Finance is the lifeblood of any business. For the smooth
functioning of a business enterprise, finance is required. Finance is the provision of money at any time the business requires it. The purpose
of financial planning is to ensure that adequate funds are available to the
business firm for its proper utilization and administration.
There are three main aspects of financial
planning:
- Estimating the amount of capital to be raised for the smooth running of the business.
- Determining the form and the proportionate amount of securities to be raised.
- Laying down effective policies for the proper administration of financial plans.
The financial policies should cover the following
points:
- The total finance required for the business.
- The proper utilization of funds.
- Controlling and handling the activities of financial collection and repayment.
- The determination of profit and its proper utilization.
- A decision regarding the terms and conditions for the funds to be collected.
- The ways and means are necessary for achieving the targets of financial planning.
The success of an organization mainly depends on sound
financial policies which should have the following essential
characteristics:
- It should be flexible.
- It should be economical.
- It should provide sufficient cash in hand.
- It should provide for maximum utilization of funds raised in the business.
- It should not fail under any circumstances.
Types of Finance
The financial requirements of a business are mainly of two types; i.e. Fixed Capital and Working Capital.
Fixed Capital
The fixed capital of the business is invested in permanent assets, such as; land and building, plant and machinery, furniture, fixtures, etc. These assets are required in a business to carry on its activities. A business may meet its fixed capital requirement from several sources, such as;
- Issue of shares
- Issue of debentures
- Ploughing back its profits
- Public deposits
- A loan from specialized institutions
- Term loan from a bank
Working Capital
The working capital is required by a business for the purchase of raw materials and for meeting day-to-day expenses such as; wages, salaries, rend, taxes, interest, etc. The working capital is also known as the revolving or circulating capital because it is invested, recovered and reinvested repeatedly during the lifetime of the business.
The working capital is of two types:
Permanent or fixed working capital:
It is always necessary for a business to maintain a certain minimum level of
stock of raw materials and finished goods and to pay regular expenses, such as;
wages, salaries, rent, interest, etc. Permanent working capital is also needed
immediately after the establishment of a new business.
Variable working capital:
The amount of variable working capital requirement depends on the particular
purpose for which it is needed for the business, further working capital is
required to meet the demands of the business.
The working capital is raised from the following
sources:
- Issue of shares.
- Issue of debentures.
- Ploughing back its profits.
- Public deposits.
- Commercial banks.
- Specialized financial institutions.
Sources of Finance
There are two methods of raising capital for any business enterprise:
Owned capital:
It is contributed by the owner, i.e. sole proprietor, partners, shareholders,
etc. It remains invested in the business so long as the business continues to
exist. The return of such capital is dependent on the availability of surplus
capital to the distributed.
Loan capital:
It may be raised from individual banks or financial institutions. It involves periodical
payments of interest at a fixed rate and repayment of loan capital after the
expiry of the stipulated period. The loan capital is available only against the
mortgage or the pledge of the property of the borrower.
The source of finance can be classified into three parts based on the duration for which it is required by the business. These are:
- Long-term finance: It remains invested in the business for a considerably long period, i.e. ten years or more. Long-term finance is often invested in fixed assets, such as; land, building, plant, machinery, etc. It may be raised through shares, debentures, ploughing back of profit, and financial institutions.
- Medium-term finance:
It remains invested in the business for a period between 3 to 10 years. The medium-term finance is generally used to implement expansion, extension or
modernization programmes of a business. It may be raised through preference shares,
debentures, and bank-term loans.
- Short-term finance:
It is raised for less than two years. Short-term finance is used to meet
seasonal or current expenditures such as; purchases of raw materials, payment
of wages and other recurring expenditures. It may be raised through trade
credits, bank credits, instalment credits and customer advances.