What is Finance?

• Finance can be defined as the art and

science of managing money.

• Finance is concerned with the process,

institutions, markets, and instruments
involved in the transfer of money among
individuals, businesses, and governments.

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Major Areas & Opportunities in
Finance: Financial Services
• Financial Services is the area of finance
concerned with the design and delivery of
advice and financial products to
individuals, businesses, and government.
• Career opportunities include banking,
personal financial planning, investments,
real estate, and insurance.

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Major Areas & Opportunities in
Finance: Managerial Finance
• Managerial finance is concerned with
the duties of the financial manager in the
business firm.
• The financial manager actively manages the
financial affairs of any type of business, whether
private or public, large or small, profit-seeking or
not-for-profit.
• They are also more involved in developing
corporate strategy and improving the firm’s
competitive position.

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Legal Forms of Business Organization

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Corporate Organization

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The Managerial Finance Function:
Relationship to Accounting
• The firm’s finance (treasurer) and
accounting (controller) functions are
closely-related and overlapping.

• In smaller firms, the financial manager

generally performs both functions.

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The Managerial Finance Function:
Relationship to Accounting (cont.)
• One major difference in perspective and
emphasis between finance and
accounting is that accountants generally
use the accrual method while in finance,
the focus is on cash flows.
• The significance of this difference
can be illustrated using the following
simple example.

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The Managerial Finance Function:
Relationship to Accounting (cont.)
• The Nassau Corporation experienced the
following activity last year:
Sales $100,000 (1 yacht sold, 100% still uncollected)
Costs $ 80,000 (all paid in full under supplier terms)

• Now contrast the differences in

performance under the accounting method
versus the cash method.
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The Managerial Finance Function:
Relationship to Accounting (cont.)

INCOME STATEMENT SUMMARY

ACCRUAL CASH
Sales $100,000 $ 0
Less: Costs (80,000) (80,000)
Net Profit/(Loss) $ 20,000 $(80,000)

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The Managerial Finance Function:
Relationship to Accounting (cont.)
• Finance and accounting also differ with respect
to decision-making.
• While accounting is primarily concerned with the
presentation of financial data, the financial
manager is primarily concerned with analyzing
and interpreting this information for decision-
making purposes.
• The financial manager uses this data as a vital
tool for making decisions about the financial
aspects of the firm.

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Primary Activities of
the Financial Manager

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The Agency Issue:
The Agency Problem
• Whenever a manager owns less than 100% of the firm’s
equity, a potential agency problem exists.
• In theory, managers would agree with shareholder
wealth maximization.
• However, managers are also concerned with their
personal wealth, job security, fringe benefits,
and lifestyle.
• This would cause managers to act in ways that do not
always benefit the firm shareholders.

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Financial Institutions & Markets

• Firms that require funds from external

sources can obtain them in three ways:
– through a bank or other financial institution
– through financial markets
– through private placements

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Financial Institutions & Markets:
Financial Institutions
• Financial institutions are intermediaries that
channel the savings of individuals, businesses,
and governments into loans or investments.
• The key suppliers and demanders of funds are
individuals, businesses, and governments.
• In general, individuals are net suppliers of
funds, while businesses and governments are
net demanders of funds.

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Financial Institutions & Markets:
Financial Markets
• Financial markets provide a forum in which
suppliers of funds and demanders of funds can
transact business directly.
• The two key financial markets are the money
market and the capital market.
• Transactions in short term marketable securities
take place in the money market while
transactions in long-term securities take place in
the capital market.
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The Relationship between Financial
Institutions and Financial Markets

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The Money Market

• The money market exists as a result of the

interaction between the suppliers and
demanders of short-term funds (those having
a maturity of a year or less).
• Most money market transactions are made in
marketable securities which are short-term
debt instruments such as T-bills and
commercial paper.
• Money market transactions can be executed
directly or through an intermediary.
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The Capital Market

• The capital market is a market that enables suppliers

and demanders of long-term funds to make transactions.
• The key capital market securities are bonds (long-term
debt) and both common and preferred stock (equity).
• Bonds are long-term debt instruments used by
businesses and government to raise large sums of
money or capital.
• Common stock are units of ownership interest or equity
in a corporation.

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