Importance of Financial Management
Finance is a key
functional area of business management. This area is commonly referred
to as Financial Management. The term defines the achievement of key
financial objectives by making investment and financial decisions.
Essentially, it is the management of all the processes associated with
the efficient acquisition and deployment of both short and long-term
financial resources. Financial Management assists an organisation's
management to reach its financial objectives such as the creation of
wealth, solvency, liquidity, growth and return on investment achieved
through a process of financial planning, control and decision-making.
Financial Control
Financial
control consists of different strategies to manage finances necessary
to achieve the primary purpose of every business; which is to earn
profit. Budgets are the traditional financial control method and provide
a measuring basis which performance can be assessed. By engaging in a
yearly budgeting process a business can make plans and forecasts for the
year ahead. Control action should be taken when actual performance
appears not to be matching the outline of the budget. Therefore by
monthly monitoring of expenses, controlling methods can be put into
place when expenses becoming higher than figures stated in budget (such
as spending cut backs or extra working hours). And by determining the
reasons why figures do not match the yearly budget plan, a business can
therefore make necessary plans for this not to occur in the future.
Monthly monitoring of expenses is another example of a financial
control. Such data includes cash balance, total wages costs and hours
worked key sources of income, unusual or above budget expenditures.
Three Main Financial Statements
The 3 main financial statements necessary to analysis and improve on finance viability:
1) Balance sheet - 'A statement of financial position that shows the assets of a business and the claims on those assets'
2)
Income Statement - 'A financial statement (also known as profit and
loss account) that measures and reports the profit (or loss) the
business has generated during a period.'
3) The cash flow statement - 'A statement that shows the sources and uses of cash for a period'
By
analysing these three financial statements on a regular basis a
business can proactively forecast problems or opportunities before they
arise. The 3 main financial statements are also considered as financial
controls as these statements are used to understand and interpret the
financial conditions of a business as a means of management and control.
The statements enable a business to set guidelines and policies that
enable growth and business success. An annual Profit and Loss statement
is considered the most important financial statement and UK businesses
are legally required to lodge a Profit & Loss Account with Companies
House. In regards to cash flow, cash inflows are payments for products
or services and interest on savings and investments. Cash outflows are a
combination of many things including purchasing stock, daily operating
expenses, fixed assets and government taxes. A business is also required
to produce a balance sheet annually for reporting purposes. It provides
a report of assets or liabilities.
Budgeting and Budgetary Control
A
budget as a qualified statement, for a defined period of time, which
may include planned revenues, expenses, assets, liabilities and cash
flows. It is a short-term plan of working towards financial objectives.
There are several styles of budgeting, these styles include -
* Fixed - does not allow for variations
* Flexible - Adjusts or flexes
* Continuous or rolling - continually amended
* Zero-based - needs assessed
* Incremental - uses previous budget with increment
Budgets
are necessary to provide a basis for control, helping identify
short-term problems and promote forward thinking. However, there is a
need for budgets to be adaptable if they become unrealistic due to
sudden changes in the business environment. This is known as 'Flexing
the Budget' (which simply means revising the budget).
A variance
report is required to indicate whether performance is below or above the
budgeted level. It is the difference between the budgeted level of
costs and revenue and the actual levels of costs and revenues also
referred to as variance analysis. Budgets can also have a behavioural
effect motivating the management team and staff to achieve better
performance and help promote forward thinking.
Effective Business Planning
A
business plan is made up of many elements but no business plan is
complete without this financial information. For business planning to be
effective, the budget and the three main financial statements (Profit
& Loss, Balance Sheet and the cash flow statement) must be taken
into consideration. A financial statement is the core of a business plan
as they are used to identify various business strategies. Financial
planning is interlinked with all elements of a business plan. Five key
strategic plans interlinked with a budget (plan); 1) establishing
mission and objectives, 2) undertaking a position analysis, 3)
identifying and assess the strategy options, 4) selecting strategic
options, 5) perform, review and control. By taking all of these elements
into considering, a business can create an effective business plan
containing financial data and projections.