Financial management is the practice of managing money, investment portfolios, and other financial assets in a manner that maximizes returns and minimizes risk. The practice involves making decisions based on research and observation to achieve an optimal investment strategy. Financial management may be implemented at an individual level, such as when someone makes investments to prepare for retirement, or at an organizational level, such as when a company develops a budget for its operations.
When applied to companies, financial management typically involves decisions about which of the following:
- Raising capital for investments: Companies must decide how to raise capital to fund projects or purchase assets. This decision can involve issuing bonds or stocks, taking out loans from banks or other lenders, or generating profits from existing business activities.
- Determining capital structure: After raising capital for an investment project, companies need to determine how best to allocate it between equity and debt sources such as preferred stock versus common stock or long-term loans versus short-term loans.
- Investing in assets: A company needs to decide what types of investments will yield the most return with the lowest amount of risk. This could include purchasing new equipment, investing in stocks and bonds, investing in real estate, etc.
- Prioritizing expenditures: Companies must have strategies for allocating available funds among various departments and projects. Decisions must be made about which areas need more funds than others based on their importance and time frame for completion.
- Managing cash flow: Companies must proactively plan expenses in order to ensure that they have adequate funding at all times with minimal disruption due to unexpected expenses or slow payment periods from customers or suppliers.
- Evaluating performance: Financial managers use various methods including ratio analysis and trend analysis in order to evaluate the performance of their organization’s assets over time and make decisions regarding further investments and operations planning.
Financial management involves decisions about which of the following?
Financial management involves decisions about which of the following: investments, funding, and risk management. It is the responsibility of a company’s finance department to ensure that financial resources are used optimally and that long-term goals and objectives are met. Objectives of financial management include the efficient use of available resources, maximizing profits, stable and steady growth, risk minimization, and satisfaction of stakeholders.
The functions of financial management include:
- Financial planning
- Investment planning
- Raising funds (equity or debt financing)
- Asset acquisition / divesting decisions
- Foreign exchange rate hedging strategies
The primary goal is to sufficient resources to meet all short-term requirements while also developing strategies to maintain long-term financial health. Financial planning looks at the immediate future needs in terms of cash flow requirements and the longer term opportunities for investment. This includes forecasting the company’s earnings for specific periods into the future with accuracy accounting for changes in forecasted demand for goods or services provided by the company. Investment planning looks at risk/return profiles against future growth potential to understand what assets are most suitable for each particular given situation. Raising funds on both equity (e.g.; stocks) or debt markets may be necessary depending on how optimistic forecasts are looking and acquiring/divesting assets such as other businesses or real estate might be required too. Ultimately, it is about creating value through decisions about using limited resources in order to maximize return on investments made by shareholders or sources providing loan capital.
Finally, financial managers must be aware macroeconomic factors such as currency pair fluctuations could have a large impact on their global operations so strategies can be put in place mitigate risks (e.g.; currency futures contracts). All aspects need careful consideration in order that corporate goals are managed effectively while protecting shareholders’ interests in view!
Objectives of Financial Management
Financial management involves making decisions about how to best use the resources available to reach certain goals. These decisions can involve a variety of tools and strategies, including investments, short and long-term budgeting, and risk management.
The objectives of financial management are to maximize cash flows and minimize risks, while also considering the need for adequate liquidity, profitability, and return on investment. Let’s explore these objectives in more detail:
- Maximize cash flows
- Minimize risks
- Ensure adequate liquidity
- Achieve profitability
- Increase return on investment
Maximization of Shareholders’ Wealth
Maximization of shareholders’ wealth refers to the objective of financial management to increase shareholders’ return over time. This objective is linked to maximizing the market value of the firm and increasing the returns generated for shareholders.
The objective involves many decisions such as financing, investments and dividend policies, share repurchasing, etc., which all have an impact on shareholders’ wealth. The goal is to maximize stockholder equity rather than firm profits or assets. Decisions taken should ensure that shareholder risk is minimized while maximizing returns. Issues like taxation, cost of capital, inflation and economic fluctuations should also be taken into consideration when making decisions in order to maximize shareholder wealth.
Optimization of Firm Value
Optimization of firm value is one of the primary objectives of financial management. Firm value, also known as shareholders’ wealth, is the market value of the company’s equity. An optimal firm value maximizes shareholders’ wealth by balancing risks and returns over time.
Financial managers look to optimize firm value by analyzing a series of possible outcomes and selecting a course that offers the best risk-adjusted return. Financial managers make decisions such as investments in stocks and bonds, assessing the costs and benefits of possible capital projects, and determining how to finance long-term projects. When making these decisions, they must consider:
- how much cash will be needed in order to cover operating costs
- potential financing costs such as interest payments on debt instruments or dividend payouts for equity instruments
- expected return on investment based on market volatility or industry trends
- other risks associated with the project’s execution
Additionally, financial managers are responsible for developing strategies that minimize operational risks related to liquidity, capital structure, and even tax efficiency. By ensuring that these objectives are taken into consideration when making financial decisions, financial managers can help optimize firm value for their shareholders.
Maximization of Profitability
Maximization of profitability is a primary objective of financial management. Profitability involves generating profits by increasing sales, reducing costs, and providing dividends to shareholders. In order to maximize profitability, financial management must make decisions about the following:
- Evaluation of investments;
- Allocation and control of funds;
- Capital structure and dividend policy;
- Selection of sources and terms of financing.
The evaluation of investments involves identifying profitable investment opportunities that are capable of generating profits while taking into account the rate of return, risk factors associated with the investment, liquidity measures, payment schedules and other factors. The most important aspect taken into consideration when evaluating investments is the rate of return. Financial managers must analyze the potential returns on a particular investment relative to other investments in order to determine whether or not it is worth undertaking.
Allocation and control of funds involve determining which areas require additional financing in order to generate a maximum return on investment as well as monitor its use so that it is effectively utilized for these purposes. Financial managers must be able to assess which areas are more profitable than others in terms at producing returns over an extended period time or within a specified period time frame.
Capital structure refers to how a business finances its operations by determining which sources it will draw from for capital such as debt, equity or dividends among others. Dividend policy involves determining how much money a business owner should keep compared with how much he/she should distribute among shareholders as dividend payments on their respective shares outstanding in the company’s stock issue(s).
Finally, financial managers must decide which sources they will tap into for funds such as debt, equity or both and what terms would best suit these funds depending on their source (i.e., interest rate applicable for loans). All these decisions help determine an organization’s overall financial strategy as well contributing towards achieving its goal maximizing its profitability over time through strategic planning and assessment processes implemented by experienced financial managers in consultation with senior decision makers.
Liquidity Management
Liquidity management is one of the major objectives of financial management. It involves decisions around maintaining adequate funds balance to satisfy current obligations, as well as decisions related to holding money in various assets that can be easily converted into available cash. This involves using liabilities and assets to make payments efficiently, while also considering return on investments, risk levels, tax consequences, transaction costs and liquidity preferences.
For businesses, liquidity management typically attempts to balance expected outflows with inflows in order to manage cash requirements and mitigate hazards such as overextending budgeted costs or running out of funds when needed. The goal is to maximize profits from current resources while simultaneously managing associated risks.
In addition to growing a business’s liquidity position through sales of goods and services for cash, firms engage in activities such as:
- Short-term debt issuance (bonds and loans)
- Trade finance (involving repayment terms such as factoring)
- Borrowing from financial institutions or other creditors
- Investment decisions
By actively monitoring income and expenses against budgeted figures, businesses can forecast their future needs for liquidity on an ongoing basis – allowing them to adjust operations accordingly or access external financing sources if desired.
Risk Management
Risk management is a major objective of financial management. Risk management involves the decision-making process of evaluating and allocating capital among various investment options. It also involves taking decisions about proper asset mix, assessing and managing investment risk, hedging market risk, optimizing return on investments and identifying the appropriate levels of debt and equity for optimal structure.
This process requires an understanding of various financial tools such as stock exchange markets, options trading markets and derivatives markets. Risk management is an important part of the overall financial strategy as it helps identify and manage potential losses or damage from unexpected changes in economic conditions or market movements. Additionally, an adequate level of risk management helps to reduce uncertainties in investments which can be beneficial for long-term sustainable financial health.
Functions of Financial Management
Financial management involves decisions about which of the following: investment, financing, and dividend activities. In simple terms, the finance manager has to decide on the best combination of resources to maximize the returns for the company.
The financial management process involves analyzing the current financial situation, setting objectives, and formulating strategies to attain the set objectives. This article will discuss the functions of financial management and the role it plays in an organization’s success.
Investment Decisions
Investment decisions are one of the most important functions of financial management and involve determining where a company’s funds should be allocated in order to maximize investment returns. A key decision involves deciding whether to invest in products with a more immediate return or those with greater potential returns over the long term. The goal is to decide which products and investments provide the greatest risk-adjusted return.
Investment decisions also involve selecting specific securities such as stocks, bonds, mutual funds, options, futures, commodities and other financial instruments.
A company’s choice of investments will also often depend on its business objectives as well as on any applicable legal and regulatory requirements. It’s important for companies to assess the market risks associated with its securities holdings, particularly if it has limited financial resources available or if its debt structure is already stretched too thin. Companies must also assess their own operational capabilities when making investment decisions since specific mechanisms may be necessary for executing the trades or establishing positions over time (e.g., scaling in or out).
Financial Decisions
Financial management involves decisions about which of the following:
- Raising Funds: This includes deciding the sources to use, negotiating with suppliers and investors, and planning how to meet future capital needs.
- Investing Funds: It involves decision making related to long-term investments such as decisions regarding mergers and acquisitions, deciding which projects are profitable and should be undertaken, and portfolio management.
- Using Funds: This relates to utilizing funds in the organization through efficient working capital management, corporate restructuring and debt financing.
- Distributing Profits: This decision is related to dividend declarations and buy backs of shares from stock markets.
Financial management also involves analyzing various financial information such as balance sheets; income statements; cash flow statements; liquidity schedules; expense reports; budgeting for capital expenditures; developing strategies for hedging risks due to foreign exchange rate movements or fluctuations in interest rates; analyzing financial instruments like bonds, derivatives etc.; creating an organizational budget reflecting overall financial goals; conducting cost effective analysis of different projects across departments/areas ; setting up credit limits for customers ; developing short-term/long term plans by considering internal/external factors that are likely to impact firm’s performance in near or distant future.
Dividend Decisions
In financial management, decisions on dividends involve whether a company should distribute any profits to its shareholders, and if so, how much should be distributed. Dividend decisions made by companies can greatly affect the shareholders’ return on investment and their satisfaction level with the firm. Companies may choose to pay dividends in cash or in shares of stock, or a combination of both.
Companies that are risk-averse may choose to pay dividends more often, while those that are more growth-oriented generally keep a larger share of their profits reinvested in the business for growth or acquisitions. Dividend decisions may also take into consideration factors such as the company’s financial performance during past periods, potential new investments or acquisitions, debt repayment obligations and other macroeconomic conditions.
Ultimately, dividend policies often reflect the firm’s attitude toward risk and its focus on either short-term profit maximization or long-term value creation for shareholders.
Working Capital Management
Working capital management is an important component of financial management. It focuses on the decisions a business must make about investing its cash in current assets and how to effectively manage the accounts receivable and payable. Working capital is generally considered to be the short-term assets and liabilities of a business, including inventory, accounts receivable, cash, marketable securities and accounts payable.
A business must decide what percentage of its current assets should be allocated towards working capital, with the goal of optimizing return on invested capital while still maintaining adequate liquidity by avoiding too much current liability exposure. To make such decisions, businesses must use forecasting methods to predict future cash flow needs and then decide which financial instruments are best suited for their needs.
Generally these decisions include choosing between:
- Short-term financing instruments such as money market funds or commercial paper, or
- Long-term sources such as bonds or loans from banks or other financial institutions.
Businesses must also determine whether to maintain or adjust levels of accounts receivables compared to competitors in order to optimize return on investment (ROI).
Capital Structure Decisions
Capital structure decisions involve the amount of leverage that a company employs. Leverage, also called financial leverage, is a concept used to describe when equity and debt are used in combination to secure financing. Because interest expenses are tax deductible, the use of debt will reduce the amount of taxes that a company pays.
The capital structure decision involves determining an optimal balance between debt and equity financing for achieving a certain goal such as maximizing shareholder wealth. Debt loans can often be obtained on more attractive terms than equity financing as long as the business is financially healthy and its debt load does not get too high. On other hand, excessively using debt could result in bankruptcy or cost savings dipping into negative territory when enough interest expenses cannot be deducted from profits due to borrowing becoming overly expensive.
Thus the choice of capital structure should be done cautiously with consideration to what serves the best interests of the business owners and shareholders in the long term while reducing risk exposure.
