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ch1 Part 1

The document provides an overview of finance, defining it as the science and art of managing money and allocating funds over time. It discusses financial management and services, the organizational structure of finance functions in businesses, and outlines the objectives of financial management, focusing on profit maximization versus shareholder wealth maximization. Key distinctions between individual and business finance are also highlighted, emphasizing decision-making processes and the importance of cash flow and risk assessment.

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6 views

ch1 Part 1

The document provides an overview of finance, defining it as the science and art of managing money and allocating funds over time. It discusses financial management and services, the organizational structure of finance functions in businesses, and outlines the objectives of financial management, focusing on profit maximization versus shareholder wealth maximization. Key distinctions between individual and business finance are also highlighted, emphasizing decision-making processes and the importance of cash flow and risk assessment.

Uploaded by

fmhmmh25277702
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Finance

Chapter one

2023/2024
first lecture
1-Meaning of Finance (Definition of Finance).
2-Financial Management and Financial Services
3- The organizational level of the finance function
4-Objectives of Financial Management.
Definition of Finance
-Finance can be defined as the science and
art of managing money/ allocating funds/
capital over time.

- It is the study of how individuals and


businesses evaluate investments and how to
raise funds to finance them.
Definition of Finance
- Finance, also, is related to how individuals
and businesses make choices between
current spending or receiving money at the
present time versus sometime in the future.
Definition of Finance
Finance function can exercise at:
1-the individual level
2-and at a business level
1-the individual level
finance is concerned with individual
activities or decision-making process related
to how an individual manages his/her money.
That is, how much of earnings / income will
spend now (current spending), how much
funds will be put aside (saved, that is;
postponed spending), and how such savings
will be invested (in the form of financial or /
and real investments (assets).
2- business level
finance is related to activities or decision-making
process involving mainly:
- planning and managing long term investment(which
called capital budgeting)
- managing long term sources of funds (that is the mix
between debt and equity) a firm utilized to finance its
operations (which called capital structure),
- managing the firm’s working capital in the form of short-
term investment (that is, current assets) and short-term
sources of funds (that is, current liabilities) and
safeguarding that the firm in good liquidity position to
maintain its day-to-day operations.
Definition of Finance
- Finance is concerned with the decision-making
process, financial institutions financial markets, and
financial instruments involved in the transfer of
savings from savers (saving or surplus sectors:
different economic sectors of the economy such as;
individuals, businesses, and government) with
excess cash to borrowers (deficit sectors: different
economic sectors of the economy such as;
individuals, businesses, and government) who have
less cash than they need so, they have financial
requirements or needs). Such flow of funds is the
main responsibility of the financial system .
Saver

Savings Borrowers

Saver
Financial Management and Financial
Services
- Financial Management: It is concerned with the
tasks/duties/activities of the financial manager
working in a business. On the other hand, it is
also concerned with how to manage capital and
how to make financial decisions within a
business.
- Financial Services: It is the area of finance
concerned with the design and delivery of
financial advice and financial products for
different economic sectors of the economy such
as individuals, businesses, and government.
The organizational level of the
finance function
The organizational level of the finance
function and its importance depends on
the size of the firm in addition to other
factors.
- In small firms/companies:
the finance function, may performed by
the company owner, or its president or
the accounting department.
- In large firms/ companies :
the finance function typically develops into a
separate department or sector and headed by
Vice President of Finance or any other title
like Chief Financial officer (CFO) who reports
directly to the president of the firm (CEO ) .
In such case, the Chief Financial officer
(CFO) is managing all the firm's financial
activities through two main offices of the
firm:
A. Treasurer: which is responsible for the
financial affairs/activities such as cash
management, credit management, capital
expenditure, raising funds, financial
planning, management of foreign
currencies.
B. Controller: which is responsible for the
accounting affairs/activities such as taxes,
preparing financial statements, cost
control…
The general organization of the corporation can be represented in the following
figure:

16
Objectives of Financial Management
(THE GOAL OF THE FIRM)
There are several goals or objectives that can be
selected, each of them would have some strengths
and some weaknesses. The most known goals are :
1. Profit maximization
2. shareholder's Wealth maximization

The difference between them can briefly explained as


follows:
1-Profit Maximization

According to this goal, management only looks for maximizing


profits.

But the question here is: what kind of profits need to


maximize?
earnings before interest and taxes (EBIT), net income (NI), or
earnings per Share (EPS)...

In brief, according to this goal, there is collective agreement to


maximize the Earnings per Share (EPS) through applying the
following criterion:
Criterion: Select activities that increase Earnings per
Share (EPS)
However, this goal has several shortcomings
(Disadvantages) such as:

• It is based on accounting numbers and principles; hence profits


can vary significantly depending on accounting policies and
methods employed by the firm.
• It does not take risk into consideration; two firms may report
identical profit figures, but one firm's return is more volatile
(riskier) than the other.
• It does not take the time value of money into consideration; (any
unit of currency today does not worth the same unit of currency in
the future
• It does not take the future value prospects into consideration; two
firms may report identical profits, but one firm is more highly
valued due to its higher relative future value potential.
2-Shareholder Wealth
Maximization
According to this goal, management only looks for maximizing
shareholder's (owners of the firm) wealth applying the following
criterion:
Criterion: Select activities that increase the wealth of
shareholders (owners).
Shareholder wealth maximization (owners of the firm) can be accomplished
through the increase of stock market price.

The stock price is equal to the present value of all expected future cash
flows shareholders expected to receive.
The main advantages shareholder wealth maximization
(owners of the firm) goal is:

• It is based on the cash flow concept; through calculating


the relevant cash flow of any alternative. Hence avoiding
the impact of accounting policies and methods employed
by the firm.
• It does take risk into consideration associated with the
return.
• It does take the time value of money into consideration.
• It does take the future value prospects into consideration.
So, according to this criterion:
- if the alternative increases the stock price it should
accepted by management
- if it will decrease the stock market price it should rejected
by management.
Why? Because finance is concerned with expected future
cash flows, hence the forecasting of the amounts and the
timing of such expected future cash flows, and the risks
associated with them, is amongst the biggest challenges the
financial managers face. Cash flows with high variability are
risky.
financial managers must take two factors into consideration
when they evaluate each alternative or course of action
which are:
1- Return (measured on a cash flow basis and its timing)
2- The Degree of Risk associated with this return.
A simple comparison between these two objectives or goals
can summarize as following:

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