Why business needs finance

Finance is the life blood of business: no business can start, run or grow without money. A business needs funds for three things:

• Fixed capital: to buy fixed assets, such as land, buildings and machinery. You spend on them once, and they serve the business for years.
• Working capital: to hold current assets (stock, money owed by customers, cash) and to pay day-to-day expenses such as wages and rent.
• Growth: to modernise and expand.

How much working capital a firm needs depends on how it works. A firm that sells on credit, or whose stock turns over slowly, has its money tied up longer, so it needs more working capital.

Sources of funds can be classified in three ways:

• By period: long term (more than 5 years), medium term (1 to 5 years) and short term (up to 1 year).
• By ownership: owner's funds, the money the owners themselves put in and leave in, on which they bear all the profit and loss; and borrowed funds, money taken from outside for a fixed time and repaid with interest. A bank loan of ₹1 lakh for 2 years at 5 per cent must be repaid after 2 years together with the interest.
• By source of generation: internal sources, from within the business (such as profits kept back); and external sources, from outside (such as banks or the public).

The golden rule: long-term needs should be met from long-term sources, and short-term needs from short-term sources.