What Are Functions Of Financial Management? (With Purpose)
Updated 30 September 2022
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Financial management involves directing a company's financial situation by producing reports, strategising for the future and managing budgets. The goals and functions of financial management remain the same regardless of the company's size. If you have an interest in working in the investment or wealth management field, knowing everything about financial management can help you make strategic decisions. In this article, we discuss what financial management is, understand the functions of financial management and its importance, explore its various types and discover the purpose of financial management.
What are the functions of financial management?
The functions of financial management involve organising, planning, controlling and directing an organisation's financial activities. It includes applying different management principles to financial assets. These efforts focus on allocating capital, monitoring foreign currency, raising capital, budgeting and following product lifecycles.
An organisation's finance manager oversees these activities. Efficient management of a company's finances allows a business to comply with regulations and succeed in its industry. The management process requires meticulous planning and execution. Some common functions of financial management are:
Estimation of the capital required
The primary function of managing business finances is estimating the amount of capital required. Estimating the capital is essential to determine how much capital a firm requires to purchase fixed assets, modernise and expand the business and meet the working capital requirement. A financial manager estimates funds required for long-term and short-term purposes during this process. Accurately estimating the capital required can help in increasing the company's revenue capacity.
Determination of the capital structure
After estimating the capital required, financial managers decide on the capital composition and structure. This might involve short-term and long-term debt-equity analysis. Through this analysis, they determine the accurate proportion of debt and equity. Determination of capital structure helps maximise shareholders' wealth and minimise capital costs.
Choice of the source of funds
The next step is to choose the source of funds. Apart from using equity capital, a financial manager can choose other funding options like preferred shareholders, banks and financial institutions, debentures, public deposits and other third-party sources. Usually, financial managers consider the advantages and disadvantages of each source and period of financing.
Procurement of financial resources
The acquisition of funds by financial managers is not solely dependent on the cost of raising funds but also on other factors, such as the choice of investors, market conditions and government policy. After choosing a funding option, managers take various steps to procure it. Procurement of funds might require some additional steps, such as issuing a prospectus and negotiating terms with creditors and financial institutions.
Utilisation of funds
Upon procuring the funds, financial managers invest in various tangible and intangible assets to maximise return on investment. These managers can allocate funds into various ventures to ensure safety on investment. They invest capital in a way that is profitable. When taking such allocation and investment decisions, the manager focuses on three principles, including liquidity, safety and profitability.
Disposal of surplus funds or profits
The next step of financial management is deciding how much funds a company retains and how much they distribute as dividends to shareholders from its overall profit. These managers decide the proportion of profits that a company ploughs back into the business. Often, companies distribute surplus funds as a bonus to employees for performing well.
Related: What Is Revenue? Definition, Types, Examples And More
Management of cash
A company requires cash to maintain enough stock, purchase raw materials and pay current liabilities. After distributing the surplus funds, a finance manager decides on cash management. It involves forecasting cash inflows or outflows to ensure the company never faces a shortage or surplus of funds. They also ensure that the company has adequate cash for different purposes like paying salaries, utility bills and creditors.
The last function of financial management is ensuring financial control of the company's finances. Usually, the return on investment (ROI) provides a holistic overview of a company's financial performance. Using techniques like financial forecasting, budgetary control, ratio analysis, cost and profit control and internal audits, managers determine the financial performance. Also, the financial control tells how much money a company has, what is the source of that money and what expenses the company incurred during a financial year or specific accounting period.
When a financial manager controls the company's financial performance and data, they can make investing and financing decisions, distribute profits and sell new shares to shareholders.
Related: What Does A Financial Controller Do? (Plus Other Job Info)
Types of financial management
Here are two types of financial management:
Strategic financial management
It is a type of financial management that involves managing the finances of a company to meet its strategic goals. Strategic financial management uses different management techniques and financial tools to create a strategic plan. This management approach helps identify and implement strategies that maximise the organisation's market value. Strategic management helps a manager make decisions related to investments in various assets. Some key features of strategic financial management are:
focusing on long-term fund management
promoting growth and profitability and maximising shareholder's wealth
utilising financial resources and focusing on the outcome of developed financial strategies
making decisions about mergers and acquisitions
choosing capital investments
Related: What Is Strategic Planning And How To Do It In 6 Steps
Tactical financial management
Tactical financial management involves managing the short-term finances of a company. This management technique involves informing a company about how to process daily transactions and comparing actual spending with the budget. Tactical management can help a company ensure compliance with tax and legal requirements. The primary aim of this financial management is taking benefit of the market condition. For instance, the tactical approach provides flexibility to increase equity exposure when the market outlook is healthy. It can help a company reduce losses and increase profits.
Why is financial management important?
Financial management is essential because of the following reasons:
Decision-making: Effective financial management can help a business leader know the best way to execute plans by providing up-to-date financial reports. This helps in making critical financial and business decisions.
Strategising: Financial management is helpful for planning and strategising how a company can achieve a company's short-term or long-term goal. The company's current performance can help managers identify potential financial outcomes and problems a company can face in the future.
Controlling: With financial management, managers control a company's financial operations and ensure that all departments operate within a budget and align with a strategy.
Related: What Is The Role Of A Financial Manager? A Complete Guide
What is the purpose of financial management?
The purpose of financial management includes:
Maximising the company's current value: A financial manager maintains a high value for the company's assets through efficient financial management. This primarily includes maintaining a high value per stock in the company.
Maximising profit: Financial management helps maximise profits by looking for better investment opportunities, developing a product and gaining a competitor. For maximising profits, these managers work with marketing and research and development teams.
Maintaining cash flow: Financial management helps a company manage its cash flows by keeping money available for daily expenses, such as paying utility bills and salaries and producing goods and services. Usually, a company that has enough cash enjoys a good reputation and credit rating.
Ensuring a company's survival: Effective financial management can help a company avoid bankruptcy and continue its operations. This also means that the company's products and services reach the market and employees receive salaries on time.
Actively managing a company's finances involves planning for how much money a company requires for running its day-to-day operations, where those funds came from and how the company is using its funds. In addition, the data these managers receive can help a company make the right business decisions, ensure higher value to shareholders, improve financial stability and increase profitability.
Examples of financial management
Here is an example of financial management:
Sameera, the CEO of a footwear company, introduces new leather-free footwear. Upon receiving an order, she asks her team to estimate the cost of producing the new footwear and identify the source of the funds, for example, a bank loan. The company's financial manager acquires those funds and ensures they allocate them to manufacture footwear cost-effectively. After the product does well in the market, the financial manager gathers data to decide whether to give the profits as dividends to shareholders, produce a new product line and pay employees a bonus. The manager ensures that the company has enough cash to pay their utilities bills and salaries throughout the process. Sameera analyses whether the company is spending and generating money as she budgeted for the project.
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