Category: Financial Management

Financial management is the process of planning, organizing, controlling, and monitoring an organization’s financial resources to achieve its goals and objectives effectively. It involves making financial decisions, managing investments, and ensuring the financial health and sustainability of the business. Financial management is essential for both businesses and individuals. As it helps in optimizing financial resources and making informed decisions about money matters.

Key aspects of financial management include:

  1. Financial Planning: This involves setting financial goals and developing a comprehensive plan to achieve them. It includes budgeting, forecasting, and identifying potential sources of funding.
  2. Capital Budgeting: This process entails evaluating and selecting long-term investment projects that align with the organization’s objectives. It involves analyzing the potential returns and risks associated with different investment opportunities.
  3. Financing Decisions: Financial managers need to decide how to fund the organization’s operations and investments. This may involve choosing between debt financing (e.g., loans, bonds) and equity financing (e.g., issuing shares).
  4. Working Capital Management: It involves managing the organization’s short-term assets and liabilities to ensure smooth day-to-day operations. The goal is to maintain an optimal balance between cash flow, inventory, accounts receivable, and accounts payable.
  5. Risk Management: Financial managers must assess and mitigate financial risks that the organization may face. This includes market risks, credit risks, liquidity risks, and operational risks.
  6. Financial Reporting and Analysis: Preparation of accurate and timely financial statements (e.g., income statement, balance sheet, cash flow statement) is crucial for decision-making. Financial analysis helps interpret these statements to assess the company’s performance and identify areas for improvement.
  7. Financial Control: Monitoring financial performance and comparing actual results with budgeted figures is essential to identify deviations and take corrective actions as needed.
  8. Tax Planning: Financial managers need to consider tax implications while making financial decisions to optimize tax efficiency and compliance.

Financial management is vital for individuals as well. It involves budgeting, saving, investing, and managing personal finances to achieve financial goals. Such as buying a house, funding education, or planning for retirement.

Overall, financial management plays a crucial role in the success and sustainability of organizations and individuals by ensuring the effective allocation and utilization of financial resources. It helps create a sound financial foundation, minimize risks, and support long-term growth and prosperity.

  • Financial Budgeting and Forecasting Difference Process

    Financial Budgeting and Forecasting Difference Process

    Financial Budgeting and Forecasting with their Meaning, Distinction, Difference, and also Process; Planning is the most important factor in business success. A good plan not only helps companies focus on the specific steps needed to successfully implement their ideas but also helps managers achieve both short-term and long-term goals. Financial forecasts and financial budgets are two of the most important planning tools in modern organizations. Used properly, financial forecasting and budgeting ensure that an organization always has enough cash on hand for the things that are most important to its short and long-term success.

    Here is the article to explain, the Distinction or Difference between Financial Budgeting and Forecasting with their Meaning and also Process

    Understand the difference between financial forecasting and financial budgeting; Unfortunately, the two terms are often confused or even used interchangeably. This hesitation is a mistake. While forecasting and budgeting are essential to an organization’s planning process, they are significantly different. This article summarizes the distinction between the two processes. A budget calculates how much money your company will make and how much it will spend over a certain period of time. Simply put, a budget lists fixed and variable costs and how the money coming into the business distribute.

    Forecasts use historical and recent transaction data; as well as industry and market information, to determine how budgets for expected costs will distribute over a given period of time. Forecasting increases the confidence of the management team in making important business decisions. Budgeting and financial forecasting have unique goals, but they work well together. While budget details await future results, forecasting focuses on probable future events to inform whether the company will achieve the goals set in the budget. To use the common analogy that a budget is a shared map, forecasting and budgeting is something like Waze or any map app on your phone. Budgeting is the map, and forecasting provides the tools to help you adjust how you reach your goals.

    What does it mean to have financial budgeting?

    Budgeting is the process of making a plan for how you will spend your business money for a certain period of time (months, quarters, years, etc.). The budget estimates your company’s income and expenses for this period. Budgets periodically reassess and adjust – in most cases quarterly. The budget is a quantitative expectation of what the company wants to achieve. Its characteristics are:

    • A budget is a detailed representation of the future results, financial position, and cash flow that management wants to achieve over a certain period of time.
    • The budget can only update once a year depending on how often management wants to review the information.
    • Budgets compare with actual results to find deviations from expected results.
    • Management takes corrective action to bring actual results within budget.
    • Comparison of budget versus actual may result in changes in compensation based on results paid to employees.

    What are the five types of budgets?

    There are five types of budgets that companies usually create to run a business.

    • Creating a static budget created by the department and accounting for fixed costs is often the first step in the budgeting process. A static budget remains unchanged, even if parts of the company, such as sales, change.
    • The articles of association cover all company departments. This budget prepare every fiscal year. The general budget provides revenues, expenses, operating expenses, sales, investments, and other items used in financial statements.
    • A financial plan is a company’s strategy for managing its assets, cash flow, income, and expenses. For example, when a company plans to go public or undertake mergers and acquisitions, it creates a financial budget to determine or represent its value.
    • The operating budget estimates revenues and expenses from ongoing operations, including cost of goods sold and sold, general and administrative expenses.
    • Finally, a cash flow budget makes assumptions about the inflows and outflows of funds over a period of time.

    Why is the budget important? Budgets can be short-term or long-term. They keep the company on track by setting cost parameters and comparing expected results with actual. By providing goals, they provide a company’s goals to pursue and a framework for responsible implementation.

    What does it mean to have a financial forecast?

    Financial forecasting is different from budgeting. It reviews budget targets and, along with market and industry analysis, provides preliminary information to predict whether the expected targets will achieve. These forecasts help finance professionals and line managers see if the company will meet budget expectations – and give them the information they need to make adjustments if they’re not on track. Prognosis is an estimate of what will actually achieve. Its characteristics are:

    • Estimates usually limit to important items of income and expenses. As a rule, there is no forecast of financial condition, although cash flows can predicte.
    • Forecasts update regularly, perhaps monthly or quarterly.
    • Forecasts can use for short-term operational considerations such as staff adjustments, inventory levels, and production schedules.
    • No analysis of variance compares estimates with actual results.
    • Changes in forecasts do not affect yield-based compensation paid to employees.

    Why are forecasts important? Financial forecasts ensure that business units have the resources needed to meet the company’s needs – almost all organizations produce quarterly financial forecasts. However, a new customer loss or an external event such as a pandemic can significantly affect the accuracy of quarterly forecasts. Mobile companies incorporate mobile forecasting to create ongoing process planning rather than quarterly events. These companies can then better respond to the fast-growing market while avoiding the surprises of their regular quarterly forecasts.

    How to know? Which comes first, the budget or the forecast?

    Budgets and forecasts have to work together – you set goals; others provide an idea of whether they can and will achieve. Forecasting can use to help budget or understand how money should allocate to specific areas of the company. But without a budget, forecasts have no real purpose.

    Comparison of budgets and forecasts;

    The main difference between a budget and a forecast is that a budget establishes a plan for what the company is trying to achieve, whereas an estimate sets out expectations of actual results, usually in a much more generalized format. In other words, a budget is a plan for where the company wants to go, whereas a forecast is an indication of where it really is. In fact, the most useful of these tools are forecasts because they are a short-term representation of the real world that is happening in the business.

    The information in the forecast can use for immediate action. On the other hand, a budget may contain goals that are completely unattainable or whose market conditions have changed so much that it is not advisable to fulfill them. If the budget is to use, it must update at least once a year so that it is in line with the current market realities. The last point is especially important in a rapidly changing market where the assumptions used to create a budget can become out of date in a matter of months. In short, businesses always need forecasts to show them their current direction, while budgeting is not always necessary.

    The main distinction or difference between the two financial processes is budgeting and forecasting;

    Now that we have a better understanding of the two processes, we can more easily summarize the differences. There are five main differences or distinctions between the two:

    Definition;

    Financial forecasts are forecasts for trends and financial results based on historical data. A financial budget, on the other hand, is a statement of the estimated income and expenses during the budget period.

    Purpose or Destination;

    Financial forecasts quantify future business activities, revealing where the organization is going for a given period of time. A financial budget, on the other hand, measures a tactical plan that represents what the organization’s management wants to achieve during the budget period.

    Duration or Timing;

    Forecasts are usually made for the long term. While you may occasionally find short-term projections that may cover a quarter, most projections last several years. In comparison, budgets cover a shorter period of time. A typical budget covers a fiscal year.

    Flexibility;

    Financial forecasts are very flexible. They regularly adapt to changing assumptions and changes in the operating environment. On the other hand, budgets are more static. Once created, the budget only adjusts if the initial assumptions have changed.

    Application;

    Forecasts are a strategic tool that companies use to plan their growth over several years. While the budget is a tactical tool used to manage operations during the reporting period. It should also note that while budgets can use to analyze differences between actual and expected results, forecasts are only estimates; do not provide a counter with which to compare.

    Final thoughts on financial forecasting vs financial budgeting;

    Businesses need to start taking financial forecasting and budgeting seriously. However, if you use the two terms synonymously or even confuse them; there is a risk that one will not use but the other. This is a dangerous precedent. Also, You cannot have one without the other; You cannot create an effective budget without good estimates, and vice versa, You need both.

    What is the budgeting and forecasting process?

    There are four types of budget processes – incremental, activity-based, value proposition, and zero.

    1. Step-by-step budgeting is the most common method. Subtract numbers from the previous period and add or subtract percentages to prepare a budget for the current period, according to the Institute of Corporate Finance. The incremental budget procedure base on the idea that a new budget can develope by making slight changes to the current budget. For example, today’s budget can be used as a basis for adding or subtracting additional assumptions to the base amount to determine a new budget amount. It’s good practice if your company’s key cost drivers don’t change every year; but, it doesn’t take into account whether some departments really need more or less money to meet current-period goals.
    2. Activity-Based Budgeting (ABB) sets goals and determines what inputs and activities are needed to achieve those goals. ABB is a budgeting method in which a budget is created based on activity-related costs (ABC). It contains 3 types of information: activities to carries out for next year, number of activities and cost of activities. For example, a car wash plans to ship 12,000 washes over the next year, and the shipping costs are $5 per wash. The activity-based budget for this initiative is $60,000 (12,000 * 5).
    3. That’s exactly what Value Proposal Budgeting does. It checks whether everything in the budget brings added value to the company and whether each line creates added value for customers, employees, or other stakeholders.
    4. Zero-based budgeting lives up to its name – every department starts from scratch and must create a budget from scratch, ignoring any resources and costs it currently has. Managers must justify each position in the budget.
    Details;

    Any budgeting method has value depending on what the company wants to achieve and where it is on its growth path. Zero budgeting, for example, is a good tool for companies that need tight cost control. The value proposition of budgeting provides valuable practice for businesses that are just starting in funding.

    The forecast includes current and historical transaction data and market conditions to help determine whether budget targets will be met. Take, for example, a monthly sales forecast that includes information on inventory levels, changes in customer habits, and news on competitor activity along with data on actual sales over time. By combining this real-world sales data with sales forecasts and budget targets, companies can confidently make the necessary changes in their approach to sales, marketing, and more to ensure their goals are met.

    The best way to improve your budgeting and forecasting;

    Budgeting and forecasting allow companies to plan their fiscal year precisely. Here are 10 ways you can improve this process to create a strategic plan that meets your company’s financial goals.

    Maintain flexible budgeting and forecasting;

    Tough forecasts and budgets are not very useful. Things change throughout the years and you should be able to consider these changes and how they will affect your business. Continuing to make decisions based on the best assumptions made months in advance can lead to wrong and costly decisions. In addition, adherence to indicators based on outdated information by employees is counterproductive and frustrating. Embedding flexibility in your budgeting and forecasting allows for greater accuracy and better results in your business.

    Implementation of current forecasts and budgets;

    You can update current forecasts and budgets based on current results, not what managers think might have been done months ago. This process provides forecasts for the next quarter, not the whole year. Forecasts are broader every quarter as they are updated again. Mobile estimates allow you to better align your budget with your plans while increasing the accuracy of your estimates.

    Budget for your plan;

    Make a plan and incorporate it into your budget. Budgeting as part of your plan “requires spending decisions based on actual income, not opportunities that those expenses may (or may not) generate. Rather than spending it and dealing with it later, budgeting your plan forces you to look at the potential impact of all costs on your business. Using this method of budget management is especially useful when considering options that weren’t part of your original budget.

    Communicate early and often;

    Since forecasting and budgeting cover every aspect of the business; you want to maintain open communication with all departments throughout the process to minimize problems and ensure consistency between your company’s operational and organizational strategies.

    Involve your entire team;

    Budgeting and forecasting should be a team effort so that departments and units better understand their needs. Except for the people in your finance department; while the people at the pulse in various departments can give you the data you need to make accurate estimates and set realistic budgets. In addition, by using your entire team, you can have multiple perspectives on your company’s current and future position.

    Be clear about your goals;

    The purpose of forecasting is to predict the financial future of your company. Forecasting helps you make business decisions and understand their implications before you implement them. Unless you know your company’s overall goals, your ability to accurately predict your company’s financial future will fluctuate. Therefore, you need to know exactly what is driving your predictions. Otherwise, it’s just a random assumption not based on your company’s goals.

    Plans in different scenarios;

    You can’t plan everything out, but you do have an idea of some of the obstacles that could affect your initial financial forecasts and financial budgets. Review external markets and economic trends that could adversely affect your business. Current forecasts help you stay informed about negative or positive changes that could seriously impact your business. Moving forecasts also allow you to rotate as needed based on the data just submitted; so all decisions are based on what’s happening now rather than what happened last year.

    Track everything;

    When budgeting and forecasting for the coming financial year, everything has to take into account, regardless of whether it’s a possible purchase from a competitor or just office supplies. Don’t underestimate the importance of seemingly inconsequential details and their ability to jeopardize a company’s financial health. Once the budget is set, make projections that take into account the many potential scenarios that may arise. Keep an eye on market trends, customer behavior, and competition as business forecasts are finalized.

    Include profit and cash flow objectives;

    Author Jean Siciliano says, “Every budget should have a profit target and a cash flow objective; because, the two extreme measures are very different and require different attention to controlling them”. If you’re not tracking these two key metrics for your business; how useful and accurate will your budget be? To keep your business from missing out on your financial goals, set realistic goals for your cash flow and profit.

    Release Excel;

    Don’t rely on Excel or other spreadsheet programs to create your budgets and estimates. Planning software can make many processes easier and less time-consuming. Cloud systems are quickly becoming the standard for all areas of finance, not just accounting services. When used, this option allows for more flexibility as well as greater security and cost savings than the manual option. They allow you to create accurate estimates and budgets quickly and with minimal errors.

    Financial Budgeting and Forecasting Meaning Distinction Difference Process Image
    Financial Budgeting and Forecasting Difference Process; Image by Mustofa Agus Tri Utomo from Pixabay.
  • Cash Conversion Cycle Working Capital Meaning and Definition

    Cash Conversion Cycle Working Capital Meaning and Definition

    Cash Conversion Cycle Working Capital, its example, importance, Meaning, and Definition; It is a formula in management accounting that measures how effectively a company’s managers manage their working capital. CCC measures the length of time between purchasing inventory from a company and receiving cash from its account. CCC uses management to see how long a company’s cash has been tied to its business.

    Cash Conversion Cycle Working Capital, it’s Meaning and Definition, also their formula examples, importance.

    What is Cash Conversion Cycle (CCC)? The Cash Conversion Cycle, also known as the Net Operating Cycle or Working Capital Cycle, shows the time span between a company’s payment of raw materials, storage, storage, and receipt of cash from the final sale of finished goods. Simply put, the cash conversion cycle is a measure of operational efficiency and describes the time it takes a company to hide its investment in inventory and other inflows in cash flow. This determines by adding the number of days required for each phase of the cycle.

    To understand it better, let’s take an example. Suppose a company holds raw materials for an average of 60 days, receives a loan from a material supplier for an average of 15 days, the production process takes an average of 15 days, finished products keep in process for 30 days, and a debtor grants an average loan of 30. day. So, the total time it takes the company to generate cash from its operations is 120 days; 60 – 15 + 15 + 30 + 30 days. That represents by the working capital cycle.

    In equation form, the cash conversion process can express as follows:

    Cash conversion cycle = R + W + F + D – C, where;

    • R as = storage time of raw materials
    • W as = retention period in progress (Work-in-progress)
    • F as = storage time of finished product (Finished goods)
    • D as = recovery phase (debtor)
    • C as = credit term of the supplier (creditor or vendor)

    What is the definition of a cash conversion cycle (CCC)?

    Cash Conversion Cycle (CCC) is a metric that expresses the time (measured in days) it takes a company to convert its investment in inventory and other resources into cash flow from sales. Also known as the net operating cycle or simply the cash cycle, the CCC seeks to measure how long each incoming net dollar tie-up in the production and sales process before being converted into cash.

    This metric takes into account how long it took a company to sell its inventory, how long it took to collect its receivables, and how long it took to pay its bills. CCC is one of several quantitative metrics that helps assess the effectiveness of a company’s operations and management. A downward trend or constant CCC value over some period of time is a good sign, while an increasing value should lead to further investigation and analysis based on other factors. It should note that the CCC only applies to certain sectors that depend on inventory management and related activities.

    How does the Cash Conversion Cycle (CCC) work?

    If a company, or its management, takes a long time to collect unpaid accounts, has too much inventory available, or pays its fees too quickly, then the CCC will extend. A longer CCC means it will take longer to make money, which can mean bankruptcy for small businesses. If a company collects unpaid payments quickly, estimates inventory requirements correctly, or pays its bills slowly, it lowers CCC. A shorter CCC means a healthier company.

    The additional money can then use to make additional purchases or pay off outstanding debts. When a manager has to pay his suppliers quickly, it calls liquidity, which is bad for the company. When a manager is not able to collect payments fast enough; this knows as liquidity delay, which is also bad for the company.

    What is the relationship between the money or cash conversion cycle and working capital?

    The company implements various procedures to give operational legitimacy to its tactics and strategies. These practices also play a key role in maintaining or improving a company’s financial and competitive prospects; particularly in valuing working capital, curbing waste, and overseeing the company’s money conversion cycle.

    Cash conversion cycle;

    A company’s cash conversion cycle consists of the operational path that transactions take to make money for the company. It begins with the review and verification of prospects, assessment of the client’s assets and creditworthiness, and approval of credit for a particular business or range of businesses. After a company ships goods to users, the accounting manager records the underlying claims; also known as customer claims or accounts receivable. The cash conversion cycle of a business also goes through the receipt of customer funds; as well as collection and recovery efforts – when it comes to the customer default, bankruptcy, or insolvency.

    Working capital;

    Working capital corresponds to the company’s current assets minus current liabilities. In financial terminology, “short term” refers to a period of 12 months or less. For example, short-term debt matures in 365 days, and cash – a short-term asset – is used in the company’s business over the next 52 weeks. Working capital is a liquidity indicator that gives an idea of ​​how much money a company will have over the next 12 months. When people in finance talk about short-term assets and debt, they are talking about short-term resources and debt.

    Connection or Relationship;

    Although the concepts are different, working capital and cash conversion cycles interact within the operating engine of a company. Businesses need cash to build strategic trading alliances, make money; and, offer items that will enhance their competitive status over time. Cash is a constant element of running a business, but is often more important in the short term because the business must pay its bills and generate income to survive into the future – say, one year, two, five, or ten years.

    Importance of Significance;

    In a corporate context, discussions about working capital help senior management sow the seeds of economic success by engaging in effective activities every day to put the business on a solid operational footing. For executives, talking about the money conversion cycle is a money saver, an initiative that will help them avoid waste; avoid significant operational losses, and replenish the company’s coffers; all of which will keep the company out of financial trouble and straying from Niagara Falls finances.

    Interpretation of the cash conversion cycle;

    The cash conversion cycle formula is designed to assess how efficiently a company manages its working capital. As with other cash flow calculations, the shorter the cash conversion cycle; the better it is for the company to sell inventory and get cashback from those sales while paying suppliers.

    The cash conversion cycle should compare with companies in the same industry and should follow trends. For example, measuring the transformation cycle of a company in its cycle in previous years can help assess whether its working capital management is deteriorating or improving. Additionally, comparing a company’s cycles to those of its competitors can help determine whether a company’s money conversion cycle is “normal” compared to competitors in the industry.

    Explanation;

    The meaning that can derive from the company’s money conversion cycle is as follows:

    • If a company’s management takes longer to collect its accounts receivable balance, has too much cash, or pays its fees and obligations too quickly; it will prolong the net operating cycle.
    • A longer money conversion cycle usually means it will take longer for the company to make money. This can lead to liquidity problems and bankruptcy for small businesses.
    • When company management collects outstanding payments from accounts receivable quickly, correctly estimates required inventory levels, or pays bills and invoices slowly; it shortens the net operating cycle.
    • A shorter cash conversion cycle usually means a healthier company. This way, the extra money can then use for further purchases or to pay off any outstanding debts.
    • When a manager with a longer money conversion cycle has to pay their supplier quickly; it’s called cashing out, which is bad for the company.
    • When a manager with a longer money conversion cycle cannot collect payments from debtors fast enough; this knows as liquidity delay, which is also bad for the company.
    • If the company’s business model results in a negative money conversion cycle; it means it can manage its working capital efficiently enough that it can, on average, buy stock, sell finished products, and collect the debt before commitments make. is because. This is an ideal situation for business.
    Cash Conversion Cycle Working Capital Meaning and Definition Image
    Cash Conversion Cycle Working Capital Meaning and Definition; Image by Mohamed Hassan from Pixabay.
  • Arbitrage Pricing Theory (APT) Advantages and Disadvantages

    Arbitrage Pricing Theory (APT) Advantages and Disadvantages

    Arbitrage Pricing Theory (APT) Advantages and Disadvantages – also explain its Meaning, Importance, Benefits, Assumptions Pros, Limitations, and Cons. Arbitrage Pricing Theory (APT) Essay is a pricing model based on the concept that an asset can produce predictable results. To do this, it is necessary to analyze the relationship between assets and their risk factors as a whole. APT was first developed in 1976 by Stephen Ross to study the influence of macroeconomic factors. In this way, both the return on the portfolio and the return on a particular asset can be predicted by examining the various independent variables in the relationship.

    Here is the article to explain, Arbitrage Pricing Theory (APT) and its main points of Meaning, Importance, Benefits, Assumptions, Pros, Advantages, Cons, Limitations, and Disadvantages.

    What are the major advantages and disadvantages of APT (arbitrage pricing theory)? It is based on the idea that in a properly functioning securities market there should be no arbitrage available. This makes it possible to predict the outcome of this certainty over a longer period of time. What is meant by Arbitrage Pricing Theory (APT)? The name itself is a suggestion of theory and what it does. This is the mechanism by which investors identify specific assets. Imagine participation at the wrong price. Investors can lower share prices by knowing the value they hold. So, without a doubt, APT can be said to be one of the most important mechanisms that should be used. Why we need to know the underlying advantages, importance, benefits, assumptions, limitations, disadvantages of arbitrage pricing theory (apt) as to give below.

    Why is the importance of arbitrage pricing theory?

    It is a theory that helps investors and analysts find the right structure and multi-pricing model for asset security based on the relationship that assets have expected returns to risk (watch in youtube). In particular, the theory does its job, which states that a security’s fair market price may not be determined correctly. The main assumption of this theory is that market action is becoming less and less effective and perfect.

    Therefore, it can be said that the pricing of acquired assets was not carried out correctly. Or the asset is over-or undervalued, which can cause problems during this period. But here too, market action should ultimately be able to remedy the whole situation or problem where the asset price returns to a fair market condition.

    For arbitration, the wrongly valued property securities represent a short-term opportunity for the realization of a practical gain, and this too without any particular risk. When we talk about APT flexibility or arbitrage pricing theory, it can be said that APT flexibility is little more than the stock model or CAPM. In addition, APT is proving to be a very complex alternative to the CAPM option.

    It is a theory that provides investors and analysts with the ability to adapt any research that carries out on the market, as well as assets. However, applying this theory is a little more difficult than you can imagine, and also takes a long time. It may take some time to determine the risk factors that could affect the price of the asset in question.

    Arbitrage Pricing Theory (APT) explain its Benefits.

    Now that you know more about this theory; let’s move on to some of the other important passages that may interest you. Why do you think this model is so popular with investors? Here we will discuss why this model is so important. So you have to read it to the end to understand what we are talking about. Arbitrage pricing theory is an asset pricing theory that measures the expected return on an asset as a linear function of various factors.

    The reason APT sees this as a revolutionary idea is that users can easily adapt this model to analyze the best security. There are several other pricing models on the market to help investors decide the value of securities. Nothing works as well as this theory and pricing model. Apart from that, APT is also very useful in building portfolios because with the help of this manager you can easily test the portfolio exposure factors.

    What are the assumptions in arbitrage pricing theory?

    Arbitrage pricing theory works with a pricing model that takes into account many sources of risk and uncertainty. Unlike the Capital Asset Pricing Model (CAPM); which only takes into account one factor for the level of risk in the market as a whole; the APT model takes into account several macroeconomic factors that theoretically determine the risk and return of a particular asset.

    These factors provide a risk premium to investors that need attention; because they involve the systemic risk that diversification cannot eliminate. APT offers investors the opportunity to diversify its portfolio; but, also to select individual risk and return profiles based on premiums and sensitivity to macroeconomic risk factors. The venture investor will take advantage of the difference between the expected and actual returns on assets using arbitrage.

    To understand APT we need to study the basic assumptions of arbitrage pricing theory as given below.

    • This theory is based on the principle of capital market efficiency; and, therefore assumes that all market participants act to maximize profits.
    • It assumes that there is no arbitrage and when that occurs; participants commit to taking advantage of it and bringing the market back to equilibrium.
    • The market assumes to be smooth; H. No transaction fees, no taxes, you can short sell, and the number of shares to choose from is unlimited.

    Pros of arbitrage pricing theory.

    We need to study the main pros or advantages of arbitrage pricing theory as given below.

    • The APT model is a multi-factor model. Therefore, the expected return is calculated by taking into account the various factors and their sensitivities that can affect stock price movements. In this way, the factors that have a strong influence on the stock price can be selected.
    • The APT model is based on assumptions of arbitrary price or market equilibrium which, to some extent, leads to reasonable expectations of returns on risk-weighted assets.
    • In contrast to CAPM, the basic multi-factor model emphasizes the covariance between return on assets and exogenous factors. CAPM emphasizes the covariance between return on assets and endogenous factors.
    • The APT model works better in cases with multiple periods than the CAPM, which is only suitable for cases with one period.
    • APT can apply to capital expenditures and capital budget decisions.
    • The APT model does not require assumptions about the empirical distribution of returns on investment, unlike CAPM, which assumes that returns on equity follow a normal distribution and therefore APT is a less restrictive model.

    Cons or Drawbacks or Limitations of Arbitration Pricing Theory.

    We need to study the main disadvantages or cons or drawbacks or limitations of arbitrage pricing theory as given below.

    • The model requires a shortlist of the factors that affect the inventory in question. Finding and listing all the factors can be a difficult task and you run the risk of ignoring several others. There may also be a risk that random correlation could cause a factor to be a supplier to have a significant impact or vice versa.
    • The expected rate of return for each of these factors must achieve, which depends on the nature of the factor may or may not always be available.
    • Such a model requires calculating the sensitivity of each factor, which in turn can be a difficult and possibly impracticable task.
    • The factors that affect the stock price of a particular share can change over time. In addition, the associated sensitivity may fluctuate which must continuously monitor, which makes computation and maintenance extremely difficult.

    Advantages of APT (arbitrage pricing theory).

    We need to learn the underlying advantages of arbitrage pricing theory as gives below.

    Allow more sources of risk.

    APT allows multiple risk factors to include in the data set, rather than excluding them. That way, individual investors can gain more information about why some stock returns move in certain ways. This eliminates many of the movement problems left by other theories because the data set contains more sources of risk.

    Allows unexpected changes.

    APT is based on the idea that no surprises will happen. These are unrealistic expectations, so Ross adds equations to support the unexpected change. This makes it easier for investors to identify the asset with the greatest potential for growth or default based on the information provided by the opportunity itself.

    There are fewer restrictions.

    APT does not have the same portfolio requirements as other forecast theories. In addition, there are fewer restrictions on the types of information a prediction can fulfill. Because more information is available with less general limitations, the results with arbitrage pricing theory are more reliable than those of competitors’ models.

    No special factors give.

    Although APT, like other pricing models, does not offer specific factors, in theory, it takes into account four important factors. APT takes into account changes in inflation, changes in industrial production, changes in the risk premium, and changes in interest rate structure when factoring in long-term forecasts.

    Allows investors to find arbitrage opportunities.

    APT’s goal is to help investors spot stocks in a market that have been misjudged in some way. Once they can identify, it becomes possible to build a portfolio based on them to produce better returns than the index offers. If the portfolio undervalues, changes in pricing theory can turn opportunities into profits.

    Disadvantages of APT (arbitrage pricing theory).

    We need to learn the underlying disadvantages of arbitrage pricing theory as gives below.

    Requires that the source of the risk is correct.

    Each portfolio exposes to a certain level of risk. To be of use to APTs, investors must have a clear understanding of the risks and sources of these risks. Only then can this theory consider a reasonable estimate of factor sensitivity with greater accuracy? If there is no clear definition of the source of risk, there are more potential outcomes that reduce the effectiveness of the predictive quality provided by APT.

    Requires that the portfolio view separately.

    APT is only useful when examining one element of risk. Because of this feature, it is almost impossible to examine an entire portfolio with a large number of assets. Therefore, the entire portfolio examines using arbitrage pricing theory. Since not every account but only the portfolio report, certain assumptions must make in the valuation. This can create uncertainties that reduce the accuracy of the analyzed results.

    A large amount of data generate.

    For a person unexpected with arbitrage pricing theory, the number of statistics to sort via can experience overwhelming. This information generates through a specific analysis of the various factors that cause growth or loss so that prognostic quality can be a factor in portfolio decision making. A person unfamiliar with the purpose of each data point will not understand the results APT produces, making it a useless tool for them.

    This is not a guarantee of results.

    The arbitrage pricing theory does not guarantee that a profit will be made. Currently, several securities in the market undervalue for reasons beyond APT’s scope. Some risks are not “real” risks because they instill by investors themselves in pricing mechanisms, who have certain fears of certain securities under certain market conditions.

    The pros and cons of arbitrage pricing theory aim to look at long-run average returns. Several systematic influences can affect this long-term average. By studying the assets and risks involved, it is possible to predict the expected rate of return. This is a great option for individual securities. However, when examining a portfolio of different securities, APT may not be the right tool.

    Arbitrage Pricing Theory (APT) Meaning Importance Benefits Assumptions Pros Advantages Cons Limitations Disadvantages ilearnlot Image
    Arbitrage Pricing Theory (APT) Advantages and Disadvantages; Image by Mohamed Hassan from Pixabay.
  • Economic Value Added (EVA) Advantages and Disadvantages

    Economic Value Added (EVA) Advantages and Disadvantages

    What are the Different Advantages and Disadvantages of the Economic Value Added (EVA)? The main advantages of using EVA (Economic Value Added) as a metric for performance appraisal are that it considers all the costs, including the cost of equity capital, which ignores in normal accounting. The disadvantages the practicability of the calculations. The first difficulty is in finding the correct cost of equity. With this EVA (Economic Value Added) Model, economic profit and loss can determine. It is unable for all types of companies. It may not correctly understand capacity as the EVA (Economic Value Added) of a higher and bigger plant will always be more than a smaller plant even when they are more masterful and maintain a better ROI comparatively.

    Here is the article to explain, Different Advantages and Disadvantages of the Economic Value Added (EVA).

    Which means of the EVA; EVA is basically the working benefit after charge less a charge for the capital, the value just as an obligation, utilized in the business. Monetary Value Added (EVA) is a strategy to ascertain the financial benefit of an organization. EVA can determine as Net Operating Profit after charges less a charge for the chance expense of the capital contributed. The hidden standard of this technique is to decide; if the organization is procuring a higher pace of return on the assets contribute than the expense of the assets. Assuming it is acquiring a higher pace of return; it infers that the administration is adding more abundance to the investor’s worth.

    Economic value added an idea characterizes to gauge the presence of an association’s administration in making value or abundance for the investors. It very well may determine utilizing a basic equation where the expense of capital deduct from NOPAT. This otherwise calls economic benefit or leftover benefit. It additionally has different benefits and impediments of EVA as a presentation metric.

    Economic value added (EVA) a hypothesis create and reserve by Stern Steward and Co. As indicated by the model of EVA, a firm ought to likewise deduct the expense of value capital from the bookkeeping benefits to show up at a value that is the real abundance make for the financial backers. This otherwise calls economic benefit or leftover benefit.

    Meaning and Definition of Economic Value Added:

    It tends to characterize as a proportion of execution of an organization that centers more around riches or value creation for the investors instead of simply the bookkeeping benefits. For discovering genuine benefits which a firm acquires, every one of the expenses deduces from the incomes made and comparably; the expense of utilizing capital ought to likewise deduct whether it is obligation or value.

    The Measure of Real Wealth CreationAn bookkeeper expressly deducts the expense of obligation for example interest from the incomes yet doesn’t think about the expense of value. In this way, positive bookkeeping benefit doesn’t mean riches/value creation however sure EVA would imply that the administration of the organization has progressed admirably and has made abundance for their investors. From that point of view, it gives an extreme rivalry to measurements like ROCE and ROI.

    Advantages of the Economic Value Added (EVA):

    The following Some outstanding advantages of economic value added (EVA) below are:

    EVA may be a tool that helps to focus managers’ attention on the impact of their decisions in increasing shareholders’ wealth.

    Also, EVA may be a good guide for investors; as on the bias of EVA, they will decide whether a specific company is worth investing money in or not.

    They can use as a basis for the valuation of goodwill and shares. Unlike accounting profit, like EBIT, net, and EPS, EVA Economic and predicate on the thought that a business must cover both the operating costs also because the capital costs and hence it presents a far better and true picture of the corporate to the owners, creditors, employees, shareholders, and everyone other interest parties.

    EVA may be a good controlling device during a decentralized enterprise. Management can apply EVA to seek out out the EVA contribution of every decentralized unit or segment of the corporate.

    It helps the corporate in monitoring the matter areas and hence taking corrective action to resolve those problems.

    It also can improve the company’s corporate governance because since a better EVA implies higher bonuses to the managers; they’re going to be working hard and also honestly; which successively augurs well for the corporate.

    They linked compensation schemes (for both operatives and managers) often develop towards protecting (or rather improving) shareholders’ wealth.

    It also helps the corporate owners identify the simplest person to run the corporate effectively and efficiently.

    Disadvantages of the Economic Value Added (EVA):

    The following Some outstanding disadvantages of economic value added (EVA) below are:

    EVA is difficult to calculate the precise and correct cost of equity in the stock market.

    Sometimes It does not helpfully the company in monitoring the problem areas; and, also hence taking misaction to not resolve those problems.

    It can also improve the company’s corporate governance because since a higher EVA implies higher bonuses to the managers; they will be working hard and also honestly; which in turn augurs well for the company.

    This can also improve the corporate governance of the company; sometimes it never can, because a higher EVA gives managers a higher bonus; Due to some negligence they do not even work hard and do not show honesty; so the companies do not well developed.

    It also helps company owners to identify the best person to run the company effectively and efficiently, and sometimes there are some omissions.

    EVA is a good control device in a decentralized enterprise, they are just right. Management can apply EVA to find out the EVA contribution of each decentralized entity or segment of the company, but sometimes management cannot apply EVA in case EVA is simply a unit number.

    What are the Different Advantages and Disadvantages of the Economic Value Added (EVA) Image
    What are the Different Advantages and Disadvantages of the Economic Value Added (EVA)? Image from Pixabay.
  • How You Can Use Your Credit Card To Save Money?

    How You Can Use Your Credit Card To Save Money?

    Use Your Credit Card To Save Money: According to a report by Economics Times, the user base of credit cards in India for 2019 stood at 47 million users. It is expected to grow at a compound annual growth rate of 25% from 2020 through 2025. These statistics evidence the growing preference towards credit cards of Indian consumers.

    Here explain How You Can Use Your Credit Card To Save Money?

    The advantages of using a credit card are plenty. Credit cards not only help you during a cash crunch but also offer a world of offers, opportunities, and discounts. Many players have entered the credit card market owing to the potential of this segment. Thus, consumers have a large variety to choose from.

    Credit cards are easy, simple, and user friendly. You can even save while using credit cards. We have shared a few ways below:

    Choose a correct variant:                                                              

    • Every bank offers many credit cards. Hence, when you applying for a new credit card search the market for the available and most suitable variants for your needs. Research the cards offered by each bank. For instance – RBL Bank itself has over 40 plus variants of credit cards for its customers.
    • Finding an apt credit card will help you with optimal usage of the cards and assist you in avoiding a cash crunch situation.

    Rewards and Bonuses:

    • Financial institutions that offer credit cards respect, honor, and value their relationship with their customers. Hence, you can earn many rewards and bonuses based on your continued spending. Higher spending means more rewards you earn. These can be in the form of discount coupons, free movie tickets, frequent flyer miles, fuel redemption points, hotel stays travel options, gifts, lounge accesses, free dining experiences, etc.
    • Bonus points can be earned if your spending on the card reaches a considerable limit. Bonus points’ redemptions and gifts are additionally offered over and above the reward points.

    Cash Back:

    • Many credit cards have the option of converting reward points into cash. It means that the spending on your card would earn points, which can pay a credit card bill. Each point is worth a monetary amount. Upon redemption of these points, the monthly bill gets reduced by the respective money value of the points you have redeemed.
    • Thus, your credit card expenditure simultaneously would pay the credit card bill itself!

    Grace Period:

    • Unlike a debit card, a credit card gives you time to repay the amount used. When you use a debit card to make a payment, you are paying for the product and service from your account. But every time you swipe a credit card to make a payment, you get the product or service immediately. However, the actual debit happens almost a month later, based on the billing cycle.
    • It means, until such time, your funds are in your account, and you can earn interest or invest or use them elsewhere as per your convenience. The due date of your credit card bill is when you debit your account.

    Bottom Line:

    • In conclusion, credit cards require financial discipline and integrity. You should keep track of your expenses and ensure that you do not overspend. You should only spend an amount that you shall be able to pay off completely by month-end.
    • Further, always keep track of your credit score. Do not delay payments or bills, as this may adversely affect your creditworthiness.

    A credit card is a great option, but remember, this is a kind of loan that has to be paid back as per your billing cycle. So, use it carefully. Shift your regular expenses to a credit card to earn rewards, bonuses, and cashback!

    For Designing Credit Card visit clipping path service providers.

    How You Can Use Your Credit Card To Save Money
    How You Can Use Your Credit Card To Save Money?
  • Audit Risk: Meaning, Characteristics, and Elements

    Audit Risk: Meaning, Characteristics, and Elements

    What is Audit Risk? It refers to the risk that the auditor expresses an inappropriate audit opinion on the financial statements containing important errors. This article explains about Audit Risk with its Meaning, Characteristics, and Elements. In simple terms, it is the risk that an auditor will issue an unqualified opinion when the financial statements contain material misstatement. As well as, it is the risk that financial statements are materially incorrect, even though the audit opinion states that the financial reports are free of any material misstatements.

    Here are explain Audit Risk and its Meaning, Definition, Characteristics, and Elements.

    One is that the certified public accountants believe that the fair financial statements are wrong, that is, the verified financial statements do not reflect the changes in the financial status, operating results and financial status of the audited unit by the requirements of accounting standards Or it may indicate that there are important errors in the audited unit or the scope of the review, which may not notice by the CPA;

    The second is the wrong accounting statement that the certified public accountant thinks, but in fact, it is fair. It includes inherent risks, control risks, and inspection risks. Due to the increasingly complex environment of auditing, the tasks facing auditing are becoming more and more arduous; auditing also needs to support the principle of cost-effectiveness. The existence of these reasons determines the existence of audit risks in the audit process. This objectively requires certified public accountants to pay attention to the possibility of risks and take corresponding measures to avoid and control risks as much as possible.

    ISA 200 states that auditors should plan and perform the audit to reduce audit risk to an acceptably low level that is consistent with the objective of an audit. (Auditing and Assurance Standard) AAS-6(Revised), “Risk Assessments and Internal Controls”, identifies the three components of audit risk i.e. inherent risk, control risk, and detection risk.

    Definition of Audit Risk:

    The following definition below are;

    It is the risk that an auditor expresses an inappropriate opinion on financial statements.

    According to Wikipedia;

    “Audit risk (also referred to as residual risk) refers to the risk that an auditor may issue an unqualified report due to the auditor’s failure to detect material misstatement either due to error or fraud.”

    As the definition explains It is the risk that auditors issued the incorrect audit opinion to the audited financial statements. For example, auditors issued an unqualified opinion to the audited financial statements even though the financial statements are materially misstated. In other words, the material misstatements of financial statements fail to identify or detect my auditors.

    Characteristics of Audit Risk:

    The nature of audit risk always shows certain characteristics or features. After discussing the connotation of audit risk; we should continue to elaborate on the characteristics of audit risk; and, explain the unique performance under our socialist market economy.

    The details are as follows;

    Universality:

    Although the audit risk manifests by the deviation from the final audit conclusion and expectations; this deviation caused by many factors, and every link of the audit activity may lead to the generation of risk factors. Therefore, there are audit risks that are suitable for any kind of audit activity, and will ultimately affect the total audit risk.

    Objectivity:

    A significant feature of modern auditing is the method of sampling auditing, which is to infer the characteristics of the population based on the characteristics of a part of the sample in the population, and the characteristics of the sample are more or less in error from the characteristics of the population. But generally difficult to eliminate.

    Therefore, whether it is statistical sampling or judgment sampling, if the population infers based on the sample review results, there will always be a certain degree of error, that is, the auditor must bear a certain degree of risk of making a wrong audit conclusion. Even in the case of detailed audits, due to the complexity of economic operations and the moral quality of managers, there are still cases where the audit results are inconsistent with objective reality.

    Potential:

    The existence of audit responsibility is a basic factor in the formation of audit risk. If the auditors are not subject to any constraints in practice and do not bear any responsibility for their work results, they will not form audit risk, which determines the audit risk for a certain period. Potential, If the auditor deviates from the objective facts, but does not cause undesirable consequences and does not cause the corresponding audit responsibility, then this risk only stays at the potential stage, and does not translate into real risk.

    Contingency:

    It is due to some objective reasons, or subjective reasons that the auditors are not aware of, that is, the auditors did not deliberately act; the auditors unintentionally accepted the audit risk, and inadvertently assumed the seriousness of the audit risk. As a result, It is very important to affirm that the audit risk is unintentional; because only under this premise, the auditors will try to avoid reducing the audit risk, and the control of the audit risk is meaningful.

    Controllability:

    Auditing has long been familiar with taking responsibility for the correctness of its reports. However, the guiding ideology of modern auditing has further evolved from system-based auditing to risk auditing. The audit profession has not been tied up by more and more audit risks. Instead of losing its vitality, it gradually develops in the direction of actively controlling audit risks. It is of great significance to correctly understand the controllability of audit risk.

    On the one hand, we need not afraid of audit risk. Although the responsibility of auditors will lead to audit risk, once it occurs, its possible impact on the audit profession is also significant; but we can By identifying areas of risk and taking appropriate measures to avoid them; there is no need to dare to accept customers because of the existence of risks.

    Audit Risk Model:

    Audit Risk = Inherent Risk * Control Risk * Detection Risk

    It may consider as the product of the various risks which may encounter in the performance of the audit. To keep the overall audit risk of engagements below the acceptable limit; the auditor must assess the level of risk about each component of audit risk. Above these risks of model define three elements or types of audit risks below you’ll understand.

    Audit Risk Meaning Characteristics and Elements Image
    Audit Risk: Meaning, Characteristics, and Elements, Image from Pixabay.

    Elements of Audit Risk:

    The following detail of elements or types of audit risk below are;

    Inherent risk:

    What is Inherent risk? Inherent risk is generally considered to be higher where a high degree of judgment; and, estimation is involved or where transactions of the entity are highly complex. They refer to the possibility of a material misstatement in a certain statement on the financial statements without considering the internal control policies or procedures of the audited entity. It is the risk inherent in the business, whether or not internal control exists. It exists independently of the audit of accounting statements and is a risk that CPAs cannot change their actual level.

    For example, the inherent risk in the audit of a newly formed financial institution that has significant trade and exposure in complex derivative instruments may be considered to be significantly higher as compared to the audit of a well-established manufacturing concern operating in a relatively stable competitive environment.

    Characteristics of inherent risks:

    The inherent risks have the following characteristics:

    • The inherent risk level depends on the sensitivity of accounting statements to errors and frauds in business processing. The more false reports in the business process, the more false the report, the greater the inherent risk, and the lower the inherent risk. The greater the possibility of problems in economic business, the higher the inherent risk level; otherwise, the smaller. That is to say, for different businesses, the inherent risk level is also different;
    • The generation of inherent risks related to the audited unit, but not to the certified public accountant. Accountants cannot reduce inherent risks through their work, but can only analyze and judge the inherent risk level through necessary audit procedures;
    • The inherent risk level indirectly affects the external operating environment of the audited unit. Changes in the external operating environment of the audited unit will cause an increase in inherent risks. For example, due to the advancement of technology, some products of the audited unit will become obsolete; which brings the risk of whether the inventory valuation is correct;
    • Inherent risks exist independently in the audit process and objectively exist in the audit process, and are relatively independent risks. The magnitude of this level of risk needs to certify by certified public accountants.

    Control risk:

    What is Control risk? Control Risk is the risk of a material misstatement in the financial statements arising due to absence or failure in the operation of relevant controls of the entity. It refers to the possibility that the internal control of the audited unit fails to prevent or discover a certain misstatement or omission in its accounting statements in time. As with inherent risks, auditors can only assess their level and cannot affect or reduce its size.

    Control risk or internal control risk is the risk that current internal control could not detect or fail to protect significant error or misstatement in the financial statements. Assessment of control risk may be higher for example in case of a small-sized entity in which segregation of duties is not well defined; and, the financial statements are prepared by individuals who do not have the necessary technical knowledge of accounting and finance.

    Characteristics of Control risk:

    The control risk has the following characteristics:

    • The level of control risk is related to the level of control of the audited unit. If the internal control system of the audited unit has important defects or cannot work effectively; then the mistakes will enter the financial reporting system of the audited unit, resulting in control risks;
    • The control of risks has nothing to do with the work of certified public accountants. As with inherent risks, certified public accountants cannot reduce control risks; but certified public accountants can set a certain level of control risk based on the soundness and effectiveness of the internal control of the relevant part of the audited unit;
    • Controlling risk is an independent risk in the audit process. Control risk exists independently in the audit process. This risk has nothing to do with the inherent risk. It is a function of the effectiveness of the internal control system or degree of the audited unit. Effective internal control will reduce control risk, while ineffective internal control will increase control risk. Since the internal control system cannot fully guarantee the prevention or discovery of all errors and deficiencies, the control risk cannot be zero; and, it will inevitably affect the final its risk.

    Detection risk:

    What is Detection risk or Inspection risk? Detection Risk is the risk that the auditors fail to detect a material misstatement in the financial statements. It refers to the possibility that a certified public accountant fails to discover a major misstatement or omission in the audited unit ’s accounting statements through a predetermined audit degree. Inspection risk is the only risk element that can control and manage by certified public accountants.

    Well, detection risk is the risk that auditor fails to detect the material misstatement in the financial statements and then issued an incorrect opinion to the audited financial statements. Some detection risk is always present due to the inherent limitations of the audit; such as the use of sampling for the selection of transactions.

    Characteristics of Detection risk:

    The detection risk has the following characteristics are:

    • It exists independently in the entire audit process. Not affected by inherent risks and control risks.
    • The inspection risks are directly related to the work of certified public accountants. It is a function of the effectiveness of audit procedures and the effectiveness of certified public accountants in using audit procedures. Its actual level is related to the work of certified public accountants. It directly affects the final risk. In practice, certified public accountants reduce the inspection risk by collecting sufficient evidence to keep the total audit risk at an acceptable level. The level of inspection risk and the importance level together determine the nature, time, and scope of the substantive tests that the auditor needs to perform and the amount of evidence required to be collected.
  • Introduction to Exit Value Accounting, Meaning, and Definition

    Introduction to Exit Value Accounting, Meaning, and Definition

    Introduction of Exit Value Accounting; Exit value accounting is a form of current cost accounting which is based on valuing assets at their net selling prices (exit prices) at the balance sheet date and on the basis of orderly sales. Exit value is a maximum price a currently held asset could be sold for in the market less the transactions costs of the sale (the net realizable value for the asset). What is Economic Value Added? Definition, Calculation, and Implementation.

    Know and understand the Exit Value Accounting.

    This normative accounting theory was developed by Raymond Chambers and labeled as Continuously Contemporary Accounting (CoCoA). The theory relies on assessments of the exit or selling price of an entity’s liabilities and assets. These values are usually calculated under the assumption that the entity which controls. The thing being valued would be going out of business and liquidating.

    By contrast, real-world values for things sold by companies which remain in business can be very different. Because these companies can afford to hold out for a good price and they are not liquidating large amounts of goods. And, alerting buyers to the fact that bargains may be obtainable with a little bit of negotiation.

    In addition, the profit for a certain time should also be related to the alteration of the current exit-prices of the assets and hence. Profit should reflect changes in an organization’s capacity to adapt. The benefit of exit value accounting system is the relevance of the information it provides.

    With this approach, the balance sheet becomes a huge statement of the net liquidity available to the enterprise in the ordinary course of operations. It thus portrays the firm’s adaptability, or the ability to shift its presently existing resources into new opportunities.

    Meaning and Definition of Exit Value Accounting:

    The exit value accounting theory was developed under the following key assumptions. Firstly, firms exist to increase the owners’ wealth. Secondly, the organization’s ability to adapt to changing circumstances is the basis of successful operations and Finally, the capacity to adapt will be best reflected by the monetary value of the organization’s assets, liabilities, and equities at balance date. Where the monetary value is based on the current exit or selling prices of the organization’s resources.

    All assets in the exit-price accounting should be recorded at their current cash equivalents. Which represented by the amounts expected to be generated by selling the assets and an orderly sale determine the net-sales or exit-prices. Depreciation costs would not be realized within exit-price accounting as the model is based on the current cash equivalents.

    Liabilities would be similarly valued at the amounts it would take to pay them off as of the statement date. The income statement for the period would be equal to the change in the net realizable value of the firm’s net assets occurring during the period, excluding the effect of capital transactions.

    Expenses for such elements as depreciation represent the decline in net-realizable value of fixed assets during the period. The exit value accounting model is based on immediate sale. Which seems under the control of the entity although some estimation of the future may be included. As a result, the asset does not contribute to an entity’s capacity to adapt to changing circumstances if it is not ready to sell (as it does not have a sales price).

    What is Fair value?

    As know, Fair Value; In accounting and in most Schools of economic thought, fair value is a rational and unbiased estimate of the potential market price of a good, service, or asset.

    Introduction to Exit Value Accounting Meaning and Definition
    Introduction to Exit Value Accounting, Meaning, and Definition, #Pixabay.

    Explanation of Exit Value:

    Exit value is the estimated price which would be received for the sale of an asset or transfer of a liability on the open market. People determine exit values for accounting purposes and these values may be used in a variety of ways. Exit values are distinct from entry values, which reflect the price which would be paid to acquire something. Several different methods can be used to think about exit value. People can look at the present value of the asset, the current selling price, or the net realizable value.

    Because times are not always favorable for sales, one important thing to consider is what the current market conditions are. If the market is poor an exit value may be low because it is determined by acting. As though something needs to be sold immediately and thus a strategic wait for a better price is not possible. Exit values can be used in the assessment of a business by a valuator. A determination of a fair asking price, and a number of other settings.

    When calculating exit value, third-party evaluators are often used to avoid bias. The person who owns the asset or liability under consideration may be inclined to overvalue it or otherwise fail to estimate the value properly. While someone who has no interest in the value can make a more neutral estimate.

  • Preference Shares: Explanation, Features, Good and Bad

    Preference Shares: Explanation, Features, Good and Bad

    What does Preference Shares mean? Preference Shares, as its name suggests, gets precedence over equity shares on the matters like distribution of dividend at a fixed rate and repayment of capital in the event of liquidation of the company. Preference shares are one of the important sources of hybrid financing. As the name suggests, these have certain preferences as compared to other types of shares. These shares are given two preferences. There is a preference for payment of dividend. Whenever the company has distributable profits, the dividend is first paid on preference share capital.

    Know and Understand the Preference Shares.

    The content of study from Preferred Shares: Explanation of Preference Shares, Features of Preference Shares, Good and Bad of Preferred Shares (Advantages and Disadvantages of Preference Shares).

    The preference shareholders are also the part owners of the company like equity shareholders, but in general, they do not have voting rights. However, they get right to vote on the matters which directly affect their rights like the resolution of winding up of the company, or in the case of the reduction of capital.

    Other shareholders are paid a dividend only out of the remaining profits if any. The second preference for shares is repayment of capital at the time of liquidation of the company. After payment of outside creditors, preference share capital is returned. Equity shareholders will be paid only when preference share capital is paid in full.

    Explanation of Preference Shares.

    They are those shares which carry certain special or priority rights. Firstly, the dividend at a fixed rate is payable on these shares before any dividend is paid on equity shares. Secondly, at the time of winding up of the company, capital is repaid to preference shareholders prior to the return of equity capital. Preferred Shares do not carry voting rights. However, holders of preferred shares may claim voting rights if the dividends are not paid for two years or more on cumulative preference shares and three years or more on non-cumulative preferred shares.

    Meaning of Preference Shares.

    The share which entitles the holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends. Preferred Shares are one of the important sources of hybrid financing. It is hybrid security because it has some features of equity shares as well as some features of debentures. The holders of preference shares enjoy the preferential rights with regard to receiving of dividend and getting back of capital in case the company winds-up.

    Definition of Preference Shares.

    They are a long-term source of finance for a company. They are neither completely similar to equity nor equivalent to debt. The law treats them as shares but they have elements of both equity shares and debt. For this reason, they are also called “Hybrid financing instruments”. These are also known as preferred stock, preferred shares, or only preferred’s in a different part of the world.

    Features of Preference Shares.

    They have the characteristics of both equity shares and debentures. Like equity shares, dividend on preferred shares is payable only when there are profits and at the discretion of the Board of Directors.

    Preferred Shares are similar to debentures in the sense that the rate of dividend is fixed and preference shareholders do not generally enjoy voting rights. Therefore, they are a hybrid form of financing.

    The features of preference shares are listed below:

    Dividends.

    They have dividend provisions which are cumulative or non- cumulative. Most shares have the cumulative provisions, which mean that any dividend not paid by the company accumulates. Normally, the firm must pay these unpaid dividends prior to the payment of dividends on the common stock. These unpaid dividends are known as dividends in arrears or arrearages. Non-cumulative dividends do not accumulate if they are not paid when due.

    An investor contemplating the purchase of preferred shares with a non-cumulative dividend provision needs to be especially diligent in the investigation of the company because of the investor’s potentially weak position vis-a-vis those preference shares with a cumulative dividend provision. In the case of cumulative preferred shares, even if the arrears of the preference dividend are cleared in full, the investor would be the loser as he is to get less in net worth.

    Participating.

    Most they are non-participating, meaning that the preference shareholder receives only his stated dividend and no more. The theory is that the preference shareholder has surrendered claim to the residual earnings of his company in return for the right to receive his dividend before dividends are paid to common shareholders.

    The participating preference shareholder receives stipulated dividend and shares additional earnings with the common shareholders. But this share is usually non-cumulative which confirms the view that preference share does have both protective and profit participating provisions.

    Voting Rights.

    They do not normally confer voting rights. The basis for not allowing the preference shareholder to vote is that the preference shareholder is in a relatively secure position and, therefore, should have no right to vote except in the special circumstances.

    The cumulative preferred shares can vote if their dividend is in arrears for 2 years. The voting right of each preference shareholder is to be in the proportion which the paid-up share capital on his shares bears to the total equity share capital of the company.

    Par Value.

    Most they have a par value. When it does, the dividend rights and call price are usually stated in terms of the par value. However, those rights would be specified even if there were no par value. It seems, therefore, as with equity shares, the preference share that has a par value has no real advantage over preference share that has no par value.

    Redeemable or Callable.

    Typically, they have no maturity date. In this respect, it is similar to equity shares. Redeemable or callable preferred shares may be retired by the issuing company upon the payment of a definite price stated in the investment. Although the “call price” provides for the payment of a premium, the provision is more advantageous to the corporation than to the investor.

    When money rates decline, the corporation is likely to call in its preferred shares and refinance it at a lower dividend rate. When money rates rise, the value of the preference shares declines so as to produce higher yield, the call price acts as an upper peg or plateau through which the price will break only in a very strong market.

    Non-callable preferred shares and bonds are issued in periods of High-interest rates. The issue is barred from redeeming them later in the event of generally falling yields or for a certain period so the investor has important protection against declining income.

    Preference Shares Explanation Features Good and Bad
    Preference Shares: Explanation, Features, Good and Bad, #Pixabay.

    Advantages of Preference Shares:

    The following advantages of preference shares are:

    The obligation for Dividends:

    No Obligation for Dividends; A company is not bound to pay the dividend on preference shares if its profits in a particular year are insufficient. It can postpone the dividend in case of cumulative preferred shares also. No fixed burden is created on its finances.

    Interference:

    No Interference; Generally, they do not carry voting rights. Therefore, a company can raise capital without dilution of control. Equity shareholders retain exclusive control over the company.

    Trading on Equity:

    The rate of dividend on they are fixed. Therefore, with the rise in its earnings, the company can provide the benefits of trading on equity to the equity shareholders.

    Flexibility:

    A company can issue redeemable preference shares for a fixed period. The capital can be repaid when it is no longer required in business. There is no danger of over-capitalization and the capital structure remains elastic.

    Variety:

    Different types of preference shares can be issued depending on the needs of investors. Participating preferred shares or convertible they may be issued to attract bold and enterprising investors.

    They can be made more popular by giving special rights and privileges such as voting rights, right of conversion into equity shares, right of shares in profits and redemption at a premium.

    Disadvantages of Preference Shares:

    They suffer from the following disadvantages:

    Obligation:

    Fixed Obligation; The dividend on preferred shares has to be paid at a fixed rate and before any dividend is paid on equity shares. The burden is greater in the case of cumulative preference shares on which accumulated arrears of dividend have to be paid.

    Appeal:

    Limited Appeal; Bold investors do not like preferred shares. Cautious and conservative investors prefer debentures and government securities. In order to attract sufficient investors, a company may have to offer a higher rate of dividend on preference shares.

    Return Earning:

    Low Return in this shares; When the earnings of the company are high, fixed dividend on they becomes unattractive. Preference shareholders generally do not have the right to participate in the prosperity of the company.

    Voting Rights:

    No Voting Rights; They generally do not carry voting rights. As a result, preference shareholders are helpless and have no say in the management and control of the company.

    Fear of Redemption:

    The holders of redeemable preference shares might have contributed finance when the company was badly in need of funds. But the company may refund their money whenever the money market is favorable. Despite the fact that they stood by the company in its hour of need, they are shown the door unceremoniously.

  • Equity Shares: Explanation, Characteristics, and Features

    Equity Shares: Explanation, Characteristics, and Features

    Equity Shares: Explanation, Characteristics, and Features

  • Business Risk: Explanation, Characteristics, and Sources

    Business Risk: Explanation, Characteristics, and Sources

    What does Business Risk mean? Business risks related to the response of the firm’s earnings before interest and taxes, or operating profits, to changes in sales. When the cost of capital is used to evaluate investment alternatives, it is assumed that acceptance of the proposed projects will not affect the firm’s business risk.

    Know and understand the Explanation of Business Risk.

    The business risk may be defined in terms of the possibility of occurrence of un-favorable events; which maximize chances of losses and minimize chances for gain, in business. The term business risk refers to the possibility of inadequate profits or even losses due to uncertainties e.g., changes in tastes, preferences of consumers, strikes, increased competition, change in government policy, obsolescence etc.

    Every business organization contains various risk elements while doing the business. Business risks imply uncertainty in profits or danger of loss and the events that could pose a risk due to some unforeseen events in the future, which causes the business to fail. The types of projects accepted by a firm can greatly affect its business risk.

    If a firm accepts a project that is considerably more risky than average, suppliers of funds to the firm are quite likely to raise the cost of funds. This is because of the decreased probability of the fund suppliers receiving the expected returns on their money. A long-term lender will charge higher interest on loans if the probability of receiving periodic interest from the firm and ultimately regaining the principal is decreased.

    Common stockholders will require the firm to increase earnings as compensation for increases in the uncertainty of receiving dividend payments or ably appreciation in the value of their stock. In analyzing the cost of capital it is assumed that the business risk of the firm remains unchanged (i.e., that the projects accepted do not affect the variability of the firm’s sales revenues).

    This assumption eliminates the need to consider changes in the cost of specific sources of financing resulting from changes in business risk. The definition of the cost of capital developed in this chapter is valid only for projects that do not change the firm’s business risk.

    Meaning of Business Risk:

    Business risk is that portion of the unsystematic risk caused by the prevailing environment of the business. In other words, business risk is a function of operating conditions being faced by a firm. These risks influence the operating income of a firm and consequently the dividends.

    Every company has its own objectives and goals and aims at a particular gross profit and operating income. It expects itself to pay to its shareholders a certain rate of dividend and plow back some profits.

    For example, an owner of a business may face different risks like in production, risks due to irregular supply of raw materials, machinery breakdown, labor unrest, etc. In marketing, risks may arise due to different market price fluctuations, changing trends and fashions, error in sales forecasting, etc. In addition, there may be the loss of assets of the firm due to fire, flood, earthquakes, riots or war and political unrest which may cause unwanted interruptions in the business operations. Thus business-risks may take place in different forms depending upon the nature and size of the business.

    Definition of Business Risk:

    Definition: By the term “Business risk” we mean the uncertainty with respect to the firm’s operations. It is a type of systematic risk wherein there is volatility associated with the future income or earnings arising from events, circumstances, conditions, action, or inactions that hinders the attainment of goals and objectives and carry out the strategies.

    Business risk refers to the anticipation that the firm may earn lower than expected profits or even suffer losses, because of the uncertainties inherent in the business such as competition, change in customer tastes and preferences, input cost, change in government policies, and so forth. It may impede the business ability to provide returns on the investment.

    Following are cited some popular definition of the term business risk:

    According to B.O.Wheeler,

    “Risk is the chance of loss. It is the possibility of some un-favorable occurrence.”

    According to C.O. Hardy,

    “Risk may be defined as uncertainty in regard to cost, loss, or damage.”

    Characteristics of Business Risk:

    Characteristics of business-risks could be highlighted with reference to its following features:

    The Time.

    In ancient times, business-risks were less and limited. In the present-day-times-characterized by intense competition, advanced technology and globalization of the economy; business-risks are quite severe. Further, in times to come, business-risks are likely to increase in intensity.

    The Size of Business Enterprise.

    Small businesses are less exposed to business-risks; because they enjoy the flexibility of operations and can easily adapt themselves to changing circumstances. On the other hand, the bigger is the size of business; the lesser is the flexibility possessed by it. Hence bigger businesses are more exposed to business risks.

    Nature of Business Risks.

    In case of business enterprises engaged in the manufacture/purchase of necessary items e.g. salt, sugar, oil, cloth etc. there is the lesser risk because demand for most of the necessary item is inelastic or less elastic. On the other hand, business enterprises engaged in the manufacture/purchase of luxury items are more exposed to business-risks; because demand for luxury items is highly elastic.

    Terms of Sales.

    In the case of business enterprises conducting sales only on a cash basis, business-risks are nil; so far as the possibility of bad debts is concerned. On the other hand, business enterprises conducting large scale credit sales are severely exposed to the risk of bad debts.

    The Degree of Competition.

    In those lines of business activities, where there is intense competition; business enterprises are exposed to severe risks caused by the actions and reactions of competitors. As such, business enterprises characterized by monopolistic situations face little risk on account of competition. Actually, in a perfectly monopolistic situation, the business enterprise has no risk caused by competition.

    The Competence of Management.

    The more competent the management of business enterprises is; the lesser is the possibility of losses to be caused as a result of business risks, and vice-versa.

    The Age of the Business Enterprise.

    From this viewpoint, old business enterprises are less exposed to business-risks, because of the experience of successfully handling business-risks, in the past. New business concerns are more exposed to business-risks, because of the lack of experience.

    Opportunities for Gains are Hidden in Business Risks.

    If the management of the business enterprise is able to successfully handle and manage business-risks; these provide many opportunities for gains to the business enterprise.

    Sources of Business Risk:

    Business risk can be divided into two broad Sources, namely;

    • Internal business risk, and.
    • External business risk.

    Now explain;

    Internal Business risks.

    Internal business risk is associated with the internal environment of the firm. The internal business-risks are such that the firm has to conduct its business within its limiting environment. The internal business-risks will vary from firm to firm depending upon the constraints in the internal environment. Thus, each firm has its own set of internal risks and the firm’s success depends upon the ability to coping with these risks.

    The important internal risks include:

    1. Fluctuations in sales.
    2. Research and development.
    3. Personnel Management.
    4. Fixed Cost, and.
    5. Production of a single product.

    The risks that emerge as a result of the events occurring within the organization is termed as an internal risk. These risks can be predicted as the possibility of their incidence, and so, they are controllable in nature. They arise due to factors like strikes & lockouts by a trade union, accidents in the factory, negligence of workers, failure of the machine, technological obsolescence, damages to the goods, fire outbreak, etc.

    External Business risks.

    External business-risks are associated with circumstances beyond a firm’s control. Each firm has to deal with specific external factors that may be unique and peculiar to its industry.

    However, important external factors influencing all businesses are:

    1. Business cycle.
    2. Demographic factors.
    3. Government policies, and.
    4. Social and regulatory factors.

    The risk arising as a result of the events external to the firm and so the firm’s management has no control over it. So, these cannot be forecasted easily. It may arise due to price fluctuations, changes in customer taste, earthquake, floods, changes in government regulations, riots, etc.

    Business Risk Explanation Characteristics and Sources
    Business Risk: Explanation, Characteristics, and Sources, #Pixabay.

    Types of Business Risks:

    Some risks are common to all human being alike everywhere e.g. risks due to fire, theft, flood, earthquakes, cyclones, drought, war, civil riots etc. As such these are not the risks peculiar only to business. Moreover, some risks are insurable with insurance companies.

    Hence, as such, in the present- day-times offering many types and varieties of insurances; these risks could not be termed as risks in the real sense of the term. Accordingly, business-risks are those which are peculiar only to business and are also not- insurable.

    Following is a brief account of the above types of business-risks:

    Natural Types.

    Risks which arise due to the actions of Nature (and hence uncontrollable) are called natural risks. For example, the risk of rainfall not occurring on time or excessive rain­fall causing flood is a serious risk for farmers. Again, there may be the risk of hail storm destroying crops in the field.

    Political Types.

    Risks due to political causes may arise, in the forms of:

    1. Price regulations, restricting profit margins for businessmen.
    2. High rates of taxes, taking away a major part of business profits.
    3. Un-favorable economic policies, discouraging some lines of business activities, and.
    4. Strict legislation imposed on business enterprises etc.

    Social Types.

    Risks due to social causes are those which may arise from consumer behavior or due to changes taking place in the social scene.

    Examples of social risks may be:

    1. Changes in fashions.
    2. Change in the tastes or preference of consumers.
    3. Changes in the income of consumers, and.
    4. Changing social values leading to a new pattern of social life etc.

    Economic Types.

    Some of the economic types leading to business-risks may be:

    1. The rising cost of raw materials due to inflation or crop failure.
    2. The economic recession in industry, leading to poor demand.
    3. Increase in the rate of interest, making borrowings costlier, and.
    4. Pessimistic capital market conditions, discouraging people to invest in companies etc.

    Managerial Types.

    Risks due to managerial types may be (a few examples only):

    1. Wrong estimation of demand by management.
    2. Poor labor-management relations, and.
    3. The inefficient operational life of the business enterprise due to incompetent or untrained managerial staff.

    Competitive Types.

    Competitive Types may cause business-risks e.g. in the form of the following:

    1. Entry of an unduly large number of persons in the same line of business activity, and.
    2. Entry of multinational companies threatening the very survival of domestic companies.

    Technological Types.

    In the present-day times, technology is changing at a very fast pace; so much so that business experts call this phase of changes as a “technological revolution”. The appearance of new technology renders the old technology as obsolete (i.e. out of use); causing severe financial losses to firms operating with old technology. They are virtually compelled to install new technology to ensure their survival amidst intensely competitive conditions.

    Miscellaneous Types.

    Some miscellaneous types of business-risks may be:

    1. Insolvency of a customer.
    2. Worker’s strike.
    3. Sudden power failure.
    4. The premature death of an expert employee or manager, and.
    5. Speculative losses.

    References;

    • https://en.wikipedia.org/wiki/Business_risks.
    • http://www.yourarticlelibrary.com/business/risk-management/business-risk-nature-and-causes-of-business-risk-risk-management/69663.
    • https://accountlearning.com/business-risk-meaning-types-categories-of-business-risks/.
    • https://businessjargons.com/business-risk.html.