The main job of financial management is to procure money for the firm at the cheapest rates , and utilize it to the best possible use , and to keep proper records of the money transactions ,
Thus it can be divided into three distinct functions
Accounting : Reporting of the financial picture as represented by the records
Book Keeping : Keeping records of money transactions
Management of Money : Arranging to get money for business purposes and putting it to the optimum use at the time .
At this stage let me make clear the scope of presentation . In this presentation we will be talking about finance as related to a manufacturing , trading or consulting organization . That is the places where finance itself is not the end product . We will not talk about banks , financial institutions and stock market manipulations , where money is the raw material and money is the end product .
So let us see, in a manufacturing firm what is the role of finance ?
The finance as shown in the accompanying slide plays a support function .
In a manufacturing organization the two pillars of the organization are Production and Sales .
Financial management supports the manufacturing by making money available for purchase of raw material , purchase of machinery and payments for personnel employed while it supports the sales by making money available for advertising campaigns , marketing infrastructure and sales and service functions .
Where does it get the money from .
The sources of money are
Private equity
Public Offering and Public Equity
Loans from banks and financial institutions
Loans from Shareholders
Deposits from lay public
There is a third source of finance which is rarely recognized as a separate source of finance but as of today it is the most important of all . Can you think what it may be ?
Let us play a game here . We are three participants . Let us make a simplistic assumption . This is an item that you make and sell .Let us consider that there is no profit involved . Let us look at the money transactions in a year . I give you this , you give me the thousand bucks and so on . All three of us will start with a thousand bucks each and let us see where we end at . Each one of you will exchange the thousand bucks for this item only and then in turn will exchange this item for 1000 bucks . Let us give ten seconds to this exercise .
Now ten seconds are over . How much does each of us get ? Each of us got goods or cash equivalent to 2000 baht . Is it not ?
Let us do it again .
This time each of us received Baht 3000 each . Baht 1000 more than the earlier time . So in the first year we received 2000 while in the second year we received 3000. The sources of finance did not change but something did change and changed for the better . Can you now identify what changed ?
Yes . The speed . The speed increased and so did our money transactions . So clearly as we see , the speed was an additional source of finance . Can we expand on this a little further ? If we do business transactions a little faster , we get more money . How do we do it faster ? By managing our money better . How do we manage our money better - by using innovative management , technology and quick response to the business situations . Thus we have an additional source of finance which is financial management itself .
The financial management can directly affect the following areas
Accounts payables
Accounts receivables
Depreciation
Turnover speed
Stocks management
Purchase management
In this case I am talking about only skills as related to monetary transactions and not otherwise . For example a purchase manager may be able to save money for the company by negotiating a contract with the supplier at a lower price . That is not counted as source of finance here . What the finance manager can do is instead of paying the supplier directly , he will extract maximum credit terms from him , then manage to procure funds just in time to pay to the supplier thus basically reducing the pay off in interest charges and making it work in his favour .
Let us consider the financial manager as a manufacturer of money . He gets money , he processes money and he produces money . Hopefully he produces more than what he consumes in the process . So now what is the scope of his work .
How much money do we need ?
Where to get the money from ?
How much to pay to get the money ?
How to give the money back ?
When to get the money ?
When to give it back ?
Why the should give me money ?
How fast to get the money ?
How fast do I have to repay the money ?
What happens if I cannot repay the money ?
How to utilize the money ?
What to buy with the money ?
How much will I get back and when ?
Who will I give the money to ?
At what price ?
How and when will I get it back ?
What happens if I do not get the money back ?
What do I do with the money I get out of the process ?
What do I do if I get less money that what I put in ?
How do I know where I got the money from and where I spent the money for ? And how much did I spend for what ?
How much does it cost me to make each product ?
Now as we answer each of these questions , the scope of financial management in the organization will become clearer to us .
You must have recognised by now that this is other way of saying the technical terms
Feasibility report
Financial Business plan
Budgeting
Capital Budgeting
Working Capital Management
Projected Financial Statements
Decision Support Systems
Account receivables management
Profit Planning
Sensitivity Analysis
Risk Management
Cost of Capital management
Variance Analysis
Accounting and book keeping
Costing and Product mix decisions
Financial mix decision
Inventory Management
Government Reporting and Taxation
Where to get the money from ?
Equity from shareholders ( Owners , Financial Institutions , General Public )
Loans ( Banks , Institutions , Public)
How much to pay to get the money ?
This decision is important especially due to the risk attached . For example if you get a foreign currency loan , it comes with interest rate at about 5 % but then it carries the risk of currency devaluation . This has been the major reason for Asian crisis that we see around us .
Many banks in Thailand had borrowed dollar loans from abroad at 5 % interest which they lent to Thai public at about 15 to 18 % interest . The currency was stable at baht 25 to a dollar thus the banks were making a cool 10 % profit .
Thus for every dollar borrowed they were paying five cents while earning more than 15 cents . A net profit of 10 cents for each dollar loan that you can get . The economy was booming so people wanted more and more loans . Thus the more loans you get from abroad the more money you make .
But when the currency devalued , and the baht went to 40 to a dollar . In this case the banks and the financial institutions had to repay as follows
For every dollar they borrowed they paid interest 5 cents .
For every dollar they borrowed they paid devaluation charge 75 cents
Thus for every dollar they paid back 1.80 dollars while earning only 1.15 dollars on the other hand . No wonder they had to close down en masse .
It depends on many considerations whether to go for loan or equity and in what proportion to each other . We will see those in somewhat detail in the next lecture .
How and when to get money ?How and when to give the money back ?
The money that is borrowed , including the equity has to be given back at some time or other . It is not a money belonging to the company . If it is loan it is given back at the end of a definite time period and if it is equity it is given back if and when the company closes after all the other creditors are paid .
This factor has to be studied in detail before we go to ask for loan or equity and depends on many factors .
Detail cash flow forecasts together with carefully planned budgets pinpoints the exact timing of financing needs .
Why they should give me money ?
Why should the public , or the banks give you money . So you have to prepare detailed report of what you are going to put the money to use and how much returns you are going to get so that it is profitable for the lenders to give you money at this stage and get more money or equivalent benefits at a later stage . This will be the financial business plan , feasibility report or the project report which is submitted to the financial institutions before any new activity is begun .
How fast to get the money ?
This is related to the question above when to get the money . Getting money from the public is the most attractive of the schemes as it comes with the least amount of interest but involves much more management and administration. It also takes anywhere between three months to six months to materialize . Thus if we need quick money this is not useful .
How fast do I have to repay the money ? How do I have to repay the money ?
For example , if you take loans in forms of deposit from the public and if your performance is good , most of the public will be satisfied and will renew the deposit with you , only a small percentage will withdraw the money . If they renew the money deposit in your company , you have less administrative expenditure and only a paper transaction takes place . This is desirable . However , if the people want to take the money back , you may face a cash crunch even if the business is doing great . For example in Thailand at the moment there are businesses who have sales orders in hand but banks are not ready to loan them money . They then take money from private moneylenders at very high rates and fulfill the orders , but then at the end of the day the interest burden is so high that they cannot continue to do the business without borrowing additional money . This is called the debt trap . And why do they accept the sales orders , if they do not have the money to fulfill the same ? Because if they do not accept the sales orders , the customers will go somewhere else and then the suppliers will lose all the business to competitors from some other country .
What happens if I cannot repay the money ?
Can there be some reschedulement of the loans ? This has happened with the loans given by the world bank to many countries . They have rescheduled the payback of the loans to times which they feel will be much more favorable than today .
How to utilize the money ?
The money thus procured can be put to variety of uses ?
Buying capital equipments
Buying building and maintaining it .
Sales expenses
Day to day revenue expenses
The finance manager has to decide the mix of the various uses of money by doing a careful budget and capital budget .
Who will I give the money to ?
At what price ?
How much will I get back and when ?
The other side of the budget is the possible revenues that will be generated when you put the cash to organizational use . This is where the Internal Rate of Return , Accounting Rate of return , Current value method are used to compare and choose between the various possible uses of money .
What happens if I do not get the money back ?
This is a separate discipline which analyses the risk attached with the various investments possibilities available. Theoretically one has to invest in the least risk avenue or at least keep the risk divided among many possibilities..
What do I do with the money I get out of the process ?
This is called as the profit planning . If you do not have plans ready for reinvesting the money earned , it will only make the company cash rich and will not earn anything thus in effect reducing all of your earnings .
What do I do if I get less money that what I put in ?
This is called as the sensitivity analysis .The manager has to minimize the risk of return by putting money in different types of projects . If some project fails the others will make for it . He also has to check the possiblility of the worst case scenario . Even if a particular project fails completely , the finance manager has to ensure that the impact on the overall company operations is not crippling . Forewarned is forearmed . By doing the risk analysis and the sensitivity testing , the finance manager can decide on the relative importance of the various projects . Thus he can decide on the internal checks and controls to be put in to be informed at various stages about the progress of the project .
How do I know where I got the money from and where I spent the money for ? And how much did I spend for what ?
This is called as the core discipline of accounting and book keeping . The finance manager keeps accurate record of all transactions involving money and funds and creates various reports which facilitate interpretation and analysis and representation of the financial situation of the company easier .
Financial Analysis , planning and Control
It is further divided into the following sub categories
Correct and accurate recording of all financial transactions of the firm (Book keeping )
Tabulating , grouping and reporting of the above transactions as per the needs of the firm and Government ( Accounting )
Budgeting , accounting and variance analysis
Product Pricing
Assessing the financial performance and condition of the firm
Making yearend financial Statements and Reports
Forecasting and planning the financial future of the firm
Estimating the financing needs of the firm
Instituting appropriate systems of control to ensure that the actions of managers are congruent with the goals of the firm
Cost Control
Determining Cost of Capital
Working capital management
Inventory Control
Cash Flow forecasting
Internal Audit of financial functions
Management of the firm's asset structure
Determine the capital budget
Manage the liquid resources
Establish and follow through the credit policy
Control level of inventories
Management of the firm's financial structure
Establishing the debt equity ratio or financial leverage
Determining Dividend Policy
Developing different sources of Finance
FINANCIAL DOCUMENTS LOG
Annual Report
Balance Sheet
Profit and Loss Statement / Income Statement
Expense Statement
Projections
Budget
Securities Documents
Tax Records
Accounts Receivable Statements
Accounts Payable Records
Appraisals
Bank Statements
Cash Receipts
Dividend Reports
Loan Documents
Vouchers
Assets Register
Stock Register
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