Financial management in the 21st centuryPosted on: February 7, 2022
by David Diaz
What is financial management?
Financial management is a key function in any company or organisation to help with budgeting, forecasting, risk management, and decision-making. It also provides vital information for investors and financial analysts who work in the trading of stocks and shares. Good financial management of a company gives a reliable insight into its profitability and potential. Financial reporting such as financial statements and annual reports are in the public domain, so can be accessed by anyone who wishes to invest or understand the valuation of a public limited company.
The traditional approach to financial management is sometimes referred to as corporate finance. Since the global financial crisis of 2008, which led to a recession, markets have been increasingly unpredictable and traditional approaches are no longer so effective. Some of the main challenges that financial management faces today are encapsulated by the acronym VUCA:
In a VUCA environment, long-term planning is near impossible, so remaining agile and implementing ongoing, iterative, short-term planning becomes crucial. Long-term planning is sometimes referred to as strategic whereas short-term planning is tactical.
Management accounting provides a framework to help organisations identify and manage disruption. It facilitates the navigation of financial risk management and can help the management team make more informed decisions. Regular management accounts can also help preserve the value of a company by reassuring shareholders with a healthy balance sheet. When financial results are not as positive, robust documentation of finances can indicate where changes in the business model are required.
What do the financial markets look like today?
Many renowned investors are surprised that the financial markets have not already experienced a crash in the wake of the pandemic hitting in 2020. Fund manager Jeremy Grantham told Reuters in July 2021 that, “The stimulus, the economic recovery, and vaccinations have all allowed this thing to go on a few months longer than I would have initially guessed.” Michael Burry, who was one of the first to identify the subprime mortgage crisis that led to the 2008 financial crisis, tweeted in November 2021, “More speculation than the 1920s. More overvaluation than the 1990s. More geopolitical and economic strife than the 1970s.” Because of his previous track record in predicting the housing bubble, Burry’s comment was taken seriously by many analysts and financial experts as an indication of a possible crash.
Inflation in the UK has reached its highest in 30 years at 5.4%, while in the USA, inflation reached a 39-year high in December 2021 at 7%. The Bank of England increased the base rate from 0.1% to 0.25% in December 2021 to try and control rising inflation.
These macroeconomic patterns have an effect on corporate finance and financial planning at a company level. With the volatility of the markets, it makes financial decisions in areas such as capital budgeting difficult. Many companies will therefore delay making decisions on big initiatives or major projects so that they can retain capital. This can then stymie growth though, which then causes economic problems to proliferate. The health of the economy can affect many business decisions such as the pricing of goods and services or whether dividends are paid out to shareholders.
Criticisms of the modern approach to financial management include the emphasis on creating funds through investment and venture capital. This has been responsible for phenomena such as unicorn start-ups and meme stocks, which can create financial bubbles. In the UK, start-ups which have experienced financial losses during the pandemic include Monzo (app-based bank), and those that have gone into administration include Farmdrop (fresh food delivery), and Bulb (energy provider). These provide useful case studies into how financial management can go wrong.
What does financial management do?
Financial managers apply general management fundamentals to the administration of an organisation’s financial resources. Some of the main objectives of financial management include:
- maximising profits
- tracking liquidity and cash flow
- maintaining compliance
- developing financial opportunities
- dealing effectively with investors and the board.
Financial accounting plays a major role in financial management but is not the same. Financial accounting involves the creation of reports through recording and tracking the flow of money and assets in a company, while financial management focuses on activities such as investment, procurement, and the allocation of capital for future ventures. Without accurate accounts, financial management can’t function.
The four major areas that financial management supports are:
A financial manager utilises financial projections to ensure positive cash flow, plan new products or services, and protect the company from unexpected events which may raise costs or create losses.
Costs such as mortgages, rents, salaries, raw materials, employee travel and expenses, as well as other obligations of the company need to be taken into account by financial management. Enough funds should be put aside for emergencies, too.
A variety of risks need to be on a financial manager’s radar including market risk, credit risk, liquidity risk, and operational risk. Liquidity risk is of particular concern as a company can appear to be healthy even when there’s not much liquidity. This is when value is held in inventory, for example, rather than being available as cash. If creditors are slow to pay invoices or there is debt, or both at the same time, this can quickly tip a company into bankruptcy if it cannot liquidate its assets fast enough.
Financial managers create procedures for the processing and secure distribution of financial data, like invoices, payments, and reports within the company. These written procedures also outline which stakeholders are responsible for making financial decisions, and who signs off on those decisions.
These four functions can be grouped into three broad financial management types:
This relates to maintaining regular payments for business to operate and for potential growth. When interest rates are low, taking on debt can be an option. Funding can also come from a private equity firm, selling assets like property, or selling equity.
This involves identifying what should happen financially in order for the company to reach both its short-term and long-term goals. Where and how can capital funds support growth?
Working capital management
This is more concerned with ensuring that there’s enough cash available for day-to-day operating requirements, like paying employees and buying raw materials for production.
Sharpen your financial management acumen
Financial management is just one part of an MBA that could help take your career to the next level.
From understanding financial reports to authorising budgets, making sound business decisions, and assessing risks, an online MBA from the University of Wolverhampton is a valuable qualification in an increasingly complex global economy. Find out more about entry requirements and register your interest in expanding your business knowledge today.