Introduction to Financial Management

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1Summary 重點摘要

Financial management raises and deploys a firm's funds: accounting ratios review operating performance; management weighs debt against equity, short-term against long-term, internal against external financing; and working capital is managed to fund growth while preserving liquidity.

2Vocabulary cards Vocabulary

3Step by step Steps

1. Step 1: The role of financial managementFinancial management handles three tasks — raising funds, deploying funds and managing funds — securing capital at reasonable cost and investing it where returns reward the risk, ultimately growing the value of the firm and shareholders' wealth. For example, a cha chaan teng owner versed in finance buys a new fridge from retained profits rather than borrowing at high interest, and keeps a month of expenses in cash to ride out the slow season — able to advance and to hold firm.
2. Step 2: Reviewing performance with accounting ratiosFinancial analysis starts from four angles: profitability via gross and net ratios; liquidity via current and quick ratios; solvency via gearing; efficiency via inventory and receivables turnover. For example, analysis shows a firm with a high net ratio but slow receivables turnover: the product earns well but collection lags, so the financial-management priority is tightening credit terms and chasing debts — not touching production or pricing.
3. Step 3: Internal versus external financingInternal financing draws on retained profits or the sale of idle assets — no interest, no dilution of control, the cheapest money there is — but its size is capped by past profits. External financing can be large: bank loans, bonds and new shares. For example, extending one more shop unit is within reach of retained profits; building a factory costing millions requires external funds. Match the source to the scale of the plan, flexibly combining both.
4. Step 4: Debt versus equity financingDebt requires scheduled interest and repayment, yet interest is generally tax-deductible, the cost is lower, and lenders have no say in management — control stays intact; but fixed interest is a hard burden, and if profits sag the firm may fail to pay, financial risk rising with gearing. New shares carry no scheduled payments and lower financial risk, but shareholders share profit and decisions — control is diluted — and future dividends are not tax-deductible. For example, family firms often prefer borrowing to issuing shares precisely to keep control.
5. Step 5: Short-term versus long-term financingShort-term financing — overdrafts, trade credit — is flexible and suits short-term needs such as inventory and receivables; long-term financing — term loans, bonds, share capital — suits long-lived assets such as plant and machinery. The core principle is maturity matching: long-term investment with long-term funds, short-term turnover with short-term borrowing. For example, buying a machine on overdraft means the loan falls due before the machine pays for itself — a liquidity break; conversely, funding seasonal purchases with a ten-year loan wastes years of interest.
6. Step 6: Weighing up the choice of financingReal decisions balance several factors: compare the cost of interest versus dividends; assess existing debt levels and profit stability to judge bearable financial risk; consider the effect on control; and match the maturity of funds to their use. For example, a firm with stable profits and low debt benefits from the economics of borrowing; one with volatile earnings or heavy debt finds shares dearer but safer. In answers, analyse factor by factor before concluding — never settle on a single point.
7. Step 7: Managing working capitalWorking capital = current assets − current liabilities — the buffer of daily operations. Manage cash, receivables, inventory and payables: keep cash at a safe level without hoarding; set clear credit periods for sales and chase collections; keep inventory turning to avoid pile-ups; and, within what suppliers allow, negotiate longer payment terms. For example, a firm with $300,000 of current assets and $150,000 of current liabilities holds $150,000 of working capital and a current ratio of 2 — a comfortable buffer for sudden orders.
8. Step 8: Budgeting and budget variancesA budget turns the financial plan into numbers, coordinating departments, controlling spending and setting targets. The gap between actual and budgeted figures is the budget variance: revenue below budget or spending above it is adverse and must be traced and corrected. For example, a department budgeted $100,000 for travel but spent $130,000 — an adverse variance of $30,000; investigation reveals fare rises and poorly sequenced trips, so next year early booking and trip consolidation can bring spending back in line.

5Worked example Example

6Common mistakes Mistakes

7Quick check Quick check

8Recap Recap

• Financial management raises, deploys and manages funds — decisions that look to the future
• Accounting ratios review performance in profitability, liquidity, solvency and management efficiency
• Three financing pairs: internal versus external, debt versus equity, short-term versus long-term
• Choosing financing means weighing cost, maturity matching, control and financial risk
• Working capital = current assets − current liabilities; managing cash, receivables, inventory and payables is the daily routine