Look through the following vocabulary notes which will help you understand the text

Reading

Financial management can be defined as: the management of the finances of a business in order to achieve financial objectives. It studies corporate finance and capital markets, emphasizing the financial aspects of managerial decisions. It touches on all areas of finance, including the valuation of real and financial assets, risk management and financial derivatives, the trade-off between risk and expected return, and corporate financing and dividend policy. New business leaders and managers have to develop at least basic skills in financial management. Expecting others in the organization to manage finances is clearly asking for trouble.

Financial management is concerned with the managerial decisions that result in the acquisition and financing of credits, selection of specific assets and it also deals with inflows and outflows of funds and their effect on managerial objectives. In short, financial management deals with procurement of funds and their effective utilization in the business.

One of the primary considerations when going into business is money. Without sufficient funds a company cannot begin operations. The money needed to start and continue operating a business is known as capital.

Finance is securing and utilizing capital and the process of managing the capital is known as financial management. The process of acquiring this capital is known as financing. There are two basic types of financing: equity financing which refers to funds invested by owners and debt financing which refers to funds borrowed from outside sources. Equity financing can be exemplified by the sale of units of ownership known as shares of stock. Often equity financing does not provide the corporation with enough capital and it must turn to debt financing, or borrowing funds.

Financial management is concerned with decision-making in regard to the level and structure of financing and size and composition of assets. To make wise decisions it is necessary to have a clear understanding of objectives which provide a framework for optimum financial decision-making.

There are two approaches to determine the decision criterion for financial management: profit maximization approach and wealth maximization approach. The profit maximization criterion implies that business decisions should be oriented to the maximization of profits and actions that increase profits should be undertaken and those that decrease profits are to be avoided.

Profit can be considered a test of economic efficiency, as it provides the yardstick by which economic performance can be judged and ensures maximum social welfare. But profitability maximization cannot be the only basic criterion for the financial management decisions. The main flaws of profit maximization as an objective of financial management are as follows: ambiguity, timing and quality of benefits.

Actually, the term profit is a vague and ambiguous concept. Profit may be short-term or long-term; total profit or rate of profit; before-tax or after-tax and so on. It’s not quite clear which of these variants of profit should be maximized? Obviously, a loose expression like profit cannot form the basis of operational financial management.

Profit maximization treats all benefits as equally valuable ignoring the distinction between returns received in different time periods. While working out profitability, the bigger the better principle is adopted because the decision is based on the total benefits received irrespective of when they were received. In practice benefits in early years should be valued more highly than equivalent benefits in later years because they can be re-invested to earn a return. The basic dictum of financial planning is the earlier the better as benefits received sooner are more valuable than benefits received later.

Quality of benefits should also be taken into consideration. It refers to the degree of certainty with which benefits can be expected. The more certain the expected return, the higher the quality of the benefits. An uncertain and fluctuating return implies risk to the investors. The investors are risk-averters, i.e. they want to avoid or at least minimize risk.

As it is clear from the above, that profit maximization criterion is inappropriate and unsuitable as an operational objective of investment, financing and dividend decisions of a firm. It is not only vague and ambiguous but also it ignores two important dimensions of financial analysis: risk, and time value of money. The alternative to the profit maximization is the wealth maximization.

Comprehension

2.4.1 Answer the questions using your active vocabulary

1. Why is money one of the primary considerations when going into business?

2. What are two basic types of financing?

3. How do corporations receive their starting capital?

4. What is financial management concerned with?

5. Why is it necessary to make wise financial decisions?

6. What actions should be undertaken or avoided according to the profit maximization goad?

7. What are the reasons for the opposition, concerning the profit maximization criterion?

8. Compare the principles “the bigger the better” and “the earlier the better” relative to profitability?

9. Do you agree that benefits in early years should be valued more highly than equivalent benefits in later years? Prove your answer.

10. How do you understand the phrase that “the investors are risk averters”?

11. What two important dimensions of financial analysis does the profit maximization criterion ignore?

2.4.2 Mark these statements T(true) or F(false) according to the information in the text. If they are false say why.

1. Financial management is concerned with decision – making in regard to the size and composition of assets and the level and structure of financing.

2. With the help of decision criterion one can judge a specific set of mutually inter-related business decisions, namely, investment, financing and credit policy.

3. According to profit maximization criterion actions that increase profits should be avoided and those that decrease profits are to be undertaken.

4. Profitability refers to a situation where input exceeds output.

5. Profit is a test of economic activity.

6. The main technical flaws of profit maximization criterion are ambiguity, timing of benefits and quality of benefits.

7. While working out profitability, the earlier the better principle is adopted.

8. Benefits in early years should be valued more highly than equivalent benefits in later years.

9. The more certain the expected return, the lower the quality of the benefits.

10. The more uncertain or fluctuating the expected benefits, the higher the quality of benefits.

11. The profit maximization criterion ignores risk and time value of money.

12. How well a company manages its finance affects the overall success of the business venture.

13. Equity financing provides the corporation with enough capital to start up, operate and expand its business.

14. Equity financing refers to funds that are borrowed from sources outside the corporation.

15. The corporation must turn to debt financing if equity financing does not provide it with enough capital.

Language practice

2.5.1 Match the English word combinations in the left-hand column with the definition in the right-hand column.

2.5.2 Complete the following text using suitable words or phrases from the box below.

It is observed that many firms have been liquidated not because their technology was……………… or because their products were not in demand, but that there was a ……………….. of financial …………... Even in ……………….., when a company make high profits there is also a fear of ……………….. because of bad financial management.

Financial management optimizes the output from the given………….. In case of newly started companies with a high………….. it is more important to have sound financial management since…………….. alone guarantees their………….

2.5.3 Complete the text. Replace the Russian words and phrases by English equivalents.

As funds can be procured from multiple sources so (привлечение капитала) is considered an important problem of business concerns. In the globalised competitive scenario, mobilization of funds (играть важную роль). Funds can be raised either through (внутренний рынок) or from abroad. Foreign Direct Investment as well as Foreign Institutional Investors are two (основные источники привлечения капитала). Funds obtained from different sources (иметь различные характеристики) in terms of potential risk, cost and control. (Стоимость капитала) should be at minimum for a proper balancing of risk and control.

(Эффективное использование средств) as an important aspect of financial management avoids the situations where funds are either kept idle or proper uses are not being made. Funds procured (повлечь затраты и риски). If the funds are not used properly (управление бизнесом) will be too difficult. So it is crucial employ the funds properly and profitably.

2.5.4 Text for discussion.

a. Look up the dictionary for the meaning and pronunciation of the following words and word-combinations.

to issue debentures

financial leverage

common shareholders

adverse affect

solvency

liquidity

to be availed

b. Briefly scan the text and outline the list of major points.

c. Read the text more carefully and comment on the following problems:

- The major sources from which a company may obtain funds.

- Speak on the methods used for the evaluation of a firm's performance