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Chapter 1 What is Finance?

Introduction 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
Md. Al Amin best source by analyzing their costs, raising fund from the
Assistant Professor best possible sources, utilizing the fund properly and then
Department of Marketing
Jagannath University
controlling the investment.
E-mail: alaminmkt06jnu@gmail.com

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So in a nut shell the term Functions of Finance:

Finance can be defined as
(1) Financial planning: Financial planning establishes
guidelines for any change in the firm. That include:
(I) Identification of the financial goals of the firm
The science and art of managing money. Finance is
(II) An analysis of the difference between these goals and the
the process of planning, identification, selection, raising
current financial status of the firm and
and utilization of fund in order to achieve the objective of
an organization. (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.

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Functions of Finance………
Functions of Finance………
(2) Identification of sources: Funds may be collected from (5) Protection of fund: Every investment decision
internal sources (such as retained earnings) and external has some degree of risk. Projects should be
sources (such as institutional sources). rejected where funds may be lost. So, Risk and
(3) Raising of fund: After considering all the sources, funds Return have to be balanced in management and
have to be subsequently acquired from the appropriate protection of fund.
source or sources.
(6) Distribution of Profit: The financial manager
(4) Investment of fund: The investment of fund in different
projects is another important task of Finance. In the decides the amount of profit to be retained and the
Investment decision, the costs and benefits of the project amount to be distributed as dividend based on the
have to be considered. financial need of the firm.

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What is Business Finance Functions of Finance Manager

Functions of Finance Manager

Capital of a business organization according to

Managerial Functions Routine Functions
its financial planning and the proper utilization of
that accumulated capital in order to achieve the • Financial planning,

objectives of that organization. Investment Financing Dividend

• Source identification,

Decision Decision Decision • Raising of fund,

In other words, after the financial planning, the • Investment of fund,
process of collection of the capital from the most • Distribution of fund,
suitable sources which would minimize the Working Capital Capital
Management Budgeting • Protection of capital,
capital cost and proper utilization of that capital
• Managing of fund,
in the most suitable projects that will lead the
• Forecasting of cashflow,
maximum cash flow for the firm so that the firm
can reach to its goal is known as business • Managing assets,

finance. 7
• Cost Control, 8
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• Pricing.

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Managerial Functions 1. Investment Decision

Three Fundamental Decisions
It is the most important decision of a financial
in Financial Management 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.
Investment Financing Dividend As future cash flow involves with uncertainty,
Decision Decision Decision so risk is also taken in to consideration along with
cash flow.
It focuses on working capital management and
Working Capital capital budgeting.
Capital Budgeting
Management
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1.a: Working Capital Management 1.b: Capital Budgeting

Working Capital Management Decision involves It is the process of planning and managing a firm’s
with the administration of Current asset and current assets into long term investment in anticipation
of an expected flow of benefit over a series of years.
current liabilities within the policy guidelines.
Managing the firm’s working capital is a day-to In this case a financial manager involves with
identifying investment opportunities that are worth
day activity which ensures that, the firm has more to the firm than they cost.
sufficient resources to continue its operations
and avoid costly interruption.
Various capital budgeting techniques such as Net
Present value (NPV), Internal Rate of Return (IRR).
The ultimate objective of working capital Profitably index (PI), Net terminal Value (NTV), Pay
management is to trade-off between Back Period (PBP) and Average rate of return (ARR)
profitability and liquidity. can be applied in the project evaluation.

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2. Financing Decision 3. Dividend Decision

Financing decision involves with identifying and Dividend decision is concerned with determining the
determining the sources of fund from which the portion of profit to be distributed among
firm can obtain and manage long-term financing shareholders as dividend out of the firm’s total
in order to support its long term investment. earning.
Here financial manager specially concentrates the
impact on share price as a result dividend payment
Determining the optimal capital structure (a as well as the need for further investment in any
combination of debt capital & equity capital profitable venture.
which results least cost of capital and maximizes Ultimate objectives of this decision are: satisfying
the market value of shares) is the main function the stockholders through dividend payment,
under financing decision. arrangement of fund for further investment and
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thereby maximizing the market value of shares. 14

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Principles of Finance Principles of Finance….

1) Principle of risk and return: Before investing to 4) Principle of profitability and liquidity: Trade-off
any particular investment project or sector, risk has to be made between profitability and liquidity
and return involves with that project has to be that means before making investment in any
considered. particular project.
2) Principle of Time value of money: When 5) Hedging principle: To minimize the risk, hedging
expecting return from a source, timing of cash mechanism need to be considered i.e. current
flow has to be considered. assets and fixed assets should be financed with
short term and long term sources respectively.
3) Principle of Cash flow: When expecting return
from any investment, its cash flow pattern has to 6) Principle of diversity: Investment has to be
be considered whether cash flow will be received made in different sectors so that risk can be
on yearly, half yearly, quarterly or monthly basis. diversified.
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Principles of Finance…. Career Opportunities in Finance

1. Financial Market & Institutions:

7) Principle of business cycle: While making Financial Institutions: FIs are firms that specialize in the
investment decision, business cycle has to be sale, purchase, & creation of financial assets. Example-
considered whether the economy is in commercial banks, savings & loan association, credit union,
insurance companies.
recession or booming or is affected by Financial Market: In a financial market, financial assets.
inflation. 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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Goal of Financial Management

3. Managerial Finance:
It is the broadest of the three areas and the one with the
greatest number of job opportunities, deals with the Objectives of Financial Management may be
decisions that firm make concerning their cash flows broadly divided into two parts such as:
The financial Manager’s Responsibilities
The financial manager’s task is to make decisions 1. Profit maximization
concerning the acquisition & use of funds for the 2. Wealth maximization.
Greatest benefit of the firm.
1.Forecasting & Planning
2.Major investment & Financing Decisions
3.Coordination & Control
4.Dealing with Financial Market
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Profit maximization Profit maximization

Profit maximization is also the traditional and

narrow approach, which aims at, maximizes the
profit of the concern. Project Year 1 Year 2 Year 3 Total income

Profit = Total Income- Total Expenses.

A 25 20 5 50

• Ultimate aim of the business concern is earning B 5 15 32 52

profit, hence, it considers all the possible ways to
increase the profitability of the concern.

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Favorable Arguments for Profit Drawbacks of Profit Maximization

Maximization:

• Main aim is earning profit. • Profit maximization objective consists of certain

• Profit is the parameter of the business operation. drawback also:
• Profit reduces risk of the business concern. • It is not clear
• Profit is the main source of finance. • It ignores the time value of money
• Profitability meets the social needs also. • It ignores risk

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What is the Goal of Financial

Maximizing the Stockholders’ Wealth
Management?

• Wealth maximization is one of the modern

Major objective is to - approaches, which involves latest innovations
Maximize the shareholders wealth and improvements in the field of the business
concern.
To maximize the value of a firm • The term wealth means shareholder wealth or
the wealth of the persons those who are involved
in the business concern.
To maximize the price of the firm’s common
stock • Wealth maximization is also known as value
maximization or net present worth maximization.

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Maximizing the Stockholders’ Wealth Agency Relationship

An agency relationship exists when one or more

• Wealth maximization is superior to the profit people (the principals) hire another person (the agent)
maximization because the main aim of the to perform a service & then delegate decision making
business concern under this concept is to authority to that agent.
improve the value or wealth of the shareholders. – Important relationship exist-
• Wealth maximization considers both time and risk • between stockholders & managers
of the business concern. • between stockholders & creditors
• Wealth maximization provides efficient allocation Agency Problem: A potential conflict of interest
of resources. between the parties.
• It ensures the economic interest of the society.
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Stockholders Vs Managers Stockholders Vs Creditors

Risky investment: Managers might choose to
invest the fund which is raised from the lenders to
– Managerial compensation a risky project to give greater benefit to the
stockholder at the expense of the creditors
• Performance Share (lenders).
• Incentives plan
• Cash bonuses How the Creditors Protect their Interest?
– Shareholder intervention First, Creditors protect themselves through restrictions
in credit agreements.
– The threat of takeover Second, If potential creditors perceive that a firm will try
to make advantage of them, they will either refuse to
deal with the firm or else will require a much higher
return.
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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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