The Structure of Financial Management Theory
Financial management theory is a composite science that interconnects various financial disciplines, combining theory, principles and tools, and is applied to analyze the asset value and to optimize the financial management of companies. Its primary purpose is to maximize stakeholder wealth. To achieve this goal, the financial manager must make decisions after considering the advantages, disadvantages and risks associated with funding and capital structure, as well as the planning and control of cash flow and profits.
The structure of financial management theory consists of four distinct components: basic financial principles and concepts, capital management, investment and financing, and risk management. These four subthemes are explained in greater detail below.
1. Basic Financial Principles and Concepts
Financial management philosophies, processes and practices must be properly understood to manage financial institutions competently. This portion of theory structures financial concepts, principles, and applications which provide insight into decision making processes and financial management.
In addition to the various financial principles, this includes the basic theoretical concepts of time preferences, interest calculations, and the time value of money. It also delves into the accounting and financial statement disclosure standards, including Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).
2. Capital Management
Capital management involves the allocation and control of capital raised from various sources, such as debt and equity funds. Capital management concepts cover portfolio optimization, liquidity management, and debt management. This includes the determination of the optimal capital structure which addresses issues such as the risk and return of capital, capital budgeting, and hedging strategies. This also involves capital valuation, capital budgeting, capital structure decisions, and debt-equity swaps.
3. Investment and Financing
The investment and financing component focuses on quantitative and qualitative decision making related to cost effectiveness and identifying the risk associated with a given investment decision. This portion of the theory covers investment criteria, portfolio planning, and liquidity management. This also covers planning for capital expenditure, the capital cost of debt, and other financing and investment decisions.
4. Risk Management
The risk management theoretical structure covers the basic concepts, principles, processes and methods to identify, measure, analyze and manage the various risks associated with financial decisions and strategies. This includes the management of exchange rate risks, interest rate risks, liquidity risks, credit risks, market risks, and other types of trading activities and risks.
By understanding and applying the basic principles and concepts of financial management, capital management, investment, and financing, and risk management, a successful financial manager can effectively manage financial resources and maximize return. By evaluating and analyzing the various risks and returns, they can select the best options and strategies they are most comfortable with to reach the desired goals.
