What are Accruals

Accruals are revenues earned or expenses incurred which impact a company’s net income on the income statement, although cash related to the transaction has not yet changed hands. Accruals also affect the balance sheet, as they involve non-cash assets and liabilities. Accrual accounts include, among many others, accounts payable, accounts receivable, accrued tax liabilities, and accrued interest earned or payable.

By recording accruals, a company can measure what it owes in the short-term and also what cash revenue it expects to receive. It also allows a company to record assets that do not have a cash value, such as goodwill. The main difference between accrual accounting and cash accounting lies in the period in which revenues and expenses are recorded as having occurred.

The accrual concept is considered to be standard accounting practice for large companies and is supported by both the International Financial Reporting Standards (IFRS) and the Generally Accepted Accounting Principles (GAAP). These accounting frameworks provide guidelines to businesses around the world on how to account for revenues and expenses apart from just using cash receipts.

What Are Distressed Securities?

Distressed securities are financial instruments issued by a company that is near to—or currently going through—bankruptcy. Distressed securities can include common and preferred shares, bank debt, trade claims, and corporate bonds. Even a particular security can be considered distressed if it fails to maintain agreement. Because of the company’s inability to meet its financial obligation their financial instruments suffer a reduction in value, although due to this they can offer a high risk investors a potential for high returns. These high risk investors are sometimes called as ‘hawks’

Example– Securities are labeled as distressed when the company issuing them is unable to meet many of its financial obligations. In most cases, these securities carry a “CCC” or below credit rating from debt-rating agencies. Distressed securities can be contrasted with junk bonds, which traditionally have a credit rating of BBB or lower.

What is a Forward Contract?

A forward contract is a customized contract between two parties to buy or sell an asset at a specified price on a future date. It can be used for hedging or speculation, although its non-standardized nature makes it particularly apt for hedging.

Unlike standard futures contracts, a forward contract can be customized to a commodity, amount and delivery date. Commodities traded can be grains, precious metals, natural gas, oil, or even poultry. A forward contract settlement can occur on a cash or delivery basis.

Forward contracts do not trade on a centralized exchange and are therefore regarded as over-the-counter (OTC) instruments. While their OTC nature makes it easier to customize terms, the lack of a centralized clearinghouse also gives rise to a higher degree of default risk.

Example– You are a farmer and you want to sell wheat at the current rate of Rs.18, but you know that wheat prices will fall in the coming months ahead. In this case, you enter a contract with a grocery for selling them a particular amount of wheat at Rs.18 in three months. Now, if the price of wheat falls to Rs.16, then you are protected. But if the price of wheat rises, then you will get the price as mentioned in the contract.

What Is EBITDA?

EBITDA, or earnings before interest, taxes, depreciation, and amortization, is a measure of a company’s overall financial performance and is used as an alternative to net income in some circumstances. EBITDA, however, can be misleading because it strips out the cost of capital investments like property, plant, and equipment.

This metric also excludes expenses associated with debt by adding back interest expense and taxes to earnings. Nonetheless, it is a more precise measure of corporate performance since it is able to show earnings before the influence of accounting and financial deductions.

Formula of EBITDA
EBITDA= Net Income+Interest+Taxes+D+A

where: D=Depreciation A=Amortization

EBITDA= Operating Profit+DE+AE

where: DE=Depreciation expense AE=Amortization expense

EBITDA can be used to analyze and compare profitability among companies and industries, as it eliminates the effects of financing and capital expenditures. EBITDA is often used in valuation ratios and can be compared to enterprise value and revenue. EBITDA does not fall under Generally Accepted Accounting Principles (GAAP) as a measure of financial performance. its calculation can vary from one company to the next.

What is a Zero-Coupon Bond

A zero-coupon bond is a debt security that does not pay interest but instead trades at a deep discount, rendering a profit at maturity, when the bond is redeemed for its full face value. A zero-coupon bond is also known as an accrual bond.

Some bonds are issued as zero-coupon instruments from the start, while others bonds transform into zero-coupon instruments after a financial institution strips them of their coupons, and repackages them as zero-coupon bonds.

Formula of Zero Coupon bond: Price= F / (1 + r)ⁿ

F= face value of the bond, R= rate of interest, N= number of years until maturity

Example- A person is looking to purchase a zero-coupon bond with a face value of Rs 1,000 and 5 years to maturity. The interest rate on the bond is 5% compounded annually. What price will that person pay for the bond today?

Price of bond = Rs 1,000 / (1+0.05)⁵ = Rs 783.53

The price that person will pay for the bond today is Rs 783.53.

What is a Furlough?

A furlough is a temporary layoff, an involuntary leave, or another modification of normal working hours without pay for a specified duration. Businesses use furloughs for a variety of reasons, such as plant shutdowns, or when a broad reorganization makes it unclear which employees will be retained. For employers, one of the main advantages of furloughs over layoffs is that they can call back trained workers when conditions improve rather than hiring and training new employees. Furloughs may be short- or long-term, depending on the circumstances

The Difference Between Furloughs and Layoffs

Furloughs are temporary cessations of work when employees retain their jobs but do not get paid. During furloughs, employees keep their benefits and anticipate that they will return to work within a certain period of time. However, in layoffs, employees are permanently discharged and have no expectation of getting their employment back. For employers, one of the main advantages of furloughs over layoffs is that they can call back trained workers when conditions improve rather than hiring and training new employees.

What Are Tranches?

The word “tranche” comes from the French word for slice. Tranches are pieces of a pooled collection of securities, usually debt instruments, that are split up by risk or other characteristics in order to be marketable to different investors. Each portion, or tranche, is one of several related securities offered at the same time but with varying risks, rewards and maturities to appeal to a diverse range of investors. Examples of financial products that can be divided into tranches include bonds, loans, insurance policies, mortgages, and other debts.

Investors who desire to have long-term steady cash flow will invest in tranches with a longer time to maturity. Investors who need a more immediate but a more lucrative income stream will invest in tranches with less time to maturity.

Tranches can also be miscategorized by credit rating agencies. If they are given a higher rating than deserved, it can cause investors to be exposed to riskier assets than they intended to be. Such mislabeling played a part in the mortgage meltdown of 2007 and subsequent financial crisis

What Is a Perpetual Bond?

A perpetual bond, also known as a “consol bond” or “prep,” is a fixed income security with no maturity date. This type of bond is often considered a type of equity, rather than debt. One major drawback to these types of bonds is that they are not redeemable. However, the major benefit of them is that they pay a steady stream of interest payments forever.

Perpetual bonds exist within a small niche of the bond market. This is mainly due to the fact that there are very few entities that are safe enough for investors to invest in a bond where the principal will never be repaid.

Example of a Perpetual Bond

Since perpetual bond payments are similar to stock dividend payments, as they both offer some sort of return for an indefinite period of time, it is logical that they would be priced the same way.

The price of a perpetual bond is, therefore, the fixed interest payment, or coupon amount, divided by some constant discount rate, which represents the speed at which money loses value over time (partly due to inflation).

Formula for the Present Value of a Perpetual Bond

Present value = D / r

Where:

D = periodic coupon payment of the bond

r = discount rate applied to the bond

For example, if a perpetual bond pays $10,000 per year in perpetuity and the discount rate is assumed to be 4%, the present value would be:

Present value = $10,000 / 0.04 = $250,000

What Is a Leverage Ratio?

A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt (loans) or assesses the ability of a company to meet its financial obligations. The leverage ratio category is important because companies rely on a mixture of equity and debt to finance their operations, and knowing the amount of debt held by a company is useful in evaluating whether it can pay off its debts as they come due.

A leverage ratio may also be used to measure a company’s mix of operating expenses to get an idea of how changes in output will affect operating income.

Common leverage ratios include the debt-equity ratio, equity multiplier, degree of financial leverage, and consumer leverage ratio.

What is a Derivative?

A derivative is a financial security with a value that is reliant upon or derived from, an underlying asset or group of assets—a benchmark. The derivative itself is a contract between two or more parties, and the derivative derives its price from fluctuations in the underlying asset.

The most common underlying assets for derivatives are stocks, bonds, commodities, currencies, interest rates, and market indexes. These assets are commonly purchased through brokerages.

Most derivatives are not traded on exchanges and are used by institutions to hedge risk or speculate on price changes in the underlying asset.

The most common forms of derivative are- Futures, Options, Forwards, Swaps.