Wednesday, 27 July 2011

Finance Glossaory-4

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Derivatives: A derivative is a security whose price ultimately depends on that of another asset.
Derivative means a contact of an agreement.
Types of Derivatives:
1. Forward Contracts
2. Futures
3. Options
4. Swaps.
1. Forward Contracts: - It is a private contract between two parties.
                                                An agreement between two parties to exchange an asset for a price that is specified todays. These are settled at end of contract.
2. Future contracts: - It is an Agreement to buy or sell an asset it is at a certain time in the future for a certain price. Futures will be traded in exchanges only.These is settled daily.       
Futures are four types:
1. Commodity Futures: Wheat, Soyo, Tea, Corn etc..,.
2. Financial Futures: Treasury bills, Commercial Paper, Equity Shares, bonds, etc..,
3. Currency Futures: Major convertible Currencies like Dollars, Founds, Yens,                                    and Euros.
4. Index Futures: Underline assets are famous stock market indicies. NewYork Stock Exchange.

3. Options: An option gives its Owner the right to buy or sell an Underlying asset on or before a given date at a fixed price.
                        There can be as may different option contracts as the number of items to buy or sell they are,
                                    Stock options, Commodity options, Foreign exchange options and interest rate options are traded on and off organized exchanges across the globe.
Options belong to a broader class of assets called Contingent claims.
The option to buy is a call option.The option to sell is a PutOption. 
The option holder is the buyer of the option and the option writer is the seller of the option.
The fixed price at which the option holder can buy or sell the underlying asset is called the exercise price or Striking price.
A European option can be excercised only on the expiration date where as an American option can be excercised on or before the expiration date.
Options traded on an exchange are called exchange traded option and options not traded on an exchange are called over-the-counter optios.
When stock price (S1) <= Exercise price (E1) the call is said to be out of money and is worthless.
When S1>E1 the call is said to be in the money and its value is S1-E1.

4. Swaps:   Swaps are private agreements between two companies to exchange casflows in the future according to a prearranged formula.
So this can be regarded as portfolios of forward contracts.
Types of swaps:
1: Interest rate Swaps
2: Currency Swaps.
1. Interest rate Swaps:  The most common type of interest rate swap is ‘Plain Venilla ‘.
Normal life of swap is 2 to 15 Years.
It is a transaction involving an exchange of one stream of interest obligations for another. Typically, it results in an exchange of ficed rate interest payments for floating rate interest payments.
2. Currency Swaps: - Another type of Swap is known as Currency as Currency Swap. This involves exchanging principal amount and fixed rates interest payments on a loan in one currency for principal and fixed rate interest payments on an approximately equalant loan in another currency. Like interest rate swaps currency swars can be motivated by comparative advantage.

Wednesday, 20 July 2011

Shares and Mutual Funds

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Company: Sec.3 (1) of the Companys act, 1956 defines a ‘company’.  Company means a company formed and registered under this Act or existing company”.

Public Company: A corporate body other than a private company. In the public company, there is no upperlimit on the number of share holders and no restriction on transfer of shares.

Private Company: A corporate entity in which limits the number of its members to 50. Does not invite public to subscribe to its capital and restricts the member’s right to transfer shares.

Liquidity:  A firm’s liquidity refers to its ability to meet its obligations in the short run.  An asset’s liquidity refers to how quickly it can he sold at a reasonable price.

Cost of Capital: The minimum rate of the firm must earn on its investments in order to satisfy the expectations of investors who provide the funds to the firm.
Capital Structure: The composition of a firm’s financing consisting of equity, preference, and debt.

Annual Report: The report issued annually by a company to its shareholders. It primarily contains financial statements. In addition, it represents the management’s view of the operations of the previous year and the prospects for future.
Proxy: The authorization given by one person to another to vote on his behalf in the shareholders meeting.
Joint Venture: It is a temporary partenership and comes to an end after the compleation of a particular venture. No limit in its.
Insolvency: In case a debtor is not in a position to pay his debts in full, a petition can be filled by the debtor himself or by any creditors to get the debtor declared as an insolvent.

Long Term Debt: The debt which is payable after one year is known as long term debt.
Short Term Debt: The debt which is payable with in one year is known as short term debt.
Amortisation: This term is used in two senses 1. Repayment of loan over a period of time 2.Write-off of an expenditure (like issue cost of shares) over a period of time.
Arbitrage: A simultaneous purchase and sale of security or currency in different markets to derive benefit from price differential.

Stock: The Stock of a company when fully paid they may be converted into stock.

Share Premium: Excess of issue price over the face value is called as share premium.

Equity Capital: It represents ownership capital, as equity shareholders collectively own the company. They enjoy the rewards and bear the risks of ownership. They will have the voting rights.

Types of Working Capital

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There are two types of working capital. They are:
I) on the basis of concept
1) Gross working capital.
2) Net working capital.

1. Gross working capital
           Refers to the firm’s investment in current assets are the assets, which can be concerned into and with in an accounting year (or operating cycle) and include cash, short-term securities, debtors (accounts receivables or book debts) bills receivable and stock (inventory) Gross working capitals points to the arranging of funds to finance current assets.
           Refers to the difference between current assets and current liabilities. Currents liabilities are those claims of outsiders, which are expected to nature for payment within accounting years and include creditors (accounts payable). Bills Payable and outstanding expenses. Networking capital can be positive or negative. A positive networking capital will arise when current assets, exceed current liabilities and a negative working capital will arise when current liabilities are in excess of current assets.
II) On the basis of time
1) Permanent/fixed/fluctuating working capital
2) Temporary working capital
1) Permanent working capital:-
            The need for current assets arises because of the operating cycle. The operating cycle is a continuous process and therefore, the need for the current assets is felt constantly. But the magnitude of current assets needed is not always a minimum level of current assets, which is continuously required by the firm to carry on its business operations. This minimum level of current assets is referred to as permanent or fixed working capital.
EXAMPLE: - Every firm has to maintain a minimum level of raw materials, work-in-progress, finished goods and cash balance. This minimum level of current assets is called permanent or fixed working capital as this part of capital is permanently blocked in current assets. As the business grows, the requirements of permanent working capital also increase due to the increase in current assets.
2. Temporary working capital:-
          Depending upon the changes in production and sales, the need for working capital over and above permanent working capital, will have in be maintained to support the peak proceeds of sale and investment in receive may also increase during such periods. On the other hand, investment in raw material, working in progress and finished goods will fall if the market is slack.
            The extra working capital needed to support the changing production and sales activities is called fluctuating, or variable or temporary working capital. The firm to meet liquidity measurement that will last only temporarily creates temporary working capital.


Friday, 15 July 2011

accounting glossaory-6

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Working Capital: There are two types of working capital: gross working capital and net working capital. Gross working capital is the total of current assets. Net working capital is the difference between the total of current assets and the total of current liabilities.

Working Capital Cycle:
                                                It refers to the length of time between the firms paying cash for materials, etc.., entering into the production process/ stock and the inflow of cash from debtors (sales)
Capital Budgeting: Process of analyzing, appraising, deciding investment on long term projects is known as capital budgeting.

Methods of Capital Budgeting:

1.            Traditional Methods
                              Payback period method
                             Average rate of return (ARR)
2.            Discounted Cash Flow Methods or Sophisticated methods
                              Net present value (NPV)
                              Internal rate of return (IRR)
                              Profitability index

Pay back period: Required time to reach actual investment is known as payback period.

                    = Investment / Cash flow

ARR: It means the average annual yield on the project.

                = avg. income / avg. investment
       = (Sum of income / no. of years) / (Total investment + Scrap value) / 2)
NPV: The best method for the evaluation of an investment proposal is the NPV or discounted cash flow technique. This method takes into account the time value of money.
              The sum of the present values of all the cash inflows less the sum of the present value of all the cash outflows associated with the proposal.
NPV = Sum of present value of future cash flows – Investment
IRR: It is that rate at which the sum total of cash inflows aftrer discounting equals to the discounted cash outflows. The internal rate of return of a project is the discount rate which makes net present value of the project equal to zero.

Profitability Index: One of the methods comparing such proposals is to workout what is known as the ‘Desirability Factor’ or ‘Profitability Index’.
In general terms a project is acceptable if its profitability index value is greater than 1.

Sunday, 10 July 2011

accounting glossaory-5

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Depreciation: It is a perminant continuing and gradual shrinkage in the book value of a fixed asset.
1. Fixed Instalment method or Stright line method
Dep. = Cost price – Scrap value/Estimated life of asset.
2. Diminishing Balance method: Under this metod, depreciation is calculated at a certain percentage each year on the balance of the asset, which is bought forward from the previous year.
3. Annuity method: Under this method amount spent on the purchase of an asset is regarded as an investment which is assumed to earn interest at a certain rate. Every year the asset a/c is debited with the amount of interest and credited with the amount of depreciation.
EOQ: The quantity of material to be ordered at one time is known EOQ. It is fixed where minimum cost of ordering and carryiny stock.
 Key Factor: The factor which sets a limit to the activity is known as key factor which influence budgets.
              Key Factor = Contribution/Profitability
              Profitability =Contribution/Key Factor
Sinking Fund: It is created to have ready money after a particular period either for the replacement of an asset or for the repayment of a liability. Every year some amount is charged from the P&L a/c and is invested in outside securities with the idea, that at the end of the stipulated period, money will be equal to the amount of an asset.
Revaluation Account: It records the effect of revaluation of assets and liabilities. It is prepared to determine the net profit or loss on revaluation. It is prepared at the time of reconsititution of partnership or retirement or death of partner.  
Realisation Account: It records the realisation of various assets and payments of various liabilities. It is prepared to determine the net P&L on realisation.

Leverage: - It arises from the presence of fixed cost in a firm capitalstructure.
                        Generally leverage refers to a relationship between two interrelated variables.
These leverages are classified into three types.
1.            Operating leverage
2.            Financial Leverage.
3.            Combined leverage or total leverage.

1.            Operating Leverage: It arises from fixed operating costs (fixed costs other than the financing costs) such as depreciation, shares, advertising expenditures and property taxes.

When a firm has fixed operatingcosts, a change in 1% in sales results in a change of more than 1% in EBIT
                         %change in EBIT 
                         % change in sales
The operaying leverage at any level of sales is called degree.
Degree of operatingLeverage= Contribution/EBIT

Significance: It tells the impact of changes in sales on operating income.
                     If operating leverage is high it automatically means that the break- even point would also be reached at a highlevel of sales.

2.            Financial Leverage:  It arises from the use of fixed financing costs such as interest. When a firm has fixed cost financing. A change in 1% in E.B.I.T results in a change of more than 1% in earnings per share.
F.L =% change in EPS / % change in EBIT
Degree of Financial leverage= EBIT/ Profit before Tax (EBT)
                      Significance: It is double edged sword. A high F.L means high fixed financial costs and high financial risks.

3.            Combined Leverage: It is useful for to know about the overall risk or total risk of the firm. i.e, operating risk as well as financial risk.
                         C.L= O.L*F.L
                               = %Change in EPS / % Change in Sales
                            Degree of C.L =Contribution / EBT

A high O.L and a high F.L combination is very risky. A high O.L and a low F.L indiacate that the management is careful since the higher amount of risk involved in high operating leverage has been sought to be balanced by low F.L
A more preferable situation would be to have a low O.L and a F.L.

Monday, 4 July 2011

accounting glossaory-4

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Fixed Cost: These are the costs which remains constant at all levels of production. They do not tend to increase or decrease with the changes in volume of production.
Variable Cost: These costs tend to vary with the volume of output. Any increase in the volume of production results in an increase in the variable cost and vice-versa.
Semi-Variable Cost: These costs are partly fixed and partly variable in relation to output.
Absorption Costing: It is the practice of charging all costs, both variable and fixed to operations, processess or products. This differs from marginal costing where fixed costs are excluded.
Operating Costing: It is used in the case of concerns rendering services like transport. Ex: Supply of water, retail trade, etc...

Costing: Cost accounting is the recording classifying the expenditure for the determination of the costs of products.For thepurpuses of control of the costs.
Rectification of Errors: Errors that occur while preparing accounting statements are rectified by replacing it by the correct one.
  Errors like: Errors of posting, Errors of accounting etc…
Absorbtion: When a company purchases the business of another existing company that is called absorbtion.
Mergers: A merger refers to a combination of two or more companies into one company.
Variance Analasys: The deviations between standard costs, profits or sales and actual costs. Profits or sales are known as variances.
 Types of variances
                                    1: Material Variances
                                    2: Labour Variances
                                    3: Cost Variances
                                    4: Sales or ProfitVariances
General Reserves: These reserves which are not created for any specific purpose and are available for any future contingency or expansion of the business.

SpecificReserves: These reserves which are created for a specific purpose and can be utilized only for that purpose.
                                   Ex: Dividend Equilisation Reserve
                                        Debenture Redemption Reserve
Provisions: There are many risks and uncertainities in business. In order to protect from risks and uncertainities, it is necessary to provisions and reserves in every business.

Reserve: Reserves are amounts appropriated out of profits which are not intended to meet any liability, contingency, commitment in the value of assets known to exist at the date of the B/S.
Creation of the reserve is to increase the workingcapital in the business and strengthen its financial position. Some times it is invested to purchase out side securities then it is called reserve fund.
            1: Capital Reserve: It is created out of capital profits like premium on the issue of shares, profits and sale of assets, etc…This reserve is not available to distribute as dividend among shareholders.
            2: Revenue Reserve:  Any Reserve which is available for distribution as dividend to the shareholders is called Revenue Reserve.
Provisions V/S Reserves:
1.     Provisions are created for some specific object and it must be utilised for that object for which it is created.
   Reserve is created for any future liability or loss.
2.     Provision is made because of legal necessity but creating a Reserve is a matter of financial strength.
3.     Provision must be charged to profit and loss a/c before calculating the net profit or loss but Reserve can be made only when there is profit.
4.     Provisions reduce the net profit and are not invested in outside securities Reserve amount can invested in outside securities.      
Goodwill: It is the value of repetition of a firm in respect of the profits expected in future over and above the normal profits earned by other similar firms belonging to the same industry.
            Methods: Average profits method
                            Super profits method
                            Capitalisatioin method

Friday, 1 July 2011

accounting glossaory-3

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Lease: A contractual arrangement whereby the lessor grants the lessee the right to use an asset in return for periodic lease rental payments.
Doubleentry: Every transaction consists of two aspects
                                                 1. The receving aspect
                                                 2. The giving aspect
The recording of two aspect effort of each transaction is called ‘double entry’.
The principle of double entry is, for every debit there must be an equal and a corresponding credit and vice versa.
BRS: When the cash book and the passbook are compared, some times we found that the balances are not matching. BRS is preparaed to explain these differences.
Capital Transactions: The transactions which provide benefits to the business unit for more than one year is known as “capital Transactions”.
Revenue Transactions: The transactions which provide benefits to a business unit for one accounting period only are known as “Revenue Transactions”.
Deffered Revenue Expenditure:  The expenditure which is of revenue nature but its benefit will be for a very long period is called deffered revenue expenditure.
Ex: Advertisement expences
A part of such expenditure is shown in P&L a/c and remaining amount is shown on the assests side of B/S.
Capital Receipts: The receipts which rise not from the regular course of business are called “Capital receipts”.
Revenue Receipts: All recurring incomes which a business earns during normal cource of its activities.
Ex: Sale of good, Discount Received, Commission Received.
Reserve Capital: It refers to that portion of uncalled share capital which shall not be able to call up except for the purpose of company being wound up.
Fixed Assets: Fixed assets, also called noncurrent assets, are assets that are expected to produce benefits for more than one year. These assets may be tangible or intangible. Tangible fixed assets include items such as land, buildings, plant, machinery, etc… Intangible fixed assets include items such as patents, copyrights, trademarks, and goodwill.
Current Assets: Assets which normally get converted into cash during the operating cycle of the firm. Ex: Cash, inventory, receivables.
Flictitious assets: They are not represented by anything tangible or concrete.
Ex: Goodwill, deffered revenue expenditure, etc…
Contingent Assets: It is an existence whose value, ownership and existence will depend on occurance or non-occurance of specific act.
Fixed Liabilities: These are those liabilities which are payable only on the termination of the business such as capital which is liability to the owner.
Longterm Liabilities: These liabilities which are not payable with in the next accounting period but will be payable with in next 5 to 10 years are called longterm liabilities. Ex: Debentures.
Current Liabilities: These liabilities which are payable out of current assets with in the accounting period. Ex: Creditors, bills payable, etc…
Contingent Liabilities: A contingent liability is one, which is not an actual liability but which will become an actual one on the happening of some event which is uncertain. These are staded on balance sheet by way of a note.
Ex: Claims against company, Liability of a case pending in the court.
Bad Debts: Some of the debtors do not pay their debts. Such debt if unrecoverable is called bad debt. Bad debt is a business expense and it is debited to P&L account.
Capital Gains/losses: Gains/losses arising from the sale of assets.