Financial Management (Key to Wealth Creation)

The Role of an Accountant and the Benefits of Preparing

Financial management is the use of resources to achieve the goals and objectives of an individual or organisation. Financial management is at the core of every business development. The projects, businesses, and companies we see today all started as ideas. These ideas were nurtured and financed based on their expected returns and eventually developed into fully fledged business entities.

The cost of equity is the net present value of expected future dividend payouts.

The fundamental objective of a company is often argued to be the maximisation of shareholders’ or owners’ wealth. This can be realised by maximising the market value or long-term profitability of the company. Wealth can be defined as the capacity to consume, or simply put, money or cash.

Financial management is underpinned by three well-crafted decisions. The investment decision addresses the question of what investments a company or business entity must undertake. The financing decision addresses what, where, when, and how much finance should be raised to undertake the project. Finally, the dividend policy directs how returns or profits should be used or distributed.

Good financial management requires the preparation of a business plan. A plan is essential to the success of every activity. If you fail to plan, then you are planning to fail. The business plan must be translated into a financial plan, which must then be implemented to ensure the achievement of the company’s objectives. The company must also source appropriate and adequate funding to undertake the project, with due consideration given to the cost of capital.

Key Accounting Practices for Enhancing Transparency

It is said that finance is the lifeblood of every enterprise. It is therefore imperative for businesses to understand how to access this “blood bank” and establish a constant supply to ensure sustenance and healthy growth.

The fate of many businesses has been determined by the quality of their financial management, including sound planning, adequate funding, and fair profit sharing. The bane of most small and medium enterprises is poor financial management and, invariably, limited access to finance. The lack of finance is the reason why many fresh and innovative ideas have never seen the light of day.

Sources of Finance

Sources of finance can be many and varied and may differ according to locality. Finance may come from internal or external sources. The primary internal source of finance is personal resources, such as life savings, which are often limited in amount. Another internal source is funding from family and friends. This traditional source works well in certain communities, such as Indians, Lebanese, and the Kwahus.

External sources of finance include equity and debt. Equity represents share capital and is finance provided by the ownership group. Equity holders are entitled to dividends from the profits generated by the business. Debt, on the other hand, refers to borrowing from third parties. Debt finance attracts interest payments, which are mandatory. Failure to meet these obligations could lead to legal implications and, in some cases, liquidation.

Debt is Cheaper Than Equity

This assertion is true from the investee company’s perspective. The underlying concept is the risk–return relationship. High-risk investments attract higher returns, while low-risk investments offer lower returns. By definition, equity capital may never be repaid and therefore qualifies as a high-risk investment. Debt capital, however, represents a loan with a contractually fixed rate of return, a fixed repayment period, and preferential payment treatment over equity capital. These factors combine to make debt capital a less risky investment and, therefore, cheaper than equity capital. This analysis is important for decision-making regarding the capital structure of a business entity.

Cost of Finance

There is no such thing as a free lunch, and this is particularly true of financial resources. Since most forms of finance carry some cost implication, it is important to take this into account when sourcing finance for business investments. The cost of equity is the net present value of expected future dividend payouts. The cost of debt, on the other hand, is the interest rate on borrowing, which is often advertised in banking halls and occasionally published in the print media.

Excessive debt may lead to financial distress, while too much equity can result in the dilution of earnings per share and a reduction in owners’ control of the business.

Duration of Loan

The duration of a loan has an implicit cost. Short-term loans are cheaper but riskier, whereas long-term loans are more secure but expensive. It is therefore important to consider loan duration carefully in any loan contract. The guiding principle is to ensure that long-term loans are used to finance long-term projects, while short-term loans are used for short-term projects. Failure to observe this principle may lead to financial mismatch, which can be costly and destructive.

Importance of Choice

The choice between equity and debt in financial management is crucial because of its impact on wealth creation. This is the financial objective of any business operating in a capitalist environment such as Ghana. Indeed, it is part of human nature to create and add value in our endeavours.

Every manager must have a good understanding of financial management. This knowledge is a vital tool for the sustainable growth and development of any business.

(The writer is a financial and management consultant and an advocate of good corporate governance.)