Operation research has wide scope and has been successfully applied in the following areas of financial management.
All are discuss as under:
1. Cash Management
- A financial manager is responsible for adequate supply of funds to all the sections, departments and units of the organisation as a funds are essential for their proper function throughout the year.
- Linear programming techniques are helpful to determine the allocation of funds to each section.
- L.P. techniques have also been applied to identify sections having excess funds.
- these funds may be diverted to the sections that need them.
2. Inventory Control
- In big organisations the amount invested in inventories can run into millions of rupees.
- Inventory control techniques of OR can help management to develop better inventory policies and bring down the investment in inventories.
- These techniques help to achieve optimum balance between inventory carrying costs.
- They help to determine,
Which items to hold,
how much to hold,
when to order and how much to order.
3. Simulation Technique
- Simulation considers various factors that affect the present and projected cost of borrowing money from commercial banks, and tax rates, etc.
- Provides an optimum combination of financing (debt, equity or retained earning) for the desired amount of capital.
- Simulation replaces subjective estimates, judgement and hunches of the management by providing reliable information.
4. Capital Budgeting
- It involves evaluation of various investment proposals (market introduction of a new product or replacement of an equipment by a new one).
- often the decisions have been made by considering internal rate of return or net present values.
- These methods, however, do not consider the risk factor in the venture.
- Risk factors can be calculated if the probability distributions of cash flows can be ascertained, say from past data.
- Hiller’s and Hertz’s models (simulation) and decision trees in conjunction with EMV (Expected Monetary Value) can be usefully employed to evaluate the various investment proposals/projects.
- OR techniques of linear programming, integer programming and dynamic programming have also been useful in selection of optimal investment portfolios (with or without estimates of risk).