Financial Statement Analysis for Sales and Marketing Executives

While it is not necessary to be a qualified accountant to design a Strategy for Sales Perfection, a basic understanding of what is involved in financial analysis is essential for anyone in sales and marketing. It is too enticing, and often too easy, to use “blue skies” thinking in planning sales and marketing activities. It is even easier to spend money without fully realizing the return one is getting for it. It is critical that sales and marketing executives be more disciplined and analytical in the way they go about planning, executing and evaluating the sales and marketing plans and strategy. One way of introducing more discipline into the process is by having a basic understanding of the financial implications of decision making, and how financial measures can be used to monitor and control marketing operations. The purpose of this text is to provide exactly that, and the first chapter deals basically with an introduction to the activities involved in financial analysis.

The Income Statement

The P&L (profit and loss) statement otherwise known as the income statement is illustrated below. This is an abbreviated version as most income statements contain much more detail, for example, expenses are typically listed based on their individual.

G/L ledger account:

The income statement measures a company’s financial performance over a specific accounting period. Financial performance is assessed by giving a summary of how the business incurs its revenues and expenses through both operating and non-operating activities. It also shows the net profit or loss incurred over a specific accounting period, typically over a fiscal quarter or year. The income statement is also known as the “profit and loss statement” or “statement of revenue and expense.”

Sales – These are defined as total sales (revenues) during the accounting period. Remember these sales are net of returns, allowances and discounts.

Discounts – these are discounts earned by customers for paying their bills on tie to your company.

Cost of Goods Sold (COGS) – These are all the direct costs that are related to the product or rendered service sold and recorded during the accounting period.

Operating expenses – These include all other expenses that are not included in COGS but are related to the operation of the business during the specified accounting period. This account is most commonly referred to as “SG&A” (sales general and administrative) and includes expenses such as sales salaries, payroll taxes, administrative salaries, support salaries, and insurance. Material handling expenses are commonly warehousing costs, maintenance, administrative office expenses (rent, computers, accounting fees, legal fees). It is also common practice to designate a separation of expense allocation for marketing and variable selling (travel and entertainment).

EBITDA – earnings before income tax, depreciation and amortization. This is reported as income from operations.

Other revenues & expenses – These are all non-operating expenses such as interest earned on cash or interest paid on loans.

Income taxes – This account is a provision for income taxes for reporting purposes.

The Components of Net Income:

Operating income from continuing operations – This comprises all revenues net of returns, allowances and discounts, less the cost and expenses related to the generation of these revenues. The costs deducted from revenues are typically the COGS and SG&A expenses.

Recurring income before interest and taxes from continuing operations – In addition to operating income from continuing operations, this component includes all other income, such as investment income from unconsolidated subsidiaries and/or other investments and gains (or losses) from the sale of assets. To be included in this category, these items must be recurring in nature. This component is generally considered to be the best predictor of future earnings. However, non-cash expenses such as depreciation and amortization are not assumed to be good indicators of future capital expenditures. Since this component does not take into account the capital structure of the company (use of debt), it is also used to value similar companies.

Recurring (pre-tax) income from continuing operations – This component takes the company’s financial structure into consideration as it deducts interest expenses.

Pre-tax earnings from continuing operations – Included in this category are items that are either unusual or infrequent in nature but cannot be both. Examples are an employee-separation cost, plant shutdown, impairments, write-offs, write-downs, integration expenses, etc.

Net income from continuing operations – This component takes into account the impact of taxes from continuing operations.

Non-Recurring Items:

Discontinued operations, extraordinary items and accounting changes are all reported as separate items in the income statement. They are all reported net of taxes and below the tax line, and are not included in income from continuing operations. In some cases, earlier income statements and balance sheets have to be adjusted to reflect changes.

Income (or expense) from discontinued operations – This component is related to income (or expense) generated due to the shutdown of one or more divisions or operations (plants). These events need to be isolated so they do not inflate or deflate the company’s future earning potential. This type of nonrecurring occurrence also has a nonrecurring tax implication and, as a result of the tax implication, should not be included in the income tax expense used to calculate net income from continuing operations. That is why this income (or expense) is always reported net of taxes. The same is true for extraordinary items and cumulative effect of accounting changes (see below).

Extraordinary items – This component relates to items that are both unusual and infrequent in nature. That means it is a one-time gain or loss that is not expected to occur in the future. An example is environmental remediation.

The Balance Sheet

The balance sheet provides information on what the company owns (its assets), what it owes (its liabilities) and the value of the business to its stockholders (the shareholders’ equity) as of a specific date. It is called a balance sheet because the two sides balance out. This makes sense: a company has to pay for all the things it has (assets) by either borrowing money (liabilities) or getting it from shareholders (shareholders’ equity).

Assets are economic resources that are expected to produce economic benefits for their owner.

Liabilities are obligations the company has to outside parties. Liabilities represent others’ rights to the company’s money or services. Examples include bank loans, debts to suppliers and debts to employees.

Shareholders’ equity is the value of a business to its owners after all of its obligations have been met. This net worth belongs to the owners. Shareholders’ equity generally reflects the amount of capital the owners have invested, plus any profits generated that were subsequently reinvested in the company.

The balance sheet must follow the following formula:

Total Assets = Total Liabilities + Shareholders’ Equity

Each of the three segments of the balance sheet will have many accounts within it that document the value of each segment. Accounts such as cash, inventory and property are on the asset side of the balance sheet, while on the liability side there are accounts such as accounts payable or long-term debt. The exact accounts on a balance sheet will differ by company and by industry, as there is no one set template that accurately accommodates the differences between varying types of businesses.

Current Assets – These are assets that may be converted into cash, sold or consumed within a year or less. These usually include:

Cash – This is what the company has in cash in the bank. Cash is reported at its market value at the reporting date in the respective currency in which the financials are prepared. Different cash denominations are converted at the market conversion rate.

Marketable securities (short-term investments) – These can be both equity and/or debt securities for which a ready market exists. Furthermore, management expects to sell these investments within one year’s time. These short-term investments are reported at their market value.

Accounts receivable – This represents the money that is owed to the company for the goods and services it has provided to customers on credit. Every business has customers that will not pay for the products or services the company has provided. Management must estimate which customers are unlikely to pay and create an account called allowance for doubtful accounts. Variations in this account will impact the reported sales on the income statement. Accounts receivable reported on the balance sheet are net of their realizable value (reduced by allowance for doubtful accounts).

Notes receivable – This account is similar in nature to accounts receivable but it is supported by more formal agreements such as a “promissory notes” (usually a short-term loan that carries interest). Furthermore, the maturity of notes receivable is generally longer than accounts receivable but less than a year. Notes receivable is reported at its net realizable value (the amount that will be collected).

Inventory – This represents raw materials and items that are available for sale or are in the process of being made ready for sale. These items can be valued individually by several different means, including at cost or current market value, and collectively by FIFO (first in, first out), LIFO (last in, first out) or average-cost method. Inventory is valued at the lower of the cost or market price to preclude overstating earnings and assets.

Prepaid expenses – These are payments that have been made for services that the company expects to receive in the near future. Typical prepaid expenses include rent, insurance premiums and taxes. These expenses are valued at their original (or historical) cost.

Long-Term assets – These are assets that may not be converted into cash, sold or consumed within a year or less. The heading “Long-Term Assets” is usually not displayed on a company’s consolidated balance sheet. However, all items that are not included in current assets are considered long-term assets. These are:

Investments – These are investments that management does not expect to sell within the year. These investments can include bonds, common stock, long-term notes, investments in tangible fixed assets not currently used in operations (such as land held for speculation) and investments set aside in special funds, such as sinking funds, pension funds and plan-expansion funds. These long-term investments are reported at their historical cost or market value on the balance sheet.

Fixed assets – These are durable physical properties used in operations that have a useful life longer than one year.

This includes: Machinery and equipment – This category represents the total machinery, equipment and furniture used in the company’s operations. These assets are reported at their historical cost less accumulated depreciation.

Buildings or Plants – These are buildings that the company uses for its operations. These assets are depreciated and are reported at historical cost less accumulated depreciation.

Land – The land owned by the company on which the company’s buildings or plants are sitting on. Land is valued at historical cost and is not depreciable under U.S. GAAP (generally accepted accounting principles).

Other assets – This is a special classification for unusual items that cannot be included in one of the other asset categories. Examples include deferred charges (long-term prepaid expenses), non-current receivables and advances to subsidiaries.

Intangible assets – These are assets that lack physical substance but provide economic rights and advantages: patents, franchises, copyrights, goodwill, trademarks and organization costs. These assets have a high degree of uncertainty in regard to whether future benefits will be realized. They are reported at historical cost net of accumulated depreciation.

Current liabilities – These are debts that are due to be paid within one year or the operating cycle, whichever is longer. Such obligations will typically involve the use of current assets, the creation of another current liability or the providing of some service.

Bank indebtedness – This amount is owed to the bank in the short term, such as a bank line of credit.

Accounts payable – This amount is owed to suppliers for products and services that are delivered but not paid for.

Wages payable (salaries), rent, tax and utilities – This amount is payable to employees, landlords, government and others.

Accrued liabilities (accrued expenses) – These liabilities arise because an expense occurs in a period prior to the related cash payment. This accounting term is usually used as an all-encompassing term that includes customer prepayments, dividends payables and wages payables, among others.

Notes payable (short-term loans) – This is an amount that the company owes to a creditor, and it usually carries an interest expense.

Unearned revenues (customer prepayments) – These are payments received by customers for products and services the company has not delivered or for which the company has not yet started to incur any cost for delivery.

Dividends payable – This occurs as a company declares a dividend but has not yet paid it out to its owners.

Current portion of long-term debt – The currently maturing portion of the long-term debt is classified as a current liability. Theoretically, any related premium or discount should also be reclassified as a current liability.

Current portion of capital-lease obligation – This is the portion of a long-term capital lease that is due within the next year.

Long-term Liabilities – These are obligations that are reasonably expected to be liquidated at some date beyond one year or one operating cycle. Long-term obligations are reported as the present value of all future cash payments. Usually included are:

Notes payables – This is an amount the company owes to a creditor, which usually carries an interest expense.

Long-term debt (bonds payable) – This is long-term debt net of current portion.

Deferred income tax liability – GAAP (generally accepted accounting principles) allows management to use different accounting principles and/or methods for reporting purposes than it uses for corporate tax fillings to the IRS. Deferred tax liabilities are taxes due in the future (future cash outflow for taxes payable) on income that has already been recognized for the books. In effect, although the company has already recognized the income on its books, the IRS lets it pay the taxes later due to the timing difference. If a company’s tax expense is greater than its tax payable, then the company has created a future tax liability (the inverse would be accounted for as a deferred tax asset).

Pension fund liability – This is a company’s obligation to pay its past and current employees’ post-retirement benefits; they are expected to materialize when the employees take their retirement for structures like a defined-benefit plan. This amount is valued by actuaries and represents the estimated present value of future pension expense, compared to the current value of the pension fund. The pension fund liability represents the additional amount the company will have to contribute to the current pension fund to meet future obligations.

Long-term capital-lease obligation – This is a written agreement under which a property owner allows a tenant to use and rent the property for a specified period of time. Long-term capital-lease obligations are net of current portion.

Statement of Cash Flow

The statement of cash flow reports the impact of a firm’s operating, investing and financial activities on cash flows over an accounting period.

The cash flow statement shows the following:

How the company obtains and spends cash

Why there may be differences between net income and cash flows

If the company generates enough cash from operation to sustain the business

If the company generates enough cash to pay off existing debts as they mature

If the company has enough cash to take advantage of new investment opportunities

Segregation of Cash Flows

The statement of cash flows is segregated into three sections: Operations, investing, and financing.

Cash Flow from Operating Activities (CFO) – CFO is cash flow that arises from normal operations such as revenues and cash operating expenses net of taxes. These include:

Cash inflow: is the positive influx of funds from (1) positive revenue from sale of goods or services (2) interest from indebtedness and (3) dividends from investments.

Cash outflow: is the negative (payments) most commonly categorized as (1) Payments to suppliers (2) payments to employees (3) payments to the government (4) payment to lenders (5) payment for other expenses.

Cash Flow from Investing Activities (CFI) – CFI is cash flow that arises from investment activities such as the acquisition or disposition of current and fixed assets. These include:

Cash inflow is the receipt of cash from (1) the sale or disposition of property, plant or equipment (2) the sale of debt or equity securities or (3) lending income to other entities.

Cash outflow is the payment of (1) the purchase of property plant and equipment, (2) purchase of debt or other equity securities, or (3) lending to other entities,

Cash flow from financing activities (CFF) – CFF is cash flow that arises from raising (or decreasing) cash through the issuance (or retraction) of additional shares, or through short-term or long-term debt for the company’s operations.

Financial Statement Analysis

Vertical Analysis

Analyzing a single period financial statement works well with vertical analysis. On the income statement, percentages represent the correlation of each separate account to net sales. Express all accounts other than net sales as a percentage of net sales. Net income represents the percentage of net sales not used on expenses. For example, if expenses total 69 percent of net sales, net income represents the remaining 31 percent. Vertical analysis performed on balance sheets uses total assets and total liabilities for comparison of individual balance sheet accounts.

Horizontal Analysis

Horizontal analysis is the comparison of data sets for two periods. Financial statements users review the change in data much like an indicator. Optimistic analysts look for growth in revenue, net income and assets in addition to reductions in expenses and liabilities. Calculating absolute dollar changes requires the user to subtract the base figure from the current figure. Expressing changes with percentages requires the user to divide the base figure by the current figure, and multiply by 100.

Trend Analysis

Review of three or more financial statement periods typically represents trend analysis, a continuation of horizontal analysis. The base year represents the earliest year in the data set. Although dollars can represent subsequent periods, analysts commonly use percentages for comparability purposes. Users review statements for patterns of incremental change representing changes in the business in questions. Financial statement improvements include increased income and decreased expenses.

Ratio Analysis

Ratios express a relationship between two more financial statement totals, and compare to budgets and industry benchmarks. Five common categories of ratios exist: liquidity, asset turnover, leverage, profitability and solvency. Reviewing ratios for performance compared with prior periods or industry specific benchmarks provides financial statements users with recognition of strengths and weaknesses.

Limitations

Analyzing financial statements presents an opportunity for reviewing past data and possibly budgets. However, the data used is historical in nature, indicating it may not be a good representation of the future due to unforeseeable circumstances. Market value of assets and liabilities can be under or overstated significantly leaving statement users unaware of the real value of a balance sheet. Pro forma statements, or forward-looking financial statements, provide estimates at best resulting in speculation.

Cost-Volume-Profit

Cost-volume-profit analysis provides owners and managers with an understanding of the relationship between fixed and variable costs, volume of products manufactured or sold and the profit resulting from sales. The financial relationship includes contribution margin analysis, break-even analysis and operational leverage. Financial statements provide the data to perform cost-volume-profit analysis.

Contribution Margin

Contribution margin analysis allows managers to look at the percentage of each sales dollar remaining after payment of variable costs, including cost of goods, commissions and delivery charges. Managers and owners use this analysis to help determine the pricing, mix, introduction and removal of products. Contribution margin analysis also aids managers with determining how much incentive to use for sales commissions and bonuses. Comparing each product offered affords the opportunity to look at product profitability and product mix.

Break-even

Break-even analysis considers the sales volume at which fixed and variable costs are even. Owners and managers must consider two primary figures when calculating the break-even. First, gross profit margin, which is the percentage of sales remaining after payment of variable costs. And fixed costs, including administration, office and marketing. Financial statements provide both sets of data necessary to calculate the break-even volume.

Operational Leverage

Every business model contains slightly different operating leverage, which compares the amount of fixed costs to sales. Businesses with higher fixed costs will experience a larger multiplier in their operating leverage, indicating less sales growth results in more profit. However, the same is true for losses, where small reductions in sales exponentially increase net losses. Less operating leverage results in less growth of net income.

Financial Ratios

A financial ratio expresses a mathematical relationship between two or more sets of financial statement data and commonly exhibits the relationship as a percentage. Profitability, solvency, leverage, asset turnover and liquidity comprise the five standard ratio categories. Managers and owners should review the ratios period over period, determining where unfavorable trends exist. After reviewing trends, benchmark ratios against industry standards, which managers can acquire from a variety of sources including industry-specific organizations.

A financial ratio (or accounting ratio) is a relative magnitude of two selected numerical values taken from an enterprise’s financial statements. Often used in accounting, there are many standard ratios used to try to evaluate the overall financial condition of a corporation or other organization. Financial ratios may be used by managers within a firm, by current and potential shareholders (owners) of a firm, and by a firm’s creditors.

Ratios can be used to judge the organization’s “liquidity”, i.e. can it pay its bills, its “leverage”, i.e. how is it financed and its “activities”, i.e. the productivity and efficiency of the organization. Taking liquidity analysis only, this has a bearing on new product planning, marketing budgets and the marketing decisions.

Financial analysis can be used to serve many purposes in an organization but in the area of marketing it has four main functions:

Gauge how well marketing strategy is working (situation analysis)

Evaluate marketing decision alternatives

Develop plans for the future

Control activities on a short term or-day to-day basis.

Understanding a company’s financial performance is critical to developing a solid Strategy for Sales Perfection as well as being an educated and well informed company executive. The purpose of this discussion is to introduce you to the concepts and points of analyzing financial statements and using ratios to develop informed business decisions. The information discussed in this chapter in no way will substitute the job function of your CFO or your CPA.

Financial statements can be quite complex and accounting principles may have significant effect on the way they are reported. Understand that a coordinated dialogue with your accounting staff is critical to obtain clear and concise knowledge of your company financial statements. Financial ratios have limitations and specific uses if interpreted properly. Attention should be given to the following issues when using financial ratios:

A reference point is needed. To be meaningful most ratios must be compared to historical values of the same firm, your company forecasts, or ratios with similar companies.

Most ratios by themselves are not highly meaningful. They should be viewed as indicators, with several of them combined to draw on a conclusion of the purpose of the analysis.

Take into account seasonal factors and business cycles when using financial ratios. Average values should be used when they are available.

Communicate with your accounting department to understand their philosophy and accounting principles.

Sales and Profit Ratio Model

Several profit models have been introduced over the years to gauge the performance of a company and to build a statistical measure to peak performance. We have developed a very simple model that measures four critical areas of performance: gross profit margin %, net profit margin %, RONA – return on net assets, and GMROI – gross margin return on inventory. Earlier in the chapter, we introduced a set of financial statements of which we will use the data from those as part of our illustration of the Sales and profit model.

Sales

COGS – cost of goods sold

Operating expenses – net of depreciation, amortization and interest charges

Fixed assets – property plant and equipment net of depreciation

Current assets

Current liabilities

Inventory

Net Income – after tax income

This model can be set up in an excel spreadsheet to keep track and measure the company’s progress in attaining peak sales performance; monthly tracking should be supported to insure constant improvements. These four ratios are the best measure of a company’s overall sales performance and should be compared to others in your industry to attain top performance standards.

Gross Margin Return on Inventory (GMROI) is a “turn and earn” metric that measures inventory performance based on both margin and inventory turnover. In essence, GMROI answers the question, “For every dollar carried in inventory, how much is earned in gross profit?” GMROI can be calculated at the organization level and, if the proper data is collected at the item level, all the way down to an individual item.

To set a benchmark for the organization, use either current financial statements or budgets for the future. Calculate the GP %, ITO and compute the existing or target GMROI. Measure every appropriate segment against this target. You will identify groups that are exceeding the targets and also those that are not pulling their own weight. While most organizations have some “loss leaders”, it is important to understand which items/groups that are under-performing. Choices are to live with the performance, improve the margin, improve the turnover or in extreme cases, discontinue the poor performing product.

Break-Even Profit Analysis

In business and economics, break-even analysis is a commonly used practice to set pricing multiples or price indexes. Companies need to use break even analysis to determine many relevant factors when designing a strategy for sales perfection. In the linear “cost-volume profit analysis”, the break-even point in terms of units (X) can be directly computed in terms of total revenue (TR) and total costs (TC) as:

The relationship between gross profit margins and sales revenue is approximately a 3.5 to 1 ratio. Simply stated, if you reduce your margin by 1/2 percentage point (.5%) you will need to raise your revenue by 1.7% to maintain the same amount of gross profit. Look at the table above which clearly illustrates this concept, now compare this illustration to your own company. Let’s assume your company has total revenue of $45,000,000, a reduction in margins of a half percent (0.5%) would require you to raise revenue to $48,375,000 to maintain the same amount of income. Your objective as an executive inside your company is to improve your company’s financial position.

Our website winning sales strategy and our book “Strategies for Sales Perfection: In the New Economy provide detailed analysis and explanations of this information along with a plethora of additional resources to allow your company to succeed during these this new economic recovery period.

The Humanization of Financial Planning

“Every time you build into the life of another person, you launch a process that will never end.”

– Howard Hendricks

The nature of financial planning has started to change dramatically in the past 10 years with the movement towards “financial life” planning. Financial life planning is about more consciously integrating both your life and money into the financial plan and investment portfolio. Some leading financial planners will say they have always helped clients plan for their life as a matter of course. They have never labeled it this way. On the other side, the wider public perception is still that financial planning is about investing and planners do not care beyond the money.

Once consumers know they can find a more “humanized” financial planning approach then there will be much greater pressure on financial planners to expand their role and processes from financial management to coaching, mentoring and life planning.

On the basis that helping clients reach their goals is fundamental to financial planning then helping them understand who they are and their life plan is critical. These aspects are fundamental to a role which involves a greater emphasis on the non-financial issues. Sounds basic but why do so many planners not perceive addressing the life and human issues to be part of their role?

The results of a survey conducted in February 2009 by David Debofsky and Lyle Sussman indicate that 89% of financial planners who are members of the CFP Board and/or Financial Planning Association do at some point engage in non-financial coaching and counseling, and 74% of these planners say they have increased this work over the last 5 years. Further, advisors are indicating 25% of their time is spent on the non-financial issues. The non-financial issues that come up the most include 81% personal life goals, 66% career and 44% physical health. Then add to this clients are now bringing up 10 to 20% of the time with their planner emotional issues like divorce, addiction, mental health and spirituality.

What all of this is showing is that the role of the planner is changing towards dealing with the life and human issues at a greater level even if the advisor is not deliberately changing his or her process. Based on our research in February 2009, we found that 50% of planners are still only spending 1 to 3 hours up-front in the client discovery phase addressing your needs as a client. This is clearly not enough to properly address the life issues. Of course, not all planners will accept their role is beyond financial analytics and also not all consumers will want to address personal issues with a financial planner. Notwithstanding, the practical issue is that many of you as clients are going to encounter situations or needs which require the planner to address the non-financial issues as part of providing financial advice. A financial planner is ideally positioned to help you on the non-financial issues because money is naturally integrated to them. Luckily, there is an increasing amount of quality training for advisors to go down the coaching, mentoring and life planning path.

The primary benefit of a financial planner becoming your coach or mentor is that it will help in building a deeper long-term relationship based on trust and a higher level of mutuality. This is vital for helping you make significant and long-term financial decisions. Walking the road of life with a financial planner will enable:

Clear guidance to be obtained on both the financial and life issues.
Wisdom from one who has both financial and life experience.
Learning from the success and mistakes of another.
A true partnership based on sharing who they are.

If you are going to choose a planner to go beyond the numbers and be a central point in your life journey then it is important you choose a person who is capable of:

Developing a safe, mutual and structured environment for the coaching or mentoring.
Developing a clear coaching or mentoring process with protocols established, including for engaging you in the discussion of the non-financial issues, asking the right questions with empathy, and facilitating difficult discussions.
Engaging in a personal development process for him or herself personally through using a coach or mentor of their own. A planner cannot guide a client to a place where they have not been themself.
Using robust assessment and facilitation tools that will provide a more objective and reliable understanding of who you are and personal development to meet your unique needs.

Start Humanizing Your Financial Planning and Increasing Your Financial Life Performance

So, whether you are an investor, entrepreneur, executive, financial advisor or a student take action with the following steps:

Complete the Financial DNA® Profiles to discover the core of who you are.
Develop your own goals based on a clear life purpose.
Define what a quality life means to you.
Identify the resources in your personal and professional life you need to grow.
Start working on the steps needed for getting to the next level of success.
Make part of your growth plan having a financial planner who can provide guidance in all the dimensions of your life.

Hugh is the President and Founder of Financial DNA Resources, a leading international Financial Behavior Consulting firm. He has 22 years of unique and diverse financial and business advisory experience. Hugh has worked with financial advisors, professionals, and coaches from all over the world to provide client centric solutions. His educational programs and services are internationally recognized and centered on client discovery, business and personal development, practice management and improving human performance to increase ROI.

Financial Advisors: Top 6 Reasons To Choose Them

Selection of the right person for managing your personal finances is one of the most crucial decisions you will be making. You entrust the job of managing your hard-earned money to an advisor with a hope to make use of his or her financial expertise. So, he or she should help you get solutions and reach your financial goals by preparing the right plan for you and also discovering the suitable investment plan for you. In fact, you are driven to seek the help of financial advisors to get serviced by them, with their professional caliber and integrity.

Desirable Duties A Financial Advisor:

1. The first and foremost desirable duty that a financial advisor (FA) should perform is to help his or her clients to make the appropriate investment choices based on an in-depth review of his or her clients’ financial circumstances.

2. A financial advisor should guide his or her clients to remain steadfast and committed to their financial strategies.

3. A financial advisor should guide his or her clients by caring that they are never carried away by excessive euphoria or pessimism about any financial offer.

4. A financial advisor should monitor and review the portfolio of his or her clients on a regular basis and manage them to keep them seamless.

5. A financial advisor should let his or her clients know the latest changes and developments in the financial world and help to visualize them their possible impacts on their investments.

6. A financial advisor should support his or her clients in documentation and paperwork related to their investments.

When You should approach a Financial Advisor:

You may have the capacity to invest, but you don’t have the idea which financial plans would be more profitable for you. In such circumstances, people like you need to be clear about a few things before they start their search. They are as follows.

1. Make sure if you have proper investment capacity. If yes, you should go to a financial advisor.

2. If you want to secure your investment with right investment planning, you need to seek advice of a financial expert.

3. When you have little bit understanding of the financial market and its products and have no idea how and where to invest, you need to seek advice of a financial expert.

4. Even if you have the capability of making your own investment decisions, you need to select someone who is expert to draw up a financial plan in sync with your financial capacity and goals.

5. As financial experts perform financial documentation and paperwork more professionally, you should seek their advices. However, the execution part of the financial planning should always be left to your discretion.

6. You need to go to a financial expert when a new financial plan is launched or when you need to save you from paying hefty taxes.

Types of Financial Experts:

There are typically three types of financial advisors. They are as follows.

i) Independent Financial Advisors (IFA or Agents)

ii) Relationship & Wealth Management Officers (RWMO)

iii) Qualified Financial Planners (QFP)

IFAs work independently, as the very name signifies. They are keener on maintaining long-term relation with their clients and are also committed to deliver quality services to their clients. Relationship and wealth management officers are associate members of financial institutions like banks or large distributors. RWMOs usually offer a large variety of financial products, but they are choosy about the profiles of their clients. They prefer to deal with HNI (High Networth Individual) clients only. The QFPs help to draw up bespoke financial plans for their clients. They can customize financial plans in accordance with the financial needs and goals of their clients because of their deep understanding of a comprehensive range of financial market. Although the right to execute a plan is absolutely up to the clients only, all these financial experts help in executing the plans.

To choose a financial advisor, clients should meet them and discuss all necessary and relevant points with them. Most importantly, clients should ask them for revealing their point of views regarding current investment opportunities and possible growth of a fund which they may be advising them to choose from many. During discussion, clients should compulsorily seek to identify if the FA is better than other FAs, what advisory process they are following, if they evaluate and monitor investment market regularly, or whether they keep their clients updated about market developments, and if they review the portfolios of their clients meticulously. Bear in mind, the financial market is rich in all aspects itself and that is needless to say, as needless to remind you that you will have hundreds of financial experts available in the market to choose from.

Joy Kumar Das wields genuine command over financial market and investment strategies, business promotion and strategies, and advertisement management, among others. His writings express his thoughts which emanate from thorough analysis. This article is an outcome of his elaborate research.

The Road to Financial Freedom – Steps You Must Take

Countless researches have been made and books written on the road to financial freedom but still yet, a lot many people are still struggling to break even and success still eludes a greater percentage of individuals in our contemporary society. What exactly is financial freedom and what are the factors responsible for it? These and similar questions I tend to answer in the course of this article.

Financial freedom put simply means having an income flow that far exceeds your compounded liabilities over your expected life span. In other words if you factor in your tax dues, your mortgages, medical or health care expenses, insurance premiums, college tuition fees, bank loans, debts, daily expenses etc and compound them over your expected life span taken into cognizance inflationary tendencies, if the result you obtain is a fraction of your annual income then, you can truly say you’ve achieve financial freedom. In a nutshell it simply implies that your income far outweighs your aggregated liabilities over your expected life span. Can this really be achieved or is it a theory propounded by financial experts? To be honest with you financial freedom is not a myth but a concrete reality that can be achieved with articulate planning and execution. The fact we are surrounded by individuals who are millionaires and billionaires is a testimony that it can be achieved. These individuals are not aliens with mystery powers but mere humans who adopted certain steps that ultimately ushered them into financial freedom. The steps they took are not mystery secrets but rather mere perfunctory considerations and exercises which many people tend to overlook in the course of their daily existence. Here are the steps they took.

Having a strong desire to be financially free. You must desire to have financial freedom before you can have it. Having a strong desire does not mean wishful thinking for something or mere day-dreaming. If you have a strong desire to be financially free, then, your thought will be saturated with you desire to be financially free and ideas on how to achieve it will start springing forth. All round us are product s of human thought from the simplest invention to the most complicated technology of recent times. All these things were once thoughts and desires but today they are now concrete realities. If you strongly desire financial freedom then, you can truly achieve it.

Next in line is financial planning. Desire will put ideas into your head but planning will order those ideas in such a way that they become realistically possible. You must have a financial plan or risk failure. A journey without a plan is an effort in futility. A financial plan must be objective, realistic, specific and quantified within a time frame. Your financial plan must be written and drawn out carefully. Don’t make abstract plans or say you have your plan in your imagination. Make it solid reality by penning it down carefully. Once your financial plans are carefully written out, you get the push to do something about them each time you view them on print.

After carefully making your financial plan and writing it out, then, you need to optimize it. Optimizing you financial plan involves cross-checking it and picking loopholes. If you are not knowledgeable enough to do it your self, you can seek expert advice on your financial plan. Why not consider giving it to financial planner for more credible assessment. Bad plans can be catastrophic and expensive in the long run. Exposing your plans to professionals or seeking expert advice will save you the agony of complete failure or fiasco and minimize the rise in carrying out your plans. Although it may cost you a bit money, but better pay and get what you pay for, than risk losing everything with a badly laid out financial plan.

Lastly, execute your financial plan. Even the best financial plan would be useless if nothing is done about it. Merely having a paper financial plan, though, a right step is not enough to usher you to the gate-way of financial freedom. Executing your financial plans may involve setting out some specific amount from your monthly stipend and investing it. If such was your plan why not go further in opening a separate bank account and lodging those monies into it. Sometimes the times may be tough but if you learn to stick to your plan, come what may, then you are on your way to financial freedom. Researches have shown that those that who stick to their plans willy-nilly still manage to turn out better than those who make no plans. So always do your best to execute your financial plan irrespective of economic climate. Manage to squeeze out something always that would aid you in keeping to your financial plan. Don’t give yourself excuses as there will always be an excuse for failure. See your plan as a no-turning-back matter. Always push forward in executing it even a little step at a time will ultimately bring you close to the doors of financial freedom. Don’t mortgage your future. Start doing something for yourself and the time to do it is right now – execute your financial plan!

Financial Markets – An Overview

FINANCIAL MARKETS – AN OVERVIEW:

In common parlance, a market is a place where trading takes place. Whenever we think about markets, a picture that flashes across our minds is of a place which is very busy, with buyers and sellers, some sellers, shouting at the top of their voice, trying to convince customers to buy their wares. A place abuzz with vibrancy and energy.

In the early stages of civilization, people were self-sufficient. They grew every thing they needed. Food was the main commodity, which could be very easily grown at the backyard, and for the non-vegetarians, jungles were open with no restrictions on hunting. However, with the development of civilization, the needs of every being grew; they needed clothes, wares, instruments, weapons and many other things which could not be easily made or produced by one person or family. Hence, the need of a common place was felt, where people who had a commodity to offer and the people who needed that commodity, could gather satisfy their mutual needs.

With time, the manner in which the markets functioned changed and developed. Markets became more and more sophisticated and specialized in their transaction so as to save time and space. Different kinds of markets came into being which specialized in a particular kind of commodity or transaction. In today’s world, there are markets which cater to the needs of manufacturers, sellers, ultimate consumers, kids, women, men, students and what not. For the discussion of the topic at hand, the different kinds of markets that exist in the present day can be broadly classified as goods markets, service markets and financial markets. The present article seeks to give an overview of Financial Markets.

WHAT IS A FINANCIAL MARKET?

According to Encyclopedia II, ‘Financial Markets’ mean:

“1. Organizations that facilitate trade in financial products. i.e. Stock Exchanges facilitate the trade in stocks, bonds and warrants.
2. The coming together of buyers and sellers to trade financial product i.e. stocks and shares are traded between buyers and sellers in a number of ways including: the use of stock exchanges; directly between buyers and sellers etc.”

Financial Markets, as the name suggests, is a market where various financial instruments are traded. The instruments that are traded in these markets vary in nature. They are in fact tailor-made to suit the needs of various people. At a macro level, people with excess money offer their money to the people who need it for investment in various kinds of projects.

To make the discussion simpler, let’s take help of an example. Mr. X has Rupees 10 lacs as his savings which is lying idle with him. He wants to invest this money so that over a period of time he can multiply this amount. Mr. Y is the promoter of ABC Ltd. He has a business model, but he does not have enough financial means to start a company. So in this scenario, Mr. Y can utilize the money that is lying idle with people like Mr. X and start a company. However, Mr. X may be a person in Kolkata and Mr. Y may be in Mumbai. So the problem in the present scenario is that how does Mr. Y come to know that a certain Mr. X has money which he is willing to invest in a venture which is similar to one which Mr. Y wants to start?

The above problem can be solved by providing a common place, where people with surplus cash can mobilize their savings towards those who need to invest it. This is precisely the function of financial markets. They, through various instruments, solve just one problem, the problem of mobilizing savings from people who are willing to invest, to the people who can actually invest. Thus from the above discussion, we can co-relate how financial markets are no different in spirit from any other market.

The next issue that needs to be redressed is what is the distinction between various financial instruments that are floated in the market? The answer to this question lies in the nature or needs of the investors. Investors are of various kinds and hence have different needs. Various factors that motivate investors are ownership of controlling stake in a company, security, trading, saving, etc. Some investors may want to invest for a long time and earn an interest on their investment; others may just want a short term investment. There are investors who want a diverse kind of investment so that their overall investment is safe in case one of the investments fails. Hence, it is the needs of the investors that have brought about so many financial instruments in the market.

There is one more player in the financial market apart from buyers and sellers. As stated above, the one who wants to lend money and the one who wants to invest the money may be situated in different geographical locations, very far from each other. A common place for this transaction will require the meeting of these persons in person to close the transaction. This may again result in a lot of hardship. It may also be the case that the rate at which the lender wants to lend his money or the duration for which he wants his money to incur interest, may not be acceptable to the borrower of the money. This would result in a lot of glitches and latches for closing the transaction. To solve this problem, we have a body called the Intermediaries, which operate in the financial markets. Intermediaries are the ones from whom the borrowers borrow the harbored savings of the lenders. Their chief function is to act as link to mobilize the finances from the lender to the borrower.

Intermediaries may be of different kinds. The basic difference in these intermediaries is based upon the kind of services they provide. However, they are similar in the sense that none of the intermediaries are principal parties to a transaction. They merely act as facilitators. The kinds of intermediaries that operate in financial markets are:

• Deposit-taking intermediaries,
• Non-deposit taking intermediaries, and
• Supervisory and regulatory intermediaries.

Deposit-taking intermediaries are those that accept deposits from a principal. They accept deposits so that the deposits can be utilized for the purpose of advancing loans to the persons who are in need of it. Example – Reserve Bank of India, Private Banks, Agricultural Banks, Post Office, Trust Companies, Caisses Populaires (Credit Unions), Mortgage Loan Companies, etc.

Non-deposit taking intermediaries are those which only manage funds on behalf of the client. They act as agents to the principal. They merely bring together the borrower and the lender with similar needs. Unit Trusts, Insurers, Pension Funds and Finance Companies are an example of this kind of intermediaries.

Supervisory and Regulatory Intermediaries do not actively participate in the trading of securities in the financial markets as parties. They perform the function of overseeing that all the transactions that take place in the financial markets are in compliance with the statutory and regulatory framework. They step in only when any error or omission has been committed by either of the parties to the transaction, and take steps as is provided by the statutory and regulatory scheme. The Bombay Stock Exchange, National Stock Exchange, etc. are examples of this kind of intermediary.

PRIMARY MARKETS AND SECONDARY MARKETS:

In financial markets, the financial instruments (securities) may be traded first hand or second hand. For example, A wants to invest Rs. 1 million in XYZ Company, which is a newly incorporated company. One share of XYZ Co. costs Rs. 500. In this scenario, A will purchase 2000 shares of XYZ Co. XYZ Co. is issuing shares to A in return to his investment, first hand.

Suppose after purchasing the shares from XYZ Co., A holds the shares for a year and thereafter wants to sell the shares, he may sell the shares through a stock exchange. B wants to purchase 2000 shares of XYZ Co. B approaches the stock exchange and purchases the shares therefrom. In this case, B has not directly purchased shares from XYZ Co., however, he is as good a holder of shares as anyone who purchased the shares from XYZ Co. directly.

In the first example, A purchased the shares of XYZ Co. directly. Hence, he purchased his shares from the Primary market. In the second example, B did not purchase the shares from XYZ directly, however, his title over the shares is as good as A’s, even though he purchased the shares from Secondary market.

KINDS OF FINANCIAL MARKETS:

When securities are issued in financial markets, the borrower has to pay an interest on the amount borrowed. Securities may be classified based on the duration for which they are floated. The kinds financial markets that exist based on the duration for which the securities have been issued are:

• Capital Markets: This kind of financial market is one in which the securities are issued for a long-term period.
• Money Markets: In this kind of financial markets, securities are issued for a short-term period.

The trading of financial instruments and the closing of transaction need not necessarily take place at the same time. There may be a time gap between the taking place of a transaction and closing or effectuating the transaction. The kinds of financial markets that can be distinguished on this basis are:

• Spot Markets: The transaction is brought into effect at the time the trading takes place. By the very nature of the transaction, it can be understood that the risk associated with this kind of market is very minimal since the parties have no scope of going back on their promised actions.

• Forward Markets: In this kind of market, the transaction takes place on one date and is effected on some future date, which is mutually accepted between parties to the transaction. As the date on which the mutually accepted transaction is effected is different from the date on which the transaction is mutually accepted, there is a risk that one of the parties may not be in a position; on the date the transaction is to be effected, to honor the transaction. Hence the level of risk in this market is higher than that of spot markets.

• Future Markets: This kind of financial market closely resembles Forward Markets, with the difference that in this market, the quality and the quantity of the goods that are traded are specified on the date the transaction is entered into, though the transaction is to be effected on some future date. There is also an added advantage in this market in comparison to Forward Markets in the sense that there is a security of guarantee in case one of the parties fails to honor his part of the undertaking which he had promised while entering into the transaction. Hence, the level of risk associated with this market is comparatively lower than that of the Forward Markets.

RISKS IN FINANCIAL MARKETS AND HEDGING THEM:

“In this business if you’re good, you’re right six times out of ten. You’re never going to be right nine times out of ten.”

~Peter Lynch (Research Consultant, Fidelity Consultant)

When a transaction takes place in financial markets, there is always a risk factor associated with the transaction. The various risks that financial markets are usually associated with are:

• The lender may not repay the money to the borrower,
• There may be an abnormal upward or a downward movement in the price of securities, thereby hampering the interest of the buyer or seller of securities respectively,
• Negative sentiments or expectations may make some financial instruments unattractive or the whole financial market an unattractive place to the investors and force them to withdraw their investments, resulting in deep plunge of prices of the securities which once seemed very luring and attractive,
• Change in the fiscal policies of the government may make the financial markets unattractive for foreign or domestic investors,
• Change in political power in a country may result in a preferential treatment to one industry, and/ or step-motherly treatment to another, which was not foreseeable by the investors, thereby sharply decreasing the value of their securities.

From the above discussion, we can understand that investment in Financial Markets entails a lot of risks. There are other risks associated to investing in financial markets which may be a result of many composite factors which are closely or remotely related; like serious fluctuations in foreign markets or in Indian scenario, failure of monsoons. To tide over this problem, various hedging securities are traded in the financial markets. The holders of these kinds of instrument lower the risk that is associated with financial markets, by purchasing the risk that is associated with a kind of transaction. Therefore, the holders of hedging instruments are not a party to the original transaction. They are merely the ones who minimize the risk in a transaction by purchasing the risk associated with a transaction. Since these financial instruments are derived from another transaction, these instruments are also called ‘derivatives’. The ones who buy the risk are compensated in monetary terms. The higher the risk, higher will be the compensation and vice versa.

CONCLUSION:

“An investor without investment objectives is like a traveler without a destination.”

~Ralph Seger (Founder, Seger-Elvekrog Inc.)

Financial Markets are complex and unpredictable. The movements in financial markets of one country may be the effect of incidents occurring in some foreign land. It may be difficult to comprehend the financial markets at a given time and place. However, an intelligent player in financial markets always takes decisions by carefully studying the trends in the financial markets and closely following the cues in the domestic and international markets.

One also needs to be clear as to why one wants to enter the financial markets. If one wants to enter as an investor, one should invest in securities which have the potential of returning his investment with interest after the period of time for which one wants to invest. In this case one should generally purchase securities which are safe and have a reputation of giving good returns. On the other hand, if one wants to trade in securities, one should carefully study the trends prevailing in the day to day markets and make an intelligent decision by basing one’s judgment on that ground. To minimize risks, one should have a diverse portfolio, so that even if one or some of the investments suffer, the others make good one’s loss.

To conclude, the author would like to admit that financial markets are a very interesting playground, in which a player needs to be flexible and patient. There may be initial hiccups when one starts investing, however, with time, as one starts to understand the financial markets, things start falling in place; and a reminder, never under-estimate the result of a remotely connected incident in financial markets.