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One of the primary objectives of all businesses is to gain financial independence. However, to be able to realize the goal of financial independence, business owners are required to understand the potential consequence of their management decisions regarding various financial aspects including profits, cash flows, financial risks, and others. The overall financial performance of businesses is directly influenced by the performance of each of the various financial decisions made by business owners and executives. For most startups, the initial period is marked by financial losses and negative cash flows. This makes it even more important for startups to have a definite financial management plan to ensure the availability of enough cash with the company to pay employees, and suppliers, even at times when the cash outflow exceeds the cash inflow. This also means that business owners are required to make accurate financial projections that can take into account such negative cash flows, and help them to be prepared with the backup funding till the time the business becomes profitable.
Over time as the business matures and expand; it required more and more cash to keep up with its growth and expansion plans. Again, in this regard, businesses need accurate budgeting and planning for their financial requirements. At this time, it’s also important for business executives to identify the right sources of raising capital; whether they want to generate funds internally or lend from outside to fuel its expansion plan requires accurate quantitative modeling from financial managers. Here again, the financial management process comes into play; helping businesses to identify the best source of funding, while simultaneously controlling the business’s cost of capital and avoiding a higher debt ratio in the balance sheet that may comprise the credit rating of the business.
What is the importance of Financial Management?
Financial management is one of the most crucial components to support business continuity. Financial planning is required by businesses at all stages of growth (from startups to SMEs, and even large organizations) to successfully manage and run the business. Let’s see in little detail about the financial management process and why it is important for businesses;
What is financial management?
The financial management process refers to the management, planning, controlling, organizing, and directing the finances of an organization. This is achieved by applying principles of management to the financial assets of a business. Here are some of the core objectives of a financial management process;
- Keeping up with the cash supply to fund the business’s core operations
- Making sure that stakeholders of the business are able to get high ROIs
- Optimal utilization of available capital
- Identifying and creating safe investment opportunities for businesses
Elements of Financial Management
Key elements involved in the financial management process includes;
Financial Planning
Financial planning involves the estimation of funds required by businesses, while also determining its optimal allocation and utilization. The key objectives of financial planning include;
- Estimation of the funds required by the business
- Creating business’s financial policies and regulations
- Keeping up with the financial controls. This involves ensuring that the business is able to meet its objectives. The financial controls help businesses to realize answers to the following questions;
- Are the financial assets of the business being used optimally and efficiently?
- Are the financial assets of the business secure?
- Is the management acting competently in the best interest of the business and stakeholders
- Financial Decision making – Identifying the right opportunities for business to raise finance and profit distribution
Responsibilities of Financial Management Department
Financial managers head the financial management departments, which are responsible for carrying out various important functions including;
Estimating the funds required
Financial managers are required to estimate the amount of capital required by a business for its operations. This is greatly influenced by the financial policies of the business with regards to expected profits, and expenses. The overall estimation of capital should be done in a way to increase the capital earning capacity of the business.
Formation of capital structure
After the amount of capital required by the business has been estimated, the next important job for the financial management department is to create a capital structure. To achieve this, the financial management team will undertake debt-equity analysis for the short, and long term. This will subsequently depend on the amount of funds owned by the business, as well as, the amount of fund that is needed to be raised through external sources.