Financing a firm properly is a critical element for business success. Many potentially successful firms have failed because they were undercapitalized. Let’s know the uses of capital in the business.
Few things are as difficult to accept as having to close the doors because the entrepreneur lacks a few hundred dollars and can’t find the money anywhere.
That’s why they use of capital in business is an essential part of business planning. If follows, then, every firm should be planned with a clear and positive understanding of two items:
- What the source of the funds will be?
- What funds will be needed?
The amount needed can be determined by developing a statement of assets to be used. While this document is being prepared, the entrepreneur will need to plan carefully to be able to provide for three things:
Uses of capital in the business
- Enough capital to support one to three months of operation
- Enough capital to pay the purchase or start-up costs,
- Some extra capital to cover unplanned expenses (perhaps as much as 10 to IS percent of the purchase price)
When the amount of the net ownership capital needed has been determined the proprietors turn to the problem of making sure the entire amount is available. The total sum should preferably be deposited in the company’s bank account before any commitments are made by the new owners.
When several sources of capital are available, the planners must still bear in mind that all sources may not be equally desirable. Borrowed capital is shown on the balance sheet as a liability. It must be paid back at specific periods.
These payments are not operating expenses, which are deducted from the income statement before planned profits are produced.
They are payments for the provision of investment capital and are to be paid out of the profits shown on the income statement. Failure to recognize this basic fact is the most common cause of financial strain among small firms. It is important, therefore, to consider the repayment schedules in choosing among sources of financing.
The various types of financing available to business firms are usually classified as:
- Short-term capital: This is borrowed capital Thai is to be repaid within 1 year.
- Intermediate capital: This is borrowed capital that is to be repaid in 1 to 5.
- Long-term capital: This is capital whose repayment is arranged for more than 5 years in the future. As new firm planners review the sources of financial assistance that follow, they may find that some of the sources fall into different categories of the above list.
For example, a note payable to a commercial bank is generally considered short-term financing, but a 3-year note payable to a finance company would be considered intermediate capital.
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