Friday, January 5, 2007
Interest
Interest is the "rent" paid to borrow money. The lender receives a compensation for foregoing other uses of their funds, including (for example) deferring their own consumption. The original amount lent is called the "principal," and the percentage of the principal which is paid/payable over a period of time is the "interest rate."
Risk-free Bonds
A risk-free bond is a theoretical bond that repays interest and principal with absolute certainty. In practice, government bonds are treated as risk-free bonds, as governments can raise taxes or indeed print money to repay their domestic currency debt. For instance, U.S. Treasury notes and bonds are considered risk-free bonds, even though investors in U.S. Treasury securities do face a negligible amount of credit risk. That this credit risk is not always negligible, is shown by the example of Russia that defaulted on its domestic debt in 1998.
Government Bonds
A government bond is a bond issued by a national government denominated in the country's own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds.
Government bonds are usually referred to as risk-free bonds, because the government can raise taxes or simply print more money to redeem the bond at maturity. Some counterexamples do exist where a government has defaulted on its domestic currency debt, such as Russia in 1998- the "rouble crisis" , though this is very rare.
As an example, in the US, Treasury securities are denominated in US dollars and are the safest US dollar investments. In this instance, the term risk-free means free of credit risk. However, other risks still exist: such as currency risk for foreign investors (for example non-US investors of US Treasuries would have received lower returns in 2004 because the value of the US dollar declined against most other currencies). Secondly, there is inflation risk - in that the principal repaid at maturity will have less purchasing power than anticipated if the inflation outturn is higher than expected. Many governments issue inflation-indexed bonds, which protect investors against inflation risk.
An example of somewhat risky bonds issued by a government can be given with countries that have less than perfect capabilities of conducting financial policies. Such an example is Bulgaria due to its being dependent on the world economy and economic institutions much more than, say, the US. Some of this country's bonds were only given an A-scale rating after 2004. As of February 2006 Standard & Poor's rates Bulgaria's long-term debt denominated in domestic currency at BBB+. And this rating is the result of almost a decade of constantly decreasing risk (and increasing ratings). We should also note that this country's short-term debt is in fact currently rated A.
Government bonds are usually referred to as risk-free bonds, because the government can raise taxes or simply print more money to redeem the bond at maturity. Some counterexamples do exist where a government has defaulted on its domestic currency debt, such as Russia in 1998- the "rouble crisis" , though this is very rare.
As an example, in the US, Treasury securities are denominated in US dollars and are the safest US dollar investments. In this instance, the term risk-free means free of credit risk. However, other risks still exist: such as currency risk for foreign investors (for example non-US investors of US Treasuries would have received lower returns in 2004 because the value of the US dollar declined against most other currencies). Secondly, there is inflation risk - in that the principal repaid at maturity will have less purchasing power than anticipated if the inflation outturn is higher than expected. Many governments issue inflation-indexed bonds, which protect investors against inflation risk.
An example of somewhat risky bonds issued by a government can be given with countries that have less than perfect capabilities of conducting financial policies. Such an example is Bulgaria due to its being dependent on the world economy and economic institutions much more than, say, the US. Some of this country's bonds were only given an A-scale rating after 2004. As of February 2006 Standard & Poor's rates Bulgaria's long-term debt denominated in domestic currency at BBB+. And this rating is the result of almost a decade of constantly decreasing risk (and increasing ratings). We should also note that this country's short-term debt is in fact currently rated A.
Discount Window
Discount window refers to the practice by a central bank of extending short-term loans secured by government bonds to financial institutions. The interest rate charged on such loans—or discount rate, an important factor in the control of money supply—is set as a matter of monetary policy. When a bank is in need of money, it can turn to the Federal Reserve for a loan, the interest that the Fed charges the bank is called the discount rate. When banks other than the Federal Reserve loan other banks money, the interest rate charged is known as the Federal Funds Rate, and is typically approximately a percentage point below the Discount Rate.
Weighted Average Cost of Capital
The weighted average cost of capital (WACC) is used in finance to measure a firm's cost of capital. It has been used by many firms in the past as a discount rate for financed projects, since the cost of the financing seems like a logical price tag to put on it.
Corporations raise money from two main sources: equity and debt. Thus the capital structure of a firm comprises three main components: preferred equity, common equity and debt (typically bonds and notes). The WACC takes into account the relative weights of each component of the capital structure and presents the expected cost of new capital for a firm.
Corporations raise money from two main sources: equity and debt. Thus the capital structure of a firm comprises three main components: preferred equity, common equity and debt (typically bonds and notes). The WACC takes into account the relative weights of each component of the capital structure and presents the expected cost of new capital for a firm.
Equivalent Annuity Method
The equivalent annuity method expresses the NPV as an annualized cash flow by dividing it by the present value of the annuity factor. It is often used when assessing only the costs of specific projects that have the same cash inflows. In this form it is known as the equivalent annual cost (EAC) method and is the cost per year of owning and operating an asset over its entire lifespan.
It is often used when comparing investment projects of unequal lifespans. For example if project A has an expected lifetime of 7 years, and project B has an expected lifetime of 11 years it would be improper to simply compare the net present values (NPVs) of the two projects, unless neither project could be repeated.
The use of the EAC method implies that the project will be replaced by an identical project.
Alternatively the chain method can be used with the NPV method under the assumption that the projects will be replaced with the same cash flows each time. To compare projects of unequal length, say 3 years and 4 years, the projects are chained together, i.e. four repetitions of the 3 year project are compare to three repetitions of the 4 year project. The chain method and the EAC method give mathematically equivalent answers.
The assumption of the same cash flows for each link in the chain is essentially an assumption of zero inflation, so a real interest rate rather than a nominal interest rate is commonly used in the calculations.
It is often used when comparing investment projects of unequal lifespans. For example if project A has an expected lifetime of 7 years, and project B has an expected lifetime of 11 years it would be improper to simply compare the net present values (NPVs) of the two projects, unless neither project could be repeated.
The use of the EAC method implies that the project will be replaced by an identical project.
Alternatively the chain method can be used with the NPV method under the assumption that the projects will be replaced with the same cash flows each time. To compare projects of unequal length, say 3 years and 4 years, the projects are chained together, i.e. four repetitions of the 3 year project are compare to three repetitions of the 4 year project. The chain method and the EAC method give mathematically equivalent answers.
The assumption of the same cash flows for each link in the chain is essentially an assumption of zero inflation, so a real interest rate rather than a nominal interest rate is commonly used in the calculations.
The Internal Rate of Return (IRR)
The internal rate of return (IRR) is defined as the discount rate that gives a net present value (NPV) of zero. It is a commonly used measure of investment efficiency.
The IRR method will result in the same decision as the NPV method for independent (non-mutually exclusive) projects in an unconstrained environment, in the usual cases where a negative cash flow occurs at the start of the project, followed by all positive cash flows. In most realistic cases, all independent projects that have an IRR higher than the hurdle rate should be accepted. Nevertheless, for mutually exclusive projects, the decision rule of taking the project with the highest IRR - which is often used - may select a project with a lower NPV.
In some cases, several zero NPV discount rates may exist, so there is no unique IRR. The IRR exists and is unique if one or more years of net investment (negative cash flow) are followed by years of net revenues. But if the signs of the cash flows change more than once, there may be several IRRs. The IRR equation generally cannot be solved analytically but only via iterations.
One shortcoming of the IRR method is that it is commonly misunderstood to convey the actual annual profitability of an investment. However, this is not the case because intermediate cash flows are almost never reinvested at the project's IRR; and, therefore, the actual rate of return is almost certainly going to be lower. Accordingly, a measure called Modified Internal Rate of Return (MIRR) is often used.
Despite a strong academic preference for NPV, surveys indicate that executives prefer IRR over NPV, although they should be used in concert. In a budget-constrained environment, efficiency measures should be used to maximize the overall NPV of the firm. Some managers find it intuitively more appealing to evaluate investments in terms of percentage rates of return than dollars of NPV.
The IRR method will result in the same decision as the NPV method for independent (non-mutually exclusive) projects in an unconstrained environment, in the usual cases where a negative cash flow occurs at the start of the project, followed by all positive cash flows. In most realistic cases, all independent projects that have an IRR higher than the hurdle rate should be accepted. Nevertheless, for mutually exclusive projects, the decision rule of taking the project with the highest IRR - which is often used - may select a project with a lower NPV.
In some cases, several zero NPV discount rates may exist, so there is no unique IRR. The IRR exists and is unique if one or more years of net investment (negative cash flow) are followed by years of net revenues. But if the signs of the cash flows change more than once, there may be several IRRs. The IRR equation generally cannot be solved analytically but only via iterations.
One shortcoming of the IRR method is that it is commonly misunderstood to convey the actual annual profitability of an investment. However, this is not the case because intermediate cash flows are almost never reinvested at the project's IRR; and, therefore, the actual rate of return is almost certainly going to be lower. Accordingly, a measure called Modified Internal Rate of Return (MIRR) is often used.
Despite a strong academic preference for NPV, surveys indicate that executives prefer IRR over NPV, although they should be used in concert. In a budget-constrained environment, efficiency measures should be used to maximize the overall NPV of the firm. Some managers find it intuitively more appealing to evaluate investments in terms of percentage rates of return than dollars of NPV.
Net Present Value
Each potential project's value should be estimated using a discounted cash flow (DCF) valuation, to find its net present value (NPV). This valuation requires estimating the size and timing of all of the incremental cash flows from the project. These future cash flows are then discounted to determine their present value. These present values are then summed, to get the NPV. See also Time value of money. The NPV decision rule is to accept all positive NPV projects in an unconstrained environment, or if projects are mutually exclusive, accept the one with the highest NPV.
The NPV is greatly affected by the discount rate, so selecting the proper rate - sometimes called the hurdle rate - is critical to making the right decision. The hurdle rate is the minimum acceptable return on an investment. It should reflect the riskiness of the investment, typically measured by the volatility of cash flows, and must take into account the financing mix. Managers may use models such as the CAPM or the APT to estimate a discount rate appropriate for each particular project, and use the weighted average cost of capital (WACC) to reflect the financing mix selected. A common practice in choosing a discount rate for a project is to apply a WACC that applies to the entire firm. Some believe that a higher discount rate is more appropriate when a project's risk is different from the risk of the firm as a whole.
The NPV is greatly affected by the discount rate, so selecting the proper rate - sometimes called the hurdle rate - is critical to making the right decision. The hurdle rate is the minimum acceptable return on an investment. It should reflect the riskiness of the investment, typically measured by the volatility of cash flows, and must take into account the financing mix. Managers may use models such as the CAPM or the APT to estimate a discount rate appropriate for each particular project, and use the weighted average cost of capital (WACC) to reflect the financing mix selected. A common practice in choosing a discount rate for a project is to apply a WACC that applies to the entire firm. Some believe that a higher discount rate is more appropriate when a project's risk is different from the risk of the firm as a whole.
Capital Budgeting
Capital budgeting (or investment appraisals) are the planning processes used to determine a firm's long term investments such as new machinery, replacement machinery, new plants, new products, and research and development projects.
Many formal methods are used in capital budgeting, including discounted cash flow techniques such as net present value, internal rate of return, Modified Internal Rate of Return and equivalent annuity method, using the incremental cash flows from each potential investment, or project. Techniques based on accounting earnings and accounting rules are sometimes used - though economists consider this to be improper - such as the accounting rate of return, and "return on investment." Simplified and hybrid methods are used as well, such as payback period and discounted payback period.
Many formal methods are used in capital budgeting, including discounted cash flow techniques such as net present value, internal rate of return, Modified Internal Rate of Return and equivalent annuity method, using the incremental cash flows from each potential investment, or project. Techniques based on accounting earnings and accounting rules are sometimes used - though economists consider this to be improper - such as the accounting rate of return, and "return on investment." Simplified and hybrid methods are used as well, such as payback period and discounted payback period.
Discounted Cash Flow (DCF)
In finance, the discounted cash flow (or DCF) approach describes a method to value a project or an entire company using the concepts of the time value of money. The DCF methods determine the present value of future cash flows by discounting them using the appropriate cost of capital. This is necessary because cash flows in different time periods cannot be directly compared since most people prefer money sooner rather than later (put simply: a dollar in your hand today is worth more than a dollar you may receive at some point in the future). The same logic applies to the difference between certain cash flows and uncertain ones, or "a bird in the hand is worth two in the bush". This is due to opportunity cost and risk over time.
DCF procedure involves three problems
1- the forecast of future cash flows,
2- the incorporation of taxes (firm income taxes as well as personal income taxes),
3- the determination of the appropriate cost of capital. Discounted cash flow analysis is widely used in investment finance, real estate development, and corporate financial management.
Depending on the financing schedule of the company four different DCF methods are distinguished today. Since the underlying financing assumptions are different they do not need to arrive at the same value of the project or company:
Equity-Approach Flows to equity approach (FTE) Entity-Approach: Adjusted present value approach (APV) Weighted average cost of capital approach (WACC) Total cash flow approach (TCF)
DCF procedure involves three problems
1- the forecast of future cash flows,
2- the incorporation of taxes (firm income taxes as well as personal income taxes),
3- the determination of the appropriate cost of capital. Discounted cash flow analysis is widely used in investment finance, real estate development, and corporate financial management.
Depending on the financing schedule of the company four different DCF methods are distinguished today. Since the underlying financing assumptions are different they do not need to arrive at the same value of the project or company:
Equity-Approach Flows to equity approach (FTE) Entity-Approach: Adjusted present value approach (APV) Weighted average cost of capital approach (WACC) Total cash flow approach (TCF)
Free Cash Flow
Free cash flow measures a firm's net increase in
cash from operations (this includes the reduction for interest), less the dividends paid to preferred shareholders, and less expenditures necessary to maintain assets. Increases in non-cash current assets may, or may not be deducted, depending on whether they are considered to be maintaining the status quo, or to be investments for growth.
cash from operations (this includes the reduction for interest), less the dividends paid to preferred shareholders, and less expenditures necessary to maintain assets. Increases in non-cash current assets may, or may not be deducted, depending on whether they are considered to be maintaining the status quo, or to be investments for growth.
Economic Value Added (EVA)
Economic Value Added (EVA) is often defined as the value of an activity that is left over after subtracting from it the cost of executing that activity and the cost of having lost the opportunity of investing consumed resources in an alternative activity. In business terms, one could calculate EVA as Income from Operations - rate of interest in sovereign debt, if sovereign debt can be considered an alternative opportunity to invest working capital and equity. The concept of Economic Profit is closely linked to EVA. However, Economic Profit is not adjusted.
Profit in Economics
In economics, a firm is said to be making an economic profit when its revenue exceeds the total opportunity cost of its inputs. It is said to be making an accounting profit if its revenues exceed the total price the firm pays for those inputs.
In a single-goods case, economic profit happens when the firm's average cost is less than the price of the product or service at the profit-maximizing output. The economic profit is equal to the quantity output multiplied by the difference between the average total cost and the price.
(In circumstances of perfect competition, average cost = marginal cost at the profit-maximizing position)
All enterprises constitute investments by their owners of capital. The return to owners' capital under competitive competition is the accounting profit and compensates the owner for not being able to make alternative use of their capital. It is the opportunity costs of a venture.
The accounting profit sometimes include an element in recognition of the risks that an investor takes. It is often uncertain, because of incomplete information, whether an enterprise will succeed or not. In these cases, economists treat returns to risk as part of the accounting profit, as it is also an element of the cost of capital.
Economic profit does not occur in perfect competition, at least not in the long run. Once risk is accounted for, long-lasting economic profit is thus viewed as an inefficiency caused by monopolies or some form of market failure.
Economic profit is sometimes referred to as supernormal profit (also supra-) and accounting profit as normal profit.
The social profit from a firm's activities is the normal profit plus or minus any externalities that occur in its activity. A polluting oil monopoly may report huge profits, but be doing relatively little for the economy and damaging the environment. It would exhibit high economic profit but low social profit.
In a single-goods case, economic profit happens when the firm's average cost is less than the price of the product or service at the profit-maximizing output. The economic profit is equal to the quantity output multiplied by the difference between the average total cost and the price.
(In circumstances of perfect competition, average cost = marginal cost at the profit-maximizing position)
All enterprises constitute investments by their owners of capital. The return to owners' capital under competitive competition is the accounting profit and compensates the owner for not being able to make alternative use of their capital. It is the opportunity costs of a venture.
The accounting profit sometimes include an element in recognition of the risks that an investor takes. It is often uncertain, because of incomplete information, whether an enterprise will succeed or not. In these cases, economists treat returns to risk as part of the accounting profit, as it is also an element of the cost of capital.
Economic profit does not occur in perfect competition, at least not in the long run. Once risk is accounted for, long-lasting economic profit is thus viewed as an inefficiency caused by monopolies or some form of market failure.
Economic profit is sometimes referred to as supernormal profit (also supra-) and accounting profit as normal profit.
The social profit from a firm's activities is the normal profit plus or minus any externalities that occur in its activity. A polluting oil monopoly may report huge profits, but be doing relatively little for the economy and damaging the environment. It would exhibit high economic profit but low social profit.
Profit
Profit, from Latin meaning "to make progress", is defined in two different ways. Under capitalism, profit is a positive return made on an investment by an individual or by business operations. Under the Marxist definition it is a mechanism of class exploitation, where surplus value is extracted by capitalists from their workers and suppliers beyond the point where costs are covered.
Under capitalism, methods of calculation differ between accountants and economists. Often, it is the difference between retail sales price and the costs of manufacture. However, the term is also used more generally to refer to the value added after all the factors of production have been credited their full opportunity cost.
The profit motive—enterprises being free to make as much profit as they can given market conditions—is regarded by capitalists to be a good thing. It is held to give firms incentives for allocative efficiency and technical efficiency. This idea is a corollary of the theorems of welfare economics and utility maximization. However, profits can include economic rents, which do not produce efficiency. For instance, a monopoly can have very high profits but produce less economic welfare. Classical economists use profits to measure the happiness/utility/general welfare, gained by society, and understand that high profits demonstrate the high value of the factors used in the production of such goods.
Under capitalism, methods of calculation differ between accountants and economists. Often, it is the difference between retail sales price and the costs of manufacture. However, the term is also used more generally to refer to the value added after all the factors of production have been credited their full opportunity cost.
The profit motive—enterprises being free to make as much profit as they can given market conditions—is regarded by capitalists to be a good thing. It is held to give firms incentives for allocative efficiency and technical efficiency. This idea is a corollary of the theorems of welfare economics and utility maximization. However, profits can include economic rents, which do not produce efficiency. For instance, a monopoly can have very high profits but produce less economic welfare. Classical economists use profits to measure the happiness/utility/general welfare, gained by society, and understand that high profits demonstrate the high value of the factors used in the production of such goods.
Microeconomics
Microeconomics is a branch of economics that studies how individuals, households, and firms make decisions to allocate limited resources, typically in markets where goods or services are being bought and sold.
Microeconomics examines how these decisions and behaviors affect the supply and demand for goods and services, which determines prices, and how prices, in turn, determine the supply and demand of goods and services. Microeconomics has been called the bottom-up view of the economy , or “how people deal with money, time, and resources.
Macroeconomics studies the “sum total of economic activity, dealing with the issues of growth, inflation, and unemployment and with national economic policies relating to these issues and the effects of government actions (e.g., changing taxation levels) on them.
Microeconomics examines how these decisions and behaviors affect the supply and demand for goods and services, which determines prices, and how prices, in turn, determine the supply and demand of goods and services. Microeconomics has been called the bottom-up view of the economy , or “how people deal with money, time, and resources.
Macroeconomics studies the “sum total of economic activity, dealing with the issues of growth, inflation, and unemployment and with national economic policies relating to these issues and the effects of government actions (e.g., changing taxation levels) on them.
Economics
Economics is the study of how human society uses resources. Beyond that necessary and basic preoccupation, some leading economists have offered alternative, more specific definitions of the subject e.g.
"Economics is the study of people in the ordinary business of life." -- Alfred Marshall, Principles of economics; an introductory volume (London: Macmillan, 1890)
"Economics is the science which studies human behavior as a relationship between given ends and scarce means which have alternative uses." -- Lionel Robbins, An Essay on the Nature and Significance of Economic Science (London: MacMillan, 1932)
Economics is the “study of how societies use scarce resources to produce valuable commodities and distribute them among different people. -- Paul A. Samuelson, Economics (New York: McGraw-Hill, 1948)
The word "economics" is from the Greek words [oikos], meaning "house, temple, hall, camp, nest" and [nomos], or "custom, law, convention" and hence literally means "rules of the household." Originally termed political economy, the term economics grew in popularity with the marginal revolution. While discussions about production and distribution date back to ancient laws, and to philosophers such as Plato, the field is generally considered to have been clearly separated from philosophy by the publication of Adam Smith's book, generally called The Wealth of Nations, which focused on how the market can regulate production and consumption through price signals.
The field may be divided in several different ways, most commonly microeconomics vs macroeconomics. It may also be divided in positive (descriptive) vs. normative, mainstream vs. heterodox, and by subfield. Economics has many direct applications in business, personal finance, and government.
There has been an increasing trend for ideas and methods from economics to be applied in other fields. Economic analysis focuses on decision making, and has been applied to various fields where people are faced with alternatives – education, marriage, health, law, crime, war, and religion
"Economics is the study of people in the ordinary business of life." -- Alfred Marshall, Principles of economics; an introductory volume (London: Macmillan, 1890)
"Economics is the science which studies human behavior as a relationship between given ends and scarce means which have alternative uses." -- Lionel Robbins, An Essay on the Nature and Significance of Economic Science (London: MacMillan, 1932)
Economics is the “study of how societies use scarce resources to produce valuable commodities and distribute them among different people. -- Paul A. Samuelson, Economics (New York: McGraw-Hill, 1948)
The word "economics" is from the Greek words [oikos], meaning "house, temple, hall, camp, nest" and [nomos], or "custom, law, convention" and hence literally means "rules of the household." Originally termed political economy, the term economics grew in popularity with the marginal revolution. While discussions about production and distribution date back to ancient laws, and to philosophers such as Plato, the field is generally considered to have been clearly separated from philosophy by the publication of Adam Smith's book, generally called The Wealth of Nations, which focused on how the market can regulate production and consumption through price signals.
The field may be divided in several different ways, most commonly microeconomics vs macroeconomics. It may also be divided in positive (descriptive) vs. normative, mainstream vs. heterodox, and by subfield. Economics has many direct applications in business, personal finance, and government.
There has been an increasing trend for ideas and methods from economics to be applied in other fields. Economic analysis focuses on decision making, and has been applied to various fields where people are faced with alternatives – education, marriage, health, law, crime, war, and religion
Business Finance
In the case of a company, managerial finance or corporate finance is the task of providing the funds for the corporations' activities. It generally involves balancing risk and profitability. Long term funds would be provided by ownership equity and long-term credit, often in the form of bonds. These decisions lead to the company's capital structure. Short term funding or working capital is mostly provided by banks extending a line of credit.
On the bond market, borrowers package their debt in the form of bonds. The borrower receives the money it borrows by selling the bond, which includes a promise to repay the value of the bond with interest. The purchaser of a bond can resell the bond, so the actual recipient of interest payments can change over time. Bonds allow lenders to recoup the value of their loan by simply selling the bond.
Another business decision concerning finance is investment, or fund management. An investment is an acquisition of an asset in the hopes that it will maintain or increase its value. In investment management - in choosing a portfolio - one has to decide what, how much and when to invest. In doing so, one needs to
Identify relevant objectives and constraints: institution or individual - goals - time horizon - risk aversion - tax considerations Identify the appropriate strategy: active vs passive - hedging strategy Measure the portfolio performance
On the bond market, borrowers package their debt in the form of bonds. The borrower receives the money it borrows by selling the bond, which includes a promise to repay the value of the bond with interest. The purchaser of a bond can resell the bond, so the actual recipient of interest payments can change over time. Bonds allow lenders to recoup the value of their loan by simply selling the bond.
Another business decision concerning finance is investment, or fund management. An investment is an acquisition of an asset in the hopes that it will maintain or increase its value. In investment management - in choosing a portfolio - one has to decide what, how much and when to invest. In doing so, one needs to
Identify relevant objectives and constraints: institution or individual - goals - time horizon - risk aversion - tax considerations Identify the appropriate strategy: active vs passive - hedging strategy Measure the portfolio performance
Finance
Finance studies and addresses the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects. The term finance may thus incorporate any of the following:
The study of money and other assets The management and control of those assets Profiling and managing project risks As a verb, "to finance" is to provide funds for business. The activity of finance is the application of a set of techniques that individuals and organizations (entities) use to manage their financial affairs, particularly the differences between income and expenditure and the risks of their investments.
An entity whose income exceeds its expenditure can lend or invest the excess income. On the other hand, an entity whose income is less than its expenditure can raise capital by borrowing or selling equity claims, decreasing its expenses, or increasing its income. The lender can find a borrower, a financial intermediary, such as a bank or buy notes or bonds in the bond market. The lender receives interest, the borrower pays a higher interest than the lender receives, and the financial intermediary pockets the difference.
A bank aggregates the activities of many borrowers and lenders. A bank accepts deposits from lenders, on which it pays the interest. The bank then lends these deposits to borrowers. Banks allow borrowers and lenders of different sizes to coordinate their activity. Banks are thus compensators of money flows in space since they allow different lenders and borrowers to meet, and in time, since every borrower, in theory, will eventually pay back.
A specific example of corporate finance is the sale of stock by a company to institutional investors like investment banks, who in turn generally sell it to the public. The stock gives whoever owns it part ownership in that company. If you buy one share of XYZ Inc, and they have 100 shares available, you are 1/100 owner of that company. You own 1/100 of the net difference between assets and liabilities on the balance sheet. Of course, in return for the stock, the company receives cash, which it uses to expand its business in a process called "equity financing". Equity financing mixed with the sale of bonds (or any other debt financing) is called the company's capital structure.
Finance is used by individuals (personal finance), by governments (public finance), by businesses (corporate finance), etc., as well as by a wide variety of organizations including schools and non-profit organizations. In general, the goals of each of the above activities are achieved through the use of appropriate financial instruments, with consideration to their institutional setting.
The study of money and other assets The management and control of those assets Profiling and managing project risks As a verb, "to finance" is to provide funds for business. The activity of finance is the application of a set of techniques that individuals and organizations (entities) use to manage their financial affairs, particularly the differences between income and expenditure and the risks of their investments.
An entity whose income exceeds its expenditure can lend or invest the excess income. On the other hand, an entity whose income is less than its expenditure can raise capital by borrowing or selling equity claims, decreasing its expenses, or increasing its income. The lender can find a borrower, a financial intermediary, such as a bank or buy notes or bonds in the bond market. The lender receives interest, the borrower pays a higher interest than the lender receives, and the financial intermediary pockets the difference.
A bank aggregates the activities of many borrowers and lenders. A bank accepts deposits from lenders, on which it pays the interest. The bank then lends these deposits to borrowers. Banks allow borrowers and lenders of different sizes to coordinate their activity. Banks are thus compensators of money flows in space since they allow different lenders and borrowers to meet, and in time, since every borrower, in theory, will eventually pay back.
A specific example of corporate finance is the sale of stock by a company to institutional investors like investment banks, who in turn generally sell it to the public. The stock gives whoever owns it part ownership in that company. If you buy one share of XYZ Inc, and they have 100 shares available, you are 1/100 owner of that company. You own 1/100 of the net difference between assets and liabilities on the balance sheet. Of course, in return for the stock, the company receives cash, which it uses to expand its business in a process called "equity financing". Equity financing mixed with the sale of bonds (or any other debt financing) is called the company's capital structure.
Finance is used by individuals (personal finance), by governments (public finance), by businesses (corporate finance), etc., as well as by a wide variety of organizations including schools and non-profit organizations. In general, the goals of each of the above activities are achieved through the use of appropriate financial instruments, with consideration to their institutional setting.
Types of Businesses
There are four main types of business unit:
Sole Proprietorship: a business owned by one person. The owner may operate on their own or may employ others.
Partnership: A partnership is a form of business in which two or more people operate for the common goal of making profit.
Private Limited Company (Ltd): a small to medium sized business that is often run by the family or the small group who own it.
Public Limited Company: a business with limited liability, a wide spread of shareholders and in the UK, a share capital of over £50,000.
There are many types of businesses, and, as a result, businesses can be classified in many ways. One of the most common focuses on the primary profit-generating activities of a business, for example:
Manufacturers produce products, from raw materials or component parts, which they then sell at a profit. Companies that make physical goods, such as cars or pipes, are considered manufacturers. Service businesses offer intangible goods or services and typically generate a profit by charging for labor or other services provided to government, other businesses or consumers. Organizations ranging from house decorators to consulting firms to restaurants and even to entertainers are types of service businesses. Retailers and Distributors act as middle-men in getting goods produced by manufacturers to the intended consumer, generating a profit as a result of providing sales or distribution services. Most consumer-oriented stores and catalogue companies are distributors or retailers. Agriculture and mining businesses are concerned with the production of raw material, such as plants or minerals. Financial businesses include banks and other companies that generate profit through investment and management of capital. Information businesses generate profits primarily from the resale of intellectual property and include movie studios, publishers and packaged software companies. Utilities produce public services, such as heat, electricity, or sewage treatment, and are usually government chartered. Real estate businesses generate profit from the selling, renting, and development of properties, homes, and buildings. Transportation businesses deliver goods and individuals from location to location, generating a profit on the transportation costs There are many other divisions and subdivisions of businesses. The authoritative list of business types for North America (although it is widely used around the world) is generally considered to be the North American Industry Classification System, or NAICS. The equivalent European Union list is the NACE.
Sole Proprietorship: a business owned by one person. The owner may operate on their own or may employ others.
Partnership: A partnership is a form of business in which two or more people operate for the common goal of making profit.
Private Limited Company (Ltd): a small to medium sized business that is often run by the family or the small group who own it.
Public Limited Company: a business with limited liability, a wide spread of shareholders and in the UK, a share capital of over £50,000.
There are many types of businesses, and, as a result, businesses can be classified in many ways. One of the most common focuses on the primary profit-generating activities of a business, for example:
Manufacturers produce products, from raw materials or component parts, which they then sell at a profit. Companies that make physical goods, such as cars or pipes, are considered manufacturers. Service businesses offer intangible goods or services and typically generate a profit by charging for labor or other services provided to government, other businesses or consumers. Organizations ranging from house decorators to consulting firms to restaurants and even to entertainers are types of service businesses. Retailers and Distributors act as middle-men in getting goods produced by manufacturers to the intended consumer, generating a profit as a result of providing sales or distribution services. Most consumer-oriented stores and catalogue companies are distributors or retailers. Agriculture and mining businesses are concerned with the production of raw material, such as plants or minerals. Financial businesses include banks and other companies that generate profit through investment and management of capital. Information businesses generate profits primarily from the resale of intellectual property and include movie studios, publishers and packaged software companies. Utilities produce public services, such as heat, electricity, or sewage treatment, and are usually government chartered. Real estate businesses generate profit from the selling, renting, and development of properties, homes, and buildings. Transportation businesses deliver goods and individuals from location to location, generating a profit on the transportation costs There are many other divisions and subdivisions of businesses. The authoritative list of business types for North America (although it is widely used around the world) is generally considered to be the North American Industry Classification System, or NAICS. The equivalent European Union list is the NACE.
Thursday, January 4, 2007
Business
In economics, business is the social science of managing people to organize and maintain collective productivity toward accomplishing particular creative and productive goals, usually to generate revenue.
The etymology of "business" refers to the state of being busy, in the context of the individual as well as the community or society. In other words, to be busy is to be doing commercially viable and profitable work.
The term "business" has at least three usages, depending on the scope — the general usage (above), the singular usage to refer to a particular company or corporation, and the generalized usage to refer to a particular market sector, such as "the record business," "the computer business," or "the business community" -- the community of suppliers of goods and services.
The singular "business" can be a legally-recognized entity within an economically free society, wherein individuals organize based on expertise and skills to bring about social and technological advancement.
With some exceptions, (such as cooperatives, non-profit organizations and (typically) government institutions), in predominatly capitalist economies, businesses are formed to earn profit and grow the personal wealth of their owners.
In other words, the owners and operators of a business have as one of their main objectives the receipt or generation of a financial return in exchange for their work that is, the expense of time, energy, and money.
However, the exact definition of business is disputable as is business philosophy; for example, most Marxists use "means of production" as a rough synonym for "business." Socialists advocate either government, public, or worker ownership of most sizable businesses.
The etymology of "business" refers to the state of being busy, in the context of the individual as well as the community or society. In other words, to be busy is to be doing commercially viable and profitable work.
The term "business" has at least three usages, depending on the scope — the general usage (above), the singular usage to refer to a particular company or corporation, and the generalized usage to refer to a particular market sector, such as "the record business," "the computer business," or "the business community" -- the community of suppliers of goods and services.
The singular "business" can be a legally-recognized entity within an economically free society, wherein individuals organize based on expertise and skills to bring about social and technological advancement.
With some exceptions, (such as cooperatives, non-profit organizations and (typically) government institutions), in predominatly capitalist economies, businesses are formed to earn profit and grow the personal wealth of their owners.
In other words, the owners and operators of a business have as one of their main objectives the receipt or generation of a financial return in exchange for their work that is, the expense of time, energy, and money.
However, the exact definition of business is disputable as is business philosophy; for example, most Marxists use "means of production" as a rough synonym for "business." Socialists advocate either government, public, or worker ownership of most sizable businesses.
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