Financial Management
Using Financial Management Functions in Decision-Making Process
The relationship between these financial management functions of Cost of capital , bond ratings, and the capital budgeting decision-making process revolve basically on the sound management of the company capital.
Cost of capital is concerned with securing the capital for operation expenditures of the company. Capital budgeting is the allocation of these cost of capital to viable investments that could enable the company to attain the highest possible gain for the capital invested. And bond ratings reflect the result of the financial management of the company involving the cost of capital and capital budgeting decision-making process.
The effect of the capital budgeting decision-making process will result in the generation of more capital needed for company operations in the form of retained earnings. This, in turn, will result in positive bond ratings. Which will consequently lead to the pouring in of additional capital investments from new investors because a positive rating such as AAA will give investors confidence in the company’s operations and ability to pay debts such as bonds.
Also, it will be difficult for companies to make proper planning during the capital budgeting process if the cost of capital is low or incapable of meeting its required financial budget such as acquiring a new business. Capital budgeting relies on the money available for disposal. How much the company can borrow from lenders or re-invest from retained earnings will help in its final decision on investments. Lenders will probably not lend money to companies who showed negative bond ratings.
Basic Principles of Financial management
Financial Management
Good financial planning cannot be underestimated. Many surveys have identified that around 74% of business closures were attributable to poor financial management. A good business will have a business plan that incorporates financial budget for projected sales, expenses, net profits, staff needs and capital acquisition (purchase of assets)
- The level of profitability in a business will have an impact on the liquidity of the business, and this must be continuously monitored. The amount of cash in the business daily and the credit available from bankers must be sufficient to allow the businesses to trade. The measure of business’s efficiency is the manner, in which it maintains its records promptly, collects its overdue receivables and maintains an inventory that turns over quickly.
- The ultimate measure of business success is the return on shareholder’s funds, often expressed as net profit divided by shareholders funds.
- Actual results should be reported against budgets at least monthly. This enables management to correct adverse trends . Corrections may include improved staff training, better cost control, improved purchasing from suppliers, and better marketing through advertising, etc.
- The importance of cash in a business and the speed with which it flows through the business accounts can be the difference between survival and failure. Cash is needed to pay bills. A business id deemed to be insolvent when it is unable to pay its debts as and when they arise. Bank lines of credit are very important to any business.
Foundations of Financial Management
Relationship between the cost of capital, bond ratings, and the capital budgeting decision-making process is quite intricate. Cost of capital data is needed by the company before it can proceed with making a sound capital budgeting decision. These financial management functions are crucial to the financial stability of the company and the assurance of its continuous operations.
Cost of Capital
Companies finance their operations in three ways: Issuing stock (equity), issuing debt (such as bonds or borrowing from a bank), and reinvesting prior earnings. Re-invested money is part of the corporation’s retained earnings being used to invest or finance operations. It forms part of the cost of equity because if the money is not reinvested it will be declared as dividends to stockholders.
Investors often expect that retained earnings have similar return rate as the original capital. The cost of debt means the cost of borrowing money. Companies often borrow money to finance further operations such as acquisitions or establishing new plants. The cost of capital is the total of cost of equity and cost of debt.
Bond Ratings
Financial Management Plans: Managing Debt is Better Than Managing Bankruptcy
Financial institutions perceive bankruptcy cases with a high level of financial mismanagement. It becomes difficult for an individual or organization to convenience the financiers to grant loans or any other financial assistance. On the other hand, debts are relatively understandable cases of financial ‘pitfalls’. Indeed, debts are ‘inseparable’ with the personal and business life. Interestingly, if debts are managed, the situation leading to bankruptcy may be averted hence saving one from the ‘misfortunes’ and misconceptions attached to this phenomenon. In defining the two (bankruptcy and debt), it’s evident that debts precedes a bankruptcy case. Therefore, if controlled, debts may not manifest into a state of bankruptcy. Furthermore, no matter how huge a debt may be, with a good financial management it can successfully be settled out. It just requires a high financial discipline and the determination to revert it.
In the business portfolio, debt management is featured as a major financial ‘discipline’ often attracting a team of expertise to handle debt management. The business is constantly settling debts which are in form of hire purchases, buying on credit or even servicing loan advances. There are lots of transactions that require the business organizations to enter into credit agreements with the business associates and this call for a thorough and concise, and comprehensive debt management system.