Running a business is challenging, there are so many variables to consider that enable the operation to run smoothly. The owner hires managers to act in leadership roles to help keep things in order and get necessary tasks completed. Management consists of activities like planning, monitoring, organizing, controlling and directing people and events that occur within the company. In an Introduction to Management you can read more about the requirements of holding a managerial position. When it comes to financial management, those in charge are required to run a tight finance ship to ensure the money is being monitored closely and being used wisely. In this CFA Institute approved course, learn all about Corporate and Business Finance.
Financial planning is usually left for the owners and shareholders to do. Sometimes managers are brought on board to help coordinate financial management. Planning involves making sure that appropriate funds are available to run the business, pay the employees and to make investments. A plan must be put into place for those handling money to follow, preferably before a business opens its doors. This plan should also be assessed throughout the year to confirm that it’s working and effectively supporting business growth. Without proper planning, the available funds may not meet the requirements for the working capital budget of the company which can lead to defunct businesses, late payments and insufficient means to continue a healthy operation. Planning also includes where the business decides to invest its money, whether it’s in stocks, upgraded equipment, or expanding the scope of business. Learn how to invest your money to increase returns and reduce investment fees in the course Investing Fundamentals.
Monitoring company finances is one of the most important functions of financial management. You may have a great plan in place that follows top-notch financial policies, but if you don’t keep tabs on what is actually happening – there is no way to evaluate whether or not it’s working. The task of financial monitoring involves creating and analyzing financial reports on a regular basis. These reports include cash flow, working capital, fixed and current assets, revenue statements, accounts payable and accounts receivable. Closely monitoring these reports and double-checking for accuracy and positive growth is essential to managing a business.
Controlling finances is the job of financial managers and company policy makers. Financial control is established by drafting policies and procedures that help prevent mismanagement of money. The policies include how to document income and expenditures, what method of financial reporting is adopted and how the company wishes to manage the money overall. In accounting, there are several methods of revenue recognition which ultimately affect how income is reported and thus how taxes are handled. These methods include: cost-recovery, installment, completion and percentage of completion. To read more about these methods check out Cost Recovery Method of Revenue Recognition.
Financial Management Objectives
Identifying what type of financial management approach the company is going to use is important to how the organization conducts business. They help provide a framework for decision making and policy creation.
- Profit Maximization
Profit maximization entails increasing profits over their net worth. In financial management this is seen as a tough sell. It’s more of a short-term plan to more money which sounds nice, but doesn’t always play out smoothly. In profit maximization, any activities or events that can be done to increase profits are priority. The term profit can be defined as the amount of income the shareholders or owners of the company receive, or, it can refer to the overall financial efficiency of a business. Generally speaking, businesses that use the profit objective seek to use as little resources as possible (input) to generate as much money as possible (output). By investing only the amount needed to execute a profit-oriented financial plan, the shareholders can maximize their incomes while continuing to run an effective business.
When considering the profit maximization plan, it is important to define what profit means to your company. If it means money in the pocket – let it be known. If it means long-term benefits, or the rate of profit, that must be discussed and agreed upon. If not, there can be complications later. Another technicality of profit maximization to consider is the quality of benefits. Quality of benefits only means the certainty with which you can assume the benefits (income) will actually arrive. If the quality is low, there is risk associated with the benefits. Likewise, with high quality, the assumption is the benefits will likely be realized. While profit-geared businesses get excited over dollar signs, it’s best to use your wise judgment before nose-diving into a potentially devastating investment situation.
- Wealth Maximization
In wealth maximization, the company is concerned with increasing their net worth. This isn’t to say that they aren’t interested in making a profit, because they certainly are, but they pay more attention to cash flow and dividends. This financial management technique is more focused on the long-term success and health of the company than it is on immediate monetary returns. While decades past, profit maximization was the primary avenue for planning and managing finances, the benefits of wealth maximization are finally being seen. Companies that utilize this approach to financial management experience more success, for longer periods of time and a generally healthy business environment.
As opposed to profit maximization’s “quality doesn’t really matter” mantra, wealth maximization proponents take both quantity and quality into consideration. They thoroughly evaluate how much the investment return would be, what the risks are and how long it will take to see the benefits. Using this objective framework for financial management involves making changes to cash flow trends. This way, current assets can be analyzed appropriately and the remaining money can be utilized for further investment, which means, more long-term financial stability.
All business have an executive that calls the shots. Most of the time it’s a team of shareholders who delegate what happens with the money being brought in and how best to use it to increase company profits. They base their decisions on type of financial objectives the company employs. The decisions necessary can be broken down into a few different categories; investments, dividends, and working capital. In the Introduction to Financial Accounting course you can brush up your finance knowledge to make educated decisions about company money.
Companies may receive requests to become investors in other company’s or ventures. Likewise, the company may be seeking investors or wish to invest their money in stocks or back into the business. It is up to the financial executives to approve or reject investment inquiries based on the financial plan and policies upheld by the organization.
Financial managers determine how the business, and when the business should obtain funds. Every company has a capital structure that maintains the best equity to debt ratio to ensure adequate growth of the venture. It’s important for shareholders to minimize the risk while attempting to maximize profits. This is easier said than done. Sometimes financial managers have to go out on a limb and spend more money (create more debt) than desired to see a substantial return (profit). Financing is the process in which managers or shareholders decide how best to bring money into the company without assuming too much risk.
All businesses are in the market to make money. The people who invest in a venture hope to see a return on their investment to make it worth their while. Profitability is key and understanding how company profit can be used to increase gross profit is incredibly important. A financial manager has to decide how the profits of a company are used. Should they be 100% invested back into the company to increase overall profitability (which ultimately means more money for the partner’s)? Should the profits be divvied up between the partners with no funds going back into the business? Or should the profits be split between the business and the shareholders? Determining the optimum policy for dividend management is crucial to the success of the business.
The working capital includes the operational budget, current assets, payroll and cash flow. In financial management it’s critical to stay on top of your working capital budget to avoid going under. Finance managers must regularly assess records, assets and cash flow to see how much money is being expended, how much is coming in, and how much is tied up in assets. From time to time asset disposal is necessary to upgrade equipment or earn back some of the initial investment. It’s up to the financial managers to analyze when this is appropriate and how it could benefit the company. Current assets, like cash and inventory, sustain a company but they are not necessarily investments. Payroll is very important because without money, you can’t pay your workers and without workers, you cannot get the work done. Managers must also refer to the financial plan and policies to determine what pay is affordable and attractive to prospective employees.
In the end, financial management functions will make or break a company. Before deciding a framework to follow or policies to uphold, make sure that all of the shareholders involved are on the same page. Assess short-term and long-term goals, obstacles that may arise and who is going to be playing what role in the financial decision making. For a broad overview of business finances, check out the course on Micro and Macro economics.