Financial management in business entails strategically navigating a company’s finances to ensure not only its success but also its compliance with regulatory standards. This process necessitates a combination of strategic planning and meticulous execution.
What is Financial Management?
Fundamentally, financial management is the discipline of devising a business strategy and ensuring all departments align with it. Effective financial management empowers the CFO or Finance VP to furnish data that shapes a long-term vision, guides investment decisions, and provides insights into funding options, liquidity, profitability, cash runway, and more.
The role of ERP Software in Financial Management:
ERP software can be a valuable asset for finance teams striving to meet these objectives. A financial management system amalgamates several critical financial functions, including accounting, fixed asset management, revenue recognition, and payment processing. By consolidating these essential elements, a financial management system provides real-time insights into a company’s financial health while streamlining daily operations such as period-end closing processes.”
Video: What Is Financial Management?
Goals of Financial Management
Acting as pillars of stability and progress, financial managers serve their organizations in various capacities, which are not limited to the following:
- Profit Maximization: Financial managers provide insights on aspects such as escalating raw material costs that may lead to a rise in the cost of goods sold, aiming to maximize profits.
- Liquidity and Cash Flow Monitoring: They ensure the company maintains sufficient funds to meet its immediate and short-term obligations.
- Regulatory Compliance: They stay abreast of and ensure adherence to state, federal, and industry-specific regulations.
- Financial Scenario Analysis: Based on the company’s present state and a broad spectrum of possible market conditions, financial managers develop forecast scenarios.
- Stakeholder Relations Management: They handle relationships with stakeholders, including investors and boards of directors, effectively.
In essence, the objective is to apply sound management principles to the financial architecture of the company for optimal performance.
Dimensions of Financial Management
Financial management traverses four primary domains:
- Financial Planning: This involves forecasting the company’s financial needs to ensure positive cash flow, facilitate growth, introduce new products or services, and tackle unforeseen events. The financial manager shares this information with business colleagues. Such planning often spans categories like capital expenses, travel and entertainment (T&E), workforce costs, and indirect and operational expenses.
- Budgeting: Here, the financial manager distributes the available funds of the company to meet expenses like mortgages or rents, salaries, raw materials, employee T&E, and other obligations. Ideally, a portion is reserved for emergencies and to capitalize on new business opportunities. Companies typically have a master budget and may have subsidiary documents for cash flow, operations, etc., which can be static or flexible.
- Risk Management and Evaluation: Business executives rely on their financial managers to assess and mitigate a range of risks, including:
- Market Risk: This can influence the business’s investments, reporting, stock performance, and industry-specific financial risks, like a pandemic impacting restaurants or retail shifting to a direct-to-consumer model.
- Credit Risk: Effects of delayed invoice payments by customers, which can cause liquidity issues, negatively impact creditworthiness, and thus affect the company’s borrowing capacity.
- Liquidity Risk: The finance team must monitor current cash flow, forecast future needs, and be ready to liberate working capital as required.
- Operational Risk: This broad category can encompass risks like potential cyber-attacks (prompting the need for cybersecurity insurance), disaster recovery and business continuity plans, and crisis management practices for situations like accusations of executive fraud or misconduct.
- Procedures: The financial manager establishes protocols on how the finance team will securely and accurately process and disseminate financial data such as invoices, payments, and reports. These formalized procedures also detail who holds responsibility for financial decisions in the company and who approves them. Companies can utilize available policy and procedure templates tailored for various organization types, eliminating the need to start from scratch.”
Responsibilities of Financial Management
In practical terms, a financial manager’s duties, while aligned with the aforementioned areas, primarily focus on planning, forecasting, and expenditure control.
The Financial Planning and Analysis (FP&A) function encompasses tasks such as issuing Profit and Loss (P&L) statements, identifying product lines or services with the highest profit margin or maximum contribution to net profitability, maintaining the budget, and forecasting future financial performance along with scenario planning.
Cash Flow Management is another crucial responsibility. Ensuring sufficient cash is available for daily operations, such as employee salaries and purchasing raw materials, is a priority for the financial manager. This requires diligent supervision of cash inflow and outflow, a practice known as cash management.
Alongside cash management, financial management also involves revenue recognition, which is reporting the company’s revenue in accordance with standard accounting principles. Managing accounts receivable turnover ratios strategically to conserve and manage cash is an integral aspect of this function. It may appear simple, but in reality, it can be complex: For instance, customers might settle invoices several months after availing of your service. Determining when to recognize that money as revenue and report it to investors presents a significant challenge.”
5 Tips to Improve Your Accounts Receivable Turnover Ratio
- Invoice regularly and accurately. If invoices don’t go out on time, money will not come in on time.
- Always state payment terms. You can’t enforce policies that you haven’t communicated to clients. If you make changes, call them out.
- Offer multiple ways to pay. New B2B options are coming online. Have you considered a payment gateway?
- Set follow-up reminders. Don’t wait until customers are in arrears to start collection procedures. Be proactive, but not annoying, with reminders.
- Consider offering discounts for cash and prepayments. Cash(less) is king in retail, and you can reduce AR costs by encouraging customers to pay ahead rather than on your normal customer credit terms.
Lastly, the responsibility of managing financial controls involves evaluating the company’s financial performance in relation to its strategic plans and budgets. This task can be accomplished through methods like financial ratio analysis, wherein the financial manager scrutinizes and compares various elements within the company’s financial statements.
Tactical Versus Strategic Financial Management
Tactical financial management is concerned with daily operational procedures, such as processing transactions, executing the monthly financial close, comparing actual expenditures with budgeted amounts, and ensuring compliance with audit and tax obligations.
Conversely, strategic financial management forms the backbone of essential Financial Planning and Analysis (FP&A) activities and vision formulation. In this capacity, finance leaders utilize data to assist business line colleagues in planning future investments, identifying opportunities, and constructing robust, resilient companies.
Significance of Financial Management
Robust financial management underpins three key facets of effective fiscal governance:
- Strategic Planning: Determines the financial course required for the company to meet its immediate and long-term objectives. It involves the need for insights into current performance for effective scenario planning.
- Informed Decision-Making: Assists business leaders in determining the most efficient execution strategies by providing current financial reports and data on pertinent Key Performance Indicators (KPIs).
- Operational Control: Ensures each department is contributing to the overall vision, operating within the budget, and aligning with the strategic plan.
Effective financial management facilitates a shared understanding among all employees about the company’s direction and provides transparency into its progress.
What are the Three Categories of Financial Management?
The functions mentioned previously can be consolidated into three overarching categories of financial management:
- Capital Budgeting: This involves formulating financial strategies for the company to achieve its immediate and long-term objectives. It includes decisions regarding where to allocate capital funds to support growth.
- Capital Structure: This refers to deciding how to finance the company’s operations and/or growth. Depending on prevailing market conditions, such as low interest rates, the company might opt for debt. Alternatively, it could consider private equity funding, selling assets like real estate, or, if applicable, offering equity.
- Working Capital Management: As previously discussed, this revolves around ensuring sufficient cash is readily available for daily operations, such as employee salaries and procurement of raw materials for production.
An Illustrative Example of Financial Management
We’ve touched upon various examples of financial management in the ‘functions’ section above. Let’s delve into an integrative example:
Consider a scenario where the CEO of a toothpaste company plans to launch a new product line: toothbrushes. She would rely on her team to calculate the cost of producing these toothbrushes, while the financial manager would be tasked with determining the source of financing, such as a bank loan.
The financial manager then procures these funds, ensuring they are channeled into toothbrush manufacturing in the most economically efficient manner. Should the toothbrushes prove to be successful in the market, the financial manager would gather data to guide the management team’s decision on how to utilize the profits. They could opt to scale up toothbrush production, introduce a line of mouthwashes, distribute dividends to shareholders, or pursue other ventures.
Throughout this process, the financial manager ensures sufficient liquidity to pay the new employees engaged in toothbrush production. Additionally, she conducts ongoing analysis to ensure the company’s expenditure and revenue generation aligns with the initial budgetary projections for the project.
Financial Management in Startups
In the early stages, the focus of financial management within a startup entails developing and adhering to a budget that aligns with the business plan, determining the usage of profits, ensuring prompt bill payments, and collecting payments from customers.
As the company expands and recruits finance and accounting personnel, either as contractors or permanent staff, financial management becomes more intricate. You need to ensure employee salaries are paid with accurate deductions, taxes and financial statements are filed correctly, and you maintain vigilance for errors and fraudulent activities.
This loops back to our initial discussion about balancing strategic and tactical elements. By crafting a comprehensive plan, you can address key questions such as: Are our products or services yielding profit? Can we afford to launch a new product or hire additional staff? What could the upcoming 12 to 18 months mean for the business?
Robust financial management equips your startup with the necessary systems and processes to confidently answer these questions.