What is Financial Management?
Financial management can be defined as the art and science of managing money. It is known that most individuals and organisations earn money in the form of salary or business profits and invest their money according to their needs. However, the amount of money that they can spend or invest or retain with themselves depends on financial management skills of the individual or organisations.
Financial management is a widely used term and is usually associated with and used when we refer to various financial processes, financial institutions, banks, financial markets, financial instruments, and transfer of money among individuals, business, and governments. A business concern needs financial management to meet its requirements in the economic world. Any kind of business activity depends on financial management.
Table of Content
- 1 What is Financial Management?
- 2 Concept of Financial Management
- 3 Objectives of Financial Management
- 4 Relation Between Finance and Other Disciplines
- 5 Scope of Financial Decisions
- 6 Relevance of Financial Management
- 7 Importance of Financial Managers
Hence, it is called as the lifeblood of business organisation. Whether the business concerns are big or small, they need financial management to fulfil their business activities. In the modern world, all the activities are concerned with the economic activities and very particular to earning profit through any venture or activities. The entire business activities are directly related with making profit.
According to the economics concept of factors of production, a business concern needs financial management to meet all its requirements. Hence, finance may be called as capital, investment, fund, etc., but each term has a different meaning and different characters. Increasing the profit is the main aim of any kind of economic activity.
Concept of Financial Management
Financial management is primarily concerned with an organisation’s accumulation and utilisation of funds. The following aspects of financial management are studied in depth under the study of financial management, based on financial management guru Ezra Solomon’s philosophy of financial management:
- Establishing the size of the business and determining its growth rate
- Establishing the enterprise’s asset composition
- Determining the mix of an enterprise’s funding, such as the debtto-equity ratio, and so on
- Analysis, preparation, and management of the company’s financial affairs
Objectives of Financial Management
Effective procurement and effective management of funds contribute to proper financial management by the business concern. It is an essential part of the financial manager’s job. As a result, the financial manager must establish the financial management’s economic objectives.
The objectives of financial management can be divided into two categories:
- Profit maximisation
- Wealth maximisation
Profit is the main objective of any type of economic activity. A business concern is often primarily operated for the purpose of benefit. Profit is a term used to describe the methods used to assess a company’s business performance. Benefit maximisation is a conventional and limited strategy that seeks to optimise a company’s profit.
Profit maximisation consists of the following important features.
- Cashing per share maximisation is another term for profit maximisation. It ensures maximisation of business operations for maximising profits.
- The ultimate goal of a business concern is to make a profit; as a result, it finds all possible avenues to maximise profitability.
- Profit is the metric by which a company’s productivity is measured. As a result, it depicts the company’s overall status.
- Profit maximisation goals assist in lowering the company’s risk.
Some of the major limitations of the profit maximisation objective are as follows:
- Vague: Here, the term profit is not defined in precise terms.
- Ignores risk: Risks may be internal or external and these usually affect the overall business operations. If risks are realised, they can hamper the profitability of the company dramatically.
- Ignores Time Value of Money (TVM): This method does not consider the timings of costs and returns and focusses only on the profits that are generated in absolute value terms without adjusting for time value.
Wealth maximisation is a better alternative to profit maximisation. This is also known as net present worth maximisation or value maximisation. The market price of the company’s equity shares reflects value. Prices in the stock market at any given time are influenced by a variety of factors, including the general economic outlook, particularly if specific companies are being considered, technical factors, and even mass psychology. On a long-term basis, however, the share market values of a company’s shares do reflect the importance that different parties place on it.
Normally, the value is a function of two factors:
- The likely earnings per share (EPS) of a company
- The capitalisation rate
EPS is determined by dividing the net earnings available for the firm’s common shares over a given period by the amount of outstanding common shares. The likely earnings per share (EPS) is determined by a forecast of how profitable a business will be in the future. An organisation usually requires money for continuing its business operations.
A major source of money is the money invested by shareholders. Therefore, according to the wealth maximisation view, the managers of a company are seen as investors or shareholders’ agents who conduct the business according to shareholders desires such as making as much money as possible while conforming to the basic societal, legal, and ethical rules and customs.
Relation Between Finance and Other Disciplines
Financial management is an essential component of overall management, as it is linked to various functional departments such as Human Resources, marketing, production, and purchase. With multidimensional methods, financial accounting encompasses a broad range of topics
The following are some of the most crucial aspects of financial management:
Financial Management and Economics
Microeconomic and macroeconomic principles are specifically applicable to financial management methods. The roles of a financial manager are inextricably linked to investment decisions, as well as micro and macro environmental factors. Economic equations such as the money value discount factor, economic order quantity, and so on are also used in financial management. Financial economics is an emerging field that offers enormous potential in finance and economics.
Financial Management and Accounting
The financial information of the company concern is held in accounting reports. As a result, the relationship between financial management and accounting is clear. Both financial management and accounting were once treated as one discipline, but they were later combined into Management Accounting because this aspect is extremely useful to finance managers in making decisions. However, financial reporting and accounting are now distinct but intertwined disciplines.
Financial Management and Mathematics
A significant number of mathematical and computational methods and techniques were used in modern financial management approaches. Econometrics is another name for them. In the field of financial management, quantitative and statistical methods and techniques such as economic order quantity, discount factor, time value of money, present value of money, cost of capital, capital structure theories, dividend theories, ratio analysis, and working capital analysis are used.
Financial Management and Production Management
Production management is the aspect of a company’s operations that makes it multiply capital into profit. The success of the company is determined by its ability to produce. Since the production department requires raw materials, equipment, salaries, and operating costs, it requires financial support.
The financial department determines and estimates these costs, and the finance manager allocates the necessary funds to the production department. The financial manager must be aware of the operating process and the financial resources needed for each phase of the manufacturing process.
Financial Management and Marketing
Produced products are sold in the market utilising cutting-edge approaches. To do so, the marketing department requires funding to meet their needs. It is the responsibility of the financial officer or finance department to assign sufficient funds to the marketing department. As a result, marketing and financial management are intertwined and interdependent.
Financial Management and Human Resource
Financial management is connected to the human resource department, which provides personnel to all of the management’s functional areas. The financial manager should carefully assess the staffing requirements of each department and assign funds to the human resource department in the form of salaries, compensation, remuneration, commission, incentive, pension, and other monetary benefits. As a result, human resource management and financial management are intimately linked.
Scope of Financial Decisions
Financial management broadly covers three decision areas namely investment decisions, financing decisions, and dividend decisions. Let us now study about these.
A financial decision which is concerned with how a firm’s funds are invested in different assets is known as investment decision. Investment decision can be long-term or short-term. A long-term investment decision is called capital budgeting decision which involves huge amounts of long-term investments and are irreversible except at a huge cost. Short-term investment decisions are called working capital decisions which affect day to day working of a business. It includes decisions about the levels of cash, inventory and receivables.
Some of the investment decision are as follows:
- Planning for capital expenditures (identification, selection and implementation of capital projects)
- Mergers, reorganisations, and divestitures management
- Working Capital management (cash, marketable securities, receivables, and inventories)
Financial management is, without a doubt, crucial to a company’s growth. No business organisation will maximise its growth and expansion capacity without proper financial management. Financial management is concerned with the acquisition, funding, and management of assets with the aim of achieving certain long-term objectives.
The Financing Decision is yet another crucial decision made by the financial manager relating to the financing-mix of an organisation. It is concerned with the borrowing and allocation of funds required for the investment decisions.
The financing decision involves two sources from where the funds can be raised: using a company’s own money, such as share capital, retained earnings or borrowing funds from the outside in the form debenture, loan, and bond. The objective of financial decision is to maintain an optimum capital structure, i.e., a proper mix of debt and equity to ensure the trade-off between the risk and return to the shareholders.
Some financing decision are as follows:
- Determining the financing mix by identifying sources of funding
- Identifying and cultivating funding sources and raising funds
This is the third and final financial judgement, and it concerns the dividend strategy. A dividend is a portion of a company’s income that can be distributed to equity owners. Dividend payments should be examined in light of a company’s financial decisions. There are two ways for dealing with a firm’s net income: distribution of profits as dividends to ordinary shareholders if no preservation of earnings is required, or retention of earnings in the firm itself where it is required for funding of any business operation.
However, the effect of dividend payment or retention on the shareholding should be considered. The financial manager can decide the best dividend strategy that maximises the share’s market value and therefore the firm’s market value. Another part of dividend policy is considering the variables to consider when deciding dividends.
Relevance of Financial Management
Finance is essential to every company’s survival. It must satisfy the needs of a business concern. Any business concern must have sufficient amount of funds on hand to ensure smooth operations and to carefully manage the business to achieve the company’s objectives. Only successful financial management will enable the company to achieve its target. We cannot overlook the importance of money at any moment or under any circumstance. Some reasons why financial management is so relevant are discussed in this section.
Financial management helps in determining the financial requirements of a company and subsequently contributes to financial plan ning. Financial planning is an essential aspect of business that aids in the growth of a company. As a student of management, you must be aware that management is based on a few critical functions including planning, organising, leading, controlling, staffing, directing, coordinating, reporting, budgeting, etc.
It is also known that financial management is a specific field of management that deals with all money related matters of an organisation. Financial planning is a specific function of financial management which deals with planning and organising the future business activities of a company. Financial planning helps the company determine the direction in which it wants to grow in the future.
Financial planning helps in developing the basic premise for procuring funds, their utilisation, and creating value. The process of financial planning helps in establishing business plans for achieving business goals such as expansion and diversification.
The financial planning function involves the following key activities:
- Translate the company vision, mission, and goals of a company into quantifiable and measurable terms
- Envisioning and developing policies, and structures for achieving the objectives
- Establish detailed procedures, activities and guidelines for ensuring that the company moves in the desired direction
Acquisition and Disposal of Fund
Financial management entails obtaining the required funds for a company. Obtaining required funds is an important aspect of financial management, which includes finding the most cost-effective sources of funding. The proper use and distribution of funds improves the business concern’s operating performance. When a financial manager raises funds wisely, he or she will lower the cost of capital and raise the firm’s value.
Financial planning helps in making sound financial decision in the business concern. Financial decisions affect the various functions such as marketing and production personnel of the company. An organisation that has a thorough decision-making process will be able to divert its funds towards the right investment opportunities and instruments which would help in achieving the business goals.
The efficiency and proper use of funds by the business concern are solely responsible for the concern’s profitability. With the aid of capital budgeting techniques like NPV, IRR, Inventory management EOQ, Receivable management, and financial management helps to increase the profitability position of the company.
Managing the Overall Cost of Capital
For achieving more growth and to expand its business, a company must aim to derive maximum profits so that it can reinvest its savings or retained earnings. A company can achieve maximum savings with the help of effective financial planning. Financial planning helps a company determine the appropriate levels of debt and capital financing and maintaining a healthy overall cost of capital.
The ultimate goal of any business concern is to maximise wealth, and higher profitability contributes to increased wealth for both investors and the economy. One important activity under financial planning relates to managing the investments of the company to create wealth. Wealth creation involves creating a pool of tangible and intangible assets such as stocks, bonds, real estate, gold, and cash. Wealth creation is significant because it acts as a regular source of income and promotes goal-based investing.
Importance of Financial Managers
The financial manager is in charge of overseeing and managing financial reports, investment portfolios, accounting, and all types of financial analyses for the company. In addition to the regulatory system, it must oversee the company’s cash management policies. It is responsible for overseeing the balance sheets, profit and loss statements, and the expense and income model to effectively control the organisation’s cash flow.
The creation of an effective financial plan, which would explain all of the organisation’s financial aspects while achieving the goal of reducing costs and optimising profit, is also part of the job description. Financial managers are also in charge of making spending decisions and putting together a financial operating plan.
The financial manager must be knowledgeable about all technical aspects of the company’s financial decisions. The Inter-American Investment Corporation also emphasises the value of providing a thorough understanding of legal legislation and statutory litigation as a lawyer.
The following are the most important aspects of financial management:
- Financial planning
- Financial control
- Financial decision-making
- Financial planning
Management must ensure that sufficient financing is available at the appropriate time to meet business’s needs. Funding can be needed in the short term to invest in stocks, pay staff, and finance credit sales. Funding will be needed in the medium and long term to make substantial additions to the business’s productive ability or to make acquisitions.
This position’s responsibilities include not only accounting functions such as Accounts Payable, Accounts Receivable, and Billing, but also budget estimates and collaboration with the Chief Financial Officer to ensure that the company’s finances are secure and to assist with any budget cuts that might be required. The finance manager is in charge of the company’s Accounts Payable and Accounts Receivable departments.
As a result, he will be in charge of establishing strategy and directing practises in both areas of business. This involves recruiting people based on need, adhering to budget guidelines for all spending, including staffing, ensuring that all employees follow policies, establishing a fair quota schedule to ensurework is done on time, and engaging with department managers on a regular basis to keep informed of what’s going onin the department.
The finance manager would also compile reports that detail all of the conditions in his department, such as expenses, open invoices, production standards, quality management standards, and invoice and payment processing timeliness. The finance manager is also in charge of the Accounts Receivable Department’s billing operations, as well as ensuring that billing protocols are followed.
The finance manager is also the one who will collaborate with other executives to create the annual budget. He will collaborate with the Chief Financial Officer and the Chief Executive Officer to create an equitable solution for the company’s annual staffing, office supply, and other needs, such as training, business trips, out-of-town meetings, and staff entertainment expenses.
The finance manager is a critical member of a company’s management team, and his decisions will decide the company’s financial health, at least in the areas under his supervision. It is also his responsibility to ensure that other departments and areas of the business stick to their budgets and make the best use of the company’s funds by preventing unnecessary spending.