Five Concepts of Finance
Written by Clayton Reeves for Gaebler Ventures
This article briefly goes over five basic concepts of finance that you should have a firm grasp on while running your small business. These are simple in nature, but their depth is significant. Getting a good grasp on them will help you run a more financially sound company.
Finance is an important concept for business owners to grasp.
It encompasses every facet of their business, and even with the best product and marketing plan in the world a business can still fail without proper financial planning. There are some concepts in finance that every small business owner should get their heads around before making too many plans to start-up a small business.
Greater Return Requires Greater Risk
This is one of the oldest financial concepts in the books. It is a simple relation between risk and return. Risk and return is one of the most correlated relationships in finance. For return to increase, you absolutely must take on more risk. If there are securities where this isn't true, then the one with the better risk return relationship will be bought, and the other will not.
This is also known as the "good deals disappear fast" phenomenon. Chances are that if you think you see a good deal because of a news release, it has already been bid up to reflect the news. Other items include arbitrage opportunities. Arbitrage is when an investor can perform a series of transactions and receive a profit without any risk.
Risk free arbitrage sometimes happens because of market inefficiencies. However, once these opportunities are identified by analysts, they are quickly taken advantage of until they disappear.
Time Value of Money
Money is more valuable the earlier in time you receive the payment. Every moment you wait to receive payment could have been spent investing that money into the market and earning a return. This applies to small businesses negotiating payment schedules and other cash flow arrangements.
Getting the money sooner is always a better option than receiving it later. Receiving the money also alleviates the risk that the paying party will not come through on their side of the contract. Delinquency of accounts can really add some costs to a small business, so make sure you receive your payments as soon as possible.
Cash is King
Cash is the king in finance. Net income, revenue and other forms of measurement for businesses are not nearly as important as the operating cash flows of a firm. Cash cannot be manipulated by accounting procedures, and represents an unbiased benchmark for where the firm stands.
Cash is also the most liquid form of payment and represents only inflation and depreciation risk. Other forms of payment can possess delinquency risks among other things. When dealing with schedules, remember that cash is the best option for your firm when accepting payment.
Don't forget that some other forms of payment are easier for customers, so don't sacrifice customer service just to get cash payments.
Someone out there knows more than you about whatever you are looking into investing in. This is the basic theory of asymmetric information. There is a difference in knowledge for every security out there.
Insider trading, industry expertise and experience generally lend themselves to a greater wealth of knowledge for analysts. If you think a deal is too good to be true, it generally is. There is no such thing as a free lunch in these markets, so be careful how much you buy into seemingly incredible deals.
When he's not playing racquetball or studying for a class, Clayton Reeves enjoys writing articles about entrepreneurship. He is currently an MBA student at the University of Missouri with a concentration in Economics and Finance.
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