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MODULE 2Finance – An Introduction
The functions of finance in an organization is interlinked with other managerialresponsibilities and in many instances, the finance manager could also done therole of a managing director. For the smooth functioning as well as to achieveexcellence, organizations have to concentrate on the financial impact of adecision and its consequences. This also helps the organization to aim at adesired competency level against its competitors.
Basic Concept In Finance
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In organizations, flow of money occurs at various points of time. In order to evaluate the worth of money, the financial managers need to look at it from a common platform, namely one time duration. This common platform enables a meaningful comparison of money over different time periods.
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An important principle in financial management is that the value of money depends on when the cash flow occurs – which implies Rs.100 now is worth more than Rs.100 at some future time.
Time Value Of MoneyTime Value Of Money
The Time-Value Of Money
Money like any other desirable commodity has aprice. If you own money, you can, 'rent' it to someone else, say a banker, whocan use it to earn income. This 'rent' is usually in the form of interest. Theinvestor's return, which reflects the time-value of money, therefore indicates thatthere are investment opportunities available in the market. The return indicatesthat there is a
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risk-free rate of return rewarding investors for forgoing immediateconsumption
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compensation for risk and loss of purchasing power.
Time Value Of Money
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Risk:
An amount of Rs.100 now is certain, whereas Rs.100 receivable next year is less certain. This 'uncertainty' principle affects many aspects of financial management and is termed as risk value of money.
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Inflation:
Under inflationary conditions, the value of money, expressed in terms of its purchasing power over goods and services, declines. Hence Rs.100 possessed now is not equivalent to Rs.100 to be received in the future.
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Personal consumption preference
: Most of us have a strong preference for immediate rather than delayed consumption. As a result we tend to value the Rs.100 to be received now more than Rs.100 to be received latter.
Future Value Vs. Present Value
Future value (FV) and present value (PV) adjust all cash flowsto a common time. This is relevant when we want to compare the cash flowsoccurring at different periods of time. Either in terms of projects, performance orturnover, the cash flows accrue to the company at different stages. Theevaluation of all these cash flows are true when they are all brought to the samebase period.
Computing Present Value
In financial parlance, a value of currency is not kept idle. Theamount, if invested would certainly bring additional returns in the future. Thisfuture expectation from the present investment is termed as the future value.
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