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Financial management can either help solve problems or it can create problems. From the moment a new business begins, it faces risks that must be managed and guided through the use of finance. Financial managers have the ultimate task of maximizing a firm’s value for its owners. This can be successfully fulfilled through financial managers that keep in mind both short-term and long-term consequences of each decision made and action taken. How do financial managers add value daily? They forecast, budget, raise funds, spend funds, and set financial goals that are in line with the business owners. Because financial managers have the strongest grasp on a company’s finances, they have the greater purpose of monitoring and maintaining the company’s financial health, by making legal and ethical financial decisions that will add value.
First, financial managers must solve problems. Financial managers can solve problems within a company by identifying problems, creating plans, implementing plans, then evaluating the consequences. These unknown consequences are referred to as risk, which can be defined as the potential for unexpected events that occur. Risk can never be entirely avoided because all companies are directly or indirectly affected, therefore, financial managers must try to find ways to reduce risk as part of the problem-solving process. Companies can reduce risk to a certain degree by reducing the volatility of fixed costs, obtaining insurance policies to protect against risk, and diversifying portfolios. Financial risk happens when companies borrow money and incur interest charges, which ultimately affects net income. Higher levels of financial risk can mean that there is a greater possibility of not being able to meet present and future financial obligations. It is up to financial managers to solve the problem of paying all obligations, both legally and ethically, through the proper management of risk.
Secondly, financial managers must define and maintain a financial strategy that involves a proper inflow of capital to continue the addition of value over the long term. This can be done through budgeting for capital projects. Because capital budgeting also involves risk, financial managers must determine how certain projects affect assets and how to compensate for degrees of risk. Financial managers must carefully allocate resources by maintaining proper estimations, timing, and predictability. Return on invested capital is just one way that financial managers measure a company’s efficiency to ensure that they are adding value.
Thirdly, financial managers must make choices about sources and allocations of funds. In order to grow and continue adding value to a company, financial managers must always decide what to do if the company is unable to meet financial obligations. Because risk is involved, managers must carefully consider financing costs, potential returns, investments, short-term versus long-term, and the issuing of shares or not. Not only does the finance manager have to plan, procure and utilize funds, but exercising control over those funds is part of their job. This is done through ratio analysis, fund analysis, financial forecasting, and cost and budget controls. All of these decisions can add or take away value from a company, so financial managers have a greater responsibility to ensure that legal and ethical choices about funds are being made.
Fourthly, finance managers have to make decisions with regard to cash management. Cash is required for paying wages and salaries, paying bills, paying creditors, meeting current liabilities, and maintaining enough stock within a company. Financial managers must determine present and future cash needs through the development of a cash budget. A cash budget is a detailed plan that shows where cash is coming and going for a specified period. Having a maximum cash balance enables companies to invest and earn even more cash so they can add value. Financial managers have an especially difficult job in the area of gaining cash since they have to be careful not to be so greedy that they forget to maintain legal and ethical standards.
Finally, financial managers have the greatest responsibility of all to ensure that all decisions and actions are performed in the utmost legal and ethical manner. All public corporations are required to follow strict guidelines when preparing taxes and financial statements. These guidelines were put into place to regulate financial and accounting practices and to ensure transparency from one organization to another.
What are some of the ethical issues involved in financial management? Ethics has become such a large part of the corporate world that most companies now have a code of ethics by which they operate. Ethics is the moral principles that guide a company’s behaviors and actions. They are values, or worth, the very thing that financial managers should be adding to companies. Value is added by being creative and proactive to bring new ideas to a company. So why does there appear to be creative resistance in corporate America when financial managers bring about change? Goetzmann, author of ‘Money Changes Everything: How Finance Made Civilization Possible’, explains that finance is historical and that financial innovations have been the driving force behind all civilizations. Goetzmann explains that finance is at the heart of almost everything, and has the power to change values, ethics, social class, goals, and self-esteem. Change is a concept that is not always accepted, but often needed. In Goetzmann’s book, he explains that in order to understand finance, one must look at history to study the building blocks of civilization. Goetzmann suggests that finance is an important technological tool that helped and continues to help, society advances through constant changes. The more society expands, the more finance is needed to keep expanding. He explains that finance is a type of ‘cycle’ that continually repeats itself through civilization. He summarizes the four key elements of finance as follows: reallocating value through time, reallocating risk, reallocating capital, and expanding those reallocations. Unfortunately, negative stereotypes of finance have emerged through civilization from corruption and failed choices caused by poor financial practices. Goetzmann suggests that studying finance is important to avoid repeating past mistakes in present and future civilizations. One historical finance idea worth analyzing is the invention of derivatives.
The video ‘Money, Power, and Wall Street’ sheds light on the origination, growth, and failures of credit derivatives, a powerful financial tool created in the early 1990s. In a quest to reduce risk, employees at JPMorgan created a new concept to swap risk by getting rid of risks not wanted and trading it for risk that was preferred. Though no longer new, credit derivatives are still a source of debate among financial managers today. Determining whether derivatives are legal or ethical requires a closer look at the results, and examining statements made by employees that worked directly with derivatives in their beginning phase.
One woman interviewed for the video was Kathy, a Yale-educated woman who felt the American goal was just to get rich. After working on Wall Street for several years, Kathy explained that although her company was getting rich, she could no longer continue working with derivatives because it felt immoral. Alexis, another woman interviewed, explained that she had no problem working with derivatives in their conception because what was happening in the future had no effect on the present value of the enormous amount of money she was obtaining. As one textbook explains, a dollar in hand today is worth more than a promise of a dollar tomorrow. Due to the lack of regulation and ethical decisions, these leveraged bets, or derivatives, eventually began to get out of hand. What was the driving force behind the success of this new idea? Money, power, and greed appeared to be the driving force. If proprietary bankers were doing their job of making legal and ethical financial decisions, why did sellers and traders of derivatives flee the country? They fled to avoid regulation which could possibly expose unethical practices. As Desiree Fixler stated in the video, one cannot sell debt created from debt, because it eventually crashes. That is what eventually happened to the U.S. economy in 2008. Fixler concluded that most of the derivatives were made up and sold for huge profits to unsuspecting victims that were being taken advantage of, simply because the incentive to cheat was so high. The economic crisis of 2008 began with defaults on mortgages that were based on speculation, not ethical decisions. Most parties involved with historic corruption ignored ethics and the time-bound value of finance where large risks and gains were involved. Poor financial decisions and a disregard for ethics led to unfortunate consequences with regard to the creation of derivatives.
Risk has been around for a very long time, and companies will almost always demand a higher rate of return to compensate for assuming risk. The riskier the project, the higher the return demanded. When investors adjust rates of return to compensate for risk, the question becomes, how much is too much? Since risk is difficult to measure, financial managers are needed to ethically determine rates of return, to add value and still retain a moral conscience. In the historic case of derivatives, most of those interviewed in the video felt that in the beginning derivatives were a great thing, but eventually greed caused them to grow into something destructive. While negotiating is a powerful tool that can make financial management easier, conflict and difficulties within those negotiations can cause breakdowns that destroy. Managing risk is a very important responsibility of financial managers to ensure that value is added to a company.
Financial management ultimately comes down to an ethical responsibility for every company. Financial managers face the important task of implementing accuracy, transparency, timeliness, and integrity in all their actions. As seen in the video ‘Money, Power, and Wall Street’ and throughout history, not all financial innovations and decisions are good ones. Was the creation of derivatives good? That is still worth debating. Derivatives, like any other aspect of finance, are powerful. Powerful tools are not necessarily bad, they just need to be monitored and controlled to make them as effective and ethical as possible, so the outcome yields value. A better question that financial managers might ask themselves each day is: are these decisions just good, or do they have good results? As financial managers, the responsibility and reward of adding value to a company come from making decisions that lead to good results. If the results are not good, a re-evaluation of the situation, more problem-solving, strategizing, and allocation assessing are necessary to ensure that the ultimate goal of adding value to the company occurs. Because financial managers have the strongest grasp on a company’s finances, they have the greater purpose of monitoring and maintaining the company’s financial health by making legal and ethical financial decisions that will add value.
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