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Thursday, 7 December 2017

Differences between a Central Bank and a Commercial Bank

Distinguish between a Central Bank and a Commercial Bank-

1. A Central bank is an apex institution in the banking structure of an economy. It is the topmost bank in the banking system of a country. It is a regulatory body of the banking system. It lays down rules and regulations to be followed by other banks in the country. No one can start a bank in the country without the license of the central bank of the country. Commercial banks, on the other hand, are the banks which run the banking business to make profits. All the commercial banks have to follow the rules and regulations laid down by the central bank of the country.

2. The main objective of the central bank is to promote social welfare, whereas the main objective of a commercial bank is to make profits.

3. The Central Bank of a country is owned by its government. Commercial banks may be owned privately or by the government

4. The Central Bank has a monopoly on issuing currency notes. Commercial banks do not have any such right

5. Central Bank is a banker to the government. It is also a banker of commercial banks. It is called a bank of bankers. However, a central bank does not deal with the general public directly. A commercial bank, on the other hand, is a banker only to the public. Commercial bank deals directly with the general public.

6. There can be only one Central Bank in a country. For example, Reserve Bank of India, Bank of Japan, Federal Reserve Bank (USA) etc. However, it may have a few branches across the country. Usually, there are many commercial banks in the country with a lot of branches spread over the length and breadth of a country. For example, ICICI Bank, State Bank of India etc.

Saturday, 18 November 2017

Henry Fayol's 14 Principles of Management

Who was Henry Fayol?

Henry Fayol was a French mining engineer. After a lot of research and studies, he had developed 14 principles of management. Due to his contribution to management studies, he is also called as a father of modern management. So let's see what are those principles of management defined by Henri Fayol

1. The Principle of Division of Work - According to Henri Fayol the total work of an organization should be divided into smaller parts and these parts should be assigned to various employees based on their skill sets. So a person who is good at sales should be given a sales job. Similarly, someone who is good at operations should be placed in operations department and someone who is good in finance must be placed in the finance department. Division of work leads to specialization. When one person performs the same task, again and again, he specializes in the performance of that task. If a person keeps on doing the same task again and again over a period of time he will be able to do it faster and better.

2. The Principle of Authority and Responsibility -  What this principle says is that whenever you assign a responsibility to a particular employee he should also be given the required authority. Unless he is given the required authority, he won't be able to perform the task which has been assigned to him. For example, if you have assigned a task of producing 10000 units of a product X to a factory manager then he should be given sufficient authority to order the raw materials required for making 10000 units of that particular product X. He should also be given authority to hire the required number of workers to achieve the target of production. With Authority also comes the responsibility. It means that when you give authority to someone it is his responsibility to complete the task assigned to him. For example, if you have given all the required authorities to factory manager to produce ten thousand units of a product X then if he cannot achieve the target he should be held responsible for the same. So with authority comes the responsibility. You can't have a scenario where there is an authority but no responsibility. An authority will always be accompanied by the corresponding responsibility

3. The Principle of Discipline - According to Henry Fayol, discipline is one of the most important aspects of any organization. Maintaining proper discipline within the organization is the responsibility of Management. If there is no discipline within the organization, then the organization cannot achieve its goals.

4. The Principle of Unity of Command - This principle states that every employee should receive orders from only one person. This is because if he is receiving orders from more than one person, it will lead to confusion and he will not be able to perform his task properly. This principle is applicable to employees at all levels right from top management to bottom.

5. The Principle of Unity of Direction - Principle of unity of direction deals with groups within the organization. The principle of unity of command is applicable to individual employees. So the previous principle talks about every individual employee of the organization, whereas this principle talks about groups within the organization. As per principle of unity of direction, each group in the organization should have the same objective. The group should be directed by only one person using one plan

6. The Principle of Remuneration -  According to this principle every employee in the organization should receive fair remuneration. The remuneration of the employees should be decided based on his skills, education, expertise, knowledge, and tenure with the organization. Principle of remuneration, says that when the employees are given a fair remuneration they work with enthusiasm and show more productivity which results in more output

7. The Principle of Subordination of Individual Interest to General interest - What this Principal says is that the interest of the organization is supreme. Individual interest is subordinate to the general interest or the interest of the company. So while taking the decisions the managers should always keep the organization's interest on the top. Individual interest should not come in the way of interest of the organization. The interest of the organization is more important as compared to the individual interest. While making the decisions managers have to realize that organization's interest is more important than the personal interest of any employee (including himself).

8. The Principle of Centralization - This principle refers to the concentration of decision making power or authority in the hands of a few people in the organization. In certain organizations, there is a high concentration of power or authority in the hands of a few people. In such organizations, only a few people control the organization and make decisions. This is especially true in case of the smaller organizations. However, the large organizations cannot have the concentration of power in the hands of a few employees. In such big organizations, the power is generally divided among different groups or different managers. This is called as decentralization of power. According to Henry Fayol, there should be a proper balance between centralization and decentralization of powers depending upon the size of the organization and the nature of business the company does. There should not be complete centralization of powers, nor there should be complete decentralization of powers. There should be a balance between the two. Decision-making power should not be given to very few people at the same time it is important that decision making power is not given to every Tom, Dick, and Harry. People to whom the decision making power is given should be responsible and mature enough to make good decisions. Otherwise, they may give self-interest more importance than the interest of the organization

9. The Principle of Scalar Chain- In any organization, usually the communication flows from top to bottom or from bottom to top. Such communications happen in a very proper manner. They generally happen in the form of a chain. So if a manager wants to convey a certain message to everybody till the level of workers, he will pass on this information to the departmental head who in turn will pass it on to the supervisor, the supervisor will pass on the information to the foreman and the foreman will inform the workers. Thus, you can see that the information is passed on in the form of a chain. This is called as Scalar Chain. Similarly, if there is any information which workers want to pass on to the manager, the process happens exactly in a reverse manner. The workers will pass on the information to the foreman, the foreman will pass on the information to the supervisor, the supervisor will pass on that information to the departmental head who will then pass on the information to the manager. However, this principle of Scalar Chain should have some flexibility because it is very time-consuming. Sometimes you may not have enough time to pass on the information in this form. So if there is some urgent information which is to be passed on, then the cross-communication should be allowed. Cross communication means the communication that doesn't happen exactly in the form of Scalar Chain. So in case, there is an urgent message, then one may not follow the scalar chain. However, if someone is not following the Scalar Chain, he/she must do it with permission of the proper authorities  

Wednesday, 8 November 2017

Basic Accounting Terms - 2

Basic Accounting Terminologies-

Purchases - Purchases refer to the total amount of goods purchased by the firm. It includes goods purchased by cash as well as goods purchased on credit. However, purchases do not include the purchase of assets. For example, purchase of machinery will not be included in purchases. In case of a manufacturing firm purchases would include raw materials purchased for further production. In case of a trading firm purchases would include the goods purchased for resale.

Purchase return - Purchase return refers to the total amount of goods returned by the firm out of the goods purchased by it.

Sales - Sales refer to the total amount of goods sold by the firm. It includes goods sold by cash as well as goods sold on credit. However, this does not include the sale of assets.

Sales return - Sales return refers to the total amount of goods returned back to the firm by the customers out of the goods sold by the firm

Stock - Stock refers to the amount of goods lying unsold as on a particular date. The stock is always valued at cost price or market price whichever is lower.

Opening stock - Opening stock refers to the amount of unsold goods (stock) at the beginning of a financial year.

Closing Stock - Closing stock refers to the amount of unsold goods (stock) at the end of the financial year.

Revenue - Revenue refers to receipts of the firm. For example, receipts from the sale of goods, rent income, dividends etc.

Expense - It refers to cost or sacrifice incurred by the firm to earn the revenues. For example purchases, salaries to employees, purchase of stationery etc.

Thursday, 26 October 2017

Basic Accounting Terms - 1

Accounting terminology-

Capital: Capital means an amount invested by the owner in the business. Investment by the owner can be in the form of cash or in kind. For example, if the owner uses personal furniture for the business it will be recognized as the capital

Liability: Liability is something which the business owes to any outsider. For example, loan from a bank

Current liabilities: Current liabilities are the liabilities which the business has to pay within a year. These are short-term liabilities. For example, trade creditors. Trade Creditors are the suppliers from whom we purchase the goods on credit. Usually, the payment to trade creditors is made within one year

Contingent Liability: Contingent Liability is that kind of a liability which is non-existent as on date, but it may become an actual liability in future. For example, if a customer has filed a suit against the company for some compensation. This can become an actual liability in future if the firm loses the case. However, as on date it is not a liability as the outcome is not known today

Asset: Asset means something with the business owns. For example, plant and machinery.

Fixed Assets: Fixed assets are long-term assets. These are assets which are purchased for use over a long period of time (Generally more than one year).  For example, land and building

Current Assets: These are short-term assets. Current assets are assets which are expected to be converted to cash within a year. For example, Debtors. Debtors are the customers to whom we have sold the goods on credit. Generally, the amount receivable from debtors is received within a year's time.

Liquid Assets: Liquid assets include cash and all other assets which can be converted into cash at a very short notice. These are the assets which can be disposed of quickly. They are also called as quick assets. For example, cash in hand, cash at bank, shares etc.

Tangible Assets: These are assets which have physical existence. We can touch, see or feel these assets. For example, plant and machinery

Intangible assets: These are the assets which do not have any physical existence. It is not possible to see, touch or feel them. For example, Goodwill (Goodwill is the reputation of the firm expressed in terms of money)

Monday, 23 October 2017

Causes of rejection of a home loan

When you are applying for a home loan, you need to know the reasons due to which your home loan may get rejected. It will save a lot of time and money for you, but more importantly, it will save you from distress you will have to undergo should your home loan get rejected

Following are some of the most common reasons why your home loan application can get rejected-

1. Bad Credit History - If you have not paid your past loans regularly, most frontline institutions would reject your home loan application. If there are just a couple of minor delays in repayment track record of any of your past loans, your application can be considered provided you can justify the delay in repayment. Some borrowers are intentional defaulters and hence most leading home finance institutions do not compromise much on this point.

2. Title of the property is not clear - The property that you are purchasing should have a clear and marketable title. The seller/s of the property must be the legal owner/s and should have right to sell the property. Banks do not want to get into legal battles over the title of the property. If the lender feels that the title of the property is not clear, the loan may be rejected

3. If the property you are buying falls in a negative area - Some banks do mark some areas as negative areas. These are generally the areas where recovery of the loans may be difficult (areas having a lot of anti-social elements) or the areas where properties generally have structural issues (land may not be very suitable for construction of buildings or the area may have a history of collapsing of some buildings etc.). These are the areas where they do not lend the money. So if the property you intend to buy falls in the negative area of the bank to which you have applied for a home loan, your home loan application would be turned down no matter how strong your financial position may be

4. Dishonor of processing fee cheque - This is one reason that the home loan borrower needs to know before applying for the home loan. If the processing fees cheque gets dishonored, your home loan will not be disbursed. Banks see this as a sign of financial distress and hence do not disburse the loan on the bouncing of processing fee cheque (even if they may have issued an in-principle sanction letter)

5. Inter-Family Transactions - If you are buying the property from anyone who has a blood relation with you, your loan might get rejected, as most banks do not offer home loans on Inter-Family Transactions. They see this as an arrangement within the family to get a loan at lower interest rate as usually other loans are priced quite higher than home loans

6. Cheque Bounces in your Bank a/c - Too many cheque bounces in your bank a/c may also lead to rejection of your loan. It gives an impression that either you are in a financial crunch or you are too casual in fulfilling your financial commitments

7. Deliberate Hiding of some vital Information - It's always advisable to correctly reveal all the important information sought by the lender. A deliberate hiding of any material information may lead to immediate rejection of your loan. You should not break the trust of the lender by holding back some vital information that may have an impact on bank's decision to provide you the home loan applied for

Friday, 13 October 2017

Types of Bank Accounts

There are basically four different types of bank accounts. They are as follows-

1. Current Deposit Account - This account is generally meant for businessmen. This is because they have a high frequency of bank transactions. They usually have multiple transactions daily. Under this account, there is no restriction on the number of withdrawals and hence is most suitable for businessmen. No interest is paid by the banks on such accounts. Some current account holders are also given overdraft facility. An overdraft is like a temporary loan given to the customer to clear/honor cheques already issued by him (in case of insufficient balance in the current account of the customer). There is an upper limit on the amount of overdraft for each eligible customer which is decided by the bank itself based on the past record and the relationship of the customer with the bank.  The customer gets cheque book facility for current account  

2. Savings Deposit Account - This account is made for the general public especially salaried people. The main objective of having the savings account is to cultivate the habit of saving among people. Interest is also paid by the banks on the savings account. The interest rate is moderate (less than the rate of interest offered on recurring or fixed deposit account). However, there are restrictions on the number of withdrawals that can be made through savings account and hence this type of account is not suitable for businessmen. Customers are generally required to maintain a certain minimum balance in the account. Failure to maintain the minimum balance may result in minimum balance charge being deducted from the savings account. No overdraft facility is offered on a savings account. Saving account holders are given cheque book facility

3. Recurring Deposit Account - This type of an account is also called as the cumulative time deposit account. It is meant to cultivate the habit of savings among poor people. Under this type of an account, the customer is allowed to deposit a certain small but fixed amount (Rs.50, Rs.100, Rs.500 etc.) every month for a fixed period of time. The customer gets back the total amount deposited along with interest at the end of the specified period. This type of an account does not have the facility of withdrawal. The cheque book facility is not given to recurring deposit account holders. However, they do get a passbook which shows the amount deposited every month along with the interest amount for each month. 

4. Fixed Deposit Account - Under this type of account, a one-time lump-sum deposit is made by the customer for a fixed period of time (generally 3 months to 10 years). The customer cannot withdraw the amount during this period. However, he can take a temporary loan against the fixed deposit receipt (FDR). At the end of the fixed period, the customer can either withdraw the amount or renew the fixed deposit. The rate of interest offered under this account is highest among all the four main types of accounts. This type of an account does not have a passbook or cheque book facility. The customer gets a fixed deposit receipt (FDR) as a proof of the fixed deposit.

Sunday, 8 October 2017

Demerits of a Joint Stock Company

Disadvantages of Joint Stock Company are as follows-

1. Difficulty in Formation - Formation of a joint stock company, especially public limited company involves a lot of legal procedures. It is time-consuming and expensive too. Registration of joint stock companies is mandatory. Also at the time of formation, certain legal documents like MOA (Memorandum of Association), AOA (Articles of Association) etc.

2. Slow Decision Making - Decision making is slower in case of public limited companies. The company is run by the Board of Directors. The decisions are taken jointly by the Board of Directors. Also in taking certain decisions, they have to seek shareholders approval by calling a meeting of shareholders. This is mandatory as per law. Since there are a lot of people involved in decision making, the process of decision making takes time

3. Low Motivation - The ownership and management of public limited companies are different. The company is run by the Board of Directors who are people appointed by the owners (shareholders). Board of Directors run the business on behalf of the shareholders. It's the Board of Directors who run the company, but profit belongs to all the shareholders of the company. Hence there is no direct relationship between efforts and rewards. (In some other forms of business organizations like sole proprietorship, more efforts lead to more profit  for the owner/s). There is no incentive for the Board of Directors to work hard.

4. Lack of Secrecy - In case of a public limited company, there is lack of secrecy. The companies have to publish their financial details/accounts on a regular basis as per law. They have to send an annual report of the business to all the shareholders every year. This means a lot of information can also be viewed by anyone (including competitors). Certain decisions cannot be taken without the approval of shareholders. This also leads to dilution of business secrecy.

5. Excessive Government Control - There are a lot of rules and regulations that have to be followed while running the business. This consumes a lot of time in certain situations. This also reduces the flexibility in doing the business.    

Wednesday, 4 October 2017

Advantages of Joint Stock Company

Joint Stock Company is one of the various forms of business organizations

Advantages of Joint Stock Company are as follows-

Large Capital - Public Limited Company can raise a huge amount of capital as there is no upper limit on the number of owners (shareholders) that a public limited company can have. You don't need a huge capital to invest in a public limited company. Owners can invest even a small amount of capital. Public Limited Companies have a large number of shareholders. So even if every shareholder invests a small amount of money still the company can create a large capital base.

Growth Opportunities - As the company has a large capital base growth opportunities are also enormous, especially in case of a public limited company. Even after the company has commenced the business, if a public limited company requires more capital, it can always issue more shares.

Democratic Management - Public Limited Companies have a large number of shareholders. The company is run by the Board of Directors. And the Board of Directors is appointed by the shareholders. The Board of Directors is answerable to the shareholders. Thus the business is run by the Board of Directors who are appointed by the owners/shareholders themselves.

Limited Liability - The owners of Joint Stock Company have limited liability. In case the company becomes insolvent/bankrupt and is unable to pay off business liabilities out of business assets, the personal assets of the owners/shareholders cannot be used to repay the liabilities of the company.

Professional Management - Since Public limited companies have access to large financial resources, it is possible for a public limited company to appoint professionals who are experts in different areas. The directors are generally well educated and are experts in different areas of management. Thus the business is managed professionally. Availability of experts of different areas results in better decision making and increased efficiency in the operation of business activities

Perpetual Existence - Joint Stock Company has a separate legal identity from its owners. It has a separate legal status, which means in the eyes of the law the joint stock company is different from its owners. Death, Insolvency or Insanity of any of the owners doesn't result in the closure of the company.

Transferability of Shares - Shares of a public limited company are listed on the stock exchange and are easily transferable. A shareholder who wants to sell his/her share can do so through a stock exchange

Economies of Large-Scale Operations - Since public limited companies have large-scale operations, they enjoy economies of the scale (Low cost due to the high volume of business). They have a better bargaining power than other form of business organizations


Friday, 29 September 2017

Various Forms of Utility

Various types or forms of utility - There are basically six different types or forms of Utility

Form utility - Form Utility is a utility created by changing the form of a particular substance or commodity. The Utility created by changing shape, size or color of a particular product is called as a form utility. For example, making furniture out of wood. Making furniture out of wood increases the utility of the wood. So utility created by converting wood into furniture is Form utility

Place utility. - Place utility is a utility created by changing the place of a particular commodity. For example, bringing crops from farms to market or to the place for consumption is an example of creation of the place utility

Time utility - Utility created by the change in time is called as time utility. For example, demand for woolen clothes is more during winter as compared to demand in summer. So the utility of the woolen clothes is more during winter than in any other season. Thus utility created due to change in time is called time utility

Service Utility - Service utility is the utility created by providing service to someone. Such services are generally provided by professionals in the society to other people in the society. For example, the knowledge given by teacher to his/her student or treatment given by a doctor to his or her patient

Knowledge Utility - Knowledge utility is a utility created due to increase in knowledge of the consumers. For example, the utility of mobile phone increases when a person understands what all functions it can perform. Thus, this is an example of knowledge utility.

Possession Utility - Possession utility is the utility created due to change in possession of a particular commodity or substance. For example, the utility created by purchasing a car from someone is an example of possession utility. Utility created by having possession of the car from the seller is possession utility

Wednesday, 9 August 2017

Understanding Features of Equity Shares

Features of Equity Shares:

Permanent Capital - The amount invested by equity shareholders is permanent capital for the business. It is not repayable to the equity shareholders during the tenure of the company. The capital is to be repaid by the company only in the event of the winding up of the company. So equity provides a  permanent/long-term capital to the organization.

Rights of Equity Shareholders - Equity shareholders enjoy the certain rights. They have a right to get a share of profit. The share in profit, which is distributed to the equity shareholders, is called dividend. Thus, equity shareholders have a right to get a share of profit of the company. Equity shareholders also have the right to vote. They have a right to vote and elect the board of directors of the company. The board of directors of the company runs the business on behalf of the equity shareholders. They also have a right to vote for the amendment of the memorandum as well as articles of association. Equity shareholders are the owners of the company and hence they have the right to inspect the books of accounts of the company anytime. They also have the right to transfer their shares. Equity share capital is not repayable during the tenure of the company. The capital of equities is paid back only at the time of winding up of the company. However, if any shareholder wants to transfer his shares, he can do so. This right to transfer the share is one of the most important rights of the shareholders.

No fixed dividend - Every equity shareholder has a right to receive a share in the profits of the company. His share in the profit of the company is called as the dividend. However, this dividend is not fixed. This dividend is not provided at a fixed rate to the shareholders. The dividend paid to equity shareholders depends upon the profit of the company. If the company makes good profits, then equity shareholders get good dividends.
However, if the company doesn't make any profit or makes very less profit, chances are that equity shareholders may not even get the dividend. So the dividend amount is very fluctuating in nature. Thus, the returns that equity shareholders get on their investment in the company are fluctuating in nature.

No Preferential Rights - Equity shareholders do not have any preferential rights, unlike preference shares. In the case of preference shares, the dividend is fixed and is paid before the dividend is paid to the equity shareholders. Equity shareholders are the last to receive the dividend. Out of the profits made by the company, the company first pays interest on external loans. So the interest on external loans is first paid. After that the dividend is paid on the preference shares and only after that, the equity shareholders get the dividend. So if no profit is left after giving the dividend to preference shareholders, then equity shareholders won't get any dividend Similarly, at that time of winding up of the company, the proceeds received from the sale of assets of the company are first used to pay off the external liabilities. Once the external liabilities are paid, then the preference share capital is repaid. Once the amount has been repaid to preference shareholders, after that the equity shareholders can get their capital. Thus, equity shareholders are the last when it comes to payment of the dividend or when it comes to repayment of the capital at the time of the winding up of the company.

Risk Takers - Equity shareholders are the ones who take the maximum risk in the company. The dividend to equity shareholders is paid at the last (after repayment of interest on external liabilities and after paying the dividend to preference shareholders). Similarly, the capital repayment also happens at the last to equity shareholders. At the time of closure of the business, the amount received by selling the assets of the company is first used to repay the external liabilities. Then the repayment of preference share capital is made and only after that equity shareholders can get their capital. Thus, they are the true risk bearers of the company.

Control of the Company - Equity shareholders control the company. The control of the company lies in the hands of equity shareholders. This is because they have the right to vote. They have the right to elect the Board of Directors who control/manage the company on behalf of equity shareholders. Thus, equity shareholders are the ones who have control over the company.

Residual Claimants - Equity shareholders are residual claimants. This is because the dividend is paid to equity shareholders only after the interest of all external liabilities is paid and after the preference dividend has been given. The profits of the company are first utilized to pay off interest on all external loans/liabilities and then it is utilized to pay off the dividend of the preference shares and the dividend to equity shareholders is paid only out of the remaining amount. Again in the case of winding up of the company, they are the last one to receive the payment. In the case of winding up or closure of the company, the amount received by the company by selling off its assets is first utilized to pay off all outside liabilities/outside loans. Then the amount is paid to preference shareholders and if there is anything left after paying off the preference shareholders, then the remaining among is paid to the equity shareholders. Thus, they are the residual claimants in the company.

Eligibility for Bonus or Rights issue - The equity shareholders are eligible to get bonus shares and rights shares. Bonus shares are the shares which are given to equity shareholders by the company out of the profits accumulated by the company. Bonus shares are given free of cost. Generally, the profit made by the company is not completely distributed among the equity shareholders as a dividend. Generally, a part of the profit is kept aside by the company and only a part of the profit is distributed as a dividend to the equity shareholders. The bonus shares are given free of cost to equity shareholders out of these accumulated profits. The profits which company accumulates over the period of time is utilized to give bonus shares to the existing shareholders. Equity shareholders also get the benefit of the rights issue.
What is a Rights Issue? -  Whenever the company requires additional capital for expansion of business or for any other reasons, they may decide to raise those funds by issue of equity shares. Thus, they may issue more shares to raise further capital. In such circumstances, companies generally give existing shareholders the right to buy those shares. These shares are not given to the shareholders free of cost. This is called as a rights issue. Thus, under the rights issue, the first option for buying the shares is given to the existing shareholders. (the option to buy the shares is first given to the existing shareholders)

Thursday, 27 July 2017

Joint Stock Companies

What is a Joint Stock Company?

In simple words, a joint stock company is a form of business organization where there are multiple owners.

There are 2 different types of Joint Stock Companies-
1. Private Limited Company and 
2. Public Limited Company

What is a Private Limited Company?

It is the kind of joint stock company which cannot have more than 50 owners. Hence, in a private limited company, the minimum number of owners are 2 and maximum no of owners are 50. 

Also in the case of a private limited company, there are restrictions on the transfer of shares. The shares of a private limited company cannot be transferred freely unlike public limited company where the shares can be transferred freely through a stock exchange.

A private limited company cannot invite the public to subscribe for its shares or debentures. A private limited company cannot accept deposits from anyone except its members (owners), directors or their relatives. 

A private limited company must have a minimum paid up share capital of Rupees One Lakh. So before starting the business, the owners need to invest minimum One Lakh Rupees as the capital of their own pocket. All private limited companies must use the words "Private Limited" at the end of their name (Example, Xxx Pvt Ltd) 

What is a Public Limited Company?

A public company is a form of joint stock company which is not a private limited company

In the case of a public company, there is no restriction on transfer of its shares. The shares can be transferred freely through stock exchanges. There should be minimum 7 members (owners) in a public company 

A public company must have a minimum paid up share capital of Rupees 5 lakhs. In other words, owners have to invest minimum Rupees Five Lakhs from their pocket in the company

A public company can invite public to subscribe to its shares. It can invite and accept deposits from public

The minimum number of members required to start a public company is 7. There is no maximum limit on the number of members that a public company can have. 

In the case of a public company, it is mandatory that the company must use word "Limited" after its name. For example Xxx Limited.

A public limited company must have at least 3 directors. Directors are the people elected by the shareholders/owners to run the business on their behalf.

Features of joint stock companies?

1. Artificial Legal person - A joint stock company is an artificial legal person created by law. So a joint stock company can enter into agreements with third parties. It can conduct transactions like buying and selling properties in its own name 

2. Separate Legal Identity -The company has its own separate legal identity. In the eyes of the law, the joint stock company and the owners are two different identities.

3. Limited liability - This is one of the biggest advantages of a joint stock company. The liability of the owners is limited. So in case, the business assets are not sufficient enough to pay off the business liabilities the personal Assets of the owners cannot be used to pay off the liabilities of a joint stock company 

4. Common Seal - Since the company has no physical existence, there is a common Seal which is used as a substitute for its signature.

Common Seal is an instrument very similar to paper punching instruments used for filing papers and looks like the image shown below
Image Source - Wikipedia

This instrument is embossed on documents to create an impression like the one which is shown below

Image Source - Wikipedia

Saturday, 17 June 2017

Break up of EMI into Interest and Principle

Loan borrowers are often confused why a major portion of EMI goes to interest and not the principal in the initial period of the loan

1. Is the Bank trying to make me pay more interest?
2. Is the Bank cheating me?
3. Why is such a big amount allocated to interest and not the principle?

These are the most common thoughts that come to a borrower who is a layman. His thoughts are justified as he doesn't know how the EMI gets divided between interest and principal

There can be 2 reasons for this-
(a) He has never asked the logic
(b) He has asked the rationale behind the bifurcation, but the banker has failed to explain the same to him

The good news is that there is no rocket science involved behind the division of EMI into principal and interest. It’s just a simple math.

Let us first understand what is EMI?

EMI stands for equated monthly installments. It is the amount that the borrower has to pay equally every month throughout the tenure of the loan such that the loan balance at the end of tenure of the loan becomes zero. (Assuming that the borrower wouldn't make any prepayments during the course of the loan)

Why is there a need to calculate EMI?

Suppose you take a loan. Can you repay the loan as per your own whims and fancies?

The Answer is a big NO. Banks do not have a system to handle so many complex transactions where each borrower can repay the loan as per his/her convenience.

So it is important for banks to arrive at a figure which borrower can pay equally every month so that the loan gets repaid within the tenure of the loan.

So how is this EMI amount arrived at?

There is a slightly complex mathematical formula involved in the calculation of EMI amount. 
You don’t need to manually calculate the EMI using the formula as there are lots of calculators available online where you just have to enter the value of the principal, the rate of interest per annum & tenure and you get EMI automatically. The formula is as given below
EMI = [P x R x (1+R)^N]/[(1+R)^N-1],

  • P stands for the loan amount or principal,
  • R is the interest rate per month. If the interest rate per annum is 11%, then the rate of interest per month will be 11% divided by 12 = (11/100)/12
  • N is the number of monthly installments.
The above mentioned formula gives you the amount which needs to be paid equally every month so that your loan gets over at the end of the tenure of the loan. (Assuming you wouldn't make any prepayments during the course of the loan)
For example, l
et's assume that-
Loan amount is Rs.25, 00,000/-, 
Rate of interest is 11% and
Tenure of the loan is 20 years.


P = Rs.25,00,000/-

R = Rate of interest per month
= (Annual Interest) divided by 12
= 11% divided by 12
= (11/100) divided by 12.

N = 240 months (In the formula N is number of months. So 20 years mean 240 months)
Applying the above formula, EMI will come to Rs.25, 805/-(Rounded off). 
Now that we know the calculation of EMI, let’s understand the bifurcation of EMI between interest and principal
The formula of EMI calculates EMI in such a way that-
(a) At least the interest portion of every month gets covered fully in EMI &
(b) Principle amount gets divided over the period of the loan in such a way that the borrower has to pay a fixed amount (EMI) every month
The bifurcation of EMI into principle and interest is called amortization.
Now let’s go back to our same example. Let’s understand the bifurcation now
The bifurcation happens in the following manner-
1st Month
Loan Amount outstanding at the beginning of first month = Rs.25,00,000/-

Interest for the 1st month
= (11% of Rs.25,00,000) divided by 12

(11% is the interest per annum. So to get interest for one month, we need to divide the annual interest by 12)
The EMI arrived as per mathematical formula of EMI is Rs.25,805/- out of which Rs.22,917/- is the interest (Refer calculation of interest for 1st month above). The balance amount of Rs.2,888/- will go towards principal.

Balance amount

(EMI) minus (interest for the month)

= (Rs.25,805/-minus (Rs.22,917/-)


The principal portion in EMI is always equal to (EMI) minus (the interest for that particular month)
So the first month’s break up of EMI into interest and principal is as follows-

EMI = Rs.25,805/-

Interest = Rs.22,917/- 

Principle = Rs.2,888/-(Balance amount remaining after deducting interest of the first month from EMI of the first month)

The loan amount outstanding at the end of first month
= (Loan amount outstanding at the beginning of the first month) minus (principal repaid in first EMI)
= Rs.25,00,00/- minus (the principal portion of the first EMI)
= Rs.25,00,000/- minus Rs.2,888/-
= Rs.24,97,112/-

(Click and then enlarge the above image for better view)

2nd Month
The loan amount outstanding at the beginning of second month

= The loan amount outstanding at the end of first month
= Rs.24,97,112/-
In the second month the interest will be calculated on Rs.24,97,112/- and not Rs.25,00,000/-. This is because the loan balance at the beginning of the second month is Rs.24, 97,112/-. 
So interest for second month
= (11% of Rs.24,97,112/-) divided by 12

The EMI of Rs,25,805/- will be the same for the entire tenure of the loan.

So balance amount of Rs.2,915/- will go towards the principal. 

The Balance Amount of Rs.2,915/- is arrived as follows -
EMI)  minus (the interest for the second month)
= Rs.25,805 - Rs.22,890
= Rs.2,915/-

So the 2nd month’s EMI break up will be as follows-
EMI = Rs.25,805/-
Interest for 2nd Month = Rs.22,890/-
Principle (Balance Amount) = Rs.2,915/-

The loan amount outstanding at the end of 2nd month 
= (Principal balance at the beginning of 2nd month) minus (principal portion of 2nd EMI)
= Rs.24,97,112/- minus (the principal portion of the second EMI)
 Rs.24,97,112/- minus Rs.2,915/-
= Rs.24,94,197/-

3rd Month 
The loan amount at the beginning of the third month
= The loan amount outstanding at the end of 2nd month
= Rs.24,94,197/- (as calculated above)

In the third month, the interest will be calculated on Rs.24,65,646/- (Outstanding Loan amount at the beginning of the 3rd month).

So interest for the 3rd month
= (11% of Rs.24,65,646/-) divided by 12
= Rs.22,863/-.

EMI for each month is Rs.25,805/-.

Hence principal portion of 3rd month's EMI
= Rs.25,805/- minus Rs.22,863/-
= Rs.2,941
If you continue bifurcating EMI for 20 years the way it is given above, you will find that each month, the interest portion of EMI keeps on decreasing and the principal portion keeps on increasing. This is because Loan amount outstanding is highest in the first month and then it keeps on reducing. Since the outstanding loan amount keeps on reducing after payment of each EMI, the interest portion of EMI also keeps decreasing. EMI will, however, remain the same for entire tenure and the amount of principal at the end of 20th year will become zero.  

This is how the EMI is bifurcated between Interest and Principal. Having gone through this, now you don't need anyone to explain you why in the initial period, the major portion of EMI  goes towards interest, do you?