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Financial Management Practices and Their Impact on Organizational Performance

Financial Management Practices and Their Impact on Organizational Performance

Financial Management Practices and Their Impact on Organizational Performance

 

The global economy is evolving. We are faced with integrated financial markets, volatile markets, evolving customer demographics, changing investor demands, as well as increased market competition and niche market monopolization. In order to compete, businesses and organizations need to evolve constantly. They need to not only improve their products and services, but internal operations as well. Efficiency is key when it comes to increasing profitability and reducing volatility, which will either attract or deter valuable investors.

 

This article examines the effects of financial management practices and their impact on organizational performance. We will analyze the relationship between organizational performance and financial management practices. These include capital structure decisions, investment appraisal techniques, dividend policy, working capital management and financial performance assessment.

 

(1) Capital Structure Decision

Capital structure is loosely defined as an organization’s debt/equity (D/E) ratio.

 

“Debt/Equity (D/E) Ratio, calculated by dividing a company’s total liabilities by its stockholders’ equity, is a debt ratio used to measure a company’s financial leverage. The D/E ratio indicates how much debt a company is using to finance its assets relative to the value of shareholders’ equity.” (Staff, 2017)

 

  • Organizational Performance and Capital Structure:

The Debt/Equity (D/E) Ratio offers a general insight into just how risky a firm is for investors. It is an indication into the firm’s financial and organizational well-being. Companies considered ‘high risk’ will attract mostly short-term investors looking to profit from the volatile stock prices and short-term gains. These companies tend to attract little to no investors at all, which limits the amount of capital available for projects and day-to-day operations.

Defining an ideal capital structure is a principal requirement of any organization’s business finance department. Capital structure optimization is critical for short-term and long-term growth. An organizations’ capital structure influence policies, product and service pricing, credit terms, management structure and resource allocation (“8 Factors That Influence Capital Structure of a Business”). Capital structure optimization reduces loan default risk, while increasing revenue and shareholder returns.

 

 

(2) Investment Appraisal Techniques

Capital investment appraisal, a.k.a. capital budgeting, is the process in which an organization defines and determines its long-term and short-term investment opportunities.

Capital investment appraisal technique, which is highly influenced by major stakeholders and decision makers, includes the following:

  1. Net present value
  2. Accounting rate of return
  3. Internal rate of return
  4. Modified internal rate of return
  5. Adjusted present value
  6. Profitability index
  7. Equivalent annuity
  8. Payback period
  9. Discounted payback period
  10. Real option analysis (“Capital Investment”)

 

  • Organizational Performance and Investment Appraisal Techniques:

The capital investment appraisal techniques mentioned above are mainly used for prioritizing projects. Organizations often have multiple projects appraised concurrently in order to study financial feasibility and make accurate projections.

 

“Financial feasibility is a projection of the amount of funding or startup capital needed, what sources of capital can and will be used, and what kind of return can be expected on the investment.” (“Feasibility Study”, 2015)

 

When the initial evaluation of a project is complete, it is compared to other similar projects. They are classified in order of Profitability Index (PI). This is calculated by dividing the Present Value of Future Cash Flows by Initial Investment Required. High ranking projects (PI >1) are executed after cautious and comprehensive analysis.

 

 

(3) Dividend Policy

“Dividend policy is the set of guidelines a company uses to decide how much of its earnings it will pay out to shareholders.” (“Dividend Policy”)

 

  • Organizational Performance and Dividend Policy:

Dividends is considered a form of revenue for investors. Most organizations consider dividend policy a vital aspect of the overall business strategy. Company leaders and managers decide the dividend amount and timing based on several internal and external factors. If revenue outweigh expenses, an organization will continue to retain capital to finance future projects, and investors will continue to receive residual dividends (earnings left after capital expenditures).

 

 

(4) Working Capital Management

Working capital management is the process of managing operations and activities related to a firm’s working capital. This ensures that cash inflow healthy enough to sustain the day-to-day operations. It is evaluated using the company’s current assets and liabilities. (“What is working capital management? definition and meaning”)

 

  • Organizational Performance and Working Capital Management:

This supervisory bookkeeping strategy monitors, analyzes and employs current company assets and liabilities, in order to facilitate a fiscally efficient day-to-day operation. Working capital management process may involve employing short-term strategies in order to ensure the organization sustain adequate cash flow to meet its operation expenses and short-term debt obligations.

 

 

(5) Financial Performance Assessment

Financial performance assessment, a vital aspect of financial risk management, is the measure of a company’s profitability, and its ability to achieve its financial goals (Verma, 2017). It is a measure of how well an organization can use assets to generate revenue. That is, it’s financial health compared to similar companies in the same industry.

 

  • Organizational Performance and Financial Performance Assessment:

Federal securities laws in the United States require public companies to disclose financial information on a regular basis. Financial performance, which is published annually (Form 10-K), include the balance sheet, the cash flow and income statement.

 

“The annual report on Form 10-K provides a comprehensive overview of the company’s business and financial condition and includes audited financial statements.” (“Form 10-K”)

 

The form 10-K is considered a reliable source of audited financial data by investors.

 

At some point, most companies (public or private) require a comprehensive assessment of their financial performance and structure. Analyzing financial performance with, without a doubt, impact decisions, as well as short-term and long-term projects. The overall financial health of an organization can be measured through the balance sheet, the cash flow statement and income statement (“Financial Performance”).

 

 

Conclusion

Based on the information provided above, it is easy to assume the financial structure and practices of an organization is key to sustainability, profitability and growth.

Capital investment appraisal, a.k.a. capital budgeting, is required for prioritizing projects.

Dividend policy a vital aspect of the overall business strategy because it is considered a form of revenue for investors.

Working capital management ensures the organization sustain adequate cash flow to meet its operation expenses and short-term debt obligations.

Analyzing financial performance with, without a doubt, impact decisions, as well as short-term and long-term projects.

To summarize, businesses need capital, investors provide capital, but need profit in return. Good and consistent returns with maintain long-term investors and attract new investment and project opportunities to the organization.

An organization’s financial health is not only dependent on the goods and services it offers. It relies heavily on the internal structure and operation efficiency. This maximizes returns, retains talent and builds investor confidence.

 


 

 

References

8 Factors That Influence Capital Structure of a Business. (n.d.). Retrieved November 18, 2017,

from https://onlinemasters.ohio.edu/8-factors-that-influence-capital-structure-of-a-business/

 

Capital Investment. (n.d.). Retrieved November 17, 2017, from

http://www.capital-investment.co.uk/capital-investment-appraisal.php

 

Financial Performance. (2015, September 30). Retrieved November 18, 2017, from

https://www.investopedia.com/terms/f/financialperformance.asp

 

Form 10-K. (2009, June 26). Retrieved November 19, 2017, from

https://www.sec.gov/fast-answers/answers-form10khtm.html

 

  1. (2017, October 10). Dividend Policy. Retrieved November 19, 2017, from

https://www.investopedia.com/walkthrough/corporate-finance/5/dividends/policy.aspx

 

Staff, I. (2015, August 11). Feasibility Study. Retrieved November 17, 2017, from

https://www.investopedia.com/terms/f/feasibility-study.asp

 

Staff, I. (2017, November 15). Debt/Equity Ratio. Retrieved November 18, 2017, from

https://www.investopedia.com/terms/d/debtequityratio.asp

 

Verma, E. (2017, July 27). Financial Performance – Understanding its Concepts and Importance.

Retrieved November 18, 2017, from https://www.simplilearn.com/financial-performance-rar21-article

 

What is working capital management? definition and meaning. (n.d.). Retrieved November 19,

2017, from http://www.businessdictionary.com/definition/working-capital-management.html

 

 

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