Introduction to Finance

With the gradual progress of society & civilization and the development of science and technology, the scope of trade and commerce has also increased. Hence, the product-market has to cope with diverse competitions. To make profit in this competition, a businessman has to utilize his capital efficiently through proper planning so that the cost of production or selling could be kept minimum price. Hence, a business firm can maximize its profit. For that purpose, every business firm collects its necessary fund for investment from the most desirable sources, and invests it in the most suitable project by analyzing various information of the product-market. This creates inflows and outflows of fund in the business. Finance regulates these flows of fund nicely. Different principles of finance are used in this process of regulation. Financial Management helps a businessman to earn enough profit from investing even a small amount of capital. Now-a-days finance is no more used as a supporting system but as the main driving force of business.

Concept of Finance

Finance deals with fund management. Finance prepares plans and implements necessary activities about what amount of fund should be collected from which sources and where & how this fund is to be invested for highest profit in the project. In case of a business firm, fund flows in the business from selling of products. Different types of fund are needed to produce and buy goods for the business, like- purchasing machinery, purchasing raw materials, paying wages to the labors, etc. These are the utilization of fund. Funds need to be collected in a planned way as per the requirement of fund to maintain an uninterrupted production process. Finance means this process related to fund collection and utilization.

If you visit a tailoring shop in your locality, you will see there one or two person sewing with a machine. Again, someone may be cutting clothes or stitching the buttons. So to continue the tailoring business properly, the shop owner has to purchase machines, threads, buttons, scissors etc. of necessary amount. At the beginning of his business he bears these expenses from his own saving. If the fund appears insufficient, then he may take loan from his relatives to overcome the shortage. When the business is in operation, at the end of every month he needs to bear expenses for the payment of workers’ wages, house rent, electricity bill etc. and he pays all these with the money earned by sewing cloths. He also has to plan to pay back the loan money from this monthly collection. An owner of a tailoring shop always expects that he can earn some amount of profit even after meeting all necessary expenditures from the income of the business, by which he can save for the future or can utilize for business expansion even after meeting regular expenses of his family. So if an owner of a tailoring shop conducts business through a proper planning regarding the source of finance and its utilization, only then he can earn profit through smooth operation of the business. Otherwise it will be found that due to cash crises sewing thread cannot be bought timely and the customers are returning. Again, it may be needed to shut down the business due to lack of money to buy a new machine replacing the old one. To conduct the business properly, Business finance deals with when and for what reason how much amount of fund is needed and from which sources this fund should be collected for smooth operation of the business.

There has implication of finance in family too. Generally, every family has one or more than one sources of finance. Income may be obtained from different sources in different families, such as, from service, business, agricultural activities, self-employment etc. Beside these, regular expenditure of a family occurs for daily shopping costs, house rent, school fees, different bills payment etc. As expenditure should be matched with income, in this way, right time of expenditure should also be maintained. If money is insufficient as per demand, then as an example, it may happen that name of the student may be cut down from the register. In case of a family, pre-planned identification of the sources of finance and its utilization is the financial process. Other than daily expenditure of this type, sometimes occasional expenditure may be required in the family which may exceed the income ability of a person. If it is not possible to collect money from regular income sources for such expenditures like buying a new television or refrigerator, then the shortage may be fulfilled through long term loan. In that case, a loan repayment plan needs to be prepared. As a result, the concept of finance helps to determine the sources of fund and make proper management of it to conduct the family smoothly.

Financial process can be understood from the perspective of a school also. School is a social organization whose main objective is not profit earning, there also has a plan of income- expenditure and fund management. Educational institutions generally collects fund from sources of their students’ tuition fees, examination fees, admission fees, etc. The institution has to meet different expenditures with this fund to run the academic activities properly, like- payment of teacher-staff’s salary, house rent, electricity bill and different types of renovation expenses, purchasing computer and furniture. So, ensuring fund management for performing various working process of the institution nicely by considering different sources of fund and different sectors of utilization is financing in the perspective of the school.

Among above examples, tailoring shop is a profit making organization, but family and school are non-profit organizations. Our present topic is involved mainly in financing of profit-making- or business organizations. How is the financial process of a grocery shop? The shop owner earns profit by selling products. But for the purpose of selling, he needs to complete on regular basis purchasing products, paying rent, electricity bill, wages of the workers, etc. as current expenditures. Moreover, sometimes he has to spend a large amount of money for purposes like- expansion of business for the need of the customers, purchasing a refrigerator, etc. These are his fixed expenditure. Thus a grocer requires investing both in fixed assets and current assets. If income from selling is not sufficient for collecting fund for investment, he has to collect fund from other sources like personal fund, friends-relatives, purchase on credit etc. Again, he may collect large amount of money which he needs to invest in fixed assets usually from commercial banks. In such financing, as there is the opportunity of repaying in long schedule of time, the risk of loan repayment is reduced a bit. In the case of a grocery shop, main activities of business finance are fund management through proper utilization of money received from sales proceeds in meeting current expenditures, some long term investments, collection of money from less risky sources, timely repayment of loan installments, etc.

Square Pharmaceuticals, Ba ta Company, Kohinoor Chemicals – these are large size business organizations which are called company. Financial process of such a company is not so simple like grocery shop or tailoring shop rather it is comparatively complex. In fund collection, a large company gets more benefit than a small organization. For example, a company collects capital by selling shares in the share market. Company’s goodwill, rate of profit, customer services or consumers’ satisfaction helps to increase the share price in share market. Business finance deals with and provides guidance regarding: from among different sources using which source, when and how much fund should be collected and in which sectors, how much amount and how will it be invested to increase the profit.

Importance of Finance in Business

In the present competitive open market economy, every government, non-government and international business institution has to finance with great importance in a pre-planned way. Through the use of a well-thought and effective financial management, the risks of the institutions are reduced and profits are increased. The following things make financial management more meaningful:

a) Capital Crisis of Business

Finance related ideas bear special importance in a situation of a poor country. As a poor country, financial crisis is a regular incident for the business organizations. Due to this crisis, to run business smoothly has become very challenging. It could be said as an example, a business organization needs to purchase raw materials, but if it cannot purchase raw materials timely due to the financial crisis then the production process of the organization may be hampered. Finance related ideas help a business entrepreneur to collect necessary amount of fund at the right time and utilize it properly in a planned way.

b) Backward Banking System

Besides, as our financial organizations are not well-organized like that of the advance countries, (usually) loan cannot be arranged within expected time after application. Sometimes, loan cannot be arranged as per required amount due to insufficiency of property as to be pledged as security for sanctioning the loan. So, to overcome this problem, business people have to collect fund at right time in a very well-planned way and also need profitable utilization of the fund with a right investment decision. Proper financial plan and management help him to predict this type of problem and give idea about the process of overcoming such situation.

c) Less Educated Entrepreneur

The majority of the entrepreneurs in a poor country is less educated and is not able to conduct financial activities through a long term plan. So, many profitable business organizations cannot operate smoothly due to the financial crisis arisen from improper financial planning and at the end it faces loss instead of profit. But, the only reason of this loss is financial ill-management. If a businessman has sufficient knowledge about financial management he can easily collect necessary amount of fund at right time from a less expensive source and can earn enough profit by running his business through investing it in a suitable project.

d) Production-Oriented Investment and National Income

A successful investment plays a direct role to increase national income. By applying financial knowledge, a business person can choose the most profitable project from among the alternatives by doing a cost-benefit analysis of the projects under consideration. This type of profitable investment is as much meaningful for the business so much it is important also for the economic development of the whole country.

Evolution of Finance

After the Industrial Revolution of 17th century, production technique becomes more complex and the production process attains its excellence through specialized and divided processes. To sustain in the market competition, finance related concept and its use become essential. With the expansion of Accounting, in 18th century Finance was involved mainly in the evaluation and analysis of the financial statements. With the development of the classical trend of micro economics, finance was also involved in the own and specialized economics of the business at the end of 19th century. The trends of this financial evolution give us the meaningful idea about the nature and scope of finance. Traditionally, financial managers’ main responsibility was accounts maintenance and making a future plan of action by analyzing it. Besides, report preparation to reflect actual condition of the business and liquid fund management to build business capacity of payment of the dues in right time, these are also added with the evolutionary process of finance. But with the expansion of civilization, the scope and technological development have changed the responsibilities of financial managers. The evolution of finance that happened in the last century in USA, the main exercising field of finance, is later known as the trend of Evolution of Finance throughout the whole world. According to that, the stages of financial evolution can be present in the following way:

a) Pre-1930 Decade: This time a trend of unification began among the companies of the USA. Financial managers had to identify a framework about which company should be unified with which one, by examining the financial statements of the companies. They took the responsibility of huge amount financing and of preparing financial statements for this unification.

b) 1930’s: Tendency of unification did not get success in USA. Many of the companies unified in the past decade turned into bankrupt in the next decade. Moreover, high depression started in USA. Many profitable companies also fell in a great loss. At that situation, how these loosing companies can be reorganized to protect them from the bankruptcy was a special responsibility of the financial managers. From that time, fund collection through share selling was started.

c) 1940’s: Necessity of liquidity was the main concentration at this time. Finance did that responsibility by ensuring well-planned cash flow with making a budget of cash flow.

e) 1950s: In this decade, finance was involved in evaluating the most suitable investment project by using different mathematical analyses. Main activity of finance then turned to profit maximization by increasing sales and decreasing expenditures through suitable long term investments based on long acting forecasting. This trend is considered as the traditional trend of finance.

f) 1960’s: Modern finance started its journey from this time. Finance started giving priority in capital market. Shareholders are the owners of a company, so maximization of the shareholders’ property or the market price of shares became the main objective of finance of this time. To achieve this objective, different activities relating to financial analysis were started. Concept of risk in finance makes us understand that risk increases with the increase of profit. So profit making may not be desirable all the time.

g) 1970’s: Era of computerized activities started in this decade. This not only changed the production techniques but also brought changes in business finance. Finance is now Mathematics-based. Most of the financial decisions are mainly based on complex mathematical calculations, and the tendency of making these calculations very effectively in computer got special popularity. For example, the concept of risk is now measured and managed more correctly. Traditional trend of capital structure are also more complex and mathematical. Among the scholars who deserve mentioning for enriching business finance with different theoretical analysis were Harry Markoiz, Murton Miller, Modigliani. After that, in 1990’s these scholars got Nobel Prize as the reward of their contribution in the development of finance through mathematical analyses.

h) 1980’s: For expansion of business and sustaining in the competitive market system, finance evolves in a new outlook by changing its previous roles. Efficient distribution of capital among alternative projects of the company and calculation & analysis of income of these projects were the main activity of finance.

i) 1990’s and Beginning of Modern Finance: World Trade Organization revealed itself in this decade. Barriers of export and import started to decrease worldwide. This time finance achieved inter-nationality. In one hand, investment decisions of finance considers where in the world production and selling of which product could achieve profit; on the other hand, the scope of finance also includes in its consideration which capital market of the world is of what type and from which sources fund collection will be profitable. As a result, finance is an applied field of solution in the financial management of a business organization which has developed in combination with accountancy, economics and some other financial subjects.

End

More topics about Banking and Finance…