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Business Finance
Principles of Business
Topic Eight

Business Finance

Business finance is a term that encompasses a wide range of activities pertaining to the management of money and other valuable assets Small business owners must have a solid understanding of the principles of finance to keep their companies profitable.

The Financial Sector - The financial sector can be defined as the interaction of lenders and borrowers in financial markets within a regulatory framework. Key in this interaction is lending and borrowing of financial capital or money. This lending and borrowing is usually achieved through financial intermediaries such as commercial banks, brokers and other financial institutions. 

Financial institutions provide services of financial intermediation between lenders and borrowers. The financial institutions of most economies include:

  • Central Bank
  • Commercial banks,
  • Stock exchange,
  • Insurance companies,
  • Credit unions,
  • Mutual funds,
  • Development banks,
  • Building societies,
  • Informal credit institutions,
  • Investment trust companies,
  • Deposit insurance corporation.
  • Financial services commissions.

Role of Commercial Banks

The main functions of commercial banks are:

Mobilizing Saving for Capital Formation - The commercial banks help in mobilizing savings through network of branch banking. They allow citizens to deposit their monies into the commercial banks and pay these depositors a rate of interest. These commercial banks then use these deposits to lend to businesses and individuals in society.

Financing Industry - The commercial banks finance the industrial sector in a number of ways. They provide short-term, medium-term and long-term loans to industry.

Financing Trade - The commercial banks also help in financing both internal and external trade. The banks provide loans to businesses which assist in the provision of goods and services in the economy.

Financing Consumer - People in less developed countries having low incomes do not possess sufficient financial resources to buy durable consumer goods. The commercial banks advance loans to these consumers for the purchase of such items.

Services Offered by Commercial Banks

Here is a brief description of each type of account:

Savings Accounts - These are intended to provide an incentive for you to save money.

Advancing of Loans - Banks are profit oriented business organizations. So they have to advance loan to public and generate interest from them as profit. 

Foreign Currency Exchange - As the requirement of customers, banks exchange foreign currencies with local currencies, which is essential to settle down the dues in the international trade.

Functions of the Central Bank

A central bank is a monopolized and often nationalized institution given privileged and control over the production and distribution of money and credit. The main functions of a central bank include:

  • Issuer of notes and coins – the Central Bank is the only issuer of notes and coins in a
  • Banker’s bank- the Central Banks is the facilitator of loans to commercial banks;
  • Government’s bank- the Central Bank acts on behalf of the government for all financial transactions. Additionally, if the government needs loans the Central Bank facilitates this;
  • Management of the economy – the Central Bank usually assists the central government in managing the economy through monetary policy.
  • Lender of last resort - if commercial banks get into liquidity shortages meaning that they cannot honour their financial obligations, then the Central Bank is able to lend the commercial banks sufficient funds to avoid the bank running short of money.

Sources of Short Term and Long Term Finance

Businesses need financing in order to achieve the goals and objectives of the business enterprise. Financing is often called capital and there are two main forms of capital:

  • Debt – which is borrowing and;
  • Equity which is the selling of shares in order to raise the required capital of the business.

The sources of financing can either be short term or long term. There are different vehicles through which short-term and long-term financing is made available. 

Short-term financing is financing with duration of up to one year. Short-term financing can be done using the following financial instruments −

  • Personal Savings and other "nest-eggs" – a business owner will often invest personal cash balances into a start-up. This is a cheap form of finance and it is readily available.
  • Bank Loans – in this case a fixed amount of money is borrowed by the business owner from lending institutions including commercial banks and even credit unions.
  • Overdraft – an overdraft is an extension of credit from a lending institution when an account reaches zero.

Long-Term Financing

Long-term financing is usually granted to businesses that are in large-scale operations that need large and heavy equipment. Such financing arrangements will be of a longer term in nature and much more complicated. The following are some of the sources of long-term financing:

  • Bonds or Debt Financing – the business can also borrow in the form of the issuance of bonds on the financial market. When the business issues a bond, this bond is sold to members of the public; the business which is issuing the bond is therefore borrowing from the public.
  • Equity Financing – Equity financing involves the selling of shares of the business to investors. This will mean that the persons who are purchasing shares of the business will be purchasing portions of the business.
  • Business angels – Business angels are professional investors who typically invest in your business.
  • Venture capital – is a specific kind of share investment that is made by funds managed by professional investors. Venture capitalists rarely invest in genuine start-ups or small businesses. Private equity is another term for venture capital.

Savings and Investments

Saving and investing are both equally important to individuals and businesses. Savings are usually done to achieve short term payment goals and needs and are low risk in nature. Investments are made with the aim of making larger profits and, therefore, involve bearing higher levels of risk.

The following are the different forms of savings in the Caribbean:

  • Deposits at Commercial Banks – both individuals and businesses deposit monies at commercial banks.
  • Credit Unions – savings can also be done through credit unions.
  • Mutual Funds – a mutual fund is a professionally-managed trust that pools the savings of many investors and invests them in securities like stocks, bonds and short-term money market instruments
  • SouSou – besides formal financial institutions, there are also some informal financial institutions and a very good example is that of a SouSou which is also known as box, syndicate or partner in other Caribbean territories. Sousou which is usually headed by one person, allows members to deposit money who reap the rewards of a return of their monies at some later date.

Accounting for the Sole Trader

The following are the main accounts for the sole trader:

Balance Sheet

The balance sheet of statement of financial position reports the financial position of a business, including a sole proprietorship, at a specific point in time.

Statement of Financial Performance

The statement of financial performance, also known as the income statement or trading account, reports the results of earnings activities for a specific time period, such as a month, quarter or year. The net income of the sole proprietorship is the excess of revenues over expenses for that time. If expenses exceed revenues, the sole proprietorship incurs a net loss. Revenues are the increases in owners' capital from the sale of goods or the performance of services. Other types of revenues include interest, dividends and rental income. Expenses are the costs incurred in the course of carrying out the business.

Statement of Cash Flows

The fourth financial statement of a sole proprietorship is the statement of cash flows, which describes where the cash came from and where it went during the period.