What is finance? A simple answer


8/1/20232 min read

This seems like a very simple and basic question, yet most of the time when students enter their first finance class they just have a vague idea of what finance is and unfortunately, many instructors skip this step and jump right into topics such as financial statements and ratios or time value of money.

In this post, I am going to provide a bird eye view of the finance discipline. Finance in its most basic definition is the management of money. You either have the money or you do not, so most financial decisions can be categorized in one of two ways.

1. Investing Decision: if you have the money, you usually look for investment opportunities to grow it. For example, savers in the economy usually invest their savings in stocks, bonds, real estate, etc. with the expectation that the money grows over time. This is an investment decision.

2. Financing Decision: if you do not have the money, however, but you have a great idea that can solve a problem, you can tap into the capital markets and raise money. For example, if you own a business that created a great new technology to store power, but do not have the funds to start manufacturing your machine, you may go to a bank, sell bonds, or sell stocks to raise the capital needed for your manufacturing plant. This is a financing decision.

Finance is usually categorized into the following 5 general areas:

  1. Corporate finance

    Corporate finance is the focus of most introductory courses, and it deals with making decisions that increase firm value. However, you need to know the skills and concepts that you learn in corporate finance can be applied to most businesses, so business finance might be a more descriptive title.

  2. Investments

    Generally, the investment area deals with financial assets such as bonds and stocks and one tries to answer questions like: What determines the price of these financial assets? What are the risk/reward tradeoffs that we need to consider when we invest in these assets? What is the best mix of these assets one should include in his/her portfolio? Potential career paths for this track may involve stockbrokers, portfolio managers, and security analysts.

  3. Financial institutions

    Financial institutions are firms such as banks and insurance companies that deal with financial matters and employees perform a wide range of finance-related tasks. For example, a commercial loan officer should be able to evaluate the financial health of a business before extending a loan.

  4. Fintech

    Finance is one of the early adopters of technologies that make transactions, and processes faster and more efficient. The combination of technology and finance is called fintech. In the past, a Bloomberg terminal or a fax machine was considered fintech, these days finance is adopting blockchain, machine learning, and AI. And it goes on!

  5. International Finance

    International finance is not really an area of finance, but it is more like a specialization within the above-mentioned areas. For example, the CFO of a multinational corporation with subsidiaries around the world or a portfolio manager who oversees managing an emerging market mutual fund should be proficient in international finance.

    It is important to note that this is not an exhaustive list of the areas of finance and there is much more to finance than the simple categorization above. But it is a good start.