Financial Management

Read the text and say whether it is easy to evaluate the level of financial performance of a firm.

There are five basic financial goals: profitability, stability, liquidity, efficiency, and growth. To survive, every business must meet each of these goals to some extent, though a business must determine for itself the relative emphasis to place on each of the five goals.

Profitability refers to the generation of revenues in excess of the expenses associated with obtaining it. This is the “bottom-line” test of how successful a firm’s operators have been as shown at the bottom of the income statements.

Stability refers to a business’s overall financial structure. For example, a businessman may wish to invest as little of his own money as possible in his firm and finance his operation mainly with debt. If the debt-equity mix is too out of balance, the firm may go bankrupt should some of the creditors want their money back at an “inconvenient” time. Many of the spectacular financial disasters reported in the newspapers resulted from neglect of the stability goal of sound financial management.

Liquidity refers to a business’s ability to meet short-term obligations. For example, a manager may wish to invest as much of his firm’s cash in inventory and equipment as possible, but if he overdoes it and cannot pay his employees or creditors on time, he can be forced into bankruptcy.

Efficiency refers to the efficient use of assets. Efficient use of assets has an impact on profitability, stability, liquidity, and the ability of the enterprise to grow.

Growth refers to increasing in size or acquiring more of something. A businesswoman may assess her financial performance by calculating, for example, how much sales or assets have increased this year over last year. While there are many widely held concerns about growth in general (for example, the zero population growth movement) business people and investors remain very interested in financial growth.

There are no clear-cut guidelines on how much or how little financial performance is adequate or on how to trade off performance of the financial goal in favour of another. For example, 10 percent sales growth may be terrible for a firm in one industry but excellent for a firm in another. Similarly, a high level of liquidity may be preferable to growth for a firm at one time and detrimental for the same firm at another.

Financial analysis and management is not just number pushing; judgment must be exercised as to what numbers to look at and how to interpret them. Often, a “qualitative factor,” something not expressed in numbers, is more important to the solution of a problem than all the numbers involved.