The Importance of Finance in Business

Business finance is the art and science of managing your company's money. The role of finance in business is also to make sure there are enough funds to operate and that you're spending and investing wisely. The importance of business finance lies in its capacity to keep a business operating smoothly without running out of cash while also securing funds for longer-term investments. Finance relies on accounting, but while accounting is mainly descriptive, finance is active, using accounting information to manifest tangible results.

Why Business Finance Is Important

Businesses run on money, and business finance guides you to make shrewd and prudent decisions about cash flow and longer-term funding strategies. As you develop skills and strategies for using the funds you have and for accessing additional capital when needed, you'll improve your company's profitability and increase your potential for leveraging new opportunities.

Business Finance and Management Accounting

The way business finance functions in an organization depends on management accounting reports. These documents should be current and accurate enough for your finance department to find them relevant and useful. There are three reports you should be looking at: the profit and loss statement, balance sheet and cash flow statement.

Reading a Profit and Loss Report

Your profit and loss report, or income statement, provides information about how much your company has earned or lost during the statement's period. Net profit (or loss) is calculated by subtracting total expenditures such as rent, materials and payroll from total revenue, which is also broken down by categories such as wholesale and retail.

A profit and loss statement is relevant to business finance because it shows whether your company can reasonably handle new expenses, such as investments in equipment or property. However, just because your business shows a net profit on its income statement doesn't mean you'll have the cash you need to pay off loans or buy new equipment. Some outgoing expenditures, such as payments on loan principal, use up available cash without appearing on your profit and loss as expenses.

Despite these discrepancies, if your income statement shows a trend toward profitability over time, you'll have greater potential for successfully paying off debt than if your income statement shows that your company has consistently lost money.

Reading a Balance Sheet

Your balance sheet provides information about how much you own and how much you owe. It is a snapshot of your overall financial picture at a moment in time. Balance sheet figures are useful for business finance because they show whether your company's level of debt is sustainable or whether you owe too much already, and it would be more advantageous for you to hold back on a major purchase you're considering.

By summarizing your assets and liabilities, a balance sheet can also give you a picture of the fluidity of your assets. Money in bank accounts is useful and available, while money tied up in inventory or equipment cannot be easily accessed.

Reading a Cash Flow Statement

A pro forma cash flow statement shows your anticipated incoming capital and outgoing expenditures over a period of time, such as a year, broken down month by month. While a profit and loss statement shows your earnings, which may show some discrepancies from your actual cash on hand because of accounting conventions, a cash flow statement specifically addresses the availability or shortage of cash.

This makes it especially relevant and useful to your finance department. However, a cash flow pro forma is still a projection. It will almost never exactly correspond with your actual financial picture. Its speculative nature makes it somewhat less useful for making financing decisions.

Sources of Finance

In a perfect world, your business would always have enough money coming in from sales of goods and services to pay for daily operations. In the real world, most businesses need some kind of funding to cover short-term expenses, which don't always correspond with incoming revenue streams. Your business may be seasonal, earning enough money over a couple of months to cover long periods during the rest of the year when you operate at a loss. Or your business may be very busy late in the month or late in the week, but you still need to make ends meet during the slower times.

Financing for working capital is easier to obtain than financing for major purchases and investments. Many banks offer unsecured credit cards and business credit lines. You can use these options to cover business expenses without staking personal collateral or filling out long loan applications requiring extensive documentation. However, interest rates for unsecured financing options tend to be considerably higher than for business-lending products that are harder to obtain, such as secured term loans. Because of these high interest rates on credit cards and credit lines, it's prudent to use these loan products only for short-term needs and to pay off balances as soon as possible.

Sources of Finance and Working Capital

Business finance is important when evaluating working capital financing because it gives you the tools and information to assess how much money you need and the best way to get it. If your company operates with a monthly cycle where it accrues most of its expenses early in the month and earns most of its income later in the month, a high-interest credit card isn't such a bad option. You'll pay the money back quickly, so you won't be seriously hurt by the interest rate.

If your business operates at a loss from January until Thanksgiving and then earns enough in December to offset these losses, it's worth doing extra research and paperwork to secure a lower-interest credit option because you'll be paying interest for a longer period of time.

Business Finance and Capital Investments

When your business makes purchases of equipment or property with lasting value, finance comes into play as you evaluate whether you're ready for the expense and then find the best way to pay for it. It is common for long-term capital investments to require loans, so you'll need to consider interest expense and principal payments. Your business needs to earn enough to cover these upcoming expenditures.

A cash flow pro forma is an indispensable tool for forecasting and planning. You can plug in the amounts of anticipated principal and interest amounts and also tinker with other variables to find ways of making these extra payments. For example, if you're investing in a piece of equipment that will reduce labor costs, your pro forma will show how far these savings in labor will go toward meeting the payments on the equipment.

Making Capital Purchases

When you're making capital investment purchases, you'll also use business finance to weigh the pros and cons of different repayment options. Let's say you have a choice between a lower-interest loan with a high monthly payment and a quick repayment period versus a higher-interest option with lower monthly payments over a longer period of time. Of course, a lower-interest option is the best option, provided you have the cash flow to pay for it. But if your cash flow is tight and the equipment upgrade will save you enough money to cover some added interest, you may actually decide that the option with higher interest and a lower monthly payment is better. Lower payments help cash flow, and good cash flow puts you in a position to take advantage of opportunities.

There is no set, reliable formula for evaluating all the costs and benefits of a long-term financing option. However, if you consider all the ways that a purchase will affect your income and expenses, you'll probably make a better decision than if you focus on the interest rate alone.

Another variable that will affect the long-term costs and benefits of a purchase is the value of the money you spend and the way it changes due to inflation. When you make a loan payment in the future, you'll use capital that is worth less than the capital you borrowed because inflation decreases the value of money over time. Accountants and finance professionals use a formula called "return on investment" to calculate all of the quantifiable benefits that an investment will bring in over time and then compare these benefits with the total cost.

The Role of Depreciation

Finance decisions for major capital improvements should also take depreciation into account. When you make a large investment, such as a van, computer or building, your business must follow a set of tax conventions for reporting the purchase. The way you log this expense into your bookkeeping system has ramifications for your income and cash flow. Instead of being able to deduct the entire cost of the major asset in the year you bought it, you are required to declare a period of time for that asset's useful life and then deduct a percentage of its initial cost during each subsequent year.

The IRS stipulates specific depreciation periods for certain types of equipment, such as vehicles and computers. Other investments, such as lease hold improvements, come with more leeway. The depreciation period you choose affects your tax liability. The more quickly you can depreciate an item, the more of its cost you can deduct each year, decreasing the taxable income that you report to the IRS. It's prudent to speak to a tax professional before making decisions about how to depreciate an especially large purchase, such as a building.

Business Finance and Retained Earnings

The term "finance" is used as a noun describing the process of managing your company's money, but it is also used as a verb meaning to secure capital from an outside source through a loan or investment. Despite this association with borrowing, you can also use business finance to manage the funds you have available from regular business activities, such as sales of products or services or rent on property you own.

These retained earnings are an appealing source of operating or investment capital because you don't have to pay interest on them. You also don't have to convince a banker or investor that your project is worthwhile, and you don't have to do all the paperwork required for a loan application.

Beware Opportunity Losses

If you rely exclusively on retained earnings for short-term cash flow and longer-term investments, you may lose out on opportunities you could have leveraged if you'd had more money available. You may get a lucrative order that requires more of a capital outlay than you can make with your available cash. The cost of losing the business can be higher than the interest you would have paid if you borrowed the money. Similarly, if you own a retail location and you're keeping strictly to a cash budget, you may be unable to buy enough inventory to offer enough of a selection to lure potential customers.

A finance strategy of working primarily or strictly with capital from retained earnings is a prudent approach, but it can also make you overly cautious. You may hesitate to buy a piece of equipment you need because you don't have the cash on hand, but you would have saved more in labor over time than you would have spent on the equipment. It's a good idea to use retained earnings whenever you can do so comfortably, but line up backup sources of financing so your business doesn't suffer on the occasions when your available capital just isn't enough to make a smart move or to recover from an emergency.

Financial Management Explained: Scope, Objectives and Importance

In business, financial management is the practice of handling a company’s finances in a way that allows it to be successful and compliant with regulations. That takes both a high-level plan and boots-on-the-ground execution.

What Is Financial Management?

At its core, financial management is the practice of making a business plan and then ensuring all departments stay on track. Solid financial management enables the CFO or VP of finance to provide data that supports creation of a long-range vision, informs decisions on where to invest, and yields insights on how to fund those investments, liquidity, profitability, cash runway and more.

ERP software can help finance teams achieve these goals: A financial management system combines several financial functions, such as accounting, fixed-asset management, revenue recognition and payment processing. By integrating these key components, a financial management system ensures real-time visibility into the financial state of a company while facilitating day-to-day operations, like period-end close processes.

Video: What Is Financial Management?

Objectives of Financial Management

Building on those pillars, financial managers help their companies in a variety of ways, including but not limited to:

Maximizing profits

Provide insights on, for example, rising costs of raw materials that might trigger an increase in the cost of goods sold.

Tracking liquidity and cash flow

Ensure the company has enough money on hand to meet its obligations.

Ensuring compliance

Keep up with state, federal and industry-specific regulations.

Developing financial scenarios

These are based on the business’ current state and forecasts that assume a wide range of outcomes based on possible market conditions.

Manage relationships

Dealing effectively with investors and the boards of directors.

Ultimately, it’s about applying effective management principles to the company’s financial structure.

Scope of Financial Management

Financial management encompasses four major areas:

Planning The financial manager projects how much money the company will need in order to maintain positive cash flow, allocate funds to grow or add new products or services and cope with unexpected events, and shares that information with business colleagues. Planning may be broken down into categories including capital expenses, T&E and workforce and indirect and operational expenses. Budgeting The financial manager allocates the company’s available funds to meet costs, such as mortgages or rents, salaries, raw materials, employee T&E and other obligations. Ideally there will be some left to put aside for emergencies and to fund new business opportunities. Companies generally have a master budget and may have separate sub documents covering, for example, cash flow and operations; budgets may be static or flexible. Static vs. Flexible Budgeting Static Flexible Remains the same even if there are significant changes from the assumptions made during planning. Adjusts based on changes in the assumptions used in the planning process. Managing and assessing risk Line-of-business executives look to their financial managers to assess and provide compensating controls for a variety of risks, including: Market risk Affects the business’ investments as well as, for public companies, reporting and stock performance. May also reflect financial risk particular to the industry, such as a pandemic affecting restaurants or the shift of retail to a direct-to-consumer model.

Credit risk The effects of, for example, customers not paying their invoices on time and thus the business not having funds to meet obligations, which may adversely affect creditworthiness and valuation, which dictates ability to borrow at favorable rates.

Liquidity risk Finance teams must track current cash flow, estimate future cash needs and be prepared to free up working capital as needed.

Operational risk This is a catch-all category, and one new to some finance teams. It may include, for example, the risk of a cyber-attack and whether to purchase cybersecurity insurance, what disaster recovery and business continuity plans are in place and what crisis management practices are triggered if a senior executive is accused of fraud or misconduct. Procedures The financial manager sets procedures regarding how the finance team will process and distribute financial data, like invoices, payments and reports, with security and accuracy. These written procedures also outline who is responsible for making financial decisions at the company — and who signs off on those decisions. Companies don’t need to start from scratch; there are policy and procedure templates available for a variety of organization types, such as this one for nonprofits.

Functions of Financial Management

More practically, a financial manager’s activities in the above areas revolve around planning and forecasting and controlling expenditures.

The FP&A function includes issuing P&L statements, analyzing which product lines or services have the highest profit margin or contribute the most to net profitability, maintaining the budget and forecasting the company’s future financial performance and scenario planning.

Managing cash flow is also key. The financial manager must make sure there’s enough cash on hand for day-to-day operations, like paying workers and purchasing raw materials for production. This involves overseeing cash as it flows both in and out of the business, a practice called cash management.

Along with cash management, financial management includes revenue recognition, or reporting the company’s revenue according to standard accounting principles. Balancing accounts receivable turnover ratios is a key part of strategic cash conservation and management. This may sound simple, but it isn’t always: At some companies, customers might pay months after receiving your service. At what point do you consider that money “yours” — and report the good news to investors?

5 Tips to Improve Your Accounts Receivable Turnover Ratio Invoice regularly and accurately. If invoices don’t go out on time, money will not come in on time. Always state payment terms. You can’t enforce policies that you haven’t communicated to clients. If you make changes, call them out. Offer multiple ways to pay. New B2B options are coming online. Have you considered a payment gateway? Set follow-up reminders. Don’t wait until customers are in arrears to start collection procedures. Be proactive, but not annoying, with reminders. Consider offering discounts for cash and prepayments. Cash(less) is king in retail, and you can reduce AR costs by encouraging customers to pay ahead rather than on your normal customer credit terms. Learn more about maximizing your AR turnover ratios.

Finally, managing financial controls involves analyzing how the company is performing financially compared with its plans and budgets. Methods for doing this include financial ratio analysis, in which the financial manager compares line items on the company’s financial statements.

Strategic vs. Tactical Financial Management

On a tactical level, financial management procedures govern how you process daily transactions, perform the monthly financial close, compare actual spending to what’s budgeted and ensure you meet auditor and tax requirements.

On a more strategic level, financial management feeds into vital FP&A (financial planning and analysis) and visioning activities, where finance leaders use data to help line-of-business colleagues plan future investments, spot opportunities and build resilient companies.

Importance of Financial Management

Solid financial management provides the foundation for three pillars of sound fiscal governance:

Strategizing Identifying what needs to happen financially for the company to achieve its short- and long-term goals. Leaders need insights into current performance for scenario planning, for example. Decision-making Helping business leaders decide the best way to execute on plans by providing up-to-date financial reports and data on relevant KPIs. Controlling Ensuring each department is contributing to the vision and operating within budget and in alignment with strategy.

With effective financial management, all employees know where the company is headed, and they have visibility into progress.

What Are the Three Types of Financial Management?

The functions above can be grouped into three broader types of financial management:

Capital budgeting Relates to identifying what needs to happen financially for the company to achieve its short- and long-term goals. Where should capital funds be expended to support growth? Capital structure Determine how to pay for operations and/or growth. If interest rates are low, taking on debt might be the best answer. A company might also seek funding from a private equity firm, consider selling assets like real estate or, where applicable, selling equity. Working capital management As discussed above, is making sure there’s enough cash on hand for day-to-day operations, like paying workers and purchasing raw materials for production.

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What Is an Example of Financial Management?

We’ve covered some examples of financial management in the “functions” section above. Now, let’s cover how they all work together:

Say the CEO of a toothpaste company wants to introduce a new product: toothbrushes. She’ll call on her team to estimate the cost of producing the toothbrushes and the financial manager to determine where those funds should come from — for example, a bank loan.

The financial manager will acquire those funds and ensure they’re allocated to manufacture toothbrushes in the most cost-effective way possible. Assuming the toothbrushes sell well, the financial manager will gather data to help the management team decide whether to put the profits toward producing more toothbrushes, start a line of mouthwashes, pay a dividend to shareholders or take some other action.

Throughout the process, the financial manager will ensure the company has enough cash on hand to pay the new workers producing the toothbrushes. She’ll also analyze whether the company is spending and generating as much money as she estimated when she budgeted for the project.

Financial Management for Startups

At the outset, financial management responsibilities within a startup include making and sticking to a budget that aligns with the business plan, evaluating what to do with profits and making sure your bills get paid and that customers pay you.

As the company grows and adds finance and accounting contractors or staffers, financial management gets more complicated. You need to make sure your employees get paid, with accurate deductions; properly file taxes and financial statements; and watch for errors and fraud.

This all circles back to our opening discussion of balancing strategic and tactical. By building a plan, you can answer the big questions: Are our goods and services profitable? Can we afford to launch a new product or make that hire? What might the coming 12 to 18 months bring for the business?

Solid financial management provides the systems and processes to answer those questions.

5 reasons why Finance is important in today’s business?

What is meant by Finance?

The large amount of managing money or cash, basically by huge private and government entities or organization is said to be Finance. It confines with the study and creation of such as –

Money matters.

Banking system.

Credit system.

Investments system.

Assets and Liabilities.

This combination of all together that makes up Financial Systems.Finance can be superceded by the word Exchange. It is therefore said as exchange of available resources or art of managing various types of resources. Finance is so important today, it is said to be as soul of all our economic activities.

Finance is a necessity for acquiring physical resources, which are very important and needed to accomplish productive economic activities and for carrying business functionalism such as–

Sales Promotion.

Pay Compensations.

Unconfirmed Liabilities.

Reason for uncertainty and many more.

Now in today’s situation, finance has become the most important natural function and inseparable part of our daily life process. Finance in more specific is solicited with the management issues such as –

Owned funds generated from promoter contribution.

Raised funds generated from equity share, preference share, etc.

Borrowed funds generated from loans, debentures, overdrafts, etc.

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Finance also at the same time, confines greater approach of managing the assets generated by the business and other valuable liabilities with better organized fashion. There are 2 main types of finances such as –

Debt finance is money borrowed from external source like bank.

Equity finance were investing your own money from other stakeholders, interchange for partial ownership.

Finance consists of 3 interconnected areas such as –

Management of financial status which involves clarifications and decisions made within the organization.

Credit and money markets which deals with the financial institutions and with business securities.

Investments of money which focuses on made by both institutional investors and individuals decisions.

In pertaining to any entity’s management decisions there are 3 types such as –

Working Capital Management.

Capital Budgeting.

Capital Structure.

Finance is the functional process of business which helps to meet its goals and objectives with responsibilities for acquiring funds for the companies, managing the funds within the companies and planning for the expenditure of funds on various business aspects.

Now 5 reasons why Finance is important in today’s business?

Managing finances is a very important business aspect of today, which means having a chance to work toward a stable and rewarding career in financial management field.Financial planning helps in deciding what to spend, when to spend, how to spend and how much to spend according to the funds availability. Here are the below given 5 reasons on importance of finance in today’s business such as –

Without financial management business cannot exists

In today’s business economy, Small businesses and Entrepreneurship are more on rise that means more positions for financial managers will continue to become much more available. Without aneligible person responsible to manage the incomingand outgoing of money a good business cannot exist.

As good business generates money, through this generated money paying bills for materials, payment of salary for the employees in an organization are done. Good business earnings happen by selling quality services or products. Managing financial aspects plays a very vital role in progress of any good business. Adequate funds availability

Sufficient funds are necessary to meet daily expenses to purchase long term assets for the company’s requirement accordingly; also funds should be there to deal with future unforeseen over costs which may arise. The company should know from where the funds have to be raised and when it should be needed in emergency to deal the monetary crisis. Cash flow management system

In an organization, excess cash flow can also become difficult to manage. Having excess amount of funds and not using it in a genuine much useful way is a greater waste of resources. When an organization is having adequate funds they should put it in good

yielding investments by thinking very wisely. And also make sure that they have expansion future plans and think about new ventures which will gain them huge profits to earn for the long run. Always keeping long term goals

Having long term goals in life or business is a very important aspect to keep, once it is done the responsibility has to be fulfilled as per the plan made at any cost to get fulfil the targeted goals to achieve success. In any business entity, financial planning is a process of engaging a proper financial plan to meet its financial goals in a specific time period. To have long term financial goals in a business is a very important part, were by doing this many upcoming financial crisisin future can be resolved without any hassle. It is always a good idea to have an early well planning goal, especially in finance sinceinvesting on any good options may earn high returns over the period of time to the company to gain financial stability.So investing money with good thoughtful planning from now will make easier to execute such long term goals. Financial Planning value and importance in a business

Financial planning creates immense value to the company, without this any of the business entity cannot function properly. It is a major vital venture for all kinds of businesses worldwide. It is done for an entire year to have control over financial activities of the company. The bigger the company, the bigger will be the size of the team working on financial planning and the greater skilled professionals needed. Financial planning needs the entire support of accurate financial analysis and reporting. It has to be done continuously, with this the outcome of the plan also need to be monitored regularly. In any case the approved plan is not working, then the plan has to be modified instantly or new plan has to be made and adopted with immediate effect to run the business successfully without any kind of hindrance occurring in between. There are 6 procedures which helps in executing the financial planning of any business such as – Effect of plans evaluating on stock price and financial quotient.

To raise the funds identifying exact means to execute systematically.

Proper forecasting of sales.

Estimation of assets required for supporting sales.

Estimation of generated funds within the company.

Estimation required for external funds.

Financial planning always should start before the beginning of any project and should be carried throughout its functioning period of time to have strong control over the finance.

Conclusion

Now finance has become anatural function and highly impossible partto get split from our day to day lives whether from our personal life or from any business.So this article will yield you the understanding of finance with its reasons why it is so important in today’s business. For more information to know about finance you can logon to our website

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