In business, financial management is the practice of handling a companys finances in a way that allows it to be successful and compliant with regulations. That takes both a high-level plan and boots-on-the-ground execution.
Video: What is Financial Management?
What is Financial Management?
At its core, financial management is the practice of making a business plan and then ensuring all departments stay on track. Solid financial management enables the CFO 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.
ERP software can help finance teams achieve these goals: A financial management system combines several financial functions, such as 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.
Strategic vs. Tactical Financial Management
On a tactical level, financial management procedures govern how you process daily transactions, perform the monthly financial close, compare actual spending to whats budgeted and ensure you meet auditor and tax requirements.
On a more strategic level, financial management feeds into vital FP&A (financial planning and analysis) and visioning activities, where finance leaders use data to help line-of-business colleagues plan future investments, spot opportunities and build resilient companies.
Lets look at both angles.
Importance of Financial Management
Solid financial management provides the foundation for three pillars of sound fiscal governance:
Strategizing, or identifying what needs to happen financially for the company to achieve its short- and long-term goals. Leaders need insights into current performance for scenario planning, for example.
Decision-making, or helping business leaders decide the best way to execute on plans by providing up-to-date financial reports and data on relevant KPIs.
Controlling, or 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.
Objectives of Financial Management
Building on those pillars, financial managers help their companies in a variety of ways, including but not limited to:
Maximizing profits by providing 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 to ensure the company has enough money on hand to meet its obligations.
Ensuring compliance with state, federal and industry-specific regulations.
Developing financial scenarios based on the business current state and forecasts that assume a wide range of outcomes based on possible market conditions.
Dealing effectively with investors and the boards of directors.
Ultimately, its about applying effective management principles to the companys financial structure.
Scope of Financial Management
Financial management encompasses four major areas:
The financial manager projects how much money the company will need in order to maintain positive cash flow, allocate funds to grow or add new products or services and cope with unexpected events, and shares that information with business colleagues.
Planning may be broken down into categories including capital expenses, T&E and workforce and indirect and operational expenses.
The financial manager allocates the companys available funds to meet costs, such as mortgages or rents, salaries, raw materials, employee T&E and other obligations. Ideally there will be some left to put aside for emergencies and to fund new business opportunities.
Companies generally have a master budget and may have separate sub documents covering, for example, cash flow and operations; budgets may be static or flexible.
Static vs. Flexible BudgetingStaticFlexibleRemains the same even if there are significant changes from the assumptions made during planning.Adjusts based on changes in the assumptions used in the planning process.
Managing and assessing risk
Line-of-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.
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 companyand who signs off on those decisions.
Companies dont 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 managers 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 companys future financial performance and scenario planning.
Managing cash flow is also key. The financial manager must make sure theres 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, a practice called cash management.
Along with cash management, financial management includes revenue recognition, or reporting the companys 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 isnt always: At some companies, customers might pay months after receiving your service. At what point do you consider that money yoursand report the good news to investors?5 Tips to Improve Your Accounts Receivable Turnover Ratio1. Invoice regularly and accurately. If invoices dont go out on time, money will not come in on time.2. Always state payment terms. You cant enforce policies that you havent communicated to clients. If you make changes, call them out.3. Offer multiple ways to pay. New B2B options are coming online. Have you considered a payment gateway?4. Set follow-up reminders. Dont wait until customers are in arrears to start collection procedures. Be proactive, but not annoying, with reminders.5. Consider offering discounts for cash and prepayments. Cash(less) is king in retail, and you can reduce AR costs by encouraging customers to pay ahead rather than on your normal customer credit terms.Learn more about maximizing your AR turnover ratios.
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, in which the financial manager compares line items on the companys financial statements.
What are the Three Types of Financial Management?
The functions above can be grouped into three broader types of financial management:
Capital budgeting, which relates to identifying what needs to happen financially for the company to achieve its short- and long-term goals. Where should capital funds be expended to support growth?
Capital structure, determining how to pay for operations and/or growth. If interest rates are low, taking on debt might be the best answer. A 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 discussed above, is making sure theres enough cash on hand for day-to-day operations, like paying workers and purchasing raw materials for production.
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What is an Example of Financial Management?
Weve covered some examples of financial management in the functions section above. Now, lets cover how they all work together:
Say the CEO of a toothpaste company wants to introduce a new product: toothbrushes. Shell call on her team to estimate the cost of producing the toothbrushes and the financial manager to determine where those funds should come fromfor example, a bank loan.
The financial manager will acquire those funds and ensure theyre allocated to manufacture toothbrushes in the most cost-effective way possible. Assuming the toothbrushes sell well, the financial manager will gather data to help the management team decide whether to put the profits toward producing more toothbrushes, start a line of mouthwashes, pay a dividend to shareholders or take some other action.
Throughout the process, the financial manager will ensure the company has enough cash on hand to pay the new workers producing the toothbrushes. Shell also analyze whether the company is spending and generating as much money as she estimated when she budgeted for the project.
Financial Management for Startups
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.
As the company grows and adds finance and accounting contractors or staffers, financial management gets more complicated. You need to make sure your employees get paid, with accurate deductions; properly file taxes and financial statements; and watch for errors and fraud.
This all circles back to our opening discussion of balancing strategic and tactical. 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?
Solid financial management provides the systems and processes to answer those questions.