Categorizing Behavioral Biases
The field of behavioral finance has become fairly developed over the years. There have been many psychologists as well as economists who have been spending a lot of time trying to obtain more information about how behavioral finance impacts decision making. This is the reason that in the past few articles, we have come across […]
What is Annuity? – Meaning and Concept
An annuity, just like a perpetuity, is a shortcut used while making present value calculations. Unlike the perpetuity, which is very difficult to find in real life, we find examples of annuity all around us. The monthly mortgage payments we make, the car loan or student loan that we pay off are all annuities. Annuities […]
Equivalent Annual Costs
In the previous articles we have seen how we can convert a possible future stream of cash flows to its present value today to make investment decisions. We choose amongst competing projects and the one with the highest NPV is usually selected. But sometimes this may not be the appropriate thing to do. Example: Consider […]
Financial Planning – Definition, Objectives and Importance
Definition of Financial Planning Financial Planning is the process of estimating the capital required and determining it’s competition. It is the process of framing financial policies in relation to procurement, investment and administration of funds of an enterprise. Objectives of Financial Planning Financial Planning has got many objectives to look forward to: Determining capital requirements- […]
Nominal and Real Value of Money
The previous article was an introduction about the two basic decisions that corporate finance helps a corporation in making. Prima-facie, these two decisions may look pretty simple. After all everyone raises money in their daily lives and puts it to productive use. Simple accounting can tell us whether or not we should make those financing […]
The economy of any nation can be viewed from the point of view of fund flow. This is a unique way to view the economy, which until now has only been viewed as a sum of all the sectors in it.
In simple words, this means that the economy as a whole is a combination of several smaller units. These smaller units are constantly transferring funds to one another. As a result, some units in the economy have a surplus, whereas others are running a deficit.
The transfer of funds is basically a map that aids in developing a clearer picture of the economic relationships which prevail in the economy. A better understanding of the economy can be obtained by using fund flow as a tool for analysis. This can be done by following the steps given below:
For instance, the economy can be viewed as a combination of the household sector, the business sector, the financial sector, the government sector, and the financial institution sector.
In some countries, the international sector may be listed down separately. This needs to be done only if international investments are significant. Otherwise, they can be added to the government, business, or financial sector depending upon who is conducting the transactions.
It is important not to create too many or too few sectors. The number of sectors created should be enough to aid analysis, but no so much that it unnecessarily creates complications.
This may not be an easy task since the financial details related to private and household sectors are not easily available. Details pertaining to the government and the financial sector are published, whereas those related to other sectors are not.
It needs to be understood that at the end of the exercise, the sum total of all surpluses and deficits should be zero. This will always be the case unless there is a lot of money flowing into or out of the entire economy. If that is the case, then, as mentioned above, the international sector should be considered to be a separate sector within the economy.
The purpose of the exercise is to understand which sectors of the economy are funding, which other sectors of the economy. Once the cash cows of the economy are identified, it is possible for the government to create schemes that help that sector grow even further.
Using this fund flow exercise, it is possible to create an entire map of the various transactions happening in the economy from a macro point of view.
This exercise enables the understanding of how financial systems play an important role in the economy. This is because all the money which is routed from any surplus sector ends up being in the hands of a deficient sector after using the financial system.
From the point of view of the government or the regulator, it is important to identify the paths between surplus and deficient sector so that that the bridge connecting the two can be built as soon as possible.
The fund flow approach, which can be used to understand the flow of funds within an economy, can also be used to understand the flow of funds between different economies.
In the international economy, there are deficit countries that are in need of funds from other countries. Also, there are surplus countries that have additional funds to lend out to other countries.
The international financial system also has to be set up in such a way that it becomes easier for the deficient countries to receive funds from countries that have a surplus.
The bottom line is that fund flows within an economy provide important clues about how the financial system operates in that country. It also provides important clues about the gaps that exist in the financial system and provides a roadmap for the steps which need to be taken to fill that gap.
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