Tag: University of Mumbai BMS Notes

Corporate finance is the division of finance that deals with financing, capital structuring, and investment decisions. Corporate finance is primarily concerned with maximizing shareholder value through long and short-term financial planning and the implementation of various strategies. Corporate finance activities range from capital investment decisions to investment banking.

Corporate finance is one of the most important subjects in the financial domain. It is deep rooted in our daily lives. All of us work in big or small corporations. These corporations raise capital and then deploy this capital for productive purposes.

Corporate finance departments are charged with governing and overseeing their firms’ financial activities and capital investment decisions. Such decisions include whether to pursue a proposed investment and whether to pay for the investment with equity, debt, or both.

Principles of Corporate Finance

Let’s understand the three most fundamental principles in corporate finance which are- the investment, financing, and dividend principles.

Investment Principle

This principle revolves around the simple concept that businesses have resources which need to be allocated in the most efficient way. The first and important decision that needs to be made in corporate finance is to do this wisely, i.e. decisions that not only provide revenue opportunities but also saves money for the future. This also encompasses the working capital decisions such as the credit days to be allotted to the customers etc. Corporate finance also measures the return on a planned investment decisions by comparing it to the minimum tolerable hurdle rate and deciding if the project/investment is feasible to be undertaken.

Financing Principle

Most often businesses are funded with either debt or equity or both. In the investment decision that we earlier discussed once we have finalized the mix of equity and debt and its effects for the minimum acceptable hurdle rate, the next step would be to determine if the mix is the right one in the financing principle section.

Dividend Principle

Businesses reach a stage in their life cycle where they grow and mature and the cash flow they generate exceeds the expected hurdle rate. At this stage, the company needs to determine the ways of rewarding the owners with it. So the basic discussion here is that if the excess cash should be left in the business or given away to the investors/owners. A company that is publicly held has the option of either pay off dividends or buy back stocks.

Types of Corporate Finance

1. Capital Investments

Corporate finance tasks include making capital investments and deploying a company’s long-term capital. The capital investment decision process is primarily concerned with capital budgeting. Through capital budgeting, a company identifies capital expenditures, estimates future cash flows from proposed capital projects, compares planned investments with potential proceeds, and decides which projects to include in its capital budget.

Making capital investments is perhaps the most important corporate finance task that can have serious business implications. Poor capital budgeting (e.g., excessive investing or under-funded investments) can compromise a company’s financial position, either because of increased financing costs or inadequate operating capacity.

 Corporate financing includes the activities involved with a corporation’s financing, investment, and capital budgeting decisions.

2. Capital Financing

Corporate finance is also responsible for sourcing capital in the form of debt or equity. A company may borrow from commercial banks and other financial intermediaries or may issue debt securities in the capital markets through investment banks (IB). A company may also choose to sell stocks to equity investors, especially when need large amounts of capital for business expansions.

Capital financing is a balancing act in terms of deciding on the relative amounts or weights between debt and equity. Having too much debt may increase default risk, and relying heavily on equity can dilute earnings and value for early investors. In the end, capital financing must provide the capital needed to implement capital investments.

3. Short-Term Liquidity

Corporate finance is also tasked with short-term financial management, where the goal is to ensure that there is enough liquidity to carry out continuing operations. Short-term financial management concerns current assets and current liabilities or working capital and operating cash flows. A company must be able to meet all its current liability obligations when due. This involves having enough current liquid assets to avoid disrupting a company’s operations. Short-term financial management may also involve getting additional credit lines or issuing commercial papers as liquidity back-ups.

Importance/Significance of Corporate Financing

1. Separation of Ownership and Management

The basis of corporate finance is the separation of ownership and management. Now, the firm is not restricted by capital which needs to be provided by an individual owner only. The general public needs avenues for investing their excess savings. They are not content with putting all their money in risk free bank accounts. They wish to take a risk with some of their money. It is because of this reason that capital markets have emerged. They serve the dual need of providing corporations with access to source of financing while at the same time they provide the general public with a plethora of choices for investment.

2. Liaison between Firms and Capital Markets

The corporate finance domain is like a liaison between the firm and the capital markets. The purpose of the financial manager and other professionals in the corporate finance domain is twofold. Firstly, they need to ensure that the firm has adequate finances and that they are using the right sources of funds that have the minimum costs. Secondly, they have to ensure that the firm is putting the funds so raised to good use and generating maximum return for its owners.

3. Financing Decision

As stated above the firm now has access to capital markets to fulfill its financing needs. However, the firm faces multiple choices when it comes to financing. The firm can firstly choose whether it wants to raise equity capital or debt capital. Even within the equity and debt capital the firm faces multiple choices. They can opt for a bank loan, corporate loans, public fixed deposits, debentures and amongst a wide variety of options to raise funds. With financial innovation and securitization, the range of instruments that the firm can use to raise capital has become very large. The job of a financial manager therefore is to ensure that the firm is well capitalized i.e. they have the right amount of capital and that the firm has the right capital structure i.e. they have the right mix of debt and equity and other financial instruments.

4. Investment Decision

Once the firm has gained access to capital, the financial manager faces the next big decision. This decision is to deploy the funds in a manner that it yields the maximum returns for its shareholders. For this decision, the firm must be aware of its cost of capital. Once they know their cost of capital, they can deploy their funds in a way that the returns that accrue are more than the cost of capital which the company has to pay. Finding such investments and deploying the funds successfully is the investing decision. It is also known as capital budgeting and is an integral part of corporate finance.

Capital budgeting has a theoretical assumption that the firm has access to unlimited financing as long as they have feasible projects. A variation of this decision is capital rationing. Here the assumption is that the firm has limited funds and must choose amongst competing projects even though all of them may be financially viable. The firm thus has to select only those projects that will provide the best return in the long term.

Financing and investing decisions are like two sides of the same coin. The firm must raise finances only when it has suitable avenues to deploy them. The domain of corporate finance has various tools and techniques which allow managers to evaluate financing and investing decisions. It is thus essential for the financial well being of a firm.

Capitalization is an accounting method in which a cost is included in the value of an asset and expensed over the useful life of that asset, rather than being expensed in the period the cost was originally incurred. In finance, capitalization refers to the cost of capital in the form of a corporation’s stock, long-term debt, and retained earnings. In addition, market capitalization refers to the number of outstanding shares multiplied by the share price.

Capitalization has two meanings in accounting and finance. In accounting, capitalization is an accounting rule used to recognize a cash outlay as an asset on the balance sheet, rather than an expense on the income statement. In finance, capitalization is a quantitative assessment of a firm’s capital structure.

Capitalization in Finance

Another aspect of capitalization refers to the company’s capital structure. Capitalization can refer to the book value cost of capital, which is the sum of a company’s long-term debt, stock, and retained earnings. The alternative to the book value is the market value. The market value cost of capital depends on the price of the company’s stock. It is calculated by multiplying the price of the company’s shares by the number of shares outstanding in the market.

If the total number of shares outstanding is 1 billion and the stock is currently priced at $10, the market capitalization is $10 billion. Companies with a high market capitalization are referred to as large caps (more than $10 billion); companies with medium market capitalization are referred to as mid caps ($2 – $10 billion); and companies with small capitalization are referred to as small caps ($300 million – $2 billion).

It is possible to be overcapitalized or undercapitalized. Overcapitalization occurs when earnings are not enough to cover the cost of capital, such as interest payments to bondholders or dividend payments to shareholders. Undercapitalization occurs when there’s no need for outside capital because profits are high and earnings were underestimated.

Undercapitalization

Undercapitalization occurs when a company does not have sufficient capital to conduct normal business operations and pay creditors. This can occur when the company is not generating enough cash flow or is unable to access forms of financing such as debt or equity.

Undercapitalized companies also tend to choose high-cost sources of capital, such as short-term credit, over lower-cost forms such as equity or long-term debt. Investors want to proceed with caution if a company is undercapitalized because the chance of bankruptcy increases when a company loses the ability to service its debts.

Being undercapitalized is a trait most often found in young companies that do not adequately anticipate the initial costs associated with getting a business up and running. Being undercapitalized can lead to a significant drag on growth, as the company may not have the resources required for expansion, leading to the eventual failure of the company. Undercapitalization can also occur in large companies that take on significant amounts of debt and suffer from poor operating conditions.

If undercapitalization is caught early enough, and if a company has sufficient cash flows, it can replenish its coffers by selling shares, issuing debt, or obtaining a long-term revolving credit arrangement with a lender. However, if a company is unable to produce net positive cash flow or access any forms of financing, it is likely to go bankrupt.

Undercapitalization can have a number of causes, such as:

• Poor macroeconomic conditions that can lead to difficulty in raising funds at critical times
• Failure to obtain a line of credit
• Funding growth with short-term capital rather than permanent capital
• Poor risk management, such as being uninsured or underinsured against predictable business risks

Examples of Undercapitalization in Small Business

When starting a business, entrepreneurs should conduct an assessment of their financial needs and expenses—and err on the high side. Common expenses for a new business include rent and utilities, salaries or wages, equipment and fixtures, licenses, inventory, advertising, and insurance, among others. Since startup costs can be a significant hurdle, undercapitalization is a common issue for young companies.

Because of this, small business startups should create a monthly cash flow projection for their first year of operation (at least) and balance it with projected costs. Between the equity, the entrepreneur contributes and the money they are able to raise from outside investors, the business should be able to be sufficiently capitalized.

In some cases, an undercapitalized corporation can leave an entrepreneur liable for business-related matters. This is more likely when corporate and personal assets are commingled when the corporation’s owners defraud creditors, and when adequate records are not kept.

• Undercapitalized companies do not have enough capital to pay creditors and often need to borrow more money.
• Young companies that do not fully understand initial costs are sometimes undercapitalized.
• When starting, entrepreneurs must asset their financial needs and expenses then err on the high side.
• If a company can’t generate capital over time, chances of going bankrupt increase, as it loses the ability to service its debts.

Causes of Under-Capitalization:

(1) A company which is floated during depression will find itself under-capitalized during boom period. The reason being that the assets were acquired at lower cost and the return during inflation will be high.

(2) If the company is working at a high degree of efficiency it will earn more profits which will push up the real value of the shares in the market, indicating under-capitalisation.

(3) The promoters of the company at the time of preparing financial plan may under estimate future earnings or make under-estimation of capital requirements.

If the earnings, later on, prove to be higher than the estimated figure, the company will become under-capitalized.

(4) The company may follow a conservative dividend policy (i.e., moderate rate of dividend) thereby leading to enough funds for business expansion, machinery replacement etc. This will lead to higher rates of earnings and hence under-capitalisation.

(5) The promoters of the company in a desire to keep control over the affairs of the concern may issue lesser number of shares and prefer to manage with their own capital or through cheap borrowings and retained earnings, it may lead the company to under-capitalisation after some time.

Effects of Under-Capitalization:

(1) Seeing the high rate of earning and profits of the company, the employees/workers shall start demanding high salaries.

(2) High profits of the company may encourage others to enter the same business line leading to sever competition.

(3) Customers may feel that they are being exploited by the company.

(4) Company will have to pay more taxes.

Where under-capitalization arises due to inadequacy of funds:

(5) At times, company may be compelled to raise funds at higher rates of interest.

(6) Due to inadequacy of capital, once the company runs into rough weather, it may lack working capital and hence a constant danger of failure of business.

Remedial Measures to Control Under-Capitalization:

(1) The existing shareholders may be allotted shares of higher face (par) value in exchange for the old shares. This procedure will bring down the rate of earning per rupee of share value but will not affect the amount of dividend per share.

(2) The shares may be splitted up. It has the effect of reducing the dividend per share. In other words, the par value of shares may be reduced by sub-dividing the shares.

(3) The management may issue bonus shares to equity shareholders. This measure shall capitalize the earnings/products, thus increase the capitalisation and the number of shares. Dividend per share and rate of earnings will be reduced.

(4) To remove the state of under-capitalisation, fresh (more) shares and debentures may be issued.

Overcapitalization

Overcapitalization occurs when a company has issued more debt and equity than its assets are worth. The market value of the company is less than the total capitalized value of the company. An overcapitalized company might be paying more in interest and dividend payments than it has the ability to sustain long-term. The heavy debt burden and associated interest payments might be a strain on profits and reduce the amount of retained funds the company has to invest in research and development or other projects. To escape the situation, the company may need to reduce its debt load or buy back shares to reduce the company’s dividend payments. Restructuring the company’s capital is a solution to this problem.

In the insurance market, overcapitalization takes on a different meaning. Overcapitalization occurs when the supply of policies exceeds demand for policies, creating a soft market and causing insurance premiums to decline until the market stabilizes. Policies purchased in times of low premium levels can reduce an insurance company’s profitability.

The opposite of overcapitalization is undercapitalization, which occurs when a company has neither the cash flow nor the access to credit that it needs to finance its operations. The company may not be able to issue stock on the public markets because the company doesn’t meet the requirements or the filing expenses are too high. Essentially, the company can’t raise capital to fund itself, its daily operations or expansion projects. Undercapitalization most commonly occurs in companies with high start-up costs, too much debt and insufficient cash flow. Undercapitalization can ultimately lead to bankruptcy.

Causes of Over-Capitalization:

(i) More shares and/or debentures might have been issued, resulting in availability of surplus funds that cannot be profitably employed, but dividend shall have to be paid on such excess capital also.

(ii) Rate of interest on borrowings might be higher than the rate of earnings of the company.

(iii) Wrong estimate of the earnings of the company. If future earning is over-estimated, the market value of shares will fall below the purchase price because shareholders will not get what they had been promised by the company.

(iv) Floating the company under inflationary conditions will lead to over-capitalisation because of purchase of assets at high prices.

(v) Payment of high promotional expenses, i.e., if the remuneration paid to promoters etc., is very high.

(vi) Provision of depreciation lass than justified. So company will find it difficult to replace the assets (machinery etc.) with the funds made available by depreciation provision.

(vii) Insufficient and extravagant management of the company. Liberal payment of dividend and low retention of earnings for self-financing.

(viii) Time lag between installation of machinery and starting production.

(ix) High tax rates and excessive tax payment also results in over-capitalisation.

Effects of Over-Capitalization:

(i) Less earnings of the company, leading to reduction of rate of dividend and hence decrease in market value of its shares.

(ii) Shareholders of the company get less dividends.

(iii) Employees are denied increase in salaries.

(iv) Prices of company products may go high.

(v) Company finds it difficult to raise capital, because in present situation of over-capitalisation, it finds it difficult to pay a fair rate of return to its investors.

(vi) To save their skin, directors of the company may resort to unfair practices like manipulation of the books of accounts to show artificial prosperity.

Remedial Measures to Correct Over-Capitalization:

(i) All avoidable costs should be avoided e.g., purchase of new vehicles, air-conditioners, sophisticated office furniture etc.

(ii) Wastage and extravagance should be avoided.

(iii) Earning capacity should be increased by minimizing scrap and by increasing efficiency of workers.

(iv) The par value of shares or the number of shares may be reduced (to eliminate watered stock).

(v) Debentures and cumulative preference shares carrying higher rate of interest and dividend should be redeemed or their holders may be persuaded to take new debentures at lower rate of interest.

Health marketing is an approach to public health promotion that applies traditional marketing principles and theories alongside science-based strategies to protect and promote the health of diverse populations. It involves creating, communicating, and delivering messages for the public on prevention, health promotion and health protection. Health marketing is one of the ways advancements in medicine and in health-protecting services, such as insurance, are made widely known.

The marketing strategy would follow the traditional “4Ps” of marketing, namely:

• The “product” in question in this case the surgical procedure.
• The “place” which refers to the access to this procedure.
• “Promotion” refers to creating awareness and hence demand.
• “Price” refers to the cost of the procedure e.g. money, time, reputation etc.

“Health marketing” is a term rarely used in public healthcare and related disciplines. “Social marketing” or “integrated marketing communication” are more commonly used in public health and other disciplines to refer to marketing-based planning frameworks for public health communication.

Medical marketing in the private sector

Health marketing or Medical Marketing is a specialized branch of marketing. Medical marketing was born from the necessity for private health professionals to attract new patients, the characteristics of the health market makes it a unique kind of marketing. Medical marketing is usually a business to consumer (B2C) services. The primary customers for these medical marketing companies are Generation Z. About 85% of Gen Zers said they are open to alternative healthcare options like telemedicine, dispatch services and membership-based services. Marketers and medobal healthcare provides offline/online medical services for healthcare seekers. Healthcare professionals using this type of marketing usually offer beauty related services, such as aesthetic medicine, plastic surgery, dental surgery or dermatology and much more.

Fundamentals

Professional Referral Marketing: A reliable and continuing stream of inbound patient referrals from other medical, dental or other professional sources is the lifeblood of many specialty providers. And whether it’s a primary or secondary channel, professional referral sources can’t be taken for granted. Doctor referrals do not happen by magic or simply because you are a good provider. Success requires a written plan and an unfailing system to preserve and grow the flow of professional referrals.

Internet Marketing: From websites and social media tools, to patient portals and mobile apps, online marketing is a mainstream channel for marketing, advertising and public relations. Exactly how you use the muscle of the digital freeway can be highly effective and profitable, or a huge waste of time and money.

Branding: This is all about standing out from the crowd in a positive way, and it includes virtually everything you do. A powerful, differentiating brand for your healthcare business is part of your reputation. Meaningful and effective branding does not occur without a deliberate effort to shape and express the right message at the right time.

Internal Marketing: This heading includes all the ways and means that you communicate with people who already know you, primarily present and previous patients. Depending on the nature of your practice or situation, this influential audience can be a rich resource for referrals, additional services, testimonials and/or word-of-mouth advertising.

External Marketing: These are the media that reach prospective patients that don’t know you. Advertising in newspapers, radio, television, billboards and the like target an audience that needs to know that you provide an answer for their healthcare need. There’s little margin for error in an external media budget that is expected to produce a measurable return-on-investment.

Public Relations: This heading includes, among other things, planning and generating healthcare publicity and free press exposure, such as newspaper articles or broadcast interviews. The end results look easy, and it can be a positive and powerful influence. But “free press” typically results from careful planning, good timing, a clear message and a deliberate effort.

Environmental Analysis is described as the process which examines all the components, internal or external, that has an influence on the performance of the organization. The internal components indicate the strengths and weakness of the business entity whereas the external components represent the opportunities and threats outside the organization.

To perform environmental analysis, a constant stream of relevant information is required to find out the best course of action. Strategic Planners use the information gathered from the environmental analysis for forecasting trends for future in advance. The information can also be used to assess operating environment and set up organizational goals.

It ascertains whether the goals defined by the organization are achievable or not, with the present strategies. If is not possible to reach those goals with the existing strategies, then new strategies are devised or old ones are modified accordingly.

Some of the features or characteristics of Environmental Analysis are:

• Holistic View: Environmental Analysis is a holistic exercise in the sense that it must comprise a total view of the environment rather than viewing a trend piecemeal. The corporate must scan the circumference of its environment in order to minimize the chances of surprises and to maximize its utility.
• Continuous Process: The analysis of environment must be a continuous process rather than being an intermittent scanning system. It must operate continuously in order to keep track of the rapid pace of development. So, Environmental analysis becomes essential due to the dynamic nature of the environment.
• Exploratory Process: While the Monitoring aspect of the environment is concerned with the present development, a large part of the process seeks to explore the unknown dimensions of possible future. The analysis emphasizes on “What could happen” and not necessarily “What will happen.”

The Importance of Environmental Analysis are:

• First Mover Advantage: Awareness of environment helps an enterprise to take advantage of early opportunities instead of losing them to competitors. For instance, Maruti Udyog became the leader in the small car market because it was the first to recognize the need for small cars on account of rising Middle class.
• Early Warning Signal: Environmental awareness serves as an early warning signal. It makes a firm aware of the impending threat or crisis, so that the firm can take timely action to minimize the adverse effects if any. For instance, A MNC entering in to the Indian market would act as a early warning signal for Indian Firms.
• Focus On Customer: Environmental Understanding makes the management or Business organization sensitive towards the changing needs and expectations of customer. For instance, Several FMCG companies have launched small sachets of shampoo and other products realizing the wishes of customers.
• Strategy Formulation: Environmental Monitoring provides relevant information about the business environment. such information serves as the basis for strategy formulation. For Instance, ITC realized that there is a vast scope for growth in the travel and tourism industry in India and therefore ITC planned New hotels in India.
• Change Agent: Business leaders acts as the agents of change. They create a drive for change at the grassroot level. In order to decide the direction and nature of change, the leaders need to understand the aspirations of people and other environmental forces through Environmental Scanning.
• Public Image: A business firm can improve its image by showing that it is sensitive to its environment and responsive to the aspirations of public. Environmental understanding enables the business to be responsive to their environment.
• Continuous Learning: Environmental analysis keeps the organization in touch with the changing scenario so that thet are never caught unaware. With the help of Environmental learning, managers can react in an appropriate manner and thereby increase the success of their organization.

The Process of Environmental Analysis/Scanning consists of the following steps:

• Environmental Scanning: It means the process of analyzing the environment for identifying the factors which may influence the business. Environmental Scanning alerts an organization to potentially significant forces in the external environment, so that suitable strategic initiatives may be taken before the organization reaches to a critical situation.
• Environmental Monitoring: At this stage, the information from the relevant environment is collected. Once this information is collected, adequate data is gathered so as to find out the patterns and trends of the environment. Further Monitoring is a follow up and deeper analysis of environmental forces. Several techniques such as company records, spying, publication and verbal talks with the customers, employees, dealers and suppliers are the main sources of collecting data.
• Environmental Forecasting: Environmental Forecasting is the process of estimating the events of future based on the analysis of past records and present behavior. Further it is necessary to analyze or anticipate the future events before any strategic plans are formulated. Forecasts are made for economic, social and political factors. Several techniques such as Time series, Graph method, Delphi method etc. are used for this purpose.
• Assessment Or Diagnosis: At this stage, Environmental factors are assessed in terms of their impact on the organization. Some factors in the environment may entail an opportunity while others may pose a threat yo the organization. For this purpose, SWOT analysis and ETOP analysis are used.

Advantages of Environmental Analysis

The internal insights provided by the environmental analysis are used to assess employee’s performance, customer satisfaction, maintenance cost, etc. to take corrective action wherever required. Further, the external metrics help in responding to the environment in a positive manner and also aligning the strategies according to the objectives of the organization.

Environmental analysis helps in the detection of threats at an early stage, that assist the organization in developing strategies for its survival. Add to that, it identifies opportunities, such as prospective customers, new product, segment and technology, to occupy a maximum share of the market than its competitors.

Steps Involved in Environmental Analysis

1. Identifying: First of all, the factors which influence the business entity are to be identified, to improve its position in the market. The identification is performed at various levels, i.e. company level, market level, national level and global level.
2. Scanning: Scanning implies the process of critically examining the factors that highly influence the business, as all the factors identified in the previous step effects the entity with the same intensity. Once the important factors are identified, strategies can be made for its improvement.
3. Analysing: In this step, a careful analysis of all the environmental factors is made to determine their effect on different business levels and on the business as a whole. Different tools available for the analysis include benchmarking, Delphi technique and scenario building.
4. Forecasting: After identification, examination and analysis, lastly the impact of the variables is to be forecasted.

Environmental analysis is an ongoing process and follows a holistic approach, that continuously scans the forces effecting the business environment and covers 360 degrees of the horizon, rather than a specificsegment.

The pay structure or salary structure defines the compensation given to the employees. It shows the breakup of the salary into various components. Based on various criteria such as the professional experience or employees, or grades or bands the employees are categorized under, different pay structures may be defined in an organization. One pay structure may be applicable to multiple bands or grades and one band or grade may have multiple pay structures.

Pay structures offer a framework for wage progression and can help encourage appropriate behaviours and performance, while pay progression describes how employees are able to increase their pay within their salary grade or band.

Pay structures can be distinguished by two key characteristics: the number of grades, levels or bands; and the width or span of each grade. For example:

Narrow-graded pay structures, often found in the public sector, typically comprise ten or more grades, with jobs of broadly equivalent worth in each grade. Progression is by service increments, although due to narrow grades employees can reach the top of the pay range relatively quickly, potentially leading to ‘grade drift’ and jobs ranked more highly than justified

Broad-graded structures have fewer grades, perhaps six to nine, and greater scope for progression that can counter ‘grade drift’ problems

Broad-banding involves the use of an even smaller number of pay bands (four or five). Designed to allow for greater pay flexibility, typical broad-banding would place no limits on pay progression within each band, although some employers have introduced a greater degree of structure

Job families group jobs within similar functions or occupations, with separate pay structures for different ‘families’ (e.g. sales or IT staff). With around six to eight levels, similar to broad-grading, job family structures allows for higher rates of pay for sought-after specialist staff

Career families extend the metaphor with a common pay structure across all ‘job families’ rather than separate pay structures for each family. Career families tend to emphasise career paths and progression rather than the greater focus on pay of job families.

Basic Pay

This is the core of salary, and many other components may be calculated based on this amount. It usually depends on one’s grade within the company’s salary is a fixed part of one’s compensation structure. Many allowances and deductions are described in terms of percentage of the Basic Salary.

Basic salary is the base income of an individual. Basic salary is the amount paid to employees before any reductions or increases due to overtime or bonus, allowances (internet usage for those who work from home or communication allowance). Basic salary is a fixed amount paid to employees by their employers in return for the work performed or performance of professional duties by the former. Base salary, therefore, does not include bonuses, benefits or any other compensation from employers. As the name suggests, basic salary is the core of the salary of an employee. It is a fixed part of the compensation structure of an employee and generally depends on her or her designation. If the appointment of an employee is made on a pay scale, the basic salary may increase every year. Else, it remains fixed.

According to experts, the basic salary differs according to the type of the industry. For instance, employees in the information technology industry prefer take-home salary (since the staff turnover is high) while employees in the manufacturing companies get more fringe benefits.

DA (Dearness Allowance)

The Dearness Allowance (DA) is a cost of living adjustment to allowance. It is calculated as a percentage of (Basic pay + grade pay). Dearness allowance is updated every quarter of calendar year to compensate for inflation in consumer price index. It may increase or decrease depending on inflation rate. (Decrease in DA is rare).

House Rent Allowance (HRA)

House Rent Allowance (HRA) is a common component of their salary structure. Although it is a part of your salary, HRA, unlike basic salary, is not fully taxable. Subject to certain conditions, a part of HRA is exempted under Section 10 (13A) of the Income-tax Act, 1961.

The amount of HRA exemption is deductible from the total income before arriving at a taxable income. This helps the employee to save tax. But do keep in mind that the HRA received from your employer, is fully taxable i f an employee is living in his own house or if he does not pay any rent.

HRA Benefit

The tax benefit is available only to a salaried individual who has the HRA component as part of his salary structure and is staying in a rented accommodation. Self-employed professionals cannot avail the deduction.

Gross Pay

Gross pay for an employee is the amount used to calculate that employees’ wages (for an hourly employee) or salary (for a salaried employee. It is the total amount you as the employer owe the employee for work during one pay period. Gross pay includes regular hourly or salaried pay and it also includes any overtime paid to the employee during the pay period.

For both salaried and hourly employees, the calculation is based on an agreed-upon amount of gross pay. That is, both the employee and employer have agreed that this is the pay rate. The pay rate should be in writing and signed by both the employee an employer.

For hourly employees, that pay rate might be negotiated by a union contract. For salaried employees, that rate might be in an employment contract or just a pay letter. In each case, the gross pay rate should be agreed to and signed before the employee begins working.

An example of gross pay calculation for a salaried employee:

 A salaried employee has an annual salary of $47,000 a year. The salaried employees at this company are paid on the 15th and 30th of each month (twice a month). The $47,000 is divided by 24 to get $1958.33, which is the gross pay for each pay period.

Take Home Pay

Take-home pay is the net amount of income received after the deduction of taxes, benefits, and voluntary contributions from a paycheck. It is the difference between the gross income less all deductions. Deductions include federal, state and local income tax, Social Security and Medicare contributions, retirement account contributions, and medical, dental and other insurance premiums. The net amount or take-home pay is what the employee receives.