Key Areas of Financial Management
Financial management in a business means planning and directing the use of the company’s financial resources – the cash it generates through its operations and the capital obtained from investors or lenders. Although a company may have accounting staff or an outside accounting firm to provide financial guidance, financial management is one of the most important aspects of the business owner’s job.
The key areas of financial management are discussed in the following paragraphs:
(1) Estimating the Capital Requirements of the Concern
The Financial Manager should exercise maximum care in estimating the financial requirement of the firm. To do this most effectively, he will have to use long-range planning techniques. This is because every business enterprise requires funds not only for long-term purposes for investment in fixed assets but also for the short term so as to have sufficient working capital. He can do his job properly if he can prepare budgets of various activities for estimating the financial requirements of the enterprise.
Carelessness in this regard is sure to result in either deficiency or surplus of funds. If the concern is suffering because of insufficient capital, it cannot successfully meet its commitments in time, whereas if it has acquired excess capital, the task of managing such excess capital may not only prove very costly but also tempt the management to spend extravagantly.
(2) Determining the Capital Structure of the Enterprise
The Capital Structure of an enterprise refers to the kind and proportion of different securities. The Financial Manager can decide the kind and proportion of various sources of capital only after the requirement of Capital Funds has been decided. The decisions regarding an ideal mix of equity and debt, as well as short-term and long-term debt ratio, will have to be taken in the light of the cost of raising finance from various sources, the period for which the funds are required, and so on.
Care should be taken to raise sufficient long-term capital in order to finance the fixed assets as well as the extension program of the enterprise in such a wise manner as to strike an ideal balance between the own funds and the loan funds of the enterprise.
(3) Finalizing the Choice as to the Sources of Finance
The capital structure finalized by the management decides the final choice between the various sources of finance. The important sources are share-holders, debenture-holders, banks and other financial institutions, public deposits, and so on. The final choice actually depends upon a careful evaluation of the costs and other conditions involved in these sources.
For instance, although public deposits carry a higher rate of interest than on debentures, certain enterprises prefer them to debentures as they do not involve the creation of any charge on any of the company’s assets. Likewise, companies that are not willing to dilute ownership may prefer other sources instead of investors in its share capital.
(4) Deciding the Pattern of Investment of Funds
The Financial Manager must prudently invest the funds procured, in various assets in such a judicious manner as to optimize the return on investment without jeopardizing the long-term survival of the enterprise. Two important techniques:
- Capital Budgeting
(5) Distribution of Surplus Judiciously
The Financial Manager should decide the extent of the surplus that is to be retained for plowing back and the extent of the surplus to be distributed as dividends to shareholders. Since decisions pertaining to disposal of surplus constitute a very important area of Financial Management, he must carefully evaluate such influencing factors as:
- The trend of earnings of the company
- The trend of the market price of its shares;
- The extent of funds required for meeting the self-financing needs of the company
- The future prospects; (e) the cash flow position, etc.
(6) Efficient Management of Cash
Cash is absolutely necessary for maintaining enough liquidity. The Company requires cash to:
- Pay off creditors;
- Buy stock of materials;
- Make payments to laborers
- Meet routine expenses.
It is the responsibility of the Financial Manager to make the necessary arrangements to ensure that all the departments of the Enterprise get the required amount of cash in time for promoting a smooth flow of all operations. A shortage of cash on any particular occasion is sure to damage the creditworthiness of the enterprise. At the same time, it is not advisable to keep idle cash also.
Idle cash should be invested in near-cash assets that are capable of being converted into cash quickly without any loss during emergencies. The exact requirements of cash during various periods can be assessed by the Financial Manager by preparing a cash-flow statement in advance.