Meaning of business finance
Business finance is the money required for the business – to carry out different activities of the business. Business finance plays a very important role in any business, be it, retail, wholesale, public, private, economic business, social business or political. Finance is required everywhere, even in non government organizations (NGOs).
Finance is required for different kinds of activities such as running the business, expanding the business, growth, development of the business, modernization, diversification, technological up gradation etc. Businesses need finance for the assets also. Assets can be classified into two categories, tangible and intangible assets. The tangible assets are the ones which the business can see or touch such as raw material, machinery, man power, factories, buildings etc. The intangible assets are the ones which the business cannot see nor touch such as copyrights, trademarks, goodwill, patents, technical expertise, brand recognitions, intellectual property rights etc.
Need for business finance
There are various areas in the business where business finance is required. These areas are integral part of the business’s working. They are:
Starting a business
Finance is required at each stage of the business. The first step is setting up a business and before staring, finance is required. Finance is needed to accumulate the resources for the business. These resources include the raw material, machinery and man power. Other assets are also acquired by business finance such as patents, copyrights etc.
Day to day activities of the businesses
Businesses not only require finance at the first stage but also require finance in day to day operations such as buying raw material from the supplier, paying wages to the workers, buying liquid assets etc.
Growth and expansion
Business finance is needed for the growth and expansion of the business. When the business starts running efficiently, then it is the time to grow the business in size or variety or investment in more fixed capital. Higher growth or expansion will require higher investment of finance.
When any business finds the idea of diversifying the business into other areas then they will require the finance. It becomes similar to starting up a new business but with already established brand name.
Technological up gradation
Many a times, businesses require technological up gradation for their business to run smoothly or to cut the cost. For adopting the new / modern technology, investment is required and thus business finance comes into scene.
Sources of business finance
There are various sources for raising the business finance. Not all businesses start with own/personal investment. Some of the sources are as follows:
- Equity shares
- Preference shares
- Loan from banks
- Public deposits
- Commercial paper
- Retained earning
- Lease financing
- Trade credit
Factors affecting the choice of finance
There are different sources of finance and they are affected by the following:
- Amount of finance required
- How quickly it is required
- The activity it is required for
- The cost involved/ cheapest option available
- Lowest risk associated
- Duration of time it is required for (long term/medium term/ short term)
Finances do not come for free, they come with some risk and cost, thus they need to be managed properly. Financial management is thus the process or activity of optimum procurement and optimal usage of the business finance.
Financial management is thus the process which includes:
- Identifying the various sources of finance
- Comparing these sources of finance based on the cost and risk associated with it.
- Make the best possible investment which provides the returns higher than the cost.
Financial management has a function of ensuring the availability of the finance to the business whenever required, thus helps in avoiding shortage of finance and at the same time avoid the excess of finance (idle finance)
Financial health of the business is directly or indirectly affected by the financial decisions that are taken by the firm and it is an important part of financial management. Some major areas of financial management are as under:
- Fixed assets of the firm: when the company decides about the size of the business, its fixed assets’ composition, then the business finance is affected. For an example: the investment of rs. 20 crores in machinery will directly impact the size of fixed assets and the finances of the firm.
- Proper allocation of funds in capital assets: finances are also required for the current assets such as cash, inventories or receivables. The quantum of current assets will affect the financial decisions of the firm directly.
- Long term and short term finance and its composition: the long term and short term finance and its composition depend on the choice made by the firm. It depends whether the firm wants more liquidity or profitability. Attracting new capital depends on the level of profitability of the firm.
This is thus a cycle. Current financial decisions affect the financial statements of the firm and future financial decisions depend upon the current financial statements. Thus the health of business finance is closely related to the financial management of the firm. Obtaining the finances at the lower risk and lower cost and deployment of these finances into the most lucrative activities where the returns are higher is the main role of the financial management but it also affects the excess of finances or shortage of finance and thus helps in balancing the composition of long term and short term finances and debt and equity.