Financial Management is the deliberate management of planning and organizing of financial activities. It applies the basic management principle to control the flow of funds and properly utilizes financial resources. It sets the financial goals by properly analyzing the available data. The common methods to carry out financial activities like accounting and budgeting are considered to be the financial management practice. Financial management practices is the discipline dealing with the financial decisions for long and short-term goals to ensure the return on capital exceeds the cost without taking an excessive financial risk. It clarifies the efficient financial management practices and is used in the business to respond to another business environment. It also entails practices across the other organizations to provide an evaluating approach to financial management. It has some impact on the organizational performance because of the relationship between them. Effective management leads to the successful growth of an organization.
The outcome of the business and the financial management is like the two sides of a coin and has turn out to be more significant to the success. The effective management of the available funds and the completion of a mission needs the right financial management practice. The top management of a company or business holds the financial management practice and then it circulates the practice to all sections of the company. Optimal application and commitment towards financial management practices result in an increased company’s performance. The interrelation between the business practices and the potential of an organization is important for the growth of an organization. The financially strong organizations are prepared and are resourceful. Since the different factors are responsible for the success of an organization, the relationship between the organization’s performance and the financial management practice also contributes some help in the growth of an organization. The profits and the cash inflows are the basis of the financial condition of a business. It is necessary to develop business objectives and performance standards for the future. In this article, we will analyze the effects of financial management practice and the impact of the practice on organizational performance. To analyze the relationship, we will explain some factors like capital structure decisions, investment appraisal techniques, dividend policy, working capital management, and financial performance assessment. Since the impact of practices on organizational performance brings improvement in products and services, it also increases profitability and attracts important sponsors.
1. Capital Structure Decision
Capital Structure is simply defined as a business’s debt and equity ratio which is calculated by dividing a business’s total debts by its stockholders’ equity. It is used to measure an organization/business’s financial leverage which means it shows how much debt is used to finance its assets in the long-term operation. The debt to equity ratio gives common insight to investors regarding how much risk is associated with a firm. It is a sign of financial well-being for a company. It shows how a business finances its activities. If it is considered a high-risk business then it will have no investors or short-term investors. Managers show their interest in the capital structure as it shows the company’s exchange theory and manages the debt ratios. Some factors like agency costs, free cash flows, and asset substitution had some effect on capital structure decisions. Financing a company solely with equity or debt may not be an optimal capital structure decision. Capital structure optimization is critical for short-term and long-term growth. An organizations’ capital structure influences policies, product, and service pricing, credit terms, management structure, and resource allocation. It reduces risk generated by loans and revenue and shareholder returns are increased.
2. Investment Appraisal Techniques
A company requires planning to use funds as long-term investments such as purchasing a brand new machine, research and development projects, etc to assess the capability of the project. This is called Capital Investment Appraisal or Capital Budgeting. In this process, a business establishes its long and short-term investment opportunities which are influenced by company stakeholders. Some of the techniques include Net present value, Pay Back Period, Accounting rate of return, Internal rate of return, Profitability index, etc. These investment appraisal techniques are used to improve financial possibility. The techniques are used to prioritize the projects. Companies may have different projects that are appraised at the same time to make the right predictions. Investment appraisal is an important area of management practices. Some of the Techniques are explained below in brief:
- Net Present Value: The Net Present Value is based on the time value of money. It is used to appraise an investment’s worth in the present day. It is determined by calculating the negative cash flows and the positive cash flows for each period of an investment. Once it is calculated, the present value is attained by discounting its future value at a periodic rate of return. Many organizations and accountants use net present value to determine the value of market premium because the value in the market is different on certain assets than the book value.
- Pay Back Period: The payback period is another capital budgeting technique where it calculates the time that s required to recover the original cost of an investment. It does not follow the time-value of money in the calculation. Most business uses this technique to choose from different possible capital projects. The analysts use cash flows and initial investments as a factor to calculate a business payback period. The net annual cash inflows are sometimes replaced by investment and it becomes the investment net annual incremental cash flows. The advantage of the payback period technique is that it favors the project that recovers their investment as quickly as possible. It focuses on cash flow than profit and it is a general technique for small businesses.
- Accounting Rate of Return: It is a capital investment appraisal technique and it is not calculated over the time value of money. It is used to measure the expected profit of an investment over the investment period so as to contribute the initial investment capital for the project. The higher return investment is chosen or preferred over the lower return investment.
- Internal Rate of Return: It is also one of the capital investment appraisal techniques where the discounted rate gives zero value to the net present value of an investment. Within all the techniques, this technique is found to measure the effectiveness of capital investment. The project is most likely to be rejected if the capital investment cost is greater than the IRR value and it has more chance of being accepted if it has a low cost of capital involved.
- Profitability Index: This capital investment appraisal technique is used to measure project costs and benefits. It is a useful tool to rank projects as it allows to measure the value produced per unit of investment. The measurement of the ratio between the present value of future cash flows and the initial investment is the probability Index. It is also called the profit investment ratio.
3. Dividend Policy
Dividends are a form of revenue for all investors. It is very important for all the investment. There are many factors involved to decide the dividend amount. Some are internal and some are external factors. No matter what, as long as the revenue is more than the expenses, the investors will continuously receive dividends. Dividend policy provides guidelines to a company on how to calculate and how much to pay out to its shareholders as a dividend. The dividend policies are important decisions taken by the organization. Repurchasing shares can also be a dividend distribution which is more appropriate and more common. Different factors outline the dividend policy of a company which includes new investment openings, the unpredictability of future earnings, financial flexibility, legal constraints, etc affects dividend policy. Dividend policy helps in the valuation of a company. The impact of dividend policies has an effect on the stock price as well. The share repurchases on the stock and the valuation are the main cause of dividend policy. The issue of dividends is the policy that outlines whether the dividends are issued on an ongoing basis or will be infrequent.
4. Working Capital Management
The process of managing operations and activities related to a firm’s working capital is working capital management. The healthy cash flows are supervised to sustain everyday operations with the help of working capital management. The company’s current assets and current liabilities provide all the information about working Capital Management. To facilitate an efficient daily operation, the working capital management monitors and analyzes the current assets and current liabilities. It may involve utilizing the company’s short-term strategies too. It ensures that the company has enough cash flow to provide its operating expenses and to pay its short-term debts. This working capital management serves as a balancing system to make the business aware that the cash flowing into the business is enough for the operation. It is a continuing process and it may involve executing short-term decisions. If working capital management is utilized correctly, it can help in doing things correctly and the right way.
5. Financial Performance Assessment
Financial Performance assessment determines the assets of an organization to generate income. According to federal securities laws, public companies in the united states are required to disclose financial information on a regular basis which is at least once a year. The financial performance of a company includes a balance sheet, income statement, and cash flow statement. Financial performance assessment, a vital aspect of financial risk management, is the measure of a company’s profitability, and its ability to achieve its financial goals. Most companies require a complete measurement of financial performance and structure. Proper analysis of the financial performance impacts decisions and the projects of short term and long term. Complete financial health also can be measured. Financial performance measures how much the use of assets can generate income. The financial performance term also compares the firms with similar other firms.
The importance of financial management practices is more important for the smooth run of the organization. If these practices are needed to be followed and it can be ensured that the financial structure and practices of an organization are the key to sustainability and growth. Good steady returns and maintaining long-term investment attract new investors on a continuous basis. An organization’s financial health also depends on internal structure and operation efficiency including goods and services. This means it can maximize returns and can make investors confident about their investment.