How the circular flow of money works What is the difference between real flows and money flows What “leakages” and “injections” are. Why your teams need this course. This training is useful for business owners and managers. It will also help anyone who struggles to keep up with the complexity and the pace of the global economy. Related: Best Tips for Forced Appreciation in Real Estate Investing. Long term rental: Our recommendations. We, on Mashvisor, recommend that you start with Airbnb rentals. It is one of the best real estate investment strategies, especially for beginner real estate investors. If you think carefully about all the pros that we have.

Difference Between Real And Money Flow In Tabular Form
Difference Between Real And Money Flow Class 12
Difference Between Real Flow And Money Flow Meritnation

The previous article was an introduction about the two basic decisions that corporate finance helps a corporation in making. Prima-facie, these two decisions may look pretty simple. After all everyone raises money in their daily lives and puts it to productive use. Simple accounting can tell us whether or not we should make those financing and investing decisions. So, why is there a need for a complicated subject called corporate finance to make these decisions? Well, it turns out there is a need? The need arises because of this concept of nominal and real value of money. This article will explain why corporate finance is required:

The Concept of Inflation

We are all intuitively aware of the concept of inflation. We know that money loses its value every year. The same amount of money will purchase less and less every year. Let’s say that $100 is required to purchase a certain commodity of goods today. So if there is an inflation of 10%, the same goods will be available for a $110 next year.

Introduction to Nominal Value of Money

So, if we made an investment that was yielding 9% return this year, we would have a total of $109 next year from the $100 we had invested. In accounting terms we would have a profit of $9. This is because we are only considering the nominal values. Nominal values do not consider the effect of inflation, opportunity cost of capital and such other forces which cause the value of money to decrease in a given time period.

The Problem with Nominal Values to Measure a Firm’s Performance:

Nominal values present a distorted image of the firm’s performance to its shareholders and this is to say the least. Consider the case we discussed above. Here, the firm has lost 1% purchasing power. This means they were better off consuming the $100 in year 1 and could have purchased more goods with it rather than investing it and consuming $109 a year later. Thus, if nominal values are considered, firms will end up eroding their capital by investing their money in projects that offer a rate of return that is below the firm’s cost of capital.

Introduction to Real Value of Money

To offset this problem, specialists in corporate finance have come up with the concept of real value of money. The real value of money takes into account inflation, opportunity cost of capital and such other forces. Thus, firms that base their calculations on these inflation adjusted values make better financial decisions as compared to those that do not. The calculation for both real as well as nominal values is simple and can be done with the help of the following formula:

Real Value = Nominal Value / (1 + (i / 100))

i = The prevailing inflation rate in the market

Subjectivity in Real Value of Money:

It must be understood that the real and nominal values of money are subjective. This is because, they are determined using the inflation rate. There is no single measure of inflation. The government itself produces multiple estimates of inflation. Also, for the purpose of the company’s calculation, these measures may not be good enough. So the company may create its own inflation index depending on which the real values are calculated. Thus, there is widespread subjectivity in this calculation. Different companies use different rates to convert nominal values to real values.

The biggest take-away from the concept of nominal and real values is that money in one time period is not directly comparable to money in another time period. It is for this reason we have to calculate present values, future values and the like. These calculations form the backbone of corporate finance.

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Basically, there are two types of circular flow of income – Real Flow and Money Flow. The biggest difference between real flow and money flow is that in case of real flow, exchange of goods and services takes place among various sectors of the economy, but when we talk about money flow, the monetary exchange between the two sectors exists.

A two-sector economy is one where only two sectors exist, i.e. the household sector, which represents the consumer group and producer sector which represents firms.

What is Circular Flow of Income?

The ongoing movement or exchange of goods and services and money across various sectors of the economy is termed as Circular Flow of Income:

Principles of Circular Flow of Income

In the process of exchange, the amount received by the seller is equal to the amount spent by the buyer.
In one direction, there is the flow of goods and services, while in the opposite direction there is a flow of money, with respect to the payments for availing the goods and services, which results in a circular flow.

In this post, we will talk about all the important differences between real flow and money flow, using diagram and examples.

Content: Real Flow Vs Money Flow

Comparison Chart

Basis for Comparison	Real Flow	Money Flow
Meaning	Real Flow implies the movement of factors services and a corresponding flow of goods and services amidst the various sectors of the economy.	Money flow implies the cycle of payment in the monetary form, from firms to households and a corresponding monetary payment from households to the firm.
Flow
Alternative Name	Physical Flow	Nominal Flow
Movement	Clockwise	Anticlockwise
Involves	Factors of production flows from households to firms. Concurrently, goods and services are supplied by the firms to households.	Remuneration is provided to households by the firms for factor services. Concurrently, goods and services are purchased from the business sector by the households.
Use of money	Exchange of goods and services without the use of money.	Exchange of goods and services by using money.

Definition of Real Flow

Real flow is when goods and services move from one sector of the economy to another sector. Real flow is named so because there is the physical transfer of goods and services amidst the two sectors, i.e. households and firms. Hence, it is also termed as product flow or physical flow.

In real flow, the household sector being the owners of the inputs supply factor services in the form of raw material, land, labour, capital and enterprise to the firm, and in exchange, the firm provides goods and services to meet the demand of the households. Therefore, real flow is in the form of:

The household sector provides factors of production to the producer sector.
The actual flow of final goods and services from producers (firms)

Difference Between Real And Money Flow