Do you want to know what is financial management? what are its basic concepts? You are on the right spot to know the answer of this query.
What is Financial Management
In simple words how to find & use financing opportunities & investments in an increasing complex & ever-changing environments know as financial management. You may also say that financial management is all about controlling the flow of money coming in and going out from the business.
Basic Concepts of Financial Management
Following are some of significant concepts of financial Management.
Analysis of Financial Statements
One of the most common techniques of financial analysis is the analysis of financial statements. In this analysis, on the basis of past performance, the financial health & financial performance of a business organization is analyzed. In the analysis process, the following financial statements are used.
- Income Statement or Profit & Loss Statement: Operating efficiency or profitability of the business organization is reflected in income statement as a consequence of its operations along with the net profit available to the shareholders for a given year. Some insight into the financial performance of the business organization is provided by this statement.
- Balance Sheet: At a particular time, the snap shot of financial health of a business organization is balance sheet. It reflects what assets are possessed by the business organization & the sources of getting these assets.
- Statement of Shareholder’s Equity: The share of owners in the business is provided by statement of shareholders equity.
- Statement of Cash Flows: The cash movement during the operations in an accounting period is reflected explicitly in statement of cash flows.
Investment Decisions & Capital Budgeting
As investment decisions usually involve huge sums of money therefore, they are the most critical. The prosperity or doom to a business is bringing by these investment decisions.
The future income of business organization depends upon on how much investment is made, in what kinds of assets and how these assets add entire value of the business organization.
Investment in fixed assets is strictly related to capital budgeting. The “capital” in this case is related to fixed assets that are employed in production.
On the other hand details of projected cash outflows & inflows over some future period are included in budget plan. While analyzing investment decisions following techniques & concepts are employed.
- Time Value of Money
- Interest Rate Formulas
- Internal Rate of Return
- Net Present Value
- Discounted Cash Flows
Risk & Return
Money is invested by investors, either individual or institution, with the expectation of earning a return on their investment. Investors are constrained by risk as they wish & attempt to earn maximum return.
Corporate Financing & Capital Structure
Capital or funds are required by business organization when it needs to expand. It is the primary responsibility of the finance department in the organization to acquire funds.
See Also: How to Set Pricing Strategy
Funds can be got in many ways. In the form of equity or debt, finances can be raised. The capital structure of the business organization is constituted by the portion of equity & debt.
Valuation
Company valuation or asset is significant not only for financial managers, but also for investors & creditors. In order to make important financing & investment choices, it is significant to know value of business organization & its assets.
Working Capital & Inventory Management
Inventory management & working capital refers to the effective management of current assets. The operating efficiency of the business organization increases by an optimal and effective utilization of inventory & working capital.
International Finance & Foreign Exchange
The role of international finance has increased manifold, with the increasing importance of global markets & international trade. The finance managers have many choices referring to financing & investing than ever before, in a global environment.
Business Legal Entities
Sole Proprietorship: Sole proprietorship refers to unincorporated business owned by one person. It is simple to start a business as a sole proprietor.
Corporation: Corporation refers to a separate legal entity registered by the government and is a limited company. It is distinct & separate from its managers & owners. It can be public limited or private limited.
Hybrids (Mixed): Specialized kinds of partnerships are hybrid organizations in which limited liability advantage of corporation is combined with the tax advantages of partnership.
S-Type Corporation: In case of S-Type Corporation there is limited liability and without double taxation. The company itself is taxed on business profits, in a regular corporation.
Furthermore, the owners pay individual income tax on the amount that they receive in the shape of dividends, salaries and bonuses.
On the other hand S-Type corporations, owners receive all business profits and report them on their personal income tax returns. The S corporation does not pay any income tax.
LLP: Limited Liability Partnership (LLP) is also a kind of partnership which avoids double taxation and allows limited liability to the owners.
These organizations have much similarity to the S corporations but more benefits & flexibility is offered by LLPs.
PC: Professional Corporation or Personal Corporations (PC) is usually made by professionals to protect them against litigations. Businesses of professionals like doctors, lawyers and accountants are registered as Professional Corporation.
Internal & External Business Environment
Internal Business Environment: Following are contained in the internal environment business.
- Marketing
- Finance
- Operations (Manufacturing, Production)
- Human Resources
- Technology
- Other Functions (Communications, Logistics)
External Business Environment: The operations & functions of the organization are affected by the following external environmental factors.
- Suppliers
- Customers
- Competitors
- Macro Economy/Markets
- Government/Legal Agencies & Regulations
- Technological Revolution
Financial Markets
Capital Markets: These are the markets for corporate stock & long term debt.
- Stock Exchange: A stock exchange is a place where Term Finance Certificates (TFC), listed shares and national investment trust units (NIT) are exchanged & traded between sellers & buyers.
- Long Term Bonds: In capital markets, corporate bonds & long term bonds are also traded.
Money Markets: A market where there are selling & buying of short term liquid debt instrument is generally made, is refer as money market.
Something which is easily en-cashable is refers to as liquid. In money markets following financial instruments are traded.
- Short Term Bonds: Examples are Federal Investment Bonds (FIB), Treasury Bills (T-Bills), Debentures, Corporate Bonds.
- Call Money, Overnight lending & borrowing, Inter-bank short-term.
- Leases, loans, Certificates of Deposits (CD’s), Insurance Policies
- Road-side money lenders, Badlah (money sending against shares)
Real Assets or Physical Asset Markets: The active markets of physical & real assets are as follow.
- Gold Market, Cotton Exchange, Kapra Market.
- Property (house, land, apartment, warehouse)
- Used cars, computer hardware, sugar, wheat, vegetables, etc
