What is Financial Management? (PDF Included) Definition, 5 Scopes, Importance, Types, Objectives, Functions, Advantages and Disadvantages
Financial Management is a crucial activity in any organization. It consists of planning, organizing, controlling, and monitoring financial resources with a view of achieving organizational objectives. It is a standard method for dealing with the financial activities of an organization, such as procurement of funds, usage of funds, accounting, payments, risk sorting, and other things related to money.
There are many options that everyone can use for managing their finances, this could manage them on your own, hire a full-time employee, hire a part-time accountant, or a third party who deals with all finance associated activities for you, for o cater t a Chartered Accountant.
Usually, organizations have an assigned department that looks after the financial involves of the company. A finance manager is appointed to control finance and managing its resources within an industry. All decisions related to finance are taken at this position. Depending on the organizational profile, the finance department can have several appointments t o o cater t t o the various demands of the company.
Definition of Financial Management
Financial management refers to the diplomatic planning, organizing, directing, and supervising of financial undertakings in an organization. It also comprises applying management principles to the financial resources of an organization, while also playing a significant part in economic or budgetary management.
Financial Management refers to planning, organizing, directing, and managing financial activities, such as procurement and application of funds for an organization.
Importance of Financial Management
Strong financial management gives the foundation for three main pillars of sound financial governance:
Strategizing, or determining what needs to appear financially for the company to reach its short- and long-term goals. Managers need insights into ongoing performance for scenario planning, for example.
Decision-making, or promoting business leaders, decide the best way to accomplish on plans by providing up-to-date financial reports and data on important KPIs.
Controlling or assuring each department is committing to the vision and operating within budget and in a change in strategy.
With an efficient financial management, all employees notice where the company is headed, and they have visibility in progress.
3 Types of Financial Management
In financial management studies, there are mainly three types of financial management;
It relates to determining what needs to happen financially for the company to reach its short- and long-term objectives. Where should capital funds be spent to support growth?
These management teams are likewise answerable for raising funds and investing funds. If an organization merges with another organization or expands, the team will aid the financial needs for merger or expansion.
Figuring out how to pay for operations and growth. If interest rates are reasonable, taking on debt might be the best response. A company might also seek funding from a private investment company, consider selling assets like real estate, or, where applicable, selling capital.
At the point when the team refers to capital structure, they are apparently dealing with a company’s debt-to-equity ratio, which gives an understanding of how strong an organization is financially or how risky the organization is financially.
Working Capital Management
Working capital management of an organization deals with managing bookkeeping methods and accounting policies intended to keep track of current assets, current debts, cash flow, inventory turnover ratio, working capital ratio, and much more.
The basic task of working capital management is to assure the organization dependably keeps up adequate liquid cash to meet its short-term debts and operational cost. This is one type of financial management where the team needs to maintain working capital management to smoother the company’s operational cycle, and also to increase the company’s earnings.
Objectives of Financial Management
The objectives of financial management should be:
- Maximizing profits by giving insights on, for example, ascending costs of raw materials that might trigger a hike in the cost of goods sold.
- To secure adequate returns to the shareholders, which will depend upon the earning capability, market value of the share, expectations of the shareholders, etc.
- Tracking liquidity and cash flow to assure the organization has enough money on hand to meet its requirements.
- To assure best funds utilization. Once the funds are bought, they should be used in the maximum way at least cost.
- Developing financial premises based on the organization’s current situation and forecasts that assume a wide range of results based on market conditions.
- To provide safety on investment, i.e., funds should be invested in safe ventures so that acceptable rate of return can be obtained.
- Dealing effectively with stakeholders, investors, and the board of directors.
- Securing compliance with state, national, and industry-specific laws.
- To design a sound capital structure-There should be a fair composition of capital so that a balance is maintained between debt and equity capital.
Functions of Financial Management/ What Does a financial Management do?
The financial department of any organization has to handle numerous functions, such as;
1. Calculating the Required Capital:
The financial manager has to calculate and estimate the amount of funds an organization requires. This depends upon the policies of the firm regarding required expenses and profits. The amount expected has to be determined in such a way that the earning capability of the organization increases.
The financial manager makes measurements of funds needed for both short-term and long-term.
2. Determining Capital Structure:
Once the need for capital funds has been decided, a decision respecting the kind and proportion of various sources of funds has to be taken. For this, the financial manager has to figure out the proper mix of capital and debt and short-term and long-term capital ratio. This is done to obtain the minimum cost of capital and maximize shareholders’ wealth.
3. Choice of Sources of Fund:
Before the exact acquisition of funds, the finance manager has to check the sources from where the funds are to be collected. The management can raise finance from different sources like equity investors, preference shareholders, debenture- holders, banks and other financial associations, public deposits, etc.
4. Investing the Capital:
Every organization or business requires investing money to raise more capital and earn regular returns. Hence, the financial manager needs to invest the organization’s funds in secure and effective ventures.
5. procurement of Funds:
The financial manager has to procure the funds required for the organization. It might involve consultation with creditors and financial associations, issue of prospectus, etc. The procurement of funds is reliant not only on the cost of raising funds but also on other aspects, like the general market situations, decisions of investors, government policy, etc.
6. Allocation of Profits:
Once the organization has received a decent amount of net profit, it is the financial manager’s duty to allocate it efficiently. This could require keeping a part of the net profit for an emergency, innovation, or expansion purposes, while another part of the profit can provide rewards to the shareholders.
7. Management of Cash:
This department is also responsible for taking care of the organization’s money. Money is needed for several purposes in the organization, such as paying salaries and bills, managing stocks, meeting liabilities, and the purchase of any materials or machinery.
It also involves estimating the cash inflows and outflows to assure that there is neither shortage nor surplus of cash with the organization.
8. Financial Control:
Not only does the financial managers have to plan, organize, and get funds, but he also has to manage and evaluate the firm’s finances in the short-term and the long-term. This can be done using some financial tools, such as financial forecasting, ratio evaluation, risk control, and profit and cost control.
Advantages of Financial Management
there are some advantages of having a Financial Management team within an organization;
1. Better Decision Making:
Financial management promotes better decision-making. It gathers and presents all financial information, considering the organization. Easy availability of all information helps managers in deciding efficiently based on facts and figures.
Financial management provides transparency of all information in the organization. It contains all information regularly and made it available to all business users. Better transparency helps in promoting proper understanding within and outside the company and avoids any complexity or errors.
3. Finance Control:
Dealing with the finance of an organization is one of the crucial advantages of financial management. It conducts all activities of the business to improve financial control. Finance managers assure that all activities of business go under the estimated cost and should not go above the pre-set budgets.
4. Maximization of Profit and Wealth:
Financial management plans to raise the profit and wealth of the organization and the shareholders. It focuses on earning high profits by cutting down the cost of service and carefully using all resources. The higher the profit, the higher would be the reward declared by the organization for its shareholders. In this way, financial management increases their wealth.
5. Avoids Debts:
Financial management helps to avoid and take any extra debt by the company. It focuses on the proper application of all funds and aims to reduce the overall cost. This leads to bypassing any need for other funds requirements by the company.
Disadvantages Of Financial Management
There are some disadvantages as well. Now I’m going to discuss those;
1. Cost Sufficient:
Practising Financial management is a cost sufficient activity for any organization. For managing and controlling the cost, financial management implies several financial control tools. These tools are very costly and also time-consuming.
2. Time Consuming:
The making of the financial strategy for an organization is not the task that can be done by a single department. The performances and purposes of the entire organization need to be aligned in order for an effective strategy. This means that implementing strategic finance takes time from line managers.
3. Determination of Standards:
Financial management involves the determination of standards for measuring exact performance, which is a hard task. There are no specific setup principles for setting up standards and there may be chances to set inappropriate standards.
4. Problems In Recognizing Deviation
The recognition of actual reasons for irregularities in a certain performance is not always possible. Financial management can work toward handling or avoiding irregularities if and only proper reasons for such irregularities are found out, otherwise, it is worthless.
Scope of Financial Management
We can explain the scope of financial management through the following points;
1. Investment Decision:
Financial management is needed for managing all investment aspects of an entity. This includes risk assessment, measuring the capital cost, and measuring benefits out of a specific project. Managers decide how available funds should be invested in fixed or current assets to get the best returns.
2. Working Capital Decision:
Working capital management is another convincing subject of financial management. The various decisions that are involved with an investment in current responsibilities and current assets are involved in working capital decision making.
The working capital decision requires effective control of current responsibilities and current assets, taking short-term financing as and when needed, and managing receivables. Current assets include cash, funds, receivables, short-term insurances, etc. while current liabilities or responsibilities include creditors, accounts payable.
3. Financing Decision
It involves determining what amount of funds require to be raised for the short term and the long term. The finance manager is put in charge of studying the specific finance mix or optimum capital system of the company to increase its value. This means that the entity shall find a suitable mix of equity and debt to give maximum profit to shareholders.
4. Devidend Decision:
In order to reach the revenue maximisation aim, a proper dividend policy must be developed. One aspect of dividend policy is to determine whether to distribute all the profits as dividends or to give away a part of the profits and keep the balance while determining the optimum dividend payout ratio.
The finance manager should analyze the investment spaces available to the organization, plans for development and growth, etc. Decisions must also be made regarding dividend stability, form of dividends, i.e., stock dividends.
5. Profit Management:
Efficient application of funds helps to make good profits in the company. The finance manager shall increase return on resources and control it over the cost of capital, meaning choosing debts wisely. Another way is to the reduction of costs and increases income items.
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