Tag: Business economics

1. Estimates and Actuals:

The cost can be computed either on actual or estimated basis. Since cost accounts are meant to function as a control device it will be appropriate to adopt estimated costing or preferably standard costing system while preparing cost accounts. Estimates or standards can be nearer to the actuals but in most cases, they cannot be the same. This necessarily means that the profit shown by the cost accounts is bound to be different from the profit shown by the financial accounts.

Following are some of the important items the costs of which may be different in financial books and costing books:

(a) Direct Materials:

The estimated or standard cost of the direct materials purchased or consumed in the production process may be different from the actual costs. This difference will be due to change in price or quantity or both.

(b) Direct Labour:

The estimated or standard cost of direct labour may be different from the actual costs because of differences in wage rates or hours of work or both. Sometimes, workers might have to be paid more due to increased dearness allowance, pay revision, bonus etc. This will cause difference between the profits shown by the two sets of books.

(c) Overheads:

In cost accounts the recovery of overheads is generally based on estimates while in financial accounts the actual expenses incurred are recorded. This results in under-or over-recovery of overheads.

The under-recovery or over-recovery of overheads may be carried forward to the next period or may be charged by a supplementary rate (positive or negative) or transferred to costing Profit and Loss Account. In case the under-recovery or over-recovery of overheads has been carried forward to the next period, the profit as shown by the costing books will be different from the profit as shown by the financial books. Such variation may be due to over-or-under charging of factory, office or selling and distribution overheads.

(d) Depreciation:

Different methods of charging depreciation may be adopted in cost and financial books. In financial books depreciation may be charged according to fixed installment method or diminishing balance method etc. while in cost accounts machine hour rate or any other method may be used. This is also an item of overheads and may be one of the reasons of difference between the overheads charged in financial accounts and overheads charged in cost accounts.

Abnormal Gains and Losses:

Abnormal gains or losses may completely be excluded from cost accounts or may be taken to costing profit and loss account. In financial accounts such gains and losses are taken to profit and loss account. As such, in the former case costing profit/loss will differ from financial profit/loss and adjustment will be required. In the latter case, there will be no difference on this account between costing profit or loss and financial profit or loss.

Therefore, no adjustment will be required on this account. Examples of such abnormal gains and losses are abnormal wastage of materials e.g., by theft or fire etc., cost of abnormal idle time, cost of abnormal idle facilities, exceptional bad debts, abnormal gain in manufacturing through processes (when actual production exceeds normal production).

The need for reconciliation will not arise in case of a business where Integral or Integrated Accounting System is in use as there will be only one set of books both for financial and costing records. But where there are separate sets of books, reconciliation is imperative.

2. Items Included in Cost Accounts Only:

There are certain notional items which are excluded from the financial accounts but are charged in the cost accounts:

(i) Charge in lieu of rent where premises are owned.

(ii) Depreciation on an asset even when the book value of the asset is reduced to a negligible figure.

(iii) Interest on capital employed in production but upon which no interest is actually paid (this will be the case when the firm decides to include interest in the overheads).

The above items will reduce the profits in Cost Accounts as compared to that in Financial Accounts.

3. Items Included in Financial Accounts Only:

There are certain items which are included in the Financial Accounts but not in the Cost Accounts.

These include the following:

(a) Appropriation of profits e.g., provision for taxation, transfer to reserves, goodwill, preliminary expenses written off.

(b) Purely financial charges e.g., losses on sale of investments; penalties and fines, expenses on transfer of company’s office.

(c) Purely financial incomes e.g., interest received on bank deposits, profits made on the sale of investments, fixed assets, transfer fees received etc.

4. Valuation of Stocks:

(a) Raw materials: In financial accounts stock of raw materials is valued at cost or market price, whichever is less, while in cost accounts stock can be valued on the basis of FIFO or LIFO or any other method. Thus, the figure of stock may be inflated in cost or financial accounts.

(b) Work-in-progress: Difference may also exist regarding mode of valuation of work-in-progress. It may be valued at prime cost or factory cost or cost of production. The most appropriate mode of valuation is at factory cost in cost accounts. In financial accounts work-in-progress may be valued after considering a part of administrative expenses also.

(c) Finished goods: Under financial accounts, stock of finished goods is valued at cost or market price whichever is lower. In cost accounts, finished stock is generally valued at total cost of production. If the circumstances warrant, prime cost or factory cost may also be taken as the basis for valuing the stock of finished goods.

Thus, mode of valuation of stocks gives rise to different results in the two sets of books. Greater valuation of opening stocks in cost accounts means less profit as per cost accounts and vice versa. Greater valuation of closing stocks in cost accounts means more profit as per cost accounts and vice versa.

1. Stores Ledger:

Stores department will maintain a record called ‘stores ledger’ in which a separate folio is kept for each individual item of stock. It records not only the quantity details of stock movements but also record the rates and values of stock movements.

With the information available in the store’s ledger, it is easier to ascertain the value of any stock item at any point of time. The minimum, maximum and reorder levels of stock are also mentioned for taking action to replenish the stock position.

2. Bin Card:

A ‘bin card’ indicates the level of each particular item of stock at any point of time. It is attached to the concerned bin, rack or place where the raw material is stored. It records all the receipts of a particular item of materials and its issues. It gives all the basic information relating to physical movements. It is a record of receipts, issues and balance of the quantity of an item of stock handled by a store.

3. Material Return Note:

If materials received from the stores are not of suitable quality or if there is surplus material remaining with the department, they are returned to stores with a note called ‘material return note’ evidencing return of material from department to stores.

4. Material Transfer Note:

If materials are transferred from one department or job to another within the organization, then material transfer note should be raised. It is a record of the transfer of materials between stores, cost centres or cost units showing all data for making necessary accounting entries.

5. Stores Requisition Note:

It is also called ‘materials requisition note’. When Production or other departments requires material from the stores it raises a requisition, which is an order on the stores for the material required for execution of the work order. This note is signed by the department in-charge of the concerned department. It is documents which authorize the issue of a specified quantity of materials.

6. Goods Received Note (GRN):

Once the inspection is completed, GRN is prepared by the stores department, and copies of GRN is sent to the purchasing department, costing department, accounts department and production department, which initiated purchase requisition.

7. Material Inspection Note:

When materials are delivered, a supplier’s carrier will usually provide a document called ‘delivery note’ or ‘delivery advice’ to confirm the details of materials delivered. When materials are unloaded, the warehouse staff check the material unloaded with the delivery note. Then the warehouse staff prepares a Materials Receipt Note, a copy of which is given to the supplier’s carrier as a proof of delivery.

After receiving the materials the Inspection Department thoroughly inspects whether the quality of material is in accordance with the purchase order and the quality of material received and it prepares a note called ‘material inspection note’, copies of which are sent to the supplier and stores department.

8. Purchase Order:

If the Purchase Requisition received by the Purchasing Department is in order then it will call for tenders or quotations from the suppliers of materials. It will send enquiries to prospective suppliers giving details of requirement and requesting details of available materials, prices, terms and delivery etc. Quotations will then be compared and will place order with those suppliers who will provide the necessary goods at competitive prices.

9. Bill of Materials:

Bill of Materials is a comprehensive list of materials, with specifications, material codes and quantity of each material required for a particular job, process or production unit. It will also include the details of substitute materials. It is prepared by the engineering or planning department for submission of quotation and after the receipt of work order. It is a method of documenting materials required for execution of the specified job work.

Bill of Material acts as an authorization to the Stores Department in procuring the materials and the concerned department in material requisition from the stores. It is an advance intimation to the concerned departments of the job, work order to be completed.

Advantages:

(a) It acts as a guide in planning the execution of job, process or product units by documenting all materials required for that specified work.

(b) It is a base for action to be initiated by the Stores Department in placing the purchase requisition with the purchase department.

(c) The information mentioned in the bill of materials act as a standard with which any deviation can be detected and remedial measures are taken if deviations take places.

(d) It is a good control measure on material cost.

(e) The material cost to be charged to a particular unit, job or process can easily be determined beforehand.

(f) It helps in submission of tenders and quotations.

(g) It is a planning exercise for the proposed production or work.

(h) It serves as an advance intimation to stores department about the raw material requirement.

10. Purchase Requisition:

CIMA defines Purchase Requisition as “an internal instruction to a buying office to purchase goods or services. It states their quantity and description and elicits a purchase order”.

The manager in-charge of Purchase Department should obtain requisition from the Stores in- charge, departmental head or similar person requiring goods before placing orders on suppliers. If the present stock run down to the reorder level, then the stores department send a Purchase Requisition to Purchase Department, authorizing the department to order further stock.

Perpetual inventory system provides a running balance of cost of goods available for sale and cost of goods sold. Under this system, no purchases account is maintained because inventory account is directly debited with each purchase of merchandise. The expenses that are incurred to obtain merchandise inventory increase the cost of merchandise available for sale. These expenses are, therefore, also debited to inventory account. Examples of such expenses are freight-in and insurances etc. Each time the merchandise is sold, the related cost is transferred from inventory account to cost of goods sold account by debiting cost of goods sold and crediting inventory account.

Perpetual inventory is a method of accounting for inventory that records the sale or purchase of inventory immediately through the use of computerized point-of-sale systems and enterprise asset management software. Perpetual inventory provides a highly detailed view of changes in inventory with immediate reporting of the amount of inventory in stock, and accurately reflects the level of goods on hand. Within this system, a company makes no effort at keeping detailed inventory records of products on hand; rather, purchases of goods are recorded as a debit to the inventory database. Effectively, the cost of goods sold includes such elements as direct labor and materials costs and direct factory overhead costs.

A perpetual inventory system is a method of inventory management that records real-time transactions of received or sold stock through the use of technology generally considered a more efficient method than a periodic inventory system.

A perpetual inventory system is distinguished from a periodic inventory system, a method in which a company maintains records of its inventory by regularly scheduled physical counts.

The perpetual inventory system is a more robust system than the periodic inventory system, which is where a company undertakes regular audits of stock to update inventory information.  These audits include regular physical inventory counts on a scheduled and periodic basis. The major difference between perpetual and periodic inventory systems is that the former has a system that updates inventory information in real-time while the latter uses a more manual process.

Perpetual inventory systems in the past were not widely used, as it was difficult to record and process the large amounts of data quickly and accurately.

In recent years, however, the technology capability has increased and has improved business and accounting practices, inventory tracking systems can now be managed through the use of computers and scanners, perpetual inventory tracking has become less burdensome.

Perpetual vs. Periodic Inventory Systems

Most small and medium-sized companies use the periodic inventory system, which involves scheduled inventory audits throughout every year. In most cases, periodic inventory counts are conducted a few times per year or even at the end of every month.

The primary issue that companies face under the periodic inventory system is the fact that inventory information is not up to date, and may be unreliable. This means that managers don’t have accurate demand forecasts or inventory levels to ensure that stockouts don’t occur.

Perpetual inventories are the solution to such an issue, giving accurate and updated information about inventory levels, COGS, allows them to check on discrepancies in real-time.

Since the periodic inventory system is only updated occasionally, managers never have current and accurate financial information to base their purchasing or manufacturing decisions on.

Perpetual inventory systems fix this problem. As soon as an inventory transaction takes place, it is entered into the system and inventory balances and costs are updated automatically. Managers can use current inventory reports any time because the system always keeps a real time balance of inventory.

The early years of the European Monetary System (EMS) were marked by uneven currency values and adjustments that raised the value of stronger currencies and lowered those of weaker ones. After 1986, changes in national interest rates were specifically used to keep all the currencies stable.

The early 90s saw a new crisis for the European Monetary System (EMS). Differing economic and political conditions of member countries, notably the reunification of Germany, led to Britain permanently withdrawing from the European Monetary System (EMS) in 1992. Britain’s withdrawal reflected and foreshadowed its insistence on independence from continental Europe, later refusing to join the eurozone along with Sweden and Denmark.

Meanwhile, efforts to form a common currency and cement greater economic alliances were ramped up. In 1993, most EC members signed the Maastricht Treaty, establishing the European Union (EU). One year later, the EU created the European Monetary Institute, which later became the European Central Bank (ECB).

At the end of 1998, most EU nations unanimously cut their interest rates to promote economic growth and prepare for the implementation of the euro. In January 1999, a unified currency, the euro, was born and came to be used by most EU member countries. The European Economic and Monetary Union (EMU) was established, succeeding the European Monetary System (EMS) as the new name for the common monetary and economic policy of the EU.

The European Monetary System (EMS) was a multilateral adjustable exchange rate agreement in which most of the nations of the European Economic Community (EEC) linked their currencies to prevent large fluctuations in relative value. It was initiated in 1979 under then President of the European Commission Roy Jenkins as an agreement among the Member States of the EEC to foster monetary policy co-operation among their Central Banks for the purpose of managing inter-community exchange rates and financing exchange market interventions.

The EMS functioned by adjusting nominal and real exchange rates, thus establishing closer monetary cooperation and creating a zone of monetary stability. As part of the EMS, the ECC established the first European Exchange Rate Mechanism (ERM) which calculated exchange rates for each currency and a European Currency Unit (ECU): an accounting currency unit that was a weighted average of the currencies of the 12 participating states. The ERM let exchange rates to fluctuate within fixed margins, allowing for some variation while limiting economic risks and maintaining liquidity.

The European Monetary System lasted from 1979 to 1999, when it was succeeded by the Economic and Monetary Union (EMU) and exchange rates for Eurozone countries were fixed against the new currency the Euro. The ERM was replaced at the same time with the current Exchange Rate Mechanism (ERM II).

The European Monetary System (EMS) was created in response to the collapse of the Bretton Woods Agreement. Formed in the aftermath of World War II (WWII), the Bretton Woods Agreement established an adjustable fixed foreign exchange rate to stabilize economies. When it was abandoned in the early 1970s, currencies began to float, prompting members of the EC to seek out a new exchange rate agreement to complement their customs union.

The European Monetary System’s (EMS) primary objective was to stabilize inflation and stop large exchange rate fluctuations between European countries. This formed part of a wider goal to foster economic and political unity in Europe and pave the way for a future common currency, the euro.

Currency fluctuations were controlled through an exchange rate mechanism (ERM). The ERM was responsible for pegging national exchange rates, allowing only slight deviations from the European currency unit (ECU) a composite artificial currency based on a basket of 12 EU member currencies, weighted according to each country’s share of EU output. The ECU served as a reference currency for exchange rate policy and determined exchange rates among the participating countries’ currencies via officially sanctioned accounting methods.

The Structure of the Federal Reserve System is unique among all the assets within central banks, with both public and private aspects. It is described as “independent within the government” rather than “independent of government”.

The Federal Reserve System (also known as the Federal Reserve or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a series of financial panics (particularly the panic of 1907) led to the desire for central control of the monetary system in order to alleviate financial crises. Over the years, events such as the Great Depression in the 1930s and the Great Recession during the 2000s have led to the expansion of the roles and responsibilities of the Federal Reserve System

The Federal Reserve does not require public funding, instead it remits its profits to the federal government. It derives its authority and purpose from the Federal Reserve Act, which was passed by Congress in 1913 and is subject to Congressional modification or repeal.

Purpose

The primary declared motivation for creating the Federal Reserve System was to address banking panics. Other purposes are stated in the Federal Reserve Act, such as “to furnish an elastic currency, to afford means of rediscounting commercial paper, to establish a more effective supervision of banking in the United States, and for other purposes”. Before the founding of the Federal Reserve System, the United States underwent several financial crises. A particularly severe crisis in 1907 led Congress to enact the Federal Reserve Act in 1913. Today the Federal Reserve System has responsibilities in addition to stabilizing the financial system.

Current functions of the Federal Reserve System include:

• To address the problem of banking panics
• To serve as the central bank for the United States
• To strike a balance between private interests of banks and the centralized responsibility of government
• To supervise and regulate banking institutions
• To protect the credit rights of consumers
• To manage the nation’s money supply through monetary policy to achieve the sometimes-conflicting goals of
• Maximum employment
• Stable prices, including prevention of either inflation or deflation
• Moderate long-term interest rates
• To maintain the stability of the financial system and contain systemic risk in financial markets
• To provide financial services to depository institutions, the U.S. government, and foreign official institutions, including playing a major role in operating the nation’s payments system
• To facilitate the exchange of payments among regions
• To respond to local liquidity needs
• To strengthen U.S. standing in the world economy

Composition

• The presidentially appointed Board of Governors (or Federal Reserve Board), an independent federal government agency located in Washington, D.C.
• The Federal Open Market Committee (FOMC), composed of the seven members of the Federal Reserve Board and five of the twelve Federal Reserve Bank presidents, which oversees open market operations, the principal tool of U.S. monetary policy.
• Twelve regional Federal Reserve Banks located in major cities throughout the nation, which divide the nation into twelve Federal Reserve districts. The Federal Reserve Banks act as fiscal agents for the U.S. Treasury, and each has its own nine-member board of directors.
• Numerous other private U.S. member banks, which own required amounts of non-transferable stock in their regional Federal Reserve Banks.
• Various advisory councils.

Fund Based Services: It refers to services that are used to acquire assets or funds for a customer. It consists of:

• Primary market activities
• Secondary market activities
• Foreign exchange activities
• Specialized financial Services

Important fund based services include:

• Leasing
• Hire purchase
• Factoring
• Forfeiting
• Mutual funds
• Bill discounting
• Credit Financing
• Housing Finance
• Venture capital

Fee based services: When financial institutions operate in specialised fields to earn income in form of fees, commission, brokerage or dividends it is called a Fee based Service.  They include:

• Issue Management
• Portfolio management
• Corporate counseling
• Merchant banking
• Credit rating
• Stock broking
• Capital restructuring
• Bank Guarantee
• Letter of Credit
• Debt Restructuring

Types of Financial Activities

Fund based Activities:

• Underwriting or investment in shares, debentures, bonds, etc. of new issues (Primary Market Activities)
• Dealing in secondary market activities
• Participating in money market instruments eg. Discounting bills, treasury bills, certificate of deposit etc.
• Involving in equipment leasing, hire purchase, venture capitals
• Dealing in foreign exchange activities

Fee based Activities:

• Managing the capital issue in accordance with SEBI guidelines enabling promoters to market their issue
• Making arrangements for placement of capital and debt instruments with investment institutions
• Arrangement of funds from financial institutions for clients project cost or working capital
• Assisting in getting all Government and other clearances

Banking financial institutions

Banks, more precisely retail or commercial banks, fall under the category of banking financial institutions. A bank is a financial intermediary with a purpose to act as a middleman between suppliers of funds or depositors and borrowers. The main task of a bank is to accept deposits and use these funds later on to offer loans to its customers. Another duty of a bank is to act as a payment agent, which is done by offering a host of payment services, such as credit and debit cards, direct deposit facilities, cheques and bank drafts. A bank makes money by investing the deposits in financial securities and assets, but mostly by lending the funds further to its customers. The primary reasons for depositing money in banks are convenience, safety and interest income.

Bank falls under one category of financial institutions known as banking financial institutions. A bank is known as financial intermediaries that act as middlemen between depositors or suppliers of funds and lenders who are the users of funds. The main tasks of a banking financial institution are to accept deposits and then to use those funds to offer loans to its customers, who will in turn utilize them to fund purchases, education, to expand business, to invest in development, etc. A bank also acts as a payment agent by offering a host of payment services including debit cards, credit cards, cheque facility, direct deposit facilities, bank drafts, etc. The primary purposes in depositing funds in banks are convenience, interest income, and safety. A bank’s ability to lend out funds is determined by the amount of excess reserves and the ratio of cash reserves held by the bank. It is relatively easy for a bank to raise funds as certain accounts such as demand deposits pay no interest to the account holder (this means that no cost is incurred by the bank in attracting deposits for demand deposit accounts). A bank makes money investing the money that they receive from deposits, sometimes in assets and financial securities, but mostly in loans.

Investment banks, leasing companies, insurance companies, investment funds, finance firms, etc. A non-banking financial institution offers a range of financial services. Investment banks offer services to corporations which include underwriting of debt and share issues, securities trading, investment, corporate advisory services, derivate transactions, Financial institutions such as insurance companies offer protection against specific losses for which an insurance premium is paid. Pension and mutual funds act as savings institutions in which investors are able to invest their funds in collective investment vehicles, and receive interest income in return. Market makers or financial institutions that act as brokers and dealers facilitate the transactions in financial assets such as derivative, currencies, equity, etc. Other financial service providers such as leasing companies facilitate the purchase of equipment, real estate financing companies make capital available for real estate purchases and financial advisors and consultants offer advice for a fee.

Non-banking financial institutions

The other type of financial institutions includes investment banks, insurance companies, investment funds and other. A range of financial services offered by non-banking financial institutions differ from those of a bank. The main difference between both is that non-banking financial institutions cannot accept deposits into savings and demand deposit accounts, while it is one of the core businesses for banking financial institutions.

Meanwhile, they offer a variety of other services. For example, investment banks offer services to their clients such as underwriting of debt and share issues, corporate advisory, securities trading and derivative transactions and other investment services. Insurance companies offer a protection against specific losses in exchange for an insurance premium. Pension and mutual funds are savings institutions where investors are able to invest their funds in collective investment vehicles. There are financial services that are provided by both banking and non-banking financial institutions, such as granting loans, financial consultancy, leasing of equipment and investment in financial securities.

Bank vs Financial Institution

• A bank is known as financial intermediaries that act as middlemen between depositors or suppliers of funds and lenders who are the users of funds.
• Financial institutions can be divided into two types: banking financial institutions and non-banking financial institutions.
• The main tasks of a banking financial institution are to accept deposits and then to use those funds to offer loans to its customers.
• The main difference between the two types of financial institutions is that banking financial institutions can accept deposit into various savings and demand deposit accounts, which cannot be done by a non-banking financial institution.
• There are also a number of non-banking financial institutions which include investment banks, leasing companies, insurance companies, investment funds, finance firms, etc. A non-banking financial institution offers a range of financial services.
• The primary purposes in depositing funds in banks are convenience, interest income, and safety. Whereas the primary purpose in investing funds in non-banking financial institutions is to gain additional income.

All India Financial Institutions (AIFI) is a group composed of development finance institutions and investment institutions that play a pivotal role in the financial markets. Also known as “financial instruments”, the financial institutions assist in the proper allocation of resources, sourcing from businesses that have a surplus and distributing to others who have deficits – this also assists with ensuring the continued circulation of money in the economy. Possibly of greatest significance, the financial institutions act as an intermediary between borrowers and final lenders, providing safety and liquidity. This process subsequently ensures earnings on the investments and savings involved. In Post-Independence India, people were encouraged to increase savings, a tactic intended to provide funds for investment by the Indian government. However, there was a huge gap between the supply of savings and demand for the investment opportunities in the country.

The health of the financial services sector is integral to the overall level of global economic activity. For this reason, the major macroeconomic indicators are also very important pieces of data for the outlook of this sector. Financial services companies rely on high levels of business activity to generate revenue because they act as the intermediary in many economic transactions.

The financial services sector is made up of firms and institutions that provide financial services to commercial and retail customers. This includes banks, investment companies, insurance companies, and real estate firms.

Economic indicators are released through studies, surveys, sector reports, and the data-gathering efforts of government agencies. These indicators have wide-reaching implications for every economic sector. However, the financial services sector is perhaps the most sensitive to large economic aggregates.

Based on this approach some researchers have used one or more indicator to denote the degree of financial development.

Finance ration

The ratio of total issues of primary and secondary claim to national income

Financial Inter-relation ratio

The ratio of financial assets to physical assets in the economy.

Intermediation ratio

The ratio of secondary issue to primary issue, which indicates the extent of development of financial institution as mobilizers of funds relative to real sectors as direct mobilizers of funds. It indicates institutionalization of financial activity in the economy.

The ratio of money to income

Higher the ratio greater the financial development because it indicates the extent of monetization and size of exchange economy in the nation.

• Developed Financial sector is fully integrated domestically as well as internationally. In such system risk adjusted rate of return doesn’t differ significantly in respect of investor as well as saver.
• The lower the transaction and information cost, the higher the financial development.
• A developed financial structure is characterized by presence of strong, active, large sized non-banking financial sector comprising stock market, debt market, insurance companies, pension fund, mutual fund etc.
• The greater the financial development, the greater the openness of the economy reflected in high level of current account openness/convertibility, minimum restriction on foreign ownership of assets and repatriation of earning and absence of parallel foreign exchange market.
• In a developed financial system, private banking not the public sector banking is predominant.

1. Interest Rates

Interest rates are the most significant indicators for banks and other lenders. Banks profit from the difference between the rates they pay depositors and the rates that they charge to borrowers. Banks find it increasingly difficult to pass on interest rate costs to consumers as rates rise. High borrowing costs correspond with fewer loans and more saving. This limits the volume of total profitable activity for lenders.

It is very clear that banks perform best (at least in the short term) when interest rates are lower.

Lower interest rates also turn savers into speculators. It’s more difficult to beat inflation when the rate on a savings account or certificate of deposit (CD) is paying a low rate. Workers will turn more often to equities to try to find ways to counter inflation and grow their nest eggs for retirement. This creates demand for asset management services, brokers, and other money intermediaries.

2. Government Regulation and Fiscal Policy

Government regulation is not necessarily an indicator in the traditional sense; instead, investors should keep an eye toward how regulations and tariffs might impact activity from the financial services sector. Banks, which comprise more than half of the entire sector in the U.S., are heavily influenced by reserve requirements, usury laws, insurance and lending guidelines as well as the possibility of government assistance.

Fiscal policy doesn’t affect banks as directly. Rather, it impacts the banks’ possible customers and trading partners. Consumer confidence tends to rise during expansionary fiscal policy and fall during contractionary fiscal policy. This could translate into fewer investments, trades, and loans.

3. Gross Domestic Product (GDP)

Countries around the world track levels of economic activity through gross domestic product (GDP) calculations. Increases in the level of spending or investments cause GDP to rise, and the financial service sector typically sees increased demand for its goods and services when spending and investment levels go up.

Since GDP is the most common and broadest measure of a region’s economy and it is often considered a lagging indicator the relationship between any one company’s stock and the GDP is tenuous at best. Nevertheless, it is considered a useful benchmark for the overall health of the financial sector.

4. Existing Home Sales

The Existing-Home Sales report is issued monthly by the National Association of Realtors. It provides banks and mortgage lenders with recent data on sales prices, inventory levels, and the total number of homes sold.

This report often impacts prevailing mortgage rates. Investors in financial services and home construction should see upticks when home sales data is rising.

The money market and capital market are closely interrelated because most corporations and financial institutions are active in both. Firms may borrow funds from the money market for a short period or for a loan period from the capital market.

Differences

1. The money market uses such instruments as promissory notes, bills of exchange, treasury bills, certificates of deposits, commercial papers, etc. On the other hand, the capital market uses long-term securities such as shares, debentures and bonds of industrial concerns, and bonds and securities of the government.
2. The money market deals in short-term funds which are used for financing current business operations and short-term needs of the government. On the other hand, the capital market deals in long-term funds required by industry and government.
3. The institutions operating in the money market and the capital market also differ from each other. The central bank, commercial banks, non bank financial intermediaries and bill brokers deal in money market instruments. On the other hand, stock exchanges, mutual funds, leasing companies, investment banks, investment trusts, insurance companies, etc. dealing capital market instrument.
4. Short-term funds in the money market refer to a period of less than a year, while in the capital market long-term funds refer to a period up to 25 years.

Interrelations between Money and Capital Markets:

The money market and capital market are closely interrelated because most corporations and financial institutions are active in both. Firms may borrow funds from the money market for a short period or for a loan period from the capital market. A number of factors may prompt borrowers and lenders to resort to either the money market or the capital market which reflect the interdependence of the two markets.

1. Some corporations and financial institutions serve both markets by buying and selling short-term and long-term securities.
2. Borrowers may obtain their funds from either or both markets according to their requirements. A firm may borrow short-term funds by selling commercial paper or it may float additional shares or bonds.
3. Funds flow back and forth between the two markets whenever the treasury finances maturing bills with treasury securities or whenever a bank lends the proceeds of a maturing loan to a firm on a short-term basis.
4. All long-term securities become short-term instruments at the time of maturity. So, some capital market instruments also become money market instruments.
5. Yields in the money market are related to those of the capital market. A fall in the short-term interest rates in the money market shows a condition of essay credit which is likely to be followed or accompanied by a more moderate fall in the long-term interest rates in the capital market. However, money market interest rates are more sensitive than are long-term interest rates in the capital market.
6. Lenders may choose to direct their funds to either or both markets depending on the availability of funds, the rates of return, and their investment policies.