Launched in 1984, Russell 1000 is a stock market index that is operated by FTSE Russell. It measures the performance of the top 1000 largest listed companies in the USA. It includes companies that relatively larger in size compared to the next 2000 companies in the Russell 3000 index.
What is accounts payable? Accounts Payable (AP) is an obligation that an individual or a company has to fulfill for purchasing goods and services bought from their suppliers and vendors. AP refers to the amount that is not paid upfront and can be paid back in a short period of time. Hence, a good or a service purchased on credit to be paid in a short period will fall under AP. For individuals, AP may include the bill paid after availing services such as television network, electricity, internet connection, or telephone. Most of the time, the bill is generated after the designated billing period, depending upon the amount of consumption. The customers have to pay this obligation within a stipulated time to avoid default. What is accounts payable from a Company’s point of View? AP is the amount of money a company is liable to pay to its suppliers or vendors and clear dues for purchases of goods and services purchased from its suppliers or vendors. AP is required to be repaid in a short period, depending on the relationship with suppliers. It is essentially a kind of short-term debt, which is necessary to honour to prevent default. As the current liabilities of the company, AP is required to be settled over the next twelve months. It is presented in the balance sheet as the account payable balance. For example, Entity A buys goods from Entity B for US$400,000.00 on Credit. Entity A has to pay back this amount within 60 days. Entity A will record US$400,000.00 as AP while Entity B will record the same amount as Account receivable. AP is also a part of the cash flow statement. The change in the total AP over a period is shown in the cash flow statement, hence it is part of the company’s working capital. It is widely used in analysing the cash flow of the business and cash flow trends over a period. AP may also depict the bargaining power of the company with its vendor and suppliers. A vendor or supplier may give the customer a longer credit period to settle the cash compared to other customers. The customer here is the company, which will incur AP after buying goods on credit from the vendor. There could be many reasons why the vendor is providing a more extended credit period to the firm such as long-term relationship, bargaining power of the firm, strategic needs of the vendor, the scale of goods or services. By maintaining a more extended repayment period to supplier and shorter cash realisation period from the customer, the company would be able to improve the working capital cycle and need funds to support the business-as-usual. However, prudent working capital management calls for not overtly stretching the payable days as it might lead to dissatisfaction of supplier. Also, investors tend to closely watch the payable days cycle to determine the financial health of the business. When the financial conditions of a firm deteriorate, the management tends to delay the payment to their suppliers. Why accounts payable is an important part of Balance sheet and Cash Flow Statement? As inferred from the previous paragraphs, AP is part of the current liabilities of the balance sheet. This is an obligatory debt that has to be paid back within a time frame so that the company does not default. AP primarily consists of payments to be made to suppliers. If AP keeps on increasing over a period of time, it can be said that the company is purchasing goods or services on credit more, instead of paying up front. If AP decreases, it means the company is reducing its previous debts more than it is buying goods on credit. Managing AP is essential to have a stable cash flow. In a cash flow statement prepared through an indirect method, the net difference in AP is shown under cash flow from operating activities. The business entity can use AP to create the desired variation in the cash flow to some extent. For example, to increase cash reserves, management can increase the duration of paying back the credit taken for a certain period, thus affecting the net difference in AP. What Is the Role of Accounts Payable Department? Every company has an accounts payable department and the size and structure depend upon how big or small the enterprise is. The AP department is formed based on the estimated number of suppliers, vendors, and service providers the company is expected to interact with; the amount of payment volume that would be processed in a given period of time; and the nature of reports that a management will require. For example, a tiny firm with a low volume of purchase transactions may require a simple or a basic accounts payable process. However, a medium or a large enterprise may have a accounts payable department that may require a set of practices to be followed before paying back the credit. What is the Accounts Payable Process? Guidelines or a process is important as it provides transparency and smoothness in facilitating the volume of transactions in any time period. The process involves: Bill receipt: when goods were bought, a bill records the quantity of goods received and the amount that needs to be paid to the vendors. Assessing the bill details: to ensure that the bill or invoice copy includes the name of the vendor, authorization, date of the purchase made and to verify the requirements regarding the purchase order. Updating book of records after the bill is collected: Ledger accounts need to be revised on the basis of bills received. The department makes an expense entry after taking approval from management. Timely payment processing: the department takes care of all payments that need to be processed on or before their due date as mentioned on a bill. The department prepares and verifies all the required documents. All details entered on the cheque along with bank account details of the vendor, payment vouchers, the purchase order, and the original bill and purchase order are scrutinized. The department also takes care of the safety of the company’s cash and assets and prevents: reimbursing a fake invoice reimbursing an incorrect invoice making double payment of the same vendor invoice Apart from making supplier payments, AP departments also takes care of travel expenses, making internal payments, maintaining records of vendor payments, and reducing costs Business Travel Expenses: Bigger entities or firms whose business nature requires all personnel to travel, have their AP department manage their travel costs. The AP department manages the personnel’s travel by making advance payments to travel companies including airlines and car rentals and making hotel reservations. An account payable department may also deals with requests and fund distribution to cover travel costs. After business travel, AP may also be responsible for settling funds supplied versus actual funds spent. Internal Payments: The Accounts Payable department takes care of internal reimbursement payments distribution, controlling and petty cash controlling and administering, and controlling sales tax exemption certificates distribution. Internal reimbursement payments include receipts or both substantiate reimbursement requests. Petty cash controlling and administering includes petty expenses such as out-of-pocket office supplies or miscellaneous postage, company meeting lunch. Sales tax exemption certificates comprise AP department handling sales tax exemption certificates supply to managers to make sure qualifying business purchases excludes sales tax expense. Maintaining Records of Vendor Payments: Accounts Payable maintains information of vendor contact, terms of payment and information of Internal Revenue Service W-9 either manually or on a computer database. The AP department lets management know through reports on how much the business owes at present. Other Functions: The accounts payable department is also responsible to lessen costs by identifying cost structures and creating strategies to reduce the spending of business money. For example, minimising cost by making payment of the invoice within a discount period. The AP department also acts as a direct point of contact between an entity and the vendor. How to Calculate Accounts Payable in Financial Modelling Financial modelling enables calculating the average number of days a company takes to make bill payments. AP days can be calculated using the following formula: AP value can be calculated using the following formula: What is accounts payable turnover ratio? AP turnover ratio shows the capability of a firm to pay cash to its customer after credit purchases. It is counted as an essential ratio to analyse the cash management attribute of the firm and its relationship with vendors or suppliers. It is calculated by dividing purchases by average AP. Purchases by the company are calculated as the sum of the cost of sales and net inventory in a given period: Now let’s understand this with the help of an example. Let us suppose, Cost of sales of Company XYZ for the period was $60,000, and XYZ began with inventories worth $21000 and ended at $15000. AP at the beginning was $20000, and $15000 at the end. Now the purchases will be $66000 (60000+21000-15000). The average AP will be $17500. Therefore, the AP turnover ratio will be 3.77x. Dividing the number of weeks in a year by the AP turnover ratio will give the number of weeks the company takes on average to settle its payables. In this case, it will be around 13.8 weeks (52/3.77). What is the difference between Accounts Payable vs. Trade Payables? Though the phrases "accounts payable" and "trade payables" are used interchangeably, the phrases have slight differences. Trade payables is the cash that a company is obligated to pay to its vendors for goods and supplies which are part of the inventory. Accounts payable include all of the short-term debts or obligations of a company.
What is depreciation? Depreciation is an accounting method used to allocate the cost of a tangible asset to the books of accounts over the useful life of the asset. It is essentially the accounting for wear and tear on the asset over its useful life. Depreciation also refers to the value of the asset that has been used over time. Assets of a firm that are used for over a one-year period largely include physical assets. Although firms incur expense while purchasing these assets, the expenses are not charged in the income statement. Such assets are recorded in the balance sheet of the firm and are expensed on the income statement as depreciation expense over time during the life of the asset. The tax authorities also decide the useful life of assets because overstating depreciation expense can lower tax liability. Now assets come in two variety: tangible assets and intangible assets. As the name suggests tangible, the tangible assets can be touched, such as equipment, machinery, computers, vehicles etc. Depreciation is used to expense the tangible assets of a firm. Intangible assets cannot be touched and include assets like licenses, copyrights, patents, brand names, logos etc. Amortisation of assets is an accounting method similar to depreciation used to expense intangible assets. Long-term assets are the source of generating revenue for firms over a long period of time, therefore the cost of acquiring tangible long-term assets is not expensed fully at the time of purchases and is expensed over the life of the asset. As the asset is used over periods, the carrying value of an asset in the balance sheet is reduced over time. Carrying value of an asset is the original cost minus accumulated depreciation on the asset over time. Since the cost of acquiring the long-term tangible asset is not expensed fully at the time of purchase and is expensed over its useful life, the depreciation expense is a non-cash charge because actual cash outgo was incurred at the time of purchase. But depreciation expense reduces the reported earnings of the company as it is charged on the income statement of the firm. Since the expenses are deducted from the revenue of the firm, the tax liability of the firm is also reduced. What are the methods of depreciation? Straight-line method The straight-line method is the most common method of depreciating an asset over its life. Under this method, the recurring depreciating amount of the asset remains constant and is not changed over the life of the asset. For example, a firm buys a machine for $10000 with a salvage value of $2000, and the useful life of the asset is ten years. The depreciable value of the asset will be $8000, which is the cost of machine minus salvage value. Now the firm will depreciate the $8000 each year at a rate of $800 per year. The per-year depreciation charge of $800 is the depreciable value of the asset divided by the useful life of the asset (8000/10). Double declining balance depreciation method It is an accelerated type of depreciation method. Under this method, the depreciation expense in higher in the beginning years and gradually reduces over the life of an asset. It also reflects that assets are more valuable in the early years of production compared to later years. In this method, the subsequent depreciation charges after the initial charge are calculated using the ending balance of the asset in the last period. Ending balance of the asset is the original cost of the asset less accumulated depreciation. Also, the depreciation factor in this method is twice of the straight-line method. Depreciation expense = (100%/Useful life of asset) x 2 Why is depreciation due diligence important? Depreciation can be used to manipulate the financials of the company. Overstating and understating depreciation charges directly impacts the profit of the company. When a firm is charging less depreciation than required, it would directly increase the profits of the firm. When depreciation expense is lesser than the actual expense, the income statement will record lower amount of expenses, therefore the deductions from revenue will lesser and profits will increase. Investors also assess whether the useful life of asset used in calculating the depreciation of firm is appropriate or not. The companies should use an appropriate useful life of the asset. When the useful life of the asset is increased, the depreciation charges will spread across an increased number of years. As a result, the depreciation expenses during the life of an asset would be understated since the actual life of an asset is less than recorded. Investors prefer checking the number of years used as the useful life of an asset. Sometimes firms may choose to change the method of depreciation. Although it could be appropriate when actual business conditions don’t match the method adopted, there remains a possibility that the decision to change the method could be driven by the motive to manipulate depreciation expenses. Companies may seek to keep the assets in the balance sheet even though the asset is of no use. This will help the company to keep incurring depreciation expense on the income statement and reduce the tax liability of the business. When the value of assets of the company has appreciated in light of the market environment, the balance sheet value of the asset will also increase. When the balance sheet value of an asset is increased, the depreciation charges should also increase. Therefore, appreciation in the value of an asset should also increase depreciation expense for the company.
What is Nasdaq? Nasdaq Stock Market is a global electronic marketplace for buying and selling securities on an automatic, transparent and speedy electronic network. It trades through a computer system rather than in a physical trading floor for the traders to trade directly between them. It is an American stock exchange located in the Financial District of Lower Manhattan in New York City. NASDAQ is owned by the company Nasdaq. Inc. and ranked second on the list of stock exchanges as per market capitalisation of shares traded. The first rank goes to the New York Stock Exchange. Nasdaq-National Association of Securities Dealers Automated Quotations, was founded in 1971 by the National Association of Securities Dealers (NASD) to avoid inefficient trading and delays. Nasdaq. Inc. company also owns the Nasdaq Nordic stock market network in addition to other exchanges. The exchange has more than 3,100 companies listed. They are the highest trade volume companies in the US market, valued more than US$14 trillion in total. Good read: NASDAQ surged up above 10,000 – Tech stocks setting a new benchmark What is Nasdaq known for? Nasdaq currently is the largest electronic stock market, and it is most well-known for its high-tech stocks. But it also has a variety of companies listed such as capital goods, healthcare, consumer durables and nondurables, energy, public utilities, finance and transportation. Nasdaq boasts of having some of the largest blue-chip companies in the world and attracts high growth-oriented companies. Its stocks are known to be volatile than those listed on other exchanges. Apart from listed stocks, Nasdaq also trades in over the counter (OTC) stocks. The ticker symbols for the listed companies’ stocks on the Nasdaq have four or five letters. The Nasdaq Composite index was initially termed as Nasdaq. It included all the stocks listed on Nasdaq stock market and also many stocks listed on Dow Jones Industrial Average and S&P 500 Index. The index has more than 3,000 stocks listed on it which include the world’s largest technology and biotech giants like Microsoft, Apple, Amazon, Alphabet, Facebook, Gilead Sciences, Tesla and Intel. Did you read: Blue-chip stocks: Value versus Growth in Covid-19 Era Companies have to meet certain criteria to get listed on the NASDAQ National Market. The entities have to meet financial, liquidity, and corporate governance-related requirements. Have to get registered with the Securities Exchange Commission (SEC) Have to maintain the stock price of at least US$1. Company’s value of outstanding stocks must total at least US$1.1 million. The small companies which cannot meet the criteria can get listed on NASDAQ Small Caps Market. Nasdaq changes the companies as the eligibility of the companies keeps changing. Image: Kalkine What are different Nasdaq indexes? Nasdaq uses an index to list its stocks like any other stock exchange. The index delivers stock performance snapshots. The New York Stock Exchange (NYSE) has the Dow Jones Industrial Average (DJIA) as its primary index; it tracks the stock price of 30 big companies. Nasdaq Composite and the Nasdaq 100 are two indices of Nasdaq. Nasdaq Composite measures the performance of more than 3,100 listed companies’ stocks trading daily on Nasdaq. Nasdaq 100 is a modified capitalisation-weighted index. This index has listed companies from various sectors, but the majority is from the technology industry. Depending on their market value, Nasdaq adds or removes the companies from its index Nasdaq 100. Both the NASDAQ Composite and the NASDAQ 100 indexes have listed companies from the United States as well as global companies. On the other hand, Dow Jones Industrial Average index does not include companies outside of the US. Did you read: Hanging Up Your Boots? Investment Strategies to Help you Relax and Build Wealth Brief history Nasdaq performance in the past has been groundbreaking and extraordinary. One of its highly regarded accomplishments is that Nasdaq was the first-ever stock exchange for offering electronic trading. It was the first to launch a website and stored all the records in the cloud. Interestingly, Nasdaq also sold its technology to other stock exchanges. Nasdaq invented the modern Initial Public Offering (IPO) as it listed venture-capital-backed companies. Initially, it merged with the American Stock Exchange. It formed the Nasdaq-AMEX Market Group, later on, the AMEX index was acquired by NYSE Euronext, and the entire data was integrated into NYSE. In 2007 Nasdaq acquired OMX which is a Swedish-Finnish financial company. Followed by which Nasdaq changed its name to NASDAQ OMX Group. NASDAQ OMX Group bought the Boston Stock Exchange and also the Philadelphia Stock Exchange which was the oldest stock exchange in the US. Also read: Nasdaq index’s Tech Titans kicks off with Bold Performances How to trade on Nasdaq? Though the New York Stock Exchange is the largest exchange by market capitalisation, Nasdaq is the largest by trading volume due to its electronic quote mechanism. Nasdaq is a dealer’s market where the public buys and sells stocks with the help of the market maker (a registered broker/dealer). The market maker provides the buy and sell quotes and takes the position in those stocks. NYSE works differently as the buyers and sellers can trade directly with each other, and a specialist allows the trade. On Nasdaq, the market maker owns inventory and trade stocks in his/her capacity. Good read: Why NASDAQ Composite index plunged 5%?
What is a Futures Contract? Futures contract refers to a binding agreement between two parties to buy and sell a fixed quantity of an underlying asset on a later date at a pre-determined price. The underlying asset upon which the futures contracts are made can be a commodity, shares of a company, or any other listed security. Futures contracts are exchange-traded contracts, and all the contract specifications are defined by the exchange. Unlike a forward contract, there is a clearing corporation which is associated with the respective exchange that guarantees the settlement of these trades. Therefore, there is almost no risk of default or counterparty risk associated with a futures contract which is one of the primary concerns in a forward contract. FOR FURTHER UNDERSTANDING OF FUTURES ALSO READ: What is a Futures Contract? How to Calculate the Contract value? Future contracts are traded in lots which is essentially the quantity of underlying upon which the futures contract is made. Contract size or value is the total worth of the contract that is being traded. For, e.g. a futures contract of XYZ share having a lot size of 100 shares is currently quoting at $50. Then the contract value would be equal to $5000 ($50 per share for 100 shares). What is Long/Short position? A person having an unsettled or outstanding buy position in a futures contract is said to have a long position. Similarly, if a person has outstanding sell position which has not been squared off is said to have a short position. What is Settlement Day? All futures contracts have a limited span of existence beyond which they cease to exist. The last trading day of the contract is the settlement day. All the obligations of buyers and sellers are needed to be settled on this day. There are two mechanisms in which settlement takes place, namely: Cash settlement At the time of expiration, the seller of the contract does not deliver the underlying asset but instead settles his net obligation in cash. For, e.g. If B goes long on a contract of 100 shares of XZY at $100 and at the expiration, the price settles at $110, then instead of delivering 100 shares at $100 (pre-determined price), the sellers settle his net loss in cash and pays the difference to the buyer. i.e $1000 Physical settlement In a physical settlement, the obligation of both the parties settles through the physical delivery of the underlying by the seller. The buyer receives the asset, unlike price difference, in the case of cash settlement. In every case, it is the exchange which defines the settlement mechanisms, and the parties cannot deviate from it despite a mutual agreement. How are futures prices determined? The prices of futures contracts move in positive correlation with the spot market prices of the underlying assets. Spot market price refers to the current price of the asset in the physical market. Let us assume a person wants to buy the shares of a company and he/she enters into a futures contract. Now if the share price of the company is rising, then it is highly likely that the futures price would also rise and the buyer can sell his futures contract at a higher price. However, many times, it is possible that the change in the price of the underlying asset does not have any impact on the futures contract prices. Although there is a precise mathematical model, i.e. “Cost of Carry” which determines the theoretical price of a futures contract. In real-time, the current market price may not be equal to the theoretical price as the forces of demand and supply also fluctuate the price. ALSO READ: An Insight Into ASX 200 And Futures What is ‘basis’ and the risk attached to it? Although spot prices are highly correlated with the prices of the futures contract, these two prices are never the same. Basis refers to the difference between the spot price of an asset and the price of a futures contract of that asset. If the price of a futures contract is greater than the spot price, the basis for the asset is negative. Similarly, if the spot price is greater than the futures price, the basis for the asset is positive. It turns to zero at the expiry of the futures contract, i.e. there should not be any difference between futures price and spot price at the time of expiry of the contract. Basis keeps weakening and strengthening according to the market situation. Thus, there are certain risks attached to basis. What futures contracts do is that they convert the price risk, i.e., the risk attached to falling and rising prices of the underlying asset, into basis risk. Basis risk is better than price risk as it provides a window between which profits and losses are locked. Thus, with the correct hedging strategy, it is possible to set a limit beyond which losses will not be incurred to either the seller or to the buyer. Who trades in futures contract and what are the benefits? Speculator/Trader Futures contracts are well suited to place directional bets on interest rates, stock market indices, currency exchange rates etc. As futures is a leveraged product; therefore, the potential return on the capital deployed is relatively high as compared to transacting the same underling in the spot market. Hedgers Hedging was the primary reason for the introduction of the derivatives market. Corporations, Government, banks etc. all hedge their exposure to their underlying business through the derivatives market. Hedging simply means to make a counter position to mitigate the risk of the initial position. Arbitrageurs Arbitrageurs are the once who try to make risk free profits by exploiting mispricing in the market. An Arbitrage opportunity occurs when a single asset is being priced differently in two different markets, and Arbitrageurs looks to buy in the market with less price and sell in the market with high price simultaneously. This helps to make the difference between the two as a risk-free profit.