Business finance is an overview of information that allows a business owner to plan for the organisation’s success, ensuring the logistics surrounding cash flow cover short-term, medium-term and long-term goals. Through an analysis of your finances, you can draw up an illustration of your logistical capabilities and gain an understanding of your avenues forward.
But what does it entail? In this article, we outline the importance of business finance, covering the initial business financing through the techniques to manage cash flow and ensure you’re avoiding bottlenecks.
What is finance in business?
Now that we’ve explored what financing your business looks like initially, what does finance mean in day-to-day business?
At its most basic, business finance is the money available for your business through tallying how much money you have, owe, are expected to receive and have allocated to expenditure. It ranges from money you have in your business to your account and fixed assets owned under its name.
Having dedicated staff to detailing and tallying your financial data is key to making healthy financial decisions and all small businesses that grow to medium-sized businesses for efficiency’s sake.
Aside from grants, loans and other third-party cash flow, your business finances will mainly be made up of the revenue and sales that your business brings in. Profit and loss statements will be an all-in-one document that helps get an idea of how much you can rely on this source of income.
How do you finance a business?
Two main genres of business financing exist:
- Debt financing – This involves borrowing money that must be repaid over time. It almost always comes in the form of both a principal and an interest. Borrowers do not give over any share of ownership as a result. In higher-risk borrowing, lenders may push higher interest rates and require collateral.
- Equity financing – This involves raising capital by selling ownership shares to investors, effectively allowing them to buy their way into a powerful position in the company. There’s no requirement to repay the debt, as their profit comes from the company’s success.
What are the business financing options?
There is no such thing as a business with zero operating costs. Every business requires money to fund activities, staff, venues and more. As a result, prospective business owners need to know their business funding options before committing. The following are the typical choices:
- Personal finance – Your business funds come from your bank account.
- Business startup loans – Plenty of banks and other financial institutions offer start-up loans for small business owners.
- Credit – By allocating start-up costs to credit, you can pay it back through your immediate revenue.
- Crowd-funding – In cases of a service or product that you’re sure there’s a market for, crowdfunding the startup can be a good idea, but you have to realise that you’ll be expected to deliver.
- Angel investors – Investments of these kinds come from people passionate about social enterprises, or looking to push a change (such as via green energy).
- Venture capitalists – If your business idea and personal capabilities seem solid, you may attract the attention of venture capital, who are professional investors who seek great potential in the financial markets.
The key to a successful business is knowing your business finances via managerial finance. This involves filling key roles that revolve around monitoring cash flow, avoiding loopholes by addressing them before they happen and ensuring all debt obligations are taken care of.
All financing options can then be split further into short-term, medium-term, and long-term finance options.
Short-Term Finance
Finance is offered over a short period, 12 months or less. Typically, they are designed to help business owners raise finances quickly for immediate business activities, sporting low interest rates due to the short nature of the loan.
You are restricted in the amount you can borrow, most often meaning it may not be useful for medium-sized businesses:
Types of short-term finance include:
- Invoice factoring
- Trade credit
- Credit cards
- Business overdrafts
Medium-Term Finance
Finance in the medium-term medium terms periods between three and five years. There’s usually a larger sum of money involved compared to short-term financing options, but also carries more risk for the lender. This means you’ll likely be dealing with higher interest.
Medium interest rates include:
- Start-up loans
- Preferred shares
- Lease finances
- Business loans
Long-Term Finance
Long-term finance options are all about helping a business grow or expand over a much longer period, usually over a decade or more, and it’s considered to be the riskiest business finance option for lenders. It does, however, allow you to raise the most capital.
Long-term finance could be:
- Commercial mortgages
- Equity capital
- Retained profits
- Shares
Five key functions of business finance
Let’s explore five reasons why finance is one of the most important aspects of running a business for business owners. Effective business planning is crucial for managing finances, ensuring businesses can cover expenses without financial strain, securing funding, and maintaining relationships with financial institutions.
1. Generate Profit
Starting a new business means you’ll likely need to borrow money to invest in your business idea and get the business off the ground. But that borrowed money will need to be paid back in time, so you should never even think of borrowing money unless you’ve got operations set up to go right away. Bear in mind that as a sole trader, you will be entirely responsible for the sum of the borrowed money.
Everyday business operations require money. Expenses on materials and supplies used in your day-to-day operations, for one, as well as marketing.
Where a business owner fails to track their finance successfully, they can find themselves generating a loss, or encountering periods where activities are bottlenecked as a result of poor cash flow.
2. Fund Business Operations
We already touched on it above, but the amount of turnover involved in simply running a business can be astronomical. If you’re to continue operating your business as normal, then you need to track your business finances to ensure you can afford your usual business activities, bills, and employee salaries.
Business owners who fail to keep their finances under careful management may find that their business operation expenditure outweighs their income and thus be unable to allocate their funds appropriately to ensure smooth operation. Where this happens, the business will likely cease trading, meaning any business loans that are pending will need to be paid another way.
3. Facilitate Business Expansion
The best way to ensure a business’s long-term success is to constantly be prepared to grow and expand. Having dedicated staff look for investment opportunities means that, over time, your growth and expansion will generate a return that you can further invest without any thought of having to repay it.
Business expansion can be any of the following:
- Offering a new service
- Developing a new product
- Expanding into new markets
- Upgrading your business premises
- Hiring new talent
Of course, growth can be a risky time for business owners if they can’t properly fund it. With poor financial management, a business will be unable to grow effectively and may find themselves growing too quickly and having to scale back and make cuts in future growth and ruining business reputation.
4. Combat Adverse Economic Situations
If you’ve owned your own business in the UK at any point over the last few years, then you’ll know how tumultuous it has been, even discounting the COVID-19 quarantine, which spelled the end for many businesses nationwide. Recessions, depressions, cost of living crises and even unexpected health crises can all impact a business – and this teaches us a lesson. Plan your business finances so that you can weather the storm.
A business can only effectively prepare for an economic downturn ifity knowsitsr business performance across a variety of different economic landscapes. Get this right and you’ll have contingency plans in place for when things go wrong. Careful financial management is the key to success.
5. Achieving Long-Term Business Goals
Long-term goals allow you to foster a sense of purpose for your business, giving your entire team something clear to aim for to ensure a united front. Achieving those goals will only further improve employee morale and business reputation whilst increasing your business’ reach.
You cannot, however, achieve these goals if you don’t properly finance the route there. You might need funds for marketing, product development and market research, but you won’t be able to fund that unless you have a tight grip on business finance.
That being said, this is mainly a problem for large and medium-sized businesses to consider.
How to report on financial health and reports?
So, now you know the importance of finance in business, but knowing your numbers is one thing; reporting on them accurately and saving those financial reports for later use requires a systematic approach to revenue and expenditure.
Keep accurate records of your finances and you’ll be able to create reports for shareholders to keep them abreast of your finances and reassure them of their investment decisions. Without them, shareholders have only your word to go on, and that’s simply not enough for many. It’ll also help with government tax returns, especially in the case of considering switching to a limited company. A well-prepared balance sheet should be included in these reports to showcase your company’s financial position and growth potential.
Conclusion
Hopefully, our guide today has shown you just how essential finance is in business but also that proper financial management is the only way you can make your business a success. The financial industry holds many experienced expert that can be an asset to your team, and you’ll see the immediate benefits of their presence when they’re able to show you your own finances in a comprehensive, digestible fashion.
FAQ – What is the role of the finance department in business?
Your finance department is the backbone of business growth. Whether you’re a large business with a separate department for managing your business finance, or you’re one of the many small business owners taking on that role yourself, you need somebody who constantly focuses on the money coming in and going out. This allows you to meet your business goals effectively and ensures you remain profitable.
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 acbusinessQ – What is corporate finance?
Corporate finance focuses on the overall strategies and decisions made using the finances of the company to create more money, usually in the context of investments. They are typically long-term avenues of building finance.
Investment decisions use the following:
- Net Present Value (NPV): Evaluates profitability by discounting future cash flows.
- Internal Rate of Return (IRR): Measures the expected rate of return on an investment.
- Payback Period: Time required to recover the initial investment cost.
Corporate financing also entails managing dividends and dealing with equity investments.
FAQ – What is the role of the London Stock Exchange in UK Businesses?
The London Stock Exchange plays several critical roles in UK businesses:
- Raise capital – This allows companies to raise funds by issuing shares or corporate bonds to investors, supporting expansion, R&D, debt finance or acquisitions.
- Valuation benchmark – Listed companies gain public valuation, helping to attract investors, partners or buyers.
- Liquidity for investors – Investors can easily buy and sell shares to make the market more attractive and increase participation.
- Credibility and visibility – Being listed boosts a company’s reputation, improving customer, supplier and lender confidence.
- Corporate governance – Listing on the LSE requires complying with strict governance, improving transparency and financial discipline.
- Exit strategy – It provides both founders and early investors with an exit route via public share sales.
- Price discovery – The exchange will offer real-time pricing based on supply and demand.
For reference, the New York Stock Exchange broadly serves the same function.
FAQ – How is personal finance relevant to business trading?
Personal finance is relevant to business trading in the following ways:
- Creditworthiness – Personal finance behaviours and credit affect access to loans, credit and asset-based lending for start-ups and medium-sized businesses without a strong track record.
- Capital sourcing – Personal investment or equity from friends and family typically provide an initial capital before attracting potential investors or banks.
- Behavioral finance discipline – Skills in managing personal finance (budgeting, saving and assessing financial products) activities translates into better business finance activities.
- Risk perception – Understanding behavioural finance in personal finance decisions helps avoid emotional choices when dealing with high-stress situation, such as equity investments, bonds or the stock market.
- Documentational habits – Good maintenance of personal financial records will help instil discipline when managing a business’ financial information. This is vital from invoice finance, invoice discounting and public finance reporting.
- Growth potential – Being familiar with personal assets, debt and interest will support smarter decision when it comes time business hire purchase, lending and working capital cycles.
- Exit strategies – Knowing how personal investments are managed can help owners to navigate financial instruments, or listing on a stock market as established businesses (or established companies).
FAQ – What does the world history encyclopedia say about public finance?
Invoice discounting is a short time finance method where a business borrows against the value of unpaid invoices. The lenders advances a percentage, typically 80-90%, of the total invoice, and the business retains control over its sales ledger and collects payments as usual.
- Improving cash flow – This kind of invoice finance allows you to convert into immediate funds for day-to-day operations.
- Bridging payment gaps – This is useful for medium-sized businesses and established businesses with long customer payment terms.
- Avoiding extra debt – Unlike loans, it is not based on fixed repayments or additional interest beyond the agreed fee.
- Growth potential – Having quick access to capital allows you to take advantage of time-sensitive opportunities.
