Business finance refers to money and credit employed in business. Finance is the basic of business. It is required to purchase assets, goods, raw materials and for the other flow of economic activities. Business finance can be defined as “The provision of money at the time when it is needed by a business”.
Financial Needs of Business
Every Business needs capital. Capital is required at the time of beginning of the business. It is also needed when the business is in operation. As an enterprise grows in size and expands, it’s needed finance to establish. The capital requirements for business are divided into two classes which are discussed as under:-
- Fixed Capital
Every business required a sufficient amount of fixed capital for beginning its operational activities. As the name indicated, the amount of capital invested in various fixed or permanent assets, which are necessary for conducting the operation of a business is known as fixed capital. These fixed assets might be land, building, machinery, equipment etc. The fixed assets normally do not change their form and cannot be withdrawn from the business at a short notice. They can, however be disposed off. Fixed capitals thus are the funds required for the purchase of those assets that are to be used over and over for a long period of time in business.
Investments in non-current assets such as goodwill, patent, rights, copyrights, long term receivables etc also from a part of fixed assets. The amount of capital required for investment in fixed assets varies with size, nature and method of production of business. Large scale industries, like railways, oil drilling operations, hydro and thermal electricity project etc required more fixed capital. Summing up fixed capital comprises of fixed assets and other non-current assets.
Importance of Fixed Capital
The importance of fixed capital can be judged from the fact that a business cannot be made operative without it. Right from the very beginning i.e. conceiving an idea of business, purchase of land, construction of building, purchase of machinery etc capital is needed. Further, for the expansion and modernization of machinery also fixed capital is required. So it is essential to have an adequate amount of fixed capital in an enterprise.
- Working Capital
In balance sheet terms, working capital is the difference between current assets and current liabilities of a business. Current assets refer to those assets, which is easily changed into cash within a short period of time in the business, in accounting year. It consists of cash in hand and bank balances, bills receivable, short term investments, and inventories of stocks. While on the other hand, current liabilities are those which are intended to be paid within a short period of one accounting year out of the current assets. It consists of bills payable, short term loans, bank overdraft, dividends payable, taxes payable etc.
Working capital also called circulating capital, which is the life blood and nerve center of a business. Working capital is mostly used for the purchased of raw material, payment of wages, seasonal urgent demands of the Business, purchase of more goods for sale, meeting the expenses of advertising, providing credit facilities to the customers etc.
Examples; Current assets – Current liabilities= Working Capital
$.5 Million – 3 Million = 2 Million
The difference between the current assets and current liabilities is surplus; the business has a positive working capital. In case the difference is negative, then the business has a negative or deficient working capital.
Importance of working capital
The importance of working capital is discus as under:-
- Solvency of business.
It helps in solvency of the business. The flow of production remains uninterrupted.
- Good will
The entrepreneur is able to pay wages to the workers and other bills in time. This helps in creating goodwill of business.
- Loans on favorable terms
A business with high solvency and greater goodwill can easily obtain loans from banks.
- Cash Discounts
A business with adequate working capital can obtain cash discounts on the purchases. This helps in reducing cost.
- Enables to face crisis
An adequate working capital enables an enterprise to face business crisis.
- Regular payment of dividend
A sufficient amount of working capital enables a business to earn profit and pay dividend to investors in time.