Financial Management Process Description Essay

Any person, corporation, or nation should know who or where they are, where they want to be, and how to get there.[2] The strategic-planning process utilizes analytical models that provide a realistic picture of the individual, corporation, or nation at its “consciously incompetent” level, creating the necessary motivation for the development of a strategic plan.[3] The process requires five distinct steps outlined below and the selected strategy must be sufficiently robust to enable the firm to perform activities differently from its rivals or to perform similar activities in a more efficient manner.[4]

A good strategic plan includes metrics that translate the vision and mission into specific end points.[5] This is critical because strategic planning is ultimately about resource allocation and would not be relevant if resources were unlimited. This article aims to explain how finance, financial goals, and financial performance can play a more integral role in the strategic planning and decision-making process, particularly in the implementation and monitoring stage.

The Strategic-Planning and Decision-Making Process

1. Vision Statement

The creation of a broad statement about the company’s values, purpose, and future direction is the first step in the strategic-planning process.[6] The vision statement must express the company’s core ideologies—what it stands for and why it exists—and its vision for the future, that is, what it aspires to be, achieve, or create.[7]

2. Mission Statement

An effective mission statement conveys eight key components about the firm: target customers and markets; main products and services; geographic domain; core technologies; commitment to survival, growth, and profitability; philosophy; self-concept; and desired public image.[8] The finance component is represented by the company’s commitment to survival, growth, and profitability.[9] The company’s long-term financial goals represent its commitment to a strategy that is innovative, updated, unique, value-driven, and superior to those of competitors.[10]

3. Analysis

This third step is an analysis of the firm’s business trends, external opportunities, internal resources, and core competencies. For external analysis, firms often utilize Porter’s five forces model of industry competition,[11] which identifies the company’s level of rivalry with existing competitors, the threat of substitute products, the potential for new entrants, the bargaining power of suppliers, and the bargaining power of customers.[12]

For internal analysis, companies can apply the industry evolution model, which identifies takeoff (technology, product quality, and product performance features), rapid growth (driving costs down and pursuing product innovation), early maturity and slowing growth (cost reduction, value services, and aggressive tactics to maintain or gain market share), market saturation (elimination of marginal products and continuous improvement of value-chain activities), and stagnation or decline (redirection to fastest-growing market segments and efforts to be a low-cost industry leader).[13]

Another method, value-chain analysis clarifies a firm’s value-creation process based on its primary and secondary activities.[14] This becomes a more insightful analytical tool when used in conjunction with activity-based costing and benchmarking tools that help the firm determine its major costs, resource strengths, and competencies, as well as identify areas where productivity can be improved and where re-engineering may produce a greater economic impact.[15]

SWOT (strengths, weaknesses, opportunities, and threats) is a classic model of internal and external analysis providing management information to set priorities and fully utilize the firm’s competencies and capabilities to exploit external opportunities,[16] determine the critical weaknesses that need to be corrected, and counter existing threats.[17]

4. Strategy Formulation

To formulate a long-term strategy, Porter’s generic strategies model [18] is useful as it helps the firm aim for one of the following competitive advantages: a) low-cost leadership (product is a commodity, buyers are price-sensitive, and there are few opportunities for differentiation); b) differentiation (buyers’ needs and preferences are diverse and there are opportunities for product differentiation); c) best-cost provider (buyers expect superior value at a lower price); d) focused low-cost (market niches with specific tastes and needs); or e) focused differentiation (market niches with unique preferences and needs).[19]

5. Strategy Implementation and Management

In the last ten years, the balanced scorecard (BSC)[20] has become one of the most effective management instruments for implementing and monitoring strategy execution as it helps to align strategy with expected performance and it stresses the importance of establishing financial goals for employees, functional areas, and business units. The BSC ensures that the strategy is translated into objectives, operational actions, and financial goals and focuses on four key dimensions: financial factors, employee learning and growth, customer satisfaction, and internal business processes.[21]

The Role of Finance

Financial metrics have long been the standard for assessing a firm’s performance. The BSC supports the role of finance in establishing and monitoring specific and measurable financial strategic goals on a coordinated, integrated basis, thus enabling the firm to operate efficiently and effectively. Financial goals and metrics are established based on benchmarking the “best-in-industry” and include:

1. Free Cash Flow

This is a measure of the firm’s financial soundness and shows how efficiently its financial resources are being utilized to generate additional cash for future investments.[22] It represents the net cash available after deducting the investments and working capital increases from the firm’s operating cash flow. Companies should utilize this metric when they anticipate substantial capital expenditures in the near future or follow-through for implemented projects.

2. Economic Value-Added

This is the bottom-line contribution on a risk-adjusted basis and helps management to make effective, timely decisions to expand businesses that increase the firm’s economic value and to implement corrective actions in those that are destroying its value.[23] It is determined by deducting the operating capital cost from the net income. Companies set economic value-added goals to effectively assess their businesses’ value contributions and improve the resource allocation process.

3. Asset Management

This calls for the efficient management of current assets (cash, receivables, inventory) and current liabilities (payables, accruals) turnovers and the enhanced management of its working capital and cash conversion cycle. Companies must utilize this practice when their operating performance falls behind industry benchmarks or benchmarked companies.

4. Financing Decisions and Capital Structure

Here, financing is limited to the optimal capital structure (debt ratio or leverage), which is the level that minimizes the firm’s cost of capital. This optimal capital structure determines the firm’s reserve borrowing capacity (short- and long-term) and the risk of potential financial distress.[24] Companies establish this structure when their cost of capital rises above that of direct competitors and there is a lack of new investments.

5. Profitability Ratios

This is a measure of the operational efficiency of a firm. Profitability ratios also indicate inefficient areas that require corrective actions by management; they measure profit relationships with sales, total assets, and net worth. Companies must set profitability ratio goals when they need to operate more effectively and pursue improvements in their value-chain activities.

6. Growth Indices

Growth indices evaluate sales and market share growth and determine the acceptable trade-off of growth with respect to reductions in cash flows, profit margins, and returns on investment. Growth usually drains cash and reserve borrowing funds, and sometimes, aggressive asset management is required to ensure sufficient cash and limited borrowing.[25] Companies must set growth index goals when growth rates have lagged behind the industry norms or when they have high operating leverage.

7. Risk Assessment and Management

A firm must address its key uncertainties by identifying, measuring, and controlling its existing risks in corporate governance and regulatory compliance, the likelihood of their occurrence, and their economic impact. Then, a process must be implemented to mitigate the causes and effects of those risks.[26] Companies must make these assessments when they anticipate greater uncertainty in their business or when there is a need to enhance their risk culture.

8. Tax Optimization

Many functional areas and business units need to manage the level of tax liability undertaken in conducting business and to understand that mitigating risk also reduces expected taxes.[27] Moreover, new initiatives, acquisitions, and product development projects must be weighed against their tax implications and net after-tax contribution to the firm’s value. In general, performance must, whenever possible, be measured on an after-tax basis. Global companies must adopt this measure when operating in different tax environments, where they are able to take advantage of inconsistencies in tax regulations.

Conclusion

The introduction of the balanced scorecard emphasized financial performance as one of the key indicators of a firm’s success and helped to link strategic goals to performance and provide timely, useful information to facilitate strategic and operational control decisions. This has led to the role of finance in the strategic planning process becoming more relevant than ever.

Empirical studies have shown that a vast majority of corporate strategies fail during execution. The above financial metrics help firms implement and monitor their strategies with specific, industry-related, and measurable financial goals, strengthening the organization’s capabilities with hard-to-imitate and non-substitutable competencies. They create sustainable competitive advantages that maximize a firm’s value, the main objective of all stakeholders.


[1] M.E. Porter, “What is Strategy?” Harvard Business Review, 74, no. 6 (1996). [purchase required]

[2] D. Abell, Defining the Business: The Starting Point of Strategic Planning, (New Jersey: Prentice-Hall, 1980).

[3] J.S. Bruner, The Process of Education: A Landmark in Education Theory, (hyperlink no longer accessible). (Boston: Harvard University Press, 1977).

[4] J.A. Pearce and R.B. Robinson, Formulation, Implementation, and Control of Competitive Strategy, (New York: Irwin McGraw-Hill, 2000).

[5] C.S. Clark and S.E. Krentz, “Avoiding the Pitfalls of Strategic Planning,” Healthcare Financial Management, 60, no. 11 (2004): 63–68.

[6] T. Jick and M. Peiperl, Managing Change: Cases and Concepts, (New York: Irwin/McGraw-Hill, 2003).

[7] J.C. Collins and J.I. Porras, “Building Your Company’s Vision,” Harvard Business Review, 74, no. 5 (1996). [purchase required]

[8] Pearce and Robinson.

[9] J.A. Pearce and F. David, “Corporate Mission Statement: The Bottom Line,” The Academy of Management Executive, 1, no. 2 (1987): 109–116. [purchase required]

[10] R.K. Johnson, “Strategy, Success, a Dynamic Economy, and the 21st Century Manager,” The Business Review, 5, no. 2 (2006).

[11] M.E. Porter, “How Competitive Forces Shape Strategy,” Harvard Business Review, 57, no. 2 (1979).

[12] Ibid.

[13] A.A. Thompson, A.J. Strickland, and J.E. Gamble, Crafting and Executing Strategy, (New York: McGraw-Hill/Irwin, 2009).

[14] Pearce and Robinson.

[15] Thompson, Strickland, and Gamble.

[16] B. Jovanovic and G.M. MacDonald, “The Life Cycle of a Competitive Industry,” The Journal of Political Economy, 102, no. 2 (1994: 322–347).

[17] C.A. Lai and J.C. Rivera, Jr., “Using a Strategic Planning Tool as a Framework for Case Analysis,” Journal of College Science Teaching, 36, no. 2 (2006): 26–31.

[18] M.E. Porter, Competitive Advantage: Techniques for Analyzing Industries and Competitors, (New York: The Free Press, 1980).

[19] Thompson, Strickland, and Gamble.

[20] R.S. Kaplan and D.P. Norton, “Using the Balanced Scorecard as a Strategic Management System,” (hyperlink no longer accessible). Harvard Business Review, 74, no. 1 (1996).

[21] Ibid.

[22] Peter Grant, “How Financial Targets Determine Your Strategy,” Global Finance, 11, no. 3 (1997): 30–34

[23] Ibid.

[24] Sidney L. Barton and Paul J. Gordon, “Corporate Strategy: Useful Perspective for the Study of Capital Structure?” The Academy of Management Review, 12, no. 1 (1987): 67–75.

[25] B.T. Gale and B. Branch, “Cash Flow Analysis: More Important Than Ever,” Harvard Business Review, July–August (1981).

[26] H.D. Pforsich, B.K.P. Kramer, and G.R. Just, “Establishing an Effective Internal Audit Department,” Strategic Finance, 87, no. 10 (2006): 22–29.

[27] Q. Lawrence, “Hedging in Perspective,” Corporate Finance, 115, no. 36 (1994).

Authors of the article

Pedro M. Kono, DBA, is a professor of finance at Graziadio School of Business and Management at Pepperdine University and Fox School of Business at Temple University. He is also the president of Key Financing Solutions, a company engaged in structuring vendor programs and international financing. Dr. Kono worked for many years for Citigroup in the U.S., U.K., Japan, and Brazil, and gained significant international and diversified management experience at commercial banking, leasing, and finance companies. He obtained his doctoral degree from Wayne Huizenga School of Business and Entrepreneurship at Nova Southeastern University and has conducted research in the fields of corporate finance, specifically in the investment area, and corporate strategy. He is currently researching the market efficiency hypothesis and the performance of Exchange-Traded Funds (ETFs) in the U.S., Japan, and Brazil.

Barry Barnes, PhD, is the Chair of Leadership at Nova Southeastern University in Fort Lauderdale, Florida, where he teaches graduate-level courses in leadership, strategic decision making, and organizational behavior. In 2009, he received an Outstanding Research Award at the Global Conference on Business and Finance; he received a Best Paper Award at the International Global Academy of Business, and he was selected as Faculty Member of the Year in 2000. Dr. Barnes has published in the International Journal of Organizational Analysis, The International Journal of Business Research, Review of Business Research, the Journal of Applied Management and Entrepreneurship, and other journals. His recent research and writing focus on the relationship between leadership, organizational change, and strategy, as well as the innovative and improvisational business practices of the legendary rock band the Grateful Dead.

Financial management plays a very significant role to make an organisation successful whether it is a non-profit organisation or a profit motive organisation. Financial management is considered as a critical path, which all organisations have to follow to attain success. This paper provides us an insight of the application of financial management techniques of a Not for profit organisation and also a comparing with For-profit organisation.

Although, the strategic management process for both the organisation is very similar. However, a non profit organisation often function in a monopolistic environment which render services or produce product which offers low measurability (profit) and depends on finances from outside sources. The nonprofit sector is growing and the need to understand its efficiency, governance is very important for its stake holders, investors, donors, tax authorities and regulators.

Introduction

A Not for-profit organisation or Nonprofit organisation or NPO is a tax exempted organisation which is formed with the primary objective or goal in mind. It renders service to the public without making a profit. To be considered as a non profit organisation an organisation needs to be classified as an educational, religious, charitable or scientific organisation. A Non profit organisation does not distribute its excess funds to its owners or stake holders rather the surplus funds are reinvested to pursue and meets the organisation mission and goals. Legally, we can say that a Not For-profit organisation are those organisation that does not declare profit rather utilises all their revenues available with them after meeting their operating expenses for the benefits of the society or public. As per Internal Revenue Service an unincorporated nonprofit organisation is not given a tax exemption status or the designation of 501(c) (3) organization.

For profit and non-profit organizations there are various things common, but they cannot be ruled out from some significant differences.

One of the main points of distinction between a nonprofit organization and profit organization are the reason of existence. A Profit organization generates income for its owners, employees, investors etc whereas a NPO are formed to serve the environmental or humanitarian needs. Under non profit organizations its income are channelized into services and programs that aims to meet people need and their benefits such as food, shelter, education, water and various other issues like deforestation, water, shelter & education and also other issues like deforestation, endangered spices etc. A profit organization offers product and services that has a demand in the market and the profit earned is shared among its owners, stake holders, investors, employees etc.

Features

For any organization revenues (cash & receivables) are considered as a life blood of the companies. In For-profit organization they reply on income earned from the suppliers, lenders to finance their operation whereas a non profit organization completely reply on the donation, grants received from the individuals, government agencies and other organization. For profit and nonprofit organization income source describes the use of its money. In an NPO the money received from the donors is used to render services for the public or to accomplish the objectives and mission of the nonprofit organization and in case of for-profit organization income earned are retained by the owners or to pay the debts. These organizations have a more ethical leeway of spending their money.

Tax and Liability Considerations

A for Profit organization is taxed in a number of ways depending on their size of organization. In case of Small businesses houses like sole proprietorships & partnerships firms IRS treats the income as a personal income and in case of debts the individual is liable for all its debt where as a nonprofit organization can register itself under section 501(c)3 of the tax code. People who contribute to nonprofit organization as donation are offered tax exemption on the money donated. As per Service Corps of Retired Executives (SCORE) a nonprofit companies are considered as a legal entities for tax purposes leaving founders of the company not liable for its debts.

Human Resources Considerations

The work force of a nonprofit organization is very different compared with the For-profit organization. For- Profit Companies are staffed with salaried and contractual employees. Whereas a nonprofit organization usually employees a small workforce with a large number of people working for the company as volunteer. The procedure of hiring of employees, firing them communication, employee motivation vary considerably in both the organization.

Financial Management in Nonprofit Organizations

Financial planning & management are the major sections of a nonprofit organization which have to be taken seriously in order to keep the organization running. However, a not for profit organisations has to face some difficulties that they must overcome in order to succeed. Proper measures have to be in place like specifying goals and having clear objectives along with the benefits required by the organisation.

Finding out the actual cash flow is difficult because the NPO depends solely on the revenues from donors who are not even beneficiaries of the service rendered. Consequently, the means of NPO’s primary purpose of financial planning & management as mentioned earlier is to capitalize on the benefits of any resource contribution. The difficulties in this area are that it is not common to predict when money will come from donors and as a result it could cause serious crisis in management when there is a high demand for their services. This, is why budgeting is very important for a not for-profit organization.

Budget of Non-profit Organisation

All the companies of Not For-profit, commercial or government organisation uses budgeting to establish a proper use of resources as planned by their management and to maintain good record keeping. The capability to budget effectively is part of being a successful not for-profit organization. Budget is important because it can be use to set performance and motivation standards of its staff & board members. It can also be use as an implementation tool for measuring results if the organization’s mission is met or not. It is imperative to include accounting staff, fundraising staff, board members & other department leaders in the process. Thus, established a clear concentration on the direction for which resource will be distributed and make good use of what is available for the delivery of services. Budgeting is an excellent planning strategy that can help sketch potential financial goals and enhance management.

Planning of Nonprofit Organisation

Planning a budget in a nonprofit organization includes an extensive glace of general operating expense, base on sizes and assets. Considering future inflows is very important in any organisation. Budgeting appears to be very complicated because of the legal structure to maintain a nonprofits organization. Nonprofits have the tendency to centre most of their issue on board development, fundraising and volunteer management, and while for profit centre on information presented in the situation of nonprofit planning. In the budgeting procedure there is a possibility of discovering future shortfalls that may lead to stringiest fundraising etc.

For example, if an organization has goals to organize for building capital than a serious campaign maybe needed or an expert may be brought in to assist with planning arrangements for the company to meet it needs. It is also important to consider the fact that, unlike commercial business; nonprofit excess might be looked upon by donors and other citizens as the organization’s failure to deliver on its defined mission. With nonprofit organization, it is imperative to approximate projects cash flows and program priorities have to be balanced in an excellent budget. Nonprofit managements have to assign its capability and capital to correspond to their intended spectators and recipients. Some nonprofits do request for some form of compensation in services and that makes things difficult for the organization to increase service prices.

The planning process must include lead-time for donations and should be included in the budget. Nonprofit financial managers preparing budgets should make sure that enough funds are available to manage programs even over the expected period of the budget circle to avoid shortages etc. Once the budget is approved by the Board of Directors, it should then be used as a managing instrument to build towards measuring efficacy. An excellent budget should show resources allocated to all programs connected to strategic goals. It should be able to show that operation objectives and performance of an organization are effectively using reassures and can show that an action is needed for modification.

A modified budget within an operational period shows proper supervision arrangement. A modified budget should be able to address unexpected circumstances. An important part of budgeting is staff management’s answerabilities because responsibility should be placed in the hands of staff that are able to lead the organization to accomplish its objectives. Thus, staff and management’s complete consciousness and involvement is highly needed if the organization wants to meet its mission and make good use of their budget.

Nonprofit funding Sources

Srinivasan in her article makes it that the one fundamental element which defines the capacity of the nonprofit zone is funding. The purpose of charitable companies is to enhance the public good. However, an organization needs working capital to be successful, along with a good team of accountant, operations, and financial management. Accounting takes care of the company’s payable and receivable, while operations focus on inventory and financial management deals. It also determines how funds are used on fixed assets and prepare dividend strategies corresponding to the companies’ goals.

Funding is solicited through two major sources public and private funding in case of an NPO so that the organisation can meet its goal.

Conclusion

For a Not For-profit organisation budgeting and cash management is very crucial. This aspect speaks loud by overextending stewardship compulsion of a nonprofit company that accepts financial donations to meet its supposed goals from the public. Management faces some challenges dealing with nonprofit company’s revenue sources because of its unpredictable switch as a result of political atmosphere or economic factors. Financial accounting takes care of the organizations payable and receivable.

A fund accounting structure in the present day may combine both traditional accounting principles and applying the classified operations of FAS 117 standards. This method is challenging for a money-making organization to trail finance at a specific time and period to make sure that limited goals are accomplished. Nevertheless, using a fund accounting structure by a nonprofit organization management must consider the two most important elements which are the financial management day to day reporting requirements and the capability to show stewardship of donated capital.

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