How Finance Works In Business?

Finance refers to the study, management, creation, and application of money. Finance impacts every part of a business operation and every operation has an impact on finance. Most decisions made in business are supported by financial data and inputs. In other words, finance is a broad term that encompasses the management, creation, and study of money, banking, credit, investments, funding, assets, and liabilities that constitute a financial system.

Key Takeaways

• Finance is related to banking, funding, leverage or debt, credit, capital markets, money, investments, and even accounting, taxation, and compliance. 
• Microeconomics and Macroeconomics have contributed to the development of basic concepts of finance 
• The finance domain can be categorised into three broad branches; personal finance, corporate/business finance, and public finance

Finance, from planning and budgeting and cash flow management to the capital structure and risk management and mitigation, and cost management, is crucial for any business decision. While finance has branches like personal, corporate, and public, we will focus on corporate or business finance in this discussion. 

Planning and Budgeting

Strategic planning is about laying down the goals of the business and the direction and roadmap to achieve those goals. Budget, on the other hand, is only one part of strategic planning. Budgeting is the process of forecasting revenue, expenses, and expected profit of a business for a specified period, typically one or two years. The combined effect of planning and budgeting ask where you want your business to reach, determine the objectives and goals, and help figure out how much money will be required to get there. Any business decisions on hiring employees, operating expenses, capital expenditure, fundraising, marketing campaigns, go to market strategies, management compensation, etc, depending on the outlook derived from the plan and budget.

Fund Raising

The planning and budget tell you how much fund is required to manage business operations and strategic initiatives like investments. It will also inform you about the optimal capital structure so that you can turn to the methods of funding a company's requirements. One of the most valuable contributions of finance is to help you decide the best source of funding - equity or debt/leverage or the proportion of equity-debt mix.

Cash Flow Management

Cash flow management is the process of tracking, controlling, and managing the money that is coming into and going out of a business. This tool helps you understand how much money will be available to the business and how much money the business will need in the short-term and long-term future. 

The cash flow is different from the Profit and Loss statement - the former shows the cash received and spent whereas the latter shows the revenue and expenses despite whether they are received in cash or paid for. Cash flow management includes the management of the constituents of working capital; receivable, payable, inventory, and cash balance.  It also looks at the opportunities for investments and sources of funds to finance operations and investments.

Profit Planning and Controls

As Peter Drucker said, “profit is a condition of survival of the business.” No business can survive for long without making a profit. It is, therefore, highly important for businesses to plan and manage profit properly. An ideal profit planning process provides a roadmap for the future income statement of a business by taking into consideration its capabilities and resources, and the market conditions and potentials.

This process could also involve analysing and identifying the profitability of individual products and making decisions on loss-making products, pointing out ways to improve productivity in operations or finding economical sources of supplies. Constant review of financial statements to look at variations from budget and previous years and taking corrective measures are critical for the success of a business. 

Managing Risks

Risk is defined as the uncertain probability of an event and its consequences. Risk management is the process of identifying, assessing and controlling the risks to the capital, earnings, growth, and survival of a business. The business risk can emanate from various sources including financial uncertainties, statutory obligations, technology issues, strategic management mistakes, accidents, and natural disasters. Out of all these, financial uncertainties like the direction of interest rates, currency fluctuations, volatile commodity prices, and risks of not receiving payment of invoices from customers, are the most critical risks in business. 

Financial management perpetually analyses the risks of international markets, keeps track of the credit standing and financial health of customers, reviews the terms of loans from lenders and term sheets from investors, and provides an assessment of the risks in these areas. All of these keep changing and finance helps put the perils in perspective.

Concluding Thoughts

Maximising the business and shareholder value is arguably the main goal of finance, with long-term effects. Needless to reiterate that the role of finance in business is indispensable in this because businesses use financial data in every business decision-making. The need for forecasting the future business and operations and analysing the actual results can be overlooked only at the peril of your business.