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Why Is Finance Important In Business – What You Need To Know

Why is finance important

Business finance is important because it lets business owners plan appropriately for their business’ future success. Through good financial management you can allocate resources, know when and where to spend, and understand the best saving strategies to ensure short, medium, and long term success. To stay ahead in business, you need to be prepared for unexpected events – and this can only be done through thorough financial analysis to ensure your company’s financial future.

Below we’ll look at the importance of business finance from initial business financing (typically through debt financing – where you borrow to get your business off the ground and then repay back that debt over time) to using financial management accounting tools for strategic planning and improving your business’s financial performance.

The Importance Of Financing Your Business

No matter if your business offers services or products to its customers, every business needs money to operate, so proper business financing is key – both in starting out, and continuing to grow your business. There are a few options open to you here:

  • self funding
  • business startup loans and grants
  • credit
  • crowd funding
  • angel investors
  • venture capitalists

 

After kickstarting your business, most owners choose to then self fund their remaining business endeavours using the profit they make from the sales of the products and/or services they offer, but some may still turn to financial institutions such as banks and building societies to support their business from time to time, where cash flow is a little stilted, but likely to pick up again soon.

Managing your finances is one of your key tasks as a business owner, so ensure you’re familiar with the financial markets and you understand all of your financial obligations to improve your chance of a successful business.

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?

Essentially your business finance is simply the money you have available for your business. Business finances are at the heart of every business and you’ll need to review them regularly to ensure proper financial forecasting. When you start a new business, expand your products or services, or invest in fixed assets for your business, finance will be the driving force and you’ll need to consult them regularly.

Regular financial reports will help you make better financial decisions day to day, and will help with risk management, too.

Most of your business finances will come from revenue and sales, so understanding your profit and loss statement is key here, but you may turn to outside sources for business finance where necessary, as discussed above.

How To Finance A Business

There are a number of financing options open to you if you require some support with your business finance – but all of them are split into two key categories: debt financing and equity financing.

Debt financing:This involves borrowing money from a financial institution via a loan or mortgage. You then pay back that money over time, alongside interest rates incurred as a result of that borrowing.
Equity financing:This involves selling shares in your business to investors interested in owning a portion of your business to receive dividends based on your profits.

All financing options can then be split further into short, medium, and long term finance options.

Short-Term Finance

Here finance is offered over a short period of time, usually less than 12 months. It’s designed to help business owners raise capital for their business quickly and with lower interest rates because of the short term nature of the loan. You are, however, typically restricted by the amount you can borrow, usually being restricted to smaller amounts of money, which may not be useful to all owners.

Types of short-term finance include:

  • Invoice factoring
  • Trade credit
  • Credit cards
  • Business overdrafts

 

Medium-Term Finance

Finance in the medium-term usually covers periods between three and five years. There’s usually a higher degree of money involved compared to short-term financing options, and usually carry more risk as a result on behalf of the lender. With that said, they’re much less risky than longer term finance options for lenders so you should still get competitive lending terms.

Medium-term finance could be:

  • 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

 

Managing Your Business Finances

Managing your business finances

The key to a successful business is knowing your business finance inside and out. And no, you don’t need a business finance degree to do it. You just need to know exactly how much money it takes each month to keep your business up and running optimally, and exactly how much money you make to ensure the business is profitable.

The best way to ensure business growth is by financing your business goals, and that involves effective and sensible financial management. Financial management accounting can help here, as it forces you to track what comes in and what goes out, so it keeps business finance at the front of your (or your accountant’s) mind.

Be sure to track cash flow, focussing on your business transactions each day, and monitor your finances carefully to support any decisions you have to make with regards to how to invest in your business successfully. Investing capital into your business is wise, but you may also think about investing your profits elsewhere, too, helping your business grow as you acquire new premises or undertake a new part of your business.

Managing business finance involves determining what money ought to be spent and where; and what money ought to be saved and how. This will give you both a snapshot look and a long term overview of the financial status of your business, so you can see patterns and work towards continuous business success.

The Importance Of Finance In Business

Let’s explore five reasons why finance is one of the most important aspects of running a business for business owners:

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 after you’ve raised the relevant capital, it’s time to start thinking about how you’ll generate profit – and fast.

Everyday business operations require money. Things like hiring employees, material costs and marketing all add up, and the only way to make a profit is to ensure that what comes into your business (money made through the sales of your goods and services) is higher than what goes out.

You can only generate profit by having a close eye on your business finances and amending your plan accordingly.

Where a business owner fails to track their finance successfully, they can find themselves generating a loss and before long their business can find itself in difficulty.

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 finance 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.

3. Facilitate Business Expansion

The best way to ensure a business’ long term success is to constantly be prepared to grow and expand. Growth and expansion can look very different depending on your business goals but could look like:

  • 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 the near future, stunting future growth and ruining business reputation.

Where businesses fail to grow, they inevitably fall behind their competitors and that can be a very hard place to recover from.

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. The economic climate has been bleak and there’s never any guarantee that things won’t turn bad economically even when things are going good. Recessions and depressions, cost of living crises and even unexpected health crises can all impact a business. Those that weather the storms, though, are those who monitor their business finance effectively and plan for rainier days ahead.

A business can only effectively prepare for an economic downturn if they know their business performance across a variety of different economic landscapes. The best way to monitor business performance is through monitoring business finance. 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 at 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.

Investment decisions in your business’ future rely on smart financial management and financial stability, and you won’t be able to achieve your long term business goals without them.

Reporting On Financial Health

Reporting on financial health

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 reference in the future is key.

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 – and it’ll also help with government tax returns.

Keeping accurate reports means you can track your business performance and make smarter management decisions accordingly, helping make informed decisions about business strategy. This can be done internally, with a financial department, or externally with the help of a business accountant.

Tracking finance through accurate and regular reports is both a legal requirement when reporting on tax, but it’s also necessary for effective strategic planning and business management.

Related Questions

What is the role of the finance department in business?

Your finance department is the back bone of your business. 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.

What does the finance department actually do?

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 account.

Effective Financial Management Is The Key To Success

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.

Keeping firm hold of the reigns for your finances is the key to successfully spending and earning as a business to ensure profits are made and objectives are met.

Effective financial planning has the potential to enhance the value of a business, whilst also increasing a business’ profits. Ensuring that your business has a strong and efficient financial team in place, along with effective and open communication channels with senior management, will be the key to the success of any business – small or large.

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