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A Guide to Financial Management Theory

Your business makes money decisions all the time – for materials, manpower, investments, and many other transactions.  The way you make those decisions is on the basis of a management theory of some kind: ‘buy low, sell high’ at the least. 

But given the fact that, over the past few decades, finance has become a massive portion of the GDP, financial management techniques have grown significantly more sophisticated.  In other words, how you spend your money may make as much or more difference to your bottom line as how you make it.  Let’s consider the application of financial management theory in more detail and discuss its potential advantages and disadvantages.

What Is It?

Financial management theory is an umbrella term for how businesses spend their money, and on what basis.  When put into practice, it’s similar to the domain of corporate finance.

It’s not a simple field.  Apart from the more obvious aspects of managing a business, which involve things like proper resource allocation, streamlining production codes, and outsourcing, there are any number of tools investors can use to inflate their earnings beyond the expected rate of return.  And some of these are devilishly difficult to follow. 

They’re called financial instruments, and they’re based on the idea of a derivative.  A derivative is a transaction based on another transaction – a real-world transaction.  So if Farmer Bob makes and sells wheat to Eater Joe, that’s a transaction.  But then Trader Frank comes along, and decides he’d like to buy the option to buy Farmer Bob’s wheat at a certain price next week.  That’s a derivative transaction, and it’s the basis of high finance.  Essentially, you can buy and sell the idea of money.

Benefits

The major benefit touted by architects of modern financial management theory is that a wide-ranging investment portfolio that includes a wealth of derivatives trading can diversify your holdings and ultimately minimize your risk.

And of course there are the massive profits that can be garnered from aggressive investment strategies not beholding to traditional methods.  Financial management theory allows for the possibility of profits from unexpected sources: the future, the feckless – sometimes the fictional.  After all, Bernie Madoff made billions.

Pitfalls

Many economists believe that the minimization of risk was an illusion shattered by the financial crisis of 2008.  Others believe it’s a goal that can still be achieved despite these setbacks.

Whatever your stance, it would seem that the modern financial management theory of derivatives is no longer on solid ground.  Profits are hard to trace, can possibly be illusory, and even if legally and ethically administered can be ethereal.

Conclusion

Financial management theory is complex and far-reaching, but begins with the simple idea of spending your company’s money correctly.  Depending on how much you want to make and how fast, that idea can stretch from being as simple as arithmetic to being as complicated as quantum mechanics.