You are from a non-financial background or you are an amateur wishing to understand “finance” in a simple and resourceful way. Don’t worry! We’ll take you on a joyful financial ride explaining the basics of finance to non-finance managers and other professionals.
Finance can be scary!! Because the general perception is that it’s about numbers, which it is. But saying finance and economic analysis is just about numbers is like saying driving a car is about moving around steering wheel. No its about knowing when to, changing gears, shifting speed, and knowing when to go to derby and drift. Getting Confused? Let’s simplify it for you.
What is Finance?
Finance is about cost of capital, time value, sales, return on investment, projected cash flow and budgets and monetary policy.
Sure, finance is about those things, but that is like describing bungee jumping as use of potential gravitational energy and elastic energy to negate the said gravitational force in order to release dopamine in human brain. Ah!! Getting too much over the head!! That’s how non-finance professionals might feel reading something financial.
So, when you think about what finance and economics is, it tells you the general psychology of consumption of all the people. A company’s sales tells you that that number of people prefer that product over others, which means there is something about the product that talks to people as a group and individuals.
Also go through Basic Financial Terms and Concepts to enhance your finance glossary.
What Finance tells You?
Finance also tells you:
- How much need to save today to get a certain sum for you goals?
- How valuation of something affects its price?
- How interests banks give you are basically a share from their profit?
- How to save money? How to invest it?
- How to manage your money, loans, investments, bills?
If you study the markets all over the world, you would know how people in different cultures think, what they consume during festivals and how products shape their lifestyle, etc. And, how the demand and supply influences the price of different products.
Basically, global economics and finance can tell you:
- How people get their products?
- How and how long do they use them?
- How and if they save money, motivation behind saving money?
For example, it could be for retirement or to buy the new Xbox. It tells you about consumption, in doing so it tells you about people, because consumption is like 90% of life. Rest is sleeping.
The point is finance is more than just numbers! Finance is very broad term that includes study of money, or you could say management of funds. You have simple concepts to complex but useful financial ratios and so much more to gather on finance.
Important Finance Concepts to Know
Let’s analyze some interesting concepts that could be useful to get rich and live rather comfortably, or just be woke.
Time Value of Money
You know that money has value right, in terms that money is what you ascertain to things and products. But it also has a time value. In very simple terms, cash in hand is worth more today than it would be tomorrow. There are various aspects to it, let’s understand the most simple and common ones:
- Inflation
- Cost of Capital
Even if you don’t have a financial background, you must make yourself familiar with these two concepts.
1. Inflation
You might have heard of inflation as simply price rise. Well it is that, but price rise is the end result, not the process. Inflation is basically decrease in value of money, which could be sue to several reasons like printing more currency, increase in power of foreign currency, etc.
Basically, you know how the elderly often say that when they were younger they could buy a bag a grocery item for 5 bucks or something? And, you get the same stuff for 25 bucks now. That’s due to inflation, because the purchasing power of rupee has decreased.
How does Inflation Impact you?
Think of it this way. Say a bank gives you interest rate of about 4% on savings account, but inflation is at 5%. So, you might think you’re earning interest over money deposited, but after one year, since the purchasing power decreased by 5%, you actually lost 1% of the money in terms of purchasing power. That means you can buy even less amount of stuff than even if you hadn’t deposited the money and earned interest.
Or maybe, consider this. You like pizza, and buy two pizzas for $50 only. Suppose, the inflation is at 5%. So, by the time you get to next year, you might end up paying $52.5 for the same two pizzas. This means you’re paying more amount because the currency’s value has decreased for the same level of satisfaction.
2. Cost of Capital (Cost of Money)
Money is cost, which is true in most cases. But money also has cost, get it? How?
Cost of capital is basically cost associated with money you obtain. It can be monetary, but that is not always true. Suppose you’re working professional, your cost of salary or income is your time and skills with job associated. The better you are, the higher on the pay scale you are.
But cost of capital has implications more than finance. It is by something called opportunity cost, which gives an insight to the science of decision making of people generally. Opportunity cost is basically income or revenue stream foregone from one avenue, in order to obtain revenue for the other.
Example to Explain Cost of Capital
Suppose you have a huge piece of land. You could either build a mall there, or build an apartment building. If you choose to build a mall, the income that could have come from selling of apartments if your opportunity cost.
Similarly, say you’re a freelancer. You get a huge project, but with thin deadlines so you can’t take any work for the next few months. During that time, say you get offered for a time-sensitive smaller project. If you choose to take that smaller one, your opportunity cost would be missed deadline on the bigger project, which may or may not financial implications. If you continue on the bigger project, your opportunity cost is income from the smaller project, as well as clients and connections that could have been made through that smaller project.
Cost of capital is not limited to opportunity cost. It is something that should be factored in even while investing money. Say you get an investment opportunity that would get you 10% interest annually. However, you will have to borrow money for that, and you’re paying 7% interest. So actually, you would only be making 3% on that some, which when accounted for inflation, means you’re actually losing money.
Also read details on Financial Intermediaries: Meaning, Types & Examples
Finance Simplified: Key Takeaways
Congratulations! You’re a finance Jedi now. Well not entirely. You see, the beauty of finance is it is limitless in its essence, mainly because it’s a continuous process.
We know, its tricky, the point is don’t stop you’re financial education, because there is something new every day. One day oil is expensive because there is going to be a World War 3 and the next day it is cheap because people are advised to stay at home. Ripple effects, gentle-people, ripple effects!!
So, better be financially verse and learn the basics of finance that you’ll need in achieving your long term objectives. Any other finance queries you have, feel free to ask in comments.