Finance: Definitions, Scope, Goals & Functions

1. What is Finance?

Finance is the art and science of managing money, including:

• Acquiring funds (from owners, lenders, or markets).
• Allocating funds (to projects, assets, or expenses).
• Controlling funds (budgeting, auditing, risk management).

Key Definitions

2. Scope of Finance

Finance is divided into three broad areas:

mindmap
  root((Finance))
    Personal Finance
      Budgeting
      Saving/Investing
      Insurance
    Corporate Finance
      Capital Budgeting
      Working Capital
      Dividend Policy
    Public Finance
      Government Budgeting
      Taxation
      Public Debt

Comparison: Finance vs. Accounting vs. Economics

3. Goals of Finance

The primary objectives of financial management (for businesses) are:

1. Profitability: Maximize shareholder wealth (e.g., higher dividends or stock prices).
2. Liquidity: Ensure the business can meet short-term obligations (e.g., paying salaries, suppliers).
3. Efficiency: Optimize resource use (e.g., reducing waste in a Kathmandu textile factory).
4. Risk Management: Minimize exposure to financial losses (e.g., hedging against currency fluctuations).

Example: A Kathmandu Retail Shop

• Goal 1: Increase monthly profit from ₹500,000 to ₹700,000 by expanding product lines.
• Goal 2: Maintain ₹200,000 in cash reserves to pay suppliers on time.
• Goal 3: Reduce spoilage of perishable goods (e.g., fruits) by 15% using better inventory tracking.
• Goal 4: Use insurance to cover theft risks (e.g., ₹50,000 annual premium for shop security).

4. Functions of Finance

Finance performs three critical functions in any organization:

A. Investment Decisions (Capital Budgeting)

• Deciding where to invest funds (e.g., buying new machinery, expanding a Daraz warehouse).
• Methods: Net Present Value (NPV), Internal Rate of Return (IRR), Payback Period.
• Example: A Nepalese tea factory must choose between:
  • Option A: Buy a ₹10M machine with 5-year lifespan, saving ₹3M/year in labor costs.
  • Option B: Renovate existing equipment for ₹4M, saving ₹1.5M/year. Which is better? (Use NPV to compare.)

B. Financing Decisions

• Deciding how to raise funds (debt vs. equity).
• Sources:
  • Debt: Loans from banks (e.g., NMB Bank), bonds.
  • Equity: Selling shares (e.g., NEPSE-listed companies like Nabil Bank).
• Trade-off: Debt increases risk but may lower taxes (interest is tax-deductible).

C. Dividend Decisions

• Deciding how much profit to distribute to shareholders vs. reinvest.
• Factors:
  • Company’s growth needs (e.g., Pathao reinvests profits to expand ride-hailing).
  • Shareholder expectations (e.g., mature companies like NTC pay higher dividends).

5. Finance in the Real World

Example 1: eSewa (Digital Payments)

• Idea Used: Liquidity Management eSewa must ensure it has enough cash to:
  • Pay merchants (e.g., ₹500M/day for utility bills).
  • Cover fraud losses (e.g., ₹10M/year in chargebacks).
  • How? It partners with banks (e.g., Standard Chartered) for instant fund transfers and maintains a ₹2B cash reserve for emergencies.

Example 2: Daraz (E-Commerce Logistics)

• Idea Used: Capital Budgeting Daraz’s decision to build ₹500M warehouses in Kathmandu and Pokhara was analyzed using:
  • NPV: Expected ₹800M savings in shipping costs over 10 years.
  • IRR: 22% return (higher than the 15% cost of capital).
  • Result: Faster delivery (1-day in Kathmandu) and lower costs.

Example 3: NTC (Telecom Infrastructure)

• Idea Used: Financing Decisions NTC raised ₹20B for its 4G expansion via:
  • Debt (60%): Loans from Asian Development Bank (ADB) at 7% interest.
  • Equity (40%): Government infusion + IPO (though NTC is state-owned).
  • Why? Debt was cheaper than issuing new shares, and the government guaranteed repayment.

6. The Financial Cycle (How Money Flows)

flowchart TD
  A["Sources of Funds"] --> B["Investment in Assets"]
  B --> C["Operations: Generate Revenue"]
  C --> D["Expenses: Cost of Goods Sold"]
  D --> E["Taxes & Dividends"]
  E --> F["Reinvest or Return to Shareholders"]
  F -->|"Reinvest"| B
  F -->|"Dividends"| A
  A -->|"New Equity/Debt"| B

Trace Example: A Kathmandu Restaurant

7. Finance vs. Accounting: Key Differences

8. Common Financial Mistakes in Nepal

1. Over-Reliance on Debt:

   • Problem: Many small businesses (e.g., tailors in Thapathali) take loans for working capital but fail to repay due to cash flow gaps.
   • Solution: Use the 50% rule—never borrow more than 50% of projected annual revenue.

2. Ignoring Liquidity:

   • Problem: A Pokhara hotel may invest all profits in renovations but run out of cash to pay suppliers.
   • Solution: Maintain a 3-month emergency fund (e.g., ₹300,000 for a ₹1M/month business).

3. Poor Dividend Policy:

   • Problem: Startups like F1Soft (gaming) reinvest everything, angering early investors who expected returns.
   • Solution: Pay stable dividends (e.g., 30% of profits) to retain investor trust.

Exam Tip

1. Definitions: Always define finance as "the management of money to achieve organizational goals." Avoid vague answers like "handling money."
2. Goals: Memorize the three primary goals (profitability, liquidity, efficiency) and give one real-world example for each (e.g., NTC’s liquidity vs. a local shop’s efficiency).
3. Functions: Link each function to a Nepali business:
   • Investment: "How would you decide whether to expand a Daraz warehouse?"
   • Financing: "Why did Khalti partner with banks instead of issuing bonds?"
4. Diagrams: Draw the financial cycle in exams—examiners love flowcharts!
5. Numerical Questions: Practice NPV/IRR calculations using Nepali currency (e.g., a ₹5M project with ₹1.5M annual cash flows).

Key Formula to Remember: $$\text{NPV}=\sum \frac{{\text{Cash Flow}}_t}{(1+r{)}^t}-\text{Initial Investment}$$ (Where $r$ = discount rate, e.g., 12% for high-risk projects.)