Financial Management
Finance is important in every
business. Decisions made by managers throughout the enterprise have financial
implications. No business can be started without raising the funds to begin
operations. How much money is needed for the business? Who will invest equity
money in the new venture? How much debt is needed and from whom can it be
borrowed? Must decisions be made by management to allocate the enterprise's
resources profitably? What is the expected rate of return on an investment?
Does an investment's expected profit justify its risk? What effect will
management decisions probably have on the value of the enterprise? All these
and more are issues involved in managerial finance.
Managerial finance, sometimes called financial
management, involves decisions within enterprise. The basic goal of managerial
finance is to maximize the wealth of an enterprise's owners over the long run.
In the proprietorship and partnership forms of business organization, this
means increasing the owners' equity. In the corporation, this means increasing
the market price of the corporation's common stock shares.
Financial management begins with the creation of a
financial plan. The plan includes timing and amount of funds and the inflow and
outflow of money.
The financial manager develops and controls the
financial plan. He also forecasts the economic conditions, the company's
revenues, expenses and profits.
The financial manager's job starts and ends with the
company's objectives. He reviews them and determines the funding they require.
The financial manager compares the expenses involved to the expected revenues.
It helps him to predict cash flow. Cash flow is the movement of money into and out of an
organization The available cash consists of beginning capital plus customer
payments and funds from financing.
The financial manager plans a strategy to make the ending cash
positive. If cash outflow exceeds cash inflow the company will run out of cash.
The solution is to reduce outflows. The financial manager can trim expenses or
ask the customers to pay faster.
Money is needed both to start a business and to keep
it going. The original investment of the owners, along with money they may have
borrowed, should be enough to get operations under way. Then, it would seem
that income from sales could be used to finance the firm's continuing
operations and to provide a profit as well.
This is exactly what happens
in a successful firm. But sales revenue does not generally flow evenly. Both
income and expenses may vary from season to season or from year to year.
Temporary funding may be needed when expenses are high or income is low. Then,
too, special situations, such as the opportunity to purchase a new facility or
expand an existing facility, may require more money than is available within a firm.
In either case, the firm looks to outside sources of financing. In this
situation the financial manager chooses either short-term or long-term
financing techniques.
Short-term financing is money that will be used for
a period of one year or less and then repaid. A firm might need short-term
financing to pay for a new promotional campaign that is expected to increase
sales revenue.
Although there are many
short-term financing needs, two deserve special attention. First, certain
necessary business practices may affect a firm's cash flow and create a need
for short-term financing. The ideal is having sufficient money coming into the firm,
in any period, to cover the firm's expenses during that period. But the ideal
is not always achieved. For example, a firm that offers credit to its customers
may find an imbalance in its cash flow. Such credit purchases are generally not
paid until thirty or sixty days (or more) after the transaction. Short-term
financing is then needed to pay the firm's bills until customers have paid
theirs. An unexpectedly slow selling season or unanticipated expenses may also
cause a cash-flow problem.
A second major need for
short-term financing that is related to a firm's cash-flow problem is
inventory. Inventory requires considerable investment for most manufacturers,
wholesalers, and retailers. Moreover, most goods are manufactured four to nine
months before they are actually sold to the ultimate customer. As a result,
manufacturers that engage in this type of speculative production often need
short-term financing. The borrowed money is used to buy materials and supplies,
to pay wages and rent, and to cover inventory costs until the goods are sold.
Then, the money is repaid out of sales revenue. Wholesalers and retailers may
need short-term financing to build up their inventories before peak selling
periods. Again the money is repaid when the merchandise is sold.
Long-term financing is money that will be used for
longer than one year. Long-term financing is obviously needed to start a new
business. It is also needed for executing business expansions and mergers, for
developing and marketing new products, and for replacing equipment that becomes
outmoded or inefficient.
At the end of the fiscal year the financial manager
reviews the company's financial status and plans the next year's financial
strategy.
