In business, financial management is the practice of handling a company’s finances in a waythat allows it to be successful and compliant with regulations. That takes both a high-levelplan and boots-on-the-ground execution.
Video: What Is Financial Management?
What Is Financial Management?
At its core, financial management is the practice of making a business plan and then ensuringall departments stay on track. Solid financial management enables the CFO or VP of financeto provide data that supports creation of a long-range vision, informs decisions on where toinvest, and yields insights on how to fund those investments, liquidity, profitability, cashrunway and more.
ERP software can help finance teams achieve thesegoals: A financial management systemcombines several financial functions, such as accounting,fixed-asset management, revenue recognition and payment processing. By integrating these keycomponents, a financial management system ensures real-time visibility into the financialstate of a company while facilitating day-to-day operations, like period-end closeprocesses.
Strategic vs. Tactical Financial Management
On a tactical level, financial management procedures govern how you process dailytransactions, perform the monthly financialclose, compare actual spending to what’s budgeted and ensure you meet auditor andtax requirements.
On a more strategic level, financial management feeds into vital and visioning activities, where finance leaders use data to helpline-of-business colleagues plan future investments, spot opportunities and build resilientcompanies.
Let’s look at both angles.
Importance of Financial Management
Solid financial management provides the foundation for three pillars of sound fiscalgovernance:
Strategising, or identifying what needs to happen financially for thecompany to achieve its short- and long-term goals. Leaders need insights into currentperformance for scenario planning, for example.
Decision-making, or helping business leaders decide the best way to executeon plans by providing up-to-date financial reports and data on relevant KPIs.
Controlling, or ensuring each department is contributing to the vision andoperating within budget and in alignment with strategy.
With effective financial management, all employees know where the company is headed, and theyhave visibility into progress.
Objectives of Financial Management
Building on those pillars, financial managers help their companies in a variety of ways,including but not limited to:
Maximising profits by providing insights on, for example, rising costs ofraw materials that might trigger an increase in the cost of goods sold.
Tracking liquidity and cash flow to ensure the company has enough money onhand to meet its obligations.
Ensuring compliance with state, federal and industry-specific regulations.
Developing financial scenarios based on the business’ current state andforecasts that assume a wide range of outcomes based on possible market conditions.
Dealing effectively with investors and the boards of directors.
Ultimately, it’s about applying effective management principles to the company’s financialstructure.
Scope of Financial Management
Financial management encompasses four major areas:
Planning
The financial manager projects how much money the company will need in order to maintainpositive cash flow, allocate funds to grow or add new products or services and cope withunexpected events, and shares that information with business colleagues.
Planning may be broken down into categories including capital expenses, T&E and workforceand indirect and operational expenses.
Budgeting
The financial manager allocates the company’s available funds to meet costs, such asmortgages or rents, salaries, raw materials, employee T&E and other obligations. Ideallythere will be some left to put aside for emergencies and to fund new business opportunities.
Companies generally have a master budget and may have separate sub documents covering, forexample, cash flow and operations; budgets may be static or flexible.
Static vs. Flexible Budgeting
| Static | Flexible |
|---|---|
| Remains the same even if there are significant changes from theassumptions made during planning. | Adjusts based on changes in the assumptions used in the planningprocess. |
Managing and assessing risk
Line-of-business executives look to their financial managers to assess and providecompensating controls for a variety of risks, including:
- Market risk: Affects the business’ investments as well as, for publiccompanies, reporting and stock performance. May also reflect financial risk particularto the industry, such as a pandemic affecting restaurants or the shift of retail to a direct-to-consumer model.
- Credit risk: The effects of, for example, customers not paying theirinvoices on time and thus the business not having funds to meet obligations, which mayadversely affect creditworthiness and valuation, which dictates ability to borrow at favourable rates.
- Liquidity risk: Finance teams must track currentcash flow, estimate future cash needs and be prepared to free up working capital asneeded.
- Operational risk: This is a catch-all category, and onenew to some finance teams. It may include, for example, the risk of a cyber-attack andwhether to purchase cybersecurity insurance, what disaster recovery andbusiness continuity plans are in place and what crisis management practices aretriggered if a senior executive is accused of fraud or misconduct.
Procedures
The financial manager sets procedures regarding how the finance team will process anddistribute financial data, like invoices, payments and reports, with security and accuracy.These written procedures also outline who is responsible for making financial decisions atthe company—and who signs off on those decisions.
Companies don’t need to start from scratch; there are policy and procedure templatesavailable for a variety of organisation types, such as this one for nonprofits.
Functions of Financial Management
More practically, a financial manager’s activities in the above areas revolve around planningand forecasting and controlling expenditures.
The FP&A function includes issuing P&L statements, analysing which product lines orservices have the highest profit margin or contribute the most to net profitability,maintaining the budget and forecasting the company’s future financial performance andscenario planning.
Managing cashflow is also key. The financial manager must make sure there’s enough cash on handfor day-to-day operations, like paying workers and purchasing raw materials for production.This involves overseeing cash as it flows both in and out of the business, a practice calledcash management.
Along with cash management, financial management includes revenue recognition, or reportingthe company’s revenue according to standard accounting principles. Balancing accounts receivableturnover ratios is a key part of strategic cash conservation and management. This may sound simple,but it isn’t always: At some companies, customers might pay months after receiving yourservice. At what point do you consider that money “yours”—and report the good news toinvestors?
| 5 Tips to Improve Your Accounts Receivable Turnover Ratio |
|---|
| 1. Invoice regularly and accurately. If invoices don’tgo out on time, money will not come in on time. |
| 2. Always state payment terms. You can’t enforcepolicies that you haven’t communicated to clients. If you make changes,call them out. |
| 3. Offer multiple ways to pay. New B2B options arecoming online. Have you considered a payment gateway? |
| 4. Set follow-up reminders. Don’t wait until customersare in arrears to start collection procedures. Be proactive, but notannoying, with reminders. |
| 5. Consider offering discounts for cash andprepayments. Cash(less) is king inretail, and you can reduce AR costs by encouraging customers topay ahead rather than on your normal customer credit terms. |
| Learnmore about maximising your AR turnover ratios. |
Finally, managing financial controls involves analysing how the company is performingfinancially compared with its plans and budgets. Methods for doing this include financialratio analysis, in which the financial manager compares line items on the company’sfinancial statements.
What Are the Three Types of Financial Management?
The functions above can be grouped into three broader types of financial management:
Capital budgeting, which relates to identifying what needs to happenfinancially for the company to achieve its short- and long-term goals. Where should capitalfunds be expended to support growth?
Capital structure, determining how to pay for operations and/or growth. Ifinterest rates are low, taking on debt might be the best answer. A company might also seek funding from a private equity firm, consider selling assets likereal estate or, where applicable, selling equity.
Working capital management, as discussed above, is making sure there’senough cash on hand for day-to-day operations, like paying workers and purchasing rawmaterials for production.
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What Is an Example of Financial Management?
We’ve covered some examples of financial management in the “functions” section above. Now,let’s cover how they all work together:
Say the CEO of a toothpaste company wants to introduce a new product: toothbrushes. She’llcall on her team to estimate the cost of producing the toothbrushes and the financialmanager to determine where those funds should come from—for example, a bank loan.
The financial manager will acquire those funds and ensure they’re allocated to manufacturetoothbrushes in the most cost-effective way possible. Assuming the toothbrushes sell well,the financial manager will gather data to help the management team decide whether to put theprofits toward producing more toothbrushes, start a line of mouthwashes, pay a dividend toshareholders or take some other action.
Throughout the process, the financial manager will ensure the company has enough cash on handto pay the new workers producing the toothbrushes. She’ll also analyse whether the companyis spending and generating as much money as she estimated when she budgeted for the project.
Financial Management for Startups
At the outset, financial management responsibilities within a startup include making andsticking to a budget that aligns with the business plan, evaluating what to do with profitsand making sure your bills get paid and that customers pay you.
As the company grows and adds finance and accounting contractors or staffers, financialmanagement gets more complicated. You need to make sure your employees get paid, withaccurate deductions; properly file taxes and financial statements; and watch for errors andfraud.
This all circles back to our opening discussion of balancing strategic and tactical. Bybuilding a plan, you can answer the big questions: Are our goods and services profitable?Can we afford to launch a new product or make that hire? What might the coming 12 to 18months bring for the business?
Solid financial management provides the systems and processes to answer those questions.
