Wednesday, April 27, 2011

Shares: An overview

In the last post, some common terms related to shares were discussed.  Now, we would get an overview of some common types of shares and differences between shares and debentures.
Shares: As mentioned in the previous post, a share represents a faction of an individual’s ownership in the company. For example, if the equity share capital of a company is Rs 500000, and it is divided into 5000 shares, the value of one share is Rs500000/Rs 5000 = Rs100. Thus, an individual holding 1000 shares has a 25% ownership in the company.
Equity shares and Preference shares are the two most common types of shares. The primary difference between equity shares and preference shares is that in the latter case the shareholders are entitled to receive  a fixed rate of dividend which is to be paid before dividend can be paid in respect of equity shares. Another important difference is that the preference shareholders enjoy priority over the equity shareholders in payment of surplus and on liquidation of the company. There are several types of preference shares, two of the most common ones are:
·        Cumulative preference shares: In this case the accrued dividend keeps on accumulating till paid.
·        Convertible preference shares: Here the preference shares are converted to equity shares after a stipulated time period or after certain conditions are fulfilled.
Rights Shares: These are those shares that are issued to existing shareholders at a certain price in proportion to the shares held by them. For example, if a company comes up with a rights issue in the ratio of 1:5, each shareholder who currently has five shares is offered one share at a definite price. The shareholder is free to accept or reject the offer.
A rights issue should not be confused with a bonus issue. In the latter case, the shares are distributed in a particular ratio among the existing shareholders free of cost. The issue of bonus shares does not bring money into the company, whereas an issue of rights shares does.
Debentures: A debenture is a certificate of acknowledgement of debt. When a company issues debentures, it raises money in the form of loan, and hence the debenture holders are creditors to the company. Debenture holders are entitled to receive a fixed rate of interest, irrespective of the profit or loss of the company. Convertible debentures are the most common types of debentures. Here, the debentures are convertible to shares after a stipulated time period or after fulfilling certain conditions.
Difference between shares and debentures
The shareholders of a company are owners of the company, whereas the debenture holders are creditors of the company. The dividend payable to shareholders varies with profit (in most cases, when there is no profit, no dividend is paid). On the other hand, a fixed rate of interest is payable to the debenture holders irrespective of the profit or loss. Debenture holders are exposed to less risks as compared to the shareholders because in the former case, the income is regular in nature. It should be noted that at the time of liquidation of the company, the claims of the debenture holders are settled before the claims of the preference and equity shareholders.
In the next post, the basics of stock exchanges and trading would be taken up. I request the readers to come up with questions, comments and suggestions.
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Friday, April 22, 2011

Shares: Basic concepts and terminology

We often come across terms related to shares and stock markets in the newspapers, and many a times we are not very clear with the meanings of these terms. In this post, an attempt has been made to explain the basic terms related to shares. In some of the following posts; the types of shares, terms related to the stock exchange, derivatives and trading will be discussed.
Share: A share represents a faction of an individual’s ownership in the company. For example, if the equity share capital of a company is Rs 500000, and it is divided into 5000 shares, the value of one share is Rs500000/Rs 5000 = Rs100. Thus, an individual holding 1000 shares has a 20% ownership in the company. There are several types of shares, equity and preference shares being the most common ones.
Face value: The face value of a share means the price of the share. For example, if a company has total equity share capital of Rs 500,000, and the number of shares are 5000, then the face value of each share is Rs 500,000/5000=Rs100.
Issue price: Issue price refers to the price at which the shares are offered to the public. Issue price of a share may be more or less than the face value. If the shares are offered at a price that is greater than the face value, it is said to be issued at a premium. On the other hand, if a share is offered for share at a price less than its face value, it is said to be issued at a discount.
Market Price: Market Price of a share is the price at which the shares are being currently changes.
Now, a trick question: Which amongst the following will be WOW choice:
  1. A Rs.9 of XYZ and Co. share with face value Rs.1; or
  2. A Rs.99 of XYZ and Co. share with face value Rs.1?
Well, as long as you have the same amount of money to invest, it doesn’t make a pinch of difference. You will end up with the same amount of percentage holding with XYZ and Co. folks.
Market Capitalisation: The term Market Capitalisation refers to the total value of all shares of a company. For example, if the number of shares are 100 and the market price of each share is Rs 50, the market capitalisation is Rs50*100=Rs 50000. It should be noted that the market capitalisation is not calculated taking into account the face value of a share.
Stock: A stock refers to a bundle of shares. It should be noted that unlike a share, a stock can be expressed in fractional terms. For example, if 1 stock=100 shares, 25% of the stock would mean     (25 %)*(100 shares) = 25 shares
Dividend: Dividend refers to that portion of the earnings of the company that are distributed between the shareholders. The dividend is always calculated on the face value of a share.
Divided per share: It is calculated by the formula-(Face value)*(%age divided declared). For example, if a company has declared a dividend of 10%, and if the face value of one share is Rs10, the dividend a person who holds 10 shares of the company is (Rs10*10%)*10= Rs10.
Bonus shares: Bonus refers to those shares that are issued by companies free of cost to the existing shareholders, generally on a pro-rata basis. For example, if a company declares a bonus issue in the ratio of 1:5, each shareholder who has five shares is entitled to receive one bonus share.
Price-Earnings Ratio: It is the ratio of the Market price per share and the Earnings per share. For example, if the market price is Rs10, and the earnings per share is Rs2, the Price Earnings Ratio is    Rs 10/ Rs2 = 5. (Earnings per share is calculated by the formula- Profit/Number of shares)
We hope were able to explain clearly the meaning of some frequently used terms. Please feel free to revert back with queries and comments. That’s our dividend for this share of information investment.
(Co-authored with Dola Halder, B. Com. (Honours), SRCC)
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Monday, April 4, 2011

Zero Base Budgeting - An overview

Zero Base Budgeting may be defined a planning and budgeting process which requires each manager to justify his entire budget in detail from scratch (hence zero base). Each manager justifies why he should spend any money at all. The approach followed Zero Base Budgeting requires that all activities be identified as decision packages which will be evaluated by a systematic analysis ranked in order of importance.
Zero Base Budgeting and Incremental Budgeting
  In case of Zero Base Budgeting, all figures are developed with zero as the base, however; in case of incremental budgeting, the current year’s budget is taken as the base for the next year’s budget.
  The process of preparation of a Zero Base Budget is a costly and complicated process as compared to incremental budgeting, and is suitable mostly for big organisations. However, it should be noted that though preparation of an Incremental Budget is much easier comparatively, it is not as effective as ZBB because past inefficiencies are not accounted for in an incremental budget.
Main features of Zero Base Budgeting:
  All proposals are considered totally afresh.
  All amounts are to be justified.
  A cost benefit analysis of each programme is undertaken.
  The stress is not on “how much” but on “why”.
  Departmental objectives are linked to corporate goals.

Merits of Zero Base Budgeting:

        Effective allocation of resources.
        Identification of ineffective units.
        Increase in accountability
        Cost behaviour analysis.
        Adds a psychological push to reduce expenditure.

Demerits of Zero Base Budgeting:

        Increase in paperwork and cost of budget preparation.
        Danger of emphasising on short term goals instead of long term goals.
        Proper training and education is required.
        Not easy to rank decision packages, hence giving rise to conflicts.

It should be noted that the merits outweigh the demerits, and more and more organisations these days are following the Zero Base Budgeting approach. This approach has also been implemented time and again by the government of several countries, including India.
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