Must know for HR....Basic understanding of Business Finance - Part 3

In my previous posts I had made you aware of basic jargons of Economy and few financial terms.  You all must be aware of basic terms “Economy”, “Consumption” and “Investment”.  Now let’s understand the relationship between them.
Nowadays everyone is talking about the GDP slowing down, consumption is dwindling, investment rates are falling, policy paralysis is troubling the economy. All these things do appear complex and to understand what they mean and how are they inter-related, let’s take analogy of a CAR and relate it to Economy.
By now you already know GDP or the ECONOMY stands for the Sum total of goods and services produced by the Economy
So let's say the CAR = the ECONOMY

What does a CAR love? Perhaps the CAR loves good roads which help it produce a smooth uninterrupted drive.

So if CAR=ECONOMY, let's say SMOOTH ROAD = GOOD CONSUMPTION DEMAND.

So Just as a good road gives the car an opportunity to go fast, so also good CONSUMPTION DEMAND would give the ECONOMY the opportunity to grow faster. But while smooth and good roads are a necessity for a smooth and fast drive, it is not sufficient. This is because the car also loves FUEL.

So if CAR=ECONOMY, let's say FUEL = INVESTMENT

As long as the CAR has FUEL it can move ahead. Likewise as long as the ECONOMY gets INVESTMENT it can grow and move ahead. So a CAR needs both FUEL as well as GOOD ROADS for a smooth and fast drive and likewise the ECONOMY too needs both GOOD CONSUMPTION DEMAND as well as INVESTMENTS to grow well and move ahead.

Thus if CAR=ECONOMY; let's say A SMOOTH AND FAST DRIVE = A SMOOTH AND FAST GROWTH OF ECONOMY.

Now let's see the impediments that can break the car's smooth journey.Clearly, if we follow the logic that we have established so far,
BAD ROADS / TRAFFIC on one hand and FUEL SCARCITY on the other hand can slow down the progress of the car. In the same way a FALL IN CONSUMPTION and LACK OF INVESTMENT slows down the economy.

So what does one do to get the car going all over again??

For the car to get going, we will need PEOPLE to PAVE the roads and build INFRASTRUCTURE like FLYOVERS and EXPRESSWAYS.  In a sense these are reforms and the PEOPLE responsible for this are the POLICY MAKERS.

In the case of the ECONOMY, we need similar things to be done. For CONSUMPTION DEMAND to pick up we need REFORMS that help in Creating better products at competitive prices, easier and cheaper credit through lower interest rates so people have easy money to buy, better infrastructure so that goods are made available more efficiently. These are some of the actions among many that would induce CONSUMPTION DEMAND.
For INVESTMENTS to pick up, the government needs to improve the SENTIMENTS of the people from NEGATIVE to POSITIVE. If people believe that the economy is well poised to grow and the future looks bright, they will be more inclined to take money out of their pockets and invest the same in the economy by way of either buying shares or Buying debt (Depositing money with banks / companies)
Now the moot question is what will make people believe in the India growth story?
This may happen if the government starts implementing REFORMS and signals to the people that it is determined to remove all the impediments that are slowing the economy so that the economy has a smooth road to drive along. When people start seeing this happen, they start believing that the economy is back on its rails. As the sentiments improve based on REAL ACTION OR REFORMS to eliminate hurdles, the positive feeling starts to spread like a contagion. This encourages other investors including investors from overseas to augment their investments. This is akin to a good and healthy supply of fuel for the CAR. So as the roads get paved and highways & bridges get built, the car resumes its journey and gathers speed. Because the car is moving fast and consuming fuel at a faster rate, the suppliers are encouraged to increase their supply for they believe that a fast moving car would be well poised to pay for the fuel. Likewise, when the ECONOMY GAINS MOMENTUM, INVESTORS are encouraged to INVEST MORE because they believe that a fast growing economy would be well poised to give healthy returns.
Hope now you have been able to establish the relationship between Economy, Consumption and Investment
In next post I will touch upon some of the financial terms which you keep hearing with respect to Companies however do not have detailed information for…

4 comments:

  1. Thanks a lot for sharing in very simple and crisp way. Interesting to read and easy to understand.

    Regards
    Neha Fatehchandani

    ReplyDelete
  2. Anonymous9:21:00 AM

    Gud sharing - Panks

    ReplyDelete

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