Tag: Formula

  • Operating margin Vs Gross margin calculation

    Operating margin Vs Gross margin calculation

    Operating margin Vs Gross margin measures a company’s profitability by calculating the ratio of operating income to net sales. It is also known as operating income margin, operating margin, earnings before interest and taxes (EBIT) margin, or return on sales (ROS). Businesses calculate operating margins by deducting the cost of goods sold (COGS), operating, depreciation, and amortization costs from net sales. Accounting software calculates and analyzes operating profit margins to help businesses visualize real-time revenue for every dollar of sales revenue.

    What is the Operating margin Vs Gross margin? Importance and calculation formula

    Operating profit = operating income – operating costs – taxes and surcharges – sales expenses – management expenses – financial expenses – asset impairment losses – credit impairment losses + gains from changes in fair value (-losses from changes in fair value) + investment income (-losses on investments ) + income from asset disposal (- loss from asset disposal) + other income

    Operating profit ratio = (operating profit/operating income) × 100%. The operating profit ratio indicates the ability of the enterprise to obtain profits through production and operation. The higher the ratio, the stronger the profitability of the enterprise.

    Extended information:

    In addition to being affected by the income from sales of goods, the operating profit is also affected by the price difference between the purchase and sale of goods sold, tax on goods sales, variable expenses of goods sales, and fixed expenses that should be borne by goods sales. The impact of these factors on the profit of commodity sales can be expressed in the following way.

    The Importance of Operating Margins

    A company’s operating margin indicates the profitability of the core business and enables stakeholders to assess an organization’s ability to pay fixed costs such as interest and taxes. Operating margins are also critical for businesses looking to optimize resource allocation based on revenue forecasts.

    How are stakeholders using operating profits to make decisions?

    • Investors: Identify growing or shrinking profit and spending patterns
    • Analysts: Assess stock value, and a company’s ability to pay for equity and debt investments
    • Senior Leadership Team (SLT): Benchmarking the Competition with Operating Margin
    • Managers: Gain insight into variable costs and decision effectiveness

    Operating Margin Formula

    The operating margin formula helps companies measure the overall business health and profitability of their core business. Business managers consider operating margin in conjunction with free cash flow, net profit, and gross profit.

    Operating profit margin = (operating income – net sales income) X 100%

    Operating income is the profit a business makes after deducting various expenses. Such as the cost of goods sold, general and administrative (G&A) expenses, depreciation, marketing, research and development, and other operating costs. Operating income helps a business determine net income before interest and taxes for a specific period. Net sales revenue is gross revenue or gross sales minus sales returns, discounts, and allowances. Net sales figures appear under direct costs on the income statement and are critical to an organization’s revenue growth.

    What is a good operating margin?

    Operating margins vary across industries due to varying levels of competition, efficiencies of scale, and capital structures. Operating efficiencies vary across industries, as do operating margins. That’s why it’s unfair to compare two different industries. Excellent operating margins that increase over time while remaining positive. Companies striving to achieve superior operating profit must improve unit economics and remain competitive and relevant.

    What does gross margin mean?

    The gross profit margin is an important indicator to measure the profitability of a company. Usually, the higher the gross profit margin, the higher the profitability of the enterprise and the stronger the ability to control costs.

    This also reminds us that when choosing stocks, we can pay attention to the company’s gross profit margin. Companies in the same industry, when other indicators are close, choose companies with high gross profit margins as much as possible, and the probability of choosing a good company will be higher.

    Gross profit margin refers to the proportion of how much money can be used for the next period after deducting the cost of sales from each yuan of sales revenue. The ratio of gross profit to merchandise sales revenue. Usually expressed as a percentage. It can be calculated by one commodity, or comprehensively by commodity category.

    Refers to the percentage of gross profit in sales revenue, also referred to as gross profit margin, where gross profit is the difference between sales revenue and sales cost.

    Calculation formula:

    Calculation formula: gross profit margin = (operating income – operating cost) / operating income * 100%

    Sales gross profit margin = sales gross profit / sales revenue × 100% = (sales revenue – sales cost) / sales revenue × 100%

    The gross profit margin is an important indicator to measure the profitability of a company. Usually, the highest gross profit margin indicates that the higher the profitability of the enterprise, the stronger the ability to control costs.

    How to Improve Operating Margins

    A healthy operating margin is critical to financial stability. Companies with higher operating margins are less likely to be exposed to risk and will constantly seek to improve margins. These organizations use the following practices to increase their operating margins.

    • Analysis category fees. Companies can improve operating margins by identifying key expenses from the business expense ledger and aligning these expenses with gross revenue.
    • Create economies of scale. Identifying process integration opportunities is another great way to improve profits. This integration requires careful evaluation, analysis, and transformation of existing processes so that new processes generate more revenue.
    • The pruning operation is wasteful. Conducting regular audits helps companies identify lengthy production processes and control the use of raw materials. Minimizing operational lag through the synchronization of production processes is key to improving the efficiency of business operations.

    Operating Margin vs Gross Margin vs Net Margin

    Operating margin evaluates operating efficiency by finding the company’s profit after variable costs are paid for. The metric does not take interest or taxes into account. Businesses looking to improve operating profits use resources efficiently, set product prices, and improve management controls.

    Gross margin is the ratio of gross profit to total revenue. Gross margin analysis is an effective way to understand production efficiency and gross profit per dollar of revenue. Product-based companies regularly analyze gross margins to see improvements or declines in product margins over time. Net profit margin measures net income or profit per dollar of revenue. This metric is an excellent benchmark for evaluating a company’s ability to generate profits from sales, including overhead and operating costs.

    What is the difference between gross profit margin and net profit margin?

    Nature is different:

    The gross profit rate is the ratio of the company’s gross income after removing the direct cost of the product (without removing the three fees and other costs such as income tax), so it is called the gross profit rate. The net interest rate is also the higher the long-term growth, the better. If the growth of net profit is faster than the growth of revenue, the net profit rate will increase, indicating that the company’s profitability is increasing; otherwise, it indicates that the company’s profitability may be declining.

    Different meanings:

    A high gross profit margin indicates that the company’s products are highly competitive in the market, which means that consumers are willing to pay a higher price than similar products to buy the company’s products. The net profit rate is also a good static indicator for assessing the management ability of the company management because only good management can gradually reduce the company’s three expenses, thereby saving more profits for the company and shareholders.

    Different calculation methods:

    Gross profit margin = gross profit / operating income × 100% = (main business income – main business cost) / main business income × 100%, net profit rate = net profit / main business income × 100% = (Total profit – income tax expenses) / main business income × 100%.

    Operating margin Vs Gross margin calculation Image
    Operating margin Vs Gross margin calculation; Photo by PiggyBank on Unsplash.
  • 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.
  • What is Working Capital? Analysis, with Management

    What is Working Capital? Analysis, with Management

    Working Capital – Its meaning is basically an indicator of an organization’s short-term financial position and is also a measure of its overall efficiency. They obtain by subtracting the current liabilities from the current assets. It is a financial metric which represents operating liquidity available to a business, organization, or other entity, including governmental entities. Along with fixed assets such as plants and equipment, they consider a part of operating capital. So, what is the question going to learn; What is Working Capital? Analysis, with Management.

    Here explains; Working Capital, Its meaning, definition, Analysis, with Management.

    Working capital meaning, also known as net-working-capital, is the difference between a company’s current assets, like cash, accounts receivable, and inventories of raw materials and finished goods, and its current liabilities, like accounts payable. Capital is another word for money and it is the money available to fund a company’s day-to-day operations essentially, what you have to work with. In financial speak, it is the difference between current assets and current liabilities.

    Current assets are the money you have in the bank as well as any assets you can quickly convert to cash if you needed it. Current liabilities are debts that you will repay within the year. So, it is what’s leftover when you subtract your current liabilities from what you have in the bank. In broader terms, It is also a gauge of a company’s financial health. The larger the difference between what you own and what you owe short-term, the healthier the business. Unless, of course, what you owe far exceeds what you own. Then you have negative working capital and are close to being out of business.

    It can calculate as – Working capital Formula:

    Working Capital = Current Assets – Current Liabilities

    What is the meaning of working capital? Also called net working capital, a liquidity ratio measures a company’s ability to pay off its current liabilities with its current assets. It calculates by subtracting current liabilities from current assets.

    Working capital Definition: They can understand as the capital needed by the firm to finance current assets. It is the amount of a company’s current assets minus the number of its current liabilities. They represent the funds available to the enterprise to finance regular operations, i.e. day to day business activities, effectively. It helps gauge the company’s operating liquidity, i.e. how efficiently the company can cover the short-term debt with short-term assets. Current Assets represent those assets that can easily transform into cash within one year. On the other hand, current liabilities refer to those obligations which are to pay within an accounting year.

    Sources of Working Capital:

    The sources for working capital can either be long-term, short-term, or even spontaneous. Spontaneous working capital majorly derives from trade credit including notes payable and bills payable while short-term capital sources include dividend or tax provisions, cash credit, public deposits, trade deposits, short-term loans, bills discounting, inter-corporate loans, and also commercial paper. For the long-term, capital sources include long-term loans, provision for depreciation, retained profits, debentures, and share capital. These are major working capital sources for organizations based on their requirements.

    Here are some additional factors to consider:
    • The types of current assets and how quickly they can convert to cash. If the majority of the company’s current assets are cash and cash equivalents and marketable investments, a smaller amount of capital may be sufficient. However, if the current assets include slow-moving inventory items, a greater amount of capital will be needed.
    • The nature of the company’s sales and how customers pay. If a company has very consistent sales via the Internet and its customers pay with credit cards at the time they place the order, a small amount of capital may be sufficient. On the other hand, for a company in an industry where the credit terms are net 60 days and its suppliers must be paid in 30 days; the company will need a greater amount of capital.
    • The existence of an approved credit line and no borrowing. An approved credit line and no borrowing allow a company to operate comfortably with a small amount of capital.
    • How accounting principles apply. Some companies are conservative in their accounting policies. For instance, they might have a significant credit balance in their allowance for doubtful accounts and will dispose of slow-moving inventory items. Other companies might not provide for doubtful accounts and keep slow-moving inventory items at their full cost.

    Types of Working Capital:

    There are several types of working capital based on the balance sheet or operating cycle view. The balance sheet view classifies working capitals into the net (current liabilities subtracted from current assets featuring in the company’s balance sheet) and gross working capital (current assets in the balance sheet).

    On the other hand, the operating cycle view classifies working capitals into temporary (the difference between net & permanent capital) and permanent (fixed assets) capital. Temporary capital can further break down into reserve and regular capital as well. These are the types of working capital depending on the view that chose. Two types of Working Capital;

    First types, Value;
    • Gross Capital: It denotes the company’s overall investment in the current assets.
    • Net Capital: It implies the surplus of current assets over current liabilities. A positive net capital shows the company’s ability to cover short-term liabilities; whereas a negative net capital indicates the company’s inability to fulfill short-term obligations.
    Second types, Time;
    • Temporary Capital: Otherwise know as variable capital; it is that portion of capital which needs by the firm along with the permanent capital, to fulfill short-term capital needs that emerge out of fluctuation in the sales volume.
    • Permanent Capital: The minimum amount of capital that a company holds to carry on the operations without any interruption, calls permanent capital.

    Other types of working capital include Initial working capital and Regular working capital. The capital requires by the promoters to initiate the business knows as initial working capital. On the other hand, regular it is one that requires the firm to carry on its operations effectively.

    What is Working Capital Analysis?

    It is one of the most difficult financial concepts to understand for the small-business owner. In fact, the term means a lot of different things to a lot of different people. By definition, it is the amount by which current assets exceed current liabilities. The working capital analysis uses to determine the liquidity and sufficiency of current assets in comparison to current liabilities, you definitely understand their meaning also. This information needs to determine whether an organization needs additional long-term funding for its operations, or whether it should plan to shift excess cash into longer-term investment vehicles.

    However, if you simply run this calculation each period to try to analyze working capital; you won’t accomplish much in figuring out what your working capital needs are and how to meet them. A useful tool for the small-business owner is the operating cycle. The operating cycle analyzes the accounts receivable, inventory, and accounts payable cycles in terms of days. In other words, accounts receivable analyze by the average number of days it takes to collect an account. Inventory analyze by the average number of days it takes to turn over the sale of a product. Accounts payable analyze by the average number of days it takes to pay a supplier invoice.

    Explains the analysis:

    The first part of the working capital analysis is to examine the timelines within which current liabilities are due for payment. This can most easily discern by examining an aged accounts payable report, which divides payables into 30-day time buckets. By revising the format of this report to show smaller time buckets; it is possible to determine cash needs for much shorter time intervals. The timing of other obligations, such as accrued liabilities, can then be layered on top of this analysis to provide a detailed view of exactly when obligations must pay.

    Next, engage in the same analysis for accounts receivable, using the aged accounts receivable report, and also with short-term time buckets. The outcome of this analysis will need to revise for those customers that have a history of paying late so that the report reveals a more accurate assessment of probable incoming cash flows.

    A further step is to examine any investments to see if there are any restrictions on how quickly they can be sold off and converted into cash. Finally, review the inventory asset in detail to estimate how long it will be before this asset can be converted into finished goods, sold, and cash received from customers. The period required to convert inventory into cash may be so long that this asset is irrelevant from the perspective of being able to pay for current liabilities.

    What is Working Capital Management?

    Above the meaning of working capital, you understand them; It is nothing but the difference between current assets and current liabilities. In other words, skilled executive capital management means ensuring adequate liquidity in the business; be able to meet short-term expenses and debt. Working Capital Management a strategy adopt by business managers to monitor the working capital of the business. It is a fundamental concept that calculates and assesses a company’s financial and operational health.

    There is a strategy adopted by business managers to monitor the capital (that means current assets and current liabilities) by the business managers. It is a fundamental concept that calculates and assesses a company’s financial and operational health. Working capital management deals with controlling the proposed free credit period for account capital management; believe that the effective implementation of the credit policy remains the optimum stock and cash level.

    It speeds up the company’s capital cycle and makes the situation of liquidity easier. Managers also try and extend the available credit from the payment of the account and thus take advantage of the business credit; which is generally considered to be free working capital for a certain period. It is an easily understood concept that can be linked to a person’s home. It seems that a person collects cash from his income and how he is planning to spend on his needs.

    Important area:

    Working capital management is a very important area of business when selling mid-market businesses. Effective working capital management means that the business owner will keep their level as low as possible; while still there will be enough funds to run the business. At the point of sale, a buyer will look at historical levels to set non-cash working capital in a reasonable amount to leave the acquisition after the business.

    Sellers will usually be able to extract extra cash from the business before the sale. If the average non-cash is maintained at a low level on the historical level, buyers will usually ask for the comparative level. The same is true if the inefficient level of working capital is maintained at a higher level. On sale, the level will have a direct impact on the total cash earnings received by the vendors.

    What is Working Capital Analysis with Management
    What is Working Capital? Analysis, with Management. Formula!
  • What does mean Capital Asset Pricing Model (CAPM)?

    What does mean Capital Asset Pricing Model (CAPM)?

    The Capital Asset Pricing Model (CAPM) establishes a linear relationship between the required rate of return of a security and its systematic or un-diversifiable risk or beta. CAPM a model use to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio. As well as, CAPM enables us to be much more precise about how trade-offs between risk; and, return determine in the financial markets. So, what is the question; What does mean Capital Asset Pricing Model (CAPM)?

    Here are explain What is the Capital Asset Pricing Model (CAPM)? with Meaning and Definition.

    In CAPM the expected rate of return can also think of as a required rate of return because the market is assumed to be in equilibrium. Also, the Expected Rate of Return is the return that an investor expects to earn. Required Rate of Return of security the minimum expected the rate of return needed to induce an investor to purchase it.

    1] According to A,

    “CAPM is a method of determining the fair value of an investment based on the time value of money and the risk incurred.”

    2] According to B,

    “CAPM is a model used to determine a theoretically appropriate required rate of return of an asset, to make decisions about adding assets to a well-diversified portfolio.”

    3] According to C,

    “CAPM is used to estimate the fair value of high-risk stock and security portfolios by linking the expected rate of return with risk.”

    Capital asset pricing model (CAPM) is a model that establishes a relationship between the required return and the systematic risk of an investment. As well as, It estimates the required return as the sum of the risk-free rate; and, the product of the security’s beta coefficient and equity risk premium. Also, Investors face two kinds of risks: systematic risk and unsystematic risk. As well as, Systematic risk is the risk of the whole economy or financial system [Hindi] going down and causing low or negative returns.

    For example;

    The risk of recession, enactment of unfavorable regulation, etc. Systematic risk can’t avoid adding more investments to the portfolio (i.e. diversification) because a downturn in the whole economy affects all investments.

    Unsystematic risk, on the other hand, is the risk specific to a particular investment. For example, unfavorable court ruling affecting the company, major disruption in the company’s supply chain, etc. Such risks can mitigate by adding additional investments to a portfolio. For example, a portfolio of 100-stocks is less prone to the negative performance of one company due to any specific event affecting it.

    CAPM calculate according to the following formula:

    Rrf + [Ba x (Rm – Rrf) ] = Ra

    Where in:

    • Ra = Expected return on a security.
    • Rrf = Risk-free rate.
    • Ba = Beta of the security, and.
    • Rm = Expected return on the market.

    Since unsystematic risk can eliminate through diversification; Also, the capital asset pricing model doesn’t provide any reward for taking such a risk. It measures the required return based on the level of systematic risk inherent in a particular investment.

    What does mean Capital Asset Pricing Model (CAPM)
    What does mean Capital Asset Pricing Model (CAPM)? Image credit from ilearnlot.com.

  • Explain How to Calculate NAV in Mutual Funds?

    Explain How to Calculate NAV in Mutual Funds?

    Learn, Explain How to Calculate NAV in Mutual Funds?

    The Net Asset Value (NAV) is the market value of the assets of the scheme deducting its liabilities. Simply put, the NAV is what investors are required to pay to buy or sell one share of the mutual fund. Keep in mind any additional fees are not included in this amount. In accounting terms, NAV is also known as the book value of the mutual fund. Also Learned, Mutual Funds, Explain How to Calculate NAV in Mutual Funds?

     

    The net asset value per mutual fund unit on any business day is computed as follows:

    NAV = (Market value of the fund’s investments + Receivables + Accrued income -Liabilities – Accrued expenses)/Number of units outstanding.

    Rules Governing the Mutual Fund NAV Calculation:

    1. Accrued Income and Expenses: The correct accrual of all incomes and expenses is a requirement for computing NAV. In practical terms, these are just estimates. For example, the investment manager’s fees have to be accrued every day for computing NAV but the fee is based on the weekly average of net assets. Changes in NAV due to the assumptions about accruals should not impact NAV by more than 1 %.
    2. Sale and Purchase of Securities and Units: The purchase and sale of securities have to be recorded in the books of the fund, and this impacts the net assets of the fund. Sale and repurchase of units alter the number of unitholders outstanding in the fund and impacts the denominator of the NAV equation.
    3. Initial Expenses: When a mutual fund scheme is launched, certain expenses are incurred. These relate to printing and mailing, advertisements, commission to agents, brokerage, stamp duty, marketing, and administration known as initial or pre-operational expenses, they are linked to the corpus of the scheme. The fund has to give a break up of these expenses in the prospectus.
    4. Recurring Expenses: Apart from the initial expenses, mutual funds incur recurring expenses every year. These expenses include items like the asset management fees, registrar’s fees, and custodial fees and are charged to the profit and loss account of the scheme.
    5. Sales and Repurchase Load: Sales or front-end load is a charge collected by a scheme when it undertakes fresh issue of units or shares. Suppose a mutual fund issues Rs.1,00,000 worth units having a face value of Rs.10 each. The company incurs some initial issue expenses, which may be around 1% of the face value, or in other words, the company may levy an entry load. Schemes that do not charge a load are called ‘No Load’ schemes. Repurchase or ‘Back-end’ load is a charge collected by a scheme when it buys back the units from the unit holders. It is because of the front-end and back-end loads the mutual fund schemes are at a premium and repurchased at a discount to NAV. The repurchase price is usually less than the reissue price.

    Learn how to calculate Net Asset Value with the following examples:

    • Example 1: If the net assets of a fund are $10 million, and the fund holds 2 million shares. Then, the NAV per share = $5 ($10 million / 2 million).
    • Example 2: YTC Corporation has total assets of $3,500,000 (including intangible asset $500,000) and total liabilities of $1,000,000. The calculation for net asset value of ABC corporation is as follows: NAV = total assets – intangible assets – total liabilities = 3,500,000 – $500,000 – $1,000,000 = $2,000,000
    • Example 3: A mutual fund has total assets of $2,800,000, liabilities of $800,000, and 200,000 outstanding shares. Then, the NAV per share = (2,800,000 – 800,000) / 200,000 = $10.
    NAV in Brief:

    The Net Asset Value (NAV) of a mutual fund is the price at which units of a mutual fund are bought or sold. It is the market value of the fund after deducting its liabilities. The value of all units of a mutual fund portfolio is calculated on a daily basis, from this all expenses are then subtracted. The result is then divided by the total number of units the resultant value is the NAV. NAV is also sometimes referred to as Net Book Value or book Value. Let’s discuss its calculation in a bit more detail.

    NAV indicates the market value of the units in a fund. So, it helps an investor keep track of the performance of the mutual fund. An investor can calculate the actual increase in the value of their investment by determining the percentage increase in the mutual fund NAV. NAV, therefore, gives accurate information about the performance of the mutual fund.

    Calculation of NAV:

    Mutual fund assets usually fall into two categories – securities & cash. Securities, here, include both bonds and stocks. Therefore, the total asset value of a fund will include its stocks, cash, and bonds at market value. Dividends and interest accrued and liquid assets are also included in total assets.

    Explain How to Calculate NAV in Mutual Funds - ilearnlot

    Also, liabilities like money owed to creditors, and other expenses accrued are also included.

    Now the formula is:

    Net Asset Value (NAV) = (Assets – Debts) / (Number of Outstanding units).

    Here:

    Assets = Market value of mutual fund investments + Receivables + Accrued Income

    Debts = Liabilities + Expenses (accrued)

    The market value of the stocks & debentures is usually the closing price on the stock exchange where these are listed.

    Some points to note:

    The mutual fund itself and/or certain accounting firms calculate the NAV of a mutual fund.

    Since mutual funds depend on stock markets, they are usually declared after the closing hours of the exchange.

    All Mutual Funds are required to publish their NAV at every business day as per SEBI guidelines.

    Also, NAV is obtained by subtracting the expense ratio of a fund. This expense ratio is the total of all expenses made by the mutual fund annually, including the operating expenses and the management fees, distribution and marketing fees, transfer agent fees, custodian fees and audit fees.