5 Basic Concepts of Financial Management, Which Must Be Understood By Everyone

Overview of the financial management

Financial management is the course that is required to be studied by the business graduates. This course deals with all the aspects related to the money. Mastering this area of study can help the person to make the right financial decision. Some basic concepts of the financial management are taught at the school level, but it may not be quite enough to understand the real-world financial scenario.

It’s necessary to understand the real-world financial scenario to make a smart financial decision on saving, investment, and expenditure. Moreover, it will also help you to find your true purchasing power.

5 Basic Financial Management Concept You Must Understand

There are many concepts in the financial management that are very helpful for everyone to make a financial decision. However, I won’t be going through all the concepts right now. I will be discussing 5 basic financial management concepts in this section of this article that are very commonly used on a day to day life.

1. How the interest rate works

I know that many of you have read about the interest rate. However, many don’t still realize how interest rate really works. I recommend you to download the financial calculator, and it will help you to make things simpler. We know that any person may require a loan at some point of time in their life, and there is also a chance that they won’t be able to pay back the loan and its interest in time.

The annual interest of $100,000 in a year is $5,000. However, the interest rate on the loan the next year will be 5% of $105,000 if you don’t pay the interest for some reason. There may also be other charges because of the late payment of the loan. The magic of compounding is what you need to understand. A very good understanding of this concept has made people poor, and it has also made some people very rich.

2. Time value of money

The concept of the time value of money must be understood by everyone. It’s important to understand this concept while making investment goal, savings, and expenditure plan. A rupee in hand today is worth more than a rupee in hand tomorrow. While making a goal of saving and investment, they tend to completely ignore the concept of time value of money. They tend to make a goal of purchasing something in today’s price after a year of saving some money from their income.

However, they fail to realize that the same amount of money after a year won’t be worth enough to purchase something at the present price. While making an investment goal, you must make a profit plan by converting the future profit into the present value. You can easily do all this calculation with the help of a financial calculator.

3. Inflation

The concept of inflation is widely discussed in both economics and the financial management. In the context of economics, the inflation rate is usually analyzed for knowing the overall economic condition. By knowing this concept you can effectively manage your wealth. It will give you an idea of how much interest you should get in a year to maintain or increase your purchasing power. You won't be in a wealth illusion after understanding this concept clearly.

4. Nominal and real rate of return

The nominal rate of return does not consider external factors, such as inflation or any others; whereas the real rate of return considers all the external factors. You should know this concept to get an idea of your actual rate of return.

5.  Portfolio and risk management

You may be thinking that each and every investment carries the same level of risk. However, it is not correct. I’m pretty sure that you’re not looking to store all your money in the closet. You either keep your money in the bank or you invest your money in some other sectors. The idea of a portfolio is to diversify your money in various sectors and companies to reduce the risk of loss. It’s applicable to both common person and a professional investor. The risk of investing your money in bonds or preferred stocks is less risky than investing your money in the common stock.

However, the return on the common stock is higher. It’s better to understand the concept of the portfolio and the risk management to make a better utilization of the money that is in your hand right now.

Final Thoughts

There is no person in this world that does not have to make a financial decision in their life. Because financial decisions are so important, many ordinary people take the help of a financial consultant to manage their budget. I won’t say that having the understanding of these concepts will help you avoid all the financial consulting services; however, it will make you smart enough to take many basic financial decisions in your life.