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should be considered alongside gross exposure | may not reflect sector or other specific risksexample of net exposurelooking at how a fund s net exposure varies over the months or years and its impact on returns gives a good indication of the managers commitment to and expertise on the short side and the fund s likely exposure to swings in the market the years 2020 2022 were extremely volatile with large up and down stock market moves driven by covid 19 and geopolitical events making it a potentially tough period for some hedge funds however many contained the damage by reducing their net exposure in certain sectors according to a morgan stanley survey 1 gross exposures declined as well reflecting a reduction in the use of leverage to boost returns with quant traders cutting total equity exposure toward the lowest in a decade 2as a concrete example say that an investor is long an index portfolio that tracks the s p 500 with a gross exposure of 1 million the investor then sells short 50 000 worth of apple shares anticipating an earnings miss apple is the largest component of the s p 500 index so that position reduces the net exposure since there is an existing long position implicit in the index portfolio | |
what is net vs gross exposure | gross exposure refers to the absolute level of a fund s investments including both long and short positions net exposure accounts for offsetting positions between longs and shorts e g hedges that effectively cancel each other out | |
what is the net exposure of market neutral funds | a market neutral fund uses offsetting long and short positions to have a net exposure of close to zero instead market neutral funds seek to make money off of relative mispricings between trading pairs | |
how does hedging reduce net exposure | a hedge is an offsetting position that reduces one s market risk suppose you own 1 000 shares of the spy s p 500 etf from 425 you can buy 400 strike puts expiring in 6 months as a hedge making the net exposure to the downside just a 25 loss during that period if the spy falls below 400 each dollar lost in the etf shares would be offset by gains in the put options investopedia does not provide tax investment or financial services and advice the information is presented without consideration of the investment objectives risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors investing involves risk including the possible loss of principal | |
what are net foreign assets nfa | net foreign assets nfa determine whether a country is a creditor or debtor nation by measuring the difference in its external assets and liabilities nfa refer to the value of overseas assets owned by a nation minus the value of its domestic assets that are owned by foreigners adjusted for changes in valuation and exchange rates a nation s nfa position is also defined as the cumulative change in its current account which is the sum of the balance of trade net income over time and net current transfers over time understanding net foreign assets nfa the nfa position indicates whether the nation is a net creditor or debtor to the rest of the world a positive nfa balance means that it is a net lender while a negative nfa balance shows that it is a net borrower an alternative definition of net foreign assets from the world bank is that it is the sum of foreign assets held by monetary authorities and deposit money banks less their foreign liabilities relating a nation s nfa position to a cumulative change in its current account is conceptually easy to understand since an entity s debt position at any point in time is the sum total of its past borrowing and lending activity if an entity s borrowings total 500 but it has loaned out 1 500 it is a net creditor in the amount of 1 000 likewise if a nation runs a current account deficit of say 10 billion it has to borrow that amount from foreign sources to finance the shortfall in this case borrowing 10 billion would increase its foreign liability and reduce its nfa position by that amount valuations and exchange rates effect on net foreign assets nfa in addition to the current account position valuation and exchange rate changes should be taken into account to get a true picture of the nfa position for example foreign governments hold trillions of dollars in u s government bonds if interest rates rise and u s government bonds decline in price this would have the effect of reducing the overall value of these nation s u s government bond holdings and their nfa too exchange rate fluctuations can also have a significant effect on the nfa position appreciation of a nation s currency against that of other nations will decrease the value of both foreign currency denominated assets and liabilities while depreciation will increase the value of these overseas assets and liabilities thus if the nation is a net debtor currency depreciation will increase its foreign currency debt burden the nfa position itself can drive changes in exchange rates since chronic current account deficits can prove unsustainable over time currencies of nations with a significantly negative nfa position and growing current account deficits can come under attack from currency speculators who may seek to drive it lower | |
what is net foreign factor income nffi | net foreign factor income nffi is the difference between a nation s gross national product gnp and its gross domestic product gdp understanding net foreign factor income nffi nffi is the difference between the aggregate amount that a country s citizens and companies earn abroad and the aggregate amount that foreign citizens and overseas companies earn in that country in mathematical terms n f f i g n p g d p g n p gross national product g d p gross domestic product begin aligned nffi gnp gdp gnp text gross national product gdp text gross domestic product end aligned nffi gnp gdpgnp gross national productgdp gross domestic product the nffi level is generally not substantial in most nations since payments earned by citizens and those paid to foreigners more or less offset each other however nffi s impact may be significant in smaller nations with substantial foreign investment in relation to their economy and few assets overseas since their gdp will be quite high compared to gnp gdp refers to all economic output that occurs domestically or within a nation s boundaries regardless of whether a local company or foreign entity owns production gnp on the other hand measures the output from the citizens and companies of a particular nation regardless of whether they are located within its boundaries or overseas for example if a japanese company has a production facility in the u s its output will count toward u s gdp and japan s gnp gdp is the most widely accepted measure of economic output having supplanted gnp around 1990 in making the switch the bureau of economic analysis bea said gdp provided a more straightforward comparison of other measures of economic activity in the united states and that it would be helpful to have a standard measure of economic output most other countries at the time had already adopted gdp as their primary measure of production 1special considerationsmany economists have questioned how meaningful gnp or gdp is as a measure of a nation s economic well being since they do not count most unpaid work while counting economic activity that is unproductive or destructive several economists still criticize gdp specifically for providing a somewhat misleading picture of an economy s true health and the well being of its citizens this is because gdp does not take into account the profits earned in a nation by overseas companies that are remitted back to foreign investors if these remitted profits are very large compared with earnings from the nation s overseas citizens and assets the nffi figure will be negative and gnp will be significantly below gdp nffi may assume increasing importance in a globalized economy as people and companies move across international borders more easily than they did in the past | |
what is a net importer | a net importer is a country that buys more from other countries in terms of global trade than it sells to them over a given period of time countries produce goods based on the resources available in their region whenever a country cannot produce a particular good but still wants it that country can buy it as an import from other countries who produce and sell that good a net importer can be contrasted with a net exporter which is a country that sells abroad more than they purchase understanding net importera net importer is a country or territory whose value of imported goods and services is higher than its exported goods and services over a given period of time a net importer by definition runs a current account deficit in the aggregate however it may also run individual deficits or surpluses with particular countries or territories depending on the types of goods and services traded the competitiveness of these goods and services exchange rates levels of government spending trade barriers etc in the u s the commerce department keeps monthly tallies on exports and imports in numerous table displays according to their aggregate tally some of the largest categories of goods that the u s currently imports are foods and beverages oil passenger cars vehicle parts and accessories pharmaceuticals cell phones and computers 2 it is important to note that a country can be a net importer in a certain area while being a net exporter in other areas for example japan is a net exporter of electronic devices but it must import oil from other countries to meet its needs example the united states as a net importerthe united states a consumer colossus has been a net importer for decades even though this country excels in a number of leading export goods and services passenger planes factory equipment luxury automobiles soybeans movies hollywood and banking services to name a few americans love to buy things and countries around the world are happy to feed the beast being a net importer is not necessarily a bad thing but running a chronic and growing trade deficit over time creates a host of issues in 2020 the imports exceeded exports by 678 7 billion exports totaled 2 131 9 billion while imports totaled 2 810 6 billion 1 the major problem with these substantial trade deficits is that they must be financed to maintain the balance of payments account the principal means of financing the current account deficit is borrowing from other countries continuous sales of treasury bonds to major trading partners from which the u s is a net importer has created a measure of dependency on these creditors which some say has the potential to lead to political or economic danger down the road in contrast saudi arabia and canada are examples of net exporting countries because they have an abundance of oil which they then sell to other countries that are unable to meet the demand for energy domestically pros and cons of being a net importerbeing a net importer implies that a country has a trade deficit a benefit of a trade deficit is that it allows a country to consume more than it produces in the short run trade deficits can help nations to avoid shortages of goods and other economic problems trade deficits can also occur because a country is a highly desirable destination for foreign investment for example the u s dollar s status as the world s reserve currency creates a strong demand for u s dollars foreigners must sell goods to americans to obtain dollars trade deficits can create substantial problems in the long run the worst and most obvious problem is that trade deficits can facilitate a sort of economic colonization if a country continually runs trade deficits citizens of other countries acquire funds to buy up capital in that nation that can mean making new investments that increase productivity and create jobs however it may also involve merely buying up existing businesses natural resources and other assets if this buying continues foreign investors will eventually own nearly everything in the country | |
what is net income ni | net income ni also called net earnings is a useful number for investors to assess how much revenue exceeds the expenses of an organization the formula to determine net income is sales minus cost of goods sold selling general and administrative expenses operating expenses depreciation interest taxes and other expenses net income appears on a company s income statement and is an indicator of a company s profitability net income also refers to an individual s income after taking taxes and deductions into account laura porter investopediaunderstanding net income ni businesses use net income to calculate their earnings per share eps business analysts often refer to net income as the bottom line since it is at the bottom of the income statement analysts in the united kingdom know ni as profit attributable to shareholders net income ni is known as the bottom line as it appears as the last line on the income statement once all expenses interest and taxes have been subtracted from revenues calculating net income for businessesto calculate net income for a business start with a company s total revenue from this figure subtract the business s expenses and operating costs to calculate the business s earnings before tax deduct tax from this amount to find the ni net income like other accounting measures is susceptible to manipulation through such things as aggressive revenue recognition or hiding expenses when basing an investment decision on ni investors should review the quality of the numbers used to arrive at the taxable income and ni to ensure that they are accurate and not misleading personal gross income vs net incomegross income refers to an individual s total earnings or pretax earnings and ni refers to the difference after factoring deductions and taxes into gross income to calculate taxable income which is the figure used by the internal revenue service irs to determine income tax taxpayers subtract deductions from gross income the difference between taxable income and income tax is an individual s ni 1for example an individual has 60 000 in gross income and qualifies for 10 000 in deductions that individual s taxable income is 50 000 with an effective tax rate of 13 88 giving an income tax payment of 6 939 50 and ni of 43 060 50 net income on tax returnsin the united states individual taxpayers submit a version of form 1040 to the irs to report annual earnings this form does not have a line for net income instead it has lines to record gross income adjusted gross income agi and taxable income 2after noting their gross income taxpayers subtract certain income sources such as social security benefits and qualifying deductions such as student loan interest the difference is their agi although the terms are sometimes used interchangeably net income and agi are two different things taxpayers then subtract standard or itemized deductions from their agi to determine their taxable income as stated above the difference between taxable income and income tax is the individual s ni but this number is not noted on individual tax forms most paycheck stubs have a line devoted to ni this is the amount that appears on an employee s check the number is the employee s gross income minus taxes and any contributions to accounts such as a 401 k or health savings account hsa | |
what is the difference between net income and gross income | gross income is the total amount earned net income is gross income minus expenses interest and taxes net income reflects the actual profit of a business or individual | |
is net income before taxes or after | net income is what a business or individual makes after taxes deductions and other expenses are taken out in business net income is what a company has left after all expenses are subtracted including taxes wages and the cost of goods | |
what is a company s income statement | an income statement is one of the three key documents used for reporting a company s yearly financial performance the income statement includes the gains losses revenue and expenses that a company reports in that period net income is the bottom line on an income statement the bottom linenet income or net earnings is the bottom line on a company s income statement it s calculated by subtracting expenses interest and taxes from total revenues net income can also refer to an individual s pretax earnings after subtracting deductions and taxes from gross income earnings per share eps are calculated using a business s net income these numbers should always be reviewed by investors to ensure that they are accurate and not inflated or misleading | |
what is net income after taxes | net income after taxes niat is a financial term used to describe a company s profit after all taxes have been paid net income after taxes is an accounting term and is most often found in a company s quarterly and annual financial reports net income after taxes represents the profit or earnings after all expense have been deducted from revenue net income after taxes calculation can be shown as both a total dollar amount and a per share calculation understanding net income after taxes niat net income after taxes niat is the net income of a business less all taxes in other words niat is the sum of all revenues generated from the sale of the company s products and services minus the costs to run it companies and analysts can also use the net of tax calculation to determine the value of revenue after the subtraction of taxes revenue and sales are sometimes used interchangeably by companies also retail companies often use the term net revenue or net sales because they often have returned merchandise by customers the total amount of rebates to customers from returns is deducted from the revenue total for the period regardless of the term used by a company to describe its total revenue earned from sales revenue is always located at the top of the income statement as a result revenue is the figure that all costs and expenses are deducted from that ultimately leads to net income which rests at the bottom of the income statement this is why revenue is referred to as the top line while net income is called the bottom line net income after taxes is calculated by taking revenue and subtracting all of a company s expenses and costs including the following although net income after taxes is essentially the same as net income it is used in financial statements to differentiate between income before taxes and income after taxes the two figures can also be described as pre tax income and after tax income interpreting net income after taxesnet income after taxes is one of the most analyzed figures on a company s financial statements the amount recorded provides an indication of the profitability of a company which determines whether the firm can compensate its investors and shareholders through dividends and share buybacks dividends are rewards usually in cash paid to shareholders while buybacks are share repurchases by a company an increase in profits over multiple periods typically leads to an increase in the company s stock price since investors would have a favorable view of the business as a company generates additional net income they have more cash to invest in the company s future which can include purchasing new equipment technologies or expanding their operations and sales a company with positive net income growth is also in a better financial position to pay down debt or make an acquisition to boost their competitiveness and total revenue a company with a net income figure that is negative or below average can be the result of a firm experiencing a decline in sales poor expense management outdated technologies excessive debt or a poorly executed management strategy a company with negative net income or losses can also be because it s a start up firm which may see years before the company turns a profit instead of watching net income investors monitor revenue growth to determine if the company has the potential to eventually be profitable a surge in a company s net income after taxes can be due to a lower tax rate or favorable tax treatment investors should crosscheck increases in niat with pre tax income to ensure that the additional profit is due to increases in revenue and not merely a tax windfall special considerationsnet income after taxes is not the total cash earned by a company over a given period since non cash expenses such as depreciation and amortization are subtracted from revenue to get the niat instead the cash flow statement is the reference to how much cash a company generates over a period while the net income after taxes calculation is one of the most solid measures of a company s performance numerous accounting scandals over the years have proven it to be less than 100 reliable it s important to note that net income is a valuable metric to use to evaluate a company s profitability however a company s reported financial numbers are only as reliable as the company behind them | |
when comparing the net income of multiple companies investors can use various financial metrics or ratios a popular profitability ratio is called profit margin which is niat as a percentage of total revenue of a company the profit margin measures how much out of every dollar of sales a company generates as profit for example a company that generates 1 million in revenue and 200 000 in profit would have a 20 profit margin 200 000 1 000 000 20 100 to convert 20 to a percent in other words for each dollar of revenue generated from sales the company earns 0 20 in profits profitability analysis can help investors determine if a company s net income is favorable when compared to other companies | real world example of net income after taxesbelow is the income statement for apple inc aapl for the fiscal quarter ending dec 28 2019 according to the company s 10 q filing 1 | |
net interest income nii is a financial performance measure that reflects the difference between the revenue generated from interest bearing assets and the expenses associated with paying on its interest bearing liabilities it s the lifeblood that sustains banks credit unions and other lenders determining their ability to generate revenue extend credit and weather economic storms in this article we ll discuss banks but many financial institutions entire economic sectors and investors can have nii 12 | below we review the factors that shape nii the formulas used to calculate it and real world examples that illustrate how to put this metric into action when reviewing a bank s profitability understanding net interest income nii a typical bank s assets include all personal and commercial loans mortgages and securities the liabilities are interest bearing customer deposits the excess revenue generated from the interest earned on assets over the interest paid on deposits is nii the nii of some banks is more sensitive to changes in interest rates than others the main changes derive from a country s central bank e g the u s federal reserve which sets its own overnight lending rates and bank use to determine the rates they offer these changes can result from the type of assets and liabilities that are held as well as whether the assets and liabilities have fixed or variable rates banks with variable rate assets and liabilities will be more sensitive to changes in interest rates than those with fixed rate holdings interest earning assets can range from mortgages to auto personal and commercial real estate loans these loans all typically carry different levels of risk thus the interest rate the bank earns for each type of loan will vary for example a personal loan will almost always carry a higher interest rate than a mortgage below is a table of the major sources of income for a bank whether they count toward nii and their relative risk the resulting nii from a bank s assets depends on their holdings moreover loans of the same type can carry fixed or variable rates depending on the consumer this is frequently seen with mortgages as most banks offer fixed and adjustable rate mortgages the quality of the loan portfolio is another factor affecting net interest income a deteriorating economy and heavy job losses can cause borrowers to default on their loans resulting in a lower net interest income about a quarter of u s banks income before expenses isn t from interest income 3 | |
how to calculate net interest income | nii is a fundamental metric used by financial institutions particularly banks to assess the profitability of their lending and borrowing activities it s calculated as the difference between the revenue generated from interest earning assets and the expenses associated with paying on interest bearing liabilities n e t i n t e r e s t i n c o m e n i i i n t e r e s t i n c o m e i n t e r e s t e x p e n s e net interest income nii interest income interest expense netinterestincome nii interestincome interestexpense | |
what is net interest margin | net interest margin nim is the net interest income a lender earns from credit products like loans and mortgages minus the interest it pays to holders of savings accounts and certificates of deposit cds expressed as a percentage the nim shows how likely a bank or investment firm is to thrive over the long haul this metric helps prospective investors determine whether or not to invest in a financial services firm by showing its interest income versus their interest expenses simply put a positive net interest margin suggests that an entity operates profitably while a negative figure implies investment inefficiency in the latter scenario a firm may take corrective action by applying funds toward outstanding debt or shifting those assets towards more profitable investments investopedia crea taylornet interest margin formulanet interest margin may be calculated by the following formula net interest margin ir ie average earning assets where ir investment returns ie interest expenses begin aligned text net interest margin frac text ir text ie text average earning assets textbf where text ir text investment returns text ie text interest expenses end aligned net interest margin average earning assetsir ie where ir investment returnsie interest expenses consider the following fictitious example assume company abc boasts a return on investment of 1 000 000 an interest expense of 2 000 000 and average earning assets of 10 000 000 in this scenario abc s net interest margin totals 10 indicating that it lost more money due to interest expenses than it earned from its investments this firm would likely fare better if it used its investment funds to pay off debts rather than making this investment the average net interest margin for all fdic insured institutions as of march 31 2024 1 | |
what affects net interest margin | multiple factors may affect a financial institution s net interest margin chief among them supply and demand if there s a large demand for savings accounts compared to loans the net interest margin decreases as the bank is required to pay out more interest than it receives conversely if there s a higher demand for loans versus savings accounts where more consumers are borrowing than saving a bank s net interest margin increases banks and other financial institutions may also use maturity transformation to profit from the difference in interest rates between borrowing and lending funds monetary policy and fiscal regulation can impact a bank s net interest margin as the direction of interest rates dictate whether consumers borrow or save monetary policies set by central banks also heavily influence a bank s net interest margins because these edicts play a pivotal role in governing the demand for savings and credit when interest rates are low consumers are more likely to borrow money and less likely to save it over time this generally results in higher net interest margins contrarily if interest rates rise loans become costlier thus making savings a more attractive option which consequently decreases net interest margins net interest margin and retail bankingmost retail banks offer interest on customer deposits which generally hovers around 1 annually if such a bank marshaled together the deposits of five customers and used those proceeds to issue a loan to a small business with an annual interest rate of 5 the 4 margin between these two amounts is considered the net interest spread looking one step further the net interest margin calculates that ratio over the bank s entire asset base let s assume a bank has earning assets of 1 2 million 1 million in deposits with a 1 annual interest to depositors and loans out 900 000 at an interest of 5 this means its investment returns total 45 000 and its interest expenses are 10 000 using the aforementioned formula the bank s net interest margin is 2 92 with its nim squarely in positive territory investors may wish to strongly consider investing in this firm historical net interest marginsthe federal financial institutions examination council ffiec releases an average net interest margin figure for all u s banks on a quarterly basis historically this figure has trended downward while averaging about 3 8 since first being recorded in 1984 recessionary periods coincide with dips in average net interest margins while periods of economic expansion have witnessed sharp initial increases in the figure followed by gradual declines 2the overall movement of the average net interest margin has tracked the movement of the federal funds rate over time case in point following the financial crisis of 2008 u s banks operated under decreasing net interest margins due to a falling rate that reached near zero levels from 2008 to 2016 during this recession the average net interest margin for banks in the u s shed nearly a quarter of its value before finally picking up again in 2015 2 | |
what factors affect net interest margin | a bank s net interest margin is affected by the supply and demand for credit products and the mix of lending products that the company offers for example credit cards typically have much higher interest rates than home mortgages and business loans so a credit card lender has a higher net interest margin than a commercial bank 1 | |
what is a typical interest margin | for banks and other financial firms a high net interest margin indicates that a company is investing its resources in a way that returns more income than its expenses for u s banks the average net interest margin is about 3 3 1 | |
how do high interest rates affect consumers | interest rates represent the cost of borrowing money when interest rates are high that means borrowers must make higher payments for mortgages cars credit cards and other loans interest rates also affect how much businesses must pay for machinery rent and new products which are often purchased on credit when interest rates are high businesses may reduce their operations and downsize their workforce contributing to higher unemployment the bottom linein financial industries the net interest margin reflects the difference between the cost of borrowing money as opposed to the gains from lending money banks and credit unions typically borrow money from their customers in order to finance loans to their clients and that difference represents how effectively a company uses its lending capital | |
what is the net interest rate differential nird | the net interest rate differential nird in international currency forex markets is the total difference in the interest rates of two distinct national economies for instance if a trader is long the nzd usd pair they will own the new zealand currency and borrow the u s currency the new zealand dollars in this case can be placed in a new zealand bank earning interest while simultaneously taking out a loan for the same notional amount from a u s bank the net interest rate differential is the after tax after fee difference in any interest earned and any interest paid while holding the currency pair position understanding the net interest rate differential nird generally an interest rate differential ird measures the contrast in interest rates between two similar interest bearing assets traders in the forex market use interest rate differentials when pricing forward exchange rates based on the interest rate parity a trader can create an expectation of the future exchange rate between two currencies and set the premium or discount on the current market exchange rate futures contracts the net interest rate differential is specific to use in currency markets the net interest rate differential is a key component of the carry trade a carry trade is a strategy that foreign exchange traders use in an attempt to profit from the difference between interest rates and if traders are long a currency pair they may be able to profit from a rise in the currency pair while the carry trade does earn interest on the net interest rate differential a move in the underlying currency pair spread could easily fall as it has historically and risk wiping out the benefits of the carry trade leading to losses the currency carry trade remains one of the most popular trading strategies in the currency market the best way to first implement a carry trade is to determine which currency offers a high yield and which offers a lower one the most popular carry trades nowadays involve buying currency pairs like the usd jpy and the aud jpy since these have interest rate spreads that are high enough to benefit from but use relatively stable currencies net interest rate differential and the carry tradethe nird is the amount the investor can expect to profit using a carry trade say an investor borrows 1 000 and converts the funds into british pounds allowing them to purchase a british bond if the purchased bond yields 7 and the equivalent u s bond yields 3 then the ird equals 4 or 7 minus 3 this profit is ensured only if the exchange rate between dollars and pounds remains constant one of the primary risks involved with this strategy is the uncertainty of currency fluctuations in this example if the british pound were to fall in relation to the u s dollar the trader may experience losses additionally traders may use leverage such as with a factor of 10 to 1 to improve their profit potential if the investor leveraged borrowing by a factor of 10 to 1 they could make a profit of 40 however leverage could also cause larger losses if there are significant movements in exchange rates that go against the trade | |
what is net internal rate of return net irr | net internal rate of return net irr is a performance measurement equal to the internal rate of return after fees and carried interest are factored in it is used in capital budgeting and portfolio management to calculate an investment s yield or overall financial quality by calculating an expected rate of return practically net irr is the rate at which the net present value of negative cash flow equals the net present value of positive cash flow a net internal rate of return is expressed as a percentage the basics of net irrthe irr is a discount rate where the present value of future cash flows of an investment is equal to the cost of the investment the net irr is a modified irr value that has taken into consideration management fees and any carried interest generally a higher net internal rate of return means that it is a better investment however a marginally lower net irr spread over a longer time period can be superior to a shorter term higher net irr investment net internal rate of return put to usecalculating a fund s net internal rate of return can help an investor or analyst determine which investment is the best option given a pair of funds that hold the same investments and are managed using the same strategy it would be wise to consider the one with the lower fee but structural similarity and fees are not enough to prove that one fund is better than another that can only be learned by calculating the net irr for both funds the one with the lower fee may not necessarily be the best choice real world example of net irr net irr and private equitynet internal rate of return is commonly used in private equity to analyze investment projects that require regular cash investments over time but offer only a single cash outflow at its completion usually an initial public offering a merger or an acquisition if the investment s net present value is the same as the net present value of benefits or if it surpasses the acceptable rate of return the project is considered profitable if two competing projects turn out to have the same net internal rate of return the one with the shorter time frame is considered the better investment in 2014 the securities and exchange commission sec began investigating whether private equity fund managers were correctly disclosing their own invested capital into their own funds when performing net internal rate of return calculations including that sum known as a general partner commitment could artificially inflate fund performance because such capital infusions do not have fees attached to them | |
what is the net interest rate spread | the net interest rate spread is the difference between the yield that a financial institution receives from loans and other interest accruing activities and the rate it pays on deposits and borrowings the net interest rate spread is a key determinant of a financial institution s profitability or lack thereof understanding the net interest rate spreadloan granting institutions such as commercial banks receive interest income from several sources deposits often called core deposits are a primary source generally in the forms of checking and savings accounts or certificates of deposit cds these are often obtained at low rates banks also obtain funds through shareholder equity wholesale deposits and debt issuance banks issue various loans such as mortgages on property home equity lending student loans car loans and credit card lending that are offered at higher interest rates the primary business of a bank is managing the spread between the interest rate on deposits that it pays consumers and the rate it receives from their loans in other words when the interest that a bank earns from loans is greater than the interest it pays on deposits it generates income from the interest rate spread in simple terms net interest rates spreads are like profit margins the greater the spread the more profitable the financial institution will likely be however this is just the basic view and financial institutions work on creative customer acquisition customer retention and loyalty and principal investing strategies their individual strategies help them compete and differentiate themselves from other financial institutions the net interest rate spread in dollar value not percentage is similar to a non financial business gross profit it demonstrates profitability after costs calculation of the net interest rate spreadto calculate an interest rate spread you use the average rate of a bank s interest bearing liabilities and the yield for its interest earning assets a formula might be | |
where | for instance in 2022 capital one financial corporation cof had 31 24 billion in interest income with an average yield of 7 68 its interest bearing liabilities for the year totaled 4 12 billion with an average yield of 1 25 for 2022 the bank had an interest rate spread of 6 43 or 27 1 billion from its interest bearing activities 1capital one 2022 annual reportnet interest rate spread vs net interest marginnet interest margin is different because it accounts for other funding sources or income that don t fit a corporation s accounting definitions such as investments or accounts that don t bear interest for example on its fy 2022 annual report capital one s net interest spread was 6 43 but after accounting for the impact of 0 24 in non interest bearing funding its net interest margin was 6 67 1its annual report doesn t explain what it considers non interest bearing funding only that it has a notional impact that affects its net interest margin 2 | |
what is an interest rate spread | interest rate spread is the difference between interest rates charged to customers and the interest rate a bank pays other banks when they borrow money | |
what is an example of bank spread | net income rate spread is sometimes called bank spread if bank a averaged 5 25 interest on interest earning assets and 1 25 on interest bearing liabilities the bank spread would be 4 0 | |
how do you calculate net interest rate spread | banks use the yield on interest earning assets and subtract the rate on interest bearing liabilities to get the net interest rate spread the bottom linenet interest rate spread is one way banks measure their profitability the measurement is a good indicator of a bank s financial performance for a period but as with all metrics it should be taken in context with other measures | |
what is a net international investment position niip | a net international investment position niip measures the gap between a nation s stock of foreign assets and a foreigner s stock of that nation s assets essentially it can be viewed as a nation s balance sheet with the rest of the world at a specific point in time understanding a net international investment position niip niip includes overseas assets and liabilities held by a nation s government the private sector and its citizens the niip is analogous to net foreign assets nfa which determines whether a country is a creditor or debtor nation by measuring the difference in its external assets and liabilities most nations release niip figures quarterly in the niip assets are divided into direct investment portfolio investment other investment and reserve assets which include foreign currencies gold and special drawing rights liabilities are reported with the same classification except for reserve assets which have no equivalent on the liabilities side a nation s niip is a key component of the national balance sheet since niip plus the value of non financial assets is equal to an economy s net worth the niip coupled with the balance of payments transactions reflects the domestic economy s set of international accounts the niip position is an important barometer of a nation s financial condition and creditworthiness a negative niip figure indicates that foreign nations own more of the domestic nation s assets than the domestic nation does of foreign assets thus making it a debtor nation conversely a positive niip figure indicates that the domestic nation s ownership of foreign assets is greater than the foreign nation s ownership of that domestic nation s assets thus making it a creditor nation two metrics used to assess the niip s size relative to the economy s size are the ratio of niip to gross domestic product gdp and the ratio of niip to the economy s total financial assets example of a net international investment position niip u s niip data is published by the bureau of economic analysis bea and accessible to all the country s niip at the end of the third quarter of 2020 was 13 95 trillion a decrease from its prior reading of 13 08 trillion at the end of the second quarter of 2020 this means that the difference in the value of foreign assets owned by the u s fell further below the value of u s assets owned by foreign nations here s how the numbers stacked up | |
what is net investment | net investment is the total amount of money that a company spends on capital assets minus the cost of the depreciation of those assets this figure provides a sense of the real expenditure on durable goods such as plants equipment and software that are being used in the company s operations capital assets lose value over time due to wear and tear and obsolescence therefore subtracting depreciation from gross capital expenditure capex provides an accounting for the cost of the using up of the asset capital assets include all property and equipment that contribute to the productive capacity of the business net investment is a component of a nation s gross domestic product gdp in a nation s gdp the figure indicates gross private domestic investment it includes all expenditures by private companies and governments on real estate and inventories thus it is a leading indicator of a nation s potential economic production capacity understanding net investmentif gross investment is consistently higher than depreciation the net investment figure will be positive indicating that the company s productive capacity is increasing if gross investment is consistently lower than depreciation net investment will be negative indicating that productive capacity is decreasing companies with a declining capital base will probably not grow revenues as they will have fewer assets employed to try and achieve that growth so companies with net negative investment may be expected to shrink in future this is true for all entities from the smallest companies to the largest national economies | |
when comparing net investment figures stick with the same industry for relevant results | net investment is therefore a better indicator than gross investment of how much an enterprise is investing in its business since it takes depreciation into account investing an amount equal to the total depreciation in a year is the minimum required to keep the asset base from shrinking this investment amount is known as the maintenance capital expenditure net investment calculationsuppose a company spends 1 million on a new piece of machinery that has an expected life of 30 years and has a residual value of 100 000 based on the straight line method of depreciation annual depreciation would be 30 000 or 1 000 000 100 000 30 therefore assuming no new capital expenditures the amount of net investment at the end of the first year would be 970 000 the formula for calculating net investment is net investment capital expenditures depreciation non cash regular investment in capital assets is critical to an enterprise s continuing success the net investment amount required for a company depends on the sector it operates in sectors such as industrial products goods producers utilities and telecommunications are more capital intensive than sectors such as technology and consumer products that s why when comparing net investment among various companies it is most relevant if they are in the same sector | |
what is net investment income nii | net investment income nii for tax purposes is the total amount of money received from assets such as stocks bonds and mutual funds minus related expenses nii may include interest income dividend income and capital gains whether this income minus the expenses is taxable is determined by the taxpayer s modified adjusted gross income magi understanding net investment income nii income can be any money or compensation that an individual or a business earns in exchange for labor the sale of products and services or from investments when investors sell assets from their portfolios the proceeds from the transaction result in either a realized gain or loss realized gains may come in the form of costs such as trading commissions are subtracted from realized gains before taxes to arrive at net investment income other forms of income such as wages are not included 1nii has been taxable above certain thresholds since jan 1 2013 known as the net investment income tax it was passed as part of the health care and education reconciliation act of 2010 the nii tax was included as a revenue raising tool to offset the costs of the affordable care act aca 2 the rate was set at 3 8 on certain net investment income of individuals estates and trusts that have income above the statutory threshold amounts 3net investment income may be either positive or negative depending on whether the asset was sold for a capital gain or loss | |
what counts as nii | the following table shows what counts and what doesn t count as net investment income 3who pays the nii tax net investment income is subject to a 3 8 tax if you exceed certain income limits the tax applies to individuals estates and trusts 3the tax is applied to individuals with nii who fall within a certain modified adjusted gross income threshold 3 these thresholds are listed in the table below and they are not indexed for inflation the net investment income tax is applied to the lesser of the net investment income or the magi amount in excess of the predetermined limit estates and trusts are subject to the nii tax if they have undistributed nii and their annual adjusted gross income agi exceeds the dollar amount at which the highest tax bracket begins 3 that level is 14 450 in 2023 and 15 200 in 2024 45a nonresident alien is not subject to the tax unless they are married to a u s citizen or resident and elect to be treated as a resident of the u s for tax purposes 3for investment companies net investment income is the amount of income left after operating expenses are subtracted from total investment income and is typically expressed on a per share basis 6to find the net investment income per share of a company divide the total investment income by the shares outstanding this amount is what is available to shareholders as dividends a publicly traded company must list its net investment income on its balance sheet | |
how to calculate the nii tax | before you can calculate the nii tax you must determine the income you earned from every one of your qualified investments be sure you account for and subtract any fees and related expenses such as commissions and brokerage charges you can refer to the list of what counts in the table above next you ll need to get your magi this figure is your agi plus any excluded income and certain deductions like student loan payments see the table above for your tax filing status if you fall above any of those thresholds you will have to pay an nii tax if you can reduce your reported magi or net investment income you can also reduce your nii tax liability some ways to do that include contributing to retirement plans or charities or tax loss harvesting you can use internal revenue service irs form 8960 to determine what your tax liability is for net investment income or you can do so on your own 7 the 3 8 tax is imposed on your net investment income or the amount by which your magi exceeds the listed thresholds whichever is less here are two simple scenarios assuming you have an nii of 25 000 the net investment income tax is in addition to capital gains tax or dividends tax which the investor still has to pay | |
how to manage the nii tax | even if you earn significant investment income you can reduce your tax liabilities by taking steps that reduce your reported adjusted gross income agi your net investment income or both one way to reduce your agi is to maximize your contributions to iras and other qualified retirement plans or by participating in deferred compensation plans if you can reduce your agi so that it does not exceed the threshold above you may not need to pay nii tax at all you can also reduce your net investment income through tax loss harvesting by selling unprofitable investments at the same time as profitable ones you can reduce your net investment income and thereby reduce your tax burden it is also possible to reduce nii through charitable contributions such as a charitable remainder trust | |
how to pay the nii tax | you must report your nii on irs form 8960 this form can help entities that are required to pay the tax to calculate their liability the figure on this form is transferred to the appropriate main tax form for individuals the nii tax is reported and paid with form 1040 estates and trusts that must report nii tax do so with form 1041 u s income tax return for estates and trusts 3example of niihere s a hypothetical example to show how net investment income works let s say an individual sells 100 shares of apple aapl for 175 per share and 50 shares of netflix nflx for 170 per share they also received coupon payments for the year on their corporate bonds in the sum of 2 650 and income from a rental property of 16 600 their net investment income can be calculated as | |
what qualifies as net investment income | net investment income is any money earned from an investment vehicle this includes interest capital gains royalties rent payments dividends and certain payments from annuities it may come from stocks bonds investment properties mutual funds and other investments taxpayers should be aware that they may incur a tax on their net investment income if their modified gross adjusted income exceeds a certain amount based on their tax filing status the tax also applies to estates trusts and other entities 3 | |
how do i calculate my net investment income tax | you can use irs form 8960 to calculate your net investment income tax you can also calculate it yourself by adding together all your investment income and subtracting any related fees and expenses then determine your modified adjusted gross income you pay 3 8 on whichever is less either your net investment income or the portion of your magi that exceeds your tax filing threshold as set by the internal revenue service 3can i avoid paying the net investment income tax there are ways to avoid qualifying for the niit the key is keeping your modified adjusted gross income under the threshold talk to a tax professional or another financial professional to see what steps you can take to decrease your tax liability when it comes to your investments the bottom lineinvestments can be used to prepare for the future or to help pay for unexpected emergencies such as car repairs or medical care although they may give you a cushion when you need it most that investment income can add to your annual tax bill this may come in the form of a net investment income tax net investment income is any money you earn from your investments less any related fees and expenses the tax will be imposed on the amount that your modified adjusted gross income exceeds your tax filing threshold or on the total amount of your nii correction nov 16 2023 this article has been corrected to state that you can reduce your adjusted gross income agi and tax liabilities with contributions to qualified retirement plans | |
what is a net lease | the term net lease refers to a contractual agreement where a lessee pays a portion or all of the taxes insurance fees and maintenance costs for a property in addition to rent net leases are commonly used in commercial real estate in the purest form of a net lease the tenant is expected to pay for all the costs related to a piece of property as if the tenant were the actual owner a net lease is the opposite of a gross lease where the tenant pays a flat rental fee while the landlord is responsible for the other costs understanding net leasesnet leases are just like owning property without actually having legal title over it they are lease agreements between landlords and tenants where the tenant pays for rent and any other cost associated with the property in question the agreement may include one or more expenses including insurance property taxes utilities maintenance and repairs and other operational costs most landlords generally accept lower rent payments because of the additional costs associated with net leases these lease agreements are a popular tool for commercial real estate investors who buy properties for the income and do not want the headaches of arranging maintenance paying municipal taxes and so on property owners use net leases to shift the burden of managing taxes insurance and fees to the tenant although the owner and or lessor may charge less overall as a result they no longer have to worry about the day to day administration of that property from the tenant and or lessee perspective a net lease must adequately compensate for the risk the tenant is taking on from the landlord stated another way the cost difference between a gross lease and a net lease must be large enough to offset the unpredictable costs of maintenance and the potentially rising costs of taxes and insurance the landlord gives up some money in rent to save headaches and the tenant takes the discount knowing that year to year property costs may vary the cost difference between a gross lease and a net lease must be large enough for a tenant to offset the unpredictable costs of maintenance and taxes and insurance types of net leasesthe definition of what constitutes a net lease is quite broad and far from uniform across the country instead net leases are broken down into three primary types that deal with the main cost categories of taxes maintenance and insurance fees in addition to the rent charged by the landlord they are even with the breakdowns above the actual definition of a net lease is dependent on the details in each contract as mentioned above net leases are the opposite of gross leases where the landlord covers all of the expense categories in exchange for a fixed payment in practice a modified gross lease and a single or double net lease can be the same thing a modified gross lease might have the tenant paying building insurance costs for example and could easily be classified as a single net lease again the details of the lease matter more than whether the lessor considers it a net or gross lease | |
what are net liquid assets | net liquid assets are a measure of an immediate or near term liquidity position of a firm calculated as liquid assets less current liabilities liquid assets are cash marketable securities and accounts receivables that can be readily converted to cash at their approximate current value understanding net liquid assetsthe amount of net liquid assets is one of a few measures that gives a snapshot of the financial condition of a firm cash and marketable securities are ready to deploy while accounts receivables could be turned into cash within a short period of time though perhaps not completely as there is typically a small percentage of bad debt associated with aged receivables inventory does not qualify as a liquid asset because it cannot be readily sold without a significant discount current liabilities mainly encompass accounts payable accrued liabilities income tax payable and a current portion of long term debt for the average company subtracting current liabilities from the above liquid assets shows the financial flexibility of a company to make a quick payment advantages of net liquid assetshaving a strong net liquid asset position is important for a firm because it demonstrates that a firm is able to pay off its short term obligations such as paying suppliers and paying off short term debt it also signifies that a company is able to make new investments such as the purchase of equipment without having to take on financing companies that have a strong net liquid asset position are also better placed in times of economic downturns they are in a position to weather the storm by relying on its liquid assets to continue paying its short term obligations even if business is not booming on the other hand a company that does not have a strong net liquid asset position and no significant revenues in an economic downturn will not be able to meet its obligations and may have to declare bankruptcy having net liquid assets also makes it easier to receive financing from a bank as it demonstrates the ability of a company to pay off its loans even in times of distress this also results in usually receiving a better interest rate on a loan though having net liquid assets is a positive position to be in having too many liquid assets is not the most beneficial use of cash as it could be invested and earning a return elsewhere rather than sitting idly in a bank account conversely it can also be used to pay dividends to shareholders there is a fine balance that a company must strike between enough liquid assets and too many liquid assets the general rule of thumb is that if a business has six months of liquid assets to meet short term obligations and cover operating expenses it is in a good position financially example of net liquid assetssay that xyz widgets incorporated has the following components on its balance sheet for current assets and current liabilities current assetscurrent liabilitiesnet liquid assets as of this date would be the negative net liquid position of the company may be a concern but this situation is typical for a retailer still it indicates that the company is not in the best financial position particularly if the economy takes a turn for the worse | |
what are common examples of liquid assets | a liquid asset is an asset that can be easily and quickly converted into cash examples of liquid assets may include cash cash equivalents money market accounts marketable securities short term bonds and accounts receivable | |
why are net liquid assets important | net liquid assets are important because a company consistently needs cash to meet its short term obligations without cash a company can t pay its bills to vendors or wages to employees liquid assets are also needed in case a short term emergency arises that requires money to be spent | |
what is the difference between a liquid asset and illiquid asset | a liquid asset is an item of future economic benefit to a company that can easily be exchanged for cash on the other hand illiquid assets are more difficult to sell examples of illiquid assets would include real estate land vehicles equipment machinery and certain over the counter otc securities among others | |
what is net loss | a net loss is when total expenses including taxes fees interest and depreciation exceed the income or revenue produced for a given period of time a net loss may be contrasted with a net profit also known as after tax income or net income understanding net lossfor a business net loss is sometimes referred to as a net operating loss nol for tax purposes net losses may be carried forward into future tax years to offset gains or profits in those years a net loss appears on the company s bottom line or income statement net loss or net profit is calculated using the following formula net loss or net profit revenues expensesbecause revenues and expenses are matched during a set time a net loss is an example of the matching principle which is an integral part of the accrual accounting method expenses related to income earned during a set time are included in or matched to that period regardless of when the expenses are paid | |
when profits fall below the level of expenses and cost of goods sold cogs in a given time a net loss results | factors contributing to a net lossbusinesses that have a net loss do not necessarily go bankrupt immediately because they may opt to use their retained earnings or loans to stay afloat this strategy however is only short term as a company without profits will not survive in the long term net loss examplessay that substantial refunds were expected as companies took advantage of outstanding tax credits previously issued as a way of retaining jobs in the state during the recession as a result the state treasurer anticipates a decrease of 99 million in revenue from the state s principal business taxes this prompts state officials to cut the current and upcoming fiscal year revenue projections by a significant amount and unless they can cut expenditures as well they will be operating at a net loss another example would be if company a has 200 000 in sales 140 000 in cogs and 80 000 in expenses subtracting 140 000 cogs from 200 000 in sales results in 60 000 in gross profit however because expenses exceed gross profit a 20 000 net loss results yet another example would be of a company that sells frozen foods and needs to pay for refrigerated storage facilities utility costs taxes employee expenses and insurance if sales are slow the company will need to hold onto its inventory for a longer time incurring additional carrying costs which could contribute to a net loss can a company with positive revenues still have a net loss yes even if a company has a large volume of sales it can still end up losing money if the cost of goods or other expenses related to those sales e g marketing are too high other factors like taxes interest expenses depreciation and amortization and one time charges like a lawsuit can also take a company from a profit to a net loss | |
what is a net loss carryforward | the irs allows certain net losses experienced in one tax period to be used to deduct from net profits earned in subsequent periods the 2018 tax cuts and jobs act tcja changed how businesses must account for net operating loss carryforwards check with your accountant for all tax matters | |
is a net loss the same as a negative profit | a negative profit technically does not exist since a profit by definition implies a gain in value however the term negative profit is used colloquially to describe a net loss | |
what is net national product nnp | net national product nnp is the monetary value of finished goods and services produced by a country s citizens overseas and domestically in a given period 1 it is the equivalent of gross national product gnp the total value of a nation s annual output minus the amount of gnp required to purchase new goods to maintain existing stock otherwise known as depreciation understanding net national product nnp nnp is often examined on an annual basis as a way to measure a nation s success in continuing minimum production standards it can be a useful method to keep track of an economy as it takes into account all its citizens regardless of where they make their money and acknowledges the fact that capital must be spent to keep production standards high the nnp is expressed in the currency of the nation it represents that means that in the united states the nnp is expressed in dollars usd while for european union eu member nations the nnp is expressed in euros eur the nnp can be extrapolated from the gnp by subtracting the depreciation of any assets the depreciation figure is determined by assessing the loss of the value of assets attributed to normal use and aging the relationship between a nation s gnp and nnp is similar to the relationship between its gross domestic product gdp and net domestic product ndp calculating net national product nnp the formula for nnp is nnp mvfg mvfs depreciation where mvfg market value of finished goods mvfs market value of finished services begin aligned text nnp text mvfg text mvfs text depreciation textbf where text mvfg text market value of finished goods text mvfs text market value of finished services end aligned nnp mvfg mvfs depreciationwhere mvfg market value of finished goodsmvfs market value of finished services alternatively nnp can be calculated as nnp gross national product depreciation begin aligned text nnp text gross national product text depreciation end aligned nnp gross national product depreciation for example if country a produces 1 trillion worth of goods and 3 trillion worth of services in 2018 and the assets used to produce those goods and services are depreciated by 500 billion using the formula above country a s nnp is nnp 1 trillion 3 trillion 0 5 trillion 3 5 trillion begin aligned text nnp 1 text trillion 3 text trillion 0 5 text trillion 3 5 text trillion end aligned nnp 1 trillion 3 trillion 0 5 trillion 3 5 trillion recording depreciationdepreciation in the overall economy also referred to as capital consumption allowance cca is a key component when calculating a country s nnp cca is an indicator of the need to replace certain assets and resources to maintain a specified level of national productivity it is divided into two categories physical capital and human capital physical capital can include real estate machinery or any other tangible resource used in the production of goods and services human capital on the other hand covers the skills knowledge and abilities of a workforce to produce goods and services as well as the necessary training or education that may be required to maintain production standards physical capital and human capital depreciate in different ways physical capital experiences depreciation based on physical wear and tear while human capital experiences depreciation based on workforce turnover when staff leave companies must spend more of their resources on training and finding new talent special considerationsnnp has particular usefulness for the field of environmental economics nnp is a model associated with the depletion of natural resources and it can be used to determine whether certain activities are sustainable within a particular environment as previously mentioned nnp also factors in the value of goods and services produced overseas that means that the activities of u s manufacturers in asia for example count toward the u s nnp that is not the case for gdp and ndp which limit their interpretation of the economy to the geographical borders of the country | |
what is net net | net net is a value investing technique developed by the economist benjamin graham in which a company s stock is valued based solely on its net current assets per share ncavps net net investing thus focuses on current assets taking cash and cash equivalents at full value then reducing accounts receivable for doubtful accounts and reducing inventories to liquidation values net net value is calculated by deducting total liabilities from the adjusted current assets 1net net should not be confused with a double net lease which is a commercial rental agreement where the tenant is responsible for both property taxes and premiums for insuring the property understanding net net investinggraham used this method at a time when financial information was not as readily available and net nets were more accepted as a company valuation model when a viable company is identified as a net net the analysis focused only on the firm s current assets and liabilities without taking other tangible assets or long term liabilities into account advances in financial data collection now allow analysts to quickly access a firm s entire set of financial statements ratios and other benchmarks essentially investing in a net net was a safe play in the short term because its current assets were worth more than its market price in a sense the long term growth potential and any value from long term assets are free to an investor in a net net net net stocks will usually be reassessed by the market and priced closer to their true value in the short term long term however net net stocks can be problematic the formula for net current asset value per share ncavps is according to graham investors will benefit greatly if they invest in companies whose stock prices are no more than 67 of their ncav per share and in fact a study done by the state university of new york showed that from the period of 1970 to 1983 an investor could have earned an average return of 29 4 by purchasing stocks that fulfilled graham s requirement and holding them for one year 2however graham made it clear that not all stocks chosen using the ncavps formula would have strong returns and that investors should also diversify their holdings when using this strategy graham recommended holding at least 30 stocks 3special considerationscurrent assets which are used in the net net approach are defined as assets that are cash and assets that are converted into cash within 12 months including accounts receivable and inventory as a business sells inventory and customers submit payments the firm reduces inventory levels and receivables this ability to collect cash is the true value of a business according to the net net approach current assets are reduced by current liabilities such as accounts payable to calculate net current assets long term assets and liabilities are excluded from this analysis which only focuses on cash that the firm can generate within the next 12 months 3criticisms of net netthe reason net net stocks may not be a great long term investment is simply because management teams rarely choose to fully liquidate the company at the first sign of trouble in the short term a net net stock may make up the gap between current assets and market cap however over the long term an incompetent management team or a flawed business model can ruin a balance sheet quite rapidly so a net net stock may find itself in that position because the market has already identified long term issues that will negatively affect that stock for example the rise of amazon com has pushed various retailers into net net positions over time and some investors have profited in the short term in the long term however many of those same stocks have gone under or been acquired at a discount the net net strategy of finding companies with a market value below its net net working capital nnwc cash and short term investments 75 of accounts receivable 50 of inventory total liabilities may be an effective strategy for small investors net net companies are sought after by day traders which may contribute to their rise in month to month valuation | |
what is net neutrality | network neutrality ensures that all data on the internet is treated equally by internet service providers isps and governments regardless of content user platform application or device for users net neutrality enables access and transparency of internet content and allows access to all internet services and applications | |
what is net of tax | the term net of tax refers to the amount left after adjusting for the effects of taxes net of tax can be a consideration in any situation where taxation is involved individuals and businesses often analyze before and after tax values to make investment and purchasing decisions net of tax is also an important part of expense analysis when reviewing annual tax filings and the net income of businesses understanding net of taxin the financial industry gross and net are two key terms that refer to before and after paying certain expenses in general net of refers to a value found after expenses have been accounted for therefore the net of tax is simply the amount left after taxes have been subtracted 1there can be several scenarios where net of tax is important three of the most common are large asset purchases with sales tax before and after tax contributions and an entity s total profit after tax taxes can be a part of asset sales and purchases most large assets like cars trucks and motorcycles require a sales tax at the time of purchase sellers of these items may also be required to pay taxes on capital gains property has its own tax rules and is often not subject to sales tax 23 many real estate owners can often qualify for tax breaks that help them reduce any capital gains taxes they might have to pay on real estate property sold 4the total taxes on a transaction are subtracted from the income or gains to calculate net of tax calculating net of taxfor purchases you ll need to consider the taxes and subtract them from the total amount you paid for income you subtract the amount you paid in taxes for the period from the amount you earned for example if you earn 60 000 per year but paid 7 200 in taxes you made 52 800 net of tax for the year another example might be a company that sells one of its assets it is usually not responsible for sales tax but may have to pay capital gains taxes if a company bought a factory for 600 000 and sold it 10 years later for 1 million it would have realized 400 000 in capital gains at a capital gains tax rate of 15 it would owe 60 000 in taxes on the sale it would have profited 340 000 net of tax 400 000 60 000 without considering other expenses for the transaction 52net of tax strategiesnet of tax strategies can be important in the investment and financial planning world since investors must pay taxes on their capital gains there are many strategies they can deploy to reduce or avoid the impact of taxes there are several investments and investment vehicles labeled as tax advantaged municipal bonds are one of the most common tax advantaged investments with most of the asset class offering no federal tax on gains 6investors can also choose to hold assets for more than one year to pay a reduced long term capital gains tax versus the short term capital gains rate which adds the gains to the investor s income if they meet the income requirements 2 moreover some investors may invest to avoid alternative minimum taxes amt which can apply to any investor but usually are a factor for taxpayers who itemize or those with higher net worth 7before and after tax investing or contributions can also be important for many investors any before tax contribution lowers the value of taxable income any after tax contribution is considered to be net of tax with taxes already subtracted investing in a 401 k plan or individual retirement account ira is often done with before or after tax contributions many investors pay into 401 k s and traditional iras with pre tax dollars which helps to lower their taxable income effectively the investor will be taxed at the time of withdrawal instead alternatively roth iras are funded with after tax dollars thus roth iras are not taxed at the time of withdrawal because the tax was paid before the roth ira was funded 8roth ira accounts can also provide unique opportunities to invest without taxation for instance if you had a roth ira account with 100 000 in stocks and 100 000 in bonds it s possible to sell stocks and bonds within the account without ever paying taxes on gains when you make a withdrawal as long as you meet the criteria for a qualified distribution 9some companies may also offer tax advantaged benefits like pre tax deductions for purchasing transportation cards as part of their employee benefit plans any pre tax deductions for regular expenses can be helpful because they lower the taxable amount and increase net of tax values net of tax and incomeanalyzing gross versus net income for an annual tax year is often an important scenario involving net of tax consideration overall individuals and businesses can take expense deductions that reduce their taxable income entities may also take credits that reduce any tax they owe both individuals and businesses make regular tax payments throughout the year which should also be monitored to ensure optimal net of tax earnings the irs taxes individuals at the following annual income tax rates for the 2023 tax year the return that is filed in 2024 10the irs taxes individuals at the following annual income tax rates for the 2024 tax year the return that will be filed in 2025 11the annual tax rate generally assessed on corporations is 21 12at the end of the tax year when entities file their tax returns certain deductions or credits can help to reduce the taxes they owe arriving at the total net of tax figure requires subtracting all the income taxes paid throughout the year from the gross income received if you receive a refund at tax time this can be a type of reimbursement for taxes already withheld your refund then offsets your net of tax income in general individuals and businesses usually seek to take advantage of as many tax deductions and credits as possible to reduce the total taxes paid and increase their annual net of tax value | |
is net of tax before or after | net of tax is what remains after all taxes have been subtracted from your gross pay or income | |
does net means including or excluding | net refers to the amount left over after reducing including a specific amount in the calculation net of taxes means income after taxes | |
how do i calculate net of tax | the easiest way is to subtract what you ve paid in taxes from what you ve earned the bottom linenet of taxes is the amount of money you have left after subtracting taxes it s generally used by businesses or investors who are measuring available capital to make decisions that affect their company or investments individuals can use it to learn how much they ve earned or spent after accounting for taxes paid | |
what is net operating income noi | net operating income noi shows the profitability of income generating real estate investments noi includes all revenue from the property minus necessary operating expenses however noi is a before tax figure on a property s income and cash flow statement that excludes principal and interest payments on loans capital expenditures depreciation and amortization investopedia jessica olah | |
what noi tells real estate investors | noi looks at the total revenue versus the total operating expenses of a rental property revenue is income from rent parking or storage fees and on site vending machines or laundry services operating expenses include maintenance and repairs property taxes and insurance property management fees janitorial services and utilities capital expenditures such as costs for a new air conditioning system for the entire building are not included in noi net operating income is a valuation method real estate professionals use to determine the precise value of income producing properties noi is used to calculate the capitalization rate a measure of the profitability of an investment property to the total cost the cap rate is calculated by dividing the noi by the total cost of a property expressed as a percentage the capitalization rate helps investors compare the returns of different properties for financed properties noi is also used in the debt coverage ratio dcr which tells lenders and investors whether a property s income covers its operating expenses and debt payments noi is also used to calculate the net income multiplier cash return on investment and total return on investment noi is used to determine the capitalization rate of a property also known as the return on investment roi in real estate it divides noi by the purchase price calculating net operating incomenet operating income r r o e where r r real estate revenue o e operating expenses begin aligned text net operating income rr oe textbf where rr text real estate revenue oe text operating expenses end aligned net operating income rr oewhere rr real estate revenueoe operating expenses noi examplethe following information is an example of a rental condominium revenue total revenues 26 000operating expenses total operating expenses 10 000the net operating income noi is 26 000 10 000 16 000 profit and lossan owner who collects 120 000 in revenues and incurs 80 000 in operating expenses will have a resulting noi of 40 000 120 000 80 000 if the total is negative with higher costs than revenues the result is called a net operating loss nol creditors and commercial lenders rely heavily on noi to determine the income generation potential of a mortgaged property noi helps lenders forecast a property s cash flows if a property is profitable the lenders also use this figure to determine the amount they are willing to lend lenders may reject a mortgage application if a property shows a net operating loss property owners can manipulate operating expenses by deferring certain expenses while accelerating others noi can also be increased by raising rents and other fees while simultaneously decreasing operating costs if an apartment owner waives a tenant s yearly 12 000 rent in exchange for that renter acting as a property manager valued as a 30 000 cost the owner may subtract the cost from revenue | |
how does net operating income differ from gross operating income | net operating income estimates the potential revenue from an investment property however it does not account for costs such as mortgage financing noi is different from the gross operating income the net operating income is the gross operating income minus operating expenses | |
what is net operating loss nol | a net operating loss nol occurs when a company s allowable deductions exceed its taxable income within a tax period the nol can generally be used to offset a company s tax payments in other tax periods through an internal revenue service irs tax provision called a loss carryforward nol tax laws have undergone significant changes in recent years net operating losses in 2021 or later may not be carried back and nol carryforwards are limited to 80 of the taxable income in any one tax period | |
how a net operating loss nol works | a net operating loss is a tax attribute that can be carried forward to offset taxable income in future years to reduce a company s future tax liability the purpose behind this tax provision is to allow some form of tax relief when a company loses money in a tax period the irs recognizes that some companies business profits are cyclical in nature and not in line with a standard tax year 1nol carryforwards are recorded as an asset on the company s general ledger they offer a benefit to the company in the form of future tax liability savings a deferred tax asset is created for the nol carryforward which is offset against net income in future years the deferred tax asset account is drawn down each year not to exceed 80 of net income in any one of the subsequent years until the balance is exhausted 1a farming business for example may have significant profits and a large tax payment in one year then incur an nol in the next followed by another profitable year to smooth the tax burden the loss carryforward provision allows for the nol in the second year to offset taxes due in the third year | |
how to calculate net operating loss nol | net operating loss is calculated by subtracting allowable tax deductions from taxable income if the resulting figure is negative there s a net operating loss when this happens the business can carry some of its tax deductions forward to years when it has a profit a net operating loss sometimes called a net loss appears on the company s bottom line or income statement net operating loss nol tax law changesnet operating loss has been subject to several tax law changes over the past few years before the implementation of the tax cuts and jobs act tcja in 2018 the irs allowed businesses to carry net operating losses forward 20 years to net against future profits and backward two years for an immediate refund of previous taxes paid because the time value of money shows that tax savings in the present are more valuable than in the future the carryback method was generally used first followed by the carryforward method after carrying losses forward for 20 years any remaining losses expired and could no longer be used to reduce taxable income 2in 2017 the tax cuts and jobs act tcja made significant changes to the laws regarding net operating losses the tcja removed the two year carryback provision for tax years beginning jan 1 2018 or later except for certain farming losses but allowed for an indefinite carryforward period however the carryforwards are now limited to 80 of each subsequent year s net income if a business creates nols in more than one year they are to be drawn down completely in the order that they were incurred before drawing down another nol 3the coronavirus aid relief and economic security cares act effectively suspended the changes made by the tcja the pandemic relief bill allowed nols arising in tax years beginning in 2018 2019 and 2020 to be carried back for a period of five years and carried forward indefinitely however those special exceptions have now expired 1losses originating in tax years beginning before jan 1 2018 are still subject to the former tax rules any remaining losses will expire after 20 years 4net operating loss nol carryforward exampleimagine a company that had an nol of 5 million one year and a taxable income of 6 million the next the carryover limit of 80 of 6 million is 4 8 million the full loss from the first year can be carried forward on the balance sheet to the second year as a deferred tax asset the loss limited to 80 of income in the second year can then be used in the second year as an expense on the income statement it lowers net income and therefore the taxable income for the second year to 1 2 million 6 million 4 8 million a 200 000 deferred tax asset does not directly represent the net operating loss nol balance but rather the anticipated tax benefit from carrying forward the nol to offset taxable income in future periods net operating loss nol carryforward limitationsa net operating loss is a valuable asset because it can lower a company s future taxable income for this reason the irs restricts using an acquired company simply for its nol s tax benefits section 382 of the internal revenue code states that if a company with an nol has at least a 50 ownership change the acquiring company may use only part of the nol in each concurrent year however purchasing a business with a substantial nol may mean a larger sum of money going to the acquired company s shareholders than if the acquired company possessed a smaller nol 5 | |
what is a net operating loss nol carryforward | the net operating loss can generally be used to offset a company s tax payments in other tax periods through an internal revenue service irs tax provision called a loss carryforward this offers a benefit to a company in that it can reduce a company s future tax liability by offsetting taxable income in future years the purpose behind this tax provision is to allow some form of tax relief when a company loses money in a tax period 1 | |
how did the tax cuts and jobs act tcja affect nol carryforwards | for tax years 2018 and later the tax cuts and jobs act tcja removed the previously allowed two year carryback provision except for certain farming losses but allowed for an indefinite carryforward period the carryforwards are now limited to 80 of each subsequent year s net income if a business creates nols in more than one year they are to be drawn down completely in the order in which they were incurred before drawing down another nol the coronavirus aid relief and economic security cares act suspended the changes made by the tcja for tax years 2018 2019 and 2020 however the new rules apply for 2021 and onward 1 | |
how are nol carryforwards accounted for | nol carryforwards are recorded as an asset on the company s general ledger a deferred tax asset is created for the nol carryforward which is offset against net income in future years the deferred tax asset account is drawn down each year not to exceed 80 of net income in any one of the subsequent years until the balance is exhausted 1 | |
what is the 80 nol rule | the 80 nol rule was introduced by the tax cuts and jobs act tcja of 2017 and limits net operating loss carryforwards to 80 of each subsequent year s net income the bottom lineposting a loss is never a good thing however there is at least one positive to take from it it s possible to use a loss to offset taxable income in future years in a process called loss carryforward there are some limitations though from the 2021 tax year you can no longer carry back a loss from one year to a previous year moreover carryforwards are now limited to 80 of each subsequent year s net income | |
what is net operating profit after tax | net operating profit after tax nopat is a financial measure that shows how well a company performed through its core operations net of taxes nopat is frequently used in economic value added eva calculations and is a more accurate look at operating efficiency for leveraged companies nopat does not include the tax savings many companies get because of existing debt 1understanding net operating profit after tax nopat net operating profit after tax nopat is a company s potential cash earnings if its capitalization were unleveraged that is if it had no debt the figure doesn t include one time losses or charges these don t provide a true representation of a company s true profitability some of these charges may include charges relating to a merger or acquisition which if considered don t necessarily show an accurate picture of the company s operations even though they may affect the company s bottom line that year analysts look at many different measures of performance when assessing a company as an investment the most commonly used measures of performance are sales and net income growth sales provide a top line measure of performance but they do not speak to operating efficiency net income includes operating expenses but also includes tax savings from debt net operating profit after tax is a hybrid calculation that allows analysts to compare company performance without the influence of leverage in this way it is a more accurate measure of pure operating efficiency to calculate nopat the operating income also known as the operating profit must be determined it includes gross profits less operating expenses which is comprised of selling general and administrative e g office supplies expenses 2 the nopat formula isnopat operating income 1 tax rate where operating income gross profits less operating expenses begin aligned text nopat text operating income times left 1 text tax rate right textbf where text operating income text gross profits less operating expenses end aligned nopat operating income 1 tax rate where operating income gross profits less operating expenses nopat examplefor example if ebit is 10 000 and the tax rate is 30 the net operating profit after tax is 0 7 which equals 7 000 calculation 10 000 x 1 0 3 this is an approximation of after tax cash flows without the tax advantage of debt note that if a company does not have debt net operating profit after tax is the same as net income after tax when calculating net operating profit after tax analysts like to compare against similar companies in the same industry because some industries have higher or lower costs than others special considerationsin addition to providing analysts with a measure of core operating efficiency without the influence of debt mergers and acquisitions analysts use net operating profit after tax they use this to calculate free cash flow to the firm fcff which equals net operating profit after tax minus changes in working capital they also use it in the calculation of economic free cash flow to the firm fcff which equals net operating profit after tax minus capital both measures are primarily used by analysts looking for acquisition targets since the acquirer s financing will replace the current financing arrangement another way to calculate net operating profit after tax is net income plus net after tax interest expense or net income plus net interest expense multiplied by 1 minus the tax rate analysts may also look at the business profitability using net operating profit less adjusted taxes noplat | |
what is net operating profit less adjusted taxes noplat | net operating profit less adjusted taxes noplat is a financial metric that calculates a firm s operating profits after adjusting for taxes by using operating income or income before taking interest payments into account noplat serves as a better indicator of operating efficiency than net income 1understanding net operating profit less adjusted taxes noplat net operating profit less adjusted taxes noplat is a company s earnings before interest and taxes ebit after making adjustments for deferred taxes the tax is adjusted to reflect the un leveraged profits of the firm without taking into account the effects of tax debt in effect this metric is a profit measurement that includes the costs and tax benefits of debt financing 21the effects of a firm s capital structure are excluded from this profit measurement tool by removing the monetary costs of equity and debt from the noplat calculation since noplat minus cost of capital equals a firm s economic profit noplat is also used to calculate economic value added eva the eva is a measure of management performance to compare economic profit to the total cost of capital 3using noplat an analyst or investor is able to look into the profits generated by a company s core operations after subtracting the income taxes related to the core operations and adding back in taxes that the company had overpaid during the accounting period any income generated from non operating assets are not included however profit from invested capital is added operating income the company s profit before interest and taxes shows what the company would earn if it had no debt no interest expense 4 since only operating income is used the evaluation of a business operating efficiency using noplat is not impacted by how much leverage the company has or how much loans it has on its balance sheet given that debt servicing that is the interest used to finance debt negatively impacts a firm s bottom line and thus decreases its tax expense example of noplatnoplat for a firm is calculated as operating income x 1 tax rate 1 for example let s compare the net operating profit less adjusted taxes for bed bath beyond inc bbby for the fiscal years ended march 3 2018 and feb 25 2017 usd in thousands 20182017revenue 12 349 301 12 215 757cost of goods sold7 906 2867 639 407gross margin4 443 0154 576 350selling general and admin expenses3 681 6943 441 140operating income or ebit761 3211 135 210interest expense65 66169 555income tax 35 57 and 33 52 respectively 270 802380 547net income 424 858 685 108noplat761 321 x 1 0 3557 490 519 1 135 210 x 1 0 3352 754 633source u s securities and exchange commission56the increase in operating costs year over year led to a decrease in operating profits from 2017 to 2018 for bed bath beyond this in turn decreased noplat generally a company that operates efficiently should have a positive nopat an increase in nopat can translate into a higher stock price for a publicly traded company noplat is used extensively in mergers and acquisitions m a discounted cash flow dcf and leveraged buyout lbo models because it enables the calculation of an investment s free cash flow fcf 1 | |
what is net premium | net premium an insurance industry accounting term is calculated as the expected present value pv of an insurance policy s benefits minus the expected pv of future premiums the net premium calculation does not take into account future expenses associated with maintaining the insurance policy net premiums along with gross premiums help an insurance company to determine how much it owes in state taxes understanding net premiuman insurance policy s net premium value differs from the policy s gross premium value which does take into account future expenses the calculated difference between net premium and gross premium equals the expected pv of expense loadings minus the expected pv of future expenses thus a policy s gross value will be less than its net value when the value of future expenses is less than the pv of those expense loadings some states tax laws may allow insurance companies to reduce their gross premium by accounting for expenses and unearned premiums because the net premium calculation does not take into account expenses companies must determine how much expense they can add without causing a loss types of expenses that a company must account for include commissions paid to agents who sell the policies legal expenses associated with settlements salaries taxes clerical costs and other general expenses commissions typically vary with the policy s premium but general and legal expenses may not be tied to the premium to estimate allowed expenses a company can add a fixed amount of expenses to the net premium called flat loading add a percentage of the premium or add a combination of a fixed amount and a percentage of the premium | |
when comparing policies with different net premiums adding a fixed amount will lead to the same proportion of expenses to premiums as long as expenses do vary by proportion to the premium determining which method to use depends on the general and legal expenses associated with the policy as they relate to commissions on the premium | most policy calculations leave a margin for contingencies such as when the money made from investing the premiums turns out to be less than expected importance of net premiumnet premiums and gross premiums are helpful in figuring out how much an insurance company owes in taxes state insurance departments often tax insurance companies income tax laws however may allow companies to reduce their gross premium by figuring in expenses and unearned premiums insurers in the united kingdom use an annual premium equivalent ape calculation to determine their premium revenue for example if the state of ohio imposes a tax on gross premiums written by ohio insurance companies but the tax does not apply to amounts deducted for reinsurance it also won t apply to gross premiums not earned because the insurance company or policyholder canceled a policy before it expired who pays net premium policyholders pay the insurance premiums the pricing is based on them being either individuals or part of a group the premiums paid are the costs associated with purchasing insurance for an individual or business | |
what is the difference between net premiums and net premiums earned | net premiums include written premiums with commissions and ceded reinsurance deducted it is a measure of the dollar amount of policies written net premiums earned is the measure of actual dollars received from premiums sold | |
what is a premium tax credit | a premium tax credit ptc is a credit available to families that helps them pay for premiums for health insurance bought through the health insurance marketplace it is a refundable credit 1the bottom linenet premiums are an essential metric for insurance companies to determine how much they owe in taxes in order to be compliant with tax law utilizing both net premiums and gross premiums allows an insurance company to better manage its accounting | |
what are net premiums written | net premiums written is the sum of premiums written by an insurance company over the course of a period of time minus premiums ceded to reinsurance companies plus any reinsurance assumed net premiums written represents how much of the premiums the company gets to keep for assuming risk understanding net premiums writtenlooking at changes in net premiums written from year to year is one way to gauge the health of an insurance company the health of an insurance company depends on the types of policies and the risks associated with those policies an increase in net premiums written represents an increase in new insurance policies written while a decrease indicates fewer policies originated decreases in net premiums written could be the result of competitors entering the market and taking up market share or it could be because premiums are not competitive with what other companies are offering companies that offer policies to a larger pool of people may reduce the possibility of declines insurance companies may receive premiums in one payment up front but they may also offer installment plans to policyholders installment plans provide the insurance company with premiums over the course of the year which are accounted for differently when determining how much revenue the insurance company brings in as policyholders using installment plans make payments a company categorizes these as net earned premiums when determining an insurance company s tax liability on premiums it is typical for reinsurance premiums paid to be deducted 1adjusting for liabilities associated with unearned premiums over the course of a year is called net premiums unearned it is a liability because if the policy is canceled early then the insurer has to return a portion of the original premium if a company is able to write more premiums over the course of the year its written premiums will exceed its earned premiums insurance providers in the united kingdom use the annual premium equivalent ape to measure new policy premiums from ongoing premiums the net premium calculationsince the net premium calculation does not take into account expenses companies must determine the number of expenses that can be added without causing a loss types of expenses that a company must take into account include commissions paid to agents who sell the policies legal expenses associated with settlements salaries taxes clerical expenses and other general expenses commissions typically vary with the policy s premium while general and legal expenses may not be tied to the premium the calculated difference between net premium and gross premium equals the expected present value of expense loadings the amount included in the premium charged for administrative costs minus the expected present value of future expenses thus a policy s gross value will be less than its net value when the value of future expenses is less than the present value of those expense loadings | |
what is net present value npv | net present value npv is the difference between the present value of cash inflows and the present value of cash outflows over a period of time npv is used in capital budgeting and investment planning to analyze the profitability of a projected investment or project npv is the result of calculations that find the current value of a future stream of payments using the proper discount rate in general projects with a positive npv are worth undertaking while those with a negative npv are not 1subscribe to term of the day and learn a new financial term every day stay informed and make smart financial decisions sign up now investopedia julie bangnet present value npv formulaif there s one cash flow from a project that will be paid one year from now then the calculation for the npv of the project is as follows if analyzing a longer term project with multiple cash flows then the formula for the npv of the project is as follows if you are unfamiliar with summation notation here is an easier way to remember the concept of npv 1n p v today s value of the expected cash flows today s value of invested cash begin aligned npv text today s value of the expected cash flows text today s value of invested cash end aligned npv today s value of the expected cash flows today s value of invested cash npv accounts for the time value of money and can be used to compare the rates of return of different projects or to compare a projected rate of return with the hurdle rate required to approve an investment 2 the time value of money is represented in the npv formula by the discount rate which might be a hurdle rate for a project based on a company s cost of capital such as the weighted average cost of capital wacc no matter how the discount rate is determined a negative npv shows that the expected rate of return will fall short of it meaning that the project will not create value 13in the context of evaluating corporate securities the net present value calculation is often called discounted cash flow dcf analysis it s the method used by warren buffett to compare the npv of a company s future dcfs with its current price 4the discount rate is central to the formula it accounts for the fact that as long as interest rates are positive a dollar today is worth more than a dollar in the future inflation erodes the value of money over time meanwhile today s dollar can be invested in a safe asset like government bonds investments riskier than treasurys must offer a higher rate of return however it s determined the discount rate is simply the baseline rate of return that a project must exceed to be worthwhile for example an investor could receive 100 today or a year from now most investors would not be willing to postpone receiving 100 today however what if an investor could choose to receive 100 today or 105 in one year the 5 rate of return might be worthwhile if comparable investments of equal risk offered less over the same period if on the other hand an investor could earn 8 with no risk over the next year then the offer of 105 in a year would not suffice in this case 8 would be the discount rate positive npv vs negative npva positive npv indicates that the projected earnings generated by a project or investment discounted for their present value exceed the anticipated costs also in today s dollars it is assumed that an investment with a positive npv will be profitable an investment with a negative npv will result in a net loss this concept is the basis for the net present value rule which says that only investments with a positive npv should be considered 1npv can be calculated using tables spreadsheets for example excel or financial calculators | |
how to calculate npv using excel | in excel there is an npv function that can be used to easily calculate the net present value of a series of cash flows this is a common tool in financial modeling the npv function in excel is simply npv and the full formula requirement is npv discount rate future cash flow initial investmentin the example above the formula entered into the gray npv cell is npv green cell yellow cells blue cell npv c3 c6 c10 c5example of calculating npvimagine a company can invest in equipment that would cost 1 million and is expected to generate 25 000 a month in revenue for five years alternatively the company could invest that money in securities with an expected annual return of 8 management views the equipment and securities as comparable investment risks there are two key steps for calculating the npv of the investment in equipment because the equipment is paid for up front this is the first cash flow included in the calculation no elapsed time needs to be accounted for so the immediate expenditure of 1 million doesn t need to be discounted periodic rate 1 0 08 1 12 1 0 64 text periodic rate 1 0 08 frac 1 12 1 0 64 periodic rate 1 0 08 121 1 0 64 assume the monthly cash flows are earned at the end of the month with the first payment arriving exactly one month after the equipment has been purchased this is a future payment so it needs to be adjusted for the time value of money an investor can perform this calculation easily with a spreadsheet or calculator to illustrate the concept the first five payments are displayed in the table below image by sabrina jiang investopedia 2020the full calculation of the present value is equal to the present value of all 60 future cash flows minus the 1 million investment the calculation could be more complicated if the equipment was expected to have any value left at the end of its life but in this example it is assumed to be worthless n p v 1 000 000 t 1 60 25 00 0 60 1 0 0064 60 npv 1 000 000 sum t 1 60 frac 25 000 60 1 0 0064 60 npv 1 000 000 t 160 1 0 0064 6025 00060 that formula can be simplified to the following calculation n p v 1 000 000 1 242 322 82 242 322 82 npv 1 000 000 1 242 322 82 242 322 82 npv 1 000 000 1 242 322 82 242 322 82in this case the npv is positive the equipment should be purchased if the present value of these cash flows had been negative because the discount rate was larger or the net cash flows were smaller then the investment would not have made sense limitations of npva notable limitation of npv analysis is that it makes assumptions about future events that may not prove correct the discount rate value used is a judgment call while the cost of an investment and its projected returns are necessarily estimates the npv calculation is only as reliable as its underlying assumptions 51the npv formula yields a dollar result that though easy to interpret may not tell the entire story consider the following two investment options option a with an npv of 100 000 or option b with an npv of 1 000 considers the time value of moneyincorporates discounted cash flow using a company s cost of capitalreturns a single dollar value that is relatively easy to interpretmay be easy to calculate when leveraging spreadsheets or financial calculatorsrelies heavily on inputs estimates and long term projectionsdoesn t consider project size or return on investment roi may be hard to calculate manually especially for projects with many years of cash flow | |
is driven by quantitative inputs and does not consider nonfinancial metrics | npv vs payback periodeasy call right how about if option a requires an initial investment of 1 million while option b will only cost 10 the extreme numbers in the example make a point the npv formula doesn t evaluate a project s return on investment roi a key consideration for anyone with finite capital though the npv formula estimates how much value a project will produce it doesn t show if it s an efficient use of your investment dollars the payback period or payback method is a simpler alternative to npv the payback method calculates how long it will take to recoup an investment one drawback of this method is that it fails to account for the time value of money for this reason payback periods calculated for longer term investments have a greater potential for inaccuracy moreover the payback period calculation does not concern itself with what happens once the investment costs are nominally recouped an investment s rate of return can change significantly over time comparisons using payback periods assume otherwise 3npv vs internal rate of return irr the internal rate of return irr is calculated by solving the npv formula for the discount rate required to make npv equal zero this method can be used to compare projects of different time spans on the basis of their projected return rates 3for example irr could be used to compare the anticipated profitability of a three year project with that of a 10 year project although the irr is useful for comparing rates of return it may obscure the fact that the rate of return on the three year project is only available for three years and may not be matched once capital is reinvested | |
why is net present value important | net present value is important because it allows businesses and investors to assess the profitability of a project or investment taking into account the average cost of capital and the expected rate of return by discounting future cash flows to their present value npv helps in making informed choices ensuring that undertaken projects contribute positively to the overall financial health and growth | |
is a higher or lower npv better | a higher value is generally considered better a positive npv indicates that the projected earnings from an investment exceed the anticipated costs representing a profitable venture a lower or negative npv suggests that the expected costs outweigh the earnings signaling potential financial losses therefore when evaluating investment opportunities a higher npv is a favorable indicator aligning with the goal of maximizing profitability and creating long term value | |
what does net present value npv mean | net present value npv is a financial metric that seeks to capture the total value of an investment opportunity the idea behind npv is to project all of the future cash inflows and outflows associated with an investment discount all those future cash flows to the present day and then add them together the resulting number after adding all the positive and negative cash flows together is the investment s npv a positive npv means that after accounting for the time value of money you will make money if you proceed with the investment | |
what is the difference between npv and internal rate of return irr | npv and internal rate of return irr are closely related concepts in that the irr of an investment is the discount rate that would cause that investment to have an npv of zero another way of thinking about the differences is that they are both trying to answer two separate but related questions about an investment for npv the question is what is the total amount of money i will make if i proceed with this investment after taking into account the time value of money for irr the question is if i proceed with this investment what would be the equivalent annual rate of return that i would receive | |
what is a good npv | in theory an npv is good if it is greater than zero after all the npv calculation already takes into account factors such as the investor s cost of capital opportunity cost and risk tolerance through the discount rate and the future cash flows of the project together with the time value of money are also captured therefore even an npv of 1 should theoretically qualify as good indicating that the project is worthwhile in practice since estimates used in the calculation are subject to error many planners will set a higher bar for npv to give themselves an additional margin of safety | |
why are future cash flows discounted | npv uses discounted cash flows to account for the time value of money as long as interest rates are positive a dollar today is worth more than a dollar tomorrow because a dollar today can earn an extra day s worth of interest even if future returns can be projected with certainty they must be discounted for the fact that time must pass before they re realized time during which a comparable sum could earn interest | |
is npv or roi more important | both npv and roi return on investment are important but they serve different purposes npv provides a dollar amount that indicates the projected profitability of an investment considering the time value of money roi on the other hand expresses the efficiency of an investment as a percentage showing the return relative to the investment cost npv is often preferred for capital budgeting because it gives a direct measure of added value while roi is useful for comparing the efficiency of multiple investments | |
what is the difference between npv and roi | npv calculates the difference between the present value of cash inflows and outflows over a period of time taking into account the time value of money it provides a dollar amount that indicates the profitability of an investment roi however measures the efficiency of an investment by calculating the percentage return relative to its cost while npv focuses on the absolute value created roi highlights the relative performance of an investment | |
why should you choose a project with a higher npv | choosing a project with a higher npv is advisable because it indicates greater profitability and value creation a higher npv means the projected cash inflows discounted to their present value significantly exceed the initial investment and associated costs this suggests that the project is likely to generate more wealth enhancing the overall financial health and growth prospects of the business ultimately a higher npv aligns with the goal of maximizing shareholder value | |
what is the net present value of growth opportunities npvgo | the net present value of growth opportunities npvgo is a calculation of the net present value per share of all future cash flows involved with growth opportunities such as new projects or potential acquisitions the net present value of growth opportunities is used to determine the intrinsic value per share of these growth opportunities in order to determine how much of the firm s current per share value is determined by them npvgo is calculated by taking the projected cash inflow discounted at the firm s cost of capital less the initial investment or purchase price of the project or asset understanding net present value of growth opportunities npvgo a company s share price may be thought of as the value per share of present and future earnings discounted by the company s cost of capital using the dividend discount model npvgo may be used to segment that value into the portion that is due to its current earnings and the portion that is due to its earnings from its future growth opportunities discounting current earnings per share by the cost of capital will give the value per share of the company s current earnings discounting the cash flows expected from growth opportunities will give the value per share due to those growth opportunities in this way npvgo can be used to determine the incremental value of an acquisition or new project it can be used to negotiate the price of an acquisition or determine any value the market might give to that company s future growth however npvgo is based on projections so it s important for analysts to exclude nonstandard cash flows such as earnings based on discontinued operations or earnings based on nonrecurring operations from those projections otherwise the projections could be skewed accurate projections are necessary because they can be so influential in making key business decisions furthermore the process of determining whether an npvgo is high or low needs to be undertaken in an industry context technology capital and other factors that go into calculating the npvgo of a specific company will depend on the sector in which it operates valuations tend to be extremely industry specific and industry standards need to be considered when calculating an npvgo example of net present value of growth opportunities npvgo for example assume that the intrinsic value of a company s stock is 64 17 if a company s cost of capital is 12 and earnings per share are 5 then the value of those current earnings is 5 12 41 67 if the expected earnings per share from future growth opportunities is 90 and the growth rate g is 8 then the value of those earnings is 0 90 12 08 22 50 the intrinsic value per share of the company is the value per share due to current earnings and the value due to future growth opportunities 41 67 22 50 64 17 | |
what is the net present value rule | the net present value rule is the idea that company managers and investors should only invest in projects or engage in transactions that have a positive net present value npv they should avoid investing in projects that have a negative net present value it is a logical outgrowth of net present value theory investopedia theresa chiechiunderstanding the net present value ruleaccording to the net present value theory investing in something that has a net present value greater than zero should logically increase a company s earnings in the case of an investor the investment should increase the shareholder s wealth companies may also participate in projects with neutral npv when they are associated with future intangible and currently immeasurable benefits or where they enable ongoing investments to happen although most companies follow the net present value rule there are circumstances where it is not a factor for example a company with significant debt issues may abandon or postpone undertaking a project with a positive npv the company may take the opposite direction as it redirects capital to resolve an immediately pressing debt issue poor corporate governance can also cause a company to ignore or miscalculate npv | |
how the net present value rule is used | net present value commonly seen in capital budgeting projects accounts for the time value of money tvm the time value of money is the idea that future money has less value than presently available capital due to the earnings potential of the present money a business will use a discounted cash flow dcf calculation which will reflect the potential change in wealth from a particular project the computation will factor in the time value of money by discounting the projected cash flows back to the present using a company s weighted average cost of capital wacc a project or investment s npv equals the present value of net cash inflows the project is expected to generate minus the initial capital required for the project during the company s decision making process it will use the net present value rule to decide whether to pursue a project such as an acquisition if the calculated npv of a project is negative 0 the project is expected to result in a net loss for the company as a result and according to the rule the company should not pursue the project if a project s npv is positive 0 the company can expect a profit and should consider moving forward with the investment if a project s npv is neutral 0 the project is not expected to result in any significant gain or loss for the company with a neutral npv management uses non monetary factors such as intangible benefits created to decide on the investment | |
what is the net present value rule | the net present value rule is the idea that company managers and investors should only invest in projects or engage in transactions that have a positive net present value npv they should avoid investing in projects that have a negative net present value it is a logical outgrowth of net present value theory investopedia theresa chiechiunderstanding the net present value ruleaccording to the net present value theory investing in something that has a net present value greater than zero should logically increase a company s earnings in the case of an investor the investment should increase the shareholder s wealth companies may also participate in projects with neutral npv when they are associated with future intangible and currently immeasurable benefits or where they enable ongoing investments to happen although most companies follow the net present value rule there are circumstances where it is not a factor for example a company with significant debt issues may abandon or postpone undertaking a project with a positive npv the company may take the opposite direction as it redirects capital to resolve an immediately pressing debt issue poor corporate governance can also cause a company to ignore or miscalculate npv | |
how the net present value rule is used | net present value commonly seen in capital budgeting projects accounts for the time value of money tvm the time value of money is the idea that future money has less value than presently available capital due to the earnings potential of the present money a business will use a discounted cash flow dcf calculation which will reflect the potential change in wealth from a particular project the computation will factor in the time value of money by discounting the projected cash flows back to the present using a company s weighted average cost of capital wacc a project or investment s npv equals the present value of net cash inflows the project is expected to generate minus the initial capital required for the project during the company s decision making process it will use the net present value rule to decide whether to pursue a project such as an acquisition if the calculated npv of a project is negative 0 the project is expected to result in a net loss for the company as a result and according to the rule the company should not pursue the project if a project s npv is positive 0 the company can expect a profit and should consider moving forward with the investment if a project s npv is neutral 0 the project is not expected to result in any significant gain or loss for the company with a neutral npv management uses non monetary factors such as intangible benefits created to decide on the investment | |
what is net profit margin | net profit margin or simply net margin measures how much net income or profit a company generates as a percentage of its revenue it is the ratio of net profits to revenues for a company or business segment net profit margin is typically expressed as a percentage but can also be represented in decimal form the net profit margin illustrates how much of each dollar in revenue collected by a company translates into profit net profit margin is determined by dividing a company s net income by its revenue and multiplying the result by 100 the net profit margin formula is described in greater detail later in this story along with hypothetical and real examples understanding net profit marginnet profit margin is one of the most important indicators of a company s financial health by tracking increases and decreases in its net profit margin a company can assess whether current practices are working and forecast profits based on revenues because companies express net profit margin as a percentage rather than a dollar amount it is possible to compare the profitability of two or more businesses regardless of size this metric includes all factors in a company s operations including investors can assess if a company s management is generating enough profit from its sales and whether operating costs and overhead costs are being contained for example a company can have growing revenue but if its operating costs are increasing faster than revenue then its net profit margin will shrink ideally investors want to see a track record of expanding margins meaning that the net profit margin is rising over time most publicly traded companies report their net profit margins both quarterly during earnings releases and in their annual reports companies that can expand their net margins over time are generally rewarded with share price growth as share price growth is typically highly correlated with earnings growth formula and calculation for net profit marginnet profit margin r c o g s e i t r 100 net income r 100 where r revenue c o g s the cost of goods sold e operating and other expenses i interest t taxes begin aligned text net profit margin frac r cogs e i t r 100 frac text net income r 100 textbf where r text revenue cogs text the cost of goods sold e text operating and other expenses i text interest t text taxes end aligned net profit marginwhere rcogseit rr cogs e i t 100 rnet income 100 revenue the cost of goods sold operating and other expenses interest taxes | |
what is net realizable value nrv | net realizable value nrv is a valuation method common in inventory accounting that considers the total amount of money an asset might generate upon its sale less a reasonable estimate of the costs fees and taxes associated with that sale or disposal investopedia zoe hansenunderstanding net realizable value nrv nrv is a common method used to evaluate an asset s value for inventory accounting two of the largest assets that a company may list on a balance sheet are accounts receivable and inventory nrv is used to value both of these asset types nrv is a valuation method used in both generally accepted accounting principles gaap and international financial reporting standards ifrs gaap requires that certified public accountants cpas apply the principle of conservatism to their accounting work many business transactions allow for judgment or discretion when choosing an accounting method the principle of conservatism requires accountants to choose the more conservative approach to all transactions this means that the accountant should use the accounting method that does not overstate the value of assets 1nrv is a conservative method for valuing assets because it estimates the true amount the seller would receive net of costs if the asset were to be sold formula and calculation of net realizable valuethe formula for determining net realizable value nrv is the expected selling price is calculated as the number of units produced multiplied by the unit selling price this is often reduced by product returns or other items that may reduce gross revenue it can also simply be done for just a single item rather than a group of units in regards to accounts receivable this is equal to the gross amount to be collected without considering an allowance for doubtful accounts the total production and selling costs are the expenses required to facilitate the trade when using nrv calculations for cost accounting these expenses are the separable costs that can be identified or allocated to each good alternatively this expense may be the anticipated write off amount for receivables or expenses incurred to collect this debt | |
what affects net realizable value | there are often four primary factors that affect a company s net realizable value collectability economic conditions obsolescence and market demand the ultimate goal of nrv is to recognize how much proceeds from the sale of inventory or receipt of accounts receivable will actually be received for this reason one of the primary drivers of nrv is collectability this relates to the creditworthiness of the clients a business chooses to engage in business with companies that prioritize customers with higher credit strength will have higher nrv collectability also pertains to a company s internal processes depending on the industry the company is it the company may decide to accept a certain amount of uncollectable sales the company may also lack the resources to pursue delinquent receivables as economies thrive clients often have more money at their disposal and are able to pay higher prices they are also able to pay on time and potentially purchase more goods alternatively when the economy is down clients may pass on orders or find it more difficult to make full payments this is especially true during inflationary periods when the federal reserve is interested in raising rates as prices are elevated the government may choose to combat rising prices however this leads to a contracting economy that increases unemployment in either situation high inflation or high unemployment it may be more difficult for clients or businesses to find budget for additional goods to buy as technology evolves and production capabilities expand unsold inventory items may quickly lose their luster and become obsolete this is true for even recently manufactured products companies not in tune with market conditions may be producing goods that are already outdated broadly speaking companies must often widely mark down products that are obsolete to garner any interest in the product as a result the company runs the risk of needing to sell goods at or below cost to retain any value from the outdated goods loosely related to obsolescence market demand refers to customer preferences tastes and other influencing factors in addition to a good becoming outdated broad markets may be interested in substitute products advanced products or cheaper products competition always runs the risk of supplanting a good s market position even if both goods are still relevant and highly functioning uses for net realizable valuean accounts receivable balance is converted into cash when customers pay their outstanding invoices but the balance must be adjusted down for clients who don t make payments nrv for accounts receivable is calculated as the full receivable balance less an allowance for doubtful accounts which is the dollar amount of invoices that the company estimates to be bad debt gaap rules previously required accountants to use the lower of cost or market lcm method to value inventory on the balance sheet if the market price of inventory fell below the historical cost the principle of conservatism required accountants to use the market price to value inventory market price was defined as the lower of either replacement cost or nrv the financial accounting standards board fasb the independent organization that establishes gaap standards issued an update in 2015 to its code that changed the inventory accounting requirements for companies provided they do not use last in first out lifo or retail methods companies must now use the lower cost or nrv method which is more consistent with ifrs rules in essence the term market has been replaced with net realizable value 2 | |
when a company buys inventory it may incur extra costs to store or prepare the goods for sale the costs associated with storing inventory are referred to as the carrying cost of inventory assume for example a retailer purchases large pieces of expensive furniture as inventory and the company has to build a display case and hire a contractor to carefully move the furniture to the buyer s home these extra costs are subtracted from the selling price to compute the nrv | cost accounting is a heuristic method used by some firms to account internally for costs associated with various business activities nrv is used to account for such costs when two products are produced together in a joint costing system until the products reach a split off point after the split off point their production separates and in turn each product s cost is accounted for separately after the split off point nrv is used to allocate previous joint costs to each of the products this allows managers to calculate the total cost and assign a sale price to each product individually it also allows managers to better plan and understand whether to stop production at the split off point or if it is more advantageous to continue processing the raw material be aware the nrv can be used for external reporting inventory and accounts receivable purposes as well as internal reporting cost accounting purposes | |
what net realizable value can tell you | because it is used in several different situations net realizable values can tell analysts and accountants several important pieces of information advantages and disadvantages of net realizable value | |
when inventory is measured as the lower of cost or net realizable value it is embracing the accounting principle of conservatism though nrv may be the most dramatically reduced valuation for inventory carrying costs and transactional costs of goods are taken into account to not overstate the income statement and accurately represent the goods value to the business | another advantage of nrv is its applicability as the valuation method can often be used across a wide range of inventory items often a company will assess a different nrv for each product line then aggregate the totals to arrive at a company wide valuation there are several glaring disadvantages to using nrv however first the approach requires substantial assumptions from management about the future of the product for goods clouded with uncertainty it may be nearly impossible to predict obsolescence product defects customer returns pricing changes or regulation for this reason nrv assumptions may lead to incorrect valuations application and analysis of nrv may also be complicated different companies may be exposed to different risks and business impacts that are factored into nrv calculations differently for example certain industries may necessitate dealing with customers that have riskier credit profiles thus forcing the company to experience larger write off allowances embraces conservatism to not overstate a company s financial statementmore accurately the future economic benefits of certain situationscan be used across individual inventory items then aggregatedrequires substantial assumptions from management that may never actually materializetakes time to calculate different options then select the lower of cost of or nrvmay reduce the comparability of the financial statements for different companies if nrv calculations widely varyexample of net realizable valueas part of its 2021 annual report public filing volkswagen disclosed ownership of 43 7 billion of inventory a very slight decline from the 43 8 billion of inventory carried at the end of december 2020 3as part of this filing volkswagen disclosed the nature of the calculation of its inventory in compliance with prevailing accounting regulation volkswagen considered net realizable value when determining its inventory value 4other companies may be a little more transparent in how they use nrv in determining their inventory level as part of its 2021 annual report shell reported 25 3 billion of inventory up more than 25 from the year prior the company states that as part of its calculation of inventory the company wrote down 592 million shell also indicated a similar write down to nrv occurred in 2020 5 | |
how do you calculate net realizable value | net realizable value nrv is a common method used to evaluate an asset s value for inventory accounting it is found by determining the expected selling price of an asset and all the costs associated with the eventual sale of the asset and then calculating the difference between these two to put it in formulaic terms nrv expected selling price total production and selling costs | |
what are some examples of nrv usage | nrv for accounts receivable is calculated as the full receivable balance less an allowance for doubtful accounts which is the dollar amount of invoices that the company estimates to be bad debt nrv is also used to account for costs when two products are produced together in a joint costing system until the products reach a split off point each product is then produced separately after the split off point and nrv is used to allocate previous joint costs to each of the products gaap rules previously required accountants to use the lower of cost or market lcm method to value inventory on the balance sheet this was updated in 2015 to where companies must now use the lower of cost or nrv method which is more consistent with ifrs rules in essence the term market has been replaced with net realizable value 2 | |
what is accounting conservatism | accounting conservatism is a principle that requires company accounts to be prepared with caution and high degrees of verification these bookkeeping guidelines must be followed before a company can make a legal claim to any profit the general concept is to factor in the worst case scenario of a firm s financial future uncertain liabilities are to be recognized as soon as they are discovered in contrast revenues can only be recorded when they are assured of being received | |
what is meant by net realizable value of accounts receivable | nrv for accounts receivable is a reference to the net amount of accounts receivable that will be collected this is the gross amount of accounts receivable less any allowance for doubtful accounts reducing the total amount of a r by the amount the company does not expect to receive nrv for accounts receivable is a conservative method of reducing a r to only the proceeds the company thinks they will get the bottom linenet realizable value is the net amount a company is able to sell an asset for or collect as part of an existing agreement nrv is calculated as the difference between the gross proceeds and associated transaction costs because nrv considers items that decrease the net benefit a company receives it is often considered a conservative accounting approach for this reason it is often acceptable for use in various situations under both gaap and ifrs accounting | |
what is net receivables and how is it calculated | net receivables are the total money owed to a company by its customers minus the money owed that will likely never be paid net receivables are often expressed as a percentage and a higher percentage indicates a business has a greater ability to collect from its customers for example if a company estimates that 2 of its sales are never going to be paid net receivables equal 98 100 2 of the accounts receivable ar understanding net receivablescompanies use net receivables to measure the effectiveness of their collections process they also utilize it when making forecasts to project anticipated cash inflows net receivables arise when companies grant credit to their customers a company s accounts receivable represents the line of credit it extends to its customers for the goods or services it provides this credit line requires the customer to make payments for an agreed upon amount due at a specific date this practice carries inherent credit and default risk as the company does not receive payment upfront for the goods or services it sells a company can improve its cash collections by tightening control over credit issued to customers maintaining efficient collection procedures and performing collection procedures promptly a company can improve its cash collections by tightening control over credit issued to customers maintaining efficient collection procedures and performing collection procedures promptly allowance for doubtful accountsthe allowance for doubtful accounts is a company s estimate of the amount of the accounts receivable it anticipates will not be collectible and will need to be recorded as a write off this estimate is subtracted from the gross amount of outstanding accounts receivable the two main methods for estimating the allowance for doubtful accounts are the percentage of sales method and the accounts receivable aging method also a specific identification method may be used in which each debt is individually evaluated regarding the likelihood of being collected net receivables are shown as an aggregated total on the company s balance sheet the gross receivables are listed first and are followed by the allowance for doubtful accounts the allowance for doubtful accounts is a contra asset account as it reduces the balance of an asset net receivables aging schedulenet receivables may be calculated using an aging schedule this schedule groups receivables by outstanding payment date ranges the aging schedule may calculate the uncollectible receivables by applying various default rates to each outstanding date range alternatively it can simply calculate the net receivables by applying the estimated collection rate for each range the concept behind an aging schedule is to apply different collectibility rates to different receivables based on age as a receivable gets older it generally becomes harder to collect special considerationsbecause all future receipts of cash as well as defaults are not known net receivables represent an estimated amount this is largely contingent on the estimated amount of uncollectible accounts management thus has the potential to manipulate the value of net receivables by adjusting the allowance for doubtful accounts in addition a company s net receivables are highly subject to general economic conditions regardless of the entity s procedures the figure tends to worsen as financial conditions worsen in the general economy | |
what is net sales | net sales is the sum of a company s gross sales minus its returns allowances and discounts net sales calculations are not always transparent externally they can often be factored into the reporting of top line revenues reported on the income statement investopedia nono floresunderstanding net salesthe income statement is the financial report that is primarily used when analyzing a company s revenues revenue growth and operational expenses 1 the income statement is broken out into three parts which support analysis of direct costs indirect costs and capital costs the direct costs portion of the income statement is where net sales can be found companies may not provide a lot of external transparency in the area of net sales net sales may also not apply to every company and industry because of the distinct components of its calculation net sales is the result of gross revenue minus applicable sales returns allowances and discounts costs associated with net sales will affect a company s gross profit and gross profit margin but net sales does not include cost of goods sold which is usually a primary driver of gross profit margins if a business has any returns allowances or discounts then adjustments are made to identify and report net sales companies may report gross sales then net sales and cost of sales in the direct costs portion of the income statement or they may just report net sales on the top line and then move on to costs of goods sold companies that sell goods and services on credit might also include the net credit purchases also called total net payables in this section of their financial statements net sales do not account for cost of goods sold general expenses and administrative expenses which are analyzed with different effects on income statement margins costs affecting net salesgross sales are the total unadjusted sales of a company for companies using accrual accounting they are booked when a transaction takes place for companies using cash accounting they are booked when cash is received some companies may not have any costs that will require a net sales calculation but many companies do sales returns allowances and discounts are the three main costs that can affect net sales all three costs generally must be expensed after a company books revenue as such each of these types of costs will need to be accounted for across a company s financial reporting in order to ensure proper performance analysis sales returns are common in the retail business these companies allow a buyer to return an item within a certain number of days for a full refund this can create some complexity in financial statement reporting companies that allow sales returns must provide a refund to their customer a sales return is usually accounted for either as an increase to a sales returns and allowances contra account to sales revenue or as a direct decrease in sales revenue as such it debits a sales returns and allowances account or the sales revenue account directly and credits an asset account typically cash or accounts receivable this transaction carries over to the income statement as a reduction in revenue in many cases the sales return can be resold this requires a company to make additional notations to account for the item as inventory allowances are less common than returns but may arise if a company negotiates to lower an already booked revenue if a buyer complains that goods were damaged in transportation or the wrong goods were sent in an order a seller may provide the buyer with a partial refund in this case the same types of notations would be required a seller would need to debit a sales returns and allowances account and credit an asset account this journal entry carries over to the income statement as a reduction in revenue net sales allowances are usually different than write offs which may also be referred to as allowances a write off is an expense debit that correspondingly lowers an asset inventory value companies adjust for write offs or write downs on inventory due to losses or damages these write offs occur before a sale is made rather than after many companies working on an invoicing basis will offer their buyers discounts if they pay their bills early one example of discount terms would be 1 10 net 30 where a customer gets a 1 discount if they pay within 10 days of a 30 day invoice sellers don t account for a discount unless a customer pays early so notations must be retroactive discounts are notated similarly to returns and allowances a seller will debit a sales discounts contra account to revenue and credit assets the journal entry then lowers the gross revenue on the income statement by the amount of the discount net sales considerationsif a company provides full disclosure of its gross sales vs net sales it can be a point of interest for external analysis if the difference between a company s gross and net sales is higher than an industry average the company may be offering higher discounts or realizing an excessive amount of returns compared to industry competitors companies will typically strive to maintain or beat industry averages often returns can be quickly resold without creating issues allowances are typically the result of transporting problems which may prompt a company to review its shipping tactics or storage methods companies offering discounts may choose to lower or increase their discount terms to become more competitive within their industry | |
what is net settlement | net settlement is a bank s routine resolution of the day s transactions at the end of the business day since many or most bank transactions are now sent electronically this is no longer a matter of counting the cash in the drawer instead the bank has to add up all of their electronic credits and debits the bank then sends its settlement file to a federal reserve bank which credits it with any funds that are due to be paid to it via the interbank settlement system 1 understanding net settlementthe net settlement system permits banks to accumulate credits and debits with each other throughout the business day only at the end of the business day are the totals calculated and only the net differential needs to be transferred between the banks net settlement also finds its place in the trading activity of the stock markets the national securities clearing corporation nscc uses continuous net settlement at the close of each day to account for security trades made through member entities throughout out the trading day a bank s net settlement is similar to balancing an individual s checkbook the balancing process gets complicated if you have money coming in as cash checks and direct deposits and money going out as cash purchases checks and credit card purchases all of those transactions including purchases returns bills paid and paychecks received must be netted to get the full picture net settlement makes it easier for banks to manage their liquidity that is they need to know that they have enough real cash on hand to pay out to their customers over the counter and at the atms there are two types of net settlement systems net settlement vs gross settlementin banking gross settlement is not the same as net settlement in particular a real time gross settlement system differs from a net settlement large interbank transfers usually occur in real time rather than as net settlements for example the u k s bacs payment schemes limited previously the bankers automated clearing services or bacs allows transactions among institutions to accumulate during the day at the close of business the central bank will adjust the active institutional accounts by the net amounts of the funds exchanged 2 large value interbank funds transfers usually use real time gross settlement these often require immediate and complete clearing which are typically organized by the nation s central bank real time gross settlement can reduce a bank s settlement risk overall as the interbank settlement occurs in real time throughout the day rather than all together at the end of the day as with net settlement this type of gross settlement eliminates the risk of a lag in completing the transaction real time gross settlement often incurs a higher charge than net settlement processes |
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