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Present Value, Multiple Flows

Principles of Finance

Principles act as a guideline for the investment and financing decision. Financial managers take operating, investment and financing decisions, some of this related to short term and some long term.

Before discussing principles of finance let’s have some idea about finance, is the process of collecting funds and ensures proper utilization of funds. Many people say that finance is the management of funds and those are responsible for managing this fund are financial managers.

There are six basic principles of finance, these are:

  1. Principles of risk and return
  2. Time value of money
  3. Cash flow principle
  4. Profitability and liquidity
  5. Principles of diversity
  6. Hedging principle
six principles of finance

Principles of Finance

The Principle of Risk & Return

This principle indicates that investors have to conscious both risk and return, because higher the risk higher the rates of return and lower the risk, lower the rates of return. For business financing, we have to compare the return with risk. To ensure optimum rates of return investors need to measure risk and return by both direct measurement and relative measurement.

Time Value of Money

This principle is concerned with the value of money, that value of money is decreased when time pass. The value of dollar 1 of the present time is more than the value of dollar 1 after some time or years. So before investing or taking fund, we have to think about the inflation rate of the economy and required rate of return must be more than the inflation rate so that return can compensate the loss incurred by the inflation.

Cash Flow Principle

This principle mainly talk about the cash inflow and outflow, more cash inflow in the earlier period is preferable than later cash flow by the investors. This principle also follows the time value principle that’s why it prefers earlier more benefit rather than later years benefits.