In business, financial management is the practice of handling a company’s finances in a way that allows it to be successful and compliant with regulations. For this to happen, you need to have both a high-level plan and boots-on-the-ground execution.
What Is Financial Management?
Basically, financial management is the practice of making a business plan and then ensuring all departments stay on track. Solid financial management enables the CFO (Chief Financial Officer) or VP of finance to provide data that supports creation of a long-range vision, informs decisions on where to invest, and yields insights on how to fund those investments, liquidity, profitability, cash runway and more.
Normally, a financial management system combines several financial functions. These include accounting, fixed-asset management, revenue recognition and payment processing. By integrating these key components, a financial management system ensures real-time visibility into the financial state of a company while facilitating day-to-day operations, like period-end close processes.
Financial management is important because it helps the business:
- See and understand its profit
- Make decisions on planning inventory and setting prices
- Determine whether it has sufficient cash flow to sustain operations and make decisions on buying assets
- Provide banks and investors with the financial reporting they need to loan money or invest in the business
- Conduct sound financial analysis for better business forecasting and projections
Financial Management Objectives
Building on those pillars, financial managers help their companies in a variety of ways, including but not limited to:
- Maximizing profits: Provide insights on, for example, rising costs of raw materials that might trigger an increase in the cost of goods sold.
- Tracking liquidity and cash flow: Ensure the company has enough money on hand to meet its obligations.
- Ensuring compliance: Keep up with state, federal and industry-specific regulations.
- Developing financial scenarios: These are based on the business’ current state and forecasts that assume a wide range of outcomes based on possible market conditions.
- Manage relationships: Dealing effectively with investors and the boards of directors.
Ultimately, it’s about applying effective management principles to the company’s financial structure.
Manage and asses risk
Business executives look to their financial managers to assess and provide compensating controls for a variety of risks, including:
Market risk
Affects the business’ investments as well as, for public companies, reporting and stock performance. May also reflect financial risk particular to 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 their invoices on time and thus the business not having funds to meet obligations, which may adversely affect creditworthiness and valuation, which dictates ability to borrow at favorable rates.
Liquidity risk
Finance teams must track current cash flow, estimate future cash needs and be prepared to free up working capital as needed.
Operational risk
This is a catch-all category, and one new to some finance teams. It may include, for example, the risk of a cyber-attack and whether to purchase cybersecurity insurance, what disaster recovery and business continuity plans are in place and what crisis management practices are triggered if a senior executive is accused of fraud or misconduct.
Financial Management Procedures
The financial manager sets procedures regarding how the finance team will process and distribute financial data, like invoices, payments and reports, with security and accuracy. These written procedures also outline who is responsible for making financial decisions at the company. They also indicate who signs off on those decisions.
Companies don’t need to start from scratch; there are policy and procedure templates available for a variety of organization types, such as this one for nonprofits.
Functions of Financial Management
More practically, a financial manager’s activities in the above areas revolve around planning and forecasting and controlling expenditures.
The FP&A function includes issuing P&L statements, analyzing which product lines or services have the highest profit margin or contribute the most to net profitability, maintaining the budget and forecasting the company’s future financial performance and scenario planning.
Similarly, managing cash flow is also key. The financial manager must make sure there’s enough cash on hand for 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. This practice is what we call cash management.
Along with cash management, financial management includes revenue recognition, or reporting the company’s revenue according to standard accounting principles. Balancing accounts receivable turnover ratios is a key part of strategic cash conservation and management.
This may sound simple, but it isn’t always. Usually, in some companies, customers might pay months after receiving your service. At what point do you consider that money “yours” — and report the good news to investors?
Finally, managing financial controls involves analyzing how the company is performing financially compared with its plans and budgets. Methods for doing this include financial ratio analysis. Here, the financial manager compares line items on the company’s financial statements.
Strategic and Tactical Financial Management: The Difference
On a tactical level, financial management procedures govern how you process daily transactions. It also direct how you perform the monthly financial close, compare actual spending to what’s budgeted and ensure you meet auditor and tax requirements.
On a more strategic level, financial management feeds into vital financial planning and analysis. It also dictates into visioning activities, where finance leaders use data to help line-of-business colleagues plan future investments, spot opportunities and build resilient companies.
Importance of Financial Management
Solid financial management provides the foundation for three pillars of sound fiscal governance:
Strategizing
Identifying what needs to happen financially for the company to achieve its short- and long-term goals. Leaders need insights into current performance for detailed future planning for instance.
Decision-making
Helping business leaders decide the best way to execute on plans by providing up-to-date financial reports and data on relevant KPIs (Key Performing Indicators).
Controlling
Ensuring each department is contributing to the vision and operating within budget and in alignment with strategy.
With effective financial management, all employees know where the company is headed, and they have visibility into progress.
Types of Financial Management?
The functions above can be grouped into three broader types of financial management:
Capital budgeting
Capital budgeting relates to identifying what needs to happen financially for the company to achieve its short- and long-term goals.
Capital structure
As a business, determine how to pay for operations and/or growth. If interest rates are low, taking on debt might be the best answer. Your company might also seek funding from a private equity firm, consider selling assets like real estate or, where applicable, selling equity.
Working capital management
As conversed above, is making sure there’s enough cash on hand for day-to-day operations, like paying workers and purchasing raw materials for production.
At the outset, financial management responsibilities within a startup include making and sticking to a budget that aligns with the business plan, evaluating what to do with profits and making sure your bills get paid and that customers pay you.
Financial management gets more complicated as the company grows and adds finance and accounting contractors or staffers. You must ensure your employees get paid with accurate deductions, properly file taxes and financial statements, and watch for errors and fraud.
It is therefore important for you to understand and balance between strategic and tactical management. By building 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 18 months bring for the business? A solid financial management provides the systems and processes to answer those questions.
Nonetheless, financial management challenges can be overwhelming for both startups and growing businesses. Note that there are financial management software that can guide and help your business scale up in financial management.
It is important to note that businesses thrive with how their finances are handled. It is paramount that as a business, you understand how effectively you can manage your finances to minimize on unwarranted spending.
