Assets – Dutch Uncles

Asset Management Company: Maximising Returns Through Their Diversified Portfolio

Shalmoli Sarkar — Mon, 27 Sep 2021 08:35:12 +0000

Individual investors or new investors lack the experience of utilising their resources to consistently produce strong investment returns. This is precisely the time when asset management companies come to the rescue. Let us deep dive a little more about what an asset management company does.

What is an asset management company?

Asset management companies are firms that collect funds from various individual and institutional investors and invest in various securities such as stocks, bonds, and real estate. They own a dedicated team of fund managers who manage the investment and the research team selects the right stocks or securities to invest in.
Fund managers identify investment options that align with objectives. For instance, if the fund objectives are to receive steady returns with low risk, then the appropriate investment option will be to invest in bonds issued by government firms or private firms. If the fund’s objective is to get maximum returns then the investment will take place in equity markets for investing in shares.

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The reputation of the asset management company (AMC) plays a pivotal role for the investors to invest in funds.

How does an asset management company work?

When investors invest in an asset management company they are investing in a fund managed by the firm. The return of the investment depends on the performance of the fund that is market-linked. A well-managed fund can give higher returns.

The source of revenue for asset management companies is through charging fund management fees from the investors. A fund is expected to generate maximum returns in its categories to increase its investor base.

The reputation of the asset management company (AMC) plays a pivotal role for the investors to invest in funds. To strengthen the investor base and deliver quality returns, an asset management company follows a three-step process.

Efficient Asset Allocation:

To maximise returns for its investors, AMCs invest their money in different investment instruments. The distribution of funds into the equity or debt market depends on favourable market conditions and interest rates. Here, the experience and expertise of fund managers play an important role in efficiently allocating money to different asset classes.

Formulating an Investment Portfolio:

Building an investment portfolio is crucial for any asset management company. For, it undergoes rigorous research and analysis so that the portfolio becomes risk-proof, and resilient during turbulent market conditions. Fund managers make investments taking calculated risks.

Assessment of Performance:

Asset management companies are answerable to their investors for the fund performance. It sends regular updates on sales and repurchases NAV (Net Asset Value), portfolio details to its investors.

How should an investor select an asset management company?

The money that investors put in is their hard-earned money, therefore investors should take extra precaution in an asset management company for themselves. Experienced investors should check the performance history of mutual funds schemes managed by the asset management company during times of market volatility. While choosing an asset firm they can do the following:

Check the reputation of an asset management firm by assessing the consistency of returns delivered from its fund management
Check the reviews of the firm by taking feedback from other investors.
Check the investment style of the fund manager. The returns received relies on the sound skills and investment style of a fund manager. Generally, mutual fund investment styles help one to gauge the competence of an asset management company.

The asset management companies are regulated by the Securities and Exchange of India (SEBI) and passively regulated by the Association of Mutual Fund of India (AMFI).

Advantages of going with an asset management company

Assets are managed by experts.
Returns are confirmed despite market volatility.
Well-diversified portfolio
Improvised investment options

There are many products that are not available for individual investors to invest in but with asset management firms, investing in those wide ranges of financial products is possible.

Drawbacks of asset management firms

Can be expensive for investors as the firms sometimes charge exorbitantly to manage assets.
If the market underperforms and the fund manager is unable to defend the risk it can result in huge losses.
Few asset management companies restrict their services to wealthy investors having high net worth, government entities, financial intermediaries, and the different corporations and shabbily manage the portfolio of investors not fulfilling the prescribed wealth criteria of the company.

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Net Worth: The Indicator of an Investors’ Financial Health

Shalmoli Sarkar — Sun, 12 Sep 2021 08:35:09 +0000

We have often come across the term ‘net worth’. Generally, common people have the notion that this term is only to be used by the industry behemoths, TATAs and Ambanis, for determining their financial worth. But, anyone can and must calculate their net worth as it presents the big picture to an individual about the overall financial health. It is a snapshot that shows where an individual is on their financial journey.

What is net worth?

Net worth is the difference between investments and liabilities. The total investment made by an individual can include investment in stocks, mutual funds, gold, real estate, equities, insurance policies, fixed deposits, etc. Liabilities, here, are the total amount of loan that we owe to the bank or any family friend or relatives for example, car loan, education loan, credit card, house loan, etc. Therefore, the difference between the two is an important metric of financial health as it helps an individual keep a check on the amount of debt affecting the future wealth. It also serves as an effective indicator to help an investor understand which liabilities to pay off before retiring.

Net worth is mathematically denoted as –

Net Worth = Investment – Liabilities

A high value of net worth indicates good financial strength and gets a good credit rating. Low or negative net worth shows a weaker financial strength and lower credit rating, thus affecting an individual’s ability to raise funds from the market.

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Net worth is the difference between investments and liabilities. It serves as an effective indicator to help an investor understand which liabilities to pay off before retiring.

Why is calculating net worth necessary?

Let us understand this with a small example –

Suppose an individual has deposited Rs 10,000 in a bank under cumulative fixed deposit that offers interest of 5 percent whose maturity value at the end of 4 years will become Rs 12,000. Meanwhile, against the savings, it has taken a loan worth Rs 20,000.

But say, fate has other plans that caused an unfortunate death of that sole bread earner right after investing in for 3 years, just one year from its maturity. Now, the family, under emergency circumstances, wants to withdraw the fixed deposit amount, which will be slightly less than the maturity amount as banks will levy penalty charges of 0.5 -1 percent due to premature withdrawal. Therefore, with a reduced interest rate of 4%, the amount at 3 years will become Rs 11600.

The family now owes Rs 8,400 (20000 – 11600) to its lenders or bank.

The example presented here is for smaller loans or liability, now imagine the same for a bigger amount of loans.

Sometimes, unforeseeable circumstances can affect a family’s financial stability making it difficult to sustain. Therefore, tracking net worth will help one understand how much money lies in the liabilities and how many investments or alternate savings one has in case of any such emergencies.

How investors can ensure to have a positive net worth?

If investors are disappointed with their current net worth, they simply need to increase the investments or assets and decrease the liabilities. Here is how they can do it –

Transfer loans to new banks: First, make a list of all loans against their interest rates and notice which liabilities have higher interest rates. The ones having higher interest rates, try to shift them in banks where they charge lower interest rates for the same loans. Always compare the interest rates charged by your current banks with others. In this way, we can bring down our liabilities.

Minimise expenses: We are not advising you to become a miser, but try to cut down on unnecessary costs which might be irrelevant now, but it can add up to savings to be used for spending on assets. To prevent unnecessary spending, we can monitor expenses daily for about a week, or even a month, and then take stock of how many expenses were relevant. Once an investor is aware of its spending patterns, one can analyse spots that can be afforded to make adjustments. This is especially when we are shopping too much on a credit card.

Invest more: Ankur Warikoo, CEO, Nearbuy.com has a simple mantra to increase more investments or assets – ‘by investing more’. He suggests investing more in direct mutual funds and not in commission or growth mutual funds since it will attract a high expense ratio. Young investors should invest in stocks, not in real estate or bonds as it usually has a low growth rate as compared to stocks and mutual funds. Also, adding the inflation rate the growth rate further slows down. One must always invest in assets where the inflation rate has minimum impact on an investment’s growth rate.

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Must-Read Book on Finance: FUNdamentals of Financial Statements

Joseph Varughese — Wed, 14 Jul 2021 13:55:45 +0000

Book: FUNdamentals of Financial Statements

Author: Chinmay Ananda

Published by: Zaang Publications/Finance Academy, Australia

Year of publication: 2015

I have got the chance to read many articles and books on finance and financial statements written to educate non-finance executives and entrepreneurs in the finance domain. I have written a few articles in this genre. So, when I picked up Chinmay Ananda’s book ‘Fundamentals of Financial Statements’ to read I thought it to be another book in the same category targeting the same type of readers. But I was taken by surprise.

The cover, page layout and the style of the book give a feel of simplicity and the initial thought that would come to the reader’s mind is of mediocrity. After finishing this book, I felt that this book could be a good read even for finance professionals. Take a look at the way the difference between Asset and Expense or between Liability and Income or between the items coming to Profit and Loss and Balance Sheet are explained. Here is an example from the book – “If any purchase is consumed before the Balance Sheet date it becomes expense in the Profit and Loss statement and if it is not consumed before the Balance Sheet date it becomes Asset in Balance Sheet.” Beautifully articulated!

However, the book is written by Chinmay with non-finance readers in mind and it does full justice to its purpose and objective. Like the FUN in capitals in the word fundamentals of the title manifests, it is fun to read this book and understand how to read financial statements. It is a book on finance that even a non-finance person who hates finance and numbers will love to read till the end. More importantly, the book will tempt you to explore more about finance and financial statements.

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If you can’t explain it simply, you don’t understand it well enough

-Albert Einstein

A Book on Finance for All Entrepreneurs

What I enjoyed more about this book is the way it is structured and narrated – storytelling style and narrative in such a way that anyone who reads English can relate to it and get a gist of the subject. There are no debits and credits explained in accountancy language, no finance and accountancy jargon and terminologies used in the book to explain the fundamentals, sometimes even complex topics, of finance and financial statements.

A lot has been written on the need for entrepreneurs to understand finance, accountancy and financial statements so that they will be able to do budgeting, manage cash flow, control expenses, make investment and funding decisions. Not just that, it will help them get a feel of the value of their business, understand growth and profitability metrics and take winning business decisions. Despite having a good idea and funding, we have seen many startups failing miserably for want of financial management and control in place. This happens mostly when the owner(s) or founder(s) have no idea of finance and its importance in business.

Non-finance Person Writes a Book on Finance

What might have worked well for this book is the author, Chinmay Ananda, himself being a non-finance person who did his bachelor degree in engineering and MBA with a non-finance specialisation. He taught finance himself and now teaches finance and consults entrepreneurs on financial and business problems. However, he has done justice to the Einstein quote “If you can’t explain it simply, you don’t understand it well enough” that he reproduced in his book a few times.

In the process of explaining financial statements in a way that anyone can understand, the author covers almost all topics coming under the umbrella of finance. The way he has explained Operating Profit, Profit Before Interest, Tax, Depreciation, amortisation (PBITDA), Profit Before Tax (PBT), Profit After Tax (PAT), Earning Per Share (EPS), Dividend Policies, Leverage / Profit Volume (PV) Ratio etc., makes the reader believe that finance is a very easy subject to learn and understand. The way Chinmay has articulated what happens to profit, what comprises owners’ funds, what is the meaning of return on capital employed, how differently debt and capital impact profit and tax etc., is simple for the understanding of non-finance readers.

It is not just about learning finance and financial statements for an academic purpose that is attempted in this book but how the knowledge of finance and ability to read financial statements can be leveraged for the profitability, sustainability and growth of your business, particularly SME and startup businesses. It provides owners and entrepreneurs insight into the nuances of finance and how they help them in steering their business to growth and profitability.

The book is not purely confined to finance in the strict sense as it ventures to explain how a company is formed and why a company is considered as a separate legal entity separate from its promoters or founders. On the way, it explains how capital is brought in and why it is shown on the Liabilities side of a Balance Sheet. It is in an amazingly simple way the debits and credits are explained without resorting to the help of the golden principle of accountancy.

Owner vs. Business Perspective

He explains Debit and Credit this way – “Debit money is going out of the business. For Assets, you may say we have got land and machinery. But to purchase land and machinery, money first goes out of the business. That is the reason it is important to see it from a business perspective and not from an owner’s perspective. From the business perspective if the money is going out of the business either it becomes an Expense or creates an Asset.

Credit, money is coming into the business. If it is by selling the product or service, it is called Income. If money comes into the business because of borrowing then it becomes a Liability.”

How beautifully he put it so that someone who has not gone to college can understand it easily! All you have to remember is, when money goes out of the business it is Debited and if money comes into the business it is Credited. However, it can confuse the reader a bit as it does not say which part or leg of the transaction is to be debited or credited.

Financial Statements for a Layman

The book then goes on to explain the three financial statements viz. Profit and Loss/Income Statements, Balance Sheet and Cash Flow Statement. In layman language the book makes you understand why there are three financial statements and what are their uses. It also throws light on the difference between profit and money/cash balance, why cash is more important than profit, all without using any finance jargon or formulas or theories.

The very easy manner in which it is explained as to what are assets, expenses, liabilities and income and how and why they are classified so, without employing the language and technical terms of accountancy but in a common man language is commendable.

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Employees should have sufficient information about the business and its model as every decision every employee takes impacts the profitability of the company.

What are the Most Common Financial Mistakes?

Look at some finance mistakes that are explained in the book, the first one is “Selling a Product or Service for Less than the Cost of Liabilities”. Chinmay goes on to explain how the cost of liabilities is calculated and the entire concept with an example for the reader of any level to understand.

Likewise, another finance mistake – “Investing Short-term Liabilities into Long-term Assets” is explained with simple examples like “Life of loan should be equal to the life of an asset”.

Learn about Financial Metrics from this Book on Finance

Equally important is the read on various financial metrics:

Profitability
Liquidity
Operating ratios
Break-even point (BEP)
Profit v Money.

BEP is an important study in managerial accounting, used to calculate the point at which a business is not at profit or loss. It is inevitable to know the difference between the fixed and variable cost to understand the fundamentals of BEP and it is also elaborated. He explains in simple terms with examples as to how this concept is important in various business decision making.

Likewise, understanding the difference between Profit and Money or Cash is crucial. All profit is not cash and therefore the profit shown in the Profit and Loss statement and cash balance in the cash flow statement won’t be the same. There are many reasons for this such as non-cash expenses like depreciation appearing in profit and loss statements but not in cash flow statements or sales invoices becoming part of profit but not of cash till the sales amount is collected.

One important chapter in the book – What is happening with Profit? – throws light into what happens to the profit you make and how important is this understanding for strategic decisions. Profit is reinvested in the business as part of diversification or expansion or acquisitions. It is also used to replay your liabilities. Using profit for paying dividends to the shareholders or the investors is arguably the most important purpose of profit.

The Untouched Topic by Many Books on Finance

He has devoted one chapter to crucial topics that most books and articles have not touched. This is about educating every employee in your organisation to make profitable decisions. For that, employees should have sufficient information about the business and its model as every decision every employee takes impacts the profitability of the company.

At times, the author has moved away from the core topic to areas like cost accounting, startup mentoring etc. However, it is not to be considered as a drawback since the author has reiterated a few times in the book that everything you do or any decisions you take in business have implications for finance.

Though looking like straying initially, touching upon the concepts of marginal costing, contribution analysis, fixed vs variable expenses is a real value add to the readers, that too without complicating the concepts. The reason why the word ‘straying’ is used here is that these analyses don’t form part of standard financial statements but internal management reporting.

Different Perspectives to Financial Theories and Metrics

Another exciting part is the last portion of the book where Chinmay explains solutions to some critical problems that small entrepreneurs face with real-life instances as part of his consulting career.

One portion of the book that I was not able to agree to fully was about the differentiation between Performing Assets and Non-Performing Assets. The performing asset should earn returns to take care of a non-performing asset is like the arguments that business functions in a company feed back-office function. This is not fully true like the fact that every organ in a human or animal body is important. Another is the fact that it can create confusion about the use of the terminology.

Non-Performing Assets

A non-performing asset to most people is a bank loan that is subject to late repayment or is unlikely to be repaid by the borrower in full. There is a high likelihood of readers getting perplexed here.

Overall, this is a fantastic book not only for non-finance executives and entrepreneurs but for finance professionals too. It gives insight into finance and business effortlessly and sometimes different perspectives to financial theories and metrics. This book is more pertinent for startup and SME entrepreneurs during uncertain times like the ongoing pandemic or recessionary period.

Expert Connect

Chinmay Ananda
Business Storyteller, Financial Educator at Finance Academy
Reach out to him for any financial advice for your business

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Understanding Business Liabilities for a Small Business

Aakash Sharma — Thu, 24 Dec 2020 11:34:50 +0000

Starting a new business can be one of the most complex and challenging tasks, especially if you are a new entrepreneur.

A lot of effort, planning, and effective execution goes into just preparing a blueprint for a business idea to make it bankable and lucrative. Any entrepreneur’s goal is to add more profitable assets to her/his business while realizing its goals and fulfilling its liabilities.

And to work on the assets and liabilities, these concepts must be crystal clear to you to have productive outcomes. So, let’s find out the liabilities that you need to focus on as a business owner and what all constitute assets for you.

What Are Business Liabilities?

A liability is defined as the state of being legally responsible for something (OED) and is synonymously used for accountability and onus in the world of business. As a business owner, you have many responsibilities that need to be fulfilled and extremely time-bound. For instance, an entire business liability can be the repayment of any form of debt. Business liabilities are the volumes of money owed by a business at a given point in time. That is why they are also referred to as “payables” for accounting purposes in the balance sheets (possible interlink) of a company’s books.

Essential things to learn here are- how business liabilities arise and impact a business, the types of liabilities, and their analysis.

Assets and Liabilities

Whatever be the model, every business has assets and liabilities. Simply put, assets are the properties owned by a person or company, which are valuable enough and available at demand to meet debts and commitments, and liabilities are a company’s commitments and obligations-either in the form of owed money or services not yet performed.

Assets are, therefore, the items that benefit your company financially and help in growing the business. Inventory, infrastructure, equipment- all are a part of your company’s assets. Your business must have more assets than liabilities so that these assets can be converted into cash for growth or in case of an emergency. If the liabilities of a small business exceed its assets, it will not fulfil the company’s demands like debt repayment and will face other financial problems as well.

But liabilities are not necessarily counterproductive. They can play a significant role in generating capital for your business’s growth. For instance, a small business can take a loan for creating its assets like tools and inventories. These tools will further help the company grow, and the loan can be repaid once the business starts to post profits. This is how a liability, in this case, a loan, is turned to grow a company and its assets.

As new business owners, a lot of people often confuse liabilities with the expenses of their business. But there is more to both the terms than what meets the eye.

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Business liabilities can play a significant role in generating capital for your business's growth.

Liabilities and Expenses: What is the difference?

Liabilities and expenses can be understood as responsibilities and costs. Business liability is the money owed by your company to another party. For example, if you buy a car for official use on a bank loan, this will become a business liability. On the other hand, an expense is a business operation in which costs are incurred in procuring goods that generate revenue for your company. For instance, when you buy office equipment like telephones and stationery, these will be counted towards your business expenses. The company will directly use them in growing the business and carrying out daily business growth activities.

Almost all the regular payments and costs incurred by a business are counted towards the company’s expenses. That is why the working capital of a company is meant for fulfilling its expenses. For example, when you pay for office services and utilities like rent or phone services, these are business expenses. If the payment of expenditures stops, the service will instantly.

Expenses and liabilities are shown in different places in the books of a company. Liabilities are charged to the bank account (balance sheets) related to the company’s assets, while expenses are put on the company’s income statement, i.e., profit or loss record.

Let us now understand the different types of business liabilities.

There are two main kinds of liabilities- those incurred in the short term and those induced in a long term.

Short-Term Business Liabilities

By definition, these liabilities are the business’s obligations that are expected to be paid off in the latest and fixed period, usually within a year. These are also called current liabilities.

Short term business liabilities usually include:

Sales Tax Dues: This amount is collected directly from the customer at the point of sale and is forwarded to concerned government revenue departments by a fixed due date.

Payroll Tax Dues: Employers collect this amount from employees. The collected amount is then paid to relevant tax agencies.

Loans and Mortgages Dues: This represents the repayments that may be required to pay-off within a year, including repayment of the instalments for a long-term loan.

Unearned Profits: This refers to the amount of money a company gets before offering their products and services. Mostly, this liability is incurred by businesses in the publishing and airline industry.

Long-Term Business Liabilities

These are the business liabilities and obligations whose repayment is expected to continue for a more extended period, usually for more than one year. These are also called non-current debts.

Long term business liabilities usually include:

Bonds Dues: These are the amounts to be paid by a company to a bondholder on a bond, or interest-bearing note, where the notice period is of more than one year.

Loans and Mortgages Dues: These are the elements of a loan or mortgage that need to be repaid after one year.

Leases: This includes parts of the lease payment, dues of which extend over one year.

You can read about GST to understand tax returns and dues filing.

Let us now understand How Business Liabilities Work.

When any item or product is bought in the name of a company, money is spent in the transaction, either directly or in the form of loans and credit lines. All the borrowed capital using which your company’s assets are amassed is categorized under the head of business liabilities. These liabilities have to be paid off at some point in time; unless paid off, creditors have a claim on your assets.

Some liability is suitable for a business from its leverage point of view, as borrowing initially helps in acquiring new assets, which, in turn, attracts and retains more customers and investors.

For example, suppose a food court has many customers but doesn’t have enough space to host the customers. In that case, the food court can borrow money in the form of loans to expand its premises and use the large footfall of customers as leverage while getting the loan approved. This way, the business will increase, and the loan’s liability, which will be paid off by the increased profits, will have proven to be beneficial in the long run.

Indeed, too many liabilities are not suitable for any business, be it a new business or an established business. Suppose most business income is spent on paying off debts for an extended period. In that case, enough money may not be left to cover even the business’s operating costs, leading to a business collapse.

Hence, it is essential to track and analyse your business liabilities.

Here is how you can Analyse Your Liabilities.

As a business owner, you can differentiate the amount of debt your company owes with other liquidity parameters, i.e., current ratio and debt-to-asset ratio, to determine if the company has too much liability.

Current Ratio

This ratio helps determine if a company can pay its ‘short-term loans’ and fulfil the cash needs as per its current assets and liabilities.

To calculate the current ratio, total existing assets are divided by total current liabilities. If a rate of 2 comes as a result, it means that the business liabilities can be repaid with the current assets whereas a ratio below 2 indicates lower money holdings of the company and weaker repaying capability.

For example, if a firm has Rs 10,00,000 in total current assets and Rs 5,00,00 in total current liabilities, the company will quickly pay off the penalties as the current ratio comes out to be 2.

Debt-to-Asset Ratio

The debt-to-asset ratio is used to measure the total debt, both ‘long-term and short-term,’ regarding the whole business assets. It tells you if you have enough assets to sell to pay off your debt, in extreme cases.

A business’s debt-to-asset ratio should not be more than 0.3 to maintain its borrowing capacity and avoid being too highly leveraged.

For example, if a company has Rs 1,00,000 in total debt and Rs 3,60,000 in total assets, the debt-to-asset ratio of 0.27 is attained. As it is less than 0.3, the business will be able to repay the loans and finance some more assets to grow the business.

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Proper management of finances and credit lines ensures the maintenance of liabilities and growth of business assets.

Conclusion

Therefore, it is clear that business liabilities are an integral part of any business and need to be correctly understood and analysed for sustainably running a business. Proper management of finances and credit lines ensures the maintenance of liabilities and growth of business assets.

Read more about the basics of business on our website like Bootstrapping and SWOT Analysis.

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