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Finance is a key aspect of every business and is required to run, expand and continue business operations. As a business owner, it is important that you understand what is business finance and its role in business.
Most businesses, especially MSMEs and emerging businesses often face financial challenges. Inability to increase sales revenue, lack of timely payments from customers, unforeseen expenses – business and finance can be said to have an inseparable co-dependence.
Whether you consider taking an offline or online business loan or want to bootstrap your business, this article on the meaning, scope, function and importance of business finance will enable you to plan and manage your finances better.
What is business finance?
Let us first understand the meaning of business finance. Business finance refers to the funds or finance that the business has.
Raising capital for business is one aspect of business finance. The second aspect is efficiently managing the finance to run the business. There can be multiple sources or ways funds can be raised:
- Bootstrapped or self-finance by business owner
- Funding availed through business loans (e.g., term loans, working capital loans etc.)
- Financial aid through MSME loan schemes by the government etc.
- Business profits and cash flow
- Investments made by business
Similarly, the part of managing finance would involve – financial planning, financial control and monitoring spends, analysing financial investments, evaluating risks, financial forecasting etc.
In small businesses, sole proprietorships and even LLP businesses, financial operations are usually overseen by the business owner. There’s usually a finance manager or similar designatory who manages the books of accounts, cash flow, budgeting and other financial transactions, and makes relevant financial decisions for the business.
Why business finance is important – Benefits
Finance is required for business operations. Lack of transparency, knowledge of financial systems and operations, and improper alignment between finance and business goals can often lead to mismanagement.
As such, the benefits and importance of business finance cannot be overemphasised. Let us take a look at them:
- Business growth and expansion:
Funds enable MSMEs to grow. Whether it is to expand to new markets, try marketing and promotional campaigns, or buy equipment, inventory, or manage daily operations, adequate finance enables smooth operations and growth. There are several banks and NBFCs offering machinery loans, working capital loans more to support MSME growth.
- Asset creation:
Every business should invest to create assets (e.g., land, property etc.). When business is doing well and there is adequate cash flow, relevant assets can be invested in with proper business finance planning. Though this will reduce the cash-in-hand it will build asset providing long-term appreciation.
For MSMEs, this can be beneficial especially if business loans are required at a later stage. Land/property are high-value collateral for business loans that makes loan approvals easier and less risky.
- Financial planning:
Planning can help in every aspect of business – and financial planning can enable MSMEs to identify which areas to spend in, how to cut costs, how and where to borrow funds, how to expand business and repay funds etc.
For instance, logistics cost is a constant challenge for most business. Analysing logistics expenses can enable MSMEs to plan if building an in-house team or logistics outsourcing is more cost-effective. Funds can accordingly be saved, allocated and invested to strengthen supply chain and logistics (instead of going for inventory loans or commercial vehicle loans).
- Risk mitigation:
Risks and unforeseen challenges are inevitable to every business. Business finance management will enable businesses to function seamlessly even when facing challenges. Moreover, having a strong financial health will enable you to take calculated risks without affecting operations. It will also enable you to try new experiments, adopt technology, and do more in a planned manner.
How to get finance for business?
There can be little debate on why finance is important to run a business. As a small business owner it is critical for you to understand how to raise and manage funds for your business. The decision to borrow money from commercial banks, or to find an investor, or to go for a small business IPO is a crucial decision that will impact how your business operates.
But, before that, there’s looking how you can get finance for your business.
Types of business finance
There are mainly two types of business financing options that you can avail in India:
- Equity finance:
In this form of business financing, external investors invest funds into the company in exchange of shares of the company. They may not be directly involved in the day-to-day operations of the business, but have their say over strategic business decisions.
When the company runs into profits, they earn their percentage of profits based on the shares they have. Many start-up businesses often debate between equity finance or business loans based on the terms of the agreement, loan interest rates, EMIs and more.
- Debt finance:
The second option of financing your business is through debt. It refers to borrowing funds from lenders (e.g., banks and NBFCs) and repaying them on scheduled dates. The befit of debt financing for business is that the ownership of the business remains with you. The lenders provide you with the funds you need for business growth, charge a standard rate of interest on business loans, and give you the freedom to run the business how you like to.
Sources of business finance
As a business owner/start-up entrepreneur it can be daunting to decide how you want to fund your business. As mentioned earlier, there are different sources to fund your business.
- Government loans:
The government is encouraging new businesses and MSMEs to grow and scale. Based on different business requirements, there are different government MSME loan schemes available (online and offline) that you can avail to grow your business.
For instance, the Pradhan Mantri MUDRA Yojana scheme offers loans up to ₹10 lakh based on the credit facility requirement and growth stage. Under the Stand-Up India scheme, SC/STs and women entrepreneurs can avail loans between ₹10 lakh and ₹1 crore for greenfield business.
- Borrowing from friends/family
This mainly refers to borrowing sums from friends and family to run business. This is commonly seen in the start-up ecosystem in India where friends invest/lend money to other friends to start their business. Risks are naturally high and since the lending is not based on any stringent legal parameters.
- Asset based funding
One can even avail long term loans by pledging their assets, mainly land and property. As mentioned earlier, land or property can be pledged as collateral during borrowing external funds. You should however ensure that the asset is not pledged for any other loan and that the documentation is in place. Also, as a best practice refrain from pledging personal assets for business loans. This reduces the risks of losing the asset in case of defaulting repayments.
- Unsecure business loans
Another source of finance in business that’s gaining popularity among small and emerging businesses is collateral-free unsecured business loans. Since MSMEs often do not have the assets to pledge as collaterals, this type of business loan is suitable for them. These are usually small value, short term loans, offered based on the creditworthiness of the borrower and the business’s financial health. For example, business loans for traders is provided to borrowers from the trading community.
Wrapping up: How to manage finance for your MSME
We’ll close discussions by sharing some tips and strategic inputs on how you can manage business finance for your MSME.
- Keep track of all expenses and spends made – You can use Excel sheets or any bookkeeping tools to record and track inflow and outflow of cash. The important thing is to maintain this data for analysis and insights.
- Forecast and plan your finances – As a business owner, though there are times you will have to make prompt spends, the goal should be to forecast and plan your finances.
- Budget your finances – Maintain a budget for all activities, whether it is purchase of raw material, rent on leased property, hiring of new talent, or any other. Budgeting will prevent you from going overboard and avoid unnecessary expenses.
- Consider multiple options of borrowing: There will be times when you will have to seek business loans. To ensure that you do not default on repayments, consider all borrowing options (e.g., business loan refinancing, bank overdraft etc.) to ensure business finance is maintained in the long run.
- Get strategic financial advice – Financial management might not be your key strength. As such, hire a professional financial advisor to help you to plan, map and manage finances. Though this is a slightly expensive investment, the ROI is equally high.