Finance Function: Meaning, Types, Needs & Importance
Finance is the blood of business. It’s growing faster. We do the planning, organising, staffing, directing and controlling. Without proper knowledge of finance functions, no business can run.
Without financing, no business exists and can’t do other business functions. Finance is used in various ways to purchase equipment, raw materials, property leasing, employee salary, marketing etc.
The financing can come from external sources like investors and lenders, or it may also come from revenue generated by the company. Finance is used to maintain daily operations and fund the projects that help in increasing market share.
Types of Finance Functions
There are different types of Finance which are discussed below:-
Investment Decisions: The investment function includes capital budgeting. Capital budgeting involves the analysis of investment opportunities in long-term projects and cash flows to determine profits.
Investment decisions are used to put the company funds. Investment decisions create revenue and profits and save costs.
Some are the popular methods to carry out capital budgeting:-
- Payback Period
- Net Present Value
- Internal Rate of Return
- Profitability Index
Financing Decisions:- Financial decisions include equity and debt mix in the capital structure. In financing decisions, we can discuss the financial conditions of the business. Where and when we invest the capital and how much we invest, we decide all this in financing decisions.
The main goal of discussing the capital aspects is to maintain a good “capital ratio” of the business so that any business can grow successfully.
Dividend Decisions:- Companies share profits with shareholders through dividends. There is not a single dividend policy for every organisation. Every company has different dividend policies.
There are different types of dividend decisions, which are discussed below:-
- Stable Dividends: The same dividend amount is paid off every year.
- Constant Dividends: A fixed percentage of profit is paid in continuous dividends.
- Alternate Dividends: Alternative dividends can be issued in cash and non-cash options.
There are a lot of factors which affect the dividend decisions as follows:-
- Cash Requirement
- Evaluation of Price Sensitivity
- Stage of Growth
Liquidity Decisions: Liquidity decisions are concerned with capital assets. If companies have good operating capital, then they can succeed. Liquidity decisions are also known as working capital decisions.
The main objective of liquidity decisions is to balance profitability and liquidity. Liquidity decisions should balance working capital management and the effective allocation of funds. Suppose a company doesn’t have enough working capital. A company lacks efficient investment decisions if it has more working capital.
The essential elements of liquidity decisions are the formulation of inventory policy, cash management strategies, and guidelines on utilising funds and receivables management.
The Finance Function has been classified into 3 categories
- Long-term Finance Function: It includes finance investment for 3 years or more. Long-term finance sources include share capital, long-term loans, debentures etc.
- Medium-term Finance Function: It includes financing between 1 to 3 years. Medium-term finance sources include bank loans and financial institutions.
- Short-term Finance Function: It needs finance for less than one year. Short-term finance sources include advances from customers, commercial papers etc.
Why is Finance a Necessary Factor For The Business?
There are various needs of Finance as follows:-
- Helps Establish a Business
- Helps Run a Business
- To Expand, Modernize, Diversify
- Purchase Assets
1) Helps Establish a Business: Without money, we can’t establish a business. To establish a business, we need finance.
2) Helps Run a Business: To run a business, we must have day-to-day operating costs such as paying a salary, buying raw materials, etc. The finance function helps to manage the funds to do all these operations.
3) To Expand, Modernize, Diversify: Without raising a company, it’s useless to start a business, or it may be of waste of time. With the help of the finance function, we can expand, modernise, and diversify the business.
4) Purchase Assets: You need money to purchase assets like furniture, buildings, trademarks, patents etc.
Importance of Finance Functions
- Identify Need for Finance
- Identify Sources of Finance
- Comparison of Various Sources of Finance
1) Identify Need for Finance: To start a business, you need to know how much finance you need to start and how much finance you put in reserve; to do all these things, you need finance functions.
2) Identify Sources of Finance: Once you know that we need finance and how much, then with the help of the finance functions, you can find out or identify the sources where we can get the finance.
3) Comparison of Various Sources of Finance: After identifying the various sources of finance, you need to compare all these sources and then find the best one with the help of finance functions.
4) Investment: Once the funds are raised, it’s time to invest in a business. We invest in industries where we get higher returns on profits.
In the above, we have discussed financial functions. Finance ensures funds at a reasonable cost, the safety of funds, and effective utilisation. Without financing, we can’t do anything to run a business, purchase assets, or extend the company.
Finance functions as a supporting function of our business. Finance provides a proper debt-equity ratio. Various types of policies are used in finance. There is no single policy for every business; different policies can vary. Finance decides policies to control risk and raise funds.
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