What is finance? What are a firms financial activities? How are they related? Firm create manufacturing capacities for production of goods, some provide services to customers. They sell goods or services to earn profit and raise funds to acquire manufacturing and other facilities. Thus, the 3 most important activities of business firm are:-
A firm secures whatever capital it needs and employs it (finance activity) in activities, which generate returns on, invested capital (production and marketing activities.)
Real and financial Assets:-
A firm acquire real assets to carry on its business. Real assets can be tangible or intangible. Plant, machinery, factory, furniture etc. are examples of tangible real assets, while technical know-how, patents, copy rights are examples of intangible real assets.
The firm sells financial assets or securities such as shares and bonds or debentures, to investors in capital market to raise necessary funds. Financial assets also include borrowings from banks, finance institutions and other sources.
Funds applied to assets by the firm are called capital expenditure or investment. The firm expects to receive return on investment and distribute return as dividends to investors.
EQUITY AND BORROWED FUNDS:-
There are two types of funds that a firm can raise:- Equity funds and borrowed funds.
A firm sells shares to acquire equity funds. Shares represent ownership rights of their holders. Buyers of shares are called share holders and they are legal owners of the firm whose share they hold share holders invest their money shares of a company in expectation of return on their invested capital. The return on shares holders capital consists of dividend and capital gain by selling their shares.
Another important source of securing capital is creditors or lenders. Lenders are not the owners of the company. They make money available to firm on a lending basis and retain title to the funds lent. The return on loans or borrowed funds is called interest. Loans are furnished for a specified period at a fixed rate of interest. Payment of interest is a legal obligation. The amount of interest is allowed to be treated as expense for computing corporate income taxes. Thus the payment of interest on borrowings provides tax shied to a firm. The firm may borrow funds from a large number of sources, such as banks, financial institutions, public or by issuing bonds or debentures. A bond or debenture is a certificate acknowledging the money lent by a bond holder to the company. It states the amount, the rate interest and maturity of bonds or dentures.
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