8.1 Functions of Money

Money is a universal tool that enables the smooth operation of the economy by performing specific roles that support business transactions and economic stability. Kenyan businesses, whether in retail, agriculture, or service sectors, rely on money to conduct daily operations efficiently. The functions of money are foundational concepts that every business manager must grasp to understand financial flows and economic interactions.

8.1.1 Medium of Exchange

The primary function of money is to act as a medium of exchange, facilitating the buying and selling of goods and services without the inefficiencies of barter. In Kenya, where the informal sector is significant, money eliminates the need for a double coincidence of wants, which is a major limitation of barter trade. For example, a retailer in Nakuru can sell products and accept Ksh payments that can later be used to pay suppliers or employees, streamlining commercial operations.

Key aspects of money as a medium of exchange:

• Universally accepted: Money must be widely accepted within the economy for it to serve as an effective medium of exchange. Kenyan shillings are accepted nationwide, from urban centers like Nairobi to rural markets in Kisumu.
• Facilitates specialization: By enabling trade, money allows businesses to specialize in production, leading to increased efficiency and productivity.
• Reduces transaction costs: Using money avoids the complexities and time delays involved in barter exchanges.
• Provides liquidity: Money allows businesses to quickly convert goods and services into purchasing power.
• Supports economic growth: Efficient exchanges promote higher trade volumes, contributing to Kenya’s GDP expansion.

8.1.2 Unit of Account

Money provides a common measure for valuing goods and services, which simplifies pricing, accounting, and economic calculation. Businesses in Kenya depend on this function to maintain financial records accurately and to compare costs and revenues across different products.

Essential features of money as a unit of account:

• Standard measurement: All goods and services are priced in Kenyan shillings, enabling clear value comparisons.
• Facilitates budgeting: Companies like Equity Bank use money’s unit of account function to plan budgets and forecast financial performance.
• Enables profit calculation: Businesses calculate profits by subtracting costs from revenues expressed in a single monetary unit.
• Supports taxation and regulation: The government uses money to assess taxes and tariffs uniformly across industries.
• Enhances price transparency: Consumers can easily compare prices, promoting competitive markets.

8.1.3 Store of Value

Money allows individuals and businesses to preserve wealth and purchasing power over time. In Kenya, this function is critical for saving and investment decisions, especially in a context where inflation can erode value.

Characteristics of money as a store of value:

• Durability: Money must retain its physical form over time; Kenyan banknotes and coins are designed for durability.
• Stability of value: While inflation affects money’s value, stable currency encourages saving and investment.
• Portability: Money can be easily carried and stored, facilitating wealth preservation.
• Divisibility: Money can be divided into smaller units, allowing precise value storage.
• Acceptability in future transactions: Money saved today can be used for future purchases or investments.

8.1.4 Standard of Deferred Payment

Money serves as a standard for settling debts that are payable in the future. This function underpins credit systems and long-term contracts common in Kenya’s business environment.

Characteristics supporting this function:

• Widely accepted for debt settlement: Kenyan businesses use money to repay loans and credit purchases.
• Predictability of value: Stability in money’s value over time is crucial for deferred payments.
• Facilitates credit extension: Banks and SACCOs in Kenya rely on money’s function to offer loans and mortgages.
• Legal recognition: Monetary debts are enforceable under Kenyan law.
• Supports economic planning: Businesses can plan investments and cash flows based on agreed future payments.

Chapter Summary

This chapter explored the essential functions of money, highlighting its role as a medium of exchange, a unit of account, a store of value, a standard of deferred payment, and a measure of value. It also examined the key characteristics that make money effective, such as durability, portability, divisibility, uniformity, and acceptability. The discussion then shifted to financial institutions, distinguishing between banking institutions, which accept deposits and provide loans, and non-banking financial institutions that offer specialized financial services without full banking capabilities. The chapter further detailed the functions of the central bank, which include regulating the money supply and overseeing financial stability, alongside the commercial bank’s role in providing credit and facilitating payments. Finally, the functions of non-banking financial institutions were outlined, emphasizing their importance in mobilizing savings and providing investment opportunities. Together, these topics provide a comprehensive understanding of money and banking within the economic system.