Anyone who knows anything about business will tell you this fact— you have to spend money to make money. Every business requires assistance to secure funding for growth and development, and that’s where business finance comes in. Business finance is needed to purchase assets, goods, raw materials, and other economic activities.
What is Business Finance
Business finance is the act of securing economic support to supply funds for your business’s everyday expenses. For every business owner, planning and budgeting, raising capital, managing cash flow, and making financial decisions that could only bring in more profits are significant concerns.
Business finance is the fuel that keeps your business running smoothly; therefore, if you are in need of funding for your business, this article will unveil how you can go about it and how to identify your business’s primary source of income. But let’s begin by discussing the objectives of business finance.
Objectives of Business Finance
1. Raising of Capital
Business finance’s first and foremost objective is to raise the capital needed for the organization’s operations. Suppose it’s an existing role for any organization. In that case, the financial manager seeks to raise capital economically so that excess funds do not remain idle or a shortage of funds does not create a bottleneck in running the business.
2. Increasing Revenue
This is the most basic financial objective for any business because the main goal of most businesses is to use available resources to bring in more revenue. This is what makes businesses successful and allows them to continue growing.
3. Investment of Capital
Another key objective is to invest the capital raised appropriately and in the proper sequence. Financial managers should decide where corporate money may be invested when investing funds. Generally, money should be invested where it will do the expected good. In a corporate setting, this means yielding surplus profits.
4. Protection of Capital
Having enough finances protects the capital invested in the business. Uncertainty always prevails in the business world. If the investment is made unwisely and un-prudently, it may bring disaster to the business unit.
Therefore, to fulfill the financial objective, the risk of loss and protection of capital must be considered.
5. Minimization of Cost
Business finance helps minimize the cost of funds to maximize shareholders’ wealth. That involves examining all alternative sources of financing. A firm may decide to issue bonds instead of stock.
Bonds are riskier than stocks; conversely, bonds cost less than stocks. Here, the firm accepts the risk of borrowing in exchange for a lower cost of funds.
6. Maximization of Profit
One of finance’s crucial objectives is maximizing the firm’s profit. The financial manager would take actions expected to significantly contribute to the firm’s overall profits. For each alternative being considered, the financial manager would select the one expected to result in the highest monetary return.
7. Maximization of Wealth
Business finance maximizes the wealth of the owners for whom it is being operated. The wealth of corporate owners is measured by the stock’s share price, which, in turn, is based on the timing of returns, capacity, and risk.
8. Maintain Firm Value
A major purpose of finance is to maintain business value. It is generally believed that a firm’s value is maximized when the cost of capital is minimized. The optimum capital structure exists when the firm’s value is constantly maintained.
Therefore, business owners should maintain the value of their firms through the formation of an optimal capital structure.
Sources of Business Finance
1. Bank loans
Bank loans are one of the most popular sources of funding for businesses. You have to find the most suitable bank for your business by enquiring and weighing your options. Also, you should know that bank loans vary according to the bank’s policies, so it all boils down to what you are looking for.
2. Personal Savings
The first place to look for money is your personal savings or equity. Personal resources include bank savings, profit-sharing or early retirement funds, real estate equity loans, or cash value insurance policies.
3. Equity Financing
Equity financing means exchanging a portion of the ownership of the business for a financial investment in the business. The ownership stake resulting from an equity investment allows the investor to share the company’s profits. Equity involves a permanent investment in a company and is not repaid by the company at a later date.
The investment should be appropriately defined in a formally created business entity. An equity stake in a company can be in the form of membership units, as in the case of a limited liability company, or in the form of common or preferred shares or stocks, as in the case of a corporation.
4. Friends and Relatives
Looking to private financing sources, such as parents or friends, is another excellent way to accumulate finances for your business. It may be in equity financing, in which the friend or relative receives an ownership interest in the business, or they could invest freely.
However, these investments should be made with the same formality used with outside investors.
5. Venture Capital
Venture capital refers to financing that comes from companies or individuals in the business of investing in young, privately held businesses. They provide capital to young businesses in exchange for an ownership share of the business.
Venture capital firms usually don’t want to participate in the initial financing of a business unless the company has management with a proven track record. Generally, they prefer to invest in companies that have received significant equity investments from the founders and are already profitable.
6. Angel Investors
Angel investors are individuals and businesses that are interested in helping small businesses survive and grow. Their objective is more than just focusing on economic returns.
Although angel investors often have a mission focus, they are still interested in profitability and security for their investment. That’s why some try to follow up on business progress.
Though they may still make many of the same demands as venture capitalists, angel investors may be interested in the economic development of a specific geographic area in which they are located. Angel investors may focus on earlier-stage financing and smaller financing than venture capitalists.
7. Government Grants
Federal and state governments often provide financial assistance through grants or tax credits for start-up or expanding businesses, but remember that you will probably be going through many checks and lengthy procedures. At this point, registering your business isn’t a choice anymore but a must.
8. Debt Financing
Debt financing involves borrowing funds from creditors and microfinance banks with the stipulation of repaying the borrowed funds plus interest at a specified future time. For the creditors (those lending the funds to the business), the reward for providing the debt financing is the interest on the amount lent to the borrower.
Debt financing may be secured or unsecured. Secured debt has collateral (a valuable asset that the lender can attach to satisfy the loan in the case of default by the borrower). Conversely, unsecured debt does not have collateral and places the lender in a less secure position than repayment in a default situation.
Major Concepts of Business Finance
Business finance involves the management of funds and resources to achieve a business’s financial goals and objectives. Several major concepts are fundamental to understanding business finance:
1. The Power of Cash Flow (Working Capital)
Cash flow is simply the amount of cash coming into a business compared to the amount leaving in the same period, such as a month or quarter. The higher the amount of revenue that is entering as opposed to the amount of cash being paid out, the healthier a company’s financial picture.
A common problem for small businesses is mistaking sales income for cash flow.
2. Profit Margins
Profit margin is a financial ratio that measures the percentage of profit a company earns concerning its revenue. Expressed as a percentage, it indicates how much profit the company makes for every dollar of income generated.
Described as a percentage, it represents the portion of a company’s sales revenue that it gets to keep as a profit after subtracting all of its costs.
FORMULA: NET PROFIT MARGIN = REVENUE – COST/REVENUE
3. Cost of Goods Sold
The cost of goods sold (COGS) refers to the direct costs of producing the goods sold by a company. This includes the materials and labour costs directly used to create the goods. It excludes indirect expenses, such as distribution costs and sales force costs. The cost of goods sold is also called the “cost of sales.”
The primary revenue definition is the total amount of money brought in by a company’s operations, measured over a set amount of time. A business’s revenue is its gross income before subtracting any expenses. Profits and total earnings define revenue. It is the financial gain through sales or services rendered.
5. Return on Investment
Return on investment (ROI), or rate of return, is a calculation of the monetary value of an asset versus its cost. It is a ratio that compares the amount of money invested to the amount of profit or loss earned. Use (profit – cost) / cost when calculating the ROI formula.
It is usually broken down into “net profit,” which represents the total revenue generated from the investment minus all the associated costs and expenses, and “investment cost,” which is the total amount of money invested in a particular project, asset, or venture. Finally, the result is multiplied by 100 to express the ROI as a percentage.
6. Return on Advertising Spend
Return on ad spend (ROAS), as it is mainly referred to, is an essential key performance indicator (KPI) in online and mobile marketing. It refers to the amount of revenue that is earned for every dollar spent on a campaign. ROAS and return on investment (ROI) differ because ROI is more expansive in scope.
While ROAS focuses on specific campaigns, ROI takes much more advertising spend, or total advertising cost, into account. This could include bringing in an agency or a particular voice for the advertising plan.
Importance of Business Finance
1. Financial Planning
The financial management department plans how much funding is needed for the firm’s operations. If a firm is to be started over, it must determine its cash needs.
It is also responsible for making financial plans for capital budgeting, asset expansion, and machine replacement if it becomes obsolete or physically deteriorates. The proper planning of expenditures is fundamental to financial management.
2. Raising of Fund
The finance management raises the requisite funds to meet the requirements of the business operations. If the firm is short of funds, the financial manager must make arrangements for obtaining funds according to operating requirements. Funds may be needed for an initial undertaking, seasonal change, or permanent expansion.
3. Investment of Funds
The collection of funds is only helpful if they can be appropriately invested. Financial management ensures the maximum utilization of funds to earn the maximum return. You must confirm your firm’s funds are efficiently managed to achieve the goal.
4. Allocation of Fund
A business’s essential finance function is to make investment decisions and determine the capital demand for these expenditures. The financial manager is concerned with the efficient allocation of funds. The distribution of funds is essential to achieving the firm’s long-term objectives.
5. Financial Control
The purpose of financial management is to control the use of funds committed to the operation of the concern. Managing business finances handles the investment by checking the actuals against the plan. The investment in operating assets must be carefully supervised to maximize their efficient utilization.
6. Understanding Capital Market
Business finance management helps the finance team manage the capital market where the firm’s securities are traded. The financial manager should fully understand the operations of capital markets and how securities are valued.
How to Classify Your Business Source of Funds
Classifying the sources of funds is whether the funds are generated from within the organization or from external sources outside the organization. Below, you will find ways to classify your business source of funds.
- Internal Sources: This is when business owners generate funds within the organization. Examples for this reference include profits from services rendered, selling off assets and retained earnings, etc.
- External Source: The fund is obtained from outside the business. For instance, grants, issuance of equity shares to the public, debentures, commercial bank loans, etc.
- Period: The duration the funds keep coming in. It is classified into long-term, medium-term, and short-term.
I. Short-Term: It refers to funds that generally have to be paid back within a year.
Ii. Medium-term: It usually requires funds to be paid back between one and five years
Iii. Long-term: Generally, anything paid back after five or more years.
- Ownership (Owner’s Fund and Borrowed Fund): The owner’s funds are the total amount invested by the owner of an enterprise and the accumulated profits that they have reinvested in the business. Borrowed funds are funds a business raises through loans or borrowings from outside parties.
When it comes to business finance, raising and managing business funds are primarily the responsibility of the firm’s owners or managers, who must use financial forecasting to develop a long-term plan. Shorter-term budgets are then created to meet the plan’s goals.
It is important to note that finance is vital to any business. You must run a business with funds. Therefore, business finances should be adequately managed for seamless operations and more income.
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