Fundamentals of Finance

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Finance is how the world works. Without it there is no trade (you can’t go into a store and buy your new toaster). It is the hidden infrastructure that allows everything to happen. Here is an analogy I really like to use when explaining a business structure and how finance fits in:

  • The arms of a business are the Production and their Employees
  • The legs of a business are Sales and Marketing
  • The head of a business is the Leadership
  • The heart of the business is Finance and Administration

Finance can be described as enriching, stimulating, essential, diverse, global and meritocratic. Using finance a company or an investor can allocate their assets over time under the conditions of certainty and uncertainty. A business needs to be always thinking about the future and using the time-value-of-money, they can predict if a dollar today is worth more or less than a dollar tomorrow, and most importantly, how much more. It is used to measure the Risk vs. Profits and gives an indication of whether the investment in the production of a product is a good one or not.

The financial sector is very large (Trillions of dollars). Within the Financial Sector you have sub-sectors :

  1. Public Finance – Deals with role of the government in the economy and is designed to maximize social benefits
    1. Used to forecast government effects on the allocation of resources
    2. Used to determine the distribution of income
    3. Microeconomics stabilization
  2. Corporate Finance – Deals with monetary decision of business enterprises with the goal of maximizing shareholder value
    1. It focuses on capital investment decisions for the long-term (which projects receive investment)
    2. It also focuses on short term decisions which deal with short-term balance of current assets and current liabilities and the management of cash, inventories and short-term borrowing and lending
    3. Investment banks are used to evaluate the company’s financial needs and raise the appropriate type of capital that best fits those needs (i.e. the valuation of Facebook before it began trading in the secondary market)
  3. Personal Finance – Deals with retirement planning, college saving, taxes, mortgages, autos, real-estate and more
    1. The focus here is on managing cash, inventories and income of individuals

Finance is everywhere, whether you like it or not. It’s used to calculate the cost of your Starbucks Mocha Frappuccino to how much taxes should the Government charge your income in order to maximize social benefits. Finance is also used to calculate the value of a corporation and if an investor is making a good bet. You can have a great idea or invent a great product to help save lives but without finance, it will not reach the mass-market where it can do good, globally.

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