Introduction to Business Finance

Chapter 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

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

Assets
Real 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.
public

investors

Financial
Institutions

Provide
funds to
busines
s

Money

Busines
s raise
money

Invest

Money
investe
d

Business finance involves the financing and

managing the resources(assets) of a business.

owner
s
Delegate the
responsibility
Manageme
nt of
resources

Manage
rs

acquirin
g

financin
g

managi
ng

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:

Corporate Finance
2. Financial Institutions and Markets
3. Investments
1.

Corporate Finance:
.Involve financial management of business
entities.
Investment:
.Involve the allocation of funds once they have

been acquired.

Financial Decisions
The major financial decisions made by the

managers of a business are

Investment decision
Financing decision

Investment decision:
Managers consider
the amount invested in the assets of the business
Composition of the investment
Investment 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
criteria:

must

meet

three

main

It must maximize the value of the firm, after

considering the amount ofrisk 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 debt
By 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

andfinancingdecisions
is
to
maximize
shareholdervalue.

Investment decisions revolve around how to

bestallocatecapitalto maximize their value.

Financing decisions revolve around how to

pay for investments and expenses. Companies

can use existing capital, borrow, or sellequity.

Primary objective of the

Firm
There 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 bythe market price of

thecompanys common stock,which, in turn, is

a reflection of the firms investment, financing,
and dividend decisions.

For example, a company can choose to

paydividends(a small payment to each person who

owns a stock of a company), which increases shortterm shareholder wealth. However, paying dividends
means that the money is not being invested in longterminvestments, 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?