Introduction to Business FinanceChapter 1

Mah-a-Mobeen Ahmed

What Is Finance?Finance is the study of how and under what terms savings (money) are allocated between lenders and borrowers.

Finance is distinct from economics in that it addresses not only how resources are allocated but also under what terms and through what channels

Financial contracts or securities occur whenever funds are transferred from issuer to buyer.

Finance is about the bottom line of business activities.• Every business is a process of acquiring and disposing assets:– Real assets (tangible and intangible).– Financial assets.• Two objectives of business:– Grow wealth.– Use wealth (assets) to best meet economic needs.

Real Versus Financial AssetsReal assets are tangible things owned by persons and businesses• Residential structures and property• Major appliances and automobiles• Office towers, factories, mines• Machinery and equipment

Financial assets are what one individual has lent to another• Stocks, bonds• Loans• Mortgages

Business Finance

•Business finance is concerned with making decisions about which investments the business should make and how best to finance those investments.•Financing and managing the resources of a business.Businesses are, in effect, investment agencies

or intermediaries.

Money

public investorsFinancial

Institutions

Invest

Provide funds to busines

s

Business raise money

Money investe

d

Business finance involves the financing and managing the resources(assets) of a business.

owners

Management of

resources

Managers

Delegate the responsibility

acquiring

financing

managing

Business assets

Managers need to raise funds through financial markets to pay for business assets.

Business may borrow from financial institution such as banks.

Business (public company) can raise funds from many investors by issuing financial assets or securities such as shares.

Nature of Business Finance suggests that finance involves three main broad aspects:1. Corporate Finance2. Financial Institutions and Markets3. Investments

Corporate Finance:Involve financial management of business

entities.Investment:

Involve the allocation of funds once they have been acquired.

Financial DecisionsThe major financial decisions made by the

managers of a business areInvestment decisionFinancing decision

Investment decision:Managers consider the amount invested in the assets of the

businessComposition of the investmentInvestment in assets are important

Assets generate cash flows

Businesses are a product of past investment decisions.

Decisions regarding the investment in non current assets have long term effects on profitability of businesses.

Managers also ensure that investment in current assets are at appropriate level.

The investments must meet three main criteria:

It must maximize the value of the firm, after considering the amount of risk the company is comfortable with (risk aversion).

It must be financed appropriately (we will talk more about this shortly).

If there is no investment opportunity that fills (1) and (2), the cash must be returned to shareholder in order to maximize shareholder value.

Financing decision:After the investment decision(amount and

composition of investment), managers have to decide how to finance them.

It involve generating funds internally or from source external to business.

External source of funds:By issuing debtBy issuing equity securities

Dividend decision also affect financing decision.Payment of dividend reduces internally generated

funds.Appropriate balance between short term and

long term finance.

The primary goal of both investment and financing decisions is to maximize shareholder value.

Investment decisions revolve around how to best allocate capital to maximize their value.

Financing decisions revolve around how to pay for investments and expenses. Companies can use existing capital, borrow, or sell equity.

Primary objective of the FirmThere are two primary schools of though as to

what the objective of a form should be. Traditionally it has be to maximize the wealth of shareholders but in recent times the view that the primary objective of a firm should be to maximize stakeholder value.

Value is represented by the market price of the company’s common stock, which, in turn, is a reflection of the firm’s investment, financing, and dividend decisions.

For example, a company can choose to pay dividends (a small payment to each person who owns a stock of a company), which increases short-term shareholder wealth. However, paying dividends means that the money is not being invested in long-term investments, which may cause the stock price to increase more in the future, and thereby increasing long-term shareholder wealth.

The technique behind maximizing shareholder value is the management of assets.

The role of finance in an organization is to make sure that money is at the right place at the right time. 

What are the Functions of Business Finance?