Distinction between policy and strategy

1.     Policy of an organization is prepared to deal with the internal affairs generally. Whereas strategy generally deals with the affairs and events that are external to the firm.

2.     Strategy produces the policies but policies do not produce strategy.

3.     Policy is concerned with both thought and actions. While strategy is concerned mostly with action.

4.     Policy deals with routine/daily activities essential for effective and efficient running of an organization. While strategy deals with strategic decisions.

5.     The strategy of a company can be known if we analyze the policy followed by a company.

6.     Policies must be within the power of the boss and can be executed by exercising the power of the boss. But strategies can’t be executed by exercising the power of the executives because many external events affect the attainment of objectives. 

7.     A policy is framed for recurring activities but a strategy is not formulated for recurring activities. It is formulated to meet the events that may arise in near future and also in the long ran.

8.     A strategic process goes through analysis and diagnosis, choice, implementation and evaluation to complete. But in framing the policies the executive does not need to scan the environment.

9.     The policy is in fact a sub-function of strategy. When recurring problems arise frequently then a best standard solution is found out and is termed as policy. So, policy implements strategy but strategy does not implement policy.

10.    Policy is a blueprint of the organizational activities which are repetitive/routine in nature. While strategy is concerned with those organizational decisions which have not been dealt/faced before in same form.

11.    Policy formulation is responsibility of top level management. While strategy formulation is basically done by middle level management.

12.    The distinction between policy and strategy is made in the context of delegation or implementation. The implementation of policy can be delegated downward in the organization, while the strategy cannot, since it requires a last-minute executive decision.

13.    Examples of policies are product policy, sales policy, purchase policy, personnel policy.

Whereas, examples of strategy are stability strategy, growth strategy retrenchment strategy and combination strategy.

Microeconomics vs Macroeconomics

Microeconomics vs Macroeconomics

There are differences between microeconomics and macroeconomics, although, at times, it may be hard to separate the functions of the two. First and foremost, both of these terms mentioned are sub-categories of economics itself. As the names of ‘micro’ and ‘macro’ imply, microeconomics facilitates decisions of smaller business sectors, and macroeconomics focuses on entire economies and industries. These two economies are mutually dependent, and together, they develop the strategy for the overall growth of an organization. They are the two most important fields in economics, and are necessary for the rise in the economy.

Microeconomics focuses on the market’s supply and demand factors that determine the economy’s price levels. In other words, microeconomics concentrates on the ‘ups’ and ‘downs’ of the markets for services and goods, and how the price affects the growth of these markets. An important aspect of this economy is also to examine market failure, i.e. when the markets do not provide effectual results. In our present time, microeconomics has become one of the most important strategies in business and economics. Its main importance is to analyze the economy forces, consumer behavior, and methods of determining the supply and demand of the market.

On the other hand, macroeconomics studies similar concepts, but with a much broader approach. The focus of macroeconomics is basically on a country’s income, and the position of foreign trades, with the study of unemployment rates, GDP and price indices. Macroeconomists are often found to make different types of models, and relationships, between factors such as output, national income, unemployment, consumption, savings, inflation, international trade, investment, and international finances. Overall, macroeconomics is a vast field that concentrates on two areas, economic growth and changes in the national income.

Governments make policy changes to avoid different types of economic distress, as they know how to steady the economy. This is one of the best approaches to stabilize and ensure the growth of the nation’s economy. Therefore, macroeconomics maintains two strategies:

Fiscal Policy: The most important aspect of fiscal policy is taxation and government spending, where the government will focus of the collecting of revenue to empower the economy. This can create a solid impact on the economic growth.

Monetary Policy: This policy controls the monetary authority, central bank, or government of a country, and focuses on the availability and supply of money and interest rates, in order to sustain the growth of the economy.

Differences

Microeconomics and macroeconomics are important studies within economics that are essential to sustain the overall growth and standard of the economy. While the two studies are different, with microeconomics focusing on the smaller business sectors, and macroeconomics focusing on the larger income of the nation, they are interdependent, and work in harmony with each other. The main differences are:

1.Microeconomics focuses on the market’s supply and demand factors, and determines the economic price levels.

2.Macroeconomics is a vast field, which concentrates on two major areas, increasing economic growth and changes in the national income.

3.Microeconomics facilitates decision making for smaller business sectors.

4.Macroeconomics focuses on unemployment rates, GDP and price indices, of larger industries and entire economies.

Microeconomics is generally the study of individuals and business decisions; macroeconomics looks at higher up country and government decisions. Macroeconomics and microeconomics, and their wide array of underlying concepts, have been the subject of a great deal of writings. The field of study is vast; here is a brief summary of what each covers:

Microeconomics is the study of decisions that people and businesses make regarding the allocation of resources and prices of goods and services. This means also taking into account taxes and regulations created by governments. Microeconomics focuses on supply and demand and other forces that determine the price levels seen in the economy. For example, microeconomics would look at how a specific company could maximize its production and capacity so it could lower prices and better compete in its industry. (Find out more about microeconomics in Understanding Microeconomics.) 

Macroeconomics, on the other hand, is the field of economics that studies the behavior of the economy as a whole and not just on specific companies, but entire industries and economies. This looks at economy-wide phenomena, such as Gross National Product (GDP) and how it is affected by changes in unemployment, national income, rate of growth, and price levels. For example, macroeconomics would look at how an increase/decrease in net exports would affect a nation's capital account or how GDP would be affected by unemployment rate. (To keep reading on this subject, see Macroeconomic Analysis.)

While these two studies of economics appear to be different, they are actually interdependent and complement one another since there are many overlapping issues between the two fields. For example, increased inflation (macro effect) would cause the price of raw materials to increase for companies and in turn affect the end product's price charged to the public.

The bottom line is that microeconomics takes a bottoms-up approach to analyzing the economy while macroeconomics takes a top-down approach. Regardless, both micro- and macroeconomics provide fundamental tools for any finance professional and should be studied together in order to fully understand how companies operate and earn revenues and thus, how an entire economy is managed and sustained. 

Hello guys, we are here to learn the difference of Micro and Macro economics. Below I have explained in brief. Just go through it and finally you will come to know the main difference between them.

Micro Economics:-

• It deals with an individual's economic behavior.
• It deals with the pricing of a particular commodity in an industry.
• It deals with the income of a particular set of people.
• Study of micro economics is important for resource utilization, public finance, and for taking business decisions.
• The concepts of micro-economics are independent concepts.
• The concepts were popularized by the famous Alfred Marshall.
• These concepts have more theoretical value.

Macro Economics:-

• It deals with aggregate economic behavior of the people in general.
• It deals with the general price level in the economy, National income accounting, etc.
• Study of macro economics is important for formulation of economic policy of the whole nation.
• The concept of macro economics is interdependent on one another.
• The concepts were popularized by the famous Lord J.M. Keynes.
• These concepts have more practical value.

Microeconomics and macroeconomics--micro and macro, as many economists call them--are the two major subdivisions in the field of economics. Micro examines the economy in miniature, while macro concerns itself with economic aggregates, such as gross domestic product or national unemployment rates.

Micro economic is a branch of economics which focuses on the market attitude of the individual customers and organizations which enables the business to understand the market behavior in micro perspective. Micro economics enables the business organizations to take decisions on the smaller and critical aspects; it also takes the factors affecting such decisions into consideration. It was Adam Smith - the father of economics who did an elaborative analysis on these concepts that is micro and macro economics. Micro economics today is become an important branch of study in the field of economics and business.

The following points will highlight the importance of micro economics:

It enables in establishing a method which can analyze individual economic forcesØ

The market behavior of the consumers can be understood which is very much helpful in decision making through micro economicsØ

It also leads to understanding of the individual supply and demand determinants of the marketØ

Now let us take look at what macro economics means. Macro economics is that branch of economics which studies the economics in a broader sense for example it deals with national income of the country or the buying behavior of the Indians and foreign trade position of India. Here the behavior of the economy is studied as a whole and as matter of fact both macro and micro economics are very inter-dependent in nature and both influence in decision making and strategy formulating of an organization.

Though they are interdependent they are still different from one another and the following points will justify their differences:

Micro economics studies the individual behaviorØ that is it studies the consumption behavior or attitude of a consumer whereas macro economics on the other hand studies the overall market structure, that is enables the organization to understand the size and capacity of the market.

The demand in micro economics directlyØ depends on the individual's expectations where as in micro economics the demand depends on the organization's expectations.

In theØ pricing method micro economics concerns with the price of a individual product whereas in macro economics the overall production costs is considered

Taxation is another example which determines theØ difference between these two fields of economics. Micro economics deals with the individual's tax aspects where macro economics deals with the overall tax aspects of the country.

Therefore by looking at the above differences between micro and macro economics we can conclude that both these approaches towards the field of economics today occupy a valuable niche.

Difference between Micro and Macro Economics

Economics as a concept is not important only for those who are studying finance or economics, but economics is important for every other individual whether he or she is a doctor or an engineer or a businessman. Everyone uses economics in daily life and therefore one should know what exactly economics is, well in simple words economics is a study of how individuals and groups make decisions with limited resources so that they can satisfy their needs and wants.

Economics is divided into two parts or branches one is micro economics and other is macro economics, let’s see what are the differences between micro and macro economics.

1. While micro economics refers to study of economic behavior of individuals, families, or a company while macro economics refers to that branch of economics which deals with the economic behavior of the society or nation as a whole.

2. The scope of micro economics is limited as it deals at individual level, while the scope of macro economics is much wider and it studies things like inflation, unemployment, interest rate effect on economy and gross domestic product of an economy of the country.

3. Example of micro economics study is what will be the consequence of increase in salary of an individual will have on his or her purchasing power, while macro economics study what will be the consequence of higher inflation on growth of the economy or how rise in gross domestic product will help in generating employment opportunities.

Macro- and microeconomics, and their wide array of underlying concepts, have been the subject of a great deal of writings. The field of study is vast; here is a brief summary of what each covers:

Microeconomics is the study of decisions that people and businesses make regarding the allocation of resources and prices of goods and services. This means also taking into account taxes and regulations created by governments. Microeconomics focuses on supply and demand and other forces that determine price levels for specific companies in specific industry sectors. For example, microeconomics would look at how a specific company could maximize its production and capacity so it could lower prices and better compete in its industry.

Macroeconomics, on the other hand, is the field of economics that studies the behavior of the economy as a whole and not just on specific companies, but entire industries and economies. This looks at economy-wide phenomena such as Gross National Product (GDP) and how it is affected by changes in unemployment, national income, rate of growth, and price levels. For example, macroeconomics would look at how an increase/decrease in net exports would affect a nation's capital account or how GDP would be affected by unemployment rate.

While these two studies of economics appear to be different, they are actually interdependent and complement one another since there are many overlapping issues between the two fields. For example, increased inflation (macro effect) would cause the price of raw materials to increase for companies and in turn affect the end product's price charged to the public.

The bottom line is that microeconomics takes a bottoms-up approach to analyzing the economy while macroeconomics takes a top-down approach. Regardless, both micro- and macroeconomics provide fundamental tools for any finance professional and should be studied together in order to fully understand how companies operate and earn revenues and thus, how an entire economy is managed and sustained.

Demand Schedule & Curve

1.  What is Demand?

2.  Demand Schedule & Demand Curve

3.  Shifts in the Demand Curve

4.  Individual Demand and Market Demand

What is Demand?

In economics demand means effective demand which meets the three crucial characteristics; desire to have a good, willingness to pay for that good and ability to pay for that good. Absence of any of these three characteristics, there is no demand. For example, a teetotaler professor may posses both the willingness to pay as well as the ability to pay for bottle of liquor, yet he does not have a demand for it. This is because; he does not desire to have that alcoholic drink. Similarly, a businessman might have the desire to have a television, he might be rich enough to be able to pay for it, but if he is not willing to pay for the television, he does not have a demand for this good. Also, a blue collar worker might posses both the desire for the scooter as well as the willingness to pay for it, but if he does not posses enough money to pay for it, he does not have a demand for the scooter. In contrast, to these three situations, a doctor, who has the desire for a car as well as both the will and ability to pay for it, he has demand for a car.

Demand Schedule & Demand Curve

The quantity demanded of a good usually is a strong function of its price. Suppose an experiment is run to determine the quantity demanded of a particular product at different price levels, holding everything else constant. Presenting the data in tabular form would result in a demand schedule, an example of which is shown below.

Demand Schedule

Price	Quantity Demanded
5	10
4	17
3	26
2	38
1	53

The demand curve for this example is obtained by plotting the data:

Demand Curve

By convention, the demand curve displays quantity demanded as the independent variable (the x axis) and price as the dependent variable (the y axis).

The law of demand states that quantity demanded moves in the opposite direction of price (all other things held constant), and this effect is observed in the downward slope of the demand curve.

For basic analysis, the demand curve often is approximated as a straight line. A demand function can be written to describe the demand curve. Demand functions for a straight-line demand curve take the following form:

Quantity = a - (b x Price)

where a and b are constants that must be determined for each particular demand curve.

When price changes, the result is a change in quantity demanded as one moves along the demand curve.

Shifts in the Demand Curve

Why Demand Curve Shift?

u   When any of the ceteris Paribas conditions changes, the entire demand curves shifts.

q     Factors of Ceteris Paribas

Ø               Income

Ø               Tastes and preferences

Ø               Prices of related goods and services

Ø               Expectations regarding the future

Ø               Number of buyers

Ø               Climate and weather

When Individual Demand Curve Shift?

u   When an individual’s income rises and everything remain constant, the person’s demand for a commodity usually increases

v    When income increases, the demand curve shifts to the right

v    When income decreases, the demand curve shifts to the left

The demand curve shifts to the left

u   An decrease in consumer’s income

u   an increase in the price of complementary goods

u   The popularity of the product decreased

u   Taste for the product changes negatively

The demand curve shifts to the right

u   An increase in consumer’s income

u   An increase in population / market size

u   An increase in the price of a substitute goods

u   Buyers expect the products price to be much higher in the future 

When there is a change in an influencing factor other than price, there may be a shift in the demand curve to the left or to the right, as the quantity demanded increases or decreases at a given price. For example, if there is a positive news report about the product, the quantity demanded at each price may increase, as demonstrated by the demand curve shifting to the right:

Demand Curve Shift

A number of factors may influence the demand for a product, and changes in one or more of those factors may cause a shift in the demand curve. Some of these demand-shifting factors are:

·         Customer preference

·         Prices of related goods

o        Complements - an increase in the price of a complement reduces demand, shifting the demand curve to the left.

o        Substitutes - an increase in the price of a substitute product increases demand, shifting the demand curve to the right.

·         Income - an increase in income shifts the demand curve of normal goods to the right.

·         Number of potential buyers - an increase in population or market size shifts the demand curve to the right.

·         Expectations of a price change - a news report predicting higher prices in the future can increase the current demand as customers increase the quantity they purchase in anticipation of the price change.

Individual Demand and Market Demand

The consumer equilibrium condition determines the quantity of each good the individual consumer will demand. As the example above illustrates, the individual consumer's demand for a particular good—call it good X—will satisfy the law of demand and can therefore be depicted by a downward-sloping individual demand curve. The individual consumer, however, is only one of many participants in the market for good X. The market demand curve for good X includes the quantities of good X demanded by all participants in the market for good X. The market demand curve is found by taking the horizontal summation of all individual demand curves. For example, suppose that there were just two consumers in the market for good X, Consumer 1 and Consumer 2. These two consumers have different individual demand curves corresponding to their different preferences for good X. The two individual demand curves are depicted in Figure 1 , along with the market demand curve for good X.

Figure 1: Derivation of the market demand curve from consumers' individual demand curves

The market demand curve for good X is found by summing together the quantities that both consumers demand at each price. For example, at a price of $1, Consumer 1 demands 2 units while Consumer 2 demands 1 unit; so, the market demand is 2 + 1 = 3 units of good X. In more general settings, where there are more than two consumers in the market for some good, the same principle continues to apply; the market demand curve would be the horizontal summation of all the market participants' individual demand curves.

Basics of Finance

Basic Elements of Financial Decision

Financial Management is the efficient and effective planning and controlling of financial resources so as to maximize profitability and ensuring liquidity for an individual is called personal finance, for government is called public finance and for profit and non-profit organization/firm is called corporate or managerial finance. Generally, it involves balancing risks and profitability.

There are three basic element of financial decision:

1.      Cash flow - realizable cash flow

2.      Timing of cash flow - profit is the part of cash flow

3.      Risk

Major Financial Decisions

Financial Management is the efficient and effective planning and controlling of financial resources so as to maximize profitability and ensuring liquidity for an individual is called personal finance, government is called public finance and for profit and non-profit organization/firm is called corporate or managerial finance. Generally, it involves balancing risks and profitability.

The decision function of financial management can be divided into the following 3 major areas:

Investment Decision

Investment decision is determining the total amount of assets needed by a firm hence closely tied to the allocation of funds. Investment decision involves investment of company’s capital in current and fixed asset.  There are two types of investment decisions namely:

• Capital Investment decisions: It means investment in fixed asset. This investment needs large amount of money for longer term and critical to the business like - purchase of plant and machinery or factory
• Working Capital Investment decisions: It means investment in current asset. It is also called working capital. This investment is routine in nature and for short term like how much and how long to invest in inventories or receivables. The amount of working capital varies depending on the nature of company. A travel company needs a little amount of working capital whereas a manufacturing company needs huge amount of working capital.

Financing Decision

After deciding on the amount and type of assets to buy, the financial manager needs to decide on how to finance these assets that is the sources of fund. Financing decision involve find out the source of fund required to invest in business. Generally a company raise fund from the following three sources:

1. Equity / Stock - ownership fund: It can be raise from two sources

Ø      External - common stock

Ø      Internal - retaining earning

2. Debt: Debt can be two type

Ø      Short term - less than 1 year

Ø      Long term - 5/7 years

Ø      Between short term and long term debt can be called medium term debt

3.   Preferred stock: It is hybrid type of financing

Financing decisions for example:

• Whether to use external borrowings /debts or share capital or retained earnings

• Whether to borrow short, medium or long term

• What sort of mix – all borrowings or part debts part share capital or 100% share capital

Dividend Decision

The term dividend refers to that part of profits of a company which is distributed by the company among its shareholders. Dividend decision determines the division of earnings between payments to shareholders and retained earnings. It is the reward of the shareholders for investments made by them in the shares of the company.

The Dividend Decision, in corporate finance, is a decision made by the Board of Directors and is confirmed generally by the annual general meeting (AGM) of the shareholders. The Dividend Decision is an important part of the present day corporate world. The Dividend decision is an important one for the firm as it may influence its capital structure and stock price.

There may be three types of dividend policy

(1)   Strict or Conservative dividend Policy which envisages the retention of profits on the cost of dividend pay-out. It helps in strengthening the financial position of the company;

(2)   Lenient Dividend Policy which views the payment of dividend at the maximum rate possible taking in view the current earning of the company. Under such policy company retains the minimum possible earnings;

(3)   Stable Dividend Policy suggests a mid-way of the above two views. Under this policy, stable or almost stable rate of dividend is maintained. Company maintains reserves in the years of prosperity and uses them in paying dividend in lean year. If company follows stable dividend policy, the market price of its shares shall be higher.

1. Stability of Earnings.

2. Age of corporation.

3. Liquidity of Funds.

4. Growth needs of the company

5. Needs for Additional Capital.

6. Trade Cycles.

7. Government Policies.

8. Taxation Policy.

9. Legal Requirements.

10. Past dividend Rates.

11. Ability to Borrow.

12. Financing Policy of the firm

13. Debt obligation

14. Profit rates

15. Attitude of the investor group

What Is a Financial Asset?

Financial asset is a claim against the income or wealth of a business firm and represented usually by certificate and issued by financial entity.

A financial asset is an intangible representation of the monetary value of a physical item. It obtains its monetary value from a contractual agreement of what it represents. While a real asset, such as land, has physical value, a financial asset is a document that has no fundamental value in itself until it is converted to cash. A financial asset can not be depreciated.

Form of financial asset - instruments

v     Money

v     Equity / stock - common stock & preferred stock

v     Debt

v     Derivatives

Common types of financial assets include certificates, bonds, stocks, and bank deposits.

Dealer verses Broker

Transformation of savings into investment is done in two ways:

• Direct method - Dealer & broker
• Indirect method - Financial intermediaries

In general, dealer is an individual or firm who purchases goods or services for resale to consumers and maintains an inventory and stands ready to buy and sell at any time. In contrast, a broker brings buyers and sellers together but does not maintain an inventory.

In the securities market, a dear stands ready to buy securities from investors wishing to sell them and sell securities to investors wishing to buy them. The price dealer is willing to pay is called bid price and the price at which dealer will sell is called ask price or offering price. The difference between the bid and ask price is called spread and it is the basic source of dealer profits. In contrast, a securities broker arranges transactions between investors matching investors wishing to buy securities with investors wishing to sell securities. The distinctive characteristic of security brokers is that they do not buy or sell securities for their own accounts. 

Financial intermediary

Transformation of savings into investment is done in two ways:

• Direct method - Dealer & broker
• Indirect method - Financial intermediaries

A financial intermediary is a financial institution that connects surplus and deficit agents. It acts as the middleman between investors and firms raising funds. Financial intermediation consists of “channeling funds between surplus and deficit agents”

The classic example of a financial intermediary is a bank that transforms bank deposits into bank loans.

Through the process of financial intermediation, certain assets or liabilities are transformed into different assets or liabilities.

Financial intermediaries provide 3 major functions:

1. Maturity transformation :Converting short-term liabilities to long term assets (banks deal with large number of lenders and borrowers, and reconcile their conflicting needs)
2. Risk transformation: Converting risky investments into relatively risk-free ones.
3. Convenience denomination :Matching small deposits with large loans and large deposits with small loans

Advantages of financial intermediaries

There are 2 essential advantages from using financial intermediaries:

1. Cost advantage over direct lending/borrowing
2. Market failure protection the conflicting needs of lenders and borrowers are reconciled, preventing market failure

Types of financial intermediaries: Financial intermediaries include -

• Banks
• Building societies
• Credit unions
• Financial advisers or brokers
• Insurance companies
• Collective investment schemes
• Pension funds
• Mutual funds

Primary market verses secondary market

Financial market is a market where financial assets are bought and sold. There are two type of financial market:

§         Money market - duration 1 year or less

§         Capital market - duration more than 1 year

In capital markets long-term securities and shares are issued and traded. Capital markets are where most of the traffic of trading occurs. Capital market are sub-divided into   a. Primary   Market b. Secondary Market

Primary Market

This is a part of the financial market where new securities / shares are traded for the first time. Companies and government can issue securities in this market through Initial public offerings (IPO’s), rights issue (for existing companies), and preferential issue. Its principal function is raising financial capital to support new investment in building, equipment and inventories.

Secondary Market

Secondary market is a market where securities are traded after they are initially offered in the primary market. Its chief function is to provide liquidity to security investors and it provides an avenue for converting financial instruments into cash.

The volume of trading in the secondary market is far larger than in the primary market.  The secondary market does not support new investment. Nevertheless, Primary and secondary markets are closely intertwined. A rise in security price in secondary market usually leads to similar rise in prices on primary market securities and vice versa.

There are two ways for investors to get shares from the primary and secondary markets. In primary markets, securities are bought by way of public issue directly from the company. In Secondary market share are traded between two investors.

Rate of return

In finance, rate of return (ROR), also known as return on investment (ROI), rate of profit or sometimes just return, is the ratio of money gained or lost on an investment relative to the amount of money invested.

Return is realizable cash flow generated by an investment over a period of time is expressed as a percentage. Formula of return is:

Rit = (Pi,t - Pi,t-1) + Ci,t          X 100

                        Pi,t-1

Example:          Price of share at the beginning of period           = Tk.150

 Price of share at the end of period                    = Tk. 160

 Dividend                                                          = TK. 10

Rit = (Tk.160 - Tk.150) + Tk.10          X 100

                                                Tk.150

                                   

     = 13.33%

Return has two components. Firstly, one may receive some money on the investment. It is called income component of investment. Secondly, the value of the asset will often change. If increase is called capital gain and loss is called capital loss.

Riskier investments must have a higher projected rate of return in order to be worthwhile. An investment with a relatively low projected rate of return generally should be low risk in order to still be worthwhile.

For example, a savings account might have a relatively low projected rate that it will return. Because the investment is safe, however, a lower rate is acceptable. Stocks typically should have a higher projected rate the money will return, since the investor takes more risk in this situation.

Time Value of Money

Time Value of Money (TVM) is an important concept in financial management. The idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. 

TVM is based on the concept that a dollar that you have today is worth more than the promise or expectation that you will receive a dollar in the future. Money that you hold today is worth more because you can invest it and earn interest. For instance, you can invest your dollar for one year at a 10% annual interest rate and accumulate $1.10 at the end of the year.  You can say that the future value of the dollar is $1.10 given a 10% interest rate and a one-year period. It follows that the present value of the $1.10 you expect to receive in one year is only $1.

The Time Value of Money concepts will be grouped into two areas: Future Value and Present Value. Future Value describes the process of finding what an investment today will grow to in the future. Present Value describes the process of determining what a cash flow to be received in the future is worth in today's dollars.

Compounding

Compounding is the process of calculating the future value of a present amount.

Compounding is the process of earning interest on a loan or other fixed-income instrument where the interest can itself earn interest. That is, interest previously calculated is included in the calculation of future interest. For example, suppose someone had the same certificate of deposit for $1000 that pays 3%, compounding each month. The interest paid is $30 in the first month (3% of $1,000), $30.90 in the second month (3% of $1,030), and so forth. In this situation, the more frequently interest is compounded, the higher the yield will be on the instrument.

Discounting

Discounting is the process of calculating the present value of a future amount. Discounting is opposite to compounding.

Discounting is a financial mechanism in which a debtor obtains the right to delay payments to a creditor, for a defined period of time in exchange for a charge or fee. Essentially, the party that owes money in the present purchases the right to delay the payment until some future date. The discount, or charge, is simply the difference between the original amount owed in the present and the amount that has to be paid in the future to settle the debt

To calculate the present value of a single cash flow, it is divided by one plus the interest rate for each period of time that will pass. This is expressed mathematically as raising the divisor to the power of the number of units of time.

Consider the task to find the present value PV of $100 that will be received in 5 years. Assuming a 12% per year interest rate.

What is financial management?

Financial Management is the efficient and effective planning and controlling of financial resources so as to maximize profitability and ensuring liquidity for an individual(called personal finance), government(called public finance) and for profit and non-profit organization/firm (called corporate or managerial finance). Generally, it involves balancing risks and profitability.

The key objectives of financial management are to:

v     Create wealth for the business

v     Generate cash, and

v     Provide an adequate return on investment 

v     Profit maximization

v     Wealth maximization

“Financial Management is the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations.”- Joseph and Massie.

Finance as a discipline

A branch of economics concerned with resource allocation as well as resource management, acquisition and investment. Finance deals with matters related to money and the markets. To raise money, corporations issue and sale equity/share and debt.

The focus of Finance is on the financial management of business firms. Simply, finance is a body of facts, principles, and theories dealing with the raising and using of money by individuals, businesses, and government.

The individual's financial problem is to maximize his or her well being by appropriately using the resources available. Finance deals with how individuals divide their income between consumption - food, clothes, etc. and investment - stocks, bonds, real estate, etc. how they choose from among available investment opportunities, and how they raise money to provide for increased consumption or investment.

Firms also have the problem of allocating resources and raising money. Management must determine which investment to make and how to finance those investments. Just as the individual seeks to maximize his or her happiness, the firm seeks to maximize the wealth of its owners (stockholders).

Finance also encompasses the study of financial markets and institution, and the activities of governments, with stress on those aspects relating to the financial decisions of individuals and companies. In addition, financial institutions and governments have financial problems comparable to those of individuals and firms. The study of these problems is an important part of the field of finance

Maximization profit as a goal

Possible goals

            Survive

            Avoid financial distress and bankruptcy

            Beat the competition

            Maximize sales or market share

            Minimize cost

            Maximize profit

            Maintain steady earning growth

            Maximize return

            Maximize wealth

Maximization of profits is generally regarded as the main objective of a business enterprise. Each company collects its finance by way of issue of shares to the public. Investors in shares purchase these shares in the hope of getting profits from the company as dividend. It is possible only when the company's goal is to earn maximum profits out of its available resources. If company fails to distribute higher dividend, the people will not be keen to invest their money in such firm and persons who have already invested will like to sell their stocks. On the other hand, higher profits are the barometer of its efficiency on all fronts, i.e., production, sales and management. A few replace the goal of 'maximization of profits' to 'fair profits'. 'Fair Profits' means general rate of profit earned by similar organization in a particular area.

Profit maximization alone cannot be an appropriate goal for a firm. It is not a precise and clear goal. Do we mean profit this year? If so, we should note that actions such as deferring maintenance, letting inventories run down and taking other short-run cost-cutting measures will tend to increase profit now, but these activities are not desirable in the long run.

Maximization owner’s wealth as a goal

Maximization of profits is regarded as a proper objective of the firm. It does not include the goal of maximizing the value of the stocks. Stockholders buy stock because they seek to gain financially. Good financial decisions increase the value of the stock and poor decisions decrease the value of the stock. Financial manager acts in the shareholders’ best interest by making decision that increase the value of the stock. Value of stock is represented by the market price of the ordinary share of the company over the long run which is certainly a reflection of company's investment and financing decisions. The log run means a considerably long period in order to work out a normalized market price. Therefore, the appropriate goal financial management is -

“The goal of financial management is to maximize the current value of the existing stock”

The total value of the stock in a corporation is simply equal to the value of the owners’ equity. Therefore, more precise goal of financial management is “maximizing the market value of the existing owners’ equity”. This goal of financial management does not mean that financial management should take illegal or unethical actions in the hope of increasing the value of the equity in the firm. What it means is that the financial manager best serves the owners of the business by identifying goods and services that add value to the firm.