Bangladesh University of Business & Technology (BUBT)

FIN 301 : Introduction to Finance

Sheet No - 1

Definition
Functions of Finance
Principles and Activities of Financial Manager

What is Finance?

"Finance" came from Latin word 'Finis' means "dealing with the
money" or managing money.

Finance can be defined as the art and science of managing money

to achieve the goal.

Narrowly speaking, Finance refers only to gather fund. But from the
broader point of view, it includes all actions concerning financing
plan, funds collection, proper utilization of funds etc.,

Virtually all individuals and organizations earn or raise money and

spend or invest money. Finance is concerned with the process,
institutions, markets and instruments involved in the transfer of
money

among

and

between

individuals,

businesses,

and

governments.

Finance is concerned with the activities and principles of raising and

using of fund.

Functions of Finance
1. Financial Planning: Financial planning means- To determine how much money is required
For what duration
In which sectors the funds need to be allocated to attain the
overall goal of the firm. etc

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This is a very important function of a finance manager. He has to

decide what are the profitable projects and in which projects the firm
should invest.
2. Identification of Sources: Secondly the finance manager has to
identify the potential sources of fund. Sources may be internal or
external to the firm.
3. Raising of Funds: After identifying the different sources, a finance
managers next function is to raise the fund from one or different
sources depending on the firms policy, cost of fund, conditions and
time within which the fund needs to be repaid.
Internal Sources: Owners own fund, from friends and relatives.
Externally: Borrowing from banks, non bank firms, leasing firms
& financial institutions.
4. Investment of Funds: A finance managers most important function
is probably to invest in profitable projects. In this case, the manager
has to analyze costs and benefits of different projects along with the
profitability of the projects.
5. Protection of Funds: Investments are always risky. But the higher the
risk, the higher the return. So, risk should always be adjusted with
return to protect funds. The manager should invest in a project which
has optimum risk-return relationship.
6. Distribution of Profits: When revenue is generated from successful
project, a managers next function is to distribute return among
different stakeholders. But the manager should not distribute all the
profit. A part of generated profit should be retained by the finance
manager to invest in profitable investment alternative in future.

Activities of Financial Manager

Financial manager is a person who oversees the monetary concerns of
businesses and other organizations. He/she actively manages the financial
affairs of all types of businesses, whether private or public, large or small,
profit seeking or not for profit. They perform such varied tasks as

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developing a financial plan or budget, extending credit to customers,

evaluating proposed large expenditures, and raising money to fund the
firms operations. Overall financial functions can be divided into two
groups:

Functions of a Financial
Manager

Routine
Functions

Managerial
Functions

Investment
Decision

Financing
Decision

Dividend
Decision

Working Capital
Management
Capital Budgeting
Fig: Functions of a Financial Manager

Managerial Functions

Investment Decision:
Investment decision is the most important among the decisions which
are made by a financial manager. That is deciding about investing in
those assets which will maximize the profit of the organization. For
that purpose a manager has to estimate the rate of return from
different projects or assets considering the risks of investing in those
projects or assets.
A manger should choose a project which has optimum risk return
relationship. Investment can be made in short term (current assets)
or long term (fixed assets). Here, it is necessary to decide how much

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cash will be invested in short term or current assets (which are

normally convertible into cash within a year) and how much in fixed
asset (non cash).
So, it begins with a determination of total amount of assets needed to
be held by the firm. Picture the firms balance sheet in your mind for a
moment. Imagine liabilities and owners equity being listed on the left
side of the firms balance sheet and its assets on the right. The
financial manager needs to determine the amount on the
right side of the balance sheet.

Assets (Right Hand Side of the

BS under British System)
Working
Capital
Mgt.

Current Assets:
Cash.
Raw materials.
Finished Goods.
Accounts Receivables.
Bills Receivables.
Fixed Assets:
Furniture.
Land.
Building.
Equipment.
Other Fixed Assets.

Capital
Budgeting

Based on this aspect, the financial manager needs to concentrate on the

following two things:
a) Working capital management: It is the investment in current
assets. The main elements of current assets are cash, stock of
raw materials or finished goods, bills receivables etc. The
financial manager will have to make a trade off between the
profitability and liquidity of maintaining current assets.
b) Capital Budgeting: Capital budgeting implies the long run
investment decision from which a firm can earn for a long period
of time. The financial manager needs to evaluate the amount of
fund needed for the project, the duration, the expected earnings
and uncertainty of earnings etc. for capital budgeting decision.

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Financing Decision: The Second major decision of the firm is the

financing

decision.

After

deciding

about

the

investment

in

projects/assets, a financial manager has to identify the requirement

and sources of finance to attain the desire project. Here the
financial manger is concerned with the make up of the left
side of the balance sheet.
Within this financing a better mix of debt and equity must be made
financial manager will choose that optimal mix where cost of capital is
low. Some firms have relatively large amount of debt while others are
almost debt free. The financing decision is influenced by the
philosophy of the management.

Liabilities & Equity (Left Hand Side

of the BS under British System)
Current Liabilities:
Accounts Payable.
Bills Payable.
Sundry Creditors.
Short term debt.
Long term liabilities/ Equity:
Long term debt.
Shareholders Equity.

A schematic Representation of Investment & Financing decision:

(Claims)

Investment (Assets)

Short term
Long term

Current Assets
Fixed Assets

Financing

Current Liabilities
Long term debt
and
Shareholders
equity

Dividend decision: Finally the financial manager has to decide

about the allocation of dividend among its stakeholders. In this case
retained earnings are also considered. Dividend policy must be
viewed as an integral part of the firms financing decision. The
dividend payout ratio determines the amount of earnings that can be
retained in the firm. A financial manager should not pay all the profit

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as a dividend among its stakeholder. Rather a portion of the profit

should be retained by the financial manager to use in future. The
higher the retained earnings, the higher will be the firms scope for
internal source of financing. So a financial manager should choose an
Optimum Dividend Payout Ratio which will satisfy the stakeholder
and give the firm the opportunity to expand the business in future
and raise value of the firm along with the share price in the market.

Routine Function:
Routine functions of manager are those functions of clerical nature which
are necessary for the execution of decision taken by the executives.
Some of the important routine functions of financial manager are
discussed below:
Supervision of cash receipts and disbursement and safe guarding
of cash balance.
Taking care of all mechanical details of financing
Cash planning and credit management.
The chief finance executive is mainly responsible for taking decision
regarding executive managerial finance functions. The incidental or
routine finance functions are performed by people at lower levels. The
involvement of chief finance executive in incidental or routine functions is
limited only to setting up rules of procedure, selecting forms to be used,
establishing standards for carrying out the functions effectively and
revising the performance whether the institutions are being followed
properly or not.

Principles of Finance / Business Finance

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1. Principles of Profitability: Principles of profitability states that a

firm should not distribute all its profit as dividend to shareholders. If
the firm distribute all its profit it may not be able invest in profitable
investment alternatives. So a portion of the profit should be retained
by the firm as reserve to meet the financial need in future. It increases
the firm capability of internal financing and reduces the dependency
on external financing.
2. Principles of Risk & Return: This principle states that investment
decision should depend on risk & return relationship of alternative
investment projects. As we know, The higher the risk, The higher
the return, but it does not mean that the firm should always invest
in risky projects. A firm should invest in a project which has Optimum
Risk-return Relationship.
3. Principles of Liquidity & Profitability: A firm can earn profit by
investing in different profitable projects. But it does not mean that a
firm should invest all their capital in assets rather they should
maintain cash in hand to maintain their day to day activities and to
run

the

Liquidity

organization
means

properly.

having

enough

money in the form of cash, or nearcash assets, to meet your financial

obligations. As because Liquidity &
Profitability has inverse or negative
relationship,

large

amount

of

investment in assets increases firms

profitability but reduces firms cash in
hand (or liquidity), on the other hand if firm maintain large cash in
hand (or liquidity) it reduces firms investment capability which in turn
reduces firms profitability. So the management should maintain
adequate amount of liquidity as well as invest in assets to earn profit.
Profitability

Capital Investment

Liquidity

Liquidity

Capital Investment

Profitability

4. Principles of Time Value of Money: Time value of money is very

much important in the time of taking financial decision. As the time

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passes the value of money decreases. A fixed amount of money

available today is more valuable than the same amount of money
available in the future. In the period of investment, Taka 100 today is
not valued equally to the Taka 100 after 1 year.
5. Principles of Diversity: Financial Managers use this principle in the
time of asset management. The main idea of this principle is that Do
not put all your eggs in one bucket. A financial manager should not
invest all their capital or fund in one project or in asset rather he/she
will invest in multiple projects to reduce the risk of loss. He/she will
invest in projects with negative relationship. By doing this the risk of
loss can be minimized. Considering the risk of loss is essential in the
time of making financial decision.
Investment Return
Investment Return
Security A

Time

Investment Return
Security B

Time

Combination
of A & B

Time

Figure: Effect of Diversification on Portfolio Risk.

Here the return over time for security A are cyclical in that time they
move with the economy in general. Returns for security B, however,
are perfectly counter cyclical. Equal amount invested in both securities
will reduce dispersion of return and hence the risk. Benefits of
diversification occur as long as the securities are not perfectly,
positively correlated.

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6. Principles of Business Cycle: According to principle, in the time of

taking a financial decision adjustment should be made with business
cycle. The demand for money
varies

depending

situation,
business

on

the

seasonality
life

cycle.

Producti
on

and
When

there is a peak season the

demand for money increases
and there is a through the
demand for money decreases.
So

the

financial

manager

should be concern about this matter and should arrange money.

7. Principle of Hedging: According to the principle of hedging each
asset should be offset with a financing instrument of the same
approximately maturity. Short-term or seasonal variations in current
assets would be financed with short-term debt; the permanent
component of current assets and all fixed asset would be financed with
long-term debt or with equity. This principle minimizes the risk that
firm will be unable to pay off its maturing obligations.
Types of Assets
Temporary Current
Asset
Permanent Current
Asset
All Fixed Assets

Sources of Finance
Short-term non-spontaneous
debt.
Long-term debt, Equity,
Spontaneous current liabilities

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