finance introduction

Chapter 1Introduction

Introductory Chapter of Finance 1

Md. Arefin DewanLecturer in FinanceFaculty of Business Studies, DIUE-mail: [email protected]

What is Finance?

Finance, in general terms, is the raising of required fund. Finance is the function of raising fund and then properly managing the collected fund.That means Finance deals with the analyzing of fund requirement, identifying the sources of fund, selecting the best source by analyzing their costs, raising fund from the best possible sources, utilizing the fund properly and then controlling the investment.


So in a nut shell the termFinance can be defined as

The science and art of managing money. Finance is the process of planning, identification, selection, raising and utilization of fund in order to achieve the objective of an organization


Functions of Finance:

(1) Financial planning: Financial planning establishes guidelines for any change in the firm. That include:

(I) Identification of the financial goals of the firm(II) An analysis of the difference between these goals and

the current financial status of the firm and (III) A statement of actions to achieve the financial goals

of the firm A detailed financial plan is needed for each

organization. The amount of cash flow, timing, risk and the different constraints have to be considered in financial planning.

Introductory Chapter of Finance

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Functions of Finance………Functions of Finance………

(2) Identification of sources: Funds may be collected from internal sources (such as retained earnings) and external sources (such as institutional sources).

(3) Raising of fund: After considering all the sources, funds have to be subsequently acquired from the appropriate source or sources.

(4) Investment of fund: The investment of fund in different projects is another important task of Finance. In the Investment decision, the costs and benefits of the project have to be considered.


Functions of Finance………Functions of Finance………

(5) Protection of fund: Every investment decision has some degree of risk. Projects should be rejected where funds may be lost. So, Risk and Return have to be balanced in management and protection of fund.

(6) Distribution of Profit: The financial manager decides the amount of profit to be retained and the amount to be distributed as dividend based on the financial need of the firm.


What is Business Finance

Capital of a business organization according to its financial planning and the proper utilization of that accumulated capital in order to achieve the objectives of that organization.

In other words, after the financial planning, the process of collection of the capital from the most suitable sources which would minimize the capital cost and proper utilization of that capital in the most suitable projects that will lead the maximum cash flow for the firm so that the firm can reach to its goal is known as business finance.


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Introductory Chapter of Finance8

Functions of Finance Manager

Functions of Finance Manager

Managerial Functions Routine Functions

Investment Decision

Financing Decision

Dividend Decision

Working Capital Management

Capital Budgeting

• Financial planning,

• Source identification,

• Raising of fund,

• Investment of fund,

• Distribution of fund,

• Protection of capital,

• Managing of fund,

• Forecasting of cashflow,

• Managing assets,

• Cost Control,

• Pricing.


Managerial FunctionsThree Fundamental Decisions Three Fundamental Decisions

in Financial Management in Financial Management

Investment Decision

Financing Decision

Dividend Decision

Working Capital Management Capital Budgeting

1. Investment Decision

It is the most important decision of a financial manager. Here Financial Manager identifies the investment project which can generate maximum financial benefit for the organization. So future cash flow from investment is evaluated here.

As future cash flow involves with uncertainty, so risk is also taken in to consideration along with cash flow.

It focuses on working capital management and capital budgeting.


1.a: Working Capital ManagementWorking Capital Management Decision involves

with the administration of Current asset and current liabilities within the policy guidelines.

Managing the firm’s working capital is a day-to day activity which ensures that, the firm has sufficient resources to continue its operations and avoid costly interruption.

The ultimate objective of working capital management is to trade-off between profitability and liquidity.


1.b: Capital BudgetingIt is the process of planning and managing a firm’s

current assets into long term investment in anticipation of an expected flow of benefit over a series of years.

In this case a financial manager involves with identifying investment opportunities that are worth more to the firm than they cost.

Various capital budgeting techniques such as Net Present value (NPV), Internal Rate of Return (IRR). Profitably index (PI), Net terminal Value (NTV), Pay Back Period (PBP) and Average rate of return (ARR) can be applied in the project evaluation.


2. Financing Decision

Financing decision involves with identifying and determining the sources of fund from which the firm can obtain and manage long-term financing in order to support its long term investment.

Determining the optimal capital structure (a combination of debt capital & equity capital which results least cost of capital and maximizes the market value of shares) is the main function under financing decision.


3. Dividend Decision

Dividend decision is concerned with determining the portion of profit to be distributed among shareholders as dividend out of the firm’s total earning.

Here financial manager specially concentrates the impact on share price as a result dividend payment as well as the need for further investment in any profitable venture.

Ultimate objectives of this decision are: satisfying the stockholders through dividend payment, arrangement of fund for further investment and thereby maximizing the market value of shares.


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Principles of Finance

1) Principle of risk and return: Before investing to any particular investment project or sector, risk and return involves with that project has to be considered.

2) Principle of Time value of money: When expecting return from a source, timing of cash flow has to be considered.

3) Principle of Cash flow: When expecting return from any investment, its cash flow pattern has to be considered whether cash flow will be received on yearly, half yearly, quarterly or monthly basis.


4) Principle of profitability and liquidity: Trade-off has to be made between profitability and liquidity that means before making investment in any particular project.

5) Hedging principle: To minimize the risk, hedging mechanism need to be considered i.e. current assets and fixed assets should be financed with short term and long term sources respectively.

6) Principle of diversity: Investment has to be made in different sectors so that risk can be diversified.


Principles of Finance….

Principles of Finance….

7) Principle of business cycle: While making investment decision, business cycle has to be considered whether the economy is in recession or booming or is affected by inflation.



Career Opportunities in Finance

1. Financial Market & Institutions: Financial Institutions: FIs are firms that specialize in the sale, purchase, & creation of financial assets. Example- commercial banks, savings & loan association, credit union, insurance companies.Financial Market: In a financial market, financial assets.2. Investment: stock brokerage firms, banks, investment companies etc.The three main functions in the investment area are- •Sales•The analysis of individual securities•Determining the optical mix of securities for a given investor.


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The financial Manager’s Responsibilities The financial manager’s task is to make decisionsconcerning the acquisition & use of funds for theGreatest benefit of the firm.1.Forecasting & Planning2.Major investment & Financing Decisions3.Coordination & Control4.Dealing with Financial Market

3. Managerial Finance:It is the broadest of the three areas and the one with the greatest number of job opportunities, deals with the decisions that firm make concerning their cash flows

What is the Goal of Financial Management?

Major objective is to - Maximize the shareholders wealth

To maximize the value of a firm

To maximize the price of the firm’s common stock


Managerial Actions To MaximizeShareholder Wealth

Profit Maximization Vs Stock Price Maximization

Corporate Profits Vs Earning Per Share

Arguments against profit maximization are, it provides vague concept regarding profit and ignores time value of money as well as risk.

Rationale Behind Wealth MaximizationWealth maximization provides a clear concept

regarding profit i.e. it considers Net Cash Benefit (NCB), & it considers time value of money as well as risk


Maximizing the Stockholders’ Wealth

Areas to be taken into consideration for Stock Price Maximization:

Projected Earning Per ShareTiming of the Earnings StreamRiskiness of the ProjectUse of DebtDividend Policy


Agency Relationship

An agency relationship exists when one or more people (the principals) hire another person (the agent) to perform a service & then delegate decision making authority to that agent.

– Important relationship exist-• between stockholders & managers• between stockholders & creditorsAgency Problem: A potential conflict of interest

between the parties.


Stockholders Vs Managers

– Managerial compensation• Performance Share• Executive Stock Option• Restricted Stock Grants

– The threat of firing– Shareholder intervention– The threat of takeover


Stockholders Vs Creditors Risky investment: Managers might choose to

invest the fund which is raised from the lenders to a risky project to give greater benefit to the stockholder at the expense of the creditors (lenders).

How the Creditors Protect their Interest?First, Creditors protect themselves through restrictionsin credit agreements.Second, If potential creditors perceive that a firm will tryto make advantage of them, they will either refuse todeal with the firm or else will require a much higherreturn.


Multinational Corporations

• A firm that operates in two or more countries.• Reasons for going international:

–To seek new markets–To seek raw materials–To seek new technology–To seek production efficiency–To avoid political & regulatory hurdles


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