THE IMPORTANCE OF FINANCIAL MANAGEMENT | WHY YOU SHOULD MANAGE YOUR FINANCE

The importance of financial management is so huge that its impact in an
economy is instantly felt whenever changes is made to prevailing financial management process of a
system. Financial management is the
process of actively seeking the best way of handling our dealings that involve finance. This article on the importance
of financial management is written to explain in plain language, the benefits
and gains of having a functional approach of dealing with your financial matters.
ECONOMIC GROWTH AND DEVELOPMENT
Quality financial management is the main force behind economic growth and development.
IMPROVED STANDARD OF LIVING
REDUCTION OF THE POTENTIAL FINANCIAL AND ECONOMIC GLOBAL CRISIS
JOB CREATION
AID PLANNING

Every economy that is the envy of all and sundry is built on solid financial management. Like a wise man will say; show me a prosperous and wealthy nation and I will show you bundles of financial planners with guts. It is evident from the above points that the importance of financial management in our lives cannot be down graded in any way. Remove proper and disciplined financial management and see the world go back to the stone age.

10 CAREER PROSPECTS | EMPLOYMENT OPPORTUNITIES IN FINANCIAL MANAGEMENT AND FINANCIAL ENGINEERING

A career in financial management is just like any other with potentials that can be tapped by only those with broad understanding of the profession. I vividly remember the question that my father asked me when I told him of my interest in financial management. He asked me to list at least 10 lucrative career prospects in the field of financial management. This proved to be a very difficult question to me then as I was ill informed to answer that question then.

The main motive behind writing of this article is that a lot of young people that would have contributed positively to the broad field of managerial finance have been literarily talked out of the field by people from outside the field. I supposed you got to this webpage by making a search inquiring into the job/ employment opportunities in financial management. If that is the case, then relax and read on as you will discover some answers to the question.

FINANCIAL MANAGERS AND FINANCIAL ENGINEERS COMPARED

For the purpose of this article, both financial engineers and financial managers will be taken to be the same thing. However, there is a distinction between the two fields in the academic world. According to the academia, while a financial engineer constantly and scientifically tweaks existing financial products to come up with new appealing products and services, a financial manager’s main duty is to execute the finance functions of a business. Like I pointed out earlier on, this distinction is non existence in practice.

FINANCIAL MANAGEMENT CAREER OPPORTUNITIES

  1. 1.      FUND MANAGERS
  2. 2.      INVESTMENT ANALYSTS/ ADVISORS
  3. 3.      DAY TRADERS
  4. 4.      EQUITY ANALYSTS
  5. 5.      CREDIT ANALYSTS
  6. 6.      EDUCATOR/ TEACHER
  7. 7.      RISK MANAGER
  8. 8.      FINANCIAL PLANNER
  9. 9.      BUSINESS OWNER

10.  CONSULTANT

You will no doubt agree with me that these are all fulfilling and challenging career opportunities for all aspiring financial management and financial engineering professionals. Good luck in your quest to choose a career in one of the most lucrative and rewarding professions.

FINANCIAL MANAGEMENT | STEPS FOR NON FINANCE PROFESSIONALS

The strange expectation of becoming financially free without the right kind of financial management skills could be likened to a person dreaming of becoming a pilot without having to take rigorous and difficult calculus needed to calculate distances. The difference however is that it takes much less than we imagined becoming good financial managers than it takes to become a successful pilot.

We all engage in financial management on a daily basis without being aware of it. Where the problem really lies is in the fact that a lot of people tend to be involved in the wrong kind of financial management that end up doing their personal finance more harm than good. You cannot expect to get healed of stomach ache when you take Paracetamol or Panadol. Same goes for managing your finance. Part of the problem of wrongly dealing with our financial problems could be linked to the inability of finance professionals to relate the financial jargons to our everyday life. This gap in knowledge is what this article is set to bridge.

Working capital management is no doubt one of the best ways of releasing funds for our business. Same can be done to our personal finance. Working capital management is the process of striving for a balance between our fixed and liquid asset, long-term and short-term loans.

STEPS TO PERSONAL WORKING CAPITAL MANAGEMENT

Yes, individuals can save fortune by simply managing their working capital effectively, efficiently and correctly. Below are steps that you need to follow in this regards:

  1. IDENTIFY ALL YOUR ENTITLEMENTS: this is the first thing that any person willing to challenge his or her financial position starts by identifying all assets and sources of income. This is where a lot of people get it wrong and that marks the beginning of poverty and hardship. You cannot make any progress in your quest to better your financial life you do not invest time to identify what your sources of finance are and evaluate how viable they are. An employee for instance who does not take time to figure how much he or she is worth in a month might end up budgeting far more than she or he is worth.
  2. IDENTIFY ALL YOUR OBLIGATIONS: your obligations are those commitments you have made in the past that requires you to give out resource that has economic value. A good example is your rent. I have seen a man who forgot that he has to make payment for his mortgages before spending on an expensive holiday only to come back meeting a final notice. This might sound strange but they do happen.
  3. COLLECT LIKE ITEMS: After identifying your entitlements and your obligations, the next step in your personal financial management is to carry out a matching activity. A matching activity includes matching regular income against regular expenditures. The benefit of doing this is that you will instantly know what is left for you to either spend or invest. In fact, this third step is the most important step in the personal finance theory. You probably will not be tempted to buy that expensive gadget if you know that you have very little left in your coffers.
  4. Arrange to make up for deficit or invest surpluses: ok, this is the point where you really need to flex your financial management muscle. From the task of matching your assets and liability, what is now left is known as ‘networth’. This figure can either be positive or negative. When it is positive, it means that your income is more than your expenses, and this will call for you to make arrangement for the excess funds to be invested profitably. If however on the other hand you discover that this figure is negative, the right and sensible thing for you to do is re-appraise your expenses and eliminate the less pressing needs. If the figure still remains negative, then make arrangement to raise the deficit while you make effort to increase your source of income and reducing your obligations.
  5. Constantly monitor your portfolio: as far as money management is concerned, no one has found the Holy Grail. The only Holy Grail is the fact that there is constant room for improvement in our personal finance room.

Financial management is a universal right of every living soul that needs to be jealously guarded or face the severe consequence of not taking responsibility. One most striking feature of personal financial management is that it is very easy to learn and that everyone can manage it personally without having to be sophisticated in the financial science. All that is required is the possession of the right quantity of self discipline.

This article evidenced the fact that sound financial management is not an exclusive right of finance professionals. Following the above five steps will be more than enough to see you through your wealth creation and sustainability struggle.

INTEREST RATE RISK (EXPOSURE) MANAGEMENT | LATEST DEVELOPMENT IN TECHNOLOGY

Interest rate risk management technologies have revolved over the years into a more robust and scalable tool to manage the ever growing financial risk that faces modern day financial managers. Interest rate risk if left unmanaged can cause disturbances in the flow of operations in any kind of business. It does not matter whether the business is an international or a domestic business.

Risks in financial management are seen from two perspectives (business and financial). Interest rate exposure falls within bother categories. This article is written to discuss the recent development within interest rate exposure. Other components of total international risks are; political risk and foreign exchange exposure.

DISCUSSION | DEFINITION | MEANING | EXPLANATION OF RELEVANT TERMS

This is a sensitivity analysis based tool used to determine a firms’ stand as far as liquidity is concerned. This is unlike most form of financial risks that are a function of leverage and other variables. This explains why interest rate exposure is both a financial and business risk. All companies irrespective of their; size, capital structure, mode of operation, etc are all exposed to the heat generated by movement in the borrowing and lending rate. There are two main types of interest risks: Basis risk and Gap risk

Basis risk

Basis risk is the misalignment of interest rate bases in select assets and liabilities. Basic accounting tells us that assets and liabilities need to be matched according to their maturity term. This in practice is somewhat difficult to effectively match these it is difficult to find perfect match (even when assets and liabilities have the same maturity terms and same currency denomination for multinational companies), chances are they will have different interest base. Interest rate base is the minimum rate that borrowing and lending cannot go below. A UK parent company with a US subsidiary obviously operate in different market using different base. While UK is basically based on LIBOR (London Inter-Bank Offered rate), the US is based on Prime rate (this is my personal observation). Alternatively, when the value of a particular asset is sensitive to the US dollar six month LIBOR, but with a corresponding liability that is based on the US prime rate. The situation just described makes it possible for movements in interest rate to easily alter the spread (difference) between the interest bases. This is to say that basis risk could be seen as an uncertainty between two interest rate points (this is technically called ‘basis’ which is the difference between present and future price).

Gap risk

Gap risk is the imbalance that arises as a result of rebalancing or re-pricing assets and liabilities that are affected by movement in interest rate. This is more predominant in the real sector of the economy (i.e. non financial institutions). Companies traditionally have lesser interest-sensitive asset in their balance sheet than interest bearing debt.

Net interest income

This is the equivalent of basis risk that is peculiar to financial institutions. This is technically defined as the difference between income in the form of interest from assets and the interest in the form of expenses linked to liabilities. The best way of managing this kind of interest rate exposure is to have a full fledge treasury department with broad mix of experience in the development and use of derivatives.

TYPES OF FOREIGN EXCHANGE EXPOSURE| DEFINITION | MEANING | HOW TO MANAGE

Foreign exchange exposure is one fact that no company involved in international business or trade can completely avoid. This article is a continuation of international financial risk management. If you got to this page through search engine, it will be wise for you to start reading from there so that you will the full picture of risk that faces multinational businesses and how to manage them properly. The mere fact that a company is involved in international business or is a multinational corporation is enough to give the entity foreign exchange exposure.

WHAT IS FOREIGN EXCHANGE EXPOSURE?

The phrase ‘Foreign exchange exposure’ is used to describe the degree at which the potential/ future profitability, net cash flow and perceived market value of a firms value changes as a result of a change in exchange rate. That is to say that it is a company’s probability of making either a loss or profit as a result of movements in exchange rate.

One of the most important task of a financial manager in today’s ever dynamic business environment is to identify, measure and control foreign exchange exposure so as to ensure that a company’s future:  net cash flows, profitability, and market value are maximised.

THREE TYPES OF FOREIGN EXCHANGE EXPOSURES

Movement in foreign exchange can affect a company in several ways. The three most common effects of a change in currency exchange are:

TRANSLATION EXPOSURE

This is a non economic and non cash flow movement in the balance sheet (statement of financial position) value of a company resulting from translating the financial statements of one subsidiary into the currency of the parent. This is also known as accounting exposure. When purchasing power parity (PPP) holds, financial managers need not worry themselves over this kind of exposure as it does not have any economic significance to the real value of the company. However, there are few occasions when managers may be compelled to take action in other to ameliorate the effect of translation exposure. Under such conditions, any of the following exposure risk management techniques can be used: Asset shifting, borrowing locally, and using a forward contract. Note that the use of forward contract has some cash flow implications.

TRANSACTION EXPOSURE

Transaction exposure arises in situation where companies in different countries have to in business deal that requires settlement to be made in future date. In other words, both parties have either exchanged values or agreed to exchange value without making any monetary consideration, but legally bound to make same when due. Most of the techniques used to manage transaction exposure are also used to manage operating exposure and will therefore be discussed together.

 

OPERATING EXPOSURE

Operating exposure (also known as; strategic exposure, economic exposure or edge exposure) measures those changes in present value that a multinational experience as a result of changes in future cash flows which in turn were caused by change in exchange rates.

The first thing that a company does is to assess the effect of movement in exchange rates (over the nearest future) and on its competitive advantage relative to other corporations. Care is taken to classify operating exposure into:

(1) Those that affect the operating cash flow and (2) those that affects the financing cash flows. The traditional strategic style of managing operations-related cash flow exposures like, receivables, royalties, etc is to (a) diversify sales channel, (b) operate from different distribution channels, and (c) obtain raw materials from different sources. For those that affect the financing aspects of the business, all that needs to be done is to raise fund from different countries and in difference currencies.

Generalised way of managing transaction and operating exposure

Generally, operating exposures can be managed in the five following ways:

(i)                 Parallel or back to back borrowing and lending: this is an over the counter (OTC) arrangement between individuals whereby they agree to exchange the equivalent of currencies. This is like the barter system. For example, a U.S firm that needs £5,000.00 could arrange with a British firm that equally needed the dollar equivalent of £5,000.00 and exchange same with the firm.

(ii)              Currency swaps: this is a contractual agreement whereby parties agree to exchange cash flows. Notice that this is a legally binding contract, meaning that the parties involved cannot back out once the contract is signed, sealed and delivered. The only way around it is to enter into what is called swaption (a hybrid form of swap and options).

(iii)            Matching and netting: this can also be seen as a natural way of hedging against currency risk. This in other words is the arrangement to lend and borrow in local currency.

(iv)            Leading and lagging: this is simply the acceleration or deceleration of the timing of receipt and payment that a company is to receive or make. There are two kinds of leading and lagging, namely, inter-firm or intra-firm leads and lags. An inter-firm leading and lagging is an arrangement between independent firms that encourages the preference of one firm to be imposed on the other. Intra-firm is an agreement between related companies with common goal. This is usually seen as a mutual agreement whereby both parties benefit from the transaction.

(v)               Risk sharing and shifting: the most popular techniques used here is for the parties to the transaction to mutually agree upon a sort of risk sharing clause that will be included in the facility agreement. When both parties involved agree that one of the partners solely bear the risk, it is known as risk shifting.

In addition to managing the above exchange rate exposures, international financial management will not be complete if interest rate movement is not considered. Hence,

INTEREST RATE RISK AND HOW TO MANAGE IT

Interest rate risks are faced by all kinds of company- domestic, transnational or multinational. This is the risk that a company’s activity might be sensitive to movements in interest rate. There are two basic types of interest rate risks: basis risk and gap risk. Interest rate risk management is a broad topic that needs to be discussed in a dedicated article. Follow the link above for more on it.

One thing that you should always bear in mind is that foreign exchange risk management is not a static process; it is a dynamic process that requires the thinking capability of a financial manager to effectively handle.

 



HOW TO MANAGE RISK IN INTERNATIONAL FINANCIAL MANAGEMENT

International financial management is all about managing risk at the international level. Risk and business are like Siamese twins that are very difficult to separate. In as much as risks are difficult to separate from businesses, the adverse effects of such risks on our business can be reduced to the barest level. Risk, in the context of this article will be seen as a measure of variability, volatility or uncertainty of transactions, investments or portfolios of investments.

Financial management as a discipline has grown so wide and complex that traditional financial managers are left with no choice but to constantly be on the move to understand the complexity involved in the financial products that are constantly rolled out by financial engineers on a continuous basis, a good example is; securitisation.

Securitisation is a financial process of bringing different kinds of debts such as; credit cards debt, residential mortgages, auto loans, students loans or commercial mortgages debt obligations, converting such pool of loans into: bonds, collateralized debt obligations (CDOs), collateralised mortgage obligations (CMOs) or pass-through securities, and subsequently selling same to the market. A major problem with securitisation is that most of the contents of the package are toxic in nature and the fact that companies floating securities are the ones that pays the rating agencies to rate the products.

This article is written to discuss modern business risks as it pertains to businesses (both local and international) with more emphasis on the financial aspects of risk management. There are two kinds of risks that businesses struggle with, they are: business risk and financial risk, management of risk will be discussed under same headings.

BUSINESS RISKS

These are those unexpected outcomes of events resulting from a company’s routine activities that have inherent to the nature of the entity’s kind of business.

MANAGEMENT OF BUSINESS RISKS

The best way to manage business risk is to set up good internal control in your business to ensure that the objectives of the business are achieved. These risks can be classified into:

Human capital risks

The most common business risk that every company faces today is the risk of going bankrupt as a result of the employees’ actions. It has been established that the weakest link in any system of control in the human-link. A system is as secured as those that make it functional. In this case, part of the process of managing such risk will be to have good human resource management procedures in place. Good practice is to have sets of conduct that every worker must observe.

The availability of good corporate governance ensures that processes are not halted as a result of inefficiencies. Drop in the motivational level of market force of a company can significantly increase the business risk of reduced contribution that might ultimately lead to business failure. I feel sad whenever I see business mangers not realising the fact that their human capital is the most important form of asset that they have. A lot of critical comments have been made in this aspect with many people pointing accusing fingers on the inability of the government to make appropriate laws to ensure that corporations realise the importance their staff members.

Globalization has made it possible for workers to be employed from all over the world and this implied that a company can use the services of a company without knowing the employee. This is technically known as outsourcing- and there lies the risk that needs to be properly managed. There are processes that need to be followed in order to carry out a security check on prospective employees.

The process of security back ground check on people before employment varies from country to country but are fairly standardised in many countries. Agencies are used to verify the identity and integrity of potential employees. Make use of them, i will not be mentioning any of them here as it might be against their terms, just do a search engine search of the phrase ‘how to perform security check on employees’ and follow the instructions.

Environmental hazards

Businesses can reduce their chances of going bankrupt through having an eye on their environment. This is where many going concerns get it all wrong by thinking that the environment in which it operates does not have much to contribute to her survival. For example, allowing your workers to work in an unhealthy environment can lead to an outbreak of pandemic and instigation of legal actions. This also will dampen the morale of workers and finally may lead to serious drop in business activities.

Government regulation and policies

Substantial amounts of business risks can be reduced by any enterprise by simply observing the legal system for any changes and respond accordingly.

FINANCIAL RISKS

These are best described as the uncertainties that are associated with changes in such factors as interest rates, stock prices, exchange rate movements and commodity prices (including factors of production). In the traditional sense of financial management, financial risk is strongly linked to the capital structure of a firm, such view is narrow in nature will therefore not be followed in this article. An integrated approach to managing financial risk will be followed.

Managing foreign exchange exposures (risk)

Businesses are exposed to four broad kinds of situations that can lead to financial instability. This is technically referred to ‘exposures’, they are: Translation exposure, Transaction exposure, Operating exposure, Interest rate exposure. In order not to make this article so long, the above identified foreign exchange risk management techniques and other factors will be discussed in types of foreign exchange exposure.

WHAT IS FINANCIAL MANAGEMENT / THE MEANING OF FINANCIAL MANAGEMENT

Financial management is the summation of those managerial functions geared towards finance performed by an organization in order to achieve her financial objectives.

This is to say that financial management is that branch of management that deals with the management of finance. Financial management has over the years grown to become key factor in strategic planning / strategic management of a business as the impact of finance functions are been felt the more in business settings.

Just like every other discipline, financial management has many branches which ensure the coverage of broader horizon.

Aspects of financial management

  • ECONOMIC ENVIRONMENT: because businesses operate in an open system, they co-operate with other subsystems that makeup an environment. Good knowledge of economic environment of a business is a must have knowledge and financial management incorporates the study of economic variables both at the micro and macro level.
  • WORKING CAPITAL MANAGEMENT: working capital management is the process of tweaking financial resources at the disposal of a company and how it will be best utilized. More on working capital management will be written in due course.
  • INVESTMENT APPRAISAL: companies and businesses don’t just go into all sorts of investment they find around, they only stake their hard earned money into worthwhile investments. The financial viability of projects and otherwise are ascertained through a process known as capital budgeting or investment appraisal processes.
  • CORPORATE FINANCE / BUSINESS FINANCE: this is the study of the movement of finance in business. It is the function of the financial manager to effectively and efficiently manage the corporate finance of an organization from the strategic point of view.
  • COST OF CAPITAL: cost of capital is the estimate of what it cost a business to have investors willingly allow their finances to be used by businesses. The process of determining the cost of capital is a complicated and complex one that will surely not be covered in an article like this. Looking around this blog may give you all that you desire and even more.
  • BUSINESS VALUATION: businesses are valued for various purposes and it is within the jurisdiction of financial management to reasonably place a value of the assets of any business.
  • RISK MANAGEMENT: business risks and financial risks are kinds of risks that can cripple a business that does not take note of them. It is through financial management that these risky variables are studied and put under control. The risk management can either be the traditional enterprise risk management or the integrated strategic risk management approach.

Financial management has things in common with management accounting. I want to assume that you already know that management accounting provides internal information that helps businesses manage variables like labour, materials, etc. In the same manner, financial management provide internal information to the management to make them make informed economic decision in the areas of; investment, financing, dividend policies, and risk management.

Again, just like management accounting, decisions made based on internally generated information go a long way in affecting the general fortune of the company. The investment decision of a company can either make or mare the public confidence on a company.

Financial management was formerly imbedded into economics but was later separated to stand alone as a full fledge discipline. Financial management make use of many mathematical tools.

FINANCIAL MANAGEMENT FUNCTIONS EXPLAINED IN A SIMPLE MANNER

Before I go on explaining the financial management functions, I would like to briefly explain what financial management is in a non technical manner.

WHAT IS FINANCIAL MANAGEMENT?

In a common parlance, financial management is all that financially responsible people do in order to ensure; safety and multiplicity of finance. Yes, if you invest your finance in a safe investment, you have taken a financial managerial action to ensure the safety of your finance while at the same time creating an opportunity for that money to grow and multiply. Simple decision of whether to buy a pair of shoe or not to buy now is a financial management decision that everyday people make on a daily basis.

According to I M PANDEY, financial management is that managerial activity which is concerned with the planning and controlling of the firm’s financial resources.

FINANCE FUNCTIONS

Investment functions: it is as sure as the ‘day and night’ for a business to die off if it fails to make investment in its business. This investment can be in any form (human resources, material, etc). It is the function of the finance arm of an organization to evaluate the numerous investments that abound everywhere in the light of a business’s standard. Investment appraisal techniques are employed to completely x-ray a company’s prospects.

Financing functions: this is simply the manipulation done on the finance structure of a business so as to get the best financial mix that will enable a company achieve her objectives (financial and non financial). Taxation aspects of financing also need to be taken into consideration while considering the best financing mix of a business.

Dividend functions: you will agree will me that businesses don’t withdraw all that are made in a given period for consumption. The ration of the profits to be retained in a business is decided by the finance department of a company. This supplements the financing function of the finance department.

Risk management: the introduction of information technology (IT) in business / finance came with lots of unattended risks that are begging for attention. The line between finance and IT continually fade away and as such requires someone or a department with good knowledge of both finance and IT to manage the emerging business risk and financial risk.

Liquidity function: a profitable business can still not survive if it fails to manage her liquidity properly. By liquidity, I mean the ability to settle claims as they fall due. It is the finance function to ensure that this objective is achieved.

REASON BEHIND FINANCE FUNCTION

We shouldn’t forget the fact that all that the financial manager does or all finance function are geared towards one thing and that thing is to maximize value for the providers of finance. That is to say that value creation.

FUNCTIONS OF A FINANCIAL MANAGER

Firstly, I would like to let you know who a financial manager is before moving on to say what he or she does. Who is a financial manager? A financial manager is an individual who is significantly responsible in carryout finance function/ financial management function.

Note that a financial manger is a key officer in every modern business enterprise as finance function is no longer a functional activity, financial manager now have strategic role to play in the overall smooth running of a business.

Profit planning: profit planning is a kind of forecasting techniques used by financial managers to get insight into what the financial position of a company is likely to be. Preparation of sales budgets is a good of profit planning activity that a financial manager performs as far as financial management is concerned.

Fund raising: one thing is to figure out the best financing mix that a company can adopt and another thing is to raise the necessary fund needed to execute a project. It is the duty and function of the financial manager to champion the fund raising exercise of a company.

Dealings with capital market: the public perception of a business is largely responsible for the success of a company. The financial manager has a great role to play in order to influence the emotion of the operators of the capital market.

Allocation of fund: it is the function of the financial manager to champion the flow of cash in a business concern.

I am sure that you enjoyed the time that you have invested into reading this piece, and have got an answer to the question that brought you here in the first place, but, if you still have any financial management question that is not answered by this article, I encourage you to explore other articles in this blog or better still leave your question as a comment right below this post.

To your successful financial management function!

CORPORATE FINANCE STRATEGIST

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