Using Economics in Your Financial Plans
A financial plan is a product used for guiding people’s actions toward the accumulation of wealth. As a product a financial plan is created from a variety of sources. One source used for creating a financial plan is economics.
What is Economics?
Google the phrase “definition of economics” and here are some answers that will appear on the first page of Google:
- The branch of knowledge concerned with the production, consumption, and transfer of wealth.
- The academic study of the production, distribution, and consumption of goods and services.
- A social science concerned with the production, distribution, and consumption of goods and services.
- Pertaining to the production, distribution, and use of income, wealth, and commodities.
When using these definitions in your financial plans the words production, distribution, and consumption are important. Production is an important word to use in your financial plan because it focuses on your effort in creating what you want to sell. Distribution also is an important word to use in your financial plan because it focuses on your effort in delivering what you want to sell. In addition consumption is an important word to use in your financial plan because it focuses on not only your effort in using resources toward what you want to sell but also your customers’ reasons in using what you want to sell. So using these definitions in your financial plan can help you begin your process to think about how to accumulate wealth however I want to go down another level.
Going down another level required some research and my research came up with a definition that serves as simple yet useful in the process to create a financial plan. This definition was found in the book Principles of Economics by Carl Menger. In page 7 of this book, Peter Klein writes that “economics, for Menger, is the study of purposeful human choice.” The purpose of a financial plan is to guide people’s actions toward the accumulation of wealth. What we can take from Peter Klein is the use of economics in your financial plan establishes a basis for choices so let’s incorporate the following definition for your financial plan
Economics is the study of choices
What are Choices?
The definition I found which I not only like but also will use is
The act of making decisions when faced with two or more possibilities
One reason this definition is applicable to the creation of a financial plan is it focuses on action, the act of making decisions. Another reason this definition is applicable to the creation of a financial plan is it focuses on commitments which are determined when a decision is made. Another reason this definition is applicable to the creation of a financial plan is it focuses on alternatives, action can be directed in a variety of ways.
The primary reason for the existence of businesses is to improve the well-being of their stakeholders. Businesses can improve the well-being of their customers through the characteristics of the products they deliver or the services they provide. Businesses can improve the well-being of their employees through the compensation they provide. Businesses can improve the well-being of their suppliers through the use of their materials or products. Businesses can improve the well-being of their service providers through the use of their expertise. Businesses can improve the well-being of their lenders through the payment of interest on loans. Businesses can improve the well-being of their stockholders through the appreciation of their investments. Improving the well-being of a business’s stakeholders does not happen by accident, improving the well-being of a business’s stakeholders happens by execution. Execution can be successful when businesses organize their choices into a financial plan.
What are the choices that exist in businesses?
Businesses have many choices to make in order to not only maintain but also enhance their existence. Choices can be made when unexpected situations occur however choices are better made when businesses engage in preparation. One person I incorporate in my work is John Wooden. John Wooden was a college basketball coach who was rated by ESPN as the greatest coach of the 20th century. Preparation was a hallmark of John Wooden and he reminded his players about preparation with the following quote:
“Failing to prepare is preparing to fail”.
A financial plan is the result of preparation. When beginning the process of creating a financial plan businesses should think about the choices they want to make in order to accumulate the wealth that is necessary for not only maintaining but also enhancing their existence. So what are the choices that exist in businesses?
Here are a number of choices that businesses have:
- Should we sell licenses, merchandise, or services?
- If we sell merchandise, should we manufacture or purchase what we sell?
- If we manufacture merchandise, should we do so internally or outsource?
- Should we hire employees or consultants?
- Should we promote what we sell through advertising or word of mouth?
- Should we advertise through media or trade shows?
- Should we advertise through print or online media?
- Should we hire employees through agencies or search engine job listings?
- Should we train employees through classrooms or on-the-job?
- Should our customers pay for what purchase only with cash or let them use credit cards?
- Should we extend credit to our customers or only accept cash on delivery (COD)?
- If we sell merchandise, should we buy or rent warehouses?
- If we sell merchandise, should we distribute internally or through carriers?
- Should we buy or rent facilities?
- Should we buy or lease equipment?
- Should we apply excess cash toward our business or investments in other businesses?
- Should our long-term assets comprise primarily of fixed assets or intellectual property?
- Should we conduct relationships with vendors who will not extend credit?
- Should we raise money from loans or stock?
- Should we issue common stock or preferred stock?
- Should we pay cash dividends or issue stock dividends?
As you can see businesses have a number of choices. The number may look overwhelming however the number can be managed. How they can be managed is through the organization of these choices into a financial plan.
A financial plan is about choices. Choices in a financial plan are made in order to accumulate wealth. So when you begin your process to create a financial plan you need to use an element that addresses the study of choices and that element is economics.