small business & epreneurship development U4.pdf

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UNIT IV FINANCIAL MANAGEMENT OF SMALL BUSINESS-
Financial management is the process of planning, organizing, directing and controlling
financial activities to achieve organizational goals. It involves managing financial resources
effectively and efficiently to meet the needs of stakeholders. The objective of financial
management is to maximize shareholder value through sound investment and financing
decisions.
One critical aspect of financial management for small businesses is cash flow management.
This involves monitoring your company’s inflows and outflows of cash regularly, ensuring that
you have enough money on hand to cover expenses while still investing in growth
opportunities.
Another important component of financial management is budgeting. Budgets help you plan
and allocate resources realistically based on your business operations‘ current state while also
accounting for future growth projections.
Financial reporting is another key element in effective financial management. Business owners
need timely access to accurate reports that provide insights into their company’s performance
metrics such as revenue, profit margins and return on investment (ROI).
Effective financial management requires a combination of skills ranging from basic
bookkeeping knowledge to more advanced areas like risk assessment, forecasting models,
capital structure optimization among others
The important of financial management for small businesses
financial management is vital. A survey of successful business by the Federal Reserve Bank of
Chicago found they had four things in common:
1. Knowledge and experience with credit
2. High level of unused credit balance
3. Budget management and monitoring
4. Cash set aside for payroll
Another survey found the more often a small business analyzes its budget, the higher its success
rate. Those that do it annually, the U.S. Small Business Administration says, have a success
rate as low as 25%. Done monthly or weekly, those rates climb to 75-85% and 95%
respectively.
Why is Financial Management Important for a Small Business?
Financial management is important because it helps the business:
• See and understand its profit
• Make decisions on planning inventory and setting prices
• Determine whether it has sufficient cash flow to sustain operations and make decisions
on buying assets
• Provide banks and investors with the financial reporting they need to loan money or
invest in the business

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• Conduct sound financial analysis for better business forecasting and projections
Common Small Financial Management Challenges
Managing your company’s finances is difficult and can be time consuming. Here’s a list of
some of the common challenges you might face, and how and why it’s important to overcome
them.
Managing a budget. Running a business is no easy task. On top of making payroll, paying for
health benefits and navigating a complex tax code, there’s often economic uncertainty.
Creating and monitoring your budget is the only way to remove some of the guesswork and
help you prepare for unforeseen circumstances and make strategic decisions, like when to
expand or hire new employees.
Making payroll with cash reserves. Consistently paying employees, payroll taxes, employee
health benefits and the owners’ salaries from available cash is a strong indicator of financial
health. Some 90% of businesses with excellent financial health in the Federal Reserve Bank of
Chicago study said they always had enough cash from operations to meet these obligations.
Only 50% of businesses that had poor financial health reported always meeting these
obligations. If you’re not using cash reserves for payroll, set a goal to do so.
Staying on top of bills. With strong financial management comes the ability to meet your
business obligations. This helps you avoid overage fees and boosts your credit. In fact, up to
35% of your credit score is based on history of on-time payment.
Controlling debt. No matter how strong your business, there’s a good chance that at some
point you’ll need more cash than you have on hand. And whether it’s a small business loan or
a business credit card, sometimes taking on debt makes financial sense. But taking on too much
debt, maxing out credit cards or not meeting payment terms can damage your credit, increase
the amount pay in interest and drag your business down. Before taking on debt, it’s important
to have a plan for how you’ll repay it.
Secure financing. Poor financial management leads to bad credit and the inability to receive
financing from a bank. This can hamper growth by not taking advantage of business
opportunities when they arise, like making capital expenditures for new equipment that could
lead to increased revenue. Securing financing is challenging, time-consuming and requires
expertise.
Understanding financing products. Good financial management helps small businesses
prepare for economic uncertainty when securing credit lines and venture capital. An
understanding of asset-based financing, accounts receivable financing, trade credit and
equipment leasing was associated with higher financial health scores in the Federal Reserve
Bank of Chicago study
Three KPIs and Metrics for Financial Management
Creating accurate financial statements is the first step in building financial discipline. Each
statement provides information that can be used to analyze profitability, efficiency and
solvency.

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1. Profitability. The income statement (or profit and loss (P&L) statement) helps a business
see its overall profit or loss during a given time period. Use the data on this statement to
calculate profit margins – including the gross profit margin, operating profit margin and the
net profit margin. Here are the formulas to calculate those margins.
Gross Profit Margin:
Gross profit margin = total sales – COGS (or cost of sales) / total sales x 100
Higher gross profit margins indicate your company is efficiently using its assets to generate
profits.
Operating Profit Margin:
Operating profit margin = operating income / revenue
Operating profit margin is also known as earnings before interest and taxes (EBIT). Increasing
operating margins can indicate better management and cost controls within your company.
Net Profit Margin:
Net profit margin = net profit / sales x 100
Higher net profit margins indicate that your company is efficiently converting sales into profit.
Profit margins will vary based on the industry. Comparing against peer companies will help
you create benchmarks and goals.
2. Efficiency. Some metrics gauge how well your company is using its capital and assets to
generate revenue. For these metrics, you’ll need information from your income statement and
balance sheet, which is a snapshot at a given time of how much your company owes and how
much it owns.
Return on Assets:
How efficiently does your business convert money invested in assets into profits? To
benchmark, compare against others in your industry, as this will vary depending on what type
of business you have.
Return on assets = net income / average value of assets x 100
Working Capital Ratio:
This ratio is a measure of liquidity and indicates your ability to pay short-term liabilities. A
ratio of around 2 indicates good short-term liquidity.
Working capital ratio = current assets / current liabilities
Working Capital Turnover:

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This measure is nuanced, and you’ll need to compare against peer companies in your same
industry. It’s an indicator of how well you’re using capital to generate sales.
Working capital turnover = net annual sales / average amount of working capital for the same
year
3. Solvency. To measure solvency, or your company’s ability to pay its long-term debts, use
the cash flow statement, which measures how much cash enters and leaves your company.
Calculating operating cash flow will indicate how well the company can cover its current
liabilities.
Operating cash flow ratio =net income + non-cash expenses + changes in working capital /
current liabilities
If operating cash flow ratio is 2, for instance, it means your company earns $2 for every dollar
of liabilities. Another way to look at it is your company can cover its liabilities twice over.
Seven Small Business Financial Management Tips
Here are seven steps you can take for better financial management:
1. Create a budget. Track your monthly expenses and compare them against historical
expenses. When you see potential problems, such as overspending or a lack of capital, put plans
in place to address them.
2. Put sound bookkeeping in place. The first step for bookkeeping according to the U.S. Small
Business Administration is to get business accounting software. Whether just starting up, or
trying to get a better hold of your finances, accounting software will save time and provide
accurate and insightful data in an easy-to-understand format.
Make sure to open a separate business checking account. Reconcile accounts at least every
month. Track all sales by register tape, invoices or a sales book (or software) and deposit all
sales and link deposits with sales documents. Don’t spend cash sales. Write checks for all
business expenses or use a business debit card.
3. Create a cash flow projection. Make sure cash inflows from accounts receivable will cover
cash outflows. This helps the business set goals and change course when needed to meet them.
This is particularly important for seasonal businesses, where a few months of the year may
account for the majority of the company’s sales, and startups just getting off the ground.
4. Get a business credit card. Charging expenses to a business credit card makes it easy to
track and monitor spending. Many business credit cards have other perks like no-interest
financing for 60 days and cash-back rewards.
5. Build financial knowledge and personal financial strength. Start developing a profit plan
when seeking a loan. It should include a statement of purpose, a list of the business owners, a
description of the business and how it makes money, financial statements and insurance
documentation. Also, improve your personal credit score. Many small business owners use
their own score to secure financing.

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6. Acquire financial management software. Key formulas and reports are built into these
solutions, which can save time and lower the likelihood of errors by automating processes for
invoices, financial reports, data collection, document storage and compliance.
7. Get help. If possible, employ a small team to handle things like accounts payable, accounts
receivable, payroll, reporting and financial statements, putting financial controls in place and
providing guidance on tax and compliance matters. A survey from Robert Half, a human
resources consulting firm, found that businesses with under $25 million in annual revenue
employed a median of three people in finance functions.
FINANCIAL PLANNING,
Financial Planning is important for every business, as it helps business owners to stay focused
on their financial goals and be prepared for any unforeseeable events. If a business has a good
financial plan, it can keep its operations running and pay its employees on time. Thus,
businesses need to understand the importance of business finance and make plans accordingly.
Financial Planning, with context to a small business, helps to prepare well in advance for details
like revenue, profits and loss, turnover, assets and liability, capital, investments etc. A solid
financial plan also helps you to review your financial assets to check the financial health of
business. Checking this information becomes crucial because it helps to make a outline future
operations for small business.
The main goal of financial planning is the achievement of all your goals. With enough funds
and good knowledge of financial management, any business can full its duties towards
employees and customers. Financial planning helps in achieving both short-term and long-term
goals of the business, with the aspect of earning profits. Because it informs business owners
where and how much funds should be allocated.
Business Financial Planning is a task to determine how a business will achieve its goals and
objective with strategic financial planning. Financial plans each activity that a business needs
to do along with funds required to complete that task. Creating financial plans also help the
business to reserve enough cash funds to make investment and save for emergencies and pay
debts
Importance of Business Finance Planning
Creating a business plan is an important task that every small business owner needs to do. And
one of the steps in this process is going through the financial planning step. It is during this
step they realise the importance of business finance. The financial plan is important for small
businesses from several points, such as:
Helps in Managing Risks :Entrepreneurship is full of uncertainties, and small business
owners need to be prepared for any unfortunate events. A business financial plan helps them
to cover and manage risks like a hike in prices of raw materials, natural calamities, low turnover
etc. And when a small business owner has done the right budget planning, they can solve such
issues easily.

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Set Personal and Professional Boundaries :Having financial plans helps small business
owner set apart their personal and business expenses. Otherwise, the line between personal and
business spending can get blurred and owners may make unnecessary expenses from the
business budget.
Achieving Long-Term Goals :Daily operations and short-term goals keep the business
running, but it’s the long-term goals which make a small business venture successful. If small
business owners have done the right financial planning, then they can achieve their long-term
goals, with enough funds and earn regular revenue.
Balance Expenses and Cash Flow : Small businesses have limited amounts of funds, and they
must use that funds wisely. Here arises the need for financial planning, as it helps them control
their expenses and maintain necessary cash funds for emergencies.
Measures Progress
Small business owners need to keep measuring their progress rate from the initial stage of the
venture. Amidst so much decision-making keeping track of progress becomes difficult,
however, if there is a proper financial plan for the business it becomes easier to measure the
progress of small business.
Financial Challenges Faced by Small Business
Starting your small business venture is not a task for faint hearts, and owners might face several
challenges to keep the business running and financially profitable. Some of the financial
challenges that small businesses might face are.
Inconsistent Cashflow :The initial stages of a small business see inconsistency in the cash
flow, which might lead inability to pay daily wages and day-to-day expenses. And this
inconsistency affects the financial health of businesses, that’s why the business financial plan
is important.
Not Creating Budget: Starting a business venture for the first time can be confusing, but if
you are thinking to be successful in this venture by creating a financial budget, then you’re
thinking wrong. Creating a budget is crucial for every small business so that they can limit their
expenses, maintain cash funds and review their business progress.
No Preparation for Risk Management: There is no business without risks, and it’s important
to be prepared for any unforeseeable events. And when small businesses don’t do financial
planning, they are at high risk of losing their assets. Thus, it’s important for maintaining enough
cash funds for any emergencies.
Scarcity of Capital Funds: Despite so many incentives and programmes launched, small
business owners find it challenging to raise capital funds for their small businesses. And limited
capital funds hamper their day-to-day operations resulting in a slow business start.
Mixing Business and Personal Finances: So many small business owners do the mistake of
mixing their expenses with business expenses. This practice makes it difficult to monitor the
expenses and can harm the business reputation in log-terms. Thus, it’s crucial to understand
the importance of business finance and make sure to open a separate business bank account.
LONG- TERM FINANCE WORKING CAPITAL MANAGEMENT,

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Long-term working capital is the amount of money that a business needs to operate its normal
activities for more than one year. It is also known as fixed working capital or permanent
working capital. Long-term working capital helps a business to meet its long-term goals, such
as expansion, diversification, research, and development, etc. It is usually financed by long-
term sources of funds, such as equity, debentures, Term Loans, retained earnings, and more.
Long-term working capital is calculated by subtracting the non-current liabilities from the non-
current assets of a business.
Working capital management is when a business plan is maneuverer in such a manner so as to
ensure that a company can operate efficiently by using and monitoring its existing assets and
liabilities in the best possible way, it is known as working capital management.
Working capital management – objectives
In order to ensure the liquidity of finance, there are two main objectives of working capital
management. The first one is managing timely payments from customers as insufficient cash
flow (working capital) will lead to the company’s failure in fulfilling obligations as they fall
due, which again might result in late salary distribution to employees, late payment to suppliers
and other credit providers. This, in turn, may result in losing the loyalty of employees, losing
supplier discounts and hence a falling credit rating. Furthermore, default on the part of a
company may give rise to consequences such as the compulsory liquidation of assets in order
to repay creditors.
The second key objective is generating profits. Funds used as working capital are more likely
to earn very little, or in fact, no, return. Therefore a company with a high level of working
capital might not achieve the expected return on capital employed, i.e., {Operating profit ÷
(Total equity and long-term liabilities)} as expected by its investors.
Hence while determining the working capital’s appropriate level there is a trade-off between
profitability and liquidity:
• Overtrading – not enough working capital to match the level of business activities.
This can also be called under-capitalization and is categorically characterized by a high
rising ratio of short-term finance to long-term finance
• Over-capitalisation – an excess level of working capital, thereby resulting in
inefficiency.
Working capital management – its importance

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Working capital means the existing net current assets required for daily operating activities. It
can also be defined as the total of current assets minus the current liabilities wherein its
components are generally trade and inventory receivables along with bank overdraft and trade
payables.
Many big businesses that, at first sight, may appear profitable often are forced to shut down
due to their inability to handle short-term obligations at times when they fall due. Hence
successful management or manoeuvrings of working capital is a necessity for a business to
remain in existence.
Working capital management needs great care owing to potential interactions among its
components. For instance, if the credit period that is offered to customers is extended it can
result in extra sales. However, in such cases, the company might have to rely on a bank
overdraft as its cash position may fall owing to the extended wait for payment from customers.
Sometimes the overdraft’s interest might surpass the profit gained from the additional sales,
particularly if there is a rise in the cases of bad debts.
The importance of managing effective working capital
Although the role of working capital is vital in any form of business, managing the working
capital is a daily activity, unlike capital budgeting decisions. Furthermore, inefficiency at any
stage of management may have a negative impact on the working capital and its management.
Given below are some important points that show why it is vital to take the management of
working capital seriously.
• Makes possible Higher Return on Capital
• Improvement in Solvency and Credit Profile
• Better Liquidity
• Increased Profitability
• Uninterrupted Production
• Business Value Appreciation
• Edge over Competitors
• Most Suitable Financing Terms
• Being Ready for Peak Demand and Shocks
Working capital relevance
The ratio of working capital is very crucial to creditors because it shows the company’s
liquidity. The current liabilities are paid with existing assets like cash, marketable securities
and cash equivalents. The faster the conversion of an asset into liquid cash, the higher are the
chances of the company successfully paying off its debts. When the current liabilities are higher
than the current assets, there will be ample capital for the company for its daily operations.
In other words, the company will have sufficient capital to work with. Hence this ratio serves
as a measuring scale of a company’s short-term financial health and efficiency. Anything below
1 indicates a negative W/C (working capital) whereas anything over 2 is indicative that the
company is not investing the surplus assets. The ratio between 1.2 and 2.0 is regarded as the
most ideal ratio. The second name for working capital is net working capital.
How is working capital calculated?

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Working capital is found out by reducing the current liabilities from the current assets which
imply that the working is calculated by the following formula:
Working capital = Current assets – current liabilities
The current assets are the current liabilities and accounts and cash receivable including the
accounts payable.
Some important things are as mentioned below: -
• DSO or Days Sales Outstanding – the no. of the days in average required by the
customers of the company for paying the necessary invoices.
• DPO or Days Payables Outstanding – the no. of the days in average required by the
company which it takes for paying the suppliers.
• DIO or Days Inventory Outstanding – the no. of the days in average required by any
business required for selling its inventory or stock.
• CCC or Cash Conversion Cycle – the no. of the days in average required by any
business for converting the investment of the inventory in cash.
The formula for calculation of CCC is as mentioned below: -
CCC = DIO + DSO – DPO
The smaller a company’s CCC is, the faster it converts the cash into the inventory and again
back to the cash. Companies may greatly reduce the cash conversion cycle or CCC in 3 ways:
• Asking their customers for faster payments (DSO)
• Increasing their payment tenure to their suppliers (DPO)
• Decreasing the time for which their inventory is being held (DIO)
Formulas for working capital analysis
There are many different formulas for analysis of working capital analysis, some of them are
mentioned below:-
Ratio Analysis – Used for measuring the short tenure of any firm’s liquidity
Ratio of Liquidity
Formula Ratio
Assets Current/ Liabilities Current Ratio of current
Assets Liquid/ Liabilities Current Quick Ratio also known as
Acid Test Ratio

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[ Short-term securities which also
includes Cash and Bank] /
Liabilities Current
Ratio of cash position/ Liquid
Ratio Absolute
The ratio of Inventory Turnover = Total cost of all the goods sold/average cost of the
inventory
When one does not know the cost of the goods of the items sold check the below formulas:-
Formula Ratio
Goods Sold Cost/Cost of Average
Inventory
Ratio of Inventory Turnover
Net Sales/Average Cost of Inventory
Total Cost of the Goods which are Sold /
Inventory at the Selling Price in Average
Working capital in simple words
Working capital, in simpler terms, is a difference between a business’s current liabilities and
its current assets.
Current assets such as inventories, receivable accounts, and cash.
Current liabilities are short-term borrowings, liabilities accrued and accounts payable. A
common approach is to subtract this cash from the current assets and from current liabilities
one needs to deduct the financial debt.
Types of working capital
Working Capital is basically divided into 2 main categories as mentioned below:-

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A. Based on the capital generated, the working capital is:-
1. Networking capital – the difference between current liabilities and current assets
2. Gross working capital – a company’s current assets
B. Depending on the time period, the working capital is:-
1. Variable working capital – extra capital left after fixed working capital
Fixed working capital – investments required for starting and managing any business.
Gross working capital’s importance
The investments in these current assets should not be inadequate or excessive than required
since it can impact negatively on the capacity of production and also lead to the solvency of
this company. This greatly undermines any business’s profit. Gross working capital helps in
maintaining this that is why it is crucial.
Net Working capital’s importance
The networking capital is important for checking the liquidity position and for ensuring that
these current assets are exceeding the current liabilities. This capital number also provides its
creditor a very clear picture of the financial soundness of the company.
Measuring the efficiency of the working capital
The efficiency of the working capital can be easily measured by various ratios. The cycle of
working capital and its corresponding ratios are generally compared to the benchmarks of other
industries and peers of the company. Some of the general measures which are generally used
while estimating the working capital management efficiency often include the current ratios,
inventory outstanding days, payables outstanding days, sales outstanding days, etc. For the
small-scale operations in the small business, the money flow is always in a tight supply and the
investment in this area of the working capital might be an issue.
Some of the small companies are mostly unable to fund these operating cycles with payable
accounts and so, need to depend on this cash which is mostly generated by various internal
income sources such as the owner, etc. if one is able to manage the working capital efficiently,
these small businesses would be easily able to free up their cash for paying debts or for the
reinvestments.
Effective capital management
Working capital management is the core factor to the effective management of running a
business because:
• current assets include the majority of the assets in case of some companies
• shareholder wealth being more closely related to the generation of cash rather than
accounting profits
• Inability to control the working capital, and hence to control liquidity, is a major reason
for the corporate collapse.

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Finding the working capital estimate of the company
1. The profits must be ignored while calculating its working capital as its profits can or
cannot be taken again as the working capital and even though this amount could be
greatly reduced due to dividends, taxes and others.
2. One should consider 100 percent WIP value unless otherwise mentioned.
3. Stock calculation of the completed products and all the debts should be done at the cost
unless otherwise mentioned.
Factors that affect the needs of working capital
The needs of the working capital are not the same for every company. It varies from business
to business. There are two factors that affect working capital needs. They are
• Endogenous – Endogenous factors are the ones that can include the size of the company,
its structure, and its strategy.
• Exogenous. – Exogenous factors are the one’s which includes
o the availability and access of banking services
o interest rates
o services or products sold
o type of industry
o macroeconomic conditions
o the number, strategy and the size of competitors of the given company

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Liquidity management:For managing liquidity properly one must ensure that a particular
business possesses proper cash resources for the daily business needs and also the required
fluidity for some unexpected needs of any amount which is reasonable. This is very important
as it affects any business’s creditworthiness, which would be contributing to determining any
business’s failure or success.The lower any business’s liquidity the more likely any company
would face financial distress while the different conditions are equal.But, too much of the cash
which is parked in or low- or non-earning assets will also reflect some poor resource
allocation.For liquidity management to be proper, it should be manifested at some proper level
of the cash or/and the ability of any organization to efficiently and quickly generating the cash
resources for financing the business needs.
Accounts receivables management:The company must grant the customers flexibility or
commercial credit level while ensuring the proper amount of cash inflow.The company would
be determining these credit terms for offerings dependent on the financial capacity of any
customer, the policies of the industry, and the policy of the competitors.Any credit term needs
to be ordinary that implies that the customer generally must be given a number of days for
paying their invoice. Any business’s policy and manager’s discretion needs to be determined
if different conditions are required, like cash on delivery, cash before delivery, periodic billing
or bill to bill.
Inventory management:The inventory management ensures that any business stays on a
proper level of the inventory for dealing with fluctuations for the demand and with the day-to-
day operations without too much investing into any asset.An excessive inventory implies that
there is an extra amount of the capital which is tied to the company. This increases any risk of
the unsold inventory and also the potential obsolescence which erodes inventory value.A
shortage of inventory must be avoided, as this would imply the lost sales of the company.
Short term debt management: Just like any liquidity management, the short-term financing
management must be focused on ensuring that any company has enough funds required in
financing the short-term operations without any excessive risk. The management of the short-
term finances requires the selection of a proper financing instrument and also sizing any funds
that are accessed through each of the instruments. Some of the popular sources are
uncommitted lines, regular credit lines, collateralized loans, revolving credit agreements,
factoring and discounted receivables. The company must ensure there would be proper access
in liquidity for dealing with the cash needs at peak. Such as, the company requires a revolving
credit agreement for dealing with any unexpected funds.
Accounts payable management: The accounts payable start from any trade credit which is
granted by any suppliers of the company, for normal operations. There is a proper balance
between commercial debt and early payments. The early payments might reduce any liquidity
available in the company that can be used in more productive ways.Late payments can destroy
the reputation of the company and its commercial relationships if it is at a high level of debt
might reduce the company’s creditworthiness.
Solutions for the working capital management
Companies can deploy a wide range of solutions to ensure effective working capital
management, both for their suppliers as well as for themselves. These include:

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• Electronic invoicing – Submitting electronic invoices results in fast delivery of
invoices to customers thereby fetching fast payments. This method enables companies
to transform purchase orders into invoices automatically.
• Cash flow forecasting – By forecasting the future cash flows the companies can
prepare beforehand for any upcoming cash gaps and ensure better use of any surpluses.
• Supply chain finance – Also called reverse factoring – it is a way of offering suppliers
early payment via one or more third-party funders. Suppliers then improve their DSO
by getting paid early at a low cost of funding.
• Dynamic discounting – This is another solution that buyers can use to make early
payments to suppliers and allow buyers to secure an attractive risk-free return on their
surplus cash.
• Flexible funding – Last but not least, working capital providers that offer flexible
funding might allow buyers to choose between supply chain finance and dynamic
discounting models. In other words, companies can adapt to their different working
capital needs while continuing to support their suppliers.
CASH MANAGEMENT,
Cash flow is the movement of funds in and out of business. Typically, businesses track cash
flow either weekly, monthly, or quarterly. There are essentially two kinds of cash flows:
Positive cash flow: This occurs when the cash entering into business from sales, accounts
receivable, etc. is more than the amount of the cash leaving businesses through accounts
payable, monthly expenses, employee salaries, etc.
Negative cash flow: This occurs when outflow of cash is greater than incoming cash. This
generally means trouble for a business, but there are steps you can take to fix the negative cash
flow problem and get into a positive zone. Cutting business expenses is one of the quick fixes,
and more strategies.
cash flow issues can happen due to multiple reasons like not understanding the cash flow cycle,
poor understanding of profit versus cash, lack of cash management skills, and bad capital
investments.
Example
Common reasons for poor cash management
Let’s break these reasons down one by one.
Don't understand the cash flow cycle:Small business owners, especially those that have
started a business for the first time, may not be aware of cash flow best practices. This can
cause issues in implementing an efficient way to deal with account payables, account
receivables, and other aspects of the cash flow cycle that may contribute to an unhealthy cash
flow.

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Poor understanding of profit versus cash: Some small businesses may confuse profit with a
healthy cash flow. It’s critical to understand the difference between profit and cash flow. Profit
is revenue minus expenses while cash flow is cash that goes in and out of your business during
a certain time period.
Lack of cash management skills: Cash management skills are related to understanding the
cash flow cycle. If small businesses do not understand the cash flow cycle, they may also have
issues with cash flow forecasting and understanding the various types of cash flows you must
track for your business.
Bad capital investments: Bad capital investments can not only be a current wasteful use of
company funds but can also create long-term cash flow problems for companies, especially for
those that are not regularly cash flow positive and susceptible to market forces
Cash flow management is how a business manages the money entering and exiting the
business. A well-crafted cash flow management strategy can help a small business understand
operating expenses and plan for future investments. When a small business manages cash flow
well, it’ll be able to identify trends that could negatively impact the business and counteract
them before the company is at risk. These 10 cash flow management tips can help businesses
more effectively meet operating expenses and invest in the future.
Cash management strategies are required for businesses of all sizes to succeed. Small
businesses are particularly vulnerable to running out of cash due to economic downturns, poor
cash flow management, and inadequate long-term planning. Cash plays a crucial role in helping
businesses grow.

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1. Understand the Importance of Cash Flow Management in Business: Healthy businesses
must be able to generate enough cash to meet daily operating expenses with enough left over
to invest in growth. This requires careful cash flow management. But the most important step
in managing cash flow is understanding what cash flow is and what it means for your business.
Put simply, cash flow is the amount of cash a business generates or consumes over a specific
period. Positive cash flow means more cash flows into the company than out of it, and is ideal
– especially long-term. Negative cash flow means outflows exceed inflows. Cash flow is not
to be confused with profit. Businesses may appear profitable on paper but can still fail because
cash flow is out of balance or negative – the company may be paying its debts too early or
customers may be taking too long to pay, for example. Some businesses incorrectly assume
they can understand cash flow by looking at a profit and loss statement, but cash flow analysis
must factor in changes in accounts receivable and payable, expenditures, inventory, and other
business expenses.
2. Establish a Break-Even Point:For small businesses just starting out, it’s important to
remember that it can sometimes take years to start earning a profit. Establishing a break-even
point – the point at which total sales equal total expenses – gives a business a tangible goal to
work toward and can create a context for managing cash flow. Understanding the break-even
point can help managers figure out the critical level of business they should be targeting. This
might inspire the need to create a more stringent budget to better costs and find ways to cut
expenses or increase sales, for example.
3. Track and Measure Cash Flow:Good cash flow management practices rely on a business’
ability to track, measure, and analyze its cash flow over time. It’s important to always know
how much working capital is needed to operate, what the business’ break-even point is, and
the state of accounts payables and receivables. Careful tracking will also help accountants
create cash flow statements, which provide an overview of how the business uses cash over a
period of time. Cash flow statements can be a valuable way to measure the financial health of
a business, and may be used by lenders to determine whether a business has enough cash to
pay its expenses, for example. An effective way to track and measure cash flow is to use a cash
flow management tool that automatically manages the flow of incoming and outgoing funds.
4. Always Keep Financial Statements Updated:A business can’t get a full picture of its cash
flow without accurate and updated financial statements. Real-time access to financial
statements can help business owners spot potential issues and be proactive about preventing a
cash flow squeeze. One of the most straight forward ways to manage financial statements is to
use accounting software that can work seamlessly with a cash flow management tool. Together,
these solutions can provide real-time visibility into all financial data and automatically generate
accurate financial statements. For businesses that prefer to outsource their accounting services
or rely on internal accounting professionals who manually manage finances, it’s critical that
they provide regularly updated financial statements.

17
5. Act Fast to Minimize Cash Flow Management Crises:It can be tempting to turn a blind
eye to small hiccups in hopes they resolve themselves, but it’s wise to never ignore even a
small cash flow issue. Don’t hesitate to act when things get tight. If potential cash flow
problems are left untouched, they may quickly get out of hand. And the bigger the cash flow
crunch, the greater the chance a business will strain its relationships with suppliers and
creditors. Consider ways to cut costs if need be, such as selling or leasing out idle equipment.
6. Aim to Increase Sales, Not Expenses: A general cash flow management best practice is to
always aim to increase sales, not expenses. Staying as lean as possible and being careful with
credit can help businesses go beyond their break-even point to turn a profit. Cut expenses
wherever possible, and use proven marketing techniques to increase sales, such as creating a
carefully thought-out marketing sales funnel that catches the attention of your desired audience.
Earning satisfied customers and working to keep them happy generally will pay off with
referrals and added business.
7. Prioritize Relationships with Customers and Suppliers: During tight times, a business
may be able to contact the customers and suppliers it has a strong history with to request more
favourable terms. Customers may be willing to pay invoices sooner, or suppliers may be willing
to offer a payment extension. However, the key is to establish strong, trusting relationships
before you’re in a situation that requires you to ask customers or suppliers to accommodate the
business’ needs. For example, a customer may be willing to pay sooner if you gave them an
extension in the past, or a supplier may be willing to extend your payment date if you have a
history of on-time or early payments. If the cash flow situation is dire, some vendors may be
willing to renegotiate contract terms to give the business more time to pay, or they may offer
discounted bills in exchange for a long-term purchasing agreement.
8. Offer Early Payment Incentives: If it makes sense for industry, it can help to ask for
deposits or early milestone payments. For example, marketing agencies, web designers, or even
construction businesses stand to benefit from advance payments to cover costs while jobs are
in progress. For other industries, avoid providing customers with leeway when appropriate.
Small businesses, especially start-ups, rely on receiving every dollar on time, so late or missed
payments can stall growth and contribute to cash flow crunches. Offering discounts for early
payments can motivate customers to pay sooner. Businesses may also wish to consider
penalizing late payments to help disincentive late payments and compensate for losses if and
when late payments do occur.
9. Build an Emergency Fund for Seamless Cash Flow Management in Tough Times:
Emergency funds aren’t limited to personal finance. Businesses should strive to build a cash
reserve as well, because most businesses won’t always be able to fall back on profits, especially
during slow seasons or market downturns. A general rule of thumb is to establish a cash reserve
that can carry the company for about four months, but three to six months is a good target range
depending on the business and its needs. This financial cushion can help businesses rise above
shortfalls. However, establishing an emergency fund requires a business has positive cash flow.
Consider stowing away profits before planning a growth initiative to ensure you have an
accessible reserve if and when needed.
10. Grow Strategically: Being too aggressive about growth, such as investing in new resources
too far ahead of the revenue they will generate, can hurt cash flow. For example, signing a new
lease, hiring more staff, or purchasing new equipment might seem necessary for growth ¬– and
they generally are – but rapid growth can lead to cash flow troubles. Be sure your business has
the sales and financial cushion to support new growth and expansion.

18
The Takeaway for Successful Small Business Cash Flow Management
Cash flow is an extremely important factor in determining the financial health of a business.
All businesses need not only enough cash to run day-to-day operations, but enough to grow the
business. Following these cash flow management best practices can help small businesses
strategically manage their inflows and outflows to increase their financial health and growth
potential.
RECOMMENDATION OF VARIOUS COMMITTEES,
The Karve Committee:.Small scale industrial committee was set up in the year 1955. It was
also called a Karve committee. It was named after Dattatreya Gopal Karve who was an Indian
economist and professor who contributed to the fields of economics, public administration, and
the cooperative movement in India. Karve committee was set up in the year 1955 for the growth
of small scale industries.It was set up to find out the potential of utilizing small scale industry
its extension for promoting rural development.
Nayak Committee: The Reserve Bank of India constituted on 9 December 1991, a Committee
under the Chairmanship of Shri P.R. Nayank, Deputy Governor to examine the difficulties
confronting the small‐scale industries ﴾SSI﴿ in the country in the matter of securing finance.
Abid Hussain Committee: The Abid Hussain Committee on SSIs (1997) examined the
problems of the SSI sector. The Abid Hussain Committee Report on Trade Policy Reform and
the Abid Hussain. Committee Report on Small Scale Industries have been regarded as
milestones in India’s economic reforms.
S. S. Kohli Committee:The RBI in November 2000 had appointed the working group under
the chairmanship of SS Kohli the chairman of the Indian Bank Association to review the
existing guidelines in regard to rehabilitation of sick units in the small scale industrial sector
and to recommend the revision of the guidelines making them transparent and non‐
discretionary
ROLE OF VARIOUS INSTITUTIONS, SUPPORT FOR SMALL BUSINESS
Introduction:
The Small Scale business in all over the world performs a strong role in national development.
This is attributed to the massive employment it provides to the people of the country where it
exists. This study explored the roles of these micro finance banks and institutions on small and
medium enterprises. Many entrepreneurs and especially those in small –scale sectors have
technology related knowledge to take care of production and quality aspects of the products.
They require guidance and support in the beginning stage and production stage of the industry
in various projects and business related activities. The entrepreneurs should be able to consider
the advantages of various government subsidies and assistance given for backward areas.
Objectives:
• To understand the need and various types of supporting institutions for small business
• To know the the Schemes of that institutions
• Knowledge about Industrial Estates

19
Need of Institution Support for Small Business
Small businesses contribute tremendously to the economy and are often termed as engines of
job creation. They account for a huge chunk of the workforce in India.
It becomes imperative for the government to support and provide the necessary resources to
help them grow and sustain themselves. With this perspective, the government of India
provides various opportunities through its ministries, bodies and programmes. Few of these
are listed below. Public Sector Banks: Banks are the most accessible source for financial
support for Small and medium-sized enterprises (SME s).
Types of Institution:
In order to accelerate the small scale industries development. Government at the central and
state levels have set up a number of development agencies or institutions such as district
industries centre (DICs) small industries services institution (SISI) and small industries
develop an organization, etc.,All Indian financial institution- IDBI, IFCI, ICICI – have
promoted a number of technical consultancy organization (TCOs) to assist small entrepreneurs
in different ways. In 1986, the small industries development fund was set up in IDBI in order
in to assist small, scale, village cottage industries and tiny sectors units in the rural areas.
Recently, the small industries development bank to India (SIDBI) has been established to help
small scale units. In addition to these institutions there are agencies like National science and
technology entrepreneurship board, MSME, khadi and village industries commission,
commercial banks, EXIM bank and co –operative banks who undertake promotion activities
aiming at facilitating industries development.
MSME -Ministry of Micro, Small & Medium Enterprises
This sector has emerged as a highly vibrant and dynamic sector of the Indian economy over
the last six decades. MSMEs play an important role in providing large employment
opportunities at comparatively lower capital cost than large industries but also help in
industrialization of rural & backward areas. It also helps to reducing regional imbalances,
assuring more equitable distribution of national income and wealth.
MSMEs are complementary to large industries as ancillary units and this sector contributes
enormously to the socio-economic development of the country. Ministry of Micro, Small &
Medium Enterprises (M/o MSME) has an vibrant MSME sector by promoting growth and
development of the MSME Sector, including Khadi, Village and Coir Industries, in cooperation
with concerned Ministries & Departments. State Governments and other Stakeholders of
MSME providing support to existing enterprises and encouraging creation of new enterprises.
Micro & Small Enterprises - Cluster Development Programme (MSE-CDP)
Micro, Small and Medium Enterprises (MSME) Scheme, Government of India has adopted
the cluster development approach as a key strategy for enhancing the productivity and
competitiveness as well as capacity building for Micro and Small Enterprises (MSEs) and their
collectives in the country. Clustering of units (including banks and credit agencies,) enables
Objectives of the Scheme:

20
(i) To support the sustainability and growth of MSEs by addressing common issues such as
improvement of technology, skills and quality, market access etc.
(ii) To build capacity of MSEs for common supportive action through formation of self help
groups, up gradation of associations, etc.
(iii) To create infrastructural facilities in the new industrial areas of MSEs.
(iv) To set up common facility centers (for testing, training centre, raw material depot, effluent
treatment, complementing production processes, etc).
Scope of the scheme:
(i) Diagnostic Study
(ii) Soft Intervention
(iii) Setting up of Common Facility Centers (CFCs)
(iv) Infrastructure Development (Up gradation / New)
National Institute for Micro, Small & Medium Enterprises
NI-MSME was initially set up as Central Industrial Extension Training Institute (CIETI) in
New Delhi in 1960 under Ministry of Industry and Commerce, Government of India.NI-MSME
was decided to keep it free from the tardy and impeding administrative controls and procedures,
so that the Institute can play a pivotal role in the promotion of small enterprise. In the year
1962, it was renamed as Small Industry Extension Training (SIET) Institute.
District Industries Centers (DICs)
Government –both central and state, have in the past taken a number of measures for the
development of small and village industries. In addition, multiplicity involved in small
industries development and complicated systems and procedures made the job of promoting
the industrial units an uphill task for small entrepreneurs.
Hence, it was felt necessary to establish a development agency which could provide all services
and facilities to village and small industries under one roof. Accordingly, the DICs were
established in May 1978 in order to cater to the needs of small units.
Functions of DIC:
Identification of entrepreneur’s .DIC develops new entrepreneurs by conducting
entrepreneurial motivation programmes throughout the district especially in panchayat union
headquarters and small towns.
Selection of project .DIC offers technical advice to new entrepreneurs for the selection of
projects suitable to them.
Provisional registration under SSI .After the selection of project, entrepreneurs are issued with
provisional SSI registration which is essential for obtaining assistance from the financial
institutions.
Purchase of fixed asset. DIC sponsors the loan application to TTIC, SIDCO and banks for the
purchase of land and building and sanction margin money under rural industries project loan
scheme payable to other financial agencies for the purchase of plant and machinery.
Get clearances from various departments. It takes the initiative to get clearances from various
departments and take follow up measures to get speedy power connection.

21
Get assistance to raw material supplies. It makes necessary recommendation to the concerned
raw material suppliers and issues the required certificates for the import of raw material and
machinery wherever necessary.
Assistance to village artisans and handicrafts.DIC arranges for the financial assistance with the
lead bank or nationalized banks of the respective areas
Interest – free sales tax loan. SSI units set up in rural areas can get IFST loan up to a maximum
limit of 8% of the total fixed assets from SIDCO .But the sanction order from the same is been
issued b DIC .The DIC also recommends the SSI units for registration for government purchase
programme.
Subsidy schemes DIC assists SSI units and rural artisans to get subsidies such as power
subsidy, interest subsidy for engineers , subsidy under IRDP, etc…. from various institution
Training Programmes. DIC gives training to rural entrepreneur and also assists other units
giving training to small entrepreneurs.
Providing self employment for unemployed educated youth. This scheme was introduced in
1983-84 for youth between 18 to 25 years with SSLC. Technocrats and women are given
preference
District industries centers are supposed to provide pre- investment, investment and post
investment assistance to entrepreneur under one roof.
INDUSTRIAL ESTATES:
Developing countries require institutional arrangements for their rapid industrialization and
balance growth. An industrial estate has been defined as a method of “Organizing, Housing
and servicing industry, a planned clustering of industrial enterprises offering slandered factory
buildings erected in advance of demand and a verity of services facilitates to the occupants”.
The main features of an industrial estate are as follows:
1. It is a tract of land sub divided and developed into factory plots or sheds
2. It provides several common facilities or infrastructural amenities such as water, power,
transportation tool room, post office to the occupants.
3. It is a planned clustering of industrial units.
4. It is designed as a tool of industrialization and balanced regional development
5. It may be developed in rural urban semi – urban areas
6. It may be small or medium or large
7. It may be set up the government or by cooperatives or by private agencies
Types of Industrial Estates
Industrial estates may be classified in to the following categories:
1. General purpose or composite industrial estates: Such an industrial estate provides
accommodation to all types of small scale industries.
2. Special purpose industrial estates: This type of industrial estate is particularly
Constructed for specified groups of entrepreneurs e.g., technically qualified persons ,
craftsmen or artisans ,etc., for example ,industrial estates for artisans and technical personnel
have been set up Hyderabad.
3. Ancillary industrial estates: Such an industrial estate houses manufacturing units , which
produce ,parts and components for a large industrial unit .

22
4. Function industrial estates: This type of industrial estate consists of industrial units
manufacturing the same product .such estates have been set up for leather goods electronics
,sport goods , food preservation , ceramics, etc..,
5. Fiatted factor estates: These are multi-storey building constructed in big cities, to provided
space to industrial units manufacturing light weight goods with the help of simple machine
tools.
Advantages of Industrial Estate
1. Economics of scale: Location of many medium are small plants within a large area
offers several economics
2. Economics of agglomeration: In an industrial estate, several industrial units are
clustered together.
3. Low investment: A small scale entrepreneur can obtain an industrial plot or shed on
rent or higher purchase basis
4. Less risk: Industrial estate serve as risk –absorbing division because of low capital
investment and profession of common facilities and services
5. Saving of time and effect: An individual entrepreneur is relevant of the trouble of the
searching for a suitable place
6. Nursery for new entrepreneur : Industrial estate reduce risk and increase profitability
through internal external economics
7. Mutual cooperation: Industrial estate promote the spirit of operation and joint effects
8. Balance regional development: By developing a state in relatively backward regions,
the government can insure the balanced industrialization of different parts of the
country.
Role of science and Technology entrepreneur Parks (STEP):First generation entrepreneurs
are emerging as an important group in the country. A major problem faced by them is the lack
of appropriate testing facilities. One mechanism for bridging gap between technical research
and industry is the science and technology entrepreneur park.
Example:
A conventional science and technology park was set up by the Birla institute of Scientific
Research (BISR) in Ranchi. It was called as Small Industries Research And Development
Organization (SIRDO).
Small Industries Development Organization (SIDO):SIDO is a policy –making,
coordinating and monitoring agency for the development of small scale entrepreneurs. It
maintains a close liaison with government, financial institutions and other agencies which are
involved in the promotion and development of Small Industries. It provides a comprehensive
range of consultancy services and technical, managerial, economic and marketing assistance to
SSI units.
National Small Industries Corporation limited (NISE): NSIC was established in the year
1955, is headed by Chairman-cum-Managing Director and managed by a Board of Directors.
The main function of the Corporation is to promote aid and foster the growth of micro and
small enterprises in the country

23
NISE was set up with the objectives of supplying machinery and equipment to small enterprises
on a hire-purchase basis and assisting them in producing government orders for various stores.
The main functions of NISE are:
1. To develop small scale units as ancillary units to large –industries
2. To provide SSIs with machines on hire-purchase.
3. To assist small industries with marketing facilities.
4. To distribute basic raw materials through their depots.
Directorates of industries of the state governments:The small scale industries are a state
subject and the development and implementation of the schemes of the assistance of state
government.Directorates of industries of the state governments run various training
programmes , production schemes and common facilities schemes.
Small Scale Industries Corporations:The state government set up Small Scale Industries
Corporations, in order to undertake many commercial activities. The most important of these
activities are distribution of scarce raw materials, supply of machines on hire- purchase basic
ect for Small industries.
Micro/ Small manufacturing enterprises/ Small & Micro exporters (SSI-MDA) - Market
Development Assistance Scheme
This scheme offers funding for:
1. Participation by manufacturing Small & Micro Enterprises in International Trade Fairs and
Exhibitions under MSME India stall.
2. Provides supports for Sector specific market studies by Industry Associations/ Export
Promotion Councils/ Federation of Indian Export Organization.
3. Initiating anti‐dumping products by SSI Associations and
4. Reimbursement of 75% of one time registration fee (Under MDA Scheme) and 75% of
annual fees (Under NMCP Scheme) paid to GSI by Small & Micro units for the first three
years for bar code.
Objective:
(i) Encourage Small & Micro exporters to their efforts for tapping and developing
overseas markets.
(ii) (ii) To increase participation of representatives of small/ micro enterprises under
MSME India stall at International Exhibitions/ Trade Fairs
(iii) To enhance export from the small manufacturing enterprises.
(iv) To popularize the adoption of Bar Coding on a large scale production and
marketing.

24
Startup India campaign:Is based on an action plan aimed at promoting bank financing for
start-up ventures to boost entrepreneurship and encourage start ups with jobs creation. It was
organized by Department of Industrial Policy and Promotion (DIPP). The Standup
India initiative is also aimed at promoting entrepreneurship among SCs/STs, women
communities. Rural India's version of Startup India was named as” Deen Dayal Upadhyay
Swani yojanYojana”.
Small Industry Extension Training Institute (SIETI):SIETI -institute entered in the field of
consultancy an ad hoc basis to support training activities of state government and development
corporations. SIETI’S consultancy services become board –based in terms of assignments was
undertaken.
The past assignments are
Identification of industrial opportunities
Identification of growth centers.
Preparation of regional development plans
Industrial profile
Feasibilities study.
Organizational development
Designing information system
Entrepreneurial development training
Management counseling for sick industrial units
Training of trainers and consultants for Entrepreneurial development.ect
National Productivity Council (NPC)
The services offered by NPC in three stages:
(i) Train young and prospective Entrepreneurs
(ii) Undertake market surveys in the states for indentifying investment opportunities
consumption patterns for the prospective Entrepreneurs
(iii) Post- investment service consultancy and follow-up.
National Reach Development Corporation Of India (NRDCI)
National Research Development Corporation (NRDC) was established in 1953 by the
Government of India. The primary objective to promote, develop and commercialise the
technologies / inventions / patents / processes from various national R&D institutions /
Universities and is presently working under the administrative control of the Dept. of Scientific
& Industrial Research, Ministry of Science & Technology.
NRDCI makes available processes which have been developed various laboratories in the
country. NRDC is recognized, particularly in the developing countries, as the source of reliable
appropriate technology, machines and services, which are typically suitable for these countries
A small business promote the development of an economy, it has not been given adequate
recognition that corresponds with intensity of its contribution. It is significant to state that both

25
financial and non-financial services provided by the banks and institutions have greatly assisted
small businesses in India and have enhanced the distribution of business skills and the sharing
of innovative ideas.
The financing sectors and institutions significantly promote businesses by reducing the
resource gap for small businesses. The above Institutions have a huge potential for increasing
the performance of small businesses through the frequent contributions in technical supports,
financial support, guidance and services.
BOTH FINANCIAL & NON-FINANCIAL INSTITUTIONS.
Financial institutions are entities that help individuals and businesses fulfill their monetary or
financial requirements, either by depositing money, investing it, or managing it. Some of the
institutions labeled under this category include – banks, investment firms, trusts, brokerage
ventures, insurance companies, etc.
As the financial institutions enable individuals and companies to save, manage, invest, and use
the funds productively, the administrative authorities of a nation take due care of their
regulations. If not dealt with well, these institutions might collapse, damaging the economy to
a great extent. In short, a properly regulated financial entity will mean a healthy economy.
• Financial institutions are the economic entities that help individuals and businesses with
several financial services, enabling them to deposit, save, invest, and manage their
monetary resources.
• Central banks, commercial banks, investment entities, credit unions, thrift institutions,
insurance companies, etc., are some of the widely available financial institution types.
• They also offer consultation services to consumers who seek advice on the pros and
cons of making a particular investment.
• These institutions are strictly regulated by national authorities to keep the financial
structure and market active and efficient.
How Do Financial Institutions Work?
• Financial institutions, as the name implies, are entities that deal in finances. They offer
a wide range of monetary or financial services to individuals and businesses. From
helping individuals save money to enabling them to invest in stocks, such institutions
serve different functions simultaneously.
• There are various types of financial institutions to fulfill different requirements of
customers. They look into the customer’s financial needs, be it an individual or a
company, and offer relevant services. These entities provide customers with valuable
pieces of advice while choosing appropriate financial investment or savings options.
The professionals explain the pros and cons of each alternative for their customers to
decide which investment they should spend on.
• The national and international financial institutions have a great role in ensuring a
healthy economy. With the give and take of the monetary resources, the flow of
transactions remains balanced, which keeps the economy going. Moreover, such
entities in the nation make the market liquid, triggering more economic activities in the
respective countries. Therefore, any damage to these financial entities can have a direct
negative impact on the economic health of the nation.

26
Functions of financial institutions
• Though the financial institutions aim to ensure a healthy economy, there are other minor
and major roles they play to ensure they achieve their final goal.
• The primary function of these institutions is to regulate the money supply. With the
regular flow of money, the financial entities keep the financial ecosystem active. The
money supply process must be efficient, given the wide use of money in carrying out
transactions.
• One of the most common functions of these institutions is banking and investment
services. They serve individual customer needs, be it a person or a business. They allow
them to deposit their money, save it, earn interest, and invest further. In addition, as a
non-banking institution, they also offer consultation facilities to customers and help
them know the pros and cons of investing in a financial product, be it stocks, bonds,
ETFs, mutual funds, etc.
• For startups, their investment advice works and helps them build huge capital by opting
for Initial Public Offering (IPO) to raise sufficient funds. Moreover, by keeping the
financial ecosystem active, these institutions ensure being ready to manage any
financial risk and foster the economic growth of a nation.
• Above all, in this era of internet banking, financial entities make transferring funds from
one account to another online easy, smooth, and safe.
Examples:Let us consider the following financial institutions examples to understand how
they work:
Example #1:The importance of the financial institutions can be observed from the way
governments interfere as and when these entities in their respective nations suffer turmoil. The
authorities try their level best to protect them from the financial crisis and help them prevent
their collapse. For example, in the 2008 financial crisis, the administrative authorities helped
many financial institutions from getting bankrupt. These entities included the American
International Group (AIG), Bank of America, Citigroup, etc.
Example #2:One of the most significant financial institutions in the United States is Wells
Fargo. It operates almost 6% of the bank branches in the nation. Though there are many other
institutions that the Americans may take into account, they prefer Wells Fargo over the rest.
The only reason behind this is the significantly low monthly fees and higher transaction limits
that it offers.
Regulations:These institutions need to be regulated strictly to ensure they keep doing their
best to maintain the financial market. Therefore, every country has a specific regulatory
mechanism to control and supervise how these entities perform. For example, in the United
States, the Federal Deposit Insurance Corporation (FDIC) takes care of the depository financial
entities. Others include the National Credit Union Administration (NCUA), Office of Thrift
Supervision, Office of the Comptroller of the Currency, etc.
Types of Financial Institutions
There is a wide range of such institutions operating around the world. However, the commonly
identified types are as follows:

27
#1 – Central Banks:These are the financial entities that monitor and oversee the procedures
of the other financial or banking institutions in the nation. They do not deal with individual
customers directly. Instead, they finance other retail banks. In short, these are banks for the
banks. Every economy has a separate central bank and is named differently. For example, in
the United States, the Federal Reserve Bank is the central bank.
#2 – Commercial Banks:Retail and commercial banks are widely available to serve the
financial needs of individuals and businesses. From depositing money to borrowing amounts
to buy property, these banks act as saviors for people in need to secure their future financially.
Some of the products that these banks offer include savings accounts, personal loans, mortgage
loans, certificates of deposits (CDs), credit cards, etc.
#3 – Non-Banking Institutions: Non-banking financial institutions (NBFIs) are entities that
neither acquire a valid banking license nor do they allow customers to deposit amounts.
However, these entities can offer alternative financial facilities to customers, including
investment, consultation, brokerage, transmission, and risk pooling services.
#4 – Credit Unions:The institutions offer traditional banking services but are not publicly
traded entities. They are established and operated by the members, the ultimate shareholders.
These associations use and reinvest the money received as an interest to keep the costs low. As
a result, they become the better choices for members to fulfill their financial needs. These
entities enjoy tax-exempt status as not-for-profit organizations.
#5 – Investment Entities:The investment banks and brokerage firms fall under this non-
depository category. The investment firms help corporations, governments, and other entities
build capital, raise funds, and gain financial advice. These entities, as brokerage ventures, let
customers acquire finances by investing in securities, like stocks, mutual funds, bonds, and
exchange-traded funds (ETFs). In addition, it acts as a guide to startups or companies in
conducting complex transactional processes. They also offer advice for initiating fruitful
mergers and acquisitions (M&A).
#6 – Thrift Institutions:Also referred to as savings and loan associations, these entities allow
up to 20% of total lending to customers, who are also their owners. They help individuals enjoy
opening accounts and acquiring personal loans and home mortgages.
#7 – Insurance Companies:These financial institutions allow individuals and businesses have
policies against monthly premiums, which they are subject to pay at regular intervals. In
addition, these schemes offer coverage or protection to assets against any financial risk they
remain exposed to.

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