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What is Finance?

Finance is the process of managing money and includes activities such as investing, borrowing,
lending, budgeting, saving, and forecasting. In a business context, finance helps organizations raise
the funds they need to operate and grow, while ensuring proper control and allocation of those
funds. It ensures efficient use of resources and helps in achieving business objectives. Finance is
important for maintaining cash flow, funding expansion, managing risk, and increasing shareholder
value. Without finance, businesses cannot survive or grow.

🔹 Functions of Finance

Finance plays a key role in the successful operation of any business. It supports both day-to-day
operations and long-term planning. The major functions of finance are as follows:

1. Financial Planning and Forecasting

This function involves estimating future financial needs, including capital and operational
expenses. Proper financial planning ensures that the business has adequate resources to
meet its goals. For example, a company may forecast its cash needs for the next quarter to
plan inventory purchases.

2. Capital Structure Management

Capital structure refers to the mix of debt and equity used to finance business operations.
Financial managers decide how much to raise through loans (debt) and how much through
share capital (equity). The right mix reduces costs and maximizes returns. For instance, a
business might use 60% debt and 40% equity to fund a new factory.

3. Investment Decision (Capital Budgeting)

This involves evaluating where to invest the company’s funds to earn the best returns.
Financial managers assess various projects like expanding a factory or launching a new
product. For example, choosing between building a new production unit or investing in R&D
is part of capital budgeting.
 4. Working Capital Management
Working capital is the money needed for day-to-day business operations. This function
ensures there is enough cash to pay bills, buy raw materials, and manage receivables.
Effective working capital management keeps the business running smoothly and avoids cash
shortages.

5. Financial Reporting and Control

Finance departments prepare financial statements like the balance sheet, income statement,
and cash flow statement. These reports help stakeholders understand the company’s
financial health. They also ensure compliance with laws and regulations. For example,
quarterly financial reports are used by investors to make decisions.

6. Profit Allocation and Dividend Policy

After profits are earned, finance managers decide how to use them. A portion may be
reinvested in the business (retained earnings) and another portion paid to shareholders as
dividends. For instance, a company may retain 70% of its profits and declare 30% as
dividends.

7. Risk Management
Finance functions also involve identifying and managing financial risks like market
fluctuations, credit risk, or currency changes. Strategies such as insurance, hedging, and
diversification are used to minimize risks. For example, an exporter may hedge against
currency fluctuations to protect profits.

8. Fundraising and Capital Acquisition

One of the core finance functions is to raise capital through various sources like loans,
equity, or public deposits. The finance team identifies the best source based on cost, risk,
and time. For example, a business may approach a venture capitalist to raise ₹5 crores for
expansion.

Each of these functions ensures that financial resources are effectively allocated and used to achieve
business success and sustainability.

🔹 What is Finance?
Finance is the process of managing money and includes activities such as investing, borrowing,
lending, budgeting, saving, and forecasting. In a business context, finance helps organizations raise
the funds they need to operate and grow, while ensuring proper control and allocation of those
funds.
🔹 Types of Finance on the Basis of Nature

Retained Earnings
Retained earnings refer to the portion of a company's profits that are not distributed to
shareholders as dividends but are instead reinvested in the business. These funds can be used for
expanding operations, purchasing new equipment, or funding research and development. Retained
earnings help reduce dependency on external sources of finance. For example, a company that earns
₹10 lakhs in profit might reinvest ₹6 lakhs into new machinery. This approach increases self-reliance
and strengthens the company's financial base.

Debt Capital
Debt capital is money that a business borrows and agrees to repay with interest. Common sources
include loans from banks, issuing bonds, or borrowing from financial institutions. Debt capital is
useful for funding large investments or operational needs. For example, a manufacturing company
may take a ₹2 crore bank loan to build a new factory. While it must be repaid, interest payments are
often tax-deductible. However, excessive debt can increase financial risk.

Equity Capital
Equity capital is raised by selling shares of the company to investors or shareholders. Investors gain
partial ownership and may receive dividends based on the company’s performance. This capital does
not require repayment, which reduces financial pressure. For instance, a startup raising ₹1 crore by
offering 20% ownership is using equity capital. However, it dilutes the control of the original owners.
It is typically used for long-term business growth.

Other Sources
Other sources of finance include alternative or non-traditional methods.

 Crowdfunding: This involves raising small amounts of money from many individuals, usually
via online platforms. For example, a tech startup may raise ₹10 lakhs on Kickstarter to fund a
new product.

 Grants and Subsidies: These are funds given by governments or institutions without the
need for repayment. For instance, a textile unit may receive a ₹5 lakh subsidy for installing
eco-friendly machinery. These sources are attractive because they reduce financial burden
and risk.
🔹 Types of Finance on the Basis of Term

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Long-Term Sources of Finance**

Equity (Selling Shares)

Equity is raised by issuing shares to investors. It provides permanent capital to the company.
Shareholders become co-owners and share in profits through dividends. There's no repayment, but
it dilutes control. For example, a company sells shares worth ₹5 crores in the stock market to build a
new plant. Equity is ideal for long-term projects and expansion.

Debentures (Company Bonds)

Debentures are long-term debt instruments used by companies to borrow funds from the public or
institutions. They carry a fixed interest rate and repayment schedule. For example, a company issues
5-year debentures at 8% interest to raise ₹2 crores. Debenture holders are creditors and do not own
any part of the business. It helps raise funds without affecting ownership.

Bank Loans (Repay Over Years)

Long-term bank loans are borrowed funds repayable over several years. These are secured or
unsecured and usually used for purchasing land, machinery, or infrastructure. For example, a factory
takes a 10-year loan of ₹1 crore to upgrade its operations. The company pays interest and
installments regularly. Banks may require collateral and business plans.

Retained Earnings (Company Profits)

This internal source of finance involves reinvesting profits into the business rather than paying them
to shareholders. For example, a firm with ₹50 lakhs profit may use ₹15 lakhs to open a new branch.
It is cost-free, does not create debt, and builds investor confidence. It also reflects the company’s
financial health.

Venture Capital (Investor Funding)

Venture capital is money provided by investors to startups and small businesses with long-term
growth potential. In return, VCs get equity and often help manage the company. For instance, a tech
startup receives ₹2 crores from a venture capital firm to develop its app. It is high-risk but offers high
returns to investors. Ideal for innovative startups.

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** Short-Term Sources of Finance**

Trade Credit (Supplier Credit)

Trade credit is when suppliers allow businesses to buy goods and pay later, usually within 30-90
days. For example, a textile retailer receives fabric worth ₹5 lakhs on credit and pays after two
months. It helps manage working capital without interest. This is a common source of short-term
finance.

Bank Overdraft (Withdraw More than Balance)

A bank overdraft allows a business to withdraw more money than it has in its account, up to a set
limit. For example, a company with ₹1 lakh in its account can withdraw ₹1.5 lakhs using an overdraft.
It is useful for managing temporary cash shortages. Interest is charged only on the amount used.

Short-Term Loans (Repay within a Year)

These are loans taken for short durations to meet urgent needs like inventory or salary. For example,
a business may take a ₹3 lakh loan for six months to manage festival sales stock. It requires quick
repayment and often has higher interest rates. These are provided by banks or NBFCs.

Accounts Payable (Delayed Supplier Payments)

Accounts payable is the amount a company owes to suppliers. Delaying payments without penalty
helps in maintaining liquidity. For example, a manufacturing unit delays a ₹2 lakh payment for 60
days. It’s a spontaneous form of credit. However, it must be used responsibly to maintain supplier
trust.

Invoice Discounting (Selling Invoices for Quick Cash)

Invoice discounting is when a business sells its unpaid customer invoices to a financial institution at a
discount. For example, if a firm has a ₹10 lakh invoice due in 45 days, it can get ₹9.5 lakhs instantly
through discounting. It boosts cash flow and is useful for businesses with long payment cycles.