Finance

Areas of Finance-

Personal Finance:

  • How can people protect themselves and their family against unforeseen personal events such as illness, injury, property damage, long-term disability and death.
  • How can people protect themselves and their family against factors in the external economy, such as, recession, job loss, currency fluctuations?
  • How to prepare for known events such as college, retirement, vacations, etc.?
  • How can family assets best be transferred across generations (bequests and inheritance)?
  • How does tax policy (tax subsidies and/or penalties) affect personal financial decisions?
  • How does credit affect an individual’s financial standing?
  • How can one plan for a secure financial future in an environment of economic instability?

 

  • Financial position: is concerned with understanding the personal resources available by examining net worth and household cash flow. Net worth is a person’s balance sheet, calculated by adding up all assets under that person’s control, minus all liabilities of the household, at one point in time. Household cash flow totals up all the expected sources of income within a year, minus all expected expenses within the same year. From this analysis, the financial planner can determine to what degree and in what time the personal goals can be accomplished.
  1. Adequate protection: the analysis of how to protect a household from unforeseen risks. These risks can be divided into liability, property, death, disability, health and long term care. Some of these risks may be self-insurable, while most will require the purchase of an insurance contract. Determining how much insurance to get, at the most cost effective terms requires knowledge of the market for personal insurance. Business owners, professionals, athletes and entertainers require specialized insurance professionals to adequately protect themselves. Since insurance also enjoys some tax benefits, utilizing insurance investment products may be a critical piece of the overall investment planning.
  2. Tax planning: typically the income tax is the single largest expense in a household. Managing taxes is not a question of if you will pay taxes, but when and how much. Government gives many incentives in the form of tax deductions and credits, which can be used to reduce the lifetime tax burden. Most modern governments use a progressive tax. Typically, as one’s income grows, a higher marginal rate of tax must be paid. Understanding how to take advantage of the myriad tax breaks when planning one’s personal finances can make a significant impact.
  3. Investment and accumulation goals: planning how to accumulate enough money for large purchases, and life events is what most people consider to be financial planning. Major reasons to accumulate assets include, purchasing a house or car, starting a business, paying for education expenses, and saving for retirement. Achieving these goals requires projecting what they will cost, and when you need to withdraw funds. A major risk to the household in achieving their accumulation goal is the rate of price increases over time, or inflation.
    Using net present value calculators, the financial planner will suggest a combination of asset earmarking and regular savings to be invested in a variety of investments. In order to overcome the rate of inflation, the investment portfolio has to get a higher rate of return, which typically will subject the portfolio to a number of risks. Managing these portfolio risks is most often accomplished using asset allocation, which seeks to diversify investment risk and opportunity. This asset allocation will prescribe a percentage allocation to be invested in stocks, bonds, cash and alternative investments. The allocation should also take into consideration the personal risk profile of every investor, since risk attitudes vary from person to person.
  4. Retirement planning is the process of understanding how much it costs to live at retirement, and coming up with a plan to distribute assets to meet any income shortfall. Methods for retirement plan include taking advantage of government allowed structures to manage tax liability including: individual retirement plans.
  5. Estate planning involves planning for the disposition of one’s assets after death. Typically, there is a tax due to the state or federal government at your death. Avoiding these taxes means that more of your assets will be distributed to your heirs. You can leave your assets to family, friends or charitable groups.

Corporate finance

Another business decision concerning finance is investment, or portfolio – one has to decide what, how much and when to invest. To do this, a company must:

  • Identify relevant objectives and constraints: institution or individual goals, time horizon, risk aversion and tax considerations;
  • Identify the appropriate strategy: active versus passive hedging strategy
  • Measure the portfolio performance

Financial management is duplicate with the financial function of the financial accounting is more concerned with the reporting of historical financial information, while the financial decision is directed toward the future of the firm.

Financial risk management, an element of corporate finance, is the practice of creating and protecting economic value in a firm by using financial instruments to manage exposure to risk, particularly credit risk and market risk. (Other risk types include Foreign exchange, Shape, Volatility, Sector, Liquidity, Inflation risks, etc.) It focuses on when and how to hedge using financial instruments; in this sense it overlaps with financial engineering. Similar to general risk management, financial risk management requires identifying its sources, measuring it, and formulating plans to address these, and can be qualitative and quantitative. In the banking sector worldwide, the Basel Accords are generally adopted by internationally active banks for tracking, reporting and exposing operational, credit and market risks.

Financial services

A bank aggregates the activities of many borrowers and lenders. A bank accepts deposits from lenders, on which it pays interest. The bank then lends these deposits to borrowers. Banks allow borrowers and lenders, of different sizes, to coordinate their activity.

Finance is used by individuals (corporate finance) and by a wide variety of other 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 and methodologies, with consideration to their institutional setting.

Finance is one of the most important aspects of business management and includes decisions related to the use and acquisition of funds for the enterprise.

In corporate finance, a company’s capital structure is the total mix of financing methods it uses to raise funds. One method is debt financing, which includes bank loans and bond sales. Another method is equity financing – the sale of stock by a company to investors, the original shareholders of a share. Ownership of a share gives the shareholder certain contractual rights and powers, which typically include the right to receive declared dividends and to vote the proxy on important matters (e.g., board elections). The owners of both bonds and stock, may be institutional investors – financial institutions such as investment banks and pension funds  or private individuals, called private investors or retail investors.

Public finance

  • Identification of required expenditure of a public sector entity
  • Source(s) of that entity’s revenue
  • The budgeting process
  • Debt issuance (municipal bonds) for public works projects

Central banks, such as the Federal Reserve System banks in the United States and Bank of England in the United Kingdom, are strong players in public finance, acting as lenders of last resort as well as strong influences on monetary and credit conditions in the economy.

Financial Capital

The deployment of capital is decided by the budget. This may include the objective of business, targets set, and results in financial terms, e.g., the target set for sale, resulting cost, growth, required investment to achieve the planned sales, and financing source for the investment.

A budget may be long term or short term. Long term budgets have a time horizon of 5–10 years giving a vision to the company; short term is an annual budget which is drawn to control and operate in that particular year.

Budgets will include proposed fixed asset requirements and how these expenditures will be financed. Capital budgets are often adjusted annually and should be part of a longer-term Capital Improvements Plan.

A cash budget is also required. The working capital requirements of a business are monitored at all times to ensure that there are sufficient funds available to meet short-term expenses.

The cash budget is basically a detailed plan that shows all expected sources and uses of cash. The cash budget has the following six main sections:

  1. Beginning Cash Balance – contains the last period’s closing cash balance.
  2. Cash collections – includes all expected cash receipts (all sources of cash for the period considered, mainly sales)
  3. Cash disbursements – lists all planned cash outflows for the period, excluding interest payments on short-term loans, which appear in the financing section. All expenses that do not affect cash flow are excluded from this list (e.g. depreciation, amortization, etc.)
  4. Cash excess or deficiency – a function of the cash needs and cash available. Cash needs are determined by the total cash disbursements plus the minimum cash balance required by company policy. If total cash available is less than cash needs, a deficiency exists.
  5. Financing – discloses the planned borrowings and repayments, including interest.

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