The field of finance encompasses numerous corporate and governmental activities. In the most basic sense, the term "finance" can be used to describe the activities of a firm attempting to raise capital through the sale of stocks, bonds, or other promissory notes. Similarly," public finance" is a term used to describe government capital-raising activities through the issuance of bonds or the imposition of taxes. The theory of finance, in the broadest sense, can be defined as an integrated body of knowledge constructed around the goal of maximizing shareholder wealth and the principles of the time value of money, leverage, diversification, and an investment's expected rate of return versus its risk.
Within the discipline of finance, there are three basic components. First, there are financial instruments. These instruments—stocks and bonds—are recorded evidence of obligations on which exchanges of resources are founded. Effective investment management of these financial instruments is a vital part of any organization's financing activities. Second, there are financial markets, which are the mechanisms used to trade the financial instruments. Finally, there are banking and financial institutions which facilitate the transfer of resources among those buying and selling the financial instruments.
In today's business environment, corporate finance addresses issues relating to individual firms. Specifically, the field of corporate finance seeks to determine a firm's best sources of capital, the optimal investments that a firm should make, the best methods of financing those investments, and the method by which to manage daily financial activities to ensure that firms have adequate cash flow. Finance influences all segments of corporate activity, both for profit oriented firms and nonprofit firms. Through the acquisition of funds, the allocation of resources, and the tracking of financial performance, finance provides a vital function for any organization's activities. Furthermore, finance provides stockholders and other interested parties with a tool with which to assess management activities and measure a firm's performance.
Like other business disciplines, the study of finance was originally part of the field of economics. By the end of the 19th century, however, the Industrial Revolution had changed the existing business environment so drastically that there was a growing need for the detailed study of business problems and processes. Thus, corporate finance was born with the purpose of describing and documenting the quickly evolving financial instruments, markets, and institutions in the newly industrialized age.
During the 1930s and the Great Depression, the field of finance underwent a series of meaningful changes. Due to the circumstances of the time, individuals involved in the field became increasingly focused on activities surrounding bankruptcy, liquidation, reorganization, and government regulation. During the 1940s and early 1950s, finance continued to exist as a descriptive field that focused on raising capital and on activities concerning stockholders' equity and liabilities.
In the mid-1950s, finance underwent further changes. The field of finance evolved from a purely descriptive discipline to a proactive field that provided managers with financial information useful in making decisions regarding their firm's operations. Many of these changes can be attributed to the work of Joel Dean (1906-1979), who furthered the understanding of the area of capital budgeting and sought to make it a major discipline within the field of finance. Capital budgeting resulted in an increased understanding of the cost of capital and the valuation of financial assets. Furthermore, these changes led to more interest in the theory of capital structure, security analysis, and portfolio management.
The field of finance continued to evolve in the 1980s and 1990s, constantly reacting to activities in the economy and to new theoretical ideas. During periods of economic volatility, finance provides managers with tools to react swiftly to economic downturns. In an era of global competition and international business, finance is used to better understand and value the operations of firms abroad. As government deregulation of various industries results in industry-wide consolidations, financial managers turn their attention to the valuation of existing firms and the pricing of mergers and acquisitions. Stock buybacks and new sources of financing represent other areas of interest to financial managers in a rapidly changing business climate.
[ Kathryn Snavely ,
updated by David P. Bianco ]
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