What is Finance?
Finance is a term describing the study and system of money, investments, and other financial instruments. Some people prefer to divide finance into three distinct categories: public finance, corporate finance, and personal finance. There is also the recently emerging area of social finance. Behavioural finance seeks to identify the cognitive (e.g. emotional, social, and psychological) reasons behind financial decisions.
Finance is a broad term that describes two related activities: the study of how money is managed and the actual process of acquiring needed funds. It encompasses the oversight, creation and study of money, banking, credit, investments, assets and liabilities that make up financial systems.
Many of the basic concepts in finance come from micro and macroeconomic theories. One of the most fundamental theories is the time value of money, which essentially states that a dollar today is worth more than a dollar in the future.
Since individuals, businesses and government entities all need funding to operate; the field is often separated into three main sub-categories: personal finance, corporate finance and public (government) finance.
“Finance is concerned with the process institutions, markets and instruments involved in the transfer of money among individuals, business and governments.”
“Finance is concerned with a decision about money or more appropriately cash flows.”
–Scott and Brigham
Types of Finances:
Corporate finance is the area of finance dealing with the sources of funding and the capital structure of corporations, the actions that managers take to increase the value of the firm to the shareholders, and the tools and analysis used to allocate financial resources. The primary goal of corporate finance is to maximize or increase shareholder value. Although it is in principle different from managerial finance which studies the financial management of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms.Correspondingly, corporate finance comprises two main sub-disciplines.
Capital budgeting and Working Capital:
Capital budgeting is concerned with the setting of criteria about which value-adding projects should receive investment funding, and whether to finance that investment with equity or debt capital.
Working capital management is the management of the company’s monetary funds that deal with the short-term operating balance of current assets and current liabilities; the focus here is on managing cash, inventories, and short-term borrowing and lending (such as the terms on credit extended to customers).
Public finance is the study of the role of the government in the economy. It is the branch of economics which assesses the government revenue and government expenditure of the public authorities and the adjustment of one or the other to achieve desirable effects and avoid undesirable ones.
The purview of public finance is considered to be threefold: Governmental effects on
- Efficient allocation of resources
- Distribution of income, and
- Macroeconomic stabilization.
Personal finance is the financial management which an individual or a family unit performs to budget, save, and spend monetary resources over time, taking into account various financial risks and future life events. When planning personal finances, the individual would consider the suitability to his or her needs of a range of banking products (checking, savings accounts, credit cards and consumer loans) or investment private equity, (stock market, bonds, mutual funds) and insurance (life insurance, health insurance, disability insurance) products or participation and monitoring of and- or employer-sponsored retirement plans, social security benefits, and income tax management.
Sources of Finance (Duration):
Businesses need finance sources to meet payroll deadlines, acquire equipment, and expand or make business acquisitions, like buying land or other businesses. The time frame can dictate which type of finance source works best for funding. Banks are an obvious choice and work well for covering many short-, medium- and long-term financial requests. However, venture capital, private funding and trade credit are also sources of business financing.
Short-term finance solutions are needed on a daily, weekly and monthly basis to pay for office supplies, rent, utilities, equipment and payroll. Credit cards and trade credit (credit established with local trades and businesses) can assist a business in managing cash flow–the use of itemised statements allow for a clear visual representation of where the cash is being spent and a single payment can be made instead of multiple payments. Many businesses arrange for short-term lines of credit with their bank, referred to as working capital, used to manage everyday business operations. Lines of credit are typically 90-day loans obtained through a commercial bank to assure that payroll and vendors are paid on time, every time.
Medium-term financing is used to fund a special business project or expansion that will increase production and revenue. Banks are a first stop when searching for this type of financing. Through letters of credit and equipment leases, banks can help with some of the financial risks involved with medium-term funding. Venture capital is also a finance source for expansion and special projects. Businesses offer venture capitalists a level of ownership in the business when they contribute funding. Another medium-term finance source is capital contributed by the existing owners—this is an additional investment the business owners make directly to the business coffers and is called owners’ equity. Owners’ equity is considered a debt owed by the business to the owners of the business.
Any financial need requiring very large amounts of cash receives long-term funding. These sources of finance are generally designed to be paid off in one or more years and not in a few months. Businesses using this type of financing do so to purchase other businesses or buildings or to invest in long-term product development. Bank loans, venture capital and private financing are sources for long-term funding. Long-term business financing can be a combination of funding sources that together cover overall costs. For example, a private finance source (such as a car manufacturer like Ford or Honda) could cover the cost of the initial purchase of fleets of vehicles needed for a business expansion. In addition, a local commercial bank loan could cover the purchase of the buildings to house the vehicles, and a line of credit could be used to cover payroll during the training of all the employees needed to run the expanded business.