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Analysing and Evaluating Financial Management
Effective financial management is essential to the success of a business or organisation. This essay will analyse and evaluate the importance of financial management to a business and the main factors which would influence the ability of the organisation to achieve its financial objectives of liquidity, growth and profitability.
Some of the main reasons for failure in the area of financial management is: lack of capital, too many long term assets, lack of control over credit (letting customers accumulate too much credit) or inventories, poor cash flow, and having too high of costs. Especially for a small business, financial management is extremely important as if you don’t keep an eye on it regularly a business can very quickly go under. Good accounting processes and sound financial management are one of the best ways that a business or organisation can make sure that they remain profitable and solvent. The foundation of many successful business operations is how you manage the finances of your business, its cash flow and profitability. (Effecta, Advanced Business Coaching, Accountancy & SME Consulting Company, 2010)
The objective of a business relates to the goals that an organisation sets out to achieve within a timeframe. For a business to successfully achieve these goals or objectives, they often create business plans that assist them in making sure that their objectives are achievable, as well as assisting them to actually achieve them. (Businesscasestudies.co.uk, n.d.) A business plan is a management tool. The plan makes benchmarks and indicators of which the progress of the business can then be assessed. The business plan shows what the business is capable of and fosters employee commitment to the business, focuses the employees concentration on the goals and objectives of the business and encourage forward thinking in regards to those goals and objectives, as well as the well-being of the business.
Another important aspect of a business plan is the break-even analysis. This is an essential step that will tell the owner if the business will make money during a specified period by showing the break-even point. The break-even point is where the business has the same amount of revenue as they do expenses. This means that the business is neither disadvantaged or advantaged.
Financial management includes the acquisition and use of finance, planning, organisation and controlling. Acquisition of finance refers to getting finance. This part of financial management asks many important questions about a business’ finances, including what type of finance and where do we get it? As well as how is it invested? You must acquire an asset which will yield the required return. To answer the aforementioned question of where do we get finance? A business must look at all of their options in order to make the best decision for the business. Most people would immediately think of a bank in regards to acquiring finance, but this isn’t the only way. There are many different ways to acquire finance, including a fast growing method called crowd sourcing through websites like KickStarter. This is when a business puts up an idea online and other people finance it through putting their own money into it in order to get something in return. This could be simply one of the products that’s being made, or even a share in part of the business.
Planning of a business refers to the extremely important aspect of setting objectives (both long term and short-term) and looking at the ‘big picture’. General objectives of a business change and grow as the business progresses. Often, the general objectives of a business revolve around the liquidity of a business (the cash flow to pay to suppliers and employees), the profitability of the business (having more revenue coming into the business than expenses coming out), risk minimization (making sure that the business has insurance in place as well as other risk management practices including training and maintenance) and growth (growing and expanding opportunities for the business).
The organisation of finance refers to the recording of a business’ finances. This can mean having in place a financial system to carry out a plan and assist people in enacting the plan, as well as having an accounting system in place for the business. Controlling finance refers to looking at the information you have on your own finances and being able to tell whether or not you’re on the right track with your finances.
The aim for most business’ revolve and profitability and growth. Put simply, the profitability of a business is the difference between the revenue and the expenses. This means that a business makes sufficient revenue over expenses to make the risks of running the business worthwhile to all of the people involved.
Ratios in business, particularly financial management are used to assess a business’ financial health. In order to measure the profitability of a business and therefore analyse how a business is progressed, you can use the Gross Profit Ratio. This tells how much money is left over to cover other expenses and still make profit, and is an indication of how effectively the business is using the revenue. This ration also compares gross profit with sales revenue.
There are a few reasons of which state why the Gross Profit Ratio can vary. This can be the changes in the costs of raw materials, as well as the changes in the sale prices (specifically what the business sells their goods for). This would affect the Gross Profit Ratio and therefore the profitability of the business. If there is a change in the relationship between the Gross Profit Ratio and the sales revenue there are also a few things of which can be done about it. This includes: finding cheaper solutions to either the way a business is run or the products which are sold in the business, buying goods in bulk and then storing them which therefore means that the business is saving money on their inventories, using alternative warehousing and holding less stock onsite, buying goods locally rather than importing them from places which are further away. It is important for a business to remember that if they have more stock than they need, it’s costing them money.
Another way of measuring profitability is with the Net Profit Ratio. This ratio relates to how much of the sales revenue is left as profit after all the expenses are taken into consideration. A business’ Net Profit Ratio can be improved by decreasing expenses as a percentage of sales and making sure that the business doesn’t hold stock for a long time if they don’t need to. For some businesses though, the holding of stock can be defining factor. This is especially in the case of a restaurant named Bcoz that is located in Melbourne. This business holds large amounts of wine for a long period of time because it is a defining factor for their business that people can come into the restaurant and get the specific wine that they want.
As the profitability on a small business isn’t as high as it is in a large business, it is extremely important that the owners or managers of a small business keep an eye on the growth of expense over time, as well as the proportion of sales revenue a business is using.
As aforementioned in this essay, one of a business’ main financial objectives relates to liquidity. Liquidity is defined as “cash, or the fact of having cash or assets which can be changed into cash easily.” (Search.credoreference.com, 2014) This means having the sufficient cash resources to allow a business to meet the day to day running costs of the business. Liquidity can be measured in several ways, one of which includes the use of a cash flow budget. A cash flow budget records all expected cash inflows and outflows and can be calculated by ratios and information found on the balance sheet. INSERT BALANCE SHEET NONSENSE
In order to effectively use financial management and therefore effectively manage a business it is important to seek out external advice to find out whether the business could save money or protect themselves from factors both externally and internally. This means speaking to not only a lawyers and accountants, but also tax specialists, business and financial consultants, government agencies, and business organisations.
Another aspect that refers to managing the business both internally and externally is the SWOT analysis. This refers to the process of analysing the strengths, weaknesses, opportunities and threats. Internally the business can manage the strengths and weaknesses through financial management processes and externally the business can attempt to manage the threats and opportunities for the business.
Internal and external finance can also be related to debt and equity finance. Within a business there are two main types of finance, equity and debt. Equity finance is internal and refers to the finance from owner/s (shareholders etc.) who will want a high rate of return in order to keep financing the business. Debt finance is external and is a liability to the business. This finance is what is obtained from banks and other sources of the like. These two types of finance are also highly reliant on interest, particularly debt finance as when borrowing money from a bank you are required to pay back that money, as well as the interest. The amount of interest that must be paid is determined by interest rates. These rates differ for almost every single business. Interest rates work in two ways – borrowing and saving money. Banks charge more interest for borrowing money and give marginally less for saving money in a bank account.
As well as equity and debt finance, there is also short and long term finance. Short term finance is generally defined as the purchasing of short term assets. And although these types of finance don’t have any clear-cut time limits, these are current assets that can generally be converted into cash within a year. Long term finance is generally defined as the purchase of long term (or non-current) assets. These are assets that are not able to be converted into money quickly.
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