Accounting for Inventories - LIFO or FIFO

LIFO = Last in First Out

FIFO = First in First Out

FIFO means that the inventories that are purchased first are the first to be sold.

LIFO means that the inventories that are purchased last are the first units to be sold.

Companies usually shift from FIFO to LIFO to show less taxable income. Since inventories purchased last would cost higher, the net Income ( Revenues - Cost of Goods) would be less and also the taxable income calculated would also be less.

Common Ratios for Financial Analysis - III

Solvency Ratios
A company being solvent means it can meet its financial obligations.
Current Ratio = Total Assets / Total Liabilities
Acid-test Ratio = Quick Assets / Total Liabilities

Debt Ratio = Total Debt / Total Assets
Debt-to-Equity Ratio = Total Liabilities / Owners quity

Time Interest Earned Ratio : This ratio is used by the creditors who lend money to the businesses. This is to make sure if it is safe to lend money to the investors.

Time Interst Earned Ratio = EBIT / Interest Expense

Commmon Ratio for Financial Analysis - II

Activity Ratios

These ratios help in understanding how well the assets are used being utilized. Efficient usage of assets allows for lesser investment by lenders and owners and thus means less risk involved in the business.

1. Days receivables outstanding : This ratio tells about the days required to make collection on the sales. If more days are required to gather sales capital then more working capital is required to run the business.

Days Receivables Outstanding = Account receivables / Average sales in a day

2. Inventory Turnover : This ratio usually tells how quickly the inventory is moving out to earn money for the company

ITR = Cost of goods sold / Average Inventory

Common Ratios for Financial Analysis - I

Return on Assets = Net Income / Total Assets
This ratio usually tells about the utilization of the assets committed to the business.

Return on Equity = Net Income / Shareholder's Equity
This ratio tells about how well the shareholders investment is used in the business.

Return on Investment
This is a very vague term since "investment" is not defined clearly. Investment may be in the form of assets or owners equity or shareholders equity.

EBIT = (Earning before Interest and Taxes) is also known as the operating margin
Operating Margin = EBIT / Net Sales

An operating margin of 0.12 means company is making 0.12 $ on every 1 $ of sales.
EBIT comes after the company has taken into the consideration the wages, the cost of production, cost of raw materials and other things.

Fully Diluted EPS = (Net Income - Preferred stock dividends)/ ( common stock + equivalent)

Profit Margin = Net Income / Net Sales. This is also known as the retun on sales

PLR - affecting the micro economics and the macro economics

Macro Economics

If the prime lending rate is increased, the borrowing cost would increase. This would slow down the production of the companies. This is would result in slower growth of the industry. The GDP would be affected. Because of lesser revenue and lesse profits, the tax to the government would decrease.

This will decrease inflation

Micro Economics

From microeconomics perspective, high PLR will hit the production. High lending rates will also hit the consumer demand. The company may then have to cut down on the production, lay off staff, take care of the inventory and other things in the purview of micro economics.

Greeshoe Option

The explanation for greenshoe option has been taken from investopedia.

Greenshoe option gives the underwriter an option to increase the allotment of shares.

In case the issuer feels there is a need for more capital or even to stabilize the price of the security it may be decided to over-allot the securities.This could also be done in case the demand for the security increases far more than expected.

Greenshoe option may allow the underwriter to issue 15% more shares than the original decided number

Difference between Bonds and Debentures

Bonds and Debentures are very similar to each other in the sense that both are fixed income instruments that offer a very safe route of investment. However there are certain differences between the two which this blog will try to clear

1. The first major difference between the two is that the bonds are secured by some underlying assets. This means that in case a company defaults on the payment of principle and interests, the investor can claim on the asset. In simple terms no collateral is offered for debentures.

2. Bonds are generally issued by the government whereas the debentures are issued by the corporates

3. Because debentures are unsafe compared to bonds, interest rates offered are higher on debentures.

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