Heritage Club India

Strategic financial management is basically about the identification of the possible strategies capable of maximizing an organization’s market value. It involves the allocation of scarce capital resources among competing opportunities. It also encompasses the implementation and monitoring of the chosen strategy so as to achieve agreed objectives.

The key decisions falling within the scope of financial strategy include the following:

1. Financial decisions – this deals with the mode of financing or mix of equity capital and debt capital. If it is possible to alter the total value of the company by alteration in the capital structure of the company, then an optimal financial mix would exist – where the market value of the company is maximized.

2. Investment decision – this involves the profitable utilization of firm’s funds especially in long-term projects (capital projects). Because the future benefits associated with such projects are not known with certainty, investment decisions necessarily involve risk. The projects are therefore evaluated in relation to their expected return and risk. For these are the factors that ultimately determine the market value of the company. To maximize the market value of the company, the financial manager will be interested in those projects with maximum returns and minimum risk. An understanding of cost of capital, capital structure and portfolio theory is a prerequisite here.

3. Dividend decision – dividend decision determines the division of earnings between payments to shareholders and reinvestment in the company. Retained earnings are one of the most significant sources of funds for financing corporate growth, dividends constitute the cash flows that accrue to shareholders. Although both growth and dividends are desirable, these goals are in conflict with each other. A higher dividend rate means rate means less retained earnings and consequently slower rate of growth in future earnings and share prices. The finance manager must provide reasonable answer to this conflict.

It should be noted that the theory of corporate finance is based on the assumption that the objective of management is to maximize the market value of the company. More specifically, it is settled in finance that the main objective of a company should be to maximize wealth of its ordinary shareholders.

This is the second article in a series of articles about the different financial statements. As we had mentioned in the last article, financial statements are the bridge that let the stakeholders know what is going on within a company. They make it easier for investors, buyers, competitors, customers and many other stakeholders to see how well the company is performing. In this article we will take a closer look at the balance sheet. The balance sheet is one of the most important financial statements of a company. While the income statement reports on all financial activities a company conducts within a period. The balance sheet reports on the general health of a company at a particular point in time (not during a period). The balance sheet is especially helpful for financial analysts. There are a few ratios that enable the financial analyst to see how well the company is managing, its receivables, payables, debt, cash, and other important aspects of the company.

The balance sheet is made up of three major sections: Assets, Liabilities, and Equity (or Stockholders equity).

Assets

The assets of a company are items owned by the company which have value and are usually something for which money was paid. This main category will be further divided into different types of assets (cash, receivables, current assets, property etc).

Liabilities

Liabilities of a company are those items that the company owes to other entities whether they be businesses, individuals, or even governments. Liabilities can also be further divided into different types of liabilities (current liabilities, long term liabilities, etc).

Equity (Stockholders Equity)

This is the third main section of the balance sheet. It includes amounts that the owners, or investors have invested into the business. This will also include part of the profit that the company chooses to retain and reinvest in new projects.

In accounting you will often find the concept of matching. Accountants and financial analysts use this concept for a range of uses including forensic accounting, financial analysis. Even the most common tasks such as reconciliation of accounts uses the balance sheet as an integral source of information. In the balance sheet, the assets must equal the sum of all the liabilities and stockholder’s equity (hence the name balance sheet). This rule can never be broken.

This equation is simply written as: Assets = Liabilities + Equity (A = L + E)

In later articles we will go over some of the parts of each side in more detail. For example we will go over Accounts Receivable, Inventory, Accounts Payable etc and the different peculiarities of each item. Before we end the article, we must explain a concept. In accounting information is very integral to running the company. The more information provided about certain accounts or transactions the better. In that line, we can see in all balance sheets that the assets and liabilities are further divided into short term and long term assets or liabilities (also current and non current). In terms of assets, all current or short term assets are those that can easily be converted (or are expected to be converted) to cash. Usually companies put a marker such as one month or 90 days. So all assets that are going to be converted to cash or liquid securities within that time frame will be put into short term or current assets. The same goes for liabilities. All liabilities that are due within 90 days (or one year for some companies) will be classified as short term liabilities. In fact all notes due are automatically considered as short term because they are due within that year. We will further clarify these in later articles along with ratios that analysts use to gauge the health of the company.

Financial management for a non-profit is as important a function of the top management as in the case of any for-profit business organization. Effective financial management ensures that the non-profit remains financially sound under all situations, and its operations run smoothly. At the same time, the best utilization of resources and donors’ funds is made when the financial management is effective.

Multiple funding sources

A good financial manager of a non-profit will have an overriding concern to ensure that the organization receives funds from different sources. It may include both private and public grants, individual donations, and fund generation through various programs and events. Heavy reliance on a single source of funds can be risky in the long run. It can destabilize the organization at any point of time if the single donor is unable to commit funds due to any reason.

Investing surplus funds wisely

To ensure efficient utilization of financial resources, the non-profit should maintain a minimum cash balance that is required to maintain a normal cash flow. But any amount over and above the cash flow limits should be invested in safe investments that produce a return on the investment as well. This is essential to keep the funds dynamic and offset the impact of inflation on the surplus funds.

Maintaining a healthy balance sheet

The success of financial management is best reflected from the non-profit’s balance sheet. It must include surplus funds for any contingency expenses, emergency based projects, future debt retirement requirements, and any fixed future expenses such as purchasing new equipment for the office. There must be sufficient working capital to ensure smooth running of the day to day activities. Finally, the balance funds must be invested efficiently in safe and high-return assets.

Effective budgeting for individual programs

A key operational part of financial management is to ensure that each project or program supported by the non-profit has a sound and viable financial budget. Accurate and detailed budgetary exercise will ensure that the non-profit does not involve with nonviable or ineffective projects. That will save any unnecessary drain on the valuable financial resources of the non-profit. Secondly, effective budgeting will account for various expenses and overheads associated with a particular program or project. It will ensure that there is no wastage of valuable resources, and overheads are kept under strict check.

It is crucial for the non-profit managers, directors and the head of the organization to have a good grasp of the basics of financial management. It is the responsibility of the men and women at the top management level to ensure sound financials for the non-profit organization.