1.3 Financial Management and Corporate Finance

What is finance? Let's start with a broad definition.  First, when we are thinking about organizations, individuals, families, companies, and governments, finance is identifying what things I need.  Second, finance is determining how to get the money to buy those things.  And third, finance is managing those things efficiently once I have them.

Let's drill down inside a company.  First, how do I decide what things I need? Well, there are long-term decisions that need to be made. Do I need to buy some land? Do I need to buy some buildings? Do I need to buy machines? That long-term decision-making process is part of finance.  Short-term finance decisions include deciding how much cash I need. How much inventory should I have on hand? Should I let my customers buy on credit? Making those short-term decisions is part of finance.  These short-term finance decision also include deciding on operating items such as the appropriate number of staff and the right amount of research and development and marketing.  All those decisions, long term and short term, are issues of finance, and they all require money.  

So, that leads into the second area of finance inside a company: Where do I get that money?  Do I borrow the money? Do I ask shareholders or partners to pool their personal savings and put them in the company so we can use that to buy the things that we need? Or do I use internally generated profits?

And the question underlying the third major area of finance is this: Once I have all those things and I've paid for them, how do I manage them? That's an issue of timing, scheduling, budgets, interfacing with my outside suppliers and my staff, and so forth.  And as part of managing things inside my company, I also need to decide how to protect those things. I need to have controls and procedures in place inside my company to effectively manage the things that I have.

Now, that is a broad description and definition of finance, but when most people say “finance” they have a more narrow set of issues in mind. They are only focusing on the second of the three broad issues: How do I get the money to buy the things that I need?  And this issue of obtaining money applies on both sides, the company seeking the money and the investors providing the money.  The companies seeking money consider whether to borrow the money from a bank or other lender or to receive the money as an investment from partners or shareholders.  In whatever way the company gets the money, they have to get the money from somebody outside the company.  So those outsiders, do they want to invest in this company or do they want to invest in that company?

And there are third parties involved, financial institutions that put these parties together.  One party needs to borrow money. Another party want to lend money. Somebody has to put these two parties together.

So when most people talk about finance, realize that they are usually just focusing on this one narrow sliver of finance: the process of a company obtaining the money it needs to buy the things it wants.  Finance, broadly defined, involves deciding what you need to buy, determining where you are going to get the money to buy those things, and then managing those things once they are inside the company.