Financial Management

Finance is the lifeline of any business. However, finances, like most other resources, are always
limited. On the other hand, wants are always unlimited. Therefore, it is important for a business
to manage its finances efficiently.
Financial management is generally concerned with short term working capital management,
focusing on current assets and current liabilities, and managing fluctuations in foreign currency
and product cycles.
It is also involved with long term strategic financial management, focused on for example capital
structure management, including capital raising, capital budgeting (capital allocation between
business units or products), and dividend policy;
Financial management may be defined as the area or function in an organization which is
concerned with profitability, expenses, cash and credit, so that the "organization may have the
means to carry out its objective as satisfactorily as possible.

Objectives of Financial Management:

1. Profit maximization, Profit maximization happens when marginal cost is equal
to marginal revenue.
Profit maximization is the short run or long run process by which a firm may determine
the price, input, and output levels that lead to the highest profit.
When profit is maximized there is a high revenue which can be used for business
expansion. Profit maximisation is when firms maximise their profits through sales and
increasing the price of products.
Profit maximization, in financial management, represents the process or the approach by
which profits Earning Per Share (EPS) is increased.
The most basic model of a firm assumes firms wish to maximise their profit. They will do
this by increasing revenue that is (price * quantity sold) and reducing costs. Higher profits
enable a firm to pay higher wages, more dividends to shareholders and survive an
economic downturn.

Marginal cost is the change in the total cost that arises when the quantity produced is
incremented by one unit; that is, it is the cost of producing one more unit of a good.
Marginal cost at each level of production includes the cost of any additional inputs
required to produce the next unit. At each level of production and time period being

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 considered, marginal costs include all costs that vary with the level of production, whereas
other costs that do not vary with production are fixed and thus have no marginal cost. For
example, the marginal cost of producing an automobile will generally include the costs of
labor and parts needed for the additional automobile but not the fixed costs of the factory
that have already been incurred.

Marginal revenue (MR) is the additional total revenue that will be generated by
increasing product sales by one unit.
In a perfectly competitive market, the additional revenue generated by selling an
additional unit of a good is equal to the price the firm is able to charge the buyer of the
good. This is because a firm in a competitive market will always get the same price for
every unit it sells regardless of the number of units the firm sells since the firm's sales can
never impact the industry's price.
However, a monopoly determines the entire industry's sales. As a result, it will have to
lower the price of all units sold to increase sales by 1 unit. Therefore, the marginal revenue
generated is always lower than the price the firm is able to charge for the unit sold, since
each decrease in price causes unit revenue to decline on every good the firm sells.
The marginal revenue (the increase in total revenue) is the price the firm gets on the
additional unit sold, less the revenue lost by reducing the price on all other units that were
sold prior to the decrease in price.
A firm’s profits will be maximized when marginal revenue (MR) equals marginal cost
(MC). If MR>MC then a profit-maximizing firm will increase output for more profit,
while if MR<MC then the firm will decrease output for additional profit. Thus, the firm
will choose the profit-maximizing output level as that for which MR=MC.
So when the marginal cost is equal to marginal revenue, then we have the profit
maximization.

Strategies to Maximize Profit

i. Convert One-Time Clients into Repeated Clients. - There are many reasons
why converting your customers into repeat clients can quickly improve your
profitability. Repeated customers tend to spend more and purchase more
frequently than new customers. Repeat customers also contribute to the long life
of your business.

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 There are many ways to convert your clients into more engaged, repeat buyers
that help maximize profit. Here are some of them:
a. Have offers with frequent billing - Another way to get return customers
is to turn your small deals into long-term billings. You can also offer
subscription-based services relevant to your business. For example, if
your business is a hair salon, you can offer customers the chance to
subscribe to a monthly refill of hair care products delivered to their door,
and even include reminders on touch-ups on their haircuts.
b. Keep in touch with customers. It means never let a transaction be the
last point of contact between you and your customer. One way to do this
is through an email autoresponder sequence, which you can trigger to
automatically send regular emails to your customers after they purchase
online or subscribe to your email list.
c. Give discounts on shipping, not products. One common mistake that
small business owners make is that they give away discounts to encourage
new and repeat purchases. The problem with this approach is that it cuts
into your profits and sets a lower price expectation on your products and
services. A study from the University of Florida found that offering "free
shipping" encourages more frequent orders and "is the most effective
policy in terms of customer acquisition". So instead of discounting your
products or having sales, regularly give discounted or free shipping.

ii. Encourage Referrals - According to a survey of small business owners, referrals are the
number one driver of new business. If there is one marketing channel that can maximize
your profits, referrals would be it.
A good referral often has nominal or no costs, plus potential customers tend to give
weight to the opinions of people they already know. In fact, research from Nielsen shows
that 84% of consumers trust product recommendations from family, colleagues, and
friends.

iii Drop Low Performers - To figure out which of your products or services should be
discontinued, you have to prepare an income statement for each of your income sources. This
will let you know how much profit and expenses each of your products and services bring into
the business.

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Basically, for each product, you'll list the total gross amount of sales and subtract all the costs
associated with creating and selling that product. A simple formula would be:
Net Income from Product = Total Amount of Sales – Total Product Costs

Once you're done computing your net income for each of your products and services, find out:
• Which products and services give you the lowest net income?
• Are there products and services that you're actually losing money on?
• For those unprofitable or underperforming items, and would getting rid of them also get
rid of the expenses associated with them, or will these expenses be passed on to your
remaining products?
• For those products and services that are unprofitable or are underperforming, would
getting rid of them affect the sales of your remaining products? For example, if
customers usually try your business by buying your underperforming products, but then
they follow up by purchasing your more profitable products, then getting rid of your
underperforming products might affect the sales of your other products negatively.

Going through the performance of each product and service in this way can help you find out for
certain how much they contribute to your bottom line — and whether you're better off focusing
on the few that really deliver.

iv. Offer Upsells or Cross-Sells on Popular Items – You can also focus your efforts on
selling customers other products means, cross-selling or offering them a higher priced
option means, upselling as they are performing with you. This raises the average profit
you get per transaction or per customer.
An upsell would mean that as a customer is buying a product, you offer them a higher
priced option from the same product line. For example, FreshBooks, an online invoicing
company, offers a monthly subscription worth Rs. 2500/-, but they highlight a package
worth Rs. 3,500/- as the recommended option, which is a higher-cost package with more
features.

v. Remove or Delegate Non-Essential Tasks - Small business owners are notorious for taking
on too much work, since they often cover everything from customer support to product creation
to marketing. If you find yourself doing too many administrative tasks, consider if those tasks
are essential to keeping or obtaining customers.

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You can delegate some tasks that take your time away from doing more profit-generating work.
For example, good customer service can lead to more purchases and increased value of
purchases. If customer service takes several hours out of your week—hours that could be better
spent on higher-level tasks such as marketing and business planning—then delegating it might
open up more opportunities for your business to grow.
Apart from delegating, don't forget to eliminate as well. For tasks that you repeatedly do that
don't seem to affect your bottom line, it might be better to take them off the to-do list as well.
These might include spending time on marketing channels that haven't brought in any results, or
long real-time meetings that address issues that could have been dealt with via email.

vi. Expand Your Reach to a Broader Market – It means to increase your profits; you might
also do well to increase your reach. Which areas—whether demographic or geographic—can
your business do better in? For example, if you're selling your products well from your city, but
you haven't maximized your opportunities in the next city, perhaps it's time to expand your
market and reach out there.
When you're focusing on attracting just a specific segment of the market, you lose sight of all
the other people who might possibly be interested in your product, or who might have contacts
who can be potential prospects for you.

vii. Eliminate Bottlenecks in Your Sales Funnel - Another way to maximize your business
profits is to take a critical look at your sales funnel and see where it can be improved. List all the
steps it takes for a customer to find out about your business and actually purchase something.
These steps could take place online, where they find your website, browse, and buy something
from your online store. An offline sales funnel might include customer walk-ins to your store,
sales calls, or incoming customer calls.
Once you have all the steps listed, ask yourself and any relevant staff the following:
• In which part of the sales process do most potential customers drop off? It means Is
it when they find out the price, get in touch with customer service, or use up a one-week
trial period? Spot the leaks in your sales funnel and see what measures you can take to
stop qualified leads from losing interest.
• Is there a way to simplify your funnel? It means the more steps a customer has to go
through before a purchase, the more chances they have for dropping out of your sales
funnel altogether. If you can make the transition from decision to purchase easier and
more satisfying for your client, the better.

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 2. Maintaining proper cash flow - and its’s a short run objective – It means
It is necessary for operations to pay the day-to-day expenses for example raw material,
electricity bills, wages, rent etc. A good cash flow ensures the survival of company.
A cash flow is a real or virtual movement of money:
A cash flow in its narrow sense is a payment, especially from one bank account to another;
the term 'cash flow' is mostly used to describe payments that are expected to happen in the
future.
Cash flow is the amount of money coming into a business and the amount of money going
out. Think of it as a water tank: water comes in at the top and drains out the bottom. So,
to keep your tank nice and full, you want more coming in than going out.
So, we can say, Cash inflow is the lifeblood of your business and comes from sources like
payments from customers, receipt of a loan, monetary infusion from an investor, or
interest on savings or investments. Cash is also important because it later becomes the
payment for things that make your business run: expenses like stock or raw materials,
employees, rent and other operating expenses.
Naturally, positive cash flow is preferred. Positive cash flow means your business is
running smoothly. High positive cash flow is even better and will allow you to make new
investments means hire employees, open another location etc. and further grow your
business.
Positive cash flow is driven by two things: organization and planning.

3. Minimization on capital cost so that operations gain more profit.

Capital costs are fixed, one-time expenses incurred on the purchase
of land, buildings, construction, and equipment used in the production of goods or in the
execution of services.
In other words, it is the total cost needed to bring a project to a commercially workable
status.
Capital costs include expenses for tangible goods such as the purchase of plants and
machinery, as well as expenses for intangibles assets such as trademarks and software
development.
Capital costs are not limited to the initial construction of a factory or other business.
Namely, the purchase of a new machine to increase production and last for years is a
capital cost. Capital costs do not include labor costs. Unlike operating costs, capital costs

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 are one-time expenses but payment may be spread out over many years in financial reports
and tax returns. Capital costs are fixed and are therefore independent of the level of output.

For example, a fuel power plant's capital costs include the following:
• Purchase of the land upon which the plant is built
• Permits and legal costs
• Equipment needed to run the plant
• Costs involving the construction of the plant
• Financing and commissioning the plant (prior to commercial operation)

They do not include the cost of the natural gas, fuel oil or coal used once the plant enters
commercial operation or any taxes on the electricity that is produced. They also do not include
the labor used to run the plant or the labor and supplies needed for maintenance.

4. Estimating the Requirement of Funds: It has been shown that the amount of funding
and resources committed to an area directly affect the development, quality, and services
related to the area. For example, the funding given to education is directly related to the
quality of education and academic achievement. Similarly, increased funding towards
healthcare increases the quality of care given – increased spending on hospitals, drugs,
and public health have been linked to improved public assessments of the system.
However, simply increasing funding is not the answer.

The mechanism of funding and the appropriation of funds is just as important. A strategy
is needed for appropriate spending to maximise the benefit on healthcare of available
funding. This is equally true for education

Therefore we can conclude two things: firstly, funding is needed to improve products,
services, and technologies and secondly, it is only beneficial if regulations are in place to
ensure that the funds are used appropriately to maximise their value.

Similar to public services the quality of product or service a business can provide is
dependent on its financial situation. A business without appropriate funding sources will
be drown in a sea of debt. Funding is the fuel that powers a business. A business can take

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 different avenues and channels to attain funding. The type of funding chosen is dependent
on the business type, the current situation of the business, and the direct that the owners
are intending to grow.

What is funding used for?

• Seed Money –funding is required to get the business running, it can be used for
materials, websites, and office supplies. Seed money can come from an investor,
a small business loan or the owner's savings account.
• Second is funding is used for - Cash Flow – the day-to-day expenses of a business
need to be met. Salaries, bills, insurance, amongst other things must be paid. The
initial period of a business generates low revenue, hence requiring funding.
• Third is funding is used for - Expansion – it means, when a business begins to
grow new locations, products, and market research may be required. These
activities add to existing costs and need additional funding.

No matter which stage the business is funding or what source the funding comes from, it
will not be an unlimited amount. There are always constraints that limit funding potentials.
Therefore, modern funding mechanisms have incorporated providing guidance and
coaching alongside funding. This is proven to be a necessary step to ensure that the
funding is properly utilised for best possible outcome.

So for Estimating the Requirement of Funds, Businesses make forecast on funds needed
in both short run and long run, hence, they can improve the efficiency of funding.

5. Determining the Capital Structure: A firm's capital structure is the composition or

'structure' of its liabilities.
Capital structure refers to a company's outstanding debt and equity. It allows a firm
to understand what kind of funding the company uses to finance its overall activities and
growth. In other words, it shows the proportions of senior debt, subordinated debt
and equity (common or preferred) in the funding.
Capital structure, broadly, is composed of the firm's debt and equity. It maximizes the
company's market price of share by increasing earnings per share of the ordinary
shareholders. It also increases dividend receipt of the shareholders. Capital

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 structure increases the ability of the company to find new wealth- creating investment
opportunities.
It refers to the proportion of money that is invested in a business. It has
four components - Equity Capital, Reserves and Surplus, Net Worth and Total
Borrowings.
So, to conclude we can say, Capital structure is how a firm finances its overall operations
and growth by using different sources of funds. Once the requirement of funds has
estimated, the financial manager should decide the mix of debt and equity and types of
debt.

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