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Chapter 3 / Exercise 11
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NATURE OF BUSINESS FINANCEINSTRUCTIONSRead Chapter 1 of Financial Management textbook by I.M. Pandey.Complete answers to reinforcementquestions at the end of the lesson.Check model answers given in lesson 10 of the study pack.Reinforcing CommentsCONTENTSRelationship between business finance and financial management.Scope of Finance functions.Goals/Objectives of the firm.Agency theory.Risk-return Trade off.Types of business organizationRELATIONSHIP BETWEEN BUSINESS FINANCE AND FINANCIAL MANAGEMENTDEFINITION:Business finance is the process by which a financial manager/accountantprovides finance for business use as and when it is needed. This provisionhas to be undertaken on the basis of the needs of a company. On theother hand, Financial Management is a branch of economies concernedwith the generation and allocation of scarce resources to the mostefficient user within the economy (or the firm). The allocation of theseresources is done through a market pricing system. A firm requiresresources in form of funds raised from investors. The funds must beallocated within the organisation to projects that will yield the highestreturn.
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Chapter 3 / Exercise 11
Leadership: Theory, Application, & Skill Development
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4Nature of Business Finance1. Needs Consequent on the Operations of a Company (Basic Needs)These have to be financed in so far as they arise out of the company’s operations e.g. salaries.2. Shortages of Cash Brought About By UnforeseeableCircumstances E.G Non Payment By DebtorsThese needs have to be financed by short term finances e.g. overdrafts,but this may be against financial prudence rather such needs should befinanced by revolving finances in the circular flow. However, the financialmanager must manage his finances using such tools as:Cash budget – statement of expected receipts and payments over aprojected period of time – a forecast.Funds flow statement – (Actual).Variance between actual funds flow with cash budget. The variance mustbe managed to keep the company liquid. On the other hand a financialmanager has to meet the company’s strategic/long term needs (long terminvestment) are useful to the company because:1.It influences the company size (assets)2.It influences its growth (plough back)3.Finances incidental needs.4.It influences the company’s long-term survival – this is throughcontinuous investment.These investments will call for long term financing in form of ownersfinance (Ordinary Share Capital and Revenue reserves). This is a base onwhich other finances are raised. The company will also use externalfinancing e.g. debts, loans, debentures, mortgages, lease finance etc.These finances have to be used in acceptable/reasonable financial mix.This implies that the company’s gearing level is kept low i.e. therelationship between owners and creditors finance. This should be below67% otherwise the company may be forced into receivership andsubsequently liquidation. Even then, when using creditors finances acompany must consider:1.That cost of finance is less than the Return which implies the rate

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