Tag: NEP 2020 Notes

A change in a country’s balance of payments can cause fluctuations in the exchange rate between its currency and foreign currencies. The reverse is also true when a fluctuation in relative currency strength can alter balance of payments.

Balance of Payments and Exchange Rates

A balance of payment is a statement of all transactions made between entities in one country and the rest of the world over a specific time frame, such as a quarter or a year. Two dynamics are in play which links a country’s balance of payment and changes in the value of its currency: the market for all financial transactions on the international market (balance of payments) and the supply and demand for a specific currency (exchange rate).

Exchange Rate Impacts:

The relationship between the BOP and exchange rates can be illustrated by use of a simplified equation that summarizes BOP data:

BOP = (X-M) + (CI-CO) + (FI-FO) +FXB

• Where: X is exports of goods and services,
• M is imports of goods and services,
• (X-M) is known as Current Account Balance
• CI is capital outflows,
• CO is capital outflows,
• (CI-CO) is known as Capital Account Balance
• FI is financial inflows,
• FO is financial outflows,
• (FI-FO) is known as Financial Account Balance
• FXB is official monetary reserves such as foreign exchange and gold

The effect of an imbalance in the BOP of a country works somewhat differently depending on whether that country has fixed exchange rates, floating exchange rates, or a managed exchange rate system.

a) Fixed Exchange Rate Countries. Under a fixed exchange rate system, the government bears the responsibility to ensure a BOP near zero. If the sum of the current and capital accounts does not approximate zero, the government is expected to intervence in the foreign exchange market by buying or selling official foreign exchange reserves. If the sum of the first two accounts is greater than zero, a surplus demand for the domestic currency exists in the world. To preserve the fixed exchange rate, the government must then intervence in the foreign exchange market and sell domestic currency for foreign currencies or gold so as to bring the BOP back near zero. It the sum of the current and capital accounts is negative, an exchange supply of the domestic currency exists in world markets. Then the government must intervene by buying the domestic currency with its reserves of foreign currencies and gold. It is obviously important for a government to maintain significant foreign exchange reserve balances to allow it to intervene effectively. If the country runs out of foreign exchange reserves, it will be unable to buy back its domestic currency and will be forced to devalue. For fixed exchange rate countries, then, business managers use balance-of-payments statistics to help forecast devaluation or revaluation of the official exchange rate. Normally a change in fixed exchange rates is technically called devaluation or revaluation, while a change in floating exchange rates is called either depreciation or appreciation.

b) Managed Floats. Although still relying on market conditions for day-to-day exchange rate determination, countries operating with managed floats often find it necessary to take actions to maintain their desired exchange rate values. They therefore seek to alter the market‘s valuation of a specific exchange rate by influencing the motivations of market activity, rather than through direct intervention in the foreign exchange markets. The primary action taken by such governments is to change relative interest rates, thus influencing the economic fundamentals of exchange rate determination. A change in domestic interest rates is an attempt to alter capital account balance, especially the short-term portfolio component of these capital flows, in order to restore an imbalance caused by the deficit in current account. The power of interest rate changes on international capital and exchange rate movements can be substantial. A country with a managed float that wishes to defend its currency may choose to raise domestic interest rates to attract additional capital from abroad. This will alter market forces and create additional market demand for domestic currency. In this process, the government signals exchange market participants that it intends to take measures to preserve the currency‘s value within certain ranges. The process also raises the cost of local borrowing for businesses, however, and so the policy is seldom without domestic critics. For managed-float countries, business managers use BOP trends to help forecast changes in the government policies on domestic interest rates.

c) Floating Exchange Rate Countries. Under a floating exchange rate system, the government of a county has no responsibility to peg the foreign exchange rate. The fact that the current and capital account balances do not sum to zero will automatically (in theory) alter the exchange rate in the direction necessary to obtain a BOP near zero. For example, a country running a sizable current account deficit with the capital and financial accounts balance of zero will have a net BOP deficit. An excess supply of the domestic currency will appear on world markets. As is the case with all goods in excess supply, the market will rid itself of the imbalance by lowering the price. Thus, the domestic currency will fall in value, and the BOP will move back toward zero. Exchange rate markets do not always follow this theory, particularly in the short-to-intermediate term.

The International Centre for Settlement of Investment Disputes (ICSID) is an international arbitration institution established in 1966 for legal dispute resolution and conciliation between international investors and States. ICSID is part of and funded by the World Bank Group, headquartered in Washington, D.C., in the United States. It is an autonomous, multilateral specialized institution to encourage international flow of investment and mitigate non-commercial risks by a treaty drafted by the International Bank for Reconstruction and Development’s executive directors and signed by member countries. As of May 2016, 153 contracting member states agreed to enforce and uphold arbitral awards in accordance with the ICSID Convention.

The centre performs advisory activities and maintains several publications.

Governance

ICSID is governed by its Administrative Council which meets annually and elects the centre’s secretary-general and deputy secretary-general, approves rules and regulations, conducts the centre’s case proceedings, and approves the centre’s budget and annual report. The council consists of one representative from each of the centre’s contracting member states and is chaired by the President of the World Bank Group, although the president may not vote. ICSID’s normal operations are carried out by its secretariat, which comprises 40 employees and is led by the secretary-general of ICSID. The secretariat provides support to the Administrative Council in conducting the centre’s proceedings. It also manages the centre’s Panel of Conciliators and Panel of Arbitrators. Each contracting member state may appoint four persons to each panel. 15 In addition to serving as the centre’s principal, the secretary-general is responsible for legally representing ICSID and serving as the registrar of its proceedings. As of 2012, Meg Kinnear serves as the centre’s secretary-general.

Features of the ICSID Convention

The ICSID Convention provides the basic procedural framework for conciliation and arbitration of investment disputes arising between ICSID Member States and investors that qualify as nationals of other Member States. It is a treaty among Member States establishing an independent, impartial and self-contained system.

ICSID proceedings are delocalized from domestic procedures. This means that local courts do not intervene in the ICSID process. Some implications of the self-contained system and other main features include:

• Awards in ICSID Convention arbitrations are final and binding, and may not be set aside by the courts of any Member State (Article 53 of the Convention).
• The limited post-award remedies available are set out in the Convention itself (Articles 49 to 52 of the Convention).
• All Members States, whether or not parties to the dispute, recognize and enforce ICSID Convention monetary awards as final judgments in any Member State (Article 54 of the Convention).
• Once disputing parties consent to ICSID arbitration and unless they agree otherwise, they accept ICSID arbitration as the exclusive remedy (Article 26 of the Convention).
• A Member State cannot give diplomatic protection to any of its nationals which have consented to arbitration under the Convention, except in limited circumstances (Article 27 of the Convention).
• The place of proceedings, i.e., where hearings are held, has no legal significance in Member States (Articles 62 to 63 of the Convention).
• Participants enjoy immunity from legal process in the conduct of the proceedings (Articles 21 to 22 of the Convention).

The International Finance Corporation (IFC) is an international financial institution that offers investment, advisory, and asset-management services to encourage private-sector development in less developed countries. The IFC is a member of the World Bank Group and is headquartered in Washington, D.C. in the United States.

It was established in 1956, as the private-sector arm of the World Bank Group, to advance economic development by investing in for-profit and commercial projects for poverty reduction and promoting development. The IFC’s stated aim is to create opportunities for people to escape poverty and achieve better living standards by mobilizing financial resources for private enterprise, promoting accessible and competitive markets, supporting businesses and other private-sector entities, and creating jobs and delivering necessary services to those who are poverty stricken or otherwise vulnerable.

Since 2009, the IFC has focused on a set of development goals that its projects are expected to target. Its goals are to increase sustainable agriculture opportunities, improve healthcare and education, increase access to financing for microfinance and business clients, advance infrastructure, help small businesses grow revenues, and invest in climate health.

The IFC is owned and governed by its member countries but has its own executive leadership and staff that conduct its normal business operations. It is a corporation whose shareholders are member governments that provide paid-in capital and have the right to vote on its matters. Originally, it was more financially integrated with the World Bank Group, but later, the IFC was established separately and eventually became authorized to operate as a financially autonomous entity and make independent investment decisions.

It offers an array of debt and equity financing services and helps companies face their risk exposures while refraining from participating in a management capacity. The corporation also offers advice to companies on making decisions, evaluating their impact on the environment and society, and being responsible. It advises governments on building infrastructure and partnerships to further support private sector development.

The corporation is assessed by an independent evaluator each year. In 2011, its evaluation report recognized that its investments performed well and reduced poverty, but recommended that the corporation define poverty and expected outcomes more explicitly to better-understand its effectiveness and approach poverty reduction more strategically. The corporation’s total investments in 2011 amounted to $18.66 billion. It committed $820 million to advisory services for 642 projects in 2011, and held $24.5 billion worth of liquid assets. The IFC is in good financial standing and received the highest ratings from two independent credit rating agencies in 2018.

IFC comes under frequent criticism from NGOs that it is not able to track its money because of its use of financial intermediaries. For example, a report by Oxfam International and other NGOs in 2015, “The Suffering of Others,” found the IFC was not performing enough due diligence and managing risk in many of its investments in third-party lenders.

Functions

Investment services

The IFC’s investment services consist of loans, equity, trade finance, syndicated loans, structured and securitized finance, client risk management services, treasury services, and liquidity management. In its fiscal year 2010, the IFC invested $12.7 billion in 528 projects across 103 countries. Of that total investment commitment, approximately 39% ($4.9 billion) was invested into 255 projects across 58 member nations of the World Bank’s International Development Association (IDA).

The IFC makes loans to businesses and private projects generally with maturities of seven to twelve years. It determines a suitable repayment schedule and grace period for each loan individually to meet borrowers’ currency and cash flow requirements. The IFC may provide longer-term loans or extend grace periods if a project is deemed to warrant it. Leasing companies and financial intermediaries may also receive loans from the IFC.

Though loans have traditionally been denominated in hard currencies, the IFC has endeavored to structure loan products in local currencies. Its disbursement portfolio included loans denominated in 25 local currencies in 2010, and 45 local currencies in 2011, funded largely through swap markets. Local financial markets development is one of IFC’s strategic focus areas. In line with its AAA rating, it has strict concentration, liquidity, asset-liability and other policies. The IFC committed to approximately $5.7 billion in new loans in 2010, and $5 billion in 2011.

Advisory services

In addition to its investment activities the IFC provides a range of advisory services to support corporate decisionmaking regarding business, environment, social impact, and sustainability. The IFC’s corporate advice targets governance, managerial capacity, scalability, and corporate responsibility. It prioritizes the encouragement of reforms that improve the trade friendliness and ease of doing business in an effort to advise countries on fostering a suitable investment climate. It also offers advice to governments on infrastructure development and public-private partnerships. The IFC attempts to guide businesses toward more sustainable practices particularly with regards to having good governance, supporting women in business, and proactively combating climate change. The International Finance Corporation has stated that cities in emerging markets can attract more than $29 trillion in climate-related sectors by 2030.

Asset management company

The IFC established IFC Asset Management Company LLC (IFC AMC) in 2009 as a wholly owned subsidiary to manage all capital funds to be invested in emerging markets. The AMC manages capital mobilized by the IFC as well as by third parties such as sovereign or pension funds, and other development financing organizations. Despite being owned by the IFC, the AMC has investment decision autonomy and is charged with a fiduciary responsibility to the four individual funds under its management. It also aims to mobilize additional capital for IFC investments as it can make certain types of investments which the IFC cannot. As of 2011, the AMC managed the IFC Capitalization Fund (Equity) Fund, L.P., the IFC Capitalization (Subordinated Debt) Fund, L.P., the IFC African, Latin American, and Caribbean Fund, L.P., and the Africa Capitalization Fund, Ltd. The IFC Capitalization (Equity) Fund holds $1.3 billion in equity, while the IFC Capitalization (Subordinated Debt) Fund is valued at $1.7 billion. The IFC African, Latin American, and Caribbean Fund (referred to as the IFC ALAC Fund) was created in 2010 and is worth $1 billion. As of March 2012, the ALAC Fund has invested a total of $349.1 million into twelve businesses. The Africa Capitalization Fund was set up in 2011 to invest in commercial banks in both Northern and Sub-Saharan Africa and its commitments totaled $181.8 million in March 2012. As of 2018, Marcos Brujis serves as CEO of the AMC.

Sustainability

IFC Sustainability Framework articulates IFC’s commitment to sustainable development and is part of its approach to risk management. IFC’s Environmental and social policies, guidelines, and tools are widely adopted as market standards and embedded in operational policies by corporations, investors, financial intermediaries, stock exchanges, regulators, and countries. In particular, the EHS Guidelines contain the performance levels and measures that are normally acceptable to the World Bank Group and that are generally considered to be achievable in new facilities at reasonable costs by existing technology.

Green buildings in less developed countries

The IFC has created a mass-market certification system for fast growing emerging markets called EDGE (“Excellence in Design for Greater Efficiencies”). IFC and the World Green Building Council have partnered to accelerate green building growth in less developed counties. The target is to scale up green buildings over a seven-year period until 20% of the property market is saturated. Certification occurs when the EDGE standard is met, which requires 20% less energy, water, and materials than conventional homes.

A common size income statement is an income statement in which each line item is expressed as a percentage of the value of revenue or sales. It is used for vertical analysis, in which each line item in a financial statement is represented as a percentage of a base figure within the statement.

Common size financial statements help to analyze and compare a company’s performance over several periods with varying sales figures. The common size percentages can be subsequently compared to those of competitors to determine how the company is performing relative to the industry.

• In financial statement analysis, it is used to compare companies that operate in the same or different industries or to compare the performance of the same company over different time periods.
• Further, it helps a financial analyst establish a relationship between each of the accounts in the income statement and the total sales and eventually helps ascertain how each of the accounts affects the total profitability.
• From an investor’s perspective, it gives a clear picture of the various expense accounts, which are subtracted from the total sales to generate the net income.

Advantages

• It helps in assessing the trend in each line item of the income statement w.r.t. across time periods. Any unusual variation can be easily identified through this technique.
• It can facilitate comprehending the impact of all line items of the income statement on the company’s profitability as it expresses them in terms of the percentage of total sales.
• It can be used to compare the financial performances of different entities irrespective of the scale of operation as it is expressed in terms of percentage.

Disadvantages

• Some of the experts find common size income statements to be useless as there is no approved standard benchmark for the proportion of each item.
• A comparative study based on a common size income statement will be misleading if there is a lack of consistency in its method of preparation.

Limitations

• It does not facilitate the decision-making process due to the lack of any approved standard benchmark.
• One can’t write-off the risk of window dressing of financial statements as the actual figures are not required since the analysis is limited to percentage.
• At times it also fails to identify the qualitative elements during the evaluation of the performance of a company.
• It can be misleading for a business that is impacted by seasonal fluctuations.

A comparative analysis is one of the widely used tools to analyze financial statements. It is an act of comparing the report for 2 or more financial years or any given period. A comparative balance sheet is one of the most sought financial statements by the business. The biggest advantage of comparing financial statements over time is discovering trends, analyzing the findings and taking suitable decisions.

To define comparative financial statements, it’s a financial statement which represents the financial position over different periods of time. The financial position is represented in a comparative form to give an idea of financial position at two or more periods.

Generally, two financial statements are prepared in comparative form for financial analysis

Included in a Comparative Balance Sheet

The line items that are included in a comparative balance sheet are the same that are included in an individual balance sheet. The general categories included are: assets, liabilities, and equity. The categories are further broken down into current assets, current liabilities, long-term assets, and long-term liabilities.

More specifically, common balance sheet items are as follows:

Current assets:

• Cash
• Accounts receivable
• Inventory
• Prepaid expenses

Long-term assets:

• Fixed assets
• Long-term investments

Current liabilities:

• Accounts payable
• Accrued expenses (such as payroll and payroll taxes)
• Notes payable

Long-term liabilities:

• Long-term bank loans
• Other long-term debt

Equity:

• Common stock
• Retained earnings

Format:

Advantages of Comparative Balance Sheet

• Trend Indicator: It shows the company’s trend by putting several years’ financial figures in one place like an Increase or Decrease in profit, current assets, current liabilities, loans, reserves & surplus, or any other items that help investors make the decision.
• Comparison: It is effortless to compare the figures for the current year with the previous years as it gives both the years’ figures in one place. It also assists in analyzing the data of two or more companies or subsidiaries of one company.
• Compare performance with the Industry Performance: Helps to compare one company’s performance with another company or the industry’s average performance.
• Ratio Analysis: Financial ratio is derived from the balance sheet items. The comparative balance sheet’s financial ratio of two years of two companies can be derived to analyze the company’s financial status. For example, the current ratio is derived with the help of current assets and current liabilities. If the current ratio of the current year is more than the last year, it shows the company’s liabilities have been reduced from last year against the existing assets.
• Helps in Forecasting: It also helps in forecasting because it provides the past trend of the company based on which the management can forecast the company’s financial position.

Limitation/Disadvantages

• Inflationary Effect is not Considered: While preparing the comparative balance sheet, the inflation effect is not considered. Therefore, only a comparison with other balance sheets will not give the correct picture of the company’s trend.
• Uniformity in Policy and Principles: Comparative balance sheets will not give the correct comparison if two companies have adopted different policies and accounting principles while preparing the balance sheet or if the same company has adopted other accounting methods in two additional years.
• Market Situation and Political Conditions not Considered: While preparing the comparative balance sheet, marketing conditions, political environment, or any factor affecting the company’s business are not considered. Therefore, it does not give the correct picture every time. For example, suppose the overall economy is going down in the current year, or the political condition is unstable compared to last year. In that case, it will decrease the demand, and general company sales will experience de-growth, not because of its performance but external factors.
• Misleading Information: Sometimes, it gives misleading information, thus, misguiding the person who reads the comparative balance sheet. For example, if a product was unavailable for last year and is available for the current year, it will show a 100% change over the previous year. It implies that one needs to read the complete financial statement, not just a comparative balance sheet.

A Comparative Income Statement shows the operating results for several accounting periods. It helps the reader of such a statement to compare the results over the different periods for better understanding and detailed analysis of variation of line-wise items of Income Statement.

• Comparative Income Statement format combines several Income Statements as columns in a Single Statement, which helps the reader analyze trends and measure the performance over different reporting periods.
• It can also be used to compare two different companies’ operating metrics. Such Analysis helps in comparing the performance with another business, which can analyze how companies react to market conditions affecting the companies belonging to the same Industry.
• Thus Comparative Income Statement is an essential tool through which the result of operations of a business (or, say, the operation of the business of different companies) over multiple accounting periods can be analyzed to understand the various factors contributing to the change over the period for better interpretation and analysis.
• It helps various stakeholders of the business and the Analyst community to analyze the impact of business decisions over the company’s top line and bottom line and helps identify various trends over the period, which otherwise would have been difficult and time-consuming.
• Comparative Income Statement shows absolute figures, changes in absolute figures, unlimited data in terms of percentages, and an increase (or decrease) in percentages over the different periods. With the help of a Comparative Income Statement format in one snapshot, a company’s performance over different periods can be compared, and changes in expense items and Sales can be easily ascertained.

Comparative income statement analysis

To understand your financial data, do a comparative income statement analysis. There are two ways you can look at information: horizontal and vertical.

Each kind of analysis gives different insights into business performance. The analyses help you make sense of your comparative profit and loss statement and see patterns.

Horizontal analysis

A horizontal, or time series, analysis looks at trends over time. You can see growth patterns and seasonality. When calculating growth, look at the percentage of change between accounting periods.

Vertical analysis

A vertical, or common-size, analysis looks at the relative size of line items. It allows you to compare income statements from different-sized companies. To compare competing businesses, find the percentage of revenue for each line item.

Income statements of companies of different sizes. It shows each item on the Income Statement as a percentage of Base figures (usually the Sales figure) with the statement. Under this, all components of Income statements are shown as a percentage of sales, such as Gross Profit, Net Profit, Cost of Sales, etc., which makes it very handy to use even when comparing differently as it removes the Size biases and makes the analysis more straightforward and understandable. It is mostly used for individual statements for a reporting period but can also be used for timeline analysis.

Reasons:

As a small business owner, you need to measure performance. If you don’t, how do you know if the decisions you make for your business are working? Looking at a comparative income statement helps you analyze profitability over time.

You can use a comparative income statement to look at important financial figures. Patterns in past figures can guide you in the future. For example, you compare last year’s return on investment (ROI) to the current year. This tells you if the money you put into your business brings in a greater amount of income.

Comparative income statements can also reveal if your costs and revenues are consistent. Let’s say in three years your cost of goods sold (COGS) goes from 25% of sales to 40% of sales. By recognizing the increase, you can find solutions to reduce COGS.

Business investors use comparative income statements to look at different companies. The comparison helps them decide which business is a better investment.

Advantages of a Comparative Income Statement

Spikes and dips in revenues and expenses are immediately obvious when this format is used, and can then be investigated by management. In particular, one could use the report to discern patterns in sales from month to month that might be used to forecast future sales.

• It makes analysis simple and fast as past figures can easily be compared with the current figures without referring to separate past Income Statements.
• It makes comparisons across different companies also easy and helps analyze the efficiency both at Gross Profit Level and Net Profit Level.
• It shows percentage changes in all income statement line items, which makes analysis and Interpretation of Top Line (Sales) and Bottom Line (Net Profit) easy and more informative.

Disadvantages of a Comparative Income Statement

The results of this comparison may not be useful if an account has been shifted into a different line item at some point during the reporting period. Such a change would cause a downward spike in one line item and an upward spike in another line item. Consequently, such changes in reporting should be as infrequent as possible, or all clustered at the beginning of a fiscal year.

• Financial Data reported in the Comparative Income Statement is useful only if the same accounting principles are followed to prepare such statements. If the deviation is observed, such a Comparative Income Statement will not serve the intended purpose.
• A comparative Income Statement is not of much use in cases where the company has diversified into new business lines, which have drastically impacted Sales and profitability.

Financial analysts play a critical role in an organization’s daily operations. At a high level, they research and utilize financial data to understand the business and market to see how an organization stacks up. Based on general economic conditions and internal data, they recommend actions for the company to take, like selling stock or making other investments.

A financial analyst is responsible for a variety of research tasks in order to inform investment strategy and make investment decisions for their company or clients. This can include things like evaluating financial data, examining current events and market developments, examining an organization’s financial statements, and creating financial models to predict future performance. Depending on the position, analysts can monitor macroeconomic trends or have a narrow focus on specific sectors and industries. These roles are data-intensive and require strong mathematical and analytical skills. Given the value of their role, financial analysts can be employed by large corporations such as investment banks, insurance companies, mutual funds, hedge funds, pension funds, securities firms, investment firms, private equity groups, venture capital firms, government agencies, and similar types of organizations.

Of course, this is just skimming the surface of a financial analyst’s responsibilities. Here are some of the more specific tasks these professionals might perform for a company, according to the Corporate Finance Institute:

Gather and organize information: Whether it’s a company’s historical financial reports and accounting data or macroeconomic information and industry research, an analyst must know how to find, collect and organize vast amounts of information relevant to their business and industry. They use their research skills to review internal databases and reports from government agencies and enter them into a database, like an Excel spreadsheet.

Examine financial statements: A company’s financial statements hold a wealth of important information for a financial analyst. Using these documents (and those sorted into internal databases), they are able to determine the value of the organization. This is one of the most important responsibilities of financial analysts, as this information guides their recommendations and serves as a benchmark for the company’s performance.

Recommend investments: After analyzing all of this information, financial analysts develop a forecast about the market and how the company will perform in the future. This is where they must use their outside knowledge alongside the financial calculations to make recommendations to company officials or investment bankers. A financial analyst will create a portfolio filled with reports backing up their recommendations.

A financial analyst must be prepared to take on many responsibilities. They must conduct research and financial analysis, connect with management teams and company officials and generate written reports and presentations. This is different from an accountant who would be concerned with a company’s financials from an operational perspective, rather than the big-picture, strategic angle of a financial analyst.

Financial analysts work in a number of different industries, including securities, commodities, contracts, investment banking and other financial services. And while the general responsibilities of this role are outlined above, the Bureau of Labor Statistics noted that a financial analyst can choose a specialization based on their professional capacities.

Here are some of the specific roles someone with this expertise can take on:

Fund management: These analysts exclusively work with hedge or mutual funds. They assist management teams and evaluate their strength to help make investment decisions in line with current market trends.

Portfolio management: Every organization wants a strong portfolio. This requires the right balance of products, services, industries and global regions in which to invest, helping the longevity and success of their company. Financial analysts use their expertise to analyze market and business data to recommend a positive investment strategy and measure results.

Ratings analysis: This niche analysis focuses on guiding businesses or government agencies through the best strategies to pay down debts, like bonds. These analysts are heavily involved in understanding a company’s debts and the risk involved if it was unable to repay them.

Risk analyses: As the title suggests, a financial analyst specializing in risk assesses the company’s financial strategy to locate potential sources of loss. However, unlike the previous role, these analysts aim to reduce the risk involved with financial investments and maximize profits.

A senior financial analyst, on the other hand, would take a more active role in building a financial model, forecasting trends and making business recommendations. That’s because they may have a master’s degree with a discipline in finance and more years of experience in the industry or with the company itself. They typically lead a team of analysts and manage workflows to ensure reports and recommendations are ready when business leaders need them.

Most financial analyst job descriptions, whether buy-side or sell-side, include the following key responsibilities:

• Research industry-specific financial developments including broad economic trends and business trends
• Analyze financial statements to evaluate investment opportunities
• Create financial modeling for investors to find profitable investments
• Recommend individual investments and collections of investments
• Asses the performance of stocks, other types of investments, and bonds
• Translate financial data into detailed presentations and easy-to-understand financial reports
• Communicate with C-suite executives from client companies to understand company needs
• Stay up to date with new technologies and market conditions

ITR-1 Form

This form is also known as the Sahaj form. Individual taxpayers should go for ITR 1 filing. Any other taxpayer is not eligible to choose this form for ITR returns.

Applicable for:

The following individuals can apply for this form:

• An individual who draws income from salary or pension.
• An individual whose income is solely dependent on single housing property.
• A person without any income from capital gains and other business.
• An individual who is not an owner of any foreign asset or does not have any foreign source of income.
• An individual whose agricultural income is up to Rs. 5000.
• A person with additional sources of income likes other investments, fixed deposits, etc.
• Any individual without having any income from winning lotteries, horse racing, and other windfalls.
• Individuals who want to club their spouses’ or underage children’s income with theirs.

Not eligible:

Any other assessee belonging to the following category is not eligible to file ITR 1 for tax returns.

• One whose income exceeds Rs.50 lakhs.
• Individuals having agricultural income above Rs.5000.
• Applicants with income from capital gains and businesses.
• In case a person is having income from many house properties.
• If an individual is a director in a company, he cannot apply for ITR 1.
• One investing in unlisted equity shares at any point of time during the fiscal year is not eligible to choose this form.
• Owners of foreign assets being a resident and having income from foreign sources.
• Individuals who are non-residents and RNOR (residents not ordinarily residents).
• A person who is assessable for another person’s income cannot file IT returns using this form. In such a case, tax deduction takes place in terms of the other person.

ITR-2 Form

ITR 2 income tax is eligible for those individuals who have their income by selling assets or properties. Individuals having incomes from outside of India can also use this form. Furthermore, HUFs can also apply for ITR 2 form to file income tax returns.

Eligibility criteria to file tax returns by using ITR 2 form

Individuals belonging to the following categories can apply for ITR 2 forms:

• Individuals who accrue income by means of salary or pension.
• One whose income source depends on capital gains, that is, from the sale of an asset or property.
• In case a person’s income is possibly coming from more than one house property.
• Owner of foreign assets and one whose income source is outside India.
• A person whose agricultural income is more than Rs.5000.
• People with incomes from winning a lottery etc.
• If an individual is a director in a company.
• Non-residents and RNOR.

Categories not eligible to apply for this form:

Not all taxpayers should avail of this form for income tax returns. We have categorised such people in the following section for your better understanding.

• Individuals whose total income is inclusive of any profits or gains of a business venture or other profession cannot opt for this form.
• Ones with total income lower than Rs.50 lakhs.

ITR-3 Form

Individual taxpayers or HUFs operating as partners in a firm without conducting any business under the firm are eligible to apply for ITR 3. Taxpayers looking in search of the meaning of ITR 3 should be thorough with the eligibility criteria of the said form.

Applicable for:

Applicants having the following income sources are eligible to file ITR 3.

• Incomes from investments on unlisted equity shares.
• Individuals continuing a business or profession are eligible.
• Company director.
• Incomes coming from house property, pension, salary, or other sources.
• A person having income by being a partner in a firm.

Not Applicable for:

Taxpayers eligible for ITR 1 and ITR 2 belong to a certain category. Similarly, some taxpayers should not file this form for IT returns. Given below are some of the individuals who are not eligible for this form.

• Any individual with a business turnover below Rs.2 crores.
• The ones who do not earn income from a business conducted by a firm cannot apply for ITR 3.
• Taxpayers can file ITR 3 if the taxable income from the business comes in the form of salary, bonus, commission, remuneration and interest. Other than this, any other source of income from the business is not eligible.

ITR-4S Form

Also known by the name Sugam, ITR 4 means that individuals who run a business and accrue income from it or other professions can file for IT returns by using this form. With this income, they can club the earning from any windfall and apply for this form. Additionally, taxpayers from professions like doctors, shopkeepers, designers, retailers, agents, contractors, etc., can file their ITR using this form.

Applicable for:

ITR 4 meaning is simple for those who are accustomed to the eligibility. Here are some of the eligibility criteria.

• Individuals earning income from businesses.
• One who has a single house property and earns income through it.
• Taxpayers not having income via capital gains or selling of assets.
• If the agricultural income of a person is below Rs. 5000, he can file ITR 4.
• Individuals not owning properties or assets outside India.
• An applicant whose source of income is within India.
• This form is also applicable to businesses where the income earned depends on a presumptive scheme under Section 44AD, Section 44ADA and Section 44AE of the Income Tax Act.

Not Applicable for:

Some individuals do not qualify for an application of the ITR-4S form to file tax returns. Such categories are mentioned below.

• Owners of a foreign asset.
• Company directors.
• A person with a foreign source of income.
• Total income of a taxpayer exceeding Rs. 50 lakhs.
• If an applicant carries forward loss under any income head, he cannot utilise this form.
• Investors of unlisted equity shares.
• A non-resident and a resident not ordinarily resident.
• Individuals generating income from more than one housing property.
• Having a signing authority in any account outside India.
• If a taxpayer is an assessee with respect to another person’s income where tax deduction takes place in the hands of another person.
• Limited Liability Partnerships (LLPs) cannot avail of this form.

ITR-5 Form

Business trusts, firms, etc., must opt for this form to file ITR. ITR 5 means forms that are eligible for partnership firms or LLPs. To understand the meaning of ITR 5 in detail, one should know in-depth about the taxpayers eligible under this form and those who are not.

Eligible taxpayers:

The following bodies can file IT returns using this form.

• LLPs (Limited Liability Partnerships).
• Co-operative societies.
• Local authorities.
• BOIs (Body of Individuals).
• Artificial judicial persons.
• AOPs (Association of Persons).
• Estate of the deceased and insolvent.
• Investment funds.
• Business trusts.

Not Eligible taxpayers:

Here is a list of persons not eligible to file ITR 5.

• Any individual filing for ITR 1.
• Hindu Undivided Families (HUFs).
• Any company.
• The ones filing for ITR 7 cannot file for this form.
• Applicants with income from capital gains.

ITR-6 Form

ITR 6 means an income tax return form eligible for companies to file tax returns. Companies can file income tax by this form only electronically.

Eligible for:

Given below are the bodies and the income sources eligible for this form.

• All companies except the ones claiming exemption under Section 11.
• Incomes earned from housing property.
• Business incomes.
• Incomes from multiple sources.

Not Eligible for:

In the following section, we enlisted a few organisations and income sources not eligible to file IT returns using ITR 6 form.

• Organisations under Section 11 can claim tax exemptions because the income accrued from these bodies is used for religious or charitable purposes.
• Incomes coming from capital gains.
• Any individual or HUFs.

ITR 7 Form

Individuals and firms that have furnished returns related to Section 139(4A), Section 139(4B), Section 139(4C), Section 139(4D), Section 139(4E) and Section 139(4F) must choose this ITR form.

Listed below are the details of the returns that should be filed section-wise:

 Section 139(4A): The ITR forms must be submitted by individuals who gain an income from a property that belongs to a charity/trust or other legal obligations and the income that is produced is solely used for charitable or religious purposes

Section 139(4B): ITR forms must be filed under this section by a political party if the gross income that has been generated is more than the maximum sum

Section 139(4C): ITR forms must be submitted under this section if it is a Scientific Research association, hospitals, medical institutions, universities, funds, News agencies and other educational institutions

Section 139(4D): Any educational institution such as a college or university that are not required to furnish any income or loss must submit ITR forms under this section

Section 139(4E): Business trusts that do not need to furnish any kind of income or loss must file ITR forms under this section

Section 139(4F): Investment funds present under Section 115UB and do not need to furnish any income or losses must also submit ITR forms under this section

The concept of Arm’s length derives its meaning from the independent relation shared between independent parties. Unlike business transactions between related parties, the transactions between unrelated parties are done at an open market price and accordingly, Arm’s Length Price (‘ALP’) demonstrates the price that should have been charged between related parties had those parties were not related to each other.  

Under Indian Transfer Pricing regulations, the entire transfer Pricing Mechanism is based on computation of income arising out of cross-border transactions having regard to the arm’s length price. The definition of ALP as defined under Organisation for Economic Co-operation and Development (‘OECD’) Transfer Pricing Guidelines means a price, at which transactions between persons other than associated enterprises are carried out in uncontrolled circumstances.

In general, the Indian Transfer Pricing Regulations provide exhaustive definitions of terms Associated Enterprise (‘AE’) and International Transactions on which the transfer pricing procedure is based. In other words, for the purpose of computing Arm’s length price, it is pertinent to understand the concept of AE and International transactions.

The term Associated Enterprises has been defined under the Income Tax Act, 1961 under section 92A(1). The concept of Deemed Associated Enterprises has been defined under section 92A(2) of the Act. Further, certain parties are defined as AE under Indian Domestic Transfer Pricing provisions.

Under Income Tax Act, 1961 Section 92F define Arm’s Length Price is the price applied (or proposed to be applied) when two unrelated persons enter into a transaction in uncontrolled conditions. Unrelated Persons;

Section 92A, the persons said to be unrelated if they are not associated or deemed to be associated enterprise.

Uncontrolled Conditions; are that conditions which are not controlled or suppressed or moulded for achievement of a predetermined results.

1. Comparable Uncontrolled Price Method(CUP) Under this method;

i) Determined the price charged or paid for the property transferred or services provided in a comparable uncontrolled transaction.

ii) Such price is adjusted to account for differences, if any, between the International transaction and comparable uncontrolled controlled transactions or between the parties entering into such transactions, which could materially affect the price in the open market.

iii) The adjusted price arrived at under ii) is taken to be Arm’s Length Price in respect of the property transferred or services provided in international transaction.

2. Resale Price Method Under this method

i) The price at which property purchased or services obtained by the enterprise from an associated enterprise are resold or are provided to an unrelated enterprise, is identified.

ii) Such resale price is reduced by the amount of normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services in a comparable uncontrolled transaction, or a number of such transactions;

iii) The price so arrived at is further reduced by the expenses incurred by the enterprise in connection with the purchase of the property or obtaining the services.

iv) The price so arrived at is adjusted to take into account the functional and other differences including differences in accounting practices , if any , between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of gross profit margin in the open market;

v) The adjusted price arrived at iv) is taken to be arm’s length price in respect of the purchase of property or obtaining of the services by the enterprise from the associated enterprise.

Cost Plus Method Rule 10B prescribes the manner in which CPM can be applied. The text reads as follows:

(i) The direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise, are determined;

(ii) The amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction, or a number of such transactions, is determined;

(iii) The normal gross profit mark-up referred to in sub clause (ii) Is adjusted to take into account the functional and other differences, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market;

(iv) The costs referred to in sub-clause (i) Are increased by the adjusted profit mark-up arrived at under sub-clause (iii);

(v) The sum so arrived at is taken to be an Arm’s Length Price in relation to the supply of the property or provision of services by the enterprise;”

Transactional Net Margin Method (TNMM)

Under this method;

i) The net profit margin realised by the enterprise from an international transaction entered into with an associate enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base;

ii) The net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same basis;

iii) The net profit margin referred to in ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences , if any between the international transaction and the comparable , uncontrolled transactions, or between the enterprises entering into such transactions , which could materially affect the amount of net profit margin in the open market;

iv) The net profit margin realised by the enterprise and referred in i) is established to be the same as the net profit margin referred in iii);

v) The net profit margin thus established is then taken into account to arrive at an arm’s length price in relation to the international transaction.

Profit Split Method Under this method;

i) The combined net profit of the associated enterprises arising from the international transaction in which they are engaged, are determined;

ii) The relative contribution made by each of the associated enterprises to the earning of such combined net profit, is then evaluated on the basis of the functions performed, assets employed or to be employed and risks assumed by each enterprise and on the basis of reliable external market data which indicates how such contribution would be evaluated by unrelated enterprises performing comparable functions in similar circumstances.

iii) The combined net profit is then split among the enterprises in proportion to their relative contributions, as evaluated under ii);

iv) The profit thus apportioned to the assessee is taken into account to arrive at arm’s length price in relation to the international transaction.

Countries around the world have huge differences in tax rates. These differences give incentive to the multinational enterprises to shift profits from high tax countries to ones with lower tax rates. This shifting of profits can be easily achieved via internal transactions, a holding company providing financing or consultancy services to its subsidiaries, a manufacturing branch supplying finished product to a distributing branch, one associated enterprise supplying provision of services to another. The MNEs can set the price and control the terms and conditions of these transactions and thereby influence the amount of profit and resultant amount of tax due. To prevent this from happening, tax administrations (organized in the OECD) invented the arm’s length principle (Article 9 of the OECD Model Convention) which requires that controlled transactions are done at market rates.

Objective of Transfer Pricing

“Associated Enterprise” means an enterprise that participates or in respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in the management, control, or capital of the other enterprise.

“Arm’s Length Price” refers to the price that should have been charged between related parties had those parties been not related to each other.

“Constituent Entity” means:

• Any entity of the international group that is included in consolidated financial statements for financial reporting purpose or included if equity share of any entity of the group were to be listed; or
• Any entity of the group which is excluded from consolidated financial statements on the basis of size or materiality; or
• Any permanent establishment of an entity of the group if separate financial statements are prepared for financial reporting, regulatory, tax reporting, or internal management control purposes.

Risks

• There can be disagreements within the divisions of an organization regarding the policies on pricing and transfer.
• Lots of additional costs are incurred in terms of time and manpower required in executing transfer prices and maintaining a proper accounting system to support them. Transfer pricing is a very complicated and time-consuming methodology.
• It gets difficult to establish prices for intangible items such as services rendered, which are not sold externally.
• Sellers and buyers perform different functions and, thus, assume different types of risks. For instance, the seller may refuse to provide a warranty for the product. But the price paid by the buyer would be affected by the difference.