The basic financial concepts are related to the types of business in the country and the management of the company, finance, operations, and other financial and legal aspects of the business.

One must be familiar with basic financial concepts to have an advance knowledge of the finance to analyze the business model and the performance of the company.

a.

The primary goal of the firm is to maximize the wealth of shareholders. The shareholders' wealth is the total number of shares outstanding multiplied by the market value of the common stock. The price of the common stock is affected by all the financial decision of the firm. The excellent decision push up the prices and wrong decision forces the price to come down. Secondly, if the wealth of the shareholders is to maximize, then it provides gain to the whole society. Hence, the primary goal of the firm is to maximize the shareholders' value.

b.

Risk-return trade-off means that there is an inverse relationship between risk and return. The return on investments increases with the increase in risk associated with it. The investors are paid off tor taking more risk and thus get a higher return. Therefore, in the long run, the return on stocks is higher than the return on bonds. In the short run, the return on stocks may be less or even negative, but in the long run, the return on stocks is higher while the return on the bond is stable but lower.

c.

The value of the business is determined by cash flows not by profit because it is cash flows which can be spent and not profits. The profit of the company may be higher, but that includes the non-cash profits which cannot be spent. This is always Incremental cash flows which nave to be looked at The incremental cash flow is the cash available with or without making Investments.

d.

The market in which all the information available is correctly reflected in the price of the

assets traded is known as an efficient market. The firms usually rely on the stocks and bonds market to raise money. If the markets are efficient, then all the released information will be correctly reflected in the stock prices of the company, and it will be beneficial for the firm.

e.

The conflict of the interest between firm stockholders and managers is known as an agency problem. Managers are the agents of the stockholders, and if the agents do not act for the interest of the principal, this leads to the agency problem. The leading cause of agency problem is the separation of

management and ownership of the firm. In some situations, it may happen that taking some decision may be beneficial for the management, but it may lead to losses for stockholders. The agency problem can be solved by aligning the interest of shareholders and managers.

f.

Ethics are an essential ingredient of everything we do in life. Without ethics, nothing can work. The business involves dealing with one other. It is important to behave ethically and trust others to run a successful business. Therefore, ethics are an essential part of the business.

g.

Sole proprietorship

Any business owned by an individual is known as a sole proprietorship. The sole proprietor is responsible for all the liabilities without any limitation arising out of business. The title of the assets owned by the owner and he also entitled to profits.

Partnership

The association of two or more persons who run the business in order to earn a profit is known as partnership. This is similar to a sole proprietorship except partnership has more than one owner.

Corporation

A corporation is a legal entity and is separate from its owners. The ownership and management are separated to preserve the interest of the firm.

 

Business organisation

A business organization is an entity which is formed to carry commercial activities. The business organization carries out a business to earn normal profits in the short run and supernormal profits in the long run.