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  • Operating Cycle Formula, Example and Calculation

    Operating Cycle Formula, Example and Calculation

    Whether you are a businessman or a student, you must have come across the term “Operating cycle”. As the word suggest the operating cycle is the number of days needed by the business to get stock, sell it and get cash from its sale. The Operating Cycle has a major role in any business. It is also important to understand that every business has a different operating cycle. Before diving into the details, let us first understand what is an operating cycle.

    What is the Operating Cycle?

    The operating cycle is the typical amount of time needed for a company to invest its initial capital to purchase raw materials, produce products, sell those products, and then get payment from customers for those products. This helps determine how much working capital a company will require to keep up with or expand its operations.

    As a result of having a very short operational cycle, a business can continue to expand while maintaining very low-profit margins. Conversely, if a company’s operating cycle is extremely long, it may have healthy profits yet still need additional funding to expand even slowly. In the case of a reseller, the operational cycle merely spans the time between the first cash outlay and the date on which the company receives payment from the consumer.

    To increase stocks, cash is needed to purchase goods such as raw materials. Such supplies are converted into final goods at the factory during processing. Additionally, when such things are sold, accounts receivable are created. After that, the business receives cash from the collection of receivables, and the cycle repeats itself as depicted in the image above. It takes a few days to finish the entire cycle. The operating cycle thus depicts the period between a company’s expenditures on labour, raw materials, and other costs and its cash inflow from sales of items. It is the period between the expenditure of cash and the realisation of cash.

    Each business entity’s working capital cycle may be different in length.

    Importance of Operating Cycle

    An Operating Cycle is important due to the following reasons:

    1. It determines a company’s efficiency- An operating cycle can tell a business owner how quickly the company can sell its inventories. A shorter cycle indicates a more efficient and successful business. It indicates that a company has enough cash in case it needs to meet its liabilities. There are many advantages of the operating cycle, one of which is that it helps the company to know its financial position. A business owner’s ability to make decisions that will benefit the firm is influenced by how well they understand the company’s operating cycle. If a business has a longer operating cycle, it means that the company will need more cash to maintain its operations.
    2. Determines Company’s Financial Position- A company’s operating cycle is influenced by a wide range of factors that affect a company’s financial position A business owner’s ability to make decisions that will benefit the firm is influenced by the company’s operating cycle.
    3. Impact on a company’s relationship with its creditors- A company’s probability of failing a debt payment increases with the length of the cycle. A company’s credit rating may be harmed, which may result in increased interest rates and fees. By determining the connection between debtors and sales, creditors and sales, and inventory and sales, the operating cycle aids in just estimating the needs of working capital.

    How to calculate the Operating cycle:

    Let us now understand how we can calculate the operating cycle of our business. The basic formula of the Operating Cycle is:

    Operating Cycle= Inventory Period+ Accounts Receivable Period

    To know the company’s efficiency, the business needs to calculate its operating cycle. By following the below-mentioned steps, you can calculate the same:

    Find the Inventory Period– While calculating the operating cycle, the first thing you need to find is the company’s inventory period. An organization’s holding period for inventory is the length of time it retains its goods before selling them. Managers can evaluate liquidity using the inventory holding period as a critical performance indicator. 

    It measures a company’s capacity to control its assets and how quickly it can turn them into cash or revenue. You can calculate the inventory period by the following formula:

    Inventory Period=365/ Inventory Turnover

    Divide the price of goods that is sold by the average goods to know the turnover. The average inventory is the average of the opening and closing stock. While the cost of products sold may be seen on the income statement of the company, this can be found on the balance sheet of the business.

    Find the Accounts Receivable period– Accounts Receivables mean the amount of money that a customer owes to a company. You can calculate Accounts Receivable by the following formula:

    Accounts receivable period = 365 / receivables turnover.

    Now, you can calculate the operating cycle using the basic formula –

    Operating cycle = inventory period + accounts receivable period,

    The result will be the number of days in the company’s operating cycle.

    Examples of the operating cycle

    Suppose Anthony owns a restaurant and he wants to know how well operations are running at his shop. To do this, he has to calculate his company’s operating cycle. That simply means his operating cycle would start when he starts paying for goods and materials used in his restaurant. This operating cycle would not end until all of his restaurant’s goods have been sold out and he receives cash from the sales.

    Similarly, suppose Kiara owns a garment shop and she needs to find her operating cycle. So, the operating cycle would start as and when Kiara starts purchasing goods and other materials for her shop and will end only when all her stock is sold and she receives cash.

    Conclusion

    Utilizing your efficiency based on its operations can benefit a company in many ways. The cost of things like inventory, accounts receivable, non-selling expenses (i.e., general administrative), payroll overhead, etc. can all be reduced, thanks to operational efficiency. An operational efficiency indicates that there is more money available for maximising shareholder value or corporate reinvestment.

  • Time Value of Money: Overview, Process, and Examples

    Time Value of Money: Overview, Process, and Examples

    There are numerous concepts in finance that help a business grow and survive. Some concepts are based on how to invest, and some are based on when to invest and why. Time Value of Money (TVM) is one such concept. It states that the return a business gets is worth more at present than it will be in the future. It is one of the core principles in finance. 

    In this article, we will cover what the time value of money is, how to calculate it, its importance for a business, and its connection with the present value and future value of money.  

    What is the Time Value of Money?

    It takes its own time for investments to grow and create a sizable corpus over a long period of time. However, at the same time, it makes investments vulnerable to long-term uncertainties such as inflation, interest rate risk, default risk, etc. As a result, the value of money is more in the present time than it would be in the future. 

    Let’s take a simple example. A company has just received a gain of Rs. 5,00,000 on one of its projects. It decides to put the money aside in a safe place instead of investing it. The question is, will Rs. 5,00,000 be worth the same after five years? The answer is no. In fact, the chances are thicker that it would reduce in value due to inflation. Instead, the money wouldn’t have lost its value if the company had invested the same amount in a bank FD, even at lower rates. We can also call it an opportunity cost. 

    The time value of money is related tightly to the rate of inflation as it directly impacts the investment. If the return earned is 7% and if the inflation is 9%, the investment is losing its principle (+7% – 9% = -2%) instead of gaining a return. Thus, it is crucial for a business to consider such factors for weighing investment options using TVM. 

    How to calculate the time value of money?

    The time value of money can be determined by calculating the Future Value (FV) of money or Present Value (PV) of money. 

    The formula for calculating FV is:

    FV = PV x [ 1 + (i / n) ] (n x t)

    Where, 

    FV= Future Value

    PV =  Present Value

    i = Interest rate 

    n = Number of interest compounding periods per year

    t = Total number of years for the calculator purpose 

    To make it easy to understand, let’s understand it with an example. 

    Company X decides to invest Rs. 2,00,000 today at an interest of 6% for 3 years that compounds annually. What would be the future value of money for the sum invested? 

    FV = PV x [ 1 + (i / n) ] (n x t)

    = 2,00,000 x (1 + (6% / 1) ^ (1 x 3)

    = 2,38,203.20

    The formula for calculating PV is:

    PV = FV / [ 1 + (i / n) ] (n x t)

    In the above example, let’s assume that the future value of the investment would be Rs. 5,00,000. If all the other conditions remain the same, how much the investment would be worth at present?

    PV = 5,00,000 / (1 + (6% / 1) ^ (1 x 3)

    = 419,809.64

    It is to be noted that even a slight change in the interest rate or the interest compounding period can have a severe impact on the FV or PV of an investment. 

    For example, if in the above example of calculating FV, the compounding period is quarterly, n would be 12 instead of 3. The FV value, as a result, would be:

    FV = 2,00,000 x (1 + (6% / 4) ^ (4 x 3)

    = 402,439.29

    What does it mean by the present value and the future value? Why do they matter for TVM?

    • Future value: It is the value of current investments on a future date determined by the required rate of interest. 
    • Present Value: It states the current value of investments based on their future cash flow based on the interest rate. 

    FV and PV are two sides of the same coin. One cannot exist without the other. They both are crucial for determining the time value of money. 

    While the future value of money tells how much the investment made in the present time would be worth in the future, the present value indicates the exact amount needed to be saved today to earn a specific return in the future. 

    For a business, both of these values are important as it helps them to understand the viability of their investments and a reality check on the amount needed to be invested. 

    Why does the time value of money matter for a business?

    • The time value of money calculation helps a business determine whether to take up a project or investment based on its worth. 
    • TVM also makes it easier for a business to compare the available alternatives and choose the best option available for investment. 
    • As TVM helps in knowing the worth of a project or investment, it helps in setting the required return rate and cost associated with the particular investment to streamline the overall business operations. 

    Conclusion

    Businesses are required to make frequent investment decisions based on how much they are worth. The time value of money considers an investment or project’s present and future value, providing their accurate value. It makes it easier for businesses to compare multiple projects and investment opportunities to make the most suitable investment decisions.

  • Technical Analysis of Stocks and Trends

    Technical Analysis of Stocks and Trends

    Introduction

    Every year, millions of young minds enter the stock markets to try their luck and become millionaires. Have you ever thought about what is the one thing that separates the few people getting the Midas touch in the stock markets from people who crashed down their entire capitals and exited the market? It is knowledge, perseverance and devotion. 

    Let’s talk about knowledge. The knowledge in the stock market field can be bifurcated into fundamental analysis of stocks and technical analysis of stocks. 

    In this blog, we will discuss what is a technical analysis of blogs and related things. 

    Let us quickly understand what is the technical analysis of stock trends.

    What is Technical Analysis of stocks?

    The technical analysis of stock trends is nothing but the study of markets including predicting the price trends as well as various patterns as seen on the stock charts. With the help of technical analysis, you can predict future price movements, which helps the stock traders to make a profit. 

    Let us understand this in more simple terms. Technical analysis is the trading and profit-making opportunities by analyzing the patterns seen on stock market charts. Performing the stock market technical analysis helps the traders and investors make strategies as well as identify points of entry plus exit.  

    Now, let us understand what are the important elements of technical analysis.

    The important elements of technical analysis.

    When a person starts trading/investing in the stock market, he needs 4 elements. These are 

    1. Trends 
    2. Patterns
    3.  Indicators 
    4. Entry Signals

    Let us quickly understand all four of these. 

    Trends

    A trend is nothing but the most basic and prominent element of Technical Analysis. The trend suggests a particular direction in which the stock is moving. It simply tells you which way the stock is currently moving. It is pertinent to note that the stock can move in upward, downward, or sideward ways. 

    Any person who has even a minute understanding of technical Analysis knows the following basic rule of the Stock Market. 

    “The trend is your friend.” 

     The above line suggests that if you are trading according to the prevalent trend that the stock has adopted, there are high chances of being successful.  

    Pattern

    Any pattern or a picture in a particular stock can only be made once the different levels(namely trends support, and resistance) have been drawn.  The interception of these levels forms different patterns which can be studied to understand what action is the stock doing so as to determine the next steps that it would take.  

    Indicators

    Indicators are formulas and ratios that try to interpret and understand the index data in order to predict the subsequent market movements.  Commonly known indicators are moving averages, balance volume, market breadth and market sentiments.  

    Studying these indicators helps you understand whether the ongoing trend will continue or will go in reverse. The indicators also help the traders make decisions regarding their entry as well as exit points.

    Entry Signals

    The entry signals in the forex represent the level or the price where the trader makes a trade. A good entry point is often the most important aspect of any stock market trade. Investors take the help of trendlines, moving averages and several other indicators and variables to determine suitable entry points.

     Let us now talk about some commonly used tools for technical analysis of stocks

    Candlestick Patterns

    A candlestick is a technical trading tool and is a key component in stock market analysis. The candlesticks taken together make a pattern which has been used for centuries to deduce the price direction that a particular stock would take. 

    Candlesticks usually make different patterns which help the traders and investors determine the short-term directions of the stock. Hence, it helps them make effective trading decisions.  

    It must be noted that trading is guided by different emotions. These emotions can be well read by using candlestick charts.   

    When candlesticks are taken together for a certain period of time, they form a candlestick pattern. The candlestick pattern shows the price movement represented graphically which can determine the price movement of stocks. There are various candlestick patterns known as the inverse hammer, bullish engulfing, piercing line, morning star, shooting star, bearish engulfing etc. 

    Moving Averages

    The moving average is one of the most crucial stock indicators used for technical analysis. Moving averages are extremely helpful in calculating the trends of a particular stock or understanding the different resistance and support levels. Moving averages are determined by calculating by adding up all the data points measured during a certain period of time which are then divided by the sum of all the time periods.

    The most popular moving averages are 10 days, 20 days, 50 days, 100 days and 200 days. 200-day moving averages are considered most reliable by the traders as they tell you the direction that the market would be taking during a long period of time.  

    Support and Resistance

    The resistance level is a point where a particular stock stops rising further and is expected to start its downward journey. Resistance is one of the most crucial aspects for traders and investors and it often acts as a trigger for initiating a sell.  In layman’s terms, resistance is the point/level where the supply is extremely strong and thus, it stops the stock from moving any higher.   

    For example, a stock was moving upwards as it was in an uptrend. Suddenly, it started taking a reversal and started moving downwards. In this example, the point where the reversal begins is the strong resistance level for the stock.  

    Support is one of the most important points and is just the reverse of resistance. A support level is a point on the trading charts which prevents the stock from falling further. Traders usually draw a support line for the stocks to ascertain the points where the stock is likely to bounce back. It must be noted that the support level is the price point where the traders/investors get triggered to buy.   The investors/traders expect maximum demand on the support level and the same is always lower than the current prevailing market prices.  

    Conclusion

    These technical tools can help one develop an investment methodology when trading in the stock markets. These indicators can help you find the probable future price moments. But it goes without saying that the markets may be subjected to unusual price movements and it is always advisable to trade with caution.

     

  • What is Short Selling? Things You Wish to Know.

    What is Short Selling? Things You Wish to Know.

    A trading or investment method known as short selling makes predictions about the price drop of a stock or other security. However, only knowledgeable traders and investors should use this sophisticated approach. 

    Investors may use short selling as a hedge against the downside risk of a long position in the same security or a comparable one, while traders may use it for speculation. Speculation is a sophisticated form of trading that entails a high potential risk. A more frequent transaction is hedging, which involves taking an opposite position to lessen risk exposure.

    When an investor borrows a security, he or she sells it on the open market with the intention of later purchasing it at a lower price. Short-sellers bet on, and benefit from, a reduction in a security’s price.

    Short selling meaning is when an investor sells all the shares he does not already possess at the moment of a trade. In essence, a trader uses brokerage to purchase shares directly from the owner with the intention of selling them in the future at a higher price.

    The seller purchases the shares and records a profit when the stock price drops. However, short selling has a high risk-to-reward ratio, and traders can use it to either make money or suffer significant losses.

    What Do You Mean By Short Selling In Stock Market

    Short selling in the stock market is a strategy employed to make a quick sale and gain a respectable profit in a short period of time. While short-sellers monitor the pricing environment and profit from declining prices, long-term investors purchase stocks in the hopes that they will grow in the future.

    Investors could engage in the short sale of shares for two main reasons:

    1. Speculation: Many important factors can influence how much a stock price rises or falls, such as the release of an earnings report.

    In this scenario, the investor buys the shares, sells them, then buys them back at a lower price, returns them to the lender, and makes money on the difference in price.

    2.Risk hedging: One of the main reasons for short selling is an investor’s long position in a related security. In order to reduce his risk of losing money, he short sells the same stock.

    What is Short Selling in Share Market?

    Short selling occurs when a shareholder transfers shares that he does not own at the time of the sale. In short selling, an online stock trader borrows shares from the owner through a brokerage and sells them at market value in the anticipation that prices will fall. The short seller buys the stock and gains money when the stock’s price drops. 

    Realizing that professional traders and investors engage in short selling, which is based on the expectation that the price of shares will decline before they are returned to the owner, is the first step in understanding what it is. Because short selling has a large potential for loss as well as gain, it carries a high risk-to-reward ratio.

    Do you know shorting a stock? When a trader borrows shares from a broker and sells them right away in the hope that the stock price will drop soon after, this is known as short selling. If so, the trader can repurchase the shares at the discounted price, return them to the brokerage, and keep the profit on the difference.

    What Is Short Selling In Stock Market?

    Selling borrowed securities, such as stocks, with the intention of later buying them again at a lower price in order to profit is known as short selling. To put it another way, when you sell a stock short, you intend to profit from a decrease in price rather than an increase.

    For seasoned investors, such as hedge fund managers, shorting stocks is a common trading strategy. Large gains may result from it. But there is also a chance that you could lose a lot of money.

    Selling stock that is not one’s own or that one has borrowed from a broker is known as “short selling” or “shorting stock.” Investors who short stocks must be prepared to accept the possibility that their bet will fail.

    Short Selling Price And Its Example

    Rising stock prices are profitable for many successful traders. However, some people use a technique known as short selling to achieve the exact opposite, earning from equities that lose value.

    Borrowing security and selling it on the open market are both examples of short selling. After paying back the initial loan, you then buy it at a lesser price and keep the difference. Short selling price can be more or less and depends upon the stock market.

    Short selling means first selling and then repurchasing at a lower cost. When you short sell, you gain a profit when the price declines.

    Suppose the share price is Rs. 100; you believe that the price will decline, so you put in a sell order at the desired price. For example, let’s say that the price is Rs. 100. You will now make a profit if the price falls below 100; otherwise, you will suffer a loss.

    The Recent Trends of Short Selling In India

    Experienced investors probably have some knowledge about short selling in India. But if you’re a new investor, you might be perplexed by this idea and scratch your head. Do not worry; it is unrelated to your height. Short selling is the act of selling a security that the seller has borrowed and hence does not actually own.

    The shares will allegedly be bought back at a later time after the sale. Short selling is driven by the expectation that a security’s price will fall, making it possible to buy it later for a profit at a lower price.

    Short Selling of Shares

    The short seller sells stock shares they do not own in a short sale. Short sellers first obtain stock shares on loan from a brokerage house. The proceeds from the sale of those loaned shares are then deposited into their account. 

    The short seller loses more money if the stock price rises and they have to buy the shares back at a higher price. As short sellers must eventually repay their broker, they risk losing more money if the stock price rises, so they may choose to hold out for a lower price.

    The broker may issue a margin call to compel the short seller to make an additional deposit into the brokerage account or close the trade by repurchasing the shares at their newly increased value if stock prices rise.

    Conclusion

    Short selling involves greater risk than conventional stock trading. You may find it exciting, but it is risky in some sense if you are new to trading. According to share market experts, bull markets often last longer than bear markets. It gives traders a shorter planning horizon for their short holdings.

    Trading requires years of commitment and training. So, start learning about the markets today if you want to be a successful trader! Practical experience is the best method to learn something, and the same applies to trading.

  • Required Rate of Return- Definition, Examples, and How to Calculate

    Required Rate of Return- Definition, Examples, and How to Calculate

    Once you have calculated the Net Present Value (NPV) of an investment project or opportunity, one of the last steps in the process is to calculate the required rate of return (also known as the discount rate). In this article, we’ll break down what exactly this value represents and how to calculate it in three simple steps

    Introduction

    The required rate of return is the minimum acceptable return on an investment. In other words, it is the minimum return that investors expect for investing in a company or project. 

    Components of Required Rate of Interest 

    1. Time Value of Money– The required rate of return is the minimum percentage of return that an investor will accept for investing in a project or security. 

    The time value of money indicates the concept that money today will always have more value than money in the future. In order to calculate the required rate of return, you must first determine the time value of money. 

    This can be done by using a discount rate or an interest rate. The discount rate indicates the rate at which the discount future cash flows back to their original value.

    1. Risk Involved– The required rate of return must also compensate investors for taking on risk. The required rate of return compensates the investor for three types of risk: business risk, financial risk, and personal risk.

    3) The expected rate of inflation during the investment period–  In order to calculate the required rate of return, it is essential to know the expected rate of inflation when you are investing. 

    The expected rate of inflation is the percentage change in prices that is anticipated over a given period of time. For example, if the current inflation rate is 2% and you expect it to remain at that level for the next year, then your expected rate of inflation would be 2%.

    Required Rate of Return- Step by step calculation

     There are several ways to calculate the required rate of return—one of which is using the dividend discount model (DDM), or the capital asset pricing model (CAPM). The choice of model used to calculate RRR depends on the situation for which it is being used.

    Calculating Required Rate of Return (RRR) Using the Dividend Discount Model

    The dividend discount model (DDM) is an investment valuation model that calculates the present value of a company’s future dividends based on growth and risk characteristics. Investors use this to determine their required rate of return (RRR). To calculate 

    RRR =  (Expected dividend payment / Share Price) + Forecasted dividend growth rate      

    Calculating Required Rate of Return (RRR) Using the Capital Asset Pricing Model (CAPM)

    The Capital Asset Pricing Model (CAPM) is the ideal model used to determine the required rate of return on an investment based on your personal risk tolerance and on the expected market returns. A good way to get started with this calculation is to use the rule of thumb that your required rate of return should be 8-10 percent higher than the expected market return before taxes. Here’s how you can calculate your personal required rate of return using CAPM in just few steps

    RRR =  Risk-free rate of return + Beta X (Market rate of return – Risk-free rate of return)      

    • Market rate of return can be calculated by subtracting the risk free rate. 
    • However, the product obtained by subtracting the two values should be multiplied by the Beta. 
    • The final step to calculate the required rate of interest is to add this result to the risk free rate of return. 

    What does Required Rate of Interest on Bond Means?

    The required rate of return on a bond, also known as the yield to maturity, indicates how much return an investor can expect to receive from that bond over time.

     This information is necessary in order to value bonds, which are used by investors and companies in order to raise capital. The required rate of return on a bond serves as one of the most important variables in the process of selecting securities, and it is crucial that it be calculated properly and carefully considered when making purchasing decisions.

    Interpretation of Required Rate of Interest

    The required rate of interest (RRI) refers to the minimum return that investors need to receive on an investment in order to take the risk of investing in that particular project or company. 

    The financial return that investors expect depends on the size of the capital investment required and the perceived risk of investing in that particular project or company.

     A high RRI indicates a high perceived risk, while a low RRI indicates a low perceived risk. The required rate of interest can be calculated with the following formula: RRI = Capital Cost x Risk Premium + (Operating Profit – Normal Profit).

    Examples of Required Rate of Return

    There are various examples of the required rate of return. Some of them are-

    Example 1: What Is the Required Rate of Return on Your Pension Fund? 

    Your pension fund’s required rate of return is the percentage it needs to earn on its investments each year to cover expenses and pay you the benefits you’ve been promised.

    For example, if your pension fund has a $1 million balance and an annual payout of $50,000, it will need to earn at least a 5% return on its investments each year to keep up with its obligations

    Limitation of Required Rate of Return

      Despite its seeming importance, the required rate of return can have limitations. These limitations are highlighted below:

    •  When calculating the required rate of return, inflation expectations can be subjective. Most of the time, inflation expectations are not accounted for in the calculation of required rates of return.
    •   Liquidity of investment is another factor that RRR does not consider.
    •   RRR may have varying results depending on the tolerance levels of various individuals and investors.

    Conclusion

    To conclude the required rate of return is a hurdle rate for investors to forecast the degree of profitability of their investment project. This hurdle rate will show the level of profitability from their investment project in order to make it a worthwhile endeavor. If this hurdle rate cannot be obtained, then a project cannot be expected to create adequate value if it is pursued. 

  • What are Mortgage Loans?

    What are Mortgage Loans?

    Amongst various means to opt for financing, getting a mortgage loan is an easy and secure way for borrowers. While opting for a loan, borrowers typically have to pledge property as collateral, depending on the nature of the loan and the amount. A mortgage loan functions on the base–a house or commercial property is pledged against the loan amount. 

    A mortgage loan, also known as a loan against the property, helps borrowers with their financial needs. Because the property acts as collateral, it helps them with favourable terms and interest rates. 

    This article will cover different components of a mortgage loan, including what a mortgage loan is, how it functions, the different types, and the advantages and disadvantages of getting a mortgage loan.

    What is a Mortgage Loan?

    Getting a loan for a significant amount is a challenge for individuals as well as for businesses. The hassle-free solution is to go for a mortgage loan. It helps in funding purchases for another property for business or personal usage. A mortgage loan allows you to access funds in exchange for marking your property as collateral to the lender, bank, or institution. 

    The typical mortgage loan interest rates vary from 8% to 12% in India. As a borrower, you can avail funds up to 60%-70% of the property’s official or registered value. In many cases, based on eligibility and credibility, the percentage can be on the higher side; however, it depends on where you opt for a mortgage loan. 

    A mortgage loan is an easier option to finance a home or commercial property with a repayment tenure of up to 15 years. Because the borrower provides the property as collateral, in case of failure to repay the amount, the lender has the right to seize it. There might be a grace period provided to repay the outstanding loan amount. Though the lender has the right to auction or sell the property to recover the amount. 

    How Does a Mortgage Loan Work?

    Let’s discuss this with an example. Suppose you have a house worth Rs. 70 lakh and now want to purchase land worth Rs. 60 lakh. You have saved around Rs. 15 lakh, and you are looking for financing options for the rest. If you choose options such as a personal loan to facilitate the purchase of land, the annual interest can go beyond 30% (depending upon the financial institution you choose). Paying long and high EMIs every month is not a wise option. Thus you decided to get a mortgage loan against your home. 

    The interest offered by public sector banks is generally favourable compared to private banks, and that’s what you chose. The bank offered you a mortgage loan for 65% of the house value at a 10% annual rate for 15 years. 

    This translates to:

    Land price

    Rs. 60,00,000

    Amount saved

    Rs. 15,00,000

    Mortgage loan approved

    Rs. 45,50,000 (70,00,000 X 65%)

    You have Rs. 50,000 in surplus balance. By opting for this mortgage loan, you are obligated to pay off the principal and interest amounts (10% annually) every month as EMI to the bank for 15 years. If you fail to do so, the bank has the right to foreclose your house to recover the money. 

    What Are the Types of Mortgage Loans?

    Depending on the requirements, mortgage loans can be classified into seven categories as below.  

        Fixed-Rate Mortgage Loan: As the name suggests, the interest rate is constant throughout the tenure of the mortgage loan, thus, requiring the exact EMI amount each month. 

        Adjustable Mortgage Loan: In this loan, you can expect a definite interest at the beginning for a short timeframe, followed by a change in rates. It favours borrowers with lower rates in the short term. 

        Simple Mortgage Loan: This is one of the most prevailing mortgage loans in which the lender has the right to sell your property to recover the amount in case of failure to repay the money. It is important to note that only the rights to sell the property are contracted, not the actual property. 

        Usufructuary Mortgage Loan: In this mortgage loan, the borrower allows the lender to have possession of the property until the repayment is made. However, the borrower can collect rent as well as can keep the profit from the sale of the property. 

        English Mortgage: This mortgage loan works on the basis of a contract that classifies that in case of failure in repayment, the borrower would transfer the property rights to the lender. However, once the borrower repays the entire amount, the property will be transferred back to the borrower. 

        Subprime or Sub Mortgage Loan: This loan is specifically designed for individuals with low credit scores. The risk is high for the lenders; thus, interest rates are also high for this type of loan. 

       Reverse mortgage: This mortgage loan is designed for senior citizens to help them live a financially secured life. The house is mortgaged, and the borrower receives regular monthly income in old age. This mortgage type has been recently introduced in India; it helps elderly people leverage their home equity to live in later years.

    What Are the Eligibility Criteria for Getting a Mortgage Loan?

    You need to fulfill the below criteria to get eligible for a mortgage loan. Please note that depending on the bank or institution, this may vary. 

    • Age should be at least 21 years or older
    • Proof of the income
    • Details of your dependents 
    • Property valuation as well as liabilities 

    Also, you would need the following documents to avail a mortgage loan.

    For salaried individuals

    For self-employed individuals

    Filled application form

    Filled application form

    Passport size photographs

    Passport size photographs

    Identity proof

    Identity proof

    Address proof

    Address proof

    Salary slips (latest)

    Business proof

    Form 16 provided by the employer

    Financial statements, including P&L statement (3 years)

    Bank statements

    Income tax return certificate (3 years)

    Cheque for paying processing fees

    Bank statements

     

    Cheque for paying processing fees

    Advantages of Mortgage Loans

    • It is a low-cost way to get credit compared to other loans. 
    • You can avail yourself of a large sum against your property without hassle. 
    • Repayment can be made via easy monthly EMI options, reducing your financial burden.  
    • The loan tenure is reasonably long (up to 15 years), providing enough time to pay it back. 
    • It helps you finance other properties or projects based on the loan type.
    • Different mortgage loan categories are available to choose from per the requirements. 

    Disadvantages of Mortgage Loans

    • It is a secured loan with your property as collateral. Thus, failure in repayment can lead to the lender selling your property. 
    • If you decide to pay a small amount in monthly EMIs, the cost of a mortgage loan increases as you pay more interest in the long term. 
    • If you have a bad credit record, the interest amount and loan condition would not be favourable. 

    Conclusion

    A mortgage loan is like any other collateral loan except for you pledging your property here. It helps you get access to funds quickly with simple monthly EMI opinions to pay back the amount. You can finance a new personal or business property or any other project using mortgage loan funds. However, if you fail to repay the loan amount, the lender has the legal right to sell your property to recoup the payment. 

     

  • Non-Operating Expenses – Meaning, Calculation, and Examples

    Non-Operating Expenses – Meaning, Calculation, and Examples

    Every business has to invest/spend money to keep it running. The expenses can come in two ways: operating or non-operating expenses. The Operational cost, also known as operating expenses, includes rents, equipment, inventory, payroll, insurance, employee/administrative personnel salaries, etc. Apart from these expenses, another type of expense is known as Non-operating expenses.

    Non-operating expenses are not directly related to the company’s day-to-day costs. Still, it is a good accounting practice to tally them in the company’s income statement separately from operating costs, which makes it easier for investors, managers, and stakeholders to analyze the company’s performance.

    Non-operating expenses may seem negligible, but for bigger organizations, it amounts to a lot of money. For example, Alphabet, the parent company of Google, had about 12 billion dollars as non-operating expenses in the year 2021. Let us now understand what a non-operating expense is.

    What is a non-operating expense?

    A non-operating expense is an expense incurred by an organization that is unrelated to the core day-to-day business operations.

    During the business analysis, these expenses can be subtracted from the income to estimate a company’s potential earnings.

    Examples of non-operating expenses include interest expense, derivative expense, lawsuit settlement expense, loss on disposition of assets, restructuring cost, inventory write-downs, etc.

    Non-operating expenses are written at the bottom of the income statement after operational costs.

    Non-operating expenses explained:

    Separating the cost required to carry on the normal day-to-day business operations from the cost not related to a company’s core operations is essential in analyzing the performance of a business or company. Non-operational costs can alter the profitability of a company. For example, if a company is initially running in profit but incurs a write-off of obsolete inventory, the company may incur a net loss.

    Separating the operational and non-operational expenses makes it easier for business owners/investors or financial managers to analyze how the core business performed over a certain period. It also helps to accurately predict how a business will perform in the future.

    Difference between Operating and Non-operating expenses:

    The primary difference between a company’s operating and non-operating expenses is the cost that a company makes to perform its day-to-day operations to generate revenue.

    Examples of operating costs include:

    • Employee salaries
    • Office Supplies
    • Marketing and advertising to boost sales
    • Revenue costs
    • Research and development cost
    • Day-to-day repair of equipment/machinery
    • Cost of various software 
    • Rent, insurance costs
    • Travel expenses 

    Whereas non-operational costs are expenses made by a company to meet certain financial obligations but are not related to revenue generation or day-to-day functioning, these expenses may occur as one-time expenses on an ad-hoc basis.

    Examples of non-operating expenses include:

    • Interest payments
    • Foreign exchange loses
    • Inventory write-offs
    • Lawsuit settlements 

    Another important distinction between operating and non-operating expenses is that operating expenses are controllable and can be used to measure a company’s performance. In contrast, non-operational expenses are random and uncontrollable and cannot be used to measure a company’s expenses.

    Operating statements are recorded under the cost of goods in the Profit/Loss statement. In contrast, non-operating statements are recorded at the end of the Profit and Loss statement and are deducted from the operational cost.

    Some common types of Non-operational expenses:

    1. Interest Payments: Various companies take loans and debts from investors or banks to grow the company. These debts are returned with interest to the investor or banks. Payment of these debts is not under the day-to-day functioning of business and is thus considered non-operating expenses.
    2. Losses from investment: Many companies have investment/stakes in other companies. If this company incurs a loss, it is accounted for as non-operating expenses. 
    3. Loses on sale of assets: Sales or transaction of assets with lower prices is a loss for the company and is considered a non-operational expense. 
    4. Inventory write-downs: Losses incurred due to Obsolete, unsold products/inventory are considered as non-operating expenses. 
    5. Law settlement: One-time legal settlement is considered under non-operating expenses. 
    6. Restructuring costs: One-time expenses by a company to restructure to improve efficiency, increase profits, etc., are considered non-operating expenses. 
    7. Fluctuations in currency: Companies might have business operations in foreign countries. Any fluctuations in the currency exchange rate can cause a company to incur a loss which is then considered as non-operating expenses. 
    8. Disasters or emergencies: Any losses incurred due to natural disaster, and national emergencies are considered under non-operating activities

    How to record non-operating expenses:

    Non-operating expenses are recorded at the end of the income statement separate from operating expenses and mentioned after the operating expenses in the income sheet. Non-operating expenses are grouped and deducted from EBITDA on an income statement. 

    Non-operating expenses example

    After subtracting the cost of goods sold and all of the operating expenses from the sales revenue, a company reported an operating income of $2,000,000 for one year.

    The company made an investment that made a profit of $100 000 in dividends and $ 50,000 as interest in income. 

    The company paid interest of $400,000 and sold a piece of obsolete equipment at a loss of $80 000. The company was also sued for land and was charged $50 000.

      Dividend income

    $100, 000

      Interest income

    $50, 000

      Interest expense

    -$400, 000

      Loss on sale of machinery

    -$80, 000

      Litigations

    -$50, 000

      Non-operational expense

    -$380, 000

     The above is an account of non-operational gains and losses of a company which resulted in a net loss of $380, 000 which is considered the non-operational expense of the company. 

    Conclusion

    Non-operational expenses are significant as it helps to assess companies’ performance and result in transparency for investors and stakeholders. 

  • Net Asset Value: Meaning, Formula and Calculation

    Net Asset Value: Meaning, Formula and Calculation

    Investment and mutual funds have become quite common with more investors choosing this option to invest via lump-sum or SIP route. There are certain factors that affect the investment returns of mutual funds such as commissions, exit load, expense ratio, etc. However, NAV or Net Asset Value tops the list for being a significant factor impacting the investment in mutual funds. 

    This article would help you understand what Net Asset Value is, its different types, how to calculate NAV and why it holds importance for investors and investment companies. 

    What is Net Asset Value?

    Net Asset Value is a measure to determine the overall performance of a mutual fund or Exchange-traded Fund (ETF). It is the per-unit value of the fund for a specific date and a majority of the time begins with Rs. 10 per unit when the fund is listed. Based on the performance, this value increases or decreases reflecting the profit/loss of investors.  Every mutual fund is required to calculate the NAV of the fund every business day, at least once.

    In other words, NAV is the book value of mutual funds which gets impacted by changes in the market value over a long period. For a business or a company, It is calculated by subtracting the total liabilities of a company from total assets. While, for mutual funds, one more step is added–dividing the outcome by total outstanding units. NAV is more helpful in the case of open-ended mutual funds compared to closed-ended funds because of the freedom to liquidate the funds as required. 

    NAV helps in identifying profitable investment opportunities because it gives the access to compare the current market value of funds to its book value and analyse if the fund is over or undervalued. The value of NAV is dynamic and changes every day based on the per-unit price. 

    What is the formula for NAV and how to calculate it?

    NAV can be calculated using the below formula.

    NAV of a fund = Total Assets – (Total Liabilities + Total Expenses) / Total Number of Outstanding Units 

    Whereas, 

    Total Assets = Total value of assets for a particular fund scheme including cash holdings by the fund if any

    Total Expenses = Other liabilities such as interest to be paid, debt to be paid in addition to the Expense Ratio

    Let’s understand it with an example.

    Suppose the total assets of a fund are Rs. 50,00,000, and total liabilities are Rs. 3,00,000, the expense ratio is 1.5%, and the number of units outstanding is 80,000.  

    We can calculate the NAV of this fund as follows. 

    NAV = Total Assets – (Total Liabilities + Total Expenses) / Total Number of Outstanding Units 

             = 50,00,000 – [3,00,000 + (50,00,000 X 1.5%/365)] / 80,000

             = 58.74

    The NAV of the fund comes at 58.74 per unit. If an investor has bought the fund units at Rs. 10 face value, the profit per unit would come at 48.74. 

    Mutual funds are required to calculate NAV on a daily basis for business days once the stock market closes at 3:30 pm. As a result, the value per unit that investors get may vary when the NAV is applied.

    Why is Net Asset Value crucial for a business/fund performance?

    For a business or mutual fund, NAV helps in assessing the overall performance and makes the comparison of past returns easier. From the viewpoint of a fund house, a change in NAV does not reflect the profitability on the balance sheet. It typically denotes how the fund has grown during a specific period. 

    For example, if the NAV of XYZ increases to Rs. 100 per unit in January from Rs. 50 per unit in December in the previous year, which means the fund has attracted more investors and has expanded. In technical words, the fund’s Asset Under Management (AUM) has increased. 

    Why is NAV important for investors?

    Unlike for a mutual fund or business, for investors, NAV is the price per unit to invest in a fund. Thus, directly affecting their overall investment returns. For example, there are two funds with the first fund having a NAV of Rs. 20 and the second fund has a NAV of Rs. 150. An investor has Rs. 10,000 to invest and can select from any of these funds. 

    If the investor chooses the first fund, he/she would get 500 units (10,000/20). If the preferred choice is the second fund, the allotted units would be 66.66 (10,000/150). The performance of both funds varies depending on the fund manager’s solicitation of investment instruments and will impact the portfolio of investors. 

    However, there is no perfect conclusion that a lower NAV is profitable or a higher one. It depends on the fund size and the overall performance. As an investor, you can check how the fund has performed in the past and based on that and your goals, make decisions on which fund to invest in. NAV would only decide how many units you will get. 

    Investors should be aware of the fact that different mutual funds have different cut-off times for NAV allotment. 

    • For Overnight/Liquid MFs: If you submit your request before 1.30 pm, you will receive the NAV of the previous day. If you submit it after 1:30 pm, you will be allotted a same-day NAV. 
    • For debt/equity MFs other than Overnight/Liquid Funds: If you submit the request before 3 pm, you will receive the NAV of the same day. However, if it is after 3 pm, you will get NAV for the next day. 

    Note: Read business day for the previous day or the next day NAV.

    Conclusion

    NAV helps a business or a fund to get an estimate of its performance in terms of growth and compare it with similar competitors. While for investors, it is more about the units they can expect to be allotted. Investors can calculate NAV as Net Asset Value divided by the number of outstanding units. Before investing in mutual funds, it is important for investors to check different aspects of funds in addition to NAV to gauge a better understanding of its overall performance. 

  • ROI vs IRR: what is the difference and which is better for your business?

    ROI vs IRR: what is the difference and which is better for your business?

    What’s the difference between Return on Investment (ROI) and Internal Rate of Return (IRR)? In short, they both measure your overall financial performance, but they take different approaches. 

    When you’re evaluating your investments, which should you choose? And what if your bank or an investor asks you to give one of these metrics? How do you decide which to use? Read on to find out!

    What Is Return On Investment (ROI)?

    A return on investment (ROI) is a performance metric used for evaluating the efficiency of an investment or to compare the efficiency of different investments. 

    ROI is calculated by dividing the return on an investment by the investment cost. The result can be obtained as a percentage or a ratio.

    For example, if you buy $100 worth of shares and they go up in value by $10, your ROI would be 10%. 

    If you buy a house worth $200 000 and sell it two years later for $240 000 after having spent $40 000 on renovations during that time period, then your ROI would be 16%. 

    However, what is more important than this percentage figure is the actual amount returned at the end of the investment

    What Is the Internal Rate Of Return (IRR)?

    When capital budgeting the IRR is used to estimate investment profitability. In simple terms it is the rate at which the recent value of a cash flow equals the investment. As a result it makes the project’s NPV equals to zero. 

    For example- If you have $10 and an interest rate of 10%, then the NPV will be $0 after one year. 

    An NPV greater than zero indicates a profitable project, whereas NPV less than zero indicates that alternative actions need to be taken. 

    What IRR and ROI measures?

    Internal Rate of Return (IRR) and Return on Investment (ROI) are two popular measures used to assess the performance of an investment. Both ratios measure the profitability of an investment, but there are some key differences and similarities between the two. Continue reading below to know.!!

    Similarities in IRR & ROI

    Financial assessment purposes

    IRR and ROI are both ways to examining the profit of investment. IRR can be used to determine whether an investment makes sense financially. And ROI will demonstrate how investment will perform financially. 

    Versatile capabilities

    An investment opportunity profitability can be determined using IRR & ROI. In addition to assessing whether a project matches expectation, financial returns can also be evaluated to improve future economic ventures.

    Differences in IRR & ROI

    There are important differences between IRR and ROI, and knowing the distinction between the two can help you make better financial decisions for your business

    Simple vs. Complex

    Compared to ROI, IRR has difficult formula. This is probably because, IRR measures four types of variables (including cash flow and dividends), while ROI focuses on only two variables: cash flow and dividends. 

    ROI uses only simple calculation like addition, subtraction, multiplication that can be easily solved whereas IRR makes use of more difficult method which can only be solved by experts having years of experience. 

    Overall scope vs. specific growth rate

      The two measurements can be used to tell how an investment is doing over a period of time. A ROI is a measure of investment overall value, while an IRR provides you with the measure of change in the value of investment annually. ROI calculations often show a consistent growth rate, regardless of how long it takes.

    On the other side, IRRs can help businesses to determine how growth rates can change over time, enabling them to make relevant decisions.

    Time value analysis vs. investment value percentage

    To compare the value of an investment opportunity with other ways of using the same funds, the IRR formula uses the expected rate of growth to calculate future value. 

    ROI focuses solely on the increase or decline of an investment’s value, but does not suggest how the investment will perform in the long run. Due to this, business professionals frequently calculate future value using the IRR formula rather than ROI.

    Actual returns vs. predicted returns

    An investment’s ROI must be measured based on actual results, whereas an investment’s IRR is calculated based on estimated results. It’s for this reason that business professionals use IRR to compare the benefits of different investment opportunities. They might perform an ROI analysis to determine overall benefits and financial value.

    How to Calculate IRR & ROI

    To calculate your return on investment (ROI), divide the net profit you made from the investment by the cost of the investment. Then, multiply the number obtained by 100 to get a percentage. That final number is your ROI.

    For example, if an investor puts $100 into stock and gains $200 in one year, their ROI would be 200% because they have gained twice as much as they invested. If someone invests $100 and gains nothing over two years, their ROI would be 0%.

    To calculate IRR, you need to know your investment’s current value, its original value, and the length of time you held the investment. You also need to know the interest rate you could have earned if you had invested the money elsewhere.

    When To Use IRR and ROI

    You should use the internal rate of return (IRR) when you’re trying to compare different investments that have different durations. For example, if you’re trying to decide whether to invest in a one-year project or a two-year project, you can use the IRR to compare the expected returns.

    You should use ROI when you want to compare the profitability of different investments. For example, if you’re considering investing in two different businesses, you can use ROI to see which one is more profitable.

    Conclusion

    Both IRR and ROI have their place in business. Many companies use a combination of the two to better determine their success when it comes to growth and profits. Whatever you choose to measure, be sure to take into account your goals, the time it will take to achieve those goals, and what value these metrics provide for your project moving forward.

  • Know what notional value vs. market value is!

    Know what notional value vs. market value is!

    Notional Value vs. Market Value

    Stock trading is an intricate subject that needs extensive knowledge about prices, techniques, companies, portfolio goals, etc. To acquire profits, one needs a diversified portfolio. To achieve this investment goal, it is important to be familiar with important terms like notional value and the market value of the stocks. Both these values determine the value of financial security but in a different context. 

    In today’s article, we will discuss the difference between notional value and market value, their definitions, and their uses with some examples. 

    What is notional value?

    Notional value is often used to define the value of underlying assets for derivatives such as swaps, futures, or equity options. It can be calculated by using the spot price per contract and multiplying the same with the number of contracts. 

    Derivatives are complex financial instruments and often use leverage–investing small amounts via borrowing to win huge. For example, an individual can leverage 1,00,000 cash available in his Demat account to trade 10X on the available cash. It means that he can do trading of Rs. 10,00,000 from a small amount. 

    Because of this, it often becomes difficult to find the actual value of derivatives, and thus, notional value is quite crucial. It helps find the total amount or the value of a derivative position. 

    It is important to know that notional value typically has higher numbers compared to the market value. It is a useful tool for risk assessment analysis of a portfolio. Unlike the market value, notional value usually remains fixed for security and is not likely to fluctuate. 

    What is market value?

    Market value is the value of a stock that is derived by the demand and supply and the way and the quantity traded by buyers and sellers based on market forces. In essence, it’s the value at which a security can be bought and sold in the market. 

    We can also call market value market capitalization when referring to the value of a company’s stock position in the market. Capitalization can be calculated by multiplying the number of shares by the current stock price prevailing in the market. The market price is volatile, and its value increases or decreases as the investors buy or sell shares. 

    For instance, if the demand for a stock exceeds its supply, the market price will rise. While, if the investors start selling a stock rapidly, the price will fall. The primary goal of market value is to decide an asset’s worth in both liquid and illiquid markets. 

    Some factors that affect the market value of a stock are:

    • Market perception
    • Economic conditions
    • Government policies/actions
    • Natural causes
    • International transactions

    When the market price rises, we typically refer to it as a bullish stance, while if it is opposite, we call it a bearish stance.

    Understanding the notional and market values with examples

    Let’s look at some examples to understand both these values in a better way. 

    Notional Value

    Equity contract A consists of 200 underlying shares, which means upon completion of the contract, the trader would get access to these shares. The option currently costs Rs. 5, and the spot price is Rs. 25. 

    The cost of buying the contract for the trader is 5 x 200 = 1000.

    The notional value for derivatives contracts will be:

    Notional value = Total underlying shares x Spot price

                           = 200 x 25

                           = 5000

    So, the trader would receive the right to buy 200 shares for Rs. 1000 instead of Rs. 5000. 

    Notional value here helps in finding the actual worth of the contact. 

    Market Value

    Suppose the company ABC has 6,00,000 shares in circulation in the market, and the price of each share is Rs. 1000. The market value of these shares would be:

    Market value = Total outstanding shares x Current price of a share

                          = 6,00,000 x 1000

                          = 60,00,00,000

    Thus, the market value or market cap of the company ABC is Rs. 60,00,00,000.

    How are notional and market values used in practice?

    Some of the most common uses of notional value are in interest rate swaps, equity options, foreign currency exchange, total return swaps, foreign currency derivatives, and ETFs (Exchange-traded funds). It helps traders and investors make important decisions related to their deals to gain the upper hand. 

    Market value is an important term because it helps in assessing the price that investors are willing to pay for a stock. It shows the worth of stock in the market and the buyer’s and seller’s perceptions of it. Companies, as well as investors, can understand whether the stocks are currently undervalued or overvalued and, if they are, how much the difference is. This is a very important piece of information for making investment decisions.

    Notional value is quoted for derivatives mainly, while market value is the current price at which a share or security can be bought or sold in the open market. 

    Basic differences between notional and market value

    The differences between these two important values that investors should know are as below.

    Notional Value

    Market Value

    Notional value is the aggregate value of the underlying assets in a derivative contract. For example, in an equity contract, the underlying value of assets is the notional value.  

    Market value is the current trading price of a security. It is often decided based on the equation of demand and supply of this security. For example, if the demand for Reliance’s share is high, its market price will increase. 

    Notional value is most likely to be fixed, especially in the cases of interest rate swaps.

    This value is volatile in nature and is affected by several factors, including the market forces of demand and supply and investor sentiments. 

    It highlights the total value of assets and is often used for swaps, futures, or equity options. 

    It highlights the value of the stock at a particular time in the market. It can also be defined as the market capitalization value.

    Conclusion

    Notional and market value — both indicate different values that investors should know before starting their investment journey. The difference between these values is simple. The notional value defines the value of derivatives in a transaction. On the other hand, market value defines the price of a company’s stock as being traded in the market. They both have their importance and are used frequently by businesses and investors in the finance world.