The organizational structure of a business is divided into various departments such as management department, purchasing department, sales department, accounting department and finance department etc. All the business functions of the organization are managed through the coordination of these departments. But among these departments the most important department is finance department, it has communication with other departments. Below are discussed the functions of finance:
1) Fund Raising
One of the tasks of a financial manager is to identify low-cost potential sources and raise the necessary funds from there. The main function of financing is to determine how much of the money required to invest in a project will be financed through own equity and how much debt capital. The mix of owners’ own capital and borrowed capital is called capital structure. The mix that costs the least is the preferred mix. And it is the job of finance to determine that. By balancing the returns and risks of the shareholders in the company, the company’s share price or shareholders’ wealth can be maximized when maximum profit can be achieved with minimum risk in the fixed capital mix. The financial manager constructs the desired capital structure by balancing profit and risk. It is the job of the financial manager to systematically raise the required funds by meeting the terms and conditions for financing. In this case, different conditions imposed for raising money from different sources have to be considered.
2) Capital Budgeting Decisions
Capital budgeting decision refers to identifying, analyzing and selecting a project. That is, capital budgeting means making long-term investment decisions. How much capital is required for a project, duration of the project, future expected income from that project, uncertainty of income etc. are taken into consideration and investment decisions are taken. Therefore, one of the functions of financing is to verify the financial feasibility of the project through capital budgeting before long-term financing.
After collecting the funds, investing in the most profitable projects is also very important for financing. Such decision is also the cost of purchasing production-oriented machines, building factories for manufacturing companies. Let’s say ABC LLC is considering purchasing a new machine. The life of the machine will be 10 years. To determine the cash flow, we must first determine the sales volume over the next 10 years. Cash inflows are determined after deducting production costs and other expenses from sales revenue. The future is always uncertain. Important factors in ABC LLC’s machine purchase decision are sales volume, product pricing, etc. over the next 10 years. Because changes in demand in the future result in changes in sales volume.
3) Current Asset Management
An organization has two types of assets, fixed and current. Fixed assets should be combined with current assets to invest money. For this, to achieve the goals of any business organization, working capital management has to be managed properly. In the case of investment in working capital, the main task is to balance the profitability and liquidity of the company. Short-term asset management refers to the management of an organization’s cash, inventories, accounts receivable, etc. The decision regarding how much money can be raised for the purchase of raw materials is called current investment decision. If a company invests more in working capital or if the capital is underutilized, the profitability will decrease. Again, if the amount of financial investment in current assets decreases, then the company has difficulties in paying its current debts. This increases the risk. Therefore, the investment decision in current assets should be taken in such a way that the profit earning capacity does not decrease, and the risk related to the inability to repay the debt is not faced. The main components of working capital are cash funds, inventories of raw materials or manufactured goods, sundry debtors, accounts receivable, etc. Capital required for running the day-to-day operations of a business is called short-term or working capital. Components of current capital are current assets and current liabilities with a maturity of 1 year or less.
4) Distribution of Funds/Profits
If there is profit in the current business, it is distributed among the owners. This is called dividend. It serves as a source of financing for business expansion. It is decided how much of the profit earned will be distributed among the shareholders and how much will be retained in the company. Therefore, the dividend payout ratio that can maximize the share price while keeping the company’s share owners satisfied and having the resources to take advantage of future investment opportunities is the optimum dividend payout ratio. Moreover, the sustainability of the company’s dividend payments and the payment of bonus shares and cash dividends have to be carefully considered.
So, distribution of funds means paying dividends to priority shareholders, dividends to shareholders, interest to creditors and taxes to the government from the profits earned. Deciding how much of profits to distribute as dividends and how much to retain is called dividend policy, which is an important function of finance. Let’s say a company’s profit for the year 2022 was 100 million. If the company decides 60% of the profit as a proportional rate of dividend payment, then the company will pay (100 million x 60%) or 60 million as dividend to the shareholders. In this case, the amount of saved income will be 40 million which the company will have the opportunity to invest in any profitable project in the future. If the entire profit is distributed in the form of dividend, there is no opportunity for future investment. Again, if the dividend is not paid, the shareholders are dissatisfied.
So, the company should take the dividend decision in a way that satisfies the shareholders and also facilitates the achievement of the long-term goals of the company. So, the dividend decision is a matter of financing.
More Resources
Thank you for reading our resources on the Functions of Finance. Enhancing your knowledge more and progressing in your career, you may find the following guides helpful: