FINANCE: Definition, Types, Importance

importance of finance

When you hear or see the word finance, what comes to your mind first? Let me guess, money, business, accounting, investment, capital, assets, liabilities, etc. Well, the truth is you are not wrong. Finance is very vast but it still cuts across all these terms and more.


This article encompasses everything you need to know about finance, which is not limited to definitions, types, importance and finance management.

Below is a proper definition of finance to help you understand it better.

Definition of Finance

People finance is the study of how money works, how to tackle money-related risks which will eventually lead to better forecasting and the right way to invest it.


We can also define finance as the management of funds, transaction with money, and how money can be acquired.

Here are a few basic terms;

  • Investment
  • Budget
  • Funds
  • Revenue
  • Capital
  • Insurance
  • Account
  • Net profit

Types of Finance

All institutions need funding needs and are directly involved with money, which is why it has three types of Finance.


There are three basic categories of Finance;

  1. Personal Finance
  2. Public Finance
  3. Cooperate Finance

#1 Personal Finance

Just like the definition of Finance, Personal Finance involves private funds management, i.e. families and individuals. It means financial analysis of an individual or family current financial situation. This analysis will include knowing the financial goals of the individual or family. And then analyzing the financial decisions they have made in the past, which includes budgets, savings, spending, insurance, investments.

For example, suppose Williams decides to create a family budget to help curtail expenditure, it means there will be proper financial management in the family. 

However, personal finance strategies are dependent on what the individual or family earns and their long term goal. One exciting thing about this type of finance is that everybody is directly involved. This is where financial literacy comes in handy.

#2 Public Finance


Public Finance involves the role of government in Finance. The way government manages revenue and expenditure. Public finance cuts across every financial decision made by the government and why they made them.

For instance, if a country decides to practice a closed-form of the economy it means that the finance professionals have previously analyzed the financial benefits of a closed economy and how it can make more positive impacts in the country.

Additionally, if farmers get federal government grants, it would be because the financial analysts have conducted a thorough analysis including the long-term results of providing that grant. One good thing about public finance is that it keeps the government accountable for how revenues and funds are managed.

Some basic terms in public Finance;
  • Tax
  • National Debt
  • Expenditures
  • National budget

#3 Corporate Finance (Business)

Corporate Finance is the type of Finance that deals with funding and capital sources of a corporation. It has to do with all the financial activities involved in running a corporation. Most of the times, it is a department that foresees all financial activities in a firm. They make decisions that range from how to invest, how much to invest, to how shareholders receive dividends.

Corporate Finance has a primary goal which is to maximize their shareholder value. It can be done by implementation financial strategies which have been initially planned.

Finance management

Finance management is essential for every organization. It is the process of strategically planning the management of financial resources in an organization. This process of controlling and monitoring Funds is to enable the organization to achieve its goals and objective.

However, in financial management, the general principles of management are applied. Any firm with proper management of Finance will function efficiently. That is to say that organizations without proper finance management will face a bunch of problems that will eventually lead to their doom if not adequately corrected.

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Objectives of finance management

  1. To make sure investments are made at an adequate rate and in the right venture.
  2. Oversee the financial matters to ensure shareholders have their returns which means making a reasonable profit.
  3. Maintaining sufficient cash flow.
  4. Regulating prices and trying to reduce cost in the best possible way.
  5. To ensure funds are used smartly and make sure all finds are correctly accounted for.

Importance of Finance

The importance of Finance cannot be overemphasized. No institution can function adequately without Finance, yes! that how important it is. Finance can make a break an institution. Imagine a family that doesn’t know how much they earn versus spend, a country without investments or a business firm without proper accounting and finance management. Just imagination of it alone seems impossible.

I will break this down in three different categories, almost based on the types of Finance above. Importance of Finance in;

  • Families and Individuals.
  • Countries
  • Business.

Families and Individuals

  • To meet financial needs.

Financial security should be the aim of every family. However, without proper planning and management that cannot happen. A family that creates a family of budget invests rightly, protect their property via insurance and even has a retirement plan has created financial security. This family is financially secure and can meet the needs of its members.

  • Scale of preference

It helps family and individual become conscious of spending habits. They can make their preference list and know what they need more than the other. A scale of preference will help them not spend beyond what they plan.

  • Increases financial understanding

Have you ever felt like you don’t understand how your earnings were spent? Like you feel robbed when you are very sure you did the robbery. Proper finance management can make you avoid all these feelings. It keeps you accountable to yourself. It might not be something you will understand in a day, but with time and effort, you will be able to get better every day.

  • Manage Debts properly

Being in debt is not a problem but the ability to manage the debt is where the trouble begins. Financial knowledge will help you make a proper analysis and informed decisions concerning your debt. How you handle debts says a lot about how our financial future will look like. Finance plays a significant role in individual and families life.

Business and firms

1.Generating funds

Funds and business sound almost like the same thing. Because business needs funds to function. The process of making a capital investment in a company is Finance. Another crucial part that Finance plays in income generation of a business is how to set up the business strategy to generate income.

Example;

Mr Peters just launched his business and in as much as he hasn’t started getting returns. finance has already played a huge role. From marketing strategy to the kind of people he would employ, to the kind of raw materials he bought and of cause how he insures them. All these steps took strategic planning of financial professionals or literates.

2.Manage cash flow

Managing cash flow in a business is a big deal because it can make or mar that business. So a proper financial skill is always needed for it. Adequate accounting of revenue which include, how workers are paid, how much to reinvest. Finance influences every decision on how money moves in and out of business to create more returns. That is to say that proper finance management can take care of the cash flow in a business.

  • It helps to sustain economic downturn well

In every business, there is always a time when the economic activities will have a general downturn. No business goes a hundred percent smooth all years long. But the ability to manage this downturn and bounce back is where Finance plays its huge role in business again. Financial literacy will help you understand the economic downturn properly and the implications it has in your business. This is the first step to solving the problem because you know when you need the help of a professional or the type of business consultant you need.

  • It helps a business set more realistic goals

Every business has a long term and short term goal. These goals are not something set out of random motivation or wants. To set realistic goals, there has to be a good overview of the business, both past and present this will help not just to set goals but to set realistic and attainable goals. Keeping records of everything happening in the industry makes the set goals informed decisions backed with data rather than random plans.

In government

  • Economic growth

A sustainable high economic growth rate is the goal of almost every country. However, for it to be achieved, the government needs to use some financial tools. These tools will increase aggregate demand and supply, which directly leads to economic growth. Some of these tools include taxes, subsidies, public expenditure, public debt. Etc.

  • Price stability

Inflation and deflation is one major determinant of price instability in a country. So in a case of inflation or deflation in an economy, the government use financial strategies to reduce the money in circulation, and that will reduce the inflation rate.

Example,

If ”country A” has inflation, the government will decide to increase interest rates which will decrease the demand for a loan and in turn reduce the amount of money in circulation.

1.Proper allocation of resources

Allocation of resources by the government requires some level of financial experts. The government monitors the resources (human-made and financial) with this it knows the kind of production to impose taxes on and the ones to subsidize. Meanwhile, financial management in a country needs experts to make informed and effective decisions like this.

2. Import and export regulation

When the imports in a country become more than the exports, the government tries to regulate by using some financial strategies. Most of the time, they increase the import duty to discourage importation. In the same hand, decrease the export duty to encourage importation.

In conclusion, now you have come to understand that the importance of Finance goes across all types of Finance which directly affects all intuitions (everybody). Finance is an essential part of practical living; this is an indisputable fact.

  1. Basics of Finance
  2. Introduction to finance by J.wang
  3. Essential Finance by Nigel Gibson
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