In an article published by Forbes in October 2013, Matthew Garrett revealed the three keys to financial success:
- Earn more money than you spend.
- Invest the difference.
- Know where your money is going.
Simple, but not that easy.
When we think about personal finances, many of us break these rules all the time, racking up debt, neglecting to save or invest, and stumbling through our day without a clear picture of how we spend our cash. Maintaining control of our spending habits with an eye toward future needs is never an easy task.
Imagine then, how much harder it must be for a multinational company. With subsidiaries spread across the world and expenditures and revenue streams coming in from multiple sources, keeping on top of the big-picture finances might seem well-nigh impossible.
This is the role of corporate financial management. Corporate financial managers plan, organize, direct and control the financial activities of an enterprise. And, though the details of its operations are more complex, the principles are still pretty simple.
Earn More Than You Spend
Now, it is true that the financial team may not play what we typically think of as an active role in increasing earnings. They don’t design new products, or test them or pound the pavement trying to sell them. Instead, financial managers offer advice to determine the initial amount of capital a company will need and how to best procure that capital.
Toward this end, they have several options from which to choose. In addition to whatever capital an owner brings to the enterprise, businesses can opt to seek out private investors, issue shares through publicly traded markets or take on loans from financial institutions. The financial manager’s role in this decision is trying to strike a balance between operating capital and debt. A company will need enough money to secure itself in the marketplace, but becoming overburdened with debt can cause companies to lose their agility and may make reorganizing more difficult to manage.
Invest the Difference
Let’s assume your company has done well. You’ve introduced a great new product, you’ve controlled costs and you have a lock on the market. What to do with all the profits? You could convert them all to gold coins and hire a dragon to sit atop the hoard, OR, you could invest. A good financial manager will always choose that second option, and she will help you learn how to invest, as well.
Financial managers seek out secure investment opportunities that provide a solid rate of return for their companies. Financial managers also help companies decide whether to invest in their own enterprises, whether in fixed assets such as land, manufacturing equipment or buildings, or in such areas as technology and personnel.
In addition, financial managers help set the initial rate of dividends for shareholders and manage expenditures like salaries, wages, utilities, debts and the purchase of raw materials.
Know Where Your Money Goes
Because financial managers keep tabs on the company’s overall expenditures and investments, they usually have this step pretty well in hand. But what’s more, quality financial managers go beyond the specifics of your company and offer a macro view of the market itself and the company’s position within the industry. One way they do that is by looking at company profit margin ratios. Profit margin ratios give analysts a way to measure how much money a company reaps from its total revenue or sales. Three key profit margin ratios financial managers use are:
Gross Profit Margins
Gross profit margin measures how much money a company brings in on its cost of sales or cost of goods sold. These numbers provide a strong indication of how well management is able to control the cost of labor and supplies during the business process. To calculate gross profit, take sales, subtract cost of goods sold, and divide by sales. So if a company earns a million dollars in sales and its cost is $600,000, its gross profit margin would be 40% ($1 million-$600,000)/$1 million). Gross profit margin ratios are useful for understanding how well management is managing raw materials costs, labor costs and manufacturing-related fixed assets. These margins typically vary widely from industry to industry.
Operating Profit Margins
Operating profit margin ratios compare earnings before interest and taxes (EBIT) to sales. So if a company’s EBIT was $200,000 on $1 million of sales, then the operating profit margin would be 20% ($200,000/$1 million). This ratio gives analyst a rough indication of how a company manages the operational side of the business. Higher ratios indicate that the company is able to effectively control costs, or that sales are growing faster than operational costs. Changes in this ratio are directly attributable to managerial decisions. Because operating profit margins take into consideration not only the raw material and labor costs, but also the administrative and selling costs, this figure should be much lower than the gross profit margin.
Net Profit Margins
A net profit margin represents the total of all profits after taxes compared to sales. So if a company made $100,000 of post-tax income on $1 million of sales, the profitability of the company would be 10%. The net profit margin is also thought of as the company’s bottom line, and investors will most often refer to it to determine a company’s overall profit performance. A large net profit ratio indicates that the company has successfully managed its advantages over its competitors. These companies have a larger cushion with which to protect themselves in the event of a downturn, while companies with low profit margins may get wiped out when hard times come.
Corporate financial management takes on many duties for the good of the company. A quality financial management team will always operate to ensure a regular and adequate supply of funds for their company while protecting solid and regular returns for investors. Corporate finance managers try to provide reliable advice concerning safe, profitable investments and optimal use of capital and profits. Finally, managers endeavor to provide the company with a secure capital structure, balancing debt and equity capital to ensure that the company is able to meet the challenges of the marketplace.
In coming weeks, we’ll explore financial management best practices and look at how technology can improve the performance of your financial management team. If you have further questions, be sure to connect with a Blueprint representative today.