Hammad Riaz

What Is Finance?
Finance is the study of how and under what
terms savings (money) are allocated between
lenders and borrowers.

Finance is distinct from economics in that

it addresses not only how resources are
allocated but also under what terms and
through what channels

Financial contracts or securities occur

whenever funds are transferred from issuer to
buyer.
Finance is about the bottom line of business
activities.
• Every business is a process of acquiring and
disposing assets:
– Real assets (tangible and intangible).
– Financial assets.
• Two objectives of business:
– Grow wealth.
– Use wealth (assets) to best meet
economic needs.
Real Versus Financial Assets
Real assets are tangible things owned by persons
and businesses
• Residential structures and property
• Major appliances and automobiles
• Office towers, factories, mines
• Machinery and equipment
Financial assets are what one individual has lent to
another
• Stocks, bonds
• Loans
• Mortgages
 Business Finance
•Business finance is concerned with making decisions
about which investments the business should make and
how best to finance those investments.
•Financing and managing the resources of a business.

Businesses are, in effect, investment agencies or

intermediaries.
Provide
public Financial funds to
investors
Institutions business

Business
Money raise
money

Money
Invest
invested
Business finance involves the financing and managing
the resources(assets) of a business.

owners

Delegate the responsibility

Management
of resources

Manager
s

managin Business assets

acquiring financing
g
Managers need to raise funds through financial
markets to pay for business assets.
Business may borrow from financial institution such
as banks.
Business (public company) can raise funds from many
investors by issuing financial assets or securities such
as shares.
Nature of Business Finance suggests that finance
involves three main broad aspects:
1. Corporate Finance
2. Financial Institutions and Markets
3. Investments
Corporate Finance:
Involve financial management of business entities.
Investment:
Involve the allocation of funds once they have been
acquired.
Financial Markets and Institutions:
 includes the study of the banking system and markets.
Financial Decisions
The major financial decisions made by the managers
of a business are
Investment decision
Financing decision
Asset management decision
 Investment decision:
Managers consider
 the amount invested in the assets of the business
Composition of the investment
Investment in assets are important
 Assets generate cash flows
Businesses are a product of past investment decisions.
Decisions regarding the investment in non current
assets have long term effects on profitability of
businesses.
Managers also ensure that investment in current
assets are at appropriate level.
The investments must meet three main criteria:

It must maximize the value of the firm, after

considering the amount of risk the company is
comfortable with (risk aversion).
It must be financed appropriately (we will talk more
about this shortly).
If there is no investment opportunity that fills (1) and
(2), the cash must be returned to shareholder in order
to maximize shareholder value.
 The financing decision
‒ As firms make decisions concerning where to invest
their (scarce) resources they have to decide how they
should raise additional resources.
 Basically there are two main classes of sources:
Internalsource of financing
External source of financing
Source of Financing
DEBT
Raising funds through
EQUITY borrowing money
Raising funds from • Fixed commitment to pay
owners Additional interest and principal;
• No fixed commitment to resources • It generates tax advantages.
pay • These payments impose to
interest and principal managers to take good projects.
• Increases the cost of
bankruptcy.
• May create conflict of interest
between borrowers and lenders
Dividend decision:
is to decide about how much cash should
returned by a business to its owners.
Dividend decision also affect financing decision.
Payment of dividend reduces internally generated funds.
Appropriate balance between short term and long
term finance.
The primary goal of both investment
and financing decisions is to maximize
shareholder value.

Investment decisions revolve around how to

best allocate capital to maximize their value.

Financing decisions revolve around how to pay for

investments and expenses. Companies can use existing
capital, borrow, or sell equity.
Primary objective of the Firm
There are two primary schools of thought as to what
the objective of a form should be. Traditionally it has
be to maximize the wealth of shareholders but in
recent times the view that the primary objective of a
firm should be to maximize stakeholder value.

Value is represented by the market price of

the company’s common stock, which, in turn, is a
reflection of the firm’s investment, financing, and
dividend decisions.
For example, a company can choose to pay dividends (a
small payment to each person who owns a stock of a
company), which increases short-term shareholder
wealth. However, paying dividends means that the money
is not being invested in long-term investments, which
may cause the stock price to increase more in the future,
and thereby increasing long-term shareholder wealth.

The technique behind maximizing shareholder value is

the management of assets.

The role of finance in an organization is to make sure that

money is at the right place at the right time. 
Organizing a Business
Types of Business Organizations
Sole Proprietorships
Partnerships
Corporations
Limited Liability Partnerships
Sole Proprietorship
Advantages Disadvantages
Easiest to start Limited to life of owner
Least regulated Equity capital limited to
Single owner keeps all owner’s personal wealth
the profits Unlimited liability
Taxed once as personal Difficult to sell
income ownership interest

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Partnership
Advantages Disadvantages
Two or more owners
More capital available
Relatively easy to start
Income taxed once as
personal income
Unlimited liability
 General partnership
 Limited partnership
Partnership dissolves
when one partner dies or
wishes to sell
Difficult to transfer
ownership
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Corporation
Advantages Disadvantages
Limited liability Separation of ownership
Unlimited life and management
Separation of ownership Double taxation (income
and management taxed at the corporate
Transfer of ownership is rate and then dividends
easy taxed at personal rate)
Easier to raise capital

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Types of Corporations
Public Companies
Private Corporations
Limited Liability Corporations (LLC)
Corporate Structure

Sole Proprietorships
Unlimited Liability
Personal tax on profits
Partnerships

Limited Liability
Corporations Corporate tax on profits +
Personal tax on dividends

Module: Financial Management

What are the Economic Objectives of Firms?