Corporate Finance Tools in Daily Life
Many of the concepts associated with corporate finance also have applications in everyday life. A range of corporate finance tools are already used in everyday life, often without realization as corporate finance tools are often an extension of common financial practices. More complex corporate finance tools may also provide a great deal of potential to enhance daily life financial management. By looking at task associated with daily life it is possible to see the alignment.
A task undertaken in almost every household will be budgeting for household expenses, for example this will include budgeting for utility bills, insurance, food and travel. The budgeting may take place at different levels, for example, monthly or daily. The main budget will be undertaken each month, accounting for the essential items and liabilities. Where wages are paid on a monthly basis assessing outgoing in the same way is common sense.
Budgeting allows an individual to ensure that they pay all essential bulls before non-essential items are purchased. The assessment of income that may be available for the non-essential purchases is a parallel to creating a forecast for a monthly income and expenditure statement. The income is made up of wages and any other income that is received, for example, interest from investments. The outgoings are all of the liabilities and planned purchases such as groceries shopping and gas for the car. A good forecast on the required expenditure will allow an individual to see the level of surplus income they have at the end of the month. By budging the individual will not over spend as they will be able to assess the level of their net income after expenditure. For a firm this is the profit, but for the household it is the remaining disposable income.
Some months may be more difficult especially if there are large infrequent costs; not all bills will be on a monthly cycle. Therefore, budgeting also requires setting aside money towards payments that are due in the future. By forecasting for the coming months, as well as the current month, forecasting will enable the expenditure to be effectively managed.
When budgeting for large annual costs, some suppliers may offer discounts if payments are made in advance, or offer payments terms to spread the cost of a large purchase over a longer term. For example, car insurance can often be paid monthly over the period of a year for an additional cost. In addition to budgeting, the ability to assess the value of paying the premium in advance against the cost of paying it monthly to determine the relevant value of each option will enable optimal decision to be made.
Budgeting may also take place on a smaller scale, such as a shopping trip. Grocery shopping for a week is also subject to planning, ensuring compliance with the allocated budget and making adjustments were necessary.
Not all of the commonplace decisions made will concern managing expenditure; it may include assessing potential investment vehicles such as bank savings accounts and savings bonds. Understanding the way interest rates are calculated and the impact of the time value on money is important to the assessment of an investment. While interest rates are low it may be tempting to take a bond or set term savings account with interest rates fixed for a period of time. However, although interest rates may be currently low, they might not remain this way. If inflation increases above the fixed rate of interest offered it is apparent that money will be losing real value over time. The ability to look at the time value of money and assess the present value of an investment with some assumed inflation rates may be very useful in assessing at the real value of an investment. Investments that may look good in numerical terms can be misleading, simply understanding the concept can aid with the assessment. Moreover, undertaking calculations can indicate the real value and may lead help with the choice between shorter or longer term investments.
When assessing investments, potential investment vehicles may include stocks and shares as well as the simpler bonds and savings accounts. Stocks and shares provide a great potential for investment. However, unless one has significant financial resources it is not possible to get the best advice from knowledge brokers. Instead, standard advice from the mass market brokers is all that is available. This can increase the challenges of investing in stocks and shares. Often individual small investors may look at a firm and see themselves as purchasing a part of that firm. While in concept this is correct, when assessing the investment such as a share price, it should be assessed not as a firm, but as the future revenues it will produce. In this way it is most effective to assess it primarily as an investment vehicle.
Understanding the way in which future values can be discounted to give a current value and the way that the markets operate can increase the ability to assess a stock for oneself. For example, basic information, such as the current risk free rates of government bonds and the current returns on the stock market may be assessed. Measures such as the beta and the dividends can also be looked up, and many web sites will give future earnings estimates from different brokerage houses. Tools such as the dividend discount model and the capital asset pricing model (CAPM) may be used to assess the value of a share and consider the current price against that value. These models will give different results and are renowned for their lack of alignment with real world prices due to the many different influences, but it gives a basis on which an assessment may be made.
Therefore, the use of the tools found in corporate finance is present in everyday personal finance management and decisions. Management of a household account, determining expenditure, forecasting and budgeting for essential costs, and assessing surplus income available for non-essential spending, or investing and the ability to assess different types of investments are all examples of the way strategies used in corporate finance can be applied in everyday financial decision.
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