Financial management means the management of money and funds of an organization in an effective way so that the company can achieve its objects. A financial manager is considered as instrumental in the company’s success (Van Horne James C, 2007).
Scope of financial management
Dr. RK Mittal, 2010 enlightened the scope of financial management can be related to three decisions making categories.
I. Investment decisions
This helps to take decisions about the investments in the business and also includes that what activities should be adopted. The investment decisions include the capital budgeting and complicated projects.
II. Financial decisions
These decisions helps to take decisions that how to finance those resources.
III. Money management decisions
These type of decisions helps to find out how to manage the firm’s financial resources in an efficient way.
Objectives of financial management:
C. Paramasivan & T. Subramanian stated that the main objective of financial management is to gain profit for the firm by maximizing the stockholders wealth.
Sources of finance available to a business
Implications of finance as a resource within a business make financial decisions based on financial information evaluate the financial performance of a business (.
· Permanent sources:
The permanent sources of finance for any firm include:
o Shared capitals:
The shared capital means the equity of a company obtained by trading stock to any shareholder for cash or equivalent items having a capital value.
For example a company “A” is providing computer services to shareholders and instead of purchasing these service companies can issue shares.
o Retained profits
Jim Riley, 2012 stated that the retained profits are the most important source of finance as these are the net profit of any organization and firm. When the company gets this cash it has the option to reinvest in the business or divide it.
· Short term
The short term sources include:
o Trade credits
In the trade credit the cash is not provided to the company but the organization can purchase goods and pay the trailer at the end of the credit period.
o Advance from dealers
The dealers can provide the company cash in advance and by the end of credit time they can get their products. This type of loans is easily provided by the permanent dealers of a company. The image of the company is also important factor.
Advantages of short term loan sources
o The main advantage of short term loans is that these are economical and have much flexibility in amount, time duration and there is no interference of management
o Secondly, the short term loans can last for a long duration.
· Long term
C. Zopounidisthe long term sources of finance for any company may include:
o Redeemable preference shares
It is an equity security generally considered as a hybrid instrument.
A debenture is a certificate or a bond that the firm or company is liable to pay a certain amount of money on interest. This money raised by the debentures becomes part of capital share in company. The debenture holders can easily transfer these debentures Mclaney (2006).
o Bank loans
Aidan Berry, 2005 described that the bank loans can be of three types depending upon the duration i.e. long term, short term and medium term. In case the loan does not return to the specific time than the bank can take serious actions against the organization which can defame the company.
o Seed capital / venture capital
A venture capital is an amount of money invested by the stockholder or the businessman on his own risk as if the business fails then it may all be lost (Atrill, 2001).
A franchising is an expansion of business on less investment. In franchising the franchisee allows to operate a local business under the franchisee's name. The main advantage of franchising is the reduction of the capital amount required to initiate a business. On the other hand the name of franchisee will be improved, so more profit can be gained.
Approaches of financial management
Theoretically the financial management is divided into two types of approaches:
· Traditional approach
· Modern approach
It is the initial stage of financial management based on the past experiences and traditionally accepted models. It was followed during 1920 to 1950’s.
The traditional approach consisted of three main parts:
o Managing the funds from the lending parties.
o Arranging funds from various financial instruments
o Finding different sources for collecting funds
Importance of financial management
The financial management is a key requirement for any organization or firm without which there is no concept of profitability and business. There are number of reasons by which the financial management gains its importance some of these are listed below:
1. Financial planning
The financial management helps in planning how to get assets for the firm, who will be the stock holders and customers and how this money will be managed to deal with internal requirements of a firm.
2. Proper use of funds
It is very importance to manage and grade the most important projects which require funds. It means that what are the appropriate places to invest in a business.
3. Improve profitability
Profitability depends upon the effectiveness and utilization of money by a business point of view.
4. Promoting savings
The aim of any business is to achieve maximum profits and to maximize the wealth of investors.
5. Increase the value of firm
The ultimate goal of any business is to increase the value of a firm by providing wealth to investors.
Functions of financial management:
The financial management has following functions:
I. Capital requirements of company:
It is the responsibility of a finance manager to estimate the capital requirements of a company. The capital requirements include the expected costs and profits and future programs.
II. Capital structure:
After the estimation of capital requirements, the capital structure has to be decided. This will involve the short term and long term debt analysis depending upon equity capital of a company. It also includes the funds raised from outside parties.
III. Deciding sources of funds:
While deciding the sources of funds there are many choices which can be taken on the basis of their merits, demerits, public support and duration. These sources include:
· The issuance of shares and debentures.
· Taking loans and financial supports from different institutions.
· Bonds or other forms of public deposits
IV. Cash management
The finance manager is responsible for dealing with payments that can be the salaries, wages, utility bills, purchasing and other company expenditures.
Financial statement analysis:
Financial statement analysis is a technique used for understanding possible risks to a firm and expected profitability by the formulation and analysis of different accounting techniques.
The financial statement consists of following steps:
· Reforming reported financial statements
· Analysis and adjustment of errors
· Financial ratio analysis
Financial management decisions
1. Capital budgeting
Capital budgeting techniques
· Net pressure value
Each potential project value is estimated by using a discounted cash flow, to calculate the net pressure value.
· Profitability index
Profitability index finds to calculate the relationship of investment to pay off of a proposed project.
· Internal rate of return
It determines the discount rate that gives NPV zero.
· Modified internal rate of return
This is a financial process used to calculate the attractiveness of any investment. It helps in ranking various investment choices.
· Equivalent annuity
Equivalent annuity determines the nonprofit value as per annual. It is calculated by dividing cash flow with current value of annuity factor. In most of the cases it is used only for calculating the costs of specific projects that are having same cash inflows.
· Project ranking
The real value of capital budget is project ranking.
2. Capital structure
The capital structure refers to the way of company finances its assets through some combination of equity, debt, or hybrid securities. There are a number of capital structure theories that suggest that the different assets of any organization are affected by the capital structure choice. Scott, 1997 argued that by selling secured debt organizations increases the value of equity.
Capital structure in a perfect market
In a perfect capital market there is no transaction, or bank rupture, perfect information, firms and individuals can take loans at the same interest rates, there are no taxes, .
Capital structure in real world.
But in the real world such perfection is not present and there are imperfections.
3. Working capital decisions
These are decisions involving managing the relationships between a firm short term assets and short term liabilities.
Working capital management:
Horne and Wachowitz, 2000 found that for manufacturing the firms, working capital management efficiency is vital, as the major part of assets is current assets. Raheman and Nasr, 2007 claimed that this directly affects the profitability and liquidity of firms. If the working capital management is not given sufficient consideration that the firms are potentially at risk of failure and can face bankruptcy (Kargar and Bluementhal, 1994).
· Cash management
The cash management helps to keep balance of the expenditures and the incomes. It reduces the cash holding costs.
· Inventory management
The inventory management helps in identification of level of inventory which allow for uninterrupted production. It reduces the investment in raw material purchases and reduces the reordering costs which results in increased cash flow.
· Debtors management
The debtor management includes designing the appropriate credit policy. It means
· In terms of credits it attracts the customers
· Any impact on cash flows and the cash conversion cycle will be offset by increase in revenue and it increases the profit and Return on the Capital
· Short term financing
Robichek, D. Teichroew & J. M. Jones, 1965 found that the cash required by the firms follow a seasonal pattern. Firms can obtain short term loan o cash from a number of sources which may include the lines of credit, delaying of account payables; term loans etc. all of these sources mentioned have their own merits and demerits and also differ in financing amounts.
Cash flow statement:
A cash flow statement is a financial statement that describes the organizations income and expenditures at the same time in a specific period of time. It contains mainly three components i.e. cash flows from operating, investing and financing activities. It helps in accessing the company’s liquidity, profits and solvency.
Developing a financial forecast
For developing a financial forecast the PDCA (Plan, Do, Act, and Check) can be followed. It has the following steps:
Plan: Identify the requirements ofr your firm and the possible financial shources.
Do: Collect all the relevant information and the missing data, relevance problems and identify the financial patterns and trends.
· Check if additional research is required or not.
· Identify the macro issues.
· Check the pros and corns
· Built the forecast.
· Test the forecast for sensitivity and review it for reasonableness and effectiveness.
Responsibilities of finance manager
A financial manager should fulfill these responsibilities:
· Manage the entity resources in an efficient way.
· Financial planning and ongoing advices for the executive bodies and management.
· Follow the strategy to determine the financial targets and budgets.
· Manage the company policies of capital requirements, debts and taxations in a good way.
· Prepare annual accounts reports.
Factors affecting financial decision making:
Vyuptakesh (2011, pg. 21-100) stated that there are a number of factors that influence the decision making of any firm. These can be divided in two main categories i.e. microeconomic and macro-economic factors.
o Microeconomic factors
The microeconomic factors are those which arise due to internal economic issues. There can be a number of reasons which may include:
I. Nature and size of organization
II. Level of risk and stability in earnings
III. Liquidity position
IV. Attitude of management
o Macroeconomic factors
The macro economic factors are the environmental concerns that the organization cannot control. These arise due to external pressures. These include the following:
I. Government based policies
II. State of economy
Financial management and internal controls
Internal financial management is a process created and implemented by management designed to give a reasonable assurance regarding the achievement of objectives in following three categories.
Internal controls are integral part of any firm’s management designed for providing effective and efficient operation, reliability of financial reporting, and following the applicable laws. The internal control is designed to achieve the goals and objectives of the organization by modifying the plans and procedures. Internal controls detect the errors and safeguard against fraud and errors. It acts as the effective stewardship of taxpayer dollars.
· Effective and efficient operations:
It includes the promotion of efficiency and effectiveness of operations through standard processes and safeguards the assets by control activities.
· Reliable financial information
The reliable financial information helps to permute the integrity of data used in taking business decisions.
It also helps to prevent from frauds and creates auditable trails of evidence.
· Compliance with laws and regulations
It helps in maintain compliance with laws and lawsuits by periodic monitoring
Internal control: integrated framework
The internal control in any organization or firm can be obtained by adopting the following components:
· Environmental control
· Risk assessment
· Information and communications
Financial risk Management
According to Howard and Upton financial management is an application of general managerial principles in the area of financial decision making.
As Weston and Brigham quoted “Financial management is an area of financial decision-making, harmonizing individual motives and enterprise goals”.
Joshep and Massie found financial management as an operational activity of a business that is responsible for obtaini=ng and effectively utilizing the funds necessary for efficient operations.
Risk can be defined as a threat of an event or action to occur that can adversely affect the entity’s performance to achieve specific goals and execute its strategies in a successful way.
Types of risks
· Strategic risks
The strategic risks mean adopting a wring strategy for doing a particular task.
· Operating risks
Operating risks involve the technical mistakes and adoption of wrong procedures for a task. It means doing a right action in an inappropriate way.
· Financial risks
The financial risks involve the Monterey damage risks like losing a financial resource or cash flow, and the inacceptable liabilities.
· Information risks
The information risks can involve the inaccurate or irrelevant information, unreliable systems and misleading or inappropriate reports.
· Physical risks
The physical risks can involve the loss or damage to a physical object. For example:
o Loss of a computer or any machinery.
o Injury or damage to a person or thing
o Degradation to the environment
Quantitative and Qualitative Risks
There can be two types of risks either qualitative or quantitative
o qualitative risks( cost of defending a lawsuit, damage to the property, equipment’s or inventory)
o quantitative risks ( like cash or monetary loss, or the loss of future cash flows, )
How to deal with risks?
There are different methods to deal with a risk. It includes
o Ignore the risk ( it might be a great risk for organization)
o Accept the risk (if you know that this type of damage can happen for example “less profit” to the company and you accept it)
o Transfer the risk (transfer the risks to the clients or stockholders)
o Mitigate the risk (take appropriate actions to deal with the risk so that no damage can occur).
The financial risks are grouped under two categories:
· Systematic risks
The systematic risks are mainly due to external factors of an organization. These are uncontrollable. These risks are macro in nature.
The systematic risks consist of:
o Market based risks: This type of risk arises with a fall in value or price of assets in financial market.
o Foreign investment risks:
It involves the rapid fluctuations and change in values due to differing accounting, reporting and auditing.
The unsystematic risk includes due to the internal mismanagement of an organization. These are micro in nature. These risks vary from company to company.
· Liquidity Risk
This type of risk arises when the firm is unable to purchase or sell a certain assets due to lack of sellers or buyers. This risk also arises when there is an excessive loss in relation to its real worth in transaction on a market.
Financial management resources and decisions is very important for any organization as it lead towards a developing and following a strategy which helps in obtaining greater wealth. The sources of financial management include the long term like the loans from banks, debentures, or short term such as trade credits and profits. The finance manager is responsible for developing the audit reports, mange the project ranking and developing strategies to increase the performance and sources of assets of the firm. There are many financial risks for an organization that can affect the performance and image of organization. These can be categorized as systematic and unsystematic risks. Managing these risks and their mitigation can help to retain profit and fame of organization.