Wednesday, 25 January 2012

7 C's of Credit

7 C's of Credit: Commercial lenders take numerous factors into consideration when evaluating a loan request. You may have heard of these before, referred to commonly as the 5 C’s (there are actually 7 at last count).

Condition:
Is there a logical need for the funds? Does it make business sense? Are the funds to be used to grow an existing and proven business product or service business or to be used for an unproven one?

Collateral:
Is the proposed collateral sufficient? Is it of value? Is there a secondary market for it? The lender wants to know, in the event of a default, that it will be likely to recoup a significant portion of the amount lent. 

Credit:
For smaller enterprises, the personal credit score of the individual owner(s) will be reviewed. As with personal loans, such as an auto or mortgage loan, the bank is looking for evidence of a history of you paying your lenders on time. For larger companies, the bank will consult Dun & Bradstreet reports for evidence of the timely payment of vendors and other creditors.

Character:
What do those who have done business with the prospective borrower have to say about its business practices? A bank will typically ask the applicant for a list of references, such as three customers and three vendors to contact.

Capacity:
Does the borrower have the wherewithal to pay the debt service? Is it generating enough free cash flow to reasonably assure timely interest payments and ultimately the repayment of the principal balance?

Due to the expanding levels of transnational business and cross-border lending over the last few decades, two new C’s should be discussed.


Currency:
What is the recent history and outlook of the primary currency in which the company will conduct its operations? Does the currency exhibit a history or likelihood of losing its value? The more stable the currency, the more attractive the loan request will be to a lender.

Country:
Does the borrower conduct a significant portion of its operations in a country with a history of political instability? Is there the possibility of an expropriation of the borrower’s assets due to a change in the country’s government? Is the country’s current political and legal system hostile to the interests of foreign countries? The more established the country’s government has been and the more its legal system has demonstrated a reverence for property rights and the rights of creditors, the more likely the bank will be willing to make the loan.

Source : -------> WikiCFO

Line of Credit

Line of Credit (Bank Line):A line of credit is a type of loan agreement between a bank and a borrower. Basically, a line of credit states that a borrower can borrow funds from the bank at will, up to a certain limit and within a specified period of time. During the specified time period and within the limitations of the allowable amount, the borrower may borrow and repay funds at the borrower’s discretion. When the line of credit expires, the borrower must repay all borrowed funds as well as any unpaid interest.

A bank charges interest on the borrowed money, charges a fee for the unused portion of the loan, and requires a collateral deposit from the borrower. A line of credit typically has a maturity of a year, though there are contracts with longer maturities, called revolving lines of credit, and contracts with no maturities at all, called evergreen credit. A line of credit is also referred to as a bank line.

Line of Credit Interest:
Banks charge interest on lines of credit. The interest rate charged depends on the borrower’s creditworthiness and risk of default. The interest rate on a bank line is often a benchmark rate, such as a Treasury bill rate or another market based rate, plus a premium. For example, the interest rate might be the rate on two year Treasuries plus 1%. Different borrowers with differing degrees of creditworthiness will be charged various interest rates on lines of credit.

Line of Credit – Other Requirements :
Banks typically require the borrower to maintain a compensating balance. A compensating balance is a percent of the value of the bank line that must be maintained as a deposit at the bank. For example, if the line of credit goes up to $100,000, and the compensating balance is 10%, then the borrower must maintain a deposit at the bank of at least $10,000. This compensating balance serves as collateral.

Banks often charge a commitment fee to borrowers for reserving the unused portion of the line of credit. For example, if the line of credit goes up to $100,000, and the borrower has borrowed $60,000, then $40,000 is left on the balance of the loan. The borrower may be required to pay a commitment fee, of perhaps 0.5%, on the $40,000 that is not being utilized. This fee represents the cost of keeping that amount available to the borrower, or committing the money to the borrower, so that it may be accessed as needed.

Line of Credit vs Loan:
There are several advantages to using a line of credit. First, a line of credit is flexible. It allows the borrower to take out loans as needed and repay them when convenient, within the limits of the contract. Second, the borrower only pays interest on the portion of the loan that is used, and does not pay interest on the unused portion. However, the borrower may have to pay a commitment fee on the unused portion of the loan. Also, using a line of credit can reduce the paperwork and administrative tasks involved with taking out loans.

Debt to Equity Ratio

Debt to Equity Ratio Definition:
Debt to equity ratio defined as an indication of management’s reliance to finance its asset on debt rather than on equity. It measures a company’s capacity to repay its creditors. The debt to equity ratio varies with different industry and company. Comparing the ratio with industry peers is a better benchmark.

Debt to Equity Ratio Meaning:
The debt ratio means an indication of the gearing level of a company. A high ratio means that a company may be over-leveraged with debt. This can result in high insolvent risk since excessive debt can lead to a heavy debt repayment burden. However, when a company chooses to rely largely on equity, they may lose the tax reduction benefit of interest payments. In a word, a company must consider both risk and tax issues to get an optimal debt to equity ratio explanation that suits their needs.

Debt to Equity Ratio Formula:
The debt to equity ratio formula is listed below:

Debt to equity ratio equation = total debt / total equity


Debt to Equity Ratio Calculation:
Debt to equity ratio calculations are a matter of simple arithmetic once the propper information is complied. Debts will include both current liabilities and long term liabilities.

Equity will include goods and property your business owns, plus any claims it has against other entities.

Example: a company has $10,000 in total debt, and $40,000 in total shareholders equity.

Debt to equity ratio = 10,000 / 40,000 = 0.25

This means that a company has $0.25 in debt for every dollar of shareholders’ equity.


Debt to Equity Ratio Example:
Shari has started a residential real estate company which has grown to success. Though the market is tough, Shari has protected her cash account in order to deal with what the future holds. Shari now needs to perform debt to equity analysis to make sure she has not become over-leveraged in her company. This could cause problems with bank loans, her company free cash flow, and more.

Shari contacts her controller for debt to equity accounting questions. She knows that there is no debt to equity calculator, so she is willing to wait for some concrete results.

$10,000 in total debt and $40,000 in total shareholders equity.

Debt to equity ratio = $10,000 / $40,000 = $0.25

Her controller finds that she is in perfect standing. Her company, though near its limit, does not have too much debt. It has enough cash to survive common issues which face the residential real estate industry.

She is satisfied that she has followed the path of a responsible business owner. She is so used to putting out fires that she is content with the status quo of her company making regular monthly profits. Shari looks forward to her next quarter.


Source:--------->wikiCFO

Return on Asset Analysis

Return on Asset Definition:
Return on asset (ROA) reveals how much profit a company earned in comparison to its overall asset. The value of ROA varies from industry and company. In general, the higher the value, the better a company is.


Return on Asset Formula:
Return on Asset = Net income ÷ Average asset


Or = Net profit margin * Asset turnover


Return on Asset Calculation:
Example: a company has $2,000 in net income, and $20,000 in average asset. Return on equity = 2,000 / 20,000 = 10%


This means that has $0.1 of net income for every dollar of asset invested.


Applications:
Return on assets measures profit against the assets a company used to generate revenue. It is an important indicator of the asset intensity of a company. A lower ratio means a company is more asset-intensive, and vice versa. And a more asset-intensive company needs more money to continue generating revenue. Return on asset ratio is useful for investors to assess a company’s financial strength and efficiency to use resources. It is also very important for management to measure its performance against its planned business goals, or market competitors .

Source:--------->wikiCFO

Return on Capital Employed (ROCE)

Return on Capital Employed (ROCE): The return on capital employed ratio is used as a meaurement between earnings, and the amount invested into a project or company.

Return on Capital Employed (ROCE) Meaning:
The return on capital employed is very similar to the return on assets (ROA), but is slightly different in that it incorporates financing. Because of this the ROCE calculation is more meaningful than the ROA. The ROCE is generally used to find out how efficient and profitable a company is from year to year. As it is a percentage a company can locate problems or areas of improvement with the fluctuation of this ratio from year to year.

Return on Capital Employed (ROCE) Equation:
The return on capital employed equation is as follows:

ROCE = EBIT or NI/(Total Assets - Current Liabilities)

Note: The earnings before interest and taxes, known as the operating income, is normally used, but people can also use the Net Income if they would like to incorporate the net interest and taxes into the ROCE formula.


Return on Capital Employed (ROCE) Example:
Tim found that the ROCE last year is 16%. He would like to compare this number to the current ROCE. He begins by finding the following numbers in the Balance Sheet as well as the Income Statement:

Net Income = $50,000
Total Assets = $360,000
Current Liabilities = $35,000

ROCE = $50,000/($360,000 - $35,000) = 15%

Note: The drop in this number means that Tim's company is not as efficient as it used to be or that it decreased it current liabilities.


 
Source:--------->wikiCFO

Return on Invested Capital (ROIC)

Return on Invested Capital (ROIC):
The return on invested capital is the percentage amount that a company is making for every percentage point over the [Cost of Capital|Weighted Average Cost of Capital (WACC). More specifically the return on investment capital is the percentage return that a company makes over its invested capital. However, the invested capital is measured by the monetary value needed, instead of the assets that were bought. Therefore invested capital is the amount of long-term debt plus the amount of common and preferred shares.

Return on Invested Capital (ROIC) Formula:
The Return on invested capital formula is as follows:

Net Operating Profit After Tax (NOPAT)/Invested Capital = ROIC

NOPAT - This is the operating profit in the income statement minus taxes. It should be noted that the interest expense has not been taken out of this equation.

Invested Capital - This is the total amount of long term debt plus the total amount of equity, whether it is from common or preferred. The last part of invested capital is to subtract the amount of cash that the company has on hand.


Return on Invested Capital (ROIC) Example:
Bob is in charge of Rolly Polly Inc., a company that specializes in heavy agricultural and construction equipment. Bob has been curious as to how his company has been performing as of late and decides to look at the company's return on invested capital analysis. Surprisingly, the company does not keep track of the return on invested capital ratio. Bob decides that he will go ahead and run the ROIC analysis, and obtains the following information:

Long-term debt - $25 million
Shareholder's Equity - $75 million
Operating Profit - $20 million
Tax Rate - 35%
WACC - 11%

plugging these numbers into the formula Bob finds the following:

$20 million - (20 million * 35%) = $13 million

$13 million/($25 milion + $75 million) = .13 or 13% = ROIC.


Source:--------->wikiCFO

Return on Equity (ROE)

Return on Equity Definition:
Return on equity, defined also as return on net worth (RONW), reveals how much profit a company earned in comparison to the money a shareholder has invested.

Return on Equity Explanation:
Return on equity, explained as a measure of how well a company uses investment dollars to generate profits, is more important to a shareholder than return on investment (ROI). It tells investors how effectively their capital is being reinvested. A company with high return on equity is more successful to generate cash internally. Investors are always looking for companies with high and growing returns on equity. However, not all high ROE companies make good investments. The better benchmark is to compare a company’s return on equity with its industry average. The higher the ratio, the better a company is.

Return on Equity Formula:
The return on equity formula listed below forms a simple example for solving ROE problems.

Return on Equity Ratio =
Net income ÷ Average shareholders equity

When solving return on equity, equation solutions only form part of the problem. One must be able to apply the equation to a variety of different and changing scenarios.

Return on Equity Calculation:
Average shareholders' equity, or return on equity, is calculated by adding the shareholders' equity at the beginning of a period to the shareholders' equity at period's end and dividing the result by two. No simple return on equity calculator can complete the job that a solid understanding of ROE can.

Example: a company has $6,000 in net income, and $20,000 in average shareholders’ equity.

Return on equity: $6,000 / $20,000 =30%

This means that a company has $0.3 of net income for every dollar that has been invested by shareholder.


Return on Equity Example:
Melanie, after seeing success in her corporate career, has left the comfortable life to become an angel investor. She has worked dilligently to select companies and their managers, hold these managers accountable to their promises, provide advice and mentoring, and lead her partners to capitalization while minimizing risk. At this stage, Melanie is ready to receive her pay-out. Melanie wants to know her Return on Equity ratio for one of her client companies.

Melanie begins by finding the net income and average sharholder's equity for the venture. Looking back to her records, Melanie has invested $20,000 in the business. Her net income from it is $6,000 per year. Performing her return on equity analysis yields these results:

Return on equity: $6,000 / $20,000 =30%

Melanie is happy with her results. Purposefully starting small, she has built the experience and confidence to be successful. She can now move on to bigger and better deals.


Source:--------->wikiCFO

Dividend Analysis

Dividends Explained:
Dividends are corporate profits distributed to shareholders. When a company makes a profit, the board of directors can decide whether to reinvest the profits in the company or to pay out a portion of the profits to shareholders as a dividend on shares. The board of directors determines the amount of the dividend on stocks, as well as the dividend payout dates.

Stockholders typically receive a certain amount of dividends per share for each share of stock they own. Tax rates on dividends, historically, have often differed from tax rates on capital gains from investments. If the dividend tax rate exceeds the capital gains tax rate, it may benefit the shareholders to avoid paying a dividend, and instead to carry out a stock repurchase.

Dividend Yield Definition:
We define dividend yield as the dividend amount expressed as a percent of the current stock price. For example, if a stock will pay a $1 dividend at the end of this year, and today the stock price is $10, then that stock’s dividend yield is 10%.

10% = 1/10

Dividend yield equation:

Dividend Yield = D1 / P0

D1 = Annual dividend per share amount (the dividend per share at time period one)
P0 = Current stock price (the price at time period zero)

Dividend Date Definitions:
The process of distributing dividends to shareholders follows a set schedule. The board of directors announces the dividend on the dividend declaration date. Once the dividend has been declared, the company is legally obligated to pay the stated dividend to shareholders.

The next significant date is the ex dividend date. Investors who purchase the stock on or after the ex-dividend date will not receive the forthcoming dividend. Prior to the ex dividend date, the stock is considered cum dividend, or with dividend. This means that anyone buying the stock during this period will receive the forthcoming dividend.

The ex dividend day precedes the dividend record date, or the dividend date of record, by three days. Shareholders documented as owning the stock on the dividend record date will receive the dividend.

Last is the dividend payable date, or the dividend distribution date. This is the actual date on which the company pays out the dividends to its shareholders. The dividend payable date is typically about a month after the dividend date of record.

Dividend Payout Dates:
• Dividend Declaration Date (stock is trading cum dividend)
• Ex-Dividend Date
• Dividend Record Date (three days after the ex-dividend date)
• Dividend Payable Date (one month after the dividend record date)


Dividend Signaling:
Dividend signaling hypothesis refers to the idea that changes in a company’s dividend policy reflect management’s perceptions of the company’s future earnings outlook. Basically, it states that a change in a company’s dividend policy can be interpreted as a signal regarding future earnings. The problem is that the signals can be interpreted as contradictory messages.

For example, if a company announces that it will increase its dividend yield, investors may interpret this as a positive signal. It could mean the company anticipates a profitable future and is allowing shareholders to benefit from these profits.

On the other hand, an increase in the dividend payout rate could be interpreted as a negative signal. It could mean that the company has no good investment opportunities, and it has nothing better to do with its cash than to pay it out to shareholders as dividends.

Similarly, if a company announces that it will decrease its dividend payout rate, this can be interpreted as either a positive or negative signal. It could be interpreted as a positive signal because it could mean that the company has so many good investment opportunities that it needs all available cash for positive-NPV investments and projects. This could mean the company is growing and expanding.

On the other hand, if a company cuts its dividend rate, that could mean that the company anticipates lower earnings or even losses. This, of course, could be a bad sign. So as you can see, the logic behind the dividend signaling hypothesis makes sense, but because it can be interpreted in contradictory ways, the reading of the signals is not necessarily very meaningful.


Source:--------->wikiCFO

Arrears

Arrears Definition:
Arrears, defined is an amount of a liability which is past due or has simply not been paid yet. There are generally two types of arrears concerning annuities and loans, and the second is in respect to preferred dividends.

Arrears Meaning:
>>The majority of the time arrears accounting is concerned with preferred dividends as most companies try and make their payments when they are due with resepct to a loan or annuity.
>>Arrearage occurs in dividends when a company issued preferred stock promising a certain percentage payment of the income every year. However, the company does not have to pay the amount that year.
>>However, the amount is put in arrears account until the company does pay the amount. It could be years or maybe just next year, but the amount keeps accumulating until the arrears payment is made. It should also be noted that the company cannot pay common stock dividends until the arrears account has totally been reduced.  

Arrears Example:
Judy has bought $4,000 worth of preferred stock that pays a 10% dividend every year. The total amount of stock outstanding is $100,000. This means that the total dividend amount paid each year by the company is $10,000. In the first year the company did not make a dividend payment. This means that the company would need to put $10,000 in the arrears account. If in the next year the company made a payment of $12,000 it would mean that the entire $10,000 in arrears would be emptied, but would fill back up by $8,000 ((10,000 * 2) - 12,000) or the new amount in the arrears account.
The payment to Judy would be in the amount of her percentage ownership of the preferred dividends, 4%, times the amount in the amount of dividends paid to date, which is $12,000. Therefore, Judy will have made $480 on her investment thus far. If in the next year the company empties the arrears account and current payment by paying dividends of $18,000. Judy will have made $720 more with the payment. The new balance in arrears would be equal to zero.

Source:--------->wikiCFO

Preemptive Right

Preemptive Right Definition:
Preemptive rights give existing shareholders the opportunity to purchase new share offerings before they are available to the investing public.
Preemptive rights are also called preemption rights or subscription rights.

Basically, when a company decides to issue more shares of stock, current shareholders have the right to buy the new shares of common stock before the general public can buy the new shares of stock. The idea is to allow current shareholders to maintain their proportional ownership of company without experiencing value or control dilution caused by the new issue.

Preemptive rights often allow the existing shareholders to purchase shares of stock at a discount to the public offering price. Existing shareholders are allowed to purchase the new issue within a set window of opportunity, often two to four weeks.

Preemptive rights also allow the existing shareholder to buy a set number of shares of the new issue depending on how many shares the shareholder currently owns. The number of shares allowed to the shareholder relative to current holdings is referred to as the subscription ratio. The subscription ratio is stated in a document given to existing shareholders, called the subscription warrant.

Because the preemptive right often allows the shareholder to purchase the new issue at a discount, and because purchasing shares of the new issue allows the existing shareholder to maintain proportional ownership and voting power, it is usually in the shareholders best interest to make use of the preemptive right and to buy the maximum allowable shares of the new issue.

Source:--------->wikiCFO

Initial Public Offering (IPO)

Initial Public Offering (IPO):
An Initial Public Offering (IPO) is the process of selling a company’s stock to the public for the first time. Before the IPO the company is private; after the IPO the company is public. The IPO process is typically underwritten by a syndicate of investment banks. The process follows several steps, described below.

Advantages and Disadvantages of IPO's:
Going public has at least two advantages:

>>Greater liquidity of equity and access to a larger pool of capital.

There are at least three disadvantages to going public:
>>Dispersion of control,
>>Required adherence to regulations and
>>Public scrutiny.

IPO Process:
The IPO process follows several steps:

1. The company chooses a syndicate of underwriters (see below).
2. The company and the underwriters compose a preliminary prospectus (see below).
3. The SEC reviews the prospectus and approves the IPO.
4. The underwriters determine the value of the firm and the structure of the IPO.
5. The underwriters go on a road show to gauge investor interest in the IPO (see below). 6. The investors express level of interest and the underwriters set the offer price.
7. The securities are distributed to the public (see below).

Underwriter Duties:
In the IPO process, the underwriters – a syndicate of one or more investment banks – are responsible for registering the IPO with the SEC, valuing the company that is going public, structuring the issuance of securities, pricing the securities, and marketing the securities to potential investors. The underwriters also bear the risk of distributing the securities.

Preliminary Prospectus:
The preliminary prospectus, or red herring, is a legal document that must be submitted to the SEC for approval prior to an IPO.

The document includes details about the company, including an explanation of the company’s operations and competitive position, and copies of its financial statements. The document also includes the details of the IPO, including the type of security (common stock, preferred stock, etc.) to be offered, the number of shares to be offered, and the anticipated share price.

Road Show:
A road show is when the underwriters travel the country, or the even the world, to pitch the IPO to potential investors. The idea is to determine whether investors are interested in the offering and, if so, to then determine how many shares they will purchase and what price they are willing to pay. The investors are typically large institutional investors – mutual funds and pension funds.



IPO Pop:
Underwriters take on significant financial risk when they commit to an IPO. If the market is not interested in the offering, the underwriters may be stuck holding securities that nobody wants.

In order to ensure market interest in the offering, underwriters will often deliberately under-price the securities for the initial public offering. They sell it for cheaper than it is worth. So when the shares go public, investors buy up the bargain-priced shares, causing them shoot up in value on the first day of trading. This is known as the “IPO pop.”

Insider Trading

Insider Trading Defined:
Insider trading is buying or selling stock based on nonpublic information that will affect the stock’s price. A company’s executives and directors have access to significant information regarding the company’s activities. These people could easily profit by buying or selling the stock based on the private information they have. However, doing so is illegal.

Insider trading, in certain circumstances, is prohibited by SEC regulations. The idea is that trading based on private information is unfair. If insider trading were legal, insiders could make huge profits by buying or selling a company’s stock just before important information is made available to the public. This behavior would put the investing public at a tremendous disadvantage in terms of buying and selling financial securities.

Insider trading is not always illegal. Typically, someone labeled an insider will have designated windows of opportunity throughout the year in which to legally buy or sell the company’s stock. Executives and managers are often awarded stock options, CEOs and directors often own significant amounts of their company’s stock. These people should be able to buy and sell their stock. And they can. But it must be done according to the rules. Insiders must notify the SEC regarding their buying and selling transactions.

Under certain conditions, if an executive announces publicly that he will sell a certain amount of shares or value of stock at a specified date every year, then he may do so each year without it being considered illegal insider trading. Likewise, managers or executives with access to nonpublic information may buy or sell stock after that information has been made available to the public.

Insider Trading Example:
For example, imagine an executive at a large publicly traded corporation who sees the company’s income statement before it is issued to the public via the annual report. The executive sees that the corporation suffered big losses in the current period. Once the Wall Street analysts see these numbers, the company will be downgraded and the stock will decline.

If insider trading were allowed, the executive could quickly go out and sell the company’s stock short, or else he could tell his broker and his friends and family members to sell the stock short. Selling a stock short makes a profit when the stock price goes down. When the reports are finally made public, the stock plummets, and the executive and his friends and family all make a lot of money. Meanwhile, the investors who owned the company’s stock but did not have access to the private information suffered losses.

Who is an Insider?:
Technically, an insider is anyone who has access to material nonpublic information regarding a company. Examples of insiders include executives, directors, managers, shareholders with a 10% or greater stake in the company, and the close family members of these people. Insiders may also include lawyers, brokers, investment bankers, and printers of financial documents. It is illegal for insiders to buy or sell a stock based on material nonpublic information.

What is Insider Information?:
Inside information is any material nonpublic information regarding a company that could affect the company’s stock price. The information is nonpublic if it has not yet been disclosed to the investing public. The information is material if its disclosure could impact the company’s stock price. Examples of insider information include access to unreleased earnings reports, knowledge of a pending or imminent takeover or merger, or knowledge of any other kind that is of value to investors.

Balance of Payments (BOP)

Balance of Payments:
In economics, the balance of payments (BOP) is a statement that summarizes the economic transactions between a country and the rest of the world. The BOP is essentially a link between a nation’s domestic economy and the global economy. The document reports the inflows and outflows of goods, services, and capital between a domestic economy and the world economy over a period of time.

The balance of payments consists of three main categories:

>>The current account,
>>The capital account, and
>>The financial account.

Each account consists of subaccounts. The sum of the accounts on the balance of payments must theoretically add up to zero in order for the statement to be balanced. The balance of payments is an economic indicator used to assess the conditions of a nation’s economy. The data are watched closely by economists, investors, foreign currency traders, businesspeople, and other interested parties. In the United States, the balance of payments is published quarterly by the Commerce Department.

Current Account:
>>The current account includes the net inflows and outflows of goods, services, and unilateral transfers. Net inflows and outflows of tangible goods, or visible trade, refers to the net imports and exports of physical merchandize between the domestic economy and the rest of the world.

>>Net inflows and outflows of services, or invisible trade, refers to the payments and receipts of services and intangible goods, such as banking, insurance, tourism, shipping, and air travel. Unilateral transfers includes inflows and outflows of capital related to gifts, grants, charitable donations, pensions, and money earned domestically by foreign workers that is sent back to their home country.

Capital Account:
The capital account includes net inflows and outflows relating to payments for and capital transfers of fixed assets and Fixed asset financing. Capital account items can be divided into short-term capital flows and long-term capital flows. Short-term capital flows may include inflows and outflows relating to foreign currency speculation. Long-term capital flows may include money invested in foreign assets or proceeds gained from the sale of foreign assets.


Financial Account:
The financial account includes net inflows and outflows of investments and financial assets. This category is divided into net foreign direct investments, net portfolio investments, and net other investments. Direct investments refer to net capital investments of over 10% in equity stakes that represent ownership or management control of a foreign entity. Portfolio investments refer to net capital investments in stocks, bonds, and other financial assets that do not involve ownership or management control of a foreign entity. Other investments refers to net inflows and outflows of financial assets and instruments such as bank deposits.


Official Reserve Account:
The official reserve account represents changes in asset values of the nation’s central bank. This account includes items such as foreign exchange reserves, official gold reserves, and special drawing rights (SDRs). Special drawing rights are assets the value of which are based on a basket of underlying currencies. SDRs are issued by the International Monetary Fund (IMF).

Errors and Omissions:

The balance of payments typically includes a line item labeled statistical discrepancy, or errors and omissions. This represents the amount by which the balance of payments did not actually balance. As stated above, a nation’s balance of payments should balance out to zero, when incorporating all relevant inflows and outflows of capital. When there is a discrepancy and the accounts to not balance out, the difference is recorded in the account for errors and omissions.

Source:--------->wikiCFO

Stagflation

Stagflation Definition:
In economics, stagflation refers to the combination of stagnation and inflation. Stagnation refers to slowing economic growth or recession. It is a period of low gross domestic product and high unemployment. Inflation refers to rising consumer prices. The combination of these two conditions makes for a troubled economy.

The term stagflation was first used by economists in the 1970s when both the U.S. and the U.K. were experiencing simultaneous stagnation and inflation. At that time much of the economic trouble was due to rising oil prices which can contribute to both inflation and stagnation.

Central Banks and Stagflation:
Central banks have certain tools for counteracting unfavorable economic conditions. Central banks can implement monetary policy tools to try to influence the conditions of the economy. Central banks can raise or lower interest rates, raise or lower reserve requirements, and buy or sell currency to influence money supply.

For example, if inflation is rising, a central bank can raise interest rates, raise reserve requirements, or purchase currency to reduce the money supply in an attempt to curb inflation.

And during a period of stagnation, if the economy is slowing down, the central bank can lower interest rates in an attempt to increase the money supply and stimulate business and economic activity.

Stagflation Dilemma:
However, when inflation and stagnation occur simultaneously, the tools of the central bank are not so simple to implement. For example, during a period of stagflation, a central bank could raise interest rates to fight inflation, but this would hurt the struggling economy. And the central bank could lower interest rates to stimulate the economy, but this would exacerbate inflation.

So one of the main reasons stagflation is such a problem is that central bank monetary policy is essentially unable to ameliorate the unfavorable economic conditions. Trying to fix one half of the problem only makes the other half of the problem worse, regardless of which side of the problem they attempt to correct or influence.

Consumer Prince Index (CPI)

Consumer Prince Index (CPI) Defined:
The consumer price index is an economic indicator that measures changes in prices of typical consumer expenses. It is used to measure inflation and the cost of living in a geographic area. For example, if living expenses rise in a particular region due to inflation, this would result in an increase in that region’s CPI. The CPI is published monthly by the Bureau of Labor Statistics in the Department of Labor.

Consumer Price Index Basket :

The CPI is calculated using the prices of items in a “basket” of typical consumer goods and services. The basket includes food, transportation, shelter, clothing, medical care, entertainment, and other items. Prices are determined by samples taken from stores or providers in the relevant geographic area. The prices are weighted according to the item’s significance to the consumer. The core CPI is a variant of the CPI that excludes food and energy prices.

Cost of Living Index:

The consumer price index is also called the cost of living index.

Headline Inflation Definition:

The consumer price index is also referred to as headline inflation.

US CPI Components:

The U.S. CPI covers more than 200 categories of goods and services. The categories fall into 8 groupings:

1. Food and Beverages

2. Housing

3. Apparel

4. Transportation

5. Medical care

6. Recreation

7. Education and Communication

8. Other Goods and Services

Consumer Price Index Homepage:

 For more information about the CPI, go to: www.blg.gov/cpi

For more information about the CPI frequently asked questions, go to: http://www.bls.gov/cpi/cpifaq.htm#Question_6

US CPI Historical Data:

For historical CPI data, go to: ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt

Deflation

Deflation Definition:
Deflation is the decline in the price for goods and services. It can also be referred to as the increase in the value of real money, or in other words the value of the current currency will go up per unit of goods or services.


Deflation Explained:
Deflation often occurs when the demand for goods or services drops. As this happens the price of the current supply will often drop in order to meet demand. Deflation economics often happen during large recessions or depression times. Deflation should also not be confused with the term disinflation which refers to a slowing effect of inflation or a slow increase in the price of goods and services.




Deflation Examples:
Some common examples of when deflation has occured are times like the Panic of 1837, the Civil War, as well as the Great Depression . The Panic of 1837 was the first major time that deflation occurred as people rushed to banks there was an overall drop in the money supply as well a major decrease in the price of goods and services. During the Civil War there was another era of deflation as the United States set the dollar on a gold standard and reduced the amount of money printed during the war. This caused an overall drop in the money supply and therefore an overall drop in the prices. Finally, the Great Depression was a time in which many banks failed and the ability to gain money became difficult thus causing deflation to occur and the price of goods to fall dramatically. This period of deflation is probably the most dramatic because of the time in which it took to climb back to normal levels of inflation.

Source:--------->wikiCFO

Inflation Analysis

Inflation Definition:
What is inflation? Inflation measures the rate at which prices increase for consumer goods and services. Inflation also measures the rate at which a currency’s purchasing power declines. If consumer goods and services are getting more expensive, inflation is rising. As inflation rises, the relevant currency’s purchasing power declines. As prices increase, the amount a consumer can purchase with one unit of currency decreases.


Inflation Information:
Inflation
is a consistent increase in the general level of prices in an economy. The inflation rate is a measure of this phenomenon.



What causes inflation? Many economists point to an increase in the rate of growth of the money supply in an economy as the primary culprit. Others point to sudden changes in aggregate demand and aggregate supply, following a Keynesian approach to macroeconomic analysis.


Inflation Rate Example:
For example, let’s take the price of a can of soda. Let’s say last year a can of soda cost $1.00. And let’s say the inflation rate for the past 12 months is 5%. We could then assume the cost of a can of soda today is $1.05. The price has gone up by 5%. The dollar’s purchasing power has gone down – one dollar is no longer enough money to buy a can of soda.


Inflation Measures:
There are two important inflation measures in the U.S. They are the headline inflation rate and the core inflation rate. These inflation rates are published monthly by the U.S. Bureau of Labor Statistics.


>>The headline inflation rate, also called the consumer price index (CPI), measures the rate at which prices are rising for a wide selection of consumer goods. Headline inflation is designed to measure the rate at which cost of living expenses increase over time.


>>The core inflation rate is the headline inflation rate but without food and energy prices. Food and energy prices are considered more volatile than other consumer prices. Therefore, some consider it important to view the inflation rate excluding these two components.


There are a variety of other approaches to estimating the inflation rate, such as calculations based off of the US Producer Price Index (PPI) and the US Gross Domestic Product (GDP Deflator).


Inflation and Monetary Polic:
Most central bank’s have a target inflation rte. For example, the U.S. central bank, the U.K. central bank, and the European Central Bank prefer to keep inflation at around 2%. A nation’s central bank can use certain monetary policy tools to influence inflation. These include foreign exchange market intervention, open-market operations, adjusting the reserve requirement ratio, and adjusting key interest rates. Central banks often implement monetary policy tools to influence the inflation rate towards the target inflation rate.


Market Intervention:
Foreign exchange market intervention refers to a central bank buying or selling currency in the open market in order to influence the nation’s money supply. Increasing the money supply devalues the currency and increases inflation. Decreasing the money supply appreciates the currency and decreases inflation. Ergo, a nation’s central bank can purchase currency in the open market to fight inflation.


Open Market Operations Definition:
Open-market operations refer to a central bank buying or selling government securities. Buying government securities increases the money supply and spurs inflation. Selling government securities decreases the money supply and curbs inflation. Therefore, a nation’s central bank can sell government securities to fight inflation.


Reserve Requirement Ratio:
The reserve requirement ratio is the amount of cash a commercial bank must hold relative to the value of its customer deposits. For example, if a bank receives customer deposits totaling $100, and the reserve requirement is 10%, then that bank must always have at least $10 cash on hand. A central bank can increase or decrease the reserve requirement ratio for the nation’s commercial banks, thereby decreasing or increasing the domestic money supply. Increasing the reserve requirement curbs inflation, decreasing the reserve requirement spurs inflation.


Key Interest Rates:
Central banks can also raise or lower key interest rates in an effort to influence inflation. In the U.S., the central bank’s key interest rate, the fed funds rate, is the rate at which banks lend to each other overnight. Raising the interest rate can reduce the money supply, damp economic activity, and curb inflation. Lowering the key interest rate can increase the money supply, stimulate the economy, and increase inflation. A central bank can raise interest rates to fight inflation.


Inflation Protection:
When faced with the threat of rising inflation, which can erode the value of investment returns, investors may seek investments that are protected from inflation. One option is to invest in U.S. Treasury Inflation Protected Securities (TIPS).


TIPS are U.S. Treasury securities that are protected against inflation. The coupon payments and the principal value automatically adjust according to the headline inflation rate. This protects investors from the negative effects inflation can have on investment returns. The downside is that TIPS offer a comparatively low interest rate.

Treasury Bills ( t- bills)

Treasury Bills :
Treasury Bills are money market instruments to finance the short term requirements of the Government of India. These are discounted securities and thus are issued at a discount to face value. The return to the investor is the difference between the maturity value and issue price.

Types Of Treasury Bills:
There are different types of Treasury bills based on the maturity period and utility of the issuance like, ad-hoc Treasury bills, 3 months, 6 months and 12months Treasury bills etc. In India, at present, the Treasury Bills are issued for the following tenors 91-days, 182-days and 364-days Treasury bills.

Benefits Of Investment In Treasury Bills :

No tax deducted at source
Zero default risk being sovereign paper
Highly liquid money market instrument
Better returns especially in the short term
Transparency
Simplified settlement
High degree of tradeability and active secondary market facilitates meeting unplanned fund requirements.

 
Features:
   Form
The treasury bills are issued in the form of promissory note in physical form or by credit to Subsidiary General Ledger (SGL) account or Gilt account in dematerialised form.
Minimum Amount Of Bids Bids for treasury bills are to be made for a minimum amount of Rs 25000/- only and in multiples thereof.
   Eligibility
All entities registered in India like banks, financial institutions, Primary Dealers, firms, companies, corporate bodies, partnership firms, institutions, mutual funds, Foreign Institutional Investors, State Governments, Provident Funds, trusts, research organisations, Nepal Rashtra bank and even individuals are eligible to bid and purchase Treasury bills.
   Repayment
The treasury bills are repaid at par on the expiry of their tenor at the office of the Reserve Bank of India, Mumbai.
   Availability
All the treasury Bills are highly liquid instruments available both in the primary and secondary market.
   Day Count
For treasury bills the day count is taken as 365 days for a year.
   Yield Calculation
The yield of a Treasury Bill is calculated as per the following formula:

(100-P)*365*100
Y =
------------------
       P*D
      
Wherein Y = discounted yield
P= Price
D= Days to maturity

   Example:
A cooperative bank wishes to buy 91 Days Treasury Bill Maturing on Dec. 6, 2002 on Oct. 12, 2002. The rate quoted by seller is Rs. 99.1489 per Rs. 100 face values. The YTM can be calculated as following:
The days to maturity of Treasury bill are 55 (October – 20 days, November – 30 days and December – 5 days)
YTM = (100-99.1489) x 365 x 100/(99.1489*55) = 5.70%
Similarly if the YTM is quoted by the seller price can be calculated by inputting the price in above formula.

Primary Market :
In the primary market, treasury bills are issued by auction technique.
CALENDAR OF AUCTION FOR TREASURY BILLS
Treasury Bill Day of auction Day of payment
91 dayEvery WednesdayFollowing Friday
182 dayWednesday preceding thenon-Reporting FridayFollowing Friday
364 dayWednesday preceding the reporting Friday Following Friday



 Salient Features Of The Auction Technique

The auction of treasury bills is done only at Reserve Bank of India, Mumbai.
Bids are submitted in terms of price per Rs 100. For example, a bid for 91-day Treasury bill auction could be for Rs 97.50.
Auction committee of Reserve Bank of India decides the cut-off price and results are announced on the same day.
Bids above the cut-off price receive full allotment; bids at cut-off price may receive full or partial allotment and bids below the cut-off price are rejected.

Types Of Auctions
There are two types of auction for treasury bills:

Multiple Price Based or French Auction: Under this method, all bids equal to or above the cut-off price are accepted. However, the bidder has to obtain the treasury bills at the price quoted by him.
Uniform Price Based or Dutch auction: Under this system, all the bids equal to or above the cut-off price are accepted at the cut- off level. However, unlike the Multiple Price based method, the bidder obtains the treasury bills at the cut-off price and not the price quoted by him.

Secondary Market & Palyers:
The major participants in the secondary market are scheduled banks, financial Institutions, Primary dealers, mutual funds, insurance companies and corporate treasuries. Other entities like cooperative and regional rural banks, educational and religious trusts etc. have also begun investing their short term funds in treasury bills.
   Advantages :
Market related yields
Transparency in operations as the transactions would be put through Reserve Bank of India’s SGL or Client’s Gilt account only
Two way quotes offered by primary dealers for purchase and sale of treasury bills.
Certainty in terms of availability, entry & exit.

Source : www.caclubindia.com

Account Reconciliation Process

Account Reconciliation Definition:
Account reconciliation, defined as the process of assuring that bank statements equal what a company expects from their internal accounting statements, is required with every business that keeps financial statements. To explain simply, account reconciliations are making sure a checkbook balance matches bank statements. Taken to the next level, account reconciliation best practices include collecting relevant account data like invoices, checking account balances, correcting these balances, finding discrepancies, controlling policy to prevent discrepancies, and more. Account reconciliation procedures can be simple or extremely complex depending on the size and scope of a company.

Account Reconciliation Explanation:
Account reconciliation, explained below, is one of the most common yet important actions taken for managerial accounting. It is important to reconcile balance sheet accounts at the end of a period (month, quarter, or year-end) as part of the closing process. Doing so helps to identify errors before closing. Balance sheet account reconciliation is the comparison of the account’s general ledger trial balance with another source, be it internal, such as a subledger, or external, such as a bank statement. Differences caused by the timing of transactions, such as outstanding checks, are identified as reconciling items.

When preparing a general ledger reconciliation of an account to an aging different detail ledgers are used. Cash accounts are reconciled against a bank statement.
Accounts receivable and accounts payable are reconciled against aging schedules. Inventory and fixed assets can be reconciled against a physical count.Account Reconciliation Formula:
There is no single account reconciliation formula. Depending on the processes of the company as well as the banking relationship, account reconciliation can occur in any number of ways. For a simplified formula, see below:

Balance per Bank Statements + Deposits in Transit - Outstanding Payments = Balance after Account Reconciliation


Account Reconciliation Calculation:
Account reconciliation calculations, for the average business, are a straightforward process.

Example: A company has a balance of $15,000 on Bank Statements; $5,000 deposits in transit; $7,000 in outstanding payments

Balance after account reconciliation = $15,000 + $5,000 - $7,000 = $13,000


Account Reconciliation Process:
Set up a reconciliation statement or reconciliation report in a spreadsheet, with the trial balance at the top of one column and the balance you will be comparing it to in the other column. Enter reconciling items below the appropriate balance and label it. When the sum of the two columns equals, then the account is reconciled.

Account Reconciliation Statement:
Balance per general ledger (source #1):

Add(Less) Items in general ledger not
in detail:

Add(Less) Items in detail not in
general ledger:

Balance per detail (source #2):

Let’s now take a look at a four step process for an accounts receivable reconciliation and an accounts payable reconciliation.


Compare Trial Balance with Aging Schedule:
Compare the trial balance of receivables and payables with the balance of their respective aging schedules. If they are equal, move on to reconcile the next account. If not, move on to step two.

Review General Ledger Entries:
If the trial balance is greater than the aging schedule balance, it is likely due to a journal entry posted directly to the general ledger instead of to the subledger. Identify any such entries and move them to the subledger. In addition, let the amount of the difference guide you in your reconciliation. For example, if the difference is $100, look for transactions whose size is close to that. If this does not resolve the difference, move on to step three.

Review Subsidiary Ledgers:
Examine the sales journal (for receivables) and the purchases journal (for payables). Look for posted entries which were posted to the wrong account. This can be done by scanning the entries, looking for abnormal entries, such as credits to the receivables account or debits to the payables account. Examine any such entries to ensure that they are accurate. Look at the cash receipts and cash disbursements journals for receivables and payables, respectively. Again, scan for abnormal entries, such as debits to receivables or credits to payables. Use the unreconciled difference between the trial balance and the aging schedules to guide you. Repeat as needed, with an examination of the invoice register for accounts receivable and the purchase order journal for accounts payable.

Divide and Conquer:
Should the account remain unreconciled, focus solely on one side of the transactions you examine in the journals and follow those debits and credits to the balance sheet account. First, print the general ledger detail for the accounts to be reconciled. Cross out the reversing or correcting entries. Print the subsidiary ledgers (either accounts receivable detail or accounts payable detail). Cross out the in and out correcting entries. Using a unique check mark trace the transactions from the general ledger to the subsidiary ledger and vice versus.

Final Steps:
Examine reconciling items that are not posted to determine if they should be prior to close. If the account is not fully reconciled, but the difference is immaterial, then an entry should be made to adjust the general ledger account balance, as long as the impact is conservative. If the difference is material, continue to examine the subledgers and journals that are a part of the revenue and expenditure cycles to identify the problem.

Tips and Tricks:
Transpositon Error - If you have an unlocated difference and it is divisible by "9" then the error may be that you have transposed a number. For example; you may have entered a "10" rather than a "1". (The difference is "9")

Account Reconciliation Example:
Molly is an CPA for a small business. She appreciates her work because she enjoys projects which take advantage of her analytical and quantitative nature.

Molly is currently doing some work for her employer. Her task today is to execute the account reconciliation policy for her boss. Molly sets down to begin her work.

Molly begins by collecting the proper data. She finds any bank statements, company financial statements, invoices, and any other relevant information which she can find.

Next, she sits down to perform the calculations.

The company has a balance of $15,000 on Bank Statements; $5,000 deposits in transit; $7,000 in outstanding payments

Balance after account reconciliation = $15,000 + $5,000 - $7,000 = $13,000

Molly performs the calculation again. Then, she performs the calculation a third time. No matter how many times she performs the calculation she gets the result of $13,000; $1,000 less than she should find. Molly does additional research and can not find any reason that this has happened.

Near the end of the day she contacts her employer with the information. At their next meeting, she shows her process and her results. The company is disturbed by these results and decides to take action. They contact the bank right away.

Molly was able to find a mistake in bank processing for the company. The company, eventually, is given $1,000 by the bank. Without Molly's help their $1,000 would have been lost in paperwork.

Molly is excited to have helped her employer recover the lost funds. She appreciates her CPA training and looks forward to helping companies in the future.


Source:--------->wikiCFO

Friday, 20 January 2012

Amortization

Amortization: In accounting, amortization refers to the periodic expensing of the value of an intangible asset. Similar to depreciation of tangible assets, intangible assets are typically expensed over the course of the asset’s useful life. Amortization represents reduction in value of the intangible asset due to usage or obsolescence. Basically, intangible assets decrease in value over time, and amortization is the method of accounting for that decrease in value over the course of the asset’s useful life. A company’s long-term capital expenditures can also be amortized over time.

Amortization Treatment:
Intangible assets are recorded on the balance sheet. Over time, as these assets are amortized, the amortized amount accumulates in a contra-asset account thereby diminishing the net value of the intangible assets. The periodic amortization amounts are expensed on the income statement as incurred. On the statement of cash flows, amortization expenses are added back to net income in the operating section because they represent non-cash expenses.

Intangible Asset Amortization:
Examples of intangible assets that a company may amortize include: trademarks, patents, copyrights, brand names, goodwill, and other intellectual property. Depending on the circumstances, some brand names or goodwill items may not decrease in value over time and therefore may not be amortized.

Amortization Regulations:
In International Financial Reporting Standards (IFRS), the rules and standards for intangible asset amortization are described in International Accounting Standard 38: Intangible Assets. In the United States, according to General Accepted Accounting Principles(GAAP), the rules and standards for intangible asset amortization are described in Statement of Financial Accounting Standards No. 142: Goodwill and Other Intangible Assets.

Amortization of Loans:
Amortizing a loan consists of spreading out the principal and interest payments over the life of the loan. The amortized loan is spread out and paid down based on an amortization schedule or amortization table. There are different types of amortization schedule, such as straight line, declining balance, annuity, and increasing balance amortization tables. Amortization of mortgages is common.

Source:--------->wikiCFO

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