Finance

In business and economic terms, finance refers to the process of allocating money for expenses under conditions of uncertainty. Finance applies the principles of economics (the study of how people allocate scarce resources) to raising funds or capital (an individual or business's assets) in managing investments.

Individuals, businesses, and governments may not have the money they need to cover their expenses, so they may use financial services, transactions that result in the acquisition of goods. Financial services, such as savings and loans, are available through financial institutions, including banks and credit unions. Experts divide finance into three main categories: personal finance, public finance, and corporate finance.

Finance is an essential part of life. Consumers, firms, and government entities make decisions every day on how to manage money.

Background

Finance concerns how financial institutions channel money and spread risk by providing financial services. The institutions act as intermediaries, directing money from those who save to those who borrow and redistributing risk.

Financial institutions include banks—such as savings banks, investment banks, and loan institutions—and other firms, including insurance companies and credit unions.

Some types of financial services include, but are not limited to, the following:

• Savings accounts—Banks pay interest to customers who place deposits in savings accounts. In turn, the bank lends or invests that money. Banks make a profit on the difference between what they pay depositors and what they receive from borrowers.
• Loans—People or firms borrow money from financial institutions and agree to pay it back under a specific set of conditions, which include maturity, the length of the loan, and the rate of interest, a percentage the borrower pays to the lender each period.
• Insurance—Customers purchase policies from insurance companies to cover the risk of an unexpected event occurring. Covered incidents may include illnesses, vehicle accidents, house fires, or natural disasters.
• Retirement plans—Individuals who put aside money throughout their careers for their eventual retirement may prefer a higher amount of risk to ensure a higher amount of return on the money they invest.
• Securities—Institutions help borrowers raise money by selling business shares or issuing bonds. A bond is a financial instrument in which the issuer, or borrower, acknowledges a debt to the holder, or lender.

Financial services play a key role in how consumers, businesses, and public entities determine how to designate funds and pay for expenses.

Overview

Finance can be divided into three categories: personal finance, corporate finance, and public finance. Personal finance concerns the financial planning and budgeting for an individual person amid the demands of daily life. It may involve paying for large purchases, such as durable goods like a vehicle or a house, or intangible goods, like a college education. It can also refer to managing credit, paying a loan, insuring against harmful events, or saving for retirement. Personal finance also includes protecting family inheritances and dealing with the effects of taxes on income.

According to the website the Motley Fool, some of the topics in personal finance that individuals should pay careful attention to include the following:

• Credit—Significant debt accumulated on credit cards can hurt an individual's credit score. People can be rejected for additional credit opportunities and loans if they have a low credit score. Individuals should try to pay off their credit debt as soon as possible and cut down on spending.
• Insurance—People should safeguard against unexpected events by purchasing insurance policies, which will cover their expenses if an unforeseen misfortune occurs. Individuals can buy life insurance, vehicle insurance, home insurance, and disability insurance.
• Real estate—This involves the process of buying and selling property. Individuals should keep their credit scores in good standing so they can qualify for home loans and low-interest mortgages.
• Taxes—Taxpayers should offset capital gains with capital losses. After stocks appreciate, taxpayers should hold onto them for a year and pay the reduced capital gains tax rate for the long term.
• Estate planning—Individuals should protect their wealth and estates before their deaths. Such measures can include drawing up a will, establishing power of attorney, making insurance beneficiary designations, or starting a living trust.

Corporate finance refers to the decisions that businesses make involving money and the investment of resources. It focuses on the funding sources that managers use to increase the value of the business's shares. Businesses rely on capital, which refers to a firm's tangible and intangible assets. This includes physical property—such as buildings, equipment, and the land itself—as well as intellectual property, such as copyrights and patents.

Firms are always investing in capital, which generates income that the businesses can use to invest more. Capital also encompasses the sources that fund a business's assets, which includes bonds, stocks, and short-term financing. Capital budgeting is the process that firm managers use to determine whether businesses should pursue capital projects or long-term investments.

Businesses can acquire capital through two main means: equity financing and debt financing. Equity financing allows businesses to sell a stake in ownership to a shareholder, the person who buys the shares. The business raises funds without accumulating debt, which minimizes risk. Debt financing may require the business's assets to be used as collateral, or security. The debt must be repaid with the agreed-upon rate of interest.

Public finance concerns budgeting, spending, and taxing by the government. This includes all levels of government: federal, state, and local. It can also include entities like school districts and public agencies. Governments pay for their expenses through borrowing or taxation.

Economist Richard Musgrave narrowed down the government's economic activity into three categories: allocation, distribution, and stabilization. Allocation refers to the government policies that impact the quality and quantity of goods and services produced. Distribution focuses on the government decisions that affect the spread of wealth and income. Stabilization covers the government actions that influence employment, prices, and output.

Decision-making in the public sector takes political and economic consequences, such as agendas and incentives, into consideration. The process is more complex because the government's decisions affect the distribution of wealth and income among all citizens.

Finance is an inescapable part of modern life that affects decisions made by individuals, companies, and governments. In dealing with a limited amount of money, the process allows people and institutions to decide how to allocate funds and use available services to meet their goals.

Bibliography

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