financial management definition

financial management definition

Exploring the Importance and Fundamentals of Financial Management

1. Introduction to Financial Management

In the case of a business, financial management is concerned with financial resources – the firm’s capital and the management of capital. To get optimum benefits from these financial resources, the company must acquire them in the right way. Otherwise, the firm may not be able to achieve its business goals. A well-managed finance function in any enterprise is the heart of the management itself. Consequently, the study of business finance is a matter of primary importance. In the case of an individual, financial prosperity depends on three important factors, namely, income, expenditure, and savings. Management of personal financial affairs is, therefore, as important for an individual as the management of an organization. The principles of financial management suggested for an organization are equally important for an individual, with suitable modifications.

Every unit of society, be it a family, an organization, or a nation, faces the problem of managing its finances. Financial management embraces all issues related to finance as it affects the organization’s life. It is not just an arrangement of money necessary for the smooth functioning of an organization or being concerned with the utilization of financial resources. The primary objective of financial management is to maximize the wealth of the owner. It involves careful planning and execution of financial activities such as procurement of funds, utilization of funds, and maintenance of proper balance between the inflow and the outflow of funds with a far-sighted view. Financial management covers the entire cycle of raising, expending, and administering funds. It also includes long-term and short-term arrangements for money.

2. Key Concepts and Principles in Financial Management

The jargon of finance can be overwhelming and confusing to the layperson. Terms like “treasury management,” “dividend policy,” “capital adequacy,” “return on capital employed,” “free cash flows,” and “cost of capital” are freely bandied about in the business press and in analyst reports. Some understanding of these concepts is necessary if managers are to contribute meaningfully in discussions at the finance sub-committees that every organization has at the board level. Since financial management involves making choices, some principles of resource management come into play.

Every organization understands that finance is crucial to its survival and sustainability. It is very important to use finance effectively and efficiently and adopt sound financial fundamentals while making strategic choices. Amar Johri, a Canada-based management consultant who has worked with leading organizations, has delved deeply into this subject and has dealt with various fundamental principles of strategic financial management. This book is essential reading for every student of management, whether pursuing a specialized course in financial management or one with a larger focus on management.

3. Tools and Techniques for Effective Financial Management

Financial planning is the process of shaping expected results through the integration of economic, accounting, and engineering data. Generally, two aspects must be considered in financial planning – the generation and allocation of funds. To implement any plan designed to cope with the problems of generation and allocation of funds, any business activity, whatever its function, must adhere to at least these fundamental principles: (1) Accounting control of operations designed to produce maximum dollars of net return after considering investment. (2) Mathematical control of financial activities and relation of money to the calendar by the schedule of debt maturities. (3) Proper balance between the expected degree of risk and the anticipated probability of success. (4) Tax consciousness in every transaction and in every accounting policy. (5) Regular and routine appraisal of the personal investment in any area of speculative enterprise. All of these activities advance the primary purpose of business or going concerns – namely, the rational allocation of capital.

Sound financial management entails a delicate balancing act between risk and return, and between levels of services and the cost of providing or obtaining them. Financial managers, including members and professionals, must learn to optimize these functions by adhering to a number of basic principles such as these: (1) Beware of anyone who claims that government entities are fundamentally different from businesses. (2) Remember that depreciation is not a declining cash balance. (3) When new money is needed, maintaining a high bond rating is essential. (4) Long-term interest rates often offer a good way to pick up on changes in the business cycle. To the extent that funds are not unlimited or that controls are at all desired over the resources within an organization, there arises a need for some financial planning and organization. Financial planning provides the basic strategic framework for decision making in financial management.

4. The Role of Financial Management in Business Strategy and Decision Making

It should be clear that regardless of the nature of the business, in order to succeed in today’s competitive economic environment, business owners and managers must possess a sound understanding of all factors which may influence the profitability, and by extension, the economic survival of the business. Financial management encompasses the processes, tools, and systems which allow an owner or manager to perform the important financial role. In this section, we focus on the implications of the key tasks of financial management for business strategy and decision making. The skills, knowledge, and insights gained in this course are particularly important in a rapidly changing business environment.

Many small business owners and executives must make business and financial decisions based on a thorough understanding of total costs, potential risks, financial benefits, and the market environment in which their business operates. Among the many kinds of decisions they must make are what to sell, whom to sell it to, and for how much. They must make decisions concerning volume and quantities to produce, their employees’ salaries, the cost of production, quality of products or services, and the costs to be incurred. They must also consider a host of additional concerns such as taxes, regulations, funding cost, lead times, and spoilage or faulty products.

5. Challenges and Future Trends in Financial Management

In the future, ongoing trends will see leverage playing an important role in the design of business problems. It will cause concern to equity holders and financial managers in the face of interest coverage potentialities. The forecast of returns at different levels of securities will concern investors as well as capital builder portfolios as the stock market propensities undergo unremitting changes. There will be perpetual concern regarding changes in dividend propensity. Periodic changes in business operations, beneficially operated, will express concern through changes in dividend. There are several financial variables that are relevant determinants of the capital program. In an effort to make the market efficient, financial managers are becoming themselves intelligent investors.

The need for better and improved portfolio performance to meet individual as well as organizational objectives will remain a challenge for financial managers. Increased resources play a very significant role. Performances depend upon analysis and timing, which are not easy to perceive and obtain. This, however, is a real challenge to a financial manager. Unearthing opportunities to obtain profits through careful selection of stocks and careful designing of a mix of financing can easily lead to jeopardizing the objectives. The financial manager chooses an objective in the form of share value maximization, maximization of earnings on the intrinsic value of shares. The advantage he can manage for his shareholders is worth the effort.