Role of financial management

Money (finance) is needed both to start a business and to keep it operating. Many businesses
have failed because they mismanaged their financial resources. Proper financial management,
however, can ensure that objectives and goals are achieved. And like all effective management,
financial management begins with setting goals and planning.

Goals are the longer-term outcomes of a business.

The main purpose or goal for a business is usually to
maximise profits. A business can only maximise
profits if it has a carefully determined process by
which it will achieve its goals. This process — its
strategy — is the major tool that assists a business
to achieve its goals.

Strategic plans are the most important plans for a business. They encompass a long- term view
of where the business is going, how it will get there and a monitoring process to keep track of
progress along the way. Strategic plans may cover periods of up to 10 years. The strategies that
a business uses to achieve its goals are incorporated into a strategic plan. For example, if the
strategic plan for Blue Green Skateboards is to be a market leader in the sale of skateboards, it
might adopt the strategy of purchasing two new stores, one north and one south of its present
location.

Managing financial resources

Financial resources are those resources of a business that have a
monetary or money value.

Financial management is the planning and monitoring of a

business’s financial resources to enable the business to achieve
its financial goals.

Financial management is crucial if a business is to achieve its

financial goals. The mismanagement of financial resources can lead
to problems such as:

 insufficient cash to pay suppliers

 inadequate capital for expansion
 too many assets that are non-productive
 delays in accounts being paid
 possible business failure
 overstocking of materials.

1
 Strategies for monitoring the financial resources of a business must be incorporated into its
strategic plan. This involves:

 monitoring a business’s cash flows

 paying its debts
 developing financial control techniques
 auditing of financial accounts
 continuing to make profits for its owners and shareholders.

Strategic planning of financial resources is essential to a business’s success and growth.

SNAPSHOT Plan for every pitfall

Businesses that put together a solid growth and financial plan are more likely to gain the finance they need to
develop and to endure the difficulties that inevitably crop up.

Take the case of Bella McFadyen. When she set up her Sydney organic food delivery business, The Vegie Trail,
in 2009 she also wrote a comprehensive business plan, detailing milestones over the next decade.

When it came time to get finance to expand the business, she was successful in her application.

‘I put together a detailed financial plan, profit and loss and forecasts, and factored into those my own time
and what I wanted to receive from the business,’ she says. ‘Looking at my bank account now, I feel pretty
good.’

The chief executive of a string of Business Enterprise Centres in Sydney, David Baumgarten, says business
plans for new enterprises should investigate every scenario and every pitfall.

‘Any new business owner should do a workshop about how to not only write a business plan but also on the
financial management of a business,’ he recommends. ‘[This will] teach them about bookkeeping, costings and
pitfalls.’

Formats vary but business plans typically look at factors including the state of the industry the business
operator is looking to enter, how the new business would fit in and attain its goals and how the business will
be structured. Also vital is looking at regulations governing the sector, business location, where finance will
come from, what the expenses will be and projections of finances.

The peak body, the NSW Business Chamber, advises the key elements of financial planning are the budget and
the cash-flow forecast. Projections should be based on the latest information available and if, during the year,
the results prove to be different from the budget, the business owner needs to ask why.

The chamber suggests business owners avoid thinking of the finance plan as a ‘big stick’ and instead see it as a
warning device that alerts them when they need to take action.

Source: Keeli Cambourne 2011, ‘Plan for every pitfall’, Daily Telegraph, 23 March.

2
The strategic role of financial management

o Set objectives
 Decide what resources are needed

o Anticipate changes
 Provide details on the threats and opportunities

o Avoid mismanagement
 Can lead to problems- liquidity, solvency, efficiency, profitability,
growth and return on investment.

o Monitoring and evaluating

 Strategies for monitoring and evaluating the financial resources
need to be incorporated into the strategic plan.

3
 Objectives of Financial Management
For a business to achieve its longer-term goals it must have a number of short-term,
specific objectives. The objectives of financial management are to maximise the business’s:

 profitability These are the key areas to measure financial performance. In the
 growth HSC exam you are given formulas and asked to calculate and
comment on these areas for a business.
 efficiency
 liquidity
 solvency.

The responsibility of financial management is to make decisions about the best way to
achieve those objectives (see diagram). This will involve identifying and evaluating alternative
courses of action and making recommendations.

Some examples of the decisions that management might face, relating to its specific, short-term
objectives. Sound financial management is about responding to such questions by choosing the most
appropriate strategies to ensure that the financial objectives of an organisation

4
Profitability

Profitability is the ability of a business to maximise its profits. Profits satisfy owners or
shareholders in the short term but are also important for the longer term sustainability of a
firm.

To ensure that profit is maximised, a business must carefully monitor its revenue and pricing
policies, costs and expenses, inventory levels and levels of assets.

Growth

Growth is the ability of the business to increase its size in the longer term. Growth of a business
depends on its ability to develop and use its asset structure to increase sales, profits and
market share. Growth is an important financial objective of management as it ensures that the
business is sustainable into the future.

Efficiency

Efficiency is the ability of a business to minimise its costs and manage its assets so that
maximum profit is achieved with the lowest possible level of assets.

Efficiency generally relates to the operations or revenue-producing activities of the business.

Achieving efficiency requires a firm to have control measures in place to monitor assets. A
business that aims for efficiency must monitor the levels of inventories and cash and the
collection of receivables.

Liquidity

Liquidity is an important financial objective of management. Liquidity is the ability of a

business to pay its debts as they fall due. A business must have sufficient cash flow to meet
its financial obligations or be able to convert current assets into cash quickly; for example, by
selling inventory.

Controls over the flow of cash into and out of the business ensure that it has supplies of cash
when needed. Cash shortfalls and excess or idle cash must be avoided as both involve loss of
profitability for a business.

Solvency

Solvency is the extent to which the business can meet its financial commitments in the longer
term. The longer term refers to a time period greater than 12 months. Solvency is particularly
important to the owners, shareholders and creditors of a business because it is an indication of
the risks to their investment.

5
 Solvency indicates whether a business will be able to repay amounts that have been
borrowed for investments in capital (such as equipment and machinery and/or premises).
Solvency (as measured by the level of gearing)

Short-term and long-term financial objectives

The financial objectives of a business are based on the goals of its strategic plan, which can be
translated into both the short and long term.

 Short-term financial objectives are the tactical (one to two years) and operational
(day-to-day) plans of a business. These would be reviewed regularly to see if targets are being
met and if resources are being used to the best advantage to achieve the objectives.

For example, if management has a goal to achieve a 15 per cent increase in profit for the next
10 years, the tactical plans might involve purchasing additional machinery, updating old
equipment with new technologies, expanding into new markets and providing new services.

 Long-term financial objectives are the strategic plans of a business. They are determined for a
set period of time, generally more than five years. They tend to be broad goals such as
increasing profit or market share, and each will require a series of short-term goals to assist in
its achievement. The business would review their progress annually to determine if changes
need to be implemented.

Objectives of financial management

o Profitability
 The ability to maximise profits and occurs when
Revenue > costs

o Growth
 The ability to increase business size in the longer term
 The ability to increase sales, profits and market share

o Efficiency
 The ability to manage assets to maximise profits with lowest
amount of costs
 It is about cost minimisation in the business

6
o Liquidity
 The ease with which assts can be converted to cash
 Cash shortfalls and excess idle cash need to be avoided

o Solvency
 Indicates the extent to which the business can meet its long term
financial commitments (over 12 months)
 Also measured as gearing

o Return on capital
 Amount of profit returned to owners/shareholders as a percentage of
capital contributed
 Compare the return against other investment options

7
Interdependence with other key business
functions

The key business functions include:

o Operations
o Marketing
o Finance
o Human resources

The interdependence of these business functions means that each one must interact with all
of the other functions in order to achieve the goals of a business.

For example, imagine if one of Sony’s goals is to increase its market share of 3D televisions.
This would result in changes to the operations function — how the televisions are
manufactured. The marketing function would need to develop plans for promoting the new
type of televisions. Finally, new employees with the necessary skills will need to be recruited
and selected, or existing employees retrained. Obviously, finance plays a crucial role in
enabling Sony to achieve its goal as additional finance would be required to fund the extra
resources needed

Without finance there would be very little business. Finance (funding) flows to each
functional area within a business, which enables it to achieve its goals.
Business goals tend to be based on improvements to profit levels and have their origins within
the financial function of a business.

Example of the
interaction of key
business functions to
achieve the goals of
the business

8
9
 REVIEW the information from p.1-9 making notes under the following
headings and then respond to Questions 4-7.

1. Interdependence
Finance plays a crucial role in funding extra resources.

Finance and operations

 Finance is required for inputs, machinery, land etc. to create value whilst receiving a
return on investments.
 Operations manages stock and outsourcing whilst finance monitors the cost.

Finance and marketing

- Marketing is the way most businesses generate sales. Sales help with managing cash flow.

 Finance establishes budgets and forecasts marketing must follow.

Finance and human resources

 Finance provides funds for wages and HR strategies such as training and development.

2. Strategic Role
The overall purpose of strategic finance is to steer the company towards its goals - revenue growth,
sustainability, environmental impact, and more. Strategic finance is simply putting the company's
growth and long-term vision at the heart of the finance function.

3. Objectives
Financial objectives are the goals or targets related to the financial performance of a business.
There are six types of financial objectives: revenue objectives, cost objectives, profit objectives,
cash flow objectives, investment objectives and capital structure objectives.

10
 Exercise 1 - Strategic

4. Senior management of a large business comes from their outlets around

Australia to discuss the business's financial plans. Which are the most likely
financial plans discussed at the meeting?

A. Strategic plans
B. Tactical plans
C. Operational plans
D. Pricing plans

5. Which of the following statements about the strategic role of financial

management is the most correct?

A. Sets short term goals

B. Separates itself from other business activities

C. Follows the lead of other business managers

D. Provides a framework for all other business

activities

6. Describe the strategic role of financial management.

Strategic financial management is about creating profit for the business and ensuring an acceptable return on investment (ROI).
Financial management is accomplished through business financial plans, setting up financial controls, and financial decision-
making. Financial management must provide the financial resources to allow the implementation of a business' strategic plan. A
strategic plan outlines goals, objectives and future direction of a business. Financial resources ensure the business continues to
grow and is able to achieve its goals and objectives.

11
 7. Explain the strategic role of financial management in the success of a
business.

(To answer: define meaning of strategic role then link it to finance function & then show the
implication on business by linking that to the other key functions to achieve long term success)

The purpose of strategic financial management is to identify the possible strategies capable of maximizing the organization's
market value. Also, it ensures that the organization is following the plan efficiently to attain the desired short-term and long-term
goals and govern all the financial activities of the company and lastly maximize value for the shareholders. However, a business
may encounter various financial challenges due to the failure of planning successfully or due to inadequate expense control and/or
poor control over cash flow. This can result in the downfall of the business.

Objectives of financial management

1. The financial manager of a furniture company has determined that improving

turnover of accounts receivable will be the goal for the next financial year.

Which objective is the financial manager aiming to improve?

A. Efficiency
B. Liquidity
C. Profitability
D. Solvency

12
3. The senior management is concerned about their business's ability to meet its long–
term debts. About which financial objective are they concerned?

A. Liquidity
B. Solvency
C. Profitability
D. Efficiency

4. The financial team of a business is monitoring the collection of accounts receivable and
end of month cash balances. Which two financial objectives are the team monitoring?

A. Efficiency and profitability

B. Solvency and liquidity
C. Efficiency and liquidity
D. Profitability and liquidity

5. Distinguish between long-term and short-term financial objectives.

Short Term Long Term

Usually achieved with 6 months – 36 36 months or more

months
Liquidity and solvency Profitability, efficiency, growth

Setting a budget, reducing debt Overall profitability and market share

of the business

Aligned with operational and tactical Usually include with business’

needs of the business profitability, improvement, competitive
position

13
Interdependence

1. The management of Soft Soul Shoes has decided to have staff placed on sales
commission and incentives as a way to reach monthly budgets. Which two key functions
are most involved in this decision?

A. Marketing and finance

B. Finance and operations
C. Human resources and marketing
D. Human resources and finance

2. Outline the interdependence of finance and operations.

Finance and operations have a key interdependence involving the transformation of inputs to outputs and the funding
required. Finance provides and allocate adequate funding to operations in order to purchase inputs and resources that
can be used in the transformation process. Finance plays a crucial role in funding extra resources. Finance is required
for inputs, machinery, land etc. to create value whilst receiving a return on investments. Operations manages stock and
outsourcing whilst finance monitors the cost.

14
3. Refer to the Business Snapshot – Plan for every pitfall (on page 3) and complete the
following questions:
a. Outline the reasons why the financial element of a business plan is essential.
A good financial plan keeps you focused and on track as the company grows, when new challenges
arise, and when unexpected crises hit. It helps you communicate clearly with staff and investors, and
build a modern, transparent business.

b. Using information from the snapshot and this lesson, construct a mind map of
financial planning for new business owners.

- Source of finance (debt/equity)

- Planning and monitoring of the business’ financial resources to achieve financial
objectives
- Solvency (long-term)
- Liquidity (short-term)
- Budgeting
- Profitability
- Forecasting
- Financial statements
- Strategic roles
- Financial objectives

15