What is Finance? Meaning, Definition & Features of Finance
Finance is the science around the management of money. Finance encompasses banking, credit, investments, assets, and liabilities. The finance function encompasses a variety of functions, activities, and processes. Finance also consists of financial systems. Acquisition, allocation, utilization, and channelizing the funds to maximize the shareholder's wealth. Finance includes public, personal, and corporate finance.
Meaning of Finance:
As per the dictionary, meaning finance is the management of large amounts of money, especially by governments or large companies. If used as a verb it may mean providing funding for a person or an enterprise. The word has its origins to the French word finance meaning an end, settlement, or retribution and used in the context of ending or settling a debt or a dispute. The notion is of "ending" (by satisfying) something that is due. After adapting to English, the word is used to define any type of management of money.
Definitions of Finance:
Finance has been closely bound with money since it replaced barter as the means of exchange. Finance is the lifeline of all activities; economic, social, and administrative. Finance flows from the public as taxes to Government, as savings to banking and financial institutions, and as share capital or bonds or debentures to the entrepreneur. It then gets used for a variety of development and non-development activities through Government and other agencies and flows back to the public as income in various ways. Given below are some commonly understood definitions of finance:
Economics: “A branch of economics concerned with resource allocation as well as resource management, acquisition and investment. Deals with matters related to money and the markets.”
Business: Finance is “to raise money through the issuance and sale of debt and/or equity”.
Experts: “Finance is the study of how people allocate their assets over time under conditions of certainty and uncertainty. Finance aims to price assets based on their risk level, and expected rate of return.”
Scientific View: Finance is “the science that describes the management, creation, and study of money, banking, credit, investments, assets, and liabilities”.
Function View: “The finance function encompasses a variety of functions, activities, and processes. It compasses financing functions, budgetary functions, risk and return management, cash flow management, cash management, financial management, risk and governance, and many more associated functions.”
Systems View: “Finance consists of financial systems, which include the public, private and government spaces, and the study of finance and financial instruments, which can relate to countless assets and liabilities.”
Features of Finance:
Channelizing Funds:
It is a well-established fact that the financial system is a critical element of any economy. The financial sector and financial markets perform the essential function of channeling funds from people who have saved surplus funds by spending less than their income to people who have a shortage of investible funds because of their plans to spend exceed their income.
Acquisition, Allocation & Utilization of Funds:
Finance as a function deals with the acquisition, allocation, and utilization of funds. A business must ensure that adequate funds are available from the right sources at the right cost at the right time. It needs to decide the mode of raising funds, whether it is to be through the issue of securities or lending from the bank. Once funds are acquired the funds have to be allocated to various projects and services and finally, the objective of the business is to earn profits which to a very large extent depends upon how effectively and efficiently allocated funds are utilized. Proper utilization of funds is based on sound investment decisions, proper control, and asset management policies, and efficient management of working capital.
Maximization of Shareholder’s Wealth:
The objective of any business is to maximize and create wealth for the investors, which is measured by the price of the share of the company. The price of the share of any company is a function of its present and expected future earnings. Finance helps in defining policies and ways to maximize earnings.
Financial Management:
The maximization of the economic welfare of its owners is the accepted financial objective of the firm. Hence, the objectives of finance are to ensure adequate and regular supply of funds to the business and provide a fair rate of return to the suppliers of capital. Finance helps by ensuring efficient utilization of capital and available resources according to the principles of profitability, liquidity, and safety. It provides a definite system for internal investment, financing, and internal controls. And finally attempts to minimize the cost of capital by developing a sound and economical combination of corporate securities.
Categories of Finance:
Finance can be broken into three different sub-categories: public finance, corporate finance, and personal finance. All three of which would contain many sub-categories.
Public Finance:
Public Finance is a part of the study of Economics. It borders on the fields of government and political science. Public finance is the study of the financial activities of governments and public authorities. Public finance describes finance as related to sovereign states and sub-national entities (like states/provinces) and related public entities (e.g. municipal corporations) or agencies. It describes and analyses the expenditures of governments and the techniques used by governments to finance these expenditures. It is concerned with the identification of the required expenditure of a public sector entity and sources of revenue and the budgeting process. Public finance analysis helps us to understand why certain services have come to be supplied by the government, and why governments have come to rely on particular types of taxes.
Corporate Finance:
Corporate finance is the task of providing the funds for a corporation's activities by raising and administering funds. Corporate finance aims at studying the funding of assets from various sources like the market, the general public, or various financial institutions. In this process, corporate finance aims to balance risk and profitability, while attempting to maximize an entity's wealth and the value of its stock. The importance of corporate finance is underlined by economic and social significance in terms of an increase in public responsibility as the organization grows and the wide distribution of corporate ownership in the process separating ownership from management.
Personal Finance:
Personal finance refers to the financial decisions which an individual must make to plan for his future. These decisions include obtaining monetary resources, planning application of income, budgeting, deciding on amounts and mode of saving, and decisions around spending monetary resources over time. During this process, one is expected to take into account various financial risks and future life events that may impact current income levels or projected incomes and must plan for them.
Other Categories of Classification of Finance:
1. Direct & Indirect Finance:
The finance could be of two types:
Direct Finance:
In this case, the borrower directly borrow funds from the lender in the financial markets by selling them securities (also called financial instruments), which are a claim on the borrower’s future income/assets or reserves and entitle the borrower with partial ownership if the funds have been raised using equity.
Indirect Finance:
In this case, the role of channelizing the funds from the savers to borrowers is done through financial intermediaries (example commercial banks).
2. Short Term & Long Term Finance:
Money is needed to set up any kind of business. A business owner can look for the investors to invest money in the business and this money can be borrowed for short term or long term.
Long Term Finance:
Long-term finance is generally used for investment in fixed assets such as land and building, plant and machinery, etc. and is not repayable within a short period of time.
Short Term Finance:
The short term finance is used for investment in working capital. It is used to meet the short term needs of the business. It may be repayable in the short term or on-demand as in the case of a cash credit account. Short term loans are usually repayable within a period of one to three years.
3. Sources of Finance:
The sources of funds can be broadly divided into owned capital and borrowed funds.
Owned Capital:
Owned capital is the money brought in by the businessman himself and sometimes referred to as capital or equity capital.
Borrowed Capital:
Borrowed capital is the money advanced by outside agencies like banks, financial institutions, etc. generally in the form of loans.
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