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Opportunity Cost of an Investment

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Opportunity Cost of an Investment

Every investment decision should take care because the opportunity cost of an investment is involved in every financial decision. Here the first question may arise, what is an opportunity cost? Opportunity cost is the cost of selecting best from the available alternatives. Opportunity cost starts generating when we decide to invest our valuable money for a particular thing by sacrifice our other opportunities.

Opportunity Cost of an Investment

Do you think, the opportunity cost is calculated for organizational investment decision making purpose only? No, the opportunity cost is calculated and evaluated or must be calculated both for individuals and organizations/ corporations. Question may arise why? The reason is investment decision is taken to make a profit from the investment by ensuring optimal use of the financial resources. Every financial decision is cost worthy and our intention is to always become gainer. So, investment is to be in a right platform, with a right amount that may provide us maximum return with minimum opportunity cost. Although investment decision also depends on the investment behavior of the investor.

Things you need to Do Before Calculating Opportunity Cost of an Investment

  1. Identifying all the investment alternatives
  2. Collect each and every information those are related with these investment alternatives
  3. What will be the investment cost of all these opportunities?
  4. Acquire knowledge of time value of money and its implications on valuation
  5. Identify potentiality of each and every investment alternatives

Importance of Evaluation of Opportunity Cost of an Investment

Evaluation of opportunity will help to through:

  1. Identifying and selecting best investment opportunity
  2. Calculate Opportunity cost of an investment and any other related opportunities
  3. The result of evaluation will guide you to pick an investment alternative where opportunity cost is minimum.

Example of Opportunity Cost of an Investment

Suppose you have two investment opportunities. Either you can deposit your money into a bank or you can invest for your own business to become an entrepreneur. Both will give you benefit, but you need to choose only one from these two.  If you choose bank deposit option, then your opportunity cost of this investment is to be the rate of earnings from another investment opportunity that is invested in your business. On the other hand, if you choose your business investment opportunity then your opportunity cost will be the earnings opportunity of bank interest rate.

You have 1 million Tk in your hand. Either you can invest this money into a bank by depositing into a fixed deposit at 10% interest rate, or you can invest the same amount to start your own coffee shop, where you will earn more than 15% annually. But you know, the return from business always uncertain where higher the risk, higher the expected rate of return. That’s why you expect more return from business. On the other hand, if you can avoid the investment opportunity in business and accept the opportunity of bank deposit, where there is nearly zero percent risk is involved.

So, in these examples, the expected rate of earnings from business is the rate of opportunity cost for depositing money into a bank.

For your day to day business operation, you always need to take a decision of whether you want to make or buy. In case of small garments sometimes, you outsourced your work. Instead of making, if you buy from the third party then, you are losing an investment opportunity of making. So, in this case, the opportunity cost of an investment will be the benefit you are losing because of buying rather than making.

Finally, you need to understand that, whatever decision you take, you just need to sacrifice an opportunity. So, the opportunity cost is always there. But the most challenging task is to take investment decision where opportunity cost is lower.

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Is It Possible to Minimize Systematic Risk

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Is It Possible to Minimize Systematic Risk?

You may have a question in your mind that is it possible to minimize systematic risk? If you have then I am right here with your answer. After reading this hope you will understand what actually systematic risk is, what are the factors related with this and is there any way to minimize systematic risk or not.

First of all, let me explain the meaning of systematic risk. The risk associated with macroeconomic factors like; market interest rate, inflation, the rate of unemployment, economic recession, oil price etc. are the source of systematic risk. These factors cannot be changed or influenced by individual or organization. Normally risk which cannot be minimized through diversification of investment is considered as a systematic risk. In another sense risk which is beyond the control of individuals or organization is a systematic risk.

Minimizing risk is possible only through investing in negatively correlated financial securities. Here negatively correlated means the return of an individual security is not directly related to the return of other securities.

The main thing is, through diversification only we can minimize unsystematic risk portion which is arisen from the microeconomic factors. Because microeconomic factors can be controlled by individuals or organization through taking a proper economic decision. So at this point, we basically can say the unsystematic risk is a controllable and systematic risk is out of control, but the question is why systematic risk is out of control?

The influencing factors of systematic risk come from macroeconomic sources which are beyond our control. As individuals we do not have control over the unemployment rate of our country, we cannot reduce or control the inflation rate, we cannot fix the oil price, we cannot change the market interest rate, we cannot improve our unexpected economic recession situation by our own. Only proper economic policy taken by government can influence/ change or control these factors. That’s why as an individual’s we cannot minimize systematic risk.

It is not necessary that the percent of systematic risk always remain fixed. It can vary according to the change of economic condition. When there is a recession, more systematic risk will be there. For economic boom situation, the market provides more income, ensure less unemployment. And for these, there will have a less systematic risk.

Is It Possible to Minimize Systematic Risk

Beta is the measures of Systematic Risk, which is the function of macroeconomic factors. We can calculate systematic risk by:

Systematic Risk (Beta) = Covariance between Individual Securities & Market/ Variance of Market

You know that a market beta (Systematic Risk) is always 1. If your investment (Securities) beta is less than 1 then your investment is more stable (less systematic risk) than the market. On the other hand if your investment (Securities) beta is more than 1 then your investment will more unstable (more systematic risk) compared with the market.

At the end of these brief explanation, we can say that it is not possible to minimize the systematic risk. So it would be wise decision to work for minimizing unsystematic risk through diversifying your investment and try to make an optimal portfolio.

If you like this article then please leave your comment, or if you have any confusion about this topic then let me know.

Is It Possible to Minimize Systematic Risk

Written by: Md. Nahian Mahmud Shaikat

Mail: [email protected]

Financial Analyst

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Financing for Textile and Garments

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Financing for Textile and Garments

A good financing decision works as a driving force for an organization to build a strong financial position. Financing decision varies industry to industry, organization to organization according to their financing requirement, financial strength and risk taking behavior of that particular parties. Here in this article you will have basic ideas of financing and how you can take financial decision for your textile and garments business.

Basically the objective of financing is to collect money from the least cost sources and then invest in the profitable sectors. Here the challenge is minimize the cost and maximize the profit of the investment. Financing is required for different stages of business, like initial startup of business, or for maintaining the operational expenditures or for expansion of business. The mechanism of these financing need varies business to business.

If you are going to finance for the manufacturing industry then you will be required a large amount of fund for startup or for expansion of your business, and for operating expenditure you will be required working capital which is much less than the initial investment. On the other hand for service industry you have to invest a large amount of capital in the initial year and the operation cost is not that much high.

Requirement of Money for Textile and GarmentsNow come to the point of financing for textile and garments industries, as this one is manufacturing industry which requires to buy different types of equipment (power and electricity generator, spinning machine, knitting machine, dyeing machine, printing machine, sewing machine, cutting machine and many more) we have to spends lots of money and our huge amount of capital will be invested for this purpose. In addition to this thousands of garments worker will be working here, for payment of salary and wages you will be required a larger amount of working capital. On the other hand for importing raw materials you will also be required huge amount of money.

If you want to expand your business to increase production capacity you have to invest huge amount of money for long term basis.

The question is how you can manage these required money and from where you can source this money. At the time of sourcing of money/ fund you always have to be careful about the cost of that fund, least costing source will be preferable.

Financing for Textile and GarmentsFinancing for Textile and Garments can be for:

  • Initial startup of business.
  • Maintaining daily expenditures.
  • Expansion of Business/ Production Capacity.

Initial Expenditure for Starting a Textile and Garments Business

You already know that for starting a new setup for textile and garments you must spend a large amount of capital for purchasing capital machinery. The important thing is how you are going to finance for this, my suggestion is, and as capital machinery and equipment’s for long term it will be a better decision of financing from the long term sources. Available options of financing are:

  1. Long term bank loan (Debt Financing).
  2. Selling share (Equity Financing); in case of public limited company.
  3. Or you can choose both debt financing and equity financing (the ratio of debt to equity will be depend on the financial strength and the business risk of that company).

From the above alternatives, my personal suggestion is to choose third one because you cannot use fully debt financing because you have to bear a fixed cost (interest) for a certain interval of time for a period.

  • Fixed cost financing may increase your financial risk, so try to avoid fully debt financing.
  • On the other hand, equity financing is more costly as you have to share your all of your profit proportionately according to the contribution of equity capital.

The right choice is to use debt and equity to minimize the weighted average cost of capital. And you have to form your optimal capital structure by considering two major factors (business risk & financial strength). Taking loan for new business is not that much easy, that’s why initially we have to depend upon our own capital first. With the passes of time, for a successful business, it will be better to increase the debt percent so that taxable income can be reduced.

Financing for Maintaining Daily Expenditures

Actually maintaining daily expenditures means, managing working capital funds for your business operations or management of current assets and current liabilities. You may source your working capital either from long term or short term sources and the decision will be depend on the working capital management policy (hedging, conservative, aggressive) of yours. Before choosing working capital management policy you have to have brief idea of these policies:

  • Hedging Policy of Working Capital Management: Hedging policy is one of the popular policy of managing funds where a matching principle is used. Financing for current obligation is done from the current assets (current sources) and on the other hand financing for long term obligation is done for the long term assets (long term sources). That means for short term requirement of funds you need to collect from short term sources and for long term requirements you have to collect from long term sources.
  • Conservative Policy of Working Capital Management: In case of conservative policy company has the intention of taking low risk for financing current asset. Additional fund required for fixed assets company keeps extra fund for using as current asset. Here company financing (collecting) more funds from the long term sources for both current asset and fixed/long term assets. The main intention is to lowering the risk of financing for current asset.
  • Aggressive Policy of Working Capital Management: Aggressive policy of working capital management is risky policy in a sense that most of required funds for current and long term assets is to be financed from the short term sources, lower amount of funds will be collected from the long term sources. Basically money will be kept less than the required amount for working capital that why risk is higher.

Before taking a policy form all these above mentioned policies you must evaluate your ability to liquid your asset and liquid (cash) required for your business. Another thing is your risk taking behavior towards working capital management.

The question is from which sources you can finance for the maintaining daily expenditures? The probable source available for the textile and garments are:

  • Lowering the collection period of accounts receivables.
  • Delaying the payment of accounts payable.
  • Delaying the payment of salaries and wages.
  • Taking short term bank loan.
  • Purchasing raw materials on credit.

Financing for Expansion of Textile and Garments Business

As you already know that for business of textile and garments you will be required a lot of money. Expansion of business or expansion of production capacity requires larger investment to for purchase machinery and equipment, land, construct building etc. This is more or less similar with the initial investment for your business. In addition with acquiring capital assets, you have to hire workers and employees for supporting your business expansion. The thing is you have to pay wages and salaries, purchase of additional raw materials or any other operating expenditures. So you can manage these extra money from both long term sources and from short term sources. Whether you choose long term or short term source, is mainly depends on your financial strength and adequacy of money of your existing business. Normally a profitable textile and garments company has intention to expand when they find that the business is profitable and they can manage their extra required fund from their own profit.

Financing for Textile and Garments

After these discussion, I think that it is clear how you can finance for your textile and garments and which sources are available for financing. Careful analysis is to be done before any larger investment because for large investment risk is higher and involve cost also.

If you have any confusion then you can comment here. I will try to give you suggestion about financing and different problematic situations.

Written by: Md. Nahian Mahmud Shaikat

Financial Analyst

Mail: [email protected]

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Difference between Systematic and Unsystematic Risk

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Difference between Systematic and Unsystematic Risk

As an investor you must know the difference between systematic and unsystematic risk because it will help you to take effective investment decision. If you observer the investment decision of an investor, you can see that their investment decision is highly influenced by their risk taking behavior. Although future is uncertain, people always try to assume how much risk may arise in future if an investment is made.

Risk is the portion of uncertainty which we can measure. Normally risk is considered the deviation between what an investor expects and in return what he/she gets.

In a broader sense risk can be categorized into two types; one is systematic risk which is non diversifiable risk and other is unsystematic risk or non-systematic risk or diversifiable risk. Let have a detail discussions of systematic risk and unsystematic risk with examples:

Systematic Risk

The percent of risk which we cannot minimize or reduce through diversification is considered as systematic risk. This means that this type of risk is impossible to eliminate by an individual. It is directly related with the market, that’s why systematic risk also known as market risk. From my point of view systematic risk is arisen from the macro economic factors (inflation, unemployment rate, oil price etc.) which is beyond our control. Only through proper economic planning of government can reduce this types of risk. One important thing you need to know that although implementation of effective economic policies by government would reduce this type of risk but it needs time to be visible in the market. That’s why we cannot consider it when taking our individual investment decisions.

examples of unsystematic riskBeta is the measure of systematic risk and market beta is always one. The reason behind market beta is to be 1 is that we cannot minimize or eliminate systematic risk by our own. Beta can be calculated through dividing the covariance between individual securities and market to the variance of market.

Beta = Systematic Risk

Examples of Systematic Risk

As we have already know that systematic risk arises because of change in macro-economic factors, for showing the example of systematic risk we will use macroeconomic factors (Inflation rate, unemployment rate, market interest, oil price and political condition).

  • Suppose market interest rate is increased, in this case if we want to borrow money from the market we have to pay more interest than previous because cost of funds increased. Individually we cannot change the market interest rate so this works as a systematic risk.
  • Increase in inflation rate, this means the buying power of money is decreased. For this reason we can buy less resource than previous. So increase in inflation works as a systematic risk which existed in the market. Only monetary policy of government can influence the inflation rate.

If there is increase in unemployment rate then people will have less money to purchase goods and services. And this will create negative impact on the business which is beyond the control of individuals.

Unsystematic Risk

Unsystematic risk also known as diversifiable risk or nonsystematic risk. This type of risk arises from the micro-economic factors which directly or indirectly related with business and through carefully managed you can eliminate this unsystematic risk.

A popular portfolio management concept is diversification, through investing in negatively correlated investment alternatives. That is invest in different companies from different industries which do not have any direct link among them. The better you manage your portfolio the lower will be your systematic risk.

As unsystematic risk is not directly related with economic system, we can manage it in a better way through taking effective decision individually and maximize our return on investment.

Examples of Unsystematic Risk

Individual industry or company related any kinds of risk is considered as unsystematic risk for the company. Examples of unsystematic risk can be:

  • Increased labor turnover rate due to dispute of payment related issues among employer and employee.
  • Increase in research and development cost of the company.
  • Increase in operational expenses.

systematic and unsystematic risk

Here in this graph you can see that systematic risk is fixed in nature, that’s why we work on with unsystematic risk to eliminate it or keep it at a lower level. If it is possible then total risk of the investment will be reduced.

Difference between Systematic and Unsystematic Risk

From the above clarification about systematic and unsystematic risk we can easily identify several difference between systematic risk and unsystematic risk of the business/investment. Here is the list of difference between systematic and unsystematic risk:

Systematic Risk

Unsystematic Risk

Systematic risk arises on account of the economy with uncertainties and the tendency of individual securities to move together with the change in the market.

Unsystematic risk is that part of risk which arises from the uncertainties and which are unique to individual securities and can be diversifiable.
Directly related with economic system of a country.

Directly not related with economic system, rather it is more about business or company related.

Systematic risk is known as non-diversifiable risk/ not diversifiable/ market risk/ macroeconomic risk.

Unsystematic risk is known as diversifiable risk, not systematic risk.
We cannot reduce this type of risk individually This type of risk can be reduced
Negatively correlated investment cannot eliminate the risk.

It is possible to eliminate the risk by forming portfolio of negatively correlated investment.
Beta is a measure of systematic risk.

Unsystematic risk is the function of may macroeconomic factors related with business.
Basically investors not try to work with systematic risk.

Investors always try to reduce this type of risk through better managing their investment.
Examples:

  • Change in market interest rate
  • Increase in inflation
  • Change in oil price
  • Unemployment rate
 Examples:

  • Increase in business operational cost
  • Workers strike in the factory
  • Employee turnover

Although we cannot work with the systematic risk but we have many things to do with unsystematic risk because if we can manage it in a better way, then our business will be more profitable with lower risk. By choosing negatively related investment alternatives we can form an optimal portfolio but it is not easy task for the financial manager.  There is involvement of risk with every investment alternatives but we have to consider the systematic portion and then work with controllable factors which we actually can improve.

difference between systematic and unsystematic riskFinally, my suggestion is for you that take a time for risk analysis before any investment, otherwise you may have to incur loss. Risk always was there and will be there, so do not afraid to take challenge, think and then take a right choice.

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List of Project Management Acronyms

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The success of a project is depends on the management of project. Managing a project is not an easy task, most of the time its challenging job for the related parties. At the time of working with project of government/ public or private you may find acronyms and abbreviations of different key points those are very much confusing in nature. To reduce you confusion I have tried to combine commonly used and make a list of project management acronyms. Hope this will be helpful for the students of finance have interest on project management and any other parties related with project (public or private).

List of Abbreviations in Project Management

List of Project Management AcronymsList of Project Management Acronyms

  • ADB- Asian Development Bank
  • AM- Aide Memoire (A document after review of a Project at any stage)
  • BB- Bangladesh Bank
  • BOO- Build Own Operate
  • BOT- Build Own Transfer
  • BOOT- Build Own Operate and Transfer
  • CFS- Combined Financial Statement
  • CONTASA- Convertible Taka Special Account
  • CSR- Combined Status Report
  • CD VAT- Customs Duty and Value Added Tax
  • CPM- Critical Point Method
  • CPA- Critical Path Analysis
  • CFS- Cash Flow Statement
  • CDR- Combined Delivery Report (For UN Project)
  • CAO- Chief Accounts Officer
  • DFID- Department for International Development
  • DP- Development Partner
  • DCA- Development Credit Agreement
  • DOSA- Dollar Special Account
  • DPA- Direct Project Aid
  • DPP- Development Project Proposal
  • ERD- Economic Relations Division
  • ECNEC- Executive Council for National Economic Council
  • FO- Field Office
  • FS- Financial Statement
  • FD- Finance Division
  • FP- Functions Point
  • GOB- Government of Bangladesh
  • GO- Government Order
  • GDR- Government Delivery Report (For UN Project)
  • HPNSDP- Health Population Nutrition Sector Development Project
  • IMED- Implementation, Monitoring and Evaluation Division
  • IRR- Internal Rate of Return
  • IT- Income Tax
  • IDB- Islamic Development Bank
  • IDA- International Development Agency
  • IDA- International Development Association
  • IIFC- Infrastructure Investment Facilitation Center
  • IMF- International Monetary Fund
  • IPFF- Investment Promotion and Financing Facility
  • JICA- Japan International Cooperation Agency
  • JVCA- Joint Venture Consortia Alliance
  • MB- Management Book
  • NPV- Net Present Value
  • NBR- National Board of Revenue
  • NEC- National Economic Council
  • PP- Project Proposal
  • PT- Project Termination
  • PCR- Project Completion Report
  • PA- Project Aid
  • PPA- Pre-financed Project Aid
  • PPR- Public Procurement Rule
  • PPP- Public Private Partnership
  • PC- Planning Commission
  • PBP- Pay Back Period
  • PEC- Project Evaluation Committee
  • PPT- Project Planning Tool
  • PERT- Programme Evaluation and Review Technique
  • PHQ- Project Head Quarters
  • PLC- Project Life Cycle
  • PPR- Public Procurement Rule
  • PPA- Public Procurement Act
  • PSC- Project Steering Committee
  • PD- Project Director
  • PM- Project Manager
  • PM- Project Management
  • PMO- Project Management Office
  • Pro Doc- Project Document (For UN supported projects)
  • PER- Project Evaluation Report
  • PPM- Project Portfolio Management
  • PSIG- Private Sector Infrastructure Guidelines
  • PAO- Principal Accounting Officer
  • PRDP- Participatory Rural Development Project
  • RPA- Reimbursable Project Aid
  • SAFE- Special Account in Foreign Exchange
  • SEIP- Skills for Employment Investment Program
  • SOP- Standard Operating Process
  • SOE- Statement of Expenditure
  • SPV- Special Purpose Vehicles
  • TPP- Technical Assistance Project Proposal
  • USAID- United States Agency for International Development
  • WA- Withdrawal Application
  • WB- World Bank

project management acronyms

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Factors are Important for Efficient Decision Making

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Why the economics analysis and in depth understanding of economic factors are important for efficient decision making in capital market?

Investors always try to formulate best possible portfolio by investing in the capital market for the purpose of getting capital gain and dividend (cash or stock). It is not an easy task to choose best investment alternatives because proper analysis is required. Only a specialized person would be able to analyze the market and identify the potentials. Many people think that only financial analysis is enough to make investment but in real sense not only financial analysis but also economic analysis is required.

In case of financial analysis we only consider company and industrial outcome by fundamental and technical analysis. But whenever we go for analysis by considering economics we have to analyze the macroeconomic factors that may have impact on the capital market. An economist or any other professionals those have knowledge of economics can do this analysis on behalf of investors. But investors also have to have basic ideas of how economics factors can influence the price of the investment securities.

Factors are Important for Efficient Decision MakingFor efficient decision making in the capital market following economic factors should be considered

  • Inflation
  • Market Interest Rate
  • Economic Recession
  • Employment Rate

Effect of Inflation in the Capital Market

In an inflationary economy investors have less money to invest because investors have to spend more money for their consumption. As because there is a less demand of the stock in the capital market, the price should be lower; we know that lower the demand lower the price. In the other sense in case of company, for inflation the production cost of the company is higher than the previous. So company’s income will be lower that stimulate the price of the stock. We know that the stock which provides more dividends to the stock holders, that stock should price higher than the other company which provide lower dividends.

Effect of Market Interest Rate in the Capital Market

If the market interest rate increases then investor will prefer fixed income securities rather lower earning risky securities. Suppose government bond providing 10% of interest then this bond will get more preference compared with risky investment. On the other hand if the interest rate is lower in the market then investor will borrow the money at lower interest and invest in the capital market.

Economic Recession

Because of economic recession there may have positive impact on the capital market. Normally at the beginning of recession investor loose but there is always an expectation that in near future there will be positive movement in the stock price in the market, so investor prefer invest when there is recession. This will happened only if there is strong form of efficiency exists in the market.

On the other hand if there is an economic boom situation exists then there may have a possibility of declining market price movement.

Employment Rate

With the increase of number of employment of a country per capital income will also increase. For this people will have extra money after consumption. If people capital market is performing well then investor will interested to invest their surplus amount of money. So higher the employment higher the earning and it does increase the investment in the capital market.

Political Condition of a Country

Political condition is one of the main factors which have a huge impact on the overall economy and the capital market. People believe that a positive economic condition is required to maintain a stable capital market. Several financial decisions taken by the government over time to time, so it is also important know how much preference a capital market gets from the government.

In a capital market investors basically invest in a long term securities so investor must consider all probable aspects and economic factors before making investment. A choice of investment in capital market can lead to a huge capital loss, so proper analysis has to done by the professional and select best opportunities.

Finally one thing is that an investor should consider economic factors which have impact on the capital market and proper financial and economic analysis must be done before investing in the capital market.

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Minimize the Risk from Your Investments

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How can you Minimize the Risk from Your Investments

Most of the people in this world are risk averser this means that normal people are not interested to take high risk for their investment. Although higher risk taking behavior also can be identified among the highly ambitious people. Actually they believed in higher the risk higher the rates of return, this type of people want to have abnormal rates of return which is much more than average rate of return.

Minimize the risk from your investments is very tough job if you are doing business of single product for a particular group of people. But investment in multi product business for different group of people actually has the potentiality to have lower or minimum amount of risk. The reason behind this is diversification of investment which actually helps to lower the investment risk.

minimize the risk from your investments

Now come to the point of risk minimization of your investments and how it works

There is a widely accepted concept of risk minimization introduced by the Markowitz which is known as Markowitz portfolio theory. This theory says that through forming portfolio (combinations of different set of investment securities) by using negatively correlated securities from the available investment alternatives investor can minimize nonsystematic (risk which is not generated from macro economic variables)proportion of risk. Here unsystematic risk can be close to zero if investor is able to form optimum portfolio. Remember that although nonsystematic/ unsystematic risk is minimized but there is still has systematic risk (arises from macro economic variables) which cannot be minimized.

Let’s consider an example of risk minimization

Example 1: Suppose you are doing retail business of potato supply. You predicted that this year there will be higher demand of potato, so you stored potato a larger quantity.

But you did not think what will happen if there is less demand for potato because of higher production and huge import by other suppliers.

So there may have huge risk of losing your business and incurring financial loss and you do not have any other alternative to recover this loss.

What if you conscious about the consequence that may arise and you invest your money in different products like Banana, Tomato, sugarcane, coconut supply etc. rather than investing whole money for only one business of Potato supply.

Here in this case if you lose some money from the potato business, you will still have chance to recover it from the other business you are engaged in. So your risk is minimized by diversification.

Let’s consider another example of risk minimization

Example 2: Suppose you want to invest in the capital market to earn capital gain and yearend dividend. You have many options to choose company from different industry, rather doing this you select a company which is doing well in capital market and invest all of your money. Guess what can be happened with you?

Either you can get a considerable amount of profit or you may incur huge amount of loss. The problem is you invest all of your money to a particular company, if this company fails then you will lose. So you should your investment decision carefully to form a portfolio by investing in different company in different industry. So that if any company unable to satisfy then other can recover your loss and you always become gainer from the portfolio.

From these two examples you can see that only proper diversification can help you to minimize the risk of your business/ investment. So think strategically and be a successful business person.

Points must keep in mind when you try to minimize your investment risk in the financial market

  • Choose as much as negatively correlated (one investment return is not related with other chosen investment) investment alternative.
  • Do not invest in the market without knowing what’s really going on. Is the market is over price or under price and what factors and forces changing the current market demand.
  • Do not invest in the market if you are found that the price of securities is manipulated by the syndicate.

My suggestion is always consider investment alternatives and try to diversify as much as you can so that your risk can be minimized and you get a reasonable profit from your investment.

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Qualities of a Good Finance Manager

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Qualities of a Good Finance Manager

Finance is the life blood of every organization because without financing it is impossible to do any kinds of economic activities for the business organization. For profit making organization or not for profit organization, financing is one of the core task done by the finance manager but whenever we want to evaluate the cost benefit analysis or prospects of the profit making organization we have to think about the proper analysis of financial statements (income statement, cash flow statement, owners equity statement and balance sheet).

qualities of a good finance managerIn addition to this analysis finance manager is required to develop financial model, ratio analysis, forecasting of different accounts, cash budgeting, common size statement analysis, sensitivity and scenario analysis, adapt least cost financing sources, investment decision in the profitable sectors, forming optimal portfolio to diversity investment for reducing overall risk. For all these analysis a finance manager or financial analyst have to have proper knowledge of financial terms and their changing affects to the financial condition of an organization.

Qualities of Financial Analyst

Although a finance manager needs to have different types of qualities but from my point of view these are the qualities that a finance manager of financial analyst must have.

Analytical Skills

Taking financial decision without any kind of analysis is throwing stone in a dark hole, but effective financial decision must not be this kind. For effective financial decision there must be proper analysis of historical data and all existing privately and publicly available information. So that finance manager actually can assume something about financial outcome that may happen.

Proper Understanding of Time Value of Money

Time value of money is one of the important concepts that must be considered when taking investment or financing decision for the company. Because by using this concept we can calculate the present value and future value of an amount. That’s why every finance manager has to have the clear understanding of time value of money concept for adapting right investment or financing alternatives.

Efficient Operator of Modern Technology

Now a day’s technology made it easy to do analysis with the help of computer based software. Popular software used for analysis are Microsoft excel, SPSS, STATA etc. so financial analyst or financial manager must need to know how to operate this software and how to interpret the result generated by these software.

Communication Skills

Whenever a finance manager wants to analyze financial performance of the company, he/she will required to have financial information about the company, so through communicating with respected department manager collect information. Also what kinds of information manager is asking mush be conveyed clearly to the respected parties.

Numerical Proficiency

Another important qualification of financial manager or analyst is proficiency in numerical calculation. For financial decision making most of the case we mainly use quantitative data which is numerical number. Ability to calculate and understand numerical variables is required to take right financial decision.

Ability to Diversify Investment

One of the main tasks of financial manager or portfolio manager or financial analysis is to find out the optimal portfolio for the company from the existing investment opportunities. You know that diversification is the only way through we can minimize our unsystematic portion of the risk, that’s why managers always try to diversify their investment to maximize the return of the company. A person who has the ability to analyze the market and identify the optimal portfolio through diversification is to be the best financial manager or financial analyst for the company.

Ability to Forecast

One of the important things that financial analyst has to do is forecasting about future. Forecast about financing requirement and investment decision considering the future economic prospects or recession. Another thing is forecast about the growth of the overall industry and the company.

Quick Decision Making

Sometimes there may have the opportunity of making huge money through investing risky project short term basis and these types of opportunities mainly chosen by the aggressive financial managers. Successful financial managers are quick decision makers and their decision is most of the time is effective one. So quick decision making is the ability of person which helps to become a financial analyst.

Ability to Analyze Quantitative Factors

Although most of the cases finance manager deals with quantitative data but in some cases they also use qualitative data also, because there may have some non monetary factors which has a great impact on the investment and financing alternatives. So both quantitative and qualitative analytical proficiency is required to have for financial analyst to take the right decision for the company.

Educational Qualification Required to Become a Finance Manager

Not every people become the financial manager because to become financial manager you have to understand all necessary concept and ideas about the financing and investment. Graduated from the background of economics, finance or from accounting may become a finance manger. But now a day’s finance background people are getting more preference because of understanding of proper understanding of what finance is all about. If you dreaming to become finance manager or analyst then you should study finance first and get BBA, MBA in finance and finally try to become CFA.

Although around the world you can find there is higher demand of finance job but in our country (Bangladesh) it was hard to find pure financial job. But now a day’s opportunity is creating for the finance students. Hope in future there will be higher demand of finance manager/ financial analyst in the corporate businesses.

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Role of Financial Intermediaries in Financing

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Role of financial intermediaries in financing corporate type of business in Bangladesh

Bangladesh is a developing country, where both manufacturing and service sector contributing together to our GDP (Gross Domestic Product). With the expansion of our economy individuals, organizations or institutions are engaged with productive sectors, for this purpose they need funds. The question is who will manage and supply this fund?

Basically financial intermediaries (bank, non bank financial institutions, investment bank) collect fund from surplus parties (those have extra idle money on hand) from an economy and then provides this fund to the deficit parties (those require fund) of the economy. For an individual it is not easy to manage huge amount of money within a short time, but in case of financial intermediaries it is possible because they have the mechanism of collecting fund and then provide it to the required parties. Although direct transfer of fund is possible but it is inefficient one because of there is a limitation of time, cost and availability. On the other hand through intermediation funds can be transferred from deficit to surplus and surplus to deficit.

Corporation or corporate types of business normally invest their huge amount of capital in profitable sources so that stock holders can get a reasonable amount of return to their investment. Corporation always try to form optimal capital structure by combining different ratios of debt and equity. When company collect fund from the external sources it requires the help of financial intermediaries. Sometimes financing is done from single financial institution or from two or more financial institutions. Choice of financial intermediaries is depends on the cost of funds and the amount of funds required.

The main thing is financial intermediary’s works as a media between the corporation’s (needs to collect fund) and surplus parties (individual or institutions), the float between these two parties is income for the financial intermediary.

role of financial intermediaries in financing

In Bangladesh you can find there are few giant corporate houses which funding their additional debt capital with the help of financial intermediaries. Corporations like Square group, Bashundhara group, Jamuna group, ACI Group of Companies, Beximco group, Akij group etc. already acquiring thousands of crore taka and financial intermediaries made it possible.

Let’s see how actually intermediation process work and how financial intermediaries plays role for the corporate types of business in Bangladesh.

Example 1: Suppose an economy has 1000 individuals or institutions with 10000 surplus amount of dollar each. But individually they cannot lend their money because it is hard for individual to find deficit parties (those requires funds) when they needed. Here available deficit fund is 10 Million dollars, if these funds collected by the financial intermediaries then it will be easy to lend to the corporate. If there is 2 corporate need 5 million, other 2 corporate need 3 million, and another two corporate need total 2 millions of dollar then these fund can be financed by the intermediaries as they have 10 millions of dollars to be lended.

Example 2: In case of financing large amount of fund there is an involvement of higher risk and sometimes the amount of required funds is too much which is beyond the capacity of a single financial institution. In this case a syndicated fund can be created by joining two or more companies together so that risk is minimized and financing of larger amount would be possible for the corporate type business by the syndicate.

At the end the discussion we can identify that the financial intermediaries playing a great role in financing corporate type of business in Bangladesh through managing required funds at a time with a market interest rate. Because of presence of financial intermediaries corporate get the benefit of lower search cost, higher liquidity, manage larger capital etc.

Written by

Md. Nahian Mahmud Shaikat

Student of MBA

Institute of Business Administration (IBA)

Jahangirnagar University

Email: [email protected]

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Determine Optimal Capital Structure

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How to Determine Optimal Capital Structure

Many people get confused about the optimal capital structure for a company because they observed that different company holding different capital structure. Capital can be formed by using only equity or combination of debt and equity, but cannot form only using debt capital. For a company debt and equity can be 50/50, for other company it can be 40/60, or 60/40, or 65/35 or any other proportion. Here question may arise that what proportion of debt and equity should use to form optimal capital structure?

The optimal capital structure is mainly depends on the two important things. These are:

  • The business risk related with the company’s business and
  • The financial risk of that company

determine optimal capital structure

Business Risk

Business risk arises when a company unable to generate sufficient amount of cash flow to pay off its operating expenditures. Operating expenditure can be rent expense, salaries expense, wages, depreciation etc. The main thing is, if the business unable to cover its business operation related expenditure then company will exercise business risk. Lower the cash inflow, higher the business risk and higher cash inflow from operation will reduce the business risk.

So when forming optimal capital structure it is required to keep in mind that the amount of business risks which may arise. If there is a possibility of higher business risk then it will be wise decision to use higher equity capital rather using debt capital. On the other hand company which generating huge amount of cash flow from its business operation can use larger amount of debt to maximize its return.

Business risk can be divided under two risk categories. One is systematic (non diversifiable) and other is unsystematic (diversifiable) risk. As we cannot reduce the systematic we must diversify our investment so that we can reduce the risk of the company.

Financial Risk

Financial risk directly related with the interest amount payable to the debt provider. That is when a company is unable to generate sufficient cash flow to pay off the financial obligations properly then that company experience financial risk. A company with sound financial position ensures less financial risk and the cost of debt financing is lower as the investment in this company is less risky.

Although business risk and financial risk are two broad things we have to keep in mind that some other factors like, availability of equity capital, cost of equity, cost of debt, cash conversion cycle of the business, profitability of the firm and corporate tax rate may involve with determining optimal capital structure. Also optimal capital structure (debt and equity ratio) depends on the type of business and economic condition of the company.