Financial management combines the two concepts of finance and management. Finance refers to monetary or economic resources while management refers to the process of planning, controlling, and organizing resources to meet organizational objectives.
What is Finance?
Finance is a word that comes from the Latin word “finis”, which means “fine” or “end.” It was later used in French to mean “payment” and “ending.” Thus, finance means to complete or end a contract. It is also used in English to mean the management of money.
Finance can be defined as the “application of and optimal utilization of scarce resources.” It also refers to the process of managing a large amount of money to meet individual or organizational needs. Finance involves the processes of investment, lending, borrowing, saving, budgeting, spending, and forecasting.
Examples of finance include:
- Investing personal income in stocks, bonds, or other financial assets
- Borrowing money for personal or business use from a bank
- Lending money through mortgages or loans to individuals and businesses
- Creating a budget or financial model for a company or a government institution
- Saving personal income in interest-earning bank accounts
- Forecasting monetary needs of an organization and developing a budget for the same.
What is Financial Management?
Financial management is defined as the process of raising and allocating funds to the most productive end user so as to achieve the objectives of a business, an individual, or a government institution.
It also means the planning, organizing, controlling and directing of financial activities to ensure efficient utilization of resources in an organization. Financial managers apply the general principles of management to financial resource planning and control in an organization.
Nature and Scope of Financial Management
Financial management can be broken down into several types, elements or decision areas. These decision areas or types of financial management include:
Investment Decisions/Capital Budgeting: investment decisions involve the allocation of financial resources to fixed assets. In this case, the role of the financial manager tries to identify investment opportunities that are worth more (benefits) than they cost to acquire. Capital budgeting is used to evaluate investment risks and returns to enable an organization to make the best financing or investment decisions, or to allocate money to viable investment projects.
Working Capital Decisions: this involves the investment in current assets such as cash, inventory, and receivables. It involves making decisions on how to allocate financial resources to immediate needs of the company, such as operations and payments for daily transactions. It involves managing funds to support current operations and meet day-to-day financial obligations.
Dividend Decisions: This has to do with financial decisions that relate to the distribution of profits to investors or owners of the company. Every year, a company has to make decisions on how much money to pay to shareholders as dividends. Net profit can be distributed in two ways: first as dividends to shareholders and secondly, as retained profits to be used in expansion and growth of the business.
Capital Structure Decisions: Capital structure refers to the financial decisions made to determine how investments should be funded. When choosing the methods of raising funds, the company decides on various alternatives such as equity and loans. Capital structure refers to the ratio of debts to equity; how much debt is used to fund investments compared to equity. A company that utilizes more debts than equity means that they have a high leverage.
