Finance in the business is like the blood in the body. Just as the body needs proper blood supply to be healthy and fit to work properly so does a business need funds to run successfully and to stand prosperously. It can be rightly said that providing funds to the business as and when needed is the key to success of a business. Nonetheless, the significance of Financial Management is not limited to providing of funds only. In fact, there is a range of other important tasks of Financial Management including the maximization of wealth and maximization of overall value of business. But in this context, we would confine our attention to finance function relating to current assets.
Finance is very much concerned with economic as well as the effective utilization of funds. It focuses on the arrangement of funds at the right time in order to carry out the activities and to achieve the determined tasks satisfactorily. Financial management plays an important role because on account of which the liquidity position of a business is affected. The term liquidity means the ability of an organization to pay its current liabilities as they come due. It emphasizes the effective utilization as well as effective management of cash. If sufficient funds are available at the right time then only a business can clear its short term debts as well as it can maintain its operations effectively. This gives rise to know the concept of working capital and working capital management.
The term working capital is used for day- to-day requirement of funds for a business. In other words, a business needs certain amount of cash for meeting routine payments, providing unforeseen events or purchasing raw materials for its production. The concept of working capital should be easily understandable to us since it is very much related to our personal lives as well. In the sense, we need to maintain sufficient funds for our cost of living. We would like to collect the cash which is owed to us by others, and at the same time we would like to pay the cash whom we owe. If we do not maintain our ready money properly and we fail to do so, we generally call the situation as bankruptcy or insolvency. The same applies to a business and the task of financial management in terms of working capital is to maintain sufficient funds for its day-to-day requirements while safeguarding the business against the possibility of insolvency. Thus the term working capital refers to the excess of the current assets over the current liabilities.
Current assets can be defined as being those that will be converted in to cash in twelve months period. They are: Cash, Receivables, inventories, marketable securities and prepayments. Current liabilities are those that are to be settled in twelve months period. Current liabilities are: Accounts payable, unearned revenues and wages payable.
Cash is the king - despite the fact that it has its own costs. Cash is the most liquid asset to be presented on the balance sheet commonly as the first item. Management of cash is of great importance for a company. If adequate cash is not available as and when it is needed, the situation leads to bankruptcy. Management of cash and liquidity involves providing sufficient funds to the business for meeting the requirement of cash at the right time. It involves several reasons. Just to name a few, repayment of bank loans, payment of taxes, payment of wages, purchases of raw materials and inventory etc. Moreover, holding the cash entails a precautionary motive in order to meet unforeseen events. Therefore, the cash must be managed properly and be provided for arising contingencies.
Apart from these, cash management also involves speeding cash inflows and slowing cash outflows. The former case indicates collection of cash payments as soon as they come due for collection while the latter indicates the payments to be made as close to the cut-off-date as possible – but this should not be taken in isolation – as it is likely to lose the facility of availing the discounts. So, the payments should be made close to the cut-off-date while utilizing the discounts if any. In this manner, in the former case the discount is offered for early payment –to generate the revenue quickly. In the latter case the discount is availed – to clear the debts as well as using the facility of discount. This is how the two-fold benefit can be obtained.
Next in importance comes the receivable. It is universal truth that every Business has receivables. They are the dues from the credit customers. There are various reasons for credit sales, such as, to penetrate and establish in the market, to increase sales, to get more customers and to help customers on whom the fortune of a business is contingent. While managing receivables, an organization develops the policies which are beneficial to both the customers as well as to the organization that makes credit sales. Credit policies must have few standards, credit period, credit terms, etc so as to manage the receivables in an efficient manner. Credit standard is meant to the classification of customers depending upon the relationships and in terms of risk etc.
The credit period is referred to how long a period should be allowed. Credit terms mean offering discount on early payment or the payment before the cut-off-date. In the point of fact, it should be understood that making too much credit sales leads to much benefit and make profit on the one hand while it involves the creation of bad debts or risks on the other. Thus, the best possible way is to be adopted for receivable is to manage within the accepted level with the establishment of planning as well as controlling measures.
The impact of inventory management on working capital is vitally important. A company, whether of trading or of manufacturing, has to carry certain amount of inventories. Inventories are classified as inventory of finished goods, of raw materials or of work in process depending upon the type of business. A trading company purchases or sells the finished goods whereas the manufacturing company deals with all types of inventories. At this juncture, it should be noted that having too much or too little inventory becomes a problematic cause in terms of sales and production. Also, even a little less or more amount of increase or decrease in the costs of inventories gives rise to a radical change in terms of overall amount of investments in the inventories.
Thus, inventory management involves planning and controlling functions with regard to the order of quantity of even single unit and the specific task of inventory management is to answer the questions: when to order the inventory, how much inventory is needed and if any discounts are likely to be lost by not ordering as per the standard limit of order etc. It is therefore necessary for the process of inventory management to find satisfying answer to the above questions pertaining to various costs of the inventories. It is appropriate to mention that there are several techniques available for the effective management of Inventories with which the management can be benefited.
Marketable securities – categorized as short term investments to earn profit rather than going for long term investments- They are regarded to be connected with the cash management. What may be briefly mentioned in terms of marketable securities is they are involved in the short term investments. A company can prefer short term investments in them rather than holding large cash. The importance lies in the fact that holding cash does not provide any return, on the contrary, marketable securities are purchased with a purpose of the generating profits.
Mention deserves to be made about the overall significance of financial management in a few words. Financial management is distinctive area of business management and the Financial Manager has a key Role in overall business management ensuring the achievement of business objectives and wealth or profit maximization. Financial management is an integral part of overall management affecting the survival, growth and strength of a business. The sole task of financial management is maximization or optimizing the value of firm. If dealt effectively, a financial manager can ward off a large number of problems.