The Primary Areas of Business Finance
Corporate Finance, Investments, and Financial Markets and Institutions
Business owners and managers should have a basic understanding of business finances even if they outsource certain areas of their financial operations. Becoming familiar with the basics of business finance can give an owner some additional tools to help understand the financial complexities of business ownership.
The three major areas of business finance are corporate finance, investments, and financial markets and institutions.
Corporate finance is a broad description of a company's balances, income, and cash flow information. This information is used to create measurements to gauge their financial performance. Performance is measured by developing metrics such as the current ratio—the ability to pay your financial obligations on time.
The balance, income, and cash flows statements are generated for accounting purposes. These statements are required for companies that are publicly traded—they have issued stocks to investors on a public trading market—but can be useful for private businesses of all sizes as well.
Some of the uses of corporate finance are budgeting, managing working capital, and financial analysis. Budgeting is more than ensuring you have enough cash to pay your bills. It is also financial planning for future business operations such as expansions or new products.
Financial analysis is usually used as a method of determining a company's liquidity, solvency and investment potential. However, it can be a vital tool for a business to use internally to view the financial performances of different departments, operations or processes.
Working capital is the capital—money—a business can use to finance its daily functions. Some working capital examples are cash or inventory.
Another area of finance is investments. Businesses may invest in assets ranging from short-term securities to long-term securities like stocks and bonds.
Companies can invest in financial assets such as stocks of other firms, or invest in themselves with physical assets such as buildings or new equipment.
Financial Markets and Institutions
Financial markets include the stocks and bonds, commodities, and derivatives markets.
Financial markets, such as the stock market, help facilitate the transfer of funds between savers of funds and users of funds. Savers are usually households, and users are generally businesses and the government.
Commodities markets are markets in which traders and investors trade for volatile commodities—prices rise and fall rapidly—such as oil or milk.
Commodities futures markets are markets where investors trade for future goods, e.g., an agreement to purchase corn when it is brought to market. However, futures are part of the derivatives market.
Derivatives are a market in which trades are conducted with products from adjacent markets. The trade is conducted in the form of a contract between two parties, and the value is based on the value of the original investment.
This agreement creates a benefit for both parties. Derivatives raise and lower risk depending on the terms agreed upon by the buyer and seller.
Financial institutions such as banks, investment companies, and brokerages work in the financial markets. Financial institutions generally act as intermediaries that help make transfers of funds between businesses and savers (working as a broker or agent for the trade).