Financial management is a key function of any organization. A Finance Manager, a CFO or or a Finance Director is the driver of the organization.This is the function which lead the company towards success (or failure if the function is not properly managed).
Makeup of a company
Financial management function decides about the makeup of a company. If company is a collection of assets then finance manager is the person who makes decision what short-term and long-term assets there will be in the organization. As part of this role it is decided that how much investment will be made in working capital and how much will be invested in fixed assets and for long-term investments.
In order to collect those assets and investments a company will require a great deal of capital. Financial management function will again come into rescue. This function will look around to search for appropriate source of capital for the entity and collect those capital.
At this stage financial management function will decide about the capital structure or gearing level of the organization.
Financial management function (FMF) is not only designed to build a company and leave that on its own. Rather this is a continuous function which aims to maximize the value of the company on an on-going basis. A company is like a piece of pie. Financial management is with the responsibility to make the pie bigger and bigger and bigger. In order to do so FMF must identify wealth maximizing projects investment opportunities and manage them properly. Also the function must make a balance between short-term profitability and liquidity in order to deliver long-term wealth maximization objective.
Capital structure and financing method
Inclusion of baking powder in the production of a pie is necessary as it is a key determinant for the size of the pie. Financial management decides about the capital structure of the company which reduces cost of capital and consequently maximizes value. In the capital structure debt is considered as baking powder. Debt finance is cheaper and tax allowance on debt interest expense makes it even cheaper (cheaper than cheaper). Whenever finance management function earns a return which is higher than the cost of debt finance, value of company increases. But inclusion of too much debt in to the capital structure may affect the company adversely. Company will become too risky and return will not be sufficient to compensate investors for the extreme risk they will be taking as a result value of the company might fall down. FMF is in a critical position to decide about the optimal mix of debt and equity in the capital structure with the objective of making a balance between risk and return which also will lead to satisfactory wealth maximization.
Distribution of wealth and retention
Investors are here for returns. Investors invested their money to the company either in debt or in equity only to earn return from those fund. Financial management is under constant pressure from the investors to provide returns adequate for them. Again FMC must also confirm long-term growth of the organization which requires constant re-investment. Re-investment is possible when generated wealth is retained for re-investment. FMC once again in a critical position to make a balance between distribution and retention of wealth that is being created.
Risk is something that you can't avoid totally if you want to make any sort of return from an investment. All the investments of the world involve undertaking of risk. Even banks to take the risk of default with the loan which may result in non payment of interest and capital though they take mortgage against loans. In most situation there is a direct link between risk and reward. Highly risky investments most often generates high reward otherwise there will be no investors to invest in those highly risky projects.
Risk is something which can not be avoided altogether but it doesn't mean that it cannot be managed. FMC is there to manage risk of the organization to reduce it to an acceptably low level.