Business Finance

The combination of internal and external factors that influence a

company's operating situation. The business environment can include
factors such as: clients and suppliers; its competition and owners;
improvements in technology; laws and government activities; and
market, social and economic trends.
Forms of Business organization
What is Financial Management.

Financial Management is concerned with the acquisition,

Financing and Management of assets with goals in mind
such as value creation, investments and disinvestments.
Financing Decision
• makeup of the right-hand side of the balance sheet.
• Debt/Equity ratio.
• dividend-payout ratio.
• Dividend paid/Retained earnings.
• mechanics of getting a short-term loan,
• entering into a long-term lease arrangement,
• negotiating a sale of bonds or stock
Assets Management Decisions

Financial manager should be more concerned with the management of

current assets ,e.g. assets such as cash or cash like product such as
short term securities which can be easily converted into cash to pay its
current liabilities such as M1, M2, M3 than with that of fixed assets
.e.g. Such as building, equipment's, computers, goodwill etc having
useful life of more than year.
Business Risk

The term business risk refers to the possibility of inadequate profits or

even losses due to uncertainties e.g., changes in tastes, preferences of
consumers, strikes, increased competition, change in government
policy, obsolescence etc .Every business organization contains various
risk elements while doing the business.
Financial Risk

Financial risk refers to the chance a business's cash flows are not
enough to pay creditors and fulfill other financial responsibilities. The
level of financial risk, therefore, relates less to the business's
operations themselves and more to the amount of debt a business
incurs to finance those operations. The more debt a business owes, the
more likely it is to default on its financial obligations. Taking on higher
levels of debt or financial liability therefore increases a business's level
of financial risk.
INTREST RATE
The interest rate is often the number-one component of financial risk.
Banks and lenders offer business loans at a specific interest rate.
Business owners should view a loan’s interest rate as the cost of
doing business. In economic terms, the interest rate is often called
the cost of money. The cost of money represents payments the
business owner must make to the bank or lender for the opportunity
to receive a loan from the bank. High interest rates can significantly
increase the cost of doing business. Adjustable interest rates can
increase financial risk since the rate fluctuates based on the nation’s
monetary policy.
AMOUNT OF CREDIT
The amount of credit represents the size of business loans offered to a
company. Banks and lenders commonly review the company’s financial history
to determine how much money to loan the business owner. Small business
owners receiving copious amounts of credit may overextend their company by
using too much credit. Conversely, small businesses experiencing high growth
and the inability to obtain credit may not grow their business as quickly as
possible. Business owners must carefully review the banking environment to
ensure enough credit is available prior to expanding operations.
Cash flow
• Cash Flow
• Cash flow plays an important role in financial risk. Business owners
often use external financing to start their new business venture.
External financing represents fixed cash outflows that must be paid
regardless of the company’s profitability. Disruptions in business
operations or economic downturns do not absolve the business
owner of the obligation to make loan payments. Businesses with
sluggish sales and high cash outflows may also endanger their
owners’ personal financial assets.
Market risk
• Market Risk
• Financial risks can also be linked to the overall market risk in the
business environment. Market risk is the probability of loss a business
owner faces from the entire banking industry. Banks who continually
engage in risky lending practices can increase the financial risks of
small businesses. Banks with increasingly diminished returns or those
that buy and sell toxic loans can increase the market risk relating to
business financing.
Cash flow
• Cash Flow
• Cash flow plays an important role in financial risk. Business owners
often use external financing to start their new business venture.
External financing represents fixed cash outflows that must be paid
regardless of the company’s profitability. Disruptions in business
operations or economic downturns do not absolve the business
owner of the obligation to make loan payments. Businesses with
sluggish sales and high cash outflows may also endanger their
owners’ personal financial assets
Discounted Cash flow
• Discounted Cash Flow (DCF)
• What is a 'Discounted Cash Flow (DCF)'
• Discounted cash flow (DCF) is a valuation method used to estimate the
attractiveness of an investment opportunity. DCF analyses use future free cash
flow projections and discounts them, using a required annual rate, to arrive at
present value estimates. A present value estimate is then used to evaluate the
potential for investment. If the value arrived at through DCF analysis is higher
than the current cost of the investment, the opportunity may be a good one.
• Calculated as:
• DCF = [CF1 / (1+r)1] + [CF2 / (1+r)2] + ... + [CFn / (1+r)n]
• CF = Cash Flow
• r= discount rate (WACC)
• DCF is also known as the Discounted Cash Flows Model.
What is Capital Budgeting?

Capital budgeting is the process in which a business

determines and evaluates potential large expenses or
investments. These expenditures and investments
include projects such as building a new plant or investing
in a long-term venture. Often, a company assesses a
prospective project's lifetime cash inflows and outflows to
determine whether the potential returns generated meet
a sufficient target benchmark, also known as "investment
Balance sheet.
A company's balance sheet, also known as a "statement of financial
position," reveals the firm's assets, liabilities and owners' equity (net
worth). The balance sheet, together with the income statement and
cash flow statement, make up the cornerstone of any company's
financial statements. If you are a shareholder of a company or a
potential investor, it is important that you understand how the balance
sheet is structured, how to analyze it and how to read it.
Accounting equation
• Assets = Liabilities + Shareholders' Equity
Accounting equation
Assets are what a company uses to operate its business, while its
liabilities and equity are two sources that support these assets.
Owners' equity, referred to as shareholders' equity in a publicly traded
company, is the amount of money initially invested into the company
plus any retained earnings and it represents a source of funding for the
business.
Current Assets.
Current assets have a lifespan of one year or less, meaning they can be
converted easily into cash. Such asset classes include cash and cash
equivalents, accounts receivable and inventory. Cash, the most
fundamental of current assets, also includes nonrestricted bank
accounts and checks. Cash equivalents are very safe assets that can be
readily converted into cash; U.S. Treasuries are one such example.
Accounts receivables consist of the short-term obligations owed to the
company by its clients. Companies often sell products or services to
customers on credit; these obligations are held in the current assets
account until they are paid off by the clients.
Inventory
• inventory represents the raw materials, work-in-progress goods and
the company's finished goods. Depending on the company, the exact
makeup of the inventory account will differ. For example, a
manufacturing firm will carry a large number of raw materials, while a
retail firm carries none. The makeup of a retailer's inventory typically
consists of goods purchased from manufacturers and wholesalers.
Non- Current assets
• Non-current assets are assets that are not turned into cash easily, are
expected to be turned into cash within a year, and/or have a lifespan
of more than a year. They can refer to tangible assets such as
machinery, computers, buildings and land. Non-current assets also
can be intangible assets such as goodwill, patents or copyright. While
these assets are not physical in nature, they are often the resources
that can make or break a company – the value of a brand name, for
instance, should not be underestimated.
Depeciation
• Depreciation is calculated and deducted from most of these assets,
which represents the economic cost of the asset over its useful life.
Systematic
risk

• Systematic risk, also known as market risk or volatility risk,

signifies the inherent danger in the unexpected nature of
the market. This form of risk has an impact on the entire
market and not on individual securities or sectors.
Systematic Risk
• Systematic risk in finance[edit]
• Systematic risk plays an important role in portfolio allocation.[2] Risk which cannot
be eliminated through diversification commands returns in excess of the risk-free
rate (while idiosyncratic risk does not command such returns since it can be
diversified). Over the long run, a well-diversified portfolio provides returns which
correspond with its exposure to systematic risk; investors face a trade-off
between expected returns and systematic risk. Therefore, an investor's desired
returns correspond with their desired exposure to systematic risk and
corresponding asset selection. Investors can only reduce a portfolio's exposure to
systematic risk by sacrificing expected returns.
• An important concept for evaluating an asset's exposure to systematic risk is beta.
Since beta indicates the degree to which an asset's return is correlated with
broader market outcomes, it is simply an indicator of an asset's vulnerability to
systematic risk. Hence, the capital asset pricing model (CAPM) directly ties an
asset's equilibrium price to its exposure to systematic risk.
CAPM.
In finance, the capital asset pricing model (CAPM) is an empirical model
used to determine a theoretically appropriate required rate of return of
an asset, if that asset is to be added to an already well-diversified
portfolio, given that asset's non-diversifiable risk.
CPAM.

An estimation of the
CAPM and the security
market line (purple) for
the Dow Jones
Industrial Average over
3 years for monthly
data.
Economic Value Addition.
Basically, EVA is the economic profit a
company earns after all capital costs are deducted.
 Economic
Value Added

• EVA=NOPAT –Net Cost of Capital

Net Present
value
NPV
Why correct measurement is required?

If the real cost is greater than that which is measured, certain investment
projects that will leave investors worse off than before will be accepted. On the
other hand, if the real cost is less than the measured cost, projects that could
increase shareholder wealth will be rejected.
Triple Bottom Line

Triple bottom line (or otherwise noted as TBL or 3BL) is an

accounting framework with three parts: social,
environmental (or ecological) and financial. Many
organizations have adopted the TBL framework to
evaluate their performance in a broader perspective to
create greater business value. The term was coined by
John Elkington in 1994.
Sole Proprietorship: Merits
• The sole proprietorship is the oldest form of business organization.
• As the title suggests, a single person owns the business, holds title to all its
assets, and is personally responsible for
all of its debts.

A proprietorship pays no separate income taxes.

This business form is widely used in service industries.
• Simplicity is its greatest virtue.
• Its principal shortcoming is that the owner is personally liable for all
business obligations.
Demerits
• Its principal shortcoming is that the owner is personally liable for all
business obligations.
• If the organization is sued, the proprietor as an individual is sued and
has unlimited liability.
• Another problem with a sole proprietorship is the difficulty
in raising capital.
a sole proprietorship may not be as attractive to lenders.
Tax deductions are not available.
Transfer of ownership is difficult.
 Features of Partnership

• More than one owner.

• Pays no income taxes.
• Relative to Propritership greater amount of capital can be raised
• In a general partnership all partners have unlimited liability;
• Legally, the partnership is dissolved if one of the partners dies or
withdraws.
• settlements are invariably “sticky,”.
• In a limited partnership, limited partners contribute capital and have
liability confined to
Features of Partnership
• In a limited partnership, limited partners contribute capital and have
liability confined to that amount of capital.
• There must, however, be at least one general partner in the Limited
Partnership.
• The limited partners are strictly investors.
• This type of arrangement is frequently used in financing real estate
ventures.
Corporations
• A corporation is an “artificial entity” created by law.
• It can own assets and incur liabilities.
• existing only in contemplation
of the law
. Intangible.
.invisible.
. creature of law.
. charter of its creation confers upon it.
Corporations
• owner’s liability is limited.
• Transferable.
• unlimited life.
• double taxation.
• length of time.
• red tape involved,
• incorporation fee.
Limited liability Company
• hybrid form of business organization.
• corporate-style limited personal liability.
• e federal-tax treatment of a
• partnership.
• well suited for small and medium-sized firms.
• limited liability,.
• centralized management,
• unlimited life,
• the ability to transfer ownership interest without prior
• consent of the other owners.
Financial Control
•prove profit margins with better cost controls.
•Implement controls on sales expenses and administrative
costs.

•Create ratio analysis reports for managers.

•Avoid excess purchases of fixed assets.

•Conduct internal audits to analyze risks and find areas for

improvement.