business finance major

business finance major

The Fundamentals of Business Finance: A Comprehensive Guide for Business Finance Majors

1. Introduction to Business Finance

Every business major should have an understanding of business finance. The purpose of business finance is to acquire funds and use these funds effectively to maximize the value of the firm. For many businesses, the chief objective is to earn a good return on the funds invested in the operations of the business. The finance function involves three decisions: investment decisions, financing decisions, and dividend decisions. The investment decision determines the composition of the total assets and how these assets will be acquired. The financing decision determines the balance between the various sources of financing. The dividend decision deals with how much of the net income will be reinvested in the business and how much will be distributed to the shareholders. The finance function is closely concerned with economic forecasting. Financial managers are also concerned with the functions of planning, organizing, and controlling, even though their major concern is the funds of the firm. In this chapter, we discuss the role of business finance, the basic goals of a business concern, and the responsibilities of a financial manager. We follow by defining the terms and concepts associated with business finance.

2. Financial Statement Analysis and Interpretation

To be an effective financial analyst requires the use of specific techniques. The single most important technique is that of inter-firm comparison, or comparing the performance of the reporting entity with that of other firms or with the industry as a whole. Only through comparison can meaningful conclusions be developed. Moreover, while the techniques themselves are straightforward, the conclusions often tend to be subjective in nature. Trends or relationships are not objectively defined under all forms of accounting methods, and accounting principles themselves are generally founded less on mathematics and more on judgment or realization. Consequently, managers and users of financial information must develop and apply judgment where standard accounting reports are inadequate to provide the information sought.

To be useful for decision-making and in overall business performance appraisal, raw accounting data, such as those contained in published financial statements, must be converted into a more digestible form. This is done through interpretation, or more formally, through accounting used as a tool of analysis. The process of formulating conclusions from financial statements and their supporting data is called financial statement interpretation.

3. Capital Budgeting and Investment Decisions

In their roles as consumers, students often (at least subconsciously) make capital budgeting decisions about everything they buy. The financial commitment necessary to purchase any product or service – from a candy bar to an education to an automobile to a home – is dominated by fun playing the role of the business finance analysts: NPV analysts use the present value rule to make a yes/no decision about each individual project. The focus is on the projects; the company is considered an “investment-only” holding company. Financial breakeven: amount that a new project must contribute to the firm’s base earnings in order to “break even” (the project’s net income exceeds the interest and amortization paid for the project). Financial overhead: fixed interest and amortization levels attributable to the investments in projects that generate the firm’s base earnings. Financial targets: financial goals that a project must satisfy to be accepted into the firm’s diversified portfolio of investments.

This chapter presents the business finance techniques used to make painful decisions about which long-term investment projects to undertake. Capital budgeting – the process of spending one dollar today to make two dollars tomorrow through long-term investments – is the “quintessential corporate problem,” and he is right. The production, marketing, and many other decisions made by modern business firms depend on the quality of investment decisions made by the capital budgeting staff and top management. In their role as prospective investors, business finance students looking to maximize their own capital gain and dividend yield must be able to evaluate the capital budgeting decisions of corporations. This chapter teaches students how to do capital budgeting.

4. Risk Management and Insurance in Business Finance

2. Theories of Insurance Risk Management Pure Risk exists when only a loss or no change can occur. It is these risks that either an individual or business is concerned with and uses risk management principles to minimize or eliminate. These risks also are the discovery of losses such as death, injury, illness, theft, fire, natural disasters, and an explosion. Overall, firms use risk management to change the adverse outcomes of these events into manageable expected values upon which to satisfactorily function. A variety of theoretical, probabilistic, and observable models on the causes, effects, and answers to these risks support the practical uses of risk management. Indeed, insurance very possibly is the oldest organized enterprise in existence to apply risk management techniques to these risks.

1. The Nature of Risk Every person, business, and even nation faces the uncertainties of everyday living. Risk is inherent in our lives whether we are at home, on the road, shopping, or at play. Accordingly, each of us must use personal risk management to minimize the adverse effect of these risks. Likewise, business firms face the adversities of theft, fire, technology, employee relations, government regulations, and increasing lawsuits. Business firms also use risk management to reduce the effect of these threats. Every business must be able to transfer these adverse effects of risk to others. Risk management and insurance are perfect vehicles through which these business risks can be carried away. Despite the close relationship that exists among risk, risk management, business finance, and insurance, elevated thought and practice have only recently appeared, which partially explains why these businesses are still largely regulated.

5. Ethical Considerations in Business Finance

In the bid to get the most out of the public trough, invest $100 million and write it off, showing a reduced tax bill that could be worth many times the written-off $100 million, and that simply by borrowing not a cent of outside money; such is the corporate practice that many point to and nickname as off-shoring. The very whiff of such activity sends flurries of ethical shudders from taxpayers, the man in the street, competitors, corporation executives, accountants, and company lawyers. The practice is the high-stakes cutting edge of corporate finance. But should such practice be seen as in any way disreputable?

The business and finance environment of a business firm, like all other domains of human behavior, is fraught, to varying degrees, with ethical challenges. This is particularly so in the realm of business finance. We can take a rather traditional view of the subject and list the kinds of major problem areas in the hope that the would-be business-financier will be alert to the contending forces that call for ethical sensitivities. The modern business environment faces a major crisis of fraud, deceit, and high-roller recklessness: just recall Enron, Worldcom, and so many others.