Finances are the lifeline of any business whether small or big. For any business to be sustainable, it must have a sound financial management plan in place.
In this article, we are going to look at the meaning of financial management, its objectives, nature, functions, and why it’s important to an organization.
The concept of financial management in a corporate perspective refers to the management of financial resources of a business or an organization so as to achieve certain set financial objectives and enhance sustainability.
In a typical commercial organization structure, the key objectives of a sound financial management system will be to help the organization in creating wealth, generate cash flows, and guarantee a return on investments at minimal risks.
Financial Management Process
The financial management process involves planning, organizing, directing and controlling different financial activities such as procurement and use of funds in an organization.
A good financial management process must adhere to general management principles so as to effectively manage the financial resources of an organization. There are three important elements that every organization must adhere to when it comes to the financial management process.
These key elements include;
1. Financial Planning
Financial planning component tasks the management with the responsibility of ensuring that funds are available as and when required so as to run business processes smoothly. Financial managers have the role of clearly setting out the organization’s short-term, medium, and long-term financial goals and requirements.
2. Financial Control System
The financial control system is an internal check and balance framework that checks whether financial resources in an organization are used in an effective manner.
It checks whether business assets and finances are used prudently and whether the management is working to the best interest of the company’s shareholders.
The financial control system is very important in the financial management process as it’s the engine that determines whether the business objectives will be achieved or the business will collapse.
3. Financial Decision Making
Financial decision-making is a key management aspect that involves making important financial decisions regarding investments, dividends, and financing options. The management is tasked with the responsibility of coming up with the best investment proposals that have a good return on investment.
When possible investments are outlined, financial managers must advise on the best alternatives of financing that are available so as to fund the projects. It mostly involves making decisions on either debt or equity financing.
Another aspect of the financial decision-making component is the issue of dividends payout to stakeholders. Financial managers are tasked with the responsibility of advising the management on whether to retain profits that the business has earned or distribute it to shareholders as dividends.
Definition of Financial Management by Different Authors
There are many financial management scholars who have come up with widely accepted definitions of the term financial management. Let’s look at what they said is the ideal meaning of financial management.
According to Dr S.N Maheshwari-
“Financial management is concerned with raising financial resources and their effective utilization towards achieving the organizational goals”.
According to S.C Kushal-
“Financial management deals with procurement of funds and their effective utilization in the business”.
According to Ezra Solomon-
“Financial management is properly viewed as an integral part of overall management rather than as a staff especially concerned with funds raising operations”.
According to Weston and Brigham-
“Financial management is an area of financial decision making, harmonizing individual motives and enterprise goals”.
According to Masse-
“Financial management is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations”.
According to Van & Matluir-
“Financial management deals with identifying and maintaining an appropriate level of assets and establishing and executing a suitable plan for financing the firm’s assets”.
Based on the above definitions of financial management, we can conclude that the finance department is an integral component of any organization. It helps the management with key managerial advice on the acquisition of funds, utilization, and investment decisions.
Financial Management Basic Principles
Just like any other discipline which is objective-oriented, financial management has some basic principles which play an important role in helping financial managers make informed financial decisions. They include;
1st Principle; The Principle Of Risk Return
It has everything to do with risks and investments. Investors cannot absorb any additional risk in their investment except in situations where there are additional returns.
2nd Principle; The Concept of Time Value Of Money
It holds that a dollar received today is much better than the one which will be received in future.
3rd Principle; Cash and Not Profits
Which holds that its cash flows and not profits that are actually received by the firm and can be re-invested back.
4th Principle; Incremental Cash Flows
It states that it’s only what changes that counts. Incremental cash flow refers to the difference between the cash flows if the project is taken on compared to what they will be if the project is not taken on.
5th Principle; The Curse of Competitive Markets
And why it’s hard to find exceptionally profitable projects? It opens minds to think wide.
6th Principle; Efficient Capital Markets
It holds that the markets are quick and the pricing is right. A good market is one which comprises a high number of profit-driven who operate independently.
7th Principle; The Agent Difficulty
There exist scenarios where there is conflict arising between the agent and stockholders over interests.
8th Principle; Uneven Taxation Business Decisions
Focusing on the tax problems that may arise from unfair business decisions
9th Principle; All Risks Are Not Equal
Focuses on business risks and what to do with them.
10th Principle; Ethics
Focuses on doing the right thing and making an ideal decision when in business
Objectives of Financial Management
The financial management function as we have discussed above, it revolves around sourcing, control as well as allocation of financial resources in different departments in an organization.
Financial managers are the ones who are in charge of financial management in bigger organizations.
The objectives of financial management are;
1. Profit Maximization
Profits mean a company is doing well and all business operations are running effectively. A financial manager in any organization is tasked with the very important task of maximizing profits.
Profit maximization is one of the main objectives of financial management. In order to achieve this crucial objective, financial managers must create effective strategies that will maximize output through optimal allocations and effective utilization of scarce financial resources.
Financial managers evaluate and identify departments that need more financial resources with a guaranteed return on investment.
2. Effective Finance Mobilization
Financial management also encompasses sourcing financial resources to fund different projects and organization operations.
Financial managers have a responsibility for mobilizing financial resources from trusted and legal sources such as banks, shares, and debentures.
The resources raised through such revenues add to the working capital base of the company.
What is working capital? The working capital of a business is the net amount left after deducting total current liabilities from total current assets.
Some examples of current assets in a typical business entity include; cash balances, pre-payments, work-in-progress, stock of raw material, finished goods, and short-term trade debtors. Current liabilities, on the other hand, include; trade creditors, account payables, accruals, and short-term loans.
It’s the role of financial managers to ensure that there is a proper balance between equity financing and debt financing.
3. To Maintain Company’s Survival and Competitiveness
Financial decisions can determine the success or failure of a particular organization. That’s why it’s important to hire professional financial managers who are skilled and are able to make sound short-term and long-term financial decisions.
An organization with proper financial management strategies and policies, it’s able to grow and remain competitive.
4. To Lower Cost of Capital
Remember, the main aim of a business is to maximize profits through customer satisfaction. In order, to achieve this goal, the cost of capital should be at a minimum.
Financial managers are also tasked with the responsibility of ensuring that the cost of capital is low as possible.
This can be achieved by negotiating better terms of interest to the borrowed business loans. When the money borrowed attracts lower interest rates, the organization’s expenses reduce translating to increased profits.
5. To Create Proper Coordination and Interdependence
A company is made up of different departments and the finance department is the engine that drives all other departments.
For smooth business operation and coordination, there should be a good understanding and co-operation between the finance docket and other departments.
Every organization’s department is usually tasked with preparing it budget estimates. Once, the proposals are forwarded to the finance department, it’s the role of financial managers through coordination with other department heads and key decision-makers to allocate financial resources accordingly.
Functions of Financial Management
Financial management functions can be grouped into two namely, routine financial functions and managerial financial functions.
Routine financial responsibilities refer to day-to-day finance tasks that are carried out to ensure smooth operations of the business. They include office accounting and short-term procurement tasks.
Managerial finance responsibilities are sophisticated and involve making important financial decisions either on investments, planning, capital structure, and dividends payout policies.
Financial management functions are executed by financial managers since they are the ones who are skilled and are tasked with the responsibility of ensuring that company finances are kept in order.
The following are the key functions of financial management in an organization;
1) To Help In Financial Planning and Forecasting
Financial managers help the organization plan for current and long-term financial needs. They do this by analyzing the existing projects, current modernization and expansion plans, investments in fixed assets as well as working capital estimates.
They prepare financial estimates and projections on both expenses and expected return on investment.
Financial planning involves the allocation of financial resources to different departments to cater for working capital and fixed assets based on need and priority.
Financial managers should also plan on the best mechanism to source the finances required and methods of repayment so as to ensure that there is cash flow.
Financial forecasting encompasses making future decisions on financial resources in order to meet the projected growth and needs of your organization.
A financial manager is tasked with the responsibility of developing financial plans and clearly stating how the finances shall be spent.
2) To Establish a Solid Fund Investment
A solid fund investment plan is very crucial as it determines business sustainability. Financial managers are tasked with the responsibility of ensuring that all the financial resources available are used prudently to grow the business.
Adequate evaluation of the cost of loans and the expected return on investments should be conducted so as to identify the best sources of funding that will provide more returns at minimum cost.
Financial managers also identify key business sectors that are doing well but financially starved and come up with new ways of financing to make them more productive. They use leverage in order to maximize the shareholder’s value.
3) Disposal of Surplus
Financial managers offer professional advice on the surplus assets and determine what percentage should go to investors or invest back into the business in order to increase profit.
Disposal of assets can be done in the form of a dividend declaration or retained profits. For dividend declaration, the financial managers have the responsibility of identifying the ideal rates of dividends plus other accrued benefits such as bonuses.
For the retained profits, financial managers also help in determining the percentage to be disposed of after putting all the expansion, innovation, and diversification plans into consideration.
4) It Helps In Creating a Good Capital Structure
Capital structure refers to the ratio of equity to debt that is used to finance the company’s projects. Capital structure managerial decision is formulated after the company has established it estimated required capital.
A financial management decision has to be made on the best sources of financing and a proportion of debt to equity.
Finance managers should come up with sound capital structure strategies which ensure that the company grows and at the same time retains its solvency. Remember that the main objective here is to maximize the shareholders’ wealth at the minimum cost of capital.
A good capital structure is developed after all the company’s financial planning and forecasting are done.
5) Establishing Financial Controls
A financial control system is established through an in-depth analysis of the company’s actual results at different levels and times compared to the already set short, medium, and long-term objectives of the company.
Financial managers are charged with the responsibility of determining the required amount of funds in each department and allocate them accordingly.
Financial controls are done according to the already set out business standards on allocation and use of financial resources. If there is any need to either increase or reduce the allocation of funds in a particular department, it’s the work of the financial manager to implement such proposals.
Financial controls also involve frequent monitoring of different financial activities in the organization in order to curb any financial flaws that may arise in good time.
Financial control mechanisms help in the evaluation of different processes so that financial managers can advise key decision-makers appropriately.
6) It Helps In Maintaining Adequate Company Liquidity Threshold
The liquidity of a company is determined by its cash flows. Since money is required in day-to-day business operations, it’s the role of financial managers to maintain good books of accounts so as to ensure that there is adequate cash whenever it’s needed.
Proper liquidity makes it easy for companies to buy any raw materials, pay salaries and handle other important expenses. Financial managers should plan the company’s liquidity properly so as to ensure that there is no scarcity of finances at any given time.
7) It Helps Boost Company’s Transparency and Credibility
Proper financial records and statements are good indications of a genuine and transparent organization. Proper financial management practices help in creating a strong and trustworthy business relationship with your suppliers, clients, lending institutions, as well as shareholders.
When there is financial transparency, it’s easy to determine the value of a company’s assets, procurement costs, and liabilities so as to ascertain the company’s status. Transparency also helps boost productivity and shareholder confidence.
The Scope of Financial Management
Financial management is wide but it can be narrowed down to three core financial management decisions. Financial decisions in a company must put stakeholders’ interests first and they must be made with a positive aim of growing the company.
Financial managers who perform well are the ones who make informed decisions with the aim of maximizing stakeholders’ wealth.
This can only be realized if there is an increase in net worth, more capital investments and ploughed-back profits which are put into productive projects.
To understand the scope of financial management better, let’s have a look at these core decisions in detail.
1. Investment Decisions
Financial managers are tasked with the responsibility of knowing the amount of investment that is available from the existing company’s finances. Investment decisions to be made can be either short-term or long-term.
Short-term decisions: Short-term investment decisions involve allocating funds for a short period of time. They are also known as working capital management decisions. Short-term investment decisions usually have a direct impact on the liquidity as well as the performance of the organization.
Examples of short-term investment decisions are reflected in the allocation of financial resources on current assets such as inventory, bank deposits, and small short-term investment opportunities.
Long-term investment decisions: Long-term investment decisions are also referred to as capital budgeting decisions. They are financial decisions which are made to allocate funds to long-term projects and money spent on long-term assets.
Long-term investment decisions require proper examination before they are executed because they are not easily reversible and can have high risks/opportunities.
Some best examples of long-term capital investment decisions include; purchasing new machinery, building or buying land, disposing of the old machinery, and buyouts.
2. Financing Decisions
Financial managers are also tasked with the responsibility of sourcing for finances that are needed in order to run the organization effectively. They can raise finances from short-term sources or go for long-term sources.
If they are funding a small project or daily business operations, working capital must be sourced. The capital structure, on the other hand, focuses on financing long-term projects.
When making financial decisions on capital structure, a finance manager must strike a reasonable balance between debt and equity financing.
3. Working Capital Financial Planning Decisions
The financial planning decisions relate to identifying sources of funds and their intended applications.
Financial managers create an estimated financial need of the organization and initiate proper mechanisms on how to source those funds.
The main aim of making financial planning decisions is to ensure that financial resources are available at any time when it’s required especially by other departments.
4. Capital Structure Decisions
In terms of making capital structure decisions, financial managers are charged with the responsibility of identifying reliable and affordable sources of funds.
In order to create a sound capital structure, they must also make informed decisions and advise key decision-makers on the best internal and external sources of funding.
External sources can involve making decisions on shares, bonds, and loans from banks. Internal sources of funding usually comprise making a decision on retained earnings.
5. Dividend Decisions
Dividend decisions are decisions made regarding the portion of profits that will be distributed as a dividend to shareholders.
The financial manager must make an informed decision when it comes to dividends payments because shareholders are always looking for higher dividends while the company may need to retain profits earned to finance business growth.
Financial management is a wide and crucial topic that must be embraced in every business entity. Since companies exist to maximize profits through customers’ satisfaction and minimum cost, the role of financial managers cannot be underestimated.
Financial managers apply key financial management concepts to realize the set organizational goals and objectives. The hallmarks of a good financial manager are demonstrated by his expertise in planning, organizing, directing, and control of cash flows in and out of an organization.
Proper financial management and planning are key to any business’s survival, value, and growth.