Financial Management: The Ultimate Guide (2022)

Summary: Financial management includes practices that allow the efficient administration of a company’s financial resources. It helps define the scope of financial management, the methods to achieve financial goals, and most importantly, remain compliant with government rules and regulations.

What is financial management?

The primary purpose of financial management is to create a sound business plan and then ensure that each business department sticks to it and achieves the expected outcomes within the specified duration. 

Financial management enables the Finance VP (or the CFO) to gain valuable insights about investments, new market opportunities, and profitable ventures. It also provides accurate data regarding the liquidity and profitability of their company.

This is where a finance ERP system comes into the picture. It monitors and tracks various financial functions, including fixed-asset management, accounting, payment processing, accounts receivable, accounts payable, revenue recognition, and many more. It also provides real-time visibility into the company’s financial state while executing daily operations such as period-end closing processes. 

Why is financial management essential?

Solid financial management models ensure that the following three pillars of financial governance remain intact. 

• Strategizing: Companies must identify their current needs and estimate future financial requirements. It helps to brainstorm appropriate strategies for achieving short- and long-term goals.

• Decision-making: Leaders must identify the best methods and practices to execute plans by referring to the latest financial reports based on industry-specific KPIs.

• Controlling: A healthy system of checks and balances monitors and tracks the daily activities of each department and ensures they are aligned with the company’s overall strategy. 

Goals of the financial department

Finance managers contribute in various ways to their organization by building on the three pillars we discussed in the previous section.

• Ensuring compliance with the union, state, international, and industry-specific regulations.
• Effectively dealing with the board of directors and investors.
• Enhancing profits by providing valuable insights based on industry-specific data. For example, the rising cost of raw materials might influence the final price of the finished product.
• Monitoring cash flow and liquidity to ensure the company has adequate money to meet its obligations. 
• Generating diverse financial scenarios based on the organization’s current performance. 

Scope of financial management

The four most significant areas of financial management are:

1. Planning

In the planning phase, the financial manager: 

• Estimates the money the organization needs to ensure positive cash flow.
• Assign funds to expand the product catalog or add new services and deal with uncalled events.
• Share critical financial data with the board of directors and investors.

For better planning, it’s broken down into three subcategories, namely capital expenses, workforce & travel-related expenses, and operational costs.

2. Budgeting

The finance manager allocates the required company fund to meet costs, such as:

• Salaries 
• Rents
• Mortgages
• Employee travel expenses
• Acquiring raw materials
• Employee travel expenses
• Investing in new/emerging business opportunities

Budgets are of two types, namely static and flexible.

3. Analyzing and managing risk

Finance managers are adept at assessing and managing various types of risks, such as:

• Credit risk: Sometimes, customers fail to pay invoices on time, impacting the organization’s ability to meet its obligations. It negatively influences the valuation and creditworthiness, restricting the company from getting loans at reasonable rates.
• Operational risk: Cybercrimes are a significant concern area today. Moreover, natural disasters are occurring at an increasing pace. Finance managers must purchase cybersecurity insurance and implement crisis management practices as a shield against such operational risks.
• Liquidity risk: Forecasting future cash needs, tracking current cash flow, and freeing up working capital are some liquidity risks.
• Market risk: It impacts an organization’s stock performance and investments. Moreover, it also talks about the financial risks specific to an industry. For example, shift from retail to direct-to-consumer model due to the recent COVID-19 pandemic.

<<<Also Read: Role of AI & Data Analytics in Finance>>>

4. Procedures

The finance manager defines the set of processes and procedures that guide the finance team’s functioning. Other responsibilities include:

• Distributing financial data, including payments, invoices, and reports ensuring accuracy and security.
• Assigning responsibilities to each employee in the finance team.
• Declaring which employee has the signatory authority.

Functions of financial management

The primary responsibilities of a financial manager are brainstorming, estimating, and controlling expenditures. It includes examining P&L statements, identifying which product lines or services make the maximum contribution to the company’s profitability, maintaining and updating the budget, scenario planning, and estimating what steps might enhance the financial performance in the future. 

Another responsibility is managing cash flow, which ensures there’s enough cash in hand for running day-to-day operations such as acquiring raw materials and paying workers. Moreover, a financial manager also needs to report the company’s revenue based on standard accounting principles. And this requires dealing with customers who pay late (after a few days/weeks/months). 

Three types of financial management

 Financial functions can broadly be classified into three categories:

1. Capital structure: This category talks about ways to pay for business operations and the company’s growth. For example, it’s good to take a loan if the interest rates are low. You can also seek funding from a private equity firm or consider selling equity if need be.

2. Capital budgeting: This category talks about how to spend funds to support the organization’s financial growth and accomplish its short- and long-term goals.

3. Working capital management: The primary topics in this category include cash management for day-to-day handling of operations like paying employee salaries, repairing and maintaining machines, and acquiring raw materials.