All strategic investment decisions are going to involve some degree of risk. Risk entails not only the profitable versus unprofitable dichotomy, but also the variability in earnings or losses emanating from an investment project. One dimension of the risk-management question is captured in the concept of operating leverage. Operating leverage is the degree of magnification of earnings or losses (expressed as cash flows or profits) set off by different levels of output. The magnification results from the variable cost versus fixed cost mix in an investment period. Generally the higher the level of fixed commitment in relation to variable costs, the greater is the leverage (and magnification). This, of course, is the central notion in the familiar break-even analysis, where concern is given not only to the break-even point, but also the levels of earnings or losses around it. Operating leverage is a double-edged sword, however. Like financial leverage, operating Continue reading
Financial Concepts
Debt Equity Ratio
Meaning of Debt Equity Ratio Capitalization of a company consists of funds raised by issuing various types of securities, i.e., ordinary shares, preference shares, debentures etc. To decide as to the ratio of various types of securities to total capitalization is a very difficult task but the decision in this important for the business to decide as to the ratio of ownership capital to the creditorship capital or loan capital. The ratio of borrowed capital to the owned capital may be called debt equity ratio. In other words, debt equity ratio is the ratio between borrowed capital on the one hand and owned capital on the other. Debt equity ratio is positively correlated with the capital gearing. If capital gearing in a company is high, debt equity ratio would also be high or vice versa. For example, if the total capital of Rs. 1,00,000 in a company consists of Rs. Continue reading
DuPont Analysis – Return on Equity (ROE) Analysis
Financial statement analysis is employed for a variety of reasons. Outside investors are seeking information as to the long run viability of a business and its prospects for providing an adequate return in consideration of the risks being taken. Creditors desire to know whether a potential borrower or customer can service loans being made. Internal analysts and management utilize financial statement analysis as a means to monitor the outcome of policy decisions, predict future performance targets, develop investment strategies, and assess capital needs. As the role of the credit manager is expanded cross-functionally, he or she may be required to answer the call to conduct financial statement analysis under any of these circumstances. The DuPont analysis is a useful tool in providing both an overview and a focus for such analysis. History of DuPont Analysis The DuPont model of financial analysis was made by F. Donaldson Brown, an electrical engineer Continue reading
Double Entry System of Bookkeeping
The recording of financial transactions undertaken by an individual or an organization defined Bookkeeping. The organization could be an enterprise, a charitable organization or even a local sports club. The necessary support for such accounting function is provided by bookkeeping as the preparation of cost reports, financial statements, and tax returns. Making entries to specific accounts with debit and credit system and keeping track of a business’s financial transactions is involved. Bookkeeping has evolved through the years from clay tablets, to paper ledgers, and now computerized systems. Even for now, bookkeeping fundamentals have not been changed through the ages. And chances are the future societies will not be able to exist without a formal system of financial recording keeping. In short, some of the same problems that plagued ancient bookkeepers still exist even with modern advancement. The process of bookkeeping is always considered to be as vital importance to categorize Continue reading
Difference between Cash Credit and Overdraft
Cash credit is a short-term cash loan to a company. A bank provides this type of funding, but only after the required security is given to secure the loan. Once a security for repayment has been given, the business that receives the loan can continuously draw from the bank up to a certain specified amount. This type of financing is similar to a line of credit. Furthermore, cash credit is a facility to withdraw the amount from the business account even though the account may not have enough credit balance. The limit of the amount that can be withdrawn is sanctioned by the bank based on the business cycle of the client and the working capital gap and the drawing power of the client. This drawing power is determined, based on the stock and book debts statements submitted by the borrower at monthly intervals against the security by hypothecating of Continue reading
Types of Investors in the Stock Market
There is a wide diversity among investors, depending on their investment styles, mandates, horizons, and assets under management. Primarily, investors are either individuals, in that they invest for themselves or institutions, where they invest on behalf of others. Risk appetites and return requirements greatly vary across investor classes and are key determinants of the investing styles and strategies followed as also the constraints faced. Primarily investors can be categorized into two groups: Individual Investors: While in terms of numbers, individuals comprise the single largest group in most markets, the size of the portfolio of each investor is usually quite small. Individuals differ across their risk appetite and return requirements. Those averse to risk in their portfolios would be inclined towards safe investments like government securities and bank deposits, while others may be risk takers who would like to invest and/or speculate in the equity markets. Requirements of individuals also evolve Continue reading