Basic Financial Terms

This articles goes through all the basic financial terms you will need to start your journey in the wonderous world of finance and economics.

Assets

Assets are the properties that a person or company owns. Its an economic resource which will benefit the owner in the future. In other words, anything that provides an economic advantage to the person or company is classified as an asset. Assets are further divided into different subdivisions based on their properties.

(i)Non-current assets:

Non-current assets in simple terms are those assets that are kept with the company or person not for the purpose of resell but to facilitate operations or as an investment. At an individual level, a house or the car one drives can be called as a non-current asset. At a company level, the machinery they use can be classified as a non-current asset. These assets are purchased with the thought of usage, not for the purpose of sale, though it can be sold in the far future.

(ii)Current assets:

Current assets are those assets which are held by a company or a person with the purpose of converting it into cash in within the time period of 1 year. These types of assets are common in the company perspective as compared to the personal perspective. An example would be the cookies a bakery makes to sell.

Liabilities

Liabilities means the amount a person or company owes. Its represents an amount that the company or person is obliged to pay to the third party. Liabilities help finance investments for which one doesn't have the required amount at that point of time. Liabilities can be further categorized based on their properties.

(i)Non-current liabilities

These are liabilities that can be paid after the term of 1 years. These liabilities are often for the large purchases. In the case of an individual, a loan to buy a house that will be paid over the course of 5 years can be considered as a non-current liability. In the case of a company, the purchase of a new manufacturing unit can be financed by a loan to be paid over the course of 5 years.

(ii)Current liabilities

These are liabilities that are to be paid in the term of 1 year. These liabilities are commonly seen for the small and regular purchases. At an individual level, the amount spent on a credit card can be considered as a current liability. At a corporate level, the goods they purchased on credit, for which has to be paid during the period of 3 months is considered as a current liability.

Inflation:

Inflation is the rise of price of goods and commodities over a period of time. The amount of goods one can purchase decreases with the rise in inflation. Inflation leads to the decline of purchasing power and and increase in prices. It usually happens when a country prints more money than what is justifiable by the country's wealth. Most central banks aim for a 2-3% inflation rate.

Net worth

Net worth from an individual and corporate perspective is basically the value of your assets minus the value of you liabilities. In other words, everything you own minus everything you owe. Net worth can be a form of assessing a person's or company's financial health. If a company has a positive net worth, this indicates the strong financial health it possess. But in the unfortunate case that its net worth does become negative, it is used to indicate financial struggles.

Diversification

Diversification is a risk management technique that is widely used. It depicts the variety of investments one has in their portfolio. It is usually executed in different asset classes (stocks, bonds, mutual funds etc.) Diversification can also be achieved by buy assets from different countries, industries and size of companies. In the unfortunate case that country A's market crashes, a diversified portfolio will be less impacted as compared to an investment portfolio concentrated on country A's market.

Liquidity

Liquidity is how quick and easy can an investment be converted into cash. Liquid assets usually are easy to convert into cash without much change in their value whereas illiquid assets are usually more difficult to convert into cash and can have constant changes in their value. Cash is the most liquid asset where as real estate is considered to be an illiquid asset as their price in the market may fluctuate drastically while having the difficulty to sell a house in a short period of time. Investors usually assess the liquidity of an asset and assess its probable possibility of gain.

Capital Gains

Capital gains is the increase in value of an asset you own when sold. If you had purchased an asset and sold it for more than what you had bought it for, you have capital gain. Capital gains are recorded only upon sale, regardless of the increase of price when the asset was under your ownership. Most countries tax you on capital gains also, but taxes depend on how long you have had that asset for i.e. long-term investment or short-term investment.

Debt to Equity Ratio

Debt to equity ratio is a measure of a company's financial leverage. Financial leverage refers to the amount of loans or borrowed funds that a company utilizes for their operations and investments. To derive this number, one has to divide the total liabilities of the company by the total equity of the company. Banks and investors use this to analyze how financially leveraged a company is. This doesn't provide the whole picture of the finances and operations of a company but this certainly acts as a tool to paint the picture.

Conclusion

In conclusion, the topics explained in this article enables one to comprehend basic financial areas. It is necessary to dig deeper into such topics to fully comprehend the market as they base areas are essential for a strong base in personal and corporate finance. Overall, this article serves as a stepping stone for future investigations and provides a solid foundation for continued exploration in this field.