Financial Management is the discipline and study of money, currencies, and capital assets. It is related to, but not the same as, economics, which is the study of the production, distribution, and consumption of goods and services. We can divide finance into personal, corporate, and public categories as they occur at different levels in financial systems.
As financial instruments, assets like currencies, loans, bonds, shares, stocks, options, futures, etc., are purchased, sold, or traded inside a financial system. Moreover, assets can be invested in, banked, and insured to increase value and reduce loss. In actuality, risks are fundamental to all financial dealings and companies.
Because finance is such a big area, it has many different subfields. Asset, money, risk, and investment management goals are to reduce difficulty and maximize value. The assessment of an action’s stability andearnings is known as financial analysis. Certain financial theories can be tested by the scientific method, known as experimental finance.
Financial engineering, financial technology, financial economics, financial law, are a few examples of broad topics. These domains form the basis of accounting and business.
What Is Finance’s Objective?
Lending, borrowing, investing, raising money, and buying and selling securities are all part of finance. These efforts assist businesses and individuals in financing current projects or activities. They expect the future revenue generated by those projects or activities to repay them.
Without finance, businesses would not grow and expand as they can now, and people could not afford to buy homes (with cash only). Thus, finance makes it possible to distribute capital resources more effectively.
The financial system
As mentioned before, the capital movements that take place between people and their families (personal finance), governments (public finance), and companies (corporate finance) create the financial system. Thus, “finance” refers to the study of how investors’ and savers’ money goes to companies in need. The funds that investors and savers possess can yield interest or dividends if judiciously utilized. People, businesses, and governments must get money from outside sources like loans or credit when they need more money to operate.
Generally, a company that makes money above its costs can provide the excess or invest it to earn a reasonable return. In considering this, a company whose income is less than its expenses can typically raise capital in one of two ways:
(i) By selling government or corporate bonds or by borrowing money from private parties;
(ii) By a company selling equity, also known as stock or shares (which can be preferred stock or common stock, as well as other forms).
Bond and stock owners can be any regular people, sometimes known as retail investors, or institutional investors, which are financial institutions like investment banks and pension funds; for further information, see Financial Market Participants.
A bank or other financial middleman or the purchase of notes or bonds (corporate, government, or mutual) in the bond market are common ways that loans are made indirectly. Interest is paid by the borrower, which exceeds the interest paid by the lender; the financial middleman keeps the difference in exchange for arranging the loan.
A bank combines the actions of multiple lenders and borrowers. Lenders deposit money with banks, and the bank pays interest on such deposits. Following that, the bank lends these deposits to debtors. Banks allow the effective management of activities between lenders and borrowers.
For example, buying stock as individual shares or through a mutual fund is the standard process of investing. Typically, firms may sell stocks to investors to raise the money they need through “equity financing,” which is different from the debt financing previously mentioned. Investment banks are the financial middleman in this case. Investment banks find the first investors and assist in listing the securities, typically bonds and shares.
They also help the many service providers who oversee the risk or performance of these assets and the securities exchanges that let them trade after that. These latter consist of wealth managers, stock brokers, mutual funds, pension funds, and stock brokers; they usually cater to retail investors or individuals.
Forms of Business Organization
The structure of your company will be one of the first choices you have to make as its owner. Every firm must have a legal framework outlining the participants’ rights and obligations regarding ownership, control, personal liability, quality of life, and financial structure. Speak to an accountant and lawyer to pick the right ownership type. It will impact you for a long time.
- When making a decision, you should consider the following:
- Your idea on the scope and character of your company.
- How much control would you like to have?
- The degree of “structure” that you are ready to handle.
- The business is exposed to legal action.
- The effects of various organizational systems on taxes.
- Expected profit—or loss—for the company.
- Whether or not profits must be reinvested in the company.
- Your requirement to withdraw funds from the company for personal use.
Here’s a summary of the four fundamental types of business structures: sole ownership, partnership, corporation, and unlimited liability company.
Sole Ownership
One person initially operates the majority of small enterprises. A single person owns these companies, typically in charge of day-to-day operations. Sole ownership owns all of the company’s assets and earnings. They also take full ownership of all of its obligations and liabilities.
Benefits of sole ownership:
● Simplest and least costly type of ownership to set up.
● Sole proprietors have total authority and are free to make any decisions they consider fit as long as they stay within legal bounds.
● Revenues from the company are transferred straight to the owner’s tax return.
● If desired, it is simple to dissolve the company.
The problems of being a sole proprietor
● Legally speaking, a sole proprietor is accountable for any obligations made by the company and is subject to infinite responsibility. Both their personal and commercial assets are in danger.
● May need help to raise money and are frequently restricted to using money from consumer loans or personal savings.
● It might be difficult to draw in top talent or workers driven by the chance to acquire an ownership interest in the company.
Partnerships
A partnership is when two or more people jointly own a single company. Like ownership, the business and its owners are treated equally under the law. A formal agreement between the partners should outline how decisions are made, profits are split, disagreements are handled, new partners are welcomed into the partnership, participants can be purchased out, and how the partnership will be dissolved when necessary.
Yes, it can be difficult to consider a “break-up” when a company is just getting started. Still, in times of crisis, many partnerships end. Without a clear procedure, the issues will worsen, and they must determine how much time and money they will contribute.
Benefits of a Partnership
- Setting up partnerships is generally straightforward, although crafting the partnership agreement requires careful consideration.
- Having multiple owners can potentially enhance the capacity to gather funds.
- The income generated by the business is directly reflected in the partners’ tax filings.
- Prospective employees may be created for the business if provided with a reason to become a partner.
- Generally, a business will gain from having partners with complementary abilities.
Drawbacks of a Partnership
- Each partner is collectively and personally responsible for the actions of the other partners.
- Earnings must be divided among others.
- Disagreements may arise because decisions are made jointly.
- Certain employee benefits are not tax deductible on business income.
- The partnership may last for a while, ending if one partner leaves or dies.
Corporations
A corporation is regarded by law as an entity that is independent of its owners once it has been chartered by the state in which it has its headquarters. A corporation can pay taxes, be sued, and sign contracts.
A corporation’s shareholders are its owners. The shareholders choose a board of directors to supervise the main choices and policies. The company has an independent existence and does not dissolve upon ownership changes.
Advantages of a Corporation
- Limited liability protects shareholders from judgments or debts against the company.
- Generally, shareholders are only liable for the money they put into business shares. However, it’s important to highlight that executives can be personally liable for their actions, for instance, not deducting and remitting employment taxes.
- Companies that want to raise more money can sell their shares.
- A corporation’s cost of perks to its officials and workers may be written off.
- May choose to become a Corporation if certain conditions are satisfied. A business may elect to be taxed like that of a partnership.
Problems of a Company
- Compared to other types of organization, incorporation is more time- and money-consuming.
- Corporations may need to submit additional paperwork to keep up with regulations since they are subject to oversight from federal, state, and local agencies.
- The total taxes may increase as a result of incorporation. Dividends to shareholders may be subject to double taxation because they are not deductible from corporate income.
Areas of finance
Personal Finance
“The planning of financial spending and saving, and also considering the possibility of future risk” is the definition of personal finance. Paying for education, financing spending, buying insurance, funding costly assets like vehicles and real estate, and setting up money for retirement are all examples of personal finance. Paying for a loan or other debt obligations may also fall under personal finance.
It is generally agreed upon that income, spending, saving, investing, and protection are the main focuses of personal finance. The Financial Planning Standards Board suggests that an individual will comprehend a possibly secure personal financial plan after doing the following steps:
- Buying insurance for protection against unexpected life disasters;
- Being aware of how tax laws, subsidies, and fines affect how a person manages their finances;
- Being aware of how credit affects a person’s financial situation;
- Creating a savings plan or getting financing for major purchases (house, vehicle, or school)
- Preparing for a stable financial future in an insecure economic climate;
- Pursuing opening a savings or checking account;
- Arranging for long-term needs such as retirement.
Corporate finance
Corporate finance covers corporations’ capital structure and funding sources, the measures managers take to make the company more valuable to shareholders, and the tools and analysis used to distribute financial resources. The field of “business finance” refers to applying principles to the financial problems of all firms, even if managing finance, which examines the financial management of all enterprises rather than corporations alone, differs from corporate finance in principle.
- Therefore, “corporate finance” usually refers to the long-term goal of managing risk and earnings while optimizing the value of the company’s assets, stock, and return to shareholders. It involves three main domains:
- Capital budgeting: choosing which projects to fund; in this case, making precise value decisions is essential since asset value determinations have a chance to “make or break” an investment.
- Dividend policy: How is “excess” money used—is it put back into the company or given to shareholders?
- Capital structure: selecting the right funding, in this case, trying to determine the best capital in terms of debt commitments vs cost of capital
The latter creates the connection between investment banking and securities trading because the capital generated typically consists of debt, such as corporate bonds, equity, and frequently listed shares. If you are considering business risk management, have a look below.
Unlike corporate financiers, financial managers focus on short-term aspects such as earnings, cash flow, and working capital management, including credit, inventory, and debtors. Their goal is to ensure the company can safely and profitably meet its financial and functioning goals, meaning that it can (1) service both scheduled long-term debt payments and maturing short-term debt repayments, and (2) have enough cash flow for ongoing and upcoming functioning expenses. Relate to Financial Planning and Analysis as well as Financial Management.
Public Finance
Finance connected to governments, subnational entities, and any related public bodies or agencies is called public finance. It often includes a long-term planned view of investment choices that impact public entities.
These long method periods usually last five years or longer. The primary issues of public finance are identifying a public sector entity’s necessary expenditures, the source of that company’s income, and the issue of government debt or municipal bonds for public works projects.
the process of creating a budget;
The cash that investors and savers possess has the potential to generate earnings through smart utilization.Financing for development is non-commercial funding given to a governmental organization. It helps with economic development projects that wouldn’t receive funding otherwise. Infrastructure projects are the primary use for public-private partnerships. In these projects, a private company finances the project upfront and receives revenue from taxpayers or consumers.
Investment management
Investment management is the professional asset management of various securities, including shares and bonds and other assets like real estate, commodities, and alternative investments. It is used to achieve specific investment goals to investors’ advantage.
As we said above, investors might be private investors or institutions like corporations, insurance companies, pension funds, charities, and educational institutions.
Investment management is based on the distribution of assets. This distribution depends on the risk profile, investment goals, and duration of investment. It varies across different asset classes and specific securities within each asset. Here:
Choosing the ideal portfolio in light of the client’s goals and limits is known as portfolio optimization.
The method commonly used to value and assess individual stocks is fundamental analysis.
Technical analysis aims to use historical data to predict future asset prices.
Risk management
Risk management is the process of understanding risk and then creating and implementing ways to manage that risk. It is the study of controlling hazards and balancing the likelihood of profits. Protecting company value from financial risks is known as financial risk management, and it often involves “hedging” exposure to these risks using financial instruments. The focus is mainly on credit and market risk, which in banks also includes working risk from regulatory capital.
- Credit risk is when a borrower might not pay back the money they owe, leading to a default on the debt.
- Losses resulting from changes in market factors like prices and exchange rates are referred to as market risk.
- Operational risk is associated with external accidents or internal systems, staff, and procedures problems.
- There are two ways in which corporate finance and financial risk management are connected. First, the firm’s exposure to credit risk comes from its credit policy. It is often managed by credit insurance and supplies. In contrast, market risk is directly related to previous capital investments and funding choices.
- Second, the objectives of both fields are to increase or maintain the company’s economic value. Risk management for companies, which is normally a part of strategic management, communicates in this way.
Risk management for banks and other wholesale institutions depends on controlling and managing the company’s different positions, including trading positions and long-term exposures. In addition to the fundamental credit risk in the banking industry, these institutions also face competitor credit risk.
Managing finance
The area of management known as managing finance focuses on the managing use of financial theory and practices, with a primary focus on the financial effects of managing choices. Financial elements of managing decisions are analyzed from the viewpoints of planning, directing, and controlling management. The techniques discussed and developed primarily are related to corporate finance and managing accounting.
The former helps management make better decisions based on financial information about performance and earnings. At the same time, the latter, as previously mentioned, focuses on optimizing the entire financial structure, including its effect on working capital. The previous description covers the application of these strategies or financial management. Experts in this field are usually connected with finance departments of business schools, accounting departments, or management science departments.
What is Financial Management?
Controlling the flow of money into and out of a business is the goal of financial management. Selling goods or services, covering costs, keeping accurate records, and filing taxes are all essential for every business. All of this is included in financial management, as are complicated processes like hiring staff, purchasing supplies, and filing paperwork for the government to demonstrate compliance with rules and laws.
When we discuss a company’s financial management, we mean the process of monitoring all these transactions. Financial management generally gets more difficult as a company grows.
All funds entering and leaving the business are controlled by staff members with expertise in financial management to carry out these transactions and monitor money flow. Smaller businesses often employ at least one accountant or bookkeeper who collaborates with the bank. CFOs or finance heads often manage finance teams at large companies.
Understanding Financial Management
Every team and department within the organization participates in business processes related to financial management. The following duties are given to a finance team:
Money that clients pay the business or agree to pay is known as receivables or invoices. The task of sending invoices and receiving and processing payments falls to the finance teams. Following up on past-due accounts is the responsibility of collections teams (this practice is frequently outsourced to third parties).
Payables:
Amounts owed by the business to its suppliers and vendors. Paying these expenses and keeping track of the payments falls within the authority of finance departments.
Reconciliations and bank transactions:
Finance departments collaborate closely with their banks to ensure accurate processing of each transaction. In addition, they should verify if the bank’s statements align with their own records. These records are maintained in the main ledger and sub-ledgers of the company. Account reconciliation is when the finance staff compare bank statements and ledgers to find and fix any differences.
The business will close the books by adding up all the transactions from a certain time period on a specific date. This is done to compare its accounts and create a financial report. This procedure, called the close, usually occurs after a month, quarter, or year.
Reporting:
Whether it is to the CEO, a board of directors, investors, shareholders, or government authorities, businesses must submit reports regularly regarding their financial performance. The accuracy and clarity of these reports are the financial team’s responsibility.
Planning, budgeting, and scenario modeling:
The financial team will determine the best course of action and provide relevant plans, estimates, and plans. The finance team often collaborates with other departments to create models incorporating information from labor costs, inventory costs, sales predictions, and HR, project management, or procurement teams. We call this connected planning.
Payroll and expenses:
Generally, the HR department oversees each employee’s paycheck. The finance team gets a summary of labor costs and can use it for their plans and budgets. Finance is also in charge of paying staff expenses like meals and travel for work-related purposes.
Cash management and forecasting:
Finance teams need to plan because money always comes in and goes out of a company. They must ensure the business has enough cash to get through the upcoming quarter, year, or possibly the next three to five years. Cash forecasting is usually done once a month in most businesses.
Tax strategies:
All companies must submit their taxes, and just like the rest of us, they want to maximize their deductions to avoid paying too much. To handle this, certain finance teams use tax experts. Those who don’t will frequently contract an accounting firm to handle this work.
Risk and adherence Financial hazards:
are present in every firm, ranging from global pandemics to rising interest rates. Controlling such risks and minimizing the company’s exposure is the finance team’s responsibility. To avoid big fines, businesses must follow the rules set by authorities, regulators, and other countries to stay legal.
Why is Financial Management Important?
Because it maintains a company’s functionality, financial management is important. Its primary objective is to prevent the company from going bankrupt. One of the most important problems a firm might have is revenue loss, which financial management addresses.
Beyond ensuring a company’s existence, sound financial management—and financial management software—can support its expansion and success. Teams in charge of finance have a wealth of resources at their service to support business growth.
Finance teams have three options when the economy is doing well, and interest rates are low:
- Borrow money from banks.
- Raise money from venture capitalists.
- Go public by selling shares on the stock market.
The company can use the money to expand into new markets, open more locations, improve facilities, and other projects. During negative market conditions, such as a recession, financial management strategies could involve cutting expenses like terminating employees or closing unproductive sites.
Increasing earnings is an important component of managing finances. Finance, sales, and marketing teams collaborate frequently to determine the costs of the company’s goods and services.
To set the appropriate prices, they have to find a balance. If prices are too high, customers may switch to cheaper competitors. If prices are too low, the business may need to earn more money to cover its expenses. Similarly, one of the main duties of the finance team is cost control, whether it relates to labor, rent, electricity, raw materials, or shipping prices.
An essential component of efficient financial management is reporting. To make the greatest choices for the company’s well-being, the CFO and other managers want to know how the company is doing. They want to know if the company is operating as expected and that investors are getting an acceptable return on their investment. Effective financial management is essential as it enables a business to achieve these objectives, if not exceed them.
Financial Management Functions
In smaller businesses, one person or a small team may complete all financial management tasks. Teams in larger organizations are usually in charge of particular tasks. Among them are:
1. Accounting
It involves keeping track of, documenting and matching every financial transaction made within the organization. Accounting software helps the accounting staff, which a controller or chief accounting officer frequently heads. They frequently employ cloud ERP systems, especially financial systems, to manage, document, and report on the business’s finances. Accounting is also in charge of closing the books and doing account reconciliation.
2. Project management
Projects are the main way professionals in law, consulting, and engineering make money and spend money. Finance teams are in charge of providing funds to projects and monitoring the income each one generates.
- Procurement
It is typically divided into two categories:
- The company purchases the components and raw materials needed to manufacture its goods directly. Supply chain and operations teams are responsible for buying directly from suppliers through an ordering system. An inventory system tracks the parts, raw materials, and final goods. The connection between these systems improves supplier and inventory management, leadership, and control.
- Supplies used for routine business operations but not included in a company’s goods and services are called indirect buying. These could include supplies like stationery, laptops, and office furniture. Finance uses a system for buying to give permission and monitor these transactions.
3. Analysis and planning of finances (FP&A)
It is sometimes a different team within the financial department of larger businesses. FP&A specialists model scenarios and estimate outcomes for best- and worst-case situations. Based on these estimates, they create financial plans and budgets for the upcoming quarter or year.
To create forecasts and budgets, FP&A specialists frequently collaborate closely with other departments within the company, such as sales, workforce, and operational planning. We call this connected planning.
5. Taxes All businesses must submit taxes, but large organizations with multiple locations to file in have additional challenges. These businesses have tax teams that use software for tax reporting to create different reports, including country-by-country reporting.
Key Finance Terms
These are some essential terms in finance that you should know.
Asset: An assetis something that has worth, such as money, property, or real estate. Both current and fixed assets are possible for a business.
Liability: A financial obligation, like debt, is a liability. A liability may be long-term or short-term.
Balance Sheet: Abalance sheet is a record that lists the assets and liabilities of a business. Deduct the liabilities from the assets to find the company’s net worth.
Cash flow refers to the movement of money into and out of a home or business.
Compound interest: It is calculated and added to the principal timely, as opposed to simple interest, which is applied only once. As a result, we calculate interest on both the principal and the already collected interest.
Ownership: It is referred to as equity. Because each share represents a piece of ownership, stocks are referred to as equities.
An asset can be changed into cash with ease, which is liquidity. For instance, because selling can take weeks or months, real estate is a moderately liquid investment.
Profit: The money that remains after expenses is known as profit. A profit and loss statement displays the amount that a company has made or lost during a specific period.
Finance Careers and Scope
Here are the list of careers in finance:
- Corporate manager
- Investment banker
- Financial Advisor
- Financial analyst
- Financial examiner
- Financial manager
- Personal financial planner
- Budget analyst
- Investor relations associate or executive
- Credit analyst
- Personal banking (or private banking)
- Commercial banking
- Investment banking
- Wealth management
- Mortgages/lending
- Accounting
- Financial planning
- Audit
- Insurance
- Corporate Finance
How Can I Learn Finance?
Finance majors pursuing an undergraduate degree will become well-versed in all aspects of the field. A master’s degree in finance will help you grow your knowledge base and refine your skills. Additionally, an MBA will cover certain fundamentals in corporate finance and related areas.
The CFA self-study program consists of three challenging exams that provide a globally recognized financial credential for non-finance graduates. Other, more specialized industry standards exist, such as the Certified Financial Planner (CFP).
FAQs about Financial Management
What does financial management actually mean?
The administration of a business’s finances, including any money flowing into the company, all money leaving, and any cash or assets held in reserve, is referred to as financial management.
What function does financial management serve?
Keeping the business solvent is the primary responsibility of financial management. Beyond that, sound financial management can support an organization’s expansion and success.
What does an example of financial management look like?
Determining the amount of money a company should borrow to invest in a new factory, product line, or service offering is an example of financial management.
Conclusion
Successful financial management is essential for long-term company success. It involves maximizing profits, lowering risks, and managing resources effectively. Companies can achieve financial stability and long-term growth through smart budgeting and wise decision-making. In the end, strong financial management increases a company’s overall competitiveness and stability.
