Importance of Finance and 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

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

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.

Considerations

All facets of the global economy depend upon an orderly process of finance. Capital markets provide the money to support business, and business provides the money to support individuals. Income taxes support federal, state and local governments. Even the arts benefit from the financial process because they draw their money from corporate sponsors and individual patrons. Capital markets create money, businesses distribute it, and individuals and institutions spend it.

Managerial and Corporate Finance

Managerial Finance

Managerial finance concerns itself with the managerial significance of finance. It is focused on assessment rather than technique. For instance, in reviewing an annual report, one concerned with technique would be primarily interested in measurement. They would ask: is money being assigned to the right categories? Were generally accepted accounting principles (GAAP) followed?

A person working in managerial finance would be interested in the significance of a firm's financial figures measured against multiple targets such as internal goals and competitor figures.They may look at changes in asset balances and probe for red flags that indicate problems with bill collection or bad debt as well as analyze working capital to anticipate future cash flow problems.

Sound financial management creates value and organizational ability through the allocation of scarce resources amongst competing business opportunities. It is an aid to the implementation and monitoring of business strategies and helps achieve business objectives.

Corporate Finance

Corporate finance is the area of finance dealing with monetary decisions that business enterprises make and the tools and analysis used to make those decisions. The primary goal of corporate finance is to maximize shareholder value. Although it is in principle different from managerial finance, which studies the financial decisions of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to financial problems of all kinds of firms.

The discipline can be divided into long-term and short-term decisions and techniques. Capital investment decisions are long-term choices about which projects receive investment, whether to finance that investment with equity or debt, and when or whether to pay dividends to shareholders. On the other hand, short-term decisions deal with the short-term balance of current assets and current liabilities; the focus here is on managing cash, inventories, short-term borrowing, and lending (such as the terms on credit extended to customers).

The terms corporate finance and corporate financier are also associated with investment banking. The typical role of an investment bank is to evaluate the company's financial needs and raise the appropriate type of capital that best fits those needs. Thus, the terms "corporate finance" and "corporate financier" may be associated with transactions in which capital is raised in order to create, develop, grow, or acquire businesses.