Business and Finance
Finance is the lifeline of business. It is required by an entrepreneur
to start a business unit and is utilized all the way through for the continuity
of the business. According to the accounting literature when the proprietor
invests some amount into the business concern it is termed as capital.
There are various reasons to invest capital into the business as follows:
Expansion: when the business unit wishes to increase its existing operating capacity or desires to widen the existing distribution network it requires investment to launch a new product. Diversification: diversification investment decision is taken by the entity when it aims to produce a new product or plans to enter into a new geographical area. Replacement or modernization decision: to improve the quality of the product or increase the operating efficiency of the firm it requires investment to replace the old assets used in the manufacture of the product.
Commence a business: To start up a business, it raises funds from the public, financial institutions or private lenders and also expends some amount from his pocket. Investment decision is the most important decision as the firms future success and growth depend on it. But this decision is difficult to make due to the following factors:
It is not easy to anticipate the rate of returns likely to be received in the future. There are numerous factors that affect the profitability factor of the business such as demand and supply factor, advertisements, promotions, sales efforts, consumer taste and preferences and change in economic and government policies. It is not easy to facilitate comparison between the costs that are to be incurred and the benefits to be reaped in future because of the time value of money. The rate of profitability cannot be exactly calculated and the costs that are to be incurred cannot be expressed in tangible terms.
The finance manager of the entity is bestowed with a number of responsibilities which need to be complied it. It is his basic duty to procure the funds and make judicious use of the financial resources. The basic objective of any business firm involves to maximize the value of the firm and control the cost of production. Traditionally the finance manager performed the following functions:
a) Arranging for short-term as well as long-term finance from financial institutions.
b) Organize the funds through various financial instruments like Equity shares, preference shares, secured and unsecured loans, which include debentures and bonds. Equity shares are also known as the owners shares because the equity owners enjoy voting rights. A fixed rate of dividend should to paid to the preference share holders whether the company incurs profit or loss. On the other hand equity shareholders are paid dividend depending upon the financial position of the business. Debenture holders are the creditors of the firm who are paid along with the rate of interest. The nature of the financial instruments should be studied by the financial manager and must be properly understood in order to forecast the market trends, economic and government policies and other factors that govern the profitability factor.
The decision of investment proposal necessarily involves risk because of the element of uncertainty. The role of the finance manager is to analyze the firm, estimate and decide the following points:
• How large the firm would be and what is the total fund requirement to start it
• What are the assets to be acquired in order to carry operations efficiently
What would be the optimum pattern for asset expenditure and what is the composition of capital and liabilities The assets to be obtained for future benefits are of two types. A) Long-term assets B) Short-term assets. The firm depends upon the long term of fixed assets for future returns. They create a major impact upon the profitability of the firm. The decision undertaken to purchase a fixed asset is known as capital budgeting. Short term assets are convertible into cash within a year and it is known as Working capital investment.
• It needs to estimate the risk and uncertainty involved in the investment proposal.
• The proprietor must ascertain the total amount of funds to be invested by the firm.
Financing decision is the next vital step to be taken. It involves at determining the best financial mix or capital structure. The study and determination of capital structure is important to the firm because it shows the relationship between the total debt employed and returns to shareholders. The firm has to later reward debenture holders and well as shareholders. If it excessively uses debts the return to shareholders will not be promising. Therefore a proper balance must be maintained between the debts and equity to reduce financial risks.
The strategy for profit maximization should be studied. As per this approach, only those actions must be undertaken that maximize the value of the firm and the actions that do not increase the profitability of the firm must be excluded. The profit maximization approach takes into consideration mainly three aspects, ie. Investment, financing and dividend decisions and they should be oriented towards maximization of profits.
Dividend decision is also significant that determines credit rating of the firm. the profit earned by the firm is utilized into two fold ways.
A) For retaining the profits in the business in the form of reserves.
B) Distributing it to the shareholders every year. a firm must be able
to stably pay the shareholders as well as retain it in the business for
future prospects proportionately because both are equally significant.
To reduce the financial risk the firm must pay the shareholders regularly
as well as to increase the profitability of the business builds large
reserves to the business. This decision is also affected by a number of
points like shareholders preference, investment opportunities and also
upon the factors of determining the dividend policy.
Capital investment decision occupies an important place in corporate finance. Huge investments are made and the decisions taken by the finance manager or proprietor create a long-term impact to the firm.
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