DEFINITION:
Business finance is the process by which a financial manager/accountant provides finance for business use as and when it is needed. This provision has to be undertaken on the basis of the needs of a company. On the other hand, Financial Management is a branch of economies concerned with the generation and allocation of scarce resources to the most efficient user within the economy (or the firm). The allocation of these resources is done through a market
pricing system. A firm requires resources in form of funds raised from investors. The funds must be allocated within the organisation to projects that will yield the highest return.
1. Needs Consequent on the Operations of a Company (Basic Needs)
These have to be financed in so far as they arise out of the company’s operations e.g. salaries.
2. Shortages of Cash Brought About By Unforeseeable Circumstances E.G Non Payment By Debtors
These needs have to be financed by short term finances e.g. overdrafts, but this may be against financial prudence rather such needs should be financed by revolving finances in the circular flow. However, the financial manager must manage his finances using such tools as:
- Cash budget – statement of expected receipts and payments over a projected period of time – a forecast.
- Funds flow statement – (Actual).
Variance between actual funds flow with cash budget. The variance must be managed to keep the company liquid. On the other hand a financial manager has to meet the company’s strategic/long term needs (long term investment) are useful to the company because:
- It influences the company size (assets)
- It influences its growth (plough back)
- Finances incidental needs.
- It influences the company’s long-term survival – this is through continuous investment.
These investments will call for long term financing in form of owners finance (Ordinary Share Capital and Revenue reserves). This is a base on which other finances are raised. The company will also use external financing e.g. debts, loans, debentures, mortgages, lease finance etc. These finances have to be used in acceptable/reasonable financial mix. This implies that the company’s gearing level is kept low i.e. the relationship between owners and creditors finance. This should be below 67% otherwise the company may be forced into receivership and subsequently liquidation. Even then, when using creditors finances a company must consider:
- That cost of finance is less than the Return which implies the rate should not be less than the bank interest + inflation + risk.
- Economic conditions prevailing – use debt under boom conditions.
- Present gearing – if high this will lead to:
- Low credit rating
- Lowering of the company’s share prices especially to less than Par value – this leads to mass sale of shares – creditors rush to draw their finances and therefore receivership.
4. Long term ventures have to call for independent feasibility studies before funds are committed i.e.
- Assessment of the return – at least should be greater than minimum return + risk + inflation.
- Economic life – if uncertain, the return ought to be higher. Such life must allow the company to pay off the loan.
The financial manager must be guided by principles of financial prudence i.e.
- He has to consult experts.
- He has to involve investment committee
- He has to ascertain whether everyone involved in the implementation of the venture has not been left out either during the planning phase or implementation phase.
