In the early years of its development, ﬁnancial management was really an offshoot of accounting. Much of the early work was descriptive, and arguments were based on casual observation rather than any clear theoretical framework. However, over the years, ﬁnancial management became increasingly inﬂuenced by economic theories and the reasoning applied to particular issues has become more rigorous and analytical. Indeed, such is the inﬂuence of economic theory that modern ﬁnancial management is often viewed as a branch of applied economics.
Economic theories concerning the efﬁcient allocation of scarce resources have been taken and developed into decision-making tools for management. This development of economic theories for practical business use has usually involved taking account of both the time dimension and the risks associated with management decision making.
An investment decision, for example, must look at both the time period over which the investment extends and the degree of risk associated with the investment. This fact has led to ﬁnancial management being described as the economics of time and risk. Certainly time and risk will be recurring themes throughout this text.
Economic theories have also helped us to understand the importance of capital markets, such as stock markets and banks, to a business. Capital markets have a vital role to play in bringing together borrowers and lenders, in allowing investors to select the type of investment that best meets their risk requirements and in helping to evaluate the performance of businesses through the prices assigned to their shares.
A key idea underpinning modern ﬁnancial management is that businesses exist to make money for their owners (shareholders). To be more precise, it is assumed that the primary objective of a business is shareholder wealth maximisation. Within a market economy, shareholders provide funds to a business in the expectation that they will receive the maximum possible increase in wealth for the level of risk that must be faced. When we use the term ‘wealth’ in this context, we are referring to the market value of the ordinary shares. The market value of these shares will, in turn, reﬂect the future returns the shareholders will expect to receive over time from the shares and the level of risk involved. Note that we are concerned not with maximising shareholders’ returns over the short term, but rather with providing the highest possible returns over the long term.