Basics of investing in share market

If you are thinking of investing in share market to earn some profit, the first thing you should remember is that making a profit in share market is not that much easy as it seems. You can easily find people around you, who have done this mistake. But if you have knowledge of market and knows some basics of investing, then it won’t appear a difficult task too.

Some other basics of investing in share market:

Stock market does not take any guarantee of profit. You have to earn by your own (or through a broker but that is another story of another time).

It is not a piece of cake to understand and predict the share market for an average investor.

Share market seems lucrative but not for everyone.

Process of investing in share market:

Experts of share market define a common process that can be useful in hedging both systematic and unsystematic types of risk. You can consider the process and can adopt if you think it can be beneficial for you. Although most of the people follow this process by modifying it according to their risk bearing capacity and preferences:

Basics of investing in share market

 

Step 1:

The first ever task one should do is to decide how much he/she has to invest in owner’s fund and borrower’s fund.

There are several methods to decide that:

Method 1: Deduct your age from 100 and the result is the %age you should invest in owner’s capital.

Method 2: Divide the amount according to given categories:

Invest 75% of your total amount in owner’s fund if your age is 20 – 40.

Invest 50% of your earnings in owner’s fund if your age is 40 – 55.

Invest maximum amount of your hard earned income in borrower’s fund if your age is above 55.

Note: The above methods are not recognized methods, so opt these methods according to your preferences.

Step 2:

After deciding the amount of money one has to invest in owner’s capital and borrower’s fund, the next step is to divide the amount (the amount that one has to invest in owner’s fund) in four categories, as given below:

Reserve: Keep 10% of your amount as reserve, so that you can take the benefit of any future opportunity.

Blue chip stock: Keep 40% of your money for the purpose of investing in blue chip stocks.

Mid cap stock: Keep 30% of the amount for mid cap stocks.

Small cap stock: Keep 20% of owner’s fund to invest in small cap stocks.

Important tips:

You can adjust the %age according to your preferences. These are general categories which are suggested by experts.

Step 3:

The next step one has to follow is to distribute the amount of each category in different industry’s stock. Diversification is very important for the purpose of hedging risk. It will work when one industry passes through a rough patch and helps in keeping your portfolio safer.

Account – Meaning and types

Meaning of account:

An Account is a record of summarized business transaction for a person, asset or gain/ loss. Each company keeps a record of its business transactions so that at the end of the period it may be able to know its financial position.

For a public limited company in India, it is mandatory to disclose its annual accounts in form of financial statements. It is done for the sake of investors and other stakeholders, who are also interested in relevant information related to expenditure and revenue of the firm.

Every account has two sides known as debit and credit. When a transaction takes place, it either increases debit side or decreases credit side and vice – versa. Here, it should be kept in mind that both sides of an account always remain equal.

 

Types of account:

Accounts can be divided in three parts based upon the nature of transaction:

Types of accountPersonal A/c

Personal accounts are related to any person or organisation.

Example:

Ram a/c, XYZ ltd a/c etc.

Real A/c

These are the accounts which are related to any asset like property, good, furniture etc.

Example:

Cash a/c, bank a/c, etc.

Nominal A/c

Nominal accounts are related to expenses, gains and loss.

Example:

Rent a/c, salaries a/c, discount a/c etc.

Meaning and types of asset

Before reading about the different types of asset, it is advisable to know the meaning of asset.

Meaning of asset:

In context of a company, an asset is a resource having some economic value which can be measured. Assets are used to increase the cash-flows for a firm. Therefore, these are bought for the purpose of adding value to a firm.

Different types of asset:

There are 7 major types of asset which falls under 3 main categories:

Convertibility: Liquid, Current and fixed assets

Physical Existence: Tangible and intangible assets

Usage: Operating and non-operating assets

Types of asset

On the basis of convertibility:

There are 3 main types of asset under this category:

Meaning of current assets:

Current asset refer to those assets which can be converted into cash within a short period of time. These assets are used to pay off short term debt obligations of a company. In other words, the main purpose of having current assets is to pay off current liabilities.

Example of current assets:

Below is a complete list of these assets:

  • Cash and bank balance,
  • Accrued interest,
  • Stores and spare parts,
  • Loose tools,
  • Stock in trade,
  • WIP,
  • Accounts receivable etc.

Treatment of current assets:

These assets are shown on the assets side on a balance sheet as highlighted in below image:

Total amount of these assets, given on the balance sheet, is also used to calculate working capital for a company. Working capital is used to pay off day to day expenses of a company.

Read about: Difference between liquid assets and current assets

Meaning of fixed assets:

Fixed assets are used to generate income for a business enterprise over a longer period of time. These assets are not purchased for the purpose of selling them to business customers or its end users. This characteristic differentiates fixed assets from current assets.

It should be noted that in some countries like India, these assets also include intangible assets like goodwill of the firm, patents, trademark etc.

Example of fixed assets:

A common list of these assets includes:

  • Land & buildings,
  • Leasehold premises,
  • Railway sidings,
  • Plant & machinery,
  • Furniture,
  • Patents and trademarks,
  • Live stock,
  • Vehicles etc.

Treatment of fixed assets:

Fixed assets are an important part of a company’s balance sheet and are shown on the asset side. The figures given on the balance sheet are net values of these assets.

Fixed assets

Net value means values which remained after deducting depreciation.

Meaning of liquid assets:

These assets are considered more liquid than current assets in sense that they can be converted into cash within a very short time (90 days).

Example of liquid assets:

  • Cash,
  • Bank balance,
  • Accounts receivable etc.

Liquid assets are assumed to be converted into cash at any point of time. That’s the reason why inventory (as it is difficult to convert, when needed) and prepaid expenses (cannot be converted into cash at all) are not considered as liquid assets.

On the basis of physical existence:

There are 2 main types of asset under this category:

Meaning of tangible assets:

As the name suggests, these are the assets which can be seen and touched.

Example of tangible assets:

  • Property,
  • Plant,
  • Equipment,
  • Furniture,
  • Machinery etc.

Meaning of intangible assets:

Unlike tangible assets, intangible assets can be seen or touched but have business value.

Example of intangible assets:

  • Patents,
  • Copyright,
  • Goodwill,
  • Trade secrets,
  • Permits,
  • Corporate intellectual property etc.

On the basis of usage:

There are 2 main types of asset under this category:

Meaning of operating assets:

These are the assets which are used to perform day to day activities in an organization.

Example of operating assets:

  • Cash
  • Stock
  • Building
  • Machinery
  • Equipment
  • Patents
  • Copyrights
  • Goodwill etc.

Meaning of non-operating assets:

These assets are not used in day to day operation but they still generate revenue.

Example of non-operating assets:

  • Short-term investments,
  • Marketable securities,
  • Vacant land,
  • Interest income from a fixed deposit etc.

Current ratio – Meaning & formula

Current ratio is one of the liquidity ratios, shows the relationship between current assets and current liabilities of a firm. Current ratio indicates a firm’s commitment to meet its short-term debt obligations.

If the value of this ratio is greater than 1, then it indicates that the company is in position to pay its current liabilities by liquidating its current assets. A value of lesser than 1 indicates that the company can not pay its current liabilities by liquidating all of its current assets.

This ratio is also known as ‘working capital ratio’.

Formula for the calculation of current ratio:

This ratio is calculated by dividing the amount of current assets by current liabilities as shown below

current ratio

Example:

Let’s suppose XYZ ltd reports total current assets of INR 80,000 at the end of financial year 2015 – 16 and current liability of INR 75,000.

Working capital ratio (for the financial year 2016 – 17) = 80,000 / 75,000 = 1.07

This shows that company is in position to pay its current liabilities.

Net sales – Meaning & Formula

Net sales (also known as net revenue) is the actual amount of sales done by a company in a given period of time. It is the amount of sales left after subtracting the amount of sales return, discount and allowances for damaged goods from gross sales.

The amount of net revenue is shown on the income statement of company. This value is used to calculate gross profit, operating profit and net profit for a company.

Formula for the calculation of net sales:

Net sales = Gross sales – (Sales return + Discount on sales + Allowance for damaged and missing goods)

Example:

Let’s suppose, XYZ ltd reports gross sales of INR 1,00,000, sales return of INR 10,000, discount on sales of INR 15,000 and allowance of INR 12,000 for financial year 2016 – 2017.

Net revenue for XYZ ltd for the financial year 2016 – 2017

= 1,00,000 – (10,000 + 15,000 + 12,000) = INR 63,000.