Responsibility accounting is an underlying concept of accounting performance measurement systems. The basic idea is that large diversified organizations are difficult, if not impossible to manage as a single segment, thus they must be decentralized or separated into manageable parts. These parts, or segments are referred to as responsibility centers that include: 1) revenue centers, 2) cost centers, 3) profit centers and 4) investment centers. This approach allows responsibility to be assigned to the segment managers that have the greatest amount of influence over the key elements to be managed. These elements include revenue for a revenue center (a segment that mainly generates revenue with relatively little costs), costs for a cost center (a segment that generates costs, but no revenue), a measure of profitability for a profit center (a segment that generates both revenue and costs) and return on investment (ROI) for an investment center (a segment such as Continue reading
Business Finance Terms
Financial Derivative Types: Swaps
Swap is yet another exciting trading instrument. In fact, it is a combination of forwards by two counter-parties. It is arranged to reap the benefits arising from the fluctuation in the market — either currency market or interest rate market or any other market for that matter. Features of Swap The following are the important features of swap: Basically a forward: A swap is nothing but a combination of forwards. So, it has all the properties of a forward contract discussed above. Double coincidence of wants: Swap requires that two parties with equal and opposite needs must come into contact with each other. As stated earlier, it is a combination of forwards by two counterparties with opposite but matching needs. For instance, the rate of interest differs from market to market and within the market itself. It varies from borrowers to borrowers due to the relative credit worthiness of borrowers. Continue reading
Asset Swaps
Unlike interest rate swaps and basis rate swaps discussed earlier, in which cash flows of debt obligation were changed, asset swaps are used to change the characteristics of an asset. For example, an investor with a ten year fixed Japanese yen bond may decide to enter into a currency swap to change his investment income into US dollar. The investor may feel that the Japanese yen will lose its value against the US dollar and would like to change his income into US dollar. Assume the current five year swap rate for US$ versus Japanese Yen to be 6.45-6.50%. The coupon rate of the investor’s bond is 7.00% and the bond has five years remaining. The investor can exchange his 50 bps Japanese Yen payments at the spot market as an extra income above LIBOR or have the dealer manage that risk as well. At the maturity date, the Continue reading
Credit Policy in Receivable Management
Concept of Credit Policy The discharge of the credit function in a company embraces a number of activities for which the policies have to be clearly laid down. Such a step will ensure consistency in credit decisions and actions. A credit policy thus, establishes guidelines that govern grant or reject credit to a customer, what should be the level of credit granted to a customer etc. A credit policy can be said to have a direct effect on the volume of investment a company desires to make in receivables. A company falls prey of many factors pertaining to its credit policy. In addition to specific industrial attributes like the trend of industry, pattern of demand, pace of technology changes, factors like financial strength of a company, marketing organization, growth of its product etc. also influence the credit policy of an enterprise. Certain considerations demand greater attention while formulating the credit Continue reading
What is Under Capitalization?
Concept of Under Capitalization The phrase under capitalization should never be misconstrued with inadequacy of capital Gerstenberge says “A corporation may be under capitalized when the rate of profit is exceptionally high in relation to the return enjoyed by similarly situated companies in the same industry or it has too little capital to conduction business”. It’s against over capitalization, under capitalization implies an effective utilization of finance, a high rate of dividend & the enhanced price of share. Here the capital of the company is less in proportion to its total requirements. In this state of affairs the real worth of the assets exceeds their book value and the rate of earning is higher than a corporation is able to offer. When a company succeeds in earning abnormally large income continuously for a pretty long time symptoms of under capitalization gradually develop in the companies. Under capitalization is an index Continue reading
Concept of Economic Value Added (EVA)
The onset of liberalization and globalization of the Indian economy over the ten years has resulted in shift of the corporate goals from socio-economic focus to an increasing shareholders value. Therefore, the present day need is to choose the right metrics that would help to measure organizational progress in meeting the above mentioned strategic goal. Although there are few traditional performance metrics like balance sheet measures (namely, rate of return, shareholders’ profit, earning per share) and market driven measures (namely, market capitalization, price earning ratio), these are subject to certain deficiencies. Balance Sheet based measures are veiled in accounting anomalies that generally measure notional profit, not real ones and market driven measures are prone to volatility of the bourses. The need is for a mix and match measure that factor in a market’s assessment of a company’s value. At the same time, it should be a real measure of its Continue reading