An overview of Business Finance

• Business finance refers to money and credit

employed in business. It involves procurement and
utilization of funds so that business firms may be able
to carry out their operations effectively and efficiently.

• Business finance includes all types of funds used in

business.

• Business finance is needed in all types of

organisations, large or small, manufacturing or trading.
 An overview of Business Finance
• The amount of business finance differs from one business firm to
another depending upon its nature and size.

• Business finance involves estimation of funds. It is concerned with

raising funds from different sources as well as investment of funds for
different purposes.

Business finance is required for:

1. the establishment of every business organization.
2. With the growth in activities, financial needs also grow.
3. Funds are required for the purchase of land and building, machinery
and
other fixed assets.
4. Money needed to meet day-today expenses e.g.raw material, payment of
wages and salaries, utility bills etc.
5. Money is required to bridge the time gap between production and sales.
 BS and Financial Managers
Financial managers are usually responsible for following finance related
activities / jobs in an organization:

• Prepare financial statements, business activity reports, and forecasts.

• Monitor financial details to ensure that legal requirements are met.

• Supervise employees who do financial reporting and budgeting.

• Review company financial reports and seek ways to reduce costs

• Analyze market trends to find opportunities for expansion or for acquiring

other companies.

• Help management make financial decisions

 BS and Financial Managers
• Monitor and control the flow of cash that comes in and goes out of
the company to meet the company's business and investment
needs.
 Forms of Business Organizations

(1)Sole proprietorships,
(2)Partnerships,
(3)Corporations, and
(4)Limited liability companies
 Forms of Business Organizations
• A proprietorship is an business owned by one individual, a person
begins business operations.

• A partnership is a legal arrangement between two or more people

who decide to do business together. Partnerships are similar to
proprietorships in that they can be established relatively easily and
inexpensively.

Moreover, the firm’s income is allocated on a pro rata basis to the

partners and is taxed on an individual basis. This allows the firm to
avoid the corporate income tax.
 Forms of Business Organizations
• A corporation is a legal entity created by a state, and it is separate
and distinct from its owners and managers. It is this separation that
limits stockholders’ losses to the amount they invested in the firm.

• Have unlimited lives, and it is easier to transfer shares of stock in a

corporation than one’s interest in an unincorporated business.
These factors make it much easier for corporations to raise the
capital necessary to operate large businesses.
Forms of Business Organizations
The Limited Liability Company is the most common legal form in
use for running a business. Companies are ‘incorporated’ to form an
entity with a separate legal personality. This means that the
organization can do business and enter into contracts in its own
name.

A Limited Company is owned by its members – those who have

invested in the business – and as the name suggests they enjoy
limited liability – i.e. the company’s finances are separate from the
personal finances of their owners and as a general rule creditors of
the business may only pursue the company’s assets to settle a debt.
The personal assets of the owners are not at risk.
 Goals of Business Finance
All businesses aim to maximize their profits, minimize
their expenses and maximize their market share.

Maximize Profits A company's most important goal is to

make money and keep it. Profit-margin ratios are one
way to measure how much money a company squeezes
from its total revenue or total sales.
There are three key profit-margin ratios: gross profit
margin, operating profit margin and net profit margin.
 Goals of Business Finance
Gross Profit Margin = (Sales - Cost of Goods Sold)/Sales
The gross profit margin is used to analyze how efficiently a company is using
its raw materials, labor and manufacturing-related fixed assets to generate
profits. A higher margin percentage is a favorable profit indicator.

Operating Profit Margin = EBIT/Sales

Operating Profit margins show how successful a company's management has
been at generating income from the operation of the business.

Net Profit Margins = Net Profits after Taxes/Sales

By comparing a company's gross and net margins, we can get a good sense of
its non-production and non-direct costs like administration, finance and
marketing costs.
Goals of Business Finance
Minimize Costs:

To be profitable, companies must not only earn

revenues, but also control costs. If costs are too high,
profit margins will be too low, making it difficult for a
company to succeed.

By evaluating all of the business's expenses,

management can determine whether those costs are
reasonable and affordable. Then, if necessary, they can
look for ways to reduce costs through methods such as
cutting back, moving to a less expensive plan or
changing service providers.
Goals of Business Finance
Maximize Market Share
Companies are always looking to expand their share of the
market, in addition to trying to grow the size of the total
market by appealing to larger demographics, lowering prices
or through advertising. Market share increases can allow a
company to achieve greater scale in its operations and
improve profitability.

Market share is calculated by taking a company's sales over a

given period and dividing it by the total sales of its industry
over the same period.
 Agency Problem
The separation of ownership and control in the modern
corporation results in potential conflicts between owners
and managers. In particular, the objectives of
management may differ from those of the firm’s
shareholders.

In a large corporation, stock may be so widely held that

shareholders cannot even make known their objectives,
much less control or influence management. Thus this
separation of ownership from management creates a
situation in which management may act in its own best
interests rather than those of the shareholders.
 Agency Problem
Agency Theory:

• A branch of economics relating to the behavior of principals (such as

shareholders) and their agents (such as management).

• Jensen and Meckling were the first to develop a comprehensive theory

of the firm under agency arrangements. They showed that the
principals (shareholders) can assure themselves that the agents
(management) will make best possible decisions only if appropriate
incentives are given and only if the agents are monitored.

• Incentives include stock options, bonuses, and perquisites, such as

company automobiles and expensive offices etc.

• Monitoring is done by bonding the agent, systematically reviewing

management perquisites, auditing financial statements, and limiting
management decisions.
 Corporate Social Responsibility
Maximizing shareholder wealth does not mean that
management should ignore corporate social responsibility
(CSR), such as protecting the consumer, paying fair wages to
employees, maintaining fair hiring practices and safe working
conditions, supporting education, and becoming involved in
such environmental issues as clean air and water.

It is appropriate for management to consider the interests of

stakeholders other than shareholders. These stakeholders
include creditors, employees, customers, suppliers,
communities in which a company operates, and others.

Only through attention to the legitimate concerns of the firm’s

various stakeholders can the firm attain its ultimate goal of
maximizing shareholder wealth.
 The Income Statement

2013 2014
Net Sales 3000 2850
Operating costs except Dep & Amort. 2616 2497
Dep & Amortization 100 90
Total Operating Costs 2716 2587
Operating Income or EBIT 284 263
Less Interest 88 60
Earning Before Taxes 196 203
Taxes 78 81
Net Income 118 122

A report summarizing a firm’s revenues, expenses, and profits

during a reporting period, generally a quarter or a year.
 The Income Statement

Depreciation: The charge to reflect the cost of assets

used up in the production process. Depreciation is not a
cash outlay.

Amortization: A noncash charge similar to depreciation

except that it is used to write off the costs of intangible
assets.
 The Balance Sheet

1 - A statement of a firm’s financial position at a specific point in

time.

2 - The left side of the statement shows the assets that the
company owns, while the right side shows the firm’s liabilities
and stockholders’ equity.

3 - assets are divided into two major categories, current assets

and fixed, or long-term assets.

3 -A - Current assets consist of assets that should be converted

to cash within one year; and they include cash and cash
equivalents, accounts receivable, and inventory.
 The Balance Sheet

3-B - Long-term assets are assets expected to be used for more

than one year; they include plant and equipment in addition to
intellectual property such as patents and copyrights. Plant and
equipment is generally reported net of accumulated
depreciation.

4 - Liabilities are divided into two major categories, current

liabilities and long-term liabilities.

4-A – Current Liabilities consist of claims that must be paid off

within one year, including accounts payable, accruals (total of
accrued wages and accrued taxes), and notes payable to
banks that are due within one year.
 The Balance Sheet

4-B - Long-term debt includes bonds that mature in more

than a year.

5 - Stockholders’ equity is the amount that stockholders

paid to the company when they bought shares the
company sold to raise capital, in addition to all of the
earnings the company has retained over the years.

Stockholders' equity = Paid in capital + Retained

earnings
Also:
Stockholders' equity = Total assets -- Total liabilities
 The Balance Sheet

CURRENT ASSETS CURRENT LIABILITIES

CASH & CASH EQUIVALENTS ACCRUED WAGES & TAXES
ACCOUNTS RECEIVABLE ACCOUNTS PAYABLE
INVENTORY NOTES PAYABLE

LONG TERM ASSETS

NET PLANT & EQUIPMENT LONG TERM DEBTS
OTHER LONG TERM ASSETS

STOCKHOLDER’S EQUITY
COMMON STOCK
RETAINED EARNINGS

TOTAL ASSETS TOTAL LIABILITIES &EQUITY

 Statement of Cash Flow

A report that shows how things that affect the balance

sheet and income statement affect the firm’s cash flow.

Net income as reported on the income statement is not

cash. Managers strive to maximize the cash flows
available to investors. The Statement is divided in to four
sections. Cash flow from Operating Activities, Investing
Activities, Financing Activities and Summary.
 ABC Co. Statement of Cash Flow for 2018

Operating Activities:
Net Income 117
Dep & Amortization 100
Increase in Inventories (200)
Increase in A/C Receivable (30)
Increase in Accrued Wages & Tax (10)
Net Cash provided by operating activities ( 3)

Long-Term Investing Activities

Additions to property, plant, and equipment (230)
Net cash used in investing activities (230)

Financing Activities
Increase in notes payable 50
Increase in bonds outstanding 170
Payment of dividends to stockholders (57)
Net cash provided by financing activities 162
 ABC Co. Statement of Cash Flow for 2018

Net decrease in cash ($ 70)

Cash and equivalents at the beginning of the year 80
Cash and equivalents at the end of the year 10