Business Financial Management Fundamentals
Finance Management Monitors Cash Flows to Ensure Funds' Availability
Jan 27, 2009
The basic goals of financial management in a business context are to make funds available for:
- Investments for expansion and maintenance
- Working capital for operations
- Providing returns to business owners.
Corporate finance and small business finance managers seek to maximize shareholder/owner value and returns by:
- Monitoring the ROI of each investment
- Leveraging debt to increase returns on equity
- Adopting suitable pricing policies and
- Exercising effective control over costs.
Finance Management Areas and Tools
Investment Decisions: Businesses have to make decisions about which projects to invest in. The typical decision support tool for investment decisions is capital budgeting. Capital budgeting estimates the cash flows associated with a particular investment over its economic life. Cash outflows (e.g. payments for equipment and premises, operating expenses) and inflows (e.g. long-term loans and collection of receivables) under different investment options are compared, and the alternative with the best return is typically selected.
Cash flows are discounted for their time value. This means that an amount paid or received after two years is reduced to a present value by considering the interest that the money could have earned.
Working Capital: A business has to meet different kinds of payments on a day-to-day basis, including:
- Repayment installments of long-term loans
- Repayment of short-term borrowings
- Payment of current liabilities (e.g. supply creditors, tax dues) and operating expenses (e.g. salaries, bank interest, travel)
- Extending customer credit (postponing a cash receipt)
Working capital management involves estimating the cash requirements for every week/month/quarter/year and exploring the best options to make required funds available.
Profit Deployment: Profits can be retained in the business or distributed to owners. Investors invest in businesses to earn a return and this return can take the form of capital appreciation (increase in the value of the business) or dividends/owners' drawings.
Retaining profits in the business and using it to expand operations typically leads to capital appreciation. However, this is possible only if profit distribution to owners is restricted to an amount less than the full amount of profit. Financial managers seek to strike a compromise between the two.
Business Financing Options
Common financing options and their typical use are:
- Owner funds in the forms of share capital or cash brought in by proprietor or partners. Lenders typically look for a level of owner funding before agreeing to advance loans.
- Venture capital funding involves getting private share capital from investors. This option is typically for innovative businesses with fast growth potential.
- Long-term loans from banks and other financing institutions are used to finance long-term investments such as setting up a new plant
- Demand loans and lines of credit from banks are used to finance working capital requirements
- Availing supplier credit to postpone payments for supplies received
- Options such as factoring receivables and government grants might also be available
- Informal borrowings from relatives and friends, or formal borrowings from associate companies
Loans are typically secured by a charge on business assets like equipment, buildings, inventories, etc.
Business financial management has the twin objectives of ensuring availability of funds when needed, and maximizing the returns to owners of the business. Financial managers use tools like financial ratio analysis discounted cash flow analysis and cash flow forecasts to achieve these objectives.
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