Finance is the method used to manage money. The word itself indicates that there are ways of using it. It is used to make money and to buy and sell as well as save it. We use finance for all purposes like buying homes, cars, equities etc.
To manage finance effectively is to invest money with the intention of a certain return in the future with the risk of losing it.
Simply put, to manage finance effectively means to invest with the intention of creating income from the investment either in the growth of the investment itself or the appreciation of the investment which is the increase in the market value of an asset over a given period of time. There are three key points that one must consider when managing finance. These are time, money and risk.
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Time is the most important aspect of finance because time is used for everything including decision making.
Finance management deals with short term financing decisions and determining the risk associated with them. An example of a short term decision would be purchasing a car or home. If the car does not pay off in time then finance would have been bad or if the loan defaults then the owner is at high risk.
The next key point in understanding finance is money.
Money is the capacity to purchase assets or produce income out of the finance that has been invest in assets. All three points of finance are inter related and must be managed as such. All three key points of finance are equally important depending on the overall health of the economy. Some key areas of concern in management of finance include:
Investment finance involves the purchase of assets with the capital coming from various sources.
One key point to consider is the return on the investment. Some investments will create more wealth than others while others may not generate any wealth at all. An example of an investment in assets would be a firm that creates new jobs.
A major area of concern in finance is debt.
Debt refers to any financial obligation of the form such as credit cards or personal loans. In comparison to savings, debt is consider a high risk investment. The best way to manage debt is through a combination of interest rates, use of credit and effective management of debt. Public finance is essentially the non-profit sector that includes such things as schools, roads and bridges. These can be view on the macro or national level.
Lastly, analyzing investment decisions is also part of behavioral economics.
Behavioral economics is the study of why people make certain investment choices. This could include the desire for safe investments, the need for inflation protection or simply a need for financial security. The most popular behavioral economics approach is the Price Theory which postulates that consumers use money they have to buy products and services but are unaware of how the funds were spent or whether those funds were used efficiently.
Modern financial theories on finance include the theory of asset allocation.
This refers to the matching of an investor’s capital to its desired purpose. Another approach to this is through the theory of demand and supply. Investors are said to be sensitive to a rising market and are willing to pay a higher price for a stock or other asset if the supply is low. Behavioral finance theories are still being studied today by modern financial theorists as the field continues to grow.
