Finance in business is important because it allows us to plan for the future by enabling informed decisions to be made about how to allocate resources, where to spend, and where to save to reach the short, medium and long term goals of the business. The importance of finance management helps businesses to operate efficiently prepare for unexpected events so they can stay on track and continue to grow and thrive.
Read on to understand the importance of business finance, as well as some of the types of business finance available to both small and large businesses.
Table of Contents
The importance of financing your business
It is not a secret that every business needs money to operate. Whether you are running a service-based or a product-based business, you’ll need capital if you want to make a profit. You may choose to self-fund your business, or you may need to turn to external funding methods to finance your business such as grants, loans and credit. However you choose to finance your business, there’s no denying that finance is critical to the success of a business.
What is finance in business?
Business finance is the money that is available to a business. Whether you are starting a new business, expanding an existing business or developing new products, finance will be at the core of every business function.
It isn’t just changes within your business that will require finance, either. Even just the day to day running of a business requires a constant stream of finance, from the cost of marketing to the cost of employing staff.
This finance will often be generated through revenue, but at the start of a new business, or if you run into difficulties, you may need to look into other options to finance your business and keep it running.
How to finance a business
If you need additional finance for your business, you may be looking into finance options. There are two main options for financing a business: debt and equity.
- Debt involves borrowing money from another institution, such as a loan or mortgage. This money is then paid back over time, along with interest incurred.
- Equity involves selling shares of your business to investors. The shareholders will then own portions of your business according to the size of their share and may receive dividends according to your profits.
Short-term finance is a type of finance which covers a short time period, which is usually less than 12 months. This type of finance allows businesses to raise money quickly and attracts a low interest rate. However, the amount of money that can be raised is small and can directly impact the business.
Types of short-term finance include:
- Invoice factoring
- Trade credit
- Credit cards
- Business overdrafts
Medium-term finance involves finance methods which typically cover a period of between three and five years. These types of finance involve more risk than short-term financing methods, but less risk than long-term methods.
Types of medium-term finance include:
- Start up loans
- Preferred shares
- Lease finances
- Business loans
Long-term finance is designed to help a business to grow and expand over time. This type of funding typically has a period of over ten years and is the riskiest type of business finance. However, it is also the type of finance that will allow a business to raise the most capital.
Types of long-term finance include:
- Commercial mortgages
- Equity capital
- Retained profits
Managing your business finances
Businesses need money to survive. They must invest a vast amount of money every month to keep the business running and functioning at optimum capacity. However, this money must be carefully managed to ensure that it is being spent or invested in the right way.
Although some may say that money is the fuel of any business, it is also important to remember that the management of that money is critical. The only way to successfully grow a business is to properly manage its money, to allow the business to reap the benefits of its finance.
With daily cash flow and continuous business transactions, carefully monitoring and managing business finance is essential. It is also a pivotal aspect of decision making at many levels of the business. This can include investment decisions, such as the acquisition of new businesses. It’s also critical that a business knows when money is tight, so that unnecessary spending can be carefully controlled.
Financial management helps a business to determine what money to spend, where to spend it and when it should be spent. It also gives an overall view of the financial status of the business, helping to determine business strategy and direction as well as contributing to the objectives of the organisation.
The importance of finance in business
We have discussed the importance of the careful management of a business’ finances. But why is finance so important in business” Here are five reasons why it’s important for a business to have adequate finances.
1. Generate profit
It is often said that “you need money to make money”, and this is true in any business. When you’re starting a new business, you’ll need capital investment to launch your business effectively. However, it is not just at the start of your business that finance is required.
Even the most established businesses will rely on finance. Purchasing materials, hiring employees, marketing your business, and developing new products all rely on having adequate funds for investment and will need careful financial management.
If the business does not have sufficient funds, it will struggle to operate and in turn be unable to generate a profit.
2. Enable operations
Businesses generate large amounts of turnover every single day, which must be used to pay the bills, invest in business activities, and pay their employees. Without finance, the business will be able to do those things, leaving the business unable to operate.
If a business does not carefully manage its income and expenditure, as well as monitoring funds, it will become difficult to allocate funds effectively, rendering the business unable to trade.
3. Facilitate business expansion
For a business to be successful, it must continuously grow and expand. This includes the development of new products and expansion into new markets. However, this growth and expansion requires capital to purchase new materials and fund marketing activities.
Without an effective financial structure in place, a business will be unable to grow, leaving the business confined to offering the same products and services to the same markets. Businesses which are unable to expand are at risk of being left behind by competitors and eventually failing.
4. Sustain through adverse economic conditions
The economic climate of the world can be a rollercoaster for any business. This includes unexpected recessions and depressions, which every business should be prepared for. In addition to this, the progress of any organisation is never linear. There are always ups and downs in business, as some products succeed, and others may fail.
Preparing for challenging situations and potential economic downturn is the best way to set your business up for success. To do this, you will need to ensure that your business has sufficient finance available to see it through challenging times. This will also require careful financial management, to ensure that your business has the right contingency plans in place no matter what happens.
5. Attaining long term goals
It is essential to have long term goals in any business, providing collaborative targets for all departments to work towards as a united front. Achieving these objectives can help the business to grow, whilst increasing customer satisfaction and loyalty.
However, a business will struggle to achieve its targets without the adequate financial support to do so. For example, the business may require extra funds for product development, marketing or growth.
Investing money into achieving business objectives will allow the organisation to achieve its goals and to improve future financial stability through long term growth.
Reporting on financial health
Every business is responsible for keeping accurate records of its finances, as well as providing reports. This includes shareholder reports which detail the return and security of investments, along with tax returns for the government.
Financial departments will also be expected to produce regular reports which detail the performance of the business, which can be fed into management decisions about the direction and strategy of the business. These reports will contain key performance indicators which monitor the performance of each area of the business.
The finance department is central in providing the necessary reports, which are both legally required and essential to the effective operation of the business. That is why the finance team is at the centre of any business, providing the necessary core to all business operations.
What is the role of the finance department in business?
Finance is the part of the business which is responsible for managing money within the organisation. This includes acquiring funds, managing the finances of the business, and planning future expenditure. The finance of the business must be carefully managed to ensure that the business is able to meet its goals and objectives, whilst remaining profitable and operating effectively.
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
It is clear to see that finance is essential for any business but the way in which those finances are managed will ultimately determines the success or failure of the business.
The finance department will need to carefully control the allocation and spending of funds, as well as the reporting of financial data to ensure that objectives can be met and profits made, whilst ensuring the effective operation of the business.
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 the organisation.