Chapter No.

1
Instructor: Ms. Rabia Habib
Learning Objective:
Identify the major decisions made by the managers of
business entities,
Identify the major types of Business entities,
Explain the role of Financial manager in companies,
Specify the objective necessary to ensure that the
financial manager makes rational decisions,
Explain the basic concepts of Finance.
Content:
Nature of Business Finance,
Financial Decisions,
Business Structures/Forms,
Financial Manager,
Financial Objective of Company,
Basic Concepts of Finance.
Finance:
Management of money.

The science that describes the management, creation and study

of money, banking, credit, investments, assets and liabilities.

A branch of economics concerned with resource allocation as

well as resource management, acquisition and investment.

Finance deals with matters related to money and markets.

Finance (cont’d):
Finance consist of financial systems, which include the
public, private and government institutions, and the study
of finance and financial instruments, which can relate to
countless assets and liabilities.

The study of finance can also take many forms, depending

on the field or area of finance which one wishes to study.
Business Finance:
“Business activities concerning acquisition and
conservation (planned management) of capital funds, in
meeting financial needs and overall objectives of business
enterprises”.

Business Finance involves financing and managing the

resources of a business.
Business Finance:
Business finance refers to money and credit employed
in business.

 It is required to purchase assets, goods, raw materials

and for the other flow of economic activities. 

 It is basically the provision of money at the time

when it is needed by a business.
Finance Manager:
The management of resources is delegated by owners to
employee managers.

Managers are concerned with acquiring, financing and

managing the business asset, both tangible and intangibles.

Finance managers play an important role in taking

different types of decisions.
Decisions taken by Finance
Manager:
Decisions that involve:
determining the proper amount of funds to be employed
in a firm;
selecting projects and capital expenditure analysis;
raising funds on the most favorable terms possible;
managing working capital such as inventory and accounts
receivable.
Financial Decisions taken by
Finance Manager:
Financial decision is a process which is responsible for all
the decisions related with liabilities and stockholder’s
equity of the company as well as the issuance of bonds.

Financial decisions refer to decisions concerning financial

matters to a business concern.

Decisions regarding amount of funds to be invested to

accomplish its ultimate goal, kind of assets to be acquired,
pattern of distribution of firm’s income and similar other
matters are included in financial decisions.
Types of Financial Decisions:
Investment decisions,
Financing decisions,
Dividend decisions.
1. Investment Decisions:
The investment decision means capital budgeting.

 Investment decision and capital budgeting are not

considered different acts in business world.

In investment decision, the word ‘Capital’ is exclusively

understood to refer to real assets which may assume any
shape viz. building, plant and machinery, raw material and
so on and so forth, whereas investment refers to any such
real assets.
Investment Decisions:
In other words, investment decisions are concerned with the
question whether adding to capital assets today will increase
the revenues of tomorrow to cover costs. 

Investment decisions are concerned with the amount

invested in assets of the business and composition of
investment.

Moreover, assets generating cash flows needed to meet

operating expenses, and to ensure that business investments
are at appropriate levels are part of investment decisions.
2. Financing Decisions:
The financing decision involves two sources from where
the funds can raise: using a company’s own money or
borrowing from outside.

Such as share capital, retained earnings or borrowing funds

from the outside in the form debenture, loan, bond, etc.

The objective of financial decision is to maintain an

optimum capital structure, i.e. a proper mix of debt and
equity, to ensure the trade-off between the risk and return
to the shareholders.
Financing Decisions (cont’d):
Involves generating funds internally or from external
sources , Funds raised externally by issuing debt or equity
securities.
The Debt-Equity Ratio helps in determining the
effectiveness of the financing decision made by the
company.
3. Payout/Dividend Decisions:
The financial decision relates to the disbursement of profits
back to investors who supplied capital to the firm.

Dividend is a payment or return made by the firm to the

shareholders, (owners of the company) out of its earnings in the
form of cash. 

The term dividend refers to that part of profits of a company

which is distributed by it among its shareholders.
Payout/Dividend Decisions
(cont’d):
It is the reward of shareholders for investments made by
them in the share capital of the company.

The dividend decision is concerned with the quantum of

profits to be distributed among shareholders.

Payment of dividend reduces the internally generated

funds.
Formulation of Financial policy
involves:
 Appropriate balance between short term and long
term
finances,
Appropriate mix of sources of finances.
Business Structures/Forms:
When a business is established, one of the first decisions is
the type of the business structure to be used. Most
businesses are structured as:

Sole Proprietorship,
Partnership,
Limited Liability Companies (LLCs),
Corporations.
1. Sole Proprietorship:
Business owned by one person,
Examples include small service businesses, retail stores
and professional practices.

Advantages:
Owners control the business,
Easy and inexpensive to form,
Tax exemption.
Sole Proprietorship:
Disadvantages:
Unlimited liability,
Difficult to raise large amount of funds,
Not Easy to transfer ownership.
2. Partnership:
Business owned by two or more individuals as partners,
Examples include small service businesses, retail stores
and professional practices.

Advantages:
No legal requirement for formation,
Employees have the prospect of becoming owners.
Partnership (contd.):
Disadvantages:
Unlimited liability,
Difficult to withdraw from partnership.

Partnership is further divided into two categories:

a. General Partnership,
b. Limited Liability Partnership (LLP)
a. General Partnership:
A general partnership is one where all partners are equally
responsible for the management of the business, and each
has unlimited liability for the debts and obligations it may
incur.

A family partnership is where two or more members are

related to one another.
b. Limited Liability Partnership:
A limited liability partnership (LLP) is one where the
liability of one or more partners for the debts and
obligations of the business is limited.

A limited liability partnership (LLP) consists of one or

more general partners (whose liability is unlimited) and
one or more limited partners (whose liability is limited in
proportion to their investment).
3. Corporation:
Corporation is a separate entity formed by following
legal
requirements.
The owners of the company are called shareholders.
Variations in size and objectives.
Shareholders and the managers are separate in large
corporations.
Corporations (contd.):
Advantages:
Limited liability,
Indefinite life,
Easy transfer of ownership of shares,
Capital can be raised easily by issuing shares and selling
existing shares in the market.
Corporations (contd.):
Disadvantages:
Expensive to establish,
Regulations,
Difficult to motivate managers,
Taxation treatment of companies, i.e. double taxation.
4. Limited Liability Companies:
Limited Liability Company (LLC) is a hybrid business
entity having certain characteristics of both a corporation
and partnership or sole proprietorship.

The primary characteristic an LLC shares with a

corporation is limited liability, and the primary
characteristic it shares with a partnership is the
availability of pass-through income taxation.
LLCs (contd.):
In Pakistan, LLCs are known as private companies that
end with Pvt. Ltd. They should have at least Rs. 100,000
as their minimum paid up capital.

Limited Liability companies (LLCs) is the term used for

United States specific form of private limited companies.
Role of Finance Managers:
“A person responsible for supervision and handling of
financial affairs of an organization”.

To acquire necessary funds,

To ensure that they are used effectively,
Distribution of dividends to shareholders,
Development and implementation of policies,
Risk management.
Financial Objective of Company:
Rational solution to investment and financing problems can
be achieved if the objective of the company is clearly
specified, i.e.

Profit maximization (short-term objective)

Shareholder wealth maximization (Long-term objective)
Four Basic principles of Finance:
Money has a time value,
There is a risk-return trade-off,
Cash Flows are the source of value,
 Market prices reflect information.
Reference:
Peirson, Brown, Easton and Howard (8 th Edition)
Business Finance, McGraw Hill.