Business finance management involves the strategic planning, acquisition, and control of funds to ensure smooth operations, support growth, and manage risks effectively within a business. It is essential for sustaining efficiency and long-term success.
Meaning of Business Finance
Business finance refers to the capital, funds, and credit utilized by a business in establishing and implementing a business venture. Business finance refers to how businesses acquire, manage and utilize the financial resources needed to satisfy immediate and ongoing needs including purchase of assets, day-to-day operating costs and finance growth or expansion projects.
Therefore, business finance can be seen as the base or lifeblood of any business. This ensures that businesses can operate at an efficient level and, if possible, increase the longevity of growth prospects.
Practical Examples of Business Finance
- Business finance is applied in real life in various scenarios such as:
- Obtaining loans or an investment to support cash flow during crisis (e.g. COVID 19 pandemic relief loans).
- Refinancing existing loans to cut interest costs and improve financial condition.
- Transfer ownership or management buyout scenarios with specialized financing and structure.
- Financing acquisitions, expansion and new product launches on behalf of businesses.
- Financing startups, early-stage venture, and growth for early-stage potential by way of venture capital or angel investments.
Nature of Business Finance
The nature of business finance is characterized by several key aspects:
Continuity and Variability
Financial needs of a business are continual but also fluctuate based on the market’s circumstances, such as demand, technology, and business cycles.
Diverse Requirements
Finance is for working capital – short-term finance to fund the operating costs and long-term capital to fund your assets and expansion.
Universality
Finance needs to be confined to all types of businesses and all sizes of businesses – the amount of financial resources is a function of how big the business is, and the nature of the business.
Decision-Making and Planning
At its simplest, finance involves analyzing, forecasting, acquiring, and utilizing funds. Planning is also an element of finance, which allows the owner(s) to determine the way to best align financial decision-making with their goals for the business.
Risk Management
From a business finance perspective, finance can help manage financial risk for the business by offering liquidity and, in turn the ability to hold reserves for unplanned contingencies.
Types of Business Finance
Business finance can be broadly categorized into several types:
- Equity Finance: Raising capital by selling shares to investors, which does not require repayment but dilutes ownership.
- Debt Finance: Borrowing money through loans or bonds that must be repaid with interest, retaining full control of the business.
- Internal Finance: Using retained earnings or savings to finance operations or investments.
- Grants and Subsidies: Non-repayable funds usually given for specific purposes.
- Trade Credit and Leasing: Short-term credit from suppliers and renting assets instead of buying them outright.
Significance of Business Finance
Business finance is vital for the following:
- Creating a business through initial expenses by covering promotion, incorporation fee, asset purchases, and office establishment.
- Satisfying the everyday operational expense of a business by ensuring there’s working capital for payments such as wages, raw materials, loan interest and other payments.
- Supporting operational growth, diversification, and modernization projects.
- Providing businesses with the opportunity to develop and enter into new markets and new opportunities to maintain business competitiveness.
- Enhancing company and brand goodwill and reputation by ensuring better customer service and after-sales services.
- Managing contingencies and risks in the financial position by creating provisions/reserves.
- Facilitating the acquisition of assets (tangible assets such as machinery or buildings) or intangible assets (patents or trademarks).
Sources of Business Finance
The meaning of sources of business finance refers to the various methods and avenues through which a company obtains the funds it needs to operate, grow, and achieve its goals. These sources provide the capital necessary for activities such as investing in assets, managing daily operations, expanding business, and covering other financial needs. Business finance sources are generally categorized as internal sources (funds generated within the business like retained earnings and sale of assets) and external sources (funds obtained from outside the business like loans, equity shares, debentures, and bank financing). The choice of source depends on factors like duration, cost, control, and purpose of the finance required.
Sources of business finance can be classified based on different criteria:
Categorization by Time
Long-term sources: Sources of funds for over five years, i.e., equity shares, preference shares and debentures.
Medium-term sources: Sources of funds for one to five years, i.e., loan from financial institutions, commercial paper, leasing funds.
Short-term sources: Sources of funds for less than one year, i.e., working capital loans, trade credit.
Categorization by Ownership
Owners Fund: Capital raised from the owners of the business, including equity shares, retained earnings and preference shares. These funds provide the base capital of the owners and convey the control rights with them.
Borrowed Fund: Capital raised as debts by borrowing from others, including bank loans and debentures; these funds also need to be repaid in future with interest.
Categorization by Generation
Internal Sources: Sources of funds generated from internal functional activities of the business, such as retained earnings and sale of the assets.
External Sources: Sources of funds generated with external sources, such as external borrowing, issue of debentures or shares to the public.
Some examples of possible sources of finance for business can include the same common examples cited above; retained earning, equity, term loans, debt, letters of credit, debentures or venture funding.
Examples of Sources of Business Finance
- Equity Shares: When public companies like Tata Motors require capital, they seek funds from investors via equity shares. Equity shares provide shareholders with permanent capital as well as ownership of the company.
- Debentures: Reliance Industries raise long-term capital by selling debentures, which are essentially IOUs. The repayment of these IOUs comes with a guaranteed payment of interest to lenders, but the burden of ownership associated with issuing equity shares is eliminated.
- Bank Loans: Bank loans are often another source of working capital for start-ups and SMEs, where a loan is made at an agreed interest rate with certain repayment expectations.
- Retained earnings: For example, Infosys; some companies function by recycling profit from their operations back into the business for expansion rather than borrowing more money externally.
Read in detail about retained earnings, features and limitations here.
- Trade Credit: Trade credit occurs when a retailer buys products from a supplier and pays later, thus acquiring a short-term source of finance.
- Crowdfunding and Grants: Crowdfunding and grants are three avenues that diverse start-up ventures, for example, and not-for-profit organizations will consider as their sources of financing and fund development.
Factors Affecting the Choice of the Source of Funds
Choosing the right source of finance requires careful consideration of multiple factors:
- Cost: The cost of acquiring and using funds always influences business decision-making. Choosing funds that cost as little as possible, all other things equal, maximizes profit.
- Financial Strength & Stability: A company’s repayment ability affects the source of funds. For example, businesses with stable earnings can deal with fixed charges derived from preference shares and debentures. A business with unstable earnings is better off without them.
- Form of Organizational Structure & Legal Status: Also determines the sources; a proprietor, partnership, or company have different available, e.g. only public companies can issue equity shares.
- Purpose & Period: The purpose (expansion; survival; working capital) can differ, as can the length (short- or long-term). It is possible that a business needs short-term money and only has access to long-term funds, which can also affect the sources available.
- Risk: Some sources possess different levels of risk. For example, a business’s obligation to pay interest on a debenture every 6 months is riskier than an obligation to pay dividends from equity.
- Control: Sometimes equity shares dilute ownership and control; debt sources do not dilute ownership.
- Effect on credit profile: Some sources can help or hurt a company’s credit rating and, consequently, its future borrowing capacity.
- Flexibility/ease: The sources that are unrestricted with easy documentation and flexible payment are more attractive.
- Tax advantages: Some sources provide tax benefits; for example. Interest on loans is typically
Case Studies Illustrating Business Finance Choices
A marketing firm in the motor industry used a bespoke banking application to obtain a £245,000 Coronavirus Business Interruption Loan to fund working capital during the pandemic. Read in detail here.
A housing association for homeless youth, which had multiple nos from lenders, obtained a £470,000 term loan to buy their property through savvy negotiation and the building of a comprehensive loan application. Read in detail here.
A fashion wholesale company secured another bank to refinance their £8 million development loan, which saved them in excess of £1 million in fees and interest while under financial distress. Look for the fashion wholesale company’s refinancing story here.
