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.

The Importance of Finance in Business

The three main sources of funding for a business are revenues from business operations, investor finances such as owner’s, partner’s or venture capital, and loans from individuals or financial institutions. Businesses need finances for daily operations and to meet essential expenses and payments. Expenses are either short term, such as payroll payments, or long term, such as purchasing buildings.

Significance

It is impossible to achieve your long-term and short-term goals without effectively managing your finances. Inefficient management of finances could lead to liquidity shortages. You need funds for business growth, market competition, and to keep your business operational and maintain your customer base. If your finances are restricted, risks that can negatively affect the accumulation of necessary business funds should be hedged with adequate insurance coverage and effective internal controls. You can obtain insurance for accidents, liabilities and business vehicles to protect your finances from sudden untoward impacts.

Short-Term Activities

Your business can come to a halt or your working capital management may be jeopardized if you do not have the essential finances to cover short-term expenses. Creditors can demand payment for the items or services they have delivered to you at any time. Failure to meet these demands can cause inventory shortages or damaged business relations. Short-term sources of finance, such as cash revenue and advance receipts, must be obtained sufficiently through effective debt and discount policies. Preparing cash budgets can help you forecast outflow of money and the amount of finances needed to meet those outflows.

Long-Term Activities

Long-term sources of finance must be available for achievement of long-term goals, such as purchasing new machines. Relying on short-term sources would lead to a finance shortage for long-term projects and could repeatedly stall these projects. Finance long-term projects using your business’s savings, or obtain bank loans. To fund expenses of such magnitude, you cannot rely on short-term financial sources, because doing so could adversely impact your short-term activities. Use tools such as capital budgeting and proper planning to time when your long-term expenses occur.

Achieving Financial Goals

Every business owner has a vision for his company, and that vision is frequently manipulated by managing and prioritizing the use of financial resources. Given a set amount of finances, your financial objectives and anticipations will shape how you spend your business funds. For example, your immediate goal may be to increase sales by financing discounts, or you may have a long-term goal of expanding your manufacturing capacity for lower average costs. If you draw most of your finances from loans, repaying the principal amount and interest should concern you. If you obtain financing from your investors’ money, giving them the best possible returns must be a key objective.