Thursday, January 21, 2010

4 Key Control Points of Financial Management. Financial Leaders Guide to manage effective Capital Management Cycle.

Control Points of Financial Management

Financial leaders coordinate four variables throughout the capital management cycle: cash, profitability, debt, and capital spending. A description of these points of control and their relative relationships follows:

    Cash: How much "free cash" should be on the balance sheet? Remember, creditworthiness is highly dependent on liquidity, and cash is a direct source of capital, especially in the not-for-profit environment.

    Profitability: Profitability from operations must be sufficient to support the required amount of debt capacity and ensure appropriate liquidity. The appropriate level of debt and cash will determine long-term profitability requirements.

    Debt: Debt should be governed by the following philosophy: Not too much, as everyone knows, but not too little. Unfortunately, this is a concept that is often not sufficiently understood.

    Capital spending: How much capital spending is too much? How much is too little? The answers obviously relate to how profitable the organization is and the appropriate mix of debt and cash. A reminder: how an organization allocates its capital spending dollars can be more important than the absolute number of dollars spent.

Based on its current financial position and external operating environment, each organization has an optimal solution set for these variables. This solution set is the preferred quantitative outcome between and among the points of control. Solving for the solution set through algebraic calculations is not required of senior management. Rather, the management team must ensure that such quantification is accomplished, that the results and interrelationships between variables are well understood by the team and board members, and that the financial performance of the organization is safely managed within identified constraints.



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