An American Energy corporation was created in the early 2000s and made a total revenue of $100 billion. They invested a lot in their marketing and published great content to promote their brand. However, after some time, they disappeared, raising many questions from the public. Their failure was so significant that it became the benchmark for other failed businesses. Imagine a company making that much revenue and then going bankrupt within a year. How?
Here's what happened. The executives concealed billions of dollars in debt from failed deals and projects using accounting loopholes, special purpose entities, and false error reporting. If they built a power plant expecting to generate $2 billion in revenue, that is what they reported, not the actual income. The company's executives not only misled the board of directors, but also pressured their auditors to shred, delete, and conceal evidence of this.
Of course, they offered good services to their clients — they wouldn't have had a business otherwise. However, that couldn’t protect them from the consequences of poor financial management. Studies into why businesses fail have shown that financial planning, personal debt, cash flow management, etc., are the leading factors. These are all facets of finance management – the key to your business’ success.
What is finance management, and why is it so important? What does it involve? Let’s find out.
What is finance management?
Financial management is the process of managing money to meet business objectives. It is often the responsibility of senior management to plan, direct, monitor, and control funds to make effective financial decisions. It seeks to apply management principles to a company's financial structure.
Finance management ensures that the company has the resources to continue operating and achieve its objectives as well as possible. Finance management is one of your most important responsibilities as a business owner. You must consider the potential effects of your management decisions on profits, cash flow, and the company's financial condition. Every aspect of a business impacts the financial performance of the company. And must be evaluated and controlled by the business owner.
The goals of financial management include; maintaining the company's growth, maximizing current value, minimizing cost and maximizing profits, and avoiding bankruptcy.
Why finance management is important for businesses
Now that we understand the concept of financial management, let’s examine why it is necessary for businesses.
Financial Planning: A company with poor financial management will struggle with planning its finances properly. Finance management assists in determining each financial requirement associated with the business concern. Effective financial management leads to better financial planning. The management and recording of cash flow are critical to the success of a business. Hence, the importance of finance management.
Investment opportunities: If you are good at saving and managing your money, you’ll find it easier to invest in opportunities that will help you build wealth and live a happy life. The same is true for businesses; when a company takes finance management seriously and accounts for every penny, it can invest in more business opportunities and increase its revenue.
Part of finance management is researching where you want to invest your money, understanding the risks involved, and calculating the return on investment. If, after reviewing these, you believe the investment is worthwhile, you can proceed.
Allocation of funds: Another importance of financial management in an organization is ensuring to allocate funds appropriately. When this happens, it improves the operational productivity of the business concerned.
Protection of company's funds: Overspending on one project can impact other business operations, which may lack adequate funding. It is critical to protect funds and invest wisely.
Financial decisions: Financial management assists the company in making sound financial decisions. As previously stated, a wrong financial decision can cause a company's downfall and lead to bankruptcy.
You can liken a financial decision to a game of chess. One wrong decision can cost you a fortune. In most cases, you can't go back in time and undo a poor financial decision because once money is spent, it often can't be recovered.
Financial decisions impact every aspect of the business because every department requires money to function correctly. As a result, financial management guides executives and prevents them from making financial decisions that will harm the company's growth.
Economic growth and stability: Proper financial management ensures your company's economic growth. It will gradually increase wealth creation, allowing your business to grow financially. Financial stability is a crucial aspect of any business. The only way to ensure financial stability is through economic growth, and the only way to do so is through financial management.
Tax planning: For instance, if you know you will spend less on taxes this fiscal year but will pay more taxes next year, you will manage your budget and save accordingly. Doing this will assist you in achieving economic growth; otherwise, you may run out of cash, disrupting your investment decisions.
What finance management involves (elements of finance management)
Apart from ensuring that a business is profitable and successful, there are other elements of finance management, and some of them include:
Maximising profits
Evaluating stakeholder returns and overall company value
Tracking liquidity and cash flow
Enabling up-to-date financial reports providing financial information and data to inform KPIs (Key Performance Indicators)
Maintaining risk management efforts by developing financial scenarios to support forecasting
Other elements of finance management include:
Budget planning and allocation: Budget planning and allocation are critical aspects of financial management. It depicts how much a company requires for business planning and goal achievement. Planning often comes before establishing a company, and it is with that plan that the company will source funds.
However, it doesn’t stop there. It is a continuous process because every organisation requires money regularly, and without proper planning, they can obtain the money and spend it with no return.
A proper budget plan should align with the business plan of the company. That way, it will be consistent with the company's vision and projected timeline, and the company will know how to raise funds for its operations at each point.
Decision making: Financial decisions are essential to financial management because they help to ensure the effective use of available resources. They also aid in achieving the minimum financial performance required for the company to survive. There are mainly three types of decision-making which are:
Financing decisions: As the name implies, these are decisions on the best way to invest the organization's funds. Long-term and short-term investment decisions exist. Long-term decisions involve large sums of money and are almost always irreversible. On the other hand, short-term investments refer to a company's day-to-day operations. I can include cash, inventory, and receivables decisions.
Investment decisions: These decisions impact how much money is raised, and how. Investment decisions relate to a company's capital structure. This involves owned and borrowed funds.
Businesses could use equity shares, preferred shares, debentures, and bank loans to raise. The main factors influencing these decisions are; cost and cash flow position. According to the financial risk management course, the risk of repayment is also noted when making these decisions.
Financial controls: Every organization should ensure that money is spent wisely and in the best interests of the stakeholders. Financial management comes into play here. Financial controls are policies established by an organization to document, assess, and report financial transactions to maximize the use of funds. The policies eliminate the possibility of missing funds and ensure the organization achieves its goals.
When financial control policies are in place, the actions that impede the firm's efficiency will be eliminated or improved to work in the firm's favor. Furthermore, financial control policies will prevent theft because overspending will be strictly controlled. To ensure the effectiveness of financial control measures, the company must ensure that only qualified personnel are involved in financial document creation.
What next?
As you’ve seen, finance management is crucial to the success of your business. So, where do you start?
You can begin by tracking your income and outflow and analysing your transactions to understand how to make your money work for you. Leatherback allows you to do this in real-time. Sign up HERE and begin your journey.
In our next article, we’ll discuss how to create a feasible budget for your business.
