Role of a Financial Manager - Essay Example

Financial Manager Role of a Financial Manager A financial manager of any company or firm is faced with most crucial options and decisions on a both day-to-day basis and for longer time durations. The primary aim of a financial manager's activities and planning should be to increase and add to the shareholders' wealth and maximize the company share's value. This implies that all the decisions taken by the financial manager must result in higher profitability and growth of the company. This would increase the company's share price in the financial markets and benefit the shareholders with increased dividend yields and capital gains. All the operations of the business are initiated and supported by the financial manager's evaluations and judgments. The cost/benefit analysis, the timings of the cash flows, the sources of finance and provision for liquidity are pivotal to the decision-making process of financial management. In the context of the above, a financial manager's role is three fold. He has to perform the functions of capital budgeting, capital structuring and working capital management simultaneously, providing effective risk management. Thus a financial manager best serves the owners of the business (shareholders) by identifying goods and services that add value to the firm because they are desired and valued in the free marketplace. Every business enters into long-term investments in anticipation of promising returns and higher growth. Such investments call for efficient assessments and effective decisions by the financial manager. This process of planning and managing a firm's long-term investments is better known as capital budgeting. In capital budgeting, the financial manager tries to identify investment opportunities that are worth more to the firm than they cost to acquire. This means that the value of the cash flow from generated by an asset exceeds the cost of that asset. Evaluating the size, timing, and risk of future cash flows is the essence of capital budgeting. Financial managers are concerned with how much cash they expect to receive, when they expect to receive it, and how likely they are to receive it. After assessing and deciding as to which long-term investments to be taken, the next concern for a financial manager is how the firm will obtain the financing it needs to support its long-term investments. In this area two main issues face the financial manager. One is that how much should the firm borrow and two is that what are least expensive sources of funds for the firm. The capital structure (or financial structure) refers to the specific mixture of long-term debt and equity the firm must use to finance its operations. In addition to deciding on the financing mix, the financial manager has to decide exactly how and where to raise the money. The expenses associated with raising long-term financing is a considerable factor. Therefore different possibilities have to be carefully evaluated. Businesses borrow money from a variety of lenders in a number of different ways. Choosing among lenders and among loan types is another job handled by the financial manager. A financial manager is also responsible for everyday financial activities and for the working capital management. Managing the firm's working capital is a day-to-day activity that ensures the firm has sufficient resources to continue its operations and avoid costly interruptions. The term working capital refers to a firm's short-term assets, such as inventory, and its short-term liabilities, such as money owed to suppliers. The working capital management involves a number of activities related to a firm's receipt and disbursement of cash. The financial manager must plan for and respond to matters as to the amount of cash and quantity of inventory to be kept on hand, should credit be allowed on sales to customers and which sources should be used for short-term financing as and when the need arises. The above three functions of financial management are very broad and only a brief overview of each category is given. By performing these functions efficiently and effectively, a financial manager succeeds and excels in maximizing the value of the company's shares and wealth of the shareholders. Comparison of financial manager's viewpoint with that of shareholders regarding maximizing share value The financial manager in a corporation acts in the best interest of the shareholders by taking actions that increase the value of the firm's stock. However, in large corporations the ownership is spread over a huge number of shareholders. This rests the whole control of the corporation on the shoulders of management. In such case, the management and the shareholders may differ on certain points of view, and the decision making process may become cumbersome. Moreover, the perspective of the financial manager may not match with that of the shareholders on many an occasion. The ability of managers to increase their own utility at the expense of shareholders is limited by two factors, namely the wealth-maximizing activities of shareholders and the danger of an involuntary take-over by a rival firm (Yarrow & G. K., 1976). The value of the company's share is dependant on more than one factor. The quantum and effect of both the risk and the return are to be considered. For instance, a corporation is considering a new investment. The new investment is expected to favorably impact the stock price, but it is also a relatively risky venture. According to Antia, Murad, Meyer and Richard (1984), in general, managers may prefer more conservative, equity-oriented financing, while stockholders desire greater financial leverage. The problem arises because of differences in the degree of portfolio diversification achieved by managers and stockholders. Stockholders tend to have reasonably well-diversified portfolios, causing them to be concerned with systematic risk. Managers' portfolios are apt to be more concentrated and directly tied to the financial success of an employer, causing managers to be concerned with total risk. Thus, for a given capital structure, each party views the firm as having a different level of risk. Seitz and Neil (1982) suggested that the interests of managers and shareholders do not automatically coincide, that information is not free, and that both parties will attempt to maximize their own self-interest when contracting with each other. The management goals need to be closely aligned with the shareholders' goals, which may relate to the way managers are compensated. If the managerial compensation is tied to the company's financial performance in general and to the share value in particular, the maximization of the share value may become guaranteed to an extent. The provision of stock option to the financial manager in particular and to the financial management team in general, proves to be a good compensation plan for making shareholders' and manager's objectives and viewpoints parallel and coinciding. This way the manager too feels as a shareholder while utilizing the management skills together. References Antia, Murad J., Meyer and Richard L. (1984). The Growth Optimal Capital Structure: Manager Versus Shareholder Objectives. In Journal Of Financial Research (Volume 7 Issue 3, p259, 9p) Seitz and Neil (1982). Shareholder Goals, Firm Goals and Firm Financing Decisions. In Financial Management (Financial Management Association) (volume 11 Issue 3, p20- 26, 7p) Yarrow and G. K. (1976). On The Predictions Of Managerial Theories Of The Firm. In Journal Of Industrial Economics (Volume 24 Issue 4, p267, 13p) Read More