What is Personal Finance?

Personal finance is the process of planning and managing personal financial activities such
as income generation, saving, protection, spending, and, investing.

What is Corporate Finance? (Managerial finance)

Corporate finance focuses on decisions relating how much and what types of assets to acquire,
how to raise the capital needed to purchase assets and how to run firm so as to maximize its
value.

What is Public Finance?

(Government Finance)
Public finance is the management of a country’s revenue, expenditures, and debt load through
various government and quasi-government institutions.

6 Core Principles of Finance You Should Know [2020]

Principles of Finance

Financing is the process of collecting funds to invest to ensures proper utilization. Proper
financing required to follow 6 core principles of finance to ensure the maximization of benefit.
Briefly, finance is the management of funds. The person who is responsible for managing the
fund is well known as financial managers.

Principles act as a guideline for the investment and financing decision. Financial managers take
operating, investment and financing decisions, some of this related to the short term and some
long term. The 6 Principles of Finance everyone should Know whether it is for individuals or
organizations.
There are six core principles of finance you should know

The Principle of Risk and Return

Time Value of Money Principle

Cash Flow Principle

The Principle of Profitability and liquidity

Principles of diversity and

The Hedging Principle of Finance

Risk and Return

The principle of Risk and Return indicates that investors have to conscious of both risk and
return, because higher the risk higher the rates of return and lower the risk, lower the rates of
return. For business financing, we have to compare the return with risk. To ensure optimum
rates of return investors need to measure risk and return by both direct measurement and
relative measurement.

Time Value of Money

This principle is concerned with the value of money, that value of money is changes or
decreased when time passes. The value of dollar 1 of the present time is more than the value of
dollar 1 after some time or years. So before investing or taking funds, we have to think about
the inflation rate of the economy and the required rate of return must be more than the
inflation rate so that return can compensate for the loss incurred by the inflation.

Cash Flow

The cash flow principle mainly discusses the cash inflow and outflow, more cash inflow in the
earlier period is preferable than later cash flow by the investors. This principle also follows the
time value principle that’s why it prefers earlier more benefits rather than later years benefits.

Profitability and Liquidity

The principle of profitability and liquidity is very important from the investor’s perspective
because the investor has to ensure both profitability and liquidity. Liquidity indicates the
marketability of the investment i.e. how much easy to get cash by selling the investment. On
the other hand profitability indicates that, investors have to invest in a way that can ensure the
maximization of profit with a moderate or lower level of risk.

Diversity

This principle helps to minimize the risk by building an optimum portfolio. The idea of a
portfolio is, never put all your eggs in the same basket because if it falls then all of your eggs
will break, so put eggs by separating in a different basket so that your risk can be minimized. To
ensure this principle investors have to invest in risk-free investment and some risky investment
so that ultimately risk can be lower. Diversification of investment ensures minimization of risk.

Hedging

Hedging principle indicates us that we have to take a loan from appropriate sources, for short-
term fund requirement we have to finance from short-term sources and for long-term fund
requirement we have to manage fund from long-term sources. For fixed asset financing is to be
done from long-term sources.

Finally, if you have a basic understanding of finance and its principles then you will be able to
take financial decisions effectively. And there is a higher possibility to become financially gainer.

Written by
Md. Nahian Mahmud Shaikat
Financial Analyst
Email: [email protected]
Facebook: Nahian Mahmud Shaikat
Features of finance

Features of Finance

The main characteristics or features of finance are depicted below.

1.profitable 2.investment opportunity 3.optimal 4.system of 5.future.

Article and Image Credits © Moon Rodriguez.

1. Investment Opportunities

In Finance, Investment can be explained as a utilisation of money for profit or returns.

Investment can be done by:-

Creating physical assets with the money (such as development of land, acquiring
commercial assets, etc.),

Carrying on business activities (like manufacturing, trading, etc.), and

Acquiring financial securities (such as shares, bonds, units of mutual funds, etc.).
Investment opportunities are commitments of monetary resources at different times
with an expectation of economic returns in the future.
2. Profitable Opportunities

In Finance, Profitable opportunities are considered as an important aspiration (goal).

Profitable opportunities signify that the firm must utilize its available resources most
efficiently under the conditions of cut-throat competitive markets.

Profitable opportunities shall be a vision. It shall not result in short-term profits at the
expense of long-term gains.

For example, business carried on with non-compliance of law, unethical ways of

acquiring the business, etc., usually may result in huge short-term profits but may also
hinder the smooth possibility of long-term gains and survival of business in the future.

3. Optimal Mix of Funds

Finance is concerned with the best optimal mix of funds in order to obtain the desired
and determined results respectively.

Primarily, funds are of two types, namely,

Owned funds (Promoter Contribution, Equity shares, etc.), and

Borrowed funds (Bank Loan, Bank overdraft, Debentures, etc).

The composition of funds should be such that it shall not result in loss of profits to the
Entrepreneurs (Promoters) and must recover the cost of business units effectively and
efficiently.

4. System of Internal Controls

Finance is concerned with internal controls maintained in the organisation or workplace.

Internal controls are set of rules and regulations framed at the inception stage of the
organisation, and they are altered as per the requirement of its business.

However, these rules and regulations are monitored at various intervals to accomplish
the same which have been consistently followed.
5. Future Decision Making

Finance is concerned with the future decision of the organisation.

A "Good Finance” is an indicator of growth and good returns. This is possible only with
the good analytical decision of the organisation. However, the decision shall be framed
by giving more emphasis on the present and future perspective (economic conditions)
respectively.

Conclusion on Finance

Finance to be more precise is concerned with the management of,

Owned funds (promoter contribution),

Raised funds (equity share, preference share, etc.), and

Borrowed funds (loans, debentures, overdrafts, etc.).

At the same time, Finance also encompasses wider perspective of managing the
business generated assets and other valuables more efficiently.
Factors that affect the level and riskiness of cash flows
A primary reason that small businesses fail is insufficient capital. Although business owners can
point to difficulty obtaining a loan or falling sales in a poor economy, various other factors
influence cash flow. Reduced cash flow often is a symptom of ineffective management. Other
times it can result from neglecting to review the cash flow statement and make predictions
about cash needs. These and other factors impact both the level and riskiness of cash flows.

Cash Flow Definition

Cash flow is the movement of cash and cash equivalents into and out of your business. While
your company's income statement shows sales, expenses and profits, the cash flow statement
shows the cash flows from operating, investing and financing activities. A net loss by your
company drains cash since it means your company did not generate enough sales to cover its
costs.

Manager Decisions - Operations

Primary factors influencing cash flow are the strategic and ongoing decisions your company's
management team makes. These include operating decisions and controls, or lack thereof. For
example, a manager-driven policy requiring customers to pay within 30 days can deplete cash
flow, while a policy requiring deposits or advance payments can increase it.

Manager Decisions - Investing/Financing

Since cash flows are also investment and finance driven, decisions involving these areas impact
your firm's position. Investment decisions involve your firm’s assets. Decisions to purchase and
hold real estate or large, expensive machinery may significantly decrease your company's short
or mid-term cash flow. Investing decisions also indirectly impact cash through the financing
decisions your company makes to fund its acquisition of assets.

Riskiness of Financing/Investing Decisions

Use of equity is less risky for the company's cash but may be difficult to obtain. Using debt can
make cash flows riskier because that debt has to repaid. Significant short-term debt is riskier
than long-term debt because short-term debt requires your company to immediately obtain
cash from somewhere. Long-term debt allows your company time to consider various options.

External Environment - Markets

Your company's operating environment also plays a key role. Even with small companies,
activity in the capital markets impacts investing and financing cash flows. If lending is restricted
for public companies, it is typically more limited for smaller companies that have fewer debt
options. When large private equity firms cannot take their companies public, small firms may
be more cautious about taking investment stakes they may be unable to sell within a specified
time period.

External Environment - Industry/Economy

Industry and economic events also impact all cash flows. For example, if your company is in the
aerospace industry and that industry experiences a pronounced downturn, your sales may
decrease or your sales-related expenses may increase as it takes more effort to drive sales.
Both translate into reduced operational cash flows. If customers are failing, then the risk
increases. If your municipality goes bankrupt, an economic event, all your company's cash flows
could be impacted.

Financial managers typically do the following : -

Prepare financial statements, business activity reports, and forecasts

Monitor financial details to ensure that legal requirements are met

Supervise employees who do financial reporting and budgeting

Review company financial reports and seek ways to reduce costs

Analyze market trends to find opportunities for expansion or for acquiring other companies

Help management make financial decisions

When a principal hires an agent to carry out specific tasks, the hiring is termed a "principal-
agent relationship," or simply an "agency relationship." When a conflict of interest between
the needs of the principal and those of the agent arises, the conflict is called an "agency
problem." In financial markets, agency problems occur between the stockholders (principal)
and corporate managers (agents). While the stockholders call on the managers to take care of
the company, the managers may look to their own needs first.
Profit maximization : The main objective of financial management is profit maximization. The
finance manager tries to earn maximum profits for the company in the short-term and the long-
term. He cannot guarantee profits in the long term because of business uncertainties. However,
a company can earn maximum profits even in the long-term, if:-

The Finance manager takes proper financial decisions.

He uses the finance of the company properly.

Wealth maximization : Wealth maximization (shareholders' value maximization) is also a main

objective of financial management. Wealth maximization means to earn maximum wealth for
the shareholders. So, the finance manager tries to give a maximum dividend to the
shareholders. He also tries to increase the market value of the shares. The market value of the
shares is directly related to the performance of the company. Better the performance, higher is
the market value of shares and vice-versa. So, the finance manager must try to maximise
shareholder's value.
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Proper estimation of total financial requirements : Proper estimation of total financial
requirements is a very important objective of financial management. The finance manager must
estimate the total financial requirements of the company. He must find out how much finance
is required to start and run the company. He must find out the fixed capital and working capital
requirements of the company. His estimation must be correct. If not, there will be shortage or
surplus of finance. Estimating the financial requirements is a very difficult job. The finance
manager must consider many factors, such as the type of technology used by company, number
of employees employed, scale of operations, legal requirements, etc.

Proper mobilisation : Mobilisation (collection) of finance is an important objective of financial

management. After estimating the financial requirements, the finance manager must decide
about the sources of finance. He can collect finance from many sources such as shares,
debentures, bank loans, etc. There must be a proper balance between owned finance and
borrowed finance. The company must borrow money at a low rate of interest.

Proper utilisation of finance : Proper utilisation of finance is an important objective of financial

management. The finance manager must make optimum utilisation of finance. He must use the
finance profitable. He must not waste the finance of the company. He must not invest the
company's finance in unprofitable projects. He must not block the company's finance in
inventories. He must have a short credit period.

Maintaining proper cash flow : Maintaining proper cash flow is a short-term objective of
financial management. The company must have a proper cash flow to pay the day-to-day
expenses such as purchase of raw materials, payment of wages and salaries, rent, electricity
bills, etc. If the company has a good cash flow, it can take advantage of many opportunities
such as getting cash discounts on purchases, large-scale purchasing, giving credit to customers,
etc. A healthy cash flow improves the chances of survival and success of the company.

Survival of company : Survival is the most important objective of financial management. The
company must survive in this competitive business world. The finance manager must be very
careful while making financial decisions. One wrong decision can make the company sick, and it
will close down.

Creating reserves : One of the objectives of financial management is to create reserves. The
company must not distribute the full profit as a dividend to the shareholders. It must keep a
part of it profit as reserves. Reserves can be used for future growth and expansion. It can also
be used to face contingencies in the future.

Proper coordination : Financial management must try to have proper coordination between
the finance department and other departments of the company.

Create goodwill : Financial management must try to create goodwill for the company. It must
improve the image and reputation of the company. Goodwill helps the company to survive in
the short-term and succeed in the long-term. It also helps the company during bad times.

Increase efficiency : Financial management also tries to increase the efficiency of all the
departments of the company. Proper distribution of finance to all the departments will increase
the efficiency of the entire company.

Financial discipline : Financial management also tries to create a financial discipline. Financial
discipline means:-

To invest finance only in productive areas. This will bring high returns (profits) to the company.

To avoid wastage and misuse of finance.

Reduce cost of capital : Financial management tries to reduce the cost of capital. That is, it tries
to borrow money at a low rate of interest. The finance manager must plan the capital structure
in such a way that the cost of capital it minimised.

Reduce operating risks : Financial management also tries to reduce the operating risks. There
are many risks and uncertainties in a business. The finance manager must take steps to reduce
these risks. He must avoid high-risk projects. He must also take proper insurance.
Prepare capital structure : Financial management also prepares the capital structure. It decides
the ratio between owned finance and borrowed finance. It brings a proper balance between
the different sources of. capital. This balance is necessary for liquidity, economy, flexibility and
stability.