Archive for Stock Terms & Definitions

Depreciation Guide: Straight-Line Method & Declining-Balance Method

Assets with finite lives lose their value over time. Land is the only asset that is not finite. For all other assets, firms depreciate their value, that is, they attribute the historical cost of the asset over its useful life (the number of years that the asset will be used).

At the end of each fiscal year, firms subtract depreciation claimed to that date from the historical cost of the asset, which results in the asset’s current book value or market value. At the end of the useful life of the asset, the portion left that has not been depreciated is the salvage value of the asset if it were to be sold.

There are two common methods used for determining the value of depreciated assets: the straight-line method and the declining balance method. The straight-line method assumes that the asset loses an equal percentage in value during each year of its useful life. The declining balance method assumes that the asset loses more value (depreciates) during the earlier years of the asset’s useful life by assuming the asset loses an equal percentage of its value every year. An example using both methods is shown below for a $10,000 asset that’s expected to be used for 10 years and then salvaged for $1000.


 

Straight-Line Method

 

Year

Annual Depreciation

Year-End Book Value

   

1

10%($9000) = $900

$10,000 - $900 = $9100

   

2

10%($9000) = $900

$10,000 - $1800 = $8200

   

3

10%($9000) = $900

$10,000 - $2700 = $7300

   

4

10%($9000) = $900

$10,000 - $3600 = $6400

   

5

10%($9000) = $900

$10,000 - $4500 = $5500

   

6

10%($9000) = $900

$10,000 - $5400 = $4600

   

7

10%($9000) = $900

$10,000 - $6300 = $3700

   

8

10%($9000) = $900

$10,000 - $7200 = $2800

   

9

10%($9000) = $900

$10,000 - $8100 = $1900

   

10

10%($9000) = $900

$10,000 - $9000 = $1000

   
 

 

Declining-Balance Method

     

Year

Annual Depreciation

Year-end Book Value

   

1

20%($10,000) = $2000

$10,000 - $2000 = 8000

   

2

20%($8000) = $1600

$8000 - $1600 = $6400

   

3

20%($6400) = $1280

$6400 - $1280 = $5120

   

4

20%($5120) = $1024

$5120 - $1024 = $4096

   

5

20%($4096) = $819.20

$4096 - $819.20 = $3276.8

   

6

20%($3276.80) = $655.36

$3276.80 - $655.36 = $2621.44

   

7

20%($2621.44) = $524.29

$2621.44 - $524.29 = $2097.15

   

8

20%($2097.15) = $419.43

$2097.15 - $419.43 = $1677.72

   

9

20%($1677.72) = $335.54

$1677.72 - $335.54 = $1342.78

   

10

20%($1342.78) = $268.44)

$1342.78 - $268.44 = $1074.34

   

 

From the table it is easy to see that the straight-line method results in the same deduction every year while the declining-balance yields much higher deductions during the earlier years. An implication of the declining-balance method is that the asset can be sold for a higher value before it is due to be salvaged and pose a greater tax gain for the firm.

Proper Estate Planning Fundamentals - How To Reduce The Burden On Our Family Members After Our Death

If you want to help in softening the impact of your death on your loved ones, then you should think of “estate planning”. This does not just include previously written wills, the distribution of one’s assets, or ensuring that all your wishes are carried out, for it includes much more.

A major element in estate planning is protecting your belongings from unwanted recipients, such as greedy relatives and strangers or the IRS itself. By carefully planning your estate, you can avoid most of the hustle that results from your death. First of all, in order to do this, you must have someone in your mind to whom will get your things after your death. Through estate planning, you can also ensure that the people you care about are provided for; it will help you find solutions to protect those you love, whether they are humans or even pets. Estate planning, moreover, entails taking care of a limitless number of details regarding you death, such as the location and method of burial.

In addition, such planning encompasses psychological aspects, for it will help you to come to terms with your own mortality and all the issues related to it. Furthermore, estate planning is a way of helping those we leave behind in one of their most chaotic situations, our death.

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Business Operating Cost & Cashflow - How To Manage Business Operating Capital

Operating expenses are those costs every business has that are not considered directly related to a company’s first line of business. Operating costs include sales and marketing, research and development (R&D), and administrative costs. Investors want to make sure management is doing the best job it can keeping these costs in control. Operating expenses are available on the financial statements that every publicly traded company files with the SEC.

Management also must do a good job turning a profit with its own operations. That means the costs associated with cost of goods sold (COGS), etc. must generate more than those costs. If not, well, the company must be in the wrong line of business. Companies should never be operating at a loss. If a company is operating at a loss exactly why needs to be interpreted by the prospective investor

Operating margins represent the direct relationship between sales revenue and operating income. The operating margin of a firm is the operating income divided by net sales. It shows how much gross profit a company generates before taxes. Well-managed companies should increase these margins from year to year. The higher these margins are the more profits are available to return to shareholders investing in the company. Operating margins can be a useful tool when comparing two prospective stocks that compete within the same market. Higher operating margins represent a company in a better position to generate income. For example, a company with a lower operating margin than a competitor in its market will have less flexibility in determining prices. It’s competitor with higher profit margins will know this about it’s competitor and can “go for the jugular” by slashing prices and stealing market share.

Understanding Cash Flow Statement - How To Make And Read Cash Flow Statement

The cash flow statement sometimes is another financial statement that investors should become familiar with. It is another tool for managers and investors that shows how changes in the balance sheet and income affect cash. The cash flows are broken down into three parts: operating activities, investing activities, financing activities and the cash flows from each source. These changes shown on the cash flow statement are useful in determining the immediate health of the firm and its ability to function as an ongoing concern.

Operating activities are the production, sales, and delivery of the company’s products. These are the regular day to day activities of the firm that put it into business in the first place. This category will include figures like depreciation, taxes, and amortization of intangible assets (things like brand-name recognition).

Investing activities include the purchase and sale of long-term assets. Items here will include capital expenditures and investments. All investments made on behalf of the firm are including here. Purchases of plant, property and equipment are included as capital expenditures.

The financing activities represent the equity of the firm. This is the money owned by outside entities such as banks and shareholders as well as the payments to these owners of the company (dividends). If the company made any purchases or sales of its own stock, it will be included here.

The cash flow statement will contain a bottom-line, the net increase (or decrease) in cash. If a company is negative in cash, it will have issues paying its short-term debts and have difficulty continuing to do business. That’s not to say it will definitely fail, but will have to find other ways to generate cash to pay its bills. Remember, this statement does not detail income; just how much cash the firm has on hand. A sample cash flow statement is pictured below.

The Guide to Understanding Financial Statement - How to Read a Financial Statement

Income statements and balance sheets are two common annual financial statements. These reports contain information about a company’s performance that year and present a snapshot of the health of the company at a given point in time. Publicly traded companies are required to file them to the SEC and they are available to the public through EDGAR. Understanding the information contained in them can help an investor make better decisions. An income statement will always contain figures for revenue, cost of goods sold (COGS), selling, general, and administrative expense (SG&A), and earnings.

Revenue is gross income. It is the total income before any deductions are made for taxes, etc. COGS is the cost of purchasing raw materials and production costs. This is where accurate inventories are important because COGS equals the beginning inventory plus the cost of produced goods during the previous year, less the previous inventory. COGS figures show the cost of producing goods. These costs can show how well managed a firm is. SG&A expenses are the sum of salaries, commissions, and traveling costs for management and salespeople, advertising costs, and payroll costs. These figures also need to be controlled by management because, if they get out of control, they affect the profitability of the firm. Finally, earnings are the company’s revenue less expenses (COGS, SG&A, and taxes).

On the income statement these figures are easy to see because they are labeled just as described. Sometimes firms may refer to COGS as cost of sales, however.

The balance sheet is a snapshot of the firm’s health at a given point in time. The balance sheet has two parts: assets and liabilities. Asset items on the balance sheet are listed in the order of their liquidity or availability for use as company funds. Commonly listed asset items on the balance sheet are cash, accounts receivable, current assets, and fixed assets. We all know what cash is. Accounts receivable are debts owed to the firm. Accounts receivable are a current asset in that they are expected to be converted to cash within the year. Other current assets are cash, inventory, marketable securities, and prepaid expenses (rent, for example). Fixed assets are depreciated over time and are tangible, long-lived resources like plants and machinery. Liabilities are current liabilities (debts owed within the year), long term debt (payments over years), and equity (total value of shares owned by shareholders).

What’s most important to investors about the balance sheet is the book value of a stock can be determined from these lists of assets. Stockholder equity, or book value, represents the amount shareholders would theoretically receive if a firm went immediately out of business. Market value of the company is generally higher as firms do tend to make money. How much higher this market value is can help the investor determine if a stock is overvalued or, perhaps, undervalued.

Stock Investing for Dummy - What are Operating Expenses, Operating Income and Operating Margin?

All three of these terms have to do with the overall health of a company’s operations and the ability for it to continue as an ongoing firm. These figures are best studied over a period of time against competing firms within the market sector of the particular firm.

Operating expenses are part of the overhead costs attached to selling products on the market. They are not necessarily directly connected to the cost of the specific product being sold but must be included when figuring the operating expenses of a company. These include fixed costs of salaried employees (administration, sales, etc.) and variable costs (labor, research and development, etc.). Operating expenses are found on the income statement.

Operating income determines a company’s earning power from ongoing operations. This is the figure equal to earnings before deduction of interest payments and taxes. This is another figure commonly found on the income statement. This figure is also commonly referred to as operating profit or earnings before income and taxes (EBIT). Operating income is a direct result of a company’s efforts to turn a profit.

Operating income is required to determine operating margin along with net sales. Net sales is another figure that can be obtained directly from the income statement. By determining operating margin we can know the proportion of a company’s revenue that is left over after paying for variable costs of production (labor, raw materials, etc.). This figure helps the investor know the overall health of the company and how well managed the firm is. A firm must have a healthy operating margin to pay for the fixed costs involved in doing business like interest on debt. Operating margin is most valuable when tracked over time and compared to the operating margin of its competitors within the same market sector. Companies competing in different market sectors have different cost structures, of course.

101 Stock Market Investing - How do you find the “Industry Beta”?

Beta is the measure of how a stock’s trading price moves compared to the market as a whole. Knowing this figure one can understand how volatile a stock is. A beta of 1 means a stock’s price fluctuates exactly as much as the market. A beta less than 1 means a stock is less volatile than the market and a beta greater than 1 means that stock is more volatile than the market.

Betas can be determined for entire industries also. The “industry beta” would compare the volatility of the industry relative to the whole market. For example, technology stocks tend to be more volatile than the industry so the beta would be more than 1, generally.

To calculate industry beta you need some historical data of the price of the industry stock and historical price data of the entire market. For example if you were going to calculate beta over the last year for compare technology stocks versus the S&P 500, you would first gather the historical data you need. Next, determine the movements of the two prices after each trading day. This will give a percentage change versus the previous day. Once we have 365 of these we can average the group to determine the average move each made over the last year. We can call the average industry movement Ri and the average market movement Rm. Finally, divide the technology industry’s average movement by the S&P’s average movement and we will have an outcome that is less than 1 (less volatile), 1 (equally volatile), or greater than 1 (more volatile). Written out this function looks like this:

Β = Ri / Rm or B = Covariance(Ri , Rm)/ Variance(Rm)

Beta can be useful in stock research when judging how risky a stock is versus a stable investment with a guaranteed rate of return. It must be noted that the longer period of time the beta is acquired the more accurate that beta will be. Also, betas are more valuable when used with stocks that have a long record of high volume trading. Smaller stocks that don’t trade a lot can fluctuate wildly on a busy day and throw the beta out of whack for the period being measured.

Stock Dividend Record - What is a “Dividend Record” Where can I find it?

Standard & Poor’s (S&P) Dividend Record provides comprehensive information on dividend payments and corporate actions of over 22,000 equity securities. It is available through S&P’s Data Services for a fee. S&P is widely accepted as the world leader in independent investment research. The information focuses on cash and stock distributions and consequences these will have on taxes. Mergers and acquisitions affecting dividend payments, redemptions, outcomes of stockholder meetings are also detailed. Dividend Record focuses on companies listed on American and major Canadian exchanges, as well as selected foreign stock issues.

The information is accessible through the Internet direct from S&P. Information from Dividend Record can be used to research individual companies, market sectors, market indices, or the market as a whole. Emerging trends can be studied from the data. Even though the information isn’t free, reports about the latest Dividend Record are widely reported every time the quarterly versions are published.

Mergent also publishes its version called, appropriately, Mergent’s Dividend Record.

Another use of the term “dividend record” has to do the date a company actually makes announced dividend payments. This record date is important because shareholders on record on that date will be paid. For example, a company would announce that it will pay a dividend on April 1 to shareholders on record as of March 15.

Weighted Average Cost of Capital (WACC), Historical Commodity Prices, Index Prices, and Country Risk

The Weighted Average Cost of Capital (WACC) is a calculation of a company’s proportionately weighted capital according to specific categories. All sources of capital – common stock, preferred stock, bonds, and any other debt are included. It’s computed by multiplying the cost of each capital source by its proportional weight (% of total capital) and then working through this equation.

Where:
Re = cost of equity
Rd = cost of debt
E = market value of the firm’s equity
D = market value of the firm’s debt
V = E + D
E/V = percentage of financing that is equity
D/V = percentage of financing that is debt
Tc = corporate tax rate

The WACC is useful in determining how a company gains its capital. Is it financing itself through debt or equity? The WACC helps answer that question. Computing WACC offers insight into a company’s ability to make returns upon its investments and, hence, money for investors. The WACC is often used by internal management to steer the company toward beneficial, moneymaking projects and away from losing ones.

A historical commodity price index will illustrate prices of a commodity at specific historical times. Over a given period of time the average of these indexed prices gives the commodity’s historical price. Speculation on future commodity prices can be made on fluctuation’s of the commodity’s historical price. The spot commodity price is the price of a commodity “on the spot” where it is being sold on the cash market.

Index closing prices are the numbers we hear given on nightly news broadcasts. The NYSE index and NASDAQ index are both examples of whole market stock indices. The Dow Jones Industrial Average and the S&P 500 are examples of broad-base stock indices. The prices of these broad indices are determined by using the closing prices issued by the primary exchange for each member stock in the index. If the price changed during the trading day, the new price is used to calculate the index closing price. Thus, with the S&P 500 calculations of price fluctuations for all 500 member stocks each day are made to determine the daily index price.

Country risk rates reflect the risk of investment in that country. Government stability, both political and financial, factor into this heavily. Banks may use this term to determine whether or not it wants to provide financing to a company that does a lot of business overseas. The magazine Euromoney puts out a survey of country risk and ranks them.