What are the 3 pillars of a company’s finances? Define two.
The 1st. two pillows are equity and liability.
1. Liability: refers to when a company borrows capital from a third party, pays interest on the same and agrees to repay the principle at a fixed time. The capital belongs to the lender.
- Equity- In this case, the company dilutes its ownership by bringing new investors in the company.
The company is required to paydindents and the investors also expect capital appreciation. The
capital though belongs to the company and they can invest it as they like. Howeverthe profit earned belongs to the shareholders. - Float→ more ahead
what are the characteristics of a float?
- with Float, the company does not need to pay interest.
- Even though the capital does not belong to the company. The company gets to use the capital.
- The company can keep the interest earned from such capital.
What are the different types of items that can be used as Floats ?
- Accounts Payable: is the money a company owes to its suppliers & vendors for products and services received but not paid for. [on credit]- it can be Classified asa liability as it is external capital.
→ The company gets capital from external supplier and money can be used to fund its working capital.
→ many companies in the market have negative working capital.. For eg retail companies buy credit from the market i.e, accounts payable, but sell the items for cash. [ buy on credit I sell for cash] Allowing retailers to finance their operations Like purchasing inventory.
note: one time advance cannot be a float, as the company would need to pay it old credit and make new available. (regular payments)
- Advance from customers: If you receive a certain advance from a customer, with a promise of offering services or products in the future. (e.g. Amazon
subscription). It can be considered as a float. [ As it is
not directly a liability and its not a equity] - Other Float Like current liabilities:
What is reverse float?
Reverse float is when a company extends a float to other com parnies or businesses.
→ this is where the company is Offering capital to other businesses without any return on the same.
→ It includes things like accounts receivable, advances paid, prepaid expenses and so-on.
- Capital is offered at no cost.
- The receiver can keep the Benefits from using the capital.
- Reverse Float acts as a Float for the party that receives the advances.
Other definations of float
- Float refers to the time-gap between when a company initiates financial transaction and when actual Cash movement occurs.
Dispursement, collection and net FLoat
what is a negative working capital?
Negative floating capital typically refers to a situation where a company’s current liabilities exceed its current assets. This condition can occur when a company has more short term obligation than it has
liquid assets available to cover them. ** It is also referred to negative working capital.**
Negative working capital can be a red flag indicating potential liquidity problems. It means that the company might struggle to meet its short-term Obligations such as paying suppliers, creditors, or covering operational expenses.
However, in some industries, particularly those with rapid inventory turnover or strong Cash flows, negative working capital may be a sign of efficient operations. For e.g. companies that can quickly convent inventory into cash or have favourable payment terms with suppliers may operate with negative floating capital without financial distress.
Float & or reverse float which is better and when?
Higher the Float, better it is generally and
lower the reverse Float- is better.
