Table of Contents
- What are the principles of finance?
- 1. Principle of Risk vs Reward
- 2. Principle of Capital Gains vs Losses
- 3. Principle of Liquidity
- 4. Principle of Common Sense
- 5. Principle of Equity vs Inequity
- 6. Principle of Resilience vs Vulnerability
- 7. Principle of Optimism vs Pessimism
- 8. Principle of Flexibility vs Inflexibility
- 9. Principle of Integrity vs Corruption
- 10. Principle of Optimization vs Maximization
- Other Principles of Finance
What are the principles of finance?
The principles of finance are a set of ideas that help define financial principles as a whole. In financial terms, a principle is an accepted standard that guarantees the value of something. In terms of finance, then, there are a set number of principles that can be regarded as universal truths in this field. There is no alternative but to adhere to these principles of finance in order for any business or other economic entity (whether it’s an organization or private citizen) to survive and thrive.
Some say that the principles of finance are like the commandments – some people follow them all their life while others ignore them at their own risk. Why take risks when you don’t need to? Keep on reading to learn what these fundamental laws of financial success are!
1. Principle of Risk vs Reward
Generally speaking, things with higher risks tend to offer higher rewards. This principle applies to all areas of life, not just finance. When it comes to finance, risk is represented by the financial losses that may occur when trading or doing business with other people. High-risk investments are very volatile but may benefit greatly if handled well; low-risk investments are less likely to generate large profits in a short time period but also much less likely to result in significant losses.
2. Principle of Capital Gains vs Losses
Profits and losses must always be distinguished strictly from each other – they’re never equal because certain things have associated costs while others don’t. For example, an investor can make huge gains on investment only to lose them again due to unrecoverable transaction fees or commissions – these costs create a net loss for the investor in question and prevent him or her from achieving maximum profitability.
3. Principle of Liquidity
Liquidity is the degree to which an asset (in this context we’re talking about financial assets, i.e. money) can be easily converted into cash. The more liquid an investment is, the easier it is to convert that investment into cash – therefore, liquidity goes hand-in-hand with marketability. An illiquid asset can’t be sold quickly because no one wants to buy them; this means that such assets aren’t exposed to market fluctuations and they’re not vulnerable to price changes following supply and demand factors (for example: when there’s low supply and demand, prices tend to soar).
4. Principle of Common Sense
This one is closely related to the previous principle – in order to succeed in the world of finance, you must be able to think critically and not blindly accept anything that doesn’t seem credible or trustworthy. You need to verify facts before acting on them – don’t ever act on “insider information”, for example, because it’s likely that this information is inaccurate or fabricated. This brings us back to the concept of capital gains vs losses: profits shouldn’t be automatically assumed while losses shouldn’t be taken for granted either. Always do your research and use common sense!
5. Principle of Equity vs Inequity
In a business context, equity refers to ownership or a percentage share in a company whereas inequity refers to the lack of it. This principle emphasizes the importance of equity and its widespread benefits: security, steady income, a better quality of life, and so on. When you feel like your company is in your hands and you’re in charge – when you have equity – it’s easier for you to take control and set business goals, knowing that you’ll be able to achieve them.
6. Principle of Resilience vs Vulnerability
This principle states that if an organization or individual acts with resilience, this means they’re less vulnerable than their competitors who may not handle unexpected events as well (or don’t anticipate such events at all). There are many books written about resilient people; they always look ahead because looking back serves no purpose except feeling bad about past mistakes. Resilient people are more likely to succeed because they don’t let themselves get discouraged by short-term failures and always do their best to not make the same mistake twice.
7. Principle of Optimism vs Pessimism
The principle of optimism is directly correlated with the previous one as resilience and optimism go hand in hand: resilient people tend to be optimistic as well. Optimistic people trust that what has happened in the past won’t stop them from achieving success – these people believe in future good outcomes without making efforts towards those goals. Additionally, pessimistic people always think negatively and expect things will turn out badly – this kind of attitude makes them less likely to take risks and they often become stressed because of all that negative thinking.
8. Principle of Flexibility vs Inflexibility
This principle can also be linked to the previous two – for example, if an individual is flexible, they’re able to think more freely and are less likely to form biases. On the other hand, inflexible people usually have a hard time choosing between multiple options because they tend to see only one solution or direction – this limits their ability to think creatively and innovate. This same principle applies towards businesses: being flexible helps them tackle any issues that may arise, while inflexible companies fall behind competitors who have shown greater flexibility in moments of crisis.
9. Principle of Integrity vs Corruption
The word “integrity” stands for honesty, decency, and morally correct behavior; this principle of finance states that businesses and individuals should always follow these rules in order to build a reputable standing. If they are perceived as corrupt, it’s likely their business will suffer in the long run. On the other hand, companies with integrity are more likely to gain customers’ trust, be profitable in the long run and expand their operations around the world.
10. Principle of Optimization vs Maximization
Optimization refers to making things better by finding ways how they can change for the better – this concept is often used when talking about economies with powerful financial systems. For example, if you have a million dollars but your spending habits are wasteful, you’re not maximizing your assets because there could be smarter uses for them – optimization allows you to find these smarter uses. Meanwhile, maximization is the process of making things to the maximum limit – sometimes it might be more efficient but not always.
The above principles of finance are just a few examples of how thinking in terms of finance can help improve one’s life and help achieve goals that may have seemed unreachable before. It doesn’t matter whether you’re dealing with people or businesses, these 10 principles of finance are universal and they apply to anything related to finance.
Other Principles of Finance
Some other useful principles to keep in mind are: being honest vs being honest according to legal standards, being objective vs subjective, minimizing risks by having multiple sources of income vs taking big risks for huge rewards, following basic rules vs breaking them while trying to find loopholes to optimize benefits while minimizing costs etc.
It’s also important to remember that even though principles of finance are universal, they don’t work in every situation and you should always take some time to think about the problem at hand before making any decisions.
Dr. Brown is the founder of Jotscroll, he is a Medical Doctor, Entrepreneur, and author. Dr. Razi Brown holds a medical degree from the University of San Diego. He has invested in many startups and is currently working on his fifth book to be published in the upcoming year.