sources. The sources will be selected in relation to the implications attached with them. The receiving of money is not enough, its utilisation is more important.

The money once received will have to be returned also. If its use is proper then its return will be easy otherwise it will create difficulties for repayment. The management should have an idea of using the money profitably. It may be easy to raise funds but it may be difficult to repay them. The inflows and outflows of funds should be properly matched.

Approaches to Finance Function:

A number of approaches are associated with finance function but for the sake of convenience, various approaches are divided into two broad categories:

1. The Traditional Approach

2. The Modern Approach

1. The Traditional Approach:

The traditional approach to the finance function relates to the initial stages of its evolution during 1920s and 1930s when the term ‘corporation finance’ was used to describe what is known in the academic world today as the ‘financial management’. According to this approach, the scope, of finance function was confined to only procurement of funds needed by a business on most suitable terms.

The utilisation of funds was considered beyond the purview of finance function. It was felt that decisions regarding the application of funds are taken somewhere else in the organisation. However, institutions and instruments for raising funds were considered to be a part of finance function.

The scope of the finance function, thus, revolved around the study of rapidly growing capital market institutions, instruments and practices involved in raising of external funds.

The traditional approach to the scope and functions of finance has now been discarded as it suffers from many serious limitations:

(i) It is outsider-looking in approach that completely ignores internal decision making as to the proper utilisation of funds.

(ii) The focus of traditional approach was on procurement of long-term funds. Thus, it ignored the important issue of working capital finance and management.

(iii) The issue of allocation of funds, which is so important today, is completely ignored.

(iv) It does not lay focus on day to day financial problems of an organisation.

2. The Modern Approach:

The modern approach views finance function in broader sense. It includes both rising of funds as well as their effective utilisation under the purview of finance. The finance function does not stop only by finding out sources of raising enough funds; their proper utilisation is also to be considered. The cost of raising funds and the returns from their use should be compared.

The funds raised should be able to give more returns than the costs involved in procuring them. The utilisation of funds requires decision making. Finance has to be considered as an integral part of overall management. So finance functions, according to this approach, covers financial planning, rising of funds, allocation of funds, financial control etc.

The new approach is an analytical way of dealing with financial problems of a firm. The techniques of models, mathematical programming, simulations and financial engineering are used in financial management to solve complex problems of present day finance.

The modern approach considers the three basic management decisions, i.e., investment decisions, financing decisions and dividend decisions within the scope of finance function.

Aims of Finance Function:

The primary aim of finance function is to arrange as much funds for the business as are required from time to time.

This function has the following aims:

1. Acquiring Sufficient Funds:

The main aim of finance function is to assess the financial needs of an enterprise and then finding out suitable sources for raising them. The sources should be commensurate with the needs of the business. If funds are needed for longer periods then long-term sources like share capital, debentures, term loans may be explored.

A concern with longer gestation period should rely more on owner’s funds instead of interest-bearing securities because profits may not be there for some years.

2. Proper Utilisation of Funds:

Though raising of funds is important but their effective utilisation is more important. The funds should be used in such a way that maximum benefit is derived from them. The returns from their use should be more than their cost.

It should be ensured that funds do not remain idle at any point of time. The funds committed to various operations should be effectively utilised. Those projects should be preferred which are beneficial to the business.

3. Increasing Profitability:

The planning and control of finance function aims at increasing profitability of the concern. It is true that money generates money. To increase profitability, sufficient funds will have to be invested. Finance function should be so planned that the concern neither suffers from inadequacy of funds nor wastes more funds than required.

A proper control should also be exercised so that scarce resources are not frittered away on uneconomical operations. The cost of acquiring funds also influences profitability of the business. If the cost of raising funds is more, then profitability will go down. Finance function also requires matching of cost and returns from funds.

4. Maximising Firm’s Value:

Finance function also aims at maximising the value of the firm. It is generally said that a concern’s value is linked with its profitability. Even though profitability influences a firm’s value but it is not all. Besides profits, the type of sources used for raising funds, the cost of funds, the condition of money market, the demand for products are some other considerations which also influence a firm’s value.