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What Is Finance? Essay Example

Pages: 5

Words: 1279

Essay

Finance can have many specific definitions depending on perspective. For example, personal finance addresses the business decisions and economic situations of individuals. In an economic and business sense, however, finance refers to an economic science that emphasizes successful performance in business. In traditional economic terminology, a successful business means turning a profit and maximizing the funds of a business. Funds can be defined itself in many different ways, and can include anything from currency to stocks. The goal of finance and the study of finance are to thus make a business as profitable as possible. Finance attempts to use economic strategies and various means that are made possible through the economy and legal system to realize this goal. In the following paper, we shall present a summary of some of the key areas of finance, with the aim of providing an introductory account of this important area of economic theory and practice.

Businesses generally have the aim of achieving maximum wealth. As Groppelli and Nikbakht suggest, “no one really knows when maximum wealth is achieved, though it is assumed to be the ultimate goal of every firm.” (4) In other words, for finance it is not important to have a definition of maximum or any limits. Finance is not concerned with any ethical questions, but is rather merely concerned with the production of wealth. But what is finance’s definition of wealth? Wealth in financial terms can be understood as how much money a company or business is worth. This worth can be calculated by figuring out how many assets a company may have, which can include the value of its properties, how much money it has in its reserves, the value of its labor power etc., For finance, one of the key means to determine wealth is to look at the value of the firm’s stocks. Stocks on the stock market indicate how much a firm is valued by the financial community. For example, a company with high prices on their stocks is viewed as a successful firm. For this reason, finance can be understood as the utilization of strategies with the intent to determine how the stock value of a company can be maximized.

Current stock prices, however, are not the only indicator of the value of a company. A crucial part of the stock exchange and financial process is to look at future trends, in order to determine the future value of a stock, and thus how viable a given company may be: “stock prices capture very quickly all available information as well as the outlook for future changes in the wealth of the firm.” (Gropelli & Nikbakht, 4) In other words, to maximize wealth one must also have an eye to future performance of a given company and stock. Finance is therefore not only concerned with present situations, but must also anticipate subsequent changes that can affect wealth.

Yet finance is not only confined to the fierce arena of the stock exchange. Finance, as Erik Banks notes, is much more extensive: “The penetration of finance is so thorough that we needn’t look far to see its impact: consider that on any given day many of us are likely to be aware of economic growth, unemployment and inflation estimates….a financial transaction occurs every time we place savings into a deposit account, or…makes  a purchase with a credit card.” (4) Accordingly, finance can be understood as a giant network of interrelated economic acts, concepts and principles that happen on a daily basis, both on major and minor scales. But what differentiates finance from economics? As stated, finance tries to understand this network in order to maximize wealth. Therefore, finance studies all these details to determine how to best create profit.

This is where some of the key concepts that are a part of financial analysis come into play. Finance has to create profit, and according to Banks, this is done in three major ways: “investing, speculating, or restructuring.” (7) Investment is not only the investment in a stock exchange. Investment means what kind of resources a given company will have. For example, a company can maximize wealth through production, such as producing certain goods, commodities or services. In the production process, therefore, many investments are made, as companies must decide on resources such as “plant and equipment, technology, intellectual property, human resources, and financial assets.” (7) For example, a company invests in its workers, paying them a salary to produce goods: for the company to be successful financially, they must have a good team of workers. Furthermore, a company has to invest in material. For example, if a company makes hamburgers it has to invest in meat for the hamburgers: this can mean having a contract with, for example, a specific farm to supply the company with meat, or a company may buy its own farming facilities. Investment considers all these factors “in order to create more value.” (Banks, 7) Therefore, it looks for the best deals to make sure that maximum wealth is generated.

Speculating, according to Banks, is another key aspect of finance. Speculating generally differs from investing, as it is not related to the direct production of goods. So for example, buying meat for a hamburger company is not part of speculation in finance, but investing; speculation for this same company would mean “purchase or sale of securities, financial contracts, or select physical assets.” (7) Speculating is another way for a company to maximize wealth that is outside of the primary production goals of the company. Speculation is therefore by definition a risky aspect of financial calculation, as these are exterior ways of making money that are often hazardous.

Restructuring refers to changing the basic business operation of the company. For example, a company may decide that the maximization of wealth is best achieved through merging with another company. This restructuring looks at ways to make the business more efficient with the aim of generating a greater profit through expanding revenue or lowering the general cost of production.

Financial decisions can also be analyzed in terms of macro factors and micro factors. Macro factors refer to the broad economic picture outside of a company’s jurisdiction. For example, the state of a country’s economy can affect how the company does business. In a bad economy, a business will have to adjust accordingly to remain afloat. Micro decisions refer to financial decisions that are internal to the company itself, such as laying off workers. While the micro and the macro levels can be sometimes interrelated, they are generally considered as separate in financial theory.

Accordingly, finance is “keenly focused on risk.” (Banks, 10) Since finance is constituted by many different decision making processes in many different arenas, there is always a calculated hazard in financial analysis. One cannot know, for example, if a national economy will suddenly implode: this will be a macro factor that affects a given business. In this regard, the best type of financial analysis must take into account all these various factors, and attempt to minimize risk and maximize profit. This is where the true art of the science of finance emerges.

In essence, finance is a complicated form of economic theory because it has to deal with many factors in its analysis, while at the same time the present business and economic world is very dynamic. While the goal of finance remains consistent – that of maximizing wealth – there are many ways to either accomplish or fail at this goal. A general understanding of the basic principles of finance can nevertheless aid one in making correct decisions.

Works Cited

Banks, Erik. Finance: The Basics. New York: Taylor & Francis, 2010.

Groppelli, Angelico A. and Nikbakht, Ehsan. Finance. New York: Barron’s Educational Series, 2006.

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