Finance

What is Finance?

 application of economic principles to decision-making that

involves the allocation of money under conditions of
uncertainty
 It is the process of raising funds or capital for any kind of
expenditure.
 Management of money, banking, investments, and credit
(or other assets)
 Primary deals with money transactions
Principles of
Finance

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Finance
Five Principles of Finance
1. Cash flow matters
2. Money has time value
3. Risk requires reward
4. Market prices are generally right.
5. Conflicts of Interest Cause Agency Problems

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Principles of
Finance

1. Cash flow matters

2. Money has time value
 Cash flow refers to the movement of
 Finance focuses on the creation and
money in and out of your business in
measurement of value.
terms of income and expenditure
 To measure value, we use the concept of
 Positive cash flow indicates that a
the time value of money to bring the
company's liquid assets are increasing.
future benefits and cost measured by its
This enables it to settle debts, reinvest in
cash flows, back to the present.
its business, return money to
 The cost-benefit relationship is a key
shareholders, pay expenses, and provide
concept in finance.
a buffer against future financial
challenges.

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Principles of
Finance

3. Risk requires reward 4. Market prices are generally right.

 A financial market is “information
 Investors will only invest if they expect
efficient” if at any point in time the
to receive a return on their
prices of securities reflect
investment. They want a return that
allinformation available to the public
satisfies two criteria:  When new information becomes
1. A return for delaying consumption –
available, prices quickly change to
no one would put off the use
reflect that information
(consumption) of their money if they  Information efficient markets provide
were not to be rewarded by earning
liquidity and fair prices
more satisfaction (money) in the
Note there are inefficiencies in the market
future.
that may distort the market prices from
2. An additional return for taken on risk
value of assets
– Investors don’t like risk and seek to
i.e. often caused by behavioral biases
avoid it. Risky investments are
unattractive, UNLESS, they offer the
prospect of greater returns.
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Principles of
Finance

5. Conflicts of Interest Cause Agency Problems

 Agency problems may result from the separation of the

management and ownership of the business.
 Management may act in their best interest even if contrary
to the interest of ownership.

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Role of Finance
in business

Businesses are, in effect, investment agencies or intermediaries.

Finance is critical in just about every business decision, from

planning and budgeting and cash flow management to the capital
structure and how you control risks and costs

Business finance is the study of how these financing and

investment decisions should be made in theory, and how they are
made in practice.

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Role of Finance
in business

1. Strategic Planning and Budgeting

You define where you want the business to go, determine the objectives
and then ask your financial people how much it will cost to get there. These
plans form the basis for hiring employees, capital spending, raising capital,
marketing campaigns and bonuses for management.

2. Equity or Loan?
After creating the strategic plan, the finances turn to the methods of
funding a company's operations. Is it better to raise more equity capital from
investors or take out loans from lenders? Financial analysis gives the answer to
this question.
3. Cash Flow Management
Business owner always wants to know how much money is in the
company's bank account. It's the job of financial managers to make sure the
business has enough liquidity to pay its suppliers and employee on time. If cash
is getting tight, the people in finance will make arrangements to use the firm's
bank line of credit.
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Role of Finance
in business

4. Profit Planning and Cost Controls

Since the basis of a business is to make a profit, it only makes sense that
finance would play a major role in finding ways to improve profitability. This might
involve determining the profitability of individual products and weeding out the losers
and promoting the winners. Finance could point out ways to improve productivity in
manufacturing or find cheaper sources of materials.

5. Managing Unavoidable Risks

An owner has concerns about the direction of interest rates, currency
fluctuations, changes in commodity prices and risks that his customers will not pay
their invoices. Financial reports monitor these areas and give reports to owners and
managers.

The role of finance in business is indispensable. Business owners use financial

data every day when making decisions. They use finance to analyze the present and
project the future. Companies cannot operate without the benefits of financial
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analysis.
Need and Importance of In Business, Finance broadly means capital. Hence,
Finance in Business: Finance means obtaining capital or loans, so that the
objectives of business entrepreneurship may be achieved.
In other words, Business finance means raising capital for
business units and their rational use.

1. Establishment of Business Enterprises

 Finance is required for the promotion of the establishment of any type of
enterprise.
 Finance is required to complete the initial activities of the business enterprise.

2. Efficient Operation of Business

 Finance is the source of business, which cannot be efficiently operated without
finance, the reason being that with the help of Finance, purchase of
commodities and raw materials, sending of products to the consumers,
conversion of raw materials into finished product and sale thereof become
possible.

3. Development and Extension of Business

 Finances are also required for the development and extension of all business
activities of the modern age. With finances, various commodities may be
purchased or sold or produced.
 Purchasing of machineries, equipment, techniques 11
Need and Importance of
Finance in Business:

4. Sound Business Position

 Finance is the only base point by which sound or weak position of business is known,
reason being that payments may be made easier to the suppliers, remuneration and
facilities may be provided to the Employees and payment of original amount and
interest may be paid to the debtors in time, only when sufficient funds are available.

5. Facing Competition
 Advertisement and publicity production and distribution of new commodities and
services, incentives to the consumers, sale promotion, providing services and
commodities at a fair price are required, to face present-day competitors.

6. For Infrastructural Facilities

 Substantial capital is required for all infrastructural facilities, place, land, office site,
plant installation for the establishment of industries, place for conversion of raw
materials into finished products, water, electricity, telephone, etc.
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Need and Importance of
Finance in Business:

7. Modernization of Business
 Finances are required for new techniques, new sources, new machinery, various new products, and
computerization, which are essential for the modernization and operation of the business.
 Feasibility studies of new products

8. For Marketing Expenses

 advertising and publicity, sales promotion, marketing mix, selection of marketing intermediaries,
distribution of goods, transportation, warehousing and marketing research, etc.

9. Labor Welfare and Social Security

 For the success of any business or enterprise, human relations between employers and workers
should be cordial. For that, the entrepreneurs should essentially safeguard the interests of the
employees and workers. They are to be provided with various facilities, like – that of housing,
primary treatment, health, education, libraries, and reading rooms, travel, etc.

10. Other Needs and Importance

 Business Finance is required for research and development, international trade and the success of
various schemes for Industrial and business development.
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Overview of financial
management:

The forms of business enterprise, the objectives of

financial management, and the relationship between
financial managers and shareholders and other stakeholders.

Financial management is not restricted to large

corporations: It is necessary in all forms and sizes of
businesses. The three major forms of business organization
are the sole proprietorship, the partnership, and the
corporation.

These forms differ in a number of factors, of which

those most important to financial decision-making are:
 Taxation
 Degree of control
 Owners’ liability
 Ease of transferring ownership.
 Ability to raise additional funds.
 Longevity of the business. 14
Legal Forms of
Business Organizations

Sole Proprietorship Partnership Corporation

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Legal Forms of
1. Sole Proprietorship
Business Organizations A sole proprietorship is a business entity owned
by one party, and is the simplest of the forms of business

Liability Taxes Advantages Disadvantages

 Owner absorbs all losses

 Tax breaks  Unlimited liability
 Owner retains all profits  Difficult to get financing
 Easy to start and dissolve  Management deficiencies
Unlimited: owner is No special taxes; owner pays
responsible for all the taxes on profits; not subject to  Flexibility of being own  Lack of stability in case of
debts of the business. corporate taxes boss injury, death, or illness
 No need to disclose  Time demands
business information
 Difficult to hire and keep
 Pride of ownership highly motivated
employees

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Legal Forms of
2. Partnership
Business Organizations Partnership is an agreement between two or
more persons to operate a business.

Liability Taxes Advantages Disadvantages

 • Unlimited financial
liability for general
 • Owner(s) retain all profits
partners
 • Unlimited for general partner;
 • Interpersonal
limited partners risk only their original
conflicts
investment. Individual taxes on business
earnings; no income taxes as a business  • Financing
Unlimited for general limitations
Individual taxes on  • Easy to form and dissolve
partner; limited  • Management
business earnings; no  • Greater access to capital
partners risk only deficiencies
income taxes as a
their original  • No special taxes
business  • Partnership
investment.
 • Clear legal status terminated if one partner
dies, withdraws, or is
 • Combined managerial skills
declared legally
 • Prospective employees may be incompetent
attracted to a company if given incentive
 • Shared decisions
to become a partner
may lead to 17
disagreements
Legal Forms of
Business Organizations

3. Corporation
A corporation is a legal entity created under state laws through the process of
incorporation. The corporation is an organization capable of entering into
contracts and carrying out business under its own name, separate from it
owners. To become a corporation, state laws generally require that a
company must do the following:

(1) file articles of incorporation,

(2) adopt a set of bylaws, and
(3) form a board of directors.

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Legal Forms of
Business Organizations

Liability Taxes Advantages Disadvantages

 Double taxation

 Limited liability  Difficult and expensive to start

 Skilled management team  Individual stockholder has little

control over operations
 Ease of raising capital
 Financial disclosure
Limited; multiple taxation  Easy to transfer ownership by selling stock
 Lack of personal interest unless
 Perpetual life
managers are also stockholders
 Legal-entity status
 Credit limitations
 Economies of large-scale operations
 Government regulation and
increased paperwork
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