Financial Terms You Must Know! The Ultimate Guide (Series 15)

Building a great and effective business needs a strategic framework and an excellent execution system on a consistent and continuous basis.
Great leaders are great planners who can analyse a given situation and build an ecosystem to reach the end potential. For the attainment of your ultimate financial objectives one must be well versed with the financial terminologies to take up the right decisions.

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Having the right and accurate financial information can be a game changer element in your personal as well as professional life, it not only helps individuals master their personal financial objectives but also helps them to be better capital allocators, financial controllers, financial managers, entrepreneurs, company owners. At the end of the day, the ultimate wealth objective is to efficiently manage, allocate and grow capital.

Finance Terms Everyone Should Know!

Finance:

Finance is the core element of every business organisation. When we mention ‘Finance’, usually it means money, but it is merely not the money, it is a vast concept which is concerned with money and its flow. The word ‘Finance’ is a French word which means ‘Management of Money’.
Finance is such a powerful medium that, it performs an important role to operate, co-ordinate and control the various economic activities of the business enterprise.
Finance is also limited resource like other resources and a business entity needs to manage its finances resourcefully, effectively and efficiently..
Finance is essential for expansion, diversification, modernization, as well as for establishment of new projects.
The financial policy of any organization mainly determines not only its existence and survival but also the performance and success of that organization. Finance is required for investment purposes and also to meet substantial capital expenditure projects.
Financial Management is a managerial process that is concerned with the planning, organizing, directing and controlling of financial resources.

Strategic Financial Management:

Strategic financial management is a process of systematically arranging, planning and regulating an organisation’s financial resources to meet or achieve it’s long term goals and obligations.
It refers to making strategic choices which will have an effect on the organisation’s overall sustainability and financial position.
It’s primary goal is to increase the performance and value of the organisation while lowering its financial risks.
Strategic financial management plays a critical role in the success and sustainability of organisation and integrates the various branches of management like financial planning, budgeting, risk management and investment research.
Strategic financial management primarily focuses on the management of finances of the organisation with the help of various financial tools and makes strategic decisions in order to achieve those financial objectives.
Financial management focuses on coordinating various financial choices with the organisation’s strategic objectives and visions.
As the word strategic financial management in itself means, financial management in a way which is strategically framed and it promotes organisation’s expansion by offering the financial foundation for growth, diversification, mergers and acquisition.

Investment Management:

An individual earns and spends money throughout his or her life. There are differences between the earnings and spending of a person. This difference will lead a person either to borrow or to save to capitalise the money for the long term benefits from the income earned today.
Investment management is the strategic and systematic process of managing a portfolio of investments to meet the estimated end goals. It involves buying and selling assets, creating investment strategies, and managing risk.
Investment management, in simple terms, is about deciding where to put your money to grow it, and then making sure those investments are working well to meet your financial goals. It involves buying and selling things like stocks and bonds, deciding how much of your money to put into each and making sure your investments are aligned with your overall financial plan.
“Investment management is the process of management of money including investments, budgeting, banking and taxes also called as money management.”
Investment management as the term suggests refers to the strategic management of the excess money by effectively deploying it in various capital appreciating asset classes like, equity assets, debt instruments, corporate or government issued bonds, etc. The primary objective is to strategically and analytically make investments with the end goal of creating wealth and having a strong financial position with the minimum risks associated.
When the income earned is more than the consumption the difference between the two is used to save. One option is to save the excess money in a cupboard until some future time when consumption exceeds current income or another option is that the person can give up the present possession of that money for a larger amount of money that will be available for the future consumption by channelizing the capital in the right avenues.
In the Economic sense there is an important concept as the time value of money. Money needs to be invested by taking into consideration the percentage rate of inflation which increases on a year on year basis and if one has to beat the inflation he or she has to earn the rate of interest greater than the inflation rate.
When the savings are made to increase the capital over a certain period of time it is known as investment. The excess money has to be invested in some financial asset to get a significant return.
Investment, therefore, is the sacrifice of some present value for the uncertain future reward. An investment decision is a trade off between risk and return.
Sound and strategic investments result in creation of a strong financial position and possession of a significant corpus over time. The main element when it comes to making successful, strategic, medium to long-term sound financial investments one has to maintain consistency, patience, the right approach towards things and simultaneously, keeping a check if the probable investments are working out well as per the expectations or keeping up with the estimated return on investments (ROI).

Warren buffet, one of the most respected investors globally and the CEO & Chairman of one of the world's famous investment companies Berkshire Hathway has opined that if a person invests money in the market with even a hint of thought of selling it once the price rises is not at all an investment.

As per Sharpe, “Investment is sacrifice of certain present value for some uncertain future value.”

The art of investment is maximizing the returns with minimum degree of risk.
The ultimate objective is to grow and preserve wealth while minimizing risk
An investment is said to be genuine if it has been made keeping in mind with a certain expected rate of return.
The three important components of investment are time, inflation and uncertainty.
Investments are generally linked to the global capital markets even though the proportions may vary as some investments are equity oriented, nevertheless, capital markets greatly influence the return on investments. Hence, investments are bound by time fluctuations in the market which makes the interest and the current inflation rate relevant within the economy.

Capital Rationing:

Capital rationing is one of the tools to manage and mitigate the financial risk associated to a business.
Capital rationing is a situation, whereby, the funds available for completing a project are limited.
It is a situation where a constraint or budget ceiling is put in place on to the total size of capital expenditure under the assumption that the availability of financial resources is quite limited.
It is a financial strategy used by companies or financial institutions or investors to limit the number of projects to be taken up at a time. If there is a pool of available investments which are expected to be profitable, the strategy of capital rationing provides the investors with the most profitable one to choose from.
Under this circumstance, the decision maker is compelled to reject some of the viable projects having positive net present value because of the shortage of funds.
It helps in effective allocation of funds available across various investment opportunities, thereby, enhancing the bottom line of the company. The company is forced to deploy the funds in such projects which are considered to be the most profitable and carrying the highest potential in terms of risks and rewards.
The limited funds are utilised in the best possible or optimum manner by using the profitability index technique.
The concept of capital rationing is used by many investors and companies to make sure that investments are made only in those projects that offer the highest returns.
It is analysed that companies which have a capital rationing strategy prevalent within their organisations typically produce a relatively higher return on investment (ROI) which is simply because its their strategy of investing its resources where it identifies the highest profit potential.
The primary intention of capital rationing is to make sure that a company does not heavily invest into its asset without much risk analysis, and invest the funds in high worthy projects or else a company may go on to witness the returns provided by the investments going on the lower side.
The typical goal of capital rationing is to direct a company’s limited capital resources to the projects/ ventures that are likely to be the most profitable.
The bottom line approach of capital rationing is that all investments with high projected returns should be taken and dealt with.

EBITDA:

An acronym standing for Earnings Before Interest, Taxes, Depreciation and Amortization, EBITDA is a commonly used measure of a company’s ability to generate cash flow. To get EBITDA, you would add net profit, interest, taxes, depreciation, and amortization together.
EBITDA is an important financial metric which shows how much money a company or a business organisation makes before taking into account the non-operating expenses like interest & taxes and non-cash expenses like depreciation & amortization.
It gives a clear cut picture to the business so as to how much money they are generatng from their core business operating activities.
This financial metric holds integral value for the potential investors and stakeholders of the company who want to know the profitability of the company. They get a strategic roadmap and a precise conclusion by analysing the company’s operating profit.
EBITDA consists of Net Income, Interest Expenses, Taxes, Depreciation and Amortization.
Net Income is derived at after providing for interest, tax, depreciation and amortization.

Depreciation and amortization are accounting methods used to allocate the cost of an asset over its useful life. Depreciation is used for tangible assets (like buildings and equipment), while amortization is used for intangible assets (like patents and copyrights). Both methods reduce the asset's value on the balance sheet and allow businesses to deduct expenses from their taxable income.