A business receives funds from various sources such as investors, lenders, and past profits. These funds are used for different purposes such as buying assets for production, maintaining inventory, and keeping cash on hand.
These funds are considered static over time, but changes in the flow of funds are known as funds flow. Finance is the management of these funds, including obtaining them and using them effectively. It involves managing the actual flow of money and any claims against it.
Financial management principles come from accounting, economics, and other fields, but are applied specifically to managing money in a business context. Finance is different from both accounting and economics, although it draws from both.
Nature of Financial Management
These are the nature of financial management explained below:
Finance Differentiated form Accounting
Accounting is a methodical approach to recording, organizing, summarizing, and presenting financial data related to a companyโs transactions. Using a double-entry bookkeeping system that is widely accepted, accounting provides information on a companyโs activities.
This data may be historical, such as last yearโs balance sheet, or a projection of future operations, such as next yearโs budget. Finance utilizes the information from accounting to make decisions regarding inflows and outflows of money to help companies achieve their objectives.
Accounting involves collecting and accurately recording data, while finance is concerned with management and decision-making. Although accountants and financial managers perform different tasks, there is often overlap between the two areas.
Someone who studies accounting may start as an accountant but may eventually become a financial analyst or manager as they become more familiar with the financial issues faced by their organization. It is important to recognize the relationship between accounting and finance, as well as their differences when studying finance.
Finance Differentiated from Economics
Economics is concerned with analyzing the distribution of resources in a society. It studies transactions among people involving goods and services with or without the exchange of money. It is interested in supply and demand, costs and profits, and production and consumption.
The broad and highly developed field of economics is closely related to other social sciences, such as sociology, political science; and psychology. Economics may be, conveniently divided into two major categories:
Micro-Economics
Micro-economics is basically a. body of theory that studies the way businesses make decisions about pricing and production in different kinds of markets and under differing assumptions. Also called price theory or the theory of the firm. Micro-economics tries to explain how rational persons make business decisions.
Macro-Economics
Macroeconomics, is the study of the overall economic situation of a nation or group of nations; it attempts to relate such factors as production and consumption into a meaningful view of national economies. It uses definitions such as gross national product (GNP) to measure the level of economic activity and has developed fairly sophisticated means for forecasting the future.
The field of finance rests heavily on the work of economists and makes use of many economic tools. It begins with the theories and assumptions developed in microeconomics and attempts to apply them to explain the workings of a modern โbusiness firm.
It borrows forecasting and other models from macroeconomics and tests them against the current situation to predict the result from varying courses of action being considered by the firm. Finance is less concerned with theory than economics. Finance analyst forecasts for the individual firm; economics forecasts for the industry and the overall level of economic activity.
