Understanding Financial Management: Scope, Objectives, and Importance (2024)

Managing finances is one of the critical foundations of all organisations. Enterprises require a higher investment return rate on market-sourced money than related expenses. Sound financial management helps companies to be successful within tax and statutory regulations.

It allows the management to track, analyse, and take corrective action on the impacts of their decisions on profits, cash flow, financial health, and the growth of the business.

Let us begin with the basic concept of financial management and learn the practices needed in a good organisation.

Key Takeaways

• The primary goal of financial management is to maximise shareholder wealth.
• The application of financial management is more crucial when companies are experiencing losses and negative cash flows.
• Financial management plays a critical role in sourcing funds to finance its growth.
• Sound financial management creates value for the business by allocating scarce resources.

What Is Financial Management?

Financial management is a strategy that focuses on planning, organising, directing, and controlling the firm's financial resources. It spans profitability and offers an efficient and effective way to achieve organisational objectives. It also balances the legal and accounting aspects of a business.

The three essential components of financial management are:

• Reducing the finance cost (interest payments on loans or other expenses related to obtaining funds)
• Ensuring sufficient funds
• Appropriate funds allocation

Example Of Financial Management

The financial team of ABC Ltd. identifies a promising investment opportunity within the plastic molding industry to yield additional cash reserves. They conduct a comprehensive financial analysis to assess potential returns, associated costs, and inherent risks. The team presents the report to their executive leader for evaluation.

The executive reviews the report and authorises the team to proceed with the investment process. They determine a suitable capital allocation for the venture and employ a dedicated platform to initiate the investment.

Further, the team also implements a tracking system to monitor progress and success to ensure transparency. It will help the finance team assess whether the company is spending and generating as much money as estimated when it budgeted the project.

Types Of Financial Management

Financial management can be classified broadly into three types.

1. Capital Budgeting

Capital budgeting means assessing and choosing long-term investments, which could involve ventures like new projects, acquisitions, or expanding current operations. The objective is to discover initiatives that offer the highest potential returns while considering associated risks and costs.

2. Capital Structure

Capital structure denotes the debt and equity financing required to support business operations and expansion. It plays a crucial role in the company's financial well-being and performance. Capital structure dictates the level of financial risk your firm can manage and the dividends and interest you can distribute to creditors and shareholders.

3. Working Capital Management

Working capital management involves maintaining adequate capital to sustain operations and address unforeseen expenses. It entails overseeing company accounts, monitoring cash flow, budgeting and optimising resource allocation, and coordinating production schedules to ensure essential resources are readily accessible.

Objectives Of Financial Management

Financial management finds answers to various questions. It can help you learn the size and composition of fixed assets and the amount of current assets and figure out the ideal fixed debt-equity ratio in the capital. Some notable objectives include:

1. Profit Maximisation

Increasing profits is the primary objective of financial management. The strategy considers involved risk and encourages informed decision-making in pricing, investment choices, and cost control to ensure success.

2. Risk-Return Tradeoff

Financial management includes return and risk. Higher returns come with increased risk exposure. Understanding the risk-return tradeoff can make your investment decisions more reliable and align them with the organisational financial goals and risk tolerance.

3. Liquidity Management

Maintaining liquidity is essential for fulfilling short-term obligations and addressing unforeseen expenses. Introducing accurate money management tips in the workplace will create a balance between cash reserves and productive investments to meet liquidity needs.

Role Of Financial Management In Business

Managing organisational finances implies establishing and following effective policies to achieve goals. The process facilitates better decision-making, profit optimisation, financial stability, and risk management. Below are some primary roles of financial management for your business.

1. Setting Up And Running Bookkeeping And Accounting

Financial management starts with bookkeeping and accounting, the most basic functions in finance. It includes recording financial transactions, managing customer collections and payments to creditors, and complying with regulations, among other activities.

A financial management system following relevant accounting standards and best practices can accurately record and report daily transactions.

2. Critical Financial Operating Activities

Significant financial operations include financial planning, budgeting, and cash and credit management. Keeping a clear record of your payables and receivables is crucial to ensure liquidity, with the appropriate amount of cash readily available whenever needed.

Introducing these money management tips can optimise the operational workflow and improve the total value of your business.

• Budgeting And Budgetary Control:A budget is a financial plan for a specified period, typically a year, that forecasts what you expect to spend (expenses) and earn (revenue). It evaluates how much money the business will need to fund major initiatives like buying an asset, adopting digital transformation, or hiring new resources. Financial management helps review the deviations in the actual budget and allows you to implement corrective measures to achieve forecasted revenue.
• Managing Cash Flow:One of the biggest challenges in businesses is managing cash flow to ensure enough cash to pay current liabilities and allocate funds for capital expenditures that drive growth and scale. Working capital management, arguably the most critical element in cash flow management, ensures the management of current assets, including cash, receivable, payable, and inventory.
• Managing Risk:Financial management can aid in assessing and providing controls for a variety of risks, including market risk, credit risk, liquidity risk, and operational risk. While market risk concerns investments and stock performance, credit risk involves not paying invoices timely. Meanwhile, liquidity risk comes from cash flow challenges, and operation risk may include, for example, the risk of a cyber-attack, disaster recovery, and business continuity plans.

3. Financial Reporting And Analysis

Financial statements are summary-level reports about an organisation's financial results, position, and cash flows. Analysing and interpreting them offers insight into reported data and information for various external purposes such as audit, tax reporting, regulatory compliance, and internal review and decision-making.

Following are the required reports and statements for accurate financial planning and analysis:

• Profit And Loss (Income) Statements: The P&L statement presents the nature of your overall profit and loss over a period. In other words, it gives you a sense of the business's performance during a specific period. The statement deducts the cost of goods sold (COGS) from sales to find gross profit, from which other operating expenses are subtracted to arrive at the net income at the bottom—“the bottom line” for the business.
• Balance Sheet: On the other hand, this statement depicts the overall financial status or position at a particular point in time. The balance sheet shows the company’s assets, liabilities, and shareholders’ equity at a point in time. Net income from the P&L statement income statement flows into the balance sheet and changes the retained earnings.
• Cash Flow Statement: This summarises the cash and cash equivalents coming into and leaving a company. The main components of cash flow are cash from operating activities, investing activities, and financing activities.

Scope Of Financial Management

Financial management serves various purposes and functions. It spans four essential areas of a business.

1. Capital Planning And Budgeting

The finance team uses current and past financial performance data to establish targets, pinpoint areas for improvement, and develop a budget for the upcoming period. They evaluate day-to-day operations and long-term objectives. It allows them to connect financial data with targeted activities necessary to achieve these goals.

2. Informed Decisions

Precise money management practices for finance allow you to grow assets and generate additional income streams. It can assist in decision-making and enhance overall personal finance management.

• Investment Decisions:Investment decisions involve fund allocation to fixed and financial assets after considering market trends and industry growth for successful outcomes.
• Financing Decisions: Financial decisions are related to procuring finance from various sources possessing different capital costs, loan durations, and returns, allowing access to more funds from the market.
• Dividend Decisions: Dividends represent the earnings distributed to shareholders for potential reinvestment. Finance managers consider the net profit and oversee profit allocation decisions.

3. Managing And Assessing Risk

Each business brings risks, frequently manifest in unanticipated market conditions and events. Financial managers must create a robust strategy to handle these risks and make an effort to avoid them.

• Market Risk: Market risk can present industry-specific risks to public firms and impact their investments, stock performance, and reporting.
• Credit Risk: Late payments or inability to pay obligations can adversely influence a business's creditworthiness and valuation.
• Liquidity Risk: The financial team must monitor current cash flow, predict future cash needs, and ensure the availability of working capital.

4. Procedures

Procedures are another essential element or scope of financial planning and analysis. The finance department establishes policies to process and communicate invoices, reports, payments, and other financial data. These written regulations highlight who is responsible and has control over such decisions.

Conclusion

Financial management broadly determines how to source funds for operational growth and working capital management to ensure enough cash is available to manage day-to-day operations.

It guides businesses through market volatility, economic complexities, and strategic venture opportunities. It helps firms identify what they need to do financially to achieve short—and long-term goals.

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