Tag: Modern Marketing Bangalore University BBA Notes

The retirement of bonds refers to the repurchase of bonds from investors that had been previously issued. The issuer retires bonds at the scheduled maturity date of the instruments. Or, if the bonds are callable, the issuer has the option to repurchase the bonds earlier; this is another form of retirement. Once bonds are retired, the issuer eliminates the bonds payable liability on its books.

Retirement of securities refers to the cancellation of stocks or bonds because their issuer has bought them back, or (in the case of bonds) because their maturity date has been reached.

Many securities are routinely bought back by their issuing company such as preferred stocks and corporate bonds. In the case of stock, this reduces the number of shares outstanding. In the case of bonds, it means that the company is essentially paying the investors who bought loaned them money their principal back and getting rid of its debt obligations.

Bond Retirement before Maturity

In some circumstances, the corporation or company wishes to retire all or some of its bonds before the maturity date. This is also called the early retirement of bonds. The main reason for the early retirement is the decreasing of interest significantly in the market. Thus, the issuers wish to replace its high-interest paying bonds with the new low-interest paying bonds.

There are two common ways that the issuers can retire their bonds before the maturity date. These are through the exercise a call option or purchase them through the open market.

Purchase on the open market: In this way, the issuers can retire the bonds early by repurchasing them on the open market. When the issuers repurchase bonds on the open market, they need to pay the bonds at the current price or current market value of the bonds.

Through exercise a call option: In this way, the issuers will need to issue a callable bond that allows them to exercise their right in order to retire the bonds early. In these callable bonds, the issuers reserve the right to exercise the option before the maturity by paying the par value bonds plus a call premium to the bondholders.

Bond Retirement at Maturity

For the retirement at maturity, the corporation issued the bond will need to repay the bondholders the carrying value of the bond. In this case, the carrying value of the bond is always equal to the par value of the bonds regardless of the bond issued at par, at a premium, or a discount.

Therefore, at the maturity date, the principal or par value of the bond will need to remove from the liability account.

Bond Retirement by Conversion

This retirement can be done through conversion. This occurs when a corporation issues convertible bonds that allow the bondholders to convert the bonds into common stock equity.

When the conversion occurs, the carrying value of the bonds is transferred to the equity account and there is no gain or loss recorded in the income statement. For a detailed calculation of the convertible bond, you can read another article on the convertible bond.

The journal entry for this retirement is as follow:

Bonds payable is a liability account that contains the amount owed to bond holders by the issuer. This account typically appears within the long-term liabilities section of the balance sheet, since bonds typically mature in more than one year. If they mature within one year, then the line item instead appears within the current liabilities section of the balance sheet.

Bonds payable are recorded when a company issues bonds to generate cash. As a bond issuer, the company is a borrower. As such, the act of issuing the bond creates a liability. Thus, bonds payable appear on the liability side of the company’s balance sheet. Generally, bonds payable fall in the non-current class of liabilities.

Terms of bonds payable are contained within a bond indenture agreement, which states the face amount of the bonds, the interest rate to be paid to bond holders, special repayment terms, and any covenants imposed on the issuing entity.

The carrying value is found through the following formula:

Carrying Value = Bonds Payable + Unamortized Premium/Discount

An entity is more likely to incur a bonds payable obligation when long-term interest rates are low, so that it can lock in a low cost of funds for a prolonged period of time. Conversely, this form of financing is less commonly used when interest rates spike. Bonds are typically issued by larger corporations and governments.

Important Terms

Coupon: Coupon payments represent the periodic interest payments from the bond issuer to the bondholder. The annual coupon payment is calculated by multiplying the coupon rate by the bond’s face value. As we note from above, Nike’s bond pays interest semiannually; generally, one half of the annual coupon is paid to the bondholders every six months.

Par value: The amount of money that is paid to the bondholders at maturity. It generally represents the amount of money borrowed by the bond issuer.

Maturity: Maturity represents the date on which the bond matures, i.e., the date on which the face value is repaid. The last coupon payment is also paid on the maturity date.

Coupon rate: The coupon rate, which is generally fixed, determines the periodic coupon or interest payments. It is expressed as a percentage of the bond’s face value. It also represents the interest cost of the bond to the issuer.

Convertible Bonds

A convertible bond is the same as the bond with warrants. The major difference between convertible bonds and warrants is that warrants can be separated into distinct securities but convertible bonds are not. Convertible bonds are the fixed income securities that would be converted into common stocks after a certain period of time. Therefore, the convertible bond gives the holder the right to exchange for its a given number of shares of common stock any time on or before the expiration date.

Convertible securities also give investors the right to exchange their bond or shares for common stock of the company. Each convertible security will give specifics on the number of shares you’ll receive upon conversion, as well as the expiration date by which the security must be converted. In some cases, conversion is mandatory, while other convertible securities leave the conversion decision at the discretion of the owner.

Warrants

Warrants are financial assets giving the holder the right but not obligation to buy shares of common stocks directly from the issuing authority at a fixed price for a given period of time. Each warrant specifies the number of shares of common stock a holder can purchase at the exercise price at the expiration date. Some features of warrants are the same as those of call options. From the viewpoint of the holders call options and warrants like the same. But still there exists a significant difference in contractual features of them. Say warrants have a long maturity period. Some warrants are the same as the perpetual having no expiration date at all. The basic difference between call options and warrants is that call options are issued by individuals and warrants are issued by the firms. When a warrant is exercised, a firm must issue new shares of stock. Each time a warrant is exercised, the number of shares outstanding increases. In case of a call, options are not necessary i.e., when a call option is exercised, there is no change in the number of shares outstanding. Warrants vs Convertible Bonds.

Warrants, on the other hand, typically don’t have any intrinsic value of their own. Unlike convertible securities, there’s no underlying bond or preferred shares that give the warrant owner any additional rights. The only value that the warrant has comes from its conversion feature.

Warrants resemble options in that they typically require investors to make an additional payment within a specified time frame in order to exercise the warrant and receive common stock in exchange. Warrants tend to have longer lifespans than ordinary options, with expiration dates as much as 10 years into the future being relatively common. Investors aren’t required to exercise warrants, but they’re worthless after they expire unexercised.

Both warrants and convertible securities have their place within the capital structure of a company. The investments have some things in common, but their differences also have maximum value to different sets of investors. Those who want maximum reward will prefer warrants, but those who want some protection from worst-case scenarios will gravitate toward convertible securities.

The major difference is that the equity option embedded in a convertible bond is not detachable from the convert, so that you have to value the bond and the embedded option together. If you want to make a direct comparison with a detachable warrant, you can think of the embedded option in a convertible bond as having a strike price equal to the value of the remaining cash flows of the convertible bond, so that the strike prices change over time as coupon payments are made, and changes with the level of both interest rates and the credit quality of the bond issuer.

Debt restructuring is a process that allows a private or public company or a sovereign entity facing cash flow problems and financial distress to reduce and renegotiate its delinquent debts to improve or restore liquidity so that it can continue its operations.

Replacement of old debt by new debt when not under financial distress is called “refinancing”. Out-of-court restructurings, also known as workouts, are increasingly becoming a global reality.

Debt restructuring involves a reduction of debt and an extension of payment terms and is usually less expensive than bankruptcy. The main costs associated with debt restructuring are the time and effort spent negotiating with bankers, creditors, vendors, and tax authorities.

Creditors of corporates are generally banks and non-banking financial companies (NBFCs). The corporate debt restructuring is done by lowering the amount of payable towards the debt. Also, the interest rate is lowered. However, the repayment tenure is enhanced, which would help the company in paying the outstanding dues.

At times, a part of the company’s debt would be waived off by the creditors. But, that would be in exchange for equities of the company. Nevertheless, this kind of arrangement is more favourable for the distressed company as compared to declaring themselves to be bankrupt and undergo tedious procedures.

Methods

Debt-for-equity swap

In a debt-for-equity swap, a company’s creditors generally agree to cancel some or all of the debt in exchange for equity in the company.

Debt for equity deals often occur when large companies run into serious financial trouble, and often result in these companies being taken over by their principal creditors. This is because both the debt and the remaining assets in these companies are so large that there is no advantage for the creditors to drive the company into bankruptcy. Instead, the creditors prefer to take control of the business as a going concern. As a consequence, the original shareholders’ stake in the company is generally significantly diluted in these deals and may be entirely eliminated.

Bondholder haircuts

A debt-for-equity swap may also be called a “bondholder haircut”. Bondholder haircuts at large banks were advocated as a potential solution for the subprime mortgage crisis by prominent economists:

Economist Joseph Stiglitz testified that bank bailouts “are really bailouts not of the enterprises but of the shareholders and especially bondholders. There is no reason that American taxpayers should be doing this”. He wrote that reducing bank debt levels by converting debt into equity will increase confidence in the financial system. He believes that addressing bank solvency in this way would help address credit market liquidity issues.

Economist Jeffrey Sachs has also argued in favor of such haircuts: “The cheaper and more equitable way would be to make shareholders and bank bondholders take the hit rather than the taxpayer. The Fed and other bank regulators would insist that bad loans be written down on the books. Bondholders would take haircuts, but these losses are already priced into deeply discounted bond prices.”

If the key issue is bank solvency, converting debt to equity via bondholder haircuts presents an elegant solution to the problem. Not only is debt reduced along with interest payments, but equity is simultaneously increased. Investors can then have more confidence that the bank (and financial system more broadly) is solvent, helping unfreeze credit markets. Taxpayers do not have to contribute dollars and the government may be able to just provide guarantees in the short term to buttress confidence in the recapitalized institution. For example, Wells Fargo owed its bondholders $267 billion, according to its 2008 annual report. A 20% haircut would reduce this debt by about $54 billion, creating an equal amount of equity in the process, thereby recapitalizing the bank significantly.

Informal Debt Repayment Agreements

Companies that are restructuring debt can ask for lenient repayment terms and even ask to be allowed to write off some portions of their debt. This can be done by reaching out to the creditors directly and negotiating new terms of repayment. This is a more affordable method than involving a third-party mediator and can be achieved if both parties involved are keen to reach a feasible agreement.

Debt Restructuring vs. Debt Refinancing

Debt restructuring is distinct from debt refinancing. The former requires debt reduction and an extension to the repayment plan. On the other hand, debt refinancing is merely the replacement of an old debt with a newer debt, usually with slightly different terms, such as a lower interest rate.

Debt Restructuring vs. Bankruptcy

Debt restructuring usually involves direct negotiations between a company and its creditors. The restructuring can be initiated by the company or, in some cases, be enforced by its creditors.

On the other hand, bankruptcy is essentially a process through which a company that is facing financial difficulty is able to defer payments to creditors through a legally enforced pause. After declaring bankruptcy, the company in question will work with its creditors and the court to come up with a repayment plan.

In case the company is not able to honor the terms of the repayment plan, it must liquidate itself in order to repay its creditors. The repayment terms are then decided by the court.

The fair value option is the alternative for a business to record its financial instruments at their fair values. GAAP allows this treatment for the following items:

• A financial asset or financial liability
• A firm commitment that only involves financial instruments
• A loan commitment
• An insurance contract where the insurer can pay a third party to provide goods or services in settlement, and where the contract is not a financial instrument (i.e., requires payment in goods or services)
• A warranty in which the warrantor can pay a third party to provide goods or services in settlement, and where the contract is not a financial instrument (i.e., requires payment in goods or services)

The fair value option cannot be applied to the following items:

• An investment in a subsidiary or variable interest entity that will be consolidated.
• Deposit liabilities of depository institutions.
• Financial assets or financial leases recognized under lease arrangements.
• Financial instruments classified as an element of shareholders’ equity.
• Obligations or assets related to pension plans, post-employment benefits, stock option plans, and other types of deferred compensation.

When you elect to measure an item at its fair value, do so on an instrument-by-instrument basis. Once you elect to follow the fair value option for an instrument, the change in reporting is irrevocable. The fair value election can be made on either of the following dates:

• The election date, which can be when an item is first recognized, when there is a firm commitment, when qualification for specialized accounting treatment ceases, or there is a change in the accounting treatment for an investment in another entity.
• In accordance with a company policy for certain types of eligible items.
• It is acceptable not to apply the fair value option to eligible items when reporting the results of a subsidiary of consolidated variable interest entity, but to apply the fair value option to these items when reporting consolidated financial statements.
• It is much easier to apply the fair value option for both subsidiary-level and consolidated financial results, so do not attempt separate treatment, even though it is allowed by GAAP.
• In most cases, it is acceptable to choose the fair value option for an eligible item, while not electing to use it for other items that are essentially identical.
• If you take the fair value option, report unrealized gains and losses on the elected items at each subsequent reporting date.

Fair value is a term with several meanings in the financial world. In investing, it refers to an asset’s sale price agreed upon by a willing buyer and seller, assuming both parties are knowledgeable and enter the transaction freely. For example, securities have a fair value that’s determined by a market where they are traded. In accounting, fair value represents the estimated worth of various assets and liabilities that must be listed on a company’s books.

Fair Value and Financial Statements

The International Accounting Standards Board defines fair value as the price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants on a certain date, typically for use on financial statements over time. The fair value of all a company’s assets and liabilities must be listed on the books in a mark-to-market valuation. The original cost is used to value assets in most cases.

In some cases, it may be difficult to determine a fair value for an asset if there is not an active market for it. This is often an issue when accountants perform a company valuation. Say, for example, an accountant cannot determine a fair value for an unusual piece of equipment. The accountant may use the discounted cash flows generated by the asset to determine a fair value. In this case, the accountant uses the cash outflow to purchase the equipment and the cash inflows generated by using the equipment over its useful life. The value of the discounted cash flows is the fair value of the asset.

Consequently, the Board considered amending IAS 39 so that the fair value option could be applied only in specified circumstances. The specified circumstances would be those that the Board had in mind when it developed the option, i.e. for a financial asset or financial liability that is reliably measurable and meets one of the following:

• The item is a financial asset or financial liability that contains one or more embedded derivatives as described in paragraph 10 of IAS 39
• The item is a financial liability whose amount is contractually linked to the performance of assets that are measured at fair value
• The exposure to a change in the fair value of the financial asset or financial liability is substantially offset by the exposure to the change in the fair value of another financial asset or financial liability, including a derivative.

An involuntary conversion occurs when your property is destroyed, stolen, condemned, or disposed of under the threat of condemnation and you receive other property or money in payment, such as insurance or a condemnation award. Involuntary conversions are also called involuntary exchanges.

Reporting Gain or Loss

Gain or loss from an involuntary conversion of your property is usually recognized for tax purposes unless the property is your main home. You report the gain or deduct the loss on your tax return for the year you realize it.

Involuntary conversion generally refers to a forced payment for property when that property is damaged or stolen. It is a common insurance term. Involuntary conversions typically also have taxation implications.

An involuntary conversion occurs when an owner loses their property unexpectedly but with certain provisions in place to cover their losses.2 An involuntary conversion is the opposite of a voluntary conversion. A voluntary conversion occurs when an owner sells, gifts, or generally exchanges their property under agreed upon terms usually with an agreed upon monetary value.

Involuntary conversions can occur when any type of individual or business property is damaged or stolen.

Property owners can take steps to mitigate the risk of involuntary losses through insurance policies. Any compensation an owner receives in exchange for property lost is associated with the “conversion” part of an involuntary conversion. Conversions may include cash payments from insurance policies and potentially accounting for replacement property. Without an insurance policy or other conversion agreement in place, involuntary damages or theft would simply result in a loss.

Insurance Policies

Property and casualty (P&C) insurance companies are typically the primary entities an owner can turn to for insurance policies that provide monetary compensation for involuntary losses. Property and casualty insurance companies can specialize in the areas of; auto, boat, home, and real estate. Individuals and business owners can pay a monthly premium to P&C companies for different types of policies that provide different amounts of monetary compensation in the event of an involuntary loss.

An intangible asset is an asset that lacks physical substance. Examples are patents, copyright, franchises, goodwill, trademarks, and trade names, as well as software. This is in contrast to physical assets (machinery, buildings, etc.) and financial assets (government securities, etc.). An intangible asset is usually very difficult to evaluate. They suffer from typical market failures of non-rivalry and non-excludability.

Intangibles can be acquired:

• By separate purchase
• As part of a business combination
• By a government grant
• By exchange of assets
• By self-creation (internal generation)

Financial accounting

General standards

The International Accounting Standards Board (IASB) offers some guidance (IAS 38) as to how intangible assets should be accounted for in financial statements. In general, legal intangibles that are developed internally are not recognized and legal intangibles that are purchased from third parties are recognized. Wordings are similar to IAS 9.

Under US GAAP, intangible assets are classified into: Purchased vs. internally created intangibles, and Limited-life vs. indefinite-life intangibles.

Expense allocation

Intangible assets are typically expensed according to their respective life expectancy. Intangible assets have either an identifiable or an indefinite useful life. Intangible assets with identifiable useful lives are amortized on a straight-line basis over their economic or legal life, whichever is shorter. Examples of intangible assets with identifiable useful lives are copyrights and patents. Intangible assets with indefinite useful lives are reassessed each year for impairment. If an impairment has occurred, then a loss must be recognized. An impairment loss is determined by subtracting the asset’s fair value from the asset’s book/carrying value. Trademarks and goodwill are examples of intangible assets with indefinite useful lives. Goodwill has to be tested for impairment rather than amortized. If impaired, goodwill is reduced and loss is recognized in the Income statement.

Intangible asset: an identifiable non-monetary asset without physical substance. An asset is a resource that is controlled by the entity as a result of past events (for example, purchase or self-creation) and from which future economic benefits (inflows of cash or other assets) are expected. Thus, the three critical attributes of an intangible asset are:

Identifiability control (power to obtain benefits from the asset) future economic benefits (such as revenues or reduced future costs)

Identifiability: an intangible asset is identifiable when it:

• Is separable (capable of being separated and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract).
• Arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.

Recognition

Recognition criteria. IAS 38 requires an entity to recognise an intangible asset, whether purchased or self-created (at cost) if, and only if:

• It is probable that the future economic benefits that are attributable to the asset will flow to the entity.
• The cost of the asset can be measured reliably.

Types

Businesses have many different types of intangible assets. Many of these can be unique to a specific business, making it very hard to compile a comprehensive list of intangible assets. However, some of the more common types include:

• Patents, copyrights and licenses
• Customer lists and relationships
• Non-compete agreements
• Favorable financing
• Software
• Trained and assembled workforces
• Contracts
• Leasehold interests
• Unpatented proprietary technology
• Trademarks/Trade names

Research and Development

Research is a planned and detailed investigation into a product or service for gaining scientific or technical know-how. Development is the application of such researches to develop new and better products and service than the current portfolio a company has.

R&D is a part of internally generated intangible assets of a company. Companies spend millions of dollars on R&D and hence, it is a valuable intangible asset capable of taking a company to new heights.

Franchise Agreements

Franchise agreements are another type of intangible asset that grants the legal right to a business to operate using the name of another company or sell a product or service developed by another company. These are classified as assets because the business owners reap monetary gains with the help of these intangible assets.

For example, many fast food restaurants like KFC, McDonald’s, Subway, Dominos, etc. operate using a franchise system. Here the franchisor grants varying amount of autonomy to the franchisees to use the brand name and benefit from franchisor’s extensive marketing.

Licenses

A licensor can permit a licensee to use a trademark, patent, or copyright through a license in exchange for a fee or a charge. Such licenses usually have fixed time validity, and may even set geographical validity or restrictions. Intellectual property licensing, such as transfer of technology, franchising, and publication rights, are very important in present-day business. Violation of the license terms by the licensee or a third-party is also a punishable offense under the law.

Trademarks

A trademark is an intangible asset which legally prevents others from using a business’s name, logo or other branding items. It is a design, symbol or a logo used in connection with a particular product or a business.

Copyrights

Copyright grants an extensive right to the business to reproduce and sell a software, book, journal, magazine, etc. It is an intangible asset used to secure legal protection by preventing others from reproducing or publishing a work of authorship.

Patents

A patent is a type of intangible asset that grants a business the exclusive right to manufacture, sell or use a specific invention. A company can purchase the patent from another company or it can invent a new product and receive a patent for it.

Capitalized interest is the cost of the funds used to finance the construction of a long-term asset that an entity constructs for itself. The capitalization of interest is required under the accrual basis of accounting, and results in an increase in the total amount of fixed assets appearing on the balance sheet. An example of such a situation is when an organization builds its own corporate headquarters, using a construction loan to do so.

Capitalized interest is the cost of borrowing to acquire or construct a long-term asset. Unlike an interest expense incurred for any other purpose, capitalized interest is not expensed immediately on the income statement of a company’s financial statements. Instead, firms capitalize it, meaning the interest paid increases the cost basis of the related long-term asset on the balance sheet. Capitalized interest shows up in installments on a company’s income statement through periodic depreciation expense recorded on the associated long-term asset over its useful life.

Capitalization is the addition of unpaid interest to the principal balance of your loan. The principal balance of a loan increases when payments are postponed during periods of deferment or forbearance and unpaid interest is capitalized. As a result, more interest may accrue over the life of the loan, the monthly payment amount may be higher, or more payments may be required.

Accounting for Capitalized Interest

This interest is added to the cost of the long-term asset, so that the interest is not recognized in the current period as interest expense. Instead, it is now a fixed asset, and is included in the depreciation of the long-term asset. Thus, it initially appears in the balance sheet, and is charged to expense over the useful life of the asset; the expenditure therefore appears on the income statement as depreciation expense, rather than interest expense.

Which Borrowing Costs to Capitalize

Generally, borrowing costs attributable to a fixed asset are those that would otherwise have been avoided if the asset had not been acquired. There are two ways to determine the borrowing cost to include in an asset:

• Directly attributable borrowing costs. If borrowings were specifically incurred to obtain the asset, then the borrowing cost to capitalize is the actual borrowing cost incurred, minus any investment income earned from the interim investment of those borrowings.
• Borrowing costs from a general fund. Borrowings may be handled centrally for general corporate needs, and may be obtained through a variety of debt instruments. In this case, derive an interest rate from the weighted average of the entity’s borrowing costs during the period applicable to the asset. The amount of allowable borrowing costs using this method are capped at the entity’s total borrowing costs during the applicable period.

When to Capitalize Interest

The record keeping for the recordation of capitalized interest can be complicated, so it is generally recommended that the use of interest capitalization be confined to situations where there is a significant amount of related interest expense. Also, interest capitalization defers the recognition of interest expense, and so can make the results of a business look better than is indicated by its cash flows.

When to Stop Capitalizing Interest

Capitalization of borrowing costs terminates when an entity has substantially completed all activities needed to prepare the asset for its intended use. Substantial completion is assumed to have occurred when physical construction is complete; work on minor modifications will not extend the capitalization period. If the entity is constructing multiple parts of a project and it can use some parts while construction continues on other parts, then it should stop capitalization of borrowing costs on those parts that it completes.

How Much It Will interest Cost

The cost of a loan, ignoring any one-time fees, is the interest you pay. In other words, you repay what they gave you, plus a little extra. Total cost is driven by:

• The amount you borrow: The higher your loan balance, the more interest you’ll pay
• The interest rate: The higher the rate, the more expensive it is to borrow
• The amount of time you take to repay the loan: If you take longer to pay, there’s more time for your lender to charge interest.

Reasons for Interest on Drawn

Drawings are opposite to capital invested i.e. these are the funds drawn by partners from the business. Therefore, in order to keep the distribution of profit fair, a clause may be inserted in the agreement, where an interest is charged on the drawings of the partners. Again, this can be on the total amount or on an amount exceeding a specific limit. Both of the above things depend upon the agreement between partners.

Accounting Treatment

One may think that as Interest on Capital is paid to the partners, so it should be treated as business expense and Interest on Drawings is charged from the partners, therefore, it should be treated as income. But this is not the case. Just like partners salaries, both these items will be included in the Profit and Loss Appropriation Account. Partners’ salaries, interests etc. are never treated as expense or income of the business. They are a part of DISTRIBUTION OF PROFIT.

To invest is to allocate money with the expectation of a positive benefit/return in the future. In other words, to invest means owning an asset or an item with the goal of generating income from the investment or the appreciation of your investment which is an increase in the value of the asset over a period of time. When a person invests, it always requires a sacrifice of some present asset that they own, such as time, money, or effort.

Financial investment refers to putting aside a fixed amount of money and expecting some kind of gain out of it within a stipulated time frame.

In finance, the benefit from investing is when you receive a return on your investment. The return may consist of a gain or a loss realized from the sale of a property or an investment, unrealized capital appreciation (or depreciation), or investment income such as dividends, interest, rental income etc., or a combination of capital gain and income. The return may also include currency gains or losses due to changes in the foreign currency exchange rates.

A financial investment is an asset that you put money into with the hope that it will grow or appreciate into a larger sum of money. The idea is that you can later sell it at a higher price or earn money on it while you own it. You may be looking to grow something over the next year, such as saving up for a car, or over the next 30 years, such as saving for retirement.

Investors generally expect higher returns from riskier investments. When a low-risk investment is made, the return is also generally low. Similarly, high risk comes with high returns.

Investors, particularly novices, are often advised to adopt a particular investment strategy and diversify their portfolio. Diversification has the statistical effect of reducing overall risk.

Important in Financial Investment

• Explore all the investment plans available in the market. Go through the pros and cons of each plan in detail. Analyze the risk factors carefully before finalizing the plan. Invest in something which will give you the maximum return.
• Planning plays a pivotal role in Financial Investment. Don’t just invest just for the sake of investing. Understand why you really need to invest money? Investing just because your friend has said you to do so is foolish. Careful analysis and focused approach are mandatory before investing.
• Appoint a good financial planning manager who takes care of all your investment needs. He must understand your requirement, family income, stability etc to decide the best plan for you.

Need for Financial Investment

• Financial Investment ensures all your dreams turn real and you enjoy life to the fullest without actually worrying about the future.
• Financial investment controls an individual’s spending pattern. It decides how and what amount one should spend so that he has sufficient money for future.
• Financial investment ensures you save for rainy days. Careful investment makes your future secure.

Types of Financial Investment

• Fixed Deposits
• Mutual Funds
• Bonds
• Equities
• Stock
• Real Estate (Residential/Commercial Property)
• Gold /Silver
• Precious stones

Investment and risk

An investor may bear a risk of loss of some or all of their capital invested. Investment differs from arbitrage, in which profit is generated without investing capital or bearing risk.

Savings bear the (normally remote) risk that the financial provider may default.

Foreign currency savings also bear foreign exchange risk: if the currency of a savings account differs from the account holder’s home currency, then there is the risk that the exchange rate between the two currencies will move unfavourably so that the value of the savings account decreases, measured in the account holder’s home currency.

Even investing in tangible assets like property has its risk. And just like with most risk, property buyers can seek to mitigate any potential risk by taking out mortgage insurance and by borrowing at a lower loan to security ratio.

In contrast with savings, investments tend to carry more risk, in the form of both a wider variety of risk factors and a greater level of uncertainty.

Industry to industry volatility is more or less of a risk depending. In biotechnology for example, investors look for big profits on companies that have small market capitalizations but can be worth hundreds of millions quite quickly.

Intermediaries and collective investments

Investments are often made indirectly through intermediary financial institutions. These intermediaries include pension funds, banks, and insurance companies. They may pool money received from a number of individual end investors into funds such as investment trusts, unit trusts, SICAVs, etc. to make large-scale investments. Each individual investor holds an indirect or direct claim on the assets purchased, subject to charges levied by the intermediary, which may be large and varied.

Approaches to investment sometimes referred to in marketing of collective investments include dollar cost averaging and market timing.

Investment valuation

Free cash flow measures the debt a company generates which is available to its debt and equity investors, after allowing for reinvestment in working capital and capital expenditure. High and rising free cash flow, therefore, tend to make a company more attractive to investors.

The debt-to-equity ratio is an indicator of capital structure. A high proportion of debt, reflected in a high debt-to-equity ratio, tends to make a company’s earnings, free cash flow, and ultimately the returns to its investors, riskier or volatile. Investors compare a company’s debt-to-equity ratio with those of other companies in the same industry, and examine trends in debt-to-equity ratios and free cashflow.

A tangible asset is an asset that has a finite monetary value and usually a physical form. Tangible assets can typically always be transacted for some monetary value though the liquidity of different markets will vary. Tangible assets are the opposite of intangible assets which have a theorized value rather than a transactional exchange value.

Companies have two types of assets; tangible and intangible. Tangible assets are the most basic type of assets on the balance sheet. They are usually the main form of assets in most industries. They are also usually the easiest to understand and value. Tangible assets are assets with a finite or discrete value and usually a physical form. A quick review of a balance sheet will provide a layout of a company’s tangible assets listed by liquidity. The asset portion of the balance sheet is broken out into two parts, current assets and long-term assets. Current assets are assets that can be converted to cash in less than one year. Long-term assets are assets that will not be converted to cash within a year. All types of assets support the operations of a company and help it to achieve its main goal which is generating revenue.

Current and Long-Term Tangible Assets

Tangible assets can be either current assets or long-term assets. Current assets may or may not have a physical onsite presence but they will have a finite transaction value. A company’s most liquid, tangible current assets include cash, cash equivalents, marketable securities, and accounts receivable. All of these tangible assets are included in the calculation of a company’s quick ratio. Other current assets are included in the calculation of a company’s current ratio. The current ratio shows how well a company can cover its current liabilities with its current assets. Current ratio assets include inventory which is not as liquid as cash equivalents but has a finite market value and could be sold for cash if needed in a liquidation.

Long-term assets, sometimes called fixed assets, comprise the second portion of the asset section on the balance sheet. These assets include things like real estate properties, manufacturing plants, manufacturing equipment, vehicles, office furniture, computers, and office supplies. The costs of these assets may or may not be part of a company’s cost of goods sold but regardless they are assets that hold real transactional value for the company.

Tangible assets are recorded on the balance sheet at the cost incurred to acquire them. Long-term tangible assets are reduced in value over time through depreciation. Depreciation is a noncash balance sheet notation that reduces the value of assets by a scheduled amount over time. Current assets are converted to cash within one year and therefore do not need to be devalued over time. For example, inventory is a current asset that is usually sold within one year.

Acquisition of Fixed Assets

Fixed assets refer to long-term tangible assets that are used in the operations of a business. They provide long-term financial benefits, have a useful life of more than one year, and are classified as property, plant, and equipment (PP&E) on the balance sheet.

Fixed asset, in accounting, is defined as a long-term asset having lifespan > 1 financial year and value > capitalizing limit. They are typically bought to generate income. They are also known as Capital Assets and Property, Plant and Equipment (PP&E). These assets are normally not meant to sell or are not easily convertible into cash and therefore are categorized under non-current assets in the balance sheet.

Characteristics of a Fixed Asset

• They can be depreciated

With the exception of land, fixed assets are depreciated to reflect the wear and tear of using the fixed asset.

• They have a useful life of more than one year

Fixed assets are non-current assets that have a useful life of more than one year and appear on a company’s balance sheet as property, plant, and equipment (PP&E).

• They are illiquid

Fixed assets are non-current assets on a company’s balance sheet and cannot be easily converted into cash.

• They are used in business operations and provide a long-term financial benefit

Fixed assets are used by the company to produce goods and services and generate revenue. They are not sold to customers or held for investment purposes.

Asset Types

Current assets or liquid assets are those assets that can easily be converted into cash and are in the business for a short period of time, generally less than or equal to one year. The liquidity of current assets is significantly greater than that of fixed assets.

Fixed assets or hard assets are those held by a business for a long time and cannot be easily converted into cash. Fixed tangible assets are depreciated over a period of time.

Business Importance of Tangible Assets

Depreciation: Depreciation on tangible assets is a non-cash expenditure. It means that it is an expenditure that helps the company receive a tax benefit, but there is no cash outflow from the business.

Liquidity: As tangible current assets can easily be converted into cash, they provide liquidity to the business and, thus, reduce risk. As long as the value of the assets owned by a business is more than the money risked in acquiring them, a business typically remains safe and solvent.

Collateral Security: The assets can be used as collateral security to obtain loans.

Valuation of Tangible Assets

1. Liquidation Method

The assets can be converted into cash. Thus, it is important for a company to know the minimum value it would receive from a quick sale or liquidation. An assessor is hired and determines the value that an auction house, equipment seller, or other bulk asset buyers would be willing to pay for such categories of assets as those owned by the company.

2. Appraisal Method

Under the appraisal method, an appraiser is hired to determine the true fair market value of a company’s assets. The asset appraiser will assess the current condition of the assets, including the degree of obsolescence and level of wear and tear. Then, the appraiser will compare these values to the values such assets can fetch in the open market.

3. Replacement Cost Method

An insurer generally uses the replacement cost method to calculate the value of the asset for insurance purposes. It helps to determine how much it would cost to replace the asset.

Examples of Fixed Assets

• Machinery
• Land
• Buildings and facilities
• Furniture
• Vehicles (company cars, trucks, forklifts, etc.)
• Computer equipment
• Tools