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FINANCE NOTES FOR PRELIM

Areas of Finance

The cycle of money is the movement of money from lender to borrower and back again.
It is often accomplished through a financial intermediary like a bank. The common
objective is to make both the lender and the borrower better off.
Distinguish the four main areas of finance and briefly explain the financial activities that
each encompasses.

The four main areas of finance are corporate finance, investments, financial institutions
and markets, and international finance. Corporate finance supports the operations of a
company. Investments are the activities centered on buying and selling stocks and
bonds. Financial institutions and markets are the organizations that promote the cycle of
money and the buying and selling of financial assets. International finance is concerned
with the multinational element of finance activities.

Explain the different ways of classifying financial markets.

There are a number of ways to classify financial markets: by type of asset traded, by
maturity of assets, by owner of the assets, or by method of sale.
Discuss the three main categories of financial management.
Financial management can be subdivided into three categories: capital budgeting,
capital structure, and working capital management. Capital budgeting is the process of
choosing the products and services the company will produce. Capital structure is
concerned with choosing the lenders the company will use to finance its operations.
Working capital management involves choosing the policies that manage the day-to-day
operating needs of the company.
Identify the main objective of the finance manager and how he or she might meet that
objective.

The primary goal of the finance manager is to maximize the current stock price (equity
value) of the firm. The finance manager works with multiple players inside and outside
the firm to create and preserve the economic value of the firm's assets.
Explain how the finance manager interacts with both internal and external players.
Business activities are accomplished by a diverse set of players inside and outside the
organization. The finance manager provides critical knowledge and guidance to
marketing, manufacturing, human resources, supporting suppliers, and customers and
interfaces with agencies like banks to meet the needs of the company.
Delineate the three main legal categories of business organizations and their respective
advantages and disadvantages.
There are three main legal categories of business organizations: sole proprietorship,
partnership, and corporation. The key advantage of the corporate form of business is
the limited liability of the shareholders (owners). The key disadvantage is double
taxation, in which profits are taxed both before and after distribution to owners. The key
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advantage for the sole proprietorship form of business is that the owner can make all
the decisions and can keep all profits. The disadvantage is the limited access to
funding. Partnerships have more funding potential, but must share the profits and
losses.
Illustrate agency theory and the principal-agent problem.
Companies are run by managers who may have different goals than the owners. The
resolution of these potential problems is the domain of agency theory. The principal-
agent problem is the conflict between the owners of the company and the managers
hired by the owners to work in the owners' best interests.
Review issues in corporate governance and business ethics.
Corporate governance deals with how a company conducts its business and what
controls are put in place to ensure proper procedures and ethical behavior. Although
many managers and owners operate in an ethical manner, some do not. The
government may add rules and regulations about the conduct of business and its
officers to encourage ethical and hones behavior.

Scope and Objectives in Finance refer to Ebook

What is a Finance Officer?

The role of the Finance Officer involves providing financial and administrative support to
colleagues, clients and stakeholders of the business. It’s a role that may attract
applicants keen to move up the financial corporate ladder; those with ambitions of being
Finance Managers, or even the CFO one day.

Finance Officer job description should highlight the need for candidates who are
focused on outcomes, excellent problem solvers and strong communicators.

What should be included in a Finance Officer job description?

Reporting to a manager and supporting the finance and accounting teams, a Finance
Officer job description should include some of the below key duties and responsibilities.
This is a role that interacts with several departments internally.

A Finance Officer job description generally includes:

 Assisting in the preparation of budgets

 Managing records and receipts
 Reconciling daily, monthly and yearly transactions
 Preparing balance sheets
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 Processing invoices
 Developing an in-depth knowledge of organisational products and
process
 Providing customer service to clients
 Resolve financial disputes raised by the customer service and sales
teams
 Being a key point of contact for other departments on financial and
accounting matters
 Supporting the Finance Manager and executives with projects and tasks
when required

What skills and qualifications should a Finance Officer have?

A Finance Officer role is well suited to candidates with university qualifications, and this
should be detailed in the Finance Officer job description. The most relevant fields of
study for this role include:

 Finance or Economics
 Accounting
 Business or Business Administration
 Mathematics

Knowledge in the below programs could also be included in the job description to
appeal to multi-skilled and high-quality candidates:

 SAP
 QuickBooks
 Tableau
 Xero Accounting Software
 HP TRIM

✔ Communication skills

✔ Interpersonal skills

✔ Problem solving skills

✔ Punctuality

✔ Critical thinking skills

✔ Teamwork and collaboration skills

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✔ Adaptability skills

✔ Work ethic

✔ Project management skills

Finance officer/administrator

What is a finance officer/administrator and what do they do?

A finance officer provides financial and administrative support to colleagues, clients and
stakeholders of a business. They help to manage the finances of an organisation by
monitoring its income and spending. They will oversee accounting and processing tasks
across income and expenditure (including payment runs), as well as reviewing bank and
balance sheet reconciliations. They are also responsible for the maintenance of
financial records, ensuring financial data accuracy, the entry of all transactions on the
accounting software and often the administration of the payroll.

A finance administrator role covers all of the above tasks, but does not have overall
accountability for them, instead performing a supportive role to the finance officer.

Key responsibilities

Responsibilities will vary, but examples include:

 Accurately recording all financial transactions, usually on computer systems

 Preparing balance sheets
 Processing invoices
 Reconciling bank statements
 Recording accounts payable and accounts receivable
 Producing financial forecasts
 Assisting in the preparation of budgets
 Preparing monthly, quarterly and annual financial reports
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 Dealing with payroll, expenses and VAT

 Participating in financial audits
 Assisting with the implementation of financial policies

Why are they important?

Finance officers and administrators contribute to the financial health of a company by

administering accounting operations to ensure that the financial systems are maintained
accurately and efficiently. They also play an administrative role in ensuring that the
business is compliant with relevant regulatory and legal requirements

Skills needed for this role

Finance officers and administrators must have a high level of numeracy as well as
excellent attention to detail. They should also have strong analytical and reporting skills,
and be good at problem solving.

Strategic Professional Options examinations linked to this role

Advanced Performance Management

Career opportunities presented by this role

This is an entry level role that may attract those who are keen to pursue a further career
in accountancy. With experience and appropriate professional training (such as through
the ACCA Qualification), finance officers can be promoted to senior finance officer,
finance manager or even finance leadership positions such as financial controller.

Competencies

High level competencies required include:

 Corporate and business reporting

 Data, digital and technology
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 Management accounting

THREE MAIN DIVISIONS OF BUSINESS

Understanding Business Activities

There are three main types of business activities: operating, investing, and financing.
The cash flows used and created by each of these activities are listed in the cash flow
statement. The cash flow statement is meant to be a reconciliation of net income on
an accrual basis to cash flow. Net income is taken from the bottom of the income
statement, and the cash impact of balance sheet changes are identified to reconcile
back to actual cash inflows and outflows.

Non-cash items previously deducted from net income are added back to determine cash
flow; non-cash items previously added to net income are deducted to determine cash
flows. The result is a report that gives the investor a summary of business activities
within the company on a cash basis, segregated by the specific types of activity.

Operating Business Activities

The first section of the cash flow statement is cash flow from operating activities. These
activities include many items from the income statement and the current portion of the
balance sheet. The cash flow statement adds back certain non-cash items such
as depreciation and amortization. Then changes in balance sheet line items, such as
accounts receivable and accounts payable, are either added or subtracted based on
their previous impact on net income.

These line items impact the net income on the income statement but do not result in a
movement of cash in or out of the company. If cash flows from operating business
activities are negative, it means the company must be financing its operating activities
through either investing activities or financing activities. Routinely negative operating
cash flow is not common outside of nonprofits.

Investing Business Activities

Investing activities are in the second section of the statement of cash flows. These are
business activities that are capitalized over more than one year. The purchase of long-
term assets is recorded as a use of cash in this section. Likewise, the sale of real estate
is shown as a source of cash. The line item "capital expenditures" is considered an
investing activity and can be found in this section of the cash flow statement.

Financing Business Activities

The cash flow statement's final section includes financing activities. These include initial
public offerings, secondary offerings, and debt financing. The section also lists the
amount of cash being paid out for dividends, share repurchases, and interest. Any
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business activity related to financing and fundraising efforts is included in this section of
the cash flow statement.

How Is the Cash Flow Statement Linked to Business Activities?

The cash flows used and created by each of the three main classifications of business
activities—operating, investing, and financing—are listed in the cash flow statement.
This financial statement is meant to be a reconciliation of net income on an accrual
basis to cash flow.

Net income is taken from the bottom of the income statement, and the cash impact of
balance sheet changes are identified to reconcile back to actual cash inflows and
outflows. Non-cash items previously deducted from or added to net income are added
or deducted respectively to determine cash flows. The result is a report that gives the
investor a summary of business activities within the company on a cash basis,
segregated by the specific types of activity.

What Are Operating Business Activities?

Cash flow from operating business activities, usually the first section of the cash flow
statement, includes many items from the income statement and the current portion of
the balance sheet. The cash flow statement adds back certain non-cash items such as
depreciation and amortization. Then changes in balance sheet line items, such as
accounts receivable and accounts payable, are either added or subtracted based on
their previous impact on net income. These line items impact the net income on the
income statement but do not result in a movement of cash in or out of the company.
Routinely negative operating cash flow is not common outside of nonprofits.

What Are Investing Business Activities?

Investing business activities are those that are capitalized over more than one year and
usually appear as the second section of the cash flow statement. The purchase of long-
term assets is recorded as a use of cash in this section. Likewise, the sale of real estate
is shown as a source of cash. The line item "capital expenditures" is considered an
investing activity and can be found in this section of the cash flow statement.

What Are Financing Business Activities?

The cash flow statement's final section includes financing business activities. These
include initial public offerings, secondary offerings, and debt financing. The section also
lists the amount of cash being paid out for dividends, share repurchases, and interest.
Any business activity related to financing and fundraising efforts is included in this
section of the cash flow statement.
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Components of Financial System

A financial system refers to a system which enables the transfer of money between
investors and borrowers. A financial system could be defined at an international,
regional or organization level. The term “system” in “Financial System” indicates a group
of complex and closely linked institutions, agents, procedures, markets, transactions,
claims and liabilities within a economy.
Five Basic Components of Financial System
 Financial Institutions
 Financial Markets
 Financial Instruments (Assets or Securities)
 Financial Services
 Money
Financial Institutions
Financial institutions facilitate smooth working of the financial system by making
investors and borrowers meet. They mobilize the savings of investors either directly or
indirectly via financial markets, by making use of different financial instruments as well
as in the process using the services of numerous financial services providers.
They could be categorized into Regulatory, Intermediaries, Non-intermediaries and
Others. They offer services to organizations looking for advises on different problems
including restructuring to diversification strategies. They offer complete array of services
to the organizations who want to raise funds from the markets and take care of financial
assets for example deposits, securities, loans, etc.

Figure 1: Five Basic Components of Financial System

Financial Markets
A financial market is the place where financial assets are created or transferred. It can
be broadly categorized into money markets and capital markets. Money market handles
short-term financial assets (less than a year) whereas capital markets take care of those
financial assets that have maturity period of more than a year. The key functions are:
1. Assist in creation and allocation of credit and liquidity.
2. Serve as intermediaries for mobilization of savings.
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3. Help achieve balanced economic growth.

4. Offer financial convenience.
One more classification is possible: primary markets and secondary markets. Primary
markets handles new issue of securities in contrast secondary markets take care of
securities that are presently available in the stock market.
Financial markets catch the attention of investors and make it possible for companies to
finance their operations and attain growth. Money markets make it possible for
businesses to gain access to funds on a short term basis, while capital markets allow
businesses to gain long-term funding to aid expansion. Without financial markets,
borrowers would have problems finding lenders. Intermediaries like banks assist in this
procedure. Banks take deposits from investors and lend money from this pool of
deposited money to people who need loan. Banks commonly provide money in the form
of loans.
Financial Instruments
This is an important component of financial system. The products which are traded in a
financial market are financial assets, securities or other type of financial
instruments. There is a wide range of securities in the markets since the needs of
investors and credit seekers are different. They indicate a claim on the settlement of
principal down the road or payment of a regular amount by means of interest or
dividend. Equity shares, debentures, bonds, etc are some examples.

Financial Services
Financial services consist of services provided by Asset Management and Liability
Management Companies. They help to get the necessary funds and also make sure
that they are efficiently deployed. They assist to determine the financing combination
and extend their professional services upto the stage of servicing of lenders.  They help
with borrowing, selling and purchasing securities, lending and investing, making and
allowing payments and settlements and taking care of risk exposures in financial
markets. These range from the leasing companies, mutual fund houses, merchant
bankers, portfolio managers, bill discounting and acceptance houses.
The financial services sector offers a number of professional services like credit rating,
venture capital financing, mutual funds, merchant banking, depository services, book
building, etc. Financial institutions and financial markets help in the working of the
financial system by means of financial instruments. To be able to carry out the jobs
given, they need several services of financial nature. Therefore, Financial services are
considered as the 4th major component of the financial system.
Money
Money is understood to be anything that is accepted for payment of products and
services or for the repayment of debt. It is a medium of exchange and acts as a store of
value.
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Financial Instrument
Understanding Financial Instruments
Financial instruments can be real or virtual documents representing a legal agreement
involving any kind of monetary value. Equity-based financial instruments represent
ownership of an asset. Debt-based financial instruments represent a loan made by an
investor to the owner of the asset.

Foreign exchange instruments comprise a third, unique type of financial instrument.

Different subcategories of each instrument type exist, such as preferred share equity
and common share equity.

 
International Accounting Standards (IAS) defines financial instruments as "any contract
that gives rise to a financial asset of one entity and a financial liability or equity
instrument of another entity." 1

Types of Financial Instruments

Financial instruments may be divided into two types: cash instruments and derivative
instruments.

Cash Instruments

 The values of cash instruments are directly influenced and determined by the
markets. These can be securities that are easily transferable.
 Cash instruments may also be deposits and loans agreed upon by borrowers
and lenders.

Derivative Instruments

 The value and characteristics of derivative instruments are based on the

vehicle’s underlying components, such as assets, interest rates, or indices.
 An equity options contract, for example, is a derivative because it derives its
value from the underlying stock. The option gives the right, but not the obligation,
to buy or sell the stock at a specified price and by a certain date. As the price of
the stock rises and falls, so too does the value of the option although not
necessarily by the same percentage.
 There can be over-the-counter (OTC) derivatives or exchange-traded derivatives.
OTC is a market or process whereby securities–that are not listed on formal
exchanges–are priced and traded.

Types of Asset Classes of Financial Instruments

Financial instruments may also be divided according to an asset class, which depends
on whether they are debt-based or equity-based.
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Debt-Based Financial Instruments

Short-term debt-based financial instruments last for one year or less. Securities of this
kind come in the form of T-bills and commercial paper. Cash of this kind can be
deposits and certificates of deposit (CDs).

Exchange-traded derivatives under short-term, debt-based financial instruments can be

short-term interest rate futures. OTC derivatives are forward rate agreements.

Long-term debt-based financial instruments last for more than a year. Under securities,
these are bonds. Cash equivalents are loans. Exchange-traded derivatives are bond
futures and options on bond futures. OTC derivatives are interest rate swaps, interest
rate caps and floors, interest rate options, and exotic derivatives.

Equity-Based Financial Instruments

Securities under equity-based financial instruments are stocks. Exchange-traded
derivatives in this category include stock options and equity futures. The OTC
derivatives are stock options and exotic derivatives.