business finance

business finance

The Importance of Business Finance: Strategies for Financial Success

1. Introduction to Business Finance

For needs as basic as paying business bills, principal investments in capital equipment, and necessary staffing, a business must have money. And for it to progress along the desired lines and in the right direction, a business must still have money. Thus, the essentially practical function of the study and teaching of business finance is to increase knowledge and improve skill in the raising and earning of business money – the generation of income – to build the business through reinvestment and the wise use of present surplus, and to maintain the financial condition of the business – with adequate cash on hand, in the form of liquid assets, to meet all obligations. Required for financing a business are both an understanding of its ownership and financial organization in the realms of the public and private sectors and a thorough knowledge of the markets from which it may be financed – money market, capital market, and financial institutions. It is to contribute to the attainment of these goals that, among other entities, the federal agency presented in this guide publishes a major portion of the educational material developed at its pioneering nationwide adult and extension programs in business administration. In this document, various strategies that business executives might consider and might follow are presented. Such instruction provided without preconceived commitment offers a stimulating approach. While most of the material in this guide has come out of formal sessions, reinvention of many ideas represented in it will, via such an offering, be promoted.

2. Key Concepts in Business Finance

• The goal of the financial manager is to create value for the firm’s shareholders. Financial managers must constantly make decisions about the sources of financing for their firms’ assets, the form of the assets, the uses of profits generated by those assets, and the return that should be required by finance suppliers in return for the use of their funds. To help make such decisions, it is essential to have a good understanding of some of the key concepts that relate to these financial-management activities. Unfortunately, many people consider financial management to be voodoo economics, particularly for fashion-related businesses. Some consider it to be wicked, assuming that the only sophisticated financial experts are prepared to impose unreasonable constraints on corporate management in the interests of finance suppliers. In reality, if fashion companies can sell their products for a profit, they have the potential to become a source of both jobs and profits over the longer term. The managers of these companies must decide how much capital to input into the business without compromising the company’s future. In addition, they must make the best possible use of the capital that has been obtained from corporate investors. Ultimately, these decisions may spell the difference between success and failure for a business. • Its ability to generate good financial returns from known risks will be fundamental to the survival of any company, however large or small it may be. Businesses cannot survive without healthy profits from which to finance both reinvestment in the firm’s capacity and growth and the owner’s return on capital and entrepreneurial skill. The fundamental principle of business finance is that a company, whatever its size or form, simply cannot afford to run out of money at the wrong time. In fact, most business failures are the end result of a combination of management misjudgments, and it is failure to manage the firm and its financial resources properly that leads to financial ruin. The price of meeting payroll can easily become overwhelming when implementing a major venture, or when marketing and production staff have overestimated the consumer market for new styles.

Business Finance: Concepts and Definitions

3. Financial Planning and Analysis

Cost drivers and predictive business and activity models are the effective mechanisms that project and interpret nonfinancial business activities. The role of the business finance team in linking both operational and nonoperational decision making with financial information indicates the enormous task associated with these activities. A very well-organized team is necessary to comfortably handle the magnitude of this activity. Business finance can at times become caught up in constant activities to raise capital and manage appropriate capital structures. The broader and even more important aspect of the function—linkage of business strategy and plan over the short and long term—requires competence in activities not traditionally associated with finance. Business finance responsibilities include everything from proposing business initiatives specific to the lines of business, developing and communicating new business models, collecting market intelligence, and interpreting key performance indicators related to product mix profitability. Establishment of financial targets and budgets, however, are relatively easy by comparison.

The business finance team is the key to linking and integrating nonfinancial business activities. This isn’t the practice in a lot of businesses. The organizational structure should have a major member of finance management at the decision-making level for major business strategies and initiatives. By being in this management “loop” of all business activities rather than merely acquiring and relocating financial assets, the finance team can effectively recommend, implement, and monitor business strategy. The business finance team specializes in financial tools, models, and processes that link across functions and even include proprietary best practices.

Financial planning and analysis work as the foundation supporting the strategies and initiatives detailed in the blueprint. Correlating existing financial information with historical and current nonfinancial information creates the “base case” of the organization’s business. This quantitative analysis model becomes the basis for comparing planned or proposed activities.

4. Sources of Business Finance

vii) Specialist Finance: Adds are available from various specialist sources – including venture capital, business angels, and government agencies – that might finance a business that has growth potential, rapid and significant cash flow, or that operates within what the financer believes to be a high-potential economic sector. These forms of finance can be more expensive than traditional loans in the first instance.

vi) Grants: The government sometimes offers financial help to businesses in the form of grants. These are regarded as an accessible but expensive source of funding, given the relatively small sums available and the administrative cost of applying for grants.

v) Trade Credit: Due to its flexibility, this is a valuable source of finance for most businesses, but purchases paid for under trade credit can incur a significant cost in terms of discounts forgone.

iv) Factoring and Invoice Discounting: Both of these services enable a business to generate cash quickly from its sales ledger by selling its sales invoices at a discount. Both facilities are more expensive than discounting, and the factor or invoice discounter assesses its risk on the Invoice and Eliga in question.

iii) Loans: Loans may be secured or unsecured and may take the form of bank loans, overdrafts, hire purchase agreements, etc. Commercial lending continues to grow with a developing economy; however, this can be a very expensive form of finance.

ii) Retained Earnings: The profit made by a business in previous periods that remains undistributed and uninvested attracts no tax and significant dividends for the shareholders. Therefore, businesses will utilize retained earnings to finance future expansion and new investment.

i) Capital: This refers to the funding available from shareholders or owners to support the business. Initially, funds may be provided to cover preliminary costs, e.g. incorporation of a company, purchase of office stationary, or other preliminary costs before trading. This initial investment made by the owners is known as share capital.

The main sources of business finance are as follows:

5. Financial Decision Making and Risk Management

On the other hand, sometimes managers need to have current assets fall to minimum levels to improve returns on total investment. This decrease in current assets can actually enhance liquidity. The success of a commercial firm can be heavily dependent on how well it manages its investments in current and fixed assets. If companies must manage to a high level of risk for stockholders, it would imply that the demand for a high level of return from equity will reduce the rate at which they invest in new, potentially profitable projects. It is true that higher rates of return on equity tend to reduce the willingness of the equity market to fund the company. Higher rates of return increase the financial risk of the company and the cost of new funding increases when the company may need it.

Ensuring the continued availability of cash and marketable securities to cover obligations without any problems associated with a lack of liquidity involves the use of planning tools such as expert planning and forecasting model from several different functions within the firm. These models depend on accurate projections of the company’s cash cycle. Failure to coordinate these forecasts and planning models can create tremendous problems for the company.

A company may hold too little in current assets or too much in current assets. Holding too little of these types of assets can lead to an inability to meet the company’s current obligations that could cost them to go bankrupt. In contrast, holding too much current assets when the company has low levels of sales can lead to a decision that is overly conservative. Holding excessive levels of current assets result in low rates of return for investors in the company in comparison to other types of investments.

One area of financial management involves investment in the short term or long term in fixed assets for the company. Managing these types of assets affects the firm’s risk and the amount of return it can expect for its investment. For example, short-term current assets such as cash, marketable securities, inventory, and receivables can be managed to have significantly different risks and returns from long-term assets such as buildings or equipment. Spending money on buildings or equipment is typically not a high-risk activity. In contrast, managing current assets and the amount of current liabilities that finance these short-term assets is more risky.