Business Finance

Business Finance

Business finance refers to money and credit employed in business. It involves procurement and utilization of funds so that business firms may be able to carry out their operations effectively and efficiently. The following characteristics of business finance will make its meaning more clear:

  • Business finance includes all types of funds used in business.
  • Business finance is needed in all types of organisations large or small, manufacturing or trading.
  • The amount of business finance differs from one business firm to another depending upon its nature and size. It also varies from time to time.
  • Business finance involves estimation of funds. It is concerned with raising funds from different sources as well as investment of funds for different purposes. Need and Importance Business finance is required for the establishment of every business organisation. With the growth in activities, financial needs also grow. Funds are required for the purchase of land and building, machinery and other fixed assets. Besides this, money is also needed to meet day-today expenses e.g. purchase of raw material, payment of wages and salaries, electricity bills, telephone bills etc. You are aware that production continues in anticipation of demand. Expenses continue to be incurred until the goods are sold and money is recovered. Money is required to bridge the time gap between production and sales.

In this case, business finance is the raising and managing of funds by business organizations. Planning, analysis, and control operations are responsibilities of the financial manager, who is usually close to the top of the organizational structure of a firm. In very large firms, major financial decisions are often made by a finance committee.

In small firms, the owner-manager usually conducts the financial operations. Much of the day-to-day work of business finance is conducted by lower-level staff; their work includes handling cash receipts and disbursements, borrowing from commercial banks on a regular and continuing basis, and formulating cash budgets.

Financial decisions affect both the profitability and the risk of a firm’s operations. An increase in cash holdings, for instance, reduces risk; but, because cash is not an earning asset, converting other types of assets to cash reduces the firm’s profitability.

Similarly, the use of additional debt can raise the profitability of a firm (because it is expanding its business with borrowed money), but more debt means more risk. Striking a balance—between risk and profitability—that will maintain the long-term value of a firm’s securities is the task of finance.

Short-term financial operations are closely involved with the financial planning and control activities of a firm. These include financial ratio analysis, profit planning, financial forecasting, and budgeting.

Whereas short-term loans are repaid in a period of weeks or months, intermediate-term loans are scheduled for repayment in 1 to 15 years. Obligations due in 15 or more years are thought of as long-term debt. The major forms of intermediate-term financing include 1) term loans, 2) conditional sales contracts, and 3) lease financing.

Long-term capital may be raised either through borrowing or by the issuance of stock. Long-term borrowing is done by selling bonds, which are promissory notes that obligate the firm to pay interest at specific times. Secured bondholders have prior claim on the firm’s assets.

If the company goes out of business, the bondholders are entitled to be paid the face value of their holdings plus interest. Stockholders, on the other hand, have no more than a residual claim on the company; they are entitled to a share of the profits, if there are any, but it is the prerogative of the board of directors to decide whether a dividend will be paid and how large it will be.

Long-term financing involves the choice between debt (bonds) and equity (stocks). Each firm chooses its own capital structure, seeking the combination of debt and equity that will minimize the costs of raising capital.

As conditions in the capital market vary (for instance, changes in interest rates, the availability of funds, and the relative costs of alternative methods of financing), the firm’s desired capital structure will change correspondingly.

The size and frequency of dividend payments are critical issues in company policy. Dividend policy affects the financial structure, the flow of funds, corporate liquidity, stock prices, and the morale of stockholders. Some stockholders prefer receiving maximum current returns on their investment, while others prefer reinvestment of earnings so that the company’s capital will increase.

If earnings are paid out as dividends, however, they cannot be used for company expansion (which thereby diminishes the company’s long-term prospects). Many companies have opted to pay no regular dividend to shareholders, choosing instead to pursue strategies that increase the value of the stock.

Companies tend to reinvest their earnings more when there are chances for profitable expansion. Thus, at times when profits are high, the amounts reinvested are greater and dividends are smaller. For similar reasons, reinvestment is likely to decrease when profits decline, and dividends are likely to increase.

Orkhan Mehdiyev