The financial aspect of management function may be viewed in terms of an arbitrage process between imperfectly competitive product markets and an efficient or more perfectly capital market. Contribution of business finance to the development of an organization.
The modern theory of business finance is based upon the objective of maximizing the market value of firm. Although the worker, the government and societies represent other sources of claim on the value of the firm apart from that of the shareholders, the objective of value maximization remains the paramount one.
Business finance refers to the various means by which organizations obtain debt capital or investment from external sources, or the ways in which they fund growth strategies. Businesses generally progress through various stages of organizational development over time, from startup to an eventual winding down or sale of the business. Whatever stage your business is in, outside financing is likely to be an important driver of success and a means to reach new levels of growth and organizational development.
Types of Business Finance in an Organization
In contribution of business finance to the development of an organization, The two most common types of financing in business are debt and equity. Debt financing includes traditional bank loans and other lender options that require small businesses to repay the principal of fixed payment system. Equity financing includes direct investments from venture capitalists, investment firms or other individuals who provide businesses with capital for organizational growth opportunities. The repayment terms for investments often depend on the individual contractual agreements signed by the business owner.
In the startup stage, financing is likely to be a bit challenging to come by, since the business has not established a financial track record. Entrepreneurs can turn to personal savings, personal loans and credit cards to finance much of a small business’s startup cost — although outside financing might still be available, and can be vitally important in this stage. Again investors can be another source of financing, provided you have a solid business plan and a unique idea with great potential.
Early Growth Stage
Financing in the early growth stage is vital to a organization’s continued growth and sustainability. A new business needs money to fund early stage marketing and expansion strategies. At this stage, profits may be slim, leaving little earned income left over to fund strategic growth plans. Banks are more likely to extend business loans to organizations in the early growth stage than to startups, as they already have financial records to prove the viability of the business model. Venture capitalists may also become more interested in this stage, since they generally prefer to invest in businesses that are already up and running.
Lines of Credit
Established organizations that make it past the early growth stage can find new opportunities to secure and maintain revolving lines of credit with banks and suppliers, allowing them to continually finance things like materials and inventory for short periods. In the expansion stage, rapid growth becomes less of a focus, while achieving operational efficiencies and steadily boosting profitability become high priorities. This can make revolving lines of credit especially important. As your business grows, you may also find yourself with greater access to bank loans and potential new investment from venture capitalists.
When an organization is ready to tackle the highest level of growth by expanding nationally or globally and fighting for market dominance, it may be time to consider incorporating the business with an initial public offering. When a small business converts to a public corporation, it gains access to significant sources of debt-free financing in the form of stock and bond sales. Selling stock in an IPO can bring in millions of Nairas virtually overnight, giving a organization the fuel it needs to make its presence felt in the marketplace. Bonds are a form of relatively low-interest debt that bypasses banks by working directly with investors, providing addition sources of debt financing for corporations.
Small business is often an exciting business environment. This business sector often contains high levels of potential growth and rapidly expanding business operations. Entrepreneurs and business organizations owners are usually required to make several decisions regarding growth opportunities, developing business strategies and financing these situations. Although different financing options are available in the business environment, each type can impact small businesses. Selecting the wrong type of financing can have a significant impact on business growth.
2Contributions of Business Finance to the Development of an Organization
In general, the central role of fiancé can be appreciated from the fact that nearly every key decision made by firm’s managers has important financial implications.
Business finance offers organizations various management tools for evaluating organizational growth opportunities. Small business owners can use mathematical formulas to assess the financial returns of different growth opportunities. These formulas evaluate future expected returns against the capital investment required for each opportunity. Formulas, such as net present value, return on investment, capital asset pricing model and weighted average cost of capital, help business owners evaluate potential cash flows, percentage rates of return and the cost of external financing, including interest and fees.
Features of Business Finance
Debt Financing Features
Debt financing often has an upfront negative impact on business growth opportunities. Most small businesses are required to go through lengthy loan processes and face intense scrutiny by banks and lenders. Sole proprietorships may also require the business owner to undergo a personal evaluation to ensure he can repay the bank debt if the small business fails to generate capital. Debt financing usually requires fixed monthly or quarterly balloon payments to repay the loan.
Equity Financing Features
Equity financing terms are usually negotiated between investors and business owners depending on the amount of capital needed and type of growth opportunity being financed. Using venture capitalists or private investment firms can require businesses to give these individuals a large percentage of the opportunity’s financial returns. Businesses may also be required to give private investors a say in management decisions. Business owners surrendering a say in management decisions can be limited in how they choose to operate their business.
Challenges of Business Finance to an Organization
Large amounts of business finance can create a variety of problems for an organization, there is . On the one hand, if the organization has too much debt, its access to financing may be constricted, perhaps before the organization had a chance to complete its growth strategy. In addition, if a organization has a high amount of debt and revenue suddenly stalls, such as in a recession, it may leave the business unable to fulfill its obligations. On the other hand, if an organization continually relies on equity financing, it may find that it loses a certain amount of decision-making authority, a factor that could inhibit growth strategies just as much as a lack of funding.
Not Enough Cash Flow
Cash flow is calculated by subtracting total expenses from total income. If the resulting number is positive, the organization is turning a profit, and is considered to “be in the black.” If the resulting number is negative, the business is losing money and considered to be “in the red.” Businesses with only modest cash flow may find it hard to expand their operations, and businesses with negative cash flow have even fewer options.
If a business lacks the ability to create cash flow, it will be forced to take on debt to continue operations. Business loans can help a organization restructure, retool, increase sales or expand into new markets. However, too much debt can sink a business permanently.
Too Much Debt
Too much debt can be detrimental to a business. High credit card interest rates and large loan payments can raise your monthly expenses, and make it harder to turn a profit. Few banks will approve loans for businesses with too much outstanding debt.
If a business reaches a point where the debts and liabilities outweigh revenue and cash flow, the business is deemed to be insolvent and bankruptcy may be the only recourse.
Poor Financial Management
All businesses, especially startups, need a business plan and a financial budget to guide how they raise and spend money, and how they handle financial surpluses and shortfalls. Organizations that fail to properly research their markets, underestimate competition or overspend wildly will have problems meeting their revenue goals, and may risk the overall health and viability of the business.
Financiers like to lend money to organizations with track records of responsible fiscal management and often decline loans to businesses that show a failure to plan ahead.
Debt to Equity Ratio
The “Debt to Equity Ratio” tells you how much debt (liabilities) you have compared with how much equity (cash) exists in your organization. It is calculated by dividing the total business debt by the total equity.
A number of 5.0 tells you that the business has five times as much debt as equity in the organization. A number of 0.5 tells you the business has half as much debt as equity, or twice as much equity as debt.
The debt to equity ratio can vary from industry to industry depending on the cost structure of the business and its reliance on debt. However, in all cases, a smaller debt to equity ratio is better.
Debt Coverage Ratio
The “Debt Coverage Ratio,” also known as DCR, is a ratio of the organization’s net operating income to its debt payments. It is expressed as a whole number and the larger that number is the better. A DCR of 2.0 means your organization has twice as much net operating income as it does debt payments each period. A number of less than 1.0 would signal negative cash flow.
Recommendations and contribution of business finance to the development of an organization
Business owners should carefully consider each growth opportunity before moving forward with financing options. Although many small businesses quickly accept any opportunity that comes their way, failing to analyze growth opportunities may overextend the business’ resources. Selecting poor growth opportunities and financing them with traditional debt loans can also create significant cash flow strains. Although a business can discontinue poor growth opportunities, it may be unable to delay loan repayments.
Distribution of financing is of serious concern. In contribution of business finance to the development of an organization , While growth can, to a certain degree, be financed solely through the revenue received by the organization, most organizations obtain financing to prevent weakening their current financial position. An organization with a high amount of debt can become over-leveraged, meaning they have high fixed costs relating to financing, and, as such, unstable. Accordingly, keeping financing to a minimum can greatly strengthen the financial health of a organization.
Paying close attention to the organization’s business plan and budget will help keep expenses in check and ensure positive cash flow. The key business ratios serve as an alarm for your business. Understanding what they are and how they work can prevent your finances from getting out of control.
In conclusion, contribution of business finance to the development of an organization planning ahead and evaluating one’s financials regularly will always help an organization or business to keep running effectively and profitably.