You might’ve heard about the current “financial issues” faced by Turkey? Or how about the first 100 Companies listed in Forbes Magazine as they are financially strong? Or maybe your friend asked you for a loan because he’s financially low? It might appear so that finance dominates every aspect of our life is it people, companies or even countries. But the question remains, what finance really is? Simply put, finance deals with managing your resources, or otherwise your money. So, if you have just received your pocket money, then the processes of budgeting, spending and saving your money are all financial decisions. Experts term it as Personal Finance. If you run a corporation with limited capital, with just a few additions to the same processes, it becomes Corporate Finance.
While if the government starts using the same processes, which by the way they do, then its Public Finance. Hence, Finance is a field so vast that almost all aspects of our life depends on it. Therefore, it is very critical that you know the basics of finance. For human survival, you should also know how to apply these basics. And if you’re aiming at excellence, finance is the roadway to get there.
However, to fully understand what finance is, we need to find out the purpose of its appearance which we can find in our early history books going back even before the evolution of societies. From there we will gather enough knowledge that will help us distinguish the common misconception of coupling Finance with Accounting, discussing the modes of finance to enhance knowledge, highlighting career opportunities for aspiring individuals along with an overall conclusion to better answer the question “What is finance?”.
History of Finance
Finance and money have always co-existed. While money has existed in many forms, the concepts of finance have only evolved, not changed. In the earliest human civilization, traces of barter trade appear through the tallies on the stones. This helps a lot to know who got the pay and whose dues are still left. Based on these tallies, merchants used to decide how to better manage their resources by clearing their debts before giving more.
From here, we can draw two conclusions; 1) Finance is not only related to paper money but can also be among different commodities and 2) Finance has been part of the society since the very beginning. The word finance itself comes from the French language that translates into “Management of Money”. From there, the term Finance introduced in English speaking areas. The colonialism helped a lot to reach this term to all parts of the world. Today, Finance is one of the most known science field.
This does not mean however that many of the financial concepts that we apply in today’s world have been dominant since the early ages. Over the years, finance has continuously evolved and helped businesses and governments better manage their limited resources before conducting operations. Some of these notable contributions are the following.
Banks are very critical in the whole history of Finance. Either directly or indirectly, all the financial activities are linked to the banks. The first banks trace back to as old as 18th century BC with an important trace in the Roman Empire. In terms of Finance and Banks, the Roman Empire owes a lot of credit. The reason is that they had a very sound system for money dealing.
The Stock Market
Originated by Dutch East India Co. in 1602, stock market has emerged as one of the most important functions of finance. Stock market is an easier and cheaper way for companies to raise money in order to conduct their operations.
Gordon Growth Model
Another important contribution in finance is that of Myron J. Gordon who gave his model for calculating intrinsic prices of stocks in the 1960s. Today a lot of people use this model to calculate the actual prices of stocks and bonds in order to better understand their value. Since stocks not only benefit the companies but also the general public investing in those companies, therefore the Gordon Growth Model helps both businesses and investors and was an important contribution to Finance.
Finance has also been an important part of Business Activities. One of the major concerns of banks is to adequately manage their debt (Loans from banks) and equity (money generated from selling shares). For this, businesses widely use the CAPM model as it provides businesses with simple equations and helps them in solving this dilemma. This model was first presented by Harry Markowitz, James Tobin, and William Sharpe. These three pioneers were even presented with the prestigious Nobel Prize for completely revolutionizing the processes involved in Corporate Finance.
Finance & Accounting: The Great Misconception
Before answering the question “What is Finance?”, it is crucial to distinguish it from the field of Accounting as the two fields of study are often coupled together. Therefore, it is important that we draw a line clearly between the two fields before understanding what finance is.
In brief terms, accounting relates to keeping tabs on your resources, or to make it simple, money. Therefore, if you “account” for all the money that you have, spend and earned in a given period of time, then that’s Personal Accounting. Similarly, businesses try to keep track of their money outflow (Expenditures) and Inflow (Profits) through the use of different modes say Balance sheets, T-Accounts, Financial Statements, and Profit/Loss Account, then that’s Corporate Accounting. For governments, all the accounting for budget surplus/deficit, expenditures, and whatnot are all categorized as Public Accounting. Hence, when we talk about Accounting, then it simply means to “Account for” and only account for the inflow and outflow of money.
Finance, however, means to make decisions upon that information. Say, for example, a company has collected all the data regarding their inflow and outflow of money using Financial Statements, Profit /Loss Account, etc. Finance then would be to make intuitive decisions based on these tools for example; deciding whether or not to borrow more money from banks or whether or not to issue more equity. These types of decisions are what Finance Managers are responsible to do while Accounting Managers are responsible for giving that data. Hence, we can say that Finance is the next step after accounting for all the money.
To make it more simple, let’s consider in terms of Personal Finance. Say you have developed the habit of writing down all your expenditures that occur from your pocket money. In this case, there is no inflow rather just an outflow of money that you are accounting for. The writing of all these expenditures would be under the study of accounting not finance. Now let’s consider you saw a jacket while passing down the road that you just have to get, however, it will completely disrupt all your budget and you will be termed, as earlier we have discussed, the financially low friend. In this scenario, you will have limited money to occupy the expensive resource.
Under this study you will have limited amount of options; 1) Either to simply walk away from the jacket and buy it after saving, retaining in terms of business 2) Buy that jacket on credit paying after a certain period as decided by you and the shopkeeper both 3) Borrowing money from family or friends. The process of analyzing these possibilities and ultimately choosing one is what we call Finance. Because now you are not just accounting for where your money went, but involving yourself in deciding the best course of action to use your available resources and options. I’d personally borrow from mom after declaring bankruptcy. You might choose on a different path. Regardless of the path or choice you make, the decision making is the core process of Finance.
Opportunities in Finance
By now, we have spent much of our debate on what finance is. Now we’ll look at the importance of finance. There are different benefits that you can get from conducting these financial activities.
One of the most common ways of earning is through the process of investments. Investments can be of two types of short term investments and long term investments. The process of investment is different in different situations.
The safest, and most commonly used process is to invest in a bank. The reason for this is that overtime banks have gained credibility and our deemed more trustworthy than most of the other sources. Banks, then on your behalf, invest your money by processes such as stock trading, mutual funds, bonds and many more. As the banks gain profits, so do you. The benefit of investing with banks is that they have hired professionals who are there to make decisions on your behalf. Therefore, new investors are advised to use banks as their trader when they use this mode of finance.
Another option, although riskier, can be more profitable as compared to investing in banks and that is to invest directly without any intermediary. This means that now you yourself are involved in trading by purchasing of shares, bonds, ForEX, and others. This, however, is riskier for newer investors as it demands superior knowledge about current trends and information about the company. Hence, it is only recommended if you are confident about your skills to grasp the market knowledge and stay ahead. There are many ways for you to pick and choose if you want to use investments such as
- Stock Exchange
- Forex Trading
- Investment Banks
The benefits of using this opportunity are ranging from:
With investments, you don’t have to report to any office or allocate a fixed amount of time in order to make wise decisions. You can simply make decisions at the touch of a hand through a simple application and that is it
With investments, it is very easier for you to get rich quick bypassing the many barriers that you would otherwise face. This makes investment stand atop on almost all of the other sources of income.
It’s not just about money, as the company with the most lucrative stocks can also be the most profitable company. That’s why investments also broaden your vision about the business world itself helping you tackle. It incorporates the importance of global Knowledge of corporate finance.
Career in Finance
Other than that, a career in this field is another importance of Finance. In US, the annual salary of a Financial Analyst has hit around $85000 as of 2018. To reach this goal you might’ve to choose many specialized programs such as CFA, Corporate Finance etc. However, the relevance and demand for financial managers are always high and therefore, a career in finance can also be a pathway to success for you.
Finance in a Nutshell
Conclusively, we can say that a better definition of finance would not simply be the management of money rather the decisions you, businesses and government make after accounting for the money.
Now, we can confidently answer the question “What is Finance?”. Finance is ever involved in our everyday lives as most of our time is spent on careful decision making on how and where to spend our money. For businesses and government, the situation is not much different.
It is a field with a rich history as its core partner accounting throughout the human civilizations. However, it has continuously evolved thanks to the continuous contributions of different civilizations, mathematicians, and analysts. It has also been established that Finance and Accounting, although co-dependent are not to be treated as the same. This is because one deals with decision making while the other provides the necessary data for making that decision.
And lastly, we also discussed the crucial opportunities that you can acquire by making types of finance a part of your life. Then the choice is yours, whether to use the investment tool to enjoy the perks of financing while sitting at home or to go even beyond that to pursue a career in this field. The main purpose of writing this piece of writing was to help you understand what finance really is as its understanding is crucial. By now, I hope when somebody asks you the question “What is Finance?” you will be better able to answer the question and even make the questioner intrigued about the depths of Finance.