Business Studies Part I
Business Studies Part II

Financial Management

All finance comes at some cost. It is quite imperative that it needs to be carefully managed. Financial Management is concerned with optimal procurement as well as usage of finance. For optimal procurement, different available sources of finance are identified and compared in terms of their costs and associated risks. Similarly, the finance so procured needs to be invested in a manner that the returns from the investment exceed the cost at which procurement has taken place.

Financial Management aims at reducing the cost of funds procured, keeping the risk under control and achieving effective deployment of such funds. It also aims at ensuring the availability of enough funds whenever required as well as avoiding idle finance. Needless to say that the future of a business depends a great deal on the quality of its Financial Management.

The role of Financial Management cannot be over-emphasized since it has a direct bearing on the financial health of a business. The financial statements such as Balance Sheet and Profit and Loss Account reflect a firm’s financial position and its financial health. Almost all items in the financial statements of a business are affected directly or indirectly through some financial management decisions. Some prominent examples of the aspects being affected could be as under:

  • The size as well as the composition of Fixed Assets of the business: For example, a capital budgeting decision to invest a sum of Rs. 100 crores in fixed assets would raise the size of the fixed assets block by this amount.
  • The quantum of Current Assets as well as its break-up into cash, inventories, and receivables: With an increase in the investment in fixed assets, there is a commensurate increase in the working capital requirements. The quantum of currents assets is also influenced by financial management decisions. In addition decisions about credit policy, inventory management affects the number of debtors and inventory which in turn affect the total current assets as well as their composition.
  • The amount of long term and short term financing to be used: Financial management, inter alia, involves a decision about the proportion of long and short-term finance. An organisation wanting to remain more liquid would raise relatively more amount on a long term basis and vice-versa. There is a choice between liquidity and profitability. The underlying assumption here is that current liabilities cost less than long term liabilities.
  • Break-up of long term financing into debt, equity, etc: Of the total long term finance, the proportions to be raised by way of debt and/or equity is also a financial management decision. The amounts of debt, equity share capital, preference share capital are affected by the financing decision, which is a part of financing management.
  • All items in the Profit and Loss Account e.g., Interest, Expense, Depreciation, etc. : Higher amount of debt means higher interest expense in future. Similarly, use of higher equity may entail higher payment of dividends. Similarly, an expansion of the business which is a result of capital budgeting decisions is likely to affect virtually all items in the profit and loss account of the business.
  • In other words, it can, thus, be stated that the financial statements of business have been largely determined by financial management decisions taken earlier. Similarly, the future financial statements would depend upon the past as well as current financial decisions. Thus, the overall financial health of a business is determined by the quality of its financial management. Good financial management aims at the mobilisation of financial resources at a lower cost and deployment of these in most lucrative activities.

Financial decisions and controls: Financial management and financial managers play a crucial role in making financial decisions and exercising control over finances in the organization. They make use of techniques like ratio analysis, financial forecasting, profit and loss analysis, etc.

Financial Planning: The finance managers are responsible for the planning of financial activities and resources in the organization. To this end, they use available data to understand the needs and priorities of the organization as well as the overall economic situation and make plans and budgets for the same.

Capital Management: It is the responsibility of financial management to estimate the capital requirements of the organization from time to time, determines the capital structure and composition and makes the choice of source of funding for the capital needs.

Allocation and Utilization of financial resources: Financial management ensures that all financial resources of the organizations are used and invested effectively and efficiently so that the organization is profitable, sustainable and viable in the long-run.

Cash Flow Management: It is extremely important for organizations to have sufficient working capital and cash flow to meet their operational expenses and emergencies. Financial management tracks account payable and receivable to ensure there is sufficient cash flow available at all times.

Disposal of Surplus: The decisions on how the surplus or profits of the organizations is utilized are taken by the financial managers of the organizations. They decide if dividends should be distributed and how much as well as the proportion of profits that must be retained and plowed back into the business.

Financial Reporting: Financial management maintains all necessary reports related to the finance of the organization and uses this as the database for forecasting and planning financial activities.

Risk Management: Sound financial management prepares the organization to forecast risks, put in place mitigation plans as well as to meet unforeseen risks and emergencies effectively.