Business Finance: Business Finance is the accumulation of the required capital for a business organization according to its financial

planning and the proper utilization of that accumulated capital in order to achieve the objectives of that organization. In other words, the process of preparing financial plans and then accordingly to collect the required capital from the most suitable sources which would minimize the capital cost and then proper utilization of that capital in the most suitable projects that will lead a good cash flow for the firm so that the firm can reach to its goal is known as Business Finance. It means that business finance helps a financial manager to make decisions about the capitalization of a firm both in the short run and in the long run.

Areas of business finance: The study of finance consists of three interrelated areas: 1) Financial markets, which deals with many of the topics of macroeconomics; these organizations which include banks insurance companies savings & loan association & credit unions are an integral part of the financial marketplace. To succeed in the financial service industry one must understand the factors that cause interest rate to rise & fall the regulations to which financial institution are subject & the various type of financial instruments such as mortgages auto loans & certificates of deposit. 2) Investments, which focus on the decisions of individuals & financials & other institutions as they choose securities for their investment portfolio. Financial graduates who enter the investment field generally work for stock brokerage firms, financial institutions, investment companies, or insurance companies. The three main functions in the investment area are:1

(a) Selling. (b) Analyzing individual securities. (c) Determining the optimal mix of securities for a given investors.

The basic knowledge of finance may help us as follows:(a) Review companies & industries to determine their prospects for future growth & ability. (b) Determine how much risk we are willing to take. (c) Evaluate how well our investments are performing.

3) Managerial finance, which is the broadest of the three areas & the one with the greatest number of job opportunities, deals with decisions that firms make concerning their cash flows. The types of tasks encountered in Managerial finance jobs range from making decision about plant expansions to choosing what types of securities to issue to finance expansions. Financial managers also have the responsibility for deciding under which credit terms can buy. On the other hand, stockholders must understand general financial principles if they are to give intelligent advice to their customers.

Functions of the Finance Manager: The finance manager of a business organization generally performs two types of functions, which are as follows:

A. Managerial Functions 1. Investment Decision

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a) Working Capital Management b) Capital Budgeting 2. Financing Decision 3. Dividend Decision B. Routine Function 1. Financial Planning 2. Source Identification 3. Raising of Fund 4. Investment of Fund 5. Distribution of Fund 6. Protection of Capital 7. Forecasting Cash Flow 8. Managing Fund 9. Forecasting Future Profit 10. Managing Fund 11. Cost Control 12. Pricing These functions discuss in short is given below:

A. Managerial Functions:
1. Investment Decision: The finance manager takes decision about the investable project. He/she evaluates the prospects of each investable project and also the risk of the project. Then he/she find out the most attractive project that will help the firm to achieve its objectives. In this respect the manager has to take two types of decisions. They are

a)

Working Capital Management: A business cant run by only investing in the long-term projects. So it needs to invest in the current assets and get the benefit out of it for one year or less than one year. This is known as Working Capital Management. In this type of decision making a manager has to make adjustment between the profitability and the liquidity of the firm as profitability decreases when liquidity is increased and profitability increases when liquidity is decreased but at this the risk of the firm increases.

b)

Capital Budgeting: Capital Budging is used in the decision making of investment from which a firm can get advantage for long-term. In this case, the fund required for the project, the period of the project, the expected earnings, riskiness etc are to be identified and evaluated.

2.

Financing Decision: The second function of a finance manager is to accumulate the required capital to invest in the decided projects. It means that after taking the investment decision, a finance manager has to identify the available sources from which the firm may collect its required capital. Then he/she considers the advantages and disadvantages of each source and thus selects the most suitable source which will minimize the cost of capital. In this case, the manager also decides the amount of capital that would be collected from the debt capital. The ratio of this equity capital and debt capital is known as the Capital
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Structure. The capital structure at which the cost of capital is minimum and the share price is maximum is known as Optimum Capital Structure.

3.

Dividend Decision: By utilizing the collected capital property according to the financial planning a firm earns some profit. The finance manager of a firm has to take decision about the distribution of this profit, which is an important function of a finance manager. He/she decides the portion of the profit that will be distributed among the shareholders and the portion that will be kept as retained earning so that the firm can further invest it in future. The percentage of the profit that is distributed among the shareholders considering the expectation of the shareholders and the reinvestment opportunity of the company is the Dividend Payout Ratio. The dividend payout ratio, at which the share price is maximized after fulfilling the expectation of the shareholders and meeting the reinvestment need of the firm, is known as Optimum Dividend Payout Ratio.

B. Routine Functions:
1. Financial Planning: The finance manager has to daily identity the required amount of capital for implementing the long-term planning of the firm.

2. Source Identification:

After financial planning the manager has to identify the possible sources to collect the required capital.

3. Raising of Fund:

After identifying the possible sources, to analyze the cost of each of the sources and then to collect fund from the most suitable source is the duty of a financial manager.

4. Investment of Fund: A manager has to invest in the most profit oriented projects by analyzing the cost and benefit of the projects. At first all those projects that have higher income than their cost have to be identified and then among them the most attractive project has to be taken.

5. Distribution of Fund: A part of the earned profit by investing in the selected projects should be distributed among the shareholders while the rest should be kept for the firm itself. This distribution decision should be taken by the finance manager.

6. Protection of capital: Uncertainty always exists in the business world. So a finance manager should always be aware of the risk associated with each investment and be protective of the invested capital so that the
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firm can increase the capital by earning profit rather to decrease it by facing loss. 7. Forecasting Cash Flow: A manager should have idea about the prospective cash inflow and outflow of the firm.

8. Managing Fund: A manager has to invest in a project by analyzing the risk-return trade-off. Thus he has to manage the fund.

9. Forecasting Future Profit: Since the manager has to forecast the future cash flows, he can easily forecast the profit and can accordingly take the financial decision for the firm for future time period.

10. Managing Asset: It is the duty of a manager to take care of the assets of the business organization, like equipments, machineries, raw materials and other investments.

11. Cost Control: A manager should control the cost so that the earning remains higher than the cost of the

firm. Again he has to be cautious about the cost of capital.

12. Pricing: A manager has to price the product that the organization produces. In this case, he has to consider the cost of production of the products and other related expenses and at the same time should not set the price at such a higher level that the target group becomes unable to purchase them.

Thus we can see that the functions of a finance manager are quite important for a firm in regarding the achievement of its objectives

Goal of Business Organization: Each and every firm has a goal. Generally, most of the people say that profit maximization should be the right goal .Hear profit means maximizing the money income of the firm. The profit maximization goal has however been criticized in recent year. But now profit maximization is not the goal of the business organization. There are some limitations for profit maximization and they are :

(a)The timing of the return: The profit maximization objective does not make distinction between return received in different time period. It gives no consideration to the time value of money and its value benefit received today and benefit received after a period as the same.
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(b)Risk: Profit maximization disregards risk .the streams of benefits may possess different degree of certainty. Two firm may have total expected earning but if the earning of one firm fluctuate considerably as compared to the other, it will be more risky. Possibly, owner of the firm prefer smaller but profit to a potential larger but less certain stream of benefit.

(c)Ambiguity or vague: The word profit is vague. Because when we say profit it is short term and long term profit, it is before tax or after tax , is it net profit or gross profit ,is it total profit or per share profit. There is no clear cut indication.

(d)Social responsibility: Certainly firm have an ethical responsibility to provide a safe working environment, to avoid pollution the air and water and to produce safe product. However socially responsible actions have cost and it is questionable whether business settled to maximize profit would incur cost voluntarily probably not. Consider those limitation we can say profit maximization is not the goal of business organization.

Maximizing Shareholder Wealth: The goal of the financial manager is to maximize the wealth of the owners for whom the firm is being managed. The wealth of corporate owners is measured by the share price of the stock,
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which in turn based on the timing of returns , cash flows, & most important on risk. Although profit is considered in the wealth maximization process it is not the key decision variable Rationale behind Wealth Maximization: 1) Clear concept. 2) It considers risk, timing of return & time value of money. 3) Focus on market price of shares.

Financial System:

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A system which deals with the supply & utilization of funds to different economic units in most efficient manner within the institutional framework on most favorable terms & conditions. There are three components of financial system. That are-

Financial Market: A financial market is a market in which financial assets (securities) such as stocks & bonds can be purchased or sold through the interaction of the buyers & the sellers. It facilitates the flow of funds from surplus unit to deficit unit. Financial market can be categorized from different viewpoints. Like-

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Money Market: Those financial markets that facilitate the flow of short term funds (with maturities of less than one year) are known as money market. Capital Market: Financial markets that facilitate the flow of long term funds are called capital market Primary Market: Primary markets facilitate the issuance of new securities. It provides funds to the initial issuer of the securities. For example- the issuance of new corporate stock or new treasury securities. Secondary Market: Secondary market facilitates the trading of existing securities. Transaction in this market does not provide anything to the issuing firm. For example- The sale of existing corporate stock or treasury holding by individuals or business organization. Spot Market: In this market the assets are delivered on the spot or at the time of transaction.

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Future Market: In this case the assets are delivered after a certain period of time or in the future. There also another two types of stock market exist. They areOrganized Market: A financial market where secondary market transactions occur at an organized exchange or a visible marketplace. Example- New York Stock Exchange & American Stock Exchange. Over- the-counter (OTC) Market: Here financial market transactions occur through a telecommunication network. Types of financial securities: Firstly we should give a definition of security: A security is a fungible, negotiable instrument representing financial value. We usually categorize securities into:

Debt securities Equity securities Derivative contracts (forwards, futures, options and swaps)

The company or other entity issuing the security is called the issuer. A country's regulatory structure determines what qualifies as a security.

For example, private investment pools may have some features of securities, but they may not be registered or regulated as such if they meet various restrictions.

Securities may be represented by a certificate or, more typically, "non-certificated", that is in electronic or "book entry" only form. Certificates may be:

Bearer: When they entitle the holder to rights under the security merely by holding the security Registered: When they entitle the holder to rights only if he or she appears on a security register maintained by the issuer or an intermediary.
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Although we have said that securities have been categorized into debt, equity and derivative securities, we will study with more emphasis debt and equity. Moreover, we will pay attention to a hybrid category. Debt securities: Debt securities are any debt instrument that can be bought or sold between two parties and has basic terms defined. The original buyer of the debt security lends the issuer money in exchange for the security.The holder of a debt security is typically entitled to the payment of principal and interest, together with other contractual rights under the terms of the issue. He also has the right to sell the security to someone else. In this case this person has the right to receive the interest and the principal from the issuer. The debt security is also called fixed-income security. Debt securities are generally issued for a fixed term and redeemable by the issuer at the end of that term. Debt securities may be protected by collateral or may be unsecured, and, if they are unsecured, may be contractually "senior" to other unsecured debt meaning their holders would have a priority in a bankruptcy of the issuer. Debt that is not senior is "subordinated". Debt securities are defined as debt obligations issued by government, governmental agencies, and corporations . Government securities are: 1). Treasury bills; 2). Treasury notes; 3). Treasury bonds; 4). Strips; 5). Municipal bonds. 1). Treasury bills are issued by United States government. They are the safest security with maturity of 26 weeks or less which are sold at a discount. 2). Treasury notes, are 2, 3, 5 and 10 year maturity in which on every sixth month is paid an interest with a fixed coupon. 3). Treasury bonds are with maturity more than 10-years, the interest is paid semi-annually with fixed coupon.
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4). Strips are created by broker-dealers. They consist of bonds sold at a discount with no interest payment. 5). Municipal bonds are issued by state on local governments and governmental agencies. Generally they are exempt from federal income tax and from state taxes for purchasers who live in the state of issue. Agency Securities are issued by government sponsored entities. They provide higher yields than direct government securities with higher risk . Corporate Bonds are Debt securities issued by corporations. They have a greater claim on the firms assets than equity instruments and are backed only by the issuing company, with risk quantified by rating agencies. Next, we must say that debt securities receive different denomination depending on certain characteristics, as the maturity. It is necessary to accentuate:
o

Corporate bond: It is a bond that a corporation issues to raise money in order to expand its business. The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date. Money market instruments are short term debt instruments that may have characteristics of deposit accounts, such as certificates of deposit, and certain org / wiki / Bill_of_exchange bills of exchange. They are highly liquid and are sometimes referred to as "near cash". Government bonds are medium or long term debt securities issued by sovereign governments or their agencies. Typically they carry a lower rate of interest than corporate bonds, and serve as a source of finance for governments. This kind of bond is usually used in the open market operations.

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A security, the document enjoyed personifying the holder the right to property. The most popular securities include stocks, bonds, treasury bills, savings bonds, bank notes, checks and bills, and units in investment funds and lots of lottery tickets. From the perspective of the type of property rights can be divided into securities representing ownership (stocks) or debt (other). The nature of income received by the securities held by the securities can extract yield fixed income (preference shares, zero coupon bonds or fixed interest rate, bills), and variable-yield securities income (such as equities, bonds, variable interest rate, the units participation in investment funds). Depending on distinguished: how the transfer of property rights are

1) The securities registered - the name (name) the owner is placed on paper and transfer of ownership may take place by notarial contract, often only with the consent of the issuer (also requires recorded in the appropriate register) or by endorsement. 2) The bearer - transfer of ownership takes place by handing them to another person. Securities may have a certain period of operation of the financial market, after which they are subject to mandatory repurchase by the issuer (eg, bonds, treasury bills, promissory notes) or remission (eg, the fate of lottery). They may also have open-ended nature and not subject to redemption (eg shares, units in investment funds, bank notes). The securities have a nominal price, written on them and giving rise to property rights, and the issue price, which should pay for them at the time of purchase on the primary securities market. The issue price is usually higher than or equal to the nominal price (it depends on the decisions of the issuer or the result of the subscription price offers), but sometimes may also be lower (in the case of zero coupon bonds or the sale of treasury bills tender.)
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Securities traded on the secondary market also have a market price, depending on the current relationship between demand and supply is not. Issuers of securities may be companies, financial institutions, local government bodies and state, their purchasers could be all business, but because of the level of the issue price or the market, not every paper is available for every buyer. Equity securities: An equity security is a share of equity interest in an entity such as the capital stock of a company, trust or partnership. The most common form of equity interest is common stock, although preferred equity is also a form of capital stock. The holder of an equity is a shareholder, owning a share, or fractional part of the issuer. Unlike debt securities, which typically require regular payments (interest) to the holder, equity securities are not entitled to any payment. In bankruptcy, they share only in the residual interest of the issuer after all obligations have been paid out to creditors. However, equity generally entitles the holder to a pro rata portion of control of the company, meaning that a holder of a majority of the equity is usually entitled to control the issuer. Equity also enjoys the right to (accounting) profits and capital gain, whereas holders of debt securities receive only interest and repayment of principal regardless of how well the issuer performs financially. Furthermore, debt securities do not have voting rights outside of bankruptcy. It is an instrument that signifies an ownership position in a corporation. It also represents a claim from the shares in the corporations assets and profits. Equity securities usually provide steady income as dividends. They may fluctuate significantly in their market value depending on the phase of the economic cycle. The partner in the company who owns equity security has the right to vote on the general meetings of the shareholders. There are many different types of stocks which can be invested in based upon the financial position, risk comfort level, and investment goals. A companys stock offerings generally fall into one of two categories: common stock or preferred stock.

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Common stock represents the basic equity ownership in a corporation. Stockholders are entitled to vote for directors and other important company matters. They also participate in the appreciation of share values and in any dividends (declared from corporate earnings that remain after debt obligations and preferred stock dividends are met). Common stock has a number of advantages which make it a desirable investment - it has the potential for delivering very large gains; the potential loss from stock purchased with cash is limited to the total amount of the initial investment; it offers limited legal liability. Most stocks are very liquid. In other words, they can be bought and sold quickly at a fair price. Preferred stock is a specific type of stock which has very different characteristics from common stock. Like common stock, proceeds from the sale of preferred stock are recorded by the company on its balance sheet as equity. Preferred stock doesn't offer the same potential for profit as common stock, but it's a more stable investment vehicle because it guarantees a regular dividend that isn't directly tied to the market like the price of common stock. This type of stock guarantees dividends, which common stock does not. The price of preferred stock is tied to interest rate levels, and tends to go down if interest rates go up and to increase if interest rates fall. Hybrid Hybrid securities combine some of the characteristics of both debt and equity securities. Lets speak about some of these hybrid securities:

Preference shares form an intermediate class of security between equities and debt. If the issuer is liquidated, they carry the right to receive interest and/or a return of capital in priority to ordinary shareholders. However, from a legal perspective, they are capital stock and therefore may entitle holders to some degree of control depending on whether they contain voting rights. Capital stock which provides a specific dividend that is paid before any dividends are paid to common stock holders, and which takes precedence over common stock in the event of a liquidation. Like common stock, preference shares
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represent partial ownership in a company, although preferred stock shareholders do not enjoy any of the voting rights of common stockholders. Also unlike common stock, preference shares pay a fixed dividend that does not fluctuate, although the company does not have to pay this dividend if it lacks the financial ability to do so. The main benefit to owning preference shares are that the investor has a greater claim on the company's assets than common stockholders. Preferred shareholders always receive their dividends first and, in the event the company goes bankrupt, preferred shareholders are paid off before common stockholders. In general, there are four different types of preferred stock: cumulative preferred, non-cumulative, participating, and convertible. also called preferred stock.

Convertibles are bonds which can be converted, at the election of the holder of the convertibles, into the common stock of the issuing company. The convertibility, however, may be forced if the convertible is a callable bond, and the issuer calls the bond. Convertibles are part debt and part equity. It is a derivative security whose value is derived from the value of the debt and equity on which it ultimately depends. The issuers have several reasons to use convertible financing: by issuing convertibles they can lower their cost of debt funding compared to straight debt alone. Lower-credit companies who may not able to acces the straight debt market can often still issue convertible debt. Companies who anticipate equity appreciation can use convertibles to defer equity financing to a time when growth has been achieved. Equity warrants are options issued by the company that allow the holder of the warrant to purchase a specific number of shares at a specified price within a specified time. They are often issued together with bonds or existing equities, and are, sometimes, detachable from them and separately tradable. When the holder of the warrant exercises it, he pays the money directly to the company, and the company issues new shares to the holder.Warrants are for experienced investors who have an understanding of risk, and who want to exploit the gearing potential in warrants. This is one of the more
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hidden - and thereby inefficient - areas of the market, offering interesting opportunities to the shrewd investor. Warrants should not be the starting point for a novice investor, and so, although not required, a good knowledge and experience of ordinary share markets is desirable. Warrants first appeared in the UK in the 1970s, but the market took some time to develop. Companies issue warrants because they are very flexible instruments, and as such can be useful in corporate finance. From the point of view of the issuer, they are cheap to issue and offer very low initial servicing costs.

Definition of Risk & Return Risk: The ISO 31000 (2009) /ISO Guide 73 definition of risk is the 'effect of uncertainty on objectives'. In this definition, uncertainties include events (which may or not happen) and uncertainties caused by a lack of information or ambiguity. This definition also includes both negative and positive impacts on objectives. Another definition is that risks are future problems that can be avoided or mitigated, rather than current ones that must be immediately addressed. Risk can be seen as relating to the Probability of uncertain future events. For example, according to Factor Analysis of Information Risk, risk is: the probable frequency and probable magnitude of future loss. Mathematically,
RISK = (Probability of an accident occurring) X (Expected loss in case of accident)

RETURN

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The change in the value of a portfolio over an evaluation period, including any distributions made from the portfolio during that period.

Rate of Return In securities, the amount of revenue an investment generates over a given period of time as a percentage of the amount of capital invested. The rate of return shows the amount of time it will take to recover one's investment. For example, if one invests $1,000 and receives $150 in the first year of the investment, the rate of return is 15%, and the investor will recover his/her initial $1,000 in six years and eight months. Different investors have different required rates of return at different levels of risk. Risk-Return Trade off The risk/return tradeoff could easily be called the "ability-tosleep-at-night test." While some people can handle the equivalent of financial skydiving without batting an eye, others are terrified to climb the financial ladder without a secure harness. Deciding what amount of risk you can take while remaining comfortable with your investments is very important.

In the investing world, the dictionary definition of risk is the chance that an investment's actual return will be different than expected. Technically, this is measured in statistics by standard deviation. Risk means you have the possibility of losing some, or even all, of our original investment. Low levels of uncertainty (low risk) are associated with low potential returns. High levels of uncertainty (high risk) are associated with high potential returns. The risk/return tradeoff is the balance between the desire for the lowest possible risk and the highest possible return. This is demonstrated
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graphically in the chart below. A higher standard deviation means a higher risk and higher possible return.

A common misconception is that higher risk equals greater return. The risk/return tradeoff tells us that the higher risk gives us the possibility of higher returns. There are no guarantees. Just as risk means higher potential returns, it also means higher potential losses. On the lower end of the scale, the risk-free rate of return is represented by the return on U.S. Government Securities because their chance of default is next to nothing. If the riskfree rate is currently 6%, this means, with virtually no risk, we can earn 6% per year on our money. The common question arises: who wants to earn 6% when index funds average 12% per year over the long run? The answer to this is that even the entire market (represented by the index fund) carries risk. The return on index funds is not 12% every year, but rather -5% one year, 25% the next year, and so on. An investor still faces substantially greater risk and volatility to get an overall return that is higher than a predictable government security. We call this additional return the risk premium, which in this case is 6% (12% - 6%). Determining what risk level is most appropriate for you isn't an easy question to answer. Risk tolerance differs from person to person. Your decision will depend on your goals, income and personal situation, among other factors.

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Agency Relationship:
An agency relationship exists when one or more individuals, who are called the principals, hire another person, the agent, to perform a service and delegate decision-making authority to that agent. An agency problem arises when the agent makes decisions that are not in the best interests of the principals. If a firm is a proprietorship managed by the owner, the ownermanager will presumably operate the business in a fashion. If the owner-manager incorporates and sells some of the firms stock to outsiders, a potential conict of interest immediately arises. Several mechanisms are used to motivate managers to act in the shareholders best interests. (a) Wealth maximization and (b) attract and retain top-level executives. Well-designed plans can accomplish both goals. That are-

1. Managerial compensation (incentives):

A common method used to motivate managers to operate in a manner consistent with stock price maximization is to tie managers compensation to the companys performance and those packages should be developed. For example, Dell uses performance targets based on growth in sales and profit margins relative to industry measures and such nonfinancial factors as customer satisfaction and product leadership. If the company achieves a targeted average growth in earnings per share, managers earn 100 percent of a specified reward. All incentive compensation plans are designed to accomplish two things:(a) provide inducements to executives to act on
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those factors under their control in a manner that will contribute to stock price.

2. Shareholder intervention:
More than 25 percent of the individuals in the United States invest directly in stocks. Along with such institution all stockholders as pension funds and mutual funds, individual stockholders are flexing their muscles to ensure that firms pursue goals that are in the best interests of shareholders rather than managers I n situations where large blocks of the stock are owned by a relatively few large institutions, such as pension funds and mutual funds, and they have enough clout to influence a firms operations, these institutional owners often have enough voting power to overthrow management teams that do not act in the best interests of stockholders. Examples of major corporations whose managements have been ousted in recent years include Coca-Cola, General Motors, IBM, Lucent Technologies, United Airlines, and Xerox.

3. Threat of takeover (Hostile takeovers):

Instances in which management does not want the firm to be taken over, are most likely to occur when a firms stock is undervalued relative to its potential, which often is caused by poor management . In a hostile takeover, the managers of the acquired firm generally are fired, and those who do stay on typically lose the power they had prior to the acquisition.

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