Financial management is the art and ability of money management to handle and manage your financial situations in a responsible manner. (Mitchell) On a personal level, financial management is how you manage your household financial situations. On a business level, financial management is how managers handle the financial concerns and needs of their company. In either situation, financial management focuses on and financial independence and achieving your financial goals (or those of your company). Although seldom taught even in affluent families, financial management is certainly one of the most important aspects of survival in society. Often, when it is picked up, the “education” is achieved in the course of learning other things such as learning a business or by sheer luck. Some parents may stress the importance of managing money, but few parents actually teach it, and it would not be far-fetched to say that relatively few people actually understand what is required to manage finances. Most people who succeed in managing their finances tend to do so by luck.
What is involved in financial management? It involves including planning, investment, credit factors and spending habits. Although these could be viewed as “money management”, for the most part, the actual task of money management involves how you actually spend and use the money you have. That use affects other aspects of financial management such as your credit, your investment and your investment habits. In business, entrepreneurs and financial managers should fully understand what information top management needs. The most common reason businesses fail is under capitalization, i.e., not starting with enough money to carry it through the growth period. Poor cash flow and inadequate expense control are two other important factors. On a similar note, you need to fully understand your personal and household needs in order to manage your personal finances.
Big and small businesses have many financial similarities. Businesses and entrepreneurs need to have knowledge of both finance and accounting. Both are important. Finance teaches how to use manage your money while accounting allows you to keep track of it. Both go hand in hand, and indeed, it is difficult to manage and use your money effectively if you lose track of it. All businesses should get budget requests from their departments. The capital budget is used for major purchases, the cash budget is used for cash flow and the operating budget determines how much profit your business can expect to make and what to do with the money.
As has been pointed out, under capitalization is a major reason businesses fail. This is mostly because businesses need cash to operate and cover their day-to-day operating expenses and costs. Both big and small businesses sometimes need short-term financing to cover the daily operating costs or for emergency situations. If a business pays its bills early but its customers pay late, the business may encounter cash problems. Sources of short-term cash include promissory notes, family and friends, commercial bank loans, factoring and commercial paper. Entrepreneurs can also barrow from themselves, but that is dangerous. When you barrow from yourself, it can ruin your credit rating and affect your business.
Although some sources of short term financing are costly, they can actually be the source of profit if used properly and effectively, and with wise money management. For example, factoring may cost 10% in 30 days (which would be 120% annualized), but it can allow businesses to take advantage of discounts and opportunities that may allow them to realize a larger profit than the cost of factoring. In that situation, the company would make money because they could take advantage of an opportunity they might otherwise lose, but wise money management is also involved. The company must pay the factor!
Large companies may issue stocks or bonds to acquire long-term finance. Small companies must take out loans. You need a good credit rating to get a loan. Initially, the funds generated by means of long term financing are used to cover short term situations such as major purchases (capital budget needs) and to provide working capital and cash flow (cash budget needs). The capital raised by issuing stocks and bonds may also establish a capital reserve that the company can draw upon in lean times.
One thing many individuals overlook when managing your personal finances is that they must pay themselves. Townsend says, “Pay yourself first by making an investment in your future.” She refers to this as a means to build a foundation for wealth and financial security. Many people invest realizing that they are investing in their future, but without really thinking about what this means. They realize the need to set money aside for their future, and many do this successfully, but they are just as likely to use their invested funds for other things so as to leave themselves with no nest egg for the future. Perhaps they are not always to blame. When an emergency arises, the nature of that situation (or those emergency situations) may well justify resorting to funds stored away for the future, but when that happens, you have created a new emergency, in a sense, because you have taken away from your future. Ultimately, you have sidetracked yourself from achieving your goals. In order to get back on track, you must find a way, if possible, to replace the funds you have barrowed from yourself.
Financial management involves setting goals, establishing a budget, following that budget and identifying sources of income. Financial management is meaningless without goals. One of your first and primary goals is to have money for later in life when income dwindles due to retirement income, the increased costs of living and your decreased access to income sources other than savings and retirement. This means that some portion of your investment should be in income stream instruments such as bonds. While many people invest in stocks, few stop to think that the only way to profit from stocks is to sell them. You may buy a stock for $1.00 and it may increase to $100 in 20 years, but the only way to access any of that money is to sell it. When sold, it no longer represents an investment, and it never represented an income stream. When looking to your future, you desire an income stream, not an investment! Perhaps that is not the best way to make the statement. Perhaps it is best to say that you desire an investment that is an income stream rather than simply an investment that grows in value. As a result, the best “investments” are those that represent some form of future cash flow.
Credit is not a dirty word. In fact, and perhaps unfortunately, credit is an important factor in any financial management plan. Credit is defined as the amount of money available through lenders (Mitchell). Credit, of course, is a form of barrowing. As you credit worthiness, or lack thereof, improves (or otherwise), you earn a credit score which ultimately determines how easy it is for you to barrow money. Businesses view your credit score as a sign of your financial character, your earning power and the your net worth. (Mitchell) Your credit score can help you because it can allow you access to other people’s money, but it can hurt you because it is viewed as a sign of your personal character. Perhaps that’s quite inappropriate, but often in the business worlds, your financial character and your personal character are one and the same.
On last consideration is very important; the taxman. Tax planning is a crucial aspect of financial management and financial planning. Tax laws change often and rapidly. While you may know accounting or have accountants on your staff, it is crucial to be in contact with accountants who keep abreast of the changing tax laws. Being aware of Uncle Sam’s requirements is central to managing your finances. Taxes are a major aspect of financial management. Financial planning, especially tax planning, is among the most tricky aspects of financial management.
Eugene F. Brigham and Joel F. Houston. Fundamentals of Financial Management, 9th Edition. New York, New York (2005).
Foerster, Stephen Robert. Financial Management, Norton & Company Ltd: Midland, Pennsylvania (2003).
Mitchell, Towanda. Financial Information Rights and Education. UMBC, Money Matters Seminar. <http://www.umbc.edu/promise/Financial%20Management%20Seminar.htm>
Financial Management Essay
Essay Writers, 3 pages due 10/17/2006