Business Principles Drive Good Financial Choices

Many of life’s decisions are directly or indirectly related to financial matters. A seemly simple choice of buying a soft drink or taking a “free to you” drink at the local water cooler requires a thoughtful approach that incorporates knowledge of fundamental business principles. The study of business identifies several very important facts about financial matters and decision making that will improve your chances of making the right choice for you. When you incorporate the basic principles of accounting, business, economics, and finance into your thought process you will find the decision making process easier, less stressful, and rewarding.

ACCOUNTING

• Assets (what you own) minus liabilities (what you owe) equals wealth. People who have a lot of “toys” are not wealthy if the “toys” are bought on credit and not paid for.

• Good financial choices will usually result in wealth accumulation over time. Growing wealth levels will create a good financial foundation for retirement and should be incorporated into a retirement portfolio.

• The value placed on assets and liabilities are usually in dollar terms and often at the historic cost. Current value estimates may be less than cost.

• Net income is often much lower than gross income (before taxes and other fees). Good financial choices consider net incomes. 

• Being aware of what is spent and on what can focus attention and may change consumption behavior.

BUSINESS 

• A rule of law is in place to protect private property and most financial transactions.

• Contracts are legally binding agreements that protect both the buyer and the seller.

• Successful businesses provide consumers what they want at a competitive yet profitable price.

• Advertising informs potential customers about goods and services and attempts to persuade them to buy.

• Profit is the reward to entrepreneurial businesses as they successfully design, build, and supply goods and services for consumers.

• Free enterprise mandates ethical conduct from people in business, government officials, and consumers. Ethical failure reduces efficiency and makes planning difficult.

 
ECONOMICS 

• Most financial transactions take place in a market environment. It is important to note that there are suppliers and consumers of goods and services including financial services.

• In many economic systems, things of value are purchased with money. For most people, money is earned by doing productive work and comes in the form of wages.

• Specialization and trade within the marketplace is facilitated with money and will usually add well-being to all participants.

• As scarcity mandates efficient choices, maximizing benefits and minimizing costs is the proper way to make choices. 

FINANCE

• Some tangible assets such as automobiles and televisions depreciate in value over time and others appreciate over time such as houses and gold coins. Depreciation and appreciation of assets will influence a person’s wealth.

• Interest rate is considered the cost of money. If the interest rate is low, money is cheap and vice a versa. If an asset appreciates at a rate higher than the cost of money used to purchase the asset, wealth is increased. If the cost of money is high relative to the rate of appreciation the opposite is true.

• The cost of funds used to finance the buying of an asset depends upon the asset's risk.

• The power of compounding demonstrates the impact of interest rates over time.

• The rate of return on an investment calculates the level of benefits an investment decision provides in comparison to costs.

• Risk management is a very important financial consideration. It is critically important to determine how risky a possible choice might be. You can then either avoid it altogether or minimize the possible negative consequences with information, long term views, or insurance.