BUSINESS FINANCE STUDY NOTES
Introduction to business finance
Business Finance includes those business activities that are concerned with the
acquisition and conservation of capital funds in meeting the financial needs and
overall objectives of a business enterprise. It is the funding a business needs for
commercial purposes. It is the money business owners require to start, run or
expand a business.
Importance of Business Finances
Business finance is an essential requirement for the establishment of any
business. Money is actually the most important tool to bridge the gap
between production and sales. The purpose of business finance is also to ensure
that a business has adequate operating funds and that it is spending and
investing its money carefully, wisely, and effectively. The importance
of finance in business is in the ability to ensure that a business operates without
any financial hiccups like running short of cash, and at the same time making
sure, that funds are secure and well invested for long-term gains. Some of the
benefits are as under.
Creating Profit for the business
Exploring new products and markets
Creating more assets for the business
Making sure operational expenses are me
Managing the cash flow of a business
Internal sources of business finance
1. Retained Profits / Retained Earnings
Retained profits/earnings are called the internal source of finance for a business
because they are the end product of running a business. The phenomenon is
also known as ‘Ploughing Back of Profits.’ Retained profits can be defined as the
BUSINESS FINANCE Notes Prepared by Mr. Antony Ambia Page 1
, profit left after paying a dividend to the shareholders or drawings by the capital
owners.
Advantages of Retained Earnings as an Internal Source of Finance
The advantage of having retained profits/earnings is in its characteristics.
First, they are long-term finance, and nobody can ask for their payments.
Secondly, since there is no additional equity to be issued, there is no dilution of
control and ownership in the business.
Thirdly, there is no fixed obligation of interest or installment payments.
Fourthly, retained earnings as an internal source of finance are cost-effective
because there is no issue cost attached to it, ranging between 2 – 3 %.
Lastly, investing retained earnings in the projects, with IRR better than the ROI
of the business, will directly have a positive impact on the shareholder’s wealth,
and thereby the core objective of management will be served.
Disadvantages of Retained Earnings as an Internal Source of Finance
There is practically no disadvantage in generating or using retained earnings to
finance the business’s investments. Assuming that the funds generated
internally are not free as they belong to the shareholders, the cost of these
funds is equal to the cost of equity. There is only one alternative that can be
explored, i.e., debt financing sources. Exploring the option leads to thinking
about two points—one, financial leverage that can be gained by introducing
debt financing. Second, if the leverage is possible and practical, a dividend
decision regarding using the retained earnings to pay dividends to shareholders
can be explored.
2. Sale of Assets
Another internal source of finance is the sale of assets. Whenever a business
sells off its assets and the cash generated is used internally for financing the
capital needs, we call it an internal source of finance by the sale of assets.
Advantages of Generating Finance by Sale of Assets
It can work as a short-term or long-term finance depending on what kind of
assets are sold. Say, selling a car can cater to short-term and smaller finance
BUSINESS FINANCE Notes Prepared by Mr. Antony Ambia Page 2
Introduction to business finance
Business Finance includes those business activities that are concerned with the
acquisition and conservation of capital funds in meeting the financial needs and
overall objectives of a business enterprise. It is the funding a business needs for
commercial purposes. It is the money business owners require to start, run or
expand a business.
Importance of Business Finances
Business finance is an essential requirement for the establishment of any
business. Money is actually the most important tool to bridge the gap
between production and sales. The purpose of business finance is also to ensure
that a business has adequate operating funds and that it is spending and
investing its money carefully, wisely, and effectively. The importance
of finance in business is in the ability to ensure that a business operates without
any financial hiccups like running short of cash, and at the same time making
sure, that funds are secure and well invested for long-term gains. Some of the
benefits are as under.
Creating Profit for the business
Exploring new products and markets
Creating more assets for the business
Making sure operational expenses are me
Managing the cash flow of a business
Internal sources of business finance
1. Retained Profits / Retained Earnings
Retained profits/earnings are called the internal source of finance for a business
because they are the end product of running a business. The phenomenon is
also known as ‘Ploughing Back of Profits.’ Retained profits can be defined as the
BUSINESS FINANCE Notes Prepared by Mr. Antony Ambia Page 1
, profit left after paying a dividend to the shareholders or drawings by the capital
owners.
Advantages of Retained Earnings as an Internal Source of Finance
The advantage of having retained profits/earnings is in its characteristics.
First, they are long-term finance, and nobody can ask for their payments.
Secondly, since there is no additional equity to be issued, there is no dilution of
control and ownership in the business.
Thirdly, there is no fixed obligation of interest or installment payments.
Fourthly, retained earnings as an internal source of finance are cost-effective
because there is no issue cost attached to it, ranging between 2 – 3 %.
Lastly, investing retained earnings in the projects, with IRR better than the ROI
of the business, will directly have a positive impact on the shareholder’s wealth,
and thereby the core objective of management will be served.
Disadvantages of Retained Earnings as an Internal Source of Finance
There is practically no disadvantage in generating or using retained earnings to
finance the business’s investments. Assuming that the funds generated
internally are not free as they belong to the shareholders, the cost of these
funds is equal to the cost of equity. There is only one alternative that can be
explored, i.e., debt financing sources. Exploring the option leads to thinking
about two points—one, financial leverage that can be gained by introducing
debt financing. Second, if the leverage is possible and practical, a dividend
decision regarding using the retained earnings to pay dividends to shareholders
can be explored.
2. Sale of Assets
Another internal source of finance is the sale of assets. Whenever a business
sells off its assets and the cash generated is used internally for financing the
capital needs, we call it an internal source of finance by the sale of assets.
Advantages of Generating Finance by Sale of Assets
It can work as a short-term or long-term finance depending on what kind of
assets are sold. Say, selling a car can cater to short-term and smaller finance
BUSINESS FINANCE Notes Prepared by Mr. Antony Ambia Page 2
