Financial management and its main components

Financial Management can be defined as the management of the finances of a business or organization in order to achieve financial objectives. Taking a commercial business as the most common organizational structure, the key objectives of financial management would be to:

1. Create wealth for the business

2. Generate cash

3. Provide an adequate return on investment bearing in mind the risks that the business is taking and the resources invested.

There are three key elements to the process of financial management: 1). Financial Planning. Management need to ensure that enough funding is available at the right time to meet the needs of the business. In the short term, funding may be needed to invest in equipment and stocks, pay employees and fund sales made on credit. In the medium and long term, funding may be required for significant additions to the productive capacity (an ability of a business to produce) or to make acquisitions.

2). Financial Control. Financial control is a critically important activity to help the business ensure that the business is meeting its objectives. Financial control addresses questions such as:

1. Are assets being used efficiently?

2. Are the businesses assets secure?

3. Do management act in the best interest of shareholders and in accordance with business rules?

3). Financial Decision-making. The key aspects of financial decision-making relate to investment, financing and dividends - the part of the firm`s profits that goes to stockholders:

• Investments must be financed in some way – however there are always financing alternatives that can be considered. For example it is possible to raise finance from selling new shares, borrowing from banks or taking credit from suppliers

• A key financing decision is whether profits earned by the business should be retained rather than distributed to shareholders via dividends. If dividends are too high, the business may be starved of funding to reinvest in growing revenues and profits further.

Efficient financial management requires the existence of some objectives, which are as follows:

1) Profit Maximization:

The objective of financial management is the same as the objective of a company which is to earn profit. But profit maximization alone cannot be the sole objective of a company. It is a limited objective. If profits are given undue importance then problems may arise as discussed below. The term profit is vague and it involves much more contradictions. Profit maximization must be attempted with a realization of risks involved. A positive relationship exists between risk and profits. So both risk and profit objectives should be balanced. Profit Maximization fails to take into account the time pattern of returns. Profit maximization does not take into account the social considerations.

2) Wealth Maximization:

It is commonly understood that the objective of a firm is to maximize value and wealth. The value of a firm is represented by the market price of the company's stock. The market price of a firm's stock represents the assesment of all market participants as to what the value of the particular firm is. It takes in to account present and prospective future earnings per share, the timing and risk of these earning, the dividend policy of the firm and many other factors that bear upon the market price of the stock. Market price acts as the performance index or report card of the firm's progress and potential. Prices in the share markets are affected by many factors like general economic outlook, outlook of the particular company, technical factors and even mass psychology. Normally this value is a function of two factors:

• The anticipated rate of earnings per share of the company

• The capitalization rate.

The likely rate of earnings per shares depend upon the assessment of how profitable a company may be in the future. The capitalization rate reflects the attitude of the investors for the company.