Finance is a broad term which can be defined in a few different ways. For one, it is referred to as the science of the management of money and other assets. It can also be said that finance is the management of banking, investments, and credit, or the monetary resources and funds of a government or corporate body. Commonly, finance refers to the supplying of funds or capital for business or other organizational needs.

What does Finance Involve?

Finance generally involves the raising of capital for funding any sort of expenditure. As it often happens, business enterprises, companies, and governments do not have adequate funds to make an investment, or for that matter, conduct their businesses. Again, there are situations where the consumers need funds for making purchases. On the other hand, the people or institutions that already have idle money lying around are on the lookout for ways to put their money to effective use so that they can earn dividends or interest from it. Finance is therefore the process which connects the ones who have money with the ones who need money. It channels the funds from savers to users in the form of credit, loans, or invested capital. A few of the agencies who are involved in this process are commercial banks, savings and loan associations, as well as non-bank organizations like credit unions and investment companies.

Finance can also be broadly categorized into Business Finance, Personal Finance, and Public Finance. To get the best results, budgeting and managing of the funds are necessary, and these are what the financial institutions are primarily concerned with. Few of the notable institutions which are involved in Private Finance are companies that deal with insurance, banking, bonds, stocks, and other securities.

Nation Stages

The emergence of nation stages throughout the world has witnessed a rise in Public Finance. The ambit of Public Finance includes the management of a country’s revenues, debts, and expenditures. Public Finance is given a lot of importance in a nation’s political and economic environment, and it receives enormous press coverage. The sources for government revenue are taxes and sales of interest-bearing bonds, public properties, and franchises. In turn, the government spends the gathered revenue in various public services such as health, education, social welfare, and repaying of national debt. Most governments also spend a large chunk of revenues to fortify the defense forces. War is yet another event which eats up large amounts of a nation’s revenue. Some of the world’s major financial institutions are the International Bank for Reconstruction and Development and the International Monetary Fund (IMF).

Financing is therefore concerned with pulling in the resources and funds from investors or creditors for a business venture. One of the chief external sources of finance is Debts, which include bank loans and bonds purchased by bondholders. The second external source is Equity, which covers stocks. As compared to bondholders and debt-creditors, equity investors take more risks, since payment is dependent on the business in which they invest. The funds are distributed to the equity investors when the management of that business decides to do so.

Business Finance

Business Finance is the wing which is associated with allocating financial resources in a manner which maximizes the profit for a business enterprise. There are three major considerations while allocating these resources, and they are Capital Budgeting, Financing, and Dividend Policy. Capital Budgeting is basically making the right choice of investment among various investment options which are available. The choice is of course determined by the Return on Investment (ROI). The Internal Rate of Return (IRR) is one of the important methods that are used to measure Return on Investment. If a situation arises where there are two or more viable investment options but they are mutually exclusive, then they are usually ranked and the option with the highest Net Present Value (NPV) will be selected. Then again, there are certain situations where the amount of funds to be invested is inadequate. It is during this time that bankers and financial advisers ensure that the business investment does not exceed the limited amount of available funds. This selection process is called Capital Rationing.

The decision pertaining to the funds which are to be distributed or returned to the investors is called Dividend Policy. The mode in which it is rendered is through common stock dividends, preferred stock dividends, or stock repurchase by the business. The objective of Dividend Policy is to retain the resources in the business and draw additional investments. Capital, on the other hand, is the aggregate financial resources which have been invested in the business. There are namely two types of Capital, and they are the Interest-Bearing Debt Funds which comprise of loans, bonds, interest-bearing payables to trade suppliers, and short-term notes, and Equity which includes common stocks, preferred stocks, and the profits that are retained by the business.

Interest Rates

The Interest Rates are determined by three important considerations which are, pure return for the investor who has provided the funds, coverage of the inflation rates to maintain the purchasing power of the proceeds from the true return, and additional return for taking of additional risks such as an equity investment in a business venture that is risky. Then again, Capital Structure represents the types of sources of capital funds that the business invests in. The company’s balance sheet is the one of the best indicators of the type of capital funds which has been used.

Usually, the total cost of capital drops as debt funds from creditors are used instead of equity funds from investors. However, the flip side is that the business becomes riskier owing to the increase in debt. This means that the business has to make a higher amount of fixed payments to the creditors. As a result, the cost of debt and equity funds is raised to a point where there is an increase in the Weighted Average Cost. Weighted Average Cost incidentally is the weighted average of the interest rates on debt for the creditors as well as the Return on Investment for the stockholders.

Acquisitions

Acquisitions are types of capital budgeting investments of a business. Simply put, they are the purchases of other businesses by a business. The effect of these purchases corresponds to that of capital investment. Before making acquisitions, businesses make use of the Price/Earnings Ratio, as Price /Earnings Ratio is ideal for making abbreviated measure of valuation. The decision of making the Acquisition falls under Capital Budgeting Decision.

Budgeting and Financial Planning

The financial analysts and managers use Budgeting and Financial Planning for forecasting future business conditions and financial results. Financial planning and budgeting is deployed in Personal Finance, Business Finance, and also Public Finance. In Corporate Finance, earnings, cash flow, and capital are projected through forecasted income statements, cash-flow statements and balance sheets, and they assist the financial managers to make a more accurate financial forecast, thereby helping the business.

International Finance

International Finance functions in more or less the same manner, except that in International Finance there are restrictions of currency and capital movements between countries and differences in currencies as well. With regards to Personal Finance, the distinguishing factor is the way some of the resources are allocated for achieving maximum consumption satisfaction at the lowest possible cost.

All in all, Finance can be regarded as the life blood of business management. If there are shortcomings in the financial planning, the business ultimately tends to suffer. Only careful handling of finances by people who have mastered the art of finance leads to the success of Personal, Corporate or Public Finance.