What is Non-Operating Expenses and Why do they matter

Posted on Nov 11 2022 by Aditya Paleri

Introduction

Every new company starts with the intention of being profitable throughout its existence. These profits are directly proportional to the quantity of money that a company can create as a result of the commercial activities it engages in, but this income cannot be generated unless the company is willing to incur certain expenditures that are associated with it. However, aside from these costs, a business has to devote its funds to such activities that do not produce anything directly but without which the business will not be able to continue its activities.

This is especially true for manufacturing businesses, which incur costs related to the production of goods (direct labour, direct material, etc.). Every business, and particularly manufacturing businesses, incur costs related to the production of goods. These expenses are classified as operational costs. There are always going to be expenses that a company needs to pay to meet the monetary obligations it has made. The phrase “non-operating costs” refers to any costs that are not considered to be production or operational expenses. Even though it is quite unusual for trade enterprises and organisations in the service sector to incur any manufacturing expenses, operating and non-operating costs are important considerations for any kind of business.

With a basic understanding of accounting terminologies, it will be much simpler for you to gain a handle on the many financial components of an operating company. The words “operational expenses” and “Non-operational expenses” are among the most important terms used in the accounting field.

What are Non-Operating Expenses?

The phrase “Non-Operating Expenses” is an accounting term used to describe costs incurred by a business that are not directly related to day-to-day operations. These are the sorts of costs that might involve reoccurring obligations, such as interest payments on debt and one-time or exceptional expenses.

For instance, a company may categorise any expense as Non-Operating Expenses if it was spent as a result of restructuring or reorganising the business, as well as any costs generated as a result of currency exchange or charges on old inventory.

It is often prudent when trying to gain a clear view of a firm’s success to separate the costs and revenue sources that are not directly tied to the central business activities. For instance, a company could be making a profit, but due to a one-time expense such as the write-off of old inventory, the company might end up making a loss overall. On the other side, the firm may decide to sell a non-core business line to realise a profit, which would temporarily increase the company’s bottom line.

On the company’s financial statements, it is made much simpler to evaluate how well the company’s primary operations performed during any given accounting period if these non-operating costs and profits are kept in a separate category. This not only helps to monitor patterns in performance but also makes it possible to make more accurate projections about the future success of the company. Accounting software assists with the fundamental monitoring of financial data, which helps to ensure that forecasts and plans are as precise as possible.

Non-Operating Expenses Examples

A business can rack up a variety of different non-running costs, and it all depends on the sector in which it operates. The following are some examples of some of the most typical types of Non-Operating Expenses:

Lawsuit Settlements
Floatation cost
Losses from Investments
Profit or loss from the sale of a subsidiary or an asset
Provision for rebates on the purchase of shares and debentures
Deduction for expenses incurred in the planning stage
Reduction in the value of the Inventory and Receivables
The destruction caused by the fire and the company’s property being taken without compensation.
Derivatives expense
Expenses incurred as a consequence of natural disasters such as earthquakes, floods, or tornadoes.
Fees for obsolete stockpiles of merchandise.

In any case, people need to get acquainted with the exceptions to correctly comprehend the components of Non-Operating Expenses. To put it another way, charges that are directly incurred as a consequence of core operations of the company are not included in the list of Non-Operating Expenses.

Non-Operating Expenses Calculation

In most businesses, Non-Operating Expenses are recorded and tracked in a general ledger account that is distinct from operational expenses. After a company’s operational expenses follow the Non-Operating Expenses, which are usually reported at the bottom of the income statement. Some businesses make a distinction between the many categories of non-operating costs that are included in their income statements.

For instance, interest payments may be recorded separately from exceptional or extraordinary Non-Operating Expenses such as a one-time write-down of inventory or damage incurred due to a natural catastrophe. In this case, the interest payments would be considered an operational expense.

At the very bottom of the revenue statement for the firm where the accountants operate, they record all of the company’s costs. This is done so that the individuals who read those financial statements are provided with the opportunity to understand and analyse the activity of the firm, which has an immediate impact on it, as a separate piece of information. It is very difficult for companies to be able to turn a profit from their primary business activities; hence, it is vital to have a good grasp of which financial activities correspond to the primary business activities of the company.

Accountants begin the process of preparing income statements by focusing first on the company’s top-line revenue. After subtracting the cost of goods sold (COGS) from the revenue, accountants arrive at the “gross income” figure for a business. After reaching at the figure for the gross revenue, they deduct the operating expenses to get to the number for the operating profit, also known as the profits before interest and tax (EBIT). After that, they deduct any expenses that are not directly related to operations to arrive at the profits before taxes. After that, they do the necessary calculations to determine the net income.

Example

The provision of IT-related services to clients is Company A Limited’s primary line of business. During the year, firm A incurs a cost as a consequence of the sale of one of its buildings at a loss of Rs 2,50,000. This loss will be classified as a non-operating expense since it is not directly related to the day-to-day activities of the firm and so does not constitute an operational cost.

In addition, during the same period, the company paid the one-time insurance premium at the beginning of the year for the entire year to one of the insurance companies. This was done to cover various types of loss that could arise from various types of unforeseen events such as flooding, theft, earthquakes, and so on. Because the identical situation does not recur as a result of the company’s primary business activities, the amount that was paid for the insurance premium will likewise be included as Non-Operating Expenses. Costs that are not directly related to the operation of the business will be grouped together.

Non-Operating Expenses components

In addition to the costs associated with operating the company itself, businesses have a variety of other expenses. The following is a list of twelve instances of various expenses that a company may incur that are not related to its operations:

Interest payments: If a firm has taken out a loan to sustain the business, it is quite probable that the company will be required to make interest payments on that loan until the debt has been repaid in full. Interest is considered a non-operating expense since it is distinct from the usual expenses associated with running a company and does not have an impact on the amount of revenue generated by the firm.
Investment losses: It’s fairly uncommon for businesses to have financial investments or investments in the assets of another firm, such as stocks or bonds, and to suffer losses on those investments. A loss from such investments would be considered a cost not directly related to day-to-day business operations.
Losses on the sale or write-off of assets: If a firm takes part in a one-time activity that results in them losing money, such as being forced to liquidate a separate business that it owns, this is considered to be a non-operating expense.
Arrangements made to end a legal dispute: The loss incurred by a company as a result of its participation in a legal settlement, in which the company is required to pay out a particular amount of money, is considered a non-operating expense. However, the expense of the associated legal expenses would be regarded as part of the standard operating expenses.
Restructure costs: If a corporation loses money due to a large change in its operations, such as a big restructuring of organisational positions, this is an example of a non-operating expense.
Currency fluctuations on a global scale: A great number of businesses either operate in or sell their wares to nations located outside of their own country. Another sort of non-operating expense might occur if the company conducts its business in a foreign currency and the value of that currency falls while it is being used in the company’s activities.
Incidents or disasters: The monetary loss that results from an isolated occurrence, such as an unanticipated fire or natural catastrophe, and the expenses that are incurred as a direct result of that loss are considered to be Non-Operating Expenses.
Alterations to the principles of accounting: Alterations in the value that an organisation has recorded for its assets or liabilities may sometimes be brought about by making adjustments to the accounting system that the organisation employs. A non-operating expense is one in which the reported value of the asset goes down.
Inventory write-downs: When a firm’s unsold inventory loses value because it can’t be sold and is no longer valuable, the company often records this as a non-operating expense.
Relocation of a business: The expenses incurred by a firm in relocating are considered to be Non-Operating Expenses. Relocation may occur when a company moves buildings or changes its principal location.
Disposal of Equipment: If a company sells or disposes of equipment that is no longer useful, such as a retailer that disposes of a delivery truck, for less money than the equipment’s initial cost minus depreciation, this is considered a non-operating expense. An example of this would be a retailer that disposes of a delivery truck.
Depreciation: A non-operating expense is a regular drop-in value that happens when objects degrade due to age or usage.

Difference between operating and Non-Operating Expenses

The following is an outline of the primary distinction between operational expenditures and Non-Operating Expenses:

The primary difference

Operating expenditures are those business expenses that are required to enable and operate a firm regularly. Because these expenditures are not involved in the primary manufacturing process of an organisation, they are not taken into account when calculating the cost of products sold. Despite this, these expenses are very vital for bringing the company’s goods or services to the appropriate markets and selling them. The expenditures that an organisation incurs to fulfil its various financial commitments but which are not directly connected to the company’s typical commercial activity are referred to as “non-operating costs.” Therefore, non-operating expenditures are not incurred as a direct outcome of the fundamental activities or operations of a corporation.

Types

The majority of a company’s operational expenditures are tied to the activities that are involved with the business’s operating cycles and throughput. These kinds of costs, which are incurred by a manufacturing company, are not connected to the manufacturing process or the production of the items, but they are essential to the company’s ability to generate sales and keep operations running smoothly. Some examples of sorts of operational expenditures include expenses related to maintenance, the salaries and wages of non-production workers, certain taxes, legal fees, sales bonuses and/or commissions, marketing expenses, advertising expenses, office and administrative expenses, and so on. In most cases, a company’s non-operating costs are the result of a financial or legal obligation that the company has and that has to be met to satisfy the responsibilities of the company. Non-Operating Expenses include things like payments for non-mandatory insurance, bad debts (if they occur outside of the normal course of business), foreign exchange losses, interest payments, and fees borne for the settlement of court cases brought against the business, costs for shifting or restructuring, and so on. On the other hand, there is a possibility that there are other kinds of expenditures, depending on the needs of certain markets and/or enterprises, may be characterised as either operational costs or non-operating expenditures.

Making decisions

The management of a firm has to differentiate between operational expenditures and Non-Operating Expenses since doing so may assist them in more accurately determining the financial and performance metrics of their organisation. The efficient management of a company’s operational expenses is closely correlated to the company’s ability to execute its operations effectively. These expenses are often within the scope of management’s ability to influence, and as a result, they may be included in assessments of that role. Non-Operating Expenses, on the other hand, are expenditures that are often uncontrollable owing to the nature of the costs themselves; as a result, non-operating costs must not be included in evaluations of management.

Classification in financial statements

In the statement of profit or loss, operating expenditures are typically written after the head of gross profit, whereas Non-Operating Expenses are recorded at the bottom of the statement of profit or loss. The consumers of this statement will find that, as a result of this categorisation, it is much simpler for them to comprehend and differentiate between the expenses that were incurred as a result of routine business operations and those that were incurred as a result of unusual business activities.

Types of Expenses

Although each category of the expense will have some impact on your financial records, the income statement is the one that will be most significantly impacted by this spending. The following are the five primary categories under which a business spending is broken down and reported on the income statement:

Cost of Goods Sold
Operating Expenses
Financial Expenses
Extraordinary Expenses
Non-Operating Expenses.

However, there are other kinds of expenses that any company will have to pay, some of which will not be reported in the income statement straightforwardly. The following are the several categories of costs that your company records in its accounting:

Cost of Goods Sold

The expenses that are incurred in the process of procuring raw materials and then transforming them into finished items are referred to as the Cost of Goods Sold (COGS). COGS does not, however, account for interest expenditure or loss on special goods. Nor does it cover selling and administrative expenses that are spent by your whole organisation.

Operating Expenses

Operating expenses are any expenses incurred as a direct result of selling products or providing services. In addition to that, it comprises the price of advertising, the rent for your business, and the wages of your salesmen.

Your general and administrative expenses are included in the category of operational expenses. These are the charges that are spent in the process of operating the primary line of your company. These costs include research and development, executive pay, travel and training costs, and information technology costs.

Financial Expenses

When your firm borrows money from its creditors and lenders, it will inevitably run up certain financial expenses. These are the costs incurred by your company that are not directly related to its primary line of activity. For instance, interest on money that was borrowed and costs associated with the origination of the loan.

Extraordinary Expenses

These are the expenses that your company incurred outside of the normal course of its business operations and in the course of a significant one-time event or transaction. For instance, companies may need to lay off staff, sell property, get rid of a big asset, repair or replace an unanticipated piece of machinery, or lay off employees.

Non-Operating Expenses

These are expenses that cannot be traced back to the actual revenues generated by the business. Interest expense is a typical example of Non-Operating Expenses, and it’s also one of the most expensive. This is because although interest payments are required to cover the cost of borrowing money from a creditor or a bank, these payments do not contribute to the business’s overall revenue. Consequently, interest payments are now included in the category of non-operational expenses.

Final thoughts

Because some occurrences are impossible to predict, it is quite feasible for businesses that are well managed to rack up unexpected costs. These costs are often categorised as Non-Operating Expenses since they are not directly related to the company’s primary business activities and hence do not directly contribute to the company’s revenue.

When a company’s operating expenses and its Non-Operating Expenses are separated on its income statement, it enables the company’s managers, investors, and other stakeholders to evaluate the actual performance of the company’s business in a much more accurate manner. In addition, if a problem arises concerning the company’s Non-Operating Expenses, it is possible to bring this problem to the attention of the company’s management promptly so that the appropriate corrective actions can be taken.

What are derivatives and why should you invest in them?

Posted on Nov 01 2022 by Aditya Paleri

Introduction

Globalisation is the reason for tremendous development in the volume of worldwide business. This incredible development has helped reduce the volume of various transactions’ economic risks. Several companies have launched new instruments for the management of this financial risk. These instruments in the financial markets are called Derivatives. Nowadays, derivatives are used by many industries for protection against challenges. Even financial organisations also get help from derivatives to change their susceptibility to give loans to more borrowers. Below are all the details about derivatives, including what is derivative? Types of derivatives, advantages and disadvantages, and more.

What is derivative?

Derivatives are economic commodities that derive their price from a connection to another underlying asset. These possessions often are currencies, indices, commodities, and equity or debt securities. Derivatives can determine the price of any underlying property. Derivatives can be beneficial in managing hazards by closing up the value of the underlying property. For instance, an industry that depends on a specific resource to regulate might be involved in an agreement with a dealer to acquire that resource for a fixed value several months in advance.

If the resource retains a market price that varies regularly, the enterprise can close on a value for a specific period of time. In such matters, the contract is considered the derivative. The underlying property is the resource being acquired. Suppose the market value of the underlying assets increases more than foreseen during the time of the agreement. In that case, the company will save capital since the property can be acquired at the fixed and lower price of the agreement. If the market value rises or drops less than foreseen, the industry will have lost capital since it will invest in the underlying property at the higher-than-market contract value.

Derivatives enable companies to adhere strictly to the investment value of raw materials needed to create their goods. With a derivative contract, an organisation can be stress-free about the value of a raw material increase, which would reduce the business’s profitability. In some matters, a minor loss is acceptable for value stability. Companies can use derivatives for the investment of commodities, including oil, sugar, wheat, aluminium, copper, etc.

How do Derivatives work?

Companies can trade derivatives in two ways. One is on an exchange, and the other is over the counter. Most of the derivatives are unregulated and marketed over the counter. Commonly, there is more risk in over-the-counter derivatives. Before involving in derivatives, dealers must know the associated threats, including expiration, price, the underlying asset, and the counterparty. Derivatives differ extensively, which means there is no fixed time; investors should avoid them or purchase them.

Why do investors enter derivative contracts?

The reasons for using derivative contracts are listed as follows:

Arbitrage advantage

Arbitrage trading requires the purchase of a commodity or security at a modest price in one type of market and selling it at a higher price in another market. Thus, in this way, you can get profit from the price variations of the product between two markets.

Protection against market volatility

A price alternation of an asset increases the probability of losses. You can see products in the derivative market which can help you for your safety against any reduction in the prices of stock that you possess. Plus, if you are planning to buy a commodity, you could purchase it to have security against the price of the stock so that if the value increases, it will be beneficial to you.

Park surplus funds

When there is a surplus of any given funds, then it is better to put money into safe investments. This is known as park surplus funds. Park surplus funds also mean the illegal holding of stocks or shares. Many people use the fluctuation in the stock price as a means to make money without actually selling their shares.

Types of derivatives

Mainly four types of derivatives can be used.

Options
Forwards
Futures
Swaps

Options:

In this derivatives type, if you are a buyer, you will have the right to buy and sell your possession at a specific price at a specific time. You will have no liability to test this option, no matter the circumstance. The option seller and the option writer are the same. Once the buyer goes for the option, he first specifies the price, which is also known as the strike price. If you go for the American options, then you can use them before the option period expires. However, when it comes to European options, you can only use them on the expiration date.

Forwards:

Forward contract is mostly like a future derivative contract where the holder of stock is under accountability for exercising the contract. Generally, these kinds of derivatives are not regularised and are not preferable for trading in stock exchanges. These can be found over-the-counter. Forwards are not marked to market. You can modify this contract as per the needs of the parties.

Futures:

These are standardised contracts where the holder is allowed to buy or sell his commodity at a specific date with an agreed price. The parties who are part of the futures contract are obligated to perform the contract anyhow. In stock exchanges, these contracts are traded. Every day the values of those contracts are marked in the market. Hence it indicates that the contrast value is adjustable to the market movements till the expiration date comes.

Swaps:

Swaps are one of the derivative contracts where two parties exchange their financial accountability. The cash flows are entirely based on the important notation, which is the principal amount agreed by both parties without the exchange of the principal. Rate of interest is one of the domains where the number of cash flows. On the criteria of the benchmark interest rate, one cash flow is normally fixed, whereas the other changes following the basis. In a remark, Swaps are not traded on exchanges, and retail investors rarely trade them; rather, they are mostly traded over-the-counter by businesses and financial institutions.

Advantages and limitations

Experts in derivatives significantly impact modern finance as they exert numerous advantages on the financial markets. Below are the advantages you can get from derivatives.

Hedging risk exposure

Since there is a direct connection between the value of the possession and the value of derivatives, you can use those contracts for hedging risks. For instance, an investor probably has a chance to buy a derivative contract whose value goes in the opposite direction of the value to which investors own the asset. Hence, in this way, the profits of the derivative contract could have the probability of offsetting losses in the asset. Traders use derivatives to speculate the asset price. Like, in the future, spot prices can serve a major role in the approximation of commodity prices.

Market efficiency:

Often it is considered that derivatives increase the efficiency of financial markets. Through the usage of derivative contracts, one can replicate assets’ payoff. Due to this, the prices of the underlying asset and the derivative associated with it tend to stay in equilibrium so that there will be no loss in the opportunities of the arbitrage.

Access to unavailable assets or markets:

Derivatives can be useful to organisations to get access to unavailable assets. A company can obtain favourable interest rates relative to available interest rates from borrowing by employing interest rate swaps.

Limitations

High risk:

Those underlying securities prices of shares or metals keep on changing fastly as in the open market, mostly derivatives are traded. A lot of risks are involved while performing this exercise in the market. A high degree of risk always hangs out while derivatives contracts are exposed due to the high volatile price of underlying securities.

Counterparty risk:

If there is a lack of due diligence in the process, then there are chances of default in the portion of the counterparty risk of the case whose derivatives are traded over the counter. Due to diligence, exchange derivatives lack counter OTC derivatives in the context of benchmarks.

Speculative Features:

Derivatives are kinds of instruments that are used for purposes like speculation for earning profits from it. Also, profit does not need to happen indefinitely. Sometimes huge losses can occur if speculations go wrong as derivatives are not constant and highly fluctuate with high risk.

Requires Expertise:

This one can be said to be the major disadvantage of trading in derivative instruments. Investors who invest their money are required to keep high knowledge and expertise in trading those instruments compared to the other stocks and metals as securities.

Who participates in the derivatives market?

The participants who participate in the derivative market horizon can be broadly divided into the following major groups:

Hedgers:

Hedgers are those who invest in reducing the price risk in the financial markets to eliminate the risk of future price movements. As we know, derivatives are one of the most well-known hedging instruments because they can offset risk with their corresponding assets.

Speculators:

It is one of the most common market activities where the participants participate in the financial market. It is a kind of risky activity that investors take part in. It also involves buying any financial instruments that the inventors speculate can become more useful in the future. Speculators are often confident in earning profits by taking risks.

Arbitrageurs:

Arbitrage is a profit-making undertaking in the finance market that affects taking advantage of the market’s volatility. These individuals make profits from the price differences from an investment. Examples include stocks, bonds, etc.

Margin traders:

In the finance industry, when an investor deposits, his margin is the collateral deposit investing in a financial instrument to the counterparty so that the credit risk is covered while investing.

Criticism and misuse of derivatives

The important argument against derivatives is that investors are allowed to obtain unsustainable positions. This increases the systematic risk at a high level which can also result in legalised gambling.

Speculation and gambling

Derivative markets can perform when speculators risk buying or investing from hedgers and speculators. It’s a short-term duration where the market efficiency gets hurt in the long term. This is the reason many people term this legalised gambling.

A destabilisation and systematic risk

Speculators may also get motivated by lower transaction costs as well as lower capital requirements to get access to high-level positions, which can be too risky. If one wrong step is taken, then all the burden will not fall on the speculator’s hands but as well on the creditors. This can lead to serious financial distress and can spread to the economy in the process of contagion.

Complexity

Some investors may criticise these derivatives because of their complexity and models, which could be a little off from reality.

How big is the derivative market?

The international derivatives market is not small. As per the survey estimation of BIS or The 2019 Bank for International Settlements Triennial Central Bank, the over-the-counter and international foreign exchange are more extra diversified and more significant than ever. The reason is the increase in automated and electronic marketing. With electronic marketing, you can decrease transaction value.

As derivatives agreements are all about increasing their price in various ways from the underlying, the real volume of the derivative market is not easy to assess. Gross and notional market prices are the two noticeable measurements.

Notional value

These are the prices of the underlying. However, people look at them in many ways. For instance, for futures derivative types, notional values are the investment volume added by the rate given in the contract. Nonetheless, for interest value swaps, notional amounts are the sum of the principal, the capital utilised to assess the interest expenses. BIS says as of June 2021, the international notional value of OTC derivatives was $610 trillion.

Gross market value

This amplifies all absolute prices of OTC derivatives, respective negative or positive, at market prices. As per BIS, $12.6T was the market price of OTC derivatives.

How is Derivative Used?

Derivatives are primarily utilised for hedging or speculation. The evolution of derivatives is noticeable to involve a variety of protection along with some objectives. The reason is investors aim to get revenue from a changed value in the underlying.

For example, the derivative enables in getting profit if the climate destroys production. However, if the climate is not bad, the farmer can make revenue from bumper production. He will only lose the price of investing in derivatives.

Derivatives are used in another way which is speculation. This is when you bet on a possession’s future value. Profit is possible only if you ignore exchange rate problems.

Examples and Interpretation

The geometrically interpreted function is derivative. It is the rise of the line deviation to the angle at any point. For example, if a is continuous and differentiable at [c, d], then a'(x) = limh→0f(x+a)−a(x)h. This modification is extremely small. We imply it by Δx. The modification in the actual function an (x) is also minor, implied by Δy. The derivative acquired by applying the boundaries is also interpreted as the immediate value of change of a purpose with esteem to a variable.

Conclusion

With derivatives, you can safeguard yourself from falling rates, increase the recoveries of your portfolio, and change possession like commodities. You can find several ways to subsidise derivatives, such as through mutual funds and ETFs. Most companies use derivatives in the day and active marketing as well. You need to ensure that you know the risk and techniques before any investment in derivatives.

How does a Bonus issue or a stock split affect your investing decisions?

Posted on Nov 01 2022 by Aditya Paleri

Introduction

Every company rewards its shareholders in different ways; some might issue Dividends, and some might give extra shares.

Bonus issues and Share splits are two such methods of rewarding shareholders.

Bonus and share split are two well-known business practices performed by listed companies to increase the number of shares sold. Investors are often confused between the two.

Let us understand the difference between the bonus issue and a stock split and why companies issue bonus shares and do a stock split and how they affect shareholders.

What is a Bonus issue?

A Bonus issue is an offer given to the existing shareholders of the company where a subscription to additional shares is offered.

The company may offer to issue bonus shares instead of increasing the dividend payout.

For example, a company may offer to issue a bonus of 1 share for every 5 shares held in the company.

Companies issue bonus shares to encourage retail participation and increase their equity capital base. When a company’s share price is high, it becomes difficult for new investors to buy shares of that particular company. An increase in the number of shares lowers the price per share.

Cash flow is not involved in the Bonus issue and it does not increase the total assets of the company as no cash flow is involved but only the share capital.

The issue of Bonus shares increases the number of outstanding shares of the company as additional shares are offered to the shareholders.

For example, if a shareholder is holding 50 shares in a company and the total number of outstanding shares is 500.

Now, the company issues a bonus of 1 share for every 5 shares held then,

Bonus shares to be issued to a shareholder holding 50 shares will be 10 shares (50*1/5) and the total number of bonus shares to be issued by the company will be 100 shares (500*1/5).

The total number of shares after the Bonus issue will be 600 shares (500 shares + 100 bonus shares).

Pros and cons of a Bonus issue

Some merits and demerits of issuing bonus shares are as follows:

Pros of a Bonus issue

There are several pros of a Bonus issue and they are as follows:

Issuing bonus shares may result in a reduction in share price, but this can turn out to be beneficial as the market reach of the stock increases due to price reduction, small investors may also invest in the company’s stock.
Investors do not have to pay any tax on bonus shares.
It is beneficial for long-term shareholders of the company who want to increase their investment.
Bonus shares strengthen investors’ confidence in the company’s operations, as it gives shareholders confidence that the company will use cash for business growth.
When the company declares a dividend in the future, the investor will receive a higher dividend because they now hold a larger number of shares in the company thanks to the bonus shares.
Bonus shares give a positive signal to the market that the company is committed to long-term growth.
Bonus shares increase the shares outstanding, which in turn increases the liquidity of the shares.
The perception of company size increases with the growth of issued share capital.
The company can maintain its liquidity resources and working capital. As a bonus issue does not impact the cash flows of the company.

Cons of a Bonus issue:

There is also a flip side to the Bonus issue. The cons of issuing bonus shares are as follows:

From an investor’s point of view:

A Bonus issue is not very disadvantageous from the investor’s point of view. However, they should know that they will receive bonus shares because the profit will remain the same, but the number of shares will increase which will result in Earnings per share falling.

From a company perspective:

The company will not receive any cash when issuing bonus shares.
The change in overall market sentiment leads to more volatility in the prices of the stock.

What are the different types of Bonus issues?

There are generally two types of bonus shares a company may issue, fully paid Bonus shares and Partly paid bonus shares. Fully paid bonus shares and partly paid bonus shares are explained in brief in the below table.

Serial No.

Basis

Fully Paid Bonus Shares.

Partly Paid Bonus shares.

Application of Bonus

When bonus shares are issued to the shareholders at no additional cost, that means; the company is not charging any amount for additional shares called Fully paid Bonus shares.

When a Bonus is applied to convert the partly paid shares into fully paid shares, it is called Partly Paid Bonus Shares.

Sources of issue

The following are some sources through which the fully paid Bonus shares can be issued:

Profit and loss Account, investment allowance reserve, capital redemption reserve, etc.

The following are some sources through which the partly paid Bonus shares can be issued:

Investment allowance reserve, General reserve, development rebate reserve, etc.

Effect on the Face Value?

The Face Value remains the same in the bonus issue. The additional shares issued carry the same face value as the already outstanding shares.

A bonus issue is made when the company is out of cash; its motive is not to increase or decrease the face value of the shares.

The face value of each share remains the same, but the number of shares increases as a result of additional shares issued and thus increases the share capital of the company.

For Example, if a company has 1000 shares outstanding with a face value of Rs.100 each and it makes a bonus issue of 1 share for every 5 shares held in the company.

The total number of shares post the bonus issue will increase to 1200 shares (1000 shares + 1000*1/5 shares), but the face value of each share will remain the same, i.e., Rs. 100 per share.

What does it mean to an investor?

An investor gets additional shares at no cost to pocket.

The share-holding of the investor increases and as a result has chances to get more dividends in the future due to an increase in the number of shares held.

For Example, suppose an investor is holding 100 shares of a company and the company issues bonus shares in a ratio of 1 share for every 4 shares held in the company.

In that case, the number of shares held by the investor will increase to 125 (100 shares + 100 shares * 1/4), and if the company issues a dividend of Rs.5 per share in future, then the investor will get a dividend of Rs. 625 (125 shares * Rs. 5 per share) instead of Rs. 500 (100 shares * Rs. 5 per share).

What is the impact of bonus issues on share capital and reserves?

When the company issues bonus shares, the share capital increases as additional shares are issued by the company, and the reserves of the company decrease as the bonus issue is made out of the reserves of the company.

(Profit and loss Account, investment allowance reserve, capital redemption reserve, General reserve, development rebate reserve).

For Example, if a company has 1000 shares outstanding with a face value of Rs.100 each and it makes a bonus issue of 1 share for every 5 shares held in the company.

The total number of shares post the bonus issue will increase to 1200 shares (1000 shares + 1000*1/5 shares), but the face value of each share will remain the same, i.e., Rs. 100 per share.

Thus, we can see that the share capital of the company has increased from Rs. 100000 (1000 shares * Rs. 100) to Rs. 120000 (1200 shares * Rs. 100).

Such an issue is made out of the reserves of the company due to which the company’s reserve decreases. The reserves of the company decreased by Rs. 20000. (200 Bonus shares * face value of Rs. 100 per share), which on the other hand, increased the share capital of the company due to the bonus issue.

The Face value of the shares remains the same. The Bonus issue is an effective way of restructuring the capital structure of the company; as it results in an increase in the share capital and a decrease in the reserves of the company. Thus, the bonus issue has no effect on the net worth of the company.

What is a Stock split?

A stock split is when the number of shares gets multiplied. As the name suggests, there is a “Split” in the number of shares held.

In case of a split of shares, no new shares are issued by the company. If a company issues a share split in the 1:3 ratio, then the total number of outstanding shares gets multiplied by 3 which means that 1 share of the company becomes 3 shares after the share split.

A share of the company is broken into parts in a share split, the face value gets reduced and the number of shares increases while the share capital remains the same as there neither is an issue of new shares nor the cashflow change.

For example, if a company has 1000 shares outstanding having a face value of Rs.10 per share and an investor is holding 100 shares out of those outstanding shares.

The company issues a stock split in the ratio of 1:2 then,

The total number of shares outstanding in the company will be 2000 (1000 shares * 2) and the shares held by the investor will be 200 (100 shares * 2) after the stock split.

The face value of the company’s share will get reduced to Rs. 5 each (10/2) resulting in no change in the share capital of the company.

What is a reverse stock split?

Reverse stock, as the name suggests is an action opposite to the stock split, which means that in the case of a reverse stock split, the shares of the company are consolidated, and the total number of shares gets reduced.

A reverse stock split divides the number of shares by the ratio the company determines. Ratios could be 1 for 4 or 1 for 5, or any other ratio.

In a reverse stock split, more than 1 share gets consolidated and makes a single stock which reduces the total number of shares outstanding, while the face value of the company’s share increases which results in no change in the share capital of the company.

For example, if a company has 1000 shares outstanding having a face value of Rs.10 per share and an investor is holding 100 shares out of those outstanding shares. The company issues a reverse stock split in the ratio of 1:2.

The total number of shares outstanding in the company will be 500 (1000 shares / 2), and the shares held by the investor will be 50 (100 shares / 2) after the stock split.

The face value of the company’s share will get reduced to Rs. 20 each (10 * 2), resulting in no change in the share capital of the company.

Pros and cons of a Stock split

Some merits and demerits of the stock split are as follows:

Pros of a stock split:

There are several benefits of splitting stocks, and they are as follows:

In the case of a stock split, the number of shares of the company increases by a substantial number, while the company’s market capitalisation remains the same. When a company with 15 Lakh shares is suddenly split up into 30 Lakh shares after a stock split, the price of existing shares decreases and makes it more affordable.
Low Share prices encourage small investors to invest in the company’s stock, and the company’s share trading increases, this will increase the demand for the company’s shares.
In the stock market, the price levels are high for a few companies only (Like MRF), and the majority of the stocks trade at a price level affordable to the investors, stock split allows the company’s stock to trade at such a price level.
Stock split sends investors a signal that the management is confident about the future of the company.

Cons of a stock split:

There is also a flip side to splitting stocks. The disadvantages of a stock split are as follows:

Stock splits do not change the share capital of the company as the face value increases proportionally in case of a stock split and increases proportionally in case of a reverse stock split and thus may be considered meaningless sometimes. Suppose you have Rs. 100 currency notes, and you exchange it for 10 notes of Rs. 10 each then the total money you have remains the same; this may be considered meaningless though it increases your liquidity.
Companies do not become more valuable due to the stock split, just because nothing changes within the company’s share capital.
The process of stock split needs money to be conducted from announcing the stock split till actually executing the scheme. The company has to hire a banker to perform the financials and plan the stock split. This cost could be seen as a cost that could have been avoided, and the money could have been used for any other purpose.

How is Stock Split different from a Reverse stock split?

Let us tell you how a stock split differs from a reverse stock split with the help of a comparison chart.

Serial No.	Parameter.	Stock split.	Reverse stock split.
1.	The number of shares.	The number of shares increases in case of a stock split.	The number of shares decreases in case of a reverse stock split.
2.	Face Value	The face value per share in the case of a stock split decreases.	The face value per share in the case of reverse stock split increases.
3.	Example	Splitting 100 shares of a company into 200 shares. (1:2)	Consolidating 100 shares of a company into 50 shares. (1 for 2)

What is the Effect of a stock split on the Face Value?

The Face Value decreases in the case of a stock split and increases in the case of a reverse stock split.

No additional shares are issued by the company, but the issued shares are split into multiple shares.

Thus, face value increases proportionately. A stock split is done when the company wants its shares to be traded in the market more often, thus face value decreases.

The face value of each share decreases, but the number of shares increases proportionately; thus the share capital remains the same.

What does stock split mean to an investor?

An investor’s shares get multiplied in case of a stock split and get divided in case of a reverse stock split.

For Example:

1) If an investor is holding 100 shares of a company having a face value of Rs.10 each and the company makes a stock split in a ratio of 1: 4, the number of shares held by the investor will increase to 400 (100 shares * 4) with a face value of Rs. 2.5 (Rs. 10 / 4).

2) If an investor is holding 100 shares of a company having a face value of Rs.10 each and the company makes a reverse stock split in a ratio of 1: 4, the number of shares held by the investor will decrease to 25 (100 shares / 4) with a face value of Rs. 40 (Rs. 10 * 4).

What is the impact of stock split on share capital and reserves?

When the company makes a stock split or a reverse stock split, the share capital does not change as the company issues no additional shares and the reserves of the company also remain the same as the stock split does not affect the reserves of the company.

For Example, if a company has 1000 shares outstanding with a face value of Rs.100 each and it makes a stock split in the ratio of 1: 5.

The total number of shares post the stock split will increase to 5000 shares (1000 shares * 5), but the face value of each share will decrease, i.e., Rs. 20 per share (100/5).

Thus, we can see that the share capital of the company remains the same at Rs. 100000. This does not affect the reserves of the company.

What is the difference between Bonus issue and Stock split?

There are several aspects in which a bonus issue differs from stock split. To ease your understanding, we have provided an all-encompassing comparison chart between bonus issue and stock split.

Stock Split vs Bonus Issue

Serial No.	Parameters	Bonus issue	Stock Split
1.	Meaning	A Bonus issue is an offer given to the existing shareholders of the company where a subscription to additional shares is offered	A stock split is when the number of shares gets multiplied. As the name suggests there is a “Split” in the number of shares held
2.	Effect on the Face Value	The Face Value remains the same in the bonus issue. The additional shares issued carry the same face value as the already outstanding shares.	The Face Value decreases in the case of a stock split and increases in the case of a reverse stock split.
3.	Effect on Shareholders.	An investor gets additional shares at no cost to pocket. The share-holding of the investor increases and as a result has chances to get more dividends in the future due to an increase in the number of shares held.	An investor’s shares get multiplied in case of a stock split and get divided in case of a reverse stock split.
4.	Impact on share capital	When the company issues bonus shares the share capital increases as additional shares are issued by the company.	When the company makes a stock split or a reverse stock split, the share capital does not change as no additional shares are issued by the company.
5.	Impact on reserves?	The reserves of the company decrease as the bonus issue are made out of the reserves of the company. (Profit and loss Account, investment allowance reserve, capital redemption reserve, General reserve, development rebate reserve).	The reserves of the company remain the same as the stock split does not affect the reserves of the company.
6.	Example.	If a company has 1000 shares outstanding with a face value of Rs.100 each and it makes a bonus issue of 1 share for every 5 shares held in the company. The total number of shares post the bonus issue will increase to 1200 shares (1000 shares + 1000*1/5 shares).	If an investor is holding 100 shares of a company having a face value of Rs.10 each and the company makes a stock split in a ratio of 1: 4, the number of shares held by the investor will increase to 400 (100 shares * 4) with a face value of Rs. 2.5 (Rs. 10 / 4).
7.	Types	Fully paid Bonus shares and Partly paid bonus shares.	Stock split and Reverse stock split.

Conclusion

Overall, the number of shares increases in both bonus issues and the stock split. The face value decreases in stock split while the bonus issue has no impact on the face value of the share of the company.

This is the main difference between the bonus issue and the stock split. A bonus issue indicates that the company has extra cash that it can convert to capital.

A stock split is a step toward making expensive stocks available to a larger audience of shareholders in the stock market.

Equity Share Capital

Posted on Nov 01 2022 by Aditya Paleri

What is Equity Share Capital?

Equity Share Capital is the capital raised by a company through its Equity Shares.

So, to understand the Equity share capital, we need to under the Equity Shares first.

What are Equity Shares?

Equity Shares are common stocks of the company and possess voting rights for its shareholders, enabling shareholders to become part owners of the company, i.e., fraction ownership of the company.

Companies issue these shares through IPO (Initial public offer) to the general public with the prime motive of generating capital for the company’s growth and expansion.

When a company raises capital by issuing an equity share, it dilutes its ownership at the cost of capital.

Equity shareholders benefit themselves by receiving capital appreciation and receiving dividends, and bonuses.

Investors with an excellent appetite for risk should invest in equity investment options. Businesses can also use equity shares in various ways, like paying off vendors in exchange for raw materials and supplies.

In addition, shareholders also enjoy a say in the critical matters of the company. Equity shareholders come last in the row of paying off dividends, whereas in the case of preference shares, shareholders have the preferential right to receive dividends and capital repayment when a company goes into liquidation.

These uses of Equity Shares make it essential for the company to have equity share capital.

The prices of equity shares are determined by the demand and supply when trading on the exchange.

Costs of the shares are inflated when people buy more and vice versa. This, in turn, results in mainly two outcomes. If the company’s growth prospectus seems promising, investors wish to invest in and reap the benefits of capital appreciation.

On the other hand, the company’s poor performance results in investors losing interest and withdrawing their funds or selling off their holdings.

The more the market price of a company’s Equity Share, the more the capital appreciation.

However, after so many uses and preferences of equity shares, we should also look into the definition of equity share capital for a crystal clear understanding.

Equity Share Capital meaning

Equity share capital, also known as share capital or equity of a company, money, and funds contributed by investors and owners of the company forms the part of equity share capital.

Equity share capital does not constitute part of a company’s assets, but it increases cash inflow as investors bring in cash in exchange for shares.

Equity Share Capital Formula

The formula for Equity Share Capital is of two types.

The first formula is as follows:

Equity Share Capital = No. of outstanding shares X Price per share.

Note – This formula is used when the company has issued no preference shares, only equity shares.

The second formula is as follows:

Equity Share Capital = No. of shares (par value of the stock + paid-in capital over par value)

Elements of the Formula

The elements involved in the formula of equity share capital are as follows:

Outstanding shares: It is the stock held by the company’s shareholders in the open market.
Par value of a share: The value per share decided by the company or mentioned in its books of accounts is the par value of a share.
Paid-in capital over par value: It is the difference between the stock’s market value and the par value of the stock.

Example of Equity Share Capital

Let us explain Equity Share Capital with the help of an example.

Assume a company named Multiverse Corporation has a share capital that only consists of Equity shares, i.e. the company has issued no preference shares yet.

The information known about the share capital of Multiverse Corporation as of 30th March 2022 is as follows:

No. of outstanding shares of Multiverse Corporation = INR 58.75 crore.

Face value of each Equity Share of Multiverse Corporation = INR 2 per share.

Now, we need to calculate the Equity Share Capital of Multiverse Corporation.

So, we know that the calculation of Equity Share Capital is facilitated by multiplying the number of outstanding shares by the face value of one share.

We have been already provided with the no. of outstanding shares and face value per share of Multiverse Corporation.

The formula for Equity Share Capital calculation is as follows:

Equity Share Capital of Multiverse Corporation = No. of outstanding shares of Multiverse Corporation X Face Value per share.

Now,

The value of outstanding shares of Multiverse Corporation = INR 58.75 crore.

And,

The face value per share of Multiverse Corporation = INR 2 per share.

So,

Equity Share Capital of Multiverse Corporation = INR 58.75 crore X INR 2 per share.

Hence,

Equity Share Capital of Multiverse Corporation = INR 117.5 crores.

Note:

The equity share capital is calculated on face value and not on market value, and the market value keeps changing once the company is listed on the stock exchange.

Thus, the equity share capital rarely experiences any change except when specific corporate actions occur.

Corporate actions like right issues, bonus issues, mergers and acquisitions, etc., are responsible for changes in equity share capital.

Interpretation

The multiverse corporation has an equity share capital of INR 117.5 crores which means it has raised INR 117.5 crores of wealth from investors or owners in exchange for ownership certificates.

The significant quantity of owners dilutes the ownership. And the intensity of ownership is subjected to the number of stocks held by an investor or owner.

Components of Equity Share Capital or Shareholder’s Equity

The ensemble of Equity Share Capital considers some components. The components are as follows:

Outstanding Shares

An integral part of equity share capital is the number of outstanding shares.

It can be defined as the number of stocks a company has sold to its investors, and these shares are not generally purchased back by the company.

And instead, they are issued to the general public, company insiders, and officers as restricted shares.

The market capitalisation and earnings per share (EPS) are also calculated based on the outstanding shares.

Additional Paid-in Capital

Another component of Equity share capital is the additional paid-in-capital.

Additional paid-in-capital is the surplus amount paid for stock units above the stated par value. The difference after deducting the par value of shares with the price at which each share is sold is the additional paid-in-capital.

APIC can only result when a company directly sells its shares to the investor. When a company launches its IPO (initial public offering), shares are offered to the general public at the list price.

The additional expense that the investor pays for the share over the face value of the share is the APIC. One can find this figure in the company’s balance sheet in the Equity section.

Retained Earnings

Retained Earnings form the most extensive item of the Equity Share Capital.

Retained Earnings are developed when a company maintains its income rather than giving it out to the investors as a dividend.

Companies use these retained earnings to pay off debt or reinvest in the business. Retention Ratio or Retained Surplus is a common term used by companies to refer to their retained earnings.

Treasury Stock

The last component of equity share capital is treasury stock. Companies sometimes re-purchase their stocks from the investors. These shares which are re-purchased by the company are known as treasury stock.

You might ask – Why does a company repurchase its own shares?

Well, there are primarily two reasons for this.

First, a company can use these stocks in the future to raise capital to expand its business.

Second, the company can use treasury stocks to prevent the company from a hostile takeover.

Treasury stock reduces the total equity share capital and is a negative number on the balance sheet, and this figure is subtracted from the company’s equity share capital.

Other terms for treasury stock are “treasury shares” or “reacquired stock.”

Types of Equity Share Capital

There are numerous types of share capital that one comes across while understanding equity share capital.

These share capital form a part of equity share capital or are required to calculate equity share capital to get a holistic view of the financial requirements and aids of the company.

The various types of Equity Share Capital are as follows:

Authorised Share Capital

When a company wants to get listed on the stock exchange, it must declare the amount of capital they wish to raise. This amount is mentioned in the Memorandum of Association (MOA).

Authorised share capital is a specified amount that states the amount of money a company can generate from the public.

A company cannot generate more capital than the amount specified as authorised share capital.

The authorised share capital is also known as registered share capital or nominal share capital.

Issued Share Capital

After a company has specified its authorised share capital; it doesn’t need to issue the whole amount altogether.

The company can issue any amount depending on its financial requirements, irrespective of the amount stated as authorised share capital.

But, the company cannot give more shares than the amount mentioned in the authorised share capital.

Issue share capital refers to all the shares held by the general public, vendors, directors, employees, and Memorandum of Association (MOA) signatories of the company.

The company can also decide to issue a part of the share capital earlier and the remaining portion later.

Unissued Share Capital

Unissued Share Capital is the part of Authorised Share Capital that has not yet been issued to the general public.

It can be calculated by deducting the value of authorised share capital from the value of issued share capital. This value does not contribute to the share capital of a company in any way.

Subscribed Capital

Subscribed Capital is the amount invested by the general public in the company. The amount of this Share Capital may or may not be equal to the Issued Share Capital.

Sometimes, the general public invests less than the company’s financial requirements. Then we say that the issued share capital has been undersubscribed.

However, sometimes the general public invests more than the financial requirements of the company. Then, we say that the issued share capital has been oversubscribed.

Called-up capital

Called-up capital is a part of the amount per share asked by the company from the shareholders.

Let us explain with the help of an example.

Suppose a company named XYZ has issued 50000 shares of INR 5,00,000 with INR 10 per share. Assuming all the shares have been subscribed, it means the issued and subscribed share capital of the company is 5,00,000.

The share amount is divided into various parts like Application, Allotment, First call, Second call, Final call, etc.

Now let us say the company XYZ has decided to ask for

INR 2 per share during the application,

INR 3 per share during Allotment,

INR 1 during the First call,

INR 2 during the Second call, and

INR 2 during the final call.

So, this is how the company decides to acquire the INR 10 per share.

But, till now, the company has called up only the application and allotment money. So, the called-up capital is as follows:

Called-up capital = No. of shares X called-up amount per share.

Called-up capital = No. of shares X (application money per share + allotment money per share )

Called-up capital = (50000X (2+3))

Called-up capital = (50000X5)

Called-up capital = 2,50,000

Hence, the called-up capital of the company is INR 2,50,000.

Uncalled Capital

Uncalled capital is the part of the amount per share that the company has not yet asked from the shareholders.

In the above example, the first call, second call, and final call have not yet been called by the company.

Hence, after deducting called-up capital from the subscribed share capital, the remaining amount can be termed uncalled capital.

This capital is the amount that the company will receive in future when it calls for the same.

The issued share capital is equal to the subscribed share capital, and then uncalled capital is calculated by deducting called-up capital with issued share capital or subscribed share capital.

However, if the issued share capital is not equal to the subscribed share capital, the uncalled capital is calculated by deducting called-up capital from the subscribed share capital.

Paid-up Capital

When the company has called up a certain amount of capital, the public does not need to pay the whole called-up capital amount.

Only the amount of the called-up capital that the shareholders have paid is known as the Paid-up capital.

The remaining amount that has not been yet paid by the shareholders but has been called up by the company is known as outstanding capital.

Reserve Capital

Reserve capital is the amount of capital mentioned in the article of association of a company.

The company cannot access this amount until the company has become insolvent or is in the process of liquidation or winding up.

If a company wants to establish reserve capital, it needs to pass a special resolution stating that 3/4th of the majority of voters favour the decision.

Even after successfully establishing the reserve capital, a company cannot use this capital as collateral for any type of loan.

The company requires a court order to change its equity share capital. And the share capital is available only to creditors during the liquidating process or winding up of the business.

Circulating capital

Circulating capital is a part of the company’s subscribed capital that has been invested in the company’s business operations.

It is also known as working capital and is used to form operation assets like Bank reserves, account receivables, etc.

Bonus share Capital

Bonus share Capital is the capital raised through Bonus Shares.

When a company has access to retained earnings, it decides to distribute its profit in the form of a bonus issue.

Hence, Bonus shares are the type of equity shares that the company issues to its existing shareholders from its earnings.

Since the issue is made to the existing shareholder, there is no increase in the company’s market capitalisation.

However, market capitalisation does increase when other types of equity shares are issued.

Right share Capital

Right share Capital is the capital raised through Right Shares.

Right shares are exclusive shares reserved for only specific or premium investors, and these shares facilitate an increase in the equity stake of a particular shareholder.

The main objective behind issuing right shares is to raise money from premium investors for a specific financial requirement. Hence, the issue of such shares happens at a discounted price.

Sweat equity share Capital

Sweat equity share capital is the capital raised through Sweat Equity Shares.

Sweat equity shares are those shares that are received only by the directors and employees of a company.

The shares are issued to the employees or directors as a token of appreciation for their excellent work.

It is issued to applaud the contribution of such employees and directors to the intellectual property rights, know-how, or value addition to the company.

Sweat equity shares are issued at a discount to such directors and employees.

Why does a company issue Equity Share Capital?

A company invites applications for its shares through IPO (Initial Public Offer) in the primary market, allowing its shareholders to acquire fractional ownership.

Companies’ primary motive for issuing equity shares is for the capital generation to fund their future growth and development plans.

Secondarily, creditworthiness is enhanced when a company acquires a large capital base in the market.

Hence, it is an extended opportunity for shareholders to earn a part of the company’s profit in the form of dividends and its stake in that particular company.

What are the risks involved in issuing Equity Share Capital?

The risk involved in issuing Equity Share Capital are as follows:

Smart investors

These days investors have developed a better understanding of the market functions and actual data, analysis of which helps them to judge the prospectus before investing.

When a company invites investors to acquire their equity, but that does not comply with investors’ requirements and expectations, they will not be willing to invest.

Hence, the company will fail to generate the desired applications for the equity share capital.

Increased liability

When a corporation issues a large number of equity shares at a low face value, it increases the likelihood of attracting many investors.

Having a large shareholder base proves effective only when the number of shareholders is within manageable limits.

When the numbers become unmanageable, it adds to the company’s liability burden as they have to pay a greater bulk of returns as a dividend than they had bargained for.

An increased liability burden defeats the purpose of raising equity share capital and is also bad for the company’s sustainability.

Shareholders can open an equity share capital account and maintain a ledger for such transactions to keep better track of their equity share investments.

Companies that offer equity shares should keep track of their equity share capital increase in an equity share capital account.

Capital generation is insufficient

Even if a company can acquire enough shareholders for their company shares, the profitability of raising sufficient cash is still limited. Investors can choose from a wide range of equity share choices on the stock exchange market.

The availability of many investment options typically limits the capacity to raise adequate equity share capital, rendering ventures that issue shares ineffective.

Final Thoughts

The Equity Share Capital of a company is essential to ascertain the value of that company.

It is one of those metrics that an investor might consider while evaluating a company’s financial position.

By gaining insights into the company’s equity share capital, one can understand if the company has enough assets to cover its liabilities.

This insight is crucial while categorising an investment as risky or safe.

Hence, a basic understanding of Equity share capital can substantially improve your decision-making skills to make well-informed decisions.

Equities and their essence in the investment world

Posted on Nov 01 2022 by Aditya Paleri

Introduction

Equities form the lion’s share of the portfolio of successful investors.

The inflation-beating returns and substantial capital appreciation make equities the golden-egg goose for smart investors.

However, the axe of risk is always hanging over this precious goose.

So, it is crucial to understand the fundamentals of equities before you decide to invest in them.

Making well-informed decisions backed by thorough research is the only way to prevent the axe from dropping on your precious goose.

In this article, we will help you gain insights into the fundamental concepts of Equities to make your concepts crystal clear.

What is Equity?

Equity is the amount of residual ownership in a company or asset after clearing all debts. It is the amount of money the company would return to its shareholders if they are winding up by selling all of the assets and paying all the remaining debts. Equity is calculated by deducting any due obligations that did not experience transfer during the sale in the case of an acquisition from the company’s revenue.

On a firm’s balance sheet, equity represents the shareholders’ stake in the company. Adding equity to your financial portfolio may help you beat inflation.

Inflation is your wealth’s worst enemy because it diminishes your money’s purchasing power over time. However, unlike many other investment vehicles, equity can generate inflation-adjusted returns over time. But, amidst all this information, how can one fixate on the equity definition? So, let us provide a crisp description of equities.

Equities meaning

Equity is the amount of capital invested or owned by a company’s owner. One can calculate equity from the difference between a company’s liabilities and assets on its balance sheet.

These are high-risk investment instruments traded on the open market to gain substantial rewards. The market price or a value set by valuation professionals or investors determines the worthiness of the investment.

Owners, stockholders, and shareholders’ equity are some terms used to describe the holders of such investments.

Formula

The formula for Shareholders’ Equity is as follows:

Shareholders’ Equity = Total Assets – Total Liabilities

Components of Shareholders’ Equity

The components of Shareholders’ Equity include retained earnings, paid-in capital, treasury stocks, and outstanding shares.

Retained earnings form a substantial part of the Shareholders’ Equity.

Example

Let us assume a company named Vivon and Co.

The balance sheet of Vivon and Co. as of 31st March 2022 provides the following information:

Total Assets = 4,50,000

Total Liabilities = 1,50,000

Shareholders’ Equity is calculated by deducting total liabilities from total assets.

So, Shareholders’ Equity of Vivon and Co. = Total assets of Vivon and Co. – Total liabilities of Vivon and Co.

Shareholders’ Equity of Vivon and Co. = 4,50,000 – 1,50,000

Shareholders’ Equity of Vivon and Co. = 3,00,000

Interpretation

Vivon and Co. have 3,00,000 amount of capital that is to be returned to the company’s shareholders during the winding up of the company.

How does shareholders’ equity work?

Investors can get a holistic picture of what the company owns and what it owes through concrete numbers determined by the shareholder equity equation, i.e. assets minus liabilities.

Equity is referred to as the capital generator by a company used to purchase assets, fund projects, investments, and operations responsible for the growth and expansion of the company.

A firm is allowed to acquire capital for financing required by two methods. First, the firm can get money by issuing debt that can be a loan or bond. Second, the firm can race capital through equity by selling stocks like equity shares and preference shares.

Most investors are on the lookout for equity investments because it provides substantial returns in the form of capital appreciation and dividend payouts, thereby allowing having a share in the profits and growth of the firm.

Shareholders’ equity represents the value owned by shareholders in the company. Owning equity gives shareholders the right to exercise capital gains and dividends.

Shareholders also take an active interest in the company’s proceedings because they are also the stakeholders of the company.

The amount of shareholders’ equity can be both negative and positive. A positive number of shareholders’ equity indicates that the company has enough assets to manage its liabilities.

Similarly, a negative number of shareholders’ equity indicates that the company’s liabilities are more than what the asset can cover.

If the shareholder’s equity remains negative for an extended period, the company can become insolvent. This situation is termed balance sheet insolvency.

Investors tend to avoid companies with negative shareholder equity as they consider it a risky investment prospect.

However, Shareholders’ Equity standalone cannot give you a complete picture of the company’s financial health. It needs to be used in tuning with other financial tools and metrics to ensure the accuracy of financial estimation.

Features of Equities

The characteristics of Shareholders’ Equities are as follows:

Maturity period claims

A company as an entity is not allowed to buy its own shares under the Companies Act of 1956. The equity shares might supply the company with capital that cannot recoup as long as the company is operational.

Individuals who buy stocks in the company can only get their money back or redeemed when the company is winding up. And after all other claims that have experienced repayment because equity shares have no maturity dates.

Liability is limited

Even if shareholders are the actual owners of a corporation, they have limited liability, which means that their responsibility is limited to the value of their own shares.

If the investor has been paid the whole amount by the company, they will not be affected by its losses, even while the company is winding up.

Ownership claims over the company’s assets

When individuals purchase equity shares of a company, they acquire the last claim on its assets.

For example, suppose a corporation is winding up.

In that case, the company utilises assets to satisfy the claims of preference shareholders and creditors at first, leaving the equity owners with whatever is left.

Return on investments

When a person buys stock in a firm, they gain the right to claim a portion of the company’s profits. When a corporation does not make enough money, equity shareholders may not see any reward from their investments.

On the other hand, they may be able to receive more enormous dividends through capital appreciation. These investors can receive a portion of the company’s residual profits after paying the preferred shareholders’ dividends.

Right to vote

Common stock ownership always comes with voting rights, but the nature of those rights and the exact matters on which shareholders can vote differ significantly from one firm to the next.

Some corporations give investors one vote per share, allowing individuals with a more significant stake in the company to have a greater say in corporate decisions.

Alternatively, regardless of how many shares of business stock they own, each shareholder may have one vote. Finally, shareholders play a critical role in decision-making because of their voting power.

They also have a say in the director and auditor appointments when the firm goes bankrupt or during the winding up of the company.

Company right comes with a commensurate obligation that the investor must execute with zeal.

Types of Equity

Equity market investments do not assure investors of the security of fixed returns, and hence the return generated from equity depends on the performance of its assets.

There are several equity instruments, and each of them has its own set of merits and demerits.

The numerous categorisations of equity investments are as follows:

Shares are units that indicate a certificate of ownership of a company in exchange for capital. They provide partial ownership in the company, and the intensity of ownership depends on the number of shares held by the shareholder.

Mainly, there are two types of shares: equity shares and preference shares. However, some other categories of shares include right shares, bonus shares, and sweat equity shares.

Trading of the shares of listed companies happens on stock exchanges like the Bombay Stock exchange or the National Stock exchange.

These equity investments can give substantial returns, but they also come with the peril of high risk.

Equity mutual fund investments

Mutual funds are a type of equity investment where the capital is collected from a pool of investors and then used for generating profits from several equities and debt instruments.

In mutual funds, investment of at least 60% of the total assets happens in equity shares of various companies.

There are several types of mutual funds based on the market capitalisation, and they are as follows:

Large-cap equity funds

Large-cap equity funds are those mutual funds that have investments only in premium large-cap companies.

Large-cap companies have the potential to provide stable returns at low risk compared to other mutual fund investments.

Mid-cap equity funds

Mid-cap equity funds are those mutual funds that have investments only in medium cap companies.

Mid-cap companies have the potential for a balanced risk-reward ratio. These companies are good investment options given their balanced nature.

Small-cap equity funds

Small-cap equity funds are those funds that have investments only in small-cap companies.

Small-cap companies have minor market capitalisation and are more volatile than large-cap and mid-cap companies. Investing in such companies comes with a high risk.

Multi-cap funds

Multi cap funds are those funds that have different investments in companies of various sectors.

These companies are diversified and have variegated market capitalisation.

Equity futures

Equity futures are speculative investment instruments where the investor is liable to purchase and sell the underlying assets at a predetermined price and a predetermined rate.

These equity futures come with an expiry of three months, and their settlement happens to be the last Thursday of the third month.

For example, An investor bought futures that state that the investor decided to purchase shares of a company named Peace and Co. at INR 15 per share for three months.

Now.

If, after three months, the share price of Peace and Co. rises to INR 17 per share, then the investor gets the benefit of buying those shares at INR 15 per share.

Similarly,

If, after three months, the share price of Peace and Co. falls to INR 13 per share, then the investor experiences a loss and has to buy the shares at INR 15 per share.

So, this is how equity futures work.

Equity Options

Equity options are equity investment instruments that function similar to equity futures.

However, in the case of equity options, the investor is not legally liable for completing the agreement.

How to Invest in Equities?

An investor can invest in equity in two ways, one is through stocks, and the other is through mutual funds.

Stocks

If investors wish to invest in equity directly to stocks, they need to open a trading account and a Demat account. The trading account facilitates the buying and selling of stock by helping the investor place orders with their stockbroker. This is why careful selection of the stockbroker is of utmost importance.

The Demat account holds the shares in an electronic form. An investor also needs to have a linked bank account to complete the transaction.

Here are a few things that one should know before they decide to invest in the equity market through stocks, and they are as follows:

Risk management is a critical factor in equity investment. Hence, an investor should be careful about their investment choices.
Before buying its stocks, the investor must thoroughly research the company on different parameters and use other financial metrics.
Investors must keep themselves updated with the recent market developments.
Investors must have stock market jargon and other fundamental details at their fingertips.
The investor must understand the company’s balance sheet and other essential accounting statements before investing in the stock market.
If an investor takes care of the point mentioned above, they are more likely to enjoy successful equity investments.

However, suppose an investor lacks in the points mentioned earlier but still wants to invest in equity. In that case, they should opt for the second option, which is investment through mutual funds.

Merits of Investing in Equities

The benefits of investing in Equities are as follows:

Yielding high returns

Investors might expect substantial profits when they invest in equity shares. Shareholders can benefit from wealth development not only through steady dividend payouts but also through capital appreciation.

Acts as a shield against inflation

Individuals who invest in equity shares have the opportunity to generate substantial returns, which acts as a cushion against inflation. The rate of return earned is frequently more significant than the pace at which the investor’s purchasing power is eroded due to inflation.

As a result, buying stock acts as a hedge against inflation.

Investment simplicity

Buying and selling stocks is straightforward. To invest through numerous stock exchanges in a country, investors can use the services of a stockbroker or financial planner. If a person has a Demat account, they can buy stocks in minutes.

So, whether an investor decides to invest through the National Stock Exchanges or the Bombay Stock Exchange, they can benefit from the ease of investment. Digitalisation has also played a significant role here as investing is a lot easier nowadays through a digital platform with easy tap access.

Diversifying investment portfolio

Investors choose debt products because they are low-risk and have reduced volatility.

Individuals can diversify their investment portfolio by investing in shares for higher profits, while debt instruments carry low risk and may not always yield high returns.

Demerits of investing in Equities

The disadvantages of investing in Equities are as follows:

Prone to high market risks

Compared to other investment options such as debt instruments, investing in equity shares can offer significant profits and expose investors to considerable risk. When investing in equity shares, an investor runs the risk of losing their entire investment, and equities are therefore known as volatile risk investment options.

Risk of liquidity

Due to liquidity risk, investors may experience the urge to sell their shares at a considerably lower price than their fair market value.

Liquidity risk occurs when a corporation cannot satisfy its short-term loan obligations.

Due to a shortage of buyers or an inefficient market, the investor or corporation may be unable to turn an asset into cash without giving up capital and revenue.

Risk related to performance in the market

Because equity investments are market-related securities, they may or may not perform as expected by investors.

This feature is known as performance-related risk, and it can influence individual stocks and stocks across sectors.

The risk associated with social and political changes

External factors and a country’s economic situation also play a significant role. Continuous social and political difficulties might impede business progress. For example, if a government intends to favour indigenous enterprises, international businesses may be restricted from entering the country.

In such cases, an investor with specific investments in home-grown enterprises will benefit from the extraordinary performance of their capital.

Inflation related risks

Inflation reduces the purchasing power of a dollar of earnings, making it difficult for investors to assess the present value of the companies that make up market indexes.

Furthermore, rising pricing for materials, inventories, and labour may impact earnings as companies respond. As a result of growing inflation, a company’s value diminishes, and its shares may no longer provide potential profits

Final thoughts

When you invest in equity, it is essential to understand that the investment is subjected to risk.

Most people invest in a particular stock because of the euphoria caused by the price rise to the other investors who have already invested in that specific stock.

This can be a huge mistake because if you invest in a stock whose price has risen significantly, you are buying high.

You may experience a profit even after buying high, but it is improbable.

To be successful in the equities market, an investor should buy low and sell high.

How does EBITDA affect your investing decisions?

Posted on Nov 01 2022 by Aditya Paleri

Introduction

Normally, investors focus on cash flow, net income and earnings as the primary measures of a company’s health and value. But over the years, another measure has crept into quarterly reports and accounts: earnings before interest, taxes, depreciation and amortisation (EBITDA).

While investors can use EBITDA to analyse and compare profitability across companies and industries, they should understand that there are serious limits to what the metric can tell them about a company. Here we look at why this measure has become so popular and why it should be used with caution in many cases.

What is EBITDA?

EBITDA, or earnings before interest, taxes, depreciation and amortisation, is a measure of a company’s overall financial performance and is used as an alternative to the net income in certain circumstances.

However, EBITDA can be misleading because it does not reflect the cost of capital investments such as property, plant and equipment. It doesn’t include the interest costs on borrowed capital either.

EBITDA as a financial metric

By adding back interest expenditure and taxes to earnings, this statistic also removes debt-related expenses. Nonetheless, because it can reflect earnings before accounting and financial deductions, it is a more precise indicator of business performance. Simply put, EBITDA is a profitability metric.

Calculating EBITDA

While there is no legal necessity for corporations to publish their EBITDA, it can be calculated and reported using information from their financial statements, according to the US generally accepted accounting principles (GAAP).

What is the EBITDA coverage Ratio?

The EBITDA-to-interest coverage ratio is a financial solvency ratio used to evaluate a company’s financial stability by determining whether it is profitable enough to pay off its interest-oriented expenses with pre-tax income. It examines what percentage of earnings before interest, taxes, depreciation, and amortisation (EBITDA) can be used for this purpose.

In general, such a ratio can be used to assess the solvency of companies with high leverage. The idea behind this ratio is that a company should earn enough money to keep a profitable cash surplus along with meeting its debt obligations.

Calculation of EBITDA coverage ratio

The EBITDA Coverage Ratio formula is as follows:

EBITDA coverage Ratio = (EBITDA + Lease payments) ÷ (Loan payments + Lease payments).

As is customary, EBITDA stands for earnings before interest, taxes, depreciation, and amortisation. In this case, where the loan payment includes both interest and principal payments, and the lease payment figure is the minimum lease payout.

If the result is greater than 1 or 1, it indicates that the company in question is financially sound. Furthermore, it implies that the company is capable of repaying its debts.

What is EBITDA Margin?

The EBITDA margin is a measure of a company’s operating profit as a percentage of its revenue. Judging by the EBITDA margin, analysts and investors can compare the performance of companies operating in the same sector, regardless of their size.

The EBITDA margin is simple to calculate. Divide the entire earnings before interest, taxes, depreciation, and amortisation by the total revenue of the firm. It is expressed as a proportion of total income.

It is calculated as EBITDA Margin = EBITDA/Revenue.

The earnings are calculated by taking sales revenue and reducing operating expenses, such as the Cost of goods sold (COGS), selling, general, and administrative overhead expenses, but excluding Depreciation and Amortisation.

The margin does not include the impact of the company’s capital structure, non-cash expenses, and income taxes. But it is considered to be a good indicator of an organisation’s financial health because it believes in an organisation’s performance without taking its financial decisions, accounting decisions, or various tax environments into consideration.

EXAMPLE OF EBITDA MARGIN

EBITDA may be used to compare two firms that are in the same industry but have differing market capitalisations. Take a look at the example in the table below to see how a comparison may be made:

Company ABC Limited.

Company XYZ limited.

Revenue R.s. 500,000

Amount of subscriptions sold R.s. 20,000

Interest (180,000 loan at 10%) R.s. 18,000

Depreciation of assets R.s. 1,000

Income (before tax) R.s. 251,000

Net income (at 30% tax rate) Rs. 196,550

EBITDA R.s. 200,000

Revenue R.s. 500,000

Amount of subscriptions sold R.s. 30,000

Interest expenses incurred R.s. 0

Depreciation R.s. 1,000

Income (before tax) R.s. 279,000

Net income (at 30% tax rate) R.s. 210,300

EBITDA R.s. 200,000

For this example above, company ABC Ltd would have a 40% EBITDA margin (Rs. 200,000/Rs 500,000). Whereas company XYZ Ltd would have a 60% EBITDA margin (Rs. 300,000/R.s 500,000).

We can observe from the above that Company XYZ has a greater EBITDA than Company ABC even though the former’s revenues are lower than the latter.

It indicates that Company XYZ is better managed and has a more cost-effective strategy than Company ABC. A larger EBITDA margin suggests a corporation that is financially secure and less risky.

What does a “GOOD EBITDA” mean?

The definition of a “good” margin varies by industry or business; also, a 60% margin in most industries would be a good sign. However, it is normally a greater percentage, preferable because it indicates that the firm can easily cover its operational expenditures. To get at a “good” margin, one must calculate and compare the margins over many periods.

Advantages of EBITDA Margin

There are several advantages of EBITDA margin, and they are as follows:

Cash flow and profitability

The EBITDA margin is a metric that evaluates a company’s annual cash profitability. For investors, looking at the company’s EBITDA margin might be a better signal than looking at other profit margins since it takes into account non-operating or other specific depreciation, amortisation, and tax variables helping companies in cost reduction ventures. A robust and efficient cash flow with low operational expenditures is indicated by a high EBITDA.

Comparison between companies

It makes it simpler to compare firms across industries because EBITDA is usually expressed as a percentage of total sales by utilising the operating profit helping investors and analysts to understand how well a company is managing its operational cash relative to the revenue it generates.

Furthermore, an EBITDA margin is very useful for owners to examine how well the firm is managing its resources and operating cash since it shows the relationship between operating cash flow and sales.

Disadvantages of EBITDA Margin

There is also a flip side to EBITDA margin. The disadvantages of EBITDA are as follows:

High-debt levels

The EBITDA margin should not be used to evaluate companies with high debt levels evaluating a company’s success; excluding debt has several disadvantages, as large interest payments should be factored into a company’s financial analysis.

It does not take into account the impact of debt; therefore, firms with a lot of debt have a greater present (earnings before interest, taxes, and depreciation and amortisation) margin.

Profit margins

EBITDA margins are often larger than net profit margins as EBITDA is earnings before deducting the Interest, Tax, depreciation and amortisation. While net profit is the amount of earnings after deducting such expenses. Companies with low profitability will emphasise EBITDA margin as a metric for success.

What are the advantages and disadvantages of EBITDA?

EBITDA has its own share of merits and demerits. It is important to look at both sides of the coin before fixating on it for your investment decisions.

PROS

The advantages of EBITDA are as follows:

It can indicate whether the company is attractive to potential investors as a leveraged buyout candidate.
EBITDA can provide you with a big picture of your company’s growth. This helps demonstrate the viability of the company model.
The EBITDA margin determines how long a company’s operational efficiency will last. Higher margins indicate that the company is doing well.
EBITDA measures the efficiency with which continuous operations generate cash flow. It also displays how much that cash flow is worth.

Cons

The disadvantages of EBITDA are as follows:

EBITDA ignores the cost of debt. It can be used to hide poor decisions and financial problems.
EBITDA cannot be wholly relied upon to measure a more accurate financial picture of a company. Other metrics should also be considered in the process to outline an apt financial position of the company.

How does EBITDA Work With Leveraged Buyouts?

Leveraged buyout investors use EBITDA to quickly calculate whether companies could pay back the interest on these financed deals.

Leveraged investors promote EBITDA as a tool to determine whether a company is able to pay off its debt in the short term. These investors argued that looking at the EBITDA to interest coverage ratio would give investors an idea of whether the company is able to meet the higher interest payments it will face after the restructuring. For example, investors might argue that a company with an EBITDA of Rs. 50 Lakh and interest charges of Rs. 2.5 lakh had an interest coverage ratio of 2, which is more than enough to pay off debt.

EBITDA vs EBT and EBIT

(EBITDA) is an acronym for Earnings Before Interest, Taxes, Depreciation, and Amortisation.

The sole difference between EBIT and EBITDA is the inclusion of Depreciation and Amortisation.

Earnings before tax (EBT) shows the amount of an operational profit achieved before taxes, whereas EBIT eliminates both taxes and interest payments.

EBT is computed by taking net income and subtracting taxes to get a company’s profit payments and represents how much of an operating profit has been earned before accounting for taxes.

EBIT reflects earnings (or net income/profit, which are the same thing) after interest and taxes have been deducted.

EBIT is a metric that is used to evaluate a company’s basic activities without taking into account tax charges or capital structure costs.

EBITDA & Adjusted EBITDA

The financial measures of EBITDA and adjusted EBITDA are frequently used to assess a company’s profitability.

While EBITDA merely evaluates a company’s earnings before interest, taxes, depreciation, and amortisation, adjusted EBITDA goes a step further to better reflect the underlying operating cash flow.

The formula for calculating EBITDA & adjusted EBITDA is as follows:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortisation.

Adjusted EBITDA = EBITDA + Adjustments ( EBITDA +/− A )

Where:

NI = Net income

IT = Interest & taxes

DA = Depreciation & amortisation

A = Adjustments

How is EBITDA different from Net profit?

The key differences between EBITDA and Net Profit are listed below in the form of an all-encompassing chart.

S.r. Number	Basis.	EBITDA	Net Profit
1	Indicator	EBITDA is a financial indicator that calculates a company’s profit before taking into account expenses, taxes, depreciation, and amortisation.	Net profit is an indicator that calculates the company’s total earnings after deducting expenses, taxes, depreciation, and amortisation.
2	Finding	EBITDA is used to determine a company’s earning potential. As a result, when investors examine a new company, they calculate EBITDA. EBITDA is also simple to calculate because it excludes depreciation and amortisation.	Net profit is used to calculate earnings per share if the company has issued any shares. We can calculate EPS by dividing net profits by the number of outstanding shares.
3	Calculation	EBITDA is calculated by adding depreciation and amortisation to EBIT or by adding net profit to interest, taxes, depreciation, and amortisation.	Net profit is calculated by deducting total operating, financial and other costs from the revenue.

Conclusion

In short, before investing in the stocks of a company, one needs to know to be able to calculate key performance metrics such as EBITDA, EBITDA multiple, and EBITDA revised.

These financial performance metrics provide a simple but accurate picture of the company’s efficiency in generating an operating profit and managing high-interest charges on its debts in the short term.

But, while EBITDA is used, investors are also warned not to rely too much on it. It can sometimes be misleading, and companies that do not have a strong profit to do the project use EBITDA to disclose their actual financial performance.

Thus, understanding EBITDA and its components to be able to use it in decision making.

Dividend Stocks – What are they, and should you invest in them?

Posted on Nov 01 2022 by Aditya Paleri

Introduction

It is common for an individual to receive questions from novice investors like “what are dividend stocks?“

There exists a very vague explanation of dividend stocks because the fundamentals behind dividend stocks rely heavily on the basics of dividends and how they work. So, to understand dividend stocks, one must understand what dividends are and how they function.

But, before getting into the heart of the matter, let us provide you with a gist about dividend stock definition.

Dividend stocks meaning

Dividend stocks are the stocks of companies listed on the stock exchange. These companies provide regular dividends to their shareholders. Established companies tend to allocate regular earnings to their shareholders in the form of a dividend.

But, “what does dividend stock mean?” is a question that one can understand only after understanding the dividends and their basics.

What are dividends?

Dividends are the benefits that a company extends to its shareholders. Public-listed companies can only develop these benefits, which are done through the company’s retained earnings.

These benefits can be provided in various kinds like cash and cash equivalents, shares, assets, etc. The dividends are paid from retained earnings only after other essential expenses of the organisation have been cleared.

The company’s board of directors has the right to decide the dividend rate along with the approval of the majority of shareholders.

However, it is not always necessary for a company to pay dividends to the shareholders. It might prioritise reinvesting those profits for growth and expansion of the business rather than distributing them to the shareholders.

The announcement of a dividend income declaration can substantially increase or decrease the company’s stock’s value.

How do Dividends work?

There are several steps when it comes to dividends. The process of how dividends work is stated below. The steps are as follows:

Step 1

The publicly listed organisations have generated a substantial income, thereby accumulating a significant amount of retained earnings or profit.

Step 2

An organisational meeting is held in the organisation to decide if they should use these earnings for the growth and expansion of the business or if they should distribute them to the shareholders.

The management might also conclude by reinvesting a portion of the earnings in the business and distributing the rest to the company’s shareholders.

Step 3

If the majority of shareholders approve the declaration of dividend income, then the company proceeds to declare the dividend to the shareholders.

Step 4

The organisation decides to announce the important dates for the declaration of dividend income.

Step 5

It is scrutinised to learn if a particular shareholder is eligible to receive a dividend.

Step 6

If the shareholders are eligible to receive a dividend, then the dividend is paid to the shareholders.

On the contrary, if, after Step 2, the organisation votes in favour of reinvesting all the retained earnings into the business for its growth, expansion, productivity, and efficiency, then there will be no declaration of dividend.

However, it must be considered that if the earnings are reinvested or distributed as dividends, both of these financial activities tend to influence the organisation’s financial strategy.

Types of dividends

There are several forms in which an organisation can pay dividends to its shareholders. But, the nature of the payouts depends on the type of shares, and there are different dividends for different shares.

However, there are two significant types of dividends provided by a company to its shareholders, and they are as follows:

Special Dividend

Special dividends are the benefits paid to the ordinary shareholders of the company. When a company has accumulated a significant amount of retained earnings over the years of its business, it decides to issue a special dividend to its equity shareholders.

These dividends are distributed from earnings that do not have any immediate use in the coming future. Hence, instead of leaving the gains idle, distributing dividends is a better strategy to enhance the company’s market value.

Preferred Dividends

Preferred dividends are the benefits distributed to the preferred shareholders of the company. These shareholders receive a fixed amount of dividend at fixed periods from the organisation. But, this dividend is earned only on preference shares.

Preference shares function less like shares and more like bonds. Preference shareholders do not receive voting rights, but the company is obligated to pay dividends to them.

There are many types of dividends. However, some of the most common types of dividends are listed below.

The list of the most common types of dividends are as follows:

• Cash

Many companies pay cash dividends to their shareholders. Whenever dividends are delivered in the form of cash, they are wired electronically, or a cheque is provided to the shareholders instead of the dividend.

• Assets

A few companies agree on distributing benefits to their shareholders in the form of tangible assets, real estate, or investment instruments. But, as exciting as it may sound, the idea of issuing assets is still rare among the companies in India.

• Stocks

Many companies distribute benefits to their shareholders in the form of stocks, and new shares are issued to existing shareholders in the name of dividends.

The companies usually distribute stocks on a pro-rata basis. The number of stocks allotted to a shareholder is decided based on the number of outstanding shares that the particular shareholder is currently holding.

• New Warrant or Shares of Subsidiary Company

The common notion is that dividends are the excess retained earnings distributed to shareholders as benefits. Mostly, the rate of this dividend is often decided by law.

The exceptional cases in which the dividend rate is decided by law are when the dividend payment happens in cash or when the dividend payments are responsible for the winding-up of the company.

Apart from such payments, the company can also offer warrants, new shares, a new company’s share, or any other financial assets in dividends to its shareholders.

Whatever may be the case, it should be taken into consideration that dividend distribution and declaration significantly affect the company’s share price.

Impact of dividends on price shares

One must consider that paying dividends to the shareholder might not influence the holistic valuation of the organisation. However, this well-thought decision might play a vital role in decreasing the overall equity of the organisation by the amount paid as a dividend.

To explain, once profits are distributed, it is irrevocably deducted from the books of accounts and cannot be reversed.

Furthermore, when a corporation distributes a dividend, its stock price may rise in the market. Investors might be willing to pay a higher price to receive dividends. Once the period of dividend eligibility ends. However, the share values begin to fall by a corresponding percentage.

When new investors are not considered valid for dividends, they are hesitant to pay the related premium, resulting in a drop in value. Similarly, if we believe that the market will remain optimistic until an ex-dividend date, the progress in the stock value may be more substantial than the dividend offered.

Regardless of the cutbacks, such incidents frequently result in a rise in the total value of a company’s shares. Investors must become aware of the crucial days concerning dividends to fully understand the dividend declaration’s influence on stock prices.

How to pick the best dividend stocks?

The stocks that yield higher dividends than marked standards are termed high-dividend yielding stocks. Dividend investing is a reliable method of accumulating wealth and helps provide and shield against inflation that bonds do not.

So, here are some factors one can look at before making their choice. Ways to pick the best dividend are as follows:

Strong cash position

Cash position is essential to consider when evaluating dividend-paying companies’ long-term profitability. Although any company can have a profitable quarter occasionally or once in a blue moon, only those with consistent annual growth should be considered while evaluating your investment choices.

The company must have a track record of consistently paying dividends in its last five years. Also, the stock’s dividend yield should always increase each year, and companies should have excellent cash flow to fund dividend programs for investors.

Keep Debt to as Minimum as possible

Investors should avoid dividend-paying companies with excessive debt. Companies with debt tend to naturally direct their resources toward debt repayment rather than dividend payment programs.

As a result, investors must scrutinise a company’s debt-to-equity ratio, and if it is more significant than 2.00, then investors should proceed.

Examining Industry related trends

While scrutinising a company’s numbers is essential, it is also crucial to look at the broader sector in order to develop a more comprehensive projection of future performance.

For example, an oil company may be doing well, but a drop in oil prices due to a specific economic situation will likely increase demand while decreasing supply. This could lead to a decline in stock prices and a reduction in dividend payments as the company cannot make enough profits.

Keep in mind that the behaviour of a sector can change over time. One should conduct an in-depth analysis to understand and review the current and future performance and how much that sector is prone to be affected in the future.

Let us see one more example of investing in the soft drink industry, listed companies like Varun Beverages and Orient Beverages. It has historically been a safe bet. Still, consumers are becoming more health-conscious as awareness can be seen. As a result, most beverage companies are shifting their focus to healthier/alternative drink options.

Similarly, many beverage companies are now shifting their product focus to diet and sugar-free alternatives as this new healthy era is boosting. However, this transition will take time, and investors should know this before putting their money into beverage companies. Hence, before investing in any industry, a thorough knowledge of its future prospectus is necessary.

How to identify stocks that pay high dividends?

To identify high-paying stocks, one needs to be observant as there is no particular set of dividend stocks that pay high dividends. The dividend stock that will give you a good dividend depends on your risk appetite and criteria of investing. If a company has N/A, which means not applicable, in the dividend yield section of its financial report, it means that the company does not pay any dividend.

Investors who want to buy stocks that pay a cash dividend can choose between equity shares and preference shares. When investors hear the term preference shares and how it facilitates regular and steady dividend payout delivery, they think it is the better deal.

But that is just one part of the story. Preference shares might offer higher dividends than equity shares as they have a fixed redemption prize. The preference shares come with a call option where the company asks the investors to sell back the shares after a specific period.

This call option is usually initiated five years after the issue of preference shares. If a preference share promises a substantial dividend rate, then there are significant chances that this company might exercise its call option soon. After the call option, the stock might be subjected to redemption, and you will not own it anymore.

Equity shares tend to have lower dividend yield. The equity shareholders are the last ones to receive dividends; hence they may not receive dividends when the company experiences a decrease in its profits. The prices of equity shares fluctuate more than preference shares, but in equity shares, there is no predetermined limit for the redemption prize, and you also do not receive a call for buyback of shares.

An investor should understand that in investing and dividend stocks be it equity shares or preference shares, there is a certain amount of risk involved. If you are investing for a short period, then you might gain quick returns. But, if you have decided to invest for the long term, then investing in individual stocks can increase your risk because the value of stocks can go down with time.

Hence, it is crucial to form a diversified portfolio to minimise risk. Many financial experts recommend index funds, a type of mutual fund because diversification gives you a low-risk investment option. The cost of index funds is also comparatively lower, and they provide dividends.

Things to remember before buying dividend-yielding stocks

Here are a few things that an investor should consider before buying stocks:

Examine the dividend ratios

A significantly high payout or yield ratio clearly shows that very little profit is being reinvested, and this can be easily derived from the formula. If the dividend is very high, the company is diverting less profit for reinvestment and more for dividend payouts.

The formula for calculating one of such ratios is as follows:

Dividend Payout Ratio = Annual dividend per share / Earnings per share.

Investors must stay aware of this before buying dividend stocks.

Examine the dividend patterns

These ratios, as mentioned above, should only be used to analyse the company’s dividend payout situation and should not be the sole reason for investing or not investing in a company’s stock. Therefore, clarity of thought regarding the same is required.

Otherwise, even the highest dividend-paying stocks can turn out to be poor long-term investments because of a lack of examination of the past performance of the dividend. Hence, investors must consider these before selecting dividend stocks.

The yield ratio is highly variable

The price of a stock on the market is a moving figure, and during a trading session, it might alter every second, which, in turn, results in varied dividend yields. Hence, an investor must be careful when they select dividend stocks with the help of dividend yields.

Absolute Dividend Numbers might not provide transparency

Judging a company’s payout by looking at the absolute number available will never fetch precise results, and make no decisions based on these figures.

If company A pays out a dividend of Rs 100 per share, that does not speak highly of the company. And contrarily, the dividend of Rs 10 per does not reflect poorly on a company. The highest dividend-paying stocks are not always the best investments.

Investors should consider other metrics such as the company’s earnings, the number of outstanding shares, and various other metrics. Here’s where the ratios come into play. So, analyse these factors well before you invest in dividend-paying stocks.

Bottom Line

The appealing part about dividend stocks is that investors can expect quarterly cash payments until they sell their shares. One should take all the above advice with a pinch of salt because it is already known that dividend stocks do not come without their share of risk.

Note that a company experiencing loss in its business operation might not pay dividends to its common shareholders.

What is Dividend Per Share

Posted on Nov 01 2022 by Aditya Paleri

Introduction

Before understanding dividend per share, we need to learn what a dividend is. When a company makes a profit and gathers retained earnings, those earnings are then paid out to shareholders as a dividend. The value of the dividend is calculated on a per-share basis and is paid equally to all shareholders. However, the payment is first approved by the board of directors. A dividend is paid on a particular date called the payable date.

Now that you know what a dividend is, we can understand dividend per share better. The dividend per share is the total sum of the dividends issued for every ordinary share outstanding of a company. By calculating the dividend per share, the investor will know how much income he/she will receive from a company on a per-share basis. Now, let’s discuss Dividend Per Share in detail.

What is the dividend per share?

The Dividend Per Share (DPS) is determined by dividing the total dividends paid out by a company, including any interim payments, during a certain period of time, often a year, by the number of ordinary shares that are still outstanding and issued. The dividend per share calculator determines the portion of earnings that will be paid to shareholders. Dividend per share is also used to determine the stock’s dividend yield and can be applied for dividend growth stock valuation models.

What is an ordinary share?

What is this ordinary share that dividend per share keeps talking about? Ordinary or common shares are stocks sold on the public exchange. Each share of stock gives the owner voting right at a company shareholders’ meeting. Generally, owners of ordinary shares are not guaranteed a dividend as opposed to preferred shareholders. Preferred shares are a hybrid of a bond and a stock. Preferred shareholders are paid dividends before ordinary shareholders.

The formula of Dividend Per Share

The dividend per share calculator provides a straightforward figure to an investor about the income he/she will receive as a dividend for every ordinary share outstanding. A constant increase in dividend per share over time provides confidence to investors that a company’s earnings growth might be sustainable.

How is DPS calculated?

Dividend Per Share Ratio (DPS) = (Total Dividends paid out over a period – Special Dividends)/ Shares outstanding

Dividend Per share = Earnings Per Share X Dividend Payout Ratio.

Dividends over the entire year must be added to calculate DPS, including interim and final dividends and excluding special dividends. An interim dividend is paid out before the company’s Annual General Meeting (AGM) and before its final financial statements are published. Special dividends, however, are non-recurring, one-time dividends issued by the company. They are bigger dividends as compared to normal dividends. They are also called extra dividends.

For example, let’s assume XYZ Company paid a total sum of $230,000 in dividends over the last year. There was a special one-time dividend during that year as well in the amount of $49,200. XYZ has 3 million shares outstanding.

So, now we calculate the DPS = $230,000-$49,200/3,000,000 = $0.06 per share.

Other financial ratios that can be calculated using DPS

Dividend Yield

Dividend Yield is a ratio that tells how much a company pays out in dividends every year relative to its stock price. It estimates dividend only return of stock investment. If the dividend is not lowered or raised, the yield will increase when the stock price falls. Similarly, if the stock price increases, the yield will fall.

Dividend yield = (Dividend Per share/ Price Per Share) x 100

Dividend Payout Ratio

The Dividend Payout Ratio is the dividend amount paid to shareholders to the total sum of net income that a company generates. There are various formulas for calculating the dividend payout ratio.

DPR = Total dividends / Net income
DPR = 1 – Retention ratio
DPR = Dividends per share (DPS) / Earnings per share (EPS)

Cash Dividend

A company pays a cash dividend to its shareholders for every ordinary share outstanding and it can be known as a cash dividend per share. They are paid on a per-share basis. Cash dividends per share are paid regularly, be it quarterly or yearly, as an interim dividend and final dividend respectively. However, they can sometimes be only one-time payouts after a legal settlement. The companies that are established, have a stable cash flow, and are beyond their growth stage are dividend-paying companies. Every company has a dividend policy, based on which it assesses if a dividend increase or cut is warranted.

Forms or Types of Dividends or Alternatives to Cash Dividends

Apart from usual cash dividends, there are other dividends that a company pays as well.

Stock dividends

A stock dividend per share is paid to shareholders in the form of shares rather than cash. The company gives extra shares based on current shares held by shareholders on a pro-rata basis. These dividends are not taxed until the owner sells the shares granted to him by the company. Stock dividends do not affect the company’s value but can dilute earnings per share. The board of directors decides when the dividend will be declared and in what form the dividend will be paid. There are two types of stock dividends, small and large dividends. A small stock dividend is when the number of shares issued is less than 25%, contrary to large dividends, where the number of shares issued is more than 25%

Liquidating dividends

A dividend is issued as a liquidating dividend by the company at the time of its liquidation. When a company liquidates, it is generally winding up its business and exiting the market. Liquidation can either be voluntary or involuntary. A liquidating dividend is also known as terminal distribution or liquidating distribution. The company liquidates all its semi-liquid and liquid assets to the shareholders. When a company cannot sustain its operations, it returns the assets to shareholders via dividend payments.

Bond dividends

Bond dividends are akin to scrip dividends. The only difference is that a scrip dividend has a short maturity period and does not bear any interest. However, a bond dividend has a long maturity period and bears interest.

Benefits of DPS

User	Indicator	Benefit
Investor	Financial Health	Investors calculate DPS to get an idea of the company’s profitability, financial growth, and stability.
Shareholder	Shareholder Value	Shareholders use DPS to calculate the portion of earnings paid out to them as an income.
Quoted Company	Performance Signal	Companies that are publicly listed calculate DPS to share a portion of their retained earnings with shareholders through dividends and lure dividend-seeking investors.

Dividend per share Example

A company that pays a steady dividend per share sends a strong performance signal to its shareholders. That is why established corporations boast about their stable DPS growth.

For example, Britannia industries are one of the major Indian food manufacturing companies. It engages in manufacturing and selling FMCG products like bread, biscuits, cakes, etc. However, the majority of its revenue (80%) is generated from selling biscuits like Marie gold, good day, JimJam, etc. Britannia has a 400 bn business market in India. And it has been consistently paying dividends since 1995. The company has already paid 26 dividends in its lifetime period.

Dividend Policy and its Types

Every company has a dividend policy to structure dividend payouts to shareholders. There are three kinds of dividend policies – stable, constant, and residual.

Stable Dividend Policy

A stable dividend policy is the most commonly used policy. This policy aims to have a predictable and steady dividend payout each year. This is what investors seek. It doesn’t matter if the earnings are high or low; the investor will receive a dividend. This policy aligns with the long-term growth of the company rather than the volatility of quarterly earnings. It assures the shareholders about the time and amount of the dividend. But an investor may not see a high dividend in a company’s boom years.

Residual Dividend Policy

The residual Dividend policy is highly volatile. The company pays out the dividends left after it has paid for the working capital and capital expenditures (CAPEX). Although it is volatile, the investors still think of it as the only acceptable dividend policy because they don’t want to invest in a company that justifies its high debt.

Constant Dividend Policy

Under the constant dividend policy, a firm pays a percentage of its earnings as dividends each year. Investors get to experience the whole volatility of company earnings. If earnings are high, the investor will get a large dividend; if the earnings are low, the investor might not receive any dividend. The only drawback of this policy is its volatile nature. As opposed to a stable dividend policy, investors under this policy enjoy increased dividends in highly profitable years of a company.

Earnings per share (EPS)

The topic will be incomplete if we do not discuss DPS’ counterpart EPS. Earnings per share (EPS) depicts the company’s net income allocated to each share of common stock. It reflects the company’s profitability and helps investors evaluate stocks.

Earnings Per Share Formula

Earnings Per Share (EPS) = (Net Income – Preferred Stock Dividends)/ Outstanding Shares

EPS vs DPS: Key Differences

Earnings Per Share (EPS)	Dividend Per Share (DPS)
Shows the company’s profitability by measuring net income for every outstanding share.	Shows the company’s profitability, a total sum of dividends issued by a company for every ordinary share outstanding.
EPS does not indicate the amount the shareholder receives; it is an accounting figure.	It indicates the income a shareholder will receive per share as a dividend.
EPS gauges how valuable an organisation is per share of its inventory.	Many growth firms don’t pay out dividends, so their DPS can’t be utilised.
There are five types of EPS; Reported EPS, Ongoing, book value, retained, and cash.	There are six types of DPS; cash, bond, scrip, property, liquidating, and stock.

What is a Good DPS?

DPS is a financial ratio that helps investors assess a company’s financial health, performance, stability, shareholder value, and long-term growth. A stronger dividend payout makes stocks attractive to investors, increasing their market value. For some investors, dividends are the primary determinant of buying stocks.

What a low DPS indicates?

A decreasing DPS ratio indicates that a company’s financial health might be deteriorating. It may lead to investors selling their stake, driving the company’s stock price and market value down.

However, not always a downward DPS trend means that the company is going through financial difficulties. Instead, it may mean that:

A company may be reinvesting in its business operations and growth so as to increase its value. It is done by only paying a small portion of its net income to stockholders and reinvesting residual profits into the business. This is commonly used by high-growth start-ups and established corporations.
It might be deleveraging, meaning reducing the debt level in a company.
Sometimes, it is also done to prevent the wrong signals to circulate in the market and to avoid high payouts of dividends in profitable years by paying either special dividends or no dividends.

Inputs to consider for comparing DPS

There are some inputs to consider for comparing the DPS of different companies against each other.

Types of shares – Common stock (primary or secondary), preferential shares.
Time Period- Annually, Quarterly
Gross/ Net amount- Pre-Tax / Post Tax
Shares Issued – Outstanding (excluding treasury stocks) or Including treasury stocks.
Form of dividend payment- Stock, Cash, Property, etc.
Cut-off point- Weighted average over a period of time; No. of shares at a specific time.

Pros and Cons of DPS

Pros	Cons
Easy to calculate and understand	It does not indicate the actual return on investment
Practical; it shows shareholders’ income directly.	It does not indicate profit per share earned vs. distributed.
Widely used to assess a company’s profitability.	Not all companies pay out dividends.

Conclusion

A smart dividend investor is not interested in companies that are giving high dividends for just one year and unable to sustain similar dividends in the future. Instead, he looks for a company that pays stable dividends consistently for years without dividend cuts.

A recession or bad market should not prevent a good company from paying dividends to its shareholders. The calculation of dividend per share tells how profitable a company is. Generally, they are paid in cash, but if the company is low on cash, it can also pay in property, stock, bonds, scrip, etc. A good DPS attracts investors, and a low DPS leads an investor to sell its stakes.

Difference between Equity and Preference Shares

Posted on Nov 01 2022 by Aditya Paleri

Introduction

Are you looking to build your wealth through stock market investments?

But, the lack of knowledge has left you feeling stuck?

…and the complex terminologies on the internet provide no hunky-dory either?

Well!

Do not worry. We have got you covered.

Let us take you through the difference between equity shares and preference shares while covering the basics of the matter entirely.

What is a share?

A share is a part of ownership in a company acquired through an exchange of capital. The market value of shares fluctuates depending on market forces or external influences on the market.

As per section 43 of the companies act 2013, the share capital of a company can have two types of shares – equity shares and preference shares.

The primary difference between the shares is dividend payouts and voting rights.

However, to fully understand the difference between equity shares and preference shares, we need to understand both of these shares in more detail.

What are Equity Shares?

Equity shares are the shares issued by the company to the public for fund generation. This raised fund is typically used for the expansion of the business. The Equity shares serve as a source of finance for the long term, and they are also non-redeemable.

The main difference between equity shares and preference shares is that the equity shareholders are the real risk bearers of the company. Equity shareholders also possess voting rights and can claim company assets and dividends.

The company’s management determines the dividend rate they want to provide to such shareholders. One can quickly transfer Equity shares and the associated rights and duties to another person without consideration.

The number of shares a person has of a particular company directly signifies a shareholder’s ownership of the company. The trading of Equity shares in the stock market happens through a stock exchange.

Types of Equity Shares

There are various types of equity shares depending on ownership, dividend payments, preference, employment in the company, etc.

So, we have listed below all the types of equity shares, and they are as follows:

Ordinary shares

Ordinary shares are the shares that a company issues to raise funds for meeting its long-term expenses. An investor gets ownership of the firm in exchange for these shares. The portion of ownership received by an investor is equivalent to the number of shares they hold. The ownership allows shareholders to have a say in the company’s decision-making, thereby providing them with voting rights.

Preference equity shares

Preference equity shareholders lack voting rights or membership rights that ordinary shareholders possess. But, these shareholders are prioritised during dividend payments above ordinary shareholders, and they also receive the assurance of cumulative dividend payments.

Preference equity shares are further classified into two types:

Participating Preference Equity Shares
Non-participating Preference Equity Shares.

Participating preference equity shareholders receive a specific amount of profits and bonus returns in a specific financial year. However, these benefits largely depend on the company’s success.

Non-participating preference equity shareholders do not receive any such benefits.

If the company goes insolvent, preference equity shareholders will receive the repayment of capital before the ordinary shareholders during the winding-up phase.

Bonus shares

When a company has access to retained earnings, it decides to distribute its profit in the form of a bonus issue. Hence, Bonus shares are the type of equity shares that the company issues to its existing shareholders from its earnings.

Since the issue is made to the existing shareholders, there is no increase in the company’s market capitalisation. However, market capitalisation does increase when other types of equity shares are issued.

Right shares

Right shares are exclusive shares reserved for only specific or premium investors, and these shares facilitate an increase in the equity stake of a particular shareholder.

The main objective behind issuing right shares is to raise money from premium investors for a specific financial requirement. Hence, the issue of such shares happens at a discounted price.

Sweat equity shares

Sweat equity shares are those shares that are received only by the directors and employees of a company.

The shares are issued to the employees or directors as a token of appreciation for their excellent work.

It is issued to applaud the contribution of such employees and directors to the intellectual property rights, know-how, or value addition to the company; sweat equity shares are issued at a discount to such directors and employees.

Employee Stock Options (ESOPs)

Employee stock options (ESOPs) are a grant provided by the company to its employees and directors for retention and incentive purposes.

This grant states that an employee can purchase certain shares at a predetermined price on a future date under the terms specified in the Employee stock option plan (ESOP).

After this grant is offered, it is exercised only for those employees or directors who have accepted it.

Treasury stock

When a company decides to conduct a buyback of its shares, the shares repurchased are called Treasury Stock.

Hence, treasury stocks are those equity shares repurchased from the stock market by the company.

Why should one invest in Equity Shares?

Equity shares offer capital appreciation to the shareholders based on their investment value. These shares also provide the benefit of substantial dividends.

Many equity shares, especially with a high trade volume, are highly liquid, enabling the shareholder to sell them quickly. They are also permanent sources of capital and help secure company credit for the long-term, thereby allowing the shareholders to receive long-term benefits.

Many investors give high credits to companies with substantial equity capital because mainly they are large-cap stocks of established companies with a long-term past record. This makes it safer for investors to invest in such companies. Further, the payment for any liability arising out of equity shares is mandatory.

However, a red flag could be that the companies are not liable to pay dividends to the shareholder, and they can use the retained earnings for the expansion and growth of the business.Hence, equity shares might not be your go-to choice if you are looking for steady dividend payouts.

What are Preference Shares?

Preference Shares are those shares given to the public at a fixed dividend rate. These shareholders are prioritised over the ordinary shareholders in terms of paying dividends, thus providing fixed-income security. These shareholders have preferential rights over the profits and claims over company assets in the event of liquidation.

Preference shareholders, however, do not have voting rights in the company as compared to equity shareholders. Preference shareholders do not have any right to influence company decisions, and they also do not have the right to claim bonus shares.

One can convert preference shares into preferred stock. However, they cannot be converted into equity shares and traded in the market except in some cases.

The issuers can repurchase preference shares on a given date. These shares provide substantial dividends.

The company may not pay dividends to preference shareholders in case of loss. However, the company must pay this dividend to its shareholders later.

Types of Preference Shares

Preference shares have been categorised into multiple types depending on various factors. The categorisation factors are dividend payout, convertibility, redeemability, participation and dividend rates.

Based on dividend payout

There are two classifications of preference shares, depending on the payment of dividends of the shares, and they are as follows:

Cumulative preference shares

A cumulative preference share is preferred stock with leverage. This agreement for this stock states that if any dividend payments are missed in the past, the company must pay the missing dividends to owners of cumulative preference shares first.

Hence, cumulative preference shares include a clause that allows stockholders to receive payments in arrears. When a company’s profits are insufficient to pay dividends in a given year, cumulative dividends are paid the following year.

Non-cumulative preference shares

Non-cumulative preference shares are the shares that do not receive a dividend if the company has missed them in a particular year.

Because non-cumulative preference shareholders are paid from the current year’s net income, this is why such shareholders do not enjoy cumulative dividends.

As a result, if a corporation makes a loss in a given year, shareholders cannot collect outstanding dividends from future revenues.

Based on convertibility

There are two classifications of preference shares based on convertibility of shares, and they are as follows:

Convertible preference shares

Convertible preference shares are essentially those shares that allow holders to convert them into equity shares at a predetermined rate.

In particular, as indicated in the memorandum, these shares can only be converted after a set period has passed.

Convertible preference shares are appropriate for investors who want to obtain preferred share dividends. It also benefits people who want to profit from changes in the price of stock shares.

As a result, such shares assist investors in generating consistent earnings while also providing the possibility to earn more significant returns regularly.

Non- convertible preference shares

Non- convertible preference shares are those shares that carry preferential rights and cannot be exchanged for an issuer’s equity share.

Instead, they are redeemed at the expiry of their tenure.

Holders of Non-convertible preference shares have no right to receive equity shares when they reach maturity.

After compensating the equity shareholders, such shares have the right to partake in any further profits.

Based on the rate adjustment

There is one category of preference shares based on the rate adjustment of shares, and that is as follows:

Adjustable rate preference shares

An Adjustable Rate preference share is a stock whose dividends are linked to a benchmark, most commonly a T-bill rate.

The adjustable-rate preference share’s dividend value is defined by a predetermined formula to change with rates. These values of frequently changing rates are more stable than fixed-rate preferred stocks, given the impact of inflation.

The rate of dividend paid on the adjustable-rate preference share is a variable rate significantly influenced by current market rates. It directly impacts the number of dividends paid to shareholders during the investment.

Based on redeemability

There are two classifications of preference shares based on the redeemability of shares, and they are as follows:

Redeemable preference shares

Redeemable preference shares are also known as callable preferred stock. These shares are one of the most efficient ways to fund large corporations.

Redeemable preference shares are easily traded on stock markets and have a mix of equity and loan funding. A firm usually has the authority to repurchase shares that have served its purpose.

As a result, redeemable preference shares are repurchased at a fixed rate on a specified date or by making an advance announcement.

These shares help reduce the impact of inflation and monetary rate declines.

Irredeemable preference shares

The irredeemable preference shares cannot be reimbursed or redeemed throughout the company’s active life.

Shareholders will have to wait until the company decides to wind down or liquidate its current activities before taking action.

The irredeemability factor turns the company’s shares into an everlasting obligation. Because these shares lack an integrated redemption clause, they cannot be purchased back at the issuing company’s discretion.

In India, a company cannot issue irredeemable preference shares.

Based on participation

There are two classifications of preference shares based on the participation of shares, and they are as follows:

Participating preference shares

Participating preference share is a preferred type that allows shareholders to participate in the company’s additional earnings. The participation feature boosts the stock’s value, allowing the issuer to sell it for more money.

The participation comes on top of the fixed dividend, similar to most varieties of preferred stock.

During liquidation, these shareholders receive additional consideration and the right to receive the repurchasing price of the stock and a pro-rata portion of any remaining proceeds distributed to common shareholders.

Non-participating preference shares

Non-participating preference shares are not entitled to any surplus earnings or assets during a company’s liquidation. This sort of stock allows its owners only to receive pre-determined dividends.

Regardless, these shares are entitled to a fixed rate of return in the form of a dividend. They enjoy preference rights that enable them to be paid before common stockholders. This right extends to even the previous unpaid dividends, which the company should clear before paying off dividends to holders of common stocks.

Why should one invest in Preference Shares?

Preference shares are a particular type of shares as they get the first claim on company profits before any other shareholder.

Preference shareholders are entitled to fixed dividends delivered at predetermined rates by the company. This policy is why preference shares are considered less risky than equity shares because there is more security in receiving dividends than in equity shares.

During the company’s liquidation process, preference shares are preferred for capital repayment over equity shares.

According to the Income tax act 1961, the dividends earned from preference shares will be exempted from tax up to INR 10 lakh.

However, the preference shareholders do not enjoy any voting rights and they might not receive dividends when the company has incurred a loss except in the case of cumulative preference shares.

What is the difference between Equity Shares & Preference Shares?

The ultimate criteria in which equity shares and preference shares differ are none other than the methodology of dividend payouts and voting rights.

In this article, we have read, time and again, that preference shares receive preference in terms of dividend payment and capital repayment.

The preference share also receives dividends at a company’s predetermined fixed rate. However, equity shares might or might not receive dividends depending on the company’s profits.

In many cases, the company is obliged to pay preference dividends year after year, but the company is in no manner obliged to pay dividends to the equity shareholders.

Hence, some investors believe that preference shares are safer than equity shares because of their steady dividend payout policy.

But, the downside happens to be a lack of say in the critical matters of the company.

Preference shares do not enjoy voting rights. Hence, they cannot interfere in the critical matters of the company, but equity shares do have exclusive voting rights to do so.

But, these differences are not enough for an investor to decide their investment choices.

So, to help the investors make a well-informed and thoughtful decision, we have provided an all-encompassing comparison chart stating the difference between equity and preference share.

The ensemble comparison chart is as follows:

Equity Shares v/s Preference Shares

Serial No.	Basis	Equity Shares	Preference Shares
1.	Definition	Equity shares represent certificates of ownership held by a company’s investors in exchange for the capital provided.	Preference shares are shares that enjoy preference over other ordinary shareholders for claims over the company’s profits and assets.
2.	Types of Return	Equity shareholders enjoy substantial returns in the form of capital appreciation.	Preference shareholders enjoy steady dividend payouts.
3.	Dividend payout	Equity shareholders receive dividends after dividend payments of preference shareholders.	Preference shareholders receive dividends before any other shareholders.
4.	Rate of Dividend	An equity share’s dividend rate is determined by the company’s profits.	Preference shareholders receive dividends at a fixed rate.
5.	Eligibility for Bonus Shares	Equity Shareholders are eligible to receive bonus shares against their existing shares holdings.	Preference shareholders are not eligible to receive bonus shares.
6.	Repayment of capital	Equity shareholders are paid at the end of the company’s liquidation process.	During the company’s winding up or liquidation process, preference shareholders are paid before the other existing shareholders.
7.	Voting rights	Equity shareholders enjoy a say and exclusive voting rights in the company.	Preference shareholders do not have any say and voting rights in the company.
8.	Say in management decisions	Equity shareholders have a say in the critical matters of the company and can participate in management decisions because of their exclusive voting rights. These shareholders are allowed to interfere in the company’s managerial decisions to the extent of their ownership.	Preference shareholders do not have any right to interfere in the company’s managerial decisions. They do not get any say in the critical matters of the company due to a lack of voting rights.
9.	Redemption	The Equity Shares cannot be redeemed, and they are the long term financial resources of the company.	Preference shares are redeemable depending on the type of their redemption.
10.	Convertibility	Equity shares are not allowed to be converted into any other type of shares.	One can convert preference shareholders into equity shares if they are convertible preference shares.
11.	Outstanding Dividends	If the company has not paid a dividend in the previous years, they are not obliged to pay outstanding compensation to the equity shareholders.	If the company has not paid a dividend in the previous years, they are obliged to pay outstanding dividends to the preference shareholders who hold cumulative preference shares.
12.	Capitalisation	There are high chances of capitalisation in terms of equity shares.	There are low chances of capitalisation in terms of preference shares.
13.	Types of shares	The various types of Equity shares are as follows: Ordinary Shares Bonus Shares Right Shares Sweat Equity Shares Employee Stock Options Treasury Stocks.	The various types of Preference Shares are as follows: Convertible preference shares Non-convertible preference shares Redeemable preference shares Non-redeemable preference shares Cumulative preference shares Non-cumulative preference shares Participating preference shares Non-participating preference shares Adjustable-rate preference shares
14.	Term of financing	Equity shares are a source of long-term financing.	Preference shares are a source of medium to long-term financing.
15.	Mandate	Companies must issue equity share capital to get listed on the Stock exchange.	All companies do not need to issue preference share capital.
16.	Investment	The investment cost for equity shares is low.	The investment cost for preference shares is comparatively higher than for equity shares.
17.	Investor suitability.	Equity shares are suitable for investors with a high-risk appetite.	Preference shares are suitable for investors with a low-risk appetite.
18.	Obligation for dividend payment	A company is not obliged to pay dividends to its equity shareholders.	A company is obligated to pay dividends to its preferred shareholders.
19.	Liquidity	Equity shares are highly liquid, and experience quick trading on the stock market.	Preference shares are not liquid, but the company can buy back these shares.
20.	Insolvency	During the insolvency of a firm, equity shareholders are paid after full repayment of preferred shareholders.	During insolvency of a firm, preference shareholders are paid before equity shareholders, and they also have a preferential claim over the company’s assets.
21.	Liquidation	Equity shareholders are paid after payment to creditors and preference shareholders during liquidation.	Preferred shareholders are paid after payment to creditors but before equity shareholders during liquidation.

Final Thoughts

The one similarity between equity shares and preference shares is that they both are the owned capital of the company.

In a nutshell, an active investor can invest in equity shares as they are traded highly in the stock market. But, an investor with a less risk appetite looking for steady returns should opt for preference shares.

How does the difference between the Equity market and debt market affect the investors?

Posted on Nov 01 2022 by Aditya Paleri

Introduction

As an investor, one must make several decisions.

Decisions like: Where should I invest?

What are my investment objectives?

Which investment will meet my investment objectives?

Answering all these questions is the most crucial part involved in the process of making a good investment.

To answer these questions, you must have a basic idea of the investment opportunities.

There are numerous investments where you could invest your funds.

Debt and Equity instruments are the two most famous ways of these investment options.

So, dig deep into the fundamentals of these investments and understand how you could invest your money in these instruments.

Both the Debt instruments and the equity instruments are traded in different markets.

Namely, the Debt and Equity markets, respectively, so let us understand what is Debt and equity market in depth without any further ado.

What is an Equity Instrument?

Equity instruments are used to fund the company’s operations by the companies relying on the equity instruments to fund their operations and provide proof to the investors of their ownership.

When any public company is required to raise funds from the market, it uses common stock or equity shares, which acts as an equity instrument for the company.

The investors who invest in these instruments get ownership associated with their holding percentage.

The investors of these equity instruments have a right to vote in company meetings, according to the intensity of their ownership.

The returns to the equity instrument holder are dividends issued by the company.

What is the Equity Market?

An equity or share market is a market where shares of the companies are issued and traded, either by way of the stock exchange or other markets.

The equity market is one of the most vital areas of a market economy.

The equity market gives companies excess to issue shares and generate capital.

On the other hand, it offers investors an access to invest in the equity shares of the companies and claim their partial ownership in the company.

This gives investors the potential to realise gains in their investment based on the company’s future.

In other words, equity markets are the point where the buyers and sellers of stock can meet.

Indian stock markets are National Stock Exchange (NSE) and The Bombay Stock Exchange (BSE).

Trading in an Equity Market

In the equity market, the investors offer a bidding price for a stock, and sellers ask for a specific price.

When the bid and the ask rate match, there happens a trade.

The buyer investors buy at the market price, and the seller sells at the market price.

A company’s stocks are considered publicly traded when a company offers its stock to be traded in the stock market.

These shares are easily traded in the stock market, and the investors are rewarded by the company’s performance as the stock price rises.

The risk in the equity market comes when the company is not doing well, and the market price of the company’s shares may fall.

The price of a stock in the equity market also depends on the demand for that stock in the equity market.

For example, if the demand for a company’s stock is high, then the price of such stock tends to rise, and when many investors want to sell the stock, the price of such stock tends to fall.

Types of trade in Equity Market

There are various types of trade that happen in the Equity Market and they are as follows:

Intraday Trades

It is a process of buying and selling the shares on the same day.

For example, if you buy four shares of Reliance on Monday and sell them off on the same day, then such trade is an intraday trade.

Buy Today Sell Tomorrow (BTST)

Buy today, sell tomorrow enables an investor to sell off the shares before they are credited to their Demat accounts.

For example, if you buy four shares of Reliance and enter into buy today sell tomorrow, you could sell the shares before they are credited to your Demat account.

Position Trades

Position trading disregards short-term specifications in favour of long-term goals.

How Does the Equity Market Work?

Shares of the companies listed on the stock exchange are traded in the equity market.

A company’s stock indicates the part of ownership in the company; the shareholder with a majority of shareholding becomes the company owner.

Equity markets are riskier than debt markets.

A daily trade of the listed shares in the market during the market working hours happens.

The returns on the investment in an equity market are not guaranteed; returns may come in the form of dividends issued by the companies or by selling the shares at a price higher than the investment and booking the profit.

The equity markets are highly fluctuating, and the price of a share in the market is affected by the following factors:

Company’s operations.
Company’s Financial health.
Industry’s overall performance.
Demand and supply.

Though investing in the equity market includes risk.

However, if it is approached with discipline, it can become one of the most effective ways to build a fortune.

Who can invest in the Equity Market?

An Equity market consists of risk and high fluctuations. To invest in an equity market, an investor must have the following characteristics:

Knowledge of the Market

“When you know better, you do better.”

Other than the time to check the stock market for a whole day, the good investor should have at least a basic knowledge of the stock market and how it works.

The investor should understand the stock’s position and analyse the company and its operational and investment strategy.

An investor should understand the growth pattern of the company.

A person ready to be an active learner can gain knowledge to invest in the stock market.

Decision Making

Investors can make decisions regarding their investment and exit decisions by analysing the trends and understanding the stock exchange.

Investors should keep an eye on the current scenario in the market.

They should keep themselves updated about the market to make rational decisions.

A person with good decision-making power can invest in the stock market by analysing the market.

Patience

“Keep calm and carry on.”

Investors who invest for some time and give time to the stock market to provide them returns.

The stock market is fluctuating; thus, patience is required to play a stock exchange game.

An investor should have confidence in his plans.

An investor who does not get carried away by the trends and loses patience can invest in the stock market.

Risk Aversion

Investment in a stock exchange comes with risks as it is a fluctuating market.

Thus an investor should know what risk he is taking.

Risk aversion is one of the essential qualities of a stock market investor, which can save him from losing investments.

Different ways to invest in an Equity Market

An investor can access the equity market in the following two ways:

Direct Investment

An investor can invest directly in shares of the companies through a stock exchange.

Investors wanting to invest directly in the stock market should research and determine which industry suits their investment needs best.

One should keep up to date regarding the companies’ current performance and the factors affecting the stock market.

Mutual funds

Mutual funds are the pooled investment vehicles.

A pool of funds is collected from the investors and then invested in the stock market.

Here an investor is not directly involved in the investment decision-making.

Fund managers are appointed experts in the stock market and invest on behalf of the mutual funds.

Here, the investor need not research the stock market. Mutual funds issue returns to the investors who invest in the units of a mutual fund.

What are the merits and demerits of an Equity market?

There are several advantages and disadvantages of investing in the Equity Market.

Listed below are some of the pros and cons of the Equity Market that will help you make well-informed investing decisions.

Pros of the Equity market

The pros of investing in an Equity market are as follows:

Dividends

An equity market has many stocks listed and traded daily. There are always low-risk stocks that give regular dividends.

Risk-free dividends are considered to be better than risky capital gains.

Availability of information

Currently, the financial market is trending; thus, financial experts are always sharing valuable information on multiple platforms.

Gaining knowledge about the stock market is not too difficult today.

If the investors know the current articles to read and the correct platform to gain the information, they can gain a good knowledge of the stock market and make informed decisions.

Long-term growth potential

Investing in the stock market requires patience.

If an investor is patient enough, he can earn long-term returns in the stock market.

Not only through the price appreciation but also by compounding the dividends received throughout the period.

Risk Management

Investors can manage their risks in the stock market. Investors having a good grip on statistical methods can manage their risks in the market.

Sometimes taking risks can make an investor hit the jackpot, but risks should be calculated under the investor’s risk appetite.

Cons of an equity market

The cons of investing in the Equity market are as follows:

Volatility

Investing in the stock market comes with a risk as the stock market is highly volatile.

Share prices increase and decrease multiple times in a single day.

These fluctuations are primarily unforeseeable that can cause risks to investments.

The chances of a high loss in a day are less, but the market may take years to recover from a financial crash.

Brokerage can decrease the profit margins

Every time an investor does a buy or sell transaction, they have to pay a brokerage fee to the broker.

This, in turn, can reduce profitability.

What is a debt instrument?

Debt instruments are tools an individual, government entity, or business entity can utilise to obtain capital.

An entity uses debt instruments to procure capital and promises to pay it back.

Credit cards, credit lines, loans, and bonds can all be types of debt instruments.

What is the debt market?

The debt market is where investors buy and sell debt securities, mostly in the form of bonds.

India’s debt market is the largest in the whole of Asia.

Mainly two categories of securities are in the Indian debt market— the government securities comprising central government and state government securities and the corporate bond market.

Classification of the Indian debt market

The Indian debt market is classified into two categories and they are as follows:

Government securities Market (G-Sec Market)

It consists of central and state government securities. By issuing such securities, the government procures finance in the form of Debt.

It is the most dominated category in the Indian debt market.

The government of India bond is an example of Government security.

Bond market

Financial institutions’ bonds, corporate bonds, public sector unit bonds, and debentures are the main components of a Bond market.

These bonds are issued at a fixed rate of interest. Funds are procured by issuing such bonds in exchange for fixed interest payments.

Thus, it reduces the uncertainty in financial costs.

How does the debt market work?

The debt market is segmented into two broad types and they are as follows:

The Primary market

A primary market is a market where the transactions occur directly between the issuer of the bond and the buys of the bond.

It is also referred to as the new issues market.

Companies issue brand new bonds in the primary market that have not previously been issued to the public.

The Secondary market

A secondary market is a market where investors can purchase bonds from the broker who works as an intermediary between the selling and the buying parties.

The securities which have already been sold in the primary market are brought and sold in the secondary market.

A debt market broadly refers to a market where buying and selling of various debt instruments by multiple entities.

The government and the corporation issue bond and other debt instruments in the market to procure funds and pay the investor fixed returns in interest payments.

They also promise to reply to the investment amount at the maturity date.

The transactions happen just like the stock market, where the ask and bid prices are matched.

Different ways to invest in a debt market

An investor can invest in the debt market in two ways and they are as follows:

Direct investment

An investor can directly invest in the debt market through private placements with the companies to invest in corporate bonds.

The Reserve Bank of India, the issuer of government bonds, organises an auction to sell the bonds.

The investor has to participate in such an auction. There are two ways an investor can participate in such auctions and they are as follows:

Competitive bidding: Competitive bidding is complicated. Thus, large investors like banks and mutual funds participate via competitive bidding.
Non-competitive bidding: Non-competitive bidding can be done through online portals and thus making it a more straightforward process. This is an easier process for retail investors to participate in the auction. The National Stock Exchange (NSE) has an application called goBid where any individual can invest in government securities.

Mutual Funds

Mutual funds work the same way in the debt market as in the equity market.

It is an indirect way to invest in bonds.

The fund manager is appointed for a mutual fund and will decide rationally which government security or bond to invest in.

Mutual funds and hybrid mutual funds are a few ways to invest in bonds.

What are the merits and demerits of the debt market?

There are several advantages and disadvantages of investing in the Debt Market. Listed below are some of the pros and cons of the Debt Market that will help you make well-informed investing decisions.

Pros of the Debt market

The pros of investing in the Debt market are as follows:

Assured returns

One of the biggest advantages of investing in a debt market is that there is a certainty of fixed returns.

By investing in the debt market, an investor issues a loan to the company indirectly and interest payments on loans are fixed and assured.

Risk-Free returns

Unlike the equity market, the Debt market provides fixed returns to the investor.

The rate of interest is pre-specified and computed every year, the market factors do not affect the returns of an investor.

High liquidity

Another advantage of investing in the debt market is that debt instruments are highly liquid.

Banks offer easy credit to the investor against government securities and other secured bonds.

Cons of the Debt market

The cons of investing in the Debt market are as follows:

Fewer returns

There is a saying that goes, higher the risk, higher the return.

The risks involved in investing in a debt market are lesser as compared to the risk involved in investing in the equity market.

The returns on investment in the debt market are lesser than the investment in the equity market.

No part in profits

Investment in bonds of a company comes with interests, and no part of profits is distributed to the bondholders.

Even if the company is earning huge amounts of profit and performing exceptionally, the bondholders will get the fixed interests only.

How is the Equity Market different from the Debt Market?

For an investor, it is important to understand the difference between the Debt and Equity market before deciding on their investment choices.

Hence, to deliver a crystal clear understanding of how the equity market differs from Debt market, we have provided an all-encompassing comparison chart providing all the details about Debt vs Equity Market.

Serial No.	Parameter	Equity Market	Debt Market
1.	Meaning	Equity is the owner’s capital. Investors become part owners by investing in the equity market.	Debt is in the form of borrowed capital; it has the same features as a loan or debt.
2.	Who can issue it?	The companies are registered with the Securities Exchange Board of India (SEBI).	Any Corporations and central or state governments.
3.	Risk.	The risk associated with the equity market is high due to the volatility.	The risk associated with government bonds is nil while the risk associated with corporate bonds is low to moderate.
4.	Returns.	Returns are high but not fixed; the returns are in the form of dividends and capital gains.	Returns are low but fixed and risk-free; the returns are in the form of interest or coupon payments.
5.	Investor’s status.	An investor who invests in the equity shares of the company becomes a part-owner of that company.	An investor who invests in the bonds of a company becomes the loan provider or Creditor of the company.
6.	Regulators.	Securities and exchange board of India (SEBI).	Reserve Bank of India (RBI) and Securities and exchange board of India (SEBI) in case of corporate bonds.
7.	Securities Traded.	Equity shares are traded in the Equity Market.	Corporate and government bonds are traded in the debt market.

Conclusion

Rational investors always make decisions after taking into consideration all the factors that affect their investment objectives.

Selecting a market where you should invest boosts your chances of getting good returns.

You have learned about the debt market and the equity market including the risks associated with them.

After gaining a basic idea about how these markets work and how you could invest in these markets, you would be able to make rational decisions to meet your investment decisions.

You could even blend your portfolio in a way that your desired risk level is met even after investing in the stock market.

Any investor should not take blind risks, one should not invest all their funds in a single investment, and one must have multiple securities who work for them.

The weights of risky and risk-free securities should be allocated in a way that the risk of investing in risky stocks gets reduced by investments made in risk-free securities (like government bonds).

Introduction

What are Non-Operating Expenses?

Non-Operating Expenses Examples

Non-Operating Expenses Calculation

Example

Non-Operating Expenses components

Difference between operating and Non-Operating Expenses

The primary difference

Types

Making decisions

Classification in financial statements

Types of Expenses

Cost of Goods Sold

Operating Expenses

Financial Expenses

Extraordinary Expenses

Non-Operating Expenses

Introduction

What is derivative?

How do Derivatives work?

Why do investors enter derivative contracts?

Arbitrage advantage

Protection against market volatility

Park surplus funds

Types of derivatives

Options:

Forwards:

Futures:

Swaps:

Advantages and limitations

Hedging risk exposure

Market efficiency:

Access to unavailable assets or markets:

Limitations

High risk:

Counterparty risk:

Speculative Features:

Requires Expertise:

Who participates in the derivatives market?

Hedgers:

Speculators:

Arbitrageurs:

Margin traders:

Criticism and misuse of derivatives

Speculation and gambling

A destabilisation and systematic risk

Complexity

How big is the derivative market?

Notional value

Gross market value

How is Derivative Used?

Examples and Interpretation

Conclusion

Introduction

What is a Bonus issue?

Pros and cons of a Bonus issue

Pros of a Bonus issue

Cons of a Bonus issue:

What are the different types of Bonus issues?

Effect on the Face Value?

What does it mean to an investor?

What is the impact of bonus issues on share capital and reserves?

What is a Stock split?

What is a reverse stock split?

Pros and cons of a Stock split

Pros of a stock split:

Cons of a stock split:

How is Stock Split different from a Reverse stock split?

What is the Effect of a stock split on the Face Value?

What does stock split mean to an investor?

What is the impact of stock split on share capital and reserves?

What is the difference between Bonus issue and Stock split?

Stock Split vs Bonus Issue

Conclusion

What is Equity Share Capital?

What are Equity Shares?

Equity Share Capital meaning

Equity Share Capital Formula

Elements of the Formula

Example of Equity Share Capital