Before a business can make money, it needs to understand finance basics. Finance is the study of money and how it is used. It includes topics such as accounting, investing, and financial planning. In some cases, finance in business is more dominant, while in others, it is less pronounced. Finance is essential for businesses because it helps them manage their resources efficiently and make sound financial decisions.
Without a basic understanding of finance, businesses would be at a disadvantage in today’s competitive economy. Fortunately, many resources are available to help business owners learn about finance and its role in their business.
Is finance an art or a science?
Finance is a part of the social science family. Social sciences focus on understanding human behavior and interactions with one another.
Some disciplines within the social science family are economics, psychology, sociology, and anthropology. Like most other areas in the social sciences.
What’s important to remember is that finance is very complex, and it takes time to learn about its concepts.
Finance is Not Just About the Money. Most business owners know that finance is about money, but they may not understand what it includes. In addition to helping a business manage its money, financing deals with other things, such as how companies work and the many different ways businesses can raise money.
What’s unique about finance is that it can be applied to virtually anything. With finance, the possibilities are endless. From financing a house to funding a startup company, there is no limit to financing.
Categories of business finance.
The main categories of finance are as follows;
Asset-based finance – deals with the management of assets. In a business, this may involve managing inventory, accounts receivable, and long-term assets such as buildings or equipment used as part of the business.
Cash flow-based finance – focuses on understanding cash within a business and how it is used. Cash flow-based finance also deals with planning for the future and understanding how much money will be needed.
Credit-based finance – this includes understanding the creditworthiness of customers, businesses, or even government agencies. It can help identify potential risks and opportunities that may arise due to better access to credit.
Merchant (or transaction)-based finance – deals with the process of shifting goods and services from one party to another. This type of finance can include everything from purchasing at a retail store to signing a contract and receiving goods and services.
What is a financial strategy for a business?
A financial strategy is a set of guidelines that help an organization manage risk, raise capital, and make sound financial decisions.
Financial strategy varies depending on the business, its industry, management preferences, government regulations, accounting practices, and other factors. However, some fundamental principles apply to most businesses.
Finance can be divided into three main areas;
The top line (sales), the bottom line (profits), and liquidity.
The top line is revenue which includes money earned through regular business operations like sales, investments, loans, etc. A company’s goal with its financial strategy is to maximize the top line by increasing revenue while controlling costs.
Conversely, the bottom line is how much money a company makes after paying all its expenses. A business’s goal with its financial strategy is to maximize profitability by increasing revenue while controlling costs and minimizing expenses.
Once they have these two numbers, companies can determine their liquidity position, determining if they can pay their bills on time. A company’s goal with its financial strategy is to make sure it has enough liquidity to pay its bills.
Key functions of finance in a business.
The fundamental purposes of finance in a business are:
To record and monitor transactions and financial events (accounting)
To make decisions regarding investments (capital budgeting)
To manage the company’s capital structure (capital budgeting, debt/equity ratio)
To assist in business planning (forecasting, budgeting).
To analyze the results of financial decisions and forecasts to determine whether they were effective (evaluation).
These key purposes of finance can’t be separated from one another because a company’s investment decision affects its capital structure, impacting its financial condition.
Businesses make efficient and effective use of financial resources.
The key to making efficient and effective use of financial resources is understanding how they are interrelated. This requires a comprehensive view of the company’s capital structure, which is the mix of debt and equity financing used by a company.
Whenever a company’s debt exceeds its equity, it may have difficulty meeting its debt obligation if its cash flow isn’t sufficient.
And if it has too little debt, it may have to be conservative in its spending, which would make it harder for it to compete. This is why understanding how its capital structure affects its financial condition is essential.
How Do Business Owners Finance Their Businesses?
Many small businesses are funded primarily by the owner’s money. These are often called “bootstrap” companies because their owners rely on their financial resources to grow the business. They may also raise funds through bank loans, credit cards, or other lenders.
However, it is becoming more common for entrepreneurs to acquire funding from investors in exchange for ownership of equity in their companies.
This is known as financing through the sale of securities, and it requires compliance with federal securities laws. Understanding your source of funds is important because it can affect how you run your business.
A bootstrap company that relies on the owner’s money to fund its operations may discourage unnecessary spending since that would reduce available cash for potentially lucrative investment opportunities.
On the other hand, investors may be more concerned with reducing expenses to improve operating margins and returns on equity.
Challenges do businesses face in financing
The main challenge is that finance tends to be more complicated than many other aspects of the business. Finance involves concepts like the time value of money, present and future values, capital budgeting analysis, debt/equity ratio calculations, depreciation expense, equity shares outstanding, and the list goes on.
Fortunately, there are resources available for small businesses to help them understand these concepts and use them to make informed business decisions. The U.S.A Small Business Administration provides a variety of online courses on finance for small businesses.
Understanding how finance impacts your business can give you a competitive advantage over other similar companies that do not understand their financial condition as well because it will allow you to make more informed business decisions.
What are the different types of debt?
There are several types of debt available for small businesses to use during their operations, including:
Accounts Payable – money that a small business owes to its suppliers for products or services purchased on credit. Typically this includes credit card debt if goods are purchased using a credit card.
Line of Credit – an account with a lending institution that allows the business to withdraw funds as needed under specified terms. A variable interest rate is usually tied to a benchmark like the prime or LIBOR.
Term Loan – a loan from a bank for a specific amount, repaid in equal installments over time at a fixed interest rate.
Trends affecting the role of finance in businesses today.
The role of finance in small businesses is evolving along with the nature of business in general. In the past, it was easy or typical for a small business to start as a sole proprietorship or partnership and then later grow into a larger corporation after reaching a certain level.
This could be done by lending money to private investors or issuing shares of company stock to the public. However, it has become more common for smaller businesses to remain unincorporated in recent years and instead uses various forms of personal financing to acquire funding, including bank loans or private lenders.
This is done partly because raising money through investments in stocks and bonds can be expensive and time-consuming compared with other options, especially for small businesses. Entrepreneurs manage their finances and increase their chances of success. There are several different things entrepreneurs can do to improve their chances of success:
role of finance in business decision making
The more profit a company realizes, the more capital it has available for growth and expansion.
Avoiding bad business decisions is critical to maintaining high-profit margins; however, all businesses face risk no matter what they do. Strong finances can help mitigate risk within the business, but it’s important to remember that there is no such condition as a 100% guarantee.
role of finance in business decision-making.
Prepare for the unexpected:
The most common reason businesses fail is that they run out of cash (from either poor financial management or external circumstances like an economic downturn).
This can be prevented by having enough capital reserves on hand at all times to fund daily operations until the next period of prosperity.
Small business owners may also want to consider investing money back into their businesses, including research and development or acquiring new equipment and technology.
This would help a company stay ahead of the trends and increase long-term profitability and success.
It’s important to consider that even the most well-financed small business can fail if they make mistakes in handling their finances. Understanding how finance impacts your business is critical. Still, you should also make sure you are diversifying your funding sources, another important thing is not to ignore your small overheads, always try to find them in your books and fix them ASAP.