For companies, finance is one of the most crucial parts of operating. Usually, this finance comes from two sources, equity, and debt. Combined, they constitute a company’s capital structure. This structure allows companies to decide the ratio between equity and debt finance.
Companies can also obtain finance from other sources, for example, hybrid instruments, etc. Nonetheless, equity and debt finance are the most common sources.
Equity finance comes from a company’s shareholders. For other businesses, the owners contribute funds, which constitute this finance source.
This finance stays with the company perpetually. Usually, equity finance generates from the issuance of stock or shares. Debt finance, on the other hand, comes from lenders.
These lenders include financial institutions. Companies can also generate this finance through debt instruments such as bonds.
Undoubtedly, all companies require funds to perform their activities. Whether running a product- or service-based business, these funds are crucial in operations. There are various reasons why financing is important for companies.
However, it is critical to understand what business finance is first. On top of that, knowing the several types of finance also helps to signify its importance.
What is Business Finance?
Business finance refers to the funds that companies or businesses use to operate. Companies can use these funds for several purposes. Usually, most companies employ business finance to purchase assets. While this finance comes in cash which is also an asset, it may not help operations. Therefore, companies utilize business finance to acquire fixed assets. These may include property, plant, equipment, etc.
Business finance is crucial for companies in running operations. However, it may also come with some costs to the company.
As mentioned above, business finance comes in two forms. Equity finance usually includes the cost of repaying shareholders.
Since this finance is perpetual, companies must compensate their shareholders until liquidated. The cost of paying shareholders is the primary expense to a company.
Debt finance also comes with its cost. However, this finance usually lasts shorter compared to equity finance. In most cases, debt finance may span between 3-7 years. However, some companies may acquire short-term or long-term debt finance as well.
The primary cost associated with debt finance is the interest payments made to the lender. However, this cost is usually lower than that paid for equity finance.
Business finance also refers to the funds or money available to a company. This finance can contribute to several areas.
For example, it can help expand operations or start a new business. Essentially, finance is the core of every activity that a company undertakes.
On top of that, companies also need business finance to continue their existing operations. In general, every action or activity requires finance.
Overall, business finance represents the funds in use at a company. This finance comes from two primary sources, including equity and debt.
However, both of these sources also come with costs. Companies can use various capital structures to optimize or minimize those costs. Business finance is highly crucial for companies in the long run. Nonetheless, it is also vital for short-term operating needs.
Why is Financing Important?
Business finance plays a crucial role in a company’s operations and activities. While each finance source can have its benefits and drawbacks, they combine into a single unit.
This unit, often known as the capital structure, provides various advantages to companies. Regardless of the individual finance source, financing is crucial on its own.
Overall, the seven reasons why financing is important to include the following.
1) Enable operations and activities
The primary reason why companies need financing is that it enables operations and activities. Usually, these activities may include daily tasks that companies perform to continue operating. For some companies, this process requires significant sums of money each day.
Financing plays a crucial role in enabling and supporting those activities. Without financing, companies cannot continue operating in the long run.
On top of daily needs, companies also require financing for long-term operations. Companies plan these operations as a part of their strategies.
Usually, they form those strategies after establishing their financial needs. Financing also plays a crucial role in those decisions. If companies do not consider these details, they can face several issues in the future.
2) Generate revenues and profits
As mentioned above, companies use financing to acquire assets. These assets can help companies run operations. From those operations, companies can make sales, which increase their income or revenues.
Therefore, financing can help companies support their operations to sell their products or services. Without financing, companies cannot support operations that allow access to several revenue streams.
On top of revenues, financing is also crucial in generating profits. While sales provide income, most operations also require companies to spend money.
This money can go toward various expenses, which support operations. Financing can help fund those expenses and increase profitability. While higher costs reduce profits, companies must still spend money to earn more.
3) Allow expansion
Companies must expand to continue growing their business. If they fail to do so, they will reach a limited performance position and lose potential profits in other areas. However, expansion does not come without challenges.
One of these most significant issues that companies face here is financing. Usually, companies aim to expand their operations rapidly. However, they may not have sufficient funds to support it.
Financing can sustain business expansion in various ways. It can help companies research new markets to enter in the future.
On top of that, it can also support the infrastructure required to make the growth possible. However, companies must have an effective financing structure. If they fail to ensure that, they can suffer significant losses.
4) Achieve long-term goals
Companies set goals for their daily operations as a part of their operational objectives. However, these objectives are a part of a larger strategy.
Companies set various long-term goals, which they seek to achieve through their operations. However, doing so is not straightforward. Companies require financing to ensure that they can accomplish their long-term goals.
Long-term goals require long-term finance, which comes from various sources. Most companies prefer a mix of equity and debt finance to support their operations.
Nonetheless, if companies cannot access funds, they cannot support the activities that support those goals. On top of that, limited resources can also hinder the process.
5) Support operations in different economic conditions
Financing is also crucial in supporting companies through various economic conditions. In a boom period, companies must ensure they have the resources to expand.
As mentioned above, business financing is crucial in helping companies grow. On top of that, they must also ascertain they have enough resources to support the increasing demands.
However, companies may also suffer from challenging economic conditions. During these times, they may not have high sales.
Therefore, profitability will also be low in those conditions. Financing can help companies sustain their operations when the economic conditions are unfavorable. If they do not have the financial resources, companies can go through liquidation or suffer substantially.
6) Fund financial transactions
Companies undertake various financial transactions during their operations. These transactions may include acquiring resources from several suppliers.
Similarly, it may involve producing items or services to sell to customers. All these operations require finance.
On top of that, the underlying transactions also entail monetary compensation. In this regard, business financing can be significantly crucial.
Financing allows companies to fund financial transactions. In most cases, it enables companies to transact with various parties.
Companies cannot undertake new financial transactions if they lack business finance. Most parties will refuse to deal with a company if it cannot offer reimbursement. Therefore, business financing is also crucial in that regard.
7) Exploit business opportunities
Companies operate in environments where they face various business opportunities. Utilizing these opportunities and exploiting them can be highly crucial. If done on time, companies can significantly increase their profitability and operations.
However, they need funds to support or utilize those opportunities on time. In the absence of business financing, companies may miss those opportunities.
Business opportunities also help generate competitive advantages. Usually, it implies that a company can increase its customers and revenues.
However, they must have the resources to avail themselves of the opportunity that brings a competitive advantage. If they fail to do so, competitors can exploit that opportunity. Therefore, they can lose their customers and profits.
Business finance refers to the various resources of finance that companies use in their operations. Usually, it comes from two sources, including equity and debt finance.
Each of these sources comes with its costs, benefits, and drawbacks. Nonetheless, they also have some advantages as a whole. The seven reasons why financing is important are given above.