The two fundamentals of financial management are represented by management accounting and corporate finance. Managerial accounting includes techniques for financial analysis, costing the activities of the business and forecasting financial requirements. Corporate finance includes functions such as valuations of assets and projects, deciding on the best investment portfolio, reducing risks through hedging operations, and choosing/monitoring the capital structure.
Financial Management in Practice
Financial managers are responsible for ensuring:
Good returns to investors who have provided funds for the business.
Monitoring the continued financial health of the business.
Reducing the risk exposure of the business.
These goals are typically achieved through:
Availability of Funds: Budgets need to be prepared at different levels from individual to corporate departments of individual business units. The budgets will include both capital budgets for facilities, operating budgets for regular operations and cash flow estimates for expected actual flows of cash. A separate article discusses funding sources.
Returns on Investment: All investment proposals are evaluated using techniques like discounted cash flows that seek to compute the net cash surpluses generated by each proposal over its lifetime. Only the best proposals with a positive net cash flow are selected and included in the capital budgets. Profitability of regular operations are monitored using management accounting techniques such as contribution analysis of products, customers and business units, and returns generated by each facility.
Financial Health: Analysis of financial statements is the standard practice used to keep a watch on the financial health. The analysis will seek to measure the proportions of debt and equity in the capital structure, the liquidity of working capital and the speed of cash conversion cycle.
Risk Exposure: The finance manager is typically responsible for hedging operations such as insurance, forward contracts and options that seek to protect the business against developments such as a disaster that destroys the organization’s facilities and variations in the prices of the business’ raw materials and products.
It will be noted that all the above functions are of a managerial nature. Accordingly, they are covered by the term managerial finance. Techniques like financial ratio analysis, activity based costing, variable budgeting and sensitivity analysis are used for discharging these functions.
Finance managers are also typically responsible for technical issues like assigning all transactions to the right accounts and ensuring that published financial reports comply with Generally Accepted Accounting Practices (GAAP) of the country.
Finance Management Functions: Some Specific Examples
The advice of finance managers are sought in instances such as those listed under, among others:
Dividend Payments: While dividend payouts can provide immediate returns to investors, profit retention can enable expansion of the business and increase shareholder value through capital appreciation. The business will also have to consider the impact a dividend payout can have on its cash flows and capital structure.
Mergers & Acquisitions (M&A): Where a company chooses the M&A route for growth, it will be the finance manager’s responsibility to help with valuation of businesses to be acquired. Such valuations will be primarily based on the future profit potential of the business rather than the value of tangible net assets of the acquired business.
Pricing Decisions: While the impact of prices on sales volumes will be assessed by marketing people, the finance manager will have to examine the financial implications of any shrinkage or growth in the volumes. For example, if the sales volumes fall too low, the overhead component of costs might be inadequately recovered. On the other hand, high sales volumes might allow prices to be lowered more than proportionately.
Share and Bond Issues: In addition to capital structure issues, share and bond issues also need to consider the prevailing conditions in the securities market. Issuing these in times when the market is low might fetch too little money for the business.
This article looked at financial management and corporate finance fundamentals as well as the functions and practices of finance management. In addition to ensuring availability of finance for investments and working capital, the finance manager is also responsible for monitoring the organization’s financial health, monitoring returns provided to investors and reducing the risk exposure of the business.
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