BASICS Meaning of Accounting: According to American Accounting Association Accounting
is “the process of identifying, measuring and communicating information to permit judgment and decisions by the users of accounts”. account s”. Users of Accounts: Generally 2 types. 1. Internal management.
2. Eternal users or !utsiders" In#estors, Employees, $enders, %ustomers, Go#ernment and other agencies, &ublic. Sub-fields of Accounting: Book-keeping: It co#ers procedural aspects of accounting 'or( and embraces
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record (eeping function. Financial accounting: It co#ers the preparation and interpretation of financial statements. Management Management accounting: It co#ers the generation of accounting information for management decisions. co#ers rs the acco account untin ing g of soci social al cost costs s Social Social responsib responsibility ility accountin accounting: g: It co#e incurred by the enterprise.
Fundamental Accounting equation:
Assets ) %apital* $iabilities. %apital ) Assets " $iabilities. element ents s dire directl ctly y relat related ed to the the meas measur urem ement ent of Accountin Accounting g elements elements:: +he elem financial position i.e., for the preparation of balance sheet are Assets, $iabilities and Euity. +he elements directly related to the measurements of performance in the profit - loss account are income and epenses. Four pases of accounting process: • • • •
ournalisation of transactions $edger positioning and balancing &reparation of trail balance &reparation of final accounts.
Book keeping: It is an acti#ity, related to the recording of financial data, relating to
busines business s operati operations ons in an orderl orderly y manner manner.. +he main main purpose purpose of accoun accountin ting g for business is to as certain profit or loss for the accounting period. Accounting: It is an acti#ity of analasis and interpretation of the boo("(eeping records. !ournal: /ecording each transaction of the business. "edger: It is a boo( 'here similar transactions relating to a person or thing are
recorded. #ypes: 0ebtors ledger %reditors ledger General ledger • • •
%oncept epts s are nece necess ssary ary assu assump mpti tions ons and condi conditi tion ons s upon upon 'hic 'hich h Conc Concep epts ts:: %onc accounting is based. Business entity concept: In accounting, business is treated as separate entity from its o'ners.hile recording the transactions in boo(s, it should be noted that business
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and o'ners are separate entities.In the transactions of business, personal transactions of the o'ners should not be mied. 3or eample4 " Insurance premium of the o'ner etc... •
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$oing concern concept: Accounts are recorded and assumed that the business
'ill continue for a long time. It is useful for assessment of good'ill. Consistency concept: It means that same accounting policies are follo'ed from one period to another. Accrual concept: It means that financial statements are prepared on merchantile system only.
#ypes of Accounts: 5asically accounts are three types, %ersonal account: Accounts 'hich sho' transactions 'ith persons are called
personal account. It includes accounts in the name of persons, firms, companies. In this4 0ebit the reci#er %redit the gi#er. 3or eample4 " 6aresh a7c, 6aresh-co a7c etc8 &eal account: Accounts relating to assets is (no'n as real accounts. A separate account is maintained for each asset o'ned by the business. In this4 0ebit 'hat comes in %redit 'hat goes out 3or eample4 " %ash a7c, 9achinary a7c etc8 'ominal account: Accounts relating to epenses, losses, incomes and gains are (no'n as nominal account. In this4 0ebit epenses and loses %redit incomes and gains 3or eample4 " ages a7c, :alaries a7c, commission reci#ed a 7c, etc. • •
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Accounting con(entions: +he term con#ention denotes customs or traditions 'hich
guide the accountant 'hile preparing the accounting statements. Con(ention of consistency: Accounting rules, practices should not change from one year to another. 3or eample4 " If 0epreciation on fied assets is pro#ided on straight line method. It should be done year after year. Con(ention of Full disclosure: All accounting statements should be honestly
prepared and full disclosure of all important information should be made. All information 'hich is important to assets, creditors, in#estors should be disclosued in account statements. #rail Balance: A trail balance is a list of all the balances standing on the ledger
accounts and cash boo( of a concern at any gi#en date.+he purpose of the trail balance is to establish accuracy of the boo(s of accounts. #rading a7c: +he first step of the preparation of final account is the preparation of trading account. It is prepared to (no' the gross margin or trading results of the business. %rofit or loss a)c: It is prepared to (no' the net profit. +he ependiture recording in this a7c is indirect nature. Balance seet: It is a statement prepared 'ith a #ie' to measure the eact financial position of the firm or business on a fied date.
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*utstanding +,penses: +hese epenses are related to the current year but they
are not yet paid before the last date of the financial year. %repaid +,penses: +here are se#eral items of epenses 'hich are paid in ad#ance in the normal course of business operations. Income and e,penditure a)c: In this only the current period incomes and ependitures are ta(en into consideration 'hile preparing this a7c. &oyalty: It is a periodical payment based on the output or sales for use of a certain asset. 3or eample4 " 9ines, %opyrights, &atent. irepurcase: It is an agreement bet'een t'o parties. +he buyer acuires
possession of the goods immediately and agrees to pay the total hire purchase price in instalments. ;ire purchase price ) %ash price * Interest. "ease4 A contractual arrangement 'hereby the lessor grants the lessee the right to use an asset in return for periodic lease rental payments. .ouble entry: E#ery transaction consists of t'o aspects +he rece#ing aspect +he gi#ing aspect +he recording of t'o aspect effort of each transaction is called
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"ongterm "iabilities: +hese liabilities 'hich are not payable 'ith in the net
accounting period but 'ill be payable 'ith in net = to 1> years are called longterm liabilities. E4 0ebentures. Current "iabilities: +hese liabilities 'hich are payable out of current assets 'ith in the accounting period. E4 %reditors, bills payable, etc8 Contingent "iabilities: A contingent liability is one, 'hich is not an actual liability but 'hich 'ill become an actual one on the happening of some e#ent 'hich is uncertain. +hese are staded on balance sheet by 'ay of a note. E4 %laims against company, $iability of a case pending in the court. Bad .ebts: :ome of the debtors do not pay their debts. :uch debt if unreco#erable is called bad debt. 5ad debt is a business epense and it is debited to &-$ account. Capital $ains)losses: Gains7losses arising from the sale of assets. Fi,ed Cost: +hese are the costs 'hich remains constant at all le#els of production. +hey do not tend to increase or decrease 'ith the changes in #olume of production. /ariable Cost: +hese costs tend to #ary 'ith the #olume of output. Any increase in the #olume of production results in an increase in the #ariable cost and #ice"#ersa. Semi-/ariable Cost: +hese costs are partly fied and partly #ariable in relation to output. Absorption Costing: It is the practice of charging all costs, both #ariable and fied to operations, processess or products. +his differs from marginal costing 'here fied costs are ecluded. *perating Costing: It is used in the case of concerns rendering ser#ices li(e transport. E4 :upply of 'ater, retail trade, etc... Costing: %ost accounting is the recording classifying the ependiture for the
determination of the costs of products.3or thepurpuses of control of the costs. &ectification of +rrors: Errors that occur 'hile preparing accounting statements are rectified by replacing it by the correct one. Errors li(e4 Errors of posting, Errors of accounting etc8 Absorbtion: hen a company purchases the business of another eisting company that is called absorbtion. Mergers: A merger refers to a combination of t'o or more companies into one company. /ariance Analasys: +he de#iations bet'een standard costs, profits or sales and actual costs. &rofits or sales are (no'n as #ariances. +ypes of #ariances 9aterial ?ariances $abour ?ariances %ost ?ariances :ales or &rofit?ariances • • • • •
$eneral &eser(es: +hese reser#es 'hich are not created for any specific purpose
and are a#ailable for any future contingency or epansion of the business. Specific&eser(es: +hese reser#es 'hich are created for a specific purpose and can
be utili@ed only for that purpose. E4 0i#idend Euilisation /eser#e 0ebenture /edemption /eser#e %ro(isions: +here are many ris(s and uncertainities in business. In order to protect
from ris(s and uncertainities, it is necessary to pro#isions and reser#es in e#ery business.
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&eser(e: /eser#es are amounts appropriated out of profits 'hich are not intended to
meet any liability, contingency, commitment in the #alue of assets (no'n to eist at the date of the 57:. %reation of the reser#e is to increase the 'or(ingcapital in the business and strengthen its financial position. :ome times it is in#ested to purchase out side securities then it is called reser#e fund. #ypes: Capital &eser(e: It is created out of capital profits li(e premium on the issue of shares, profits and sale of assets, etc8+his reser#e is not a#ailable to distribute as di#idend among shareholders. &e(enue &eser(e: Any /eser#e 'hich is a#ailable for distribution as di#idend to the shareholders is called /e#enue /eser#e. •
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%ro(isions /)S &eser(es: •
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&ro#isions are created for some specific object and it must be utilised for that object for 'hich it is created. /eser#e is created for any future liability or loss. &ro#ision is made because of legal necessity but creating a /eser#e is a matter of financial strength. &ro#ision must be charged to profit and loss a7c before calculating the net profit or loss but /eser#e can be made only 'hen there is profit. &ro#isions reduce the net profit and are not in#ested in outside securities /eser#e amount can in#ested in outside securities.
$ood0ill: It is the #alue of repetition of a firm in respect of the profits epected in
future o#er and abo#e the normal profits earned by other similar firms belonging to the same industry. Metods: A#erage profits method :uper profits method %apitalisatioin method • • •
.epreciation: It is a perminant continuing and gradual shrin(age in the boo( #alue of
a fied asset. Metods: Fi,ed Instalment metod or Strigt line metod 0ep. ) %ost price :crap #alue7Estimated life of asset. .iminising Balance metod: Bnder this metod, depreciation is calculated at a certain percentage each year on the balance of the asset, 'hich is bought for'ard from the pre#ious year. Annuity metod: Bnder this method amount spent on the purchase of an asset is regarded as an in#estment 'hich is assumed to earn interest at a certain rate. E#ery year the asset a7c is debited 'ith the amount of interest and credited 'ith the amount of depreciation. +*1: +he uantity of material to be ordered at one time is (no'n E!C. It is fied 'here minimum cost of ordering and carryiny stoc(. 2ey Factor: +he factor 'hich sets a limit to the acti#ity is (no'n as (ey factor 'hich influence budgets. Dey 3actor ) %ontribution7&rofitability &rofitability )%ontribution7Dey 3actor Sinking Fund: It is created to ha#e ready money after a particular period either for the replacement of an asset or for the repayment of a liability. E#ery year some amount is charged from the &-$ a7c and is in#ested in outside securities 'ith the
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idea, that at the end of the stipulated period, money 'ill be eual to the amount of an asset. &e(aluation Account: It records the effect of re#aluation of assets and liabilities. It is prepared to determine the net profit or loss on re#aluation. It is prepared at the time of reconsititution of partnership or retirement or death of partner. &ealisation Account: It records the realisation of #arious assets and payments of #arious liabilities. It is prepared to determine the net &-$ on realisation. "e(erage: - It arises from the presence of fied cost in a firm capitalstructure. Generally le#erage refers to a relationship bet'een t'o interrelated #ariables. +hese le#erages are classified into three types. !perating le#erage 3inancial $e#erage. %ombined le#erage or total le#erage. • • •
*perating "e(erage4 It arises from fied operating costs fied costs other than the
financing costsF such as depreciation, shares, ad#ertising ependitures and property taes. hen a firm has fied operatingcosts, a change in 1 in sales results in a change of more than 1 in E5I+ 3cange in +BI# 3 cange in sales +he operaying le#erage at any le#el of sales is called degree. 0egree of operating$e#erage) %ontribution7E5I+ Significance4 It tells the impact of changes in sales on operating income.
If operating le#erage is high it automatically means that the brea(" e#en point 'ould also be reached at a highle#el of sales. Financial "e(erage: It arises from the use of fied financing costs such as interest.
hen a firm has fied cost financing. A change in 1 in E.5.I.+ results in a change of more than 1 in earnings per share. F4" 53 cange in +%S ) 3 cange in +BI# .egree of Financial le(erage5 +BI#) %rofit before #a, 6+B#7 Significance: It is double edged s'ord. A high 3.$ means high fied financial costs and high financial ris(s. Combined "e(erage: It is useful for to (no' about the o#erall ris( or total ris( of the
firm. i.e, operating ris( as 'ell as financial ris(. C4"5 *4"8F4" 5 3Cange in +%S ) 3 Cange in Sales .egree of C4" 5Contribution ) +B# A high !.$ and a high 3.$ combination is #ery ris(y. A high !.$ and a lo' 3.$ indiacate that the management is careful since the higher amount of ris( in#ol#ed in high operating le#erage has been sought to be balanced by lo' 3.$ A more preferable situation 'ould be to ha#e a lo' !.$ and a 3.$. 9orking Capital: +here are t'o types of 'or(ing capital4 gross 'or(ing capital and
net 'or(ing capital. Gross 'or(ing capital is the total of current assets. 6et 'or(ing capital is the difference bet'een the total of current assets and the total of current liabilities.
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9orking Capital Cycle: It refers to the length of time bet'een the firms paying cash
for materials, etc.., entering into the production process7 stoc( and the inflo' of cash from debtors salesF %ash
/a' meterials $abour o#erhead
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0ebtors
Capital Budgeting: &rocess of analy@ing, appraising, deciding in#estment on long
term projects is (no'n as capital budgeting. Metods of Capital Budgeting: 4
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#raditional Metods
&aybac( period method A#erage rate of return A//F .iscounted Cas Flo0 Metods or Sopisticated metods 6et present #alue 6&?F Internal rate of return I//F &rofitability inde
%ay back period: /euired time to reach actual in#estment is (no'n as paybac(
period. 5 In(estment ) Cas flo0 A&&: It means the a#erage annual yield on the project. 5 a(g4 income ) a(g4 in(estment *r 5 6Sum of income ) no4 of years7 ) 6#otal in(estment < Scrap (alue7 ) ;7 '%/: +he best method for the e#aluation of an in#estment proposal is the 6&? or
discounted cash flo' techniue. +his metod ta(es into account the time #alue of money. +he sum of the present #alues of all the cash inflo's less the sum of the present #alue of all the cash outflo's associated 'ith the proposal. '%/ 5 Sum of present (alue of future cas flo0s = In(estment I&&: It is that rate at 'hich the sum total of cash inflo's aftrer discounting euals to the discounted cash outflo's. +he internal rate of return of a project is the discount rate 'hich ma(es net present #alue of the project eual to @ero. %rofitability Inde,: !ne of the methods comparing such proposals is to 'or(out
'hat is (no'n as the <0esirability 3actor or <&rofitability Inde. In general terms a project is acceptable if its profitability inde #alue is greater than 1. .eri(ati(es4 A deri#ati#e is a security 'hose price ultimately depends on that of
another asset. 0eri#ati#e means a contact of an agreement. +ypes of 0eri#ati#es4 3or'ard %ontracts 3utures !ptions :'aps. • • • •
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For0ard Contracts4 " It is a pri#ate contract bet'een t'o parties. An agreement
bet'een t'o parties to echange an asset for a price that is specified todays. +hese are settled at end of contract. Future contracts4 " It is an Agreement to buy or sell an asset it is at a certain time in the future for a certain price. 3utures 'ill be traded in echanges only.+hese is settled daily. 3utures are four types4 %ommodity 3utures4 heat, :oyo, +ea, %orn etc..,. 3inancial 3utures4 +reasury bills, 0ebentures, Euity :hares, bond s, etc.., %urrency 3utures4 9ajor con#ertible %urrencies li(e 0ollars, 3ounds, Hens, and Euros. Inde 3utures4 Bnderline assets are famous stoc( mar(et indicies. 6e'Hor( :toc( Echange. • • •
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*ptions: •
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An option gi#es its !'ner the right to buy or sell an Bnderlying asset on or before a gi#en date at a fied price. +here can be as may different option contracts as the number of items to buy or sell they are, :toc( options, %ommodity options, 3oreign echange options and interest rate options are traded on and off organi@ed echanges across the globe. !ptions belong to a broader class of assets called %ontingent claims. +he option to buy is a call option.+he option to sell is a &ut!ption. +he option holder is the buyer of the option and the option 'riter is the seller of the option. +he fied price at 'hich the option holder can buy or sell the underlying asset is called the eercise price or :tri(ing price. A European option can be ecercised only on the epiration date 'here as an American option can be ecercised on or before the e piration date. !ptions traded on an echange are called echange traded option and options not traded on an echange are called o#er"the"counter optios. hen stoc( price :1F ) Eercise price E1F the call is said to be out of money and is 'orthless. hen :1JE1 the call is said to be in the money and its #alue is :1"E1.
:'aps are pri#ate agreements bet'een t'o companies to echange casflo's in the future according to a prearranged formula. :o this can be regarded as portfolios of for'ard contracts. +ypes of s'aps4 Interest rate :'aps %urrency :'aps. S0aps:
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Interest rate S0aps: +he most common type of interest rate s'ap is <&lain ?enilla <.
6ormal life of s'ap is 2 to 1= Hears. It is a transaction in#ol#ing an echange of one stream of interest obligations for another. +ypically, it results in an echange of ficed rate interest payments for floating rate interest payments. Currency S0aps: - Another type of :'ap is (no'n as %urrency as %urrency :'ap. +his in#ol#es echanging principal amount and fied rates interest payments on a loan in one currency for principal and fied rate interest payments on an approimately eualant loan in another currency. $i(e interest rate s'aps currency s'ars can be moti#ated by comparati#e ad#antage.
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9arrants: !ptions generally ha#e li#es of upto one year. +he majority of options
traded on echanges ha#e maimum maturity of nine months. $onger dated options are called 'arrants and are generally traded o#er" the" counter. American .epository &eceipts 6A.&7: It is a dollar denominated negotiable instruments or certificate. It represents non"B: companies publicly traded euity. It 'as de#ised into late 1K2>s. +o help American in#estors to in#est in o#erseas securities and to assist non B: companies 'ishing to ha#e their stoc( traded in the American mar(ets. +hese are listed in American stoc( mar(et or echanges. $lobal .epository&eceipts 6$.&7: G0/s are essentially those instruments 'hich posseses the certain number of underline shares in the custodial domestic ban( of the company i.e., G0/ is a negotiable instrument in the form of depository receipt or certificate created by the o#erseas depository ban( out side India and issued to non" resident in#estors against the issue of ordinary share or foreign currency con#ertible bonds of the issuing company. G0/s are entitled to di#idends and #oting rights since the date of its issue. Capital account and Current account: +he capital account of international purchase or sale of assets. +he assets include any form 'hich 'ealth may be held. 9oney held as cash or in the form of ban( deposits, shares, debentures, debt instruments, real estate, land, antiues, etc8 +he current account records all income related flo's. +hese flo's could arise on account of trade in goods and ser#ices and transfer payment among countries. A net outflo' after ta(ing all entries in current account is a current account deficit. Go#t. ependiture and ta re#enues do not fall in the current account. .i(idend >ield: It gi#es the relationship bet'een the current price of a stoc( and the di#idend paid by its issuing company during the last 12 months. It is caliculated by aggregating past years di#idend and di#iding it by the current stoc( price. ;istorically, a higher di#idend yield has been considered to be desirable among in#estors. A high di#idend yield is considered to be e#idence that a stoc( is under priced, 'here as a lo' di#idend yield is considered e#idence that a stoc( is o#er priced. Bridge Financing: It refers to loans ta(en by a company normally from commercial ban(s for a short period, pending disbursement of loans sanctioned by financial institutions. Generally, the rate of interest on bridge finance is higher as compared 'ith term loans. Sares and Mutual Funds Company: :ec.L 1F of the %ompanys act, 1K=M defines a
means a company formed and registered under this Act or eisting company”. %ublic Company4 A corporate body other than a pri#ate company. In the public company, there is no upperlimit on the number of share holders and no restriction on transfer of shares. %ri(ate Company4 A corporate entity in 'hich limits the number of its members to =>. 0oes not in#ite public to subscribe to its capital and restricts the members right to transfer shares. "iquidity: A firms liuidity refers to its ability to meet its obligations in the short run. An assets liuidity refers to ho' uic(ly it can he sold at a reasonable price. Cost of Capital: +he minimum rate of the firm must earn on its in#estments in order to satisfy the epectations of in#estors 'ho pro#ide the funds to the firm. %apital :tructure4 +he composition of a firms financing consisting of euity, preference, and debt. Annual &eport: +he report issued annually by a company to its shareholders. It primarily contains financial statements. In addition, it represents the managements #ie' of the operations of the pre#ious year and the prospects for future. %ro,y: +he authori@ation gi#en by one person to another to #ote on his behalf in the shareholders meeting.
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!oint /enture: It is a temporary partenership and comes to an end after the
compleation of a particular #enture. 6o limit in its. Insol(ency: In case a debtor is not in a position to pay his debts in full, a petition can be filled by the debtor himself or by any creditors to get the debtor declared as an insol#ent. "ong #erm .ebt: +he debt 'hich is payable after one year is (no'n as long term debt. Sort #erm .ebt: +he debt 'hich is payable 'ith in one year is (no'n as short term debt. Amortisation: +his term is used in t'o senses 1. /epayment of loan o#er a period of time 2.rite"off of an ependiture li(e issue cost of sharesF o#er a period of time. Arbitrage: A simultaneous purchase and sale of security or currency in different mar(ets to deri#e benefit from price differential. Stock: +he :toc( of a company 'hen fully paid they may be con#erted into stoc(. Sare %remium: Ecess of issue price o#er the face #alue is called as share premium. +quity Capital: It represents o'nership capital, as euity shareholders collecti#ely o'n the company. +hey enjoy the re'ards and bear the ris(s of o'nership. +hey 'ill ha#e the #oting rights. Autori?ed Capital4 +he amount of capital that a company can potentially issue, as per its memorandum, represents the authori@ed capital. Issued Capital: +he amount offered by the company to the in#estors. Subscribed capital4 +he part of issued capital 'hich has been subscribed to by the in#estors %aid-up Capital: +he actual amount paid up by the in#estors. +ypically the issued, subscribed, paid"up capitals are the same. %ar /alue4 +he par #alue of an euity share is the #alue stated in the memorandum and 'ritten on the share scrip. +he par #alue of euity share is generally /s.1> or /s.1>>. Issued price: It is the price at 'hich the euity share is issued often, the issue price is higher than the &ar ?alue Book /alue: +he boo( #alue of an euity share is ) &aid up euity %apital * /eser#e and :urplus 7 6o. !f outstanding shares euity Market /alue 6M4/7: +he 9ar(et ?alue of an euity share is the price at 'hich it is traded in the mar(et. %reference Capital 4 It represents a hybrid form of financing it par ta(es some
characteristics of euity and some attributes of debentures. It resembles euity in the follo'ing 'ays &reference di#idend is payable only out of distributable profits. &reference di#idend is not an obligatory payment. &reference di#idend is not a ta deductible payment. %reference capital is similar to debentures in se(eral 0ays4 +he di#idend rate of &reference %apital is fied. &reference %apital is redeemable in nature. &reference :hareholders do not normally enjoy the right to #ote. .ebenture: 3or large publicly traded firms. +hese are #iable alternati#e to term loans. :(in to promissory note, debentures is instruments for raising long term debt. 0ebenture holders are creditors of company. Stock Split: +he di#iding of a companys eisting stoc( into multiple stoc(s. hen the &ar ?alue of share is reduced and the number of share is increased. Calls-in-Arrears: It means that amount 'hich is not yet been paid by share holders till the last day for the payment. • • •
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Calls-in-ad(ance: hen a shareholder pays 'ith an instalment in respect of call yet
to ma(e the amount so recei#ed is (no'n as calls"in"ad#ance. %alls"in"ad#ance can be accepted by a company 'hen it is authori@ed by the articles. Forfeiture of sare: It means the cancellation or allotment of unpaid shareholders. 3orfeiture and reissue of shares allotted on pro rata basis in case of o#er subscription. %rospectus: In#iting of the public for subscribing on shares or debentures of the company. It is issued by the public companies. +he amount must be subscribed 'ith in 12> days from the date of prospects. Simple Interest: It is the interest paid only on the principal amount borro'ed. 6o interest is paid on the interest accured during the term of the loan. Compound Interest: It means that, the interest 'ill include interest caliculated on interest. #ime /alue of Money: 9oney has time #alue. A rupee today is more #aluable than a rupee a year hence. +he relation bet'een #alue of a rupee today and #alue of a rupee in future is (no'n as “+ime ?alue of 9oney”. 'A/: 6et Asset ?alue of the fund is the cumulati#e mar(et #alue of the fund net of its liabilities. 6A? per unit is simply the net #alue of assets di#ided by the number of units out standing. 5uying and :elling into funds is done on the basis of 6A? related prices. +he 6A? of a mutual fund are reuired to be published in ne's papers. +he 6A? of an open end scheme should be disclosed ona daily basis and the 6A? of a closed end scheme should be disclosed atleast on a 'ee(ly basis. Financial markets: +he financial mar(ets can broadly be di#ided into money and
capital mar(et. Money Market: 9oney mar(et is a mar(et for debt securities that pay off in the short term usually less than one year, for eample the mar(et for K>"days treasury bills. +his mar(et encompasses the trading and issuance of short term non euity debt instruments including treasury bills, commercial papers, ban(ers acceptance, certificates of deposits, etc. Capital Market: %apital mar(et is a mar(et for long"term debt and euity shares. In this mar(et, the capital funds comprising of both euity and debt are issued and traded. +his also includes pri#ate placement sources of debt and euity as 'ell as organi@ed mar(ets li(e stoc( echanges. %apital mar(et can be further di#ided into primary and secondary mar(ets. %rimary Market: It pro#ides the channel for sale of ne' securities. &rimary 9ar(et pro#ides opportunity to issuers of securitiesN Go#ernment as 'ell as corporate, to raise resources to meet their reuirements of in#estment and7or discharge some obligation. +hey may issue the securities at face #alue, or at a discount7premium and these securities may ta(e a #ariety of forms such as euity, debt etc. +hey may issue the securities in domestic mar(et and7or international mar(et. Secondary Market: It refers to a mar(et 'here securities are traded after being initially offered to the public in the primary mar(et and7or listed on the stoc( echange. 9ajority of the trading is done in the secondary mar(et. It comprises of euity mar(ets and the debt mar(ets. .ifference bet0een te primary market and te secondary market: In the primary mar(et, securities are offered to public for subscription for the purpose of raising capital or fund. :econdary mar(et is an euity trading a#enue in 'hich already eisting7pre" issued securities are traded amongst in#estors. :econdary mar(et could be either auction or dealer mar(et. hile stoc( echange is the part of an auction mar(et, !#er"the"%ounter !+%F is a part of the dealer mar(et. S+BI and its role: +he :E5I is the regulatory authority established under :ection L of :E5I Act 1KK2 to protect the interests of the in#estors in securities and to promote •
•
•
•
11
the de#elopment of, and to regulate, the securities mar(et and for matters connected there'ith and incidental thereto. %ortfolio: A portfolio is a combination of in#estment assets mied and matched for the purpose of in#estors goal. Market Capitalisation: +he mar(et #alue of a uoted company, 'hich is caliculated by multiplying its current share price mar(et priceF by the number of shares in issue, is called as mar(et capitali@ation. Book Building %rocess: It is basically a process used in I&!s for efficient price disco#ery. It is a mechanism 'here, during the period for 'hich the I&! is open, bids are collected from in#estors at #arious prices, 'hich are abo#e or eual to the floor price. +he offer price is determined after the bid closing date. Cut off %rice: In 5oo( building issue, the issuer is reuired to indicate either the price band or a floor price in the red herring prospectus. +he actual disco#ered issue price can be any price in the price band or any price abo#e the floor price. +his issue price is called “%ut off price”. +his is decided by the issuer and $9 after considering the boo( and in#estors appetite for the stoc(. :E5I 0I&F guidelines permit only retail indi#idual in#estors to ha#e an option of applying at cut off price. Bluecip Stock: :toc( of a recogni@ed, 'ell established and financially sound company. %enny Stock: &enny stoc(s are any stoc( that trades at #ery lo' prices, but subject to etremely high ris(. .ebentures: %ompanies raise substantial amount of longterm funds through the issue of debentures. +he amount to be raised by 'ay of loan from the public is di#ided into small units called debentures. 0ebenture may be defined as 'ritten instrument ac(no'ledging a debt issued under the seal of company containing pro#isions regarding the payment of interest, repayment of principal sum, and charge on the assets of the company etc8 "arge Cap ) Big Cap: %ompanies ha#ing a large mar(et capitali@ation 3or eample, In B: companies 'ith mar(et capitali@ation bet'een O1> billion and O2> billion, and in the Indian contet companies mar(et capitali@ation of abo#e /s. 1>>> crore are considered large caps. Mid Cap: %ompanies ha#ing a mid si@ed mar(et capitali@ation, for eample, In B: companies 'ith mar(et capitali@ation bet'een O2 billion and O1> billion, and in the Indian contet companies mar(et capitali@ation bet'een /s. =>> crore to /s. 1>>> crore are considered mid caps. Small Cap: /efers to stoc(s 'ith a relati#ely small mar(et capitali@ation, i.e. lessthan O2 billion in B: or lessthan /s.=>> crore in India. olding Company: A holding company is one 'hich controls one or more companies either by holding shares in that company or companies are ha#ing po'er to appoint the directors of those company. +he company controlled by holding company is (no'n as the Subsidary Company. Consolidated Balance Seet: It is the b7s of the holding company and its subsidiary company ta(en together. %artnersip act @;: &artnership means an association bet'een t'o or more persons 'ho agree to carry the business and to share profits and losses arising from it. 2> members in ordinary trade and 1> in ban(ing business I%*: 3irst time 'hen a company announces its shares to the public is called as an I&!. Intial &ublic !fferF A Furter public offering 6F%*7: It is 'hen an already listed company ma(es either a fresh issue of securities to the public or an offer for sale to the public, through an offer document. An offer for sale in such scenario is allo'ed only if it is made to satisfy listing or continuous listing obligations. &igts Issue 6&I7: It is 'hen a listed company 'hich proposes to issue fresh securities to its shareholders as on a record date. +he rights are normally offered in a particular ratio to the number of securities held prior to the issue.
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%referential Issue: It is an issue of shares or of con#ertible securities by listed
companies to a select group of persons under sec.P1 of the Indian companies act, 1K=M 'hich is neither a rights issue nor a public issue.+his is a faster 'ay for a company to raise euity capital. Inde,: An inde sho's ho' specified portfolios of share prices are mo#ing in order to gi#e an indication of mar(et trends. It is a bas(et of securities and the a#erage price mo#ement of the bas(et of securities indicates the inde mo#ement, 'hether up'ard or do'n'ards. .ematerialisation: It is the process by 'hich physical certificates of an in#estor are con#erted to an eui#alent number of securities in electronic form and credited to the in#estors account 'ith his depository participant. Bull and Bear Market: 5ull mar(et is 'here the prices go up and 5ear mar(et 'here the prices come do'n. +,cange &ate: It is a rate at 'hich the currencies are bought and sold. Fore,: +he 3oreign Echange 9ar(et is the place 'here currencies are traded. +he o#erall 3!/EQ mar(ets is the largest, most liuid mar(et in the 'orld 'ith an a#erage traded #alue that eceeds O 1.K trillion per day and includes all of the currencies in the 'orld.It is open 2R hours a day, fi#e days a 'ee(. Mutual Fund: A mutual fund is a pool of money, collected from in#estors, and in#ested according to certain in#estment objecti#es. Asset Management Company 6AMC7: A company set up under Indian companys act, 1K=M primarily for performing as the in#estment manager of mutual funds. It ma(es in#estment decisions and manages mutual funds in accordance 'ith the scheme objecti#es, deed of trust and pro#isions of the in#estment management agreement. Back-+nd "oad: A (ind of sales charge incurred 'hen in#estors redeem or sell shares of a fund. Front-+nd "oad: A (ind of sales charge that is paid before any amount gets in#ested into the mutual fund. *ff Sore Funds: +he funds setup abroad to channalise foreign in#estment in the domestic capital mar(ets. Under 9riter: +he organi@ation that acts as the distributor of mutual funds share to bro(er or dealers and in#estors. &egistrar: +he institution that maintains a registry of shareholders of a fund and their share o'nership. 6ormally the registrar also distributes di#idends and pro#ides periodic statements to shareholders. #rustee: A person or a group of persons ha#ing an o#erall super#isory authority o#er the fund managers. Bid 6or &edemption7 %rice: In ne'spaper listings, the pre"share price that a fund 'ill pay its shareholders 'hen they sell bac( shares of a fund, usually the same as the net asset #alue of the fund. Scemes according to Maturity %eriod: A mutual fund scheme can be classified into open"ended scheme or close"ended scheme depending on its maturity period. *pen-ended Fund) Sceme An open"ended fund or scheme is one that is a#ailable for subscription and repurchase on a continuous basis. +hese schemes do not ha#e a fied maturity period. In#estors can con#eniently buy and sell units at 6et Asset ?alue 6A?F related prices 'hich are declared on a daily basis. +he (ey feature of open"end schemes is liuidity. Close-ended Fund) Sceme A close"ended fund or scheme has a stipulated maturity period e.g. ="S years. +he fund is open for subscription only during a specified period at the time of launch of the scheme. In#estors can in#est in the scheme at the time of the initial public issue and thereafter they can buy or sell the units of the scheme on the stoc( echanges
13
'here the units are listed. In order to pro#ide an eit route to the in#estors, some close"ended funds gi#e an option of selling bac( the units to the mutual fund through periodic repurchase at 6A? related prices. :E5I /egulations stipulate that at least one of the t'o eit routes is pro#ided to the in#estor i.e. either repurchase facility or through listing on stoc( echanges. +hese mutual funds schemes disclose 6A? generally on 'ee(ly basis. Scemes according to In(estment *becti(e:
A scheme can also be classified as gro'th scheme, income scheme, or balanced scheme considering its in#estment objecti#e. :uch schemes may be open"ended or close"ended schemes as described earlier. :uch schemes may be classified mainly as follo's4 $ro0t ) +quity *riented Sceme +he aim of gro'th funds is to pro#ide capital appreciation o#er the medium to long" term. :uch schemes normally in#est a major part of their corpus in euities. :uch funds ha#e comparati#ely high ris(s. +hese schemes pro#ide different options to the in#estors li(e di#idend option, capital appreciation, etc. and the in#estors may choose an option depending on their preferences. +he in#estors must indicate the option in the application form. +he mutual funds also allo' the in#estors to change the options at a later date. Gro'th schemes are good for in#estors ha#ing a long"term outloo( see(ing appreciation o#er a period of time. Income ) .ebt *riented Sceme +he aim of income funds is to pro#ide regular and steady income to in#estors. :uch schemes generally in#est in fied income securities such as bonds, corporate debentures, Go#ernment securities and money mar(et instruments. :uch funds are less ris(y compared to euity schemes. +hese funds are not affected because of fluctuations in euity mar(ets. ;o'e#er, opportunities of capital appreciation are also limited in such funds. +he 6A?s of such funds are affected because of change in interest rates in the country. If the interest rates fall, 6A?s of such funds are li(ely to increase in the short run and #ice #ersa. ;o'e#er, long term in#estors may not bother about these fluctuations. Balanced Fund
+he aim of balanced funds is to pro#ide both gro'th and regular income as such schemes in#est both in euities and fied income securities in the proportion indicated in their offer documents. +hese are appropriate for in#estors loo(ing for moderate gro'th. +hey generally in#est R>"M> in euity and debt instruments. +hese funds are also affected because of fluctuations in share prices in the stoc( mar(ets. ;o'e#er, 6A?s of such funds are li(ely to be less #olatile compared to pure euity funds. Money Market or "iquid Fund +hese funds are also income funds and their aim is to pro#ide easy liuidity, preser#ation of capital and moderate income. +hese schemes in#est eclusi#ely in safer short"term instruments such as treasury bills, certificates of deposit, commercial paper and inter"ban( call money, go#ernment securities, etc. /eturns on these schemes fluctuate much less compared to other funds. +hese funds are appropriate for corporate and indi#idual in#estors as a means to par( their surplus funds for short periods. $ilt Fund +hese funds in#est eclusi#ely in go#ernment securities. Go#ernment securities ha#e no default ris(. 6A?s of these schemes also fluctuate due to change in interest rates and other economic factors as is the case 'ith income or debt oriented schemes. Inde, Funds Inde 3unds replicate the portfolio of a particular inde such as the 5:E :ensiti#e inde, :-& 6:E => inde 6iftyF, etc these schemes in#est in the securities in the
14
same 'eightage comprising of an inde. 6A?s of such schemes 'ould rise or fall in accordance 'ith the rise or fall in the inde, though not eactly by the same percentage due to some factors (no'n as Ttrac(ing errorT in technical terms. 6ecessary disclosures in this regard are made in the offer document of the mutual fund scheme. +here are also echange traded inde funds launched by the mutual funds 'hich are traded on the stoc( echanges. +arning per sare 6+%S7: It is a financial ratio that gi#es the information regarding earing a#ailable to each euity share. It is #ery important financial ratio for assessing the state of mar(et price of share. +he E&: statement is applicable to the enterprise 'hose euity shares are listed in stoc( echange. #ypes of +%S: • •
5asic E&: 'ith normal sharesF 0iluted E&: 'ith normal shares and con#ertible sharesF
+%S Statement:
:ales $ess4 #ariable cost $ess4 3ied cost
UUUU UUUU %ontribution UUU UUUU E5I+
$ess4 Interest E5+ $ess4 +a Earnimgs $ess4 preference di#idend Earnings a#ailable to euity :hare holders AF
UUUUU UUU UUUU UUUU UUUU UUUU UUUUU
E&:)A7 6o of outstanding :hares E5I+ and !perating Income are same +he higher the E&:, the better is the performance of the company. Cas Flo0 Statement: It is a statement 'hich sho's inflo's receiptsF and outflo's
paymentsF of cash and its eui#alents in an enterprise during a specified period of time. According to the re#ised accounting standard L, an enterprise prepares a cash flo' statement and should present it for each period for 'hich financial statements are presented. Funds Flo0 Statement: 3und means the net 'or(ing capital. 3unds flo' statement is a statement 'hich lists first all the sources of funds and then all the applications of funds that ha#e ta(en place in a business enterprise during the particular period of time for 'hich the statement has been prepared. +he statement finally sho's the net increase or net decrease in the 'or(ing capital that has ta(en place o#er the period of time. Float: +he difference bet'een the a#ailable balance and the ledger balance is referred to as the float. Collection Float: +he amount of cheue deposited by the firm in the ban( but not cleared. %ayment Float: +he amount of cheues issued by the firm but not paid for by the ban(.
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*perating Cycle: +he operating cycle of a firm begins 'ith the acuisition of ra'
material and ends 'ith the collection of recei#ables. Marginal Costing:
:ales ?arible%ost)3ied%ost V &rofit7$oss %ontribution) :ales ?arible%ost %ontribution) 3ied%ost V &rofit7$oss & 7 ? /atio) %ontribution 7 :alesFU1>> &er 1 unit information is gi#en, & 7 ? /atio ) %ontribution per Bnit 7 :ales per BnitFU1>> +'o years information is gi#en, & 7 ? /atio) %hange in &rofit 7 %hange in :alesF U 1>> +hrough :ales, & 7 ? /atio %ontribution ):ales U & 7 # /atio +hrough & 7 ? /atio, %ontribution :ales ) %ontribution 7 & 7 ?/atio Break +(en %oint 6B4+4%7
I6 ?alue ) 3ied %ostF 7 & 7 # /atioF !/ 3ied %ost 7 %ontributionF U :ales In Bnits ) 3ied %ost 7 %ontribution !/ 3ied %ost 7 :ales&rice per Bnit ?.% per BnitF Margin of Safety ) +otal :ales :ales at 5.E.& !/F &rofit 7 &? /atio Sales at desired profit 6in units7 ) 3ied%ost* 0esired&rofit 7 %ontribution per Bnit Sales at desired profit 6in /alue7 5 3ied%ost* 0esired&rofit 7 &? ratio !/F %ontribution 7 &? /atio &A#I* A'A">SIS:
A ratio analysis is a mathematical epression. It is the uantitati#e relation bet'een t'o. It is the techniue of interpretation of financial statements 'ith the help of meaningful ratios. /atios may be used for comparison in any of the follo'ing 'ays. %omparison of a firm its o'n performance in the past. %omparison of a firm 'ith the another firm in the industry %omparison of a firm 'ith the industry as a 'hole #ypes *f &atios $iuidity ratio Acti#ity ratio $e#erage ratio profitability ratio • • •
• • • •
4 "iquidity ratio: +hese are ratios 'hich measure the short term financial position
of a firm. i4 Current &atio: It is also called as 'or(ing capital ratio. +he current ratio measures the ability of the firm to meet its currnt liabilities"current assets get con#erted into cash during the operating cycle of the firm and pro#ide the funds needed to pay current liabilities. i.e %urrent assets %urrent liabilities Ideal ratio is 241 ii4 1uick or Acid test &atio: It tells about the firms liuidity position. It is a fairly
stringent measure of liuidity. )Cuic( assets7%urrent $iabilities
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Ideal ratio is 141 Cuic( Assets )%urrent Assets :toc( " &repaid Epenses iii4 Absolute "iquid &atio: A.$.A7%.$ A$ assets)%ash * 5an( * 9ar(etable :ecurities. ;4 Acti(ity &atios or Current Assets management or +fficiency &atios: +hese ratios measure the efficiency or effecti#eness of the firm in managing its resources or assets :toc( or In#entory +urno#er /atio4 It indicates the number of times the stoc( has turned o#er into sales in a year. A stoc( turn o#er ratio of
sol#ency position of the company. 0ebt Euity /atio4 +he debt"euity ratio sho's the relati#e contributions of creditors and o'ners. ) outsiders fund7:hare holders fund Ideal ratios 241 &roprietary ratio or Euity ratio4 It epresses the relationship bet'een net'orth and total assets. A high proprietary ratio is indicati#eof strong financial position of the business. ):hare holders funds7+otal Assets ) Euity %apital *&reference capital */eser#es 3ictitious assetsF 7 +otal Assets 3ied Assets to net 'orth /atio4 +his ratio indicates the mode of financing the fied assets. +he ideal ratio is >.MS )3ied Assets After 0epreciation.F7:hareholder 3und
4 %rofitability &atios: &rofitability ratios measure the profitability of a concern
generally. +hey are calculated either in relation to sales or in relation to in#estment. /eturn on %apital Employed or /eturn on In#estment /!IF4 +his ratio re#eals the earning capacity of the capital employed in the business. )&5I+ 7%apital Employed /eturn on &roprietors 3und 7 Earning /atio4 Earn on 6et orth )6et &rofit After taF7&roprietors 3und /eturn on !rdinary shareholders Euity or /eturn on Euity %apital4 It epresses the return earned by the euity shareholders on their in#estment.
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)6et &rofit after ta and 0i#idend 7 &roprietors fund or &aid up euity %apital &rice Earning /atio4 It epresses the relationship bet'een mar(etprice of share on a company and the earnings per share of that company. )9&: 9ar(et &rice per :hareF 7 E&: Earning &rice /atio7 Earning Hield4 ) E&: 7 9&: E&:) 6et &rofit After ta and InterestF 7 6o. !f !utstanding :hares. 0i#idend Hield ratio4 It epresses the relationship bet'een di#idend earned per share to earnings per share. ) 0i#idend per share 0&:F 7 9ar(et #alue per share 0i#idend pay"out ratio4 It is the ratio of di#idend per share to earning per share. ) 0&: 7 E&: 0&:4 It is the amount of the di#idend payable to the holder of one euity share. )0i#idend paid to ordinary shareholders 7 6o. of ordinary shares %.G.:):ales" G.& G.&) :ales %.G.: G.&./atio )G.&76et salesU1>> 6et :ales) Gross :ales /eturn in'ard" %ash discount allo'ed 6et profit ratio)6et &rofit7 6et :alesU1>> !perating &rofit ratio)!.&76et :alesU1>> Interest %o#erage /atio) 6et &rofit 5efore +a - InterestF 7 3ied Interest %lasses &eturn on In(estment 6&*I7: It re#eals the earning capacity of the capital
employed in the business. It is calculated as, E5I+7%apital employed. +he return on capital employed should be more than the cost of capital employed. %apital employed )Euity%apital*&reference sharecapital*/eser#es*$ongterm loans and 0ebentures " 3ictitious Assets 6on !peratingAssets
18
