While having a well-organized bookkeeping system is vital to business operations, more critical to success is having established methods to control how finances are managed. Financial management is the term to describe those methods, which is like the engine of a car. The bookkeeping system is the body of the car; paint, finish and engineering structure makes the car look sleek and powerful. However, the car cannot go anywhere without an engine. Bookkeeping performs at its peak level when you have a solid financial management system.
Essentially, financial management is the process of putting numbers to work for your business. The goal is to reach for success with a good financial management system designed to provide guidance and updates of how your business is performing. Not only do you know how your business is performing financially, but you will understand why. With this type of information, you can make decisions that help to improve operations.
Why is Financial Management Important?
Financial management enables you to make accomplishments in daily financial objectives. A good system will allow you to:
- Be proactive and not reactive to situations
- Borrow easily as needed by planning ahead
- Share budget information with your banker to simplify the loan approval process
- Update investors on financial planning information
- Have profitable and efficient operations
- Access a good decision-making tool when considering key financial issues
On the micro level, solid financial planning and control empowers you by:
- Avoiding unnecessary heavy investments in fixed assets
- Maintaining enough short-term working capital needs that support inventory and accounts receivable collections
- Setting sales goals that are growth-oriented and not simply operating as an order taker
- Improving gross profit margins with effective pricing of goods or services
- Reducing direct labor costs, supplier prices and other items that affect the cost of goods sold
- Operating efficiently with overall administrative expenses
- Performing better tax planning
- Performing a sensitivity analysis, which determines how independent variables will impact a decision
- Planning ahead for employee benefits
Reasons to Develop a Financial Management System
The first step towards developing a good financial management system is to create financial statements generating these statements monthly allows you to manage proactively for targeted success. Important financial statements to maintain include a balance sheet, cash flow statement and income statement.
Developing a financial management system helps to manage capital expenditures that every business must consider. In general, you make asset purchases to generate income. Any financial considerations related to capital expenditures should balance with the amount it takes to make the purchase and the income it will produce. Managing your capital expenditures effectively ensures you will not overextend the business by borrowing too much. Income generated should justify the expense.
Another reason to develop a financial management system is to manage your cash flow. Operating expenses such as payroll, office supplies, insurance and utilities must be paid. You want to look ahead to see how much is due in your accounts receivable and whether it is enough to meet those expenses by the due dates. Better management of your cash flow is possible if you shorten the amount of time customers have to pay invoices. Additionally, you could renegotiate due dates with vendors.
One of the primary financial responsibilities of any business is to keep expenses as low as possible. You can attempt to accomplish this in many ways such as asking vendors to lower prices, reduce staff or reduce energy usage – all without compromising the quality of business production. Nevertheless, if you do not manage costs, your business will be on an endless cycle to stay afloat just to pay operational costs.
Paying taxes is a certainty in your personal life and business. You have a financial responsibility to plan for payments to local and federal taxing authorities. Otherwise, profits can evaporate in penalties and interest on late payments. Tax planning involves making sure there is enough cash on hand to make estimated tax payments each quarter they come due. Failing to plan and maximize available deductions will cost more in taxes and leave less to invest in the growth of your business.
Roles within a Financial Management System
There are several important roles that a good financial management system has in the success of your business. Therefore, you should include this system as a key component to overall organizational management. Strategic and tactical goals are included in financial management to ensure financial resources are used wisely and effectively. Some of the specific roles within a financial management system include:
- Accounting and bookkeeping
- Accounts payable and receivable
- Investments and risks
Accounting and Bookkeeping
Typically, a financial management system will identify, record, measure and communication financial information about a business. The foundation for this system is to have good bookkeeping practices. Whether you hire someone in-house or use an outside entity, bookkeeping gives accurate and complete information to your accountant to execute financial tasks. Where accounting deals with the overall financial health of your business, bookkeeping handles specific, day-to-day transactions.
Accounts Payable and Accounts Receivable
Accounts payable is responsible for information about your vendors and suppliers. This part of the financial system shows how much items cost, how payments were made and any other details about a transaction. There should also be a record of outstanding money owed to vendors and suppliers. In addition, accounts payable shows the progress of workflow, which allows you to approve invoices for payment.
Where accounts payable is responsible for cash outflows, accounts receivable records cash inflows. The role of accounts receivable is to keep track of what customers owe through invoices and reminder notifications for any outstanding payments. Accounts receivable helps your business recover past due invoices before they enter the bad debt territory.
Investments and Risks
Another essential role for the financial management system is to find investment opportunities that will benefit or complement your business. The only way you can exploit investment opportunities is to have the ability to pay for the desired acquisitions when they occur. While your team finds possible opportunities, good financial management ensures an efficient and effective process. Through different aspects of your financial system, you can evaluate the business’s overall health for making such investments.
Likewise, you want to be able to carefully evaluate risks, whether with an investment opportunity or other areas. This may include hiring more staff or making a capital purchase. Evaluation looks at the current market to determine if it is the best time to make such investments.
Looking at risks solves a primary goal of your financial management system: minimizing risks with strategies that counteract unforeseen liabilities. You want to have adequate insurance coverage for employees, equipment and property. Controlling debt and having an effective credit system with financial institutions and suppliers gives your business more operational flexibility and less financial risk if you experience cash flow problems.
Financial Management is More Than Keeping Accurate Records
Beyond keeping accurate records and balancing the company check book, financial management is important for your business success. You want a good financial system that helps you make sound decisions without overspending. It is important to be prepared for expenditures and profit distributions. Poor financial management affects all areas of your business. Good financial management ensures that what your business accomplishes daily is not lost on wasteful spending.
