Importance of Finance & Its Role Within Business

Finance is the elixir that assists in the formation of new businesses, and allows businesses to take advantage of opportunities to grow, employ local workers and in turn support other businesses and local, state and federal government through the remittance of income taxes. The strategic use of financial instruments, such as loans and investments, is key to the success of every business. Financial trends also define the state of the economy on a global level, so central banks can plan appropriate monetary policies.

Types of Finance

Venture capital is an area of finance that specializes in funding new companies and their expansion efforts. Trade finance makes international trade possible by issuing Letters of Credit (LOC) used to purchase goods from overseas companies. An LOC funds the manufacturing of products when a company uses the LOC as collateral for a manufacturer's loan.

Bank loans help finance accounts receivable, and credit cards help finance a company's travel and entertainment expenses. All this activity in turn serves to keep money flowing throughout the global economy.

Functions in Finance

Finance is the process of creating, moving and using money, enabling the flow of money through a company in much the same way it facilitates global money flow. Money is created by the sales force when they sell the goods or services the company produces; it then flows into production where it is spent to manufacture more products to sell. What remains is used to pay salaries and fund the administrative expenses of the company.

Benefits of Finance

The flow of finance starts on Wall Street with the creation of capital used to fund business through the issuance of common stock to provide capital, bonds to lend capital and derivatives (packaged groups of securities that help to hedge against financial risk and replace the money banks lend out to borrowers). Public companies and municipalities use this capital to help fund their operations, and banks use it to lend to companies, municipalities and individuals to finance the purchase of goods and services.

Significance of Finance

When some element of the finance process breaks down companies go out of business and the economy moves into recession. For example, if a major bank loses a significant amount of money and faces the risk of insolvency, other banks and corporate customers will stop lending or depositing money to the problem bank. It will then stop lending to its customers and they will not be able to purchase the goods or pay the bills for which they were seeking funding. The flow of money throughout the financial system slows down or stops as a result.

Why is finance important? Here’s what you need to know.

Whether you are thinking about starting a business, or you are already in the early days of running your small business, you might be thinking about finances. After all, it is difficult to get a business off the ground without investing money into it. So, why is finance important in business? In this article, we will talk you through the importance of business finance, as well as some of the types of business finance available to both small and large businesses.

The importance of financing your business

It is not a secret that every business needs money to operate. Whether you are running a service-based or a product-based business, you’ll need capital if you want to make a profit. You may choose to self-fund your business, or you may need to turn to external funding methods to finance your business such as grants, loans and credit.

However you choose to finance your business, there’s no denying that finance is critical to the success of a business. But why is finance important” Read on to learn everything you need to know about business finance.

What is business finance?

Business finance is the money that is available to a business. Whether you are starting a new business, expanding an existing business or developing new products, finance will be at the core of every business function.

It isn’t just changes within your business that will require finance, either. Even just the day to day running of a business requires a constant stream of finance, from the cost of marketing to the cost of employing staff.

This finance will often be generated through revenue, but at the start of a new business, or if you run into difficulties, you may need to look into other options to finance your business and keep it running.

How to finance a business

If you need additional finance for your business, you may be looking into finance options. There are two main options for financing a business: debt and equity.

Debt involves borrowing money from another institution, such as a loan or mortgage. This money is then paid back over time, along with interest incurred.

Alternatively, you may choose to finance your business with equity. This involves selling shares of your business to investors. The shareholders will then own portions of your business according to the size of their share and may receive dividends according to your profits.

Let’s take a look at some of the types of finance available to businesses.

Short-term finance

Short-term finance is a type of finance which covers a short time period, which is usually less than 12 months. This type of finance allows businesses to raise money quickly and attracts a low interest rate. However, the amount of money that can be raised is small and can directly impact the business.

Types of short-term finance include:

Invoice factoring

Trade credit

Credit cards

Business overdrafts

Medium-term finance

Medium-term finance involves finance methods which typically cover a period of between three and five years. These types of finance involve more risk than short-term financing methods, but less risk than long-term methods.

Types of medium-term finance include:

Start up loans

Preferred shares

Lease finances

Business loans

Long-term finance

Long-term finance is designed to help a business to grow and expand over time. This type of funding typically has a period of over ten years and is the riskiest type of business finance. However, it is also the type of finance that will allow a business to raise the most capital.

Types of long-term finance include:

Commercial mortgages

Equity capital

Retained profits

Shares

Managing your business finances

Businesses need money to survive. They must invest a vast amount of money every month to keep the business running and functioning at optimum capacity. However, this money must be carefully managed to ensure that it is being spent or invested in the right way.

Although some may say that money is the fuel of any business, it is also important to remember that the management of that money is critical. The only way to successfully grow a business is to properly manage its money, to allow the business to reap the benefits of its finance.

With daily cash flow and continuous business transactions, carefully monitoring and managing business finance is essential. It is also a pivotal aspect of decision making at many levels of the business. This can include investment decisions, such as the acquisition of new businesses. It’s also critical that a business knows when money is tight, so that unnecessary spending can be carefully controlled.

Financial management helps a business to determine what money to spend, where to spend it and when it should be spent. It also gives an overall view of the financial status of the business, helping to determine business strategy and direction as well as contributing to the objectives of the organisation.

The importance of finance in business

We have discussed the importance of the careful management of a business’ finances. But why is finance so important in business” Here are five reasons why it’s important for a business to have adequate finances.

1. Generate profit

It is often said that “you need money to make money”, and this is true in any business. When you’re starting a new business, you’ll need capital investment to launch your business effectively. However, it is not just at the start of your business that finance is required.

Even the most established businesses will rely on finance. Purchasing materials, hiring employees, marketing your business, and developing new products all rely on having adequate funds for investment and will need careful financial management.

If the business does not have sufficient funds, it will struggle to operate and in turn be unable to generate a profit.

2. Enable operations

Businesses generate large amounts of turnover every single day, which must be used to pay the bills, invest in business activities, and pay their employees. Without finance, the business will be able to do those things, leaving the business unable to operate.

If a business does not carefully manage its income and expenditure, as well as monitoring funds, it will become difficult to allocate funds effectively, rendering the business unable to trade.

3. Facilitate business expansion

For a business to be successful, it must continuously grow and expand. This includes the development of new products and expansion into new markets. However, this growth and expansion requires capital to purchase new materials and fund marketing activities.

Without an effective financial structure in place, a business will be unable to grow, leaving the business confined to offering the same products and services to the same markets. Businesses which are unable to expand are at risk of being left behind by competitors and eventually failing.

4. Sustain through adverse economic conditions

The economic climate of the world can be a rollercoaster for any business. This includes unexpected recessions and depressions, which every business should be prepared for. In addition to this, the progress of any organisation is never linear. There are always ups and downs in business, as some products succeed, and others may fail.

Preparing for challenging situations and potential economic downturn is the best way to set your business up for success. To do this, you will need to ensure that your business has sufficient finance available to see it through challenging times. This will also require careful financial management, to ensure that your business has the right contingency plans in place no matter what happens.

5. Attaining long term goals

It is essential to have long term goals in any business, providing collaborative targets for all departments to work towards as a united front. Achieving these objectives can help the business to grow, whilst increasing customer satisfaction and loyalty.

However, a business will struggle to achieve its targets without the adequate financial support to do so. For example, the business may require extra funds for product development, marketing or growth.

Investing money into achieving business objectives will allow the organisation to achieve its goals and to improve future financial stability through long term growth.

Reporting on financial health

Every business is responsible for keeping accurate records of its finances, as well as providing reports. This includes shareholder reports which detail the return and security of investments, along with tax returns for the government.

Financial departments will also be expected to produce regular reports which detail the performance of the business, which can be fed into management decisions about the direction and strategy of the business. These reports will contain key performance indicators which monitor the performance of each area of the business.

The finance department is central in providing the necessary reports, which are both legally required and essential to the effective operation of the business. That is why the finance team is at the centre of any business, providing the necessary core to all business operations.

Related questions

What is the role of the finance department in business?

Finance is the part of the business which is responsible for managing money within the organisation. This includes acquiring funds, managing the finances of the business, and planning future expenditure. The finance of the business must be carefully managed to ensure that the business is able to meet its goals and objectives, whilst remaining profitable and operating effectively.

What does the finance department actually do?

The finance department of a business is responsible for managing the finances of the business. This includes the preparation of balance sheets, cash flow reports, financial statements, record keeping and reporting. It also includes managing the payroll and accounts of the business. The finance department will also be involved with managing and conducting internal audits and for dealing with the business’ tax account.

The success of a business depends on effective financial management

It is clear to see that finance is essential for any business, playing a central role in the successful operation of the business. However, it is the way in which those finances are managed that determines the success or failure of the business.

The finance department will need to carefully control the allocation and spending of funds, as well as the reporting of financial data to ensure that objectives can be met and profits made, whilst ensuring the effective operation of the business.

Effective financial planning has the potential to enhance the value of a business, whilst also increasing a business’ profits. Ensuring that your business has a strong and efficient financial team in place, along with effective and open communication channels with senior management will be the key to the success of the organisation.

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

As the term suggests, finance is the available cash that makes an organization can use. Whether you want to start a business, or expand an existing one, add more pieces of equipment or develop new products, finance is the core of every business organization today. Liquid money is important to run the day to day operations for the organization. Right from the smallest spending to huge business expenses, finance is a must. Agree?

Well, yes. But, is that enough to run a business venture successfully and without fail? I don't think so.

Businesses today are extremely fragile. Organizations invest an enormous amount of money in order to keep their business running and fully functional. But you cannot just keep on spending lavishly or not spend at all. Now for one, it can be said that finance is the fuel of business today, but its management is equally important for organizations to emerge successful. Only when you add proper management to the field of finance, can you reap it's benefit?

While this might not convince you about the importance of financial management in every business, I will magnify the same. But, before getting into the importance of financial management for every business, let's see what does the term actually means?

Financial Management

Undoubtedly, finance is one of the most important aspects of a business. With huge funds, daily cash flow and continuous transaction, managing and monitoring all of the above turn necessary. As a matter of fact, managing finance is influential when it comes to making decisions. For instance, if the organization has greater funds, a part can be used for investment purposes and similarly, if the organization has funds lesser than the threshold value, it is important to put unnecessary spending to a stop.

To be specific, financial management helps the organization determine what to spend, where to spend and when to spend. It gives a better view of the financial status of the organization, which further outlines the financial processing of the same.

Taking this discussion forward, we highlight six reasons why financial management is important for your business?

Why Financial Management?

Generate Money

To start a business, you would need money. It is obvious that to make the first step and launch your business, capital investment is required. Further, as you move up the timeline, getting materials, hiring professionals, marketing and testing, every single step would need financial management.

Organize Operations

Businesses generate enormous amounts of money every day. This money has to be used further to pay bills, delegate funds, invest in multiple engagements and monitor all. Managing the inflow and outflow of money within your organizations is important. Failing the above, it becomes tough to allocate funds efficiently and effectively. Not to forget that irregular flow of money can turn a business insolvent.

Manage Cash Flow

Having excessive funds is at fatal as having lesser ones. For an organization to be carried on with their day to day processing, it becomes imperative to manage the cash flow. In case you have higher funds and you aren't using it as needed, it signifies wastage of resources. For an enterprise that has surplus cash, putting them to use and investing in significant engagements would yield better returns and help them expand their business.

Strategize Funding

Of course, you would want to allocate funds and use it to map the expenses that take place on a regular basis. However, spending any or every cash without proper planning is not wise. You need to keep track of the expenses, monitor the frequency and then decide how to spend and how much to spend. At times, it is important to cut down extra costs and reduce expenses. And this can only be done when you manage your financial undertakings effectively. It is advocated that companies must have sufficient funds to deal with situations of monetary crisis.

Outline Long Term Goals

Organizations work to grow and scale their business high. To do so, it is important to have significant future goals that the organization aims to accomplish in a span of five or ten years. Financial Management helps an organization achieve its goals without fail. Consider that you have planned to expand your organization to three new cities. While actually implementing the plan, you run out of money. This wouldn't have happened had you managed your organization's finance and then executed. Pre-planning and working on the available cash of the organization helps you eliminate the future possibilities of crisis while moving ahead to attain your goal.

To Sustain Economic Downturn

If you look at the growth graph of an organization, you will never find one that rises straight or is without any bends. The growth of the cycle of business organization is a mix and merge of highs and lows which of course could be due to various reasons. Recession, depression, boom or failure, all add up to the fall of a business. With sufficient finance and significant financial management, it becomes easier for the organization to walk down the business cycle. No matter how bad the situation is, they are always ready to face the problem and bear the consequences without being under the threat of shutting down. Failure-proof financial management plans help the organization thrive even know adverse economic conditions.

Final Word

Having said all of the above, it is clear that as much as finance is important for your business, so is the management. Right from collecting funds to allocating and spending them, organizational leaders must have a transparent view of all financial undertakings within their organization and likewise, indulge in planning for efficient utilization of available resources.

Author Profile-

Nikhil Bansal is the CEO and Founder of Apptunix, a leading Mobile App Development Company helping businesses in streamlining their processes with powerful and intuitive mobile apps. With extensive experience in iOS app development, he has established himself as a highly-focused Solution Architect and UX expert, the one who is always ready to make efforts in the direction where technology blends with lives.