Financial Management – explained Simply and Concisely

Financial Management sometimes can be a  hard topic to wrap your head around. With the terms and information associated with it, it can easily get confusing . . . and boring. Well, what this article will do for you is the opposite of that. Financial management simply means acquiring and spending money smartly. You can’t make money without spending money and this is what financial management is all about.  Here, you’d get to understand the basics of financial management and you’d get to see examples that’ll make the explanation clearer.

 

What is Financial Management?

According to S.C.Kuchal,

Financial Management deals with procurement of funds and their effective utilization in the business.

It includes the process of obtaining the funds needed by the company, how this fund is spent and what the fund is spent on. It is not unlike your day-to-day job. You receive an income at the end of the month and this is the money (finance) you’ll spend (manage) throughout the course of the next month. In order to supplement your income, you may look for alternate sources that’ll generate money for you e.g doing some jobs on weekends such as mowing lawns or selling home-made products. All these are measures of efficient financial management. Just like spending your salary unwisely before the end of the month will result in debts (from borrowing from friends and family), unintelligent financial management in a business will result in the accumulation of debt. And if this continues for a while, it may lead to the death of the business.

Financial management entails the process of planning, organizing, monitoring and controlling the financial resources of an organization. Planning includes having an allocated budget for each department in the company, estimating the total amount of money that will be spent in a year and ensuring the estimated cost is well below the estimated profit for the year. You want to ensure that each dollar you spend is well spent and necessary/important. Organizing involves creating a structured flow of funds into and out of the organization. Monitoring involves watching the financials of the company and ensuring that it’s in line with the company objective while controlling mainly has to do with the procurement of funds, use of funds, payments, accounting and risk management.

Unwise financial management can drive a business into bankruptcy just like a sub-standard product, high production costs or inefficient marketing will. Even if you have a thriving business – sales are breaking the roof, the demand for your product is more than you can supply and everyone is talking about how great your product is – the business is bound to run down if you cannot account for how money is utilised. You’d just discover that at the end of the day, there’s nothing to write home about.

However, efficient use of financial resources can grant the company an advantage in the market place. The success of a business enterprise is largely determined by the way its capital funds are raised, utilised and disbursed. How is the capital to run the business obtained? Is it through borrowing? How much is being spent on what? These are questions the financial manager must answer.

The financial manager is in charge of the finances of the company. This department will give a breakdown of how money is spent and how much income the company earns. Then the profit will be calculated. Finance is one thing all business have in common and the success (or failure) of a business is measured in terms of the financial capacity of the company.

piggy bank depicting need for financial management

Need for Financial Management

1.  Survival of the Company

Inefficient financial management will gradually kill a company. In fact, it will speedily end it. For a company to survive, the inflow of cash must be greater than the outflow and this is the overall objective of most businesses. Therefore, the manager has to make great decisions concerning the finances of the company.

2. Maximizing profit

Ensuring the company survives per year is one thing, ensuring the profits keep growing every year is another. The purpose of any business is to make profit. And after the profit is made, the next financial objective is basically to increase the profit. This will be done by providing the best product (or service) at the lowest cost possible.

3. To ensure availability of funds

Acquiring assets is an important part of business, but for the business to function, cash in it’s raw form – in it’s liquid form – is needed. How will salary be paid and monetary transactions such as payment of wages and salaries, payment of electricity and water bills, payment to creditors, meeting current liabilities, maintenance of enough stock, purchase of raw materials be carried out if all the finances of the business are tied down? Financial management therefore constitutes having the right amount of money at the right time to carry out the company’s activities. You don’t want to have too much funds (as this should be invested) and you don’t want to have too little. Therefore a balance is required and this is what you should have in mind as a financial manager.

4. To ensure safety on investment

Investing in viable commodities and following the required procedure, policy and guideline is important for every business. You don’t want to suffer a loss (huge or not) based on poor decisions or preventable circumstances. Financial Management puts in check every investment decision by analysing the risk and profit associated with it while making sure it is obeying the relevant policies.

5. To make sure Shareholders receive adequate returns

There’s a difference between making profit and making the expected/estimated profit. You can invest $2000 (cost price) in a business and end up generating an income of $3000. You obtain a profit of $1000. That’s great, right? No! not if your estimated income is $6000. So even though you make a profit, it is not the one you estimated or expected and this will generally affect the budget for the next quarter or year. So, obtaining a return is different from obtaining estimated return and this is a reason financial management is needed – to make sure the estimated return (or more) on investment is achieved. And this depends on the earning capacity of the company, market price of the share and expectations of the shareholders.

How financial management is carried out

Financial Management is carried out by:

1. Coordinating the allocation of financial Resources (Financial Control)

The financial manager is responsible for the disbursement of funds to the various departments of the business per time. Each department is allocated a budget. The manager ensures that each department gets the money needed per time and calculates the amount left for the department after each withdrawal. The financial Manager also ensures that each department do not spend more than the amount allocated to the department. It’s just like you managing your salary. You can make sure you don’t spend more than your salary each month. In that way you’re also managing your finance effectively. And if you have to borrow, let it most of the time be to grow your assets or invest in your business. Avoid borrowing to purchase liabilities.

2. Financial Forecast and Planning

The management needs to know how much they need to spend on working capital and fixed assets for the business. And it is the job of the financial manager to provide them with the information. He/she should project the financial need of the company and proffer solutions to meeting these needs. It’s not enough for the manager to just manage what the company has. It is the duty of the manager to look for viable means other than the one already obtained by which funds can be generated. E.g by the issue of more shares and debentures and the taking of loans from banks and financial institutions.

This can then be invested both for Working Capital and Capital budgeting purposes.  Financial management also includes making plans for the financial need of the company in the future. Is the cost of production likely to rise as time passes? Will inflation affect the business negatively? These are questions that need to be answered by the manager.

3. Fund Investment

You can’t just accumulate money and then keep it. Money is made to be spent. Even if you have a million dollars, you’d be surprised how quickly you’d burn through it if investment isn’t part of the plan. The same applies to companies. A necessary part of financial management is the investment of funds.

As a financial manager, it is your job to invest in various channels both internal and external in order to grow the returns acquired by the company. Long term investments require the commitment of funds into assets such as building and/or land, acquiring new plants/machinery or replacing the old ones. This reduces the cash the company has at hand for a long period and therefore should be well thought out before used. Short term investments takes a shorter time to yield results and this includes investment of funds in the inventory, cash, bank deposits, and other short-term investments. This kind of investment directly affect the liquidity and operations of the business.

4. Determination of capital composition

Once the estimation of capital composition has been made, the capital structure have to be decided. This entails how the company funds its overall operations and growth and it involves short- term and long- term debt equity analysis. It is determined by the amount of equity capital (which is the funds paid into a business by investors) a company is possessing and additional funds which have to be raised from outside sources. This represents the core funding of a business, to which debt funding may be added.

5. Disposal of surplus

When a company makes the estimated (or more) profit in a year, it is necessary to plough back some of the profits into the business. This allows the business to keep growing, expanding and prevent competition from taking over the market place. This disposal is done by the financial manager and it can occur either by dividend declaration which is the portion of profits earned by the company that the company’s board of directors decides to pay off as dividends to the shareholders.  It can also be used as Retained earnings which is the amount of net income left over for the business after it has paid out dividends to its shareholders. Retained earnings increases the amount of capital the business has for the next year.

Types of financial management

Types of Financial Management

1. Working Capital Management

The working capital management of a company refers to the managing of records and accounting strategies intended to monitor current assets, current liabilities, cash flow, inventory turnover ratio etc. Working capital management is basically to ensure the company keeps up adequate cash to meet its short-term debts and operational cost. In this instance, financial management is needed to keep every wheel in the business turning through the good management of working capital.

2. Treasury and Capital Budget Management

With a lot at stake with huge capital expenditures, companies need something to measure the progress of big projects. This is done by a means of financial management known as Capital budgeting. This is the planning procedure used to decide if a company’s long-term investments e.g new plant, new machinery; new research projects is worth the allocation of funds through the company’s capitalization structure (equity, debt or profit earnings). Numerous formal strategies are utilized in capital budgeting e.g Profitability index, real options valuation, internal rate of return, equivalent annual cost and more.

3. Capital Structure Management

Capital structure is the manner in which a company finances through a mix of debt or equity securities. Debt financing comes as bond issues, while equity comes from retained earnings or as a stock. Short-term debt financing, for example, working capital necessities is likewise viewed as a major aspect of the capital structure. Here the financial management team is responsible for capital structure of a company’s short-term debts, long-term debts, equities, preferred stocks and more. At the point when team refer to capital structure, they are probably considering a company’s debt-to-equity ratio, which gives understanding into how healthy organization is financially or how risky organization is financially.

The Importance of financial Management

  • It makes sure there is adequate funds for operations in a company
  • It ensures that cash outflow does not exceed cash inflow
  • Financial management ensures the company invests in itself and keeps growing
  • Financial Management helps in stabilizing a company
  • It helps organisations to effectively utilise and allocate funds received
  • Financial management assists organisations in making critical financial decisions and financial plans
  • It provides economic stability

Financial management is a term mostly associated with businesses and organizations but even in our personal lives, some form of financial management is required if we really want to maintain or/and increase our personal assets. Be it in your business or personal life, endeavor to manage your finances optimally.

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