Overview Finance

Finance studies and addresses the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects. The term "finance" may thus incorporate any of the following:

• The study of money and other assets;
• The management and control of those assets;
• Profiling and managing project risks;
• The science of managing money;
• As a verb, "to finance" is to provide funds for business or for an individual's large purchases (car, home, etc.).

The activity of finance is the application of a set of techniques that individuals and organizations (entities) use to manage their money, particularly the differences between income and expenditure and the risks of their investments.

An income that exceeds its 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 in a process called "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, 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.

Capital

Capital is the money which gives the business the power to buy goods to be used in the production of other goods or the offering of a service.

Sources of capital

Capital market

• Long-term funds are bought and sold:
  • Shares
  • Debentures
  • Long-term loans, often with a mortgage bond as security
  • Reserve funds
  • Euro Bonds

Money market

• Financial institutions can use short-term savings to lend out in the form of short-term loans:
  • Credit on open account
  • Bank overdraft
  • Short-term loans
  • Bills of exchange
  • Factoring of debtors

Borrowed capital

This is capital which the business borrows from institutions or people, and includes debentures:

• Redeemable debentures
• Irredeemable debentures
• Debentures to bearer
• Hardcore debentures

Own capital

This is capital that owners of a business (shareholders and partners, for example) provide:

• Preference shares:
  • Ordinary preference shares
  • Cumulative preference shares
  • Participating preference shares
• Ordinary shares
• Bonus shares
• Founders' shares

Differences between shares and debentures

• Shareholders are effectively owners; debenture-holders are creditors.
• Shareholders may vote at AGMs and be elected as directors; debenture-holders may not vote at AGMs or be elected as directors.
• Shareholders receive profit in the form of dividends; debenture-holders receive a fixed rate of interest.
• If there is no profit, the shareholder does not receive a dividend; interest is paid to debenture-holders regardless of whether or not a profit has been made.

Fixed capital

This is money which is used to purchase assets that will remain permanently in the business and help it to make a profit.

Factors determining fixed capital requirements

• Nature of business
• Size of business
• Stage of development
• Capital invested by the owners

Working capital

This is money which is used to buy stock, pay expenses and finance credit.

Factors determining working capital requirements

• Size of business
• Stage of development
• Time of production
• Rate of stock turnover
• Buying and selling terms
• Seasonal consumption
• Seasonal production

The desirability of budgeting

Capital budget

This concerns fixed asset requirements for the next five years and how these will be financed.

Cash budget

Working capital requirements of a business should be monitored at all times to ensure that there are sufficient funds available to meet short-term expenses.

Management of current assets

Credit policy

Credit gives the customer the opportunity to buy goods and services, and pay for them at a later date.

Advantages of credit trade

• Usually results in more customers than cash trade
• Can charge more for goods to cover the risk of bad debt
• Gain goodwill and loyalty of customers
• People can buy goods and pay for them at a later date.
• Farmers can buy seeds and implements, and pay for them only after the harvest.
• Stimulates agricultural and industrial production and commerce.

Disadvantages of credit trade

• Risk of bad debt
• High administration expenses
• People can buy more than they can afford.
• More working capital needed

Forms of credit

• Suppliers credit:
  • Credit on ordinary open account
  • Instalment sales
  • Bills of exchange
  • Credit cards
• Contractor's credit
• Factoring of debtors

Factors which influence credit conditions

• Nature of the business's activities
• Financial position
• Product durability
• Length of production process
• Competition and competitors' credit conditions
• Country's economic position
• Conditions at financial institutions
• Discount for early payment
• Debtor's type of business and financial position