Good financial management is the secret to a profitable business – it is the key that successful founders use to ensure that their investment brings them maximum return.
Let’s understand what financial management is, the various activities that come under its scope, and the 5 laws of financial management that you must know.
Table of Contents
What is Financial Management?
Financial Management is a function of business that ensures that financial resources are invested and allocated efficiently to ensure maximum returns. Simply put, financial management is knowing where to put money for maximum profit.
Financial managers work to first identify the source of capital, and then the best way to allocate that money to the various departments in the business. Efficient fund allocation promotes business growth and paves the way to profitability.
How Financial Management Works
A business runs on capital – the investment put into the business. Investment can come from a variety of sources. In most cases, the founder of the business puts some of his own money into the business. His investment is supplemented by loans from banks or investments from investors.
It is up to the business management to then decide where to put this money.
How much of the capital should be used to buy fixed assets for the business? How much for employee well-being? How much should the business invest in deposits or bonds?
If you make these decisions for your business, then congratulations! You are a financial manager.
Of course, there are many dimensions to financial management for businesses. Huge multinational corporations have entire departments dedicated to financial management. Let’s take a look at why financial management is probably the single most important thing for a business founder to know.
Objectives of Financial Management
The objectives of financial management encompass a range of goals and aims that guide organizations in effectively managing their financial resources. Here are some common objectives:
Maximizing profits is a fundamental objective of financial management. This involves increasing revenues, minimizing costs, and generating sustainable profitability for the organization.
Financial management aims to maximize shareholder wealth by increasing the overall value of the organization. This objective considers not only short-term profits but also long-term growth and the organization’s ability to generate cash flows and create value for shareholders.
Ensuring adequate liquidity is crucial for financial stability. Financial management focuses on managing cash flow, maintaining sufficient working capital, and having access to funds to meet short-term obligations and unforeseen financial needs.
Financial management aims to identify, assess, and manage financial risks to protect the organization’s financial health. This includes mitigating risks related to market volatility, credit default, interest rate fluctuations, currency exchange rates, and other financial uncertainties.
Capital Structure Optimization
Financial management strives to optimize the capital structure by determining the right mix of debt and equity financing. Balancing the cost of capital, risk exposure, and capital requirements is essential to maximize the organization’s value and minimize the cost of financing.
Efficient Resource Allocation
Financial management aims to allocate financial resources efficiently and effectively across different projects, departments, and investment opportunities. This involves evaluating and selecting the most viable projects and ensuring optimal utilization of available resources.
Compliance and Governance
Financial management focuses on adhering to legal and regulatory requirements, financial reporting standards, and corporate governance practices. Ensuring transparency, accountability, and ethical behaviour in financial decision-making is a key objective.
It’s important to note that the objectives of financial management can vary across organizations depending on factors such as industry, ownership structure, and strategic priorities. These objectives provide a framework for making sound financial decisions and driving the organization towards financial success and sustainability.
Scope of Financial Management
The scope of financial management in a business is across four major areas:
This involves setting financial goals, creating budgets, and developing strategies to achieve those goals. It includes forecasting future financial needs, estimating revenue and expenses, and determining the appropriate mix of financing.
Cash Flow Management
Managing cash inflows and outflows is crucial for maintaining liquidity and ensuring that an organization has sufficient funds to meet its obligations. Financial managers monitor cash flow patterns, project future cash flows, and implement strategies to optimize cash management, including cash conversion cycles and working capital management.
Financial managers assess and manage various financial risks that can impact the organization’s financial stability and profitability. This includes identifying and mitigating risks related to interest rates, foreign exchange, credit, market fluctuations, and other factors that can affect financial performance.
Financial management involves analyzing financial statements, performance metrics, and other financial data to assess the organization’s financial health and performance. It includes preparing and presenting financial reports to management, investors, regulators, and other stakeholders.
The 5 Laws of Financial Management for Businesses
A big part of why businesses fail has to do with improper management of funds. In the initial stages of a business, when money is fresh and spirits are high, it is important to know how to make the most of the money in your coffers.
What does “proper management of finances” look like? Here are the 5 laws of financial management every business founder should know.
Every Rupee Makes (at least) Two
Money invested into a business must benefit the business, and ultimately, all business functions must aim at this.
A business becomes profitable when the money earned is less than the money spent. Let’s say Shalini spends Rs 100 every month on running her e-commerce shop. If she sells goods worth Rs 250 in her first month, she’s made a profit of Rs 150.
Every rupee she spent on her business multiplied 2.5x!
This is the basic principle of financial management. Any money spent on the business must bring more money back!
Of course, nobody can run a business without taking on losses. But it is important to ensure that losses are as minimal as possible.
Business Takes Off On Long Runways
The cash runway of a business is how long a business’s cash is able to sustain operations.
Shalini’s business incurs expenses of Rs 100 every month – let’s say her business has Rs 10,000 in cash at the moment. This means her cash runway is 100 months or around 8 years!
Even if Shalini’s business does not earn even Rs 1 in profit, the cash that she has will sustain operations for 8 years to come.
A long, healthy cash runway is an important part of financial management. Businesses should not only have enough money to sustain operations for a long time, but they should also be able to extend that runway continuously by earning profits.
Compliance is Key
There are laws and taxes in place to ensure that businesses contribute positively to society. A business has to comply with these laws, for its own best interest.
Taxes like TDS, TCS, and GST make sure that the business gives back to the government and community. Laws like the Minimum Wages Act and the Sale of Goods Act protect the employees and the public from the dangers of profit-mongering that businesses are prone to.
Financial Management for businesses includes compliance: making sure that the business pays its taxes on time and correctly, and follows all the necessary laws.
In bigger companies and MNCs, there are experts and whole teams responsible for compliance – but in a small business or startup, the founder is generally responsible for ensuring compliance, and this can be challenging.
Tax calculation is not easy, especially when businesses absolutely have to get the numbers right, or be at risk of having to pay a fine.
Thankfully, there are many tools to help businesses with tax payments and compliances.
Forecast Your Future
Risk is inevitable. If business owners and managers do not anticipate and provide for potential risk, they are setting themselves up for failure!
There are many different kinds of risks that can affect a business. Some of these risks can be anticipated, like risks due to price hikes or interest rates. But most of these risks cannot be anticipated, like the COVID pandemic, or the Russia-Ukraine crisis.
Ensuring that there is money kept aside for unforeseen crises is also financial management. Businesses that have this reserve can thrive even in the most difficult conditions!
Only the Best Financial Support For Your Business
A big part of financial management is handling money – the biggest part, in fact! Businesses deal with big amounts of money coming in and going out on a daily basis, and need specialized banking services to handle these transaction volumes.
Businesses also have other needs: payroll, vendor management, tax payments and compliances, corporate credit cards, business loans and so much more.
A growing business needs a good bank to support its financial management – this is possibly the most important rule of all. But what makes for good banking support?
- Provides all banking-related services for a business in one place
- Reliable and sturdy with zero downtime, because business banking never stops
- Debit cards, credit cards, net banking, mobile app, and other accessibility services
- Integrations with accounting software so business owners don’t have to manually reconcile every transaction made
- Best customer service in case of any issue
These are a few of the things that founders should look for when picking a bank for their business. RazorpayX provides all the services listed above and even some special features, specifically for Indian business founders!
What is financial management?
Financial management is knowing how and where to put your money to ensure maximum returns. Successful financial management for a business would include efficiently allocating finances to the various departments in such a way that profitability is maximum.
Do I need to hire a financial manager for my business?
If you are a small business owner or a startup founder, chances are you are the financial manager for your business already! You only need to keep in mind the 5 laws of financial management and you're good to go.
Is financial management important?
Yes, it is possibly the most important thing for a business. It ensures that the business's resources are being used in the best way possible and brings the business up to profitability.
What is good financial management?
Good financial management follows the 5 Laws of Financial Management. Each law in this blog talks about an aspect of financial management that is important to businesses.