Central Financial Management Activities - Essay Example

This paper describes and discusses the importance of financial analysis, judgment, and cash flow monitoring. While financial analysis happens to be the first essential step in the financial management process, without which financial judgments hold no meaning, cash flow management is the only way to make sure that a company can survive in the long run. Central Financial Management Activities Being a manager in today’s competitive marketplace requires a sound understanding of the key aspects of finance. Financial management involves both judgment and analysis, for both of which a manager needs complete information that paints the financial picture of an organization at any point in time (Spiro 1996). It is not uncommon for an organization to employ its directors and/or its chairperson when it comes to judgment in the financial management process. Judgment must be borne on issues of strategy, performance, and resources, including key appointments and standards of conduct. Organizations may also employ non-executive directors for the judgment process, as an independent judgment that is free from bias is superior (Mcmenamin 1999). It is the task of the judgment personnel to evaluate what has taken place in relation to how the financial picture of an organization can be improved. The judges in the financial management process have the capacity to do away with certain decisions and thereby begin a new financial year with better prospects. Most Fortune 500-size firms use sophisticated mathematical and statistically-based methods in the financial management of inventory. A firm’s financial managers concentrate on the allocation and efficient management of financial resources in various inventory categories, for example, raw materials, work-in-progress, and finished goods. A firm’s production and inventory managers, on the other hand, are more interested in the efficient production of different finished goods items, and therefore pay close attention to employee production schedules, long production runs, and the storage of finished goods. It is not infrequent for a conflict of interest to arise between these two branches of management. The top management must intervene in this case to determine the proper investment of financial resources in the production function. Now a great deal of analysis enters the picture. For this, all firms must have data necessary to make precise calculations of cost-convenience-profit trade-offs (Grablowsky 1984). Large businesses almost always use quantitative techniques, such as EOQ and linear programming, to provide the additional information required for decision-making. Small firms, in contrast, rely on simpler controls. Historically, management judgment without the quantitative back up has worked satisfactorily for smaller firms. In a research on financial management of inventory, it was discovered that the most frequently used qualitative methods for determining inventory order and stock levels were “past experience” and “executive judgment” in the case of small businesses. Even Fortune 500 companies (studied previously) relied heavily on “executive judgment” (Grablowsky). It is the job of a finance manager of an organization to ask: ‘Is my organization using correct methods of financial analysis and judgment?’ Financial analysis happens to be the backbone of financial management, the first essential step toward gaining a solid understanding of a business, whether it is our own organization or our competitor’s. It is financial analysis that brings to our awareness an organization’s financial strengths and weaknesses, and the financial opportunities and risks. It is in fact an evaluation of a firm’s past, present, and anticipated future financial performance and financial condition. A finance manager sees the objectives of financial analysis to be the identification of a firm’s financial strengths and weaknesses in order to provide the basic foundation for financial decision-making and planning (Mcmenamin). While judgment in the financial management process occurs at many levels, financial analysis is a necessary prelude to judgment. Financial analysis is much more than a number crunching exercise (Spiro). Even though financial ratios are the principal tools of financial analysis and help diagnose the financial well-being of an organization, financial analysis requires interpretative skills to assess the expected strategic potential of our firm in addition to evaluating its past performance. There is a difference between the financial condition of a firm and its financial performance. Whereas the latter can be measured by means of profitability rations, financial condition is usually assessed with the use of liquidity ratios. As part of the financial management process, it is imperative for financial analysts to compare a firm’s performance over time and to evaluate its performance as compared to other like firms using financial ratios (Grablowsky). Without a clear current view of our financial picture and resources as compared to our past and our competitors, our organization does not have the means to move into the future with high profitability as its goal. There are four key questions to be answered as we analyze our firm’s financial position: (1) Is our business profitable?; (2) Is our business liquid enough to pay its bills on time?; (3) Is our business operating efficiently, that is, using its assets productively?; and (4) Is our business too highly geared, that is, overly dependent on borrowed money? To answer these questions, the financial analyst must develop ratios to measure profitability, liquidity, operating efficiency, and capital structure or gearing. Two of the most important outcomes which the analyst will hope to achieve from the analysis are an assessment of the firm’s level of return and its level of risk. In financial ratio analysis, a firm’s financial return is measured with the use of profitability ratios, and financial risk is measured by the help of liquidity, efficiency, and gearing ratios (Grablowsky). While it is true that the financial management process holds little or no meaning without financial analysis and judgment, there is more on the list of top concerns facing a financial manager. In a 2005 survey by Liverpool’s Bibby Financial Services it was found that small business owners and managers believe that cash flow management is the most significant day-to-day issue facing their businesses (“Cash Flow” 2005). Financial managers must closely track money flows, and there is no way to discount the importance of cash flow monitoring (Spiro). According to Bridget Mccrea (2002): “Cash flow is simply the money going into a business and out again—cash on hand and/or in a business account that’s used to pay company bills, salaries, and other expenses. Companies that are cash flow negative are simply spending more than their revenues bring in.” Because all firms minus the non-profit ones are running to make a profit, it is bad news for any business to run out of cash to meet its expenses. Mccrea reports that many small firms do indeed run into cash flow trouble, especially in the beginning, during growth spurts, or in shaky economic times. This is the reason why “cash flow” was the key word at corporate headquarters around Korea in 2001, as top executives scrambled to find ways to improve liquidity amid uncertain economic and business conditions (“Businesses Placing” 2001). To avoid running into cash flow trouble, accurate cash flow projections, including realistic projections of our financial results are required, or a company may not be able to survive in the long run (Lewis 2004). Additionally, businesses must be able to negotiate better terms with vendors and do background and reference checks on new customers. Adequate budgeting of income and expenses with an eye on receivables, set goals, and using the assistance of financial experts outside the company can also help in proper cash flow management (Mccrea). Cash flow management is about tracking cash and making sure it is there when we need it (Mach 1994). Any organization without the day-to-day cash to run itself can borrow money. But if a company runs into cash flow trouble time and time again, it may lose its credibility as a sound business operation and eventually there would be no entity willing to lend it cash. Even financial analysis and judgment would be of no use for a business that is failing due to cash flow trouble. Hence, cash flow management is of the essence. References 1. “Businesses Placing Top Priority on Improving Cash Flow this Year.” 12 January 2001. Korea Times. 2. “Cash Flow and Time Management are Top Business Woes.” 5 September 2005. Liverpool Echo. 3. Grablowsky, B. J. 1984. “Financial Management of Inventory.” Journal of Small Business Management, Vol. 22. 4. Lewis, Nicole. July 2004. “Avoiding a Cash Flow Crunch: Accurate Projections are Key to Your Business’ Survival.” Black Enterprise, Vol. 34. 5. Mack, Gracian. October 1994. “Keeping Track of Your Cash Flow.” Black Enterprise, Vol. 25, Issue 3. 6. Mccrea, Bridget. July 2002. “Going with the (Cash) Flow: Entrepreneurs can Look at these Strategies to Help the Bottom Line.” Black Enterprise, Vol. 32. 7. Mcmenamin, Jim. 1999. Financial Management: An Introduction. London: Routledge. 8. Spiro, Herbert T. 1996. Finance for the Nonfinancial Manager. 4th ed. New York: John Wiley & Sons Inc. Read More