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  • Depreciation vs. Amortization: Meaning, Differences, and Examples

    Depreciation vs. Amortization: Meaning, Differences, and Examples

    Introduction

    Business assets usually cost a fortune and have a limited lifespan. Hence, it is necessary that this cost be expensed proportionately across their functional life. Depreciation and amortization are two such accounting processes that involve spreading out the cost of these assets throughout their useful life. 

    Before understanding how these two methods work, let us understand what business assets are. 

    What are Business Assets?

    Business assets refer to items of value owned by firms/companies, etc. Assets play a vital role in increasing productivity, revenue and efficiency. 

    Based on physical characteristics, the assets of a business are of two types: 

    • Tangible Assets: Tangible assets refer to those resources that have a physical form. Examples of tangible assets include plant, building, machinery, etc.  
    • Intangible Assets: Intangible assets are resources without any physical form. Trademarks, patents, goodwill are examples of intangible assets.  

    Now let’s find out how depreciation and amortization works.

    Understanding the Meaning of Depreciation and Amortization

    In simple terms, depreciation refers to the reduction in a tangible asset’s monetary value due to prolonged usage. This accounting technique enables businesses to spread the cost of their fixed assets over the span of their useful life. This allocation is reflected in the business’s profit and loss account for the particular financial year.

    On the flip side, amortization refers to the reduction in the monetary value of intangible assets over time. It involves prorating the cost of intangible assets over the course of their useful life. Similar to depreciation, amortization appears as an expense in the income statement or profit and loss account of a business.

    Why are depreciation and amortization shown in the income statement?

    As per Indian Accounting Standard 6, “The depreciable amount of a depreciable asset should be allocated on a systematic basis to each accounting period during the useful life of the asset.” This is because the annual depreciation of an asset is an expense, and hence, is a charge on profits.

    Similar rules are applicable on amortization as well, as mentioned in Indian Accounting Standard 38. 

    Common Methods of Computing Depreciation and Amortization

    Here are some popular methods that businesses use to calculate depreciation and amortization:

    Straight Line Method

    When a business opts for the straight-line method, the depreciation is spread out evenly over a period until the salvage value is reached. In other words, if a company computes depreciation using this process, the depreciation expense will be the same in each year over an asset’s lifespan. Note that salvage value refers to the estimated book value of tangible long-term assets at the end of their useful life.

    The straight-line method is the most straightforward process of distributing the cost of business assets over their useful life.

    Example 1: Amortization Using Straight Line Method

    Suppose Company XYZ has a patent worth ₹15,00,000 expiring in 30 years. But since the patent’s estimated useful life is 15 years, note that the amortization interval must be 15 years. 

    To compute the amortization of the patent, the company has to divide the patent’s cost price by its estimated useful life. 

    Therefore, the amortization of XYZ Company’s Patent will be ₹15,00,000/ 15 = Rs. 1,00,000 

    Example 2: Depreciation Using Straight Line Method

    Let’s say ABC Company purchased a machine worth ₹50,00,000 to manufacture garments. The estimated lifespan of this machine is 10 years, and its salvage value is 10% of the cost price. 

    ABC can compute the value of depreciation using this formula: 

    Depreciated Value = Machine’s Purchase Price – Salvage Value 

                                      = ₹(50,00,000 – 5,00,000) 

                                      = ₹45,00,000

    Now, considering that the useful life of the machine is 10 years, the calculation of depreciation per year will be as follows:

    Annual Depreciation = ₹45,00,000/10 

                                          = ₹4,50,000

    Reducing Balance Method

    The reducing balance (or written down value) method involves charging depreciation based on the previous year’s closing balance of an asset. Closing balance refers to the credit/debit balance of an account at the end of an accounting period.

    To calculate closing balance, businesses have to deduct the previous year’s depreciation from the asset value. Under this method, the profit for a financial year will be lower in the first few years. But in the later years, it will be higher.

    Generally, a company uses the same method for computing amortization as well as depreciation. That said, note that amortization schedule is used in the case of loans.

    Example 3: Depreciation Using Reducing Balance Method

    Some companies use the reducing balance method to compute depreciation instead of the straight-line method. Here’s an example to explain this method:

    Let’s say ABC purchased new machinery worth ₹5,00,000 to increase production and strengthen its top line. As per the manager, this machine’s estimated useful life is 10 years, and salvage value is ₹10,000. The depreciation rate is 20% 

    ABC can use the following calculation to ascertain the amount of depreciation resulting from regular usage: 

    Depreciation Percentage x Annual Depreciation Amount 

    Year
    Depreciation Calculation
    Amount of Depreciation (₹)
    Value at the End of the Year (₹)
    1
    20% of ₹(5,00,000 – 10,000)
    98,000
    4,02,000
    2
    20% of 4,02,000
    80,400
    3,21,600
    3
    20% of ₹3,21,600
    64,320
    2,57,280
    4
    20% of ₹2,57,280
    51,456
    2,05,824
    5
    20% of ₹2,05,824
    41,164.8
    1,64,659.2
    6
    20% of ₹1,64,659.2
    32,931.84
    1,31,727.36
    7
    20% of ₹1,31,727.36
    26,345.47
    1,05,381.89
    8
    20% of ₹1,05,381.888
    21,076.38
    84,305.51
    9
    20% of ₹84,305.5104
    16,861.10
    67,444.41
    10
    20% of ₹67,444.40832
    13,488.88
    53,955.53

    Key Differences between Depreciation and Amortization

    This table represents a head-to-head comparison of depreciation and amortization: 

    Basis of Comparison
    Depreciation
    Amortization
    Definition
    Depreciation is an accounting technique for computing the reduced net worth of tangible fixed assets. The reduction in cost price over an asset’s life is proportional to its usage in a particular year.
    Amortization is an accounting technique that measures the reduction in the value of intangible assets.
    Implementation Method
    Accountants can use the straight-line method or the declining/reducing balance method to compute depreciation. Note that there are other methods of calculating depreciation as well.
    In most cases, one can use the straight-line method for computing amortization. Businesses can use other methods such as reducing the balance to compute amortization.
    Salvage Value
    The salvage value of the fixed asset is taken into account when computing depreciation.
    Unlike tangible assets, intangible assets usually have no salvage value. Accordingly, amortization is calculated using the full value of the intangible asset.
    Formula
    Annual Depreciation = The Cost of the Tangible Fixed Asset ÷ Useful Life
    Annual Amortization = The Cost of the Intangible Asset ÷ Useful Life
    Depreciation
    Depreciation is a charge against profit. Accordingly, it is a debit entry (an accounting entry that increases an expense or asset account). Simultaneously, the accumulated depreciation account is credited with the same amount.
    Similar to depreciation, amortization is an expense. Thus, it is a debit entry. Simultaneously, the accumulated amortization account is credited with the same amount.

    Final Word

    It is crucial for businesses to account for both these non-cash expenses every financial year. After all, assets have a limited lifespan and must be replaced eventually to avoid manufacturing downtime. A business, irrespective of its size, must comprehend the essentiality of depreciation and amortization and understand how it should set sufficient funds aside to finance the purchase of an asset, when necessary, in the future.

  • Cash Flow Statement: Meaning, Examples and How to prepare it?

    Cash Flow Statement: Meaning, Examples and How to prepare it?

    Introduction

    ‘Cash is king’ is a popular saying that you might’ve heard. This is particularly true for all types of businesses, as cash is a measure of their financial standing in the long run. Hence, cash management is an essential skill to sustain the ongoing activities of a business, mobilize funds where needed and optimize its liquidity. A company’s liquidity can accordingly be measured adequately via its financial statements – income statement, balance sheet and cash flow statement.

    1. Statement of Profit & Loss or Income Statement: An account of all the revenues and expenses of a firm during an accounting period, which then ascertains the net profit (or loss).

    2. Balance Sheet: A summary of a firm’s total assets, liabilities, and capital. As a result, it evaluates the firm’s financial standing at the end of an accounting period.

    3. Cash Flow Statement: A report of all cash inflows and cash outflows incurred by a firm in an accounting year. That is, it determines the net cash utilized/generated by the business.

    Let us take a closer look at what is cash flow statement, its examples, and the cash flow statement format.

    Cash Flow Statement Meaning

    In general, a cash flow statement is a financial statement that details a company’s inflows and outflows of its cash and cash equivalents. Cash equivalents simply refer to those assets that can be converted into cash immediately, like bank accounts and marketable securities.

    A key objective of the cash flow statement is to lay out how much cash is moving and in which direction. Furthermore, it helps a business understand how much net cash they are generating from their operating, financing, and investing activities.

    Thus, the cash flow statement acts as a bridge between the income statement and the balance sheet. For instance, we can infer from the balance sheet a change in the cash position of a company from Rs 1,00,000 to Rs 2,00,000 in a particular year. On the other hand, the cash flow statement highlights the activities which have resulted in this net cash inflow of Rs 1,00,000.

    It also evaluates the financial performance of a company, just like the income statement. However, CFS gives an entirely different result, as it is not affected by non-cash transactions. Basically, the income statement reflects a company’s performance via its revenues, expenses by determining its net profit/loss for a given period; whereas, a cash flow statement shows how that profit or loss moves across the company.

    Cash vs Non-Cash Transactions

    Cash transactions are those transactions directly involving the inflow and outflow of cash and cash equivalents. For example, cash sales, interest paid or received, cash purchases, sale/purchase of fixed assets using cash or bank balance.

    Non-cash transactions are those transactions that do not have an actual cash flow associated with them. One major example of such a transaction is depreciation. Depreciation is the distribution of the cost of an asset over its useful life.

    For example, a company buys a machine for Rs, 10,00,000 and estimates its useful life to be 5 years. So, the company decides to spread this expense equally over the years, instead of writing it down as a single, big expense. Dividing Rs 10,00,000 by 5, gives us depreciation of Rs 2,00,000 every year for the next 5 years. However, no cash was actually paid out when these expenses were recorded, so they appear on the income statement as a non-cash expense.

    Now that we have some idea as to what is cash flow statement, let us dive deeper into its intricacies and understand what constitutes a cash flow statement.

    Components of Cash Flow Statement

    • Cash flow from Operating Activities

    Operating activities are the day-to-day business activities of a company. For example, a grocery shop’s business activities could be buying and selling groceries. Therefore, the cash spent or earned from operating activities is the cash flow from these operating activities.

    Examples of operating activities include income tax payments, payments made to suppliers, salary and wages to employees, rent payments, etc.

    • Cash flow from Investing Activities

    The next component is cash flow from investing activities. Investing activities are integral to a business as, without these activities, the business cannot conduct its day-to-day operations.  As a result, the business would be unable to determine its cash flow from operating activities. For example, a manufacturing firm has to acquire relevant plant and machinery in order to produce finished goods.

    The cash spent or earned from buying or selling fixed assets refers to cash from investing activities. Put simply, any payment regarding a company’s changes in equipment, plant, long-term investments, etc., are included in this section. Some common investing activities include purchasing fixed assets, stocks, bonds, securities, selling off securities, etc.

    • Cash flow from Financing Activities

    Lastly, to invest in assets, so that a firm can run its operations and generate profits, it needs funds – which can be raised via financing activities. Financing activities are those transactions that affect the capital or long-term borrowings of a company.

    These can be – positive cash flows, like capital raised from investors, issuing shares, debentures, etc. or negative cash flows, like repurchasing stock, paying dividends to shareholders, repayment of loans, etc. So, net cash generated or utilized in these activities is the cash flow from financing activities.

    How to prepare the Cash Flow Statement format?

    Calculate Cash Flow from Operating Activities

    Calculating the operating cash flow is the first and most important step of the process. This is because it reveals the cash flow generated by the day-to-day activities of the company, like sales, purchases, etc.

    There are two methods of determining operating cash flows: Direct Method and Indirect Method. It is important to note that the resultant cash flow will be the same through either method.

    The Direct Method

    The direct method is straightforward and simply adds all cash receipts and subtracts all the payments that the business incurs. This method is more favorable for small businesses as they have fewer transactions to evaluate. Refer to Table 1 for a detailed example.

    The Indirect Method

    Since companies generally use the accrual basis of accounting, i.e., they record transactions when they are incurred and not when cash is exchanged, incomes shown on the income statement do not indicate the actual amount of cash-in-hand.

    Conversely, in the indirect method, the company selectively reverses the transactions from the income statement and adds or deducts balance sheet items from the net income – to arrive at cash generated from operations. A general formula for calculating operating cash flow is:

    OCF = Net income + Non-cash expenses – Increase in current assets + Decrease in current assets + Increase in current liabilities – Decrease in current liabilities

    • Non-cash expenses are added back as they do not involve an actual cash inflow or outflow, like depreciation, amortization.

    • An increase in current assets is subtracted as the company incurs a cash outflow in order to acquire more current assets; whereas, a decrease in current assets is added to the net profit, as it results in a cash inflow.

    For example, if a company increases its inventory, it would’ve made some purchases, which ultimately leads to outflow of cash and cash equivalents. Similarly, if the company sells some of its stock, it would result in a cash inflow.

    • A decrease in current liabilities is subtracted as there is a cash outflow when a company pays off its liabilities; whereas, an increase in current liabilities is added as the company incurs a cash inflow when it acquires a new liability.

    For example, if a company raises a short-term loan, it would lead to a cash inflow. On the contrary, repayment of the short-term loan will lead to a decrease in cash and cash equivalents. Refer to Table 2 for detailed example.

    Calculate Cash Flow from Operating Activities

    The next step is calculating the cash flow of all investing activities like buying and selling of non-current assets. For example, buying or selling machinery. Buying fixed assets would be considered as a cash outflow. Whereas, selling any fixed assets would result in a cash inflow.

    Calculate Cash Flow from Financing Activities

    The next step of calculating cash flows is calculating the cash flow generated from financing activities. Mainly, it includes cash flows that affect the debt-equity composition and size of a company. Such as paying interest on loans, dividend payments, taking bank loans, issuing debentures, etc.

    Determine the Opening and Closing Balance

    The last step of preparing a cash flow statement is determining the opening balance and the closing balance of cash and cash equivalents of the reporting period. By and large, this can be easily determined from the balance sheet of the company.

    The difference between the opening and closing balances is the sum of net cash flow from all the activities. Notably, this can also be seen as a way to cross-verify whether or not the net cash flow determined by the cash flow statement is correct or not. 

    A positive net cash flow indicates that the business had more cash inflows than outflows. On the other hand, a negative cash flow indicates that the business had more cash outflows than inflows.

    Examples of Cash Flow Statement

    Example One [1]

    Cash flow statement 1 Direct method

    Cash flow from operations
    ₹
    ₹
    Receipts from customers
    4,58,00,000
    Cash paid to suppliers
    (2,98,00,000)
    Cash paid to employees
    (1,12,00,000)
    Net Cash generated from operations
    48,00,000
    Interest paid
    (3,10,000)
    Income taxes paid
    (17,00,000)
    Net cash from operating activities
    27,90,000
    Cash flow from investment activities
    Purchase of property, plant, equipment
    (5,80,000)
    Proceeds from sale of equipment
    1,10,000
    Net cash from investing activities
    (4,70,000)
    Cash flow from financing activities
    Cash from issuing stock
    10,00,000
    Cash from issuing long-term debt
    5,00,000
    Dividends paid
    (45,00,000)
    Principal payments under lease obligations
    (10,000)
    Net cash used in financing activities
    10,40,000
    Net increase in cash and its equivalents
    33,60,000
    Cash at the beginning of the period
    16,40,000
    Cash at the end of the period
    50,00,00

    In this example, there is a positive cash flow in the company. Moreover, most of its cash is generated through operating activities, indicating a healthy business.

    Example Two

    Cash flow statement 2 Indirect method

    Cash flow from operations
    ₹
    ₹
    Net income
    60,000
    Additions to cash
    Depreciation
    20,000
    Increase in notes payable
    10,000
    Subtractions
    Increase in accounts receivable
    Increase in inventory
    (30,000)
    Net cash from operations
    40,000
    Cash flow from investment activities
    Purchase of equipment
    (5,000)
    35,000
    Cash flow from financing activities
    Long term loans
    7500
    42,500
    Cash flow for the month ended 31 December 2020
    42,500
    • In this example, the cash flow of the company is positive.
    • As can be seen, the liabilities of the company are low, and the operating activities generate ample cash.

    Uses of Cash Flow Statement

    Creditors and investors

    Firstly, investors use the CFS to deduce whether a company is on sound financial footing. They look at where the company is getting its cash. If the company has a positive cash flow from operating activities, it is seen as a good investment. Whereas a company generating cash from selling stocks is seen as a dubious investment. In addition, creditors use the CFS to establish whether the company can pay its debts while maintaining its operations.

    Potential employees or contractors

    Employees or contractors use the cash flow statement to know whether the company can afford compensation for their labour.

    Company directors

    Company directors are accountable for the governance of the company. Hence, they use the CFS to keep track of the company’s financial situation while making sure that the company does not trade whilst insolvent.

    Company directors

    A cash flow statement is a cash management tool used by companies to ascertain where their trouble spots are by detailing their sources of cash inflows as well as outflows. It helps to determine a company’s liquidity position and financial health. Having a positive cash flow is indicative of a sound financial position, however, that may not always be the case. For instance, a net negative cash flow might be indicative of a company’s expansion strategy.

  • Book Building Process of IPOs in India

    Book Building Process of IPOs in India

    Book building can also be called the process of price discovery. Under this, the company collects bids at various prices from the investors at the time when the IPO is open. The prices may be above or equal to the floor price. Once the bidding is closed, the price of the shares is determined.

    The book-building method was introduced by SEBI (Security And Exchange Board of India) in October 1995. It helps in the preparation and implementation of the IPO filing by providing detailed information about the company’s financial status, business strategies, and future plans.

    This blog explains the exact meaning of book-building and discusses the steps in the book-building process.

    What Do You Mean by Book Building?

    In most layman’s terms, we can define book building as the collection of information regarding how much the investors want and what they are willing to pay. And by using that information, a demand curve is built by the investment bankers or the underwriter. Based on this information alone, they are able to look at the X amount of shares that the company is going to offer, and, based on the amount of interest in this issue, they can price it at X rupees. So, by using this information available, they can accurately project what is a good price and what will be met in the market with strong demand.

    Book building is a part of a three-step process that is required to complete an Initial Public Offering. The other two processes are the auction and fixed price offering.

    An auction is a process in which the company sells its shares to the highest bidder. The company will not sell all of its shares at one time, but it can sell as many or as few shares as it wants. In order for an IPO to be successful, investors must bid on and purchase enough stock that would make them eligible for future dividends.

    Fixed price offerings: Fixed price offerings are a type of offering that is almost always used in the initial public offering (IPO) process. The fixed price offer is an option for companies to sell shares at a set price, which is usually higher than the current market value of the company. In this way, investors can buy shares at a lower cost and still make money on their investment as long as they hold onto them until after the IPO date.

    The book-building process includes all the steps that will help the company to build its book. They can also use some other strategies like selling shares, options, and other things that may help them to get listed on the stock exchange. The book-building process is a very important part of the IPO. If they are not able to build their book in the best possible way, then it will be difficult for them to get listed on the stock exchange.

    What Are Fixed Price Issues And Book Building Issues?

    Once the valuation is done by the investment bank, the next step that comes is to decide what type of issue is to be brought. So there are two types of issues. One is the Fixed Price Issue, and another is the Book Building Issue. 

    Fixed Price Issue: Fixed price issues are those in which the share price of a company is fixed for a period of time. In a fixed price issue, the price is fixed and no bidding is done. There is a situation of taking it or leaving it. That is, the offer price is given, and people who want to invest can, and whoever doesn’t want to can leave it. So the demand is not properly assessed, which is why the book-building issue is highly recommended.

    The issue will be listed on the stock exchange and traded as per the terms and conditions laid out by SEBI. This means that there will be no change in the share price during this period, unlike other issues where it is possible to see changes in its value depending on market forces.

    Book Building Issue: Under the Book Building Issue, the price is not fixed, rather the price band is kept. The maximum amount is known as the “cap price,” and the minimum amount is known as the “floor price.” And people who are willing to invest and want to subscribe to that issue can place their bids. The maximum difference between the floor price and the cap price can only be 20%. Under this method, the risk of the issuer or underwriter is reduced because he is assessing the demand for how much investment will be kept at what price.

    The most crucial reason why the book-building issue is recommended is that while making the decisions, the qualitative factors are also assessed. When a huge number of people bid on it, they will also analyze the qualitative factors, and collectively, market forces will also be an important factor in the pricing.

    What are the Major Steps in Book Building?

    In order to have a deeper understanding of Book Keeping, you need to learn about the steps involved in it.

    • Appointment of Investment Banker: An investment banker is appointed by the company for the purpose of selling its shares in the public market. The appointment of an investment banker is a legal requirement under the Securities and Exchange Board of India (SEBI) rules. According to SEBI, it will be mandatory for all companies to appoint an independent investment banker before they can sell their shares in public markets. This means that when you are buying or selling your stock, there should be a third party involved who can help you with your transaction without any interference from the company itself.
    • Filling Out Draft Draft Prospectus With SEBI: It is mandatory for every issuing company that is planning to issue shares in the market to prepare a draft and submit it to SEBI at least  21 days prior to filing the offer document with the Registrar of Companies (ROC) and Stock Exchange (SE).

    Then SEBI is responsible for uploading the same prospectus on its official website and asking people to mention any errors they may find.

    • Appointment of Syndicate Members: It refers to a group of individuals or companies that consists of brokers who are responsible for reaching out to the general public from different cities and states and convincing them to invest in your company. 

    Then we have underwriters whose job is to underwrite the issue to the extent of its “net offer to the public.”

    1. Request For Bids On The Price And Quantities Of Securities: Under this process, the syndicate members (brokers) will reach out to convince the general public to purchase the shares of the particular company by filling out the forms and asking questions about how many shares they would like to buy.
    • Aggregate And Forward All Offers To The Book Runners: 

    The reason why this process is called Book-Building is that the company creates a digital book that consists of all the details of the applicants, including their name, phone number, PAN number, Demat Account number, Bank Account Number, the number of shares they want, and the price that they want to purchase the shares.

    After the collection of the details from the investors, all brokers are responsible for delivering the pieces of information to the merchant bankers, also known as book-runners.

    • Maintenance of the Subscriber and their order: This process includes the daily updating in the Digital Book of the new forms that the general public applies to purchase the security. The process runs until the issue is open. The general duration is 7 days.
    • Determination Of Cut-Off Price:  The most important thing is to decide the price of the share at which the shares will be allotted to the general public. That is the determination of the cut-off price. The cut-off price at which the shares will be allotted to the general public will be decided by the company’s closure along with the syndicated merchant bankers.

    Allotment Of Securities To The Successful Bidders: The allotment of securities to the successful bidders will be made on the basis of their bids. The number and type of security allotted to the successful bidders will depend upon the value of their bids as determined by a committee appointed by the company. Companies reserve the right to increase or decrease the number, type, and/or value of securities allotted in any particular allotment round based on various factors, including but not limited to: (i) market conditions; (ii) the assessment that there are insufficient shares available for sale at a price equal to or less than their fair value; (iii) changes in their estimate of expected demand, etc.

    Why Does SEBI Not Recommend Fixed Price Issues?

    SEBI does not recommend fixed price issues because it is difficult to determine the fair value of securities. The prices of shares are determined by supply and demand. If there are a large number of investors who want to sell their shares at a particular price, then the price will fall due to this imbalance in supply and demand. This means that the market has already decided on what the fair value should be for that security, so if SEBI were to fix that price, then it would be setting itself up for failure.

    Understanding The Timeline Of A Public Issue.

    The timeline of a public issue is the time period in which a company has to disclose information about its financial performance. This period is also known as the “period of concern” or “period of interest,” and it usually lasts for four months, but can be extended if necessary. The disclosure must be made within this timeframe so that the investors know how well their investment will perform over the next few months.

    Conclusion:

    To understand how exactly an IPO works, you need to first acknowledge how the book building is done, what the steps are, and who the people involved in running the IPO successfully are. The collection of data, price determination, and finally share allotment is a complex process that requires time and effort. In this blog, we have tried to give you a firm understanding of all the necessary details that you need to figure out to understand the whole mechanism of the Book Building Process in IPOs. Keep reading for more such articles related to finance.



  • Joint Stock Company

    Joint Stock Company

    There are multiple forms in which a business can be incorporated like proprietorship, partnership or joint stock company. A joint stock company, as the name suggests, is jointly owned by a large number of owners in the proportion of their contribution towards the total capital of the company. The total capital of the company is divided into smaller units called shares. This form of business is favourable  when huge amounts of funds are required as a single owner or a group of people can raise limited funds only as is the case of proprietorship and partnership. In words of Prof. L.H. Haney,

    “A Joint Stock Company is a voluntary association of individuals for profit, having a capital divided into transferable shares, the ownership of which is the condition of membership.” 

    Elaborating the definition above, a joint stock company is an association of members who are willing to share profits and losses and cohesively invest their funds in the company. The shares of a joint stock company are transferable, i.e., these shares can be bought and sold in the secondary market. In the case of a private company, there are certain restrictions but there are clauses for transfer of shares. 

    Features

    Joint Stock Company is one of the most popular and desired forms of business and following characteristics of company differentiate it from other traditional forms:

    1. Incorporation: A company gets incorporated after it is registered under the Companies Act, 2013. According to this act, it is mandatory for all the joint stock companies to get themselves registered with the Registrar of Companies to legally commence business.
    2. Separate Legal Entity: In the eyes of the law, a joint stock company is a separate unit than its shareholders and management. It has a separate existence in the eyes of law
    3. Artificial Person: Created under the provisions of Companies Law, a joint stock company has a special identity as an artificial person. It has gained the title of an artificial person since it can’t perform the basic human functions like eating, sleeping, breathing, etc but it has the authority to sign and get into contracts with third parties in its own name. 
    4. Perpetual Existence: Unlike partnership or proprietorship, the life of a joint stock company is not affected by the admission or withdrawal of its members. Since it is created by law, it can only be dissolved by law. Death, insolvency or quitting of any member will not result in the dissolution of the joint stock company.
    5. Limited liability of shareholders: The most attractive feature of this form of business is the limited liability of its shareholders. The personal assets of the owners cannot be claimed in case the company fails to repay its debt as there is in the case of other two most common business forms. 
    6. Common Seal: After incorporation, every company has a common seal (a stamp) which can be used to enter into contracts by a company. A company is only bound to the contracts that carry its seal along with the signatures of its directors. 
    7. Transferability of shares: the shares of a joint stock company can be transferred easily from one shareholder to another. There are some conditions in case of a private company applied to transfer of shares whereas the shares of a public company are easily transferable from one person to another. The market where these shares are sold and purchased is called Stock Exchange.

    Merits

    The popularity of joint stock companies has increased since they offer the advantage of raising more capital and a clear distinction between the firm, its management and its owners. To understand this in depth, let’s look at the various advantages/ merits of a joint stock company.

    1. Limited liability: In a joint stock company, the liability of its shareholders is limited to the unpaid amount of the shares allotted to them which means that their personal assets are not under the risk of being claimed in case of the insolvency of the company. This is one of the major advantages of incorporating a company. This benefit is not enjoyed by sole proprietorship or partnership form of business. 
    2. Large amount of funds: one of the major drawbacks of other forms of business is limited funds.There is a limit as to how much money a single owner or a group of partners can raise. This problem is solved by a joint stock company. The capital that can be raised in a company is more than any other form as many people pool in their funds. Although there is a limit of 200 members in a private company, the number of shareholders in a public company can be unlimited, therefore, large funds are available.  
    3. Perpetual Succession: The life of a joint stock company is never ending. Members may come, members may go, but the company will go on forever. In other forms, the business life is intact with the life and will of its owners and that is a major drawback that restricts their growth.
    4. Transferability of Shares: People are hesitant when it comes to blocking their money in long term funds as huge risk is involved. However, the shares of a joint stock company are easily transferable. This allows people to invest in the shares of a company and then sell off their shares when it is profitable.
    5. Efficient Management: In a joint stock company, owners are separate from the management and the top executives are appointed cohesively by the shareholders so they make sure that most efficient people are selected who will manage the company effectively and increase the wealth of shareholders eventually.

    Types

    A joint stock company can be differentiated on the basis of liability, number of members or on the basis of ownership. The different types of companies are as follows:

    On the basis of liability:

    1. Limited Liability: a company in which the liability of its members is limited up to the unpaid amount on their shares. This is the most common type of company seen in practice.
    2.  Unlimited Liability: when the liability of shareholders is unlimited just like in the case of partnership. This type of company is rarely found in practice at present.
    3. Limited Liability by Guarantee: when the liability of the shareholders is limited to the level of amount guaranteed by them. 

    On the basis of number of members:

    1. Private Company: a private company is the one in which the shares are issued to a handful of investors and the subscription of shares is not available to outsiders.
    2. Public Company: a public company is the one in which the general public can subscribe to the shares of the company and there is no limit on the number of shareholders.

    On the basis of ownership:

    1. Government Company: a company whose 51% or more stake is owned by the Central Government, State Government, or partially by both, is called a government company. The government has a major role in its management.
    2. Non-government company: A company that is owned by private entities is called a non-government company.
  • What is RBI’s Monetary Policy? Objectives, Tools, and Types

    What is RBI’s Monetary Policy? Objectives, Tools, and Types

    If you’ve ever asked yourself, “what is the meaning of the monetary policy,” this article is for you! This article aims to explain the ins and outs of monetary policy in a simple, easy-to-understand way.

    As the name suggests, monetary policy concerns an economy’s monetary aspects. It manages/controls the overall supply of money in an economy. The monetary policy covers a set of tools governed by the central bank and is used to control two major variables of an economy: inflation and unemployment.

    In India, monetary policy is governed by the central bank of India, i.e. Reserve Bank of India. RBI controls liquidity in the Indian economy using various instruments, thus bringing stability to the country. 

    Objectives of Monetary Policy

    The primary objectives of the monetary policy in India include:

    • Inflation: Controlling inflation is one of the main objectives of monetary policy, as neither too much nor too little inflation is ideal for an economy. Hence, the monetary policy of an economy can be employed to maintain healthy inflation levels in the country.
    • Unemployment: An expansionary monetary policy focuses on increasing the country’s money supply, production, and employment opportunities.
    • Exchange rates: Exchange rates also get affected due to changes in monetary policy. An expansionary monetary policy increases the money supply in the economy and makes domestic currency cheaper in the foreign market.

    Tools of Monetary Policy and How They Work

    The central government employs several monetary policy tools to manage the money supply in the economy. These instruments of monetary policy are:

    Open Market Operations: 

    Open market operations refer to when the central bank buys or sells securities from/to private banks. Banks’ cash reserves rise when they buy securities, and so does their ability to lend. This is done when monetary policy is to be expanded. When central banks sell securities, liquidity is soaked, and it is often done when a tight policy is needed.

    Statutory Liquidity Ratios(SLR): 

    SLR can be described as a minimum percentage of liquid funds (cash, gold, government securities, etc.) to be mandatorily held by commercial banks. To increase liquidity in the economy, the central bank will reduce the percentage of minimum funds to be held by banks. If the central bank wishes to tighten the money supply, it will raise the liquidity ratio.

    Repo Rate: 

    Repo rate refers to the rates at which the central bank lends funds to commercial banks for short-term needs against collateral (treasury notes and treasury bills). Suppose the central bank wishes to combat inflation. In that case, it will increase the repo rate as it will discourage commercial banks from arranging funds from the central bank, and thus lesser funds are available with the central bank to disburse as loans. As a result, it aims to curb spending and keep inflation within a range.

    Reverse Repo Rate: 

    It refers to the rates at which a central bank borrows money from commercial banks of an economy. An increase in the reverse repo rate will help in combating inflation/reducing the money supply as it will encourage banks to park funds with RBI. Alternatively, a reduction in the reverse repo rate is used to increase the money supply in the economy. 

    Marginal Standing Facility: 

    This facility is often used when interbank liquidity dries up. In such emergencies, banks can borrow funds from RBI against securities.

    Types of Monetary Policy

    Based on the objectives of the monetary policy can be divided into two types: Expansionary and Contractionary

    Expansionary Monetary Policy

    The expansionary policy aims to expand or increase an economy’s overall money. The policy is usually implemented to boost the country’s economic growth by increasing the money supply, employment, and overall production in the economy. This can be done by lowering repo rates for commercial banks, purchasing securities from banks, or decreasing statutory liquidity ratios. The other aspect of expansionary policy is that it can lead to inflation in the country.

    Contractionary Monetary Policy

    The contractionary policy aims at reducing the money supply in an economy. This policy is adopted when the government wants to control inflation in the economy. The same can be achieved by increasing the repo rates for commercial banks, selling securities to the banks, or increasing statutory liquidity ratios. 

    Difference Between Monetary Policy and Fiscal Policy

    Both monetary and fiscal policies are policies of the central government aiming to bring stability to the country and boost economic growth. However, these two have basic differences as below.

    Meaning:

    Monetary policy refers to the central government’s policy to regulate the economy’s overall money supply. 

    Fiscal policy refers to the policy concerned with the government’s tax revenue and expenditure for economic growth.

    Management:

    The RBI is in charge of monetary policy. Fiscal policy is operated by the Ministry of Finance of India.

    Concern:

    Monetary policy is concerned with banks and credit control. Fiscal policy is concerned with the government’s revenue and expenditure.

    Aim:

    Monetary policy aims for economic stability, and fiscal policy focuses on overall economic growth.

    Nature:

    Monetary policy meetings occur at regular intervals, and decisions are taken when the need arises. Fiscal policy, on the other hand, changes every year.

    Conclusion

    Monetary policy is the act of controlling the amount of money in circulation. It involves controlling interest rates, adjusting reserve requirements, and using government spending (government spending stimulates the economy because when the government spends, it adds to the money supply).

  • What is the bullish engulfing pattern, and why does it matter for investors? 

    What is the bullish engulfing pattern, and why does it matter for investors? 

    Japan is known to be the origin of candlestick patterns, and as a result, candlestick patterns are also called Japanese candlestick patterns. They have been implemented in Japan since the 18th century, and now it has become a popular practice in the investment and trending space to predict the trend of the market, stocks, or other financial assets. 

    There are thousands of candlestick patterns available, and it can be hard to identify them. A bullish engulfing pattern is one of those candlestick patterns used in technical analysis. This article is your guide to know everything you need to know about this candlestick pattern. We will cover what a bullish engulfing pattern is, what it indicates with an example, its limitations, and how it is different from a bearish engulfing pattern in this article. 

    What is the bullish engulfing pattern?

    A bullish engulfing pattern is a part of the candlestick-based technical analysis performed to know the trend reversal possibility and the best time to invest in equity stock. It helps technical analysts know that a trend reversal is in store, and it’s time to take advantage of that. 

     

    As its name suggests, a bullish engulfing pattern shows a positive change in the trend, and it completely covers (engulfs) the red/bearish candle. It typically appears when the market or a stock is in a red and downward trend. The appearance of a bullish engulfing candle means that the trend will reverse, and the market or the stock will go upwards. 

    How to identify a bullish engulfing pattern?

    These are the main traits of a bullish engulfing pattern that helps you identify it. 

    • It appears during a downward trend.
    • A big and strongly positive (green) candle engulfs the previous red candle.
    • It is a strong indication if a Doji candle appears before the bullish candle. (A Doji candle forms when the opening and closing price are almost similar with no major changes during the day.)
    • The next candle following the bullish engulfing candle closes above its high (this is not mandatory, though).

    The bullish engulfing pattern shows a reversal and indicates that the selling pressure is reducing with investors and traders focusing on buying momentum. 

    What are the trading implications of this pattern?

    Now that the base is clear, let’s understand the implications this pattern has on investors and their decisions.

    As the image shows, a bullish engulfing pattern comes after a downward trend when the selling pressure is already high. When a giant green candle overshadows the red bearish candle, it is the start of a bullish trend. This is day one for investors. 

    On the second day, bears again try to take the market down, and that reflects in the red candle as shown in the picture. However, the closing is still higher than the previous day’s candle as the bulls try to take charge. That is day two. We can also call this candle a gap up after a gap down in the morning session. 

    A risk-taking investor may enter the trade on the first or second day, while a risk-averse investor would wait for two to three days for the reversal trend to confirm and continue. 

    The reversal of the trend occurs as the investor sentiments change from bearish to bullish, and that reflects in the candles. Eventually, it is a win for bulls over bears. 

    What is the key difference between bullish and bearish engulfing patterns?

    A bearish engulfing pattern is the counterpart of a bullish engulfing pattern. It appears when the market is in an upward trend. Opposite of the bullish engulfing, a big red candle covers a bullish candle and engulfs it completely in the bearish engulfing pattern. 

    It sets a new course of trend as the market sentiments change to bearish, and investors put pressure on selling. You can see how the candlestick pattern looks in the image below. 

    Bullish and bearish, both the engulfing patterns work similarly for different market scenarios. The only difference is that the first one leads to an upward market trend, while the latter is a reversal pattern that invites a market downturn. 

    When doesn’t the bullish engulfing pattern work?

    No candlestick pattern ensures a sure shot result, and a bullish engulfing pattern is no different. If the candles following the bullish candle are Doji, or let’s say the market is going sideways, then even if the market is rising eventually, it doesn’t confirm a trend reversal. This can reduce the effect of the bullish engulfing pattern. 

    While a bullish engulfing pattern confirms a trend reversal, it does not necessarily help investors determine the range for the coming trend with a price target. Thus, the pattern alone is not enough for investors. They need to combine it with other candlestick patterns or other technical analysis techniques to secure a profitable trade. 

    Conclusion

    Bullish engulfing patterns help investors find a reversal in trend and take advantage of the upcoming market bullishness. It appears when the market is already in the downward trend and covers the bearish candle. It is suggested for investors to wait for two to three days to make sure that the trend reversal alarm is not false. Investors should also use other candlestick patterns or tools to analyze the perfect price target and know when to exit the market. 

  • Average Directional Index (ADX)

    Average Directional Index (ADX)

    Introduction

    Trend chasing is an important trait for trading in the stock market. It helps one better analyze the market movements and devise a trading strategy to capitalize on gains. Knowledge of trend-chasing strategies can reduce the risk of the trader and increase their potential profits. Several different trading indicators are used by traders to access the market momentum. One such indicator is the average directional index. 

    In this blog, we will study the ADX indicator and understand how to use the ADX indicator to measure a trend strength. Let us first understand what the average directional index is.

    What is the ADX indicator?

    ADX indicator was first developed by an American engineer Welles Wilder to determine the price movements in the commodity industry, but due to its high relevancy, today this is an important indicator for technical trading of stocks and for analyzing stock trends. ADX is primarily used to study the strength of the trend. Let us now understand how ADX works.

    How average directional index works:

    ADX is an important trend indicator that is used to assess the strength of a stock market trend. ADX is derived from two indicators, the positive directional index (DI+) and the negative directional index (DI-). Therefore an ADX indicator will always have 3 lines: 

    • The positive directional indicator (DI+) line
    • The negative directional indicator (DI-) line
    • The ADX line.

    The value of ADX lies in a range of 0-100 and is used to signify the strength of a trend irrespective of its direction. The strength of the trend generally refers to the level of influence that the buyers and sellers have over the market over a specific period of time.

    The readings that are closer to zero or greater than 60 are generally a rare occurrence. 

    Another important aspect of the ADX indicator is the DM which stands for Directional Movement.

    Let us now understand what these lines tell us

    What do ADX lines tell you?

    Let us now learn about some ADX indicator strategies that help the analysts study the ADX charts. 

    If the DI+ line is above the DI- line, it indicated the upward price trend with the ADX line measuring the strength of the uptrend. Similarly, if the DI+ line is below the DI- line it shows a downtrend in the prices. Here the ADX line is used to measure the strength of the downtrend.

    A strong trend is reflected, if the ADX line is above 25. However, if the ADX line is above 40, it shows a very strong trend. Similarly, if the ADX line is below 20, it means that no trend can be shown. 

    If the ADX line drops after reaching a high value, it indicated the end of a trend. If the ADX line starts going up it shows a strengthening trend.

    How to Calculate ADX

    To calculate ADX, you first need to find +DM, -DM, and the true range (TR). Typically TR is calculated for fourteen periods.

    +DM is calculated by reducing the value of the previous high from the current high.

    -DM  is calculated by reducing the value of the current low from the previous low.

    Then the True range(TR) is calculated by reducing the low price (of the day) from the High price.

    For example, Assume that for the stock of XYZ, there were the following figures on 1 March

    Day low = Rs. 160
    Day high = Rs. 200

    Previous low = Rs. 166
    Previous high = Rs. 180

    Day high – previous high = Rs. 200 – Rs. 180 = Rs. 20 
    Previous low – current low = Rs. 166 – Rs. 160 = Rs. 6 

    Since Rs. 20 > Rs. 6, DM is positive in the above case and vice versa.

    Now, to calculate the ADX, continue to calculate DX values for at least 14 periods. 

    After calculating DM, one can derive the value of DI

    Then the DX is calculated as = DI 14 difference/ DI 14 sum x 100 

    ADX = Simple average of DX (taken for 14 periods)

    ADX is undoubtedly an important tool to study stock trends but it comes with its own set of limitations. Let us now discuss some of the limitations of ADX:

    Limitations of ADX

    • ADX is not always considered a good indicator for the less volatile stocks, and for the more volatile stocks, it may generate some false signals.
    • Since ADX is based on moving averages, it reacts slowly to any changes in the price. Hence, It is a laid-back indicator.
    • ADX is not a wholesome tool for analyzing stock trends and it must be used in conjunction with other indicators when trading.

    Conclusion:

    When investing in the market, the trend is your only friend. It is extremely important to analyze the trend and devise a suitable strategy. ADX is one of the most used technical indicators because it is simple to use and when combined with other indicators it can help one analyze the market trends with accuracy.

    ADX indicator can help one identify the strength of trends and make profits out of them. It allows one to detect favourable trading conditions and invest in profitable trends. ADX also helps one find the changes in trend momentum and allows them to manage their risks. One can get the highest returns by trading in the strongest trends. It also helps one identify the exit points from the markets and provides them with analytical insights. 

  • How to read a CIBIL report?

    How to read a CIBIL report?

    Established in 2000, CIBIL is an entity liable for maintaining credit information. The full form of CIBIL is the Credit Information Bureau (India) Limited.  

    Generally, such Credit Information Companies (CICs) are third-party, independent organizations that accumulate credit card and loan data. 

    And then, they share this data with associated financial institutions and banks. Individuals can obtain their CIBIL report with credit score, history, and more information. 

    However, for a layperson, decoding this report can become quite taxing. If you are also feeling the heat, find the easy way to read a CIBIL score report and familiarize yourself with your credit situation in this post.

    What is a CIBIL report?

    Once CIBIL has accumulated the financial data of individuals and companies, it creates a Credit Information Report (CIR), also known as a CIBIL report. This report comprises vital information that financial institutions can view if that concerned individual has applied for a credit card or a loan.

    This information discusses previous loans, such as home, car and personal loans. Along with that, it also has information regarding your overdraft facilities and credit cards. 

    One detailed section is dedicated to your repayment history and how quick you have been with your EMIs. Ultimately, this report helps the lender comprehend whether you can return the loan or repay the bills on your credit cards. 

    But how to get CIBIL report? You can go to the CIBIL website and click on the ‘know your score’ option. Fill out an online form with information like your name, date of birth, income, identity verification, address, phone number, and the loans you have taken out. 

    In addition to individual CIBIL reports, financial institutions also get CIBIL Commercial Report to make better lending decisions when they get loan requests from public limited corporations, private limited companies, partnership firms, and sole proprietorships.  

    What is the CIBIL score?

    Your CIBIL score is a three-digit numeric summary of your credit history calculated using information from your CIBIL report’s ‘Accounts’ and ‘Enquiries’ sections, which includes your loan accounts or credit cards, payment status, and outstanding amounts’ that are past the due date. The score indicates your credit worthiness, as determined by lenders, based on your borrowing and payback history. The CIBIL score ranges from 300 to 900, and the higher your score, the more likely you will be approved for a loan. 

    How is the CIBIL report calculated?

    Four significant factors influence your CIBIL score:

    Payment history: Your CIBIL score depends on your payment history of loan EMIs and credit card dues. If you pay your payments on time without missing a payment, it will positively impact your score.

    Credit mix: A well-balanced mix of secured and unsecured loans is likely beneficial.

     Multiple loan queries: Having too many loan inquiries will lower your score because it shows that you might depend more on credit. 

    Credit utilization ratio: The credit utilization ratio is the proportion of the credit amount you have used out of the total available credit. A low credit utilization ratio has a positive impact on your credit score. 

    How to read a CIBIL report?

    In a CIBIL report, you will find 7 primary sections. While they have varying roles, each of these sections is equally vital. The objective of these sections is to offer genuine and complete information. Find out more about these sections in the following points: 

    • CIBIL Score

    Your CIBIL score, based on ‘Accounts’ and ‘Enquiries’ in your CIR, ranges from 300 to 900. 

    • Personal Information

    CIBIL collects personal information to help NBFCs and banks in verifying your data. This section contains:

    • PAN card details
    • Name
    • Date of birth
    • Voter’s ID
    • Other identification proofs

    It collects this information through a variety of methods. If there is any data that has been collected from previous lenders, it will be marked with an ‘e’ to ensure accuracy. 

    • Contact Information

    As the name suggests, this column contains all of your contact information. This is additional proof of genuineness. This section offers a variety of contact information and addresses, such as:

    • Addresses (permanent, temporary, work, and home)
    • Email IDs
    • Contact numbers (home and mobile)

    This information is taken from previous and current lenders to ensure accuracy.  

    • Employment Information

    In this section, you will find data related to the companies and your jobs. They check your records at the companies and how frequently you switched from one organization to the other. 

    This way, the lender gets to comprehend your income patterns. Anybody who frequently switches jobs has fewer chances of getting a loan disbursed because of consistent income changes and unstable earnings. 

    • Account Information

    This is the most vital section of a credit report. Account Information connects the financial institutes and banks to your financial status. You will find records of your ongoing and previous credit card statements and loans here. 

    It also contains information regarding how frequently you make your repayments or if you have missed any payments. The account information also has your bank account details. 

    It also mentions your account type, be it savings or current, single or joint. With this data, they can comprehend your behavior and determine your creditworthiness. 

    • Red Box

    Sometimes, you can see a red box above the ‘account details’ table. If any disputes are linked to the account information, the red box will come up with the text citing the fields under the question. 

    They will remove the box after the dispute is resolved. There could be or could not be any change in your information based on the lender’s input on the disagreement. 

    • Inquiry Information

    This is one such section that has details of all the banks that are thinking of lending you credit cards or loans. Such inquiries are made by varying NBFCs and banks that have kept your credit score in mind. 

    Thus, to be a worthy candidate for getting a loan, make sure your credit score is good enough. 

    Conclusion

    A good credit score is a score that is above 700. If your score is lower than this benchmark, availing of loans or credit cards could be a hassle. So, make sure you do everything possible to improve your score. 

  • Fama And French Three Factor Model

    Fama And French Three Factor Model

    Introduction

    The Fama and French model is the updated form or has evolved from the primary Capital Asset Pricing Model (CAPM). When dealing with shares and stocks, knowing about all these related models is pertinent, which will help you analyze the returns and market values. The risk factors involved in trading the stocks and associated returns of the portfolio are calculated using such formulas of the model. 

    As there are two types under the name Fama french model itself, we will look at how the Fama and French Three Factor Model works. This guide will shed light on the principle and the formula with relevant examples. 

    Formula and Explanation

    The formula for Fama French Model is simple, and anyone with proper knowledge about the stock exchange will be able to understand it quickly. It is written as: 

    Where, 

    ra is the rate of return 

    rf is the risk-free rate 

    ß is the factor of coefficient for sensitivity 

    (rm – rf) is the market risk premium 

    SMB is Small Minus Big 

    HML is High Minus Low 

    α is the investment’s alpha factor and; 

    e is the total risk. 


    This innovative formula for the Fama french 3-factor model makes predicting returns and risks easier.

    The Principles on Which this Model Works

    As this is a three-factor model, it works on three aspects or factors. They are:

    1. a) market risk 
    2. b) size risk 
    3. c) value risk. 

    To be precise, the detailed factor it runs on is the SMB and the HML. SMB is in line with the performance of small-cap companies over the large-cap companies. In comparison, HML is under the high book-market-value company versus the low book-to-market value company.

    The size risk pertains to the Small Minus Big (SMB) factor. The beta coefficient in the formula can be either positive or negative. This coefficient concerns the capitalization of the company. It is believed under this model that small-cap companies can expect high rates of return when compared with large-cap companies. Therefore, the beta factor is vital for determining the risks. 

    The value risk is under the High Minus Low (HML) factor. The companies with a high book-to-market ratio will yield higher returns than the low book-to-market value companies. The book-to-market value is the difference between the predicted value in the book and the actual market value of the company. 

    If the coefficient factor is positive in the case of SMB, the returns are directed more towards a small-cap company. Similarly, if the coefficient is positive for the HML factor, the returns are more related to the high book-to-market value company. 

    There are two main aspects, namely the “value” and “growth.” In both cases, the returns pertain to value. If the condition is vice versa to the one cited above, the returns will be under the terms of growth and not value. 

    Why is this model considered the best?

    The Fama and French Model is the advancement of the CAPM, a traditional model. This model knows and calculates the risk factors precisely. The risk-free rate is known to be applied when there are no possible risks while receiving the returns. The market risk premium is the estimated returns where the market with risks and risk-free markets are compared. All such important factors are used in applying the Fama and French models. 

    The fama french 5-factor model is more advanced as it includes two more factors: profitability and investment. These two factors are used in addition to the factors of the three-factor model. 

    As CAPM used only a single factor to assess the market risks, this model serves the best. Determining the beta coefficient factor with just a single element is challenging. Further, the volatility of the investment alone is estimated using the CAPM, and the risk-free rates determined might fluctuate from time to time. All such drawbacks can be overcome using the Fama and French Models. 

    Who can find this model to be useful?

    Investors who are new to the field might not be able to find the model helpful as compared to experienced investors. As they might take time to understand all the terms and principles of trading, they can prefer simple methods to know the risks of returns after investment.

     A professional investor can use this Fama and French model to know the intricate details of the returns. A mediocre investor can get help from an advanced analyst for investing in stocks. The analyst might then use the model to calculate the risks of the stock portfolio. 

    This model came into existence in 1992 and was developed by Eugene Fama and Kenneth French. The model’s name comes from their names, and there is no specific fama full form as such. Eventually, after the three-factor model, the five-factor model also developed. 

    Conclusion

    Summing it up, a wise investor will gain lucrative profits without much loss by using this model. It is preferred to use Fama and French models and the related formula to know all the stock returns and market risks involved. Moreover, the working of the model must be thoroughly understood, and the relevant values should be appropriately applied. Therefore, one must invest only after knowing and accepting the risks involved in stock returns. 

    References

  • What are Bills of Exchange?

    What are Bills of Exchange?

    While payments are an integral part of a business, you’d know that ensuring payment inflow isn’t effortless if you’ve ever chased an invoice. Thus, a bill of exchange is curated to keep everybody liable for making timely payments. 

    The Negotiable Instruments Act 1881 regulates the provisions for bills of exchange. As per Section 5 of this specific act, it’s an instrument in writing that contains total order signed by the maker, directing a particular individual to pay an amount sum of money to the instrument’s bearer.

    When such an order is acknowledged in writing, it becomes a legal bill of exchange. In this post, let’s find out everything about the bills of exchange. 

    What is Bills of Exchange in India?

    If we have to define the bill of exchange, it is a formally written IOU that cites when a specific amount of money must be paid. This is a bill that a person draws to direct another person to pay the money to somebody else. If accepted, somebody has to pay the amount; it becomes real. 

    Generally, the seller provides a credit period to the buyer upon selling products or services. For example, suppose A orders B to pay Rs.10,000 for 100 days after the date, and B accepts the order by signing the bill. Then, it will become a bill of exchange. 

    However, there are certain situations when the seller may not be in the position to provide a credit period to the buyer. And then, the buyer may not be in a position to pay instantly. 

    In such a scenario, the seller would ask the purchaser to give a written promise to pay the sum of money on a specific date. This written promise becomes a valuable credit instrument when properly made and stamped. 

    Often, banks accept these written instruments, and you can withdraw money against them. Moreover, you can also endorse the instrument, meaning you can pass it to somebody else. 

    Parties to a Bill of Exchange

    A bill of exchange has three different parties, such as:

    Drawer

    • A drawer is the creator of the bill of exchange
    • They have to sign the bill
    • A creditor who is permitted to get payments from the debtor can draw the bill


    Drawee

    • Drawee is somebody upon whom the bill is drawn
    • He is the debtor who should pay the drawer
    • A drawee is also called an Acceptor


    Payee

    • The payee is somebody to whom the payment should be made
    • The payee could be either the drawer himself or the third party

    Example of Bills of Exchange

    Let’s take up an example here to understand bills of exchange in a better way. Suppose Mr Sharma has drawn a bill on Mr Bansal for three months for Rs.1,00,000. The bill is payable to Mr Gupta on 17th June 2022. 

    Mr Sharma ordered Mr Bansal to pay Rs.1,00,000 to Mr Gupta. If Mr Bansal accepts the order, he will write a bill as follows:

    Accepted

    Mr Bansal

    Delhi

    17th June 2022

    When the drawee pens down this type of acceptance on the bill, it turns into a bill of exchange. In the example above, Mr Sharma is the bill’s drawer, Mr Bansal is the acceptor, and Mr Gupta is the payee. In the end, Mr Bansal will pay the money to Mr Gupta.

    Features of Bills of Exchange

    Here are the features of bills of exchange:

    • It comes with the date by which the money should be paid.
    • The amount is payable to the person whose name is mentioned on the bill or to their bearer.
    • A bill of exchange should have a revenue stamp.
    • The bill payment should be in the legal currency of the nation.

    Format of a bill of exchange

    Here is a format of a bill of exchange 

     Stamp                                                                          Name and address

    Amount                                                                          Date             

    One month after the date pay to (name and address of payee) or order, the sum of (mention the amount) for value

    Accepted     Drawer

    (Signed)     (Signed)

    Drawee’s name     Drawer’s Address

    Drawee’s Address

    Types of Bills of Exchange

    Jotted down below are the types of bills of exchange for your reference:

    • Documentary Bill: Here, the bills of exchange are supported by related documents that validate the authenticity of the transaction or sale between the buyer and the seller.
    • Supply Bill: This is a bill that a contractor or a supplier withdraws from the government.
    • Demand Bill: This bill is due when it is demanded, as the name implies. There is no set payment date on the demand bill. Thus, it should be cleared whenever put forth.
    • Trade Bill: This type of bill is relevant only to trade.
    • Usance Bill: This one is a time-bound bill. It means the payment must be made within the given time.
    • Accommodation Bill: An accommodation bill is the one that is sponsored, drawn and accepted without conditions.
    • Inland Bill: It is payable only in one nation. In this bill, both the acceptor and the drawer live in the same country. 
    • Foreign Bill: Opposite the inland bill, this one can be paid outside the country. For instance, import bills and export bills.
    • Clean Bill: This bill doesn’t have any documented proof. Thus, the interest is higher as compared to other bills.  

    Discounting Bills of Exchange

    A payee could sell a bill of exchange to a different party for a discounted price to acquire funds before the payment date that is put on the bill. The discount signifies the interest cost that is related to being paid early. 

    Difference between promissory notes, bills of exchange, and cheques 

    Bills of exchange and promissory notes confirm a financial transaction between two parties. In international trade, bills of exchange are more common than promissory notes. A promissory note is an informal loan document. It’s a written document that guarantees to pay a specified sum to a specific person or the instrument’s holder.  A cheque is considered a negotiable instrument. One person/party instructs the bank to transfer money to another’s account by cheque. Cheques are safe and secure because they don’t involve cash.

    Conclusion

     Now that you have understood everything about the bills of exchange, you will be able to use them better. Also, know that the bill matures when the tenure expires. Thus, the maturity of the bills of exchange is defined as the tenure’s end.