Financial Management

Financial management is not just about arranging money — it is about making every rupee work for the business. Since all finance comes at some cost, a firm cannot afford to be careless with how it raises or uses funds. The core idea is simple: the returns from any investment must exceed the cost of the funds used to make that investment. If this condition is not met, the business will eventually bleed value.

Financial management is therefore defined as the optimal procurement as well as the optimal usage of finance. "Optimal procurement" means identifying different available sources of finance, comparing them in terms of their costs and associated risks, and choosing the best mix. "Optimal usage" means investing the procured funds in such a way that the returns from the investment exceed the cost at which the funds were obtained.

The aims of financial management can be summarised as:

• Reducing the cost of funds procured.
• Keeping the associated risk under control.
• Achieving effective deployment of funds (i.e., putting money to work where it earns the most).
• Ensuring availability of enough funds whenever required.
• Avoiding idle finance (money that sits unused and earns nothing).

The quality of a firm's financial management has a direct bearing on its financial health. This health is reflected in the financial statements — the Balance Sheet and the Profit and Loss Account. Almost every item in these statements is affected, directly or indirectly, by some financial management decision. Some of the clearest examples of this are:

1. The size and composition of the firm's fixed assets — a capital budgeting decision to invest ₹100 crore in fixed assets directly raises the size of the fixed-assets block by that amount.
2. The quantum of current assets, and how they split between cash, inventory and receivables — a rise in fixed-asset investment usually brings a matching rise in the working-capital requirement, and the firm's own credit and inventory management decisions further shape how much gets tied up in debtors and stock.
3. The proportion of long-term versus short-term funds used — a firm that wants to hold more liquid assets tends to raise more of its funds on a long-term basis, weighing the trade-off between liquidity and profitability, since short-term liabilities are usually cheaper than long-term ones.
4. The break-up of long-term financing between debt and equity — deciding how much of the long-term finance comes from debt versus equity (or preference capital) is itself a financing decision, and it directly changes the amounts of debt, equity share capital and preference share capital shown in the accounts. …