In simple words, how to find & use financing opportunities & investments in an increasingly complex & ever-changing environment is known as financial management. You may also say that financial management is all about controlling the flow of money coming in and going out of the business.
Basic Concepts of Financial Management
Following are some of the significant concepts of financial management.
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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 are 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 the 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 snapshot of the financial health of a business organization is the balance sheet. It reflects what assets are possessed by the business organization & the sources of acquiring these assets.
Statement of Shareholder’s Equity:
The share of owners in the business is provided by the statement of shareholders’ equity.
Statement of Cash Flows:
The cash movement during the operations in an accounting period is explicitly reflected in the statement of cash flows.
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Investment Decisions & Capital Budgeting
As investment decisions usually involve huge sums of money, they are the most critical. The prosperity or doom of a business is determined by these investment decisions.
The future income of a business organization depends upon how much investment is made, in what kinds of assets, and how these assets add overall value to 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 the budget plan. While analyzing investment decisions, the following techniques & concepts are employed:
- Time Value of Money
- Interest Rate Formulas
- Internal Rate of Return
- Net Present Value
- Discounted Cash Flows
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Risk & Return
Money is invested by investors, either individuals or institutions, with the expectation of earning a return on their investment. Investors are constrained by risk as they wish & attempt to earn maximum return.
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Corporate Financing & Capital Structure
Capital or funds are required by a business organization when it needs to expand. It is the primary responsibility of the finance department in the organization to acquire funds.
Funds can be obtained 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.
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Valuation
Company valuation or asset valuation is significant not only for financial managers but also for investors & creditors. In order to make important financing & investment decisions, it is essential to know the value of the business organization & its assets.
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Working Capital & Inventory Management
Inventory management & working capital refer to the effective management of current assets. The operating efficiency of the business organization increases through optimal and effective utilization of inventory & working capital.
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International Finance & Foreign Exchange
The role of international finance has increased manifold with the increasing importance of global markets & international trade. Finance managers now have more choices regarding financing & investing than ever before in a global environment.
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Business Legal Entities
Sole Proprietorship:
Sole proprietorship refers to an unincorporated business owned by one person. It is simple to start a business as a sole proprietor.
Corporation:
A 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 the limited liability advantage of a corporation is combined with the tax advantages of a partnership.
S-Type Corporation:
In the case of an S-Type Corporation, there is limited liability 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 they receive in the shape of dividends, salaries, and bonuses.
On the other hand, in 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 S corporations, but more benefits & flexibility are offered by LLPs.
PC:
Professional Corporation (PC) is usually formed by professionals to protect themselves against litigation. Businesses of professionals like doctors, lawyers, and accountants are registered as Professional Corporations.
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Internal & External Business Environment
Internal Business Environment
The following are contained in the internal business environment:
- 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
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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 the buying & selling of short-term liquid debt instruments takes place is referred to as the money market.
Something which is easily encashable is referred to as liquid. In money markets, the following financial instruments are traded:
- Short-Term Bonds (e.g., Federal Investment Bonds, Treasury Bills, Debentures, Corporate Bonds)
- Call Money, Overnight lending & borrowing, Inter-bank short-term
- Leases, loans, Certificates of Deposits (CDs), Insurance Policies
- Road-side money lenders, Badlah (money lending against shares)
Real Assets or Physical Asset Markets
The active markets of physical & real assets are as follows:
- Gold Market, Cotton Exchange, Kapra Market
- Property (house, land, apartment, warehouse)
- Used cars, computer hardware, sugar, wheat, vegetables, etc.
