Finance. We all have heard this word somewhere or another in our lives. But what exactly is finance? Is it limited to just its practitioners? Or does its implication affect all of us in one way or another? In this article, I am going to look to answer all these questions and many more.

A quick google search on the word finance tells us that “Finance is the study of money and how it is used. Specifically, it deals with the questions of how an individual, company or government acquires the money needed – called capital in the company context – and how they then spend or invest that money.”

I believe that the above definition gives an incredibly good summarized definition of the word finance. Simply put, finance deals with just three key decisions out of which two correspond to both individuals and companies whereas the third normally pertains to companies. Below, I have illustrated the three decisions with the objective of explaining each one and its implication.

Investing decisions:

Investing decision is related to the buying of assets or items with a view of earning some form of benefit from it. In personal aspects, think of this as deciding on what to buy with the money you have. It could be with a view of generating monetary return which is the case with buying shares and bond or it could even be related to buying personal assets that provide us with utility such as a car, a home or even something as trivial as a book.

So, in simple terms, we can say that investing decisions are related to decisions on how we spend our money.

Financing decisions:

We know that in order to spend money (investing decision), we first need to have money. Financing decision deals with the decision of how we source our funds for our expenses. If we think of buying a car or a house, we can think of it like this: is it better to buy a car or house with a bank loan or is it better to save up from our income and then go ahead and buy. Or is there a mix of savings and borrowings that would give us the most benefit? In terms of running a company, we must see if we should apply retained earnings for new projects or is it better to borrow funds for the project. If so, how do we raise borrowings?

So, financing decision in simple terms simply means how we source the funds for our expenditure.

Dividend decision:

This is the decision that solely relates to profit-making entities. The managers of these organizations must decide on what amount to distribute to the owners or take out of the business. This is a delicate decision because owners always look to gain the highest amount of payback from the business. At the same time, if the business decides to pay back all the profits, it may not have anything left for in house expansion and may have to rely on borrowings.

As we saw above, financial decisions are more elaborate than just yes or no decisions. It requires a clear understanding of how money works and the limits on the spending of money. So, in short, we can say that finance, in general, pertains to the obtaining, spending and distribution of funds.

I am sure now that all of us can relate to finance. We make decisions every day that even though we may not know it at first, is very much a finance-related decision. Things, like buying a book, or buying a car, deciding on whether to use cash or credit card, are all within the purview of the field of finance.

Then why is it that not a lot of people have a good grasp on the field of finance? I believe this is to do with the fact that finance is not taught as a compulsory subject unlike mathematics or physics to young children despite being totally aware of how much this field affects each one of us.

This unfortunate problem of financial illiteracy has led to unchecked and irresponsible spending among the newer generations, with concerns that many will retire with not enough in the bank. Companies have moved from traditional lifelong pension payments to one-off bullet payments at the end of the service term thereby reducing the risk to the company of the person surviving longer than expected.

In a world that is changing so rapidly, it is of utmost importance that people of all walks of life get a solid understanding of the basics of finance so as to not suffer problems like personal bankruptcy or run out of savings during retirement.

Even in companies and organizations, it is particularly important that the key decision-maker has a solid grasp of finance to make the right decisions. At the end of the day, a business only exists if it makes money and financial literacy helps to make the decision that ends up making money for the company. Financially irresponsible firms have ended up not just taking away the investor’s money but also the livelihoods of hundreds of thousands of people. Examples of such major bankruptcies are Satyam, Lehman Brothers, Bear Stearns, Enron and the most recent being the Commonwealth Trade Bank which is in liquidation at the time of writing this article.

As we can see, finance is a subject in which everyone needs to have at least a fundamental understanding as this is a field that we apply in our daily lives, knowingly or unknowingly and also has long term effects for us and our stakeholders.

Our next series of “Learn with Leap” is on the subject “Finance for non-finance professionals” and I strongly recommend you go through it on our YouTube channel. This course was designed to give everyone a very good understanding of the fundamental concepts of finance especially the ones with no prior exposure to finance and if you are already a finance professional then it can help to serve as a brush-up of concepts.