Introduction To Financial Management
Financial Management is about preparing, directing and managing the money activities of a company such as buying, selling and using money to its best results to maximise wealth or produce best value for money. It is basically applying general management concepts to the cash of the company. Financial Management can also be defined as – The management of the finances of a business / organisation in order to achieve financial objectives
“Financial management is concerned with raising financial resources and their effective utilisation towards achieving the organisational goals” Dr. S. N. Maheshwari
“Financial management is the process of putting the available funds to the best advantage from the long term point of view of business objectives” Richard A. Brealey
It is crucial for both public and private sector organisations.
Taking a commercial business as the most common organisational structure, the key objectives of financial management would be to:
• Create wealth for the business
• Generate cash, and
• Provide an adequate return on investment bearing in mind the risks that the business is taking and the resources invested
There are three key elements to the process of financial management:
(1) Financial Planning
Management need to ensure that enough funding is available at the right time to meet the needs of the business. In the short term, funding may be needed to invest in equipment and stocks, pay employees and fund sales made on credit.
In the medium and long term, funding may be required for significant additions to the productive capacity of the business or to make acquisitions. This links in with the financial decision making process and forecasting.
(2) Financial Control
Financial control is a critically important activity to help the business ensure that the business is meeting its objectives. Financial control addresses questions such as:
• Are assets being used efficiently?
• Are the businesses assets secure?
• Do management act in the best interest of shareholders and in accordance with business rules?
(3) Financial Decision-making
The key aspects of financial decision-making relate to investment, financing and dividends:
•Investments must be financed in some way – however there are always financing alternatives that can be considered. For example it is possible to raise finance from selling new shares, borrowing from banks or taking credit from suppliers. This is connected with the capital budget and forecasting when dealing with fixed assets and projects.
•Financial options – this is connected to the raising of finance from various sources like banks or financial investors, which will depend on the options of the type of source, period of financing, cost of financing and the net present returns generated.
•A key financing decision is whether profits earned by the business should be retained rather than distributed to shareholders via dividends. If dividends are too high, the business may be starved of funding to reinvest in growing revenues and profits further.
All these areas of financial management apply to your personal life and family life, how families finances are managed are all related to financial management.
Scope of Financial Management
Financial management has a wide scope. According to Dr. S. C. Saxena, the scope of financial management includes the following five ‘A’s.
1.Anticipation : Financial management estimates the financial needs of the company. That is, it finds out how much finance is required by the company.
2.Acquisition : It collects finance for the company from different sources.
3.Allocation : It uses this collected finance to purchase fixed and current assets for the company.
4.Appropriation : It divides the company’s profits among the shareholders, debenture holders, etc. It keeps a part of the profits as reserves.
5.Assessment : It also controls all the financial activities of the company. Financial management is the most important functional area of management. All other functional areas such as production management, marketing management, personnel management, etc. depends on Financial management.
Efficient financial management is required for survival, growth and success of the company or firm.
What does Financial Management Achieve?
Summarising so far:
Financial management essentially means:
1. To collect finance for the company at a low cost and
2. To use this collected finance for earning maximum profits.
Thus, financial management means to plan and control the finance of the company. It is done to achieve the objectives of the company.
Financial management is usually concerned with the flow and control of money within an organisation be it either private or public sector.
The main objectives of financial management are:-
NOTE: Within the Public Sector the main objective of financial management is to deliver the goals and projects within the set budget agreed, managing those funds, planning and forecasting and delivery of VFM – Value for money.
1.Profit maximisation : The main objective of financial management is profit maximisation within the private sector. The finance manager is responsible to assist in earning maximum profits for the company, in the short-term and for the long-term. However they cannot guarantee profits in the long term because of the uncertainty of business. However, a company can earn maximum profits if:-
A.Management and the finance manager take proper financial decisions and plan well.
B.The organisation uses the finances of the company carefully and strategically.
2.Wealth maximisation : Wealth maximisation (shareholders’ value maximisation) is also a main objective of financial management. Wealth maximisation means to earn maximum wealth for the shareholders. So, the finance manager will attempt to achieve maximum dividends to shareholders, and they will also try to increase the market value of the shares. The market value of the shares should be directly related to the performance of the company. The better the performance, the higher is the market value of shares and vice-versa. So, the finance manager must try to maximise shareholder’s value.
3.Adequate forecasting of the total financial cash requirement : Proper estimation of the total financial requirements is a very important objective of financial management. The finance manager must forecast the total financial requirements of the organisation.
They must find out how much finance cash will be required to start and run the organisation. They must find out the fixed capital and working capital requirements of the company. Their forecasting must be as accurate as possible. If not, there could be a shortage or surplus of finance available. Forecasting the financial requirements is a very difficult job. The finance manager must consider many factors, such as the type of technology used by company, number of employees employed, scale of operations, legal requirements, competition, external environment, economy etc.
4.Proper resourcing : Collection of finance is an important objective of financial management. After forecasting the financial requirements, the finance manager must decide where the finance cash will be sourced.They can collect finance from many sources such as shares, debentures, bank loans, etc. There must be a proper balance between owned finance and borrowed finance. The company must borrow money at as low a rate of interest as achieveable.
5.Proper utilisation of finance cash : Proper utilisation of finance is an important objective of financial management. The finance manager must plan the optimum use of finance. They must use the finance profitably delivering best value for money. They must not waste the money of the organisation. They must assist and advise not to invest the company’s financial resources into unprofitable projects. They must forecast adequately the cash flow to enable smooth stock control. They must have a good supply of short credit.
6.Maintaining proper cash flow : Maintaining proper cash flow is a short-term objective of financial management. The company must have a proper cash flow to pay the day-to-day expenses such as purchasing of raw materials, the payment of wages and salaries, rent, electricity bills, etc. If the company has good cash flow, it can take advantage of many opportunities such as taking cash discounts on purchases, large-scale purchasing, giving credit to customers, etc. A healthy cash flow improves the chances of survival and success of the company. Also gives strength against competition and the ability to make acquisitions.
7.Survival of company : Survival is the most important objective of sound financial management. The company must survive in this competitive business world. The finance manager must be very careful while making financial decisions.
8.Creating reserves : One of the objectives of financial management is to create reserves. The company should not distribute the full profits as a dividend to the shareholders. It should keep a part of its profit in reserves. Reserves can be used for future growth and expansion. It can also be used to face contingencies in the future if any emergencies should arise, or give strength for a possible merger or acquisition.
9.Proper co-ordination : Financial management assist and try to have proper planning and coordination between the finance department and other departments of the company.
10.Creating goodwill : Financial management must try to create goodwill for the company. It must improve the image and reputation of the company. Goodwill helps the company to survive in the short-term and succeed in the long-term. It also helps the company during bad times. It also adds value to company’s net worth in an event of a takeover or buy out.
11.Increase efficiency : Financial management should facilitate increasing the efficiency of all the departments of the company. Proper distribution of finance to all the departments will increase the efficiency of the entire company.
12.Financial discipline : Financial management should create a financial discipline within the organisation. Financial discipline means:
•To invest finance only in productive areas. This will bring higher returns (profits) to the company.
•To avoid wastage and misuse of finance.
13.Reducing the cost of capital : Financial management try to reduce the cost of capital. That is, it will attempt to borrow money at a low rate of interest. The finance manager must plan the capital structure in such a way that the cost of capital it minimised, either through debt, gearing or equity finance.
14.Reducing operating risks : Financial management also tries to reduce the operating risks. There are many risks and uncertainties in a business. The finance manager must take steps to reduce these risks. They must avoid high-risk projects unless it is the policy of the company. They must also take proper adequate insurance.
15.Constructing the best capital structure : Financial management help prepare the capital structure of the organisation. It assists in the ratio between owned finance and borrowed finance. It brings a proper balance between the different sources of capital. This balance is necessary for liquidity, economy, flexibility and stability. This is connected to gearing.
At the end of the day senior management have to take responsibility for financial decisions, the finance manager is there to guide and give best advice, if senior management refuse to heed the advice the finance management department cannot be held responsible.
Functions of Cost-effective Management
Functions of financial management can be broadly divided into two groups.
1. Executive functions of financial management, and
2. Routine functions of financial management.
Executive Functions
Executive functions of financial management (FM) are:
1.Forecasting capital requirements : The company must estimate its capital requirements (needs) very carefully. This must be done at the promotion stage. The company must forecast its fixed capital needs and working capital needs. If not, the company could become over-capitalized or under-capitalized.
2.Determining the capital structure : Capital structure is the ratio between owned capital and borrowed capital. There must be a balance between owned capital and borrowed capital. If the company has too much owned capital, then the shareholders may demand more dividends. Whereas, if the company has too much of borrowed capital, it has to pay a lot of interest. It also has to repay the borrowed capital after some time. So the finance managers must prepare a balanced capital structure.
3.Forecasting cash flow : Cash flow refers to the cash which comes in and out of the business. The cash comes in mostly from sales. The cash goes out for business expenses. So, the finance manager must forecast the future sales of the business. This part is called Sales forecasting. They also have to forecast the future operational expenses.
4.Investment Decisions : The business gets cash, mainly from sales. It also gets cash from other sources. It gets long-term cash from equity shares, debentures, term loans from financial institutions, etc. It gets short-term loans from banks, fixed deposits, dealer deposits, etc. The finance manager must invest the cash properly. Long-term cash must be used for purchasing fixed assets. Short-term cash should be used for working capital.
5.Allocation of surplus funds: Surplus means profits earned by the company. When the company has a surplus, it has three options:
a.It can pay dividend to shareholders.
b.It can save the surplus. That is, it can have retained earnings.
c.It can give a bonus to the employees.
6.Deciding Additional finance : Sometimes, a company needs additional finance for modernisation, expansion, diversification, etc. The finance manager has to decide on the following questions:
a. When the additional finance will be needed?
b. For how long will this finance be needed?
c. From where to source and collect this finance?
d. How to repay this finance?
Additional finance can be collected from shares, debentures, loans from financial institutions, fixed deposits from the public, etc.
7.Negotiating for additional finance : The finance manager has to negotiate for additional finance. That is, they have to speak with the banks to get the best deal. He has to persuade and convince them to give loans to his company. There are two types of loans, short-term loans and long-term loans. It is easy to get short-term loans from banks. However, it may be very difficult to get long-term loans.
8.Monitoring financial performance : The finance manager has to monitor the financial performance of the company. This is a very important finance function. It must be done periodically. This will improve the financial performance of the company. Investors will invest their money in the company only if the financial performance is good. The finance manager must compare the financial performance of the company with the targets. They must find ways of improving the financial performance of the company at all times. The finance manager has not only to obtain and utilize finances but he also has to exercise control over the cash. This can be done through many techniques like ratio analysis, forecasting, cost and profit control, etc.
For public sector surplus funds may need to be returned to ministry of finance or more projects delivered within the scope.
Routine Functions of Financial Management
Routine functions are clerical functions. They help to perform the Executive functions of financial management:
1. Supervision of cash receipts and payments.
2. Safeguarding of cash balances.
3. Safeguarding of securities, insurance policies and other valuable papers.
4. Taking proper care of mechanical details of financing.
5. Record keeping and reporting.
6. Credit Management.