Operation Research In Financial Management

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Or In Financial Management

Operation research has wide scope and has been successfully applied in the following areas of financial management.

  1. Cash Management
  2. Inventory Control
  3. Simulation Technique
  4. Capital Budgeting

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).

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