Finance and Banking · Classes 9-10 · Chapter 1 · 1.5

Principles of Business Finance.

A grocer ends the day counting the cash from sales. Keep all of it, or bank all of it? Either can go wrong. Three principles tell a business where its money should come from and where it should work.

1. Three principles

Business finance management means managing three jobs: collecting funds as the business needs them, investing those funds for the short and the long term, and distributing them. It follows a few principles.

The book gives three: (a) liquidity versus profitability, (b) competence, also called appropriateness, and (c) diversification of business and risk distribution.

2. Liquidity versus profit

Liquidity is cash in hand, or property that turns into cash easily. The grocer can keep all the cash from sales. Or he can keep some for raw materials and deposit the rest in a bank to earn interest or profit.

Keep a lot of cash in hand and your income from the bank falls, so profit falls. Push the other way, and put a lot into deposits or investment for profit, and daily work gets stuck: a liquidity shortage, a cash crisis. So cash and profit pull in opposite directions.

The grocer holds a month's sales money. Drag the slider to decide how much to keep as cash and how much to deposit in the bank. Each week's raw materials are paid from the cash in hand.

Keeping the two in balance is the liquidity versus profitability principle: a cash reserve for daily expenses on one side, some money invested for profit on the other. The book's figure says the same: high liquidity goes with low profit, high profit with low liquidity.

3. The competence principle

The competence principle, which the Bangla book calls উপযুক্ততার নীতি, says the term of the fund must match the term of the need: acquire current capital with short term funds and fixed capital with long term funds.

Current capital is the money for a business's daily expenses, such as buying raw materials and paying wages. Things like buying machinery and constructing buildings need fixed capital. Sort four items below.

Current capital is small, so it should be managed from regular sales proceeds. Long term loans come from commercial banks, financial institutions, investment banks and debenture holders.

Long term loans carry a high rate of interest. Borrow one for daily expenses and you cannot pay the interest out of what you earn.

4. Diversification and risk distribution

This principle says: make the products or services you invest in as varied as you can. Then the risk is spread and shrinks.

Risk comes from changes in the economic, political or social background, new products entering the market, natural calamity and sudden accidents. A manager cannot control these uncertainties. But by following the risk distribution principle, profit is possible even in an uncertain market.

Doing business on a single product is risky. With many products, a fall in one product's sales is made up by the profit on the others.

A grocer who keeps both Halal soap and traditional soap draws both kinds of customers. Keep only traditional soap and the Halal customers go to another shop, so total sales fall.

A dress seller who stocks both summer and winter wear is not hurt when demand rises and falls with the season. A book stall with poetry, stories, religious and instructive books draws the most customers.

Two clothes shops: one keeps winter wear only, the other both winter and summer wear. Drag through the months and go round the whole year.

The same principle applies to collecting funds: when raising money, priority goes to collecting it from different sources.

5. The three together

Now drop six cases into the three principles.

6. Check yourself

The first is about the principles.

In the second, match the terms.

For the last, think about risk.

The whole note on eight cards.

Source: Finance and Banking, Classes 9-10 (NCTB), Chapter 1 “Finance and Business Finance”, section 1.5.