What is Financial Management? Definition and Examples

What is Financial Management? Definition and Examples

Finance

The technique of managing a business’s finances in a way that enables it to be profitable and compliant with rules is known as financial management. That requires both a comprehensive strategy and hands-on implementation.

Financial management is the division of a company or organization that looks after cash flow, profitability, credits, costs, etc. to make sure the business has the resources required to meet its goals and objectives. In other words, it involves applying general management principles to a company’s financial resources.

Financial management, in general, is the act of handling a business’s finances in a way that enables it to be successful while still adhering to legal requirements. That requires both a comprehensive plan and practical implementation on the ground. Any business looking to expand must invest money such that the benefits of the investment outweigh the cost of borrowing.

Definition of financial management

Financial management seeks to utilize capital funds, which also happen to be a considerable economic resource, as Solomon put it: Another author’s definition of financial management – Phillippatus – has provided a more comprehensive definition. He asserts that “financial management” is concerned with managerial choices that lead to the organization’s purchase and financing of short- and long-term credits.

“Financial management should be seen as an application of general managing ideas to the area of financial decision-making,” according to Howard and Upton. Financial management, according to Weston and Brigham, is the domain of financial decision-making that balances the objectives of the person and the company.

The whole field of finance revolves around financial management. There are other definitions for the phrase financial management as well. S.C. Kuchhal provided the most common and well-accepted definition of financial management out of all the concepts. Financial management, in his words, “deals with the purchase of cash and their efficient usage in the organization.”

Definition of Financial Management in Procurement

Financial management in procurement, according to the Financial Management Institute, refers to the successful management of all processes associated with the acquisition and deployment of short- and long-term financial resources as they relate to the purchase of goods and services.

Simply put, the source-to-pay procedure, also referred to as the source-to-settle process, is what financial management in procurement refers to. The selection, evaluation, and creation of formal contractual agreements are some of its duties. The Relationship between procurement and finance department management is also important, in addition to managing the company’s continuous supplier connections.

A complex topic, procurement includes a variety of interconnected processes as well as the relationship between purchasing and other departments. Financial management is more than just raising money.

Basic Financial Management Concept

Financial management can be explained simply as, “If you rescue me today, I’ll save you tomorrow.” In today’s cutthroat economy, money comes from a variety of sources. The acquisition of these monies has traditionally been seen as a barrier.

Cost, risk, management, and control are distinct ways that funds obtained from various sources are classified. A savvy manager will understand that the funds need to be obtained at the lowest possible cost with a balance of risk and control aspects.

Organizations and firms frequently sign multiple option convertible bonds to satisfy investor needs. For instance, money may also be brought in from abroad. Foreign Institutional Investors (FII) and Foreign Direct Investment (FDI) are the two main sources of money from outside (FII). American Depository Receipts (ADRs) and Global Depository Receipts (GDRs) are additional contributions among foreign-based investors.

A financial manager’s responsibility is to properly analyze how those acquired monies were used. He is in charge of notifying the company or the person whether or not their finances are being allocated effectively.

The financial manager must be knowledgeable, diplomatic, and funny to carry out this role. In order for the latter to benefit fully, he must comprehend the needs and requirements of the person or business and develop some strategically sound plans.

Financial management example

Depending on a company’s accounts, business activities, or personal accounts, finance management is categorized. Managing telephone costs, employing new employees, purchasing facilities, creating project budgets, etc. are a few examples of financial management for a corporation or firm. Individuals can use controlling monthly budgets, expenses, shopping, etc. as an example of financial management.

Example 1 of Financial Management

You intend to take out a business loan to buy a new location for your company’s office. It is recommended to consult a real estate professional in this situation, and you must determine whether the property’s value will be higher than renting it out after 20 years or longer. Additionally, you should speak with the financial department to determine whether making a 20% down payment and taking out an 80% business loan will result in profitable investments.

Whether you’re leasing a residence, software, or a vehicle, there are frequent situations when renting might be more cost-effective than buying.

Example 2 of Financial Management

Assume you want to fulfill your financial objectives by purchasing a new home with a mortgage loan, where you will be contributing about 80% of your earnings in EMI (equated monthly installment) payments. – Here, it is advised to use the 50/30/20 planning technique, which provides excellent financial management results. It can be summed up as follows:

  • Your pay or total in-hand compensation is split equally between essential necessities of living and other expenses. For instance, transportation, rent, utilities, and groceries.
  • Lifestyle costs make up 30% of the budget. For instance, dining out, shopping, and so forth.
  • 20% goes toward future expenses like debt reduction, retirement planning, unexpected expenses, etc.
  • According to this law, such financial strategies must be reviewed and improved if more than 80% of your wage is used to pay off your mortgage.

Financial Management’s Goals

Financial managers support their companies in a number of ways based on those pillars, including but not limited to:

Increasing profits

Describe how, for instance, rising raw material costs could lead to an increase in the price of the commodities sold.

Monitoring cash flow and liquidity

Make sure the business has sufficient funds on hand to fulfill its responsibilities.

Ensuring adherence

Observe local, national, and sector-specific regulations.

Creating financial simulations

These are based on the existing state of the company and predictions that make a variety of assumptions about potential outcomes from market conditions.

Manage relationships

Effective communication with the boards of directors and investors.

In the end, it comes down to incorporating sound management practices into the financial framework of the business.

Financial Management’s Scope

The four main aspects of financial management are as follows:

Planning

The financial manager estimates the amount of cash the business will require to maintain a positive cash flow, allocate funds for expansion or the addition of new goods or services, deal with unforeseen events, and then communicates this information to other business associates.

Planning can be divided into different categories, such as capital costs, T&E, and manpower, as well as indirect and operating costs.

Budgeting

The company’s financial management divides up the available funds to pay for expenses like mortgages or rent, salaries, raw supplies, T&E for employees, and other commitments. Ideally, there will be some money left over to set aside for unexpected expenses and to finance new company ventures.

Businesses often have a master budget as well as additional documents that cover specific topics like cash flow and operations. Budgets can be rigid or flexible.

Analyzing and managing risk

The following risks are just a few that line-of-business leaders want their financial managers to evaluate and provide compensatory controls for:

Market hazard

Impacts the company’s investments, reporting, and stock performance for public corporations. may also be an indicator of industry-specific financial risks, such as a pandemic that affects restaurants or the transition of retail to a direct-to-consumer model.

Credit danger

Repercussions of, for instance, clients not paying invoices on time and the company not having the money to meet obligations, which may negatively influence creditworthiness and valuation, which determines the ability to borrow at advantageous rates.

Availability risk

Accounting and finance teams must monitor current cash flow, predict future cash requirements, and be ready to release working capital as necessary.

Operational hazard

This is a broad category that several financial teams are unfamiliar with. It might cover topics like the possibility of a cyberattack, whether or not cybersecurity insurance should be purchased, the existence of disaster recovery and business continuity plans, and the crisis management procedures that should be used in the event that a senior executive is accused of fraud or misconduct.

Procedures

The financial manager establishes policies for how the finance staff will accurately and securely process and communicate financial data, such as invoices, payments, and reports. These written policies also specify who in the organization is in charge of making financial decisions and who approves those decisions.

There are policy and procedure templates available for a range of organization kinds, like this one for NGOs, so businesses don’t have to start from scratch.

Financial Management’s Purposes

Practically speaking, a financial manager’s responsibilities in the aforementioned domains center on budgetary planning, forecasting, and management.

The FP&A role entails producing P&L statements, determining which product or service lines have the highest profit margins or contribute the most to net profitability, managing the budget, and projecting the company’s future financial performance and scenario planning.

Controlling the financial flow is also crucial. The financial manager is responsible for ensuring that there is adequate money available for daily tasks like paying employees and buying supplies for production. This entails managing the inflow and outflow of cash, a process known as cash management.

Financial management also includes revenue recognition or reporting the business’s revenue in accordance with generally accepted accounting rules. Strategic cash management and conservation include balancing accounts receivable turnover ratios, which is a critical component. Although it may seem straightforward, it isn’t always: Customers may pay at some businesses months after obtaining your service. When do you declare that money “yours” and inform investors of the good news?

Last but not least, monitoring financial controls entails comparing the company’s financial performance to its plans and budgets. The financial manager can compare the line items on the company’s financial statements using techniques like financial ratio analysis.

Finance: Strategic vs. Tactical Management

Financial management procedures control the tactical level of how you execute daily transactions, complete the monthly financial close, compare actual expenditure to budgeted amounts, and make sure you abide by auditor and tax regulations.

Financial management contributes to crucial FP&A (financial planning and analysis) and visioning activities on a more strategic level, where finance leaders use data to assist line-of-business colleagues in making future investment decisions, spotting opportunities, and creating resilient businesses.

Importance of Financial Management

Three pillars of strong fiscal governance are supported by sound financial management:

Strategizing

Figuring out what financial changes are necessary for the business to meet its short- and long-term objectives For example, while preparing a scenario, leaders need to have insights regarding existing performance.

Decision-making

Delivering current financial reports and information on pertinent KPIs to assist business leaders in making decisions regarding the best approach to carry out goals.

Controlling

Ensuring that each department is working within its budget, in accordance with the plan, and contributing to the overall vision.

All employees have visibility into developments and know where the company is headed thanks to efficient financial management.

Forms of Financial Management 

The three different categories of financial management:

Capital planning

Relates to determining what fiscal changes are necessary for the company to meet its short- and long-term objectives. Which capital investments should be made to support growth?

Capital arrangement

Decide how you will finance operations and/or expansion. Taking on debt might be the smartest course of action while interest rates are low. A business may potentially think about selling assets like real estate or equity, or it may decide to seek finance from a private equity firm.

Working capital administration

Making sure there is adequate money on hand for daily operations, such as paying employees and buying raw materials for production, is important, as was previously described.

Questions and Answers-

To further comprehend it, let’s look at a few of the questions and their responses. To guess the right response, you must fill in the blanks. Which of the following is an illustration of sound financial management?

Question-1) The idea of financial leverage is directly related to the concept of _______.

Answer- The concept of capital structure management is intimately tied to the idea of financial leverage. Businesses with a capital structure that includes debt are more likely to use financial leverage. The term “leverage” describes how the use of debt in the capital structure affects a corporation’s performance and, in turn, the amount of return that a business can offer to its shareholders. Therefore, the concept of financial leverage is directly related to the management of the capital structure’s finances.

Question-2) Generally speaking, permanent working capital is funded by _______.

In general, long-term capital funds are used to finance permanent working capital. Every business needs cash to finance its assets and operations. To get the desired results, investments in both current and fixed assets are necessary. It must be financed using long-term capital sources, such as stock or preference shares, debentures, long-term loans, and retained earnings from the company. Never use short-term borrowings or equity to finance fixed assets.

To understand more about which of the following is an example of financial management, you can also take the quiz on the fundamentals of financial management.

Conclusion

After reading the definition and examples of financial management, it is clear that financial management is an important component for everyone. Every person, company, or organization needs to learn about and practice financial management. Please share your opinion in the section below, as it will help others who read it to reach their goals in life.

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