Financial Concepts – Dutch Uncles

Goal Based Investing In The Journey Of Wealth Creation

Vaishali Das — Mon, 27 Sep 2021 13:06:45 +0000

If you desire a secured future, it is in your hands entirely how you set a financial goal in mind. But again, without clarity, you might end up with a complicated, risky and ill-planned strategy. Creating a successful ‘wealth creation’ journey and ruling out the unpredictability by having a goal-based investment plan, is the key to a successful wealth creation path.

In the recent episode of MentorED – a LIVE Workshop Series by Dutch Uncles – the esteemed speaker, Mr. Dilip Shenoy enlightened the audience – who joined LIVE across four platforms – LinkedIn, YouTube, Facebook and Twitter – about the important steps of goal-based investing and ways to have a risk-free and safe wealth creation journey. Mr. Dilip Shenoy is the Founder of Moneytree Financial Services and has more than two decades of experience as a Financial Coach specialising in the wealth management and banking industry. With a vision of simplifying financial aspects of life, he extends support and guidance in the wealth management sector.

In brief, the session had the following takeaways:

Understand your financial self
The various cycles: age cycle, wealth, growth, recession, rate, economy and the cycle of credit
Risk mitigation
Projecting the road ahead

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Fulfill the nearer and easier goals first, it's easier to do that. But start early for the long term.

-Mr. Dilip Shenoy

Wealth Creation Journey: A Six Step Process

Everyone across age, borders, caste, creed, sex, likes to travel, meet new people, witness various cultures, experience food, weather, etc. When we travel we decide on a destination, then the mode of transportation as per our convenience and personal preferences. Similarly, an investment journey is like planning a vacation, one has to know all the parameters and evaluate different aspects before setting foot into this sector. It is very important to plan your investment in detail. Wealth creation journey or wealth management is a six step process, namely: (1) Knowing oneself, (2) Investing time before investing money, (3) Identifying goals, (4) Evaluating options, (5) Selecting a vehicle, and (6) Periodic Maintenance.

“You need to know yourself.” As the speaker mentioned, in wealth management parlance, there are usually three cycles, human life cycle, wealth cycle and the credit cycle. If human life cycle and wealth cycle are superimposed, then they are: early career or saving stage (between 25-30 years), wealth creation stage (30-40 years), wealth accumulation stage (40-60 years) and wealth distribution and succession planning stage (50-60 years).

The wealth cycle is typically dependent on wealth creation and savings. In order to understand your own self, it is important to prepare a risk profiling questionnaire, which will help you to evaluate your knowledge about the financial product and categorise yourself whether as a conservative, moderate or aggressive investor. Most importantly, distinguishing between your needs and wants will give you a profound understanding of yourself. Time is of paramount significance here as advised by Mr. Shenoy who asked to first invest your time before money. “Start with a budgeting exercise, whatever gets measured gets treasured, like a wise person had put it earlier.” Moreover, it is wise to always evaluate the alternatives as unlike the yesteryears when there used to be only limited options to choose from. But amidst all the information, making a smart and cautious decision is the key.

In the goal identification step, it gets very challenging to look beyond the long term horizon, so one should categorise it into short, medium and long term. After identifying these goals you need to calculate the approximate values that you will be needing. Mr. Shenoy advised, “Fulfill the nearer and easier goals first, it’s easier to do that. But start early for the long term.” In all these comes the power of compounding, the 8th wonder, which will eventually help an investor to fulfill their long term goals. With the new products in the market coming each day, it makes our tasks more challenging to find the right financial product. “First and foremost, whenever you decide to invest, be clear in your mind whether you are looking at a wealth preservation objective or a wealth creation objective. There is no other third objective in my opinion.”

As far as selecting the right vehicle is concerned, always look for your own comfort level. Get a right time frame for your investments so that you do not regret the lost opportunities. Be patient and stay focused on real returns and never ever get swayed away by the luring market values. Instead be patient, as the journey of wealth creation needs persistence and determination. Last but not the least, drawing the analogy of a road trip throughout, the mentor underlined the relevance of periodic checks. Similarly, your investments and your portfolio needs to have a periodic review. Get this review done by a financial coach, or an advisor to get a third party perspective. Monitor and rebalance your portfolio and avoid over-information.

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First and foremost, whenever you decide to invest, be clear in your mind whether you are looking at a wealth preservation objective or a wealth creation objective. There is no other third objective in my opinion.

-Mr. Dilip Shenoy

Audience Asks

There is always a dilemma regarding the duration of my investments. I want to have some clarity on this.

What is important here is to try to map your investment vehicle to the time horizon. For example, my son is in the 10th standard and he has a higher education corpus outflow which will be coming in another 2-3 years’ time, so this time frame is very small to put your money in equity. So this rules out the equity option and you would want to park it into a fixed deposit or a bond fund. But if your time horizon is on the higher side, then drawing a timeline becomes essential and these are the major outflows. There cannot be one template that fits all, depending upon factors like your balance sheet, lifestyle.

There is so much information on the internet regarding investments, wealth management, financial needs, etc. and it is usually very confusing. How do you suggest that one can refine this information and make the most out of it?

I would explain it with something like cricket, everybody understands and follows cricket. So at the start of Sachin’s career he had a coach, Mr. Achrekar, who could probably guide him. Similarly, when you start playing in the investment world, it is best to have somebody as an expert, could be from family, a chartered accountant, an advisor, or a mutual fund distributor. There are a lot of products but not necessarily all these products will suit you. So avoid the noise, avoid the information overload, get an expert in the initial 5-10 years, get into simpler products that you understand, and get into a vehicle that you know how to drive and know how to fix.

Get ready to walk the journey

As Mr. Dilip Shenoy opined, finance is something like an ocean, you really need to dive through to experience it. It does not have any tangibles. The investment planning or products do not have any features so only when you burn your hands or walk the journey is when you realise the product potential.

Watch the entire episode on YouTube, LinkedIn, Twitter or Facebook to devise your goal based investment plan.

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Don’t Get Confused Between Stakeholders And Shareholders

Aakash Sharma — Thu, 09 Sep 2021 05:35:08 +0000

Investments in listed companies are majorly made through the stock market. When you invest in a firm’s shares, you become a shareholder of the company and can participate in its functions in the same capacity. As you become shareholders, you also become stakeholders of that company.

Although their names seem similar, shareholders and stakeholders’ investments in a company are entirely different. Stakeholders are always the company’s shareholders, but shareholders are not always stakeholders.

Shareholders are part of a listed company through the ownership of shares. On the other hand, participants via a stakeholding relationship in a company are interested in the company’s performance for reasons other than financial performance or stock valuation. These reasons translate into a stakeholder’s more vital need for a company’s success over a longer term.

Stakeholders

For a company, its stakeholders can be the owners and shareholders as well as the employees of the company. Bondholders who own company-issued debt and customers who may rely on the company to provide a particular good or service are also considered stakeholders of any institution.

Although a shareholder may be the most significant type of a stakeholder because s/he is impacted directly by an organisation’s execution, different groups that are part of an organisation are also considered stakeholders.

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Shareholders are always stakeholders in a firm, but the vice-versa is not true - stakeholders are not always shareholders.

Shareholders

Shareholders of a company can be a person or an investment organisation that owns at least some part of the company’s shares. In this event, a company’s profits directly and primarily become the goal for shareholders. A shareholder only invests in a company with the hopes of increasing their portfolio value and wealth.

Shareholders generally do not concern themselves with the company’s secondary benefits and long-running values. They also have a significant influence and voting rights in the company. While shareholders own the company, they are not directly responsible for its debts.

Key Differences

Shareholders can sell a company’s shares and buy different ones in search of more profit as they do not have long binding interests in one company. On the other hand, the stakeholders have to stick with the business for a long time as they are part of it for more than just profits.

If a company suffers financial setbacks, the businesspeople in its supply chain might be hurt if the company no longer use their services and products. Likewise, the company’s employees, who are stakeholders and depend on it for wages, might end up suffering job losses in the event of bankruptcy.

Shareholders own shares and equity in a corporation. A stakeholder wants the company to thrive for reasons other than profits. Shareholders do not need the company’s perspective to succeed and can sell shares at any time. But a stakeholder joins a company for the long haul and needs to see the company prosper on all fronts.

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Margin Pledge Rules By SEBI: What It Means For Retail Investors?

Aakash Sharma — Wed, 08 Sep 2021 08:35:11 +0000

The financial security of investors and market participants is essential for the expansion of activities and the entry of new investors. The Securities & Exchange Board of India’s new Stock Margin Pledge rule is a step in the right direction to ensure safety.

But first, let us understand margin pledging and then see how the new rules will impact retail investors.

What is Margin Pledging?

A margin pledging works just like any other mortgage programme. In margin pledging, you use your stocks assets as collateral to apply for a loan, similar to the mortgaging of real estate as collateral for a loan. Futures and options (F&O) traders often use Margin Pledging as collateral to obtain brokerage margin funds to invest in larger trades through initial investments.

Margin is a widely used tool in stock trading. Using this tool, investors can invest in commodities for a portion of their absolute value. By using margin pledging, you can save on investing real money by using an acceptable share price as collateral. This indicates that if you don’t reimburse the loss/depreciation, the broker holds the right to invoke and sell the shares of stock pledged for the margin for debt recovery.

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Margin Pledging, by definition, refers to the process of using your stock as collateral for a loan. If you cannot pay the margin, brokers liquidate the stocks in the margin account to collect their debt.

What will the new rules prevent?

Before the introduction of the new stock margin pledge rule, a broker was promised the client’s shares utilising a power of attorney (PoA) signed by the client on the broker’s account. The broker then placed these shares in the clearing corporation.

The PoA used by some brokers was problematic. Some brokers often misuse PoAs to transfer their clients’ shares to other clients or utilise their shares as collateral and borrow money for themselves.

The new stock pledge rule abolished the PoA system and has introduced a new equity guarantee method. The pledged shares and promised promotions shall always remain in the customer’s Demat account under the new rules. The client would need to authorise a pledge request in favour of his broker. If the depositor takes responsibility, the broker can pledge shares to the corporation for the stake.

What are the changes in margin pledging rules?

Investors and brokers can no longer use a Power of Attorney (PoA) as proof of title transfer. They can, however, use it to transfer shares to the stock market in cases of debt recovery. It can also be used to initiate orders on behalf of clients, meet margin requirements, or provide trading limits to clients.

The shares need to be compulsorily put in the investor’s account. The stock can be directly pledged to the concerned person/authority, ensuring that investors continue to receive all the company’s benefits in their dealings.

The broker must invoice investors in advance for any trading margins. Any client who fails to do so is subject to penalisation.

A penalty on a short collection of 20% upfront margin and any other additional margin plus MTM loss within two days is required in the cash segment.

Under the new standard, investors must pay a minimum margin of 20% to use the trading system to buy and sell stocks.

Unlike the previous system’s end-of-day module, investors will have to fulfil their margin duties at the start of the deal.

Any investor looking to avail margin shall create a margin pledge.

Impact on the stock market and retail investors

The financial share of the trading volume may decrease due to the new margin norms. This is because SEBI has almost finished excessive leverage trades and directed brokers to collect higher margins from investors.

In addition, depositors must wait T+2 days before pledging newly bought shares. But it will not have a significant influence on ultra-short-term trading investors. However, active traders can increase the value of their business via trading costs as they will have to provide higher margins now.

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Bonds And Stocks – What Are They And Which Should Be Your Investment Choice

Aakash Sharma — Tue, 07 Sep 2021 10:35:10 +0000

There are many ways to invest. You can invest in gold, real estate, land holdings, and others. But these traditional methods are restrictive as investors need an already established financial buildup for them. As a new and aspiring investor, you can acquire a good position in the financial world of bonds, stocks, and other security holdings.

While the financial markets have many entities for you to learn, understand, and trade, the two primary entities are stocks and bonds. So let’s know what they are and how they can end in different results for your investments.

Bonds

Bonds are a type of loan that the buyers of bonds provide to companies or governments issuing them. When you buy bonds, the company or the government pays you interest on the number of bonds you purchase for a predetermined period. The total amount of the bonds purchased is also paid at the end.

For example, If you buy a bond for Rs. 2,500 and get an annual interest rate of 2% over ten years, you will receive Rs. 50 in interest per annum, which will be evenly dispersed throughout the term of bonds. After ten years, you will earn Rs. 500 in interest and recover the original investment of Rs. 2,500.

Stocks

Stocks are representative of partial ownership or equity in a company. When you buy stocks, you buy a small part of the business. You can start by buying as small as one stock and can acquire as per your investment goals. Shareholding is directly proportional to the ownership stake – the more shares you own, the more ownership you have.

Let’s say that a company’s stock costs Rs. 50 per share. You decide to invest Rs. 2,500, i.e. buy 50 stocks at Rs. 50 per unit. If the stock price reaches Rs. 75 per unit, it will indicate a 50% price increase. This will increase your investment increment by 50%, and your Rs. 2500 will become Rs. 3,750.

How does the difference affect you?

It is clear that owning shares gives you partial ownership of a business, and in buying bonds, you give a credit loan to the issuing corporation or government. The way these instruments make money is very different.

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Shares are valued and sold on the stock market, and most bonds pay a fixed interest rate over time.

A bond usually has a fixed maturity or repayment period after which it matures. Stocks typically remain outstanding indefinitely. Equities provide a higher return than a bond but also have a greater risk. In general, bonds offer relatively reliable and lower returns.

The value of the shares is equal to the company’s value, and the resulting share price depends on the company’s market value. A bond, on the other hand, is a loan offered at a fixed interest rate. Ultimately, choosing an investment channel that best suits your goals depends on you, but you must select that channel based on an intelligent understanding and analysis.

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Decoding Public Offering – Pre-IPO, IPO, Listing

Aakash Sharma — Mon, 06 Sep 2021 11:35:11 +0000

Today, companies view the public offering as one of the most effective ways to raise funds and plan an exit strategy. Established companies go public to raise large sums of money to fund their expansion plans, and start-ups that have built their brand to the limit see this as a good exit strategy.

However, a firm has to go through many nuances of the public offering process and numerous phases before going public. Let’s see what they are.

Pre-IPO (Pre-initial Public Offering)

Pre-IPO is a stage for a company when it puts shares up for private sale as a last measure to raise capital before it goes public. By introducing more funds, the private company adopts a matured outlook and prepares itself better for going public.

Pre-IPO shares can only be bought by professional investors, high net worth individuals, venture capitalists, private companies, and corporate insiders such as company founders and employees.

Investors invest in private companies a few months or one year before the IPO registration in the pre-IPO phase. This also means that the more significant risks are associated with pre-IPO transactions than with actual IPOs.

Moreover, it is not easy to objectively estimate the value of shares at the pre-IPO stage because a privately held company, unlike a public one, does not disclose financial statements.

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Companies in the pre-IPO stage are not required to provide investors with financial information or corporate rights.

Disadvantages of Pre-IPO over IPO

There are risks and downsides to investing in pre-IPO stocks that you should understand. As investors cannot access information about the company’s trades, including financial statements, pitch deck, or final business plans, they take a high risk of indulging in this investment stage. There is a lack of transparency and openness in the private market.

Initial Public Offering (IPO)

The Initial Public Offering (IPO) is a public issuance in which the shares of a company are sold to investors on a stock exchange. The IPO of a company is usually supported by one or more bank investors and a stock manager who arranges for the shares listed on stock exchanges. The process is commonly known as going public or floating. Following the IPO announcement, a private company becomes a public company.

With the IPO finalised, the company’s shares are issued and traded on the stock exchanges, also called the free market. While the offering offers several benefits, there are also significant costs, especially those related to the system, such as security, banking and legal fees.

Listing

A listing (of a company) refers to the company’s shares being on the list of legitimately traded stocks on a stock exchange. Usually, the issuing company is the one that applies for a listing. Company stocks whose market value and turnover fall below critical levels are often delisted by a stock exchange. Delisting can also result from a takeover or a merger of a company going private.

Each stock exchange has its requirements for a company’s listing, which include:

Annual financial reports for recent years,
Offering investor benefits at a fraction of the outstanding charges, and
An approved prospectus including opinions from independent assessors.

The Bombay Stock Exchange (BSE), for example, requires a minimum market capitalisation of Rs. 25 core and minimum public float equivalent to Rs. 10 crore for a company to be listed on it.

So, this is the basic know-how of the public offering process of companies. Before you start investing, start by analysing stocks and shares based on their IPO history and other financial proofs of stability.

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What Is Dividend Investing?

Aakash Sharma — Sun, 05 Sep 2021 08:35:10 +0000

Payments from a company to its shareholders and partners are termed dividends. When you receive dividends, you get a share of the company’s profits in sales. This entire process aims to increase the company’s value, which also proliferates your portfolio’s investment growth.

What is a dividend?

The dividend is a section of a company’s profit income that is distributed to its shareholders. Some established companies disburse most of their annual profits annually among investors to establish goodwill in the market.

A company’s dividend strategy is considered proof of its belief in the model of growth and continuity. A good dividend is a significant indicator of reliability and helps ensure reasonable stock prices for the future.

If you choose to invest in shareholdings or mutual funds, you have to decide several paths for such an initiative. But, one of the most crucial features is to choose between a fund with a dividend reinvestment option and a fund with a growth option.

Dividend reinvestment

A dividend investment program (DRIP) is a programme that allows investors to reinvest cash dividends in additional or fractions of the underlying stocks when the premium is paid.

Growth and investing

Each type of investment strategy has its limits. Choosing the right way depends primarily on your needs and requirements as an investor. Investors who don’t want to take their dividend payouts can choose either dividend reinvestment or growth options.

In a growth option, investors allow fund companies to invest their dividends in other debt securities to stimulate growth and, ultimately, increase value. If the dividend share is reinvested, the investors can use the profits to buy additional shares in the holding.

Dividend coverage – The payout ratio

The most well-known indicator when choosing a dividend coverage is the return. In most cases, the computation of interest payable is based on dividends per share and earnings per share:

If a firm showcases a dividend payout ratio of over 100, it is paying more in dividends than its earnings for the year.

Dividend rate – Frequency of dividend payments

The dividend rate refers to the cycle of dividends paid during a fiscal year. The central dividend rates are annual, semi-annual, quarterly and monthly.

The risk factor

Having a stake in a company that pays fixed dividends can increase your future earnings. As an investor, you can use the accumulated profits to buy additional stocks and benefit from reinvesting the profits.

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Dividend stocks are usually considered to be less risky than non-dividend stocks. When looking at the most profitable stocks, look for the most productive stocks as well.

Please note that dividend payments are not mandatory, and the company can decide at any time to reduce or stop the dividend payout. The company decides whether or not it will distribute the dividend.

If the tax rate on dividend income increases, the dividend model can also become a less attractive payment option. In addition, any decline in regular dividend returns weakens investor confidence and results in stock prices falling. This type of risk factor about dividends can pose problems for stock investors as well as companies.

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Why Do I Need A Demat Account?

Aakash Sharma — Sat, 04 Sep 2021 10:30:10 +0000

Careful and intelligent investments in stocks involve lengthy processes, paperwork, and weighing the risks of misrepresentation. To indulge in the financial world of stocks and shares successfully and seamlessly, one of the most revolutionary methods in India is the simple and effective Demat account (dematerialisation account).

Demat accounts are used to store stocks and shares in a non-physical or electronic format when trading online. As part of the dematerialisation, an investor’s share certificates are converted from physical to electronic format for easier access. A Demat number is required to process transactions electronically.

Facilities offered by a Demat Account

Dematerialisation into different forms

If you have a Demat account, you can easily convert your stocks and securities into different formats. You can ask the depository participant (DP) for specific actions, including turning physical share certificates into electronic formats. A DP is an agent or the registered stockbroker of your depository.

Several login options

You can access your account through various media given its digital and electronic nature. You can use the internet to invest, trade, monitor and perform other stocks-related activities on your PC, smartphone or other mobile devices.

Credit facility

This account allows you to withdraw additional securities deposited into your account and receive interest from your bank. You can give these securities as collateral for loan obligations with your bank.

Stock transfer

It is used to transfer investor shares. An account holder can do this utilising a Delivery Instruction Slip (DIS) for stock trading.

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Brokers, either digital platforms or the traditional ones, are needed for opening a Demat account.

How to open a Demat Account?

First, select the Depository Participant (DP) with whom you want to open a Demat account. Once you have opened your Demat, be sure to attain the POA number, Demat Account number, and the Depository Participant (DP) ID.

The account number is called the ‘beneficiary ID’. You can open this account without deleting or having any shares or securities under your portfolio. In addition, a minimum balance does not have to be observed for Demat.

Necessary documentation

The opening process and documentation requirements for Demat are the same as for all financial organisations.

Income proof: Copy of income tax return (ITR), current payslip, or form-16

Proof of Identity: PAN card / Aadhar card / Voter ID / Driving license / Passport

Address proof: Passport / Identity Card / Utility (Ration) card / Driving license / Insurance / Bills (such as telephone bill, electric or gas bill)

When is it compulsory to have a Demat Account?

If you want to indulge in the share market, investing and trading, it is essential to have a Demat account. Possessing it makes the stock trade safer and faster. You can buy and hold shares in your account. In simple words, Demat is just like a bank account, where you can make deposits, and the debit/credit balance is kept in the registered account.

When you buy or sell stock units, expenses or gains are invoiced via Demat after your approval. It can further be used for a wide range of investments, such as stocks, securities, mutual funds, government bonds, etc. And the best part is, you can open a Demat account without possessing any claims and with zero balance in your account.

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Here’s How To Read The Market Chart: Check The Pulse Of Stocks

Aakash Sharma — Sat, 04 Sep 2021 03:35:10 +0000

To understand a stock market chart and stock selection, the first important task for beginners is to read stock charts. If you are even minutely familiar with investing, you might agree that reading stock charts is neither easy nor very much enjoyable. But it is an essential skill that is necessary to generate future profits on the stock market.

Stock charts and their readability are part of the technical analysis of the market’s investment strategies and processes. It primarily gives you an overview of the current value of an investment and how it has changed over time.

What is the share market chart?

Whether it’s a stock chart or a technical share chart, they all play a vital role in identifying current trends and reversing trends. The share market chart is a unique format that can generate trading signals and show future price trends on a chart.

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You can consult the chart and view stock prices over periods if you want to see each item's final price on each trading day.

Volume (Quantity) and Price

Stock charts are divided into two main areas: price and volume. The volume represents the quantity and the number of shares traded on the market. You have to look at both merit (price) and magnitude (volume) to understand the fundamental nature of particular markets and shares.

For example, if a stock falls 2% per day, you may panic. It means that if trading volumes are well below average, the major investors in the market may not be actively selling. Conversely, if a stock is performing well but the number of shares traded is deficient, it simply means they are fake.

Types of charts

Bar Charts

These are the most standard charts for stock market traders and investors. Bar Charts provide various important information about the transactions related to the securities and their prices. The details include the opening price, the closing price, the high price and the low price on a particular day.

Line Chart

This is a chart that tracks daily closing prices. It is plotted daily and eventually forms a line.

Candlestick Chart

Candlestick charts (also known as Japanese Candlestick charts) display price data in various formats divided into two parts, with each piece plotted on a line. The thin line shows the price range between high and low, and the current unit shows a large area, which helps calculate the difference between the closing price and the opening price.

Head and Shoulder Chart

The head and shoulder chart is a tabular table model that shows the changes in securities, i.e., their volatility against previous market trends. The top of the trend forms the chart’s top, and the bottom marks the end of the trend. The bottom line is also known as the descent and reverse signal.

Reading stock market charts

Recognise the chart

Identify the charts at the top. A ticker designation or symbol, a short alphabetic identifier of a company, is located here. It is essential to have a correct sign while looking for the company’s information.

Select a period

This can be daily, weekly, monthly or yearly, depending on which period you want to access on the chart. Examining different timescales helps identify long-term and short-term trends and verify stability.

Watch the prices

A typical chart is divided into two parts, one above and one below, with information about the prices. Prices are generally shown in different colours; for example, the marker might be black if the closing price for the period is lower than the opening price. Whereas the chart may mark the price at which the stock closed in the red.

Check the summary key

You should always check the summary key as it contains essential information about the market that can be quickly read from charts. The details generally include the most recent price, the moving average price and the transaction volume.

Keep in mind the volume traded

Below a chart, you can see the number of shares traded in the market. The coloured area helps determine whether there is a positive or negative trend in the market. The colour code is not fixed, so read it carefully. The colour represents an increase or decrease in the closing price from the previous day’s closing price.

This is the most basic pathway for new investors learning to read the stock market trends and figures via graphs. By following this technical route and mixing it with the fundamental analysis of a company’s books, shares, management, etc., you can devise a practical investment strategy by starting small in the investment world.

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When The Market Is Up Or Down, What Does It Actually Mean?

Aakash Sharma — Fri, 03 Sep 2021 05:35:07 +0000

There are two significant parameters that experts use to weigh and analyse the state of a nation’s economic and financial health. One is the GDP – Gross Domestic Product – the monetary measure of the market value of all the final services and goods made in a specific period.

The other is the financial performance of a company’s shares – stock market indices. But, some questions arise – which companies matter in a stock market index? Are all companies included in the performance analysis of market indices? And what exactly is a market index?

Stock market index – which companies matter?

By definition, a market index is a portfolio of investment holdings representing a financial market segment. The market index value is calculated from the prices of the underlying holdings. The market index analysis helps identify if the market is up or down (and also shows the economic growth or decline). Indices are the report card of the market’s top companies’ performance in the market.

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If not the biggest by size, each sector's top and leading companies are included in making a market index.

Companies with considerable value in their respective industries are basically the ones accounted for in the analysis by a market index. For example, Indian companies with significant market shares, such as Infosys, Tata, Reliance, Hero, etc., represent the entire market in a stock market index.

It is important to note that not all companies listed on a stock exchange are included in making a stock market index. For a reference point, the Bombay Stock Exchange has 5000+ companies listed on it. Out of those 5000+, only the top 30 companies are considered based on their market capitalisation.

What is market capitalisation?

Market capitalisation (market cap) is the total market value of a company’s shares of stock. It is calculated by the product of the total number of a company’s shares and the price per equity share. In calculating the market cap, promoter shareholdings are not included.

For example, suppose Reliance (RIL) has 10,00,000 shares in the market. If out of those 10 lakh shares, 3 lakh are owned by promoters (say, the members of the Ambani family and relatives), then the market cap will be calculated only for the rest 7 lac shares and not for those held by the private promoters.

The publicly traded shares, i.e., the shares held by public shareholders, give the free-float market capitalisation. This shows that the total market cap and free-float market cap can be different.

SENSEX and NIFTY50 – The indices of the BSE and NSE

Based on the free-float market cap, the top 30 companies are shortlisted on the Bombay Stock Exchange (BSE) from different sectors. The base year for calculating the average of the companies’ points is 1978-79. The points calculation started from 100 points, and the collective standard of the top thirty companies on the BSE is called the SENSEX (S&P Bombay Stock Exchange Sensitive Index).

In the National Stock Exchange (NSE), the top 50 companies are included based on their free-float market cap to make the NSE stock market index – the NIFTY 50 index. Companies in NIFTY 50 (NSE Index) do not remain constant but keep changing as per their free-float market capitalisation.

What does it mean when the market is up or down?

Suppose the SENSEX is at 28000 points, and it falls in points to 27900. This fall of 100 points will indicate that a majority of those 30 companies are not doing well at share prices. And this is what is known as the ‘market is down’ situation. The reverse situation (a rise to 28100) will be called a ‘market is up’ situation.

When the index is down, i.e., the market is down, it indicates that companies accounted for in the index are making less profit and development. Thus people are not buying the shares or are selling the existing ones.

For a reference basis, before the 2008 financial crash, SENSEX was at a high of 21,000 points. But after the crash and recession, it came down to 8000-9000, showing a severe loss of points and top companies’ average share valuations.

Bull and Bear markets

If the market is down, it means people (investors and shareholders) are selling their shareholdings. When the index is up, i.e., SENSEX or NIFTY 50 are up, it points towards good economic growth and stock market activity.

Colloquially, it is called a bull market when the market is up, meaning that investors are buying. When the index is down, selling shares takes place faster than buying; it is called a bear market.

It is therefore clear that the stock market index is critical to see the state of a market. That is why, when the Government of India announces the national budget, the market indices witness a lot of activity. If the budget is positive for the market, then the market registers a high growth in index points and vice versa.

Interestingly, the first Index – BSE SENSEX – was first started in India in 1986 and NIFTY 50 was established in 1997. Both have been recorded continuously since then, helping investors analyse market trends, companies make profit valuations, and economists see the health of the Indian economy.

The post When The Market Is Up Or Down, What Does It Actually Mean? appeared first on Dutch Uncles.

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

The post Must-Read Book on Finance: FUNdamentals of Financial Statements appeared first on Dutch Uncles.