Traditional or Absorption Costing System reflects full cost pertaining to a product. It is easy to use and, therefore, is practiced widely. The allocation of overhead costs under the system is based on a rate determined by either a percentage of direct labor cost or number of labor hours worked or another. Therefore, the reported allocation of overheads for a given product may be incorrect. It is the main defect of absorption costing. During 1980’s, the limitations of absorption costing system were felt with severity. Companies were looking for a system that could reflect true product cost in order to fight competition. The absorption costing system was designed decades ago, when most companies produced narrow range of products. Further, overhead costs were small enough to make a big difference in the identification of cost of a product. This criticism of absorption costing led to generation of the idea of ABC Continue reading
Financial Concepts
Junk Bonds in India
Sharp movements in the Indian equity market may be par for the course. But when it comes to the market for corporate bonds, it’s constantly stagnant. The reason is, we don’t have a corporate bond market. But this is overwhelmingly dominated by government securities (about 80% of the total). Of the remaining, close to 80% again comprises privately placed debt of public financial institutions. An efficient bond market helps corporate reduce their financing costs. It enables companies to borrow directly from investors, bypassing the major intermediary role of a commercial bank. One of the important instruments in corporate market is Junk Bonds which could be great source of financing for countries like India where markets are not much regulated. A speculative bond rated BB or below, “Junk bonds” are generally issued by corporations of questionable financial strength or without proven track records. They tend to be more volatile and higher 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
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
What is Cost Of Money?
The cost of money refers to the price paid for using the money, whether borrowed or owned. Every sum of money used by corporations bears cost. The interest paid on debt capital and the dividends paid on ownership capital are examples of the cost of money. The supply of and demand for capital is the factor that affects the cost of money. In addition, the cost of money is affected by the following factors as below: Production Opportunities – Production opportunities refer to the profitable opportunities for investment in productive assets. Increase in production opportunities in an economy increases the cost of money. Higher the production opportunities more will be the demand for money which leads to higher cost of money. Time Preference For Consumption – Time preference for consumption refers to the preference of consumers for current consumption as opposed to future consumption. The cost of money also depends Continue reading
Factors Influencing Dividend Payouts of a Company
Dividend is a form of payment made to shareholders by an organization; It’s a profit which is paid out to the company shareholders. When a profit is earned by the company, the profits are used again to invest for a better growth of the company for its future, or it can also be paid to the company shareholders in the form of dividends. Dividends are also paid to the shareholders in the form of cash or shares. The company must have sufficient funds in order to pay dividends to its shareholders. Dividends are generally paid out by a company only when the company make good profit and it’s been paid form its earnings. Dividend policy is of great interest n today’s financial industries when the joint stock companies came into existences. Dividends can also be defined as “a distribution of company’s earnings which is decided by the board of directors Continue reading