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The Role of Financial Management in Promoting Sustainable Business Practices

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Article  in  SSRN Electronic Journal · January 2019

DOI: 10.2139/ssrn.3472404

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 The Role of Financial Management in Promoting Sustainable Business

Practices and Development

Mariam Salem Al Breiki

Abu Dhabi University, email: 1070460@students.adu.ac.ae

Haitham Nobanee

Abu Dhabi University, email: haitham.nobanee@adu.ac.ae

Abstract

The number of organizations that embrace societal expectations as part of their business

strategies is on the rise. Increasing reliance on sustainable issues by a business is critical to the

growing interconnectedness and future value of a business. This study aimed at exploring the

role of financial management in promoting sustainable business practices and development.

Based on thematic analysis of resources from varied scholars, it confirms that appropriate

financial management models are necessary to enhance productivity while mitigating issues of

financial risks. The findings also indicated that allocating capital budgeting for sustainable issues

enhances the competitive advantage of the business, and utilization of western and the Islamic

financial are efficient sustainability measures. The study concludes that financial management

plays a vital role in promoting sustainable business practices and developmt.

Electronic copy available at: https://ssrn.com/abstract=3472404

1. Introduction

Organizations are increasingly becoming motivated to embrace societal expectations as

part of their business strategies. This has contributed to the concept of corporate sustainability.

Many institutions are currently responding to the demands of consumers by allowing the

stakeholders alongside employees to explore alternative opportunities towards the realization of

competitive advantage. Importantly, financial management is often used as part of the process of

promoting sustainable business practices and development. Accounting management, for

instance, is applied to measure, evaluate and disclose the progress that has been achieved or

expected to be achieved by an organization within a specified period. Consequently, financial

management acts as a guideline that translates to the bottom line of organizational development.

The importance of high-quality financial management is to ensure financial stability and

development of the entire organization particularly while reaping the benefits of a considerable

amount of revenues. According to Morgan (2011), financial management promotes the effective

operations of an organization based on the available income and projected expenditure.

1.1 Problem Statement

The concept of financial management is a critical part of planning towards the realization

of profitability and a primary concern for every business. Therefore, financial managers and

accountants often use recommendable effort and skills to minimize the cost of the expenses

while seeking to attain a huge amount of revenues at the benefit of the organization (Ekpo,

Etukafia & Udofot, 2017). However, this will not happen if an organization does not set up the

right measures to improve its operations in terms of governance and leadership. Although many

studies have been conducted to explain how appropriate financial management enhances the

profit margins of a business, there is a deficiency of research to support the idea of financial

Electronic copy available at: https://ssrn.com/abstract=3472404

management as a concept that promotes sustainable business development. Therefore, this paper

aims to explore the role of financial management in promoting sustainable business practices and

development. To discuss this topic, different approaches to structuring the role of the financial

management process in the sustainable development of business were applied.

2. Literature Review

Financial management is derived from a broader category of organizational finance or

corporate finance. Many authors tend to use the concept of corporate finance as an alternative

name to business finance, but the reality is that business finance is much broader because it

conceptualizes the sole proprietorship, partnership, and company business (Fonseka, Ramos &

Tian, 2012). On the other hand, corporate finance is restricted to company finance only. This is

the premise for financial management. To realize the effectiveness of business finance, there is a

need for proper financial management. According to Presber (2011), financial management is a

concept of corporate finance that deals with a decision related to acquisition, financing, and

management of assets, acquiring financial resources, and what is expected of a firm to maximize

its shareholders' wealth. Skilled financial management is vital as it helps in streamlining the

organizational plan. Effective administration and compliance, including cash flow management,

for instance, are just a few financial management prospects for the future productivity of an

organization. Skills of financial management, on the other hand, enhances tracking of the

organizational performances, identification of financial problems, and exploration of new

opportunities to reduce risks occurrence.

The right financial management remains vital throughout the survival of a business,

whether it is just commencing or looking forward to liquidity. In that respect, it must

continuously evolve depending on the circumstances of the change. Based on a report published

Electronic copy available at: https://ssrn.com/abstract=3472404

by Ekpo, Etukafia & Udofot (2017), it was observed that a growing business must take a

proactive approach to financial management and ensure that they are within the right capabilities.

In his sentiments, Presber (2011) explains that financial management is applicable on a day to

day management of the strategic planning of the business. For that reason, the management is

required to recognize the needs of a business change as the business grows while ensuring that

the right financial skills are put in place to promote the sustainable future of the business.

The concept of corporate sustainability and financial management started gaining relevance as a

result of external pressure on big companies getting pushed by communities to practice

environmental sustainability.

Some of the notable occurrences that led to a widespread call for corporate sustainability

as part of the financial management was the controversial disposal of Shell's Brent Spar oil

platform (Makarenko & Plastun, 2017). This constituted a proposed idea to dispose of an oil ship

owned by Shell Company in the UK. Experts warned that the sinking of an oil tanker would

cause damages to the environment, a concept that spark activism for environmental

sustainability. It is under this premise that the societal concerns for environmental accountability

by companies were conceptualized. Consequently, the implementation of corporate sustainability

comes at a financial cost to an organization. It is for the same reasons that appropriate financial

management is necessary to foster future sustainability. The role of financial management in the

realization of the sustainable prosperity of a business is discussed in varied academic literature.

According to Makarenko and Plastun (2017), the need for a critical approach in

understanding the role of financial management in the context of sustainable development is

inevitable. Another pressure that advocated for corporate sustainability emanated from the Kyoto

Protocol Climate Conference in 1997. From the Kyoto Principles, it was proposed that all

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industries, including small companies, should advocate for sustainable development. From the

onset of such a discussion, several interested users of the information contained in corporate

environmental disclosure have been on the rise following the accounting principles and

utilization of financial management models to ensure that objectives are attained. To achieve a

higher degree of business success, an organization's financial department must be committed to

employing an appropriate financial management process that focuses on promoting a clear

understanding of the role.

In a study conducted by Alshehhi, Nobanee, and Khare (2018), a literature analysis about

how corporate sustainability affects the financial performance of corporates, they found that

literature, at least 78% supporting a positive link between financial performance and corporate

sustainability. These researchers say that markets are slowly becoming more competitive and

that there is a growing need for change, which has put pressure on companies to succeed by

sustaining their excellent performance today and in the future. Alshehhi, Nobanee, and Khare

(2018) say that corporate sustainability is currently the main focus as consumers, investors, and

companies are increasingly turning towards enhancing corporate sustainability. In this regard,

these researchers point out that organizations are not only expected to surpass the limited short-

term financial goals but also go beyond encompassing social, environmental, and economic

sustainability.

2.1 Corporate Sustainable Reporting Disclosure and Shared Value

In the past few decades, corporate sustainability disclosure was mainly considered as a

voluntary activity. Presently, businesses are shifting from voluntary disclosure to compulsory

disclosure orchestrated by external pressure. Such a level of demand is perceived as external

pressure, as expressed in the legitimacy theory. According to Wilmshurst and Frost (2010),

Electronic copy available at: https://ssrn.com/abstract=3472404

legitimacy theory spells out that organizations must take part in voluntary social and

environmental disclosures if they intend to attain social contract enablers. In that respect, it

supports the idea as to why organizations such as banks are often subjected to pressure to ensure

environmental compliance as a meaningful way of gaining legitimacy (Mchavi, 2017).

Research evidence published by Presber (2011) indicates that environmental

sustainability can be used to illustrate long term liquidity above-average returns to the

stakeholders. Some of the corporate governance practices such as financial management, risks,

and crisis management, compliance to code of conduct, talent attraction and retention fosters

share value of the business (Székely & vom Brocke, 2017). For example, Al Ghurair Group of

companies in Dubai took part in providing free healthcare services on to the society, a concept

that led to its popularity in the United Arab Emirates, hence more revenues. Therefore, the idea

of corporate governance promotion of economic viability, economic profitability, and economic

equity (Székely & vom-Brocke, 2017).

Based on research conducted by Presber (2011), the findings indicated that institutions

reporting poor environmental performances are often faced with more political and social

pressure that weaken their legitimacy. In such a case, they may have inclined to broad off-setting

or positive environmental disclosure during the presentation of their annual report to the

stakeholders. For instance, Dana Gas also increased its revenue having taken part in educational

sponsorship for needy students (Makarenko & Plastun 2017). The study further indicated that

overreliance on external sources of finance, including the stock exchange, also contributes

significantly in encouraging organizations to take part in environmental disclosure as a

meaningful way of drawing a pool of capital from the external stock suppliers. It is for the same

Electronic copy available at: https://ssrn.com/abstract=3472404

reasons that institutions involved in the stock exchange disclose more environmental reports to

boost their ability to attract external capital to run their business (Mchavi, 2017).

Nobanee and Ellili (2017b) researched the effect of social, environmental, and economic

sustainability reporting on the UAE Bank’s performance. The findings from this study show that

sustainability disclosures, social, environmental, and economic disclosures have no substantial

impact on the performance of banks in the United Arab Emirates. However, they claim that there

is a robust association between the financial performance of corporates and economic measures

of sustainable development. These individuals highlighted the importance of organizational

sustainability achieved by improving management systems, creation or developing financial

value, increasing transparency to all stakeholders, motivating staff members, increasing

innovation, attracting long-term capital as well as enhancing corporate reputation.

In another study by Nobanee and Ellili (2017a) on whether the quality of risk disclosure

about operations increases cash flows in operation, they found no relationship between cash flow

in all banks and the extent of disclosure of operational risks. However, they say that banking

systems are crucial as they play a vital role in the economy and influence the performance of the

economy immensely as they are involved in significant financial crises. These two individuals

claim that efficient risk management aids banks in accurately estimating performance, avoiding

perilous financial losses, ensuring persistence in takeovers and restructuring services and

products.

Additionally, Nobanee and Ellili (2017a) say that management of operational risk is

looked at as having great significance in enhancing or ensuring sustainability within the banking

sector. In a different study by Ellili and Nobanee (2017a) [Corporate risk disclosure of Islamic

and conventional banks. Banks and Bank Systems] on disclosure of the corporate risk of

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conventional and Islamic banks and how this influences performance, they indicate a low level

of association between corporate disclosure of risk and improved performance. However, they

claim that when organizations disclose their risks, they improve risk management and enhance

transparency in financial reporting and enhance the quality of their disclosure, further helping

both current and potential investors in their economic decisions and proper assessment of the

company’s performance.

In other studies by Nobanee and Ellili (2017a) and Ellili and Nobanee (2017b) [Does

Operational Risk Disclosure Quality Increase Operating Cash Flows? and Degree of Corporate

Social Responsibility Disclosure and Its Impact on Banking Performance respectively], they also

found no association between cash flow in both conventional and Islamic banks and the quality

of disclosing operational risks. They, however, believe that efficient management of operational

risks helps financial institutions to avoid loses and measure performance accurately. Despite the

similarities between these studies to the other ones concerning examining risk disclosure, they go

a notch higher in assessing the level of certain operational risks. These individuals found that the

initial announcements of operational risks of a company often raise information asymmetry

usually estimated by trade price impacts and bid-ask spreads.

Additionally, a robust corporate structure of governance lowers information asymmetry

around risk disclosure of operations. Reducing information asymmetry is mainly linked to

institutional ownership, equity incentives, and board independence. As a result, these individuals

recommend that banks should increase the disclosure of their operational risks to enhance the

processes of risk management, sustainability, and stability. Similar results were also found by

Nobanee and Ellili (2017c) on their study of disclosure of corporate sustainability in yearly or

annual reports.

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2.2 Sustainability Issues to Financial Decisions and Key Value Drivers

2.2.1 Capital Budgeting

While many companies proclaim a commitment to sustainability, research evidence

indicates that they are not keeping up to standards of commitments in their routine. A report

published by Fonseka, Ramos, and Tian (2012) indicates a significant disconnection between

how the company addresses sustainability issues and how it carries its activities (Meyer, 2015).

One of the most significant factors that influence and impact organizational sustainability issues

is capital budgeting. This involves the decision and desire to popularize corporate reputation

within the financial limits of the organization. According to Meyer (2015), capital budgeting is

classified as a sustainable risk when it is meant to promote sustainability issues of an

organization because it does not contribute directly to the revenue of the firm. Moreover, Zhang

& Chen (2017) point out that financial decisions should look into the long-term development

strategy of an organization.

2.2.2 The Cost of Capital

The cost of capital constitutes the potentiality of an organization to participate in

environmental protection of the industry by taking part in proportional management of intangible

assets and providing quality pledge to lenders as a shred of evidence for debt financing to obtain

tax benefits. According to Berk (2012), environmental technology is the foundation of the

environmental protection industry. Investment in a sustainable environment can affect the future

profitability and development of an enterprise, either positively or negatively.

2.2.3 Profitability

There is a growing demand to attain profitability by enforcing dimensions of

sustainability as part of financial management. Supply chain sustainability, for instance, is

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advancing towards the realization of long-term profitability while focusing on innovation.

Considering the dimensions of sustainability, Zyadat (2016) explains that while corporate social

sustainability is voluntary, it does affect the profitability of the business in many ways. A study

conducted in Qatar indicated that the use of sustainable activities by an organization encourages

more purchases e from potential customers who consider sustainability as a crucial factor

towards the realization of the future prosperity of the business (Zyadat, 2016).

2.2.4 Working Capital Management

The ability to manage working capital is closely linked to the sustainable growth of a

business. According to Nastiti, Atahau & Soprano (2019), employing appropriate sales policies

to a business that produces sufficient cash flows for operating activities eventually leads to

higher profit margins. In his sentiments, Nastiti, Atahau, and Soprano (2019) explain that the

operating working capital covers varied dimensions of organizational adjustments to operating

and financial conditions. Issues such as sales growth, president occurrences affecting sales, hat

costs associated with external financing may subject an organization to consider pursuant for

more capital management strategies. It is also important to note that companies that look in

working capital from greater prospects tend to employ more conservative working capital

policies at thereby resulting in a robust to unobserved heterogeneity and industry effects.

2.2.5 Investment Returns

The guide towards a sustainable, inclusive economy is based on the principles of the

2030 agenda. According to Weber (2017), sustainable development goals are instrumental in

combating issues of climate change. Therefore, appropriate income and decent organizational

activities that are aimed at attaining the societal goals form the basis for sustainable investments.

According to Weber (2017), adopting a more behavioral approach to finance is vital. Recently,

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business activities have been focused on themes such as ethics, sustainability, and investments in

the financial market while targeting the concept of sustainability.

2.3 Corporate Sustainability Risks and Opportunities

In financial management, a risk constitutes the business of doing another business while

maintaining profits, sustaining economic growth, and protecting the share value of the

stakeholders in the market. One of the principles behind corporate sustainability risk

management is to prevent fluctuations in the market. As indicated by Wong (2014), the need to

ensure the elimination of sustainable corporate risks is under the docket of the financial risk

officer. Therefore, it must be taken care of as one of the most critical parts of financial

management. In the past, risk management was only focused on substantial uncertainties under

which probabilities could be quantified. However, it is different in the present business

environment where various measures must be applied to safeguard not only the interest of the

stakeholders but also by doing well to the society (Hashim & Koon, 2017).

According to Gramlich and Finster (2013), various measures have since been

implemented to help incorporate sustainable risk management. The variables used to assess the

market risk of socially responsible companies consider risk as a controlled variable, and it is

classified as a long-term asset ratio in the financial statement. Moreover, measures of risks,

including those expected and unexpected, are evaluated and applied in a different ration from

probability to liquidity (Gramlich & Finster, 2013). Corporate sustainable managers are required

to link up with financial managers towards achieving the competitive advantage of an

organization by focusing on issues of sustainability to outdo rivals financially. According to

Weber (2017), the concept of sustainability demands that the general management, which

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constitutes representatives from different departments of an organization must embrace the idea

of sustainability and operate in a synergistic way to mitigate possible chances of risk occurrence.

According to Wong (2014), the key benefit of nonfinancial risk management, such as

corporate sustainability, is that it covers a wide range of issues that support the ultimate revenues

of an organization. This is not limited to environmental risks, social risks that are more critical

for the survival of a business than mere boardroom management. Moreover, it enables financial

managers to put together all the relevant probabilities of emerging risks into financial

management issues of a company while ensuring that an organization operates without lethargic

at best (Wong, 2014). The actual budget figure that has been set aside to cover sustainable risks

should not affect the net income of a business. Therefore, a more diverse and sophisticated

approach to risk management would be vital to project possible chances of occurrences.

Similarly, Flouris and Yilmaz (2016) confirmed that several sustainability risks of a company

could be corrected by adjusting the figure of control-variables in the course of financial

management. The assessment is often represented, as shown below:

Risk = F (sustainability, control variables)

Where F is treated as the dependent variable of risk and driven by the company's attitude to

sustainability.

2.4 Sustainability Practices and Sustainable Financial Growth

A minimum attitude of growth is expected of a company to continue in its operations, to

compete well and adequately attain a competitive advantage. As pointed out by Fonseka and

Tian (2012), the sustainable growth rate is treated as a percentage of the maximum growth in

sales that can be achieved based on the target operating debt and dividend payout ratios. From a

study conducted by Amouzesh, Moeinfar & Mousavi (2011) to establish the relationship

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between sustainability and sustainable financial growth from 54 listed companies in Oman, the

findings indicated that there is a significant relationship between sustainability and actual growth

rate of a company.

A different study by Mukherjee and Sen (2017) further revealed that ROA and current

financial ratios posit a significant negative deviation in actual growth rate from the sustainable

growth rate. As a consequent, stock returns are considered to exhibit significant adverse

outcomes from the real growth rate from the sustainable growth rate. Therefore, Fonseka,

Ramos, and Tian (2012), a sustainable growth rate is treated as a maximum feasible growth rate

of an organization that is attained based on their financial, operational, managerial conditions

and policies.

2.5 Different Financial Systems

The current business trend shows that sustainability is obligatory to business operations.

It is under this premise that organizations are expected to take part in social responsiveness

through proactive sustainable practicing and reporting (Aioanei, 2007). By observing the

detrimental effects of business operations in the banking industry, western financial models were

developed to promote efficient sustainability by controlling the negative impacts of

organizational activities on the environment (Aioanei, 2007). Through the utilization of western

financial models, suitable sustainability measures were adopted, comprising economic,

environmental, and social sustainability dimensions targeted at improving the organizational

revenues. On the other hand, the Islamic financial model was adopted as a sustainable concept to

promote equity through 100% reserve banking by prohibiting interest on the debt. According to

Askari and Krichene (2014), the model contributes a significant difference to members of society

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by creating a negotiated effort between lenders and borrowers. As a consequent, it serves the

interest of both the business and society.

2.6 Corporate Bankruptcy and Sustainable Growth

Sustainability and future development of the industry is much determined by an effective

banking system within a country because the banking industry holds a key position in the

economy. To anticipate a bankruptcy situation of an organization, varied models such as the Zeta

model and the Altman model were established to provide possible solutions to incidences of

bankruptcy, especially to this emanating from corporate sustainable practices. According to

Askari and Krichene (2014), corporate life and bankruptcy risk propensity is becoming a popular

area of study. For instance, Fonseka and Tian (2012) found out that bankruptcy has a significant

impact on the operating performance of a company.

This is not limited to investment and dividend decisions. Besides, studies on financial

distress also show that there is a significant relationship between the investment decisions of an

organization, stock returns, and bond returns that form the most significant determinants to the

bankruptcy situation of an organization. Therefore, it is proposed that a firm must pass through

feasible series of sustainable development to attain the corresponding phase of sustainable

growth.

3. Results and Discussions

From the findings obtained in this study, it is evidenced that companies that are engaged

in sustainability orchestrated through regulatory pressure, employee pressure, organizational

management pressure, and sustainable investment pressure in line with sustainable practices are

most likely to improve their financial performances. Consequently, attaining sustainability within

an organization requires that the process is embedded within the entire organizational support

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right from the executives to junior staff. The results compared to findings by Ekpo, Etukafia, and

Udofot (2017) who argue that stakeholders are intrinsically motivated and can effectively deliver

sustainability performance if they are made to understand that the organization is fighting in the

same direction. It was also noted that there are barriers to the realization of corporate sustainable

reporting disclosure and shared value. In essence, the adoption of a suitable sustainable practice,

mainly where funds are utilized, often affects the financial aspect of the organization. Székely

and vom Brocke (2017) agree with the idea when they clarify that appropriate financial

management models are required to enhance productivity while mitigating issues of financial

risks. Most importantly, an organization can become sustainably visible through the publication

of corporate sustainability reports. That, in turn, promotes the share value of the organization to

the community.

Regarding budgeting, as part of sustainable financial management, the results confirmed

that allocating capital budgeting for sustainable issues may subjectively fail to reap the revenue

benefits to an organization that should not be prioritized. Fonseka, Ramos, and Tian (2012) were

to a similar opinion when he points out that poor sustainable performances lead to liability and

lawsuits, thereby increasing the amount of debt while reducing the figure for new debt as

indicated in the capital budget. However, organizations excel best in corporate sustainability

increases their capacities to access government subsidies and a reduction in tax rebates that, in

turn, increase their potentiality for more revenues. By investing in environmental protection

facility, a company increases its expenditure in the short term while benefiting in the long run,

and this is the premise for capital budgeting.

In addressing the cost of capital as part of sustainable financial management, the result

indicated that uncertainty in the economic environment would require the imposition of a higher

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cost of capital in the budget, a concept that would increase the financial burden to the company

and risk of bankruptcy. A similar ides was a firmed by (Berk, 2012). With research evidence

obtained from Qatar airlines, restaurants, and tourist clubs, it was clear that different dimensions

of corporate sustainability including employee relations, product quality, community relations,

environmental issues, issues of diversity posit different effect on the company’s profitability

To harmonize working capital amid the incorporation of sustainable financial

management, acts collected from the study showed that the deficiency of competence from

investors concerning financial matters that are needed to realize investment returns requires

disclosure of the financial position of an organization. In this regard, investor's behaviors and

their decision-making processes concerning the projected investment return should be considered

and analyzed based on investors’ cognitive factors.

In support of Webers' (2017) idea that corporate sustainability and risk opportunities are

manifested as a strategy that affects various financial dimensions of an organization, the findings

indicated that net effects that emerge from the risks of sustainability are fundamental to business

operations. Therefore, corporate sustainability and organizational risk management correlate. In

that respect, sound financial management would promote the practice of corporate sustainability

because it avails the necessary financial resources needed to invest in the benefit of corporate

sustainability. Facts obtained from the findings indicated that utilization of western and the

Islamic financial models had been adopted as efficient sustainability measures were adopted,

comprising economic, environmental, and social sustainability dimensions targeted at improving

the organizational revenues. On the other hand, bankruptcy has a significant impact on the

operating performance of a company, as Fonseka and Tian (2012) indicated that financial

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management promotes the sustainable future of a business, mainly when it is not limited to

investment and dividend decisions.

4. Conclusion

The support for sustainability in the realization of business objectives is significantly

gaining concerns among the business elites. The growth rate of the business in terms of the

scientific and cultural economic fields of activities requires the input of financial management.

This paper has demonstrated that a company must take a proactive approach to financial

management and ensure that they are within the right capabilities. It has also been asserted that

organizations must take part in voluntary social and environmental disclosures if they intend to

attain social contract enablers. The study has also illustrated that sustainability issues are critical

in the making of financial decisions and essential drivers of value. The findings further revealed

that risk management should also be conceptualized as part of sustainable management practices

to prevent substantial uncertainties that may affect the business revenues. In summary, financial

management plays a vital role in promoting sustainable business practices and development.

Electronic copy available at: https://ssrn.com/abstract=3472404

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