Introduction to Business Finance

 The term finance is used to mean money used to run a business or to carry out an activity. Finance is important to carry out any types of business activities. Organizations do not survive without finance. That is why it is known as lifeblood of business firms. The term finance is also used to refer to an academic discipline or subject of study. As an academic discipline, in finance, we study principles and practices relating to the activity of managing money. We study number of concepts, tools and theories in finance which are very useful in making rational decisions for individuals, organizations and the government. For example, concept like time value of money is very useful to compare the value of money received at two points of time, e. g. right now and after one year. Similarly, other concepts like risk and return are fundamental for any decision- making. In addition, in finance we also study financial decision-making tools and techniques like capital budgeting techniques. These techniques help us to decide which project we should undertake and which we should not. Finally, we study very useful theories in finance which explain and guide how financial decisions should be taken. The study of finance helps us to search the cheapest source of funds, use them in most productive projects, and distribute the benefits in an equitable manner. 

A firm may set its goal in different terms. But from the perspective of managing financial resources, the goal of wealth maximization is considered the superior than profit maximization. Managing finance is one of the important activities in a firm, therefore, finance department is placed directly under the supervision of the Chief Executive Officer (CEO) in the organization structure of a firm. The person responsible to look after the finance function in a firm is known as the financial manager, with title like Chief Finance Officer (CFO) or Vice President (Finance) The CFO is assisted  by many subordinate staffs. They perform managerial and routine function The scope of finance has widened over period. It covers fields, like business finance, financial stations and markets, investment management and international finance. Here we cover only business finance.

An overview of Business Finance

Business finance is used to refer to the management of funds in the context of a business firm Traditionally, business finance used to focus only on the procurement of funds required to set up business firm and expansion of its activities. The person responsible to manage funds in the business was known as the financial manager who was responsible to estimate and raise the funds to meet the requirement of funds of a company. With the passage of time, the scope of business finance has widened. Previously, it was limited to the fund-raising activities (such as estimating the need of the fund, identifying the sources of funds, deciding the methods of raising funds, etc.); but now it has expanded to cover the acquisition, financing, and management aspects of a company's assets. This approach to the concept of business finance is known as modern concept. To illustrate this concept, let us take an example of a hypothetical company- Nepal Café. Nepal Café is a restaurant chain with several outlets in Kathmandu. Suppose Nepal Café plans to open an outlet in Pokhara. Before it implements the plan, the manager will have to answer to a number of questions such as:


  • How much will it have to invest to start an outlet in Pokhara? How much investment will require for fixed assets and how much for working capital? Will the benefit exceed the cost? 
  • How much fund does the company will be able to invest from its past earnings, and how much does it need to borrow? From where to borrow?
  • Should all the profit earned by the business be taken away by its owners (shareholders), or a part of the profit should be retained in the business for future investment?
  • How much current assets (inventory or stocks, receivables and cash) should the company hold? How should they be financed?


The first set of questions is related to whether Nepal Cafe should invest in the project (opening a café in Pokhara) or not. In the language of business finance, such kind of decision is known as investment decision. The second set of questions is related to financing of the project. In the language of business finance, such kind of decision is known as financing decision. The third set of questions is related to the distribution of profit. In the language of business finance, such kind of decision is known as dividend decision. Finally, the last set of questions is related to holding appropriate level of current assets. In the language of business finance, such kind of decision is known as current assets or working capital management decision. The study of business finance helps us to answer to these types of questions and take investment, financing, dividend, and working capital management decisions. The financial manager must consider the best interest of its owners as well as that of other stakeholders while taking these decisions.


Relationship of business Finance with other Discipline

Business finance which studies the acquisition and use of a firm's financial resources is an essential component of business studies. It is an integral part of the overall management, therefore, it should be studied along with other disciplines. It is because finance derives heavily the conceptual and analytical foundations from other disciplines particularly from economics and accountancy. In the following section we examine relationship between finance and other disciplines


Relationship with Economics

The relationship between business finance and economics can studied from two basic aspects of economics: macroeconomics and microeconomics Macroeconomics is concerned with broad aspects of an economy such as output, employment and income. The government changes its policies (monetary and fiscal policy) to influence the level of economic activities. The financial manager must understand the consequences of these policies on the level of output. employment and income; and ultimately on the firm's performance. S/he should evaluate various financing and investment alternatives in such macroeconomic framework. Microeconomics is concerned with the economic issues relating to individual firms operating within the economy. It deals with the economic problems related to individual firms. Many principles associated to microeconomics such as demand and supply analysis, profit maximization strategies, pricing theories have practical application to finance. In this sense. finance is regarded as applied microeconomics. The principle of marginal analysis technique of microeconomics - is widely used in business finance for decision-making


Relationship with Accounting

The relationship between finance and accounting is quite close. Accounting is concerned with collecting processing and presenting financial data, whereas business finance is concerned with using these data for financial decision making? The financial manager, as per the requirements, recasts the statements prepared by accountants, generates additional data, and use them for decision making.


Relationship with Other Disciplines

Besides its direct relationship with economics and accounting, business finance is also related other disciplines, such as mathematics, statistics and quantitative techniques. In fact, it draws heavily on mathematics and quantitative techniques. The uses of several quantitative and mathematical techniques have been extremely useful for solving complex financial problems a firm.


Roles and Responsibilities of a Financial Manager

Who is the financial manager in a firm? Simply put, the financial manager is one who is responsible for taking major financial decisions (investment, financing, dividend, and working capital management) in a firm. The title of the financial manager differs among organizations In a typical large organization, the title Chief Financial Officer (CFO) or Vice President (Finance) is used to refer to the financial manager, and they are assisted by people with titles like treasurer, controller, etc. But, in a small firm, the owner himself/herself may be taking the role of the financial manager. Whatever the title, the financial manager plays important role and responsible for the following in her/his organization.


Planning and Controlling

The financial manager works in a team of managers representing different functional departments such as production, marketing, and human resource department/ Any decisions taken in those departments have financial implications. For example, if the production manager comes with an idea of replacing an existing plant, or the marketing manager with the proposal of launching a mass advertisement campaign, the financial manager will have to analyze the financial implications of those decision, and plan for the resources required to exercise the proposal. S/he should be involved in forecasting the firm's production and sales. S/he should forecast the inflation and interest rates and their effects on firm's cost of capital, profitability and ultimately on share price of the firm. S/he involves in the planning and controlling process in coordination with other managers. But his/her major responsibility lies on formulating financial plans and developing control parameters.


Investment, Financing and Dividend Decision 

The financial manager's responsibility under investment decision involves deciding what specific assets (fixed as well as current assets to acquire, and support to realize projected growth) Under financing decision, s/he has the responsibility to decide from what sources the required funds to be collected. The financial manager is responsible to make an optimal capital structure so that the cost of capital will be at minimum level, Financial managers of multinational companies need to perform those investment and financing decisions from global perspective meaning that they need to think of events worldwide. The financial manager makes dividend decision that involves not only cash dividend, but also stock dividend, stock split, reverse stock split, stock repurchase etc.


Dealing with Financial Markets

The financial manager stands between firm's operations and financial markets. S/he must deal with money market for short-term funds and capital market for long-term fund Financial markets are important not only for collecting funds but also for trading securities. It is the financial market where a firm's securities are priced and traded. Therefore, the financial manager must disclose important financial data to the participants of the financial markets.


Risk Management

Risk management is one of the most important responsibilities of the financial manager. The financial manager identifies and measures the risk, and uses it to decide whether the expected returns from the projects is fair enough to compensate the risk. Further, a number of factors such as natural disasters, changes in price level, interest rates, taxation policy, foreign exchange rates etc. affect risk. The financial manager should manage these risks by using appropriate risk management tools such as insurance, portfolio management, derivative securities, etc.


Ethical Concerns in Financial Decisions

The dictionary meaning of ethics refers to moral principles that control or influence a person's behavior. In other words, ethics are moral rules people apply in making decisions. Ethics are generally defined in the context of individuals; hence ethical behavior varies from one person to another person. For example, one student who finds a hundred rupee note in the school compound believes that it is okay to put it in his/her pocket whereas other feels compelled to put a notice in lost-and-found notice board. Individual ethics are determined by family and peer influences, experiences, personal values and morals, and situational factors. Though, ethics is a personal issue and determined by many factors, we expect an individual's ethical behavior to confirm to generally accepted social norms.

Business ethics, also known as managerial ethics, are a company's attitude and conduct towards its employees, customers, community and stockholders. They guide individual managers in their work. The issue of business ethics has been a matter of concern these days because of misrepresenting performance of products, misleading advertisements violations of social norms, etc.

Basically, there are three areas of concern for business ethics. The first relates to how a firm treats its employees. It includes areas such as hiring and firing, wages and working conditions, and employee privacy. For example, a manager paying an employee less than s/he deserves, simply because of the gender might be unethical. Similarly, a manager spreading a rumor that an employee is a gay or is having affair with a coworker is generally seen as unethical breach of privacy. The second relates to how the employees treat the firm. It includes areas such as breach of secrecy, and dishonesty in keeping expenses account. For example, disclosing company secrets by employees is clearly against business ethics Similarly, inflating expenses bills or paying more than desired payment are other examples of unethical behavior on the part of employees. Finally, business ethics encompass how the organization treats other stakeholders. It means how the organization treats to its customers, competitors, stockholders, suppliers, dealers and unions. Normal business ethics in relation to customers requires that product and services are safe. There be no unfair business practices such as false claims on advertising. Similarly, ethical standards also dictate that managers be truthful with stockholders. For example, Nepalese stockholders have raised questions on the ethics of managers of some companies whose audited figures of financial statement deviate widely with the provisional figures they publish.

What should we do to restrain unethical practices and promote ethical behavior? Of course, there must be appropriate legal and institutions set ups, enforcement of the rule of law and adherence to the principles of good governance, etc. But, on top of that, we must have firm commitment on our ethical values. When these values guide our decisions - the way we treat our employees, our organization, and our (our firm's) stakeholders - all will be all right. Value guided activities take us to the real definition of ethics - the fragrance of wisdom.


Also read Financial Statements And Reporting