Management Consulting/2.4 MANAGEMENT OF FUNDS AND ASSETS
1. Discuss the benefits of effective allocation of funds and dangers of misallocation of funds.
Allocation of funds is quite serious. As every business has different costs, each business must allocate their funds appropriately
Fair and appropriate - Allocation of funds ought to be fair and appropriate when all is said and done. Of course to do so seems easier said than done, but in some cases allocating funds does not need to be an extremely complicated procedure appropriate only for accountants. If you are sure that the funds you have are in the areas and amounts that are most appropriate for your company that is a good place to start.
Legal - As was alluded to earlier, allocation of funds carries with it a certain caution that no matter how you decide to allocate your funds you had better do so legally. Embezzlement and any other method of using company funds for personal gain in any of its forms is to be avoided and protected against.
Necessary - In order to maintain a successful business, funds need to be allocated where they are most necessary. There are many differences of opinions on this topic. Staff members might insist that they are the most vital part of the business and should have more funds allocated to their compensation. Other business might see long term growth as their most necessary need and therefore allocate funds back into the building up of the company.
Urgency - It would be inappropriate to discount the need for the allocation of emergency funds or to withhold funding in the event of an urgent matter. Establishing a procedure now for the amounts and policies for distributing funds on an emergency basis will make the actual allocation of those funds run more smoothly.
Simple and flexible - There are many times when through the natural course of events the allocation of a business' funds will need to be adjusted in order to create better cash flow or to prevent unnecessary spending. Your allocation of funds ought to be simple and flexible enough that these productive changes can be accommodated.
Allocation of funds is essential to a business from the very beginning. You need to have a clear idea of how you will allocate your funds before you can hope to receive financial assistance from investors or capitalists. If you are really at a loss for how to begin this process you may look into the financial records of companies that are in your similar industry. Publicly held companies will have their financial statements available and simply looking at how a respected company in your similar field allocates their finances might give you the start-up direction that you are looking for. After you have an outline or an idea for how you think funds should be allocated, you can use trial and error to fine tune the allocation that you have put in place. Change is a necessary part of any business, and so long as you have a good foundation for how you believe your funds should be allocated, do not worry if you feel changes need to be made down the road.
The scope of fund management includes the following activities:
determination of total capital to be raised
determination of the debtequity ratio or the proportion of debt to equity capital and the mix of long term and short-term capital.
determination of the level of fixed-change funds like bonds, debentures, loans, etc.
determination of the sources of borrowing development banks, public or private, domestic or overseas.
determination of the securities/ charges to be given
determination of the cost of capital
determination of the degree of sensitivity of earnings per share to earnings before interest and taxation.
determination of the method of raising capital-public issue or private placement; under-writing and brokerage, rights issue and the like
the legal restrictions, in any, on the scale, form, timing and other aspects of raising capital.
management of treasury operations
dealing with bankers
credit management, collection efforts and systems
management of short-term borrowings and trade credits availed
determination of debt-swap opportunities
determination of opportunities for interest rate swap
determination of scope for forward rate agreements
management of short-term investments
keeping informed of money market and capital market conditions.
Importance of Fund Management
Fund management affects the liquidity (less short term debt means more liquidity), solvency (more equity means more solvency), profitability (low cost capital means more profitability), flexibility of capital structure (more equity means, more flexibility), control on business (more debt and less equity mean more concentration of control on the affairs of the business) and so on. That is, fund management influences the fortunes of the business greatly. Fund Management covers a very large spectrum of activities of a business. True, whatever a business does it has a financial implication. Hence its pervasiveness and significance. Finance knowledge is a must for all irrespective of position, place, portfolio and what not.
Fund Management influences the profitability or return on investment of a business. Yes, the choice of sources of capital and investment decisively affect the profitability of an undertaking.
Fund Management affects the solvency position of a business. Solvency refers to ability to service debt (that is paying interest and repaying principal as these become govern the solvency aspect. Hence the significance of fund management.
Fund Management affects the liquidity position of a business. Liquidity refers to ability to repay short term loans. Efficient cash management, cash flow management and management of relations with the bankers influence the level of liquidity. All these factors are aspects of fund management.
Fund Management affects cost of capital. Able financial managers find and use less cost sources, which in turn contributes to profitability. In using fixed cost instruments of capital, the efficacy of sound financial management would be known well. Variable cost instruments of capital are the order of the day. Finance savvy persons go for such instruments.
Fund Management, if well steered can ward off difficulties such as restrictive covenants imposed by lenders of capital, inflexibility in capital structure, dilution of management control on the affairs of the business and so on. Failure to do so, has landed many firms in difficulties and financial mess.
Effective fund management enables a business to command capital resources flowing into the business. There is always capital available at attractive terms, if business finance is handled well. Even overseas capital can be easily mobilized, if sound fund management is ensured.
Market value of the business can be increased through efficient and effective fund management. As share and stock are quoted at high prices, more funds, when needed, can be mobilized easily either through public and or rights offers or private placement.
Efficient fund management is necessary for the survival, growth, expansion and diversification of a business.
Fund Management significantly influences the businesss credit rating, employee commitment, suppliers confidence, customers patronage and the like.
Fund management is an exercise on optimizing costs given revenues, or optimizing revenues given costs. this is vital to ensure purposeful resource allocation.
Today Fund Management has global dimensions with opportunity to mop up resources and put up investments across borders. Global trend in finance is better learnt by all.
Fund management affects all vital aspects of business health namely, liquidity, solvency, risk, return, control, flexibility, etc.
Effective Allocation of Funds
Allocation of funds is concerned with the following specific activities:
The total amount to be committed in assets
The proportion of fixed to current assets
The mix of fixed assets to be acquired
The timing, sourcing the acquisition of fixed assets
The evaluation of capital investments as to risk and return features
The mix of current assets
The management of each item of current assets to optimize liquidity and return
The effecting of a healthy portfolio of assets
Actually the above aspects of allocation of function are concerned with much pregnant issues with which fund management is concerned. The first aspect deals with the size of the firm, the second and third deal with the level of risk the business is willing to assume, the fourth with appraisal of investments as to their profitability, pay back period, etc. fifth with actual execution of investment decisions, the sixth with the liquidity of the business, the seventh with structural and circulatory aspects of current assets and the eighth with the overall balancing of various investments held by the business taking into account competing and divergent claims.
Fund allocation is, concerned capital budgeting and current asset management. Capital budgeting deals with fixed assets management. Investment appraisal, capital rationing, and acquisition, maintenance, replacement and renewal of fixed assets. Inventory management, receivables management, marketable securities management, cash management and working capital administration come under current asset management. A good deal of planning, organisation, coordination and control is needed in every decision area.
Dangers of Mis-allocation
Mis-allocation is the worst of all wrongs that management might commit, inadvertently or wantonly. Mis-allocation means faulty allocation. Wrong priority or choice is a grave form of mis-allocation. Over-allocation or under-allocation is another form of mis-allocation even though the choice or priority is valid.
Wrong project choice is a total wqaste of all resources and efforts. This may even have a cascading effect on other rightful project on hand. This is what is called as cannibalism effect. Worng-project does not contribute to organizational goals. May be some vested interests get the benefit. Funds allotted to wrong-project do not earn any return. But enlarges the risk to which the whole organisation is exposed. Profitability falls, liquidity dries up, solvency vanishes, mis-match in assets-liabilities creeps in and a whole of other miseries befall the organisation. Sometimes, even some further good moneys may be thrown on the already wasted resources. A full round of vicious-cycle thus is run emptying the coffers of the organisation. Eventually, the organisation goes sick. It is a social liability. All the stake-holders in the organisation, saving perhaps the few vested interests, if any, share nothing but misery.
Over-allocation or under-allocation, the other form of mis-allocation of fund has many dangers too. Over-allocation leads to wastage and idle capacity. To that extent return-on-investment declines. Further, over-allocation may mean that some other project is given under-allocation. Hence, over-allocation may leads to under-allocation with attendant ills of under-allocation. The ills of under-allocation are: time over-run, cost over-run, missed opportunities, long gestation period, increased competition because of delayed execution, etc. Businesses fail more because of mis-allocation of resources than due to any other cause.
Rectifying mis-allocation of fund is difficult. A quick U turn is good, but seldom practiced. So, before a realization of mis-allocation is made, lists of fund already stood committed without commensurate return. So, the solvency, liquidity, profitability, flexibility, etc. of the organisation go to peril.