Introduction to Finance
Hi! Welcome. What is Finance? In this article, we are going to discuss about the definition of finance and then we will see the finance from different contexts and also we will focus on the areas of business finance and last but not least, we will try to discuss how we can we can relate the different areas of finance with the balance sheet model of a form they start the finance can be defined as the science and art of managing money in order to achieve the appropriate objective.
You can see that there are two components, two important components in the definition. One is managing money, therefore, finance involved with managing money and the other component is appropriate objective that means finance involve managing money with an appropriate objective in mind.
In this course we will discuss different aspects of managing money as well as about the appropriate objective. What should be the appropriate objective in your mind when you are managing money?
Finance – Types and Context
Finance is a wide area and it can be thought in different contexts like from personal context government context or business context from, personal context. If you think about finance it is the management of money for personal objective.
For example, if you are thinking about personal finance ,perhaps you will think about how to earn adequate amount of money how much money to spend and save. How much to borrow if necessary. How much money to invest if you have extra and if you want to increase your consumption in future where the in where to invest the money and when to invest the money. So, these are some examples of questions that you answer if you are dealing with personal finance.
Government context in the finance will be dealing with generating government revenue. For example, by deciding how much to tax public spending the amount of public, spending budgeting government depth production, distribution of public goods.
And if we think about business context of finance then it will be dealing with, for example, in what fixed assets should we invest our money, how to raise money for the investment of the business, how to manage the short-term cash flows, how much to reinvest in the business if you want to expand the business.
So, these are the different context of finance but now we are going to focus on business finance and learning about business finance can also help you to understand the finance in other contexts.
So, what are the areas of business finance?
One is capital budgeting. Capital Budgeting answers in what fixed asset and when a forum should invest the other relative related area is dividend policy when a firm makes profit. The firm will normally distribute the profit to the owners but if the firm decides to reinvest how much of the profit should be reinvested. So, if the firm reinvest the dividend will be lower.
So, these kind of decisions are the area of dividend policy then again the area of capital structure which deals with raising money. how to raise money for the investment and it also involved deciding when to raise the money and from which sources the forum should raise money. Should the firm raise money more from the owners or more from the creditors.
The other area of Finance is working capital management which is related to the management of short-term assets. More particularly short-term cash flows, so, it involved. For example, cash budgeting managing of current assets, managing up current liabilities, etc.
So, these are the areas of Finance which can be related with the balance sheet of a business organization. You know that the balance sheet of a business organization has two sides. The left-hand side contains the assets and the right-hand side contains the liabilities and owner’s equity in other words we can say that liabilities and owner’s equity x’ are the sources of fun because when you are liable to someone that means you are supposed to pay. That means you have other people’s money borrowed from them and equity is also other people’s money but it is the owners money that you have in your business. Okay! So, we can say that the right-hand side of the balance sheet actually indicate the sources of money the business organization has and the left-hand side of the balance sheet contains the assets which are essentially the uses of money because how do you use the money?
Normally you buy different types of assets. So, this type of assets are contained in the left hand side, so, a business organization can have assets only if the business organization has money in the first place then the organization can use the money to buy assets. This is why the sources of money and the users of money should be equal and this is why the left hand side and the right hand side of the balance sheets are equal.
Types of Assets
If we focus on the left hand side of the balance sheet, we have assets. Assets can be classified into two types: current asset and fixed asset.
So, the current assets are the assets having shorter lives usually less than one year. For example, cash accounts receivables and inventories the other type of asset is the fixed assets which has longer lives. For example, equipments, machineries, building patterns. These assets normally have life more than one year now if we focus on the right hand side the first thing is current liabilities which contain the liabilities of the firm that must be repaid within one year period. For example, accounts payable among the long term depths we can give example like corporate bonds or long term borrowing from the banks okay so these are the liabilities that does not have to be repaid within one year and the owner’s equity are essentially the claims of the owners. Maybe, it is their investment or maybe the profit generated from their investments. For example, common stock or retained earnings.
So, these are the components of the balance sheet and these components can also be related to different areas of finance. For example, the fixed assets are related to capital budgeting because when the firm decide in which assets which long-term assets that form should invest they actually determine the fixed asset component of the business organization. So this is related to capital budgeting.
Now, the long-term depth and owner’s equity. These part of the balance sheet is related to capital structure decision because if the firm decide how much to borrow and how much to get from the owner. That is essentially the capital structure of the firm now the remaining portion.
Current Assets and Current Liabilities
Both of these two have shorter lives. less than one year one year or less. So, the management of current assets and current liabilities, this is related to the working capital management area of business finance.
I hope that you have understood what is finance and which areas are within the scope of business finance and also how we can relate the balance sheet offer form with the areas of Finance.
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