Introduction

to Basic
Concepts in
Finance

Chapter 1
 What is Financial Management?

Sources of Fund
Utilization of

Financial
Management

Optimum Return
 Language of Finance

Finance

Accounting Economics

Income Statement Central Bank

Balance Sheet Financial System

Economic
Statement of Cash
Variables: GDP,
Flows
Interest rates,
inflation, exchange
rate etc.
 Functions of the Financial Manager

Daily Occasional

Capital budgeting
Cash management Profitability
(receipt and disbursement of Intermediate financing
Bond issues
Goal:
funds)
Credit management (S/T) Stock issues Maximize
Trade-off
Inventory control shareholder
Dividend decisions
wealth
Forecasting
Risk
 The Goals of Financial Management

Earn the highest possible

profit for the firm!!!
Drawbacks

Change in profit may Complications in

represent change in risk measuring profit

Timing of the profit is Increase profit in the short

important run may hamper firm’s
value in the long run
ISSUE 1: Risk Return Trade-Offs

Low Risk High Risk

Low Return High Potential Return

Investing in Investing in Stocks and

Government Bond Corporate Bonds

A manager needs to decide how to balance investment

decisions with respect to Risk and Return trade-offs.
 ISSUE 2: Timing of the Profit

Earnings per share

Period 1 Period 2 Total

Alternative 1 $1.5 $2.0 $3.5
Alternative 2 $2.0 $1.5 $3.5
 ISSUE 3: Complications in Measuring
Profit

Accounting Profit Profit from Economists’ point of view

Explicit Costs Explicit and Implicit Costs

Revenue – Total Cost (Explicit

Revenue – Total Explicit Cost > + Implicit) = Economic Profit
= Accounting Profit

Moreover, inflation and international currency

transaction complicates profit measurement
 ISSUE 4: Increase profit in the short run
can hamper firm’s value in the long run
Social Responsibility and Ethical Behaviour
• Equitable hiring practices
• Fair pricing
• Pollution control
• Recycling industrial wastes
• Ensure balanced work-life for everyone
• Fair treatment of employees
• Corporate policies that benefit the environment
• Reduce carbon footprint

Consequences

Results in social and

Negative Return
Pollution Control even financial benefit
in the Short Run
in the long run
 Goals of Financial Management

Shareholder wealth
maximization
Results in

Activities of Finance
Stock Price
Manager Influence
Corporate Governance: Principal—Agent
Relationship
Principal
e.g. Shareholder

May have conflicting Management acts to increase

interests shareholders’ wealth

Agent
e.g. Manager
 Financial Market

◆ Money markets deal in short-term securities (<1 year)

◆ E.g. Commercial papers sold by corporations to finance their
daily operations; certificate of deposits sold by banks

◆ Capital markets deal in long-term securities (>1 year)

◆ E.g. Common stock, preferred stock, corporate bonds,
government bonds
 Concept Test
◆ Why is profit maximization, by itself, an
inappropriate goal? What is meant by
the goal of maximization of shareholder
wealth?

• Risk Return Trade Offs

• Timing of the Profit/Cash Flows
• Complications of Measuring Profit
• Social Responsibility and Ethical Behaviour
Application of Concept

Page 23 of Chapter 1