Nature, Scope of Business Finance Part 1

Agenda
 Introduction
 Role of finance in the firm
 Finance functions
 Objectives/goals of the firm
 Financial Markets

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 What is financial management

 Managerial activity which is concerned with the planning & controlling of the
firm’s financial resources.
 It was a branch of economics till 1890, and as a separate discipline, it is of
recent origin.
 What does financial management entail? (From a corporate perspective)
It is the study of how firms;

 Raise funds required by business

 Allocate this funds in most productive way
 Exercising controls over the funds daily
 Distribute returns to various business stakeholders
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 Role of finance in a firm
A financial manager aids the firm in attainment of firm goals by making decisions
related to acquisition & investment of funds.
The finance functions can be classified into:
1. Managerial functions
2. Routine/non-managerial functions

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 Managerial functions
 This are the most important functions as they require technical
expertise and skills in order to be executed.
 They include:
Financing Decisions
Investment Decisions
Liquidity Decisions
Dividend Decisions

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 Financing Decisions
Also referred to as capital mix decisions.
The financial manager is expected to undertake the following in
regards to this function:
1. Determine the appropriate sources of capital
2. Identify the capital with the lowest cost
3. Identify whether the firm needs short term or long-term
capital
4. Establish the optimal mix /composition of various capital
components

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 Investment Decisions
Also referred to as capital budgeting decisions.
They involve decisions of capital allocation to long term assets/
projects that could yield extra returns in the future.
It entails the following:
1. Identification of the appropriate investment opportunities
2. Estimation of future benefits /cash flows from each investment
opportunity project.
3. Appraisal of each project.
4. Select the project that maximizes wealth

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 Liquidity Decisions
Also referred to as short term asset mix decisions.
Short term functions involve a period of less than one year.
 They are important for managing the firms day to day
finance requirements.
 They relate to management of current assets and current
liabilities to avoid liquidity problems.
 Liquidity refers to firm ability to meet its short term
obligations when they are due.
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 Dividend Decisions
This decisions concern determination of;
How much earnings will be allocated to ordinary shareholders as
dividends
Proportion of the earnings that should be retained to finance future
projects of the company
The dividend policy of the firm should guide on the following critical issues:
How much dividend per share to pay to shareholders
How to pay dividends (cash dividends or bonus shares)
When to pay dividends (i.e. interim and quarterly dividends or final
dividends only)

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 Non-managerial/routine functions
These functions involve the day-to-day activities of the finance
department.
They are supportive functions to the managerial functions that do not
require technical expertise and skilful planning.
They may be called the accounting function.
In most cases, they are delegated to the junior staff in an organisation.
They include;
 Supervision receipts and payments and safeguarding of
cash balances
 Custody and safeguarding of securities, insurance policies
and other valuable papers
 Record keeping and reporting
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 Goals/objectives of the firm
Any business should have certain goals that it aims to achieve:
The goals can be categorised into two:
Financial goals
Non-financial goals

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 Financial goals
In order to make financial decisions, a firm has two main financial
goals namely:
Shareholder’s Wealth Maximization
Profit maximization (profit after tax)

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 Profit maximization
 The objective was developed in the 19th century when most businesses
were individual businesses and the single entrepreneurs aim was to
enhance their personal [Link] was easily achieved by the profit
maximisation objective.
 This goal is achieved when a firm either produces maximum output for a
given amount of input or uses minimum input to produce a given output.
 Profit maximization is assumed to lead to efficient allocation of
resources under a competitive market (prices are determined by demand
and supply)
 Traditionally profit was considered as the most appropriate measure of
firms performance.
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Limitations Of Profit Maximization
1. It ignores the welfare of other stakeholders of the [Link] the modern day,
businesses have various stakeholders (shareholders, customers,employees ,
government, society) with different objectives beyond profit maximisation .
2. The defination of profit is [Link] it short term or long term profit?Profit
before or after tax?Total profit or profit per share?
3. The objective does not differenciate between benefits received in different time
periods i.e. ignores time value of money.
4. It ignores uncertainity and risk of [Link] stream of expected benefits may
have different levels of certainity and risk.

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 Shareholder’s Wealth Maximization
 The objective was developed to overcome the weaknesses of the profit
maximization goal.
 The objective is achieved when market value of shares is maximized.
Shareholder wealth= no of shares held X share price of the company
 Firms maximize the value of shares through maximizing the net present
value (NPV) of course of actions in the firm ie Through investing in
projects with positive NPV.
 NPV=PV of the cash flows - PV of costs incurred
Positive NPV projects means increased cash flows and increased share
price.
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Advantages of shareholder’s wealth
maximization
The objective:

 Considers time value of money by discounting cash flows

to the present.
 It is a long-term objective and therefore consistent with the
going concern assumption.
 It considers risk by discounting at the required rate of return
(which is the rate that compensates for risk and time)

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 Non-financial goals

A firm needs to embrace this goals as well since they are also
important. They include:
Social responsibility
Business Ethics

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 Social responsibility
 This objective states that businesses should account for decisions that affect the society at
large.
 Maximizing shareholder’s wealth does not mean that a firm is free to ignore the interests of
the society.
 Firms should focus on the needs of its employees, customers, the environment and the
community.
 Businesses that ignores the welfare of the society will most likely incur other costs such as
negative publicity and lawsuits.
 A company should be involved in activities that benefit the society such as promotion of
education in the society, minimizing hunger and poverty levels, ensuring environmental
sustainability, enhancing employee skills etc
 There is a wide range of opinions regarding the balance between shareholder interest and
societal stakeholders.
 All in all, corporate managers should not ignore society interests in their quest of maximizing
shareholder value.
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 Business Ethics
 This goal has been strongly advocated for as a result of financial scandals in
firms.
 Ethics refers to standards of moral behaviour or standards of conduct or norm.
 High standards of moral behaviour require that the company treats each of its
stakeholders fairly.
 Business ethics can be measured by the tendency of the firm to adhere to rules
and regulations relating to:
Product quality and quantity
Fair employment practices
Fair marketing and selling practices
Insider trading and bribery

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Financial Markets
FINANCIAL MARKETS
FINANCIAL MARKETS
Financial Markets
❖Financial markets bring together lenders and borrowers of capital.
❖ Lenders save their surplus capital with the goal of accumulating funds while
borrowers need to raise capital to finance expenditure/ investments.
❖The markets also provide a platform for sale and purchase of financial assets and
commodities by facilitating the transfer and allocation of funds from savers to
borrowers.
❖Savers include individuals, small businesses, family units etc.
❖The main borrowers include government, companies, individuals etc.
❖[Link]
v=A7fZp9dwELo&ab_channel=ConcerningReality

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Functions of Financial Markets

⮚ Facilitate the market participants access to short term and

long term funds.
⮚ Promotes liquidity of financial assets through offering buyers
and sellers of financial assets a platform to trade securities as
desired.
⮚ Provision of professional investment advice to investors
through financial experts.
⮚ Promotes the allocation of funds to the most productive units.

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Classification Of Financial Markets
▪ The two broad classification of Financial markets are:
1. Capital Markets
2. Money Markets
▪ This classification is based on time horizon of instruments traded

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 Capital markets
▪ This market focuses on the trade of long term assets that have a maturity period of
more than one year.
▪ Capital markets comprise of stock market and bond market.
▪ Examples of financial assets traded in the capital markets are debentures, bonds,
preference shares, ordinary shares etc.
▪ Investors tap the capital markets to raise funds for long term purposes.
▪ Companies for example may issue equity in stock market and bonds in bond
market to finance their long term investments.
▪ The capital market is further divided into two, i.e. the primary market and the
secondary market.

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 Primary Capital Markets

▪ This market deals with securities (bonds and stock) issued for the first time. The
money flows directly from the buyer of the security to the issuer.
▪ The main issuers in this market are governments that seek to raise funds through
issue of bonds and companies that issue new stock and bonds.
▪ The institutional buyers in this market include pension firms, mutual funds,
insurance companies etc

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 Secondary Capital Markets

▪ The Secondary market deals in securities previously issued.

▪ The secondary market enables those who hold securities to adjust their holdings in
response to changes in their assessment of risk and return.
▪ They also sell securities for cash to meet their liquidity needs.

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 Money Markets

▪ The Money market refers to the market where borrowers and lenders trade short-
term instruments, which typically have a maturity lower than one year.
▪ Money market instruments are generally financial claims that have low default
risk and high marketability.
▪ The assets traded in the money markets include treasury bills and treasury bonds.
▪ Institutions operating in money markets include central banks, commercial banks
among others.

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