Finance and Business Finance
With the gradual progress of society & civilization and the development of
science and technology, the scope of trade and commerce has also increased.
Hence, the product market has to cope with diverse competition. To make a
profit in this competition, a businessman has to utilize his capital
efficiently through proper planning so that the cost of production or selling
could be kept minimum. Hence, a business firm can maximize its profit. For
that purpose, every business firm collects its necessary fund for investment
from the most desirable sources and invests them in the most suitable project
by analyzing various information about the product market.
This creates inflows and outflows of funds in the business. Finance regulates
these flows of funds nicely. Different principles of finance are used in this
process of regulation. Financial Management helps a businessman to earn enough
profit from investing even a small amount of capital. Nowadays finance is no
more used as a supporting system but as the main driving force of business.
Concept of Finance
Finance deals with fund management. Finance prepares plans and implements
necessary activities about what amount of funds should be collected from which
sources and where & how this fund is to be invested for the highest profit
in the project. In the case of a business firm, fund flows in the business
from the selling of products. Different types of funds are needed to produce
and buy goods for the business, like- purchasing machinery, purchasing raw
materials, paying wages to the laborers, etc. These are the utilization of
funds. Funds need to be collected in a planned way as per the requirement of
funds to maintain an uninterrupted production process. Finance means this
process is related to fund collection and utilization.
If you visit a tailoring shop in your locality, you will see there one or two
people sewing with a machine. Again, someone may be cutting clothes or
stitching the buttons. So to continue the tailoring business properly, the
shop owner has to purchase machines, threads, buttons, scissors, etc. of the
necessary amount. At the beginning of his business, he bears these expenses
from his own saving. If the fund appears insufficient, then he may take a loan
from his relatives to overcome the shortage. When the business is in
operation, at the end of every month he needs to bear expenses for the payment
of workers’ wages, house rent, electricity bill, etc. and he pays all these
with the money earned by sewing clothes. He also has to plan to pay back the
loan money from this monthly collection. An owner of a tailoring shop always
expects that he can earn some amount of profit even after meeting all
necessary expenditures from the income of the business, by which he can save
for the future or can utilize for business expansion even after meeting the
regular expenses of his family. So if an owner of a tailoring shop conducts
business through proper planning regarding the source of finance and its
utilization, only then he can earn profit through the smooth operation of the
business.
Otherwise, it will be found that due to cash crises sewing thread cannot be
bought timely and the customers are returning. Again, it may be needed to shut
down the business due to a lack of money to buy a new machine to replace the
old one. To conduct the business properly, Business finance deals with when
and for what reason how much amount of fund is needed, and from which sources
this fund should be collected for smooth operation of the business.
There have implications for finance in the family too. Generally, every family
has one or more than one source of finance. Income may be obtained from
different sources in different families, such as, from service, business,
agricultural activities, self-employment, etc.
Besides these, regular expenditure of a family occurs for daily shopping
costs, house rent, school fees, different bills payment, etc. As expenditure
should be matched with income, in this way, the right time of expenditure
should also be maintained. If money is insufficient as per demand, then as an
example, it may happen that name of the student may be cut down from the
register. In the case of a family, pre-planned identification of the sources
of finance and its utilization is the financial process. Other than daily
expenditure of this type, sometimes occasional expenditure may be required in
the family which may exceed the income ability of a person. If it is not
possible to collect money from regular income sources for such expenditures as
buying a new television or refrigerator, then the shortage may be fulfilled
through a long-term loan. In that case, a loan repayment plan needs to be
prepared. As a result, the concept of finance helps to determine the sources
of funds and make proper management of it to conduct the family smoothly.
The financial process can be understood from the perspective of a school also.
School is a social organization whose main objective is not profit earning,
there also has a plan of income- expenditure and fund management. Educational
institutions generally collect funds from sources of their student’s tuition
fees, examination fees, admission fees, etc. The institution has to meet
different expenditures with this fund to run the academic activities properly,
like- payment of teacher-staff salary, house rent, electricity bill, different
types of renovation expenses, and purchasing computers and furniture. So,
ensuring fund management for performing various working processes of the
institution nicely by considering different sources of funds and different
sectors of utilization is financing from the perspective of the school.
Among the above examples, a tailoring shop is a profit-making organization,
but family and school are non-profit organizations. Our present topic is
involved mainly in the financing of profit-making- or business organizations.
How is the financial process of a grocery shop? The shop owner earns a profit
by selling products. But for the purpose of selling, he needs to complete on a
regular basis purchasing products, paying rent, electricity bill, wages of the
workers, etc. as current expenditures. Moreover, sometimes he has to spend a
large amount of money for purposes like- expansion of business for the need of
the customers, purchasing a refrigerator, etc. These are his fixed
expenditure. Thus a grocer requires to invest both in fixed assets and current
assets. If income from selling is not sufficient for collecting funds for
investment, he has to collect funds from other sources like personal funds,
friends-relatives, purchases on credit, etc. Again, he may collect large
amounts of money which he needs to invest in fixed assets usually from
commercial banks. In such financing, as there is the opportunity of repaying
over a long schedule of time, the risk of loan repayment is reduced a bit. In
the case of a grocery shop, the main activities of business finance are fund
management through proper utilization of money received from sales proceeds in
meeting current expenditures, some long-term investments, collection of money
from less risky sources, timely repayment of loan installments, etc.
Square Pharmaceuticals, Bata Company, Kohinoor Chemicals – these are large
size business organizations that are called companies. The financial process
of such a company is not as simple as a grocery shop or tailoring shop rather
it is comparatively complex.
In fund collection, a large company gets more benefits than a small
organization. For example, a company collects capital by selling shares in the
share market. A company’s goodwill, rate of profit, customer services, or
consumer satisfaction helps to increase the share price in the share market.
Business finance deals with and provides guidance regarding: from among
different sources using which source, when and how much fund should be
collected and in which sectors, how much amount and how will it be invested to
increase the profit.
Classification of Finance
The financial process is as important for a business organization as so
important for a nonprofit organization too. Every organization is involved in
a financial process. The financial process takes different forms for different
organizations. Now we will discuss the classification of this finance. Though
our main concentration is business finance, we will also get a brief idea of
the financial processes of some other organizations also.
a) Family Finance
In family finance, the sources and amount of income of the family are
identified and how this income can be utilized for the overall welfare of the
family members is determined. Among numerous necessary expenditures, the most
important expenditures are fulfilled on a priority basis. If family income is
not sufficient, the loan can be taken from relatives, familiar persons, or
friends. Regular expenditures are determined by considering the regular
income. Bank loans can be arranged for fixed assets like television, freeze,
car, building construction, etc. But, as the collected fund is limited, it
needs proper utilization. If the collected money is in excess, the remaining
amount can be saved for future use.
b) Public Finance
Every government has its own financial management. In the case of a
government, how much in what areas will be the probable yearly expenditures of
the government, and how that money can be arranged from which sources are
discussed in public finance. Government has to spend a lot of money for the
overall development of the country in various sectors like- roads, bridges,
government educational institutions, government hospitals, law and order,
defense, social infrastructure, etc. The government collects money to bear
these expenses from different sources like- income tax, tat, gif tax, import
custom, export custom, saving certificates, prize bonds, treasury bills, etc.
In public finance, first, the amount of expenditure is determined and then the
fund is collected according to the needs. The main objective of public finance
is social welfare. Public finance is usually non-profitable. Expenditure may
be greater than income in public finance. There exist a number of business
organizations under government ownership, which may be less profitable also,
for example, chemical industries under BCIC.
Again, a large amount of money is required for big projects like Jamuna
Bridge, if the total amount of money is collected from the government budget.
On many occasions, financial crises may occur to the government due to public
expenditure for social and state security. For that reason, many times the
government collects foreign loans from organizations like ADB (Asian
Development Bank), World Bank, IDB (Islamic Development Bank), etc.
But at the time of sanctioning the loan, such organizations impose different
types of conditions, which may not be consistent with the need for the
country’s development and image protection. Considering these conditions, the
government wants to collect funds from other sources. Nowadays, big projects
are financed worldwide and also in our country through public-private
cooperation. This type of arrangement is called PPP (Public Private
Partnership).
c) International Finance
In international finance, the export and import sectors are discussed and
analyzed. Bangladesh is mainly an import-oriented country. Every year a huge
amount of foodstuff, raw materials, machinery, medicine, petroleum, etc. are
imported from different countries. On the other hand, jute and jute products,
readymade garments, agricultural products, etc. are being exported. Trade
deficiency of large amounts occurs as the volume of imports is greater than
the volume of export. Remittances sent by foreign dwellers play a vital role
to compensate for this deficiency. International finance covers discussion
about export and import sectors and the way of management to compensate for
the trade deficiency.
d) Finance of Non-Profit Organization
In our society, there are some institutions or organizations which are
involved in the welfare of mankind, or providing services for the poor and
distressed people. To run this type of business, money or products or services
similar to money are required and it is necessary to utilize that money
efficiently. In this connection, the role that finance plays is the
identification of the sources of finance or wealth similar to money and
ensuring its proper utilization for the purpose of achieving service-oriented
objectives. As an example it could be mentioned: an orphanage is not a
profit-making institution, but it also has a need for finance. These types of
institutions collect money through different grants. This collected money is
spent on various development activities for the orphans. So source
identification and proper utilization of funds to achieve its motto is the
main objective of finance of non-profit organizations.
e) Business Finance
The most important type of finance is business finance. An organization formed
with the purpose of earning profit through the risk of profit and loss is
called a business organization. So, business finance is the process used to
collect fund and invest it for business purposes. Business organizations are
classified into three types:
Sole Proprietorship Business, Partnership Business, and Joint Capital Business
organizations. The general feature of these three types of organizations is
fund collection and fund management. For fund collection, own capital and loan
are used as sources. Business finance is the main theme of this lesson.
The most famous business organizations in Bangladesh are usually formed as
sole proprietorship businesses and partnership businesses. Varieties of small
and cottage industries, hotel & restaurant businesses, grocery shops,
saloons, boutique shops, etc. are of these kinds of business. In a sole
proprietorship business, if profit is earned the owner enjoys it alone, and if
any loss occurs the owner’s personal properties also be used to repair the
loss.
In a partnership business, the risk is distributed among all partners, so the
partners are to be prepared to use personal properties to bear the loss in
business (if any). In these types of businesses – sole proprietorship or
partnership – sources of finance are the owner’s own capital, profit, loan
from relatives, and loan arranged on interest from bank or village money
lenders. So, earning profit from investing own funds by proper utilization of
money is the main objective of these types of business organizations.
The financial process of a joint stock company is different. Government
approval is required to form such a company. Before giving approval, the
government evaluates and analyses the minimum amount of capital, directors’
identity, business objectives, and various documents. After getting approval,
a company divides its expected big amount of total capital into small portions
of equal amounts and sells these as shares in the share market. For example, 1
lac shares of 1000 taka may be sold to the public when the business has a
capital of 100 million taka. As each share costs only 1000 taka, small
investors from remote places in the country also can purchase shares.
Shareholders are the owners of the company and if the company is profitable
they usually get dividends on a regular basis. Shareholders can convert their
shares into cash by selling those in the share market like Dhaka Stock
Exchange. Other than shares, a joint stock business can raise funds by taking
loans from the public through selling bonds and debentures to them. In that
case, the company has to pay interest on a regular basis at a certain rate to
the debenture holders. Because they are not the owners of the company like the
shareholders.
f) Bank and Financial Institutions
In any country, economic activities usually revolve centering banks and
financial institutions. Sonali Bank, Janata Bank, Rupali Bank, Prime Bank,
Shahjalal Islami Bank – These types of government and privately owned banks
are profit-oriented organizations but their financial process is usually
slightly different from business organizations.
These banks collect small amounts of fund from the people, create a deposit
for different terms with this fund, and provides a fixed rate of interest to
the depositors. Again, banks provide loans to entrepreneurs in different
businesses from this fund. Loans can also be taken for personal purposes.
Banks impose interest on certain rates against these loans. But the rate at
which a bank receives interest on granted loans is greater than the rate of
interest the bank pays to the depositors. This difference between these two
rates of interest is the profit of banks. In the banking chapter, we will
learn in detail about these institutions. Besides commercial banks, some
financial organizations also play an important role in the country’s economic
activities. In the Bangladesh context, some examples of these types of
organizations are the Investment Corporation of Bangladesh (ICB), Bangladesh
House Building Finance Corporation, Bangladesh Agricultural Bank, etc. These
financial institutions play their own special roles in the development of
different sectors of the economy of Bangladesh.
Importance of Business Finance
In the present competitive open market economy, every government,
non-government, and international business institution has to finance with
great importance in a preplanned way. Through the use of well-thought and
effective financial management, the risks of the institutions are reduced and
profits are increased. The following things make financial management more
meaningful:
a) Capital Crisis of Business
Finance-related ideas bear special importance in the situation of Bangladesh.
As Bangladesh is a poor country, the financial crisis is a regular incident
for business organizations. Due to this crisis, running the business smoothly
has become very challenging. It could be said as an example, a business
organization needs to purchase raw materials, but if it cannot purchase raw
materials timely due to the financial crisis then the production process of
the organization may be hampered. Finance-related ideas help a business
entrepreneur to collect the necessary amount of funds at the right time and
utilize it properly in a planned way.
b) Backward Banking System
Besides, as our financial organizations are not well-organized like that of
the advanced countries, (usually) loans cannot be arranged within the expected
time after application. Sometimes, the loan cannot be arranged as per the
required amount due to the insufficiency of property to be pledged as security
for sanctioning the loan. So, to overcome this problem, business people have
to collect funds at the right time in a very well-planned way and also need
profitable utilization of the fund with the right investment decision. A
proper financial plan and management help him to predict this type of problem
and give an idea about the process of overcoming such a situation.
c) Less Educated Entrepreneur
The majority of the entrepreneurs in Bangladesh are less educated and are not
able to conduct financial activities through a long-term plan. So, many
profitable business organizations cannot operate smoothly due to the financial
crisis arising from improper financial planning, and in the end, it faces loss
instead of profit. But, the only reason for this loss is financial
ill-management. If a businessman has sufficient knowledge about financial
management he can easily collect the necessary amount of funds at the right
time from a less expensive source and can earn enough profit by running his
business by investing it in a suitable project.
d) Production-Oriented Investment and National Income
A successful investment plays a direct role to increase national income. By
applying financial knowledge, a business person can choose the most profitable
project from among the alternatives by doing a cost-benefit analysis of the
projects under consideration. This type of profitable investment is as much
meaningful for the business so much it is important also for the economic
development of the whole country.
Principle of Business Finance
Business finance management means fund collection as per requirement,
investment of this fund in short and long terms, and the management of fund
distribution. This management process follows some principles which are
furnished below:
a) Liquidity vs. Profitability Principle
A grocer may keep all the cash money (liquid property) earned from daily sales
for the purpose of buying raw materials and other related expenses, or he may
keep with him some portion of this cash for buying raw materials and deposit
the rest amount in a bank account from which it is possible to get some amount
of interest/ profit after a certain period. In this situation, the grocer has
to decide on how much-earned cash should be retained with him to meet the
current needs. If the grocer keeps a large amount of cash with him to meet the
daily expenses then income from the bank will decrease. Again, if a large
amount of cash is deposited in a bank, the business may fall into a financial
crisis which may hamper daily activities. So, business people have to do
financial management in such a way that can create a balance between liquidity
and investment. It means, as on one side business people need cash reserve to
bear the daily expenses, thus on the other side cash should be invested for
making a profit too. There is an inverse relationship between cash and
liquidity. Huge cash decreases profitability, again excess investment for the
purpose of high profit causes a cash crisis. Maintaining a balance between
liquidity and profitability is one of the principles of finance.
b) Competence Principle
Acquiring current assets through short-term funds and fixed assets through the
long-term fund –is a principle of finance. The current asset is the money that
is required to run the daily expenses of a business, like- raw materials
purchase, payment of labor wages, etc. On the other hand, machinery purchase,
building construction for the business, etc. are fixed capital. As the amount
of current capital is small, it also yields less; for this reason, this type
of capital should be collected from a short-term source of finance. Commercial
banks, different financial institutions, investment banks, and debenture
holders these types of sources provide long-term loans. On the other hand,
current capital should be managed from regular sales proceeds. A high rate of
interest has to be given to the loan-providing institutions for collecting
loans from long-term sources. So, if a loan is collected from long-term
sources to bear the current expenses, then it appears that repayment of
interest from the earned income becomes impossible.
c) Diversification and Risk Distribution Principle
In the case of fund investment, if business products or services are as much
as possible diversified, the risk is distributed and reduced. Every business
organization tries to earn profit centering on an uncertain future. So
business has to face a lot of risks. These risks may be created for many
reasons, like- changes in economic, political, or social scenarios, the
arrival of new products in the market, natural calamity, sudden accident, etc.
It is not possible for the managers to control these uncertain situations or
take preparations for them. But through following the principle of risk
distribution, profit is possible to be earned in this uncertain market. If a
business person does business only for a single product, then profit earning
becomes very risky. On the other hand, if the products of the business are
different and diversified, then the risk is distributed. It means, in any
situation if the selling of a single product is deteriorate then the decreased
amount of profit can be compensated by the profit earned from the other
products; and as a result, expected profit can be achieved in any situation.
If a grocer sells both Halal soap and traditional soap, then customers of both
kinds of soap will arrive in his shop. If the grocer keeps only general or
traditional soaps, the customers of Halal soap will go to another shop to buy
Halal soap and the total sales of the grocer will decrease. Sales of some
products rise or fall due to the differences in weather or season also. As an
example, the demand for winter wears increases only in the winter season. So,
the sale of winter wears increases in that season. If a dress seller sells
both summer and winter wear in his shop, then his profit earning will not be
hampered by the rise and fall of demand for the products in different seasons.
If in a book stall only textbooks are sold and if in another shop textbooks,
story books, religious books, and different instructive books are sold, then
it appears that maximum customers will prefer the second stall even to buy
textbooks. Because they can purchase different types of necessary books from a
single shop at a time. Besides, if the book seller sells only textbooks, then
the sale may increase at the beginning of the year but at other times of the
year, these sales may decrease abruptly. This principle of risk distribution
through diversification can be applied in fund collection. In the case of fund
collection, priority is given to fund collection from different sources.
Functions of Financial Manager
The financial manager deals with two types of decisions:
1. Income or Finance Decision
2. Expenditure or Investment Decision
Income or Financing Decision
Income decision mainly means the process of fund collection. The scope of this
decision covers selection of the alternative sources of funds and taking
financial plans by analyzing the advantages and disadvantages of these
sources. Generally, to bear the current expenses fund is collected from
short-term sources, and to bear the fixed expenses fund is collected from
long-term sources. For the purpose of fund collection, it is collected through
own capital and arranging loans from different sources. Besides, large
companies may gather capital by selling shares. Shareholders are the real
owners of a company. The portion of capital which an organization collects
through loans increases the liability of the organization; again ownership
right is established on the basis of the amount of capital collected through
the owners’ fund. Thus, an institution becomes successful to create a balance
between the liability of the loan and the rights of the owners through a right
finance decision.
Expenditure or Investment Decision
The machine purchasing decision is an investment decision for a tailoring
shop. In the case of a grocery shop, the decision for furniture purchasing or
refrigerator purchasing is also an investment decision. For a production
organization, production machines purchase or factory construction is also
this type of decision. Through this decision, a plan of the expected inflow
and outflow of funds has to be calculated. For example, a production
organization decides to buy machines only when the selling of the machine-made
products is greater than before and if thus profitability and inflow of funds
are increased and if the total inflow of funds is greater than the purchase
price of the machine.
That means, if it seems that the machines can be utilized for 10 years, then,
for the purpose of investment decision, a comparison has to be made with the
10 years inflow of funds from sale proceeds for adding the new machines and
the purchase price of these machines. So, it is possible to find out the 10
years cash flow from selling only by considering the product price in 10 years
and the volume of sales. Production and other expenses are deducted from the
sales earnings to measure the profit from the cash flow.
The investment decision is very tough for an organization because measuring
the amount of selling in the future and determining the selling price is a
very difficult task.
Other Decisions
Above two decisions are very important for financial managers. Besides,
financial managers have to take some other decisions, such as:
a) Purchase of how much amount of raw materials is suitable and from which
sources this fund can be collected – this type of decision is called a current
investment decision.
b) How much amount of cash reserve should be kept for daily expenses is
another important decision too.
c) Dues payment for the sources of funds is another decision.
If the fund is collected through a bank loan and other loans like- bonds,
debenture, etc., then payment of a certain amount of interest at the right
time is an important responsibility for the financial manager. In the same
way, if a fund is collected through selling shares, then earning profit at the
expected rate and distributing dividends is another important thing to be
considered by the financial manager.
Evolution of Finance
After the Industrial Revolution of the 17th century, production technique
becomes more complex and the production process attains its excellence through
specialized and divided processes. To sustain in the market competition,
finance-related concept and their use become essential. With the expansion of
Accounting, in the 18th century, Finance was involved mainly in the evaluation
and analysis of financial statements. With the development of the classical
trend of microeconomics, finance was also involved in the own and specialized
economics of business at the end of the 19th century. The trends of this
financial evolution give us a meaningful idea about the nature and scope of
finance.
Traditionally, financial managers’ main responsibility was account maintenance
and making a future plan of action by analyzing it. Besides, report
preparation to reflect the actual condition of the business and liquid fund
management to build the business capacity of payment of the dues at the right
time, are also added to the evolutionary process of finance. But with the
expansion of civilization, the scope and technological development have
changed the responsibilities of financial managers. The evolution of finance
that happened in the last century in the USA, the main exercising field of
finance, is later known as the trend of Evolution of Finance throughout the
whole world. According to that, the stages of financial evolution can be
present in the following way:
a) Pre-1930 Decade: This time a trend of unification began among the
companies of the USA. Financial managers had to identify a framework about
which company should be unified with which one, by examining the financial
statements of the companies.
They took the responsibility of huge amount financing and of preparing
financial statements for this unification.
b) 1930’s: The tendency of unification did not get success in the
USA. Many of the companies unified in the past decade turned into bankrupt in
the next decade. Moreover, high depression started in the USA. Many profitable
companies also fell into a great loss. In that situation, how these losing
companies can be reorganized to protect them from bankruptcy was a special
responsibility of the financial managers. From that time, fund collection
through share selling was started.
c) 1940’s: The necessity of liquidity was the main concentration
at this time. Finance did that responsibility by ensuring well-planned cash
flow by making a budget for cash flow.
e) 1950s: In this decade, finance was involved in evaluating the most
suitable investment project by using different mathematical analyses. The main
activity of finance then turned to profit maximization by increasing sales and
decreasing expenditures through suitable long-term investments based on
long-acting forecasting. This trend is considered the traditional trend of
finance.
f) 1960’s: Modern finance started its journey from this time. Finance
started giving priority to the capital market. Shareholders are the owners of
a company, so maximization of the shareholders’ property or the market price
of shares became the main objective of finance at this time. To achieve this
objective, different activities relating to financial analysis were started.
The concept of risk in finance makes us understand that risk increases with
the increase in profit. So profit making may not be desirable all the time.
g) 1970’s: Era of computerized activities started in this decade. This
not only changed production techniques but also brought changes in business
finance. Finance is now Mathematics-based. Most of financial decisions are
mainly based on complex mathematical calculations, and the tendency of making
these calculations very effectively in computers got special popularity. For
example, the concept of risk is now measured and managed more correctly.
Traditional trends of capital structure are also more complex and
mathematical. Among the scholars who deserve mention for enriching business
finance with different theoretical analyses were Harry Markowitz, Murton
Miller, and Modigliani. After that, in 1990’s these scholars got Nobel Prize
as a reward for their contribution to the development of finance through
mathematical analyses.
h) 1980’s: For the expansion of business and sustaining in the
competitive market system, finance evolves in a new outlook by changing its
previous roles. Efficient distribution of capital among alternative projects
of the company and calculation & analysis of income of these projects was
the main activity of finance.
i) The 1990s and the Beginning of Modern Finance: World Trade
Organization revealed itself in this decade. Barriers to export and import
started to decrease worldwide. This time finance achieved internationality. On
one hand, investment decisions of finance consider where in the world
production and selling of which product could achieve profit; on the other
hand, the scope of finance also includes in its consideration which capital
market of the world is of what type and from which sources fund collection
will be profitable. As a result, finance is an applied field of solution in
the financial management of a business organization which has developed in
combination with accountancy, economics, and some other financial subjects.
