Financial management is the process of planning and controlling a company’s financial resources. Economics used to be a branch of ____________ till 1890; as a separate discipline it is of recent origin. Although it has made great strides, sociology is still not an independent body of knowledge and relies heavily on economics for its theoretical concepts.
Both academicians and practicing managers are interested in financial management. The subject of whether homework is beneficial or not is still being developed and there are areas of controversy where no solutions have been reached yet. This subject is of interest to practicing managers because many of the most important decisions made by a company relate to finance. Understanding the theory of financial management gives these managers the ability to make these decisions confidently and effectively.
What is Financial Management?
Financial management is the business function that invests the available financial resources in a way that maximizes business success and ROI. Financial management professionals are responsible for the financial planning, organization, and control of all transactions in a business. They work to ensure that the financial health of the company is maintained and that all financial regulations are followed. They focus on finding the money for the business, whether it is from the entrepreneur’s own money, borrowing, investors, or a public offering. Financial management professionals are responsible for allocating funds in a way that is optimized for stability and growth.
Importance of Financial Management
The financial management of an organization is responsible for all financial activities related to a business, including setting objectives, formulating policies, laying out procedures, implementing programs, and allocating budgets. By having a good financial management practice, it is possible to make sure that the company has enough money at any time. The importance of financial management can be assessed by taking a look at its core mandate:
- Availability of sufficient funds
- Maintaining a balance between income and expenses to ensure financial stability
- Ensuring efficient and high ROI
- Creating and executing business growth and expansion plans
- Safeguarding the organization against market uncertainties through ensuring buffer funds
We will examine the role of financial management in more depth to gain a greater understanding of why it is important.
Financial Management Scope
The financial interests of investors and shareholders must be protected in order for a company to grow. Financial managers are expected to not only secure the interests of shareholders, but also generate more wealth through increased ROI. The objectives of financial management are important to understand for anyone in a business leadership role, as they help to outline what is within the scope of financial management and what its functions are.
Objectives of Financial Management
Certain specific and highly impactful objectives that financial managers aim to attain are:
Assessing Capital Needs
Financial managers need to evaluate various factors in order to make sound financial decisions for their company. These factors can include the cost of current and fixed assets, the cost of marketing, the need for buffer capital, long-term operation, human resources cost, etc. Successful businesses have a clear understanding of their short-term and long-term financial needs and they have suitable plans in place to meet those needs.
Determination of Capital Structure
The capital structure of a company determines the debt-equity ratio in both the short and long term.
Creation of Effective Financial Policies
More effective financial policies are needed to control cash, lending, and borrowing.
Resource Optimization
The ability to make the most of the available financial resources to get through different situations is what makes a great financial manager. Reducing cash burn and increasing cash churn would generate more ROI.
Functions of Financial Managers and Advisors
To reach these goals, financial directors and counselors must do particular responsibilities. These include:
Fundraising
Having enough cash and liquid assets is crucial for a business to grow with confidence and have a good reputation in the market. Therefore, businesses raise funds by equity or debt financing. Financial managers are responsible for ensuring that a company’s debt-to-equity ratio is healthy and that the company’s financial health is not impacted.
Fund Allocation
How a business allocates its money is just as important to its financial health as how much money it raises. The funds that a company has must be allocated in the best way possible after due diligence on:
- Business size and growth potential
- Whether the assets are short-term or long-term before spending on them
- Mode of fundraising
Profit Planning
For most businesses, making more profit is one of the main goals. A company’s financial health and future growth is determined by the profits it makes. Therefore, the money generated as profit needs to be used adequately. Whether they have to be plowed back to acquire assets and expand coverage, or to be spent on marketing, acquiring other businesses, or invested to act as a buffer resource, all these considerations are made by financial leaders.
Why and how do firms raise funds? Check Your Concepts
Long-term Finance Decisions
while short-term finance has a time horizon of a year or less The functions and decisions related to long-term finance have a time horizon that is generally greater than one year. On the other hand, those related to short-term finance have a time horizon of one year or less. These changes could have a negative impact on the company’s success and value in the future. Important decisions made by a company are usually related to the company’s strategy, and these decisions are usually made by senior management.
Investment Decisions
A firm’s investment decisions involve capital expenditures. They are, therefore, referred to as capital budgeting decisions. A capital budgeting decision is allocating funds to long-term assets that will have future benefits. There are two key factors to consider when making investment decisions: (a) judging the potential profitability of new investments, and (b) setting a benchmark rate of return against which to compare the new investments. It is difficult to measure the future benefits of investments and to predict them with certainty. Risk in investment arises because of the uncertain returns. Proposals for investments should be looked at in terms of how much money is expected to be made from them, as well as how risky they are. Besides making decisions about investing in new proposals, capital budgeting also involves making decisions about whether to keep investing in an asset that has become less productive or isn’t profitable anymore.
Most people agree that the best way to figure out how much money you should earn from investments, or the “required rate of return,” is to look at the potential earnings you could get from alternative investments. This opportunity cost of capital is what economists call the ” cutoff rate.” The opportunity cost of capital is the rate of return an investor could earn from investing in a financially similar but less risky asset. Although the opportunity cost of capital can be calculated in theory, there are challenges that prevent its accurate computation in practice due to limitations in data and information. A decision maker should be aware of these problems.
Financing Decisions
A financing decision is the second important function to be performed by the financial manager. The individual in this role must decide when, where, and how to acquire the funding needed to meet the investment needs of the firm. The issue before him or her is how much equity and debt to use. The proportion of a company’s capital that is made up of debt or equity is known as the firm’s capital structure. The financial manager’s goal is to ensure the firm has the best financing mix or optimal capital structure. The goal of the firm is to have an capital structure that results in the market value of shares being maximized.
Shareholders’ return in the absence of debt is the firm’s return. The use of debt affects the return and risk of shareholders. Shareholders’ return may increase when a company uses debt, but the risk always increases as well. The financial leverage is the difference in shareholders’ return caused by the change in profits. There needs to be a good balance between the amount of risk and the return. The optimum capital structure for a firm is the one that maximizes shareholder return while given the level of risk. The financial manager has to find the best combination of debt and equity and then get the right amount of money from the best sources. A firm will usually consider many other factors such as control, flexibility, loan covenants, and legal aspects when deciding on its capital structure.
Dividend Decisions
Short-term Finance Decisions
A dividend decision is the third major financial decision. The financial manager needs to figure out if the company should give away all its profits, keep them, or give some away and save the rest. The amount of money that a company gives to its shareholders as dividends is called the dividend payout ratio. The amount of money that a company keeps for itself is called the retention ratio. The dividend policy should be based on its impact on the shareholders’ value. The ideal dividend policy is the one that will maximize the company’s stock value. This means that the financial manager must find the best dividend-payout ratio for the company if the shareholders are not okay with the current policy. Dividends are generally paid in cash. But a firm may issue bonus shares. existing shareholders are given extra shares without having to pay anything extra. The financial manager should address practical questions regarding dividend stability, bonus shares, and cash dividends.
Short-term finance involves making decisions about money that will be used within a year. Making decisions about how to spend the company’s money in order to meet its daily needs. This text is discussing the general topics of financial management which relate to the management of current assets, current liabilities, short-term borrowings, and the investment of surplus cash.
Liquidity Decision
The profitability and liquidity of a firm are affected by investment in current assets. The management of current assets affects a firm’s liquidity, which is another important finance function. Asset management is important to keep the company running smoothly and to avoid any risks that could come from being unable to pay back debts. A lack of liquidity can make it difficult for a company to pay its debts, which can eventually lead to the company going bankrupt. There is a trade-off between profitability and liquidity when managing current assets. If a firm does not invest enough money in current assets, it could become unable to pay its debts, making it a riskier investment. Without profitability, idle current assets would not earn anything. In order to balance profitability and liquidity, a trade-off must be met. The trade-off between profitability and liquidity means that the financial manager should know how to manage current assets effectively. The individual responsible for this task should estimate the company’s need for readily available cash and make sure that there are sufficient funds to cover this.
In conclusion, financial decisions are directly related to the company’s decision to buy or sell assets and require a continuous commitment of funds. Finance functions are said to influence production, marketing and other functions of the firm in this context. Finance functions can therefore have an impact on a company’s size, growth, profitability, and risk, as well as the firm’s overall value. To quote Ezra Solomon:
“The function of financial management is to review and control decisions to commit or recommit funds to new or ongoing uses. Thus, in addition to raising funds, financial management is directly concerned with production, marketing and other functions, within an enterprise whenever decisions are made about the acquisition or distribution of assets.
Financial Procedures and Systems
In order for the finance functions to be executed effectively, other functions have to be performed regularly. Procedures and systems take a lot of time and paperwork. They do not require specialized skills of finance. Some of the important routine finance functions are:
The owner is responsible for: -Receiving and paying cash -Storing securities and other valuables -Coordinating new financing -Keeping records and providing reports
The financial manager’s involvement in the managerial financial functions is recent. The financial manager’s role was limited to routine activities about three decades ago. The following section discusses how the scope of the finance function has widened or how the role of the finance manager has changed. The finance manager in modern enterprises is mainly involved in managerial finance functions; executives at lower levels carrying out routine finance functions. A financial manager’s typical responsibilities includes overseeing the financial well-being of an organization, developing financial reports and strategies, and making sure that the organization complies with financial regulations. They may also be responsible for setting up rules and procedures, selecting forms to be used, establishing standards for personnel, and checking performance to ensure that rules are being followed and forms are being used correctly.
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