Finance means activities related to management, creation and study of investment and money. Small enterprises need money to host various requirements. It is the lifeblood of any enterprise as it is required to assemble the inputs that are land, labor, machinery, staff etc. Finance acts as a lubricant in the process of production. Proper financing is essential for the smooth running of the business.
For a successful running of a business, it is important to have an optimum capital structure that is the ratio of equity and debt capital whereas optimum capital structure means debt capital maybe twice or even more than equity capital in favorable condition, but in an unfavorable condition, debt capital should be as low as possible.
The features of optimum capital structure are:-
- The capital structure should involve minimum cost and maximum yields.
- The adopted fulfill structure should be flexible enough to fulfill the future requirements of the capital as and when needed.
- The use of the debts should be within the repaying capacity of the enterprise.
- Proper control over the affairs of the enterprise should be ensured by the capital structure.
Now, you’ll wonder why over capitalization and under capitalization are not beneficial for the small businesses the simple answer to this is as Over-capitalization signifies a situation when an enterprise possesses an excess of assets about its requirement. Such a situation has its bearing on the earning capacity of the enterprise. In the case of over-capitalization, the actual earnings are lower than is expected. Over-capitalized can be caused due to both internal and external factors.
The various causes of over capitalization are as under:-
- Raising more money by the issue of shares and debentures than what the enterprise can profitably use.
- Acquiring fixed assets on excessive amounts.
- Inappropriate provisions for depreciation and replacement of fixed assets.
- Payment of dividend at a fairly high rate.
- High rates of the taxation imposed by the government.
- Over-estimation of earnings for enterprise concern.
Whereas under-capitalization is just the reverse of over-capitalization. An enterprise is said to be under-capitalized when its actual capitalization is lower than the proper capitalization.
Some of the causes of under-capitalization are:-
- Under-estimation of the initial rate of earning.
- Capitalizing at a lower rate.
- Conservative dividend policy.
Factors Determining Capital Structure:-
Purpose of Financing
In case funds are required for some directly productive purposes, for example, purchase of new machinery, the enterprise may rely on external sources for raising the required funds. In contrast, in case the enterprise is required to raise funds for unproductive purposes like spending on the employees’ welfare facilities, it will have to depend on the owner’s capital.
The ability of a business to discharge its fixed obligations depends upon the availability of cash, i.e., cash flow.
Nature of Business
The business with wide fluctuations in sales need to maintain a smaller proportion of borrowed funds, (i.e.) debt capital. Companies manufacturing televisions, refrigerators, machine tools etc have fluctuations in their sales. On the contrary, the business firms dealing in items/goods having inelastic demand like essential consumer goods may have a larger proportion of borrowed capital because these firms generally have stable earnings.
Size of the Enterprise
Small enterprises have to rely less on borrowed capital and depend more on owner’s capital as investors find small business riskier than large business. Therefore investors feel that their money is safe in the hand of large firms.
It is important to match the use of funds with appropriate funding methods, to do so, financial planning is done. Financial planning means the decision taken well in advance by the entrepreneurs regarding the future financial needs of an enterprise. In other words, the financial forecast made at the time of inception of business is known as financial planning.
Finance is considered as the life-blood of the organization, therefore appropriate financial planning is required as:-
- Financial Planning Creates a Revenue Model
A good financial plan acts as a revenue model which includes calculating potential profit and loss. Tracking your cash flow with that of the financial plan would help to analyze the current position of the business.
- It Provides Logic For Sound Decision Making
Financial plan is a guide for running of the business, it helps to create a realistic strategy with well-defined steps for achieving profitable growth. Appropriate financial planning maintains stability and control.
- To Ensure Availability Of Funds Whenever Required
The main objective of financial planning is that sufficient funds should be available for different purposes such as for the purchase of long term assets, day to day activities, etc. to avoid wastage of resources and avoid the situation of over-capitalization.
Thus, it is important to have a smooth flow of funds and we at SpiderG take all initiatives so that there is no hindrance in the flow of funds as we understand the importance of the optimum flow of funds in the business. We send gentle reminders with payment links to your customers for making timely payments. Customers can make both partial and full-time payments to any bill using multiple options to pay. You can even track the status of pending and as well of the payments that have been received and you would also be notified by an SMS. Hassle in reconciliation? but not anymore! you would have complete records of all your paid, due bills and remove manual glitches. So, just invest all your time for the growth of your business and leave all other worries to us. Spider G will never let you down.
By Vanshika Tandon