Scope of Financial Management
Financial management is a vital component of success and sustainability for organizations across industries because it encompasses a broad range of activities and responsibilities designed to manage an organization’s financial resources efficiently.
A wide variety of functions and decisions fall under the umbrella of financial management, including financial planning and capital budgeting, working capital management, risk mitigation, and financial analysis.
Financial management involves strategic planning, operational execution, and monitoring of financial activities in order to ensure that the organization is financially stable, profitable, and growing over the long run.
Financial management describes the range of activities and responsibilities involved in managing the financial resources of an organization effectively.
In addition to maximizing the value of the company, financial management ensures financial stability and sustainability by combining various functions, decisions, and strategies.
Let’s take a closer look at the scope of financial management:
Financial Planning:
➔ The goal of financial planning is to develop a roadmap for a company’s financial activities. It begins with identifying short-term and long-term financial goals and objectives.
➔ It may be necessary to increase profitability, expand operations, invest in research, or enter new markets to achieve these objectives.
➔ It is also important to estimate the financial requirements to achieve these goals, taking into account factors such as operating expenses, capital expenditures, and working capital requirements.
➔ Financial managers develop strategies to allocate resources effectively, prioritize investments, and ensure the organization’s financial stability and sustainability based on these estimates.
| Example: John, 30, aims for financial stability by building a three-month emergency fund, contributing 15% to his retirement with employer matching, and strategically managing expenses, debt, and investments for a secure future. |
Capital Budgeting:
➔ Budgeting for capital is a crucial aspect of financial management that involves evaluating and selecting long-term investment projects.
➔ The organization’s cost of capital, expected cash flows, and risk factors are factors that financial managers consider when evaluating potential investment opportunities.
➔ NPV, IRR, and payback period are techniques used to determine whether an investment project is profitable and viable.
➔ It is the responsibility of financial managers to decide which projects to undertake and to allocate capital accordingly, aiming to maximize returns on investments while managing risk.
| Example: A company evaluates a $5 million investment in a new facility with anticipated annual cash inflows of $1.5 million for seven years. Calculating a positive net present value (NPV) of $2 million, the project is deemed financially viable, leading to its approval in the capital budgeting process. |
Financing Decisions:
➔ A company’s financing decisions are based on how it obtains funds to support its operations and investments. Financial managers evaluate different financing options, such as equity financing, debt financing, or hybrid financing.
➔ Based on the percentage of debt and equity used to finance the business, they determine the organization’s capital structure.
➔ Among other things, the decision-making process considers the organization’s risk tolerance, market conditions, and funding sources.
➔ To ensure the organization has adequate funds to meet its financial obligations and achieve its goals, financial managers negotiate with financial institutions, investors, or capital markets to secure the necessary financing at favorable terms.
| Example: A company opts for a financing mix to fund a project, securing a $3 million loan and issuing $2 million in new shares. This decision aims to optimize capital structure, balancing debt tax shields and equity funding for strategic initiatives |
Working Capital Management:
➔ In working capital management, the organization’s short-term assets and liabilities are managed.
➔ In addition to ensuring the efficient use of current assets, such as cash, inventory, and receivable, financial managers manage short-term liabilities, such as accounts payable and loans, effectively.
➔ As well as minimizing the costs and risks associated with excess or insufficient working capital, it is important to maintain sufficient working capital to support day-to-day operations.
➔ To ensure smooth operations and liquidity, financial managers maintain cash flows, optimize inventory levels, implement effective credit and collection policies, and manage supplier relationships.
| Example: A retail business extends supplier payment terms, implements just-in-time inventory practices, and optimizes receivables to efficiently manage working capital. These strategies enhance liquidity and support day-to-day operations, ensuring financial agility. |
Risk Management:
➔ An organization’s financial stability and performance is affected by the way it manages its financial risks. Risk management involves identifying, assessing, and mitigating the risks that might impact these factors.
➔ A financial manager analyzes a wide range of risks, including market risk (interest rate, exchange rate, or commodity price fluctuations), credit risk (defaults or nonpayments by customers or counterparties), liquidity risk (deficit of cash or inability to meet financial obligations), and operational risk (failure of internal processes, systems, or human error).
➔ Diversification, hedging, insurance, and contingency planning are some of the techniques they use to manage risk. To mitigate legal and regulatory risks, financial managers ensure compliance with relevant regulations and internal controls.
| Example: A multinational corporation employs financial derivatives like forward contracts to mitigate foreign exchange risk, securing exchange rates for global operations. This proactive risk management strategy protects the company’s financial performance from adverse currency fluctuations, ensuring stability in cash flows. |
Financial Analysis and Reporting:
➔ A financial analysis involves evaluating the profitability, performance, and health of the organization.
➔ An organization’s revenue, expenses, assets, liabilities, and cash flow are assessed by financial managers by analyzing financial statements, like the income statement, balance sheet, and cash flow statement.
➔ The ratios and indicators they use to evaluate liquidity, profitability, solvency, and efficiency are used by financial analysts. An organization’s financial strengths, weaknesses, and areas for improvement can be identified through financial analysis.
➔ The purpose of financial reporting is to provide investors, lenders, regulators, and management with accurate and timely financial statements, disclosures, and reports.
➔ Accountability, trust, and decision-making are all enhanced by transparent and reliable financial reporting.
| Example: A company conducts financial analysis by examining income statements, balance sheets, and cash flow statements to assess performance and trends. The resulting financial report aids informed decision-making and communicates the company’s financial health to stakeholders, supporting effective financial management. |
Finance and Governance of Corporations:
➔ Financial management plays an integral role in corporate finance and governance. Managers of finance are involved with mergers and acquisitions, divestitures, capital restructuring, and investment evaluations as part of their strategic responsibilities.
➔ These decisions are analyzed for financial implications, risks assessed, and long-term goals and shareholder value taken into consideration.
➔ In addition to ensuring compliance with legal and regulatory frameworks, financial managers oversee internal controls.
➔ To protect shareholders’ interests and maintain stakeholder confidence, they promote transparency, ethical behavior, and accountability.
| Example: A corporation emphasizes financial management by implementing internal controls and transparent reporting, ensuring compliance with accounting standards. Simultaneously, governance practices, such as effective board oversight, align with long-term financial objectives, fostering trust and sustainable success. |
International Financial Management:
➔ Management of international financial operations is part of financial management as business becomes increasingly globalized. When operating across multiple countries, financial managers are faced with currency fluctuations and exchange rate risks.
➔ They are responsible for evaluating foreign market entry strategies, assessing international investment opportunities, and handling cross-border transactions.
➔ International financial decisions are influenced by factors such as foreign exchange rates, trade regulations, tax implications, cultural differences, and geopolitical risks.
➔ In addition to navigating the complexity of global financial markets, they ensure compliance with international accounting standards and regulations.
➔ As financial managers, we contribute to the success and financial well-being of the organization by effectively managing the various components within the scope of financial management.
➔ Profitability is maximized, growth initiatives are supported, risks are mitigated, financial stability is maintained, and shareholder value is maximized.
➔ In order to effectively manage financial resources, firms need to know how to analyze financial data, make strategic decisions, manage risks, and comply with regulations.
| Example: A multinational company practices international financial management by hedging against currency fluctuations through options or futures. This strategic approach helps mitigate currency risk, ensuring optimal financial performance in a global economic context. |
| References:
Bhasin, T. (2024, January 3). Financial Planning: definition, importance, and benefits. Learn About Investment Tax Saving, and Financial Planning. https://www.etmoney.com/learn/personal-finance/financial-planning-definition-importance-and-benefits/ |
I am Bijisha, an enthusiast with a profound eagerness for learning. I hold a Bachelor’s degree in Business Administration(BBA) from Apex College. I am constantly driven by a relentless curiosity and a genuine desire to expand my knowledge horizons.
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