# Two Basic Functions of Financial Management

Financial management revolves around two core functions.

## 1. Procurement of Funds

Funds can be raised from various sources, each with a different mix of risk, cost and control.

Source	Risk	Cost	Notes
Equity shares	Lowest — repaid only on liquidation	Highest — dividend expectations	Best from a risk view
Debentures (debt)	Higher — fixed repayment & interest	Cheaper — interest is tax-deductible	Tax advantage

The finance manager must balance risk, cost and control to minimise the cost of funds without taking on undue risk or losing management control.

## 2. Effective Utilisation of Funds

Once raised, funds must not lie idle or be used improperly. The finance manager must ensure:

Funds generate a return higher than the cost of capital.
Investment in fixed assets is taken only after capital budgeting analysis.
Adequate working capital is maintained to avoid the risk of insolvency.

## Why the Distinction Matters

Raising funds at the lowest cost is wasted if the funds are then deployed inefficiently. Both functions must work together for value creation.

Worked example

### Example 1

Q (Nov 09, 2 marks): Explain the two basic functions of financial management.

A: (i) Procurement of funds — raising capital from sources like equity, debt or hybrid instruments, balancing risk, cost and control (equity is low risk but high cost; debt is cheaper but riskier). (ii) Effective utilisation — deploying funds so they earn more than the cost of capital, undertaking fixed-asset investments only after capital budgeting, and maintaining adequate working capital to avoid insolvency.

⚠️ Common exam mistakes

Listing 'investment, financing, dividend decisions' as the two functions — those are the three classical decisions, not the basic procurement/utilisation pair asked here.
Saying equity is the cheapest source because there is 'no interest' — equity is actually the most expensive source due to high dividend and capital-gain expectations of shareholders.

Reference:

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