INTRODUCTION

TO FINANCE

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LEARNING OUTCOMES
 Discuss the importance of Finance
 Identify the three primary business
decisions of financial managers
 Differentiate the three major forms of
business
 Describe the role of the financial manager
within the firm and the goal for making
financial decisions
 Explain the four principles of financial
management

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What is Finance?

Finance is the study of

how people and
businesses evaluate
investments and raise
capital to fund them

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Three Basic Questions in the
study of Finance:
What long term investments should
be undertaken (Investment decisions
i.e. Capital Budgeting)
How should the firm raise money to
fund these investments (Financing
decisions ie Capital structure)
How can the firm manage its day to
day cash flow (Working capital
management)

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Importance of Financial
Management

Finance deals with decisions

concerning cash inflows and cash
outflows.
Emphasis is on cash flows rather
than income because most
liabilities—that is, debts—must be
paid with cash.
Importance of Financial
Management in
NonfinanceAreas
Most decisions cannot be made
without considering the impact on
the financial well-being of the
firm.
Must determine whether the
funds needed to implement
decisions are available.
 Career Opportunities in Finance

Financial Markets and

Institutions
Investments
Managerial Finance
 Career Opportunities
in Finance
Financial Markets and
Institutions:
Relates to the financial services
industry, which includes banking,
insurance, estate planning, and so
forth.
 Career Opportunities
in Finance
Investments:
Involves evaluating financial
assets, such as stocks and bonds,
and determining which
investments to include in a
portfolio of financial assets.
 Career Opportunities
in Finance
Managerial Finance:
Involves decisions regarding
investments in real assets, such as
plant and equipment, and how
such investments should be
financed (i.e., stocks or bonds),
whether dividends should be paid,
and so forth.
Alternative Forms of Business
Organization

Proprietorship
Partnership
Corporation
Proprietorship

Advantages:
 easy and relatively inexpensive to form
 affected by few regulations
 business is taxed as an individual
Disadvantages
 unlimited personal liability
 firm’s life is limited
 ownership transfer can be difficult
 firm’s credit and its ability to raise funds
Partnership

Advantages:
 fairly easy and relatively inexpensive to form
 affected by few regulations
 business is taxed as an individual
Disadvantages
 unlimited personal liability
 firm’s life is limited
 ownership transfer can be difficult
 firm’s credit and its ability to raise funds—
better than for a proprietorship, however
Corporations

Advantages:
 unlimited life
 transfer of ownership is relatively simple
 limited liability of owners
Disadvantages:
 earnings can be taxed twice
 setting up a corporation is more difficult than
either a proprietorship or a partnership
Goals of the Corporation
Maximize wealth—should be the
primary goal of the financial manager.
Social Responsibility—firms should be
socially responsible at the same time
they earn “normal” profits.
Wealth Maximization/Social
Responsibility—actions that maximize
the value of the firm also are
beneficial to society; wealth
maximization improves the standard
of living.
Agency Relationships
An agency relationship exists when
owners do not manage the firm’s day-
to-day operations.
An agency “problem” exists if managers
attempt to satisfy interests that differ
from the best interests of the firm’s
owners.
Two important agency relationships
that exist are between managers and
stockholders and stockholders and
creditors.
Stockholders versus Managers
 An agency problem is possible if owners do
not run the company.
 An agency problem can be mitigated by the
following means:
 threat of firing
 takeover threat
 reward managers for acting in the best interests of
owners
 make managers owners
Stockholders versus Creditors

 If stockholders approve actions that harm the

positions of the firm’s creditors, it is likely that
the firm will find it difficult to borrow funds in
the future.
 Financial Manager’s
Responsibilities
 Forecasting and Planning—financial decisions
impact the future of the firm.
 Investment and Financing Decisions—
determine which assets to purchase and how to
finance them.
 Coordination and Control—financial decisions
must be made in coordination with other
functional areas, such as marketing,
accounting, and so forth.
 Dealing with Financial Markets—the firm must
go to the financial markets to raise needed
funds.
 Financial Management Functions
 CEO
 CFO
 CONTROLLER / TREASURER
CONTROLLER TREASURER
 Financial Accounting  CASH & M/S
 Cost accounting Management
 Taxes  Capital Budgeting
 Data processing  Financial Planning
 Credit Analysis
 Investor relations
 Pension fund
management
FINANCIAL MANAGEMENT
ACCOUNTING ACCOUNTING
 Involves systematic  Is concerned with
recording of business providing financial
transactions governed by information to
a body of generally
accepted accounting
persons within the
principles firm for effective
 Financial statements for decision making
external and internal use  For internal use
The Four Basic Principles Of
Finance
1. Money has a time value
2. There is a risk-return trade-off
3. Cash flows are a source of value
4. Market prices reflect information

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Principle 1: Money has time
value
 A dollar received today is more than a dollar
received in the future and vice versa

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Principle 2: There is a risk-return
trade-off
 We won’t take additional risks unless we are
paid with additional return
 The higher the risk, the higher the return
vice versa

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Principle 3: Cash flows are the
source of value
 Cash flow is the amount of cash that can be
taken out of the business within a specific
period of time
 Actual money that can be spent from an
investment
 Determines the investment’s value

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Principle 4: Market prices reflect
information
 Investors respond to new information buy
buying and selling investments
 The speed to which investors respond
reflects the efficiency of the market.

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