Importance of Financial Management and Use of Ratios in Financial Management

This report discusses the concept and importance of financial management, financial statements, and the use of ratios in financial management. It also covers profitability, liquidity, and efficiency ratios. The report suggests ways to improve financial performance. The subject is Applied Business Finance, and the course code is BSc (Hons) Business Management with Foundation. Get study material, solved assignments, essays, and dissertations on Desklib.

BSc (Hons) Business Management with Foundation
Applied Business Finance
The concept and importance of financial
management and the processes businesses
might use to improve their financial
performance
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Contents
Introduction 2
Section 1: Definition and discussion of the concept and
importance of financial management
2
Section 2: Description and discussion of the main financial
statements and explain the use of ratios in financial management
3
Section 3: Using the template provided 5-8
i. Completing the Information on the ‘Business Review Template (Ensure
that you display your calculations for this detail)
6
ii. Using Excel producing an Income Statement for the Sample Organisation
(see Case Study). This should be included within your appendices
6
iii. Using Excel completing the Balance Sheet 7
iv. Using the Case study information describing the profitability, liquidity and
efficiency of the company based on the results of ratio analysis
8
Section 4: Using examples from the case study describing and
discussing the processes this business might use to improve their
financial performance 9
Conclusion 10
References 11
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Appendix 12
Introduction
Business finance can be defined as funds that are arranged by a owner of the business for
meeting the requirements of company. This money is required to be properly managed by
organisation so that it can be used for increasing the profits of the entity. There is a need of
preparing accounting reports with the help of which the performance of business can be
analysed (Gomez and et. al., 2017). This report has four sections. Its first sections discuss
about the essence of accounting management. The second part ascertains the importance of
accounting standards and usage of financial ratios for managing the performance of company.
Its third portion deals with preparation of some reports in addition to its performance
analysis. The fourth part analysis the steps for improving the financial performance of
institution.
Section 1: Definition and discussion of the concept and
importance of financial management
Preparation of financial statements is of utmost importance for the organisations.
They present all kinds of expenses, incomes, revenues and shifts in the cash balance of the
business. With the use of these reports, companies can redirect their resources and can control
them so that targets of firm can be achieved properly. Management of finance refers to the
work of controlling the capital of organisation so that it could be applied optimally.
Normally, the plans made on the basis of these statements are fir shorter duration so that the
working requirement of firm can be arranged properly keeping in view the current assets and
liabilities. Efficient management of financial resources helps organisations in attaining its
long term vision by raising its profits and reducing its cost.
Importance of Financial management
 Maintaining Adequate Funding - It ensures that the company has sufficient funds
while day-to-day operations can run smoothly. It focuses on creating the optimal
balance between debtors and creditors, which ensures businesses have a chance to use
cash before making payments to their creditors. It helps find different sources of
funding that are less costly and easily available to the company (Fu and et. al., 2020).
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 Ensuring a Good Return on Investment - It is very important that the funds
invested by investors bring good results to both the company and its shareholders. The
managers of this department find the optimal level of investment opportunities that
are profitable and less risky. It also ensures that the funds are not used on wasteful
spending as this affects the company's ability to generate profits.
 Efficient use of funds - Capital management simply means using resources carefully
so that every penny in the company brings a certain profit. It helps identify the assets
that are causing losses and that must be acquired to increase profitability. Financial
management ensures that no funds are invested in tasks that are expected to result in
high losses for the company (Chavali and Rosario, 2018).
The financial statements refer to a written report that contains a summary of all
accounting activities carried out during a given accounting period. It provides brief
information on the ending balances of all expenses, income, assets and liabilities. These
reports have a well-structured format that makes them easy and understandable to use for
both external and internal parties.
Section 2: Description and discussion of the main financial
statements and explain the use of ratios in financial management
The financial statements refer to a written report that contains a summary of all
accounting activities carried out during a given accounting period. It provides brief
information on the ending balances of all expenses, income, assets and liabilities. These
reports have a well-structured format that makes them easy and understandable to use for
both external and internal parties.
There are mainly three types of financial statements, which are discussed below:
 Balance Sheet - It is one of the most important financial statements that shows all of
the company's assets, liabilities, and equity in a financial year and helps in
recognizing its financial achievements. It works on the formula:
Assets = Liabilities + Shareholders' Equity
As per the equation above, the sum of one side must equal the balance of the other side. This
report can be presented in both horizontal and vertical formats according to the choice of the
organization and the accounting rules in force in the country (Falcone, P.M., 2020). Both
sides are further divided into two parts - short term and long term - based on their useful life
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and liquidity position. Long-term assets and liabilities are usually for a period longer than a
year and are useful for the day-to-day running of the business. They cannot be realized in
cash in a very short time. On the other hand, short-term ones are usually and must be realized
within the fiscal year for better business growth. They occur from the day-to-day running of
the company. For example, cash, accounts receivable, payable, etc.
 Profit and Loss Account - It is a summarized report of all expenses and income
incurred by the company in calculating the profit or loss made by the company in a
given accounting period. It can be done quarterly, monthly or annually. It is also
known as the profit and loss account. The basic formula used in this equation is:
Income = Revenue - Expenses
This declaration is also divided into two parts, depending on the business activity. Its
first part deals with the aspects that are directly related to the manufacture of goods. It
calculates gross profit by subtracting the cost of goods sold from the sales for that
period. This income is then carried over to the next part of this (Tongpoon-
Patanasorn, 2018). It determines the companies' net profit from all post-production
activities. A balance of all indirect income and expenses is calculated, which is further
deducted from gross profit. This net profit is then taken into account when calculating
the dividend distribution to different types of shareholders.
 Cash Flow Statement- It recognizes the flow of money in the company in a certain
period of time, which can be monthly, quarterly, semi-annually or annually. In other
words, it's a brief recap of cash and cash equivalents deposits and withdrawals in the
field. The main objective of this report is to know where the funds are being used and
how well the company is making the most of its resources. It complements various
users of annual financial statements in carrying out the study of the balance sheet and
income report. This description is divided into three types.
◦ Operating activities- It deals with the activities that help generate money for the
entity by covering the regular operations. This section is the largest part of that
statement. It includes actions such as cash sales of inventory, payments, receipts
of all types of transactions related to the day-to-day running of the company
(Goovaerts and Verbeek, 2018).
◦ Investing activities- It involves the flow of money through investment sources.
These are generally long-term activities such as selling or buying fixed assets,
lending to a seller, buying stocks or bonds, changing the value of assets, etc.
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◦ Financing activities- It includes all sources of money that are acquired to run the
business smoothly. This includes issuing shares and bonds, paying dividends and
interest, taking out loans from institutions, etc. It also takes into account the
repayment of shares or long-term debt.
All of the above statements are very helpful for the organizations to assess the health
of the institute and present the data to the investor community. There are a number of
techniques for studying a company's performance, but accounting measures are the most
important tool because they can be used by both internal and external users
Use of ratios in financial management
Accounting ratios can be defined as a means of creating a relationship between the different
values of the balance sheet and the income statement in order to analyze the business
situation. They help in determining its efficiency and profitability (Nicoletti, 2018). The
results of these metrics are used by various users by comparing them with previous reports or
with other competing companies. Various uses of these ratios have been discussed below:
 Performance Monitoring Tool - The management team can use the results of these
metrics as a benchmark for the next year that needs improvement. By setting a
standard, employees generate their own understanding of how to improve their actions
so that the desired results can be achieved. This also helps the company identify the
areas where it can be flexible and which section requires maximum attention.
 For preparing future plans - It helps to interpret the trend by studying the metrics of
the past few years and analysing the company's performance. A positive transfer of
these results helps to create a good image of the company in the eyes of external
parties. In addition, the internal users can create improvement plans by reviewing the
results they have achieved. For example, the company has analysed that its
profitability metrics are falling due to spending too much on advertising that doesn't
actually produce results. This effort can therefore either be omitted or reduced to a
particular extent (Mayer, 2018).
Section 3: Using the template provided:
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v. Completing the Information on the ‘Business Review Template (Ensure
that you display your calculations for this detail)
vi. Using Excel producing an Income Statement for the Sample Organisation
(see Case Study)
This is included within appendix
6

vii. Using Excel completing the Balance Sheet
7

viii. Using the Case study information describing the profitability, liquidity
and efficiency of the company based on the results of ratio analysis
Analysing the position of firm
 Profitability ratio- It helps in determining the profits generated by companies at the end
of a fiscal year. This income can be related to investing, general business activity,
earnings from stocks, etc. In other words, it determines its ability to generate income from
its earnings.
From the graph above it can be concluded that the profitability of companies is
increasing. The company's gross profit has fallen by the minute compared to the previous
year. On the other hand, the company's net profit was very small in 2015, but in 2016 there is
a sharp increase in that revenue. The reason for this increase is that the company has tightly
controlled its indirect spending. This means that the organization is taking serious steps to
improve its profitability index.
 Liquidity ratio - These metrics help determine a company's ability to use current
assets to meet its short-term liabilities. This ratio is very useful for creditors to
determine whether and to what extent they should or should not provide credit lines to
the company.
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The company's liquidity position is good. Looking at the current relationship, the
company is able to repay its liabilities twice with the short-term assets it holds. Even if it is
unable to dispose of its inventory, it will have enough assets that can be used to pay off its
ongoing debt. After the payment, there is enough amount left for day-to-day operations.
 Efficiency Ratio- It measures a company's ability to generate income from the assets
it holds. It also tracks the time it can turn its sales into real money.
It can be concluded that the turnover rate of debtors and creditors works correctly in
the context. The company has enough time in between to make payments and collect money.
That is, it is able to satisfy its creditors without delay. A company's inventory turnover rate
cannot be interpreted without comparing the data with another company or with previous
results from one company. It takes about 3 months to sell all of the inventory, which can be
considered good.
Section 4: Using examples from the case study describing and
discussing the processes this business might use to improve their
financial performance.
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Accounting metrics are only useful if they are used to improve business performance. This
can be done by recognizing all expenses that do not add value to the company's profitability and
are unnecessary (Taffler, 2018). It should also focus on improving its marketing techniques,
which will help further increase sales. The company's finance department can also play an
important role in improving the health of the organization by revising its collections policy and
recognizing the assets that are not worthy of the business.
Conclusion
From the above report it can be concluded that financial management is a very important
aspect of doing business for planning and controlling the funds of business. It uses financial
statements to analyze the company's performance. For this purpose, the manager uses
accounting metrics to evaluate the position. Its results are also used by external parties for
accounting decisions.
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References
Gomez, E.T. and et. al., 2017. Minister of Finance Incorporated: Ownership and control of
corporate Malaysia. Springer.
Fu, J. and et. al., 2020. Trade openness, internet finance development and banking sector
development in China. Economic Modelling. 91. pp.670-678.
Chavali, K. and Rosario, S., 2018. Relationship between capital structure and profitability: A
study of Non Banking Finance Companies in India. Academy of Accounting and
Financial Studies Journal. 22(1). pp.1-8.
Falcone, P.M., 2020. Environmental regulation and green investments: The role of green
finance. International Journal of Green Economics. 14(2). pp.159-173.
Tongpoon-Patanasorn, A., 2018. Developing a frequent technical words list for finance: A
hybrid approach. English for Specific Purposes. 51. pp.45-54.
Goovaerts, L. and Verbeek, A., 2018. Sustainable Banking: Finance in the Circular Economy.
In Investing in Resource Efficiency (pp. 191-209). Springer, Cham.
Nicoletti, B., 2018. Procurement Finance: The Digital Revolution in Commercial Banking.
Springer.
Mayer, C., 2018. Prosperity: Better business makes the greater good. Oxford University
Press.
Taffler, R., 2018. Emotional finance: investment and the unconscious. The European Journal
of Finance. 24(7-8). pp.630-653.
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Appendix:
Income Statement
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