Fundamental Concepts and Tools of Business Finance

Chapter 3
Fundamental Concepts and Tools of Business Finance

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

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

Basic Concepts
Categories of Finance

• 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.

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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 finance 2. Corporation finance 3. Multinational Business finance

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Goals of Business Finance
1. Maximizing profit 2. Maximizing profitability 3. Maximizing profit subject to cash constraint 4. Maximizing net present worth 5. Seeking an optimum position along a risk-return frontier

Goals of Business Finance
Maximizing Profit

• Means realizing the highest possible peso or dollar income.
Maximizing Profitability

• Means obtaining a higher rate of return on its investment

Goals of Business Finance
Maximizing Profit Subject to Cash Constraint

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

Goals of Business Finance
Maximizing Net Present Worth

• 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.

Goals of Business Finance
Maximizing Net Present Worth

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

Goals of Business Finance
Seeking an Optimum Position Along a Risk-return Frontier

• 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.

Goals of Business Finance
Seeking an Optimum Position Along a Risk-return Frontier

• Risk is the uncertainty as to loss.

The Financial Statement
Balance Sheet

 Assets
    Current Assets Trade Investments Fixed Assets Intangible Assets

The Financial Statement
Balance Sheet

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

The Financial Statement
Balance Sheet

 Net Worth
 Capital Stock  Common  Preferred  Paid-in Surplus

The Financial Statement
Income Statement

 Revenues  Expenses  Cost of Goods Manufactured and Sold  Operating Expenses  Other Expenses  Other Income  Net Profit or Net Loss

The Financial Statement
Budget

• Budget is defined as an estimate of income and expenditures for a future period.
 Sales Budget  Materials and Purchases Budget  Production Budget

Significance of Financial Statements and Budgets
• Persons interested in knowing the financial standing of the firm: 1. Owners – anticipated financial benefits 2. Management – effective planning and control of the activities of the firm 3. Creditors – if the firm is credit worthy 4. Government – for tax and regulatory purposes 5. Prospective Investors – protection of their investments and earnings

Annual Reports
• A report sent annually to the stockholders • Contains the following: 1. Balance Sheet 2. Profit and Loss Statement 3. Auditor’s report 4. Chairman’s report

Next Meeting
Readings
Continuation of Chapter 3, 4 and 5

Quiz
Review on Chapter 1 and 2