6 Principles of Finance You Must Know
Financing is the process of collecting funds to invest to ensure proper utilization. Proper
financing is required to follow 6 core principles of finance to ensure the maximization of
benefits. The person who is responsible for managing the fund is well known as a financial
manager. Briefly, finance is the management of funds. Knowledge of how to run your
finances is very important not only for your own life but also for your future or existing
business. Doing a finance assignment can help you gain insights into economic trends and
financial instruments as well as manage your funds effectively. In this article, we will briefly
explain the principles of finance.
Contents hide
Principles of Finance
There are six principles of finance you must know
Risk and Return
Time Value of Money
Cash Flow
Profitability and Liquidity
Diversity
Hedging Principles
Principles of Finance
Principles act as a guideline for investment and financing decisions. Financial managers take
operating, investment, and financing decisions. Some of this is related to the short term and
some long term. The 6 Principles of Finance everyone should Know whether it is for
individuals or organizations.
There are six principles of finance you must know
The Principle of Risk and Return
Time Value of Money Principle
Cash Flow Principle
The Principle of Profitability and liquidity
Principles of diversity and
The Hedging Principle of Finance
Risk and Return
The principle of Risk and Return indicates that investors have to be conscious of both risk
and return, because the higher the risk higher the rates of return, and the lower the risk, the
lower the rates of return. For business financing, we have to compare the return with risk. To
ensure optimum rates of return investors need to measure risk and return by both direct
measurement and relative measurement.
Time Value of Money
This principle is concerned with the value of money, that value of money is decreased when
time passes. The value of $1 of the present time is more than the value of $1 after some time
or years. So before investing or taking funds, we have to think about the inflation rate of the
economy and the required rate of return must be more than the inflation rate so that the return
can compensate for the loss incurred by the inflation.
Cash Flow
The cash flow principle mainly discusses the cash inflow and outflow, more cash inflow in
the earlier period is preferable to later cash flow by the investors. This principle also follows
the time value principle that’s why it prefers earlier benefits rather than later years benefits.
Profitability and Liquidity
The principle of profitability and liquidity is very important from the investor’s perspective
because the investor has to ensure both profitability and liquidity. Liquidity indicates the
marketability of the investment i.e. how easy to get cash by selling the investment. On the
other hand, investors have to invest in a way that can ensure the maximization of profit with a
moderate or lower level of risk. This is best overlooked by a qualified accountant to ensure
all tax obligations are met.
Diversity
This principle helps to minimize the risk by building an optimum portfolio. The idea of a
portfolio is, never to put all your eggs in the same basket because if it falls then all of your
eggs will break, so put eggs separated in different baskets so that your risk can be minimized.
To ensure this principle investors have to invest in risk-free investments and some risky
investments so that ultimately risk can be lower. Diversification of investment
ensures minimization of risk.
Hedging Principles
The hedging principle indicates that we have to take a loan from appropriate sources, for
short-term fund requirements we have to finance from short-term sources, and for long-term
fund requirements, we have to manage funds from long-term sources. For fixed asset
financing is to be done from long-term sources.
Finally, if you have a basic understanding of finance and its principles then you will be able
to take financial decisions effectively. And there is a higher possibility to become financially
gainer.