What is Finance? Definition & Types of Finance
You cannot run your business effectively without knowing how finance works and having a money plan. Understanding money management helps small companies coordinate financing activities, avoid bankruptcy, limit risks, and get the most returns on different investments.
Finance is a broad subject, and it can get overwhelming along the way. To help you grasp the basics, we've covered essential information you need to know about how finance works for small businesses.
Here’s What We’ll Cover:
What is Finance?
First, small businesses need to understand that finance means more than money. While money is a legal tender used for transaction settlements, finance refers to asset allocation and management of monetary resources.
Finance cuts across multiple activities like developing a cash flow forecast for your business, keeping money in a high-interest savings account, and creating budgets and financial models.
Types of Finance
Finance is broadly categorized into:
- Personal Finance
- Public Finance
- Corporate or Business Finance
Personal finance refers to managing an individual’s monetary resources across five key areas—income, savings, investments, expenditure, and assets protection. The goal is to make intelligent investment decisions and build a safety net that sustains the individual without constraints or bad debts.
Business owners need to develop a strategic personal finance plan to protect them from unforeseen circumstances. For example, saving for your retirement helps you create adequate structures and avoid running out of money. Personal finance also cuts across generational wealth transfer, tax management and compliance, credit cards, asset management, hedge funds, and debt servicing.
Personal finance is always tailored to one's specific needs in the short, medium, or long term.
This means that two people may not have the same financial plan because of their different goals, earning potentials, incomes, and time frames. For example, paying off a loan can be your short-term goal while setting up pension funds, or a real estate investment might be another individual’s short-term priority.
Like individuals, governments need to allocate their resources to different sectors of the economy. Public finance is how federal, state, and local institutions track revenue and manage expenses for all the services they provide to the public.
One of a government's most essential functions is generating money through trade, taxes, and loans and distributing income across multiple functions like debt servicing, infrastructural development, and recurrent expenditure. By overseeing income generation and allocation, government agencies ensure a stable economy and prevent market failure.
Other aspects of public finance include tax management, debt issuance, budgeting, international trade, and inflation regulation. These factors have a direct and lasting effect on business and personal finance.
Corporate or Business Finance
Corporate finance covers all the financial activities related to running a business. You can think of this in terms of acquisitions and investments, funding, capital budgeting, risk management, and tax management needed for business growth in financial markets.
Companies need to maintain a balance between cash flow, risks and investment opportunities to increase their value and strengthen their capital structure.
A great example of corporate finance is when a business chooses between equity financing and debt financing for raising capital. Equity financing is the act of securing funding through stock exchanges and issues, while debt finance is a loan that must be repaid with interest on an agreed date.
Companies have to develop a revenue generation plan which determines business profitability in the medium and long term.
What is the Difference Between Finance And Accounting?
Accounting and finance are important to the success of any small business; however, they are not the same. The key difference between finance and accounting comes down to how they consider a company's financial records.
Accounting focuses on cash inflow and outflow, reconciling a company's financial statements and records, and managing reports. On the other hand, finance uses accounting reports and documents to develop strategies that improve growth and profitability for businesses.
Why Is Finance Important For Your Business?
- It drives strategic financial decision-making for small businesses.
- Companies depend on finance to allocate resources and manage cash flow.
- It enables businesses to define long-term goals that will allow them to grow and scale.
- Finance helps businesses to understand the time value of money.
Running any company without knowing how finance works puts a lot of things on the line.
Apart from putting your company at risk of bankruptcy, poor management of money comes with too much unpredictability that is bad for every business. The good thing is you do not need a degree in finance to understand the basics highlighted in this article and apply them to your business.
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