Finance is a field, concerned with the allocation of assets and liabilities over space and time under conditions of risk or uncertainty. Finance can be defined as the art of money management. Participants in the market aim to price assets based on their risk level, fundamental value, their expected rate of return. Finance can be split into three sub-categories: public finance, corporate finance and personal finance. Matters in personal finance revolve around: Protection against unforeseen personal events, as well as events in the wider economies Transference of family wealth across generations Effects of tax policies management of personal finances Effects of credit on individual financial standing Development of a savings plan or financing for large purchases Planning a secure financial future in an environment of economic instability Pursuing a checking and/or a savings account Personal finance may involve paying for education, financing durable goods such as real estate and cars, buying insurance, e.g. health and property insurance and saving for retirement.
Personal finance may involve paying for a loan, or debt obligations. The six key areas of personal financial planning, as suggested by the Financial Planning Standards Board, are: Financial position: is concerned with understanding the personal resources available by examining net worth and household cash flows. Net worth is a person's balance sheet, calculated by adding up all assets under that person's control, minus all liabilities of the household, at one point in time. Household cash flows total up all from the expected sources of income within a year, minus all expected expenses within the same year. From this analysis, the financial planner can determine to what degree and in what time the personal goals can be accomplished. Adequate protection: the analysis of how to protect a household from unforeseen risks; these risks can be divided into the following: liability, death, disability and long term care. Some of these risks may be self-insurable, while most will require the purchase of an insurance contract.
Determining how much insurance to get, at the most cost effective terms requires knowledge of the market for personal insurance. Business owners, professionals and entertainers require specialized insurance professionals to adequately protect themselves. Since insurance enjoys some tax benefits, utilizing insurance investment products may be a critical piece of the overall investment planning. Tax planning: the income tax is the single largest expense in a household. Managing taxes is not a question of if you will pay taxes, but when and how much. Government gives many incentives in the form of tax deductions and credits, which can be used to reduce the lifetime tax burden. Most modern governments use a progressive tax; as one's income grows, a higher marginal rate of tax must be paid. Understanding how to take advantage of the myriad tax breaks when planning one's personal finances can make a significant impact in which can save you money in the long term. Investment and accumulation goals: planning how to accumulate enough money – for large purchases and life events – is what most people consider to be financial planning.
Major reasons to accumulate assets include purchasing a house or car, starting a business, paying for education expenses, saving for retirement. Achieving these goals requires projecting what they will cost, when you need to withdraw funds that will be necessary to be able to achieve these goals. A major risk to the household in achieving their accumulation goal is the rate of price increases over time, or inflation. Using net present value calculators, the financial planner will suggest a combination of asset earmarking and regular savings to be invested in a variety of investments. In order to overcome the rate of inflation, the investment portfolio has to get a higher rate of return, which will subject the portfolio to a number of risks. Managing these portfolio risks is most accomplished using asset allocation, which seeks to diversify investment risk and opportunity; this asset allocation will prescribe a percentage allocation to be invested in stocks, bonds and alternative investments.
The allocation should take into consideration the personal risk profile of every investor, since risk attitudes vary from person to person. Retirement planning is the process of understanding how much it costs to live at retirement, coming up with a plan to distribute assets to meet any income shortfall. Methods for retirement plans include taking advantage of government allowed structures to manage tax liability including: individual structures, or employer sponsored retirement plans and life insurance products. Estate planning involves planning for the disposition of one's assets after death. There is a tax due to the state or federal government at one's death. Avoiding these taxes means that more of one's assets will be distributed to one's heirs. One can leave one's assets to friends or charitable groups. Corporate finance deals with the sources of funding and the capital structure of corporations, the actions that managers take to increase the value of the firm to the shareholders, the tools and analysis used to allocate financial resources.
Although it is in principle different from managerial finance which studies the financial management of all firms, rather than corporations alone, the main concepts in the study of corporate finance are applicable to the financial problems of all kinds of firms. Corporate f
A dividend is a payment made by a corporation to its shareholders as a distribution of profits. When a corporation earns a profit or surplus, the corporation is able to re-invest the profit in the business and pay a proportion of the profit as a dividend to shareholders. Distribution to shareholders may be in cash or, if the corporation has a dividend reinvestment plan, the amount can be paid by the issue of further shares or share repurchase; when dividends are paid, shareholders must pay income taxes, the corporation does not receive a corporate income tax deduction for the dividend payments. A dividend is allocated as a fixed amount per share with shareholders receiving a dividend in proportion to their shareholding. For the joint-stock company, paying dividends is not an expense. Retained earnings are shown in the shareholders' equity section on the company's balance sheet – the same as its issued share capital. Public companies pay dividends on a fixed schedule, but may declare a dividend at any time, sometimes called a special dividend to distinguish it from the fixed schedule dividends.
Cooperatives, on the other hand, allocate dividends according to members' activity, so their dividends are considered to be a pre-tax expense. The word "dividend" comes from the Latin word "dividendum". In financial history of the world, the Dutch East India Company was the first recorded company to pay regular dividends; the VOC paid annual dividends worth around 18 percent of the value of the shares for 200 years of existence. Cash dividends are the most common form of payment and are paid out in currency via electronic funds transfer or a printed paper check; such dividends are a form of investment income and are taxable to the recipient in the year they are paid. This is the most common method of sharing corporate profits with the shareholders of the company. For each share owned, a declared amount of money is distributed. Thus, if a person owns 100 shares and the cash dividend is 50 cents per share, the holder of the stock will be paid $50. Dividends paid are not classified as an expense, but rather a deduction of retained earnings.
Dividends paid does appear on the balance sheet. Stock or scrip dividends are those paid out in the form of additional stock shares of the issuing corporation, or another corporation, they are issued in proportion to shares owned. Nothing tangible will be gained if the stock is split because the total number of shares increases, lowering the price of each share, without changing the market capitalization, or total value, of the shares held. Stock dividend distributions do not affect the market capitalization of a company. Stock dividends are not includable in the gross income of the shareholder for US income tax purposes; because the shares are issued for proceeds equal to the pre-existing market price of the shares. Property dividends or dividends in specie are those paid out in the form of assets from the issuing corporation or another corporation, such as a subsidiary corporation, they are rare and most are securities of other companies owned by the issuer, however they can take other forms, such as products and services.
Interim dividends are dividend payments made before a company's Annual General Meeting and final financial statements. This declared dividend accompanies the company's interim financial statements. Other dividends can be used in structured finance. Financial assets with a known market value can be distributed as dividends. For large companies with subsidiaries, dividends can take the form of shares in a subsidiary company. A common technique for "spinning off" a company from its parent is to distribute shares in the new company to the old company's shareholders; the new shares can be traded independently. The most popular metric to determine the dividend coverage is the payout ratio. Most the payout ratio is calculated based on earnings per share: Payout ratio = x 100A payout ratio greater than 1 means the company is paying out more in dividends for the year than it earned. Dividends are paid in cash. On the other hand, earnings are an accountancy measure and do not represent the actual cash-flow of a company.
Hence, a more liquidity-driven way to determine the dividend’s safety is to replace earnings by free cash flow. The free cash flow represents the company’s available cash based on its operating business after investments: Payout Ratio = x 100 A dividend, declared must be approved by a company's board of directors before it is paid. For public companies, four dates are relevant regarding dividends:Declaration date — the day the board of directors announces its intention to pay a dividend. On that day, a liability is created and the company records that liability on its books. In-dividend date — the last day, one trading day before the ex-dividend date, where the stock is said to be cum dividend. In other words, existing holders of the stock and anyone who buys it on this day will receive the dividend, whereas any holders selling the stock lose their right to t
Interest is payment from a borrower or deposit-taking financial institution to a lender or depositor of an amount above repayment of the principal sum, at a particular rate. It is distinct from a fee which the borrower may pay some third party, it is distinct from dividend, paid by a company to its shareholders from its profit or reserve, but not at a particular rate decided beforehand, rather on a pro rata basis as a share in the reward gained by risk taking entrepreneurs when the revenue earned exceeds the total costs. For example, a customer would pay interest to borrow from a bank, so they pay the bank an amount, more than the amount they borrowed. In the case of savings, the customer is the lender, the bank plays the role of the borrower. Interest differs from profit, in that interest is received by a lender, whereas profit is received by the owner of an asset, investment or enterprise; the rate of interest is equal to the interest amount paid or received over a particular period divided by the principal sum borrowed or lent.
Compound interest means. Due to compounding, the total amount of debt grows exponentially, its mathematical study led to the discovery of the number e. In practice, interest is most calculated on a daily, monthly, or yearly basis, its impact is influenced by its compounding rate. According to historian Paul Johnson, the lending of "food money" was commonplace in Middle Eastern civilizations as early as 5000 BC; the argument that acquired seeds and animals could reproduce themselves was used to justify interest, but ancient Jewish religious prohibitions against usury represented a "different view". The first written evidence of compound interest dates 2400 BC; the annual interest rate was 20%. Compound interest was important for urbanization. While the traditional Middle Eastern views on interest was the result of the urbanized, economically developed character of the societies that produced them, the new Jewish prohibition on interest showed a pastoral, tribal influence. In the early 2nd millennium BC, since silver used in exchange for livestock or grain could not multiply of its own, the Laws of Eshnunna instituted a legal interest rate on deposits of dowry.
Early Muslims called this riba, translated today as the charging of interest. The First Council of Nicaea, in 325, forbade clergy from engaging in usury, defined as lending on interest above 1 percent per month. Ninth century ecumenical councils applied this regulation to the laity. Catholic Church opposition to interest hardened in the era of scholastics, when defending it was considered a heresy. St. Thomas Aquinas, the leading theologian of the Catholic Church, argued that the charging of interest is wrong because it amounts to "double charging", charging for both the thing and the use of the thing. In the medieval economy, loans were a consequence of necessity and, under those conditions, it was considered morally reproachable to charge interest, it was considered morally dubious, since no goods were produced through the lending of money, thus it should not be compensated, unlike other activities with direct physical output such as blacksmithing or farming. For the same reason, interest has been looked down upon in Islamic civilization, with all scholars agreeing that the Qur'an explicitly forbids charging interest.
Medieval jurists developed several financial instruments to encourage responsible lending and circumvent prohibitions on usury, such as the Contractum trinius. In the Renaissance era, greater mobility of people facilitated an increase in commerce and the appearance of appropriate conditions for entrepreneurs to start new, lucrative businesses. Given that borrowed money was no longer for consumption but for production as well, interest was no longer viewed in the same manner; the first attempt to control interest rates through manipulation of the money supply was made by the Banque de France in 1847. The latter half of the 20th century saw the rise of interest-free Islamic banking and finance, a movement that applies Islamic law to financial institutions and the economy; some countries, including Iran and Pakistan, have taken steps to eradicate interest from their financial systems. Rather than charging interest, the interest-free lender shares the risk by investing as a partner in profit loss sharing scheme, because predetermined loan repayment as interest is prohibited, as well as making money out of money is unacceptable.
All financial transactions must be asset-backed and it does not charge any interest or fee for the service of lending. In economics, the rate of interest is the price of credit, it plays the role of the cost of capital. In a free market economy, interest rates are subject to the law of supply and demand of the money supply, one explanation of the tendency of interest rates to be greater than zero is the scarcity of loanable funds. Over centuries, various schools of thought have developed explanations of interest and interest rates; the School of Salamanca justified paying interest in terms of the benefit to the borrower, interest received by the lender in terms of a premium for the risk of default. In the sixteenth century, Martín de Azpilcueta applied a time preference argument: it is p
Risk is the possibility of losing something of value. Values can be gained or lost when taking risk resulting from a given action or inaction, foreseen or unforeseen. Risk can be defined as the intentional interaction with uncertainty. Uncertainty is a potential and uncontrollable outcome. Risk perception is the subjective judgment people make about the severity and probability of a risk, may vary person to person. Any human endeavour carries some risk; the Oxford English Dictionary cites the earliest use of the word in English as of 1621, the spelling as risk from 1655. It defines risk as: the possibility of injury, or other adverse or unwelcome circumstance. Risk is an influence affecting strategy caused by an incentive or condition that inhibits transformation to quality excellence. Risk is an uncertain event or condition that, if it occurs, has an effect on at least one objective.. The probability of something happening multiplied by benefit if it does; the probability or threat of quantifiable damage, liability, loss, or any other negative occurrence, caused by external or internal vulnerabilities, that may be avoided through preemptive action.
Finance: The possibility that an actual return on an investment will be lower than the expected return. Insurance: A situation where the probability of a variable is known but when a mode of occurrence or the actual value of the occurrence is not. A risk is not a peril, or a hazard. Securities trading: The probability of a loss or drop in value. Trading risk is divided into two general categories: Systematic risk affects all securities in the same class and is linked to the overall capital-market system and therefore cannot be eliminated by diversification. Called market risk. Non-systematic risk is any risk. Called non-market risk, extra-market risk or diversifiable risk. Workplace: Product of the consequence and probability of a hazardous event or phenomenon. For example, the risk of developing cancer is estimated as the incremental probability of developing cancer over a lifetime as a result of exposure to potential carcinogens; the International Organization for Standardization publication ISO 31000 / ISO Guide 73:2002 definition of risk is the'effect of uncertainty on objectives'.
In this definition, uncertainties include events and uncertainties caused by ambiguity or a lack of information. It includes both negative and positive impacts on objectives. Many definitions of risk exist in common usage, however this definition was developed by an international committee representing over 30 countries and is based on the input of several thousand subject matter experts. Different approaches to risk management are taken in different fields, e.g. "Risk is the unwanted subset of a set of uncertain outcomes". Risk can be seen as relating to the probability of uncertain future events. For example, according to Factor Analysis of Information Risk, risk is: the probable frequency and probable magnitude of future loss. In computer science this definition is used by The Open Group. OHSAS defines risk as the combination of the probability of a hazard resulting in an adverse event, the severity of the event. In information security risk is defined as "the potential that a given threat will exploit vulnerabilities of an asset or group of assets and thereby cause harm to the organization".
Financial risk is defined as the unpredictable variability or volatility of returns, this would include both potential better-than-expected and worse-than-expected returns. References to negative risk below should be read as applying to positive impacts or opportunity unless the context precludes this interpretation; the related terms "threat" and "hazard" are used to mean something that could cause harm. Risk is ubiquitous in all areas of life and risk management is something that we all must do, whether we are managing a major organisation or crossing the road; when describing risk however, it is convenient to consider that risk practitioners operate in some specific practice areas. Economic risks can be manifested in higher expenditures than expected; the causes can be many, for instance, the hike in the price for raw materials, the lapsing of deadlines for construction of a new operating facility, disruptions in a production process, emergence of a serious competitor on the market, the loss of key personnel, the change of a political regime, or natural disasters.
Risks in personal health may be reduced by primary prevention actions that decrease early causes of illness or by secondary prevention actions after a person has measured clinical signs or symptoms recognised as risk factors. Tertiary prevention reduces the negative impact of an established disease by restoring f
Discounted cash flow
In finance, discounted cash flow analysis is a method of valuing a project, company, or asset using the concepts of the time value of money. All future cash flows are estimated and discounted by using cost of capital to give their present values; the sum of all future cash flows, both incoming and outgoing, is the net present value, taken as the value of the cash flows in question. Using DCF analysis to compute the NPV takes as input cash flows and a discount rate and gives as output a present value; the opposite process takes cash flows and a price as inputs, provides as output the discount rate. Discounted cash flow analysis is used in investment finance, real estate development, corporate financial management and patent valuation, it was used in industry as early as the 1700s or 1800s discussed in financial economics in the 1960s, became used in U. S. Courts in the 1980s and 1990s; the act of discounting future cash flows answers "how much money would have to be invested at a given rate of return, to yield the forecast cash flow, at its future date?"
In other words, discounting returns the present value of future cash flows, where the rate used is the cost of capital that appropriately reflects the risk, timing, of the cash flows. This "required return" thus incorporates: Time value of money – according to the theory of time preference, investors would rather have cash than having to wait and must therefore be compensated by paying for the delay Risk premium – reflects the extra return investors demand because they want to be compensated for the risk that the cash flow might not materialize after all. For the latter, various models have been developed, where the premium is calculated as a function of the asset's performance with reference to some macroeconomic variable. An alternate, although less common approach, is to apply a "fundamental valuation" method, such as the "T-model", which instead relies on accounting information. Note that "expected return", although formally the mathematical expected value, is used interchangeably with the above wording, where "expected" means "required" in the corresponding sense.
Discounted cash flow calculations have been used in some form since money was first lent at interest in ancient times. Studies of ancient Egyptian and Babylonian mathematics suggest that they used techniques similar to discounting of the future cash flows; this method of asset valuation differentiated between the accounting book value, based on the amount paid for the asset. Following the stock market crash of 1929, discounted cash flow analysis gained popularity as a valuation method for stocks. Irving Fisher in his 1930 book The Theory of Interest and John Burr Williams's 1938 text The Theory of Investment Value first formally expressed the DCF method in modern economic terms; the discounted cash flow formula is derived from the future value formula for calculating the time value of money and compounding returns. D C F = C F 1 1 + C F 2 2 + ⋯ + C F n n F V = D C F ⋅ n Thus the discounted present value is expressed as: D P V = F V n where DPV is the discounted present value of the future cash flow, or FV adjusted for the delay in receipt.
Where multiple cash flows in multiple time periods are discounted, it is necessary to sum them as follows: D P V = ∑ t = 0 N F V t t for each future cash flow at any time period in years from the present time, summed over all time periods. The sum can be used as a net present value figure. If the amount to be paid at time 0 for all the future cash flows is known that amount can be substituted for DPV and the equation can