Learning The Important Functions of Financial Management

This article will take you into the details of the functions of financial management. You will also learn about its scope. Before we directly discuss the functions of financial management, we must learn what this skill is all about. Let us get started by understanding financial management.

Table of Contents

• What is Financial Management?
• Scope of Financial Management
• Importance of Financial Management
• Explain the Functions of Financial Management
  1. Financial Planning and Forecasting
  2. Cash Management
  3. Forecast of Cash Flow
  4. Estimating Capital Expenses
  5. Determining Capital Structure
  6. Choosing Sources of Funds
  7. Procurement of Funds
  8. Investment of Funds
  9. Surplus Disposal

What is Financial Management?

Financial management refers to the application of management principles to financial resources to better manage them. It is a management skill to plan, organize, direct and control the financial activities of the enterprise. According to the definition, one of the objectives of financial management is dealing with the procurement of funds and the effective utilization in business. 

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According to Weston and Bringham, it is an area of financial decision making, harmonising enterprise goals and individual motives. Businesses can have effective financial management with a proper set of tools, practices and strategies.

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Since finances are always limited, it is important to properly manage them. Especially if you are running a business, it is a crucial activity for the sustenance of every business. Without proper financial management, your business may soon lack sufficient funds to carry out business operations. Through this management activity, businesses can ensure no wastage of funds. 

Scope of Finance Management

As a management activity, the scope of finance management extends to the following:

1. Profit Maximisation: For any business, the ultimate goal is to make a profit. This is why financial management is extremely important. Businesses should follow practices that will ensure maximum profits. 

2. Acquiring funds: The scope of financial management extends to acquiring the funds to run the business. These funds may be collected from a financial institution for a duration. Some businesses even go public to gain capital.

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Importance of Financial Management

The following points highlight the importance of financial management:

1. Financial management is useful for organizations in financial planning
2. Organizations can easily plan the acquisition of funds through proper financial management.
3. Through proper financial management, organizations can wisely make financial decisions in favour of the business.
4. Financial management is an efficient way of promoting economic stability within an organization.

9 Functions of Financial Management

In this section, we will explain the functions of financial management briefly:

1. Financial Planning and Forecasting

One of the financial management functions involves financial managers performing financial planning. It is the estimation of the value of the set of variables at some point in the future. It is a blueprint of what a firm should do in the future. To do so, financial managers need to take various factors into account. 

These include a sales forecast, pro forma statements, asset requirements, economic assumptions and mode of financing investments. Financial planning can be done for a budget, expenditure and to save future income. 

If financial planning is related to investing, then the capital must be allocated to projects for assets that can produce income. This may include starting a new business or launching a new product. 

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Financial forecasting refers to the annual projection of income as well as expenses of the company. It involves the estimation of cash needs and making decisions for raising capital through different sources of funds. 

The objective of financial planning include:

• Identifying capital requirements: While determining these requirements, a business must look at the duration. Whether you need capital for the long term or the short term. Capital needs will depend on factors such as the cost of current and fixed assets, long-term planning and promotional expenses.
• Determining capital structure: Capital structure is the composition of capital. This includes the relative kind and proportion of capital needed in the business. 
• Framing financial policies: As a part of financial planning, policies must be framed for cash control, lending, borrowings, etc.

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2. Cash Management

One of the functions of financial management is cash management. Decisions must be made in regards to what is to be done with the cash. Financial managers need to decide if they want to pay back to creditors, pay bills, meet current liabilities or invest in maintaining stock.

3. Cash flow forecasting

Another important function of financial management is the forecast of cash flow. It involves the estimation of future sales as well as expenses. This forecast helps the business in understanding if it has enough cash for expansion in future. Through the forecast, businesses can identify the time when cash outflow exceeds the cash inflow.

4. Estimating Capital Expenses

While estimating the capital expense, a company must keep the following points in mind:

• Promotional expenses: It must be kept in mind that promotional expenses are incurred before any receipt. Promoters must be ready to bear these expenses since promoting a company is an expensive task. This stage requires investment and for that financial managers must be ready. 
• Cost of current assets: While estimating capital expenses, expenses on current assets must be included. These are the day-to-day expenses that are not fixed.
• Cost of fixed assets: Machinery, land, and buildings are all part of fixed assets whose expenses can be calculated quite accurately. Their valuation helps in the accurate estimation of the capital requirements. Inflationary economic conditions and escalation features guide financial managers to do accurate valuation of fixed assets. This will be extremely important for estimating total capital requirements.

5. Determining Capital Structure

One of the functions of financial manager is determining the capital structure. Capital structure is the combination of debt and equity used to finance the overall operations and growth of a company. This is an important function of financial management. The following are the factors that help in determining capital structure:

• Loan covenant: Loan covenants restrict companies from using strategies to cover debts. It can make it impossible for companies to raise money from the market after a certain limit. This can be detrimental to companies in the long run. 

• Sustainability and Feasibility: To determine a capital structure, the model should be feasible and sustainable if the company has to grow and make profits. To analyse growth and profitability, a sustainable growth model is used. 

• Financial Slack: Financial slack provides financial flexibility to a company. It consists of the serviceable and non-serviceable debt capacity of the firm. The higher the debt capacity, the higher will be the flexibility.
• Debt and Non-debt Tax Shields: These have a very profound impact on the capital structure of the company. Debt allows interest tax shield from tax-deductible income, carried forward losses and reduced taxes that are levied on depreciation. 

6. Choosing Sources of Funds

Another important financial management function is choosing the source of funds. This choice should be made after assessing the advantages and disadvantages of sources of finance as well as the financing period. Funding options such as equity capital, banking institutions, debentures, preferred shareholders and third-party sources can be utilized as the source of funds.

7. Procurement of Funds

One of the functions of financial management includes the procurement of funds to run the business. This is performed after deciding on the sources of funds. The sources of procuring funds differ according to the period of financing. These can include:

1. Gaining capital in lieu of equity
2. Releasing IPO to raise money from public
3. Taking loans from financial institutions

8. Investment of Funds

While procuring funds is difficult, it is important to wisely invest these funds so that profit can be maximised. Proper calculation of the risk and ROI is crucial to prevent loss of funds. For this purpose, different tools such as net present value, internal rate of return and portfolio analysis are important. The investment decisions must be guided by 3 important principles viz. profitability, safety and liquidity. 

9. Surplus Disposal

After investment and expenditure, the financial manager must decide on what is to be done with the surplus profit. They have to decide if the surplus profit should be reinvested in the business as retained profits or distributed as dividends. They can identify the rate of dividends and benefits like bonuses.

Hope that through this article, you have been able to learn what is financial management. These are the major functions of financial management. However, at the micro-level, there are many functions of this type of management. The scope of financial management is immense and is not just limited to the above-given functions.