Finance

I'm finding out that finance uses accounting data and economic principles to make decisions that effect the well being of a business. You want to look at the cash flows of a business. In accounting they use the accrual method. For example if you build a pool table for $1000 and sell it for $5000, according to the accrual method you have made a $4000 profit. But the table was sold on credit and has not yet been paid for. By using the cash flow method your business is actually $1000 in the red. The economic principal used here is marginal cost benefit analysis. What is the marginal cost that will give us the most profit? Accounting tends to use a max profit outlook but does not take into account actually cash flow.

You must also take into consideration the present value of money. If your business makes an investment now, what will the return be and how far in the future will your investment turn a profit? Everyone should know that a dollar today is not worth a dollar tomorrow. Let's say you have two options for investing. Option 1 returns $2 next week and $4 next month and option 2 returns $2.50 next week and $3 next month. Which option would have a higher ROI?

Even though option 1 has a higher total ROI, option 2 returns a higher ROI sooner which can be reinvested to provide greater future earnings. This is why you must take into consideration the present value of money.

Not only can this be applied to business but also personal finances. If you think in terms of your actual cash flow and not what cash you will be getting, people would not go into debt easily.