Finance Functions Definition Types Business Examples

Finance Functions Definition

Finance is the lifeblood of any business; without proper financial resources, no business can run smoothly; the finance processes can be related to planning, execution, control, and maintenance of financial resources. Moreover, its scope is ever increasing; it widens as the company grows because larger companies have the resources to support the increase in functions.

Key Takeaways

The finance function in business refers to the functions intended to acquire and manage financial resources to generate profit.It produces relevant financial resources and information contributing to the productivity of other business functions, planning, and decision-making activities.The four major types of financial decisions are investment, liquidity, financial, and dividend decisions.

Types of Finance Functions

There are different classifications for finance functions, and it varies with organization types. The finance department functions like bookkeeping, budgeting, forecasting, and management of taxes, and the finance manager functions like financial report preparations contribute to the overall financial wellbeing of an entity. Let’s look into some of the popular classifications.

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Investment decision

The investment decision function revolves around capital budgeting decisions. Capital budgeting in an organization involves the analysis of investment opportunities, specifically long-term projects, and associated cash flowsCash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more, to determine the profit potential. They revolve around making a sound investment that must ripe sufficient and sometimes maximum returns for the business in the long run. Hence these decisions are challenging and complex. Payback Period, Net Present Value (NPV) Method, Internal Rate of Return (IRR), and Profitability Index (PI) are the popular methods to carry out capital budgeting.

Financing decision

Expertise in forming financing decisions leads to optimized capital structure, enhanced performance, and growth. Financing functions deal with acquiring capital (like when and how) for the various functioning of the entity, like whether to use equity capitalEquity CapitalEquity Capital refers to the capital collected by a company from its owners and other shareholders in exchange for a portion of ownership in the company.read more or debtDebtDebt is the practice of borrowing a tangible item, primarily money by an individual, business, or government, from another person, financial institution, or state.read more to finance business events. The debt and equityEquityEquity refers to investor’s ownership of a company representing the amount they would receive after liquidating assets and paying off the liabilities and debts. It is the difference between the assets and liabilities shown on a company’s balance sheet.read more mix of an entity are called its capital structureCapital StructureCapital Structure is the composition of company’s sources of funds, which is a mix of owner’s capital (equity) and loan (debt) from outsiders and is used to finance its overall operations and investment activities.read more. The financing decisions always focus on maintaining good capital structure ratios.

Dividend decision

Companies share profits with their shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company’s total shares.read more in the form of dividends. There are different types of shares, shareholder’s dividends, and dividend policiesDividend PoliciesDividend policy is the policy that the company adopts for paying out the dividends to the company’s shareholders, which includes the percentage of the amount at which the dividend is to be paid out to the stockholders and how frequent the company pays the dividend amount.read more. Furthermore, a company’s dividend policy influences the company’s market value and stock prices. Hence dividend decision, including the division of net incomeNet IncomeNet income for individuals and businesses refers to the amount of money left after subtracting direct and indirect expenses, taxes, and other deductions from their gross income. The income statement typically mentions it as the last line item, reflecting the profits made by an entity.read more between dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more and retained earningsRetained EarningsRetained Earnings are defined as the cumulative earnings earned by the company till the date after adjusting for the distribution of the dividend or the other distributions to the investors of the company. It is shown as the part of owner’s equity in the liability side of the balance sheet of the company.read more, is an important function.

Liquidity decision

Liquidity decision generally revolves around working capitalWorking CapitalWorking capital is the amount available to a company for day-to-day expenses. It’s a measure of a company’s liquidity, efficiency, and financial health, and it’s calculated using a simple formula: “current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)“read more decisions and management. Therefore, the priority is managing current assets to follow the going concern conceptGoing Concern ConceptGoing Concern concept is an accounting principle which states that the accounting statements are formulated with a belief that the business will not be bankrupt or liquidated for the foreseeable future, which generally is for a period of 12 months.read more. The lack of liquidity results in issues like financial crisisFinancial CrisisThe term “financial crisis” refers to a situation in which the market’s key financial assets experience a sharp decline in market value over a relatively short period of time, or when leading businesses are unable to pay their enormous debt, or when financing institutions face a liquidity crunch and are unable to return money to depositors, all of which cause panic in the capital markets and among investors.read more and insolvenciesInsolvenciesInsolvency is when the company fails to fulfill its financial obligations like debt repayment or inability to pay off the current liabilities. Such financial distress usually occurs when the entity runs into a loss or cannot generate sufficient cash flow.read more. At the same time, a lot of liquidity can also lead to more danger. Hence, it is important to have the right mix of current assetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more and current liabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They’re usually salaries payable, expense payable, short term loans etc.read more.

Examples

Example 1

Let’s look into a finance function scenario and the application of technological evolutions like business intelligence into the functions of an organization.

Tax deadline extensions are usually beneficial to financial functions. They want deadline extensions due to the impact created by finance functions following legacy systems, heterogeneous information sources, manual-intensive tasks, etc. Finance and accounting teams must view data as a prime factor in improving these operations. Organizations may exploit data efficiently. It is possible by integrating human expertise with big data, artificial intelligence (AI), machine learning (ML), blockchain, and cognitive computing.

Techniques like automation and artificial intelligence can reform finance functions. Robotic process automation (RPA) contributes to efficiencies and creates value for the organization. Incorporating a business intelligence process to develop a digital tax function that provides benefits like real-time reporting can improve the output of financial functions. RPA and intelligent workflows can optimize the tax accounting process, AI data mining can identify potential tax fraud or errors, and a unified view of tax data can boost the time spent on analysis and review.

Example 2

Generally, finance processes focus on cost controlCost ControlCost control is a tool used by an organization in regulating and controlling the functioning of a manufacturing concern by limiting the costs within a planned level. It begins with preparing a budget, evaluating the actual performance, and implementing the necessary actions required to rectify any discrepancies.read more, operating budgets, and internal auditing activities in small organizations. But for large organizations and MNCs, the process is complex; for example, they engage in profitProfitProfit refers to the earnings that an individual or business takes home after all the costs are paid. In economics, the term is associated with monetary gains. read more repatriation policies of their companies’ subsidiaries, and capital budgetingCapital BudgetingCapital budgeting is the planning process for the long-term investment that determines whether the projects are fruitful for the business and will provide the required returns in the future years or not. It is essential because capital expenditure requires a considerable amount of funds.read more decisions and valuation must reflect divisional differences and the complications introduced by currency tax and country risks. In addition, incentive systems need to measure and reward managers operating in various economic and financial settings. Finally, global exposure presents new challenges, and some companies recruit finance professionals specifically to rotate globally.