What is Finance

Posted on November 26, 2009 | What at mybiginfo.com | What is Finance | | View all What | |

We all have a general idea of what Finance is, but to make sure we are on the same page, let’s let others define Finance for us.

Webster’s New World dictionary defines it as

(1.) money resources, income, etc
(2.) the science of managing money.

Used in this context it is a noun.  It can also be used as a verb in which case it is to supply or get money for a project.

Finance is the set of activities dealing with the management of funds. More specifically, it is the decision of collection and use of funds. It is a branch of economics that studies the management of money and other assets.

Finance is also the science and art of determining if the funds of an organization are being used properly. Through financial analysis, companies and businesses can take decisions and corrective actions towards the sources of income and the expenses and investments that need to be made in order to stay competitive.

Of these there is also a definition as the management of money.  Finance is the most encompassing of all business enterprises.  To understand finance you must know about the entire business, indeed the entire economy.  So for a few minutes lets step back and pretend that we never took economics and are new to this earth.

The Financial system (or the economy, your choice) is composed of consumers, manufacturers, distributors.  These groups need money to purchase products and services. One way of looking at Finance is that it is getting the money to purchase these goods and services.

Many economists assume that households have excess money and corporations need money.   (This is obviously a gross simplification.  At any given point some individuals have excess money to invest where others need to borrow.  The same is true for corporations and other organizations, but the simplified model makes things easier for the moment.)

The purpose of the Financial System is to make sure that the money flows to those who value it the highest (that is those who can put it to the “best” use).

The main techniques and sectors of the financial industry

An entity whose income exceeds their expenditure can lend or invest the excess income. On the other hand, an entity whose income is less than its expenditure can raise capital by borrowing or selling equity claims, decreasing its expenses, or increasing its income. The lender can find a borrower, a financial intermediary such as a bank, or buy notes or bonds in the bond market. The lender receives interest, the borrower pays a higher interest than the lender receives, and the financial intermediary pockets the difference.

A bank aggregates the activities of many borrowers and lenders. A bank accepts deposits from lenders, on which it pays the interest. The bank then lends these deposits to borrowers. Banks allow borrowers and lenders, of different sizes, to coordinate their activity. Banks are thus compensators of money flows in space.

A specific example of corporate finance is the sale of stock by a company to institutional investors like investment banks, who in turn generally sell it to the public. The stock gives whoever owns it part ownership in that company. If you buy one share of XYZ Inc, and they have 100 shares outstanding (held by investors), you are 1/100 owner of that company. Of course, in return for the stock, the company receives cash, which it uses to expand its business; this process is known as “equity financing”. Equity financing mixed with the sale of bonds (or any other debt financing) is called the company’s capital structure.

Finance is used by individuals (personal finance), by governments (public finance), by businesses (corporate finance), as well as by a wide variety of organizations including schools and non-profit organizations. In general, the goals of each of the above activities are achieved through the use of appropriate financial instruments and methodologies, with consideration to their institutional setting.

Finance is one of the most important aspects of business management. Without proper financial planning a new enterprise is unlikely to be successful. Managing money (a liquid asset) is essential to ensure a secure future, both for the individual and an organization.

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