NOTES 1 FOR AFM 101

UNIT I – OVERVIEW OF FINANCE AND FINANCIAL MANAGEMENT

LESSON 1: INTRODUCTION TO FINANCE

I. Learning Objectives:

At the end of this lesson, you should be able to:

   define what is finance;

   describe the functions of finance;

   identify the classifications of finance;

   know the various areas of finance; and

   appreciate the role of finance in the business world.

What is Finance?

 The word “finance” is derived From the LATIN word “finer” meaning “to end”
or “to pay”. When a person pays his bills, the financial matter is ended.

 A family needs financing to survive; so, do companies.

 Finance and Financial Decisions are part of our daily life’s Economic
activities, like business transactions, personal investment, or even simple
borrowing entail finance or have financial implications.
  Even the government needs to be financed for a country to survive.

 In simple terms, finance is concerned with the decision about money, or more
appropriately cash flows.
 According to Brigham & Besley (2015), finance decisions deal with how money is
raised and used by businesses, governments, and individuals.
 Medina (2014) viewed “finance as a branch of economics concerned with resource
allocation as well as resource management, acquisition, and investment.”

Finance (is defined by Webster’s Dictionary)

 “the system that includes the circulation of money, the granting of credit, the
making of investments, and the provision of banking facilities.”

 Finance has many facets, which makes it difficult to provide one concise
definition. The discussion in this section will give you an idea of what finance
professionals do and what you might do if you enter the finance field after you
graduate.

Functions of Finance

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 According to Mariano (2014), finance is the function of:

1. Allocating available funds

2. Acquiring needed funds; and
3. Utilizing these funds to achieve set goals

Allocation

 Determining where to use funds currently available to the firm.

Acquisition

 obtaining funds from the right sources at the right time.

Utilization

 means using the funds.

This definition will apply to persons and entities (private enterprises and government) where
they are aiming for profit (increasing wealth) or not (non-profit organizations).

Funds are needed to finance the operations of people and organizations.

Classification of Finance

According to Mariano (2014), finance can be classified into different types, the most
common of which are:

1. As to Form of Negotiation

 Direct Finance- involves indirect borrowing; direct negotiation between

borrower and lender. Like a friend borrowing money from one another.

 Indirect Finance- involves financial Intermediaries. Financial institutions

acting as middlemen between the source of funds and the users of funds.

2. As to User

 Public Finance- involves the government; deals with the revenue and
expenditures patterns of the government.

 Private Finance- involves individuals and entities. Individuals borrowing money

from another individual; company borrowing from financial institutions. Private
finance is divided into:

Areas of Finance

1. Personal finance – refers to finance conducted by individual/consumers

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 2. Finance of non-profit organizations- involves those conducted by charitable,
civic organizations, among others.

3. Business finance- deals with financing for business firms or commercial use, the
goal of which is to make a profit.

Areas of Finance (according to Brigham)

According to Brigham Finance is generally divided into three areas: (1) financial
management, (2) capital markets, and (3) investments.

Financial management

 also called “corporate finance”

 focuses on decisions relating to how much and what types of assets to acquire,
how to raise the capital needed to purchase assets, and how to run the firm to
maximize its value. The same principles apply to both for- profit and not-for-profit
organizations.

Capital markets

 related to the markets where interest rates, along with stock and bond prices, are
determined.

 Also studied here are the financial institutions that supply the capital to
businesses.

Investments

 relate to decisions concerning stocks and bonds and include several activities:

 Security analysis
o deals with finding the proper values of individual securities (i.e., stocks
and bonds).
 Portfolio theory
o deals with the best way to structure portfolios, or “baskets,” of stocks and
bonds.
 The market analysis
o deals with the issue of whether stock and bond markets at any given time
are “too high,” “too low,” or “about right.”

Finance in the Business World

Business

 is any lawful economic activity that involves rendering service; buying and selling
goods; converting raw materials into finished products and selling the same;
borrowing and lending money; acquiring funds and investing the same; extracting
mineral resources; constructions buildings, road, and infrastructure; providing

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 insurance for a sense of peace; and serving the public as public utilizes,
transportation, and communication entities. In all these activities, effectively and
efficiently acquiring and utilization funds (finance) make the difference and that is
what business finance is all about.

 Efficiency

 is all about saving time, money, or effort. It is the relationship between input and output.
Effectiveness is a measure of quality. It means producing desired results. All business
activities involve funds. Finance is, therefore, indispensable in the business world
(Mariano, 2014).

Summary

  Finance is the efficient acquisition, allocation, and unitization of funds.

  Finance functions include:

 allocating available funds;

 acquiring needed funds;

 and utilizing these funds to achieve set goals

 Finance can be classified as:

 to form of negotiation (direct or indirect) and;

 as to user (public or private finance).

 Also, it can be classified as microfinance and macro-finance.

 Financial intermediaries

 are business organizations that receive funds in one form and repackage them
for use by those who need funds. Through financial intermediation, resources
are allocated more effectively, and the real output of the economy is thereby
increased.

  Public Finance

 deals with taxation, bond issues, budgeting, asset management, and financial
planning of activities.

 Corporate Finance

 deals with the proper acquisition of cash and the efficient allocation of that
cash within the corporation

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 Personal Finance is an area of finance that deals with the proper management of an
individual’s money to achieve personal economic satisfaction.

 Investment

 is an asset or item acquired to generate income or appreciation.

 In an economic sense, an investment is the purchase of goods that are not

consumed today but are used in the future to create wealth.

 In finance, an investment is a monetary asset purchased with the idea that the
asset will provide income in the future or will later be sold at a higher price
for a profit.

 Financial institution (FI)

 is a company engaged in the business of dealing with financial and monetary

transactions such as deposits, loans, investments, and currency exchange.

 Financial institutions encompass a broad range of business operations within the

financial services sector including banks, trust companies, insurance companies,
brokerage firms, and investment dealers. Virtually everyone living in a developed
economy has an ongoing or at least periodic need for the services of financial
institutions.

 Financial markets

 refer broadly to any marketplace where the trading of securities occurs, including the
stock market, bond market, forex market