• 5 MIN READ
What Is Financial Management?
September 16, 2022
Financial management is the science of how to use capital, both your own and borrowed, to get the greatest profit with minimal risks, increase capital faster, and make an enterprise financially successful, attractive, and sustainable. Using the best financial management practices, a company can increase its market power and liquidity. At the same time, the company must comply with regulations. This requires a high-level plan and its prompt implementation.
The main goal of financial management is to control the movement of financial flows and financial relations in the short and long term efficiently. In short, this is the practice of creating a business plan, and then ensuring that all parts and stages are carried out competently and on time. Proper financial management and strict reporting during subsequent analysis allow the CFO or VP of finance to determine where to invest, which areas to develop, and how to reallocate resources.
Objectives of Financial Management
Based on these principles, financial managers help their companies in various ways, including:
Ultimately, we are talking about applying the principles of effective management to the financial structure of the company.
The Sphere of Financial Management
Financial management covers four main areas:
- Planning. The planning process can be divided into several categories, including capital expenditures, T&E, and labour, as well as indirect and operational costs. A financial manager needs to develop a plan, that is, to predict how much money the company will need to maintain a positive cash flow, allocate funds for the development or creation of new products or services and overcome unforeseen events, as well as to share the plans and calculations with business colleagues.
- Budgeting. The financial manager distributes the funds available to the company to cover such expenses as a mortgage or rent, raw materials, wages, employee T&E, and other obligations. In the ideal case, there should be a little left to set aside to finance new business opportunities or pay for emergencies. Companies usually have a master budget, the aggregation of all lower-level budgets, and also may have separate supporting documents covering operations and general cash flow. A company’s budget may be static or flexible.
- Procedures. A financial manager establishes procedures to securely and accurately regulate the processing and distribution of financial data, such as invoices, payments, and reports. The written procedures also indicate the employees that are responsible for making and signing financial decisions in the company. There are templates of policies and procedures available for various types of organisations, for example, for small and medium-sized businesses or nonprofits.
- Risk management and assessment. Business leaders turn to their financial managers with a request to assess and provide compensatory control over various risks, including:
- Market risk. Market risk affects business investments, and for public companies, it affects the reporting and performance of shares. Market risk may also reflect financial risks specific to a particular industry, for example, the recent pandemic affecting many sectors of production and services, or the outcomes of the transition of retail trade to a direct-to-consumer business model can be attributed to risks of this type.
- Credit risk. Credit risk includes the consequences of the fact that customers are late paying their bills, which causes a shortage of funds for the business to fulfill obligations. This situation negatively affects creditworthiness and valuation, which dictates the possibility of borrowing at favourable rates.
- Liquidity risk. Liquidity risk is a type of financial risk associated with the inability to sell assets, securities, or manufactured goods in a short time at a market price or close to it without significant losses. A financial manager should monitor current cash flow, estimate future cash needs and be prepared to free up working capital if needed.
- Operational risk. Operational risks are a general universal category that includes the risk of an accident or breakdown, cyber-attacks and the need to buy cybersecurity insurance, crises, and more. Financial managers are considering possible recovery and business continuity plans, as well as anti-crisis management methods. An example is a situation where a high-ranking executive like the CEO is accused of fraud, and the financial team should be ready to take over the management.
Types of Financial Decisions
Each company has to make three main financial decisions, namely:
1. Investment Decision:
This is a type of financial decision that includes any decisions on enterprise management, the consequences of which will be felt for a relatively long time, at least more than a year. Decisions relating to how the firm's funds are invested in various assets.
Investment decisions can be divided into long-term or short-term.
A long-term investment decision is called a capital budgeting decision that involves large amounts of long-term investments and is irreversible. The wrong decision during the preparation of the capital investment budget can cause serious damage to the financial stability of the business.
A short-term decision is called a working capital decision that affects the everyday operation of a business. They include decisions on the levels of cash, inventory, and accounts receivable. The wrong decision on working capital affects the liquidity and profitability of the business.
2. Financing Decision:
Financial decisions are decisions related to the monetary obligations and equity of the company, for example, the decision to issue shares, debentures, and the attraction of investments from third-party sources, such as bank loans. In other words, it is a decision about the capital structure of the company (Capital Structure Owner's Fund + Borrowed Fund)
Part of the financial decisions in the process of their implementation, one way or another, can be adjusted in order to eliminate any deviations or take into account new factors. Some solutions are typical or repetitive and they can be successfully automated, i.e. accepted according to a predetermined algorithm.
3. Dividend Decision:
A dividend decision is a financial decision related to determining which part of the profit received by the company should be distributed among shareholders as dividends and which part should be saved for future unforeseen expenses (retained earnings).
Dividends are related to the part of the profit that is distributed among shareholders. The decision to pay dividends should be made taking into account the overall goal of maximising the wealth of shareholders. The source of payment of dividends is the net profit of the organisation, that is, the profit remaining after paying all taxes. The number of dividends can be an additional indicator for investors because it is an indirect indicator of the success of the enterprise.
Automation Tools for Financial Management
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