INTRODUCTION TO ECONOMIC ACTIVITY
Economic activity began with the caveman, who was economically self-sufficient. He did his own hunting, found his own shelter and provided for his own needs. As primitive populations grew and developed, the principle of division of labour evolved. One person was more able to perform an activity than another and therefore each person concentrated on what he did best. While one hunted, another fished. The hunter then traded his surplus to the fisherman, and thus each benefited.
In today's complex economic world, neither individuals nor nations are self-sufficient. Nations have utilized different economic resources; people have developed different skills. This is the foundation of world trade and economic activity. As a result of this trade and activity, international finance and banking have evolved.
For example, the United States is a consumer of coffee, yet it does not have the climate to grow any of its own. Consequently, the United States must import coffee from countries (such as Brazil) that grow coffee. On the other hand, the United States has large industrial plants capable of producing a variety of goods, which can be sold to countries that need them.
If nations traded item for item, such as one automobile for 10,000 bags of coffee, foreign trade would be cumbersome and restrictive.
But instead of barter, which is the trade of goods without an exchange of money, all countries receive money in payment for what they sell. The United States pays for Brazilian coffee with dollars, which Brazil can then use to buy the wool from Australia, which in turn can buy textiles from Great Britain, which can then buy tobacco from the United States.
Foreign trade, the exchange of goods between nations, takes place for many reasons such as: no nation has all the commodities that it needs, a country often does not have enough of a particular item to meet its needs, and one country can sell some items at a lower cost than other countries.
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EXCHANGE RATES
Money is demanded in order for it to be used to buy and sell goods and services. The same applies to international currency. Foreigners buy pounds in order to buy British and other goods and services. The exchange rate is the rate at which the £1 will exchange with other currencies. For example in the Spring of 2004, the £1 exchanged for about 1.40 euros. Let us assume that one pound exchanges for 1.40 euros. Demand for pounds may come from two sources. Firstly, when British producers sell goods in France they will want payment in pounds, but will often be paid in euros. Secondly, French citizens who want to purchase shares in British assets, e.g. shares in Manchester United plc or Cadbury Schweppes, must change their euros into pounds to buy them.
On the other side of the equation, a supply of pounds may arise in the foreign exchange market because UK firms and households want to purchase French goods, and because UK citizens want to purchase French assets.
To make the maths in this case study easier we will assume that £1 initially exchanges for 2 euros. If Cadbury Schweppes sells a bar of chocolate for 50p in this country, this will cost the French consumer 1 euro. However if the £ falls in value to £1.50 euros the same type of chocolate bar will only cost 75 cents (0.75 euros). We would therefore expect Cadbury Schweppes to sell more chocolate bars and other goods in the European Union at the lower exchange rate.
We can therefore make a generalisation that a larger quantity of pounds will be demanded at lower euro-sterling exchange rates.
You should be able to see that if the £ rises relative to the euro it will become harder for UK firms to sell into European Union markets.
The exchange rate is the rate at which one currency will exchange for other international currencies. This rate will vary over time depending on the relative strength of the trading economies of the countries considered.
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FINANCIAL PLANNING
A financial plan consists of sets of financial statements that forecast the resource implications of making business decisions. For example, a company that is deciding to expand e.g. by buying and fitting out a new factory will create a financial plan which considers the resources required and the financial performance that will justify their use. You can see from this statement that the financial plan will need to take into account sources of finance, costs of finance, costs of developing the project, as well as the revenues and likely profits to justify the expansion programme.
Planning models may consist of thousands of calculations. Typically these plans will be constructed with the aid of forecasting models and spreadsheets that can calculate and recalculate figures such as profit, cash flows and balance sheets simply by changing the assumptions. For example, the business may want to do one set of calculations for low, medium, and high demand figures for its products.
Financial plans are typically made out for a given time period, e.g. one, three or five years. The length of the time considered depends on the importance of projecting into the future and the reliability of estimates the further we consider the future.
Long-term plans are created for major strategic decisions made by a business such as: take over and merger activity, expansion of capacity, development of new products, overseas expansion.
In addition financial planning will be carried out for shorter time spans. For example, annual budgets will be created which can be analysed by month and by cost centre.
Short term financial plans then provide targets for junior and middle management, and a measure against which actual performance can be monitored and controlled. In addition it is normal practice for a business to prepare a three- or five-year plan in less detail, which is updated annually.
A budget is a short term financial plan. It is sometimes referred to as a plan expressed in money - but it is more accurately described as a plan involving numbers. A cost centre is defined by CIMA as 'a production or service location, function, activity or item of equipment whose costs may be attributed to cost units'.
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BANKS AND BANK ACCOUNTS
Banks and bank accounts are regulated by both state and federal statutory law. Bank accounts may be established by national and state chartered banks, and savings associations. All are regulated by the law under which they were established.
Until the early 1980's interest rates on bank accounts were regulated and controlled by the national government. A ceiling existed on interest rates for savings accounts. Interest payments on demand deposit accounts were generally prohibited. Banks were also prohibited from offering money market accounts. The Depository Institutions Deregulation Act of 1980 (D1DRA) eliminated the interest rate controls on savings accounts. The restrictions on checking and money market accounts were lifted nationwide.
The operation of checking accounts is governed by state law supplemented by some federal law. Article 4 of the Uniform Commercial Code, which has been adopted at least in part in every state, "defines rights between parties with respect to bank deposits and collections." Part 1 of the Article contains general provisions and definitions. Part 2 governs the actions of the first bank to accept the check (depository bank) and other banks that handle the check but are not responsible for its final payment (collecting banks). Part 3 governs the actions of the bank that is responsible for the payment of the check (payer bank). Part 4 governs the relationship between a payer bank and its customers. Part 5 governs documentary drafts. These are checks or other types of drafts that will only be honored if certain papers are first presented to the payer of the draft.
The banking crisis of the 1930's led to the development of federal insurance for deposits which is currently administered by the Federal Deposit Insurance Corporation. Funding for the program comes from the premiums paid by member institutions. The bank accounts of individuals at institutions which are insured are protected for up to an aggregated total of $100,000.
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