FINANCE – Business Finance (Areas of Business Finance)
FINANCE can be defined as the science and art of managing money
in order to achieve the appropriate objective. There are two important
components in its definition, one is managing money which involved
with the management of money and the other component is an
the appropriate objective that means management of money with
an appropriate objective in mind.
In terms of Personal Context, if we think about finance,
it is actually the management of money for personal
objectives. For example, if we are thinking about
personal finance, perhaps we are thinking about
how to earn an adequate amount of money, how
much money to spend and save, how much to
borrow if necessary, how much money to invest if
we have extra and if we want to increase our
consumption in future, where to invest the money
when to invest the money. So, these are some
examples dealing with personal finance,
In Government Context, finance deals with generating
government revenue by deciding how much of tax to be
collected, public spending the money, the amount of
spending on public, budgeting, government debt,
production and distribution of public goods.
And if we think about the Business Context of finance, then it deals with investment in Assets, how to raise money for the investment of the business, how to manage the short-term cash flows, how much to reinvest in the business, if we want to expand the business.
So, these are the different contexts of finance.
In order focus and learn on business finance, the areas of business finance should be understood properly. The areas of business finance are as under
- Capital Budgeting:
It deals with fixed assets and the investment of a farm.
- Dividend Policy.
When a farm makes a profit, profits will normally be distributed to the owners, but if the farm decides to reinvest how much of the profits should be reinvested then the dividend will be lower. So, these kinds of decisions are the area of dividend policy.
- Capital Structure:
It deals with raising money and how to raise money for the investment. It also involves deciding when to raise the money and from which sources the farm should raise money, should the farm raise money more from the owners or more from the creditors.
- Working Capital Management:
It is related to the management of short term assets, more particularly short term cash flows. So, it involves cash budgeting, managing of current assets, managing of current liabilities, etc.
So, these are the areas of finance that can be related to the balance sheet of a business organization. The balance sheet of a business organization has two sides. The Left Hand Side (LHS) contains the assets and the Right Hand Side (RHS) contains the liabilities and owner’s securities. In other words, we can say that liabilities and owner’s equity are the sources of funds because when we are liable to someone that means, we are supposed to pay. That means we have other people’s money borrowed from them.
Equity is also other people’s money, but it is the owner’s money that we have in our business. So, we can see that the Right Hand Side of the balance sheet actually indicate the sources of money the business organization has and the Left-Hand Side of the balance sheet contains the assets, which are essentially the uses of money. The money is used normally when we different types of assets. So, these types of assets are contained in the Left Hand Side. So, a business organization can have assets only if the business organization has money in the first place.
Only then the farm can use the money to buy assets. This is why the sources of money and the uses of money should be equal. The LHS and the RHS of the balance sheet are equal. If we focus on the LHS of the balance sheet, we have assets that can be classified into two types, current assets, and fixed assets. So, the current assets are the assets having shorter lives, usually less than one year like cash, accounts receivables, and inventories. The other type of asset is the fixed assets which have longer lives such as equipment, machinery, building patterns. These assets normally have a life of more than one year.
On the RHS, the first thing is current liabilities, which contain the liabilities of the firm that must be repaid within one year period. For example, accounts payable is such current liability. Among the long term depths like corporate bonds or long term borrowing from the banks. So, these are the liability that does not have to be repaid within one year.
The owner’s equity is essentially the claims of the owners which may be their investment or the profit generated from their investments, such as common stock or retained earnings. So, these are the components of the balance sheet. These components can also be related to different areas of Finance. For example, the fixed assets are related to capital budgeting, because when the farm decide in which assets and which long term assets the firm should invest, they actually determine the fixed asset component of the business organization. So, this is related to capital budgeting.
Now, the long term debt and owner’s equity is the part of the balance sheet and it is related to capital structure decision. If the firm decides how much to borrow and how much to get from the owner, it is essentially the capital structure of the firm. The remaining portion viz., current assets and current liabilities, both have shorter lives, one year or less. So the management of current assets and current liabilities is related to the working capital management, area of business finance.