Introduction to Business Finance

Finance is the management of money and other financial resources: it covers how funds are raised, invested and used by individuals, businesses and governments, with the aim of creating value and meeting financial goals.

The financial manager plans, organises, directs and controls the financial activities of the firm. The main managerial functions are:

1. Financial planning and forecasting. Estimating the funds needed in the short and long run and preparing budgets, so that the firm neither runs short of money nor holds idle cash.
2. Investment (capital budgeting) decision. Choosing which projects and assets to invest in, by comparing expected returns with risk and cost, so that scarce funds are put to the most profitable use.
3. Financing decision. Deciding the best mix of debt and equity, and the sources and timing of raising funds, so that the cost of capital is minimum and risk is acceptable.
4. Dividend decision. Deciding how much profit to pay out to shareholders and how much to retain for growth.
5. Working capital management. Managing cash, receivables, inventory and payables so that the firm can meet daily obligations and stay liquid.
6. Financial control and reporting. Comparing actual performance with plans, analysing financial statements, correcting deviations and keeping owners, lenders and regulators informed.

Through these functions the manager aims to maximise the wealth of the shareholders.

(b) The management of money and other financial resources of a business concern

Business finance deals with the planning, raising, managing and utilisation of funds in a business, not with recording transactions (accounting), auditing or tax computation.

Meaning of Financial Management

Financial management is that part of management which deals with the planning, organising, directing and controlling of the financial activities of a business, such as raising funds, investing them and distributing the returns earned. It is concerned with the efficient acquisition and use of funds so that the firm can achieve its goals. In simple words, financial management means managing the money of the business — deciding how much finance is needed, from where it should be raised, where it should be invested, and how the profits should be used. It covers both the procurement of funds (financing decision) and their effective utilisation (investment decision), along with the distribution of profits (dividend decision).

Objectives of Financial Management

1. Profit maximisation. A primary objective of financial management is to earn maximum profit. Every business invests funds in various assets and activities with the aim of getting the highest possible return. Profit is the reward for the risk borne by the business, and it is needed for its survival and growth. Financial decisions regarding investment, financing and dividend are therefore taken in such a way that the earnings of the firm increase.

2. Wealth maximisation. The more modern and broader objective is to maximise the wealth of the owners, i.e. the shareholders. Wealth means the net present value or market value of the firm's shares. Financial management aims to increase the market price of equity shares so that the net worth of the shareholders rises. This objective is superior to profit maximisation because it considers the time value of money and the risk involved in earning profits.

3. Proper utilisation of funds. Funds are scarce and costly, so financial management aims at their judicious and effective use. It seeks to avoid idle or excessive funds and to ensure that every rupee raised is invested in productive assets that give a fair return. This helps in maintaining liquidity as well as profitability and prevents wastage and misutilisation of resources.

4. Maintaining liquidity and meeting obligations. Financial management aims to keep sufficient liquid funds in the business so that short-term and long-term obligations — such as payment to creditors, wages to workers, interest to lenders and taxes to the government — can be met on time. A proper balance between liquidity and profitability is maintained so that the firm neither faces a shortage of cash nor keeps excessive idle cash.

Other objectives (may also be mentioned): ensuring a regular and stable supply of funds, reducing the cost of capital, and maximising the value of the firm.

Meaning of Business Finance

Business finance refers to the activity of planning, raising, managing and utilising funds required by a business enterprise for its establishment, operation, expansion and modernisation. It covers the estimation of financial needs, selection of appropriate sources of funds (such as shares, debentures, loans and retained earnings), proper allocation of funds among various assets, and effective control over their use so as to maximise the wealth of the owners. In short, business finance deals with the acquisition and management of capital in a business.

Importance of Business Finance

1. Basis of starting a business: Every business needs funds to purchase fixed assets like land, building, plant and machinery, and to meet working capital requirements such as wages, raw materials and salaries. Without adequate finance, even a sound business idea cannot be converted into a real enterprise. Thus finance is the foundation on which the whole structure of a business is built.

2. Smooth running of business operations: Day-to-day activities require a continuous flow of funds to pay creditors, workers, suppliers and other expenses. Adequate and timely finance ensures that production, purchase and sales activities go on without interruption. Lack of working capital may result in stoppage of production and loss of goodwill.

3. Expansion and modernisation: Growing enterprises need additional funds to increase production capacity, enter new markets, install modern technology and undertake research and development. Business finance makes such expansion, diversification and modernisation possible, thereby helping the enterprise to remain competitive and grow in size and profit.

4. Meeting unforeseen contingencies and building goodwill: Business is exposed to risks such as fire, theft, natural calamities, price fluctuations and bad debts. Adequate financial strength enables the enterprise to face such emergencies without difficulty. Moreover, a financially sound firm can pay its dues promptly, offer credit facilities to customers and attract investors and lenders, which enhances its reputation and creditworthiness in the market.

Thus, business finance is rightly regarded as the lifeblood of a modern business enterprise, as without it no business can be promoted, operated or expanded successfully.

Business Finance

Business finance refers to all those activities concerned with the acquisition, management and utilisation of funds required by a business to carry out its operations and achieve its objectives. It includes estimating the financial needs of the business, deciding the sources from which funds will be raised, and ensuring that the funds so raised are used efficiently and profitably. In short, business finance deals with the planning, raising, controlling and administering of the funds used in a business.

Sources of Raising Required Funds

The sources from which a business can raise funds may be broadly classified into three groups:

1. Long-term Sources (for permanent capital and fixed assets)

(a) Equity Shares: These are the shares representing the ownership capital of a company. Shareholders are the real owners, receive dividend (which depends on profit) and bear the ultimate risk. Equity capital is permanent, needs no repayment, and forms the base of the company's financial strength. However, it dilutes control of existing owners.

(b) Preference Shares: These shares carry a fixed rate of dividend and have a preferential right over equity shares both in payment of dividend and repayment of capital at the time of winding up. They carry limited voting rights, so control is not diluted. Dividend on them is payable only when profits exist.

(c) Debentures: These are instruments acknowledging debt. Debenture holders are creditors of the company and receive a fixed rate of interest, which is a charge against profit and is tax-deductible. They have no voting rights, so control remains with owners. However, interest must be paid even in loss, and the principal has to be repaid.

(d) Long-term Loans: Loans taken from banks and financial institutions for a long period, generally against mortgage of assets. They carry a fixed rate of interest and are repayable as per agreed terms. They are suitable for expansion and modernisation.

(e) Retained Earnings (Ploughed-back Profit): A portion of profit kept in the business instead of being distributed as dividend. It is an internal, cost-free and permanent source that strengthens the financial position, though the amount available is limited by the size of profit.

2. Medium-term Sources

(a) Term Loans: Loans from banks and financial institutions repayable within one to five years, used for working capital needs, purchase of machinery, etc.

(b) Leasing: The business obtains the right to use an asset (land, building, machinery) by paying periodic lease rent, without owning it. It saves the large initial outlay.

(c) Hire Purchase: The asset is purchased by paying a down payment and the balance in instalments. Ownership passes to the buyer only after the last instalment is paid.

3. Short-term Sources

(a) Trade Credit: Credit allowed by suppliers of goods and services, allowing the business to buy now and pay later. It is a convenient and common source of working capital.

(b) Bank Overdraft and Cash Credit: The bank allows the business to withdraw more than its balance up to a sanctioned limit. Interest is charged only on the amount actually used.

(c) Commercial Paper: An unsecured short-term promissory note issued by large, creditworthy companies to raise funds for a short period at a lower rate of interest.

(d) Factoring: The business sells its accounts receivable to a factor (financial institution) at a discount and obtains immediate cash.

(e) Loans from Directors and Friends: Short-term loans raised from directors, relatives and friends, generally without much formality.

Functions of a Finance Manager

The finance manager is the executive responsible for the financial health of the business. His major functions are:

1. Estimating Financial Requirements: He must estimate both short-term and long-term financial needs of the business. This depends on the nature and size of the business, its plans for expansion and modernisation, and the funds needed for fixed assets and working capital. Under-estimation may lead to loss of opportunity, while over-estimation means unnecessary interest burden.

2. Deciding the Capital Structure: He decides the proportion of equity, preference shares, debentures and loans in the total capital. The aim is to maintain a balanced mix of debt and equity so that the cost of capital is minimum and the risk is within safe limits.

3. Selecting the Sources of Funds: He chooses the most appropriate source of finance, keeping in view the cost, risk, control, duration of need and the financial condition of the business. For example, long-term needs are met from equity or debentures, while short-term needs are met from bank overdraft or trade credit.

4. Utilising the Funds Properly: Raising funds is not enough; they must be invested wisely in profitable ventures. The finance manager allocates funds among various assets and projects so that maximum return is obtained with minimum risk.

5. Managing Cash Flow: He ensures that the business always has enough cash to meet its obligations and that idle cash is not kept unnecessarily. This involves preparing cash budgets, forecasting receipts and payments, and maintaining a proper balance between liquidity and profitability.

6. Disposing of Surplus (Profit Distribution): He decides how much of the profit should be distributed as dividend to shareholders and how much should be retained in the business. This decision affects the wealth of shareholders as well as the future growth of the company.

7. Financial Control: He keeps a check on the use of funds through budgetary control, ratio analysis and cost control techniques, so that wastage and misuse of funds are prevented and the financial objectives of the business are achieved.

8. Maintaining Relations with Financial Institutions: He maintains good relations with banks, financial institutions, shareholders and creditors so that funds can be raised easily whenever required.

Thus, business finance deals with the procurement and effective use of funds, and the finance manager performs the vital task of planning, raising, allocating and controlling these funds for the growth and stability of the business.

Finance is the lifeblood of every business and of the economy. Its importance can be seen in the following points.

1. Starting and running a business. Funds are needed to buy assets, raw materials and pay wages. Without finance no enterprise can be formed or continue to operate.
2. Growth and expansion. Finance allows a firm to modernise, add new products and enter new markets.
3. Efficient use of resources. Sound financial planning places scarce funds in the most profitable uses and avoids waste.
4. Meeting obligations. Adequate finance helps pay suppliers, employees, lenders and taxes on time, building credit and goodwill.
5. Facing risk and uncertainty. Reserves and insurance prepared through financial management help a firm survive losses and economic downturns.
6. Economic development. Finance channels savings into investment, creating employment, income and growth in the nation.
7. Increasing wealth. Good financial decisions raise profits and the value of the firm for owners.