The term Business Finance refers to the amount of money invested in a business. Finance is essential for every business and it is needed to purchase assets, raw materials, to keep the business and to handle all the financial activities related to the business.
In simple words, Business Finance can be defined as “The facility to avail money whenever it is needed in a business”.
Financial Needs Of A Business
To start a business the primary requirement is to have some capital (money for investment). Capital is very essential for not only to start a business but to run it in a flow. When the company grows and expands more finance is required at each step.
The requirement of capital for a business is categorized into two main classes:
- Fixed capital
- Working capital
Fixed Capital
Every business requires an adequate amount of money i.e. the capital to get started. Fixed capital refers to the permanent assets which may include land, building, machinery or equipment, etc. and which is necessary to conduct the operation of a business.
Normally, fixed assets can neither be easily withdrawn from a business on a short notice nor change their form. However, they can be discarded when required. Thus, fixed capitals are the reserves required to purchase assets that are to be used over and over again for a long time in business.
The investment in intangible assets like goodwill, rights, copyrights and the long-term receivables is also a part of fixed assets. The amount of fixed capital may vary and depends upon the size and nature of the industry.
The requirement of fixed capital increases with the size of industry such as; railways, oil refineries, hydro and thermal power projects, etc. require more fixed capital. Therefore, we can say that fixed capital includes fixed and intangible assets.
Importance of Fixed Capital
Fixed capital is very important in order to make a business start its operation. Fixed capital is involved from the very first step towards establishing a business i.e. perceiving the idea of business, purchase of land, construction on the land, purchasing equipment etc.
All of them are not possible without having an ample amount of fixed capital. Moreover, in order to expand the business and equipment, fixed capital is required. Therefore, it is very important to have a sufficient amount of fixed capital for an enterprise.
Working Capital
Working capital is the difference between the current assets (accounts receivable) and current liabilities (account payable) of the company. All the current assets and current liabilities are checked through the balance sheet.
The current assets refer to the assets which can be changed into cash in a short period of time in the business such as cash in hand, bank balances, bills receivables, short term investments and records of shares.
On the other hand, current liabilities as its name shows are the amount to be paid within a short period of time in an accounting year. It includes short term loans, bill payable, payable taxes and payable dividends, etc. Working capital is also referred to as circulating capital which acts as blood and nerve of a business.
The main purpose of working capital is to purchase raw material, payments of wages, seasonal demands of business, to purchase more goods to sell, to come across the advertising expenses, and to provide credit facilities to the customers, etc.
Example
- Current assets – Current liabilities= Working Capital
$7 Million – 5 Million = 2 Million
The difference between the current assets and current liabilities is positive. The difference in the positive figures indicates that the industry has a construction working capital.
- Current assets – Current liabilities= Working Capital
$5 Million – $6 Million = – $1 Million
In case the difference is negative, it indicates that the business has a negative or a scarce working capital.
Importance of Working Capital
The importance of Working Capital is explained below:
- Solvency of Business
It provides privileged circumstances to the business and helps the entrepreneur to continue the production without any interruption.
- Good Will
It allows the business person to pay workers’ wages and other utility bills in time. It also helps the business to maintain its goodwill.
- Loans on favorable terms
The high affluence and more goodwill of a business can help it get loans from the bank easily.
- Cash Discounts
A sufficient amount of working capital helps a business to acquire cash discounts on their purchases. It also reduces the cost.
- Enables to face crisis
A business with an ample amount of working capital can face financial crises and can sustain for a longer time.
- Regular payment of dividend
An adequate working capital allows an enterprise to make more profit and pay dividends to the investors in time to maintain the goodwill of the business.
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Hello everyone! This is Richard Daniels, a full-time passionate researcher & blogger. He holds a Ph.D. degree in Economics. He loves to write about economics, e-commerce, and business-related topics for students to assist them in their studies. That's the sole purpose of Business Study Notes.
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