C1: INTRODUCTION TO FINANCE

What is Finance

Finance is the science and art of how individuals and firms raise, allocate, and invest Money.

THE GOAL OF THE FIRM

MAXIMIZING PROFIT

MAXIMIZING SHAREHOLDER WEALTH

Emphasizes accounting profit for a short term.

Emphasizes shareholder wealth for a long term.

  • A financial manager can boost short-term profits by cutting costs or reducing spending on research and development (R&D).

  • While this increases immediate profits, it may hurt the business in the long run.

  • Lack of investment in R&D can cause the company to fall behind competitors.

  • Companies that are willing to spend on research and development will be more advanced and competitive in the industry.

Ignore the risk of return.

Considering the risk of return

  • When evaluating investments, looking only at profit or cash flow without considering risk can be misleading.

  • Investments that seem highly profitable might also carry high risks that aren’t immediately obvious.

  • There's a key principle in finance: higher returns usually come with higher risk.

  • Ignoring risk can lead to inaccurate financial decisions and unexpected losses.

  • To make smart investment choices, you should always consider both return and risk together.

Ignore the timing of return.

Considers the timing of return.


RM1 today is more valuable than RM1 in the future because you can use it now to invest, earn interest, or generate returns.

  • So, receiving money sooner is better than receiving it later, even if the amount is the same.

  • That's why, in investments, returns received earlier are more valuable.

  • If you only look at total returns without considering when the money is received, your financial analysis might be inaccurate or misleading.

In short: The timing of money matters. Sooner is better.

Ignore the cost of capital.

Considers the cost of capital.

  • When calculating accounting profit, loan interest is counted as a cost.

  • For example, a company borrows RM100,000 from a bank at 5% interest per year (which is RM5,000 annually) and invests it in government bonds that give a 10% return (RM10,000 a year).

  • Even though the bonds earn RM10,000, the company has to pay RM5,000 in interest to the bank.

  • So, the actual accounting profit is RM5,000 after deducting the interest expense (RM10,000 - RM5,000)