Fundamentals of Finance - Lesson 1 2024

FIN 120301 Fundamentals of Finance Piyumika Rathnasuriya Department of Finance Faculty of Management and Finance University of Colombo  Lesson 1 INTRODUCTION TO THE FINANCE DISCIPLINE 2  Finance...

FIN 120301 Fundamentals of Finance Piyumika Rathnasuriya Department of Finance Faculty of Management and Finance University of Colombo  Lesson 1 INTRODUCTION TO THE FINANCE DISCIPLINE 2  Finance is…. Definitions of Finance “art and science of managing money” (M. Y. Khan & mudal kalamakrnaya kirime kalawak ha widywk. P. K. Jain) “Business activity which concerns with the athpth krgnima acquisition and conversation of capital funds in meeting financial needs and overall objectives of a business enterprise” (B. O. Wheeler) 3  “Business finance can broadly be defined as the activity concerned with planning, raising, controlling, administering of the funds used in the business”. (Guthumann & Dougall) *simply, Finance refers to the ways in which funds are generated and used. * Accounting is the process to recording and summarizing business and financial transactions and analysing, verifying, and reporting the results. capital, investments & funds lifeblood of business organization 4 Types of Finance 5 6  Definitions of Financial management It is concerned with the efficient use of an important economic resource namely, capital funds. (Solomon) purchasing Financial Management deals with procurement of funds and their effective utilization in the business. (S.C. Kuchal ) An application of general managerial principles to the area of financial decision-making. (Howard & Upton) 7 Finance as an interdisciplinary subject subject area Primary disciplines – Accounting – Macro-Economics – Micro-Economics Other related disciplines – Marketing – Production – Quantitative methods 8  Assets = Capital + Liabilities Investment = Financing Uses of funds = Sources of funds 9 equity assets NCA- LAND,PPT CA debts NCL 10 Finance within the organization structure owners Shareholders Board of chairman Directors Chief Executive working for salaries Officer (CEO) Operational Marketing Finance HR Manager Manager Manager Manager Employees 11  ACT + FIN Finance 12 FIN activities ACT activities 13  Importance of Finance Financial planning Acquisition of funds athpth krgnnw Allocation of funds – Investment decision Decision making Improve profitability Increase the value of the firm 14 Reason for placing the finance function in the hands of top management pawathme theeranathmka. – Financial decisions are crucial for the survival of the firm. – The financial actions determine solvency of the wypryk kochchr durkt strong d? kadawatenne nedd wge thirny wenw. firm. madyagthakarnwa – Centralisation of the finance functions can result in a number of economies to the firm. 15  Roles of Financial Manager karyabarya Traditional role of Financial Managers: – Accurate record keeping – Preparation of financial reports – Managing the cash resources of the firm 16 Modern role: forecast the future – Forecasting financial requirements *Eg: solar power projects – Raise funds from investors – Invest funds in value-enhancing projects – Manage funds generated by operations – Returns funds to investors Capital Gain+ regular – Reinvest funds in new projects – Coordination with other departmentsEvery departement, they all need money. eg: whwn person is become a investor, otherwise he get shares in HNB........... 17 Decisions taken by Financial Manager: The assets that a firm should acquire Financing method The proper mix of various sources of funds The distribution of profits / Dividend policy Does the firm has adequate cash? Which customer should be offered credit? How much inventories should be held? Is merge or acquisition advisable? 18  Key decisions taken by the Financial Manager Investment decisions Financing decisions Long Term Dividend decisions Liquidity decisions - Short Term CA AND CL 19  Objectives of Financial Management Objectives of Financial Management may be broadly divided into two parts such as: Profit Maximization earlier concept Wealth Maximization 20  Profit Maximization Main aim of any kind of economic activity is earning profit. A business concern is also functioning mainly for the purpose of earning profit. Profit is the measuring techniques to understand the business efficiency. Profit maximization is also the traditional and narrow approach which aims at maximizing the profit of the organization. 21  Drawbacks of Profit Maximization Objective profit is vague concept. we are only focus on profit. apahadili-vague Profit is not defined precisely It ignores the time value of money It ignores risk In profit risk is ignore Profit maximization leads to exploiting workers and consumers Profit maximization creates immoral practices such as corrupt practice, unfair trade practice, etc. 22  Wealth Maximization Wealth of the shareholders or shareholders’ value maximization. A process that increases the current net value of business with the objective of bringing in the highest possible return. Shareholder wealth is represented by the market price of Oridanary shares the firm’s common stock. Managers should attempt to maximize the market value of the company’s shares. 23  Fin mgt What is the fundamental objective of a firm? Wealth Maximization Whose wealth? Ordinary shareholders / Common shareholders What is wealth? Market price of an ordinary share How? By increasing/ maximizing the market price 24  shareholders wealth maximizating How does SWM overcome 3 main drawbacks in Profit Maximization? Vague Wealth = market price present Ignores time value of money Ignores risk 1. unethical business practices have companies do not invest SWM 25 26 Agency Problem 27  Shareholders Agency relationship Board of Directors BOD salaries and other cost are called agency cost. cuz CEO and other managers are expectation Chief Executive for shareholders. Officer (CEO) Operational Marketing Finance HR Manager Manager Manager Manager Employees 28  Managers Versus Shareholders’ Goals Agency Agency Problem / Conflict Agency Cost Relationship E.g.: SWM principle and agents are two different people 29  Managers Versus Shareholders’ Goals shareholderslat oni widiyt thm ceola asirenn oni kyl hithnw In large companies, there is a separation between shareholders CEO, BOD ownership and management. Shareholders as owners of a company are the principals and managers are their agents. Managers should act in the best interests of shareholders. In practice, managers may not necessarily act in the best interest of shareholders, and they may pursue their own personal goals. 30  Managers may pursue their own personal wealth at the cost of shareholders, or may play safe and create satisfactory wealth for shareholders than the maximum. Managers may avoid taking high investment risks and financing risks that may otherwise be needed to maximize shareholders’ wealth. Such ‘satisfying’ behaviour of managers will frustrate the objective of SWM. managers, are focus abot their own wealth eg: their salaries and others Actions of the managers are very likely to be directed towards the goal of survival. 31  Managers may perceive their role as reconciling conflicting objectives of stakeholders. This stakeholders’ view of managers’ role may compromise with the objective of SWM. Shareholders have to continuously monitor the managers in order to ensure they work to the best interest of the shareholders. Cost incurred in such monitoring activities is known as ‘Agency Cost’. 32  Agency Cost Cost of auditing Cost of monitoring Cost of contractual bonds Agreements Gains from lost opportunities oymnm me company eke thirna gnne oyt e desicion ek gnn thibuna. e gnneagency kenek nm oyt e opportunity ek nthi wenw Stock options (ESOPs) issuing share to employees Cost of implementing an effective corporate governance system cost of having BOD encouragement. it is not monitoring, rewards, promotions. like motivatons Cost of other financial and non-financial incentives Monitoring, CCTV are set. after BOD are work well. cuz they are monitoring by shareholders with CCTV. 33 These are agency cost End of Lesson 1