Financial planning

What is Financial Planning ?

Financial Planning is the process of estimating the capital required and determining it’s competition. It is the process of framing financial policies in relation to procurement, investment and administration of funds of an enterprise.

PROFITS PLANNING

Objectives of Financial Planning

Financial Planning has got many objectives to look forward to

Determining capital requirements- This will depend upon factors like cost of current and fixed assets, promotional expenses and long- range planning. Capital requirements have to be looked with both aspects: short- term and long- term requirements.
Determining capital structure- The capital structure is the composition of capital, i.e., the relative kind and proportion of capital required in the business. This includes decisions of debt- equity ratio- both short-term and long- term.
Framing financial policies with regards to cash control, lending, borrowings, etc.
A finance manager ensures that the scarce financial resources are maximally utilized in the best possible manner at least cost in order to get maximum returns on investment.

Importance of Financial Planning

Financial Planning is process of framing objectives, policies, procedures, programmes and budgets regarding the financial activities of a concern. This ensures effective and adequate financial and investment policies. The importance can be outlined as-

Adequate funds have to be ensured.
Financial Planning helps in ensuring a reasonable balance between outflow and inflow of funds so that stability is maintained.
Financial Planning ensures that the suppliers of funds are easily investing in companies which exercise financial planning.
Financial Planning helps in making growth and expansion programmes which helps in long-run survival of the company.
Financial Planning reduces uncertainties with regards to changing market trends which can be faced easily through enough funds.
Financial Planning helps in reducing the uncertainties which can be a hindrance to growth of the company. This helps in ensuring stability an d profitability in concern.

Finance Functions

Investment Decision

One of the most important finance functions is to intelligently allocate capital to long term assets. This activity is also known as capital budgeting. It is important to allocate capital in those long term assets so as to get maximum yield in future. Following are the two aspects of investment decision

Evaluation of new investment in terms of profitability
Comparison of cut off rate against new investment and prevailing investment.

Since the future is uncertain therefore there are difficulties in calculation of expected return. Along with uncertainty comes the risk factor which has to be taken into consideration. This risk factor plays a very significant role in calculating the expected return of the prospective investment. Therefore while considering investment proposal it is important to take into consideration both expected return and the risk involved.

Investment decision not only involves allocating capital to long term assets but also involves decisions of using funds which are obtained by selling those assets which become less profitable and less productive. It wise decisions to decompose depreciated assets which are not adding value and utilize those funds in securing other beneficial assets. An opportunity cost of capital needs to be calculating while dissolving such assets. The correct cut off rate is calculated by using this opportunity cost of the required rate of return (RRR).

Financial Decision

Financial decision is yet another important function which a financial manger must perform. It is important to make wise decisions about when, where and how should a business acquire funds. Funds can be acquired through many ways and channels. Broadly speaking a correct ratio of an equity and debt has to be maintained. This mix of equity capital and debt is known as a firm’s capital structure.

A firm tends to benefit most when the market value of a company’s share maximizes this not only is a sign of growth for the firm but also maximizes shareholders wealth. On the other hand the use of debt affects the risk and return of a shareholder. It is more risky though it may increase the return on equity funds.

A sound financial structure is said to be one which aims at maximizing shareholders return with minimum risk. In such a scenario the market value of the firm will maximize and hence an optimum capital structure would be achieved. Other than equity and debt there are several other tools which are used in deciding a firm capital structure.

Dividend Decision

Earning profit or a positive return is a common aim of all the businesses. But the key function a financial manger performs in case of profitability is to decide whether to distribute all the profits to the shareholder or retain all the profits or distribute part of the profits to the shareholder and retain the other half in the business.

It’s the financial manager’s responsibility to decide a optimum dividend policy which maximizes the market value of the firm. Hence an optimum dividend payout ratio is calculated. It is a common practice to pay regular dividends in case of profitability Another way is to issue bonus shares to existing shareholders.

Liquidity Decision

It is very important to maintain a liquidity position of a firm to avoid insolvency. Firm’s profitability, liquidity and risk all are associated with the investment in current assets. In order to maintain a tradeoff between profitability and liquidity it is important to invest sufficient funds in current assets. But since current assets do not earn anything for business therefore a proper calculation must be done before investing in current assets.

Current assets should properly be valued and disposed of from time to time once they become non profitable. Currents assets must be used in times of liquidity problems and times of insolvency.

The Role of the Finance Function in Organizational Processes

The Finance Function and the Project Office

Contemporary organizations need to practice cost control if they are to survive the recessionary times. Given the fact that many top tier companies are currently mired in low growth and less activity situations, it is imperative that they control their costs as much as possible. This can happen only when the finance function in these companies is diligent and has a hawk eye towards the costs being incurred. Apart from this, companies also have to introduce efficiencies in the way their processes operate and this is another role for the finance function in modern day organizations.

There must be synergies between the various processes and this is where the finance function can play a critical role. Lest one thinks that the finance function, which is essentially a support function, has to do this all by themselves, it is useful to note that, many contemporary organizations have dedicated project office teams for each division, which perform this function.

In other words, whereas the finance function oversees the organizational processes at a macro level, the project office teams indulge in the same at the micro level. This is the reason why finance and project budgeting and cost control have assumed significance because after all, companies exist to make profits and finance is the lifeblood that determines whether organizations are profitable or failures.

The Pension Fund Management and Tax Activities of the Finance Function

The next role of the finance function is in payroll, claims processing, and acting as the repository of pension schemes and gratuity. If the US follow the 401(k) rule and the finance function manages the defined benefit and defined contribution schemes, in India it is the EPF or the Employee Provident Funds that are managed by the finance function. Of course, only large organizations have dedicated EPF trusts to take care of these aspects and the norm in most other organizations is to act as facilitators for the EPF scheme with the local or regional PF (Provident Fund) commissioner.

The third aspect of the role of the finance function is to manage the taxes and their collection at source from the employees. Whereas in the US, TDS or Tax Deduction at Source works differently from other countries, in India and much of the Western world, it is mandatory for organizations to deduct tax at source from the employees commensurate with their pay and benefits.

The finance function also has to coordinate with the tax authorities and hand out the annual tax statements that form the basis of the employee’s tax returns. Often, this is a sensitive and critical process since the tax rules mandate very strict principles for generating the tax statements.

Payroll, Claims Processing, and Automation

We have discussed the pension fund management and the tax deduction. The other role of the finance function is to process payroll and associated benefits in time and in tune with the regulatory requirements.

Claims made by the employees with respect to medical, and transport allowances have to be processed by the finance function. Often, many organizations automate this routine activity wherein the use of ERP (Enterprise Resource Planning) software and financial workflow automation software make the job and the task of claims processing easier. Having said that, it must be remembered that the finance function has to do its due diligence on the claims being submitted to ensure that bogus claims and suspicious activities are found out and stopped. This is the reason why many organizations have experienced chartered accountants and financial professionals in charge of the finance function so that these aspects can be managed professionally and in a trustworthy manner.

The key aspect here is that the finance function must be headed by persons of high integrity and trust that the management reposes in them must not be misused. In conclusion, the finance function though a non-core process in many organizations has come to occupy a place of prominence because of these aspects.

Role of a Financial Manager

Financial activities of a firm is one of the most important and complex activities of a firm. Therefore in order to take care of these activities a financial manager performs all the requisite financial activities.

A financial manger is a person who takes care of all the important financial functions of an organization. The person in charge should maintain a far sightedness in order to ensure that the funds are utilized in the most efficient manner. His actions directly affect the Profitability, growth and goodwill of the firm.

Following are the main functions of a Financial Manager:

Raising of Funds

In order to meet the obligation of the business it is important to have enough cash and liquidity. A firm can raise funds by the way of equity and debt. It is the responsibility of a financial manager to decide the ratio between debt and equity. It is important to maintain a good balance between equity and debt.

Allocation of Funds

Once the funds are raised through different channels the next important function is to allocate the funds. The funds should be allocated in such a manner that they are optimally used. In order to allocate funds in the best possible manner the following point must be considered

The size of the firm and its growth capability
Status of assets whether they are long-term or short-term
Mode by which the funds are raised

These financial decisions directly and indirectly influence other managerial activities. Hence formation of a good asset mix and proper allocation of funds is one of the most important activity

Profit Planning

Profit earning is one of the prime functions of any business organization. Profit earning is important for survival and sustenance of any organization. Profit planning refers to proper usage of the profit generated by the firm.

Profit arises due to many factors such as pricing, industry competition, state of the economy, mechanism of demand and supply, cost and output. A healthy mix of variable and fixed factors of production can lead to an increase in the profitability of the firm.

Fixed costs are incurred by the use of fixed factors of production such as land and machinery. In order to maintain a tandem it is important to continuously value the depreciation cost of fixed cost of production. An opportunity cost must be calculated in order to replace those factors of production which has gone thrown wear and tear. If this is not noted then these fixed cost can cause huge fluctuations in profit.

Understanding Capital Markets

Shares of a company are traded on stock exchange and there is a continuous sale and purchase of securities. Hence a clear understanding of capital market is an important function of a financial manager. When securities are traded on stock market there involves a huge amount of risk involved. Therefore a financial manger understands and calculates the risk involved in this trading of shares and debentures.

Its on the discretion of a financial manager as to how to distribute the profits. Many investors do not like the firm to distribute the profits amongst share holders as dividend instead invest in the business itself to enhance growth. The practices of a financial manager directly impact the operation in capital market.

Capital Structure - Meaning and Factors Determining Capital Structure

Meaning of Capital Structure

Capital Structure is referred to as the ratio of different kinds of securities raised by a firm as long-term finance. The capital structure involves two decisions-

Type of securities to be issued are equity shares, preference shares and long term borrowings (Debentures).
Relative ratio of securities can be determined by process of capital gearing. On this basis, the companies are divided into two-
Highly geared companies - Those companies whose proportion of equity capitalization is small.
Low geared companies - Those companies whose equity capital dominates total capitalization.

For instance - There are two companies A and B. Total capitalization amounts to be USD 200,000 in each case. The ratio of equity capital to total capitalization in company A is USD 50,000, while in company B, ratio of equity capital is USD 150,000 to total capitalization, i.e, in Company A, proportion is 25% and in company B, proportion is 75%. In such cases, company A is considered to be a highly geared company and company B is low geared company.

Factors Determining Capital Structure

Trading on Equity- The word “equity” denotes the ownership of the company. Trading on equity means taking advantage of equity share capital to borrowed funds on reasonable basis. It refers to additional profits that equity shareholders earn because of issuance of debentures and preference shares. It is based on the thought that if the rate of dividend on preference capital and the rate of interest on borrowed capital is lower than the general rate of company’s earnings, equity shareholders are at advantage which means a company should go for a judicious blend of preference shares, equity shares as well as debentures. Trading on equity becomes more important when expectations of shareholders are high.
Degree of control- In a company, it is the directors who are so called elected representatives of equity shareholders. These members have got maximum voting rights in a concern as compared to the preference shareholders and debenture holders. Preference shareholders have reasonably less voting rights while debenture holders have no voting rights. If the company’s management policies are such that they want to retain their voting rights in their hands, the capital structure consists of debenture holders and loans rather than equity shares.
Flexibility of financial plan- In an enterprise, the capital structure should be such that there is both contractions as well as relaxation in plans. Debentures and loans can be refunded back as the time requires. While equity capital cannot be refunded at any point which provides rigidity to plans. Therefore, in order to make the capital structure possible, the company should go for issue of debentures and other loans.
Choice of investors- The company’s policy generally is to have different categories of investors for securities. Therefore, a capital structure should give enough choice to all kind of investors to invest. Bold and adventurous investors generally go for equity shares and loans and debentures are generally raised keeping into mind conscious investors.
Capital market condition- In the lifetime of the company, the market price of the shares has got an important influence. During the depression period, the company’s capital structure generally consists of debentures and loans. While in period of boons and inflation, the company’s capital should consist of share capital generally equity shares.
Period of financing- When company wants to raise finance for short period, it goes for loans from banks and other institutions; while for long period it goes for issue of shares and debentures.
Cost of financing- In a capital structure, the company has to look to the factor of cost when securities are raised. It is seen that debentures at the time of profit earning of company prove to be a cheaper source of finance as compared to equity shares where equity shareholders demand an extra share in profits.
Stability of sales- An established business which has a growing market and high sales turnover, the company is in position to meet fixed commitments. Interest on debentures has to be paid regardless of profit. Therefore, when sales are high, thereby the profits are high and company is in better position to meet such fixed commitments like interest on debentures and dividends on preference shares. If company is having unstable sales, then the company is not in position to meet fixed obligations. So, equity capital proves to be safe in such cases.
Sizes of a company- Small size business firms capital structure generally consists of loans from banks and retained profits. While on the other hand, big companies having goodwill, stability and an established profit can easily go for issuance of shares and debentures as well as loans and borrowings from financial institutions. The bigger the size, the wider is total capitalization.

Capitalization in Finance

What is Capitalization ?

Capitalization comprises of share capital, debentures, loans, free reserves, etc. Capitalization represents permanent investment in companies excluding long-term loans. Capitalization can be distinguished from capital structure. Capital structure is a broad term and it deals with qualitative aspect of finance. While capitalization is a narrow term and it deals with the quantitative aspect.

Capitalization is generally found to be of following types-

Normal
Over
Under

Overcapitalization

Overcapitalization is a situation in which actual profits of a company are not sufficient enough to pay interest on debentures, on loans and pay dividends on shares over a period of time. This situation arises when the company raises more capital than required. A part of capital always remains idle. With a result, the rate of return shows a declining trend. The causes can be-

High promotion cost- When a company goes for high promotional expenditure, i.e., making contracts, canvassing, underwriting commission, drafting of documents, etc. and the actual returns are not adequate in proportion to high expenses, the company is over-capitalized in such cases.
Purchase of assets at higher prices- When a company purchases assets at an inflated rate, the result is that the book value of assets is more than the actual returns. This situation gives rise to over-capitalization of company.
A company’s floatation n boom period- At times company has to secure it’s solvency and thereby float in boom periods. That is the time when rate of returns are less as compared to capital employed. This results in actual earnings lowering down and earnings per share declining.
Inadequate provision for depreciation- If the finance manager is unable to provide an adequate rate of depreciation, the result is that inadequate funds are available when the assets have to be replaced or when they become obsolete. New assets have to be purchased at high prices which prove to be expensive.
Liberal dividend policy- When the directors of a company liberally divide the dividends into the shareholders, the result is inadequate retained profits which are very essential for high earnings of the company. The result is deficiency in company. To fill up the deficiency, fresh capital is raised which proves to be a costlier affair and leaves the company to be over- capitalized.
Over-estimation of earnings- When the promoters of the company overestimate the earnings due to inadequate financial planning, the result is that company goes for borrowings which cannot be easily met and capital is not profitably invested. This results in consequent decrease in earnings per share.

Effects of Overcapitalization

On Shareholders- The over capitalized companies have following disadvantages to shareholders:
- Since the profitability decreases, the rate of earning of shareholders also decreases.
- The market price of shares goes down because of low profitability.
- The profitability going down has an effect on the shareholders. Their earnings become uncertain.
- With the decline in goodwill of the company, share prices decline. As a result shares cannot be marketed in capital market.
On Company-
- Because of low profitability, reputation of company is lowered.
- The company’s shares cannot be easily marketed.
- With the decline of earnings of company, goodwill of the company declines and the result is fresh borrowings are difficult to be made because of loss of credibility.
- In order to retain the company’s image, the company indulges in malpractices like manipulation of accounts to show high earnings.
- The company cuts down it’s expenditure on maintenance, replacement of assets, adequate depreciation, etc.
On Public- An overcapitalized company has got many adverse effects on the public:
- In order to cover up their earning capacity, the management indulges in tactics like increase in prices or decrease in quality.
- Return on capital employed is low. This gives an impression to the public that their financial resources are not utilized properly.
- Low earnings of the company affects the credibility of the company as the company is not able to pay it’s creditors on time.
- It also has an effect on working conditions and payment of wages and salaries also lessen.

Undercapitalization

An undercapitalized company is one which incurs exceptionally high profits as compared to industry. An undercapitalized company situation arises when the estimated earnings are very low as compared to actual profits. This gives rise to additional funds, additional profits, high goodwill, high earnings and thus the return on capital shows an increasing trend. The causes can be-

Low promotion costs
Purchase of assets at deflated rates
Conservative dividend policy
Floatation of company in depression stage
High efficiency of directors
Adequate provision of depreciation
Large secret reserves are maintained.

Effects of Under Capitalization

On Shareholders
- Company’s profitability increases. As a result, rate of earnings go up.
- Market value of share rises.
- Financial reputation also increases.
- Shareholders can expect a high dividend.
On company
- With greater earnings, reputation becomes strong.
- Higher rate of earnings attract competition in market.
- Demand of workers may rise because of high profits.
- The high profitability situation affects consumer interest as they think that the company is overcharging on products.
On Society
- With high earnings, high profitability, high market price of shares, there can be unhealthy speculation in stock market.
- ‘Restlessness in general public is developed as they link high profits with high prices of product.
- Secret reserves are maintained by the company which can result in paying lower taxes to government.
- The general public inculcates high expectations of these companies as these companies can import innovations, high technology and thereby best quality of product.

Financial Goal - Profit vs Wealth

Every firm has a predefined goal or an objective. Therefore the most important goal of a financial manager is to increase the owner’s economic welfare. Here economics welfare may refer to maximization of profit or maximization of shareholders wealth. Therefore Shareholders wealth maximization (SWM) plays a very crucial role as far as financial goals of a firm are concerned.

Profit is the remuneration paid to the entrepreneur after deduction of all expenses. Maximization of profit can be defined as maximizing the income of the firm and minimizing the expenditure.

The main responsibility of a firm is to carry out business by manufacturing goods and services and selling them in the open market. The mechanism of demand and supply in an open market determine the price of a commodity or a service. A firm can only make profit if it produces a good or delivers a service at a lower cost than what is prevailing in the market. The margin between these two prices would only increase if the firm strives to produce these goods more efficiently and at a lower price without compromising on the quality.

The demand and supply mechanism plays a very important role in determining the price of a commodity. A commodity which has a greater demand commands a higher price and hence may result in greater profits. Competition among other suppliers also effect profits. Manufacturers tends to move towards production of those goods which guarantee higher profits. Hence there comes a time when equilibrium is reached and profits are saturated.

According to Adam Smith - business man in order to fulfill their profit motive in turn benefits the society as well. It is seen that when a firm tends to increase profit it eventually makes use of its resources in a more effective manner. Profit is regarded as a parameter to measure firm’s productivity and efficiency. Firms which tend to earn continuous profit eventually improvise their products according to the demand of the consumers. Bulk production due to massive demand leads to economies of scale which eventually reduces the cost of production. Lower cost of production directly impacts the profit margins. There are two ways to increase the profit margin due to lower cost. Firstly a firm can produce at lower sot but continue to sell at the original price, thereby increasing the revenue. Secondly a firm can reduce the final price offered to the consumer and increase its market thereby superseding its competitors.

Both ways the firm will benefit. The second way would increase its sale and market share while the first way only tend to increase its revenue. Profit is an important component of any business. Without profit earning capability it is very difficult to survive in the market. If a firm continues to earn large amount of profits then only it can manage to serve the society in the long run. Therefore profit earning capacity by a firm and public motive in some way goes hand in hand. This eventually also leads to the growth of an economy and increase in National Income due to increasing purchasing power of the consumer.

Profit Maximization Criticisms

Many economists have argued that profit maximization has brought about many disparities among consumers and manufacturers.

In case of perfect competition it may appear as a legitimate and a reward for efforts but in case of imperfect competition a firm’s prime objective should not be profit maximization.

In olden times when there was not too much of competition selling and manufacturing goods were primarily for mutual benefit. Manufacturers didn’t produce to earn profits rather produced for mutual benefit and social welfare. The aim of the single producer was to retain his position in the market and sustain growth, thereby earning some profit which would help him in maintaining his position. On the other hand in today’s time the production system is dominant by two tier system of ownership and management. Ownership aims at maximizing profit and management aims at managing the system of production thereby indirectly increasing the income of the business.

These services are used by customers who in turn are forced to pay a higher price due to formation of cartels and monopoly. Not only have the customers suffered but also the employees. Employees are forced to work more than their capacity. they is made to pay in extra hours so that production can increase.

Many times manufacturers tend to produce goods which are of no use to the society and create an artificial demand for the product by rigorous marketing and advertising. They tend to make the product so tempting by packaging and labeling that its difficult for the consumer to resist. These happen mainly with products which aim to target kids and teenagers. Ad commercials and print ads tend to provide with wrong information to artificially hike the expectation of the product.

In case of oligopoly where the nature of the product is more or less same exploit the customer to the max. Since they form cartels and manipulate prices by giving very less flexibility to the consumer to negotiate or choose from the products available. In such a scenario it is the consumer who becomes prey of these activities. Profit maximization motive is continuously aiming at increasing the firm’s revenue and is concentrating less on the social welfare.

Government plays a very important role in curbing this practice of charging extraordinary high prices at the cost of service or product. In fact a market which experiences a high degree of competition is likely to exploit the customer in the name of profit maximization, and on the other hand where the production of a particular product or service is limited there is a possibility to charge higher prices is greater. There are few things which need a greater clarification as far as maximization of profit is concerned

Profit maximization objective is a little vague in terms of returns achieved by a firm in different time period. The time value of money is often ignored when measuring profit.

It leads to uncertainty of returns. Two firms which use same technology and same factors of production may eventually earn different returns. It is due to the profit margin. It may not be legitimate if seen from a different stand point.

3 Modern Financial Management Techniques that Will Change Your Business

Whether you’re a business or an individual, you have to find a way to manage your finances now and in the future. The cost of everything continues to increase and there’s no sign that this trend of price increases will stop anytime soon. As a result, all entities have to develop a financial management system to ensure their stability for many years to come.

This system has to provide the businesses in question with enough flexibility for them to continue to grow and pay for their necessary expenses. It also has to be stringent enough to allow for money to be put away in the event of future catastrophes.

In the case of a business, all expenses have to be prioritized in the interest of spending money on the right things.

When it comes time for cost cutting measures to be implemented, they have to be come with consequences in mind. Everything that’s done to cut costs has an end result once it becomes a common procedure.

You have to ponder whether you’re cutting enough or you’re cutting too much. Work has to be done to ensure that cutting individuals from the workforce is the last possible resort. Odds are there are expenses that can be sliced without having to touch the workforce.

Individuals in the private sector have to manage their finances in the interest of being able to acquire credit.

A person’s credit score can affect every possible aspect of their life. The biggest issue currently impacting the financial future of most people is the regular use of high interest credit cards.

Most retail establishments try to push their credit card on their customers on a regular basis. These cards should only be used for small purchases that can be paid shortly after they have been completed.

Financial management is a challenge in a world where spending is seen as the key to getting ahead.

You have to exercise the utmost level of restraint if you want solvency to be in your future. Once you have established an effective budget, your worries about finances will become a thing of the past.

Financial Intermediaries - Meaning, Role and Its Importance

Introduction

A financial intermediary is a firm or an institution that acts an intermediary between a provider of service and the consumer.

It is the institution or individual that is in between two or more parties in a financial context. In theoretical terms, a financial intermediary channels savings into investments. Financial intermediaries exist for profit in the financial system and sometimes there is a need to regulate the activities of the same. Also, recent trends suggest that financial intermediaries role in savings and investment functions can be used for an efficient market system or like the sub-prime crisis shows, they can be a cause for concern as well.

Financial Intermediation

Financial intermediaries work in the savings/investment cycle of an economy by serving as conduits to finance between the borrowers and the lenders. In the financial system, intermediaries like banks and insurance companies have a huge role to play given that it has been estimated that a major proportion of every dollar financed externally has been done by the banks. Financial intermediaries are an important source of external funding for corporates. Unlike the capital markets where investors contract directly with the corporates creating marketable securities, financial intermediaries borrow from lenders or consumers and lend to the companies that need investment.

Role of the Financial Intermediaries

The reason for the all-pervasive nature of the financial intermediaries like banks and insurance companies lies in their uniqueness. As outlined above, Banks often serve as the “intermediaries” between those who have the resources and those who want resources. Financial intermediaries like banks are asset based or fee based on the kind of service they provide along with the nature of the clientele they handle. Asset based financial intermediaries are institutions like banks and insurance companies whereas fee based financial intermediaries provide portfolio management and syndication services.

Need for regulation

The very nature of the complex financial system that we have at this point in time makes the need for regulation that much more necessary and urgent. As the sub-prime crisis has shown, any financial institution cannot be made to hold the financial system hostage to its questionable business practices. As the manifestations of the crisis are being felt and it is now apparent that the asset backed derivatives and other “exotic” instruments are amounting to trillions, the role of the central bank or the monetary authorities in reining in the rogue financial institutions is necessary to prevent systemic collapse.

As capital becomes mobile and unfettered, it is the monetary authorities that have to step in and ensure that there are proper checks and balances in the system so as to prevent losses to investors and the economy in general.

Recent trends

Recent trends in the evolution of financial intermediaries, particularly in the developing world have shown that these institutions have a pivotal role to play in the elimination of poverty and other debt reduction programs. Some of the initiatives like micro-credit reaching out to the masses have increased the economic well being of hitherto neglected sectors of the population.

Further, the financial intermediaries like banks are now evolving into umbrella institutions that cater to the complete needs of investors and borrowers alike and are maturing into “financial hyper marts”.

Conclusion

As we have seen, financial intermediaries have a key role to play in the world economy today. They are the “lubricants” that keep the economy going. Due to the increased complexity of financial transactions, it becomes imperative for the financial intermediaries to keep re-inventing themselves and cater to the diverse portfolios and needs of the investors. The financial intermediaries have a significant responsibility towards the borrowers as well as the lenders. The very term intermediary would suggest that these institutions are pivotal to the working of the economy and they along with the monetary authorities have to ensure that credit reaches to the needy without jeopardizing the interests of the investors. This is one of the main challenges before them.

Financial intermediaries have a central role to play in a market economy where efficient allocation of resources is the responsibility of the market mechanism. In these days of increased complexity of the financial system, banks and other financial intermediaries have to come up with new and innovative products and services to cater to the diverse needs of the borrowers and lenders. It is the right mix of financial products along with the need for reducing systemic risk that determines the efficacy of a financial intermediary.

Role of the Finance Function in the Financial Management for Corporates

The Finance Function in Corporates

We often read about how corporates are doing financially with reference to their profits, asset values, debt, equity, and other measures. These measures are indicative of how well the corporate is doing financially. The next time you read about these measures, do think about the people who enable these performance indicators and these are the finance and treasury functions of the corporates.

Before we proceed further, we would like to remind you that the Treasury or the Finance function does not actualize the broader financial performance which is determined by the various strategic, operational, and financial management. Rather, the role of the finance function is to record, and keeps track of the various matters related to financial management in corporates.

The finance and the treasury functions are also responsible for tax calculations, social security payments, payroll, managing the receivables and the payable, and in recent years, the emergence of the treasury function has meant that they also deal with foreign exchange management and hedging that has been necessitated due to globalization which means that many corporates are now actively dealing in multiple currencies and hedging.

The External Functions of the Finance Department

The functions of the finance department can be broadly broken down into external and internal financial management. The external function encompasses the entire range of activities to do with paying the suppliers, vendors, and the other stakeholders who do business with the corporates.

In addition, the finance function also keeps track of the receivables meaning that they follow up with the clients and the customers who owe the corporate money for the services rendered. Apart from this, the finance function also handles the social security payments of the employees wherein each month or quarter (depending on the prevailing laws of the country), the finance department makes payments into the 401(k) accounts in the United States and the Provident Fund Accounts in India.

Further, the finance function is also responsible for remitting the TDS or the Tax Deducted at Source from the employees into the relevant accounts of the governmental agencies. Above all, the finance department also liaises with the banks in which the corporate holds account.

Indeed, in recent years, it has become the norm to have a single banking relationship in an “Umbrella” format where the corporate engages and partners with a single bank for the entire financial needs of the corporate.

The Internal Functions of the Finance Department

The internal functions of the finance department are similarly important wherein it stars the payroll processing and ensures that employees are paid on time. Indeed, payroll is perhaps the most visible interface that the finance department has with the employees.

The next time when your salary is credited, do think of the people sitting in the secluded (usually the finance department in many multinationals is seated separately in glassed enclosures for diligence and compliance reasons) areas working to get your salary paid on time.

Further, the internal functions of the finance department also encompass the processing of reimbursements on account of travel, dining and hospitality, same city transportation, perks, and any other benefits that are due to the employees. Indeed, perhaps the biggest reason why many employees either praise or curse the finance department is when their vouchers and bills have to be cashed.

In many corporates, this takes some time as not only are the finance personnel overworked but also they have to perform due diligence before processing the payments. Therefore, the next time you have a bill to be cashed, you can think of the various steps and the approvals needed before you shoot off a mail or message on the Bulletin Boards of the organization.

The Treasury Function

We have considered the external and internal functions of the finance department. In recent years, many multinationals as well as domestic companies that operate globally have added another key and vital function to the tasks of the finance department and this is the Treasury Function.

Simply put, Treasury is all about managing the foreign exchange payments and ensuring that the corporate does not lose money due to fluctuations in the exchange rates. Indeed, as those who have received payments in Dollars or Euros would cash them when the exchange rate is favorable.

Similarly the Treasury’s job is to ensure that the corporate does not lose out and towards this end, it ensures that hedging and escrow accounts are managed. For instance, there are active treasury desks in the headquarters of most corporates worldwide due to their global payments.

Most of the time, the employees are unaware of this function since the Treasury staff do not sit in the operational offices but instead, are based in the financial capitals such as New York, London, and Mumbai. Further, details of hedging and treasury management are usually revealed in the annual reports that many employees do not usually read and hence, little is known to them about this vital function.

Conclusion: The Finance Departments are Like Ants

Finally, the finance department is like a pump which keeps the fluids of money and commerce flowing through the system. Indeed, it can be said that though the finance function is a support function and is away from the limelight unlike the marketing, or the project staff, they are vital cogs in the machine which keep the wheels greased and the organization moving.

Some people like to call the finance function in corporates as ants who go about their work quietly and diligently. To conclude, just as one needs the financial advisor from time to time, all employees need the finance function and especially when one sees the money in one’s account for salaries or bills.

Why Financial Innovation can be both a Force for Good and Bad ?

Exotic Innovations or Weapons of Mass Destruction ?

Anybody who has followed the severe and protracted financial crises of the last Eight years would be aware of the damaging role played by Exotic Financial Products such as Derivates, Swaps, Credit Default Swaps, and Options.

These instruments that are supposedly in place to hedge against risk instead have become so toxic to the health of the global financial system and the global economy that it was no wonder the legendary American investor, Warren Buffett called them “Financial Weapons of Mass Destruction”.

This is because the financial innovative instruments which were hailed as bringing a measure of stability and hedge against risk when they were first invented instead turned into liabilities because as it turned out, they were not that good at pricing risk and hedging against defaults after all.

What is Financial Innovation and Why it was Welcomed ?

Before proceeding further, it would be in the fitness of things to understand what is meant by Financial Innovation. As management students learn during their MBAs and other courses, financial instruments are usually invented to price, factor in risk, hedge against risks such as counterparty default. In addition, innovations in finance are also due to the very real possibility that financial and physical assets might lose value suddenly due to economic cycles and at the same time, they can also inflate beyond measure leading to wild gyrations in the financial markets.

Thus, derivatives which are so named because they “derive” their value from underlying assets are created in a manner that protects both the buyers and sellers of the assets against excessive volatility and wild price movements.

When is Financial Innovation Bad ?

So, one might very well ask, what is the problem if risk is priced in and credit events such as defaults are hedged against?

The partial answer to this is that innovation is good as long as it is directed and controlled in a stable manner. Once innovation takes on a life of its own, the net result or the end result is that it often leads to a situation where neither its creators nor its users understand what exactly they are all about.

Of course, this does not mean that innovation is per se bad and more so, financial innovation is something that is inherently wrong. Indeed, it is only because of the financial innovations of the last few decades that consumers and especially the retail ones like you and we have been able to have greater control over our savings, portfolios, and assets.

How can we use Financial Innovation for Good ?

Thus, while we are not suggesting that financial innovation should cease, we are certainly advocating financial innovation that benefits society and which does not become overly complicated and complex that very few of the financial experts understand what it is all about. Indeed, there are numerous examples of how financial innovation is undertaken with a view to genuinely improving the condition of the poor rather than solely as a way of making profits alone.

These include the Microcredit Initiative that was pioneered by the Nobel Prize Winning Bangladeshi Banker and Social Entrepreneur, Mohammed Yunus, who with his Grameen Bank succeeded in bringing banking to poor women who were hitherto denied access to structured credit and were at the mercy of unscrupulous money lenders.

Or, banks such as Bandhan in the Eastern Indian State of Bengal which similarly, is spearheading a revolution in banking for the masses. Of course, even in the West, there are numerous instances such as the Commodity Bourses which as a result of Bankers merging the financial profit imperative with that of social responsibility has helped the farmers in hedging against bad harvests, weather changes, and even pure speculation that can result in the volatility of the prices.

Profits are not the Only Criteria

Thus, it can be said that like everything else in the world of business and finance, as long as financial innovation has the underlying them of genuinely merging the profitability with that of social change, then it must be welcomed and even supported and encouraged at all costs. However, when financial innovation becomes yet another instance of speculation wherein the sole objective is to make as much money as possible, then it is certainly something that we must be worried about.

The Emerging Threats of High Speed Trading with Uber Complex Financial Instruments

Moreover, with the advent of high speed trading and electronic trading, it is certainly the case that the marriage of advanced technology with that of overly complex financial products is leading us to a dangerous situation where the speed of technological change and the increase in complexity results in a high stakes game of cards where the decisions are not made by humans but machines which though supposedly objective can also veer out of control. Indeed, the fact that at the moment, computers have taken over the roles that traders used to perform in the markets means that there is every chance that one day, there would not be too many of the experts who understand what is going on.

Conclusion

To conclude, financial innovation has certainly lead to efficiencies in the markets. However, at times, such innovation has to be tempered with human and humane considerations. Just like the inventions such as Dynamite and the scientific achievements such as splitting the atom led to devastating outcomes, even financial innovation that is not grounded in the realization that greed can sometimes lead to disaster would definitely lead to that as the world learned the hard way over the last decade or so.