Corporate Finance and the Role of Money in the World
Corporate finance is the study of relationships between groups of people that quantifies the otherwise immeasurable. Take a look at the role of money in the world to understand how this definition makes any sense at all.
According to Adam Smith, an 18th century economist, the use of money was preceded by a barter system. In a barter system, people exchange goods and services of relatively equivalent value without using money.
Perhaps if you worked growing hemp and making rope out of it, you could give that rope to people in exchange for food, clothes, or whatever else you needed that the people around you might be offering. What happens, though, when someone wants rope but that person has nothing you want? What about those times when you need food but no one needs rope?
Because of these times, people started to use a rudimentary form of money. So, say that you sell your rope to someone but he has nothing you want. Instead, he gives you a credit for his services that you’re free to give to anyone else.
You decide to go and buy a bunch of beer, giving the brewer the note of credit, ensuring that the person who bought your rope would provide the brewer a service in exchange for giving you beer. Thus, the invention of money was born, though in a very primitive form.
Looking at money in this way, you come to realize that money is actually debt. When you hold money, it means that you’ve provided goods or services of value to someone else and that you are now owed value in return.
The development of a standardized, commonly used currency among large numbers of people simply increases the number of people willing to accept your paper or coin I.O.U.s, making that currency easier to exchange among a wider number of people, across greater distances, and for a more diverse variety of potential goods and services.
According to 21st century anthropologist David Graebner, this story was probably something closer to bartering with the government as a taxation, which meant providing goods and services to the government (for example, the emperor) and then being provided units of currency worth production rations.
So you can say that money was invented for the first government contractors as a method for the government to acquire resources in return for units of early currency worth specific amounts of resources rather than a true barter
Simply put, money is debt for the promise of goods and services that have an inherent usefulness, but money itself is not useful except as a measure of debt. People use money to measure the value that they place on things.
How much value did a goat have in ancient Egypt? You could say that one goat was worth five chickens, but that wouldn’t be very helpful. You could say that a brick maker’s labor was worth half that of a beer maker, but you couldn’t exactly measure that mathematically, either. Using these methods, there’s no real way to establish a singular, definitive measurement for the value that people place on different things.
How can you measure value, then? You measure value by determining the amount of money that people are willing to exchange for different things. This method allows you to very accurately determine how people interact, the things they value, and the relative differences in value between certain things or certain people’s efforts.
Much about the nature of people, the things they value, and even how they interact together begin to become very clear when you develop an understanding of what they’re spending money on and how much they’re spending.
Fast-forward more than eight millennia — well after the establishment of using weighted coins to measure an equivalent weight of grain, well after the standardized minting of currency, and well past the point where the origins of money became forgotten by the vast majority of the world’s population (welcome to the minority) — all the way into the modern era of finance.
Money begins to take on a more abstract role. People use it as a way to measure resource allocations between groups and within groups. They even begin to measure how well a group of people are interacting by looking at their ability to produce more using less. Success is measured by their ability to hoard greater amounts of this interpersonal debt.
The ability to hoard debt in this manner defines whether the efforts of one group of people are more or less successful than the efforts of another group. People use money to place a value on everything, and, because of this, it’s possible to compare apples and oranges. Which one is better, apples or oranges?
The one that people place more value on based on the total amount of revenues. Higher revenues tell you that people place greater value on one of those two fruits because they are willing to pay for the higher costs plus any additional profits.
Corporate finance picks apart the financial exchanges of groups of people, all interconnected in professional relationships, by determining how effectively and efficiently they work together to build value and manage that value once it’s been acquired. Those organizations that are more effective at developing a cohesive team of people who work together to build value in the marketplace will be more successful than their competitors.
In corporate finance, you measure all this mathematically in order to assess the success of the corporate organization, evaluate the outcome of potential decisions, and optimize the efforts of those people who form economic relationships, even if for just a moment, as they exchange goods, services, and value in a never-ending series of financial transactions.