Dividend Discount Model: Advantages
Dividend discount models are the first type of discounted cash flow models that we will study. The model simply discounts cash flows at a given rate just like any other DCF model. The difference lies in the fact that dividend discount models consider only “dividends” as being legitimate cash flows. Therefore, if a firm pays […]
The Chinese Pension System
There has no doubt about the fact that the Chinese economy is one of the largest economies in the world today. Theoretically, China is the second-largest economy in the world. It is widely believed that the Chinese economy will surpass the American economy to become the largest in the world. However, many economists believe that […]
Free Cash Flow to the Firm vs. Free Cash Flow to Equity
Free cash flow models can be further categorized into two types. There are certain kinds of models which pertain to free cash flow that the firm as a whole will generate whereas there are others that pertain solely to the perspective of equity shareholders. These models are quite different from each other. It is therefore […]
Veto Rights – Meaning and its Importance
The process of negotiations between startup companies and investors is often hotly debated and contested. There are several points of contention between the two parties. However, the two parties are often able to reconcile most of their differences. However, when it comes to controlling of the startup firm, both the startup founders as well as […]
Intermediaries to a Credit Card Transaction
In the past couple of decades, banks have started providing a new type of product called the credit card. The credit card is a revolving line of credit which is offered to customers. Customers can use the card to borrow money to make purchases. They are then offered a credit free period. If they are […]
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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