Financial process is as important for a business
organization so important for a nonprofit organization too. Every organization
is involved with a financial process. Financial process takes different forms
for different organizations. Now we will discuss about classification of this
finance. Though our main concentration is business finance, we will also get a
brief idea of the financial processes of some other organizations also.
Family Finance
In family finance, the sources and amount of income of the
family is identified and how this income can be utilized for the overall
welfare of the family members is determined. Among in-numerous necessary
expenditures the most important expenditures are fulfilled on priority basis.
If family income is not sufficient, loan can be taken from the relatives,
familiar persons or friends. Regular expenditures are determined by considering
the regular income. Bank loans can be arranged for fixed assets like
television, freeze, car, building construction etc.. But, as the collected fund
is limited, it needs proper utilization. If the collected money is excess,
remaining amount can be saved for future use.
Public Finance
Every government has its own financial management. In the
case of a government, how much on what areas will be the probable yearly
expenditures of the government and how that money can be arranged from which
sources are discussed in the public finance. Government has to spend a lot of
money for overall development of the country in various sectors like- roads,
bridge, government educational institutions, government hospital, law and
order, defence, social infrastructure etc.. Government collects money to bear
these expenses from different sources like- income tax, tat, gif tax, import
custom, export custom, saving certificates, prize bond, treasury bill etc. In
public finance, first the amount of expenditure is determined and then fund is
collected according to the needs. The main objective of public finance is
social welfare. Public finance is usually non-profitable. Expenditure may be
greater than income in public finance.
International Finance
In international finance, export and import sectors are
discussed and analyzed. A country every year huge amount of foodstuff, raw
materials, machinery, medicine, petroleum etc. are imported from different
countries. On the other hand, jute and jute products, ready-made garments,
agricultural products etc. are being exported. Trade deficiency of large amount
occurs as the volume of import is greater than the volume of export. Remittance
sent by the foreign dwellers play vital role to compensate this deficiency.
International finance covers discussion about export and import sectors and the
way of management to compensate the trade deficiency.
Finance of Non-Profit Organization
In our society there are some institutions or organizations
which are involved in the welfare of mankind, or providing services for the poor
and distressed people. To run this type of business, money or products or
services similar to money is required and it is necessary to utilize that money
efficiently. In this connection, the role that the finance plays is
identification of the sources of finance or wealth similar to money and
ensuring its proper utilization for the purpose of achieving the
service-oriented objectives. As an example it could be mentioned: an orphanage
is not a profit making institution, but it also has need of finance. These
types of institutions collect money through different grants. This collected
money is spent in various development activities for the orphans. So source
identification and proper utilization of fund to achieve its motto is the main objective
of finance of non-profit organization.
Business Finance
The most important type of finance is business finance. An
organization formed with the purpose of earning profit through the risk profit
and loss is called a business organization. So, business finance is the process
used to collect fund and invest it for business purposes. Business
organizations are classified into three types: Sole Proprietorship Business,
Partnership Business and Joint Capital Business organizations. General feature
of these three types of organizations are fund collection and fund management.
For fund collection, own capital and loan are used as sources. Business finance
is the main theme of this lesson.
The most famous business organizations in the world are
usually formed as sole proprietorship business and partnership business.
Varieties small and cottage industries, hotel & restaurant business,
grocery shop, saloon, boutique shop etc. are of these kinds of business. In
sole proprietorship business, if profit if earned the owner enjoys it alone and
if any loss occurs the owner’s personal properties also be used repair the loss.
In partnership business, the risk is distributed among all
partners, so the partners are to be prepared use personal properties to bear
the loss in business (if any). In these types of businesses – sole
proprietorship or partnership – sources of finance are owner’s own capital,
profit, loan from relatives, loan arranged on interest from bank or village
money lenders. So, earning profit from investing own fund by proper utilization
of money is the main objective of these types of business organizations.
The financial process of a joint stock company is different.
Government approval is required to form such a company. Before giving approval,
the government evaluates and analyses the minimum amount of capital, directors’
identity, business objectives and various documents. After getting approval, a
company divides its expected big amount of total capital into small portions of
equal amount and sells these as shares in the share market. For example, 10
million shares of $1000 may be sold to the public when the business has a
capital of $100 million. As each share costs only $1000, small investors of
remote places of the country also can purchase shares. Shareholders are the
owners of the company and if the company is profitable they usually get
dividend on a regular basis. Shareholders can convert their shares into cash by
selling those in the share market like New York Stock Exchange. Other than
shares, a joint stock business can raise fund by taking loans from the public
through selling bonds and debentures to them. In that case, the company has to
pay interest on regular basis at some certain rate to the debenture holders.
Banks and Financial Institutions
In any country, economic activities usually revolve centering
the banks and financial institutions. Government and privately owned banks are
profit-oriented organizations but their financial process is usually slightly
different from business organizations. These banks collect small amounts of
fund of the people, create deposit for different terms with this fund and
provides fixed rate of interest to the depositors. Again, banks provide loans
to the entrepreneurs in different businesses from this fund. Loans can also be
taken for personal purposes. Banks impose interest on certain rate against
these loans. But the rate at which a bank receives interest on granted loan is
greater than the rate of interest the bank pays to the depositors. This difference
of these two rates of interest is the profit of banks. In banking chapter we
will learn in details about these institutions.
Principle of Business Finance
Business finance
management means fund collection as per requirement, investment of this fund in
short and long terms and the management of fund distribution. This management
process follows some principles which are furnished below:
Liquidity VS Profitability Principle
A grocer may keep all
the cash money (liquid property) earned from daily sales for the purpose of
buying raw materials and other related expenses, or he may keep with him some
portion of this cash for buying raw materials and deposit the rest amount in a
bank account from which it is possible to get some amount of interest/ profit
after a certain period. In this situation, the grocer has to decide on how much
of earned cash should be retained with him to meet the current needs. If the grocer
keeps large amount of cash with him to meet the daily expenses then income from
bank will decrease. Again, if large amount of cash is deposited in bank, the
business may fall in financial crisis which may hamper the daily activities.
So, business people have to do financial management in such a way that can
create balance between liquidity and investment. It means, as in one side
business people need cash reserve to bear the daily expenses, thus in other
side cash should be invested for making profit too. There is an inverse
relationship between cash and liquidity. Huge cash decreases profitability, again
excess investment for the purpose of high profit causes cash crisis. To
maintain a balance between liquidity and profitability is one of the principles
of finance.
Competence Principle
Acquiring current
asset by short term fund and fixed asset by long term fund –is a principle of
finance. Current asset is that money which is required to run the daily expenses
of a business, like- raw materials purchase, payment of labor wages, etc. On the
other hand, machinery purchase, building construction for the business etc. are
fixed capital. As the amount of current capital is small, it also yields less;
for this reason this type of capital should be collected from the short term
source of finance. Commercial banks, different financial institutions,
investment banks and debenture holders these types of sources provide long term
loans. On the other hand, current capital should be managed from regular sales
proceeds. High rate of interest has to be given to the loan providing institutions
for collecting loan from the long term sources. So, if loan is collected from
long term sources to bear the current expenses, then it appears that, repayment
of interest from the earned income becomes impossible.
Diversification and Risk Distribution
Principle
In the case of fund
investment, if business products or services are as much as possible
diversified, the risk is distributed and reduced. Every business organization
tries to earn profit centering an uncertain future. So business has to face a
lot of risk. These risks may be created for many reasons, like- changes of
economic, political or social scenario, arrival of new products in the market,
natural calamity, sudden accident etc. It is not possible for the managers to
control these uncertain situations or take preparations for them. But through
following the principle of risk distribution, profit is possible to be earned
in this uncertain market. If a business person do business only for a single
product, then profit earning becomes very risky. On the other hand, if the
products of the business are different and diversified, then the risk is
distributed. It means, in any situation if selling of a single product is
deteriorate then the decreased amount of profit can be compensated by the
profit earned from the other products; and as a result expected profit can be
achieved in any situation. If a grocer sells both the Halal soap and the traditional
soap, then customers of both kinds of soaps will arrive in his shop. If the
grocer keeps only general or the traditional soaps, the customers of Halal soap
will go to another shop to buy Halal soap and the total sales of the grocer
will decrease. Sales of some products rise or fall due to the differences of
weather or season also. As an example, demand of winter wears increases only in
winter season. So, the sale of winter wears increases in that season. If a
dress seller sells both summer and winter wears in his shop, then his profit
earning will not be hampered for rise and fall of demand of the products in
different seasons. If in a book stall only text books are sold and if in
another shop text books, story books, religious books and different instructive
books are sold, then it appears that maximum customers will prefer the second
stall even to buy text books. Because, they can purchase different types of
necessary books from a single shop at a time. Besides, if the book seller sells
only text books, then though the sale may increase at the beginning of the year
but in other times of the year this sale may decrease abruptly. This principle
of risk distribution through diversification can be applied in fund collection.
In the case of fund collection, priority is given on fund collection from
different sources.
Functions of Financial Manager
Financial manager
deals with the two types of decisions:
1. Income or Finance Decision
2. Expenditure or Investment Decision
Income or Financing Decision
Income decision mainly
means the process of fund collection. The scope of this decision covers
selection of the alternative sources of fund and taking financial plans by analyzing
the advantages and disadvantages of these sources. Generally, to bear the current
expenses fund is collected from short term sources, and to bear the fixed expenses
fund is collected from long term sources. For the purpose of fund collection,
it is collected through own capital and arranging loan from different sources.
Besides, large companies may gather capital through selling shares.
Shareholders are the real owners of a company. The portion of capital which an
organization collects through loan increases the liability of the organization;
again ownership right is established on the basis of the amount of capital
collected through the owners’ fund. Thus, an institution becomes successful to
create a balance between the liability of loan and the rights of the owners
through a right finance decision.
Expenditure or Investment Decision
Machine purchasing
decision is an investment decision for a tailoring shop. In the case of a
grocery shop, decision for furniture purchasing or refrigerator purchasing is
also an investment decision. For a production organization, production machines
purchase or factory construction is also this type of decision. Through this
decision a plan of expected inflow and outflow of fund has to be calculated.
For example, a production organization decides to buy machines only when the
selling of the machine-made products is greater than before and if thus
profitability and inflow of fund are increased and if the total inflow of fund
is greater than the purchase price of the machine.
That means, if it
seems that the machines can be utilized for the 10 years, then, for the purpose
of investment decision, comparison has to be made with the 10 years inflow of
fund from sale proceeds for adding the new machines and the purchase price of
these machines. So, it is possible to find out the 10 years cash flow from
selling only by considering the product price in 10 years and the volume of
sales. Production and other expenses are deducted from the sales earnings to
measure the profit from the cash flow.
The investment
decision is very tough for an organization because to measure the amount of
selling in future and determining selling price is a very difficult task.
Other Decisions
Above two decisions
are very important for the financial managers. Besides, financial managers have
to take some other more decisions, such as:
1) Purchase of how
much amount of raw materials is suitable and from which sources this fund can
be collected – this type of decision is called current investment decision.
2) How much amount of
cash reserve should be kept for daily expenses is another important decision
too.
3) Dues payment for
the sources of fund is another decision.
If fund is collected
through bank loan and other loans like- bond, debenture etc., then payment of
certain amount of interest at the right time is an important responsibility for
the financial manager. In the same way, if fund is collected through selling of
shares, then earning profit at the expected rate and distributing dividend is
another important thing to be considered by the financial manager.
End
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