Running Head: PRINCIPLES OF FINANCE 1

Principles of Finance

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Principles of Finance

Introduction

As many organizations and people steer their financial aspects, they encounter many

decisions variations and alternatives. Financial products market sets the basis of financial

alternatives that individuals organizations have. Financial decisions affect the ability of the

organization to attain its set objectives and goals. The main purpose of financial education is to

support individuals in making their personal decisions. It is therefore important to endorse

financial education programs that are effective in decision making process to help both

organizations and individuals in their financial well-being (Magee, Brealey, and Brealey,

2015). For instance, my experience as a senior financial coach will apparently suffice for class.

There is a growing demand of need for financial education globally. People are seeking advice

from financial coaches, educators, planners, and counselors daily as there are apparent financial

opportunities and challenges.

The diversity of financial needs is reflected on the wide array of methods and approaches

of financial educations. For instance, money management education, investment education, and

studying simple finance rules and guidelines. Other areas of study include budgeting, credit, and

mortgage. According to Baker and Clark (2011), organizations play a major role of educating

their employees on different aspects of finance such as pension, credit use and repayment,

expenditure management, and investments. There are varied positive outcomes of educating

people about managing their finances. However, with the ever-widening ranges of financial

approaches and goals, financial educators are facing varied challenges in defining the ultimate

success for finance. The ultimate goal for financial education is the people’s financial well-

being. That is, helping people to make adequate financial decisions and goals. Financial
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educators elaborate ultimate framework and strategies to improve the financial well-being of

consumers.

Financial Well-being

Financial well-being is a condition wherein an individual or organization can wholly

meet current and progressive financial requirements, feels secure about future finance

obligations, and can make varied choices about her spending. In short, financial well-being is the

state of enjoying financial security and freedom in the present while considering the safety of

future. Financial well-being is determined by various factors. It is pinned to the opportunities and

actions of an individual. Hassan and Rashid (2019), suggests that both the situational prospects

and the structural opportunities influence the actions of an individual or an organization. The

former actions determine the latter financial well-being. Some of the prevalent factors that affect

the daily financial decision making of an organization and individual include: financial

knowledge, skills, personality and attitudes, and decision setting. Financial coaches are therefore

important to educate people about these disciplines to promote financial well-being.

Financial Action Model

The figure below shows how the drivers of financial well-being work collectively to

support a specific course of action.

Figure 1

For an individual to choose a specific alternative (action), an individual requires factual

information (knowledge), and a clear understanding of how to employ the action (skills). An

individual’s potential action is determined by his/her know-how. To achieve the purported

action, it necessitates two supplementary elements; motivation and opportunity. An individual’s

personality affects the outcome of an action. If a person believes that he has the potential to take

an action to achieve the set goals, then he will persevere the obstacles and other setbacks and

vice versa. Opportunity on the other side is key for individual decision making (Magee, Brealey,

and Brealey, 2015). Opportunity is structural. If the path is well planned and designed to achieve

the set goal then the person would require less motivation and know-how to success. Secondly,

opportunity is a situational element. For instance, how well can an individual learn and stand the
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process to achieve the set goals? In essence, the specific setting of a situation determines the

action to be taken (MacLeod, 2016). Understanding the financial action model will enable

individuals to take the correct action towards their financial well-being. These can only be

achieved through thorough financial education.

Principles for Effective Financial Education

Structural and situational opportunities form the basis on which action is to be taken for

an individuals’ well-being. Therefore, how can financial education enhance financial well-being?

Economic opportunities are key for an individual’s financial success. In the presence of such

opportunities, education become the backbone to set a clear path towards success. Understanding

the principles of finance will help individuals take opportunities and barriers into account for

enhance their financial well-being. The principles of finance are set guidelines used to make

financing and investment decisions. There are five essential principles that are apparent to be

comprehended by both individuals and organizations for their financial well-being. They include;

a) Risk and Return Principle

The risk and return principle, is the first core element for finance. Risk is the variability

of probable returns of a particular investment. It provides indicators to organizations and

individuals to have a conscious of risk and returns before investing. According to Tarantino and

Cernauskas (2011), the higher the risk, the higher the return rates and vice versa as illustrated by

the figure below. Risk and return trade-offs are commonly known as risk-return spectrum. It is

essential to compare the return on investment before investing. It is therefore apparent to

measure the risk and return by both using direct and relative measurement. There are various

modules of investment with varies risk-return spectrum. The overall advancements include
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equity, high yield dept, long-term dept, short-term dept, and property. If a given investment is

risker to perform, it means that it needs more resources and time to execute. Risk attracts

compensation, the higher the risk taken the higher the obligatory compensation (Tarantino and

Cernauskas, 2011). It is important for individuals to be risk aversive when exposed to uncertainty

situations to cut uncertainty. Individuals can also use Beta to determine their investment return

sensitivity relative to the market risk.

b) Time Value of Money Principle

This principle is associated with value of money. It is the concept based on the ideology

that people or organizations would rather have money now than in the future. Although money

can earn compound interest, its value is more appreciated in the present than in the future. To

compute time value of money, one considers the current payment, future value, time frame, and

the interest rate. Another determinant of time value of money is the number if compounding

periods (MacLeod, 2016). For instance, if offered two options to choose to receive $1000 now
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versus $1000 in three months. Its rational most people will choose the first option. Receiving

$1000 now has more utility to the beneficiary as compared to the future due to linked

opportunity cost. Such opportunity costs encompass potential gain on interest because the money

has a potential to grow over time as illustrated in the figure below.

Figure 2

c) Cash Flow Principle

The principle of cash flow, mainly discuses cash inflow and outflow of individuals and

organizations. Cash flow is the amounts of money and cash-equivalent that are transferred into

and out of individual or organization accounts. More cash flow now is ideal than later cash flow.

An organizations capacity to create value for shareholders is based on its capability to generate

positive cash flows which maximizes long-term free cash flow. Financial education provides the

basic literature for individuals and organizations to understand hoe to asses cash, timing, and

uncertainty associated with cash flow (Rudman, 2015). Positive cash flow suggests growing
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individual or organizational liquid assets thus able to take care of future expenses. Strong

financial flexibility enables people or organization to take advantage of profitable ventures.

d) Profitability and Liquidity Principle

The profitability and liquidity principle, is crucial for investors perspective. Both are

ingredients for successful and sustainable business. Liquidity measures immediate short-term

financial obligations including purchasing of assets, loans processing and repayments, repayment

of expenses, and distribution of dividends and profits. An organization is said to liquid if it has

cash or assets that can be easily be converted to cash. Current ratio is used to measure liquidity

(that is the ratio of current assets to current liabilities). Profitability on the other is a measure of

business financial success. It is the amount of revenue remaining after reducing all expenses

incurred (Barrow and Barrow, 2008). It is a financial performance measure. It provides financial

rewards to the business. High profitability helps the business maintain liquidity through

reinvesting. It is important to understand how to maximize profits with moderate or lower risk.

e) Diversity Principle

Diversity principle helps to build a business optimum portfolio. It is the process of

allocating capital in a manner that cuts the exposure of one specific risk or asset. This can be

done through investing in different assets. Basically, if you put all your liquid cash into one

asset, it may collapse. The latter leads to the collapse of your business. It is apparent to consider

other ventures that you can invest in to diversify your business (Tarantino and Cernauskas,

2011). Risk-free investment lowers the ultimate risk. Business diversification increases returns

through minimizing vulnerable risks.

Financial Education Principles and Financial Well-being

While the paper has pinpointed the core principles of finance, it is hard to educate

consumers on all the aspects at the same time. It is therefore apparent for educators to have a set

of skills guided by a set of principles to help them execute financial tutoring. There are five

designed principles that should guide the educators in their work.

i) Understanding the individual or organization

As a financial service provider, you should understand your customer’s specific needs,

challenges, and objectives. This will help to service provider define the appropriate measures to

be undertaken. The consumer will benefit from the appropriate advice thus seeking better future

financial well-being (MacLeod, 2016). 

ii) Providing actionable and relevant information in time

It is apparent that most people take actions with regards to the information they have at

hand. For some, they take action regarding to the challenges at hand. Financial service providers

therefore should provide actional and reliable information to the clients on time. This will help

them make correct decisions that favors their financial well-being.

iii) Improvement of financial skills

After learning the basics of finance, consumers should develop a culture to build their

financial skills. Core knowledge such as understanding how, when, and where to find reliable

financial information to make personal decisions is important.

iv) Building motivation to financial well-being

Educating people on the principles to financial well being helps then develop positive

finance qualities and attributes. Finance service providers should focus to help their clients to
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focus on their own values (Barrow and Barrow, 2008). Such teaching will help clients to

preserve when they encounter obstacles. Positive people always achieve good results. This

implies if an individual is positive about the set financial goals then they will be confident to face

obstacles.

v) Simplify financial decision-making process and follow-ups

The challenges people go through positively correlates with their actions. Finance

specialists can help individuals to follow through their intentions by pointing out the external

forces that influence their decision making. Mostly the surrounding of an individual affects the

decisions of a person.

The above five effective financial education principles are key drives to financial well-

being. An individual or organization financial well-being are defined and measured with their

sense of control and freedom with finances (Barrow and Barrow, 2008). Only the most

disciplined individuals attain their ultimate goal of financial freedom. They control today’s

finances with a keen forecast of the future.

Conclusion

All the two sets of principles discussed above are relevant to developing people’s abilities

to take actions that will improve their financial well-being. Financial education programs should

support at least one of these finance principles depending on specific concerns to be addressed.

Organizations on the other hand, should partner with financial education providers to address

these principles. This depends on the organization’s goals, available tools, and available

resources. Magee, Brealey, and Brealey, (2015) suggests that to effectively implement these
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strategies the companies or individuals seeking the services should fully collaborate with the

educators.

The service providers should clearly understand the challenges and needs of their clients.

To solve a problem, you should first understand the root cause. The financial action model

should be used to implement the principles of finance. Learning the challenges different

organizations and individuals face in their current economic and social environment,

understanding possible opportunities, contemplating on their financial goals will help attain

financial well-being. Effective financial principles and finance education principles help people

and organizations to bridge the gap between their desires and actions they take at a moment. By

understanding and implementing the financial action model, an individual will understand how

know-how, motivation, and opportunity work collectively to support their course of action in

every situation.
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References

Baker, D., & Clark, R. (2011). Finance. Oxford: Oxford University Press.

Barrow, C., & Barrow, C. (2008). Practical financial management: a guide to budgets, balance

sheets and business finance. London: Kogan Page.

Girling, P. (2013). Operational risk management: a complete guide to a successful operational

risk framework. Hoboken, NJ: John Wiley & Sons.

Hassan, K., & Rashid, M. (2019). Management of Islamic finance: principle, practice and

performance. Bingley, UK: Emerald Publishing.

MacLeod, S. (1976). Financial environmental measures in developing countries: the principle of

additionality. Morges, Switzerland: International Union for Conservation of Nature and

Natural Resources.

Magee, S., Brealey, R. A., & Brealey, R. A. (2015). AFCP810 finance principles. North Ryde:

McGraw-Hill.

Rudman, J. (2015). Principles of finance. Place of publication not identified: Natl Learning Corp.

Tarantino, A., & Cernauskas, D. (2011). Essentials of risk management in finance. Hoboken, NJ:

J. Wiley & Sons.