Introduction to Finance

Dr Prashant Kumar Gupta

SoM, Mahindra University, Hyderabad
 Why do we study the basics of finance?

The We Work Story!

What’s the story? What business are they in?

Progress from a startup to a multi-billion dollar enterprise

What problems did it face?

What’s the fuss around ‘FINANCE’
Corporate
Finance

Fintech Investment
5 Basic Areas
“The Hum Paanch”

International Financial
Finance Institutions
Corporate Finance-Business Finance-Basic ideas and principles
Investments- Stocks and Bonds-Pricing, risks and rewards
Financial Institutions- Regulators and Enforcers
International Finance- international aspects of corporate finance,
investments or financial institutions
Fintech: Finance and Technology
Why should I care about Finance?
• Everyone should know finance; atleast a working knowledge
• Marketing
• Top Level Management
• Technology
• Personal Life
Let’s talk about the subject- Finance in
Business

The Three
Questions

Long Term Long Term Everyday

Assets Financing Financing
Business Finance Decisions

Decisions

Capital Capital Working

Budgeting Structure Capital
Capital Budgeting

Planning and managing long-term investments

Should be worth more than the cost

• Cash inflows due to assets
• Cash outflows
• Time of receipt and payment
• Risk Involved
Capital Structure

How to fund long-term investment?

Mixture of debt and equity

• What factors do we consider?

Factors to consider:
• How much is to be borrowed?
• Cost of borrowing? Equity and Debt?

Where to raise the money from?

Working Capital

Short terms assets and liabilities

Questions that need an answer?

• How much cash should I keep?
• The inventory I should hold!
• Where do I get finds to finance my day-to-day
operations.
Which form of organization should I choose?

Sole Limited Liability

Partnership Company
Proprietorship Corporation
Sole Proprietorship
Single ownership
Least regulated
Unlimited Liability
Easy to set up
Taxes- Income Tax
Limited life
Limited Resources
Personal Control
Privacy due to limited regulation
Partnership
Partnership Agreement
Shared ownership
Unlimited Liability
Individually or collectively liable
Profit Sharing
Tax- On the share of profit as Income Tax
Easy to set up
Limited Life
Complementary skills and resources
Corporation
Legal status

Limited liability

Separate management

Perpetual existence

Transferable ownership

Taxed as the separate legal entity

Regulated by Companies Act, 2013

Cost of formation
Limited Liability Partnership/Companies
Limited Liability
Members managed or manager-managed
Separate Legal Entity
Taxed as Income tax
Limited life
Fewer complications as compared to corporations
Unlimited members
Operating agreement under LLP Act, 2008
Goal of Financial Management

Profit Wealth
Maxim Maxim
isation isation
Profit Maximisation

Duration
• Short term
• Long term

Profit is an ambiguous term

• Accounting profit
• Cash profit
• Normal profit
• Do we account for abnormal gains as well?
Wealth Maximisation
What do shareholders want? Just profit?

What if it is not listed? Maximise the market value/valuation

Increase the value

Generate the highest possible returns for investors

Considers long-term consequences as well

Value of business is also linked with cash flows

Is it just profit that contributes to a higher value?

• Efficiency
• Ability to manage risk
• Ability to make decisions
 Let’s discuss a case on Agency Relationship
• ABC Corp, a manufacturing company, is facing challenges with its sales team. The sales
team is underperforming and failing to meet its sales targets, resulting in a decline in
revenue. The company's management team is concerned about the situation and decides
to investigate the issue.
• Upon investigation, it is discovered that the sales team's performance is a result of a
misalignment of incentives. The sales team is compensated based on the number of units
sold, but the company's objective is to increase revenue and profits. As a result, the sales
team is incentivized to push low-margin products to customers, rather than higher-margin
products that would benefit the company
• The management team realizes that this misalignment of incentives is an example of an
agency problem. The sales team is acting as an agent for the company, but its actions are
not aligned with the company's best interests.
• To address the issue, the management team decides to revise the sales team's
compensation structure. Instead of compensating the sales team based on the number of
units sold, the team will be compensated based on the revenue and profitability of the
products they sell. This change in compensation structure aligns the sales team's incentives
What are the consequences of misaligned incentives on the performance of an organization?

How can a company address the problems, as demonstrated in this case?

Can you think of other examples of agency problems that a company might face, and
how might they be addressed?

What is an agency problem?

Agency Problem
Management/Manager’s goals

Organisation’s Survival

Independence, managers do not like interference

Increased growth and size

• Eg: Overpaying to acquire a company just to increase its size.
• Eg: Owners are willing to make a risky investment as it increases
the share price but managers do not want it due to risk factors.
Questions arise?

How to solve the issue?

• Managerial compensation
Do managers act in the • Tied to Revenue
shareholders’ interest? • Stock options- Find out about the
• Alignment of management and stock options of Elon Mush and
shareholders’ goals Sunder Pichai
• Replacement of managers if they • Promotions for performance
• Control
do not pursue shareholders’ goals
• Shareholders have it
• Proxy fight- replacing management.
Eg: CCD
Time Value of Money?
Would you want to receive ₹1,00,00 today or after 5 years?
Why?
 Some concepts- Future Value & Compounding
Value of investment after one or more periods.

Principal: ₹1,000 A= P*1+(r/100)

Interest rate: 10% = 1000*1.1
Time: 1 year = ₹ 1,100
Amount: ?
What if you left the money invested for another year?
Now invest this money in the third year as well! What is the amount now?
You get interest on interest as well; this is called compounding
𝑡
𝐹𝑉 = 𝑃𝑉 ∗(1+𝑟 )
𝑡
(1+𝑟 ) 𝑖𝑠 𝑐𝑎𝑙𝑙𝑒𝑑 𝑡h𝑒 𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝐹𝑎𝑐𝑡𝑜𝑟
Power of Compounding
Some concepts- Present Value & Discounting
I want ₹ 11,000 after 1 year. If the interest rate is 10%, how
much should I invest today?

𝐹𝑉
𝑃𝑉 = 𝑡
(1+ 𝑟 )

11000
𝑃𝑉 = 1
(1+ 0.1)

= ₹10,000
Practice Questions
You want to save $5,000 in 3 years from now for a down
payment on a house. If your bank offers an interest rate of 5%
per annum, how much do you need to invest today to reach
your goal?
You want to have $100,000 in 10 years from now for your
education. If your bank offers an interest rate of 8% per
annum, how much do you need to invest each year starting
today to reach your goal?
You want to have $1,000,000 in 20 years from now for your retirement.
If your bank offers an interest rate of 6% per annum, how much do you
need to invest each month starting today to reach your goal?