Importance of financial management
Decisions taken in every functional area of a firm has a financial implication. Therefore, every major decision must be judged from the perspective of financial management to avoid sure failure of the business. Financial management is important mainly because it helps to make decisions that are consistent with the maximization of the value of the firm to its owners. The importance of financial management to a firm can be presented as below.
- Helps to set a clear goal:
The clarity of the goal is important for any firm. Financial management defines the goal of the firm in clear terms – ‘maximization of the shareholder wealth’. A setting goal like this helps to judge whether the decisions taken are in the best interest of the shareholders or not. It also directs the efforts of all functional areas of business towards achieving the goal and facilitates coordination among the functional areas of the firm.
- Helps the efficient utilization of resources:
Firms use fixed as well current assets which involve huge investment. Acquiring and holding assets that do not earn a minimum return required by the firm do not add value to the shareholders. Moreover, the wrong decision regarding the purchase and disposal of fixed assets can cause the throat to the survival of a firm. The application of financial management techniques (such as capital budgeting techniques) helps to answer questions like which asset to buy when to buy, and whether to replace the existing asset with the new one or not.
The firm also requires current assets for its operation. They absorb a significant amount of a firm’s resources. Excess holdings of these assets mean inefficient use and inadequate holding exposes the firm to higher risk. Therefore, maintaining a proper balance of these assets and financing them from proper sources is a challenge to a firm. Financial management helps to decide what level of current assets is to be maintained in a firm and how to finance them so that these assets are utilized efficiently.
- Helps to decide sources of financing:
Firms collect long-term funds mainly for purchasing permanent assets. The sources of long-term finance may be equity shares, preference shares, bonds, term loans, etc. the firm needs to decide the appropriate mix of these sources and the number of long-term funds; otherwise, the firm will have to bear the higher cost and expose to higher risk. Financial management (capital structure theories) guides us in selecting among these sources of financing.
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Helps to make dividend decision:
The dividend is the return to the shareholder. The firm is not legally obliged to pay dividends to the shareholders. However, how much to pay out of the earning is a vital issue. Financial management (dividend policies and theories) helps a firm to decide how much to pay as dividend and how much to retain in the firm. It also suggests answering questions such as when and in what form (cash dividend or stock dividend) should the dividend be paid?
The importance of financial management is not limited to managers who make decisions in the firm. Proper financial management will help firms to supply better products to their customers at lower prices, pay a higher salary to its employees, pay higher taxes to the government, and still provide a greater return to investors.
