Fundamentals of Business Finance

Businesses can raise capital through various sources of funds which are classified into three categories.

1. Based on time Period – The period basis is further divided into three dub-division.

• Long Term Source of Finance

• Medium Term Source of Finance

• Short Term Source of Finance

2. Based on Ownership in the company's source – These sources of finance are divided into two categories.

• Owner’s Fund – This fund is financed by the company owners, also known as the owner’s capital.

• Burrowed Funds – These are the funds accumulated with the help of borrowings or loans for a particular period of time.

3. Based on Source – This source of income is categorized into two divisions.

• Internal Sources – The owners generated the funds within the organization. An example is retained earnings.

• External Source – The fund is arranged from outside the business. For instance, issuance of equity shares to the public, banks loan, etc.

The finance department is a key player in the planning process. Businesses face a lot of hindrances to improve their corporate planning, it is essential that finance executives use effective financial planning to solve the business problems. Some of the problems include:

• Regulatory compliance

• Being competitive

• Reconciliation problems between management and statutory bodies

• Inflexibility in the planning process

• Desire to gain high ROI

• Macro threats - PESTLE

Capital structure refers to the amount of debt or equity employed by a firm to fund its finance and business operations. A firm’s capital structure is typically expressed as a debt-to-equity ratio.

The cost of equity is the return a company requires to decide if an investment meets capital return requirements. Firms often use it as a capital budgeting threshold for the required rate of return. A firm's cost of equity represents the compensation the market demands in exchange for owning the asset and bearing the risk of ownership.

The cost of debt is the effective interest rate a company pays on its debts. It’s the cost of debt, such as bonds and loans, among others. The cost of debt often refers to the before-tax cost of debt, which is the company's cost of debt before taking taxes into account.

The weighted average cost of capital (WACC) is used by analysts and investors to assess an investor's returns on an investment in a company. As the majority of businesses run on borrowed funds, the cost of capital becomes an important parameter in assessing a firm’s potential for net profitability. WACC measures a company’s cost to borrow money, where the WACC formula uses both the company’s debt and equity in its calculation.

A balance sheet is a financial statement that reports a company's assets, liabilities, and shareholders' equity at a specific point in time, and provides a basis for computing rates of return and evaluating its capital structure.

The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS).

The Profit Volume (P/V) Ratio is the measurement of the rate of change of profit due to a change in volume of sales.

The stock market refers to the collection of markets and exchanges where regular activities of buying, selling, and issuance of shares of publicly-held companies take place.

Market capitalization refers to the total market value of a company's outstanding shares of stock. Commonly referred to as "market cap," it is calculated by multiplying the total number of a company's outstanding shares by the current market price of one share.

A capital market is a market where buyers and sellers engage in the trade of financial securities like bonds, stocks, etc. The buying/selling is undertaken by participants such as individuals and institutions.

The money market involves the purchase and sale of large volumes of very short-term debt products, such as overnight reserves or commercial paper.

NIFTY is a market index introduced by the National Stock Exchange. It is a blended word – National Stock Exchange and Fifty coined by NSE on 21st April 1996. NIFTY 50 is a benchmark-based index and also the flagship of NSE, which showcases the top 50 equity stocks traded in the stock exchange out of a total of 1600 stocks.

LPG stands for Liberalization, Privatization, and Globalization. India under its New Economic Policy approached International Banks for the development of the country. These agencies asked the Indian Government to open its restrictions on trade done by the private sector and between India and other countries.

Mergers and acquisitions (M&A) is a general term that describes the consolidation of companies or assets through various types of financial transactions, including mergers, acquisitions, consolidations, tender offers, purchase of assets, and management acquisitions.

Accounting rate of return (ARR) is a formula that reflects the percentage rate of return expected on an investment, or asset, compared to the initial investment's cost.

The payback period refers to the amount of time it takes to recover the cost of an investment.

The break-even point is a point of sales of a company wherein total sales cover exactly its total costs. In the other words breakeven point is the point of zero loss or profit. It means profit is zero at the break-even point of sales.

The margin of safety (MOS) is the difference between actual sales and break-even sales. In other words, all sales revenue above the break-even point represents the margin of safety.

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.

The time value of money (TVM) is the concept that money you have now is worth more than the identical sum in the future due to its potential earning capacity.

A cost sheet is a device used to determine and present the cost under unit costing. Cost sheet format is a statement of costs incurred at each level of manufacturing a product or service. It includes Prime cost, Factory/manufacturing cost, cost of production, cost of sale, Profit/loss

A cash budget is an estimation of the cash flows of a business over a specific period of time. This could be for a weekly, monthly, quarterly, or annual budget

The just-in-time (JIT) inventory system is a management strategy that aligns raw-material orders from suppliers directly with production schedules. Companies employ this inventory strategy to increase efficiency and decrease waste by receiving goods only as they need them for the production process, which reduces inventory costs.

Economic order quantity (EOQ) is the ideal order quantity a company should purchase to minimize inventory costs such as holding costs, shortage costs, and order costs. This production-scheduling model was developed in 1913 by Ford W. Harris

Bonus system is a wage payment whereby a worker is paid an additional amount for accomplishing more than a specified measure of work

Prospect theory is a behavioral model that shows how people decide between alternatives that involve risk and uncertainty (e.g. % likelihood of gains or losses). It demonstrates that people think in terms of expected utility relative to a reference point (e.g. current wealth) rather than absolute outcomes.

The equity premium puzzle (EPP) refers to the excessively high historical outperformance of stocks over Treasury bills, which is difficult to explain. The equity risk premium, which is usually defined as equity returns minus the return of Treasury bills, is estimated to be between 5% and 8% in the United States.

The small firm effect is a theory that predicts that smaller firms, or those companies with a small market capitalization, tend to outperform larger companies.