Issues of Financial Structure, Systems in Handling Public Finances Efficiently - Literature review Example

FINANCIAL MANAGEMENT ASSIGNMENT [NAME] [SUBJECT] [CODE] The recent economic turmoil coupled with the uncertainties of political environment has necessitated the need for effective and efficient financial management. Political institutions play an important role in building and sustaining a nation’s economic growth which in turn has a bearing on financial systems. Ideally, financial systems are fundamental in allocating resources to the economy and these resources require strong financial structure and controls to avert misappropriations and other risks. It is against such background that issues of financial structure, systems and controls are significant in handling public finances efficiently and effectively. Many are the business commentators that have lent credence to an organisation’s financial structure as the pillar of any firm’s integrity. The reasoning behind this rationale is the fact that a firm’s financial structure forms the backbone that provides the capacity to withstand not only the forces of economic nature but also the self-imposed forces. This is even more important in the current economy that has to deal with deep financial and political uncertainties. Consequently, any keen creditor will first look at a firm’s financial structure when evaluating an enterprise. In the wake of such an assertion, financial commentators have argued that the more leverage an entity has, the greater is the risk (Hackel 2010). This then calls for the setting of financial structure of any authority on a firm foundation. Hackel (2010) has argued that if the financial structure of a firm has not been built on a solid ground, there arises a marginal turn of events that can put the health of an enterprise at a risk. Under such a risk, the ability of such an entity to satisfy claims, including fixed obligations, becomes questionable. This was the case for many organisations during the 2008 global financial crisis that saw many of them recess into liquidity and insolvency. The main cause of this was in part due to the inability of their respective financial structure to withstand the forces of the economic turmoil. Common for many entities has been the over-capitalisation of their financial structure. This puts them in a position to buy time and take advantage of its competitors’ weakened market conditions. Such entities can also gain market share or severely weaken their competitors for instance through the setting of pricing conditions that its weakened competitors cannot afford to match profitably. However, overcapitalisation has its costs in the form of foregone free cash flow. This free cash flow is based on the returns of lower-yielding cash assets versus anticipated achievements had the cash been invested in value-enhancing investment (Hackel 2010). It is against such a backdrop that Hackel (2010) has observed that most financial executives shy away from significant overcapitalisation on the basis that a larger than necessary equity cushion has the potential of harming a firm’s financial ratios. In addition to this risk of overcapitalisation, the yield on cash is unpredictable besides to not being the purpose for which the organisation was founded. The establishment of financial structure therefore becomes phenomenal in the finance of assets which the inclusion of debt and equity issues. To this end, it is quite clear that the optimal financial structure is established on the basis of a firm’s ability to predict its cash flows accurately. For cases where an organisation lacks this foresight, the financial structure must be set by its ability to withstand a probable worse-case scenario. In the current business environment, such a probable scenario is no longer occurring at a hundred-year frequency but rather comes around all too frequently (Hackel 2010). The firm’s financial structure is portrayed by its balance sheet and becomes outdated a moment after it is prepared. The reason for this assertion is the fact that the value of a firm’s assets and liabilities shifts with the respective markets, the company’s clients’ business and financial conditions. Consequently, errors on forecasts or shifting industry conditions are detrimental to the optimal financial structure. The only way out of a critical situation such as recession is the ability of financial analysts to go over the board in an event that additional capital is needed. This will entail considering where, how and at what cost that capital could be raised (Hackel 2010). Financial structure deals with asset financing including debt and equity issues. It therefore follows that a financial system has to exist to facilitate the transfer of financial resources as well the allocation of the same into the economy. The financial system plays a key role in the smooth and efficient functioning of the economy. Fundamental to this role is the channelling of resources from individuals and companies with surplus resources to those with deficits and therefore acting as an intermediary between the same. This translates to the system not only satisfying the savings needs of the economy but also facilitates the accumulation of investment capital that is critical to growth and development (Charmichael and Pomeileano 2002). Nevertheless, the primary function of the financial system is to match the needs of primary issuers of financial promises with the ultimate holders of the provisions. Toward this end, the system provides the framework within which these promises are created and exchanged. As these systems continue to develop in sophistication, specialist financial institutions have evolved that intermediate the promises between issuers and holders. Most of these institutions essentially change the nature and risks of the primary promises (Charmichael and Pomeileano 2002). As mentioned earlier on, financial systems are tied up to the economies of different states and it is these world economies that display an array of financial systems. These financial systems are therefore usually dependent on the economic histories as well as the legal and institutional frameworks of these states. Even though institutions and markets form the basic elements of financial systems, the mixture of these elements differs across different nations of the world. For instance, some economies may stress on competition and efficiencies while others may put more emphasis on insurance and stability (Neave, 2009). Having transferred and allocated financial resources into the economy, financial control become critical for the purposes of managing a firm’s costs and expenses in relation to budgetary allocation. Financial management and control issues in the realm of the public sector have gained prominence in recent years with cuts in public expenditure appearing to be the driving force behind these emerging issues. In addition, fraud and waste in the public sector have also intensified public sector accounting, reporting and auditing. Under such circumstances, public authorities are now under intense pressure to maintain services with limited money. In order to accomplish this taunting task, these authorities have had to improve their financial analysis so that the actions can be taken to improve efficiency and value of money (Henley et al. 1989). Ideally, the funding of most public service is controlled by central governments by way of annual cash-spend allocations that have been commonly referred to as ‘cash limits.’ The most important task for financial management in cash-limited service is to assist the other managers to meet their operational objectives and scope with funding new developments and expected contingencies while at the same time completing each year within the totals of the cash limits. This therefore translates into having some form of foresight of the likely cash limits in time well advanced in the internal budgeting before a new fiscal year begins. This thus makes close monitoring and control of cash critical at all times even though it can become doubly critical for fine-tuning to balance to the cash limit targets close to the year end (Chan and Xiao 2009). Indeed, the determination of the performance of a business as well as the determination of the action that is needed for improving its financial liability can be only accomplished through the analysis of that business’s financial controls. Financial controls therefore provides the platform upon which sound management practices can be build in addition to allowing the establishment of guidelines and policies critical to the growth and success of the business. Currently, the knowledge on the financial health of any authority is very critical when considering the fact that such knowledge is fundamental in the allocation of resources as well as pinpointing the various areas requiring development and problem resolution. Typically, the information generated from the accounting system plays a key role in making financial decisions of any authority. This information is normally in the form of reports that have been incorporated in a company’s annual report. These reports are usually the balance sheet, income statement and statement of cash flow (Brigham and Ehrhardt 2009). The balance sheet indicates the financial position of a business at a specified point in time. This usually includes what the business owns (total assets) and owes (total liabilities). The total assets must be equal to the total liabilities in addition to owner’s equity at the end of every financial year. The profit and loss statement (P&L) on the other hand indicates the relation that exists between income and expenses and this relation is usually for a specified time interval. Additionally, the cash flow statement represents the most critical financial control tool to any business. It details the cash received and expended for every month of the year and therefore monitoring the cash flow in the business. This monitoring function is important in effectively managing the assets that are considered most vital to the business (Brigham and Daves, 2010). Therefore, budgeting has become the current tool for financial control in the public service since these financial reports forms the backbone of budgeting and resource allocation. A budget has been long established as a key performance indicator as it targets can be reviewed to identify any deviation from revenue or expenditure forecasts. A budget system is therefore very important to organizations making a budget a key element of the management process in the organisation. This is so because it aims to improve the overall organisation performance in terms of the quantity, quality and cost of services provided and show how plans for change are to be implemented (Prowle, 2000). [1668 Words] REFERENCES Brigham, F. and Ehrhardt, M., 2008. Financial management: theory and practice. 12th ed. Mason, OH: South-Western Brigham, F. and Daves, P., 2010. Intermediate financial management. 10th ed. Mason, OH: South-Western Carmichael, J. and Pomelleano, M., 2002. The development and regulation of non-bank financial institutions. Washington, D.C: The World Bank Chan, L. J. and Xiao, X., 2009. Financial management in public sector organization. In: A. G. Bovaird and L. Elke, eds. Public management and governance. 2nd ed. New York: Routledge. Pp109-118 Hackel, K. S., 2010. Security valuation and risk analysis: assessing value in investment decision. New York: McGraw Henley, D., Holthan, C., Liklerman, A. and Perrin, J., 1989. Public sector accounting and financial controls. London: Van Nostrand Reinhold Neave, E., 2009. Modern financial systems: theory and applications. New Jersy, NJ: John Wiley and Sons Prowle, M., 2000. The changing public sector: a practical management guide. Hampshire, England: Gower Publishers Read More