Everyone knows for sure that finance is the most critical part of every business. It is not just in business but even in our daily lives finance plays a highly crucial role. We need money to meet all our needs. Proper management of cash is essential to make sure that there is enough for fulfilling our requirements. In the same way, companies must also manage their finances well if they should function and progress. Before we try to understand the various elements of financial management, let us first see what and why it is of the highest importance to business.
What Is Financial Management?
Like all resources, finance is also in limited supply all the time. But the various needs of a business are ever-increasing. If the available funds are not managed properly, an organization can find itself short of cash to meet its expenses. This is why financial management is essential for all firms. It is the function of managing money in such a way that the return of investment remains higher than the cost of finance. Finance courses offered by various prestigious institutions are the best place to learn more about this essential function.
In a nutshell, one can define financial management as a process that reduces the cost of finance while ensuring that there are enough funds for necessary activities. It deals with the planning and execution of financial activities like procurement and spending of funds. Financial managers are tasked with making judicious use of available money. They must also select the source of such income very carefully. These experts will also make sure that the funds enable the company to move towards its objectives.
The Importance Of Financial Management For Businesses
Aids Businesses To Succeed
Businesses need money to run and succeed. Even if a company starts with a considerable amount of cash, there will be additional needs as it functions. Without expansion and growth, companies cannot succeed, and this needs money. Proper financial planning is essential to make sure that there is enough money for all the company’s activities and business growth. A company that is running in profit can find itself not having enough money for regular operations if there is no proper financial management.
Financial management is executed by experts in this field. Company owners may plan for more expenses over revenues. This can land the company in serious trouble as vendors and others the firm owes money start demanding their payment. A company that doesn’t make payments promptly loses its reputation. Without getting supplies from the vendors, the organization may have to close down. A financial risk management course teaches its students many examples of such companies that have shut down.
Helps The Company Remain Compliant
Organizations need to remain compliant with all financial regulations. The government lays down various rules regarding conducting financial transactions and maintaining records. These must be followed strictly to avoid penalties. Enterprises must perform all transactions following statutory regulations. All organizations must also maintain a record of their financial dealings promptly. Government agencies can inspect these records, hence, they must contain all necessary information.
The financial department is responsible for ensuring strict compliance with all regulations. They must know the latest laws in this regard and enforce them in the firm. Maintaining accounts and books is also part of financial management. It is not just helpful in abiding by the law but also for a company’s future use. Companies can also use such records for resolving disputes with any external entities. Those attending a financial management course know that up-to-date accounts help in calculating and paying taxes promptly.
Facilitates Better Access To Finance
All companies need money to run. This could be needed at the start of a company and during the course of its operation. There are various ways in which a company can get funds for its functioning. But not all sources are viable because some may be too expensive. There are other sources that may force the owners to lose their control, at least partially. The most beneficial source of funds will be different for different companies.
Finding the right source of funds is one of the prominent roles of financial management. Financial managers are regularly in touch with the market to determine the cost of funds and where it is available cheaply. These experts also know the kind of finance they must source for different types of company activities. Finance courses also teach students to prepare a business plan that can convince lenders to finance a company.
Helps Control Expenses
There are various types of expenses for every organization. These could be fixed expenses like salaries and rents. There can also be variable costs for different utilities that the company uses. Apart from this, a company must purchase raw materials for the production of goods. All these expenses must be met if the company has to continue its operations. Even if the costs remain constant, the same cannot be said about income. It can be affected by various internal and external factors.
Also Read: Best Practices in Financial Management
Financial managers must ensure that the company can meet all its expenses. Delaying payments can result in penalties. Sometimes the expenses are planned without giving much thought to earnings. Budgeting is a critical role that financial managers play in a company. They will constantly assess the expected income and plan to spend on that basis. Excess spending can cost the company money by way of interest. Aspirants to a financial job can learn budgeting at the financial management course conducted by reputed institutions.
Forecasting Risk And Mitigating Them
Risks are a part of life. This is even more so for a commercial establishment. It must face a variety of dangers that come due to internal and external factors. A sudden change in business rules can reduce a company’s earnings. The entry of a competitor will reduce sales and affect revenues. There are also unpredictable natural calamities that can minimize business. An epidemic like what we see presently can also affect normal operations. Companies must prepare for all these.
Predicting and managing risks is a significant role for finance managers. These experts are constantly looking out for dangers lurking around the corner to ensure that the firm is not affected by them. Certain risks can be predicted, whereas finance managers cannot foresee various others. Companies must have ways to overcome all types of threats. Finance managers use advanced analytics to know the risks in advance and take adequate measures to mitigate their effect. The financial risk management course offered on Talentedge teaches how to manage and mitigate risks.
Measures The Success Of A Company
Success is what every company aims at. Looking at the money earned is the best way to assess a company’s performance. Such an assessment helps to know if the business is viable and if there are any prospects for growth. Understanding the performance also allows a company to change its ways if there can be more earnings. When there is more earning, the company’s shareholders are happy, and it can expect more investment for expansion and development.
Also Read: Top 5 Activities of Financial Management
Financial management helps to assess the performance of a firm properly. Finance managers use various parameters to see how well their organization has done for a specific period. They also make comparisons between similar periods every year. This will help them know whether there is any improvement in sales and profits. A study is also made about how the enterprise has functioned in comparison with competitors. Finance courses teach different ways to analyze a company’s performance.
Identify And Improve Weak Areas
It is not just a company’s total assessment that financial managers do. They also look at different areas in a firm that are doing well or badly. There are various departments and regions in an organization, and each one of them contributes to its profitability. The finance department looks at each of these and finds out if any units affect the organization’s overall performance. Such identification is essential for improving profits.
A company’s revenues come from selling products. But not all products bring the same amount of earnings. It is necessary to see if there are any items that are losing money instead of getting profits. Financial managers will not only identify these areas but also offer solutions to improve them. The assessment and the solutions are submitted to the top management for taking necessary action. Aspirants to a job in this department must attend the financial management course to contribute to a company’s success.
Ensuring Returns From Marketing Activities
Marketing is an activity that companies cannot do without. Without marketing, it is not possible for them to sell the products or services they produce. But marketing doesn’t come cheap. It is an activity that sucks a lot of money. In many cases, even experts cannot accurately gauge the returns on the amount spent as the results may be seen only after a period. Companies must take utmost care when spending on publicity and advertisement.
Monitoring the marketing activities and assessing their effect is a major responsibility of the financial department. The money experts must keep track of all expenses on different kinds of publicity. They must see which ones are bringing good results. It is also necessary to see which campaigns are more effective during certain periods of the year. Such assessment is very useful for reducing marketing expenses and improving returns. The financial risk management course teaches students about market risks and how to avoid them.
Fuels Growth And Expansion
No business wants to remain where it is. One of the main objectives of all companies is to expand and grow. This can be done in various ways. Some companies may choose to add more regions for their operations. Other firms may find introducing new products a good way to expand. Building new factories and increasing production capacity is also a way to improve business. But who will decide which method is most suitable for a firm?
Financial experts must analyze various growth methods and find out which one is apt for an organization. They must see which course of action can bring in the best returns for the money that is being spent. Every growth activity needs funds, and getting them is not easy. Financial managers must search for funds to fuel growth. They will look at various finance options and decide which one is most beneficial for the firm. One can learn from a finance management course which growth path brings maximum profits.
Helps Enhance Staff Strength
Isn’t staffing the job of the HR department? Aren’t they the ones who must select the best candidates for the company? It is so amongst most cases. But it is necessary to find out which posts need to be filled immediately and which ones can wait. This decision is arrived at by analyzing who is bringing more returns on the salary they earn. Such analysis helps to inform the HR department where they must increase staff strength to get more revenues.
The financial department performs an analysis of the performance of every member. This helps to know whether all employees are contributing equally to the company’s profits. Once this is known, it is easy to find out where the company must employ more people to get better results. Monitoring the performance of staff members also helps in deciding the people who must be rewarded with salary hikes or promotions. Those who wish to join the finance department must learn about this at the finance courses conducted by various institutions.
Now that we have seen the important part financial management plays in the functioning of an organization, we must see what the key elements in financial management are.
Key Elements Of Financial Management
This is the main component of financial management. It is not enough for them to source and utilize funds for the organization. They must also share the information with others. There are various stakeholders like investors, creditors, lenders, and the government. In some cases, the public must also know how the funds have been used and how they have performed. Financial reporting is a result of accounting. These reports can show the concerned people whether the organization has benefited from the money it holds.
The financial statements include balance sheets, profit & loss accounts, cash flow statements, and a statement of change in shareholders’ equity. The report will also include notes on the financial information. In the case of listed companies, financial departments must prepare both quarterly and annual reports. The government provides guidelines following which such reports must be prepared. This ensures uniformity in reporting by various organizations belonging to different industries. Another report that the financial management team prepares is a prospectus issued when companies go for an IPO.
The objective of financial reporting is to inform various stakeholders about the financial position of an organization and changes in it. Such reporting helps the management in making better decisions. It also helps them plan for the future. Investors and lenders can decide on the benefits of investing in such an organization by reading these reports. The financial risk management course teaches that auditors and government agencies use these reports to ensure that the money has been used for the purpose it is meant for.
This is another key element of financial management. Financial planning reflects the cash needs of a company in line with its business planning. This activity helps an organization know how much funds it will require to achieve its goals. Planning is done even before a company has been set up. It is on that basis that the firm will go for sourcing of funds. But planning doesn’t stop at that stage. It is a continuous process as every commercial organization needs money continuously, and without proper planning, it can be sourced expensively and spent without any returns.
For financial planning, the first requirement is to lay down the financial objectives. This will be based on the business plans of the company. Both fixed and variable requirements of the firm must be taken into account when making the plan. Fixed capital is needed for developing infrastructure and buying machinery. Such money doesn’t earn returns immediately. Variable capital is used for the regular working of the firm and to hold stocks. This money will earn returns when goods are sold.
Financial planning helps the company know how to raise money for its operations. The other benefit is that it will help in planning expansions in the future. It also makes sure that funds are available for the smooth functioning of the firm. Planning helps to develop policies and procedures for handling money. They help in the proper administration of the firm. With better planning, a company remains liquid, and this improves its reputation. Students of the financial management course learn that planning helps to keep finance costs low.
Every organization must make sure that the money it has is being utilized correctly and in the best interests of the shareholders. This is where financial controls are necessary. It includes the policies put in place by the organization to manage, document, assess, and report financial transactions. Such controls help in optimum utilization of funds. This will prevent funds from leaking. The result will be the realization of desired returns on the investments made. There will also be sufficient cash flow with the plugging of leaks.
When there is proper control over finances, there will be better operational efficiency. The processes and procedures that affect efficiency are removed or optimized. This results in better profitability. This exercise is performed in every department, adding greatly to the earnings of the company. Another significant benefit of financial controls is the prevention of theft. When there are strict controls on overspending, there is little opportunity for fraud. Strict monitoring also prevents online theft.
One of the best ways to implement financial controls is to ensure that only properly qualified persons are involved in the formulation of financial policies. There must be direct communication between the financial managers, accounting staff, senior managers, and the CFO for implementing these controls. The accounting staff must be regularly updated about the latest laws and financial practices. Companies must put in place stringent credit policies for customers. Finance courses recommend that authorization must be made compulsory for business expenses.
Financial decisions are necessary elements of financial management that help to ensure that the available resources are used most beneficially. They also help in achieving a minimum financial performance that will enable the company to survive. Decisions can be of two types – long-term and short-term. Financial management provides the framework within which these decisions are taken. There are mainly three types of decision-making which are investment decisions, financing decisions, and dividend decisions.
- Investment Decisions As the name suggests, these are made about how the organization’s funds are invested to its best benefits. There are both long-term and short-term investment decisions. The long-term decisions involve large amounts and are most irreversible except by incurring huge costs. Short-term investments are made for the daily work of a company. This can include decisions on cash, inventory, and receivables.
- Financing Decisions These decisions affect the amount of finance raised and the methods used for it. These decisions are on the capital structure of a company which is made up of owner’s and borrowed funds. Companies could use sources like equity shares, preference shares, debentures, and bank loans to raise funds. Cost and cash flow position are the main factors that affect these decisions. The financial risk management course says that risk of repayment is also considered when making these decisions.
- Dividend Decisions Financial managers consider various factors before deciding how much of the profit earned must be paid to shareholders as dividend. All companies retain a portion of the earnings for development activities and emergencies. These decisions are taken with the objective of increasing shareholder wealth. Companies with stable and high earnings can pay more dividends to their shareholders. The dividends don’t change with small or temporary fluctuations in earnings.
Allocation And Utilization Of Funds
It is not enough to collect funds to run the company. Investors provide funds intending to see the company grow and earn a profit on the investment. This means that whatever funds have been received from different sources must be allocated and utilized with the utmost care by the financial department. This is why this forms an essential element of financial management. The funds that are received from banks or institutions as loans must also be used in such a way to cover the finance costs.
There are various areas in a company that will need money for their daily operations. But financial managers must see which departments will give the best returns on the amount allocated. There must be a percentage allocation for different functions. Marketing will probably get a higher percentage than staffing because it will earn better returns. But there are also other areas that are necessary for a company, but they may not earn any returns. This is why this topic is given much importance in a financial management course.
When acquiring funds, financial managers must be ready with a plan to utilize the funds in the best manner. They must also know how the funds will earn money for the company. Investing in fixed assets will earn better returns as their value depreciates over the years. Short-term investments like work capital should not be allowed to block funds. It is best to allocate funds for inventories, cash, and book debts from profits earned, sales of shares, or bank loans.
Cash Flow Management
No business person can ignore cash flow. Whether it is a company of small or large size, cash flow is like their pulse. One must monitor it regularly to ensure that the company functions well and grows. Many companies have suffered due to cash flow mismanagement which can result in various unpleasant consequences. Cash flow is defined as the journey of money through a company. It represents the income and expenditure of a firm. All businesses must preferably have a positive cash flow which means that there should be more money coming in than going out.
Knowing the net cash flow is easy. Take all the expenses for a period and subtract them from the income earned. If the balance is positive, then you have a positive cash flow. A negative cash flow can adversely affect the functioning of a firm. Many companies take a three-month period for calculating cash flow because almost all businesses suffer from periodic ups and downs. Looking at the turnover may make one feel good. But the reality of a business will be known only when one looks at the net cash flow.
Poor cash flow results from various factors. Ordering too much material when there is a demand skew can result in carrying more stock than necessary. This can cause your cash flow to slow down. Offering long credit periods can also adversely affect a company’s cash flow. Some companies spend on getting fancy furniture and stuff for their office when they get a big customer. However, they don’t realize that the money is still not in their hands. Finance courses caution aspiring financial managers that they should never take their eyes off cash flow movement.
Risk management is a critical element that needs a lot of attention. Whenever a business starts and makes investments in various items, it opens itself to many risks. This can be both internal and external. Risk management is the process of knowing such risks, measuring them, and taking adequate measures to escape from them or lessen their impact on the business. Financial experts identify various types of risks that can affect their business. The loss that can occur due to these events is calculated before looking at ways to overcome them.
Internal risks in a company can come from machine failure, wrong operational practices, or poor product selection. Companies must take maximum precaution because good planning and taking steps beforehand can avoid all these risks. It is more difficult to predict and avoid external risks. The recent pandemic is an example of a disaster that nobody foresaw. Changes in government policies can also affect organizations very badly. The rise or fall of exchange rates can affect import and export companies. A variation in interest rates can also affect firms.
Risks are classified as per their chances of occurrence. Some are very likely to occur, whereas others are not so common. Financial managers give priority to these risks on this basis and take measures to protect the firm. Prevention is the best form of risk management. Most organizations can prevent hazards like fire or explosion by taking precautionary steps. Organizations can mitigate market risks by doing analytics and seeing patterns that can throw light on future events. Students of a financial risk management course understand that it is a continuous process requiring constant attention.
Though the listing of elements may be different by various experts, the above are commonly known as the main components of financial management. Tabulating the elements and their impact will give readers an easier way of understanding them.
|Financial Reporting||Preparation of financial statements
Making quarterly & annual reports
|Sharing information with stakeholders
Showing compliance to government agencies
Convincing investors about the company’s performance
|Financial Planning||Planning for acquiring funds for the operation
Looking at best fund sources
Preparing policies for handling finances
|Availability of funds for starting a company and its continuous functioning
Helps get funds at best costs
The company remains financially strong and stable
|Financial Controls||Controlling the use and allocation of funds
Strict monitoring of fund movement
|Better operational efficiency
Prevents fraud and theft of funds
|Financial Decisions||Investment decisions for better use of funds
Financing decisions for finding the best source
Dividend decision to decide how much of profits must be shared
|Results in getting better returns for investment
Companies can source funds at a lesser cost
Shareholders are happy and ready to invest more
|Fund Utilization||Judicious allocation of funds to different departments
Using the available funds to earn maximum returns
|Departments that bring more returns get more funds
All departments function without suffering lack of money
The company earns best returns on investment
|Cash Flow Management||Keen attention on inflow and outflow of money
Planning expenses based on income
|Ensures that cash is available for daily functioning
Preventing overspending on luxury
Cautions against over-stocking goods
|Risk Management||Forecasting risks
Measuring their severity
Taking precautions to avoid or mitigate loss
|Predicting risks helps to safeguard companies
Insuring helps compensate losses
Helps take precautionary measures
We have seen how important financial management is and what elements comprise the system. Though an organization benefits greatly by managing finances well, the situation is not so favorable for these managers in most firms. They face numerous challenges, and it is good for a financial manager aspirant to know what they are.
Challenges Faced By Financial Managers
Financial teams can work only if there are accurate records. They know the importance of documenting every financial transaction and how it can help in various other processes. However, not all departments are aware of the importance, and financial teams are left constantly following up for updated records. If all business heads attend a financial management course, they would better appreciate the importance of updated financial records.
Also Read: What is the Role of Financial Manager?
This is yet another essential area. Reporting of financial data is crucial for various purposes like getting loans, meeting government obligations, and keeping shareholders happy. But the lethargic approach by various unit heads prevents timely reporting, and financial managers are left running from pillar to post to achieve this goal.
An accurate forecast of how much business a company expects to do in the coming quarter or year will help financial managers plan funds correctly. But most unit heads take a long time planning their activities and coming up with correct numbers. Finance courses teach how difficult it is for financial managers to plan funds without precise business forecasting.
Ensuring Regulatory Compliance
Companies are currently working not just inside a country but with many partners beyond the borders. This makes it very difficult for financial managers to comply with financial regulations. They must be familiar with the financial laws in all these countries. It is also highly essential to make sure that they don’t break any domestic rules while doing business with overseas companies.
FAQs on Financial Management
Q. What is the cost of capital?
Ans: Cost of capital is the rate of returns an organization must earn to meet the expectations of investors who make a long-term investment in it. The entity that links investment and financing decisions as both are involved in this.
Q. What factors must the financial managers consider when calculating the cost of capital?
Ans: It is the average cost of various sources of finance. Hence, one must know the cost of each source of finance. Those attending a finance management course know that it is also necessary to know the percentage of each source of funding in the total capital.
Q. What is working capital?
Ans: Working capital is arrived at by subtracting current liabilities from current assets. It is the amount of money tied up in inventories and receivables. It also includes the cash that a company needs to meet short-term obligations, usually for 12 months.
Q. What is a cash-flow statement?
Ans: A cash-flow statement represents all the cash inflow a company receives from its operations and investment sources during a specific period. It also includes all expenditures incurred during the period by way of business activities and investments. You also include the cash balances at the beginning and end of the same period.
Q. What is preference capital?
Ans: Preference capital is the money that a company raises by issuing preference shares. This method of financing has some features of debentures and some of the equity shares. While the payment dividend happens, preference is given to preference shareholders over equity shareholders.
Q. What is hedging?
Ans: Hedging is a risk management method. Here companies take an opposite position in a related asset to offset the loss incurred in investment. In such cases, the amount of profit earned is also limited to the extent of loss suffered. A financial risk management course teaches that this is not a method for making profits but only for recovering losses.
Q. What is the difference between costing and cost accounting?
Ans: Costing is the procedure used for arriving at the cost of a product or service. Cost accounting is used to determine the expenses incurred from a venture by analyzing and predicting the cost data. While the former is a technique, the latter is an accounting method.
Q. What are adjustment entries, and why are they passed?
Ans: They are entries made at the end of an accounting period to ensure that the profit and loss are correctly indicated to keep the balance sheet accurate. The financial management course will teach you that these are passed so that the balance sheet shows the accurate position of the company.
Q. Is financial planning a one-time task?
Ans: Not at all. The financial position of a company is constantly affected by various external factors. This necessitates the firm to review its financial plan periodically. It must be tweaked and corrected as situations change.
Q. What is the difference between a journal and a ledger entry?
Ans: In a journal entry, all transactions are recorded in such a way to show one account getting debited and another account getting credited. In a ledger, both these accounts are maintained separately, and hence there will be only one entry against each of them.
It is essential for all aspirants to a finance job to be familiar with all the financial management elements to be successful in their profession. Good courses in financial management offered by reputed institutions can greatly help job seekers learn all about the subject and its components.