Overview of Business Finance

Hyder Ali (PhD, FHEA)

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 Finance
• Dictionary Definition
– Managing the large amount of Money

Finance is:
“attaining the amount of money, using it by
investing and gaining return on your
investment”

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 Finance
• How to allocate scarce resources across
various assets overtime to achieve a particular
objective.
– Scarce resources
• Debt and Equity
– Overtime
• In future [Risk]; Dynamic not static
– Particular objective
• Profit vs wealth maximization?

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Finance (Interrelated areas)

1.Financial Management
(Decisions within the
org)
2. Investment
( Institutional and
individual decisions)
3. Financial Markets and
Institutions
(Money Market, Capital
Markets, Banks and other F.Is)
 Business Finance

• BF is that managerial activity which is

concerned with the planning and controlling
of the business's financial resources.

• Making financing and investment decisions to

achieve a particular goal.

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The Balance-Sheet Model of the Firm
Total Value of Assets: Total Firm Value to Investors
Investment Financing
Current Liabilities

Current Assets

Long-Term Debt

Fixed Assets
1 Tangible
Shareholders’
2 Intangible Equity

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The Balance-Sheet Model of the Firm
The Capital Budgeting Decision
(Investment Decision)
Current Liabilities

Current Assets

Long-Term Debt

Fixed Assets What long-

1 Tangible term
Shareholders’
2 Intangible investments Equity
should the
firm engage
in?
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The Balance-Sheet Model of the Firm
The Capital Structure Decision
(Financing Decision) Current Liabilities

Current Assets

Long-Term Debt

How can the firm

raise the money
Fixed Assets for the required
1 Tangible
investments?
Shareholders’
2 Intangible Equity

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The Balance-Sheet Model of the Firm
The Net Working Capital Investment Decision
(Financial Decision) Current Liabilities

Current Assets
Net Long-Term Debt
Working
Capital

Fixed Assets How much

short-term cash
1 Tangible
flow does a Shareholders’
2 Intangible company need Equity
to pay its bills?

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Corporate Organization

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 Finance function in Corporation
• The top financial manager within a firm is usually the Chief
Financial Officer (CFO)

Treasurer
• oversees cash management, credit management, capital expenditures, and
financial planning
Controller
• oversees taxes, cost accounting, financial accounting and data processing

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 Corporate Governance
Separation of Ownership and Control

Board of Directors

Debtholders

Shareholders
Management

Debt
Assets
Equity

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 The Agency Problem

Agency relationship
• Principal hires an agent to represent his/her interests
• Stockholders (principals) hire managers (agents) to
run the company
Agency problem
• Conflict of interest between principal and agent

Management goals and agency costs

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 Objective of Firm

To maximize the Shareholders’ Wealth

• Firm Value
• Share Price

Why?

• It is easily observable
• It is a real measure of stockholder wealth, since
stockholders can sell their stock and receive the
price now.

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FACTORS AFFECTING THE VALUE OF
THE FIRM/ Share price
SIZE OF CASH FLOW

TIMING OF CASH FLOW

ELEMENT OF RISK

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 Role of Financial Manager

To achieve Maximize
Objective Share Price

Forecasting and planning

Investment and financing decisions
Coordination and control

Dealing with financial markets

Managing risk

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 FUNCTIONS OF FM

Planning

Decision making

• Financing
• Investment
• Distribution Decision (Dividend policy)
• Risk Management

Controlling

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 FINANCIAL MANAGEMENT DECISIONS
Fruit
Net Goods &
Earnings Services
Operating
Activities

Reinvested Investment
Investing in Producing
Activities Assets

Debt Branches
Payment Trunk &
Debt
Financing Financing
Activities Dividends Equity
Financing Roots

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 FINANCIAL MANAGEMENT DECISIONS
Fruit
Working
Net Goods &
Capital
Earnings Services Management
Operating
Activities

Reinvested Investment
Investing Capital
in Producing
Activities Budgeting
Assets

Debt Branches
Payment Trunk &
Debt
Financing Financing
Activities
Distribution Dividends Capital
Equity
Decisions Structure
Financing Roots

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Financial Management Decisions
Capital Structure

Capital Budgeting

Working Capital Management

Distribution Decisions

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 Five Principles of Finance
1. Cash flow is what matters
• Difference between profits and cash flow
• Care about incremental cash flow (marginal)
2. Money has a time value
• Dollar today is worth more than a dollar tomorrow. Why?
• Opportunity cost
3. Risk requires reward
• Return for delaying consumption
• Return for taking risk – investors & business people hate risk
• Risk requires expected return

Exp return

Risk 21
 Five Principles of Finance
4. Market prices are generally right
• Markets fully reflect all available information at any instant in time
• Efficient market hypothesis [Market Value = Intrinsic Value]
• Stock prices can be used to measure the value of a firm
5. Conflicts of interest cause agency problems
• “Agents” are managers who act on behalf of the owners
• Problem due to separation of ownership and management
• May result in conflicts of interest
o E.g. managers may try to keep jobs rather than max firm wealth
o E.g. managers may work to get a bonus
• “Not my money”

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 According to Finance with Excel
• According to the book
– Principles of Finance with Excel, 2nd edition
– By Simon Benninga
• 8 Principles of Finance

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 8 principles of finance
1. Buy assets that add value, avoid buying
assets that don’t add value
2. Cash is king
3. The time dimension of financial decisions
is important
4. Know how to compute the cost of
financial alternatives

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 8 principles of finance
5. Minimize the cost of financing.
6. Take risk into account.
7. Diversification is important.
8. Markets are efficient and deal well with
information.
– One form of information
• Financial Report
– Analysis of Financial Statements

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