DEFINITION AND NATURE OF FINANCE

1.0 INTRODUCTION

Every business is a financial entity and finance is the life blood that sustains every
business. Management requires finance to make essential and crucial decision in an
organization. In all new and already existing companies, decision may be made with
respect to the plant and machinery to purchase, how much to invest in inventories,
what should be the credit policy and how to monitor the financial performance. All the
aforementioned decisions carry important financial implications which involve or base
on profitability and liquidity. Prior to the industrial revolution, finance needs were
limited as most of the production was labour intensive because businesses were small
but after the industrial revolution businesses expanded. Industries became more capital
intensive and therefore, more capital was required to run businesses efficiently. This
situation led to the growth of financial institutions and insurance firms which provided
the large capital required for businesses.

Finance is the most essential of all business functions. It is indispensable to all other
business activities. It remains a focus of all activities. This function cannot be substitute
because the business will close down in the absence of finance. The need for money is
continuous. It starts with the setting up of an enterprise or business activity to the
sustenance or continuation of the business activity and the expansion of the business.
The development and expansion of business usually require more commitment of
funds. The funds will have to be raised from various sources (such as equity, retained
earnings, debenture or bonds, term loans, etc.). The sources will be selected in relation
to the implications attached with them. However, the generation of fund is not enough,
its utilization is more important.

The fund once generated will have to be paid back. If fund is used properly then its
refund will be easy otherwise it will create difficulties for repayment. The management
should plan how to utilize the fund profitably even before thinking of how to raise the
funds. It may be easy to raise funds but it repayment may be difficult if not properly
used. The inflows and outflows of funds should be properly matched to achieve
effective and efficient use of funds. That is, the maturity of Funds generated must be
matched with the maturity pattern of the investments to which the funds are spent on.

However, this is an introductory course in finance which designed to give a firm

foundation in finance. This chapter will cover the fundamental issues in finance,
meaning of finance, objectives of a firm, roles and functions of finance manager,

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relationship between risk and return, finance functions and goal of financial decisions.
The readings on any of the topics are selected to provide exposures to fundamental
issues in finance.

2.0 Objective

At the end of this chapter, students should be able to:

i. Discuss the evolution of finance

ii. Explain the need for finance

iii. Identify the various type of finance

iv. Give different definitions of finance

v. Explain the objectives of a firm

vi. Discuss the roles and functions of finance manager

vii. Understand the relationship between risk and return

viii. State the finance functions

ix. Understand the concept of time value of money

x. Be aware of the goal of financial decisions

3.0 Main Content

3.1 Brief Evolution of Finance

The word finance originated from the French and is subsequently adopted by English-
speaking regions to refer to as the "management of money". Today, Finance is more
than just a word; it has emerged into a highly significant professional and academic
discipline. Finance evolved from economics as its branch in the later part of the 19th
century; but later became a separate discipline. It evolved as an important branch of
economics, covering the areas of financial and monetary economics, business and
public finance and international finance. It graduated in response to the complexity of
business from sole proprietorship to corporate organization. Finance was initially
concerned mainly with the keeping of records of receipts and payments; dealings
simply on bonds, debentures, banks. Nowadays, it has extended the 'coast' to various
aspect or aspects of company survival, introduction of new technologies in operation,

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the application of computers and its closeness to economy.

3.2 The definition of finance

Finance involves planning, obtaining and using of funds for maximizing the value of the
firm which represents the main functions and areas of responsibilities of finance
managers. The basic finance tasks include:

i. Raising of funds from external financial sources.

ii. allocating of funds among different uses.

iii. managing the flow of funds involved in the operations of the firm

iv. allocating of benefits to sources of financing in the form of returns,

repyament or

products and services.

Webster 's Ninth New Collegiate Dictionary defines as "the science on study of the
management of funds' and the management of funds as the system that includes the
circulation of money, the granting of credit, the making of investment, and the
provisiion of banking facilitates. In brief, it is however important to know what financial
management mean. Another definition of finance by Blazenko (2008), states that
finance is an academic and a professional discipline devoted to the study and pratice of
making "investments". An investment is anything owned or controlled and that has the
potential to increase future consumption at the expense of current consumption. This
definition highlights the fact that we make investments not simply formonetary
gain.There must be something that underlies the monetary gain (or loss). This
something is the level of your consumption. If you make wise investrment decisions,
then you , your clients, or financial assets holders of your firm, enjoy greater future
consumption. The definition highlights the inter-temporal dimension of all
investments. The benefits of today's investment is at a future date. The delay can be
short for some investment (speculative, investment, for example) or long for others
(business investment, for example). The work "potential" in this definition indicates
that all investments are risky, which is, of course, an investment attribute all investors
should consider. An investment is expected to increase future consumption but it
might, unexpectedly, decrease future consumption. Since risk can never entirely be
avoided risk, risk management is a fundamental investor-skill that requires the ability to
identify and measure risk. Thus, risk is a principal topic of any finance study. Finance is

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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. Without adequate finance, no enterprise can possibly accomplish its
objectives. So, finance is regarded as the lifeblood of any business enterprise.

The subject of finance has been traditionally classified into two:

a. Public Finance: It deals with the requirements, receipts, and disbursement of funds
in the government institutions like states, local self-government, and central
government.

b. Private Finance: It is concerned with requirements, receipts, and disbursement of

funds in the case of an individual, a profit-seeking business organization, and a non-
profit organization.

Thus, private finance can be classified into:

i. Personal Finance: Personal finance deals with the analysis of principles and practices
involved in managing one's own daily need of funds.

ii. Finance of Non-Profit Organization: The finance of non-profit organization is

concerned with the practices, procedures, and problems involved in financial
management of charitable, religion, educational, social, and other similar organizations.

iii. Business Finance: The study of principles, practices, procedures, and problems
concerning financial management of profit-making organizations engaged in the field of
industry, trade, and commerce is undertaken under the discipline of business finance.

Business finance deals with the finance of business objectives and it is concerned with
the planning and controlling firm's financial resources.

According to Guthman and Dougal, business finance can be defined as "the activity
concerned with planning, raising, controlling, and administering of funds used in the
business".

Wheeler defines business finance as "that business activity which is concerned with the
acquisition and conservation of capital funds in meeting the financial needs and overall
objectives of business enterprise".

However, finance can be viewed from three different perspectives: these are finance as
a fund, finance as a field, and finance as a function.

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a. Finance as Fund

Finance is the fund required to be committed into either long term assets or short term
assets that would yield benefit in the distant or near future as return on the investment
for the maximization of the value of the firm. Finance is the scarce capital resources or
scarce economic resources which can be committed to alternative investment.
According to Pamela and Fabozzi (2010), Finance involves the allocation of money
under conditions of uncertainty, provides the framework for making decisions as to
how to get funds and what we should do with them once we have them and also
provides the platform by which funds are transferred from those entities that have
funds (from the surplus) to those entities that need funds (to the deficit sectors).

Finance can be viewed from three different perspectives these are finance as fund,
finance as a field and finance as a function.

b. Finance as a Field of Study

Finance is a field or course studied as an academic discipline in the universities,

polytechnics and other business school as simply Finance, Banking and Finance or
Accounting and Finance. Finance is one of the courses or course work studied as simply
Finance, Financial Management, Corporate Finance, Managerial Finance or Strategic
Finance Management in universities, polytechnics, business schools and professional
examination bodies as one of the requirements for the award of degrees diplomas or
professional qualifications.

c. Finance as a Function

Finance is the function performed as finance function by the members of the finance
department: the finance director, financial manager, financial controller, finance
officers, finance clerks etc. whether managerially (managerial finance functions) or
routinely (routine finance function. Finance is the function i.e department of finance
and accounts where finance and accounting functions are performed. In this regards,
Howard and Upton, defined finance as that administrative area or set of administrative
functions in an organization which relates with the arrangement of each and credit so
that the organization may have the means to carry out the objectives as satisfactorily as
possible.

3.3 Financial Management

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Financial management is the management of money. Financial management is the
application of planning and control to the finance function. It helps in profit planning,
measuring costs, controlling inventories, accounts receivables. It also helps in
monitoring the effective deployment of funds in fixed assets and in working capital. It
aims at ensuring that adequate cash is on hand to meet the required current and
capital expenditure. It facilitates ensuring that significant capital is procured at the
minimum cost to maintain adequate cash on hand to meet any exigencies that may
arise in the course of business. Financial management helps in ascertaining and
managing not only current requirements but also future needs of an organization.

In summary, financial management perform the following task:

i. it ensures that funds are available at the right time and procurement of funds does
not interfere with the right of management / exercising control over the affairs of the
company.

ii. it influences the profitability/return on investment of a firm.

iii. it influences cost of capital. Efficient fund managers endeavour to locate less cost
source so as to enhance profitability of organization.

iv. it affects the liquidity position of firms.

v. it enhances market value of the firm through efficient and effective financial
management.

vi. financial management is very much required for the survival, growth, expansion and
diversification of business.

vii. it is required to ensure purposeful resource allocation.

3.3.1 The Scope of Finance Functions

Finance functions are the decisions made by the financial manager with the aim of
maximizing the wealth of the shareholders. Finance function is the most important of
all business functions. It remains a focus of all activities. It is not possible to substitute
or eliminate this function because; the business will close down in the absence of
finance. According to Solomon Ezra "finance function is the study of the problems
involved in the use and acquisition of funds by a business". It starts with the setting up
of an enterprise and remains at all times (i.e the principle of going concern, where the
company is expected to be in operation in perpetuity.). The funds will have to be raised

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from various sources (from owners and various creditors). The receiving of money is not
enough, its utilization is more important (rationally and objectively allocating of the
funds to various users in other to maximise profit). The money once received will have
to be returned also (inform of interest and principal payment to debt instruments
holders where applicable, payment of debt owed to other creditors and preference
divided to owners of preference shares where applicable and ordinary divided to
owners of the company when declared and approved at Annual General Meeting (AGM)
of the company. It may be easy to raise funds but it may be difficult to repay them.

The scope of finance functions are classified into two:

A. The managerial finance functions

B. The routine finance functions

A. The Managerial Finance Functions (i.e. Financial Decisions)

Finance functions are related to the overall management of an organization. Finance

function is concerned with the policy decisions such as like of business, size of firm, type
of equipment used, use of debt, liquidity position. These policy decisions determine the
size of the profitability and riskiness of the business of the firm. The function which
finance covers is all encompassing from the establishment of a firm to liquidation of
such an organization. These functions have been grouped and classified by various
scholars which includes:

i. Raising of funds from external financial sources

ii. Ensuring that the funds maturity is equal to the uses to which it is put

iii. Allocation of funds among different uses

iv. Managing the flow of funds involved in the operations of the firm

v. Allocation of benefits to sources of financing in the form of return.

The above functions can be summarized as the basic decision of a firm as:

a. Financial decision

b. Investment/Capital budgeting decision

c. Dividend decision

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 d. Liquidity decisions

In any organization, the above functions are the major responsibilities of a particular
officer known as the financial manager. The decisions do not necessarily occur in a
sequence. These decisions call for skillful planning, control, and execution of a firm's
activities. It is pertinent to note that the shareholders are made better off by a financial
decision that increases the value of their shares. Thus, performing the financial
functions, the financial manager should strive to maximize the market value of shares.
The decisions above are briefly explained below:

i. Capital Budgeting Decision or Investment Decision

This involves the decision to commit funds to long-term assets which would yield
benefits in the future. It is otherwise referred to as Investment Decision. The long-term
activities are those activities that affect the firm's operations beyond the one-year
period. One of the problems here is that future benefits are difficult to measure and
predict with certainty. Because of the uncertainty attached to the future, capital
budgeting decisions involve risk. Hence, in taking capital budgeting decisions, the
finance manager needs to do the following:

i. Identifies the asset to be acquired, which could either be one of:

(a) modification and replacement of fixed assets

(b) acquisition of fixed assets for expansion and/or diversification

(c) investment in bonds and shares among others

ii. Determines the cost of acquiring the assets

iii. Estimates the projected incomes from and expenditures on the assets

iv. Determines the opportunity cost of the investment

Factors Influencing Investment Decisions

a. technological change

b. competitors' strategy

c. demand forecast

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 d. type of management

e. fiscal policy

f. cashflows

g. return expected from the investment

ii. Financing Decisions / Capital Structure Decisions

Once the firm has taken the investment decision and committed itself to new
investment, it must decide the best means of financing these commitments. It involves
decisions on when, where, and how to acquire funds to meet the firm's investment
needs. The proportion of equity to debt must be determined to enhance the optimum
capital structure for the firm. The financial manager must strive to obtain the optimum
best capital structure for his/her firm. The mix of debt and equity is known as the firm's
capital structure. Optimum capital structure means capital structure that maximizes the
value of the firm and minimizes the cost of capital. The raising of more debts will
involve fixed interest liability and dependence upon outsiders. It may help in increasing
the return on equity but will also enhance the risk. The raising of funds through equity
will bring permanent funds to the business but the shareholders will expect higher rates
of earnings. The financial manager has to strike a balance between anxious sourses so
that the overall profitability of the concern, improves. If the capital structure is able to
minimize the risk and raise the profitability then the market prices of the shares will go
up maximizing the wealth of sharehholders.

Factors Influencing Financial Decisions

There are numerous factors that influence the financial decision. They are classified as
external factors and internal factors.

External Factors

a. Capital structure

b. Capital market and money market

c. State of economy

d. Requirements of investors

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 e. Government policy

f. Taxation policy

g. Financial institutions/banks' lending policy

Internal Factors

a. Nature of business

b. Age of the firm

c. Size of the business

d. Extent and trend of earnings

e. Liquidity position

f. Working capital requirements

g. Composition of assets

h. Nature of risk and expected return

iii. Current Asset Management/Liquidity Decision

Current assets are those assets that can be converted into cash within one accounting
year. Investment in current assets affects firm's profitability and liquidity. If the firm
invests sufficient funds in current assets particularly cash, it will become liquid, but it
would lose profitability as idle cash would not earn anything. Thus a proper trade off
must be achieved between profitability and liquidity. This is the job of the financial
manager. He should estimate the firm's working capital needs and make sure that
funds will be made available when needed in the right amounts. Liquidity means the
capacity of a firm to convert an asset into cash within a short period without much loss.
It is a decision regarding the outflow and inflow of cash. In addition to the
management of long-term asset, the current assets should be managed efficeintly
against the dangers of ill liquidity.

iv. Dividend Decision

Dividend decision relates to how profit would be distributed. The term dividend refers
to that part of profits of a company which is distributed by it among its shareholders. It
is the reward of shareholders for investments made by them in the share capital of the

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company. The financial manager must decide whether the firm should distribute all
profits or retain them or distribute a portion and retain the balance. And when losses
are recorded, the manager tries to see the expediency of borrowing to pay dividends
from appropriation account. He seeks answers to the following questions:

a. Should we pay dividends?

b. If yes, what is the payout ratio and retention ratio?

When losses are recorded, is it expedient to borrow to pay dividends? A firm's dividend
policy is usually shaped by two conflicting desires of a firm:

i. to use retain earning as an internal source of long-term finance.

ii. to maximize the wealth of the shareholders.

Generally however, the optimum dividend policy of the firm should achieve maximum
market value per share and hence shareholders wealth.

B. Routine Finance Functions

These are finance functions which are performed by operational level (i.e lower level)
finance executives. They are the day-to-day routine finance operations of the
organization, which are required for effective execution of the managerial finance
functions. They include:

i. The record making aspect of finance and accounting involving:

a. Record keeping

b. Book-keeping, which is the recording aspect of accounting i.e the record making
phase of accounting.

ii. Bank Reconciliation

a. Adjusting cash book entries with the bank statement.

b. Reconciliation proper (reconciling the cash book with the bank statement)

iii. Safeguarding and safe keeping of security documents. Such as:

a. Cheque books

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b. Financial instruments

c. Vouchers and receipts

d. Insurance policies

iv. Safeguarding and safe keeping of assets

a. Maintaining fixed assets register with the required checks on them

b. Stores keeping and stock control procedures

3.3.2 Aims of Finance Function.

The primary aim of finance function is to arrange as much funds for the business as are
required from time to time. This function has the following aims:

1. Acquiring Sufficient Funds: The main aim of finance function is to assess the financial
needs of an enterprise and then finding out suitable sources for raising them. The
sources should be commensurate with the need of the business. If funds are needed for
longer periods, then long-term sources like share capital, debentures, term loans may
be explored. A concern with longer gestation periods should rely more on owner's
funds instead of interest-bearing securities because profits may not be there for some
years.

2. Proper Utilization of Funds: Though raising of funds is important, but their effective
utilization is more important. The funds should be used in such a way that maximum
benefit is derived from them. The returns from their use should be more than their
cost. It should be ensured that funds do not remain idle at any point in time.

3. Increasing Profitability: The planning and control of finance function aims at

increasing profitability of the concern. To increase profitability sufficient funds will have
to be invested. Finance function should be so planned that the concern neither suffers
from inadequacy of funds nor wastes more funds than required. A proper control
should also be exercised so that scarce resources are not frittered away on
uneconomical operations.

4. Maximizing Firm's Value: Finance function also aims at maximizing the value of the
firm. Besides profits, the type of sources used for raising funds, the cost of funds, the
condition of money market, the demand for products are some other consideration
which also influence a frim's value.

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Scope or Content of Financial Management/ Finance Function

The main objective of financial management is to arrange sufficient finances for

meeting short-term and long-term needs. A financial manager will have to concentrate
on the following areas of finance function:

1. Estimating Financial Requirements

The first task of a financial manager is to estimate short-term and long-term financial
requirements of his business. For this purpose, he will prepare a financial plan for
present as well as for future. The amount required for purchasing fixed assets as well as
for working capital will have to be ascertained.

2. Deciding Capital Structure

The capital structure refers to the kind and proportion of different securities for raising
funds. After deciding about the quantum of funds required, it should be decided which
type of securities should be raised. It may be wise to finance fixed assets through long-
term debts and current assets through short-term debts.

3. Selecting a Source of Finance

After preparing capital structure, an appropriate source of finance is selected. Various

sources from which finance may be raised include: share capital, debentures, financial
institutions, commercial banks, public deposits, etc. If finance is needed for a short
period, then banks, public deposits, and financial institutions may be appropriate. On
the other hand, if long-term finance is required, then share capital, and debentures may
be useful.

4. Selecting a Pattern of Investment

When funds have been procured, then a decision about the investment pattern is to be
taken. The selection of an investment pattern is related to the use of funds. A decision
will have to be taken as to which asset is to be purchased. The funds will have to be
spent first on fixed assets and then an appropriate portion will be retained for working
capital. The decision-making techniques such as capital budgeting, opportunity cost
analysis, etc. may be applied in making decisions about capital expenditures.

5. Proper Cash Management

Cash management is an important task of finance manager. He has to assess various

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cash needs at different times and then make arrangements for arranging cash. The cash
management should be such that neither there is a shortage of it and nor it is idle. Any
shortage of cash will damage the credit worthiness of the enterprise. The idle cash with
the business will mean that it is not properly used. Cash Flow statements are used to
find out various sources and application of cash.

6. Implementing Financial Controls

An efficient system of financial management necessitates the use of various control

devices. Financial control devices generally used are budgetary control, break even
analysis, cost control, ratio analysis etc. The use of various techniques by the finance
manager will help him in evaluating the performance in various areas and take
corrective measures whenever needed.

7. Proper use of Surplus

The utilization of profit or surplus is also an important factor in financial management.

A judicious use of surpluses is essential for expansion and diversification plan and also
in protecting the interest of shareholders. The finance manager should consider the
following factors before declaring the dividend:

a. Trend of earnings of the enterprise

b. Expected earnings in future.

c. Market value of shares.

d. Shareholders interest.

e. Needs of fund for expansion etc.

3.4 The Need for Finance in an Organization

i. Life blood of an Organization: Every business, regardless of its legal form of existence,
whether 'sole proprietorship, partnership, corporate organization or any other, is faced
with economic realities, and as such, requires sourcing and application of finance i.e.
fund, as finance is essential to proper functioning and smooth running of the firm as
blood is the body system: any part of the body that does not allow for smooth blood
flow would definitely experience paralysis, so also is finance to firm.

ii. Bedrock of an Organization: Finance is the bedrock of a sound, solvent and stable
organization whether profit making or not for profit making, government or non-

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government. All financial activities of the firm require acquisition and utilization of
funds. These financial activities includes: facing production, marketing and
administration. Government activities, on the other hand include provision of
infrastructures, regulatory and supervisory functions in the economy.

iii. Backbone of an Organizational Decisions: All organizational decisions require the

consideration of finance i.e availability of funds: available funds and access to external
funds. Hence, every organizational decision depends on finance. A firm that has
unrestricted access to funds will be dynamic in its organizational decisions but any firm
that operates under financial constraint, will subject its decisions to the extent of
available funds.

iv. Nutrients for Business Growth and Survival: Every business is a problem child,
needing to be well nursed and catered for. It needs finance for its survival and growth.
For any firm that is starved with funds will definitely die or experience stunted growth
in its quest to survive.

3.5 The Firm and its Objectives

The firms' investment and financing decisions are unavoidable and continuous. In order
to make them rationally the firm must have a goal. It is generally agreed in theory that
the financial goal of the firm should be the maximization of owner's economic welfare.
Owner's economic welfare could be maximized while maximizing the shareholders
wealth as reflected in the market value of shares. The main objectives of a business firm
are:

Profit Maximization

Profit maximization means maximizing the Naira (N) income of a firm. Profit earning is
the main aim of every economic activity. No business can survive without earning profit.
Profit is a measure of efficiency of a business enterprise. Profit also serves as a
protection against risk which enables a business to face risk like fall in prices,
competition from other units, adverse govt. policies etc. So the profit maximization is
considered as the main objective of business.

Arguments for profit maximization:

i. When profit earning is the aim of business, the profit maximization should be the
main objective.

ii. Profitability is a barometer for measuring efficiency and economic prosperity of a

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business enterprise.

iii. Profits are the main source of finance for the growth of a business.

iv. Profitability is essential for fulfilling social goals.

v. A business will be able to survive under unfavorable situations only if it has some past
earnings.

Criticism of Profit Maximization

i. It is Vague: The price meaning of profit maximization objective is unclear. Whether

short term or long term profit, profits before tax or after tax, total profit or earning per
share and so on.

ii. Ignores the timing of the return: The profit maximization objective ignores the time
value of money. If values benefits received today and benefits received after a period as
the same, it avoids the fact that cash received today is more important than the same
amount of cash received after some years.

iii. Ignores risk: The streams of benefit may possess different degrees of certainty. Two
firms may have the same total expected earnings, but if the earnings of one firm
fluctuate considerably as compared to the other, it will be more risky. Profit
maximization objective ignores this factor.

iv. Effect of dividend policy on the market price of share is also not considered in the
objective of profit maximization.

v. Profit maximization criteria fail to take into consideration the interest of govt,
workers and other persons in the enterprise.

The firm's goals cannot be to maximize profit but to attain a certain level or rate of
profit, holding a certain shares of the market or a certain level of sales.

Wealth Maximization

It is assumed that the goal of the firm should be to maximize the wealth of its current
shareholders. Wealth maximization is the appropriate objective of an enterprise.
Financial theory asserts that wealth maximization is the single substitute for a
stockholder's utility. When the firm maximizes the stockholder's wealth, the individual
stockholder can use this wealth to maximize his individual utility. It means that by

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maximizing stockholder's wealth the firm is operating.

Growth Objective

Growth can be in terms of profit or size. Growth, as an objective of profit, seems to be

more realistic and appears to reflect attitudes of managers. The implication is that
short-term profit maximization will not be pursued at the cost of long-term stability.
However, growth objective is not a sufficient objective that a firm can pursue since it
can be achieved by raising new finance.

Survival Objective

This objective is necessary but insufficient objective to pursue by corporate

organization. It is a short-term objective especially for infant firms in competitive
industry. During economic downturn, it is an objective to pursue but no investor will be
interested in investing in company that is objective is just to survive without long-term
ambition.

3.6 Goal of Financial Decisions

The primary goal of financial decision is to maximize the value of the firm. This is
broader than profit maximization because it takes time value of money and the
riskiness of the income stream into consideration. This provides basis for vigorous
analysis before decision making.

3.7 Risk

Risk means possibility of loss or injury. In other words, Risk is the difference between
expected return and actual return. Risk can be traditionally classified into two. They are:

1. Systematic risk

2. Unsystematic risk

1. Systematic risk: Systematic risk represents that portion of the total risk of an
investment that cannot be eliminated or minimized through diversification. Systematic
risk is also known as non-diversifiable risk or market risk e.g.

i. The govt. changes the interest rate policy.

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ii. The corporate tax rate is increased.

iii. Changes in inflation rate.

iv. Changes in investor's expectation.

v. Respective credit policy.

2. Unsystematic risk: Unsystematic risk represents that portion of the total risk of an
investment, which can be eliminated or minimized through diversification.
Unsystematic risk is also known as diversifiable or unique risk e.g.

a. Strikes

b. Availability of raw material

c. Management capabilities and decisions

d. Competition

3.8 Risk-return trade-off

Financial decisions affect the level of firm's stock prices by influencing the size of the
cash flow stream and riskiness of the firm. Policy decisions, which are subjects to
government constraints, affect both returns and risk; these two factors jointly
determine the value of the firm. Return and risk are further influenced by decision
relating to the industry to operate, size of the firm, its growth rate, the types and
amounts of equipment, the extent to which debt is employed and firm's liquidity
position, etc. such decisions generally affect both risk and return. An increase in cash
position, for instance, reduces risk; however, since cash is not an earning asset,
converting other assets to cash reduces return. Similarly, the use of additional debt
raises the rate of return on shareholders' net worth, at the same time more debt means
more risk. Therefore, "the higher the risk, the higher the returns." The financial
manager seeks to strike a balance between risks and return that will maximize the
wealth shareholders.

Financial decisions of a firm often involve alternative courses of actions. A finance

manager has to select amongst the various alternatives available to him. For example,
while making an investment decision, he has to decide whether the firm should go in
for a machinery having a capacity of 50,000 units or 2,00,000 units. In the same
manner, the financing decision may involve a choice between a debt-equity ratios of 1:1

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or 2:1, the dividend decision may be concerned with the quantum of profits to be
distributed. The alternative course of action implies a different risk-return relationship
as there is a positive relationship between the amount of risk assumed and the amount
of expected return. A machine with a higher capacity may give a higher expected return
but involves a higher risk of investment, whereas the machine with a lower capacity
may have a lower expected return and a lower risk of investment. A higher debt-equity
ratio may help in increasing the return on equity but will also enhance the financial risk.
While making a financial decision, one has to answer the basic questions: What is the
expected return? What is the risk involved? How would the decision influence the
market value of the firm? The financial manager has to strike a balance between
various sources so that the overall profitability of the firm and its market
value increases.

3.9 Time Value of Money

The time value of money is perhaps the most fundamental principle needed to
understand and make financial decision. The concept, in general, implies that a Naira
(N) today is worth more than a Naira (N) a year later. The computation of value over
time is done through the process of compounding and discounting.

3.10 Financial Manager

The financial manager occupies a key position in the management of an enterprise. His
role is significant in solving most recurring and strategic management complex
problems. The word management itself implies the management of company’s
resources for efficient accomplishing of enterprise goals. A financial manager is a
person who is responsible to carryout finance functions. He is one of the members of
the top management team. The financial manager, therefore, must have a clear
understanding and strong grasp of the nature and scope of the finance functions.

3.10.1 Roles Functions of a Finance Manager

Financial management in a business firm deals with identifying and managing

appropriate levels of assets, establishing and executing sustainable plan for financing
the firm’s assets. Two specific responsibilities of financial manager can be identified:

a. Managing the assets structure of a firm

b. Managing the financial structure of a firm

The first is about acquisition and disposal of assets, while the second is about the desire
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to maintain a suitable combination of debt and equity in financing these assets.
Decisions involved in the two functions will be discussed later. The changed business
environment in the recent past has widened the role of a financial manager. The
Functions of a Finance Manager are:

1. Financial Forecasting and Planning: A financial manager has to estimate the financial
needs of a business. How much money will be required for acquiring various assets?
The amount will be needed for purchasing fixed assets and meeting working capital
needs. He has to plan the funds needed in the future. How these funds will be acquired
and applied is an important function of a finance manager.

2. Acquisition of Funds: After making financial planning, the next step will be to acquire
funds. There are a number of sources available for supplying funds. These sources may
be shares, debentures, financial institutions, commercial banks etc. The selection of an
appropriate source is a delicate task. The choice of a wrong source for funds may
create difficulties at a later stage. The pros and cons of various sources should be
analyzed before making a final decisions

3. Investment of funds: The funds should be used in the best possible way. The cost of
acquiring them and the returns should be compared. The channels, which generate
higher returns, should be preferred. The techniques of capital budgetting may be
helpful in selecting a project. The objectives of maximizing profist will be achieved only
when funds are efficiently used and they do not remian idle at any time. A financial
manager has to keep in mind the principles of safety, liquidity and soundness while
investing funds.

4. Helping in Valuation Decisions: A number of mergers and consolidatiions take place

in the present competitive industrial world. A finance manager is suppposed to assist
management in making valuation etc. For this purpose, he should understand various
methods of valuing shares and other asstes so that correct values are arrived at.

5. Maintain Proper Liquidity: Every concern is required to maintain some liquidity for
meeting day-to-day needs. Cash is the best source for maintaining liquidity. It is
required to purchase raw materials, pay workers, meet other expense,, etc. A finance
manager is required to determine the need for liquid asstes and then arrange liquid
assets iin such a way that there is no scarcity of funds.

4.0 conclusion

Finance is the basic foundations of all kinds of economic activities. It is simply defined

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as the sources and uses of funds, Every individual, enterprise or government needs
funds to carry on its day to day operations in order to achieve stated objectives. The
finance functions performed by the finance manager are capital budgetting decisions,
current asset management decision, financing decisions, dividend decisions. While the
objectives of the firm are profit maximization, growth, survival and wealth
maximization. Wealth maximization is said to be the goal of all financial decisions.

5.0 Summary

This chapter exposed students to essential topics in nature and scope of finance,
starting from meaning of finance, objectives of a firm, roles and functions of finance
manager, relationship between risks and return, finance functions and goal of financial
decisions

6.0 Review Exercise

1. What is finance?

2. Highlight the finance functions

3. Explain the goal of financial decision

4. Discuss the objectives of a firm

5. Discuss the centrality of wealth maximization objective in relation to other objectives

of the firm.

6. How relevant is investment decision to other critical decisions taken by the finance
manager in organizations?

7. Explain the roles and functions of finance manager

8. Discuss the relationship between risk and return

9. Discuss the concept of time value of money

7.0 References

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S. O., Oke, M. O., Ajayi, L. B., Adaramola, A. O. (Ed.), Book of Readings in Finance,
222-239. Ado-Ekiti: Olugbenga Press and Publishers.

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Blazenko, G. W. (2008). The goal of finance: Relative valuation.

Charles, O. K., Erwin, Esser N., & Nence. (1970). Managerial finance: Essentials, (2nd Ed)
Minnesota, USA West Publishing Co.

Grunewald, A. (1970). Managerial finance: Essentials. 2nd Ed. Minnesota, USA West
Publishing Co.

James, C. H. (1980). Fundamentals of financial management (4th Ed) New Jersey:

Prentice Hall, Ind.

Kolapo, F. T. (2007). Business Finance. Akure, Adeyemo Publishing House 3-4

Oke, M. O. (2002). Investments and Management Decisions. Lagos. Libra Publishers. 8

Oke, M. O., & Sulaiman, L. A. (2007). Basic Finance. Mushin Lagos Graams Prints.

Oloyede, B. A. (2005). Introduction to Finance. Ikeja, Lagos. Balobay Publications 1-10

Oloyede, B. A. (2000). Principles of Financial Management. Yaba Lagos Forthright

Educational Publishers. 6-11

Oyekan, A. (2003). Basic Concepts and Applications in Business Finance Ikadan TL

Peakline Publishers

Pamela. P. D., & Fabozzi, F. J. (2010). The basics of Finance: an introduction to financial
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Pandey, I. M. (2005). Financial Management 9th edition New Delhi VIKAS Publishing
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Sulaiman, E. A. & Oluwaleye T. O. (2019). The Finance Function. In Oloyede, J. A.,

Adeasi, S. O., Oke, M. O., Ajayi, L. B., Adaramola, A. O.1" ed. Book of Readings in
Finance, 222-239. Ado-Ekiti: Olugbenga Press and Publishers.

Wars, S. C. (1979). Principles of firms el mongemer. US. The Maple cross

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