Lecture 1 INTRODUCTION TO FINANCE

‘management of money’.
Webster’s Ninth New Collegiate Dictionary defines finance as

“the Science on study of the management of funds and the management of fund as the system that includes the circulation of money, the granting of credit, the making of investments, and the provision of banking facilities.

what terms the savings (i.e. 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.

three areas:

Financial Institutions

Investments and

Business Finance

of money

Like Economics, it explores allocation of resources.

Because the future

is unknown, finance studies the allocation of resources in uncertainty. The uncertain events infuse financial decisions with risk.

management of assets with some overall goal in mind”

J.C. Van Horne
The most popular and acceptable definition of financial management as given by S.C. Kuchal:
“Financial Management deals with procurement of funds and their effective utilization in the business”.
Financial management “is an area of financial decision-making, harmonizing individual motives and enterprise goals”. Weston and Brigham
Financial management “is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations
Joshep and Massie

with the role of the
Finance

Manager

Financial
Institutions

almost every decision. Assessing the returns and risks is an

integral part of financial management.

The objective in the decision making process in financial management is not to avoid risk but to properly assess it and to determine whether the risk is worth bearing.

/ Capital markets

sloped yield curve).

in the future.

No individual or firm

would purchase an asset unless there was an expected return to compensate for the risk.

Since the return is earned in the uncertain future, there has to be a way to express the future in terms of the present. The process of determining what an asset is currently worth is called valuation.

name implies, is concerned with institutional aspects of

the discipline, which encompasses the creation of financial assets, the markets for trading securities (for example, the New York Stock Exchange) and the regulation of financial markets.

of individual assets and the construction of well-diversified portfolios.

It

encompasses financial planning, specifying the investor’s financial goals, analyzing various securities that the individual may acquire, and constructing diversified portfolios.

role of a finance manager.

The finance manager must make

certain that the firm can meet its obligations as it become due, determine which are the best sources of financing for the firm, and allocate the firms’s resources among the competing investment alternatives.

is to help others see how their actions affect the

company’s ability to generate cash flow and hence its fundamental value.

Finance managers must also decide how to finance the firm.

In particular they must choose what mix of debt and equity should be used, and what specific types of debt and equity should be used, and what specific types of debt and security should be issued.

percentage of current earnings should be retained and reinvested rather

than paid out as dividends.

Along with these financing decisions, the general level of interest rates in the economy, the risk of the firm’s operations and stock market investors’ overall attitude towards risk determine the rate of return that is required to satisfy a firm’s investors.

of Finance Manager

generated by operations
(1)
(2)
(3)
The Role of Finance Manager

generated by operations
(4a) Cash reinvested
(1)
(2)
(3)
(4a)
The Role of Finance Manager

generated by operations
(4a) Cash reinvested
(4b) Cash returned to investors
(1)
(2)
(3)
(4a)
(4b)
The Role

of Finance Manager

perspective and also from an investor’s

perspective. This ability to approach finance from more than one perspective is important.

Corporate finance or financial management approaches finance from a business perspective.

While corporate finance emphasizes raising funds and their subsequent allocation, investment emphasizes the construction of diversified portfolios and the allocation of wealth among competing securities. Thus, both perspectives are often the opposite sides of the same coin.

divided into two parts such as:

1. Profit maximization
2. Wealth maximization

profit.
(ii) Profit is the parameter of the business operation.
(iv) Profit

is the main source of finance.
(v) Profitability meets the social needs also.

Unfavourable Arguments for Profit Maximization

(i) Profit maximization creates immoral practices such as corrupt practice, unfair trade practice, etc.

(ii) Profit maximization objectives leads to inequalities among the sake holders such as customers, suppliers, public shareholders, etc.

profit is not defined precisely or correctly. It creates some

unnecessary opinion regarding earning habits of the business concern.
(ii) It ignores the time value of money: Profit maximization does not consider the time value of money or the net present value of the cash inflow. It leads certain differences between the actual cash inflow and net present cash flow during a particular period.
(iii) It ignores risk: Profit maximization does not consider risk of the business concern. Risks may be internal or external which will affect the overall operation of the business concern

involves latest innovations and improvements in the field of the

business concern.
The term wealth means shareholder wealth or the wealth of the persons those who are involved in the business concern.
Wealth maximization is also known as value maximization or net present worth maximization. This objective is an universally accepted concept in the field of business.

superior to the profit maximization because the main aim of

the business concern under this concept is to improve the value or wealth of the shareholders.
(ii) Wealth maximization considers the comparison of the value to cost associated with the business concern.

Unfavourable Arguments for Wealth Maximization
(i) Wealth maximization leads to prescriptive idea of the business concern but it may not be suitable to present day business activities.
(ii) Wealth maximization is nothing, it is also profit maximization, it is the indirect name of the profit maximization.
(iii) Wealth maximization creates ownership-management controversy.

time and risk of the business concern.
(iv) Wealth maximization

provides efficient allocation of resources.
(v) It ensures the economic interest of the society.

(iv) Management alone enjoy certain benefits.
(v) The ultimate aim of the wealth maximization objectives is to maximize the profit.
(vi) Wealth maximization can be activated only with the help of the profitable position of the business concern