Brigham and Houston (2012) noted that financial management is a core aspect of any organization that aims at meeting its objectives. It involves the process of planning, directing, organizing, and controlling all financial activities that include but not limited to procurement and utilization of funds meant for an enterprise. Financial management is about utilizing management principles to the financial resources that run a company. Every manager must come to terms with three major elements that constitute financial management. They include investment decisions, financial decisions, and dividend decisions. Investment decisions include those targeting fixed and current assets while financial decisions involve raising finances from various resources. Lastly, the dividend decisions are mainly concerned with the net distribution of the profit. Some of the objectives of financial management include ensuring regular supply of funds in an organization, guaranteeing returns to the shareholders, and ensuring that funds are optimally utilized (Brigham, & Houston, 2012). The financial manager in an organization must always ensure that they assess the financial health of an organization through analyzing the key indicators. Furthermore, critical recommendations should be suggested from time to time to ensure that the company adopts sound financial control.
Analyzing the Financial Functions of an Organization
The profit margin is the single best measure of the financial functions of an organization. It further gives an indicator if the company has long-term viability. Although analyzing the financial functions of an organization is not an easy task, financial managers must consistently find ways of measuring their financial efficiency by constantly assessing financial statement and evaluating stocks amongst others. In keeping tabs with the financial health of an organization, the management of the company must familiarize themselves with several metrics. Four of the major areas that an organization can rely on while assessing their financial functions include profitability, liquidity, solvency, and operating efficiency. However, it remains vital to keep in mind that the best measure is profitability.
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A company can exist for many years without necessarily making huge amounts of profits. However, the long-term health of an organization and its prospects sustainability requires the company to make significant profit margins. The best metric utilized in evaluating the company's profitability is known as the net margin which is a ration gained after dividing the profits by the overall revenues. The net margin ratio is an important figure because a dollar figure cannot sufficiently provide information regarding the company's financial health. An organization can record a net profit amounting to a hundred million dollars or above, but the net margin remains at 1% or less. The implication here is that any slight increase in the marketplace competition or operational costs could plunge the company into a crisis. A bigger net margin, therefore, means that the company enjoys a better financial safety and further depicts that the company is in a better financial position to utilize their capital in growth and expansion.
The second indicator of the financial functions of an organization is the operating efficiency. The operating efficiency determines the organization's financial success. The operating margin is the primary measure to indicate a reliable operating efficiency. Some of the aspects that the operational efficiency shows in an organization include the business' basic operational profit margin and management control costs of the organization. Navajas and Thegeya (2013) noted that good management and operational efficiency go hand in hand. Therefore, when there is operational efficiency, it means that the organization’s management operates well and the company is in a position to make future advancements.
The third major measure of the financial functionality of an organization is solvency. Solvency refers to the ability of an organization to pay its debts on a continuous basis. Therefore, when a company can only meet its debts on a short-term basis, then its solvency comes into question. The metric utilized here is known as the solvency ratio which comes as a result of a quotient between the organization's long-term debt and the assets it posses. Another measure is known as the debt-to-equity ratio (D/E) which is regarded as a major indicator of the long-term sustainability of an organization. The D/E measures several factors that include the debt against the equity of the stakeholders (Higgins, 2012). As such, such a metric can provide the organization with vital information regarding the level of investor interest and confidence in the organization. A lower D/E ratio indicates that the shareholders fund most of the company's operations as opposed to the creditors. In such a scenario, the company assumes a stronger position because the shareholders do not charge interest on the financial services they provide an organization. The ratios of D/E vary from company to company. However, irrespective of the type of business, a lower D/E ratio always shows a positive sign that the company is gaining a strong financial ground.
The fourth important tenet in analyzing the financial function of an organization is known as liquidity. Liquidity is defined as the amount of cash or assets that could easily be converted into cash that a company owns. As such, a company that has liquidity is in a position to solve its short-term debt issues more effectively. Important to note is the fact that any company that wants to succeed in the long-term must show long-term strength. Higgins (2012) asserted that the metrics that could assess liquidity include the current ratio and quick ratio. The quick ratio is also known as the acid test and is regarded as the most precise. The quick ratio takes cognizance of the current assets and current liabilities. It, therefore, provides a more practical approach that a company can use to measure whether it can meet its short-term obligations by utilizing cash and assets. A quick ratio lower than 1.0 means that the company is in danger because the current liabilities are more than the current assets.
Recommendations to Establish Sound Financial Control
Every organization must ensure that they remain profitable by employing activities that are within the applicable laws. Therefore, financial managers have an obligation of developing not only sound but also transparent management system towards achieving better financial control systems. It is also important that finances are one of the most vital tenets of a company because they play an essential role in a wide range of activities that include purchasing materials, supplying commodities, remuneration, and the delivery of value to the stakeholders. Therefore, any person in need of developing a sound management system must follow a certain criterion of operation.
The first principle that enterprises must follow to ensuring successful financial health is careful budgeting. The budget for an organization is a financial framework that acts as a benchmark from which all the financial decisions in an organization are made. Every manager must ensure that they develop a realistic budget that that ensures that a business is in a position to finance its continuous commitments, control its spending, and finally meet its financial objectives. Vijayakumar and Nagaraja (2012) opined that a budget further enables the manager to measure the performance of each department and identify potential challenges because they lead to a crisis. A good manager will ensure that the budget comes out of accurate and proper forecasting of various tenets in the business such as the sales, direct, and fixed costs amongst others. Larger organizations depend on annual reviews and planning of their budgets to come up with an effective financial plan. However, small organizations must do it from time to time to determine the variance and trends in the organization's revenues and expenses. Budgeting, therefore, allows an organization to create a spending plan thereby guaranteeing that the company will always have enough amount of money to cater to its needs. Furthermore, remaining within the realms of the budget will likely keep a business out of debt or provide a company with a framework of coming out of a huge debt.
Secondly, establishing a sound financial control requires that an enterprise adopts rigorous internal controls. One major importance of the internal controls is that it guarantees that the company remains compliant with the laws and regulations and further prevents the likelihood of losing assets through theft or misappropriation. Several benefits come with a system that follows a rigorous internal control. First, it provides a system of check and balances that assist in evaluating the maximum and minimums that each department should spend in a given amount of time. Secondly, it ensures that there is a proper authorization of expenditure (Kasselaki, & Tagkalakis, 2014). As such, the organization will only spend on the necessary projects that have a positive impact on the well-being and sustainability of the company. Thirdly, it further ensures that physical control, especially of hard assets, becomes a possibility. It further ensures that documents and records supporting financial activities are kept well thereby minimizing the likelihood of foul play and increasing accountability. A rigorous internal control system also provides for a platform for review and reconciliation so that all activities reported in the accounting files of an organization correlate with supporting documents. Developing such a culture sets positive precedence for an organization to remain within the realms of accountability and further seal all the possible loopholes which might be used by malicious people to loot the company.
Käfer (2016) noted that establishing a sound financial control requires an organization to develop a culture of regularly reporting especially for the publicly traded companies. A regular internal reporting mechanism ensures that an organization creates a platform for attaining its financial goals and objectives. Some of the areas that the company must pay a keeninterest inn include the financial statement, balance sheet, and income statement. Performing this on a monthly basis ensure that the company is better placed to tackle to foresee its futuristic engagementsand the possibilityy of a sustainable future. Käfer (2016) further intimated that the company must remain sure to complement this reports with others information from departments to provide the business with a complete picture of where it should shift its focus.
Another strategy for ensuring that the organization adheres to strict financial policies is by providing for an internal audit process. An internal audit process differs significantly from an external audit. The latter involves evaluating the accuracy and veracity of financial documents and attempts to look for possible problems in the area of financial reporting. However, an internal auditing process is more vigorous and works towards ensuring that the company remains accountable for any dollar they put into use. An experienced business accountant carries out an internal audit. They go beyond simply assessing the numbers and further analyze various processes and controls in a bid to identify the possible risks and opportunities for improvementSoundnd financial management can only be achieved when an internal audit is out in place. Mitchell (2017) illustrated that it also provides a framework for which an organization identifies risks that threatens its profitability and financial health. Through the internal audit process, the accountant can suggest the ways through which the identified risks can be mitigated.
Lastly, in recommending ways in which business can adopt a sound financial control, the organization must develop a policy of transparency. Every public traded company must have a transparent accounting system. However, critical to note is the fact thaa transparent internal policyegoeses beyond official regulations. Managers must ensure that the transparent financial records are not only accessible but are also easy to read and understand. Additionally, they should not contain any hidden entries or gimmick and must disclose all the relevant information and transactions that the company has undertaken. A sound financial management system can only be achieved when the business adopts a culture of transparency throughout various departments including finance and accounting.
In conclusion, financial management is an essential factor that every organization must prioritize. A stable financial organization can meet all its short-term and long-term goals thus enhancing sustainability. Financial managers must, therefore, device several ways of measuring the financial health and functions of an organization. The most commonly used strategies include assessing the profitability, liquidity, solvency, and operational efficiency. All these indicators have metrics for measurement which every company must attain failure to which the organization can easily fall into crisis. Another important role of financial managers is to ensure that they lay down mechanism for enhancing a sound financial system. As such, all the indicators and metrics of financial stability will go upwards. Examples include creating a budget, an internal auditing system, regular reporting, internal controls, and a system of transparency. Therefore, organizations will set a clear path for financial prosperity by eliminating all the risks that threatens its financial viability.
References
Brigham, E. F., & Houston, J. F. (2012). Fundamentals of financial management . Cengage Learning.
Higgins, R. C. (2012) Analysis ofor financial management . McGraw-Hill/Irwin.
Käfer, B. (2016). The Interaction between Financial Stability and Financial Institutions: Some Reflections . Kassel: Kassel University Press.
Kasselaki, M. T., & Tagkalakis, A. O. (2014). Financial soundness indicators and financial crisis episodes. Annals of Finance , 10 (4), 623-669.
Mitchell, G. E. (2017). Fiscal Leanness and Fiscal Responsiveness: Exploring the Normative Limits of Strategic Nonprofit Financial Management. Administration & Society , 49 (9), 1272-1296. Doi: 10.1177/0095399715581035
Navajas, M. C., & Thegeya, A. (2013). Financial soundness indicators and banking crises (No. 13-263). International Monetary Fund.
Vijayakumar, A. N., & Nagaraja, N. (2012). Internal Control Systems: Effectiveness of Internal Audit in Risk Management at Public Sector Enterprises. BVIMR Management Edge , 5 (1long-t).
