Yesterday, I was watching the above video of osmannal in which he explained 10 principles of finance, all are most important. Today, I am explaining these principles in my words.
Principle of Finance 1. The risk-return trade-off
As per this principle of finance, every businessman should aware that return will only increase in trade by taking more risk. If you are not capable to take risk, you will never get higher profit or return. This principle is taken from our simple saying no pain, no gain. Actually, pain is our tolerance of higher risk. As reward, we get gain. When we understand this principle of finance, we take the help of different advance techniques of finance for creating balance between risk and return.
Principle of Finance 2. The time value of money
I already explained the time value of money in past content. In this principle of finance, we try to make you understand that only money is in the world which have large number of uses. Due to this, today received money is more valuable than next day receivable money. If anybody do not do any work but has large money, he can enjoy his life by getting interest on that money. Same money is used by bank for providing loan to the big companies and big projects.
Principle of Finance 3. Cash—Not Profits—is King
In finance, cash is king because cash is only liquid asset which can be used for buying goods, paying the expenses. Other assets needs time for converting into cash. Our profit may be in credit form because some sales are on the basis of credit without getting cash. So, if our customer will not pay us the money in future, our hand will be tight to pay our creditors. So, we see net profit in cash. For this, we make the statement of cash flow which tells us the net cash flow from operating, financial and investment activities.
Principle of Finance 4. Incremental cash flows
As per this principle of finance, finance manager will always interested to know incremental cash flows. It means to change in the cash flow due to increasing more resources for output or sales. You know when we use new resources, we need big cash for this. So, if it increase our profitability, it will surely increase our cash inflows. So, this will be the positive incremental cash flows.
Principle of Finance 5. The curse of competitive markets
Competitive markets will always curse to the businessman because everyone can enter. So, after utilization of large financial resources, businessman will get only normal profit. So, finance manager should either leave this market or make his product different from competitors. With this, company can get super profit because no one can make same product due to trade mark rights.
Principle of Finance 6. Efficient Capital Markets
Every company wants to increase its wealth. Wealth can only be increased by increasing its shares value. Now, in finance, there is the existence of efficient capital market where every information relating to share prices will be available to each shareholder. With if company is growing, all the interested investor will buy the shares at higher price. If there is lack of information who will know which company is growing. So, efficient capital market knowledge is the backbone of financial sector.
Principle of Finance 7. The Agency Problem or Management of Company Problem
As per this principle, managers should happy with company. Without this, it will be the problem for company. We know that company management is done by managers not shareholders. Managers' salary is the expense of business which reduces the shareholder's earning. But if company do not give good package, management will search new way to get money from company. Due to this, financial resources will not be utilized properly. So, company should pay good amount to managers. It is the only solution for company.
Principle of Finance 8. Taxes bias business decisions
It means, managers take decisions without seeing the effect of tax. It is biggest mistake of finance managers. Managers and govt. should do work with great co-operation. Every decision relating to investment should be done after seeing its tax effect. How much tax will be paid to govt. if any new project is taken in the hand.
Principle of Finance 9. All risk is not equal
Every finance manager should understand all risks are not equal. It means we do not invest all money in one project. We have to diversify all investment.With this, we can minimize our loss due to happening of risk.
Principle of Finance 10. Ethical Dilemmas Persist
Ethical dilemmas means the problems relating to finance. Why in finance, problems are everywhere. We have just doing right thing. What do you think? As per best judgement, you have to take decision. In finance, you have also to take best decision after analysis each and every aspect.