Fundamental Concepts and Tools of Business Finance

Chapter 3

Basic Concepts

• Study of the acquisition and investment of cash for the purpose of enhancing value and wealth.

• Public Finance – general finance which deals with revenue and expenditure patterns of the government and their various effects on the economy.

Finance

Categories of Finance

Basic Concepts

• Private Finance – area of general finance not classified under public finance. • Personal Finance – concerned with

fundmentals of managing one’s own personal money and affairs.

• Finance of Non-Profit Organizations – includes private undertakings such as charity, religion, and some private educational institutions.

Categories of Finance

Business Finance• Business Finance – refers to the provision of

money for commercial use.• Also concerned with the effective use of funds.• Covers the financial management of private-

profit seeking concerns in the business of service, trade, manufacturing, mining, public utilities, and financing

• May be concerned with the following 3 Aspects:1. Small business finance2. Corporation finance3. Multinational Business finance

Goals of Business Finance1. Maximizing profit2. Maximizing profitability3. Maximizing profit subject to cash

constraint4. Maximizing net present worth5. Seeking an optimum position along a

risk-return frontier

Goals of Business Finance

• Means realizing the highest possible peso or dollar income.

• Means obtaining a higher rate of return on its investment

Maximizing Profit

Maximizing Profitability

Goals of Business Finance

• Maximizing profits while at the same time maintaining a cash balance that can take care of cash requirements anytime.

Maximizing Profit Subject to Cash Constraint

Goals of Business Finance

• Maximizing the current value of the company to its owners.

• Net present worth of a company is equal to the value now of the firm plus values arising in the future.

Maximizing Net Present Worth

Goals of Business Finance

• Time Value of Money – money increases in value with the passing of time.

Maximizing Net Present Worth

Goals of Business Finance

• A firm can set a goal of achieving the best possible combination of risk and return.

• Return on investment is the net income generated by the use of investments or the net worth. When expressed in percentage it is called the Rate of Return.

Seeking an Optimum Position Along a Risk-return Frontier

Goals of Business Finance

• Risk is the uncertainty as to loss.

Seeking an Optimum Position Along a Risk-return Frontier

The Financial Statement

Assets Current Assets Trade Investments Fixed Assets Intangible Assets

Balance Sheet

The Financial Statement

Liabilities Accounts Payable Loans and Notes Payable Advances from customers Accrued Expenses Mortgage Expenses Bonds Payable

Balance Sheet

The Financial Statement

Net Worth Capital Stock

Common Preferred

Paid-in Surplus

Balance Sheet

The Financial Statement

Revenues Expenses

Cost of Goods Manufactured and Sold Operating Expenses Other Expenses

Other Income Net Profit or Net Loss

Income Statement

The Financial Statement

• Budget is defined as an estimate of income and expenditures for a future period.

Sales Budget Materials and Purchases Budget Production Budget

Budget

Significance of Financial Statements and Budgets

• Persons interested in knowing the financial standing of the firm:1. Owners – anticipated financial benefits2. Management – effective planning and

control of the activities of the firm3. Creditors – if the firm is credit worthy4. Government – for tax and regulatory

purposes5. Prospective Investors – protection of their

investments and earnings

Annual Reports• A report sent annually to the

stockholders• Contains the following:

1. Balance Sheet2. Profit and Loss Statement3. Auditor’s report4. Chairman’s report

Next Meeting

Continuation of Chapter 3, 4 and 5

Review on Chapter 1 and 2

Readings

Quiz