– written by Karthik Palaniappan
Finance is a very unique industry – its basic tenets are not beyond the grasp of the simplest of people. Take the example of a person who sets up a simple tea shop in rural India. This person needs a space to set up shop, and some simple kitchen apparatus for which there is an initial expenditure. While it would, of course, be wonderful if he had the means to pay for this himself, chances are very high that he has to borrow money from someplace – either a bank, or a rich money-lender. Both these players expect to be paid back, along with interest, in a reasonable timeline. (Interest, at some level, is not very different from rent paid to occupy a space that belongs to someone else – it is just the cost of access to money)
On an ongoing basis, he needs to spend on consumables such as tea, sugar, and milk, on staff salaries, on rent, and on payments made to his financier towards interest and capital repayment. The business is considered profitable only if the income that he makes from his sales exceeds his expenses.
Our tea-shop owner knows this. He also knows a few other things. He knows where to raise capital from. He knows how much interest is reasonable. He knows how to set up his infrastructure at a reasonable cost. Finally, he knows how to price his tea (as compared to the market rate), and how many cups of tea he needs to sell at that price in order to make a profit. Our tea-shop owner does not have an MBA – and yet he understands the basics of finance and how money makes the business ecosystem run.
We’ve entered several financial transactions in our life too – and we’ve been both buyers and sellers of products or services. Case in point – buying or selling a used car. As a buyer, we are looking to pay as little as possible. As a seller, we try to sell for as much as possible. Depending on how important the transaction is to the buyer and the seller, we settle on a price in the territory between the buyer’s price and the seller’s price. And where the buyer does not have access to personal funds, he or she depends on a bank loan or other source of financing.
Such transactions are at the heart of the finance industry – although for much more complex products (which could even be whole companies, themselves). Consider the recent mergers in the Indian business landscape – Flipkart acquiring Myntra, Olacabs merging with TaxiForSure, and Kotak Mahindra Bank merging with ING Vysya bank – in all of these cases there were financial components involved that required two things: A comprehensive valuation by both the buyer and the seller – Flipkart needed to ensure that it did not pay too much for Myntra, and the Myntra executives needed to ensure that they didn’t get paid too little, and a source of funds to finance the transaction.
There are finance professionals involved in every step of such transactions. This series of articles aims to throw more light on what it means to work in finance.