The term finance can be defined as an art and techniques of money management. It is a type of business-related with acquisition of monies and converting them into capital funds that can fulfill the financial needs of different organizations.
An organization is established for the achievement of predetermined and well defined one or more goals. To achieve these predetermined goals, several programs are implemented which include manufacturing, trading or services, and so forth.
Implementation of such programs requires various resources like natural resources, human resources, financial resources, and informational resources. Effective management of financial resources is very essential to make the best use of other resources in the organization.
Financial management is concerned with the procurement of funds from various sources and making the effective allocation of financial resources into productive use. It is a decision-making process relating to investment financing, asset management, dividends, and so on.
Every organization is established for some specific goals, whether it be profit maximization, sales revenue maximization, value maximization, or shareholders’ wealth maximization. Financial management plays a crucial role to achieve these goals of the organization.
Effective management of funds is very essential to manage other organizational resources. Thus, we can define financial management as a decision-making process relating to procurements, financing, and effective allocation of funds.
Importance of Financial Management
Every business organization requires different inputs like materials, plants and machinery, labors, information’s and financial resources to produce goods and generate services. Every input can be hired or purchased from a place called factor or input market. Thus, there is a market for each of the factor inputs.
The place where financial resources can be obtained is called the financial market. A business organization before going into manufacturing or production has to first of all deal with the financial market for financial management.
The following diagram shows the meaning and importance of financial management in the business organization.
It is because the procurement of all other resources is based on financial resources and its management. Finance, therefore, occupies a prime place at every stage of operation of a business like production, marketing, distribution of returns, and so on. The overall meaning and importance of financial management can be briefly explained with the help of the following points;
It helps in setting clear objectives
The clarity of objective is important for any organization. Financial management clearly defines organizational goals or objectives to be achieved.
Every objective has a certain cost and finance helps in directing efforts of all functional areas of business towards the achievement of organizational objectives at possible least cost. A clear objective helps to determine whether the activities are going in the right direction or not.
Effective utilization of other organizational resources
An organization uses various resources that require a huge investment. Investments on the resources that do not earn a minimum return required by an organization do not add value to the shareholders.
A wrong financial decision might create a threat to the survival of a firm. Therefore, financial management plays a great role in deciding where to invest or how to make the best use of funds available in an organization.
It helps in searching least cost sources of financing
An organization to run its business collects funds from various sources. Financial management helps in deciding the sources from where the funds are to be collected and brought into operation.
The sources may be shares, bonds or debentures, preference share, and so on. Financial management guides in selecting the sources that are beneficial to an organization. Effective financial management ensures the possible least-cost source of financing to the organization.
It helps in making dividend decisions
The dividend is the amount paid by the organization to shareholders as a return. Financial management helps an organization to make dividend decisions. It helps an organization to decide how much to pay as a dividend and how much to retain in the firm.
It helps to manage personal resources
The concepts and principles of financial management help to systemize and organize the individual’s personal resources in profitable manners. An individual can get practical types of answers to issues like where to invest his or her small amount of monies and how to make a profitable investment portfolio from his or her earnings.
It helps to generate more profit
Effective, appropriate, and less cost bearing financial management increases the profitability ratios of the business. Financial management encourages controlling the cost through different financial control tools and devices like budgetary control, cost volume profit, and financial ratio analysis. Proper understanding and evaluation of these financial tools ensure the procurement of profitable financial resources in the business.
It helps to encourage and promote saving
Business savings are possible only when there is a higher profitability ratio. Efficient financial management always helps to promote savings and make the internal financial capacity of the organization more and stronger.
Helps in increasing the value of the firm
The fulfillment of the above use of financial management automatically will maximize the value of the firm. Here the value of the firm refers to the value of the share of the business firm.
Higher profitability ratio, strong financial condition, and efficient financial management will increase the efficiency of the firm and this ultimate value of the firm will also increase. Achieving higher profitability is one of the essentials for maximizing the value or wealth of the firm.
Financial management is therefore usable and important in the business organization as well as in the daily life of every human being. That is it is not only important to managers. Effective financial management will help an organization to offer a superior product to the consumers, pay a higher amount of tax to the government, pay a higher salary to its employees and run a greater return to its investors.
Financial management is thus the lifeblood of effective operation and promising future of an organization. Knowing the meaning and importance of financial management is always beneficial for individuals and businesses.
References and suggested readings
Pradhan, S. (1992). Basis of Financial Management. Kathmandu: Educational Enterprise (P) Ltd.
Paudel, Rajan B., Keshar J. Baral, Rishi R. Gautam, and Surya B. Rana. (2010). Fundamentals of Financial Management. Kathmandu: Asmita Books Publishers & Distributes.