written by | March 7, 2022

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Table of content


Table of content

Why Do You Need Financial Management in Business?

Managing Finance is one of the vital aspects of every organization. The business promoters should carefully analyze the effect of all the finance-related decisions on the organisation's revenue generation, overall profit, and other attributes before the actual framing of financial strategies. Maintenance of working capital to meet operational expenditures of the company enables the continuity of production in the organization. Expansion of business requires market analysis and the availability of resources with the company. Thus financial management is highly critical. In this article, we will cover the role of financial management in the enterprise's progress, why financial management is important in a business, and more.

Did you know? One of the critical factors of start-up failure is a lack of financial management and improper financial planning.

What does a Financial Manager do? 

At the introductory stage of any business, any start-ups or an organization have to bear losses and insufficient cash flow. Many start-ups undertake operational business activities after obtaining loans from different financial institutions. Hence, the financial manager must ensure that the cash inflows and outflows are appropriately managed. The management of cash flows should be where deposits should mature when the demand to pay the loan arises.  Finance managers also have to take care of the payment to employees and creditors to maintain the reputation of the organization. So, the responsibility of a financial manager is significantly higher than any other position in a company.

Once the product is established in the market, the losses will gradually be converted into profit. Along with the financial manager, the management needs to take expansion decisions to provide effective returns. In case of insufficient funds for a particular expansion decision, further investment can be made by obtaining external and internal sources. At the maturity level of the product, it is always advisable to refrain from making further investments in the same product. Instead, business organizations should think of innovating or enhancing the same product.

The significance of financial management can be established by collaborating and explaining to members of different departments about managing business finance. Financial Management works to reduce financial costs, facilitates the availability of investment, and handles planning, organizing, directing, and controlling financial activities. Therefore, it is not only the responsibility of a finance manager of an organisation to manage its finances carefully, but it is everyone's responsibility in one way or the other.

Also Read: Super Tips To Start A Small Business By Yourself

Why is Financial Management important in business operations? 

The need for financial management has doubled with the increasing competition in all the industries. To excel in capital management, companies require converting their efforts into profit. One dent in the overall finance can harm the company's profit, leading to losing stakeholders' confidence. This whole cycle can adversely affect the market value of the firm. In recession times, the importance of financial management increases multifold. Several logical decisions during such times enable the company to maintain liquidity. If an organisation's funds aren't managed properly, it will approach the shutdown stage pretty soon.

Financial management not only involves managing and rotating the cash invested in the business, but it also involves calculating effective returns. Several financial ratios assist in financial management and arrive at meaningful financial conclusions such as Profit volume, inventory turnover, debtors and creditors ratio, etc. 

Maintenance of Reports: 

Business financial reports have great significance for internal and external stakeholders as it forms the basis of the financial decisions. These reports provide confidence to the investors to hold their investment in the company. Different types of financial reports, including stock reports, debtors and creditors reports, department-wise sales and purchase reports, and many others, provide early information regarding the performance of business operations. Financial management assists business managers in providing them with all these reports. Here is a list of methods to follow to maintain financial reports:

  • The finance manager should prepare the reports with the highest level of integrity and responsibility.
  • Keep track of the operations undertaken by the business to control and monitor any deviation from business functions.
  • Share the reports regularly with the shareholders to help them make investment decisions in the company.
  • Share the reports with the state and local governments for making payments of indirect tax returns.

Managerial and Financial reports are also referred by the top management (Strategic level) to take the expansion of business and related decisions which further enhances the importance of financial management

Statutory Compliance: 

Timely statutory compliance will help the organization to stay away from any legal proceedings. Payment of direct and indirect taxes on a timely basis is important to avoid the issuance of interest and penalty by the income tax authorities. Statutory Compliance has been enhanced with the introduction of the digital era. To avoid any statutory default, it is necessary to prepare monthly, quarterly, and annual reports. Thus, adherence to government regulations is very important. Any default in compliance can be a setback for the image of the organization.

Financial Management Cycle: 

Business goals can be accomplished only after effective financial management. To understand financial management more precisely, let's first understand the financial management cycle.

It is divided into four stages.

  • Planning and Budgeting
  • Resource acquisition
  • Operating, monitoring, and safeguarding financial assets
  • Evaluation and Reporting. 

Let's discuss every stage mentioned above in brief:

  • Financial Planning and Budgeting: Financial management plays a significant role in determining the requirements of the business in advance. The availability of funds will determine the level of operations an organization can undertake. Identifying the demand for the product in the market is important before conducting production activities. Preparing budgets helps to provide a roadmap to the different departments and enables them to control their normal and abnormal losses. 
  • Acquisition of Resources: After planning and budgeting, organizations need to focus on the acquisition of resources. Acquiring adequate finance from different sources before undertaking operations is an important part of conducting business. Efforts should be made to acquire finance from sources where the finance cost is minimum to maintain the working capital levels in the company. 
  • Utilization of Funds: Once the allocation of the funds is completed from different sources, adequate and efficient utilization of these allocated resources is essential to achieve effective returns. Effective management of funds can enhance the operational efficiency of the business. It assists in enhancing the net worth of the organization in its starting years. 
  • Evaluation and Reporting: Financial management enables an organisation to make effective financial decisions related to the business by evaluating the results on a monthly and quarterly basis. Financial decisions have a great impact on the future of the organization. Hence, financial decisions should be taken after analyzing the reports and after conducting an in-depth discussion with the finance team. 

Importance of Financial Management: 

From start-ups to well-established business entities, financial management forms an integral part of the ecosystem. Financial statement analysis is the easiest resource available with financial managers. The surplus funds, procured in form of loans or through the issuance of financial instruments, should be invested in the proper direction to earn returns higher than the cost of capital. This in turn increases the profitability of the company.

  • Financial management helps to achieve the business objectives with ease
  • Interpretation of balance sheet helps in indicating the present financial position. 
  • The cash flow statement provides insights into the methods of cash generation, its utilization and also the departments that contribute to the firm's growth
  • Financial management enables the generation of surplus funds that are utilized for investment purposes
  • The increased profits and net-worth imparts the business with an opportunity to save for future investment decisions
  • Sound financial management helps to capitalize and promote the capital of the organisation

Financial management assists in the increase of the total value of the firm. The increment in profit ensures the enhancement of General Reserve which supports the net worth of the business positively. This motivates shareholders to continue to hold their investments in the company. Different stakeholders can also decide to increase their investment.

Also read: All About GST Audit For Taxpayers With Annual Turnover Above Rs. 2 Crores

Elements involved in financial management: 

Investment Decisions

It includes investments in fixed and financial assets. In the modern business era, considerably-developed business entities also make investments in different business ventures. However, business ventures can be successful or at times can be a failure. Hence, while investing, it becomes important to study the market trends and industry growth. 

Financial decisions

Financial decisions are related to procuring finance from several sources that possess different costs of capital, duration of the loan, and returns. Enhanced return of income will provide the firm to procure more funds from the market. 

Dividend decisions

The finance manager is responsible to make appropriate decisions regarding the distribution of net profit earned with business operations. Net profits consist of two key factors that are mentioned below: 

  •  Shareholders' Dividend: The rate of dividend is to be decided by the finance manager. The dividend rate plays an important role in retaining the shareholder's interest in the organization. Meanwhile, it is also important to retain the funds for future investments in the enterprise.
  • Retaining funds: The manager is also required to finalize the retention ratio to maintain the availability of funds for business expansion and diversification.

Objectives of Financial management: 

  • Financial management ensures a regular and appropriate supply of finance to the company. 
  • It also assures effective and timely returns to the shareholders that primarily depend upon the market value of the share, profits, and the expectations on the performance of the company. 
  • Facilitates optimum utilization of funds.
  • It also enables to make decisions for investment in profit ensuring ventures.
  • Maintaining an effective capital structure that helps in maximum tax savings and thus protecting profits. Trading on equity and debt is one such well-known concept. 
  • It imparts economic stability to the net worth of the organisation.

Also read: What is Accounts Receivables?

Conclusion

From determining the capital structure to establishing the rate of dividend, financial management has a great impact on the financial stability of the organization. Thus, the importance of financial management will always gain significance in every era.  Financial management also includes cash management as it is one of the important areas to overcome the cash crunch experience while meeting routine expenses. Control over finances is also a key aspect and that can be achieved through techniques such as ratio analysis, financial forecasting, profit and cost ratio, and so on to keep the organization ready to meet adverse situations. 

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FAQs

Q: Explain the term "Trading on Equity" in brief.

Ans:

It refers to the arrangement where the company can increase the earnings of shareholders by the issuance of debentures since the companies can claim the deduction of interest as an expense from the revenue. This results in a decrease in the profits that are chargeable to tax. Thus, more profits become available for distribution among shareholders.

Q: What are two decisions are required to be taken by the finance manager while determining capital structure?

Ans:

Types of Securities to be issued such as equity shares, preference shares or debentures, and procuring of debt funds from financial institutions are the two decisions to be taken by the finance manager while determining capital structure.

Q: Is knowledge of capital markets required for financial management?

Ans:

Yes. If a company is a public listed company then the shares of such company will be traded frequently in the stock market. These shares go through continuous sale and purchase by the investors. Also, even private companies and business concerns need to be in touch with the capital market to keep track of their investments. Hence, it is essential to know about capital markets.

Q: What are the points that need to be considered while allocating funds?

Ans:

The finance manager should remember to calculate the size of the firm, its growth capability, assets status (short term or long term), and sources of the fund before resorting to further allocation of funds.

Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.

Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.