Why Financial management is critical for businesses, start-ups’ & Individuals’
A comprehensive financial management is critical to the success of any business, start-ups, and individuals since it defines the current condition of the business and also forecasts into the near future.
This article covers the meaning, objectives, scope, importance, functions & key decisions involved in the financial management section with the help of the latest methods of key metrics and robust evaluation methods.
Financial management is critical towards the evaluation of any success since the basic accounting & book keeping won’t help with understanding of the situation & scenarios.
Strong financial reporting with backed-up data should be the basis for informed & sustained decisions to be taken.
A traditional book of accounts would show you the details of transactions that took place over a certain period, its volumes & size could be a major factor for key decisions.
However, it’s very important for all accounts not only to be updated but also key financials to be recorded, reported & also analysed for proper interpretations & key note decisions to be taken and presented.
What is Financial Management?
A Financial management process is a strategic process wherein the investment decisions (Capital budgeting & working capital), Financial decisions, Dividend decisions, Liquidity management, Risk management & Financial controls, Financial management, key areas & functions, Strategic vs tactical financial management, what are the three types of financial management decisions, and how financial management works.
Scope of Financial Management: Core Areas You Must Know
1. Investment decisions (Capital budgeting & working capital)
A Strong investment decision forms as a cornerstone for the most critical decision, which involves choosing where to allocate the firm’s resources to generate the highest possible returns for investors.
This later leads to the calculation of key metrics such as Net present value (NPV), Internal rate of return (IRR), Profitability Index (PI) and the payback period.
Risk Assessment: The choice of discount rate (Often the weighted average cost of capital or a risk-adjusted hurdle rate) for NPV & PI calculations helps incorporate risk into the analysis.
2. Financing Decisions (Capital Structure & Sources of Funds)
A key step (in case of any start-ups, especially) is on the capital structure & the source(s) of funding. Unless this decision is carefully & cautiously made there could be cascading inaccuracies that could be very tedious to rectify & repair.
This later could lead to performance assessments using various metrics such as Return on Equity (ROE) and earnings per share (EPS).
A few of the other important metrics that are to be considered as critical factors to assess the financial health of the business is the debt to EBITA ratio – A metric used by investors to assess the time period for the return recovery process to be completed.
3. Dividend Decisions
Solvency & debt service ratios such as debt to EBITA ratio & Interest coverage ratios are derived from these financing decisions made previously.
A dividend decision not just shows the health of the business, but it also shows its integrity towards the respectable investors.
There are a number of metrics that are used to assess the dividend factor; however majority of it is after the declaration & pay-outs of the dividends.
However, even before the dividends are paid, their declaration, communication, amount, ratios & the period to be disclosed are of higher significance.
4. Liquidity Management:
Having good liquidity for any business enterprise, whether small or big, is as important as having a business setup established. There are a number of metrics that are used to measure these; however, it’s equally important not just measure but also to be aware of what those key metrics are.
Metrics could range from basic to advanced; however, having a theoretical understanding of those fundaments are fundamentally necessary before any of it could be applied in practise.
5. Risk management & Financial control
In the case of a business setup, there could be numerous risks that it has to take.
However, it’s important to take calculated and analysed risks similar to the controls that are necessary to be put up in place.
These factors would ensure that the decisions that are taken are ethical, data driven & not just intuitive, strategic (long-term)
More aligned to the mission, vision, long-term & short term objectives of the business.
These could also be aligned towards the prevention of any possible losses, protection of existing assets, and reputation of the business.
Following of the regulatory compliance and ethical governance happens to come under risk management & Financial controls.
Operational efficiency & optimization of available resources happens to come under the controlling section.
Financial Management key areas and functions
As we have been deliberating on the key areas and functions of this article, it primarily revolves around the investment decisions (capital budgeting), financing decisions (Structure of the available capital), and dividend decisions (Interest repayments).
Other essential functions include financial planning and forecasting, financial control and reporting, and risk management.
Strategic vs tactical financial management
A tactical finance action is just as important as having a strategic financial plan in place.
However, having a strategic or even a tactical plan largely relies upon the current condition of the business.
| Strategic Financial Management | Tactical Financial Management |
| A plan is to have a long term plan of close to 3 to 5 years more aligned towards the vision, mission & the goals of the business enterprise | A tactical plan is more focused on avoiding any misfortunes on the shorter run could be daily, weekly, monthly or even an annual plan. |
Importance of financial management
The importance of financial management lies in its ability to ensure a business can meet its obligations, utilize capital efficiently, and maximize wealth for its owners. It provides the structure for a company to not just survive, but to thrive and grow sustainably.
The key aspects of importance can be broken down into the following areas:
- Optimal Utilization of Funds
- Sound financially well planned
- Ensuring financial stability & solvency
- Effective risk management
- Informed key decisions made
What are the three types of financial management decisions?
As we stated the three main types of decisions made in case of financial domain are:
- Investment decisions it focuses upon strategically allocating of funds into profitable returns.
- Financial decisions determining on how the company raises its capital and the proper applicable & returnable use of the same bearing in mind to derive a tangible output that is of a sizeable nature.
- Dividend decisions form a part of the corporate action which is very important for a reputable standing.
Proceeds could be reinvested into the existing business or it might as well be distributed however the best interest of the business establishment needs to be prioritized or the prevailing markets could define standards.
How Financial Management works
- Asses financial needs
The assessment of financial needs happens to take place during the initial planning stages/phases, these plans would later form steps laying foundation for all of the subsequent decisions that’s to be made in the later stages.
- Arranging of funds
Once the need is assed the next step involves identifying and securing the most cost effective investor for the business, arranging of funds these days considering the current conditions haven’t posed a threat or any challenge in the recent past.
- Allocate/invest funds
Allocate/investing of funds is a crucial foundation part of any future successful business as it doesn’t need to have the best interest of the investors considered but also requires considering other factors such profitability & risk.
- Monitoring of performance
Monitoring of performance happens to be a key financial indicator ascertaining of financial health of any business is critical just as much as running of the business. These could be measured with the help of various tools, reports ratios & variances.
There could be various key performance indicators (KPI), Early warning indicators (EWI), accountabilities, responsibilities, duties, risks and controls (R&C) that needs to be observed, measured, analysed & reviewed periodically.
- Taking corrective/strategic decisions
These decisions taking corrective/strategic decisions is an indicator of the tactical decisions that have been taken in the past, considering the conditions prevailing.
However, having a long term strategically aligned goals & targets were of equal priority as much having a corrective decision being taken. Look of it as a rhetorical (What if?).
This may involve gap analysis and closure, real-time course corrections, and rescaling existing goals and targets.
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- Finance-focused, industry-aligned curriculum
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Frequently Asked Questions (FAQs)
- What is financial management?
Financial management is the process of planning, organizing, directing, and controlling financial resources to achieve an organization’s short-term and long-term objectives. It focuses on efficient use of funds, profitability, liquidity, and risk management.
- What are the three types of financial management?
The three main types of financial management are:
- Investment Management: Deciding where and how funds should be invested for maximum returns.
- Financing Management: Determining the optimal mix of debt and equity to fund operations.
- Dividend Management: Deciding how profits should be distributed or reinvested.
- What are financial decisions?
Financial decisions are strategic choices related to investments, funding, and profit distribution made to ensure business growth, stability, and value creation. These decisions are data-driven and supported by financial analysis and key performance metrics.
- What is the difference between strategic and tactical financial decisions?
- Strategic financial decisions are long-term decisions aligned with an organization’s vision, growth, and capital structure.