Financial Needs of Business

Every business needs capital; it is required at the time of starting a business and also needed when the business is in operation. As an enterprise grows in size and expands its need for finance increases. The capital requirements for business are classified under two main categories. Fixed and working capital.

Fixed Capital

No business can be started without an adequate amount of fixed capital. Fixed capital as the name signifies is the amount of capital invested in various fixed or permanent assets which are necessary for conducting the operation of a business. These fixed assets are land, building, machinery, equipments etc. The fixed assets normally do not change their form and cannot be withdrawn from the business at a short notice. They can, however, be disposed of fixed capital thus are the funds required for the purchase of those assets that are to be used over and over for a long period such as land, building, machinery etc.

Investments in non-current assets such as goodwill, patent rights, copyright, long-term receivables etc also form a part of fixed assets. The amount of capital required for investment in fixed assets varies with the nature of a business, size of business unit and technique of production, large scale industries, like railways, oil drilling operations, hydro and thermal electricity projects etc require fixed capital. Summing up fixed capital comprises of fixed assets and other non-current assets.

• Importance of fixed capital  

The importance of fixed capital can be judged from the fact that a business cannot be made operative without it. Right from the very beginning i.e. conceiving an idea of business, purchase of land, construction of building, purchase of machinery etc needed fixed capital. Further, for the expansion and modernization of machinery also needed essential and an adequate amount of fixed capital in an enterprise.

Working Capital

In balance sheet terms, working capital is the difference between current assets and current liabilities of a business. Current assets are those assets, which in the ordinary course of business, can be converted into cash within a short period of normally one accounting year. Current assets include cash in hand and bank balances, bills receivable, short-term investments, and inventories of stocks. While current liabilities are those which are intended to be paid within a short period of one accounting year out of the current assets. The current liabilities include bills payable, short-term loans, bank overdraft, dividends payable, taxes payable etc.

Working capital also known as circulating capital is the life blood and nerve centre of a business. Working capital is mostly used for the purchase of raw material, payment of wages and bills, seasonal urgent demands of the business, purchase of more goods for sale, meeting the expenses of advertising, providing credit facilities to the customers etc.   

Current assets – Current liabilities = Working capital

500,000 - 425,000 = 75,000

The difference between the current assets and current liabilities is surplus; the business has a positive working capital. In case the difference is negative, then the business has a negative or deficient working capital.  

• Importance of working capital

Solvency of business

Working capital helps in solvency of the business, the flow of production remains uninterrupted.

Good will

The entrepreneur is able to pay wages to the workers and other bills in time. This helps in creating goodwill of business.

Loans on favorable terms

A business with adequate working capital can obtain cash discounts on the purchases. This helps in reducing overall cost.

Enables to face crises

An adequate amount of working capital enables a firm to face business crisis on time.

Regular payment of dividend

A sufficient amount of working capital enables a business to earn profit and pay dividend to investors in time.