In this unit of the course, we will discuss the scope of finance to be reached, emphasizing on the relevant areas of concern because finance is a wide area of studies with much interrelationship in business. It is part of management.
At the end of this unit, you should be able to:
- discuss the scope of finance
- explain the financial and real asset market
- identify types of financing
- Discuss finance as part of management.
3.0 MAIN CONTENT
3.1 Scope of Finance
In Unit 1 of this Module, money (finance) was presented as a common denominator in doing business (trading). The other two elements that will combine to strike a balance in order to enhance the optimum utilization of resources of the business are: production and marketing.
The business cycle in Unit 1 explains financial (fund) activities and how they are related to the enterprise’s other activities. Manufacturing / operation activities provide goods/services to customers. They sell their goods or services to earn profit. They raise funds to acquire manufacturing and other facilities. A firm generates whatever capital it needs and utilises it (finance activity) in activities which generate returns on invested capital (production and marketing activities) as indicated in figure 1, Unit 1 earlier.
3.2 Internal and External Finance
There are two types of financing an enterprise can apply.
- Internal Finance – also known to as equity fund/finance is referred to as Equity. This is solely owned/contributed by the stakeholders (within) and is referred to as an internally-generated fund.
- External Finance – This is called borrowed fund/finance and referred to also as debt. The stakeholders source this from outside. This could be through direct loan, shares, etc. A firm/business can sell shares to acquire equity funds.
Shares represent ownership rights of their holders. Buyers of shares are called shareholders/stockholders and they are the legal-owners of the business whose shares they hold. For example, recruitment and promotion of employees in an organization, payment of their wages and salaries etc. involves finance. The evolvement of sales promotion/advertisement policies is within marketing preview. All these activities require cash budgeting, hence they affect financial resources.
Shareholders invest their money in the shares of a company in the expectation of a return on their invested capital. The return consists of dividend and capital gain.
Shareholders can be of two types
- Ordinary and
3.3 Financial and Real Assets Markets
There are two kinds of markets, namely:
- Financial Market
- Real Assets Market
3.3.1 Real Markets
Real markets are for physical or tangible assets such as plant, machinery wheat, office, gold, buildings etc. Intangible real assets include copyrights, patent, technical know-how.
3.3.2 Financial Markets
Financial market trades on financial assets. This asset promises future benefits in the form of cash payments such as is applicable to bonds, certificate of deposits, treasury bills, etc.
SELF ASSESSMENT EXERCISE 1
Give examples each of financial and real assets
3.4 Finance and Management Function
There is a relationship between finance and other functions in business enterprises. You should know that all business activities, directly or indirectly, involve the acquisition and utilization of funds. All the activities and decisions undertaken in respect of the day-to-day financing of a business make finance and management functions interrelated. For example, decisions on the following finance issues are taken by management upon recommendation of the Financial Controller:
Preference shareholders receive dividend at a fixed rate and they enjoy a priority over ordinary shareholders. The dividend rate for ordinary shareholders is not fixed and can vary from year to year depending on the board of directors.
A company can also obtain equity funds by retaining earnings available for shareholders. This is known as retained earnings (an internal equity) undistributed profits of equity capital.
- Rights Shares – after a company distributes all earnings to shareholders, it can re-acquire new capital from the same source (existing shareholders) by issuing new shares.
- Public Issue – may be made to attract new (and the existing) shareholders to contribute equity capital.
- Creditors/Lenders (External Finance) – They are not owners of the company. They provide money to enterprises as loan which are debt.
The loans are furnished for a specific period of time at a fixed rate of interest.
Payment of the interests is a legal obligation. The business can borrow fund from many sources like banks, financial companies, public or issuing bonds or debentures.
A bond/debenture is a certificate stating the amount of money lent by a bond holder to the company.
SELF ASSESSMENT EXERCISE 2
What is dividend?
The unit concludes that the scope of financing a business entity is from internally and externally generated fund. This keeps the business cycle turning to produce earnings (profits).
In this unit, the scope of finance is summarized along with types of financing, real and financing market and finance as part of management.
6.0 TUTOR-MARKED ASSIGNMENT
- Discuss the scope of finance
- Identify types of financing in business enterprises.