What Is Finance?

Finance is the study of how individuals, institutions, governments, and businesses acquire, spend, and manage money and other financial assets. Understanding finance is important for all students, regardless of discipline or field of study, because almost all business and economic decisions have financial implications.

Choosing to spend or consume money now (for new clothes or dinner at a fancy restaurant) rather than save or invest (to spend or consume more in the future) is an everyday decision we all must make.

The financial environment includes the financial system, intermediary institutions (we will use these terms interchangeably in this text), financial markets, firms, individuals, and global interactions that contribute to an efficiently functioning economy.

Within the financial environment, there are three areas of finance – institutions and markets, investment, and financial management. Note that while we distinguish three distinct areas of finance, these areas do not function in isolation from each other, but rather interact or influence each other.

Financial institutions are organizations or intermediaries that help the financial system function efficiently and transfer funds from savers and investors to individuals, businesses, and governments that want to spend those funds or invest them in physical assets (stocks, buildings, and equipment). Financial markets are physical locations or electronic forums that facilitate the flow of funds between investors, businesses, and governments.

Investments include the sale or marketing of securities, the analysis of securities, and the management of investment risk through portfolio diversification. Financial management includes financial planning, asset management, and fundraising decisions to enhance the value of businesses.

Finance has its origins in economics and accounting. Economists use supply and demand to explain how the prices and quantities of goods and services are determined in a market system.

Accountants keep records of ownership of financial instruments used to flow funds between savers and borrowers. Accountants also record the income, expenses, and profitability of organizations that produce and exchange goods and services.

Efficient production methods and labor specialization are only possible if there is an effective means of paying for raw materials and finished products. Companies can obtain the money they need to purchase capital goods such as machinery and equipment only if there is a mechanism that makes savings available for investment.

Similarly, state and other governmental units, such as state and local governments and taxing districts, can only carry out their many activities if there are efficient means of raising money, making payments, and borrowing.

Financial institutions, financial markets, investment, and financial management are critical elements of the financial environment and well-developed financial systems. Financial institutions are intermediaries such as banks, insurance companies, and investment companies that conduct financial activities to support the flow of money from savers to borrowers or investors.

Financial markets provide the mechanism for allocating financial resources or funds from savers to borrowers. Individuals make decisions as investors and financial managers. Investors include savers and lenders as well as equity investors.

Investment management involves decisions related to issuing and investing in stocks and bonds. Financial management in business involves making decisions about the efficient use of financial resources in the production and sale of goods and services.

The goal of the financial manager in a for-profit business should be to maximize the wealth of the owners. This is achieved through effective financial planning and analysis, asset management, and the raising of financial capital.

Financial managers in nonprofit organizations aim to provide a desired level of service at an acceptable cost and perform the same financial management functions as their for-profit counterparts.

Successful organizations typically go through a series of lifecycle stages – from idea to exit. More specifically, a successful business typically goes through five phases: Development, Startup, Survival, Rapid Growth, and Maturity.

People who decide to start a small business do so for a variety of reasons. Some small business owners focus on the opportunity to replace their salary, meaning they seek an income comparable to what they could have earned in much larger companies.

Others strive to have a small business that fits their lifestyle and where they get paid for doing something they love to do. Entrepreneurs strive to own and run businesses that have high growth rates in sales, profits, and cash flow.

Entrepreneurial Finance addresses how early-stage (development to rapid growth) growth and performance-oriented companies raise financial capital and manage their businesses and assets.

Personal Finance addresses how to prepare for financial emergencies, protect against premature death and loss of property, and accumulate wealth over time.

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