nature of manegrial economics

Nature of Managerial Economics               inShare0                      Managers study managerial economics because it gives them insight to reign the functioning of the organization. If manager uses the principles applicable to economic behaviour in a reasonably, then it will result in smooth functioning of the organisation. Managerial Economics is a Science Managerial Economics is an essential scholastic field. It can be compared to science in a sense that it fulfils the criteria of being a science in following sense: Science is a Systematic body of Knowledge. It is based on the methodical observation. Managerial economics is also a science of making decisions with regard to scarce resources with alternative applications. It is a body of knowledge that determines or observes the internal and external environment for decision making.

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In science any conclusion is arrived at after continuous experimentation. In Managerial economics also policies are made after persistent testing and trailing. Though economic environment consists of human variable, which is unpredictable, thus the policies made are not rigid. Managerial economist takes decisions by utilizing his valuable past experience and observations.

• Science principles are universally applicable. Similarly policies of Managerial economics are also universally applicable partially if not fully. The policies need to be changed from time to time depending on the situation and attitude of individuals to those particular situations. Policies are applicable universally but modifications are required periodically.

Managerial Economics requires Art

Managerial economist is required to have an art of utilising his capability, knowledge and understanding to achieve the organizational objective. Managerial economist should have an art to put in practice his theoretical knowledge regarding elements of economic environment.

Managerial Economics for administration of organization

Managerial economics helps the management in decision making. These decisions are based on the economic rationale and are valid in the existing economic environment.

Managerial economics is helpful in optimum resource allocation

The resources are scarce with alternative uses. Managers need to use these limited resources optimally. Each resource has several uses. It is manager who decides with his knowledge of economics that which one is the preeminent use of the resource.

Managerial Economics has components of micro economics

Managers study and manage the internal environment of the organization and work for the profitable and long-term functioning of the organization. This aspect refers to the micro economics study. The managerial economics deals with the problems faced by the individual organization such as main objective of the organization, demand for its product, price and output determination of the organization, available substitute and complimentary goods, supply of inputs and raw material, target or prospective consumers of its products etc.

Managerial Economics has components of macro economics

None of the organization works in isolation. They are affected by the external environment of the economy in which it operates such as government policies, general price level, income and employment levels in the economy, stage of business cycle in which economy is operating, exchange rate, balance of payment, general expenditure, saving and investment patterns of the consumers, market conditions etc. These aspects are related to macro economics.

Managerial Economics is dynamic in nature

Managerial Economics deals with human-beings (i.e. human resource, consumers, producers etc.). The nature and attitude differs from person to person. Thus to cope up with dynamism and vitality managerial economics also changes itself over a period of time.

Basic Concept of Time Value 1

Basic Concept of Time Value

of Money

1.1 INTRODUCTION

Money has time value. A rupee today is more valuable than a year hence.

It is on this concept “the time value of money” is based. The recognition of

the time value of money and risk is extremely vital in financial decision

making.

Most financial decisions such as the purchase of assets or procurement

of funds, affect the firm’s cash flows in different time periods. For example,

if a fixed asset is purchased, it will require an immediate cash outlay and

will generate cash flows during many future periods. Similarly if the firm

borrows funds from a bank or from any other source, it receives cash and

commits an obligation to pay interest and repay principal in future periods.

The firm may also raise funds by issuing equity shares. The firm’s cash

balance will increase at the time shares are issued, but as the firm pays

dividends in future, the outflow of cash will occur. Sound decision-making

requires that the cash flows which a firm is expected to give up over period

should be logically comparable. In fact, the absolute cash flows which differ

in timing and risk are not directly comparable. Cash flows become logically

comparable when they are appropriately adjusted for their differences in

timing and risk. The recognition of the

time value of money

and risk is

extremely vital in financial decision-making. If the timing and risk of cash

flows is not considered, the firm may make decisions which may allow it to

miss its objective of maximising the owner’s welfare. The welfare of owners

would be maximised when

Net Present Value is created from making a

financial decision. It is thus, time value concept which is important for

financial decisions.

Thus, we conclude that time value of money is central to the concept of

finance. It recognizes that the value of money is different at different points

of time. Since money can be put to productive use, its value is different

depending upon when it is received or paid. In simpler terms, the value of

a certain amount of money today is more valuable than its value tomorrow.

It is not because of the uncertainty involved with time but purely on account

CHAPTER

Basic Concept of Time Value

1

of Money

1

2

FINANCIAL MATHEMATICS

of timing. The difference in the value of money today and tomorrow is

referred as time value of money.

1.2 REASONS FOR TIME VALUE OF MONEY

Money has time value because of the following reasons:

1.

Risk and Uncertainty : Future is always uncertain and risky. Outflow

of cash is in our control as payments to parties are made by us.

There is no certainty for future cash inflows. Cash inflows is

dependent out on our Creditor, Bank etc. As an individual or firm is

not certain about future cash receipts, it prefers receiving cash now.

2.

Inflation: In an inflationary economy, the money received today,

has more purchasing power than the money to be received in future.

In other words, a rupee today represents a greater real purchasing

power than a rupee a year hence.

3.

Consumption: Individuals generally prefer current consumption to

future consumption.

4.

Investment opportunities: An investor can profitably employ a

rupee received today, to give him a higher value to be received

tomorrow or after a certain period of time.

Thus, the fundamental principle behind the concept of time value of

money is that, a sum of money received today, is worth more than if the

same is received after a certain period of time. For example, if an individual

is given an alternative either to receive

` 10,000 now or after one year, he

will prefer

` 10,000 now. This is because, today, he may be in a position to

purchase more goods with this money than what he is going to get for the

same amount after one year.

Thus, time value of money is a vital consideration in making financial

decision. Let us take some examples

Objectives of Financial Management

DEFINITION OF FINANCIAL MANAGEMENT

Financial management is an integral part of overall management. It is concerned with the

duties of the financial managers in the business firm.

The term financial management has been defined by

Solomon, “It is concerned with

the efficient use of an important economic resource namely, capital funds”.

The most popular and acceptable definition of financial management as given by

S.C.

Kuchal

is that “Financial Management deals with procurement of funds and their effective

utilization in the business”.

Howard and Upton

: Financial management “as an application of general managerial

principles to the area of financial decision-making.

Weston and Brigham

: Financial management “is an area of financial decision-making,

harmonizing individual motives and enterprise goals”.

Joshep and Massie

: Financial management “is the operational activity of a business

that is responsible for obtaining and effectively utilizing the funds necessary for efficient

operations.

Thus, Financial Management is mainly concerned with the effective funds

management in the business. In simple words, Financial Management as practiced by

business firms can be called as Corporation Finance or Business Finance.

SCOPE OF FINANCIAL MANAGEMENT

Financial management is one of the important parts of overall management, which is directly

related with various functional departments like personnel, marketing and production.

Financial management covers wide area with multidimensional approaches. The following

are the important scope of financial management.

1. Financial Management and Economics

Economic concepts like micro and macroeconomics are directly applied with the

financial management approaches. Investment decisions, micro and macro

environmental factors are closely associated with the functions of financial manager.

Financial management also uses the economic equations like money value discount

factor, economic order quantity etc. Financial economics is one of the emerging

area, which provides immense opportunities to finance, and economical areas.

2. Financial Management and Accounting

Accounting records includes the financial information of the business concern.

Hence, we can easily understand the relationship between the financial management

and accounting. In the olden periods, both financial management and accounting

are treated as a same discipline and then it has been merged as Management

Accounting because this part is very much helpful to finance manager to take

decisions. But nowaday’s financial management and accounting discipline are

separate and interrelated.

3. Financial Management or Mathematics

Modern approaches of the financial management applied large number of

mathematical and statistical tools and techniques. They are also called as

econometrics. Economic order quantity, discount factor, time value of money,

present value of money, cost of capital, capital structure theories, dividend theories,

ratio analysis and working capital analysis are used as mathematical and statistical

tools and techniques in the field of financial management.

4. Financial Management and Production Management

Production management is the operational part of the business concern, which

helps to multiple the money into profit. Profit of the concern depends upon the

production performance. Production performance needs finance, because

production department requires raw material, machinery, wages, operating expenses

etc. These expenditures are decided and estimated by the financial department

and the finance manager allocates the appropriate finance to production department.

The financial manager must be aware of the operational process and finance

required for each process of production activities.

5. Financial Management and Marketing

Produced goods are sold in the market with innovative and modern approaches.

For this, the marketing department needs finance to meet their requirements.

Introduction to Financial Management

5

The financial manager or finance department is responsible to allocate the adequate

finance to the marketing department. Hence, marketing and financial management

are interrelated and depends on each other.

6. Financial Management and Human Resource

Financial management is also related with human resource department, which

provides manpower to all the functional areas of the management. Financial

manager should carefully evaluate the requirement of manpower to each

department and allocate the finance to the human resource department as wages,

salary, remuneration, commission, bonus, pension and other monetary benefits

to the human resource department. Hence, financial management is directly

related with human resource management.

IMPORTANCE OF FINANCIAL MANAGEMENT

Finance is the lifeblood of business organization. It needs to meet the requirement of the

business concern. Each and every business concern must maintain adequate amount of

finance for their smooth running of the business concern and also maintain the business

carefully to achieve the goal of the business concern. The business goal can be achieved

only with the help of effective management of finance. We can’t neglect the importance of

finance at any time at and at any situation. Some of the importance of the financial

management is as follows:

Financial Planning

Financial management helps to determine the financial requirement of the business concern

and leads to take financial planning of the concern. Financial planning is an important part

of the business concern, which helps to promotion of an enterprise.

Acquisition of Funds

Financial management involves the acquisition of required finance to the business concern.

Acquiring needed funds play a major part of the financial management, which involve

possible source of finance at minimum cost.

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Financial Management

Proper Use of Funds

Proper use and allocation of funds leads to improve the operational efficiency of the business

concern. When the finance manager uses the funds properly, they can reduce the cost of

capital and increase the value of the firm.

Financial Decision

Financial management helps to take sound financial decision in the business concern.

Financial decision will affect the entire business operation of the concern. Because there is

a direct relationship with various department functions such as marketing, production

personnel, etc.

Improve Profitability

Profitability of the concern purely depends on the effectiveness and proper utilization of

funds by the business concern. Financial management helps to improve the profitability

position of the concern with the help of strong financial control devices such as budgetary

control, ratio analysis and cost volume profit analysis.

Increase the Value of the Firm

Financial management is very important in the field of increasing the wealth of the investors

and the business concern. Ultimate aim of any business concern will achieve the maximum

profit and higher profitability leads to maximize the wealth of the investors as well as the

nation.

Promoting Savings

Savings are possible only when the business concern earns higher profitability and

maximizing wealth. Effective financial management helps to promoting and mobilizing

individual and corporate savings.

Nowadays financial management is also popularly known as business finance or

corporate finances. The business concern or corporate sectors cannot function without

the importance of the financial management.

Objectives of Financial Management

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Objectives of financial management fix the target of finance manager. Under the scope of financial management, he has to achieve different objective of financial management.

We can make the list of these objectives:

1. To Reduce the Misuse of Funds

It is the objective of financial management to reduce the misuse of funds. I can take my own example. I hate misusing of my hard earned money. Last month, I have bought DVD writer for starting business of CD and DVD of educational tutorials. But, after spending one month, DVD writer is being used for production or business purposes; I think this is misuse of my fund. If I deposited it in bank, I can earn interest on saving account on daily basis. Like me, company also misuses his funds in bad projects. We should learn from objective of financial management and reduce the misuse of even one rupee.

2. To Maximize the Profit in Long Run

If a businessman invests his money and wants to earn high profit, it means, it is taking high risk according to risk theory of financial management. This is not objective of financial management, but to maximize the profit in long run is real aim of financial management.

3. To Maximize the Wealth of Company

An investor only purchases shares, if he hopes that he will earn high profit on it, otherwise, he can deposit his money in saving account of bank. So, it is the objective of financial management to maximize the value of share. It can be possible by following way.

a) To Increase Dividend per share

b) To Increase Earning per share

c) To Analyze  the value of share in market

4. To Fulfill the Social Responsibility

Company uses the natural resources and earns money and funds. Suppose Xyz Company started a plant in F place and use water, land and machines, it earned 10 million dollars from that plant. According to my view, Xyz Company takes his all natural resources from society in the form of land, water, metal and minerals. God has made these things for whole society not a particular Xyz company. If Xyz Company has used these resources, then it is the duty of xyz Company to fulfill his responsibility toward society. This is the main objective of financial management. Company’s reputation can be calculated with how many employees are working in it. What facilities are given by company to his employees? If company only shows his balance sheet of dead plants, machinery and other assets but there is not provision of any social activity or donation, that company will not get any goodwill. Some companies are being operated on the basis of public deposits instead of share capital. Why? And answer is security and that company can give only the security who wants to benefit of society like a social worker. Ok

FUNCTIONS OF FINANCE MANAGER

Finance function is one of the major parts of business organization, which involves the

permanent, and continuous process of the business concern. Finance is one of the interrelated

functions which deal with personal function, marketing function, production function and

research and development activities of the business concern. At present, every business

concern concentrates more on the field of finance because, it is a very emerging part which

reflects the entire operational and profit ability position of the concern. Deciding the proper

financial function is the essential and ultimate goal of the business organization.

Finance manager is one of the important role players in the field of finance function.

He must have entire knowledge in the area of accounting, finance, economics and

management. His position is highly critical and analytical to solve various problems related

to finance. A person who deals finance related activities may be called finance manager.

Finance manager performs the following major functions:

1. Forecasting Financial Requirements

It is the primary function of the Finance Manager. He is responsible to estimate

the financial requirement of the business concern. He should estimate, how much

finances required to acquire fixed assets and forecast the amount needed to meet

the working capital requirements in future.

2. Acquiring Necessary Capital

After deciding the financial requirement, the finance manager should concentrate

how the finance is mobilized and where it will be available. It is also highly critical

in nature.

3. Investment Decision

The finance manager must carefully select best investment alternatives and consider

the reasonable and stable return from the investment. He must be well versed

in the field of capital budgeting techniques to determine the effective utilization

of investment. The finance manager must concentrate to principles of safety,

liquidity and profitability while investing capital.

Introduction to Financial Management

9

4. Cash Management

Present days cash management plays a major role in the area of finance because

proper cash management is not only essential for effective utilization of cash but

it also helps to meet the short-term liquidity position of the concern.

5. Interrelation with Other Departments

Finance manager deals with various functional departments such as marketing,

production, personel, system, research, development, etc. Finance manager should

have sound knowledge not only in finance related area but also well versed in

other areas. He must maintain a good relationship with all the functional

departments of the business organization.