Business Finance: What Is It and Why Is It Important?
What is the role of finance in business? What is the most common way that entrepreneurs finance the start-up of a new business? These are the questions most people ask when they want to build and grow a company of their own. After all, you can’t really get any business off the ground without investing money into it. But how big do these investments have to be and where can you get them from? Well, that’s what you’re here to find out.
What Is Business Finance?
The business skill that revolves around managing your company’s money — that is the simplest business finance definition out there. Of course, the very term “managing” can be a bit vague, especially to new business owners. In short, it covers everything from buying new equipment, handling taxes, selling assets, or borrowing money for future projects.
Several finance categories comprise business finance as a whole. They include:
- Borrowing money
- Lending money
- Saving money
Each of these categories relates to the flow of financial assets within your business. As such, you have to maintain a careful balance between all of them. A single misstep can lead to financial troubles that can last for years, even decades.
Types of Business Finance
Most versions of business funding fall under one of two categories.
The first is debt, i.e., you borrow money from an existing institution (e.g., a bank) and then return it with interest over time.
The second category is equity, wherein you sell shares of your business off to investors. More often than not, you will combine both categories in order to maintain a solid cash flow.
In terms of duration, business finance is divided into three types, those being short-term, medium-term, and long-term finance.
As its name implies, this type of finance covers a short period of time, usually no longer than a year. Some of the key methods of short-term finance include working capital loans, factoring, invoice discounting, trade credit, and business line of credit.
By far, the biggest benefit of short-term financing is that you can do it quickly, pay at a low interest rate, and deal with less paperwork than usual. However, the amount of money you get is small, and there’s a fixed period for the loan. Moreover, short-term finance can directly affect the business, up to and including its liquidity.
Medium-term finance covers a period between 3 to 5 years. While they are more conservative than long-term investments, they also involve more risk than short-term ones. Bonds, preferred shares, and lease finances are among the most popular methods of medium-term finance
Equity capital, preference capital, termed loans, debentures, and retained earnings all fall under long-term finance. The main goal of this model is to help a business grow and expand over the years. That is also why it’s the riskiest type of business financing. Typically, this model covers any type of funding with a period of over 10 years.
What Do You Need to Finance?
Fixed Capital Requirement
There are some assets that your business will always need, i.e., that are fixed. For example, no matter what kind of company you own, you will need land, buildings, plants, and machinery. That is called a fixed capital requirement and you will use long-term financing to acquire it.
Working Capital Requirement
Aside from fixed assets, your business will also have a working capital requirement. After all, you need to cover payment for day-to-day activities. These include paying wages, salaries, taxes, and rent. They can also include buying raw materials. To acquire these assets, you will use short-term financing.
Companies grow, and sometimes they can expand into other ventures. For example, a consumer electronics company like Sony might decide to go into the movie business. In order to grow your business, you will need to diversify its activities. Every single new activity is an investment, and you will need to finance it.
All modern businesses rely on cutting-edge technology. With that in mind, you must have a financing plan to keep up with the times. That will include covering the cost of software updates and brand new hardware.
The Importance of Business Finance
Most new entrepreneurs think that they don’t have to worry about proper business financing while their company grows and expands. However, that’s not the case. All of the biggest conglomerates on the planet take financial management seriously. In fact, they also have to take out loans and pay interest when investing in new projects.
There’s a very good reason behind the need for proper financial planning. For example, you can lose lots of money if you overpay for an asset. In addition, a wrong revenue forecast can cripple your business for decades. Therefore, it’s always important to think a few steps ahead. If you want to keep your business afloat, make sure to finance it in the safest, smartest way possible.
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