Balance Sheet  

A balance sheet is a statement of a business’s assets, liability and net worth. It is normally laid out according to the Companies Act formats although some bookkeeping and accounting systems produce documents in alterative layouts.

The purpose of a balance sheet is to show the type of assets a business has and then to describe how these have been financed.

Fixed Assets

Assets shown on a balance sheet can be sub-divided in to intangible and tangible groupings. The former category contains items such as goodwill, trademarks and research and development expenditure.

The valuation of these items is subjective as their true worth can only be known following a successful sale of either the asset separately or the business as a whole.

Prudence and caution in assigning amounts to intangible assets might result in the balance sheet displaying them with conservative valuations, far removed from what they are actually worth.

Tangible assets typically attract far more objective valuations as they exist usually as a result of a measurable transfer or exchange on which a monetary value can be assigned.

Items within the category include furniture, machinery, computers and other assets which are typically used in a business for a number of years.

Depreciation and Amortisation

Both intangible and tangible assets are usually subject to depreciation or amortisation which represents the usage of those items during the year.

Different classes of assets may have varying periods over which they can be used, for example, a building will be capable of serving the business for a longer time than a desktop computer would.

The depreciation of the computer would therefore be faster than the amortisation of the building. The reduction in the asset’s value shown of the balance sheet would therefore reflect the expected useful life over and benefit which would typically accrue to the business.

Current Assets

The term current assets is used to describe items which are held in cash or which have a high liquidity rate, for example, shares and trade debtors.

This class of assets are shown below fixed items on the balance sheets and represent the working capital of the business. Cash and other current assets are used to pay suppliers and other short term creditors so that the operations remain solvent.

Where current assets are not available for this purpose, the business will be forced to liquidate some from the fixed category which may in turn significantly curtain its ability to conduct its operations in the longer term.

Liabilities

For the purposes of this article liabilities will be used to describe all items involved in financing the business including shareholders funds.

In order for the business to have commenced its operations it would have had to have received an injection of funds from some source. This might have been from the entrepreneur’s own savings or alternatively from an external body such as a bank or suppliers in the form of credit.

At any one time, it is likely that the business owes money to creditors for purchases it has made and perhaps to other financiers of its operations. These amounts are depicted either current or long term liabilities.

Generally, those amounts form any source which are repayable within one year will be shown as current and those which are due after this period will be described as long term.

Some money might be owed to the shareholders, partners or sole trader who provided the business with its initial financing and expansion capital.

The distinction between owner liabilities and those which are owed to third parties in reality show the amounts which the business has some discretion over. It is unlikely that the owners would demand repayment of the sums of owed to them to the detriment of the operations.

Other third party creditors however would more likely be driven by self interest and would not have the long term future of the business at the forefront of the decision of whether to claim payments for amounts owed to them.

Fixed Assets are the assets of permanent nature that a business acquires. Examples include machinery and equipment, building, furniture, vehicles etc. These assets are not sold or purchased occasionally and therefore considered fixed. You usually get them

when starting your business and retain them for the life-time of your business or company (but it depends on the asset life, too). However, these assets have more life than the long-term assets that usually last for a year or more.

Current Assets are the receivables that are expected to be received within a year as per balance sheet. These include any assets that are to be converted into cash within a financial year. Examples include cash, accounts receivables, short-term investments, and other cash-equivalents.

Current Liabilities are the liabilities (or the business obligations/debts) that are payable within a year as per balance sheet. These are the payments that are to be paid by a company within a financial year. Examples include accounts payable, and short-term debts.

Tax Liability is the amount of tax payable on your annual income, sale of an asset etc. and is different from other types of liabilities. Fixed assets have no direct influence on tax liability but if planned properly can reduce the overall tax liability of a firm. If this liability is payable in a year, then tax liability is a current liability.

Hope it helps! source(s):My financial accounting knowledge http://www.allaboutfinances.com/fixed-asset-accounting/

Assets

Gross block is the sum total of all assets of the company valued at their cost of acquisition. This is inclusive of the depreciation that is to be charged on each asset. Net block is the gross block less accumulated depreciation on assets. Net block is actually what the asset are worth to the company.

Capital work in progress, sometimes at the end of the financial year, there is some construction or installation going on in the company, which is not complete, such installation is recorded in the books as capital work in progress because it is asset for the business.

If the company has made some investments out of its free cash, it is recorded under the head investments. Inventory is the stock of goods that a company has at any point of time. Receivables include the debtors of the company, i.e., it includes all those accounts which are to give money back to the company. Other current assets include all the assets, which can be converted into cash within a very short period of time like cash in bank etc.

Equity Share capital is the owner's equity. It is the most permanent source of finance for the company. Reserves include the free reserves of the company which are built out of the genuine profits of the company. Together they are known as net worth of the company.

Total debt includes the long term and the short debt of the company. Long term is for

a longer duration, usually for a period more than 3 years like debentures. Short term debt is for a lesser duration, usually for less than a year like bank finance for working capital.

Creditors are those entities to which the company owes money. Other liabilities and

provisions include all the liabilities that do not fall under any of the above heads and various provisions made.

Role of Balance Sheet in Investment Decision making

After analyzing the income statement, move on to the balance sheet and continue your analysis. While the income statement recaps three months' worth of operations, the balance sheet is a snapshot of what the company's finances look like only on the last day of the quarter. (It's much like if you took every statement you received from every financial institution you have dealings with — banks, brokerages, credit card issuers, mortgage banks, etc. — and listed the closing balances of each account.)

When reviewing the balance sheet, keep an eye on inventories and accounts receivable. If inventories are growing too quickly, perhaps some of it is outdated or obsolete. If the accounts receivable are growing faster than sales, then it might indicate a problem, such as lax credit policies or poor internal controls. Finally, take a look at the liability side of the balance sheet. Look at both long-term and short-term debt. Have they increased? If so, why? How about accounts payable?

After you've done the numerical analysis, read the comments made by management. They should have addressed anything that looked unusual, such as a large increase in inventory. Management will also usually make some statements about the future prospects of business. These comments are only the opinion of management, so use them as such.

When all is said and done, you'll probably have some new thoughts and ideas on your investments. By all means, write them down. Use your new benchmark as a basis for analyzing your portfolio next time. Spending a few minutes like this each quarter reviewing your holdings can help you stay on track with your investment goals.

Introduction

Joint Stock Company is the most practical form of organization for large scale business. In India

the Indian Companies Act of 1956 governs joint stock companies. Owners of a company are

known as shareholders, because they hold the shares of capital of the company.

 

Share and Share Capital: Meaning, Nature and Types

The most striking feature of a joint stock company is its ownership structure. The capital in a joint

stock company is divided into small shares of fixed value. This facilitates easy investment.

Shareholders do not directly mange the company. They elect directors who carry out

management of a joint stock company. The shareholders have only limited liability in the event of

extreme loss or liquidation with excessive outside liability. The face value of the shares held by a

person is the maximum amount that he can lose in a joint stock company. If the shares are fully

paid up he need not pay anything further even if the company is liquidated with heavy unpaid

claims. If the shares held are partly paid up, the unpaid portion of the shares may be called up if

the assets available in the company are not enough to pay off liabilities.

 

Shares can be sold and purchased in the stock exchange. By purchasing shares a person gets

part ownership of the business. By becoming a share holder a person cannot immediately start

managing the company. Directors are the people who manage the business. Directors are

elected representatives of shareholders who carry out the management of a joint stock company.

Thus a shareholder can vote to elect directors. He can also contest in the election to become

director. A joint stock company is regarded as an artificial person. It is considered to have an

identity apart from the shareholders. A company can enter into contract, buy or sell properties in

its own name, file lawsuits or can be sued.

 

Types of share capital

Share capital is basically classified into equity and preference share capital. Equity capital is that

part of the share capital whose fortunes are directly linked to the performance of the business.

Preference shares on the other hand are the ones having priority in the payment of dividend and

repayment of capital in the event of liquidation of a company. Divided for the preference shares

are paid at a prescribed rate. Preference shareholders have fixed income irrespective of the

performance of the business. Equity dividend is declared each year, which will vary according to

the profit earned by the business. The equity shareholders are the ones who actually bear the

risk in business. When the performance of the business is good, they get a high percentage of

income. The value of shares will also increase in the market. Capital appreciation is the prime

attraction of equity shares in a company having consistently good performance.

 

Apart from the basic classification of equity and preference share capital may be referred by

different qualifying terms highlighting certain specific aspects of share capital. Following terms

used to qualify share capital.

 

1. Authorized Capital or Registered Capital

This is the maximum amount of capital a company is authorised to raise from the public. This is

specified in the Memorandum of Association of the company.

 

2. Issued Capital

Issued capital indicates that part of the authorised capital offered to public subscription.

 

3. Subscribed Capital

This is the part of the issued capital actually purchased or subscribed by the public.

 

4. Called up Capital

Called up capital indicates the portion of the subscribed capital called up by the company for

payment.

 

5. Paid up Capital

This the amount of called up capital actually paid up by the public. Paid up capital becomes the

liability of the company towards its shareholders.

 

6. Reserve Capital

Reserve capital is the part of the uncalled capital set aside as reserve, by the company to call up

only in the event of liquidation of the company.

  

Accounting for Share Capital

Capital of joint stock companies is referred as share capital because it is divided into shares.

Share capital is usually not collected in lump sum, but in instalments at various stages, such as

application, allotment, 1st call etc. For the purpose of convenient accounting, a temporary

account representing each of these stages will be opened in the ledger which will be closed once

the amounts expected on that stage is fully collected or the shares are cancelled for unpaid

amounts.

 

Following are the journal entries for issue of share capital:

 

Share Application Stage

The first stage in issue of share is the application stage. At this point the company will give

extensive publicity to the share issue and invite the public to apply for the shares. A prospectus

which is official invitation to the public, containing details of the company, proposed number of

shares, its type, value etc. will be issued to the pubic and registered with the registrar of

companies.

 

In response to the invitation by the company, public will apply for the shares. A part of the value

of shares will be specified as application money which is to be paid along with the application.

This amount will be deposited in the bank account of the company. Application money cannot be

less than 25% of the issue price. Following journal entries are passed at the collection and

capitalisation of application money.

 

i.. When share application money is received

 

Bank Account       Dr.

              To Share Application Account

 

ii. Application money credited to Capital Account

 

Share Application Account Dr.

               To Share Capital

 

The second entry will close the Share Application Account, and in the ledger there will be Cash

at Bank on one side and Share Capital on the other, provided the number of applications invited

and the number of applications received are the same.

 

 Over-Subscription and Under-Subscription

 

Over-subscription: It is unlikely that the public apply for the exact number of shares invited by

the company. When applications received exceed the number invited, the share is said to be

over-subscribed. It also means that the company received more application money than what

was originally invited. Now the company cannot conveniently increase the number of shares and

keep the money as capital. Instead, it must refund the excess amount received or make a part

allotment on applications from each individual, and adjust the money on the subsequent

payments due from the same applicant.

 

Under-subscription: Under-subscription is a situation just the opposite of over-subscription.

Here the company received less number of applications than what was invited. In case of under

subscription the company will proceed to allotment and subsequent stages with the actual

number of shares applied by the public.

 

When there is over subscription share capital account will not be closed by the transfer to capital

alone (second entry above). This is because the company has received more money. This

excess amount should either be paid off or adjusted to subsequent payments due by passing

one of the following entries depending on what is decided by the directors.

 

i. If the excess amount is refunded to applicants

 

            Share Application Account Dr.

                        To Bank

 

ii. If the excess amount is adjusted to Allotment

 

            Share Application Account Dr.

                        Share Allotment

 

Share Allotment Stage

After the closure of share issue the directors proceed to the allotment of shares. An additional

amount towards the capital on the allotted shares is collected at this stage. This amount is called

allotment money.

 

Following journal entries are passed at allotment stage:

 

i.. Allotment money credited to capital

 

Share Allotment Account Dr.

            To Share Capital

 

ii. Collection of allotment money

 

            Bank Account Dr.

                        To share Allotment Account

 

 

Share 1st Call

 

After the share allotment, the company will collect the remaining capital in one or two additional

instalments which are known as calls on shares. Same accounting entries are passed for all

calls.

 

Following are the typical entries:

 

i. Call money credited to capital

 

Share 1st Call Dr.

                        To Share Capital

 

ii. Collection of call money

 

            Bank Account Dr.

                        To Share 1st Call

 

Issue and Allotment of Preference Shares

Preference shares as also part of capital. But these shares as the name suggest are having

some special privileges or preferences. Following are the important features of preference

shares.

a. Preference shares are issued with a prescribed rate of dividend. Thus such shareholders

have an assured income from their shares. When the company does not make huge

profits there is an advantage to the Preference shareholder. But when the profit is high, a

preference shareholder must satisfy with his prescribed rate of dividend.

b. In the event of liquidation of the company the preference shareholders get a priority over

the equity shareholder in the repayment of capital.

c. Preference shareholders have less say in the management of the company. Equity

shareholders who are the real risk bearing investors mainly control management.

 

Form the accounting point of view there is no much difference between the issue of equity

shares or preference shares. The only difference is that the preference capital account will be

clearly stated as “preference share capital” in the journal entry.  But there is no need to specify

“equity capital” when it is issued.  The term capital is understood as equity capital.

 

Private Placement and Public Subscription of Share Capital

Issue of shares under private placement implies the issue of shares to a selected group of

persons. Private placement is an issue that is not a public issue. In order to make private

placement, a company should pass a special resolution to that effect. If the number of votes cast

in favour of private placement is not sufficient to pass a special resolution, but more than the

number of votes cast against, the directors can approach Central Government for approval,

stating that the proposed private placement is most beneficial to the company.

 

1.     What is authorized capital? What is its significance? How does it differ from issued

capital?

Authorized capital is also known as registered capital. This is the capital registered by stating

it in the in the Memorandum of Association of a Joint Stock Company. It is the maximum

amount of capital that a company is normally allowed to raise by way of share capital. If a

company needs to raise more amount it must first alter the Memorandum of Association.

Authorized capital is different from issued capital. Out of the authorized capital the portion

that is issued to public is known as issued capital. Therefore issued capital can be equal or

less than the authorized capital, but can never be more than the authorized capital.

 

2.     State the provisions of the Companies Act, 1956 for the issue of shares at discount.

Conditions regarding the issue of debentures at discount are stated in Section 79 of the

Indian Companies Act, 1956. Following are the important conditions:

1. A new company cannot issue shares a discount. A company is allowed to issue shares at

a discount only one year after commencement of business.

2. An ordinary resolution authorizing the issue of shares at a discount must be passed in the

general meeting of shareholders.

3. A new class of share cannot be issued at a discount.

4. Rate of discount cannot exceed 10% of the face value, unless special permission from the

Company Law Board is obtained.

5. The shares must be issued within two months of obtaining permission from the Company

Law Board

 

3.     Distinguish between over-subscription and under-subscription. How is over

subscription dealt with?

When a company issues shares to the public it is very unlikely that the public apply for the

exact number of shares issued. Application can either beyond or below the actual number of

shares issued, depending on the reputation of the company of attraction of the offer. When

the application received exceed the issue it is said to be “over subscribed”. The company

has the following options in dealing with the over-subscription.

1. The company can reject the excess application with refund of application money.

2. It can make a pro-rata allotment, which is proportionate allotment on the basis of number

of applications and the number of shares issued.

3. It can work out a combination of the above two options.

 

5.     State any three purposes for which ‘securities premium’ can be used.

According to Section 78 of the companies Act 1956, amounts raised by way of securities

premium can be utilized for the following purposes:

1. Issue of fully paid bonus shares

2. Writing off preliminary expenses

3. Writing off discount on issue of shares or debentures

4. Providing for the premium on redemption of debentures

5. Writing off the expenses incurred on the issue of shares or debentures.

 

6.      Write notes on ‘capital reserve’ and ‘reserve capital’.

Capital reserves are generated out of capital profits. A company is not allowed to utilize

these reserves for paying dividends. Following are the common source of capital reserve in a

company:

i) Profits prior to incorporation

ii) Profit on the reissue of forfeited shares

iii) Profit on sale or revaluation of fixed assets; and

iv) Profit on purchase of business.

 

Reserve Capital is not a generated reserve. This only a part of uncalled portion of issued

capital, which a company has decided not to call unless it goes into liquidation. This

arrangement indirectly assure the creditors that the shareholders shall be liable to pay

additional amount in the event that the company does not have enough assets to settle the

creditors claim in the event of liquidation of the company. However, this method is hardly

practiced in real life, because the company can offer more meaningful assurance to creditors

without keeping the shares partly paid up.

 

 

7.      Distinguish between Capital Reserve and Reserve Capital 

Basis Capital Reserve Reserve Capital

1. Meaning   2. Disclosure   3. Availability  4. Application of reserve  5. Special Resolution

Capital reserve is generated out of capital profits  Capital reserve is disclosed in the balance sheet of the company Capital reserve is readily available for writing off capital losses.  Capital reserve is retained in the existing assets of the company  Capital reserve is created without any resolution

Reserve capital is not a reserve generated. It is only capital not to be called up unless the company goes into liquidation. Reserve Capital is not mentioned in the balance sheet. Reserve capital is available only during liquidation process  Reserve capital is not retained in the existing assets of the company.  A special resolution should be passed to set aside reserve capital.

 

8.     Write a note on the issue of shares for consideration other than cash.

a. Normally shares are issued for cash. But a company can issue shares for consideration

other than cash. For example a company purchases fixed assets and issues shares to the

vendor instead of paying cash or issues shares in settlement of loans or other creditors. In

these transactions the company does not receive cash directly but it receives benefits

equivalent to cash by way of assets or settlement of liabilities.

 

Issue of shares in this case also can be made at par, premium or discount. The value of

assets purchased or liabilities settled will be considered equivalent to cash received in

normal transactions and the amount of discount premium or discount will be worked on that

basis.

 

 8.     What is meant by private placement of shares?

Issue of shares under private placement implies the issue of shares to a selected group of

persons. Private placement is an issue that is not a public issue. In order to make private

placement, a company should pass a special resolution to that effect. If the number of votes

cast in favour of private placement is not sufficient to pass a special resolution, but more

than the number of votes cast against, the directors can approach Central Government for

approval, stating that the proposed private placement is most beneficial to the company.

 

9.     Distinguish between equity and preference shares.

 

Equity Shares Preference Shares

1. Equity shares do not carry any assurance as

to dividend payment

 

 

2. Equity share holders have voting rights to

elect directors

 

3. In the event of liquidation of the company,

equity shareholders get what money left after

settling all other claims

 

4. Equity shares are not redeemed or taken

back by the company. Once they are issued,

they remain permanently with the company

Preference shares are issued with a conditional

assurance regarding and a prescribed rate of

dividend

 

Preference shareholders have no voting rights

 

 

Preference shareholders get a priority over

equity shareholders in repayment of capital in

the event of liquidation of the company

 

There are redeemable preference shares,

which the company can pay off

 

 

10.   Can forfeited shares be reissued at discount? If yes, to what extent?

A forfeited share can be reissued at discount. The amount of capital paid by the previous

shareholder is retained in the share forfeiture account. A forfeited share can be reissued at

discount to the extent of amount so retained on that share reissued. In case the share was

originally issued at discount, the old discount can be allowed in addition to the amount

available in the forfeiture account.

 

11.   Explain pro-rata allotment of shares

Pro-rata allotment means proportionate allotment. When there is over subscription of

applications, the company has the option to either reject the excess applications or to issue

lesser number of shares on the applications adjusting the excess application money in to

the amounts due at subsequent stages. The second option is known as pro-rata allotment.

 

 

12.   What is meant by forfeiture of shares?

Normally a company is not allowed to cancel or take back its shares. But when a person fails

to pay the allotment money or call money due on a share, the company is allowed to

withdraw those shares and reissue them to another party. Forfeiture is withdrawal of shares

due to non-payment of dues by the shareholder.

i.                   Capital representing the forfeited shares removed from share capital account

ii.                Unsettled balances in temporary accounts such as Share Allotment, Share Call

etc. (or calls in arrears account) are wiped out from the books.

iii.             The paid up portion the forfeited shares is transferred from the capital account to a

separate account called ‘Share Forfeiture Account”.

 

13.   Explain the accounting treatment of forfeiture of shares, when they have been issued

at a discount.

Accounting treatment on forfeiture of shares will vary according to the conditions under

which they have been issued. Shares issued at par, premium and discount are treated

differently at the time of forfeiture.

When the shares have been issued at discount the capital representing the shares to be

forfeited includes discount as well. When we reverse the capital the calls in arrears as well

as the discount accounts have to be credited to clear those balances from the account.

When the company reissues the shares issued at discount it is allowed to reinstate the

discount that was originally allowed.

 

14.   Explain the accounting treatment of forfeiture of shares when they have been issued

at premium.

Accounting treatment on forfeiture of shares will vary according to the conditions under

which they have been issued. Shares issued at par, premium and discount are treated

differently at the time of forfeiture.

 

When shares are issued at premium and the premium has been collected by the company

before forfeiture, no special treatment is required for the premium portion. The shares can be

treated as shares issued at par, on which the capital is debited and the portion of capital

received is credited to share forfeiture account and capital not received credited to calls in

arrears account.

However if the premium is not received, the premium account should be reversed along with

the capital account at the time of forfeiture. This is because the premium not collected

inflates the calls in arrears account and a mere reversal of capital account will not be enough

to wipe out the calls in arrears account.

 

15.   Where will you show the ‘discount on issue of shares’ in the balance sheet?

Discount on issue of shares is treated as expenditure to be written off. This is placed on the

assets side of the balance sheet under the heading Miscellaneous Expenditure, along with

other fictitious assets such as preliminary expenses, commission and brokerage.

 

16.   What is meant by private placement of shares?

Issue of shares under private placement implies the issue of shares to a selected group of

persons. Private placement is an issue that is not a public issue. In order to make private

placement, a company should pass a special resolution to that effect. If the number of votes

cast in favour of private placement is not sufficient to pass a special resolution, but more

than the number of votes cast against, the directors can approach Central Government for

approval, stating that the proposed private placement is most beneficial to the company.

 

Don’t waste your time reading the stuff below – Out of Syllabus Items from your Text

Book

 

What is Escrow Account?

The word escrow means a contract or bond deposited with a third person, who is to deliver it to

the party involved in a contract on fulfilment of certain conditions. In order to ensure that the

company fulfils the obligation under buy back it is required to open an escrow account with a

merchant banker with an amount equivalent 25% of the total obligation under buy-back scheme,

where the total is not more than Rs.100 crores: and 10% of the obligations exceeding Rs.100

crores. This account can consist of (a) cash deposit with commercial bank (b) bank guarantee (c)

deposit of acceptable securities with adequate margin against prince variance. This amount is

kept as a guarantee, and after payment of all the amounts due on buy-back scheme, it will be

released to the company. In case of non-fulfilment of obligation under buy-back, SEBI can forfeit

the escrow account.

 

What is Preferential Allotment?

Preferential allotment is the bulk allotment to an individual, venture capitalist or a company.

Preferential allotment is made to a pre-identified buyer at a predetermined price. SEBI prescribed

that the price shall be the average of highs and lows of the last 26 weeks preceding the date on

which the directors have resolved to make such preferential allotment. Preferential allotment is

made to individuals or institutions wish to make a strategic investment in the company. They may

or may not be existing shareholders. Preferential allotment can take place only if three-fourth of

the existing shareholders approve such an allotment. Shares issued on preferential allotment are

not to be sold in the open market for a period of three years. This period is known as lock in

period.

 

What is Sweat Equity?

Sweat equity are shares issued to employees or directors of a company at reduced rate. They

are issued for consideration other than cash for such as technical know how or intellectual

property. Following are the conditions to be fulfilled for the issue of sweat equity:

1.       The company must have been in business for not less than 1 year.

2.       Sweat equity shares should belong to a class of shares already issued.

3.       Issue of sweat should be authorized by special resolution passed by shareholders.

4.       SEBI regulations should be followed where the shares are listed in a stock exchange.

 

What is ‘Rights Issue’?

When a company makes fresh issue of shares, the existing shareholders have the right to

subscribe them in the proportion in which they are holding shares. This condition is a safeguard

that enables existing shareholders to retain their control over the company. They have the option

to accept the offer, reject the offer or to sell their rights.

Share capital is another term for equity capital. It is the funds that a company raises in exchange for issuing an ownership interest in the company in the form of shares.

There are two general types of share capital, which are common stock and preferred stock. The characteristics of common stock are defined by the state within which a company incorporates. These characteristics are relatively standardized, and includes the right to vote on certain corporate decisions, such as the election of a board of directors. In the event of a corporate liquidation, the common stockholders are paid their share of any remaining assets after all creditor claims have been fulfilled. If a company declares bankruptcy, this usually means that the holdings of all investors are either severely reduced or completely eliminated.

Preferred stock is shares in the equity of a company, and which entitle the holder to a fixed dividend amount by the issuing company. This dividend must be paid before the company can issue any dividends to its common shareholders. Also, if the company is dissolved, the owners of preference shares are paid back before the holders of common stock. However, the holders of preference shares do not usually have any voting control over the affairs of the company, as do the holders of common stock.

The types of preferred stock are:

Callable. The issuing company has the right to buy back these shares at a certain price on a certain date. Since the call option tends to cap the maximum price to which a preferred share can appreciate (before the company buys it back), it tends to restrict stock price appreciation.

Convertible. The owner of these preferred shares has the option, but not the obligation, to convert the shares to a company's common stock at some conversion ratio. This is a valuable feature when the market price of the common stock increases substantially, since the owners of preferred shares can realize substantial gains by converting their shares.

Cumulative. If a company does not have the financial resources to pay a dividend

to the owners of its preferred shares, then it still has the payment liability, and cannot pay dividends to its common shareholders for as long as that liability remains unpaid.

Non-cumulative. If a company pays a scheduled dividend, then it does not have the obligation to pay the dividend at a later date. This clause is rarely used.

Participating. The issuing company must pay an increased dividend to the owners of preferred shares if there is a participation clause in the share agreement. This clause states that a certain portion of earnings (or of the dividends issued to the owners of common stock) will be distributed to the owners of preferred shares in the form of dividends.

Primary and Secondary Market

Posted in Definitions on Mar 25, 2008

For the shares, its possible for investors to buy them from  two different sources. From the company itself and then from other investors. First one is called the Primary Market and the later is known as Secondary Market.

PRIMARY MARKET

This is the market where initial shares and bonds are sold by companies themselves directly and hence the proceeds of the same goes to them, the issuer. This is the place where the company gets cash for selling its financial assets

SECONDARY MARKET

This is the place where shares and bonds are bought by investors from other investors. This is the place of high activity when compared to the primary market. It is a organized market for securities. New York Stock Exchange (NYSE), Bombay Stock Exchange (BSE),National Stock Exchange NSE, bond markets, over-the-counter markets, residential mortgage loans, governmental guaranteed loans etc. are some examples.

Hybrid securities are a broad group of securities that combine the elements of the two broader groups of securities, debt and equity.

Hybrid securities pay a predictable (fixed or floating) rate of return or dividend until a certain date, at which point the holder has a number of options including converting the securities into the underlying share.

Therefore, unlike a share of stock (equity) the holder has a 'known' cash flow, and,

unlike a fixed interest security (debt) there is an option to convert to the underlying equity. More common examples include convertible and converting preference shares.

A hybrid security is structured differently and while the price of some securities behave more like fixed interest securities, others behave more like the underlying shares into which they convert.