Running a business has always been a demanding task, and people from different backgrounds are required to contribute their skills and intelligence to build a robust structure that can survive in the market. Business pioneers cannot rely on a single function since it never guarantees smooth operation, and numerous aspects have to be taken into consideration.
Finance is the lifeblood of a business. Businesses need an adequate amount of funds to run their operations smoothly as well as achieve their overall strategic objectives. Eventually, finance is what drives each of the activities of the business. From sourcing the raw materials needed to carry out production to running successful marketing campaigns, every business activity is dependent on the availability of investment. Hence, it is essential for any business, regardless of its size and the industry it operates in, to manage its finances effectively if it wishes to survive and thrive in the market.
Due to the importance of financial management for a business, the finance department has a vital role to play in any organization. It wouldn’t be wrong to consider it the heart of the company. Just as the heart supplies blood to the rest of the body to keep it functioning, the finance department provides every business department with the funding they need to run their operations. It is the finance department that raises the funding required by the business and then ensures that it is allocated between the different functions in a way that generates the maximum return and allows the company to achieve its goals.
Let’s take a closer look at what financial management is and the numerous ways in which it contributes to the success of a business.
WHAT IS FINANCIAL MANAGEMENT?
Financial management includes all activities concerned with the planning, organizing, monitoring, and controlling the financial resources of the business in a way that allows it to achieve its objectives. For anyone interested in this field, a managerial finance online course can teach you all the skills needed to manage the finances of your own business or pursue a career as a finance professional.
Financial management focuses on three main areas:
1. CAPITAL DECISIONS: Finance managers are required to calculate the funding requirements of the business and raise the necessary capital. They must decide the debt to equity ratio in the capital structure and find the most suitable sources of finance for the industry, taking into account factors like the period of financing, cost of financing, and other terms and conditions attached to the funding.
2. INVESTMENT DECISIONS: Every business needs to invest money to make it, but the question is: which investment decisions can generate the best returns for the company without exposing it to unnecessarily high levels of risk? The finance manager must make these decisions and ensure efficient allocation of the available resources between competing uses.
3. DIVIDEND DECISIONS: The finance manager has to decide how to distribute the profits made by the business. He/she must determine the amount of profit to retain in the business for its future funding requirements (e.g., for growth or expansion) and the number of dividends to be paid to shareholders.
HOW DOES FINANCIAL MANAGEMENT ASSIST YOU IN RUNNING A SUCCESSFUL BUSINESS?
1) ENSURES SUFFICIENT LIQUIDITY: Liquidity is essential for the short-term survival of the business. Without enough cash, the business cannot pay salaries and bills, maintain adequate inventory, meet customer orders, and pay its creditors. Financial management ensures that the company has enough cash at all times to achieve its day-to-day expenses.
2) FINANCIAL REPORTING: Every business needs to produce reports related to its performance. The management needs reports on the performance of different departments, products, and employees of the company. Business owners and shareholders need to know the return on their investment. Government organizations need reports to collect taxes. A financial management system provides detailed financial reports to all these stakeholders.
3) FINANCIAL PLANNING: Sound financial management is also about planning the future finances of the business. With time, every company intends to grow and expand its operations. Financial planning is vital during such times. Finance managers can prepare budgets and forecasts so that the management knows the financial implications of its growth plans. They also decide whether the financing for growth should come from internal sources or external, choosing the most cost-effective funding option for extension.
4) CAPITAL MANAGEMENT: Financial management determines the optimal capital structure for the organization based on its funding requirements. It calls for the need for maintaining a balance between the amount of debt and equity. Too much debt increases liabilities of the company and related interest payments, which could put a strain on cash flows. Moreover, further borrowing becomes difficult in case of emergencies, as the company is considered a risky investment by lenders. On the other hand, giving away too much equity results in loss of control. Financial management avoids both situations by maintaining the right balance.
5) IMPLEMENTS FINANCIAL CONTROLS: Financial management isn’t just about spending; it is also about maintaining a check and balance on the finances. The task is done in several ways, such as through ratio analysis, comparing actual performance with budgets, calculating variances, and investigating them to ensure expenditure stays within acceptable limits. Such practices ensure business performance rests on the right track to achieve its objectives.
6) PROVIDES ACCURATE FORECASTS: Forecasts of future performance are beneficial for the business. They give the management an overview of the expected future costs and revenues, allowing them to plan. For instance, if the forecasts show cash shortfalls during a specific period, the finance manager will have an idea of the additional funding that will be needed and can arrange it in advance to avoid the chances of an unexpected cash crisis bringing business operations to a halt.
7) INCREASES PROFITABILITY: Profitability is the primary objective of most businesses, and they can achieve it by allocating its resources to projects that can yield the highest returns. Financial management evaluates different investment projects using various techniques such as accounting rate of return, payback period, and discounted cash flow so that businesses opt only for those projects with the highest profit margins.
8) PAYABLES AND RECEIVABLES MANAGEMENT: Offering credit facilities to customers is one of the most powerful tools to increase sales. However, by managing this credit, one can avoid the risk of bad debts. It ensures regular payment follow up and appropriate action taken against slow-paying customers. Moreover, financial management also ensures that the business negotiates attractive payment terms with its creditors and pays them on time.
9) PAYMENT OF TAXES: Financial management involves ensuring that the taxes of the business are filed accurately and paid on a timely basis to avoid any penalties.
10) RISK MANAGEMENT: Every organization is exposed to several kinds of risks as part of its business operations, such as credit risk, foreign exchange risk, inflation risk, and liquidity risk, to name a few. Financial management requires identifying the different risks faced by the business, measuring them, and taking steps to manage them. It also involves setting up reserves to deal with any unforeseen financial problems the company could face in the future.
THE BOTTOM LINE
While a great product and effective marketing are at the core of the business, sound financial management is just as crucial for its success. Look around you, and you will find plenty of examples of the companies that fail, despite having a strong market standing and sustainable competitive advantage, only due to a lack of proper financial management.
Thus, it is essential for business owners today to either have the necessary financial management skills themselves or engage finance professionals who will help secure the economic future of their business. Without a solid financial plan, no business can survive in the long-term and achieve its full potential.