The Definition, Types and Importance of Finance

The Definition, Types and Importance of Finance

What is Finance?

Finance is defined as the management of money and includes activities like investing, borrowing, lending, budgeting, saving, and forecasting. There are three main types of finance: (1) personal, (2) corporate, and (3) public/government. This guide will unpack the question: what is finance?

Finance Examples

The easiest way to define finance is by providing examples of the activities it includes. There are many different career paths and jobs that perform a wide range of finance activities. Below is a list of the most common examples:

  • Investing personal money in stocks, bonds, or guaranteed investment certificates (GICs)
  • Borrowing money from institutional investors by issuing bonds on behalf of a public company
  • Lending money to people by providing them a mortgage to buy a house with
  • Using Excel spreadsheets to build a budget and financial model for a corporation
  • Saving personal money in a high-interest savings account
  • Developing a forecast for government spending and revenue collection
Finance People at Work

Finance Topics

There is a wide range of topics that people in the financial industry are concerned with. Below is a list of some of the most common topics you should expect to encounter in the industry.

  • Interest rates and spreads
  • Yield (coupon payments, dividends)
  • Financial statements (balance sheet, income statement, cash flow statement)
  • Cash flow (free cash flow, other types of cash flow)
  • Profit (net income)
  • Cost of capital (WACC)
  • Rates of return (IRR, ROI, ROA)
  • Dividends and return of capital
  • Shareholders
  • Creating value
  • Risk and return
  • Behavioral finance

Sources of Financial Information

To learn more about the industry, here are some of the most popular and helpful resources:

  • Google Finance (market data, stock prices, news, etc.)
  • The SEC website (company filings)
  • Bloomberg news (company and industry news)

Finance Careers

A definition of finance would not be complete without exploring the career options associated with the industry. Below are some of the most popular career paths:

  • Commercial banking
  • Personal banking (or private banking)
  • Investment banking
  • Wealth management
  • Corporate finance
  • Mortgages / lending
  • Accounting
  • Financial planning
  • Treasury
  • Audit
  • Equity research
  • Insurance

The Finance Function is a part of financial management. Financial Management is the activity concerned with the control and planning of financial resources.

In business, the finance function involves the acquiring and utilization of funds necessary for efficient operations. Finance is the lifeblood of business without it things wouldn’t run smoothly. It is the source to run any organization, it provides the money, it acquires the money.

Read Also: Definition, Types and Importance of a Business

The Finance function has been classified into three:

  • Long-Term Finance– This includes finance of investment 3 years or more. Sources of long-term finance include owner capital, share capital, long-term loans, debentures, internal funds and so on.
  • Medium Term Finance– This is financing done between 1 to 3 years, this can be sourced from bank loans and financial institutions.
  • Short Term Finance – This is finance needed below one year. Funds may be acquired from bank overdrafts, commercial paper, advances from customers, trade credit etc.

Objectives of Finance Functions

  • Investment Decisions– This is where the finance manager decides where to put the company funds. Investment decisions relating to the management of working capital, capital budgeting decisions, management of mergers, buying or leasing of assets. Investment decisions should create revenue, profits and save costs.
  • Financing Decisions– Here a company decides where to raise funds from. They are two main sources to consider mainly equity and borrowed. From the two a decision on the appropriate mix of short and long-term financing should be made. The sources of financing best at a given time should also be agreed upon.
  • Dividend Decisions– These are decisions as to how much, how frequent and in what form to return cash to owners. A balance between profits retained and the amount paid out as dividends should be decided here.
  • Liquidity Decisions– Liquidity means that a firm has enough money to pay its bills when they are due and have sufficient cash reserves to meet unforeseen emergencies. This decision involves the management of the current assets so you don’t become insolvent or fail to make payments.

Why a Business Needs The Finance Functions

  • Helps Establish a Business– Without money, you cannot get labor, land and so on with the finance function you can determine what is required to start your business and plan for it.
  • Helps Run a Business– To remain in business you must cater to the day to day operating costs such as paying salaries, buying stationery, raw material, the finance function ensures you always have adequate funds to cater to this.
  • To Expand, Modernize, Diversify– A business needs to grow otherwise it may become redundant in no time. With the finance function, you can determine and acquire the funds required to do so.
  • Purchase Assets-You need money to purchase assets. This can be tangible assets like furniture, buildings or intangible like trademarks, patents, etc. to get this you need finances.

Importance of Finance Functions

  • Identify Need of Finance-To starts a business you need to know how much is required to open it. So, the finance function helps you know how much the initial capital is, how much of it you have and how much you need to raise.
  • Identify Sources of Finance-Once you know what needs to be raised you look at areas you can raise these funds from. You can borrow or get from various shareholders.
  • Comparison of Various Sources of Finance– After identifying various fund sources compare the cost and risk involved. Then choose the best source of financing that suits your business needs.
  • Investment-Once the funds are raised it is time to invest them. Investment decisions should be done in a manner that a business gets higher returns. Cost of funds procurement should be lower than the return on investment, this will show a wise investment was made.

The Finance Function Involves

  • Ensure enough funds at a reasonable cost.
  • Ensure the safety of funds.
  • Ensure efficient effective and profitable utilization of funds.
  • Ensure that finance funds don’t remain idle.

Reference

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