## PE Ratio – Price to Earnings Ratio in the Share Market

The PE ratio basks in its glory of significant fame when investors dive into Share Market discussions.

If you are a market-savvy investor who wants to make intelligent investing decisions, you must already keep your tabs on the PE Ratio.

It is the most popular financial tool in the cohort of investors.

But why?

## Why is the PE Ratio important?

The PE Ratio facilitates investing decisions by determining the relative value of a stock. It aids peer to peer comparison between the companies of the same industry and helps to point out whether a stock is overvalued or undervalued.

The PE Ratio is easy to calculate, and it helps investors gain an edge over calculating the expected future earnings of a company. The standardised ratio status makes it less time consuming and more informative for the investors.

To know the secrets behind this never-ending fame, we need to dive into the details of the PE Ratio.

## PE Ratio Meaning.

The Price to Earnings Ratio evaluates the Market Price per Share of a company considering its Earnings Per Share (EPS).

Earnings multiples and Price multiples are some synonyms for the Price to Earnings Ratio.

## PE Ratio Formula

The formula for calculating the Price to Earnings Ratio divides the Share’s Current Market Price by Earnings per Share (EPS).

Price to Earnings Ratio = Market Price per Share / Earnings per Share

If there is a lack of clarity about the number of shares, then PE Ratio Formula is as follows:

Price to Earnings Ratio = Market Capitalisation of the company / Net Earnings.

## Components of the Formula

Market Capitalisation is the total market share of the company.

Net Earnings of a company is the overall profit made by a company during a financial year.

Market Price per Share is the current stock price of the company’s share in the stock market. It is a value that represents the price that investors need to pay to purchase a particular company’s stock. One can easily find this value through market infographics.

Earnings per Share, however, is a little complicated. It is either calculated by looking into the company’s performance for the last 12 months or by waiting for the company to release their expected earnings.

The calculation of the PE Ratio through this 12-month performance is known as Trailing Price to Earnings. It is also popularly abbreviated as TTM in Wall Street Magazine, where TTM means trailing twelve months.

The company’s earnings release estimates the potential earning expectations of the company.

If the calculation of the PE Ratio executes from this figure, it is known as Forward Price to Earnings.

So, Forward Price to Earnings and Trailing Price to Earnings are two varieties of Earnings Per Share.

There is a third method of finding the PE Ratio by using the company’s average earnings over a while. This method is called the Shiller Price to Earnings.

Read on for a detailed description of these three methods.

## Forward Price to Earnings.

Forward PE is a forward-looking method of calculating a company’s earnings, and it is also known as Leading PE or Estimated PE. This metric provides investors with some clarity into the future of the company.

Investors use this figure to compare the current earnings with the expected gains. This comparison tells you what the future looks like for a particular company.

However, one of the significant drawbacks of this methodology is the potential underestimation. A company can underestimate this figure to achieve a high PE during the announcement of upcoming quarter earnings. One can also overestimate this figure and adjust it similarly during the report of subsequent quarter earnings.

Sometimes, market experts provide their estimates about the future of a company. These estimates can turn out to be different from that of the company. This difference in opinion can cause chaos among the investors.

## Trailing Price to Earnings.

This methodology is the most popular metric for calculating PE. In this method, the total Earnings Per Share (EPS) of the past 12 months facilitates the calculation of PE.

Trailing PE is more popular than Forward PE because some investors are sceptical about future estimates. They like to look at proofs rather than estimates.

A significant drawback of Trailing PE is that it demonstrates the past performance of a company rather than the future. But, Investors mostly shell out their money based on future expectations.

Another drawback could be that past earnings are constant, whereas market prices fluctuate. Hence, the trailing PE is highly volatile because any significant changes in the stock market reflect in the trailing PE.

Many investors prefer Forward PE because of the highly volatile nature of Trailing PE.

From the analysts’ point of view, if the Forward PE is less in value than the Trailing PE, the earnings are supposed to rise. And, if the Forward PE is more in value than the Trailing PE, the profits are supposed to fall.

Let us demonstrate the use of the PE Ratio with the help of an example.

## Example of the PE Ratio.

To understand better, let us take an example of this MNC named Moodle. It is known that the stock price of Moodle for 5th March 2022 is INR 100.50 per share, and the Earnings per Share (EPS) for Moodle is INR 10.50.

We need to calculate the given company’s Price to Earnings Ratio for a specific period.

To get started with the calculations of the PE Ratio, we require just these two pieces of information, the company’s closing stock price per share and the company’s earnings per share.

As we know, the formula for the PE Ratio is as follows:

PE ratio = Market closing stock price per share/ Earnings per share

OR

Market capitalisation/ Total net earnings.

In this scenario, the stock price and EPS are on display. Hence, we need to use the former formula.

So, the P/E Ratio for Moodle as of 5th March 2021 will be as follows:

Moodle’s PE Ratio = INR 100.50 / INR 10.50 = 9.57

## Interpretation

The current market value of Moodle is 9.57 times more than its net earnings of the year. If you buy all the shares of the company named Moodle, it will take you 9.5 years to earn back that amount through the profits made by this investment.

## How to compare companies using the PE Ratio?

Let us take an additional example where we can look at two MNCs and compare their PE ratio to understand earning growth in the future relative to the market.

If Stock A is trading at \$40 and Stock B is trading at \$30, now determining P/E from a cheaper valuation perspective, P/E can be of much help.

Assuming that the FMCG sector’s average P/E is 20, stock M has a P/E of 20, and stock N has a P/E of 40. This result concludes that stock M is cheaper despite the higher absolute price because one has to pay less for every \$1 of current earnings.

On the other side, Stock N has a higher P/E compared with its competitor and the sector, enabling investors to expect higher future earnings growth relative to the market.

## What is an Ideal PE Ratio?

The most vital aspect for an investor while analysing their investment options using PE Ratio is the ideal range of the Ratio.

At the onset, we must clarify that the ideal PE Ratio varies from sector to sector, and it is also dependent on the market conditions and the industry-wise performance.

Therefore, while assessing the PE Ratio of a company, one should perform a peer to peer comparison to know how a specific industry is performing.

There is no specific value for the investors to rely on while analysing the PE Ratio of a company. A higher value of the PE Ratio can signal risky value trap investments. In comparison, a lower value might indicate fundamental faults in the company that might result in its sub-par performance.

To analyse their investment options successfully, one should use other indicators, like, cash flow at a discount, the weighted average cost of capital, etc., to ascertain the credibility of their investment choice.

## ABSOLUTE P/E RATIO.

The absolute PE ratio is the classic method of calculating the PE Ratio. While calculating the Absolute PE Ratio, the Current Market Price per share is divided by EPS. Here, the EPS is either the trailing EPS or the forward EPS.

Sometimes, the EPS can also combine the trailing EPS of the last two quarters and the forward EPS of the following two quarters.

Therefore, the significant difference between the Absolute PE Ratio and the Relative PE Ratio is that the Absolute PE ratio considers earnings based on the current period.

## RELATIVE P/E RATIO.

The Relative PE Ratio is a complex methodology that compares the latest Absolute PE Ratio with a range of past PE Ratios from a specific period, like the last decade.

This comparison tells an investor about the percentage increase or decrease in the current PE ratio concerning the past PE Ratios. The chosen base for comparison is the highest value from the range of past PE Ratios. But, sometimes, investors also select the lowest PE Ratio from the ridge to calculate the difference in the current PE ratio from the lowest range by far.

A PE ratio below a hundred per cent indicates that the current PE ratio is lower than what it has been in the past.

A PE Ratio above a hundred percent indicates that the current PE Ratio is higher than all the past PE Ratios.

## How to evaluate stock by using the PE Ratio?

Stock Analysis and the PE ratio go hand in hand. It is impossible to analyse a company’s stock without looking at its PE Ratio. The PE Ratio is vital for estimating the value of a company, as it helps the investor understand whether a stock price is overestimated or underestimated. This Ratio is also beneficial for the sector to sector comparison and evaluation of past performances.

It helps the investor compare the market price with the company’s earnings. This comparison dictates what the market thinks about the company based on its past performance or future potential.

A higher PE ratio signals a higher market value than the actual earnings, indicating that the stock might be overvalued.

Conversely, a low PE Ratio indicates a lower market value than the actual earnings.

## How to understand an investor through the PE Ratio?

We can find out what an investor is expecting from a stock company by analysing the PE Ratio of that company. A company with a high PE Ratio suggests that the investor expects the company to deliver increased earnings in the future. However, a low PE Ratio may indicate that the company is undervalued and is performing better than in its past performances.

## What does it mean if the PE Ratio is Not Applicable (N/A)?

Sometimes, the PE ratio is given as N/A, which means not applicable. There can be various reasons behind this input.

The first and foremost reason can be a loss-making company or a company that has made no earnings this financial year. When a company incurs a loss or has made no profit in a financial year, the PE ratio is not provided for that company. One can calculate a negative PE Ratio in this case. But, N/A is the general trend.

The second reason for a N/A input for the PE Ratio can be a new company. A company that has recently been listed in the stock market or is a case of initial public offering (IPO) can have its PE Ratio as N/A. The N/A can also mean that the company has not made any earnings or it has not reported them yet.

The PE Ratio can also be used as a standard measurement to decide whether a stock is worth investing in or not.

## Few financial decisions may affect the PE Ratio.

When a company takes certain financial decisions, they affect the PE Ratio of the company.

For example, when a company buys back its shares, it reduces the number of claims in the market, thereby increasing the earnings per share and decreasing the value of the PE Ratio.

However, when a company executes the right issues and dilutive FPOs, there is a rise in the number of shares, increasing the value of the PE Ratio.

Share prices also represent the market sentiment of a company, and it hints at the narrative and thought process of the company. This representation is subject to the sectors. Hence, it is crucial to consider an intra-sector comparison while analysing the PE ratio of a company.

## Merits of the PE Ratio.

When investors want to evaluate a stock, the PE Ratio is their go-to tool. But, one must remember that it is not the only tool.

• A PE ratio can help an investor identify an overestimated or underestimated stock.
• It also helps an investor compare its performance with other companies in the same sector. It is mainly helpful in vast markets like the S & P 500 index.
• When an investor wants to look at the long-term past performance of the company, they can easily consider the Trailing PE of the last two-three decades of the company.
• A vital usage of the PE Ratio is to determine whether the figure of earnings stated by the company stands true in comparison with their market performance or not. It helps the investor in understanding the position of the company.

## Demerits of PE Ratio.

The Price to Earnings Ratio is a good starting point but not the ultimate valuation measure and financial tool for investment decision analysis. However, it is a quick metric for the valuation of a company’s stock price.

But, there are certain limitations which are as follows:-

• Different industries can have varied PE Ratios, so it does not serve the purpose of investment decisions until it compares the same sectors with similar characteristics. But, it does not work well when used for comparing industries from varied sectors.

• Varying accounting methods may lead to misleading estimations while displaying the PE Ratio. Companies can report positive and higher earnings while having negative cash flow, which explains that they are spending more than they are earning. Still, a high PE Ratio can be deceptive of the actual financial situation of the company.

• The PE Ratio cannot be taken as a reliable method for investment decisions as stock prices fluctuate every day and a company’s earnings are released every quarter, leaving room for misinterpretation on the investor’s part.

## ANALYSIS AND OTHER CONSIDERATIONS.

Analysing the PE ratio with an apple to apple comparison can better picture your investment choices.

Let us say you are evaluating the PE ratio of an automobile firm.

If the PE Ratio of that automobile firm is high, it can be a cause of concern because it might look like a risky value trap investment. But, if you look at the PE Ratio of other companies in the same sector and find a similar trend of high PE ratio among all those companies, you might feel relieved about your investment choices.

The accuracy of the PE ratio depends on the accuracy of inputs in the formula, and this mandate limits the PE Ratio. The current market price can be deemed accurate because it is estimated through an auction and is shared worldwide through various sources.

But, the company executes the calculation of earnings per share. Because the company is the single and only source of information, this input is taken with a pinch of salt.

The company has complete authority to manipulate its Earning Per Share, and this manipulation can help the firm gain investors’ and analysts’ trust. But, once a company breaks the trust of its investor, the value of the company falls in the market.

Companies might manipulate data to trap investors. But, expert investors say that one needs to change the values of all the other parameters accordingly if one wants to control the PE Ratio, and this is a nearly impossible task. Hence, the PE Ratio can be a reliable metric when considering the other financial tools.

The company’s debt also plays a significant role in the distortion of the PE Ratio Value, and a company’s obligation also affects the market price of its share. Debt can also affect a company’s earnings, which can bring higher gains because of good operations and risk rewards of the debt. However, a burdensome debt followed by a lousy business can be lethal for a company. A company with more debt tends to have a lower PE Ratio value than the one with less debt.

Conclusion

Overall, one can say that the PE Ratio is a vital tool for financial analysis. It aids investors in identifying overvalued and undervalued stocks, thereby helping them make better investment decisions.

But, it also has its shortcomings. The PE Ratio can be manipulated easily. This manipulation is why an investor should look at multiple financial tools to gain a holistic picture instead of focusing on just one statistic.

## P/B Ratio: Price to Book Ratio Meaning and In-Depth Analysis

There are multiple secrets to being a successful investor. Financial markets are thrilling, and we always see some star investors profiting off their instincts.

But, as exciting as it may sound, it is not always instinct.

These successful investment tactics are a combination of intensive research and systematic analysis combined with a pinch of instinct.

One thing that has always been a constant in the investing practices of these intelligent investors is seeking stocks of undervalued companies. They do it with the help of the PB Ratio. The PB Ratio is not the only factor, but it is undoubtedly essential.

How? Well! Read on to know the details.

## Why should you know about PB Ratio?

PB Ratio helps investors identify whether a stock is undervalued or overvalued. In turn, this Ratio helps the investor invest in stocks whose prices might rise in the future. After finding an undervalued stock, the investors buy it at low prices and wait for them to skyrocket.

As soon as there is a sufficient price rise in these companies’ stock, investors sell them at their desired profit. But, how is PB Ratio capable of identifying stocks? First, we need to understand PB Ratio in detail to answer this question.

## PB Ratio Meaning

The Price to Book Ratio is the proportion of an organisation’s Stock Price to its Book Value per share.

## PB Ratio Formula

Price to Book Ratio = Market Price per Share / Book Value per Share

## Components of the Formula

Book Value per Share is calculated by dividing net assets by outstanding shares in the company.

where, Net Assets = Total assets – Total Liabilities.

The Market Price per Share represents the current price of the company’s share in the stock market. One can derive the market price by quoting the stock market value of the company through the price charts.

## Example of PB Ratio

Suppose an organisation named Alliance owns assets of INR 200 crores and has liabilities of INR 150 crores. The share price of Alliance happens to be INR 10 per share.

One more detail is that Alliance possesses outstanding shares worth 20 crores. So, what is the PB ratio of Alliance?

To calculate the PB ratio, we need to know two things. First, the Market Price per Share and second, the Book Value per Share.

We already know the Market Price per Share of the Alliance, and it is INR 10 per share.

Let us calculate the Book Value per Share of the Alliance.

Book Value Per Share = (Total Assets – Total Liabilities) / Number of Outstanding Shares in the company.

Hence, Book Value per Share of Alliance = (200 crores – 150 crores) / 20 crores.

Book Value per Share of Alliance = 50 crores / 20 crores.

Book Value per Share of Alliance = INR 2.5

Now that we know the Market Price and the Book Value, let us determine the PB ratio.

Price to Book Ratio = INR 10 / INR 2.5 = 4

Hence, the PB Ratio of Alliance is 4.

## Interpretation

A Price to Book Ratio of value 4 indicates that the company’s Market Value is four times its Book Value.

## What is the ideal Price to Book Ratio?

The ideal PB Ratio is subjective and different for different industries. A PB Ratio of less than 1 is the perfect consideration for any organisation, and it directs you to potentially undervalued companies.

But, in the upper range, a PB Ratio of 3 is considered acceptable. However, companies with higher PB ratios are considered overvalued, and hence they are ruled out by investors looking for value investing.

The best use of PB Ratio is when comparing companies that belong to the same industry, and PB Ratio is ideal for peer to peer comparison.

One crucial shortfall of the PB Ratio is that it is useless in sectors that possess intangibles as their most valuable assets, like the Information and Technology industry.

## Merits of PB Ratio

Investors who are constantly looking for undervalued stocks execute their search with the help of the PB ratio. PB Ratio helps an investor know whether the stock is undervalued or overvalued.

An undervalued stock is an ultimate catch for bullish investors looking to obtain profit by selling these undervalued shares at a higher price when their market value has risen.

The PB ratio aids the identification of undervalued shares depending on the industries. For example, an IT company with a PB ratio below one could indicate an undervalued stock because of the absence of valuable intangible assets from the book value.

Overall, the PB ratio is a good indicator of worthy investments. It follows the method of comparing the book value of a company with its market value, thereby giving us insights into the company’s fundamentals.

PB ratio also facilitates the investors in identifying problems in a company, if any.

Suppose an organisation that belongs to tangible assets heavy industry has a low PB ratio. It might indicate issues in a company because book value accounts for all tangible assets. Hence, if such a company has a low PB ratio, it hints toward internal issues in a company like management problems or ownership arguments.

Given the conflicts, these problems could be the primary reason behind a company’s complete non-disclosure of income because they might be unsure of how to account for them.

Therefore, the PB ratio can save you from potential pitfalls.

## Demerits of PB Ratio

We have been well-versed in the importance of the PB Ratio as a metric to gauge the value of a company’s shares. However, there are certain areas where the PB ratio falls short.

The first limitation of the PB ratio is its inability to compare companies from different industries. Industries with a higher intangible asset worth have low PB ratio than industries with more tangible assets. For example, an IT company will have a low PB ratio than an FMCG organisation. But, this does not mean that the IT company is incapable of gaining a high market value.

So, the PB ratio can be deceiving when evaluating companies with ideas, innovation, patents, copyrights and goodwill as their core assets.

Another limitation of the PB ratio is its conservative approach in scenarios like acquisition write-offs or buybacks, and these scenarios tend to deform the book value figures. Hence, while searching for undervalued stock, market savvy investors look at multiple financial tools and the PB Ratio.

## How to use PB Ratio in Stock Market?

The PB Ratio of a lower value helps the investor identify an undervalued stock with an exceptional future earning potential to be a solid investment.

But, a low PB Ratio might not always signal an undervalued stock, but it may signify underlying issues within a business. So, one must evaluate the sectors and peers of a company before banking on the PB Ratio.

This Ratio is also well suited for capital intensive companies. Companies like energy firms that have high tangible assets and their ledgers can be judged perfectly with the help of PB Ratio. Telecom, transport and Oil refining are a few industries that complement PB Ratio. But, it is strictly advisable to execute a peer to peer comparison before investing in these companies.

The PB Ratio fails to incorporate any potential earnings and intangible assets. But, it is efficient to identify companies that have overvalued stock prices without any significant asset value.

Hence, the PB Ratio is an accurate measure for identifying overvalued and undervalued stocks.

## When should you restrict yourself from using PB Ratio?

•       Malpractices are common in every industry. Similarly, some companies use artificial ways to portray a high PB Ratio. High Debt Companies possess a high PB Ratio artificially. Hence, the general suggestion is always to avoid high debt companies.

But, there is a caveat. One can invest in a high debt company with a high-interest coverage ratio.

•       Another instance where one should avoid using PB Ratio is for companies that possess high depreciating assets, and companies that manufacture steel or cement mostly misquote their assets. The original cost price is there in the balance sheet, which keeps changing due to wear and tear.

However, such companies often overvalue their assets after deducting the depreciation. This practice, in turn, leads to an incorrect PB Ratio, thereby giving a blurry picture of the company’s book value.

The absence of accumulated depreciation in the Balance Sheet is also one of the artificial ways to showcase a high PB Ratio.

•       IT companies are a no-brainer when it comes to PB Ratio. As mentioned several times in the article, companies with a high value of intangible assets have a low PB Ratio. But, the holistic picture is different from what the PB Ratio tries to portray. Hence, one should not trust PB Ratio in companies whose core activities include assets like innovation, ideas, patents, copyrights, etc.
•       Any industry other than capital intensive firms with ample assets in their accounting books is less suited for this Ratio.

Conclusion

In a nutshell, one can say that PB Ratio is a valuable tool for financial analysis, but its usage should be wise. Simply knowing the Ratio is not enough; one must consider various factors before going ahead with their investment.

Market savvy investors use PB Ratio to find the undervalued stock. But, it is not always the undervalued stock with a low PB Ratio. Sometimes, the company may be devoid of earnings due to fundamental problems. Hence, focusing only on the PB Ratio can be risky. Instead, it would be best to consider several parameters for a holistic view.

## Assets and Liabilities: Everything You Need to Know

Every financial tool requires information from the balance sheet to carry out its economic analysis. The balance sheet comprises assets along with equity and liabilities.

Therefore, assets and liabilities are crucial aspects of every business.

One can easily understand a business’s financial status by looking at the health of assets and liabilities on a balance sheet.

These metrics have been used repeatedly to gauge the actual performance of a business.

Let us dive into the details of assets and liabilities better to understand balance sheets and other financial analysis tools.

## What is an asset?

### Asset – meaning

An asset is an owned resource with a quantifiable financial value, and it can be owned by an individual, organisation, or country, or one can also possess it through a partnership.

The primary purpose of owning an asset is to reap benefits that aid revenue formation or future earnings. According to accounting fundamentals, assets are displayed on the right side or bottom of a balance sheet, depending on the balance sheet format.

The primary purpose of an asset is also to facilitate revenue formation in a firm or increase future earnings. If a commodity increases sales or decreases expenses, it can be regarded as an asset. Assets are primarily known for generating cash flow.

## Attributes of an asset

There are three main attributes of an asset, and they are:

### Liquidity:

Liquidity means that an asset can be turned into cash or cash equivalents. Different assets have different liquidity periods, but they all possess an economic value, irrespective of the liquidity.

### Cost/Price:

Every asset has a specific cost or price, and this price means that an asset can be exchanged for another asset or sold to settle a liability or generate cash.

### Source of benefits:

The primary use of an asset is to generate financial benefits for a person or firm in the future.

## In how many categories can you classify assets?

The categorisation of assets is based on three factors:

### Liquidity:

Commonly, assets are categorised by their liquidity. Liquidity indicates the conversion capability of an asset to cash and cash equivalents.

Assets that can be converted easily into cash or cash equivalents have a high conversion capability. Such assets are called current assets.

Similarly, assets with low conversion capability are called fixed assets, and these assets cannot be easily converted into cash or cash equivalents.

### Physical state:

The categorisation of assets based on physical existence has two varieties.

Tangible assets are assets with a solid physical existence that can be felt through touch.

Assets that do not exist in a solid form but still have a monetary value are known as intangible assets.

### Utilisation:

Assets are also categorised according to their usage.

Assets that carry out the core operations in a business are called Operating Assets.

But, assets that do not take an active part in business operations are called non-operating assets.

## Why is it important to categorise assets?

Categorising an asset is very vital in a business environment.

For instance, knowing which asset is a current asset and which one is a fixed asset plays a valuable role in evaluating a company’s capital.

In an extreme case, where the company is in a high-end risk industry, knowing which assets are tangible and not tangible helps assess its risk and solvency.

Knowing the operating and non-operating assets helps claim the revenue contribution from each asset. It also facilitates the evaluation that states, what percentage of the company’s revenue it earns from its core activities.

## Categorisation of Assets – LIQUIDITY

If liquidity is the basis of asset categorisation, then assets are classified into two types – current or fixed assets.

From the other point of view, the classification also has types called short-term assets or long-term assets.

## Current Assets

Current assets have high liquidity, i.e. one can convert these assets into cash and cash equivalents with ease.

Hence, these assets are also synonymous with liquid assets.

Listed below are a few examples of such assets:

1. Cash
2. Cash Equivalents
3. Short Term Deposits
4. Accounts Receivables
5. Inventory
6. Marketable Securities
7. Office supplies.

## Non-current Assets

Non-current assets are the exact opposite of current assets, and they possess stern liquidity capabilities, so it is no child’s play to convert them into cash and cash equivalent.

Hence, they are also synonymous with long-term assets.

Listed below are a few examples of such assets:

1. Land
2. Building
3. Machinery
4. Equipment
5. Patents

## Categorisation of Assets – PHYSICAL STATE

Assets can also be categorised based on their physical availability into tangible or non-tangible assets.

## Tangible Assets

Tangible assets are assets that we can see, touch and feel.

A few examples of such assets are:

1. Land
2. Building
3. Machinery
4. Equipment
5. Cash
6. Office Supplies
7. Inventory
8. Marketable Securities

## Intangible assets

Intangible assets are assets that lack physical existence.

A few examples of such assets include:

1. Goodwill
2. Patents
3. Brands
7. Licences and Permits
8. Corporate intellectual property.

## Categorisation of Assets – UTILISATION

If usage and motive are the basis of asset categorisation, those assets have two varieties – operating and non-operating assets.

## Operating Assets

The operational activity of a business environment requires certain assets to function with ease. Those assets are known as operating assets, and they are primarily used to extract revenue from a company’s core activity.

A few examples of such assets include:

1. Cash
2. Accounts receivable
3. Inventory
4. Building
5. Machinery
6. Equipment
7. Patents
9. Goodwill

## Non-operating Assets

These are the assets which are not required in day to day activities but are still capable of extracting revenue.

A few examples of such assets include:

1. Short-term investments
2. Marketable securities
3. Vacant land
4. Interest income from a fixed deposit

## Examples of assets

Flourishing companies have assets in all nooks and crannies of their business. Here are some insightful and variegated examples that will help you identify assets in a business.

1. Every business’s first and foremost asset is cash, irrespective of its scale. It is the ultimate liquid asset. A company with a higher stack of cash has higher liquidity. An increase in liquidity strengthens the financial position of a company.
2. Copyright, patent, goodwill, and intellectual property are intangible assets. These intangible assets have low liquidity. But, they represent a company with higher intellectual capital, and such a company is highly expected to have a successful future.
3. Land, buildings and other real estate are appreciating assets. They gain value with time and can be a perfect source for future revenues. These assets are tangible. They do not enjoy high liquidity, but they are not precisely low liquidity either. They are pretty flexible and can be used to borrow loans when in need. However, that loan will create a long term liability on the balance sheet.
4. Plant, Machinery and other types of equipment are depreciating assets. These assets are corporate assets used to perform the core activities of the business. Hence, they are subjected to wear and tear. This wear and tear is termed as Depreciation. Depreciation is used as an expense for a tax deduction in a business.
5. Brand recognition, goodwill and work culture are certain intangible assets without the possibility of correct valuation. These sets might not frequently appear on the balance sheet. But, they provide benefits like employee retention and consumer bias.

## What Does a Treasury Bill & How Does It Benefits to an Investor?

For most countries, the monarchy came to an end aeons ago and ended the supreme authority of the monarchs to own the whole kingdom. Now, we have governments.

A government is an organised community that functions for the people and does not own everything in the country. They have their share of assets and obligations.

So, when the government requires funds, it tours the financial market for fundraising.

The government has been raising money with the help of two debt instruments – treasury bills and government bonds.

When the government requires quick money for a short period, they issue treasury bills.

But the main question is, what are treasury bills and who buys them?

## So, what is a treasury bill?

The central government issues treasury bills when they need funds to clear their short-term obligations.

They are not interest-generating securities, and they are sold at a discounted rate, but the government pays in total face value during maturity. Hence, treasury bills are a powerful financial instrument for booking capital gains.

These bills are short-term financing instruments marketed by the government to increase liquidity. It is a money market instrument and can be easily converted into cash.

Because the treasury bill is a money market instrument, it is usually traded over the counters and cannot be done by an investor alone; one needs a certified broker to do so.

However, this is some random information about the treasury bill. The exact definition of a treasury bill is as follows:

## Treasury bills definition

In India, Treasury Bills were first issued in 1917. T-Bill or Treasury Bill, in simple words, refers to the government bonds or government debt securities, the maturity period of which is less than a year.

Also, Treasury bills are financial tools issued by the Reserve Bank of India for short-term borrowings on behalf of the government. They are a type of promissory note because they promise full payment at a later date. The maximum tenure of treasury bills is 364 days.

## Properties of treasury bills

Treasury bills have some caveats that an individual should know before deciding to make an investment choice.

The features of treasury bills are as follows:

1. If an individual wants to purchase a treasury bill, they need to invest a minimum amount of INR 25,000 to secure a short-term treasury bill.
2. One cannot buy treasury bills with a random value. The amount you plan to invest in a treasury bill should be in multiples of INR 25,000.
3. Treasury bills are zero-coupon securities, and these government securities do not give any interest on the bills. So, investors should book capital gains from these investments.
4. Treasury bills are sold at a discounted rate. But, during the repayment, investors are paid the total face value of the treasury bills.
5. The Reserve Bank of India auctions the treasury bills on behalf of the Central government in the market. Every Wednesday, the auctions occur depending on the total bids placed on significant stock exchanges.
6. The process behind investing in treasury bills is the most integral part of the investing procedure. Investors buy these securities through registered primary dealers (PDs), brokers, depository participant commercial banks or brokers, where the bill transfer follows T+1 settlement.

P.S. – T+1 settlement means that one must meet all the trade-related settlements within a day after completing the transaction.

## How do treasury bills work?

To understand how exactly the treasury bill works, let us know by taking the help of an example.

A treasury bill is available in the market at INR 95. But, the face value of that bill is declared to be INR 100 on the maturity date. The issue date is 1st March 2022, and it is a 91-day treasury bill.

Hence, after 91 days from 1st March 2022, the value of this treasury bill will increase to INR 100.

The treasury bills are issued at a discount, and the redemption happens at total face value, and the investors receive the full value at the maturity date.

The returns from treasury bills can be higher if they are issued during a liquidity crisis in the country.

Similarly, the returns are lower if the treasury bills are issued when the country has strong liquidity.

## Types of treasury bills meaning

The treasury bills are classified into four types depending on their tenure. These four types of treasury bills are as follows:

## 14-day treasury bill

The Reserve Bank of India announced the 14-day treasury bills as substitutes for the on-tap treasury bills. After 14 days from the issue date, treasury bills are either repaid or renewed.

The minimum value for buying 14-day treasury bills is INR 1 lakh, and these bills are sold only at 1 lakh or multiple.

The 14-day treasury bills have been designed to be sold only to state governments, foreign Central banks, and some particular structures. They are non-transferable and are available for re-discounting. One can re-discount these bills at 50 basis points higher than the initial discount rate.

These treasury bills are auctioned every week, possibly on Wednesday. The payment for these bills is made on the following Friday.

## 91-day treasury bill

The 91-day treasury bills are repaid or renewed 91 days after the issue. This treasury bill matures within 91 days and is auctioned weekly, possibly every Friday.

The minimum amount for investment in a 91-day treasury bill is INR 25 thousand and its multiples thereof. These bills are issued at a discounted rate, and the final price is determined through auctions.

## 182-day treasury bill

The 182-day treasury bills are bills that mature within 182 days from their date of issue. The minimum amount to purchase 182-day treasury bills is INR 25 thousand, and its multiples.

Like 91-day treasury bills, these bills are also issued at a discounted rate, and the final price is determined through auctions.

However, the auction takes place on a fortnightly basis, unlike 91-day treasury bills.

## 364-day treasury bill

The 364-day treasury bills are bills that mature within 364 days from the issue date. The minimum amount to purchase these bills is INR 25 thousand and multiples thereof.

These bills are issued at a discounted rate, and the final price is determined through auctions—the auction state place on a fortnightly basis, possibly every alternate Wednesday.

## How to calculate the yield rate of treasury bills?

The formula used for the calculation of the percentage of yield generated from treasury bills is as follows:

Y = (100-P)/P X 365/D X 100

where,

Y = yield per cent or return per cent.

P = Discounted price of the bill or purchase price of the securities.

D = tenure of the bill.

Let us understand the above formula with an example for crystal clear understanding.

The Reserve Bank of India decides to issue a 182-day treasury bill.

The discounted value of the bill, or the value at which investors can purchase this security is INR 98, and the face value of the treasury bill is 100.

We have to determine the yield of this government security.

Discounted Price of the treasury bill (P) = 98

Tenure of the bill (D) = 182

Hence, yield rate (Y) = (100-98)/98 X 365/182 X 100

Yield rate (Y) = 2/98 X 365/182 x 100

Yield rate (Y) = 4.09 %

Hence, the yield rate of the given 182-day treasury bill is 4.09 per cent.

## Merits of treasury bills

Some merits of treasury bills are as follows:

1. Treasury bills are risk-free money market securities, and it is a tool of obligation to the Indian government that they will repay within the decided date.

The Reserve Bank of India issues the bills on behalf of the central government, which is the supreme authority in the country.

As the government backs the bills, it gives investors a sense of complete security.

1. Treasury bills have high liquidity, and the government uses these bills to raise funds for a short period. The maximum maturity period of a treasury bill can last up to 364 days.

Investors looking for short-term and secure investments should invest their funds in treasury bills.

If the investor wants to encash them, this standard security can also be sold to others in the secondary market. This quality of immediate encashment and less maturity period makes treasury bills highly liquid and desirable for investors.

1. The auction for treasury bills happens every week through non-competitive bidding, and this allows small-scale and retail investors to take part in the bidding without worrying about quoting the yield price.

This unbiased allotment approach attracts potential investors to the government securities market, thereby bringing higher cash inflows to the capital market.

## Demerits of treasury bills

A few demerits of the treasury bill are as follows:

1. Treasury bills are zero-coupon securities, and they do not generate any interest and remain constant until maturity, irrespective of economic growth or seasonal fluctuations.
2. Treasury bills are known to deliver a lower rate of return than other securities. Other securities of the same category promise higher returns than treasury bills with the same conditions.
3. A change in the market conditions affects the yield rate of other securities. However, there seems to be no upswing or downswing in the treasury bill because of market rumours or expectations.

## Why are treasury bills crucial for the government?

Primarily, treasury bills are short term money market securities generated by the Reserve bank of India on behalf of the central government. The primary purpose of the government behind issuing treasury bills is to raise short-term funds to meet its short-term obligations that are more than the annual revenue generated by the government.

The primary purpose of issuing treasury bills is to lessen the fiscal deficit and regulate the currency circulating in the market.

The open market operations (OMO) methodology of the Reserve Bank of India includes issuing treasury bills. The reason behind giving treasury bills is to regulate citizens’ borrowing and spending habits to keep inflation in control. During an economic boom, there is a lot of money available in the market, and issuing Treasury bills help reduce the currency circulating in the market. This reduction, in turn, creates a healthy balance between demand and supply and prevents the upsurge of inflation.

On the contrary, a reverse OMO strategy is used when there is less currency circulating in the market. The government repays the treasury bills, leading to an inflow of money in the market, leading to increased demand, supply, and economic growth. The repayment of treasury bills also boosts cash inflow in the stock market as the investors try to channelise their money to alternative sources.

Overall, Treasury bills are of substantial importance. With the help of treasury bills, the government can generate short-term funds during a liquidity crisis in the company. The government also uses treasury bills for the open market operations strategies to regulate the currency circulating in the market.

## What type of investors should invest in treasury bills?

Any investor looking for a safe investment and decent returns should invest in treasury bills issued by the government.

To provide an equal platform to all the investors, the Reserve Bank of India facilitates non-competitive bidding.

This non-competitive bidding process helps small investors participate in the bidding process and place bids alongside pioneer investors without hesitation.

The government also releases the details of the discounted value and face value before publishing these treasury bills. This process of disclosing information beforehand helps an individual identify the transparency of the process. If someone is planning for wealth accumulation robustly, this is the go-to tool.

In most countries, the treasury bill is the safest money market security. Investors who have been tired of losing their money in the risky stocks in the stock market can safely put their money into treasury bills.

Experienced investors always have a part of treasury bills in their financial portfolio for diversification purposes. The presence of a treasury bill helps an investor dilute the overall portfolio risk.

So, investors looking for a safe investment with a low risk can invest in treasury bills with a blindfold.

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