Business finance, also known as corporate finance in the business world, is responsible for allocating resources, creating economic forecasts, reviewing opportunities for equity and debt financing, and other functions within your organization. In general, some small businesses may not have a large business finance department but nonetheless will have these functions operating throughout the company. Where the function does not exist in-house, you might rely on advice from outside sources to make financial decisions about your business.
Business Finance Formulas
Generally, business formulas provide specific information related to investments made for growth opportunities and business operations. Each formula can help you compare the total cost of business decisions that can impact your organization financially in terms of profits or losses. A good practice is to set the minimum return percentage higher to give yourself a buffer. This helps to make sure your organization achieves maximum profitability.
Formulas are commonly used in various business finance functions to determine such things as return on investment, net present value and payback period. Generally, ROI formulas look at the total gain from an investment minus investment costs, which is divided by initial investment costs. This formula is important to help you ensure the long-term viability of your organization.
Net present value formula is used to determine the present value of cash inflows and future cash inflows from capital budget projects, which is discounted back to the present dollar value. As an example, assume that you wanted to expand your operations to another store across town. Future cash flow estimates for the additional location is projected at $500,000. The current owner of the store wants to sell it for less than $500,000. You would want to make that purchase because it would be a positive NPV investment.
For the payback period, you are using a basic calculation to divide initial capital inlay for a project by the number of months it would take to recuperate that amount. This formula is calculated as the cost of a project divided by the annual inflows of your organization. Typically, this is important to determine because the longer it takes to recover costs, the less desirable it is to begin a project.
Misconceptions and Considerations
In general, you should not rely solely on formulas when you need to make business decisions such as assessing new growth opportunities. For some businesses, a qualitative analysis can round out the decision-making process by including expertise and personal experience. You could use survey results, your organization’s brand image, or any other type of non-measurable data.
With qualitative analysis, you apply subjective information that cannot be quantified when determining whether an opportunity makes good business sense. This is not to say that qualitative analysis trumps the use of formulas. Rather, an additional analysis tool might give you a greater level of comfort when you make a final decision.
Business Finance Establishes Facts
The good thing about business finance is that mathematical or statistical formulas can create factual financial results related to business information. Internal business formulas are typically based on how you can eliminate waste and maximize production output in operations. For external business finance formulas, you examine potential opportunities that are associated with goals and objectives. You can also establish facts based on current economic conditions and whether the market is ready for your product or plan.
Helps to Set Financial Goals and Strategies
With every business, there is a bottom line that flows directly from organizational goals. By using business finance, your organization can define financial objectives to determine what success looks like in the bottom-line. Financial goals tell you whether you are reaching the threshold of profitability, or if after consistent efforts the organization remains stagnant.
Well-designed strategic planning efforts will give your organization a blueprint for achieving profitability. Financial strategies tie back to organizational goals. Therefore, business finance is responsible for making sure your organization has a plan for meeting bottom line targets.
Guides Financial Planning
Another function of business finance for your organization is to guide financial planning. Where financial goals determine profitability, financial planning determines how much you need to operate on and have in reserves for slow periods. Financial planning also determines where operating dollars come from, such as business loans or revenue. Also part of financial planning is how to allocate and spend the money.
Sets Budgets and Forecasting
Financial planning leads to the next function of business finance, which is budgeting and forecasting. Budgeting is a popular financial planning tool that comes from forecasting efforts. Generally, you prepare budgets with multiple line items that represent the dollar value of how much money is allocated for a particular expense. Most – if not all – organizations find that creating and adhering to a budget is useful in keeping financial activity on track. Just like in personal finances, a budget will gauge spending and saving habits that could help or hinder financial goals.
Forecasting acts as a predictor in calculating what the future financials of your organization may look like. Under business finance principles, forecasting determines what your sales volume might be and any capital expenses that may arise. Financial forecasts are of particular interest to investors and stakeholders. This type of data informs investors and stakeholders of the profitability of your organization.
Additionally, the use of forecasting techniques can also assess financial risks. Stakeholders might withdraw their investments when forecasts show less than promising financial and risk is elevated. You can use forecasts to develop new strategies that could help the future growth of your organization and make it more appealing to investors.
Assists with the Bookkeeping Process
Depending on the size and complexity of your organization, the bookkeeping process can be short or long. You could have a simple process to chronicle financial transactions that occur, or you might have a complicated system to record, analyze and interpret day-to-day transactions.
Provides Accurate Reporting
If you received outside financing or have shareholders, you will automatically have standard external reporting requirements. These external reports focus on how shareholders, lenders, and the general relates to your organization. Reports on budgeting and data forecasting are used by stockholders to determine the right time to buy and sell. The entire process relies on accurate data for making such decisions.
Manages Payables and Receivables
Using business finance to manage payables and receivables is a natural part of running your organization. Generally, you will have a finance department – whether it is several staff positions or a one person operation – to manage cash inflows and outflows. Creditors, vendors and employees expect prompt payments. You need the right amount of liquidity to keep operations running smoothly.
Business Finance Functions are Important for Your Organization
So much of how your organization operates on a daily basis is connected to following business finance functions. Although separate, the goal of any function within finance is to achieve three essential benefits: low costs, business support and control the environment effectively. Cash is king and money is the lifeblood of an organization that wants to excel. Innovation focuses on vision-oriented, intuition, risk-taking and growth opportunities. Finance is required to create strategies that help you bring opportunities into fruition.
The success and growth of your organization is greatest when there are procedures and principles to follow. In general, business finance represents the backbone of your organization. Unless information is timely and accurate, the entire operations could fall to pieces.
