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 finance.
What is finance?
Google the phrase “definition of finance” and here are some answers that will appear on the first page of Google:
- The management of large amounts of money.
- The monetary resources and affairs of a country, organization, or person.
- The study of how money is managed and the process of acquiring needed funds.
- The allocation of assets and liabilities over space and time.
- The management, creation, and study of money, investments, and other financial instruments.
The definitions of finance emphasize money. Money is an important part of our lives because money is needed to buy things. This need influences acts like creating, managing, and studying. What these acts do is recognize the fact that an entity without money will fail to survive. What we must acknowledge however is money is not enough, money is only part of the process. This is a reason why I like the definition that includes investments as well as other financial instruments. So how can we come up with a working definition of finance?
The answer is in textbooks I’ve used for teaching financial management. I have used many textbooks as a financial management lecturer and the precision of material will differ however there has been one constant. The constant is the goal of the firm: maximize shareholder wealth. When we compare this goal to the above listed definitions the goal limits itself to shareholders so should we limit our definition? The answer is no because we are not limiting ourselves to money. What should we do? What I do is use the following statement as a definition of finance:
Finance is the study of wealth.
What is wealth?
Google the phrase “definition of wealth” and here are some answers that will appear on the first page of Google:
- An abundance of valuable possessions or money.
- The state of being rich.
- Plentiful supplies of a particular resource.
- A large amount of something good.
- A measure of net worth.
- Tangible or intangible thing that makes a person, family, or group better off.
These definitions go beyond money. Terms like possessions, resource, and thing indicate a larger concept of wealth. Taking this larger concept to the next levels means a simple, workable definition of wealth. So what is a simple, workable definition of wealth? My answer is the following:
Wealth is the abundance of valuable possessions.
What are some examples of valuable possessions?
- Net Income
- Retained Earnings
When we think about possessions we think about what we own. What we own typically appears on the balance sheet as assets so cash through copyrights appear to be obvious examples of valuable possessions. What may not look obvious as valuable possessions are sales, net income, and retained earnings however these items are in fact valuable possessions.
- Sales are validations of value propositions and value propositions are valuable possessions because they not only maintain but also enhance the existence of organizations.
- Net income measures the effectiveness of delivering products or providing services and this measurement provides insights into what an organization is doing well, what an organization is not doing well, and what an organization can do better.
- Retained earnings is an accumulation of income and this accumulation can be put into opportunities that can increase the number of valuable possessions, most notably cash.
What I hope readers take away from this section is our possessions have characteristics. These characteristics are not adequately described in financial statements. As a result we should consider what else comprises wealth. The “what else” is a topic I’ve used when teaching managerial accounting through the use of a video. Here’s the link to this video
What people must take away from this section is the term “valuable.” Businesses can have the possessions listed above however these possessions have to generate something. What these possessions must generate is cash inflows/receipts. The ability of these possessions to generate cash inflows/receipts demonstrates value. It is the ability of these possessions to demonstrate that puts businesses in a position to move forward due to the wealth that these possessions can ultimately create.
A Time to Review
This article is the third in a series of insights into disciplines you can use in your financial plans. The purpose of this series is to expand on the definition of financial planning, the process of thinking about how to accumulate wealth. The process of thinking about accumulating wealth can be organized into two systems
Whether you organize your financial plans by disciplines or studies you have something very important in place, a process. The process allows for structure and flexibility. Structure allows you to not overthink the simple and flexible allows you to adapt to changes in your lives.
A financial plan, like any other object, needs to have a purpose. The purpose of a financial plan can be described through the application of finance. Finance is the study of wealth and the application of finance can provide people who are engaged in the preparation and use of a financial plan with direction that can help not them but others move forward.