Abstract
Financial management is a critical component of an organizations success. A well-implemented financial management system ensures that resources are efficiently used to maximize profits, increase value and build a sustainable business. This paper will review the Financial Management Ability Model (FMAM), a holistic tool for assessing and predicting organizational financial performance. The paper will assess the theoretical basis for the model, the type of data required, and the advantages and limitations of this viability tool.
Introduction
Financial management is essential for a successful enterprise. It combines accounting, financial reporting, forecasting, budgeting and management of organizational resources in a comprehensive approach. Financial management also includes risk management, cash flow management and stewardship of shareholders’ equity.
Financial decisions taken by the business leadership not only affect the quantity of resources available but also the quality of how those resources are used to achieve organisational objectives. The earlier those decisions are made with a full appreciation of external factors such as the interest rate environment and the competitive landscape, the better the ultimate results (Bougen, 2019). The Financial Management Ability Model (FMAM) provides a holistic activity-based approach to understanding and predicting financial performance within an organization. The model is designed to be a comprehensive yet streamlined tool that allows financial management to be benchmarked, monitored, and improved over time.
Theoretical Basis of the Financial Management Ability Model
The FMAM is founded on activity-based costing theory. Activity-based costing (ABC) is an accounting and costing methodology intended to provide more accurate costing information on activities (Kroft & Vroon, 2017). The theory of ABC states that the cost of any activity is driven by the decisions taken in relation to the design of the products or services offered by an organization, how those products and services are produced, and how resources are used to produce them. As such, ABC attempts to capture the linkages between activities and their associated costs, providing an accurate picture of resource utilization and cost centres within an organization. Put simply, ABC is an accounting approach to discovering the root causes of cost, and how these costs can be managed in order to reduce expenses and improve profitability.
The FMAM takes activity-based costing one step further, by applying ABC and other financial theories to answer the more complex question of how cost and revenue decisions affect organizational performance. The model uses specific data inputs, such as the cost structure of current products, the average cost of new products, and the cost of different resources, and then evaluates the likely effect of alternative production and pricing decisions on financial performance and organizational success. By analyzing a wide variety of financial and operational data, the model can identify a range of alternative financial scenarios and their potential impact on the organization.
Data Required by the Financial Management Ability Model
The FMAM relies on both financial and non-financial data to assess and predict financial performance. Financial data is used to identify and measure the cost structure of existing and proposed products and services, and to forecast the cost of different production and pricing decisions. Non-financial data, such as customer data and market research, is used to support decision making in terms of resource allocation, marketing and product positioning.
The model assumes that certain financial and non-financial factors will have a direct impact on the performance of the organization, and that these factors can be quantified and used to predict the long-term outcomes of financial decisions. As such, the model requires comprehensive data on a variety of variables such as:
• Cost structure and pricing decisions;
• Non-financial factors such as product positioning, customer segmentation and market dynamics;
• Competitor behaviour;
• Regulatory and political environment;
• Economic environment.
In addition, the model requires historical financial performance data of the organization, such as revenue and profit margins, for benchmarking and comparison purposes.
Advantages of the Financial Management Ability Model
The FMAM provides organizations with an efficient and comprehensive way of assessing and predicting their financial performance. The model’s activity-based approach allows organizations to better understand the effect of different financial decisions on the organization’s performance. Furthermore, the model’s ability to take account of external factors, such as the competitive market and the external economic environment, allows financial managers to understand the potential implications of their decisions.
The advantages of using the FMAM to assess and predict financial performance include:
• Comprehensive view of the financial performance of the organization;
• Ability to identify and assess the impacts of different financial decisions;
• Improved understanding of the cost structure of current and proposed products;
• Ability to benchmark performance against similar organizations;
• Improved decision-making ability with respect to resource allocation;
• Ability to accurately predict the effects of changes in the external market;
• Increased visibility of potential risks and opportunities.
Limitations of the Financial Management Ability Model
Despite the advantages of the FMAM, there are certain limitations to the model. As the model relies heavily on data, the quality and accuracy of the data affects the model’s accuracy. Furthermore, the data must be updated in real-time to ensure that the models reflects the most current information.
In addition, the model is only as reliable as the assumptions that it is based on. As the model is used to predict future performance, incorrect or outdated assumptions can lead the model to produce inaccurate results.
Finally, the model is intended as a tool for financial managers, but it does not guarantee better performance. The model cannot replace the judgment of financial managers, who are ultimately responsible for making the decisions that will drive an organization’s financial performance.
Conclusion
The Financial Management Ability Model is a comprehensive and effective tool for assessing and predicting financial performance. The model combines financial and non-financial data to provide an accurate picture of the performance of an organization. The model can be used to evaluate the cost structure of existing and proposed products, to identify potential risks and opportunities, and to benchmark performance against similar organizations.
Despite its advantages, the model is limited by its reliance on data and assumptions. Furthermore, the model cannot replace the decision-making abilities of financial managers. Therefore, while the FMAM is an invaluable tool, it should be used to support financial managers in their decision-making, rather than being relied upon to provide definitive answers.
