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Areas of finance

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Personal finance

Questions in personal finance revolve around:

• How can people protect themselves against unforeseen personal events, as well as those in the external economy?
• How can family assets best be transferred across generations (bequests and inheritance)?
• How does tax policy (tax subsidies or penalties) affect personal financial decisions?
• How does credit affect an individual’s financial standing?
• How can one plan for a secure financial future in an environment of economic instability?

Personal financial decisions may involve paying for education, financing durable goods such as real estate and cars, buying insurance, e.g. health and property insurance, investing and saving for retirement.

Personal financial decisions may also involve paying for a loan, or debt obligations. The six key areas of personal financial planning, as suggested by the Financial Planning Standards Board, are:

1. Financial position:
2. Adequate protection:
3. Tax planning:
4. Investment and accumulation goals:
5. Retirement planning
6. Estate planning

 

Corporate finance

Managerial or corporate finance is the task of providing the funds for a corporation’s activities (for small business, this is referred to as SME finance). Corporate finance generally involves balancing risk and profitability, while attempting to maximize an entity’s wealth and the value of its stock, and generically entails three interrelated decisions. In the first, „the investment decision”, management must decide which „projects” (if any) to undertake. The discipline of capital budgeting is devoted to this question, and may employ standard business valuation techniques or even extend to real options valuation; The second, „the financing decision” relates to how these investments are to be funded: capital here is provided by shareholders, in the form of equity (privately or via an initial public offering), creditors, often in the form of bonds, and the firm’s operations (cash flow). Short-term funding or working capital is mostly provided by banks extending a line of credit. The balance between these elements forms the company’s capital structure. The third, „the dividend decision”, requires management to determine whether any unappropriated profit is to be retained for future investment / operational requirements, or instead to be distributed to shareholders, and if so in what form. Short term financial management is often termed „working capital management”, and relates to cash-, inventory- and debtors management. These areas often overlap with the firm’s accounting function, however, financial accounting is more concerned with the reporting of historical financial information, while these financial decisions are directed toward the future of the firm.

Another business decision concerning finance is investment, or fund management. An investment is an acquisition of an asset in the hope that it will maintain or increase its value. In investment management ? in choosing a portfolio ? one has to decide what, how much and when to invest. To do this, a company must:

• Identify relevant objectives and constraints: institution or individual goals, time horizon, risk aversion and tax considerations;
• Identify the appropriate strategy: active versus passive hedging strategy
• Measure the portfolio performance

Financial management is duplicate with the financial function of the Accounting profession. However, financial accounting is more concerned with the reporting of historical financial information, while the financial decision is directed toward the future of the firm.

Financial risk management, an element of corporate finance, is the practice of creating and protecting economic value in a firm by using financial instruments to manage exposure to risk, particularly credit risk and market risk. (Other risk types include Foreign exchange, Shape, Volatility, Sector, Liquidity, Inflation risks, etc.) It focuses on when and how to hedge using financial instruments; in this sense it overlaps with financial engineering. Similar to general risk management, financial risk management requires identifying its sources, measuring it (see: Risk measure: Well known risk measures), and formulating plans to address these, and can be qualitative and quantitative. In the banking sector worldwide, the Basel Accords are generally adopted by internationally active banks for tracking, reporting and exposing operational, credit and market risks.

Public finance

Public finance describes finance as related to sovereign states and sub-national entities (states/provinces, counties, municipalities, etc.) and related public entities (e.g. school districts) or agencies. It is concerned with:

• Identification of required expenditure of a public sector entity
• Source(s) of that entity’s revenue
• The budgeting process
• Debt issuance (municipal bonds) for public works projects

Central banks, such as the Federal Reserve System banks in the United States and Bank of England in the United Kingdom, are strong players in public finance, acting as lenders of last resort as well as strong influences on monetary and credit conditions in the economy.

 

Exercise 1 – UNDERSTANDING THE TEXT

Answer the general questions about the text:

1. What are the three main areas of finance?
2. How important is personal finance and what decisions may it involve?
3. What is corporate finance about?
4. What is public finance and what is it concerned with?

Exercise 2 – UNDERSTANDING THE TEXT

Decide which sentenses are TRUE or which are FALSE:

1. Managing taxes is not only a question of if you will pay taxes, but also when and how much you will pay.
   

   TRUE

   FALSE

2. Corporate finance generally involves balancing risk and profitability, while attempting to minimize an entity’s wealth and the value of its stock, and generically entails three interrelated decisions.
   

   TRUE

   FALSE

3. However, financial accounting is more about reporting of historical financial information, while the financial decision is directed toward the future of the firm.
   

   TRUE

   FALSE

4. Financial risk management, an element of corporate finance, is the practice of creating and protecting economic value in a firm without using financial instruments to manage exposure to risk, particularly credit risk and market risk.
   

   TRUE

   FALSE

5. Public finance relates to finance in connection with sovereign states and sub-national entities (states/provinces, counties, municipalities, etc.) and related public entities (e.g. school districts) or agencies.
   

   TRUE

   FALSE

[key]

F   1. Managing taxes is not a question of if you will pay taxes, but when and how much.

F   2. Corporate finance generally involves balancing risk and profitability, while attempting to maximize an entity’s wealth and the value of its stock, and generically entails three interrelated decisions.

T   3. However, financial accounting is more concerned with the reporting of historical financial information, while the financial decision is directed toward the future of the firm.

F   4. Financial risk management, an element of corporate finance, is the practice of creating and protecting economic value in a firm by using financial instruments to manage exposure to risk, particularly credit risk and market risk.

T   5. Public finance describes finance as related to sovereign states and sub-national entities (states/provinces, counties, municipalities, etc.) and related public entities (e.g. school districts) or agencies.

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Exercise 3 – VOCABULARY EXERCISE

Read the definitions below. In the text try to find the words that mean the same what a definition.

 

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EXERCISE 2: Match the words from the previous exercise with their definitions.

NB	Words	Answer	NB	Definition
1	tax inspector		A	The amount of sales generated for every dollar’s worth of assets. It is calculated by dividing sales in dollars by assets in dollars.
2	market analyst		B	It is a professional who helps clients to maintain the desired balance of investment income, capital gains, and acceptable level of risk by using proper asset allocation.
3	tax consultant		C	A government official who ensures that organisations and individuals pay the correct amount of tax at the right time.
4	financial advisor		D	A resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit
5	stockbroker		F	A distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders.
6	letter of credit		G	A financial statement that summarizes the revenues, costs and expenses incurred during a specific period of time – usually a fiscal quarter or year. These records provide information that shows the ability of a company to generate profit by increasing revenue and reducing costs.
7	business plan		H	A document issued by an insurance company/broker that is used to verify the existence of insurance coverage under specific conditions granted to listed individuals.
8	insurance certificate		I	It is a formal statement of a set of business goals, the reasons they are believed attainable, and the plan for reaching those goals.
9	profit and loss account		J	It is a document that a financial institution or similar party issues to a seller of goods or services which provides that the issuer will pay the seller for goods or services the seller delivers to a third-party buyer.
10	tender		K	This person studies market conditions in local, regional, or national areas to examine potential sales of a product or service.
11	capital spending		L	It is a regulated professional individual, usually associated with a brokerage firm or broker-dealer, who buys and sells shares and other securities for both retail and institutional clients, through a stock exchange or over the counter, in return for a fee or commission.
12	pension		M	A formal letter with an offer to supply goods or devices, containing a description of the project, including costs, materials, personnel, time plans, etc.
13	dividends		N	A unit of ownership interest in a corporation or financial asset.
14	assets		O	Spending for long-term assets such as factories, equipment, machinery, and buildings that permits the production of more goods and services in future years.
15	shares		P	A financial expert specially trained in tax law, usually advises a company or an individual on how to pay less tax.
16	turnover		R	Post-retirement benefits that an employee might receive from some employers.

 

[key]

tax inspector	A government official who ensures that organisations and individuals pay the correct amount of tax at the right time.
market analyst	A person who studies market conditions in local, regional, or national areas to examine potential sales of a product or service.
tax consultant	A financial expert specially trained in tax law, usually advises a company or an individual on how to pay less tax.
financial advisor	It is a professional who helps clients to maintain the desired balance of investment income, capital gains, and acceptable level of risk by using proper asset allocation.
stockbroker	It is a regulated professional individual, usually associated with a brokerage firm or broker-dealer, who buys and sells shares and other securities for both retail and institutional clients, through a stock exchange or over the counter, in return for a fee or commission.
letter of credit	It is a document that a financial institution or similar party issues to a seller of goods or services which provides that the issuer will pay the seller for goods or services the seller delivers to a third-party buyer.
insurance certificate	A document issued by an insurance company/broker that is used to verify the existence of insurance coverage under specific conditions granted to listed individuals.
profit and loss account	A financial statement that summarizes the revenues, costs and expenses incurred during a specific period of time – usually a fiscal quarter or year. These records provide information that shows the ability of a company to generate profit by increasing revenue and reducing costs.
tender	A formal letter with an offer to supply goods or devices, containing a description of the project, including costs, materials, personnel, time plans, etc.
capital spending	Spending for long-term assets such as factories, equipment, machinery, and buildings that permits the production of more goods and services in future years.
pension	Post-retirement benefits that an employee might receive from some employers
dividends	A distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders.
assets	A resource with economic value that an individual, corporation or country owns or controls with the expectation that it will provide future benefit.
shares	A unit of ownership interest in a corporation or financial asset.
turnover	The amount of sales generated for every dollar’s worth of assets. It is calculated by dividing sales in dollars by assets in dollars.

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EXTEND YOUR FINANCE VOCABULARY ? verbs

Fill the gaps with the words from the box. Remember to put the verbs in proper grammar forms.

analyze	trade	invest	advise
merge	debit	credit