Unit V

Business Finance Definition and Meaning

Finance is the lifeline of every business as it helps in the overall conduct, growth, and
expansion of a business. It is next to impossible to conduct a business without finance.
Therefore, it is imperative and unavoidable to thoroughly understand the working of business
finance. In the subsequent sections of this article, we’ll cover – what is business finance, what
is financial management, and various other aspects of business finance.

Meaning of Business Finance

Business finance is the cornerstone of every organization. It refers to the corpus of funds and
credit employed in a business. Business finance is required for purchasing assets, goods, raw
materials and for performing all other economic activities. Precisely, it is required for running
all the business operations.

To understand what business finance is, we must know that business finance includes
activities concerning the acquisition and conservation of capital funds for meeting an
organization’s financial needs and objectives. The importance of business finance is evident
from the fact that business finance is required to undertake every business operation
successfully.

The amount of capital that is pooled by a business owner into their company is often not
enough to meet the financial needs of a company. Herein, the importance of business finance
and its management rises even more. Consequently, business owners along with their teams
look out for various other ways to generate funds.

A business may require additional funds for anything ranging from buying plant or apparatus,
raw materials or further development. Different types of business finance are:

 Fixed Capital
 Working Capital
 Diversification
 Technology upgrading

Importance of Business Finance

Here are some reasons why business finance is important for all organizations:

Maximization of wealth

Business finance ensures that a shareholder’s wealth is maximized. It is also important to

understand that wealth maximization is different from profit maximization. Wealth
maximization is holistic and ensures the growth of an organization.

Ensure constant availability of money

For any business to survive, it should be in optimum financial condition. This includes the
availability of funds at the time they are needed. Unless there are enough funds, the business
may not be able to function properly.
Attaining optimum capital structure

This requires a perfect combination of shares and debentures. This way the organization will
be able to maintain a perfect balance and not give away too much equity

Effective utilization of funds

This is another reason for the high importance of business finance and its efficient utilization.
A business should be able to cut down unnecessary costs and not invest funds in assets that
are not required. An exhaustive course in financial management, diploma in banking and
finance or any other course related to finance can give your career in financial management a
head start. Or, if you are already in the field, it can give your career the necessary boost.

What is Financial Management in Businesses?

Now that you know all about what business finance is and its importance, it’ll be easier for
you to understand financial management.
Financial management can be defined as the activities involving planning, raising, controlling,
and administering money that is used in the business. Financial management involves
procuring funds for buying fixed assets, raw materials, and working capital. Now that we
know what financial management is, it is also important to understand that proper financial
management helps businesses supply better products and services to customers besides
offering other benefits.

Meaning of Financial Management

Financial Management means planning, organizing, directing and controlling the financial
activities such as procurement and utilization of funds of the enterprise. It means applying
general management principles to financial resources of the enterprise.

Scope/Elements of Financial Management

1. Investment decisions includes investment in fixed assets (called as capital
budgeting). Investment in current assets are also a part of investment decisions called as
working capital decisions.
2. Financial decisions- They relate to the raising of finance from various resources
which will depend upon decision on type of source, period of financing, cost of
financing and the returns thereby.
3. Dividend decision- The finance manager has to take decision with regards to the net
profit distribution. Net profits are generally divided into two:
. Dividend for shareholders- Dividend and the rate of it has to be decided.
. Retained profits- Amount of retained profits has to be finalized which will
depend upon expansion and diversification plans of the enterprise.
Objectives of Financial Management
The financial management is generally concerned with procurement, allocation and control of
financial resources of a concern. The objectives can be-

1. To ensure regular and adequate supply of funds to the concern.

2. To ensure adequate returns to the shareholders which will depend upon the earning
capacity, market price of the share, expectations of the shareholders.
3. To ensure optimum funds utilization. Once the funds are procured, they should be
utilized in maximum possible way at least cost.
 4. To ensure safety on investment, i.e, funds should be invested in safe ventures so that
adequate rate of return can be achieved.
5. To plan a sound capital structure-There should be sound and fair composition of
capital so that a balance is maintained between debt and equity capital.

Functions of Financial Management

1. Estimation of capital requirements: A finance manager has to make estimation
with regards to capital requirements of the company. This will depend upon expected
costs and profits and future programmes and policies of a concern. Estimations have to
be made in an adequate manner which increases earning capacity of enterprise.
2. Determination of capital composition: Once the estimation have been made, the
capital structure have to be decided. This involves short- term and long- term debt equity
analysis. This will depend upon the proportion of equity capital a company is possessing
and additional funds which have to be raised from outside parties.
1. Choice of sources of funds: For additional funds to be procured, a company has
many choices like-
. Issue of shares and debentures
. Loans to be taken from banks and financial institutions
. Public deposits to be drawn like in form of bonds.
Choice of factor will depend on relative merits and demerits of each source and period of
financing.
2. Investment of funds: The finance manager has to decide to allocate funds into
profitable ventures so that there is safety on investment and regular returns is possible.
3. Disposal of surplus: The net profits decision have to be made by the finance
manager. This can be done in two ways:
. Dividend declaration - It includes identifying the rate of dividends and other
benefits like bonus.
. Retained profits - The volume has to be decided which will depend upon
expansional, innovational, diversification plans of the company.
4. Management of cash: Finance manager has to make decisions with regards to cash
management. Cash is required for many purposes like payment of wages and salaries,
payment of electricity and water bills, payment to creditors, meeting current liabilities,
maintainance of enough stock, purchase of raw materials, etc.
5. Financial controls: The finance manager has not only to plan, procure and utilize the
funds but he also has to exercise control over finances. This can be done through many
techniques like ratio analysis, financial forecasting, cost and profit control, etc.

What is Profit Maximization in Financial Management?

The profit maximization principle is an important concept to understand, especially for any
company that wants to maximise its profits. In financial management, profit maximization
refers to finding the most profitable way to produce goods or provide any services. It simply
means to maximise the profits of the company.

Profit maximization, in economics, is one of the most common objectives of every company.
Generally, profit in accounting and business terms means that part of the amount which
arrived after revenue exceeds the cost of production involved
Here, revenue is the money a business receives from selling its goods and services, and the
cost is the money invested into production. In other words, this profit can be looked at as the
net benefit earned for the shareholders by a company in the long run

What is Wealth Maximization in Financial Management?

Wealth maximization is a goal that all individuals and businesses should aim to achieve. Not
only will it improve one's quality of life, but such wealth maximisation will help sustain the
company's business in the long run. While wealth maximization is the company's objective,
profit maximization is the objective of every company owner.

In other words, wealth maximization is the maximization of the owner's wealth, and its value
is calculated by the computation of stock value. Hence, maximizing wealth is comparatively
different from maximizing profit.

Profit Maximisation vs Wealth Maximization: The Differences

The prime consideration in managing every business is profitability. But only looking for
profits would not make the business thrive in the long run. Therefore, this necessitates the
combination of both profit maximization and wealth maximization in the company.

Profit maximization is the management of financial resources through a range of activities to

increase the profits of the company. Wealth Maximization manages financial resources in
such a way that there is increase in the value of shares of a company’s shareholders.

Now let’s look into the differences between profit maximization and wealth maximization:

1. Profit maximization is done by increasing the earning capacity of the company.

Whereas, if the company's ability is focused on increasing the value of stocks for the
shareholders and stakeholders, this is known as Wealth Maximization.
2. While profit maximization is a short-term goal of any business, Wealth Maximisation
is a long-term goal.
3. Risks and uncertainties do not form part of the entire process of profit maximization.
While as Wealth Maximization considers and recognises the need to assess all
possible risks and uncertainties.
4. Profit maximization ensures the survival and growth of the business. In contrast,
Wealth Maximization focuses on a company’s long-term growth rate by increasing its
share in the market.
5. The time value of money is not accounted for in the profit
maximization, whereas wealth maximisation acknowledges it. According to the
 concept of time value of money, a certain amount of money is worth more now than it
will be in the future. This is so because investment is the only way to make money
grow. An opportunity is lost when an investment is postponed.
6. Companies with profit maximization as their main goal focus on efficiency
improvement with less cost and maximum profitable output. While in the case of the
companies whose focus is wealth maximization, they heavily concentrate on
increasing and improving the share market price of the company so that the value of
the shareholders is increased.
7. The benefits of profit maximization limit the company's growth to the current
financial year, whereas the benefits of wealth maximization extend beyond the
current year with a huge market share and higher share price, which ultimately
benefits every stakeholder related to the company.
8. In the case of profit maximization, a company prefers to maximise its profits. It solely
relies on the profits made from the difference between the total revenue and cost plus
tax expenses of the current financial year. In contrast, a company with a wealth
maximization goal aims to increase the value of the shareholders' wealth as they are
the real owners of the company. It does so by investing its capital in the market with
uncertain risks but with higher returns.
Modern Approach of Financial Management

The modern approach does bring financial managers to consider the analytical and border
point. They asked to consider both the optimum use of resources and distribution of funds. As
the arrangement of funds is an important component which does mean for short time and long
term financial problems. The below three decisions may taken by the finance manager.

Investment Decision

The decision relates to selection of assets which invest by firms and the assets which firms
acquire which might for long term or short term. Capital budgeting is the process of selecting
assets or investment proposals which yield for the long term. They deal with assets of current
which are highly liquid in nature.

Financing Decision

The scope of finance indicates the possible sources of raising the finance. The financial
planning decision attempts sources and possible accumulation of funds. As the decision to
ensure the availability of funds whenever required.

As the financial decision made to raise funds at the right time, and financial decision has to
opt for various cost effective methods to run business smoothly.

Dividend Decision

The decision taken in regards to net profit distribution which divides into dividend for
shareholders and retained profits. This may concerned with determining the percentage of
profit earned and paid to every shareholder as dividend. The financial manager makes
decisions regarding such profits paid out and works for a better firm.
Investment Decision (Capital Budgeting Decision):

This decision relates to careful selection of assets in which funds will be invested by the firms.
A firm has many options to invest their funds but firm has to select the most appropriate
investment which will bring maximum benefit for the firm and deciding or selecting most
appropriate proposal is investment decision.

Financing Decision
The financing decision is about the amount of finance to be raised from various long-term
sources, this determines the various sources of finance, as well as it also provides the cost
of each source of finance. The main sources of finance are:
 Shareholders’ Funds
 Borrowed Funds
The shareholders’ funds or owners’ funds consist of equity capital and retained earnings,
whereas borrowed funds refer to finance raised as debentures or other forms of debt. The
borrowed funds contain risk because they involve a commitment of fixed interest payment,
although there will be loss in the organisation.On the other hand, owners’ funds have less
risk because there is no such commitment regarding payment of dividends and replacement
of the capital amount. Financing decisions involve analysing the risk and cost associated
with each source of finance. Both sources have their own merits and demerits.Burrowed
funds are considered to be the cheapest source of finance because interest paid is a
deductible expense for the calculation of tax liability. The cost of raising finance is known
as floatation cost, and it is also considered while taking financing decisions. In this way, the
financing decision is related to deciding how much amount is to be raised from each source.
This decision determines the overall cost of capital and the financial risk of the enterprise.
The Dividend Decision is one of the crucial decisions made by the finance manager relating
to the payouts to the shareholders. The payout is the proportion of Earning Per Share given
to the shareholders in the form of dividends.

The companies can pay either dividend to the shareholders or retain the earnings within the
firm. The amount to be disbursed depends on the preference of the shareholders and the
investment opportunities prevailing within the firm.

The optimal dividend decision is when the wealth of shareholders increases with the increase
in the value of shares of the company. Therefore, the finance department must consider all the
decisions viz. Investment, Financing and Dividend while computing the payouts.

If attractive investment opportunities exist within the firm, then the shareholders must be
convinced to forego their share of dividend and reinvest in the firm for better future returns.
At the same time, the management must ensure that the value of the stock does not get
adversely affected due to less or no dividends paid out to the shareholders.

The objective of the financial management is the Maximization of Shareholder’s Wealth.

Therefore, the finance manager must ensure a win-win situation for both the shareholders and
the company.

What is inter-relationship between investment, financing and dividend decisions?

Although the basic decisions of finance includes three types of decisions i.e. investing,
finance and dividend decisions but they are interlinked with each other somehow. It can be
evident from the following points:

 The main objective of all the above decisions is same which is profit maximization of
business and wealth maximization of shareholders.
 In order to make investment decisions such as investing in some major projects, the
first thing we need to consider is the finance available and required to make investment.
 Finance decision is also influenced by dividend decision. If more of the dividend is
distributed, there is a need to raise more finance from external sources.
 If more of the profits are retained for long term investment, there is less need of
outside financing.
Hence, there is a need to take into account the joint impact of all the three decisions and effect
of each of the decision on the market value of the company and its shares to achieve the
overall objective of the business.