17.3Business Finance : Meaning, Need and Importance

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explain the importance of business finance

identify the types of business finance

differentiate between long-term, medium-term and short-term finance

distinguish between fixed and working capital.

17.3 Business Finance : Meaning, Need and Importance

Business finance refers to money and credit employed in business. It involves procurement and utilization of funds so that business firms may be able to carry out their operations effectively and efficiently. The following characteristics of business finance will make its meaning more clear:-

(i) Business finance includes all types of funds used in business.

(ii) Business finance is needed in all types of organisations large or small, manufacturing or trading.

(iii) The amount of business finance differs from one business firm to another depending upon its nature and size. It also varies from time to time.

(iv) Business finance involves estimation of funds. It is concerned with raising funds from different sources as well as investment of funds for different purposes.

Need and Importance

Business finance is required for the establishment of every business organisation. With the growth in activities, financial needs also grow. Funds are required for the purchase of land and building, machinery and other fixed assets. Besides this, money is also needed to meet day-today expenses e.g. purchase of raw material, payment of wages and salaries, electricity bills, telephone bills etc. You are aware that production continues in anticipation of demand. Expenses continue to be incurred until the goods are sold and money is recovered. Money is required to bridge the time gap between production and sales. Besides producers,

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may be necessary to change the office set up in order to install computers. Renovation of facilities can be taken up only when adequate funds are available.

7. To meet contingencies

Funds are always required to meet the ups and downs of business and unforeseen problems. Suppose, some manufacturer anticipates shortage of raw materials after a period. Obviously he would like to stock raw materials. But he will be able to do so only when money would be available.

8. To promote sales

In this era of competition, lot of money is required to be spent on activities for promoting sales like advertisement, personal selling, home delivery of goods etc.

9. To avail of business opportunities

Funds are also required to avail of business opportunities. Suppose a company wants to submit a tender but some minimum amount is required to be deposited along with the application. In the case of non-availability of funds it would not be possible for the company to apply.

Intext Questions 17.1

Write `T' before statements which are true, and `F' before statements which are false. 1. Purchase of fixed assets is a day to day expense. 2. Business finance means money and credit employed in business

firms. 3. Business finance deals only with investment of money. 4. Business Finance is concerned with estimation of funds, raising of

funds from different sources and their investment in different types of activities. 5. Without adequate finance, business may run into difficulties.

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main sources of short-term finance.

All organisations need different types of finance i.e. long-term, mediumterm and short-term, but the combination in which these are used differ from one organisation to another. For example, steel industry requires more long-term finance to be invested in plant and machinery than in the manufacture of leather goods or plastic buckets. On the other hand, for manufacturing hosiery items, use of short-term finance would be more than that of long-term finance.

Difference between long-term, medium term and shortterm finance

You have already learnt about long-term, medium-term and short-term financial needs. You have also learnt that long term finance is generally needed for the purchase of fixed assets. On the other hand, medium term finance may be required to modernise machinery and to improve other facilities. Short-term finance is generally required for meeting expenses on day-to-day operations. The difference between these three types of finance are :

Basis of Difference

Long termfinance

Medium termfinance

Short-term finance

1. Time period :

This is required for a long period which is generally 5 years of more

This is required for a period exceeding one year but not exceeding 5 years.

This is required for a period up to one year.

2. Purpose

This is required for the purchase of fixed assets and financing part of working capital which is fixed or permanently required.

This is generally required for modernisation and renovation of machinery etc.

This is required mainly to finance day to day operations.

3. Duration of Need for long-term

operating cycle finance does not

(Time gap

vary with the

between

length of opera-

This type of finance is not likely to vary on account of length of

Need for shortterm finance varies with the operating cycle. Longer the

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of finished goods etc. Some of these assets are used over a long period of time and hence are generally of a permanent nature. Fixed capital refers to the total value of assets in a business which are of durable nature and used in a business over a considerable period of time. It comprises of assets like land, building, machinery, furniture etc. The capital invested in these assets is fixed in the sense that these are required for permanent use in business and not for sale.

Working capital consists of those assets which are either in the form of cash or can easily be converted into cash, e.g. cash and bank balances, debtors, bills receivable, stock, etc. These assets are also known as current assets. Working capital is needed for day to day operations of the business. However, a part of working capital is required at all times to maintain minimum level of stock and cash to pay wages and salaries etc. This part of working capital is called `permanent' working capital.

The need for fixed and working capital varies from one organisation to another depending upon the nature and volume of operation. The difference between fixed and working capital is as follows:-

Basis of Difference Fixed capital

Working capital

1. Nature of Business

Business with manufacturing activity requires more of fixed capital as large investments have to be made in fixed assets.

Trading business requires more working capital, since in such a type of business, finished goods are bought and sold and money remains in circulation. Hence fixed capital needs are less in trading business.

2. Time of Requirement

Fixed capital is normally required at the time of setting up of business.

Working capital is required at all times i.e. at the time of setting up of business and to carry on the business.

3. Length of operating cycle

Need for fixed capital does not change with change in the length of operating cycle.

Working capital requirements are likely to increase with the increase in the length of operating cycle.

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durable nature and are used in the business for a considerable period of time.

(8) Working capital means total value of such assets which are either in the form of cash or are easily convertible into cash.

(9) A part of working capital is of fixed nature which is known as regular or permanent working capital.

17.7 Terminal Exercise

1. Define the following :

(a) Business finance (b) Long-term finance (c) Working capital

2. What is the difference between long-term and medium-term finance with respect to time?

3. Give any three examples of fixed assets. What type of finance could be used for their purchase ?

4. If you are to set up a small factory for making detergents, how would you meet the different financial requirements? Explain in brief.

5. Write, in brief, any two points of difference between fixed capital and working capital.

6. How can shortage of working capital put a business organisation into difficulties?

17.8 Answers to intext questions

17.1 1. F 2.T 3.F 4.T 5.T.

17.2 1. Three 2. Five

3. Medium term finance

4. Working/Circulating 5. Fixed.

17.3 1. (iii)

2. (i)

3. (v)

4. (ii)

5.(iv)

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