Some basics of trade - Foreign Exchange

Last week I was teaching in my college and an interesting topic came up regarding foreign exchange. The students were keen to know about the foreign exchange and how the foreign exchange actually functions.

So today, I would particularly speak about 'exchange'.

In early days, when there was no currency in use, people used to trade using 'barter' system of trade. People used to give the commodity which they have for exchange of the required commodity. For example, a person would give one pound of grains for having a gallon of milk.

This was an excellent practice when there were less customers, less sellers and the geographical spread was also small.

The earlier trade used to happen on the basis of a barter trade. However the quantification (measurement) of the exchange of good was a problem.

Hence that gave rise to a single medium of exchange which could be measured, has denominations and can be measured for all commodities, services and goods. This gave rise to currency.

Every country was earlier a closed economy. The trade used to happen within the country itself. Hence the trading of goods and services started happening in the currency.

Now, the trades started to cross the boundaries of a country and started to trade goods and services to other countries. This gave rise to the give and take of currencies of each country.
Hence the countries started questioning the denomination or the base for their currency to be traded against other country's currency. This gave rise to the exchange market.

The exchange market reflect the strength or weakness of one currency against the other currency with which it is being traded.
For example, the exchange shows 1 pound = 1.6 Dollars.

Which means that u need to give 0.6 dollar as an addition to trade for some good/service which is labeled in pounds. This theory has a different approach too. However we would cover the same in the later discussions.

So, the way pound and dollar is being compared, all currencies across the world are compared and are being used as a barometer for all global trades and transactions.

Today, the whole world is a truly global economy, whereby all countries are trading good and services all across the world. This trade is increasing with the increase in time.

Hence in coming years, foreign exchange is going to gain much more importance in the global economy and globalized nations.

Cycle of Financial Management

SOURCE OF FUNDS -> OPERATIONS -> PRODUCT / SERVICE -> SELLING PRICE -> AFTER SALES -> SALES

Financial management can be defined as an ongoing activity which takes care of every facet of the organization. An organizations functionalities can be classified broadly as mentioned above.

These are the areas which need financial management as a key factor, and the decision of finance has an impact of these areas of an organization.

A - SOURCES OF FUNDS
For any organization, the firm requires capital to have its operations rolling. Also, the initial funding is crucial for sustainability of the firm. The firm needs to plan not only for operations, but also the buffer period, till the time the organization starts generating revenue.

B - OPERATIONS
Every business has a operation module. This module is the period or the working or back-end of the firm. The financial management for the money required for operations is very crucial. This determines the output as well as productivity of the firm.

C - PRODUCT / SERVICES
This is when the company needs to have a planning for the exact output that needs to be generated. The financial management of this module is very important, as it is directly affecting the deliverable to the customer or the consumer.

D - SELLING PRICE
For any product or service, there has to be a good financial analysis in order to determine the sale price of the product or service.

E - SALES
Sales means realizing value for any product or delivery. In financial sense the sales are dependent on different key factors, responsible for increase and decrease of sales. The management of the financial aspects of these key factors is an important aspect of financial management.

F - AFTER SALES
After sales is basically delivering the product, accessories, service and all other services - after the sale is being done.These aspects require monetary terms to be considered in order to calculate cost and profit from the same.

When all these aspects are considered and then the management of finance is being done, it gives a true and clear picture for the financial management.

Ratio Analysis

Ratio analysis is one of the prime indicator for analysis in finance.

Ratio analysis is used to evaluate the performance in different areas of an organization. Ratio analysis uses key components present in financial statements for comparison and the ratios (answers) are used as a base for further financial analysis. The financial statements comprises of different cost centers and income centers.

By doing a comparison of two components, we arrive at a barometer indicating the performance.

In financial sense, ratio analysis is comparing two financial components as per the nature of components, and arriving at a logical conclusion. Broadly, the ratios are classified as per their nature.

The classification of the ratios are -

- Liquidity Ratios
- Profitability Ratios
- Activity Ratios
- Investment Ratios
- Leverage Ratios

Profit and Loss Account - Basic step by step explanation

Another important financial statement used in the corporate world in the 'Profit and loss' statement. This is one the final account which is used for many financial analysis as well as to know the profits posted by the firm in the whole financial year.

The profit and loss account, also known and 'Income Statement' or 'Income and Expenditure Statement' is written with a step by step reduction of different expenses involved in the organization.

The firm is able to find out the exact computation of profitability at each step and also arrive at a analysis of where is the expenditure more and potential area for cutting cost and thereby improving profits.

The steps involved in the profit and loss account are -

SALES
(-)COGS (Cost of Goods Sold)
GROSS PROFIT
(-)Operating Expenses
(-)Depreciation
OPERATING PROFIT
(-)Non operating Expense
PBIT
(-)Interest
PBT
(-)Taxes
PAT

This is typically called the 'vertical' or 'corporate' format of profit and loss account. In this section, typically the 'final' profit computation from Sales is done with a step-by-step computation. Different types of expenses are getting deducted from the sales.

Typically for any organization, the calculations would start with the 'sales' number or the 'gross revenue'.
From Sales, firstly the costs which are directly proportional to the selling of the goods is deducted. This is typically called "Cost of Goods Sold" (COGS).
COGS included all expenses which are 'directly' responsible for the selling of the goods. This typically includes cost of material, transport, labour, etc which directly contribute to the sales.

After deducting COGS from Sales, we arrive at 'Gross Profit'. Hence

SALES - COGS = GROSS PROFIT

From gross profit, when the operating expenses and depreciation is deducted, we arrive at 'operating profit'. The operating expenses include all expenses which are indirectly related to sales and are responsible for the operations of the firm.
These include administration costs, electricity, telephone, etc. Hence,
GROSS PROFIT - OPERATING EXPENSES & DEPRECIATION 
= OPERATING PROFIT

From operating profit, the next component which is deducted is 'non operating expenditure'. Non operating expenditures are the expenses which are not a part of operations, but are an expense which need to be done. A simple example is insurance. The insurance expenses are not a part of operating activites of a business, but are a expense. Hence
OPERATING PROFIT -  NON OPERATING EXPENSES 
= PBIT (profit before interest and taxes)

PBIT is the first component of calculation of profit, after paying the organization expenses. This is the first profit, before you pay out the interest and taxes.

From PBIT now the 'interest' component is deducted. This is the deduction of the interest payable for the long term loan that has been raised by the company. This is the loan portion in balance sheet called 'debt'. For every loan raised, there is a interest that in being charged, and we need to pay the interest. This deduction gives the profit which is profit before taxes. Hence,
PBIT - Interest   = PBT

Profit before Taxes is the profit which is computed before paying 'taxes'. From profit before taxes the taxes need to be deducted from PBT. The tax component includes the taxes which are liable to be paid by the organization. After paying the taxes, the remaing profit is PAT 'profit after tax'. Hence
PBT - Tax  =  PAT

PAT / 'profit after tax' / 'net income' is the final profit that remains with the firm after paying all direct, indirect and all other expenses of the firm. Hence this is the final profit can be said, what a firm gets.

From PAT, the dividends are being paid to shareholders of the firm. The shareholders are the people who have invested money in the firm by purchasing their shares. This money is called the equity of the firm.

This is the step-by-step explanation of the profit & loss account which is one of the most crucial statement which determines the profitability of the firm in the current accounting year. This statement is ideally calculated on the last day of the financial year.

Significance of Balance Sheet

There is a popular myth that there a lot of basic concepts required to be understood and analyzed before analyzing the balance sheet. The truth is that balance sheet is derived from the basic working of the funds flowing the organization.

When a balance sheet is formed, it basically depicts how the money has come in the organization, what all are the aspects where the money is used, and how much money should be paid out too.
The company basically looks at the overall status and the position of its working year after year by having a look at the balance sheet.

As we saw, the balance sheet is basically divided in 'Liabilities' and 'Assets'.
The 'Liabilities' now can be segregated in two parts - Long term and short term.

The long term liabilities are the components from the area, from which the company has raised money for its operations. Hence it is called "Sources of funds". These sources of funds have two components "Equity" and "Debt".
Just to have a overall feel, "Equity" is the component wherein the company has raised money by issuing shares to the public. "Debt" is the component wherein the company has taken a loan or borrowed money for operations.

The short term liability by-and-large looks at the 'Current Liabilities'. Wherein there are current payments deliverable like creditors, bills payable, short term loans, etc.



Now at the Assets side, the Asset part is divided in 'Long Term Assets' and 'Short Term Assets'.

The 'Long Term Assets' comprise of Fixed Assets and Investments. These are the components which are directly or indirectly responsible for generating revenue and sales of the firm.

The 'Short Term Assets' are mostly the Currents Assets wherein the assets which are in hand or going to receive within one financial year.


Now the very basic analysis or significance of the balance sheet is -

The LONG TERM ASSETS should be able to suffice the LONG TERM LIABILITIES, and
The SHORT TERM ASSETS should be able to suffice the SHORT TERM LIABILITIES.

Hence this means that the company's operations are so strong that the current operation payables can be paid from the operating activity itself.
And the long term assets are so strong that they sufficient enough that the firm can payoff their long term liabilities.

Liabilities in Balance Sheets

As we discussed previously in Balance Sheet post,
Now we have seen the Asset part. Lets look at the Liabilities part of the Balance Sheet.

Liability is a part of the balance sheet which is the part which is 'payable'. Which means that the portion which the company should give back or is supposed to give back. This means that the company might have either taken money from someone or might have borrowed money.

This money can be either taken for running day to day operation or doing some investment for the company of expansion of the company. This decides the nature and the classification of the money used and treated in that way.

In Liability there are three major parts -

Equity
Debt
Current Liabilities.

Overall, the liability portion can be classified in these three categories. Over and above this, there are different areas which add and get reduced as per the nature and requirements of the organization and industry.

The first two parts are called 'Sources of Funds'. This means that they are the ways of raising the money for the organization. A firm can raise money in two parts, Through raising equity of the company and borrowing money in the form of loan, which is 'debt'.

The equity part is basically issuing of shares of the company to people who are ready to give money to company for business. The person who gives money, is given part of company's profit sharing pattern, hence it is called 'share' which is issued.

The debt of the company is the part in which the company raises money, either from banks or investors, or promoters of the company. If there is money raised by giving some security as a 'collateral', it is called 'secured loan'. The money raised without security, or given by promoter of the company is called 'unsecured loan'.

The current part in which the company is liable to pay to the person from whom some business transactions have been done in this current year, are the payable parts which come in 'current liability' of the company. This part has components like creditors, bills payable, etc which are the components which make the current part of the company's workings.

Assets in Balance Sheets

As we discussed previously in Balance Sheet post, there are two components of balance sheet ; Assets and Liabilites.
Among them we would discuss about the asset part in this post.

The students from commerce and MBA education field would find this information useful.

Assets are the components which are owned by the company either in physical form or on paper.
The assets are in short what the company has got in its hand, which can be used to repay the liability if required. Hence it balances the liability.

As discussed, The assets include three major parts

-Fixed Assets
-Investments
-Current Assets

Lets talk about each component of the assets.

The Fixed Assets are the portion of the assets column, which include all the components which can be categorized as fixed in nature. The classical components which fall under this category are Building, Machinery, Land etc, which have the nature of fixed property.

The Investments is the part which includes all components which are investments done by the organization. The organizations purchase of shares of other companies, Investment done in other companies, purchase of shares of other companies are the common examples of investments done by the organization.

The Current Assets incorporate the current savings and income of the company gained within this present financial year. These are the assets which are generally used for the present working of the company. The current assets are also the components which, if are able to be equal or more than 'current liability' of the company, it is considered to be a healthy situation of the company. The common components of current assets are; cash in hand, cash in bank,debtors, work in progress, raw materials, etc.

These more or less form to be components of balance sheet's asset side. The components may add up or get deleted from each balance sheet, depending upon the nature and components required for that nature of business.

For example, if we are looking at a balance sheet of a recruitment firm, we surely wont have any 'raw material' component in the asset side, as it is a service oriented business, and the 'raw material' component is generally referred for a manufacturing business.

Balance Sheet

In accounts and finance world the most important final account considered is the Balance Sheet.
It is basically a document which depicts the financial position of the company. The document is generated generally on the last day of the financial year.

There are two parts of balance sheet; Assets and Liabilities.
The Assets contain all the components which are owned or belong to the organization.
The Liabilities are the payables or components which the company is liable to repay.

The balance sheet gives a correct depiction of what is the current state of the organization. This document is used as a base to evaluate many financial analysis and a platform for many analytics.

The assets include three major parts

-Fixed Assets
-Investments
-Current Assets

The liabilities include three major parts

-Equity
-Debt
-Current liabilities & provisions.


Different accounting standards have defined different formats in which the balance sheet and its components should be represented. However, looking at a larger picture of the balance sheet, these are the pre-dominant components which formulate the balance sheet.

The assets components should be able to equate the liability, which the payment liability for the company. Hence it is called a 'Balance' sheet, wherein the components are balanced.

More clarity will be seen in the coming posts where I would demonstrate a balance sheet with help of a balance sheet example.

Reserve Bank of India

Folks, today I am speaking in depth about the RBI and the functions of RBI in the market. I hope this explanation gives an insight about the Reserve Bank of India.
Reserve Bank of India is the main and core bank of India. It can be called the head that performs different roles of monitoring finance, regulating and controlling finance, guidance and promotion to all finance institutions in India. The RBI institution has come into existence in 1935 and is the core part of the whole functioning of Indian Government.
The operations of the RBI is expanding from time to time and is playing a crucial role in the developments of the country’s economic state with necessary policies, expansions, collaborations and agreements with different financial systems all over the world.
The primary function of RBI is to maintain monetary stability in the market so as to have a maximized profit for the trades. RBI also plays an integral part in the financial aspect of the national and social policies delivered by the government. Take care of the monetary policy and credit policy in the market so that the prices are stabilized.
One of the crucial roles played by RBI in the financial industry is to issue the currency in the market. The RBI is the sole institution which has authority to issue notes and coins which are authorized by Government of India. Next function of the RBI is that it acts as government’s banker. Roles and functions such as deposits, withdrawals of funds by cheques, and making payments as well as receipts. Often in banking world RBI is called the bank of the banks. This means that it is the apex body which takes care and monitors the functioning and credit control of the banks, nationalized banks and co-operative banks in India.
Hence, RBI is a very crucial blood line of the financial domain of Indian government.

Accounts and Finance

Now to begin with, many people have a mindset that finance and accounts are the same. According to many people these two fields belong to a same domain of knowledge. However, the fact persists that these two subjects are alotgether different and have got each area to be explored and learn in its own fashion.

To put the description in simple words, the whole functioning of an organization cannot start without finance. For an enterprise, finance is one the blood line which brings in monetary aspects which mobilize the operations and hence make the business move. However, we can have exceptions to this rule too. There are organizations who have made it successful and have started without and finance or capital.

When the organization takes a momentum, there are daily aspects of monetary mobilisation. Which simply means that there is money required for everything, right from purchase, procurement, transport, delivery, manufacturing, storage, power, safety, deployment and sale. Hence for each of this factor to be incorporated in the functioning of an organization, there are money transactions happening. It is very essential for an organization to have a written record of all the money transactions happening in the whole functioning of the business. This is the step where 'accounts' come into picture. This is the point where the role of 'Accounts' start.

Accounts are primarily the process of recording the daily transactions happening in the business. These transaction are both ways; it is income as well as expenditure record.

Now after putting in the records of all monetary transactions the company also needs a overall picture of all the transactions that have occured in the whole year. Hence at the end of the year, the organization reviews all the transactions and prepares some accounts which give a bird's eye view of all the monetary transactions happend in the whole year. And also they come to know the present situation of the assets and liabilities of the organization. These are called the 'final accounts' of the organization.

The 'finance' domain starts with going skin deep of all these transactions happening in the market. The finance asks question, "Why is this transaction done?", "What is the relation of the spend to the financial position of the company?". These are the areas where the finance domain really starts in the organization's transactions. The finance stream covers aspects like risk allocation, investment, sources of funds, shares, equity, debt, ratios, investment portfolios, market portfolios and many more. We will be looking at each topic in detail ahead, so that the concepts of each topic are covered more detailed.

Basics about Finance

Dear Readers,

I am sure you guys are surfing on the net to find out more depth and insights about the practical aspects of finance. The reason i am starting this blog is to bring about the knowledge about each topic of finance delivered to you in a crisp and practical form. Today many management aspirants are very keen to have a knowledge delivered to them. However, most of the times, all they find is loads and loads of information, and no knowledge as such.

This is my attempt to cover the main topics of finance and put them in front of you in a blog form so that you can refer to the postings when required.

Good luck.

Ameya Nisal