1. What is finance?

INTRODUCTION:
In our present day economy, Finance is defined as the provision of money at the time when it is
required. Every enterprise, whether big, medium or small needs finance to carry on its operations and to
achieve its targets. In fact, finance is so indispensable today that it is rightly said to be the life blood of an
enterprise.

MEANING OF FINANCE:
Finance may be defined as the art and science of managing money. It includes financial service and
financial instruments. Finance also is referred as the provision of money at the time when it is needed. Finance
function is the procurement of funds and their effective utilization in business concerns. The concept of
finance includes capital, funds, money, and amount. But each word is having unique meaning. Studying and
understanding the concept of finance become an important part of the business concern

2. What are the three basic questions addressed by the study of finance?

1. What long-term investments should the firm undertake? capital budgeting decisions
2. How should the firm fund these investments? capital structure decisions
3. How can the firm best manage its cash flows as they arise in its day-to-day operations? working capital
management decisions

3. What is the importance of studying finance?

Knowledge of financial tools is critical to making good decisions in both professional world and
personal lives. Finance is an integral part of corporate world. Many personal decisions require financial
knowledge (for example: buying a house, planning for retirement, leasing a car)
The business goal can be achieved only with the help of effective management of finance. We can’t
neglect the importance of finance at any time at and at any situation. Some of the importance of the
financial management is as follows:
Financial Planning, Acquisition of Funds, Proper Use of Funds, Financial Decision, Improve Profitability,
Increase the Value of the Firm, Promoting Savings.

4. What is the role of a treasurer?

The main role of a treasurer is to account for the money received, spent and invested by an
organization. He is ultimately responsible for ensure all the money is accounted for and is the go-to person
when management has concerns or needs financial advice. He must maintain high ethical standards and
analytical ability.
Receivables and Payables
On a day-to-day basis, the treasurer is responsible for ensuring that all monies spent or earned are
recorded. While larger organizations may hire bookkeepers for this routine work, the treasurer typically
oversees the bookkeeper's work. In smaller organizations with infrequent daily transactions, the treasurer
may do the actual bookkeeping himself, including depositing funds in the bank, preparing checks for
signatures and monthly bank statement reconciliation.
Reporting
 At routine intervals, usually at least quarterly, the treasurer is responsible for creating financial
statements to present to management. The financial statements summarize how the organization's money
was spent, what funds were received, and how much money is invested or in reserves. He may be asked
to provide special reports detailing the benefits of spending funds on hew projects or comparing the
earnings potential of different investment opportunities. He may be required to present financial reports
verbally during meetings or simply provide a paper or electronic version to management.
Budgeting
Each year, the treasurer is responsible for providing an annual budget that details the expected
revenues and expenses for the next year. He may also prepare budgets for each special project undertaken
by the organization. For example, a treasurer for a charity may prepare a budget of the cost to provide
heath services to single parents in the community based on promised donations from local corporations.
His budget would also include the expected cost per patient and the number of patients the organization
could help in a year.
Recommendations
As the expert on the organization's finances, the treasurer is responsible for making sound financial
recommendations to management. He makes these recommendations based on analysis of financial data.
He also is responsible for tracking investments and recommending the purchase or sale of stocks and bonds
as needed to meet the needs of the organization. While this part of the job may be limited in smaller
organizations, due to limited budgets, the treasurer's recommendations can mean the difference between
success and failure in larger, more lucrative organizations.

5. What is the role of a controller?

 A controller is in charge of the company’s accountants. They are the highest in the food chain, as far as
accounting goes. A financial controller is in charge of supervising the preparation of financial reports and
presenting them to management. In some governmental organizations, a controller is also known as a
financial comptroller.
 A controller reports to the chief financial officer (if the company has one), formulates policies for the
company and oversees the audit, budget and accounting departments in their company.
 The primary responsibility of the financial controller is producing and presenting timely reports. These
reports form the basis of the management’s decisions and economic predictions. They are also tasked
with explaining to the management what the various items of the financial statements mean and, in some
ways, offering advice following the reports that they present.
 Controllers are also responsible for the company’s compliance with the law regarding taxes and other
financial matters. They will be the ones who are directly presenting compliance documents and filing tax
returns.
 A controller should hold a degree, majoring in finance, economics, or business. They should also be a
licensed CPA, ideally with at least five years of experience as an accountant. This will ensure they have
been exposed to creating financial statements and have the expertise necessary to perform in such an
important role.

6. What is the goal of a financial manager?

Profit Maximization
This considers that those actions that increase profits should be undertaken and those that decrease
profits are to be avoided. According to this goal, finance function should be oriented towards maximization of
profit. Financial managers select assets, projects and the decisions that are profitable and reject, which are
not.
Value Maximization Goal
 This considers that managers should take decisions that maximize the value of the firm, which is the
total of the firm. The value of the firm is the total market value of the equity and total market value of debt.
Debt holders have fixed claim to the firm. So if value of firm is maximized, the market value of equity will
increase.

7. Cite some examples of ethical dilemmas faced by a financial manager.

Financial managers prepare reports, oversee accounting functions, plan investment strategies and
direct cash management functions. They also are involved in branch management functions at banks and other
financial institutions. They are required to uphold the highest ethical standards because internal and external
stakeholders depend on transparent, timely and complete financial documents to make decisions.

Accuracy
A company’s financial manager ensures that all financial publications accurately and fairly reflect the
financial condition of the company. Accounting errors and financial fraud, such as what was seen in the cases
of Enron and WorldCom, damage the interests of shareholders, employees and affect confidence in the
financial system. Some organizations document ethics guidelines specifically for financial managers. For
example, the ethics code of the United States Postal Service requires senior financial managers to maintain
accurate records and books, maintain internal controls and prepare financial documents in accordance with
generally accepted accounting principles.
Transparency
Financial documents reflect a company's performance relative to its peers, and its internal strengths
and weaknesses. Regulatory agencies require publicly traded companies to submit periodic financial
statements and make full disclosures of material information. A change in the senior executive ranks, buyout
offers, loss or win of a major contract and new product launches are examples of material information.
Transparency also means explaining financial information clearly, especially for those who aren't familiar with
the company’s operations. Financial managers should not hide, obscure or otherwise render relevant financial
information impossible for ordinary shareholders to understand.
Timeliness
Timely financial information is just as important as accurate and transparent information.
Management, investors and other stakeholders require timely information to make the right decisions. Many
cases exist of a publicly traded company's stock reacting sharply and negatively to negative earnings surprises
or unpleasant product-related news. For example, a company should promptly disclose manufacturing
problems that could temporarily affect sales. Similarly, the company should not hold back news of a major
contract loss in the hope that it can replace the lost revenue with new contracts.
Integrity
Financial managers should strive for unimpeachable integrity. Customers, shareholders and employees
should be able to trust a financial manager's words. Managers should not allow prejudice, bias and conflicts of
interest to influence their actions. Managers should disclose real or apparent conflicts of interest, such as an
investment position in a stock or an ownership interest in one of the bidding companies for a procurement
contract. The structure of certain stock-based incentive compensation schemes could also result in ethical
issues. For example, managers might be tempted to manipulate stock prices by selectively disclosing or not
disclosing relevant financial information.

8. Explain the following basic principles in finance.

8.1 Money has a time value.
 The time value of money (TVM) is the concept that money available at the present time is worth
more than the identical sum in the future due to its potential earning capacity. This core principle of
finance holds that provided money can earn interest, any amount of money is worth more the sooner
it is received. TVM is also sometimes referred to as present discounted value.
The time value of money draws from the idea that rational investors prefer to receive money
today rather than the same amount of money in the future because of money's potential to grow in
value over a given period of time. For example, money deposited into a savings account earns a certain
interest rate and is therefore said to be compounding in value.

8.2 There is a risk-return trade off.

 The risk-return tradeoff is an investment principle that indicates that the higher the risk, the higher the
potential reward.
 To calculate an appropriate risk-return tradeoff, investors must consider many factors, including overall
risk tolerance, the potential to replace lost funds and more.
 Investors consider the risk-return tradeoff on individual investments and across portfolios when making
investment
For example, if an investor has the ability to invest in equities over the long term, that provides
the investor with the potential to recover from the risks of bear markets and participate in bull markets,
while if an investor can only invest in a short time frame, the same equities have a higher risk
proposition.

8.2 Cash flows are the source of value.

Net income is an accounting concept designed to measure a business’s performance over an

interval of time. Cash flow is the amount of cash that can actually be taken out of the business over this
same interval.
Profits versus Cash It is possible for a firm to report accounting profits but have no cash. For
example if all sales are on credit, the firm may report accounting profits even though no cash is being
generated.
Incremental Cash Flow Financial decisions in a firm should consider “incremental cash flow” ◦
The difference between the cash flows the company will produce with the potential new investment
and what it would make with t ou the investment.

8.3 Market prices reflect information.

Investors respond to new information by buying and selling their investments. The speed with
which investors act and the way that prices respond to new information determines the efficiency of
the market. ◦ In efficient markets like United States, this process occurs very quickly. As a result, it is
hard to profit from trading investments on publicly released information.
Investors in capital markets will tend to react positively to good decisions made by the firm
resulting in higher stock prices. Stock prices will tend to decrease when there is bad information
released on the firm in the capital market.

1. What are the basic financial statements? Briefly describe each.

1. Income statement – how much money you made last year?

• Revenue, expense, profits over a year or quarter.
 2.Balance sheet – what’s your current financial situation? A snap shot on a specific date of:
• Assets (value of what the firm owns) • Liabilities (value of firm’s debts) • Shareholder’s equity
(the money invested by the company owners)
3. Cash flow statement – how did the cash come and go?
• Cash received/cash spent by the firm over a period of time.

2. What is the importance of studying financial statements?

1. Assess current performance through financial statement analysis. – Next chapter provides more tools
for the analysis.
2. Monitor and control operations. – Both insiders (such as managers, board of directors) and outsiders
(such as suppliers, creditors, investors) use the statements to monitor and control the firm’s operations. 3.
Forecast future performance. – Financial planning models are typically built using the financial statements.

3. Briefly explain the following principles used to prepare financial statements.

3.1. Revenue recognition principle
Revenue should be included in the income statement for the period in which: – Its
goods/services were exchanged for cash or accounts receivable. – It has completed what it must do to
be entitled to the cash.
3.2. Matching principle
Expenses are matched with the revenues they helped produce. – For example, employees’
salaries are recognized when the product produced as a result of that work is sold, and not when the
wages were paid.
3.3. Historical cost principle
Most assets and liabilities are reported in the financial statements at historical cost. – For
example, the price the firm paid to acquire them. – The historical cost generally does not equal the
current market value of the assets or liabilities.

4. Define the following income statement items.

4.1. Revenues
Revenue, often referred to as sales, is the income received from normal business operations and other
business activities.
Operating income is income derived from normal business operations, such as sales of good or services.
Non-operating income is infrequent or nonrecurring income derived from secondary sources (e.g.,
lawsuit proceeds).
4.2. Cost of Goods Sold
Cost of goods sold (COGS) is the direct cost attributable to the production of the goods sold in a
company. This amount includes the cost of the materials and labor directly used to create the good. It
excludes indirect expenses, such as distribution costs and sales force costs.
COGS is deducted from revenues (sales) in order to calculate gross profit and gross margin.
The value of COGS will change depending on the accounting standards used in the calculation.

4.3. Gross Profit

Also called gross income, gross profit is calculated by subtracting the cost of goods sold from revenue.
Gross profit only includes variable costs and does not account for fixed costs.
 Gross profit assesses a company's efficiency at using its labor and supplies in producing goods or
services.

4.4. Operating Expense

Operating expenses are incurred in the regular operations of business and include rent, equipment,
inventory costs, marketing, payroll, insurance, and funds allocated for research and development.
Operating expenses are necessary and mandatory for most businesses.

4.5. Net Operating Income

Net operating income (NOI) is a calculation used to analyze the profitability of income-generating real
estate investments. NOI equals all revenue from the property, minus all reasonably necessary operating
expenses. NOI is a before-tax figure, appearing on a property’s income and cash flow statement, that
excludes principal and interest payments on loans, capital expenditures, depreciation,
and amortization. When this metric is used in other industries, it is referred to as “EBIT”, which stands
for “earnings before interest and taxes”
4.6. Net Income
Net income is known as the bottom line, and is the amount of profit the company made after paying
all of its expenses. This is also known as the company's earnings.
How net income is calculated
When calculating net income, start with the top line, or revenue number. Then, subtract the
cost of goods sold in order to calculate the gross profit. Cost of goods sold refers to the amount the
company paid to manufacture and sell its product. Next, subtract the operating expenses such as
research and development costs and administrative expenses. This will result in the company's
operating income. Finally, subtract taxes, interest, and any other expenses to arrive at the net income.

4.7. Earnings per share

Earnings per share is a company's profit divided by the number of common stock shares it has
outstanding.
EPS shows how much money a company makes for each share of its stock.
A higher EPS indicates more value because investors will pay more for a company with higher profits.
EPS can be calculated in various ways, such as excluding extraordinary items or discontinued
operations, or on a diluted basis.

5. What will you find in the left side of the balance sheet?
The left side of the balance sheet outlines all of a company’s assets.
6. Define current assets.
Current assets are all the assets of a company that are expected to be conveniently sold, consumed,
utilized, or exhausted through the standard business operations over the next one year period.
Current assets include cash, cash equivalents, accounts receivable, stock inventory, marketable securities,
pre-paid liabilities, and other liquid assets.
Current assets are important to businesses because they can be used to fund day-to-day business
operations and to pay for the ongoing operating expenses.

7. Define fixed assets.

Fixed assets are items, such as property or equipment, a company plans to use over the long-term to help
generate income.
Fixed assets are most commonly referred to as property, plant, and equipment (PP&E).
Current assets, such as inventory, are expected to be converted to cash or used within a year.
Noncurrent assets besides fixed assets include intangibles and long-term investments.
Fixed assets are subject to depreciation to help represent the lost value as the assets are used, while
intangibles are amortized.

8. What will you find in the right side of the balance sheet?
On the right side, the balance sheet outlines the companies liabilities and shareholders’ equity.

9. What is liquidity?
Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market at
a price reflecting its intrinsic value. In other words: the ease of converting it to cash.
Liquidity reflects whether there is a ready market for an asset—the ease of converting it to cash.
Cash is the most liquid of assets; tangible items, among the less liquid.
There are different ways to measure liquidity, including market liquidity and accounting liquidity.

10.What is net working capital?

Working capital, also known as net working capital (NWC), is the difference between a
company’s current assets, such as cash, accounts receivable (customers’ unpaid bills) and inventories of
raw materials and finished goods, and its current liabilities, such as accounts payable. Net operating
working capital is a measure of a company's liquidity and refers to the difference between operating
current assets and operating current liabilities. In many cases these calculations are the same and are
derived from company cash plus accounts receivable plus inventories, less accounts payable and less
accrued expenses.
Working capital is a measure of a company's liquidity, operational efficiency and its short-term
financial health. If a company has substantial positive working capital, then it should have the potential to
invest and grow. If a company's current assets do not exceed its current liabilities, then it may have trouble
growing or paying back creditors, or even go bankrupt.

11.What is meant by debt and equity financing?

Definition of Equity Financing
Equity financing involves increasing the owner's equity of a sole proprietorship or increasing the
stockholders' equity of a corporation to acquire an asset.
When a corporation issues additional shares of common stock the number of issued and outstanding
shares will increase. This increase will cause the previous stockholders' ownership percentage to be
reduced.
Definition of Debt Financing
Debt financing means borrowing money in order to acquire an asset. Financing with debt is referred
to as financial leverage. Using debt financing allows the existing stockholders to maintain their percentage
of ownership, since no new stock is being issued. However, the additional debt adds risk and may result in
higher interest rates for future loans.
Debt financing often comes with strict conditions or covenants regarding interest and principal payments,
maintaining certain financial ratios, and more. Failure to meet those conditions can result in severe
consequences. In the U.S., a benefit of debt financing is that the interest on the debt is an income tax
deductible expense. This income tax savings will partially offset the interest expense on the debt.
12.Differentiate book value, historical cost, and market value.
The book value of an asset is its original purchase cost, adjusted for any subsequent changes, such as for
impairment or depreciation.
Market value is the price that could be obtained by selling an asset on a competitive, open market.
A historical cost is a measure of value used in accounting in which the value of an asset on the balance
sheet is recorded at its original cost when acquired by the company.

13.What will you find in a firm’s cash flow statement?

The first section of the cash flow statement is cash flow from operations, which includes transactions from
all operational business activities.
This section of the statement lists the sources and uses of cash that arise from the normal
operations of a firm. The net cash flow from operations is computed as the net income reported on the
income statement including changes in net working capital items (i.e., receivables, inventories, and so
on) plus adjustments for non-cash revenues and expenses (such as amortization).
Cash flow from investment is the second section of the cash flow statement, and is the result of investment
gains and losses.
A firm makes investments in both its own non-current and capital assets and the equity of other
firms (which may be subsidiaries or joint ventures of the parent firm—they are listed in the “investment”
account of the balance sheet). Increases and decreases in these non-current accounts are considered
investment activities. The cash flow from investing activities is the change in gross plant and equipment
plus the change in the investment account. The changes are positive if they represent a source of funds
(e.g., sale of some plant and/or equipment); otherwise they are negative

Cash flow from financing is the final section, which provides an overview of cash used from debt and equity.
Cash inflows are created by increasing notes payable and long-term liability and equity accounts,
such as bond and stock issues. Financing uses (outflows) include decreases in such accounts (i.e., repaying
debt or the repurchase of common shares). Dividend payments are a significant financing cash outflow.
For many firms, the repurchase of shares has also been a main financing outflow in recent years

14.Define the following:

14.1. Operating activities
Operating activities are the functions of a business directly related to providing its goods and/or
services to the market. These are the company's core business activities, such as manufacturing,
distributing, marketing, and selling a product or service.
14.2. Investment activities
Investing activities is a term for a broad group of activities that encompasses any money spent on
something likely to increase in value. Most commonly, investing activities involve the purchase of
stocks, bonds, certificates of deposit, mutual funds, or real estate
14.3. Financing activities
Financing activities are transactions or business events that affect long-term liabilities and equity. In
other words, financing activities are transactions with creditors or investors used to fund either
company operations or expansions.