What Is Financial Management And Its Functions?
Are you someone who keeps a tab on monthly expenses? Whether it’s through money management applications or spreadsheets; if you…
August 10, 2021 | 6 mins read
Are you someone who keeps a tab on monthly expenses? Whether it’s through money management applications or spreadsheets; if you keep track of the amount you earn and spend, then you engage in personal financial management. The process isn’t only limited to mere calculation of expenses but also helps us plan better for future spending and saving.
In organizations, finance is one of the most important aspects of conducting business. For successful business outcomes and growth, an organization needs to prioritize good financial management. Read on to explore the meaning of financial management, its benefits and its functions.
Before we deep dive into the functions and advantages, let’s understand the meaning of financial management. Whether a business follows a for-profit or not-for-profit model, it needs sound financial standing to stay afloat. It can be said that finance is the lifeline of any business, irrespective of the business model and industry. However, like any other resources, finances are limited. Therefore, businesses need to manage them effectively.
In its most basic form, financial management involves planning, organizing, directing and controlling financial activities in an organization. The process also helps apply management principles to financial assets or resources. The practice of managing an organization’s finances allows the business to be compliant with regulations and be successful in its field. The financial management process entails high-level planning and proper execution.
Here are the common objectives of financial management across organizations:
But what is financial management without effective application? When done right, that is, when management principles are properly applied, there is visible progress.
Financial management takes various forms; however, there are two key types of financial planning that inform business decisions and solutions. They are:
What is financial management without strategy? In the strategic approach, you focus on long-term success. If you’re being strategic, you make financial decisions based on what you want to achieve in the future. This means that you may even have to tolerate small losses and navigate your strategy around them. Therefore, effective strategic financial management may push you to adjust or compromise on some short-term goals, if needed. Such trade-offs are necessary to consider if you want to prioritize the long-term financial health of the organization.
There are some core elements of strategic financial management, such as:
On a tactical level, financial decisions relate to short-term positioning. Tactical financial management procedures inform how to process daily transactions and compare actual spending with what was budgeted for. It helps you ensure compliance with auditor and tax requirements.
In the tactical approach, the primary intent is to take advantage of market conditions. For example, if the market outlook is poor, tactical financial management involves acting more defensively and reducing equity exposure. Alternatively, if the market outlook is healthy, the tactical approach provides flexibility to move to a higher end. The approach is also useful for dynamic markets to help increase gains or mitigate losses.
Financial management functions are critical for fund procurement, allocation of financial resources and utilization of funds, among others. The responsibility typically lies with financial or fiscal managers. Let’s navigate the financial management functions through the roles of a manager:
Financial managers shoulder the primary responsibility of making decisions and controlling the finances. Through various techniques like financial forecasting, ratio analysis and profit and loss analysis, they prepare for potential threats.
Decision-making also spills into planning financial activities and resources. Managers use available information to gauge an organization’s priorities and needs. They also analyze the overall economic situation to plan budgets and make decisions accordingly.
Managers need to make sure that all financial resources are being utilized in appropriate ways. They oversee whether businesses have invested effectively and efficiently. Proper allocation of financial resources leads to profitability in the long run.
Managers have the responsibility of ensuring cash management. In other words, they need to make sure that organizations are able to meet operational expenses and emergencies. This is done by checking if businesses have sufficient working capital and cash flow.
Decisions regarding the net profits of an organization are taken by fiscal managers. They calculate the profits at the end of the accounting year. This helps them make pivotal decisions—whether dividends should be distributed or retained for internal purposes.
An organization may take critical strategic turns to maintain relevance in the competitive market. They can either expand by acquiring new businesses or through mergers, where they enter into a new business. Such decisions deal with the complex valuation of securities, and financial managers are the ones who oversee such processes.
Capital budgeting refers to decisions that involve investing in shares or bonds, building new plants and purchasing new equipment, among others. Financial managers need to identify opportunities and challenges before organizations decide to invest a huge amount of capital.
In short, financial management functions help businesses maximize their wealth. However, it’s a continuous and interrelated process and financial managers need to be prompt and efficient.
It’s evident that proper planning and decision-making lies at the core of financial management. However, there are different types of management decisions that govern an organization.
Here, financial managers need to determine the investment amount available out of existing finance. They make such decisions on the basis of long-term and short-term needs. Long-term investment decisions are also known as capital budgeting, where organizations commit to funds for long periods (for example, fixed assets). Short-term investment decisions are also known as working capital management, where businesses commit to funds for short periods. It includes decisions regarding investing funds in inventory, banks and others.
Financing decisions are concerned with the amount of finance to be raised from various sources. It can be both long-term sources (capital structure) or short-term sources (working capital). Here, managers need to pre-estimate financial needs and ensure the availability of adequate finance. The core objective is to ensure that funds are available as and when needed.
Such decisions are concerned with how much of the profits earned by an organization should be distributed and how much should be retained. Typically, when funds are distributed among shareholders, it’s known as dividends. When funds are saved for future investments and contingencies, it’s known as retained earnings. Such decisions are complex and require deep insights and critical thinking.
Financial management decisions impact everyone in an organization. The more successful a business is, the better it is for individual employees. It can be said that the finance department has a central role in ensuring that an organization heads in the right direction. If you’re a financial manager or leader and you want to make sound decisions, try Harappa’s Making Decisions course. You’ll not only learn the fundamentals of good decision-making, you’ll also identify challenges that often affect decisions. The Good Decision Process framework will teach you how to arrive at smart decisions by analyzing situations properly. The PRISM Framework will help you avoid any negative consequences from personal biases. Start your free trial and never doubt your decisions again!
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