10 Essential Financial Management Principles Every Manager Should Know
What is Financial Management?
Financial management is considered one of the essential features for organisations as well as individuals in this fastly evolving world. It mainly focuses on handling and expanding money. For a business to run effectively and efficiently and attain its purpose and objectives, individuals must learn and better understand financial management and accounting. It handles and controls the organisation’s finances so that it attains benefits and is expandable in the coming years.
It is essential for companies and businesses because it sets down the accurate path to attain the goals and objectives of the business. Some of the reasons why it is considered important in running a business are discussed below –
- It assists in the financial planning of the business.
- It helps in managing and acquiring the funds of the business.
- It aids in the allocation of funds.
- It also helps to provide an understanding of the decisions in financial organisations.
- It helps in cutting down costs of financial organisations.
- It also enhances the profits as well as the value of the organisation.
- It helps in making the employees conscious about financial investments and savings.
- It aids in planning and arranging the growth of the business in the coming future.
- It also assists in obtaining a stable nation.
Objectives of Financial Development
Some of the objectives of the financial development are discussed below –
- Profit maximisation – The organisation’s most important goal assures the maximum benefits the company earns in the long and short run. This remains at the top of the priority list of a financial manager. This is so because the results of the maximum gains indicate that the organisation’s performance gives profit.
- Business Survival – The main goal of a business or a company is to survive in this competitive world, where there is so much competition. For a business to survive, they need to take decisions attentively.
- Risk reduction – Any business involves risks which also include uncertainties with them. Financial managers must avoid high-risk situations, and appropriate measures must be taken to calculate them by taking expert suggestions and advice.
- High efficiency – Any organisation needs to enhance the efficacy of the business by working on financial management. Accurate funding or financing to every company department contemplates all the work and resources involved in boosting the organisation’s efficiency.
- Balanced structure – Balancing business is the basic and most important thing to do in business. The managers must be ready with a strong structure of capital which involves all the sources of the capital. Balancing a business is crucial for flexibility, stability, liquidity and the economy.
- Proper mobilisation – There is a need to mobilise the business’s finances properly. The managers must assess and evaluate to make important decisions for utilising and allocating funds. All the important elements, whether sharing, investing or a product in a small business, must be considered before investing.
Components of Financial Management
Some of the components of financial management are essential for a financial manager to focus on. These are discussed below –
- Financial Planning – It is the process by which the organisation or the business calculates and measures the required capital, and also resource allocation is done by this process accordingly. For a business to run effectively, the financial manager must focus on the objectives and goals of the organisation; they should understand the long-term plan of the organisation; to sustain the business in this rapidly growing and competitive world, the manager must know about the required capital that the organisation needs; the manager must also know about the various policies, rules and regulations of the business that are important for the organisation to run. That’s Why it is very important to plan everything adequately to achieve the objectives and goals of the organisation.
- Financial Control – Financial control is crucial to ensure the organisation works properly to meet its goals. It mainly focuses on the fixing of accurate KIPs instead of cost reduction. It is very important to make everyone in the organisation conscious and aware of the business, financial objectives, and goals.
- Financial Decision-making – As the financial manager accurately plans and understands all the business’s financial characteristics, and it is time for the decision-makers to decide and assess the profit distributions, allocation of resources, funding and more.
10 Principles of Financial Management
Some of the important basic principles of Financial Management are important for a financial manager to understand are –
- Trade-off Risk and Return – Financial managers must be aware and conscious when creating a portfolio from the available investment opportunities where the investment choice depends on the tradeoff between the returns and risks of the individual. This indicates a positive correlation between the two. As the risk is higher, the rate of return will also be higher. The portfolio must have investments with low risks and investments with higher risks. The finance manager has to deal carefully with trade-off risk and returns, considered one of the most important financial management principles.
- Forecast Cash Flows – Cash is considered a liquid asset that flows outward and inward. Also, financial decisions are made depending on the patterns of flows. Cash flows are more reliably preferable instead of uncertain cash flow. To ensure the requirement of cash supply in all financial activities, it is important to assess the cash flow and handle and control the cash flow depending on the organisation’s requirements. Providing organisations with an accurate amount of cash flows also shows the utilisation of financial management principles.
- Diversification of Borrowing and Investment – The formation of the portfolio with the help of diversification is applicable for borrowing and investment. The main goal is to ensure that the cost of financing or borrowing is minimum and that the investment is the maximum reward. It is important to balance return and risk while making a decision. This makes the overall risk of money remain affordable.
- Formation of Optimal Capital Structure – Capital structure is called the debt ratio and the percentage of equity of an organisation’s total assets. A financer or an investor can learn a company’s finance pattern by going through the capital structure. An organisation in a financially good condition depends more on the financing of debt rather than equity financing. And this is because financing equity is more expensive than financing debt. So, a finance manager must ensure that the organisation’s equity and debt mix keeps the average weighted capital cost minimum.
- Conscious of Money’s Value over Time – There is a chance of becoming a loser in financial management if the financial manager needs to be conscious of money’s value over time. Money which is received at present is more important as compared to that of the money which is received after a short length of period. So, it is critical for a financial manager, who is responsible for managing the company’s finances, to always be aware of the money’s value over time and the average worth of the reduced value due to inflation or some other factors.
- Financial Decision Align with Business Life Cycle – Any company or business has its ups and downs, which works like a cycle in the business. The financial manager needs to focus on the current life cycle of the business as well as its position in the future of the business life cycle to take a financial decision. This makes the financial manager develop a plan to make sure that the advantages from the financial decisions that were taken give profits to the business or the organisation. To bring out the best results from the opportunities and investments in finance needs to work out the best financial plan. Businesses need to take various financial decisions in their lifespan, which need to be related to the financial problems or conditions of the organisation.
- Reinvest Instead of Consume – If the business has an appropriate amount of financial strength, then there is a need to consume the opportunities generated by the business and not only this, but there is also a need to invest in the business productively. To broaden the business, reinvestment aids, eventually generating value-creation, employment, and value exchange for the nation. Always looking for novel opportunities is considered a good practice of financial management, and if the financial manager finds any good opportunities for investment, he must reinvest the available funds.
- Taking Right Plan for Insurance – The organisation’s risks are diverted to the insurance company with the help of the right insurance plan. The insurance taker pays the premium of the insurance to divert the risk. Decisions made by the financial manager involve choosing the appropriate policy for insurance as well as the accurate amount for the premium of insurance, which depends on the nature of the insurance policy. The company needs to take a proper plan for insurance as it is a part of financial management.
- Determining Cost of Capital – Determining capital cost shows all the expenses related to the payment imposed on the fund supply for equity and debt. The mean weighted capital cost refers to the actual capital cost, the mean financing cost of debt and equity. A comparison of the cost related to the capital cost and the financial rewards always results in effective financial management. And the financial manager can invest when the expected return rates exceed the capital cost.
- Concentrating on Maximising Wealth – Wealth maximisation accelerates the organisations value. In other words, it is represented to maximise the business’s net present value (NPV). Being a company’s finance manager, focussing on managing and handling the financial conditions, there is a need to make a plan concentrating on maximising the organisations value. A wealthy organisation invests more in the development of innovative products. This also helps in developing the business more smoothly.
Author Bio: Mark Edmonds is a seasoned financial management expert at Academic Assignments, a leading financial management assignment help provider. With a wealth of knowledge and experience, Mark is committed to helping students grasp essential financial principles and excel in their academic pursuits. Trust Academic Assignments for expert guidance and support.