Financial management - one of the most important responsibilities of business owners and leaders - is the practice of managing the finances of a business in a way that helps companies to be successful, and compliant with tax and statutory regulations. It allows the management of a company to track, analyse, take corrective action on the impacts of their decisions, on profits, cash flow, financial health, and the growth of the business.
- The primary goal of financial management is to maximise shareholder wealth
- Application of financial management is more crucial during the time the companies experience 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 through the allocation of scarce resources
The following discussion will help you understand the basic financial management practices needed in a good organisation.
Setting up and running bookkeeping and accounting
Financial management starts with book-keeping and accounting - the most basic functions in finance - which is about recording financial transactions, managing the collections from customers and payments to creditors, providing data for preparation of financial statements and analysis, getting financial records audited, paying taxes and filing returns, and complying with regulations, among other activities.
A good accounting system that follows the relevant accounting standards and best practices help ensure that financial transactions are recorded and reported accurately, and sufficient controls are in place to guard the company against intentional and unintentional corrupt and fraudulent activities.
Critical financial operating activities
Key parts of financial operations include financial planning, budgeting, and cash and credit management.
- 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). Budget is also used for evaluating how much money the business will need to fund major initiatives like buying a facility or asset, adopting digital transformation, expanding or diversifying the business, hiring new resources, implementing a go-to-market strategy, etc. The deviations of the actual budget are reviewed and corrective measures are taken to achieve forecasted revenue and control budgeted expenses.
- Managing cash flow: Probably, the biggest challenge in most businesses is managing the cash flow to make sure that there is enough cash to pay current liabilities and allocate funds for capital expenditure that drives growth and scale. Working capital management, arguably the most critical element in cash flow management, is the management of current assets that include cash, receivable, payable, and inventory.
- Managing risk: Assessing and providing controls for a variety of risks, including market risk, credit risk, liquidity risk, and operational risk. While market risk is about investments and stock performance, credit risk involves the situation of not paying their invoices on time. Liquidity risk comes from cash flow challenges and operation risk may include, for example, the risk of a cyber-attack and disaster recovery and business continuity plans.
Financial statements are summary-level reports about an organisation's financial results, financial position, and cash flows, which are required for various external purposes such as audit, tax reporting, regulatory compliances, and internal review and decision making.
- Profit and Loss (Income) Statements: The P&L statement presents the nature of your overall profit and loss over a period or in other words gives you a sense of the performance of the business during a certain 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 amount of cash and cash equivalents coming in and going out of a company. The main components of the cash flow are cash from operating activities, investing activities, and financing activities. There are two methods of calculating cash flow - the direct method and the indirect method. The indirect method - the most common - starts with net income and adjusts it for any non-cash expenses and changes in various assets and liabilities in the balance sheet between the beginning and closing of the reporting period.
Financial statements don’t serve any purpose unless the data and information reported in them are analysed and understood. The financial analysis examines both historical and projected profitability, cash flows, and risk, resulting in the reallocation of resources to or from a business or a specific internal operation.
Some of the techniques and tools employed in the financial analysis include - analysing profit and loss, balance sheet, cash flow, budget deviation, break-even analysis, capital expenditure feasibility, ratios analysis, and such analyses.
In nutshell, financial management broadly involves capital budgeting, which relates to identifying what needs to be done financially for the company to achieve its short- and long-term goals, the capital structure that determines how to source funds to pay for operations and/or growth, and working capital management, that ensures there’s enough cash on hand to manage day-to-day operations.