Key Concepts Of Finance
Kelly Greenwood (2023-11-07)
In response to Re: shtr
Finance refers to money management and involves various activities like borrowing, investing, budgeting, lending, forecasting and saving. An individual needs to understand the basic knowledge of the financial concepts so that they can make informed and better decisions. Gaining fluency in finance aids in evaluating news, understanding the trends and businesses in a better way and also helps in managing the finances personally and professionally. Some of the important concepts of finance are as follows.
Net worth - This concept explains the financial worth of the organization. It is assessed by determining the asset's value and subtracting the liabilities owned by the organisation. This concept aids in determining the health of the organisation and also explains the financial position of the company at present. It can be demonstrated positively or negatively. Positive net worth indicates that the organization has more assets and fewer liabilities, having good health while negative net worth explains more liabilities and fewer assets, facing loss.
Liquidity - It is defined as money accessibility by which assets are transformed into cash. These are of two types, market liquidity and accountability liquidity. Accounting liquidity is termed as the ability of a business or individual to meet the requirements of financial obligation when their debts are due. Market liquidity is the degree to which markets enable the buying and selling of assets at a fair price. The real state market is one of its examples. Liquidity in finance is evaluated by the current ratio, cash ratio or quick ratio.
Asset allocation and diversification - This means the categorisation of investment portfolios into several items like cash and cash equivalents, alternative assets, fixed-income investments, stocks, futures and alternative assets. And, diversification is a crucial feature of the strategy used in investment making as it helps in variegating assets into different categories of assets. This further aids in the tolerance of risk and hence enhances the overall objective of the investment.
Bear market - This is the most important concept in finance. This indicates that the market is facing a loss by showing high unemployment and lowering the prices of shares for a longer period. This offers a chance for investors to buy stocks at reduced prices so that they can hold the market without any market rebounds.
Bull market - This is another important concept of finance and this market indicates that the financial market is rising. The prices of stocks are high and there is a low unemployment level. Mainly, this represents that the market is in good condition and is healthy. When the economy is in good condition, investors often think of purchasing securities by establishing a market for buyers.
Inflation - Inflation refers to the increasing price of goods and services and also explains the fall in purchasing power of a given currency. When there is an increase in price for a given commodity, the demand for the commodity decreases. This simply means that when inflation rises, purchasing power decreases. The rate of inflation is determined by utilising the wholesale price index (WPI) and consumer price index (CPI). When there is increasing inflation, the organization as well as individuals can have benefits. This is so because it aids in increasing their asset's value.
Depreciation - Depreciation is the value reduction of a tangible asset of an organization because of obsolescence, use and wear and tear. It is significant for organizations to calculate the rate of depreciation so that they can easily understand the asset value of the company when there is a loss in property, plant and equipment. These can be analyzed by observing the costs and performances.
Risk tolerance - Risk tolerance explains the individual`s extent to which they can take risks with their decisions to make investments. It determines the comfort level of individuals during the time of economic swings like the bear market. When there is higher risk tolerance, they tend to make investments for a shorter period but when there is lower risk tolerance they tend to make investments for a longer period.
CAPM - Capital Asset Pricing Model is used by financial professionals to price investments based on the expected rate of returns. This model analyzes the association between the expected rate of return for assets and risks, for instance, stocks. This model is used by most professionals in the financial industry to analyze the investments of the organization and decide which is best to achieve the overall objective of the organization.
Amortization - It explains the debt pay-off in the businesses. This function of financial organisations aids in lowering the value of intangible assets for a longer period. Amortization schedules are utilized by lenders so that they can easily structure the loan repayments depending on the specific dates of maturity. It also enables investors and businesses to forecast the costs after specific periods and this helps in calculating the interest payments for tax.
In a nutshell, finance is the management of money which involves budgeting, borrowing, investing, lending, forecasting and saving. There are various concepts of finance. Individuals and businesses must understand these concepts of finance as this will help them make informed decisions for the business and achieve greater success in the long term.
