Finance is described as ‘the application of economic principles to decision-making that involves the allocation of money under condiditons of uncertainty’ (Fabozzi & Drake, 2009). In principal it is the management of money and assets. Finance can be broken down into different sub-categories; personal finance, public finance, private finance and corporate finance. Private finance refers to an individual or familys’s management of assets and wealth, and their ability to apply the principles of finance in their decision-making. This includes the means by which an individual or family is able to budget, save and spend their monetary wealth. In that, they must also take into account life events in the future and any variables that may pose a financial risk. Public finance is the State’s management of income and expenditure. Essentially it is the governments collection of funds and then the allocation of these funds within government branches. For example, health care or infrustructure. Private finance is an alternative method for organisations to raise cash and limit monetary shortfalls. Often this is applicable to organisations that are not listed on such markets/securities exchange where they are able to seek financing. Corporate finance specifically refers to finance activities of a corporation. A particular department is designed to oversee the financial activities. The main objective is to implement strategies that maximise shareholder value through financial planning, both in the short and long term. It is important to define short-term and long-term finance. Short-term finance refers to what is needed in the day-to-day activities to run an organisation. This period can run up to 3 years. For this purpose, understanding cashflow is vital. Cashflow is the inflow and outflow of money in an organisation. This includes the money received and paid out by a business. Long-term finance usually exceeds a period of 10 years and involves securing resources for long-term growth. In order to do this an organisation needs to consider raising finances either through borrowing (through a loan) or issuing shares. The financial system is a means by which investors are enabled to invest/transfer their funds into entities that require investment. Finance helps set the framework required for how those funds are obtained and furthermore invested. Moreover, the financial system is the platform in order to transfer those funds between entities. Individuals, business and governments use these financial instruments to enable investors to allocate funds. Fabozzi and Drake (2009) provide three components within their framework. These main areas are as follows:
This area of finance focuses on the study of the financial system, the structure of interest rates, and the pricing of risky assets (Fabozzi and Drake, 2009). Firstly, the financial systems can be broken down into three primary components – these include financial markets, financial intermediaries, and regulators of financial activities. Financial markets are markets where financial instruments are exchanged or traded. Financial instruments are defined as intangible assets; these are assets that represent a legal claim to some future economic benefits (Fabozzi and Drake, 2009). Financial markets allow for buyers and sellers in a financial market to determine the market price of a traded asset. It is also a more efficient way for investors to trade assets as it reduces the cost of transacting. Financial intermediaries are a special type of financial entity that make it more difficult for lenders or investors of funds to deal directly with borrowers of funds in financial markets (Fabozzi and Drake, 2009). These include entities such as insurance companies, investment banks and depository institutions. Their role is to create more favourable terms when transacting than if traders were dealing directly with each others. Governments understand the significant role of having a strong financial system. Therefore regulating various aspects of the financial system is important. However, the degree of regulation varies from country to country.
Financial management involves the decision-making process of investing and financing. Investing decisions refer to the use of funds whereas the financing decisions involve the day-to-day acquisition of funds. It is important note that financial decisions can involve both investing and financing. “Financial managers assess the potential risks and rewards associated with investment and financing decisions through the application of financial analysis” (Fabozzi and Drake, 2009).
Fabozzi and Drake (2009) define the investment management process as involving the following five steps: