By Daniel Archibald | CFA
For most of us, the concept of managing costs and sticking to budgets is part of everyday life. In fact, failure to stay on top of the family finances can lead to, among other things, high indebtedness, risk of bankruptcy and relationship stress. For business, improper financial management can have similarly dire consequences.
The role of the finance controller, CFO or finance manager is to ensure the ongoing liquidity and solvency of the business. This is true for big companies, with their CFOs and financial controllers, as well as for small businesses, with their owners who wear many managerial hats. And this role is primarily accomplished by focusing on the structural integrity of the organisation's capital.
Managing the balance sheet
A company's financial position is captured in its balance sheet. This provides a quick look at the capital that the business has access to (surplus cash and investments, debt, equity) and how it is deployed (assets).
The balance sheet elements can be metaphorically viewed as parts of a car:
- the long-term (non-current) assets can be thought of as the car's engine and parts. The success of the car will be primarily down to what is under the hood. For the finance manager, this is known as capital budgeting; that is, how to deploy capital to the right assets (e.g. a new machine, better software, etc)
- the short-term (current) assets and liabilities (also known as working capital) can be thought of as the oil in the engine. Too much oil can flood the engine, but too little will destroy it. In the world of business finances this is known as working capital management. The primary decisions for the finance manager in this regard is making sure current assets such as cash and inventory are high enough to ensure that payments and sales are not missed, but small enough to make sure that as much capital is invested in assets that can produce earnings
- the long-term debt and equity (as well as surplus liquid assets) can be thought of as the make and model of the car. Some cars are small and sleek so they can get you from A to B quickly, some are big and heavy so they can haul large loads. In financial management this is known as financing, which is decisions around how much capital is needed and how much to borrow.
The finance manager needs to make sure that all the parts and inputs that make up the structure of the business are well tuned and tested so that the business will perform as it should. The last ingredients, the skills and knowledge of its workforce (the fuel), can then be added so that managers (drivers) can steer the organisation to success.