the financial management essay

the financial management essay

The Importance of Financial Management: Key Concepts and Practices

1. Introduction to Financial Management

In the narrow sense of business, finance is concerned with providing and utilizing the funds of the business. It plays a major role in determining the business success/failure. In layman’s language, finance is primarily concerned with the ways and means to ensure that funds are raised from various sources and utilized in the most advantageous way. With the growing importance of the finance function in society, there has been an increasing tendency to absorb the financial activities of concerns into broader concepts called financial management. But the two are slightly different concepts.

In the early stages of business, finance is considered to be of little significance and the entrepreneur can easily control all the functions of a small business. But as the business grows, the importance of financial management also grows. Sometimes this function is neglected in a small concern. But in the long run, experience will indicate that this function merits full attention at all stages of the business as accountants and production experts join the top management team. The growth of the finance function is generally attributed to the emergence of a considerable size company or a large and complex business. As knowledge about business operations increases, the complexity and intricacy of business also increases. This is a natural development.

Financial management is very important in the business concern. It is concerned with the acquisition, financing, and management of assets with some overall goal in mind. The goal can involve maximization or minimization of some value or costs. For some managers, these goals are consistent with a goal of survival and growth.

2. Key Concepts in Financial Management

To achieve the objective of profit maximization, a businessman must engage in activities which will yield the largest sum of liquid cash or its equivalent over the long run. Each business activity should add to the profits over the long run. Indeed, the need to maximize profits has led some business units to engage in speculative and hazardous activities which have led to spectacular success or failure. The knack here is to pick those activities which are best adapted to satisfy personal profitability goals and the investment needs peculiar to each business. The business manager cannot wait indefinitely for this promising, attention-grabbing perfect activity. In fact, the crucial question is to find the best activity that is practical at this time. This involves a combination of judgment and scientific procedures such as financial studies, marketing research, product development, and the work of operating and financial managers. The corporate comptroller can make a signal contribution by designing and operating these scientific procedures which help the business manager improve allocation, control, and performance appraisal of the specialized human, financial, and physical capabilities of the business.

The orientation in the practices suggested in the earlier chapter would be sharpened by discussion in the context of the ultimate long-term objective of the enterprise. A satisfactory rate of return on investment is the ultimate objective of business enterprises since a businessman risks his funds to earn profits and to exploit new commercial opportunities. It is a matter of controversy to fix what represents a solid performance, but it is generally conceded that the rate of return on capital employed should not fall short of the average rate of general business earnings. Therefore, any firm whose earnings are less than the average of similar organizations possesses a marginal rating and is often close to a danger zone. Actually, its creditors take serious risks. In fact, many companies sow their own seeds of destruction by paying inadequately low returns on their own and creditors’ investments.

3. Practical Applications of Financial Management

Budgeting Besides its roles in affecting strategies and control devices, financial management influences business firms in several other subtle yet important ways. It not only affects methods and incentives that some use in budget decision-making, but also affects the methods by which other organizational result data are reported and evaluated. In addition, essentially similar methods are used to do capital budgeting, evaluate risks, and make other financial business policy decisions. Business after business prepares so-called financial plans that span longer periods of time and attempt to forecast sales and costs with more care than the typical business firm would use in preparing ordinary annual plans.

Sometimes there are factors that loom as being so critically important that there is a firm conviction that such a policy should encourage its path of action only after the firm has exclusively considered a lot of alternatives. A full appreciation of risk and appropriate incorporation of it into the capital budgeting process, it seems appropriate to infer involves a weighing of the full spectrum of possible future states of nature and incorporates into the analysis the study of the valuations that the people involved in a project might make concerning them. While very few capital budgeting decisions are made with such a broad perspective, the same can probably be said about whole business device collectively drawing up and implementing corporate objectives that a well-run, sophisticated system of strategic planning might produce.

The traditional application of capital budgeting focuses on the financial aspects of investment alternatives. For instance, the payback period and the net present value of a project are calculated in the preceding analysis. The qualitative aspects of a given investment, however, must also be considered before a satisfactory decision can be made concerning the project’s feasibility. Decisions of strategic significance by their very nature, moreover, often render these traditional capital budgeting techniques less useful in such problem solving. Our experience working with business firms has shown us that the reasoning that supports the extension of the payback period, or the elimination of projects from consideration solely as a consequence of an unfavorable payback period, is not distinctly circumscribed by a lack of intelligence concerning its validity.

Integration of Capital Budgeting Techniques and Project Management Issues

4. Challenges and Future Trends in Financial Management

These trends represent a convergence of challenges and pressures on companies that are forcing companies to think more about talent and strategy and how to evolve their traditional financial structure to support what the business will need. Companies will need to decide on the ‘right’ corporate financial structure to best communicate and predict long-term results and risks of the company. However, having the right messaging developed to ‘sell’ this information to banking and rating agencies may potentially contradict what the company wants to construct.

2. Industry Trends: – Regulations – Globalization – Managing knowledge assets

1. Structural Forces and Trends: – Changes in financial markets – Cost of capital – The weighting of tangible vs. intangible assets – Financial reporting – M&A activity

While financial management has remained and will remain critical to the growth and sustainability of organizations, the challenges and forces of change that financial executives face are constantly evolving. Overall, financial managers and financial executives are being asked to play a more strategic role in their organizations and take a longer-term perspective. Several structural forces and industry trends contribute to these changes:

5. Conclusion and the Impact of Effective Financial Management

Although it is often considered that the creation of financial data is a necessary consequence of the need to report the financial results of the organization, some studies have suggested that creating accounting information may be something that the organization carries out as part of its activities to attain its corporate objectives. It seems unlikely that the vast majority of the finance officers in the region share this business focus and thus seeing accounting information as a business tool. It may well be, therefore, that the majority of the finance officers will not play a part in the strategic aspects of producing accounting information that the organization ultimately wishes to achieve.

Although the finance officers’ roles have changed significantly in the last few years, effective financial management plays an essential role in enabling all public organizations in the region to achieve their corporate objectives and demonstrate the value they provide as part of the democratic process. Clearly, the nature of effective financial management goes beyond the mere generation of financial information. Unfortunately, many finance officer positions, including most of those in this study, are still perceived to be associated with predominantly technical tasks. As a result, finance officers take little part in the strategic issues within the organization. However, this may be a result of the finance officer’s interest more in the technical side of the department rather than the strategic aspects that they themselves feel uncomfortable with. There seemed to be a lack of understanding about the strategic financial management role that finance officers play.