Financial investments may include the purchase of stocks, bonds, mutual funds, etfs, options, annuities, bank products and more. The purpose of these assets could be to provide future income, or simply greater future overall value. When the investor decides to sell their asset, they aim to produce a good ROI (Return on Investment).

Types of Investments (Financial)

There’s are many investment vehicles and asset classes for investors to choose from. Knowledge of the asset, risk level and tolerance are some things to consider before deciding to invest.

Growth Investments

Growth investments are best for those who intend to hold on to their asset for longer time periods. 

• Shares. These are equity investments that represent your interest in a company’s growth and success. As the company grows and makes money, so do you—be it through share price, dividend payments, or other means.
• Bonds. These are debt equities that represent a promissory note. The issuer agrees to pay you back your principal investment with a fixed rate of interest over a fixed term. This debt helps issuers finance new growth opportunities.
• Funds. Index funds, mutual funds and exchange-traded funds (ETFs) are all managed investments. You’re pooling your money with other investors and letting an expert leverage larger sums and expertise to generate ROI.
• REITs. Real estate investing without actually owning the real estate. REITs return 90% of their income to shareholders, which means strong compounding power through dividend reinvestment—or a passive revenue stream.
• Derivatives. Options and other derivatives allow investors to make money without holding assets. They’re a riskier form of investment with big upside for those who understand market tendencies and catalysts.
• Commodities. Everything from gold and silver to livestock and crops have intrinsic value. Investors in commodities capitalize on these values without owning the commodities themselves.
• Property. From rental houses to multifamily properties and commercial real estate, there’s wealth-generating power in property. Collecting rent passively, fix-and-flip sales, buy-and-hold appreciation and more are all forms of investing.
• Private equity. If you own a stake in a local business or fund a startup with an infusion of capital, you own private equity. This stake entitles you to a portion of the revenue or value of the asset.

There are four main investment types, or asset classes, that you can choose from, each with distinct characteristics, risks and benefits.

Once you are familiar with the different types of assets you can begin to think about piecing together a mix that would fit with your personal circumstances and risk tolerance.

Growth investments

These are more suitable for long term investors that are willing and able to withstand market ups and downs. These are high risk investments that have the largest potential gains. A lot of tech stocks are considered growth investments.

Shares

Shares are considered a growth investment as they can help grow the value of your original investment over the medium to long term.

If you own shares, you may also receive income from dividends, which are effectively a portion of a company’s profit paid out to its shareholders.

Of course, the value of shares may also fall below the price you pay for them. Prices can be volatile from day to day and shares are generally best suited to long term investors, who are comfortable withstanding these ups and downs.

Also known as equities, shares have historically delivered higher returns than other assets, shares are considered one of the riskiest types of investment.

Property

Property is also considered as a growth investment because the price of houses and other properties can rise substantially over a medium to long term period.

However, just like shares, property can also fall in value and carries the risk of losses.

It is possible to invest directly by buying a property but also indirectly, through a property investment fund.

Defensive investments

These are more focused on consistently generating income, rather than growth, and are considered lower risk than growth investments.

Cash

Cash investments include everyday bank accounts, high interest savings accounts and term deposits.

They typically carry the lowest potential returns of all the investment types.

While they offer no chance of capital growth, they can deliver regular income and can play an important role in protecting wealth and reducing risk in an investment portfolio.

Fixed interest

The best known type of fixed interest investments are bonds, which are essentially when governments or companies borrow money from investors and pay them a rate of interest in return.

Bonds are also considered as a defensive investment, because they generally offer lower potential returns and lower levels of risk than shares or property.

They can also be sold relatively quickly, like cash, although it’s important to note that they are not without the risk of capital losses.

Cryptocurrency

Cryptocurrency is another high risk investment, that many say will payoff in the long run. It’s founded on the idea that currency shouldn’t be centralized and controlled by anyone, be it individual, bank, or government. Anyone with internet access can get a piece of the pie. 

Conclusion

This was just a brief overview of different types of investments. Please use our search function or check out related articles to dive deeper into each one of these topics.

The post Investment Meaning – What is an Investment? appeared first on Investment U.

Symmetrical bell curves are an important tool in finance and investing. At a glance, they show the mean, median and mode of a data set, along with the probability of data above or below that point. The width of the bell curve represents total range, to provide context for the data.  

You don’t need to be a statistician to appreciate the information a bell curve offers, especially as an investor. A simple understanding of what one represents and the insights gleaned from it can fuel informed decision-making. 

A Normal Distribution of Data

Bell curves represent normal probability distribution. The highest point of the curve (the middle) represents the most likely outcome. Everything to the left and right of the middle represents decreasing probability down to zero, at an exponential rate. Usually, they’re divided into standard deviations from the mean, representing different probability ranges. The further from the mean, the lower the probability:

• 68% of data points land within one standard deviation of the mean
• 95% of the data stays within two standard deviations of the mean
• 99.7% of all data within a range sits within three standard deviations

Here’s a look at a couple of simple examples of data you might find on a bell curve:

• Employee performance tends to fall on a bell curve. Adequate employees make up the mean, while underperforming employees skew down to the left and over performing employees skew down to the right. 
• Investing risk-return analysis happens over a bell curve. Balanced risk and return represent the median, while overly conservative portfolios fall to the left and overly aggressive portfolios fall to the right. 

While bell curves may not always present as perfectly symmetrical, they nevertheless represent normal distribution based on available data. Identifying the mean, median and mode, along with the standard deviations to both sides, allows investors to identify probabilities for positive return. 

How to Read a Bell Curve

When analyzing something like risk-reward, investors need to know how to read the data. Say, for example:

• The median return for the Telecom Sector in a given year is 14%, represented by 62% of all companies in the sector. 
• A standard deviation of -1/+1 might represent 12% and 16%, encompassing 76% of all companies. 
• Further, deviation of -2/+2 might represent 10% and 18%, encompassing 95% of Telecom Sector companies. 

In this example, investors can analyze the potential for profits across the Telecom sector by recognizing the distribution of data from the mean. For instance, there’s only a 5% chance of beating the sector average by 4% when handpicking stocks, an indicator that risk outweighs potential reward. 

Bell Curve Applications in Investing

Investors can use bell curves to examine datasets in regard to a wide assortment of investing approaches. Risk-reward analysis is the biggest and broadest application, but the following practices also rely on assessment:

• Speculative traders use bell curves to assess future stock prices based on previously established support and resistance levels. 
• Fundamental investors may plot a company’s potential for future earnings growth on a bell curve, as a way to understand probability thresholds for growth. 
• How likely is a company to default on its debts or axe its dividend? Investors can model these probabilities for better risk analysis. 

So long as the data represents a standard distribution, a bell curve is a powerful analytical tool for investors. If the data doesn’t represent a standard distribution, investors risk misinterpreting probabilities. 

Limitations of Bell Curve Representations

As mentioned, these statistical representations aren’t always symmetrical. Some can have long tails, for example, which actually skew probability. While the curve itself still represents normal distribution, the statistical outcomes outside of the norm are actually higher, called “excess kurtosis.” 

Another limitation of bell curves is the pervasiveness of “grouping.” Bell curves plot data based on static datasets or constants, when in reality, data is dynamic. As a result, some points may move between standard deviations depending on when the data was taken. Reconstituting the bell curve can change the skew of the data and the value of each standard deviation. 

Finally, relying too heavily on a bell curve for probabilities can result in skewed decision-making. Markets can behave irrationally, outside of statistical probability. Use a bell curve as a theoretical tool; not a hard-and-fast benchmark for probability. 

A Quantitative Tool to Measure Risk

Ultimately, a bell curve is a visual, statistical representation of risk. By showing investors the mean, median and mode, as well as the range and statistical standard deviation, it’s possible to assess risk and reward at a glance. And, for applications like portfolio distribution analysis, it’s easier to understand how different asset allocations will fare in given market conditions. 

When assessing a bell curve, make sure to also factor in the context. Is it a normal distribution of data? Is the data relevant and timely? What’s the context for each standard deviation outside of its representation? The ability to apply bell curve insights to investing analysis gives investors a powerful edge in setting expectations for their decision-making.

The post What is a Bell Curve? appeared first on Investment U.

And it isn’t just a term for bonds. It can reference the initial value of any asset that may rise or fall in value as it’s traded. It simply means “original value.”

Here’s a closer look at par value in the context of investment products, specifically bonds and other fixed income instruments that have accompanying coupon rates. 

How Much is a Bond’s Par Value?

The value of a bond depends on the type of bond it is. Most bonds start at a $1,000 par value, with nominal values ranging as high as $10,000:

• Corporate bonds traditionally sell for $1,000 
• Municipal bonds generally have a $5,000 face value
• Federal bonds can have par values as high as $10,000
• Baby bonds are the exception to these examples, and tend to have par values up to but below $100. It’s also important to note that not all bonds hold fast to $1,000, $5,000 and $10,000. In many situations, investors can buy bonds in increments of these numbers.

Benchmark

After they’re issued, bonds trade on the open market like any other investment product. The appeal of a bond is usually the combination of the value and coupon rate, which determine the interest payments for the bond. The higher they are, the more desirable the bond.

Desirable bonds trade at a premium, that is, higher than their par value. Conversely, bonds with little-to-no carrying value might trade at a discount: lower than this value. There are other factors that can dictate a premium or a discount as well, such as whether or not the bond is callable or the credit rating of the issuer. Regardless, it serves as the benchmark for determining the value of the bond at its current market rate. 

Indicator of Value

Because a bond’s par value stays the same, it’s a representation of its minimum carrying value: the total outstanding worth of the bond, including interest payments. Even if the bond has no more interest payments remaining, the bond holder can still redeem the bond for its par value. More often than not, however, bonds have a carrying value that includes remaining interest payments. This is what drives the bond’s value on the market. 

The Relationship Between Par Value and Coupon

Because par value and coupon rate go hand-in-hand, issuers often consider them in tandem. The higher a bond’s value, the lower the coupon rate. 

For example, a 10-year $1,000 bond might have a coupon rate of 5%, meaning it pays $50 per year. The total carrying value of the bond at issuance is $1,500. Meanwhile, a 10-year $5,000 bond might have a coupon rate of 2%. It’ll pay $100 each year and has a carrying rate of $6,000 at issuance. Income investors look at these variables to better understand which bonds offer the best value.

Depending on where the bond is in its maturity, investors may prize the high par value over the higher coupon rate. The younger the bond, the more coupon rate matters; the older it is, the more the par value comes into play. 

Par Value of Stocks

As mentioned, this value is a term that applies beyond bonds. In reference to stocks, it takes on a slightly different meaning. A stock’s par value is the absolute lowest price a shareholder can redeem it for. Most companies today issue stock with this value of $0.01, sometimes fractions of a cent. 

The reason for this extremely low value is to protect against liability in the event a company liquidates. Shareholders are only entitled to the par value per share, which is just a cent. If the par value was high like a bond, say, $100, the company would have a liability to pay that amount to every shareholder. By making it just a penny, a company strategically absolves itself of any real debt obligation. 

Not every company records this value for shares and often, it depends on the state the company files its articles of incorporation in. Many states allow companies to issue “no par” shares, which have no value and thus, aren’t worth anything in the event of liquidation. 

Par Value Says a Lot About a Bond

Par value is one of the critical variables in determining the worth of a bond—alongside coupon rate and carrying value. While a high par value might entice investors on the surface, it’s important to explore that value in the context of these other variables. As a bond comes to maturity, this value becomes a clearer and clearer indicator of its value. 

Bond values may rise and fall based on market demand, but par value always stays the same. It’s a constant: something you can use as a benchmark to better understand the efficacy of an investment. For income investors, it’s an extremely important factor in deciding which bonds to invest in, and when. 

The post Par Value: What Does it Mean? appeared first on Investment U.

Let’s take a closer look at investment transactions: what they are, what they mean and the implications that come with them. 

Opening or Closing a Position

At the simplest level, there are two types of investment transactions: opening and closing transactions. When you buy an asset, you open a position; when you sell it, you close that position to realize gains (or losses). Both types of transactions come with implications.

• Opening a position means assuming risk. The value of your investment will go up or down, because the value of the overall asset is subjective. The value is uncertain and changing while the position remains open, which is why movements are “unrealized” gains or losses. 
• Closing a position locks in the investment, turning unrealized gains or losses into real gains or losses. You no longer have a stake in that investment, which means your capital isn’t affected by future price increases or decreases. 

Transacting to open or close a position is the fundamental nature of investing. To participate in the stock market (or any other market), investors need to buy in. And, to tap into the wealth they’ve presumably gained at some point in the future, they’ll need to sell out. An investment transaction happens on both sides. 

What to Know About Taxable Events

Almost every time you make an investment transaction, you also trigger a taxable event. Some have immediate implications; others won’t register any action until further down the road. 

For example, when you open a position in a stock, you’re opening yourself to the potential for capital gains. Capital gains are a form of income, reported on your annual tax returns. However, they’re not accounted for until they’re realized. The first transaction (opening) creates a passive taxable event: eventual taxation. The second transaction (closing) realizes gains or losses, creating an active event: capital gains taxation. 

Because of their nature to appreciate or depreciate, every opening position starts a taxable event and every closing transaction ends it. Throughout the life of the investment, gains or losses remain unrealized and thus, untaxed. 

It’s also important to remember that there are some investment transactions that are automatic, which also have tax implications. Dividend payments, for example. Whether they’re pocketed or reinvested, each time they’re paid out to a stockholder it triggers a taxable event. The IRS taxes dividend payments as income because, in effect, they’re a form of passive income. Distribution of dividends is an investment transaction and thus, a taxable event. 

Consider Time Between Transactions

Investment transactions aren’t only important for measuring tax implications. They’re also used as a judge for determining what type of investor you are. The time between opening and closing a position delineates your investment strategy:

• Same-day entry and exit marks you as a day trader.
• Entry and exit within a day or two makes you a swing trader.
• Those who buy and sell on technical signals are pattern traders.
• Those who transact into and out of a position in under a year are short-term investors.
• Investors who enter, hold and exit a position past a year are long-term investors. 

Time between investment transactions is important because it’s directly tied to risk. That risk is on a bell curve. Extremely short times in a position come with low risk because the investor seeks to capitalize on very small price movements. Likewise, a very long time in a position smooths out intermittent turbulence. 

There are also tax implications that differential short- vs. long-term investment transactions. The IRS taxes short-term investments at a higher rate than long-term investments. Investors need to be mindful of their time horizon when transacting different securities. 

Other Types of Investment Transaction

Buying and selling (opening and closing) are the primary modes of investment transaction—but they’re not the only ones. As mentioned, dividend payouts constitute another type of transaction, since investors receive funds. Other investment transaction examples include:

• Mergers, which may involve buyouts or new share distribution. 
• Stock splits and reverse splits, which see investors holdings change. 
• Redemptions, which see warrants and units redeemed for shares. 

These types of transactions aren’t as straightforward as buying or selling; however, they have important ramifications for the investment. It’s up to investors to make sure these types of transactions benefit them—especially if they have little-to-no control over them. 

Transact Only When You’re Certain

The most important thing to remember about an investment transaction is that it’s final. The moment you open a position, you expose yourself to risk—risk that you can’t take back. If your stock plummets from $40 to $30 minutes after you open your position, that’s your reality. Closing that position locks in the loss. However, waiting for the stock to rebound could see it turn a profit. It depends on your patience and risk tolerance in-between investment transactions. 

To learn how you can build wealth in your life through the stock market, sign up for the Liberty Through Wealth e-letter below. This daily newsletter gives you expert analysis on the best investment opportunities available.

It’s best to think about every investment transaction for what it is: the culmination of a decision. Opening a position means you have the confidence to grow your wealth. Closing a position is the decision to take profits or lock in losses before they get worse. In either case, it’s the decision to transact against your wealth.

The post What is an Investment Transaction? appeared first on Investment U.

Here’s a look at what it means to be a stockholder—also called a shareholder—and what it means beyond simply appreciating your wealth in the public markets.

A Claim to Profits (and Losses)

Investors buy stock in public companies because there’s a promise of return on investment (ROI). They believe that over time, their initial investment will appreciate, generating wealth. So long as they hold the rights to shares, they hold a claim to the percentage of a company’s profits represented by those shares.

There are several ways in which a company can return value to stockholders. 

• Price appreciation. If you buy a stock for $10 and sell it for $20, you profit $10 or 100% of the original investment value thanks to price appreciation. 
• Dividend payments. If you own a stock that pays a dividend, you’re entitled to the payout amount associated with each share, whether reinvested or pocketed.
• Share buybacks. As a stockholder, you’re entitled to the cash buyback price offered by a company, including any premiums associated with it.  

In each of these scenarios, stockholders find themselves entitled to profits because they’ve purchased and held a stake in the company. The shares they hold are a form of contract that facilitates their worth. 

It’s also important to note that while stockholders are entitled to profits, they’re also responsible for losses. If shares depreciate in price or the company cuts its dividends, the value of a stock investment falls. So long as they remain vested, investors will see their stock claims rise and fall. It’s not until they sell their stock that any gains or losses become real. 

Basic Stockholder Rights

While a stock entitles the holder to profits, it also opens them up to a slew of additional shareholder rights. Common stockholders can expect six fundamental rights that accompany their investment:

• Voting power (depends on class)
• Ownership (claim to profits)
• Right to transfer ownership (buy and sell)
• Dividends (profits paid)
• Inspection of documents (access to financials)
• Ability to sue (for malfeasance)

Most public companies have different stockholder levels that dictate the power of particular shares. For example, Class A shares may have 10x the voting rights of common Class B shares. Larger companies such as Alphabet (NASDAQ: GOOG), Meta (NASDAQ: FB) and Berkshire Hathaway (NYSE: BRK.A) delineate stockholder rights based on share class. 

Majority vs. Minority Shareholders

In public markets, virtually everyone is a minority shareholder—that is, they hold less than 50% of the company’s total issued stock. In the world of private equity investments, however, it becomes important to distinguish between majority vs. minority shareholders. Majority shareholders are those who control 51% of the company or more via issued shares. 

Ownership stake becomes important because of the rights that accompany each share. Notably, any single entity that controls 51% of the shares also controls a majority of the voting rights. Thus, they have sizable control over the company. Generally, owners and founders are majority stockholders, and many companies structure equity distribution to create groups of minority shareholders.

Common vs. Preferred Stockholders

There’s also a distinction between common and preferred stockholders. Most people will hold common shares; however, investors, management and special interests may hold preferred shares. The chief difference is that while preferred shares see less price movement, they’re entitled to priority dividends of a higher value than those issued to common shareholders. Preferred stockholders also lack voting rights. 

Who Can be a Stockholder?

Anyone with the capital to make an investment can become a stockholder through public markets. This sentiment applies to individual people, companies, non-profit organizations and anyone else recognized as a legal entity. The other important stipulation for investing is that the stockholder is also a taxpaying entity—whether through business taxes or personal income tax. Capital gains and passive income received through stock investments are subject to tax, and the stockholder is responsible for reporting and paying those taxes. 

Shareholder Incentives to Consider 

Sometimes, companies offer perks and incentives to shareholders, as a form of reward for their confidence. These incentives aren’t necessarily tied to the performance of an investment—rather, they’re an incentive to attract and maintain more passive investors. For example:

• Ford Motor Company (NYSE: F) offers its Friends and Family Discount to shareholders. 
• Intercontinental Hotels Group (NYSE: IHG) offers hotel discounts to shareholders. 
• Carnival (NYSE: CCL) and Royal Caribbean (NYSE: RCL) both offer room discounts.

Many, many companies offer some form of shareholder perks like these. Not only is it a simple way to reward shareholders for their continued confidence in the company, it’s often a low-cost way for companies to entice new investors. They shouldn’t be the only incentive for new investors, however! 

Should You Become a Stockholder?

For most investors, becoming a stockholder is the easiest way to accumulate wealth. Whether it’s a company sponsored 401(k) retirement plan or an individual brokerage account, access to the stock market means access to wealth-building investments. The question isn’t whether you should become a stockholder; it’s which stock(s) you should invest in. Choose those with a track record of rewarding existing stockholders or those in a position to generate strong returns on future growth. 

For the latest stock insights and analysis, sign up for the Trade of the Day e-letter below. This team of Wall Street experts provides daily market tips and trends for both novice and experienced investors!

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Because they’re speculative investments, options contracts represent an investor’s thesis. The strike price at which they purchase the investment represents their speculative threshold. If it’s a call option, they believe the price will go higher. If it’s a put option, they believe the price will fall lower. Therefore, it determines the validity of the contract when the time comes to execute, or let it expire.  

Here’s a closer look at the exercise price, including how it works and what its impact is on options contracts during the exercise period. 

Purchasing Options Contracts Based on Exercise Price

Options contracts are available at different strike prices and with different expiratory periods. These variables have an impact on how much it costs to purchase the contract. It also impacts whether it’s a put or a call contract. 

When buying an options contract, the further away the exercise price is from the current price, the less expensive it becomes to secure the contract. This is representative of its extrinsic value. That is to say, the more movement a stock needs to experience to reach the exercise price, the less likely it is to actually reach that price. Conversely, the closer it is to the exercise price, the more likely it is to reach and exceed it; thus, the more valuable it is. 

Options traders need to strike a balance between an attainable exercise price and an expiratory date in the future. An exercise price that’s too high or an expiratory date that’s too soon could leave the contract worthless.

In the Money vs. Out of the Money

A contract’s exercise price vs. its current market price determines whether it’s In the Money (ITM) or Out of the Money (OTM). These terms represent the current value of the contract: whether it’s exercisable for a profit or whether it’ll expire worthless. 

• ITM contracts are profitable, meaning the exercise price of a call option is higher than the current stock price. Conversely, it means the exercise price is lower than the current stock price for a put option. 
• OTM contacts are worthless because the current market price is below a call option or above a put option. Exercising would mean choosing to pay more than market rate for the underlying security. 

Options contracts can straddle the line between ITM and OTM, depending on the exercise price. Traders need to mind the expiration date of the contract and the current share price as they determine whether to exercise the option or let it expire. 

To hedge against volatility, many investors will buy both call and put options. This is a strategic investment tactic that involves monitoring both exercise prices and making the decision to exercise based on a stock’s behavior or patterns. It means letting one contract expire worthless—which one depends on clear price movement in one direction or investor sentiment at the time the contract(s) expire.  

Determining the Profitability of an Unexercised Option

Holders of options contracts need to pay close attention to the current price of a security relative to the exercise price and expiration date of its contracts. Together, these three variables determine the profitability of an unexercised option. 

The exercise price vs. current market price tells investors whether their contract is currently in or out of the money. If it’s in the money, the difference between the two prices is equivalent to the profitability of the option. However, market price is always in flux, which makes time-to-expiration a consideration. 

Jeremy holds a call option for ABC Company with a strike price of $100. Right now, his contract is in the money because the share price of ABC Company is $105. The share price of the company has been rising steadily for the past two weeks, and there are two more weeks left on Jeremy’s contract. He can exercise now and profit $5/share (less the cost of the contract) or continue to hold his contract in favor of further price appreciation. If, in two weeks, ABC Company stock reaches $110, his profit rises to $10/share; however, if it falls, he’ll lose money. If it falls out of the money, his contract will become worthless. 

Because it’s a fixed figure, the exercise price of an options contract plays an important role in when investors choose to exercise. Its relativity to market price constantly changes. This means the profitability of an unexercised option also changes. 

Exercise Price: The Most Important Factor in Option Value

The exercise price is far and away the most important factor in determining the value of an option contract. As investors speculate about price, they’ll choose strike prices that reflect their thesis. They’ll choose contract expiration periods that tend to reflect the riskiness of their position. Throughout the duration of a contract, the exercise price remains static, which makes it the benchmark for profitability and the clearest determinate of the contract’s value. 

To learn more about the importance of a strike price and it’s impact on options, sign up for the Trade of the Day e-letter below! Trading experts Bryan Bottarelli and Karim Rahemtulla share their market insights, trading tips and more.

Whether you’re just getting into options trading or are using derivatives to offset risk, exercise price is the first and most important concept to learn. Choosing the right strike price when buying a contract has everything to do with how lucrative it could be.

The post What is an Exercise Price? appeared first on Investment U.

It starts by understanding the different types of losses, and that some are worse than others. Some losses are bumps in the road on the way to growth. Other losses warrant concern. How they’re reported, what they represent and their place in context all matter. Let’s take a closer look at business losses to better-understand what they mean for a company. 

Defining a Business Loss

In financial accounting, a business loss is simply the result of more expenses than revenue. The company didn’t bring in enough money to cover its expenses and is thus operating at a loss. Continuing on this trajectory will leave a business insolvent and bankrupt. However, many businesses make the necessary changes to avoid this: reducing expenses, increasing sales, etc. 

As mentioned, there are different types of losses. While the term “business loss” generally refers to an operating loss, there are capital losses, irregular losses and tax losses. 

• Capital losses are revenue lost through the sale of investments below the purchase price. 
• Irregular losses are one-time losses that are generally out of the company’s control.
• Tax losses occur when a company’s deductions exceed accessible income.

Companies may record these different types of losses in very different ways. This creates different tax liabilities and benefits. For example, a business can carry its net operating losses forward indefinitely, while it’s only able to deduct the amount not covered by insurance after an irregular loss. 

Delving into the nature of a loss yields more information about it. Instead of seeing it as a surface loss, investors are wise to look at how it’s categorized and any implications for mitigating that loss. 

Looking at the Profit and Loss Statement

As the name implies, most of a company’s losses show up on its profit and loss statement. If the final figures of the statement are negative, it means expenses outweighed revenue. Companies need to comb through individual expense line items to see where, specifically, costs were higher. Some of the common culprits include: 

• Cost of goods sold (COGS) expenses
• Selling, general and administrative (SG&A) expenses
• Marketing and advertising expenses
• Technology, research and development expenses
• Interest expenses

Investors evaluating a company’s balance sheet will pay keen attention to the profit and loss statement, probing deeper to understand where the company is spending and whether that spending is fruitful or reckless. 

“Losses” for Growth Hacking Startups

In today’s public markets, many new companies engage in a practice called growth hacking. The idea is to bring a disruptive product or business model to market and capture as much market share as possible, as quickly as possible, regardless of the expense. Then, once the company becomes ubiquitous, it can begin to realize profits. 

On a balance sheet, growth hacking often shows up in the form of ongoing business losses. Amazon (Nasdaq: AMZN) is perhaps the best historical example of a growth hacking company. Founded in 1994, the company didn’t turn a profit until 2004—even despite revenues in excess of $5 billion at the time. Why? Because it continually ramped up spending on technology, marketing and SG&A, with no regard for profitability. It captured market share by reinvesting in itself and today, as of 2020, the company reports in excess of $21.33 billion in annual income. 

Many other companies have followed or are currently following the growth hacking model, including Netflix (Nasdaq: NFLX), Airbnb (Nasdaq: ABNB) and Uber (NYSE: UBER), among others. 

Net Operating Loss and Tax Implications

Part of the reason growth hacking works—and why it’s often not a surprise for established companies to post business losses—is due to Net Operating Loss (NOL) tax implications. Specifically, NOL carryforward (carryover) rules. 

According to IRS carryforward rules, companies experiencing a net operating loss in one year can deduct that loss from a future year’s profits. In fact, businesses can carry these losses forward indefinitely, so long as they don’t exceed 80 percent of taxable income. This is the fundamental principle behind growth hacking. It’s essentially a way to defer taxes by incurring losses. 

When are Business Losses a Concern?

Business losses become a concern when they’re not the result of positive reinvestment in the company. It’s one thing to spend heavily on R&D to grow market share; it’s another to lose control of COGS and see reduced sales revenues. 

It behooves companies and investors to closely examine business losses: the reason for them and the amount of the loss. Small losses may not seem problematic, but they will become problematic if they’re indicative of poor operational trends. Conversely, irregular losses may seem dramatic, but they’re easy to put in the rearview mirror—especially if the company has sound operations. 

Business Losses Demand Further Scrutiny

It’s easy to take a business loss at face value. Unfortunately, there’s more to that loss under the surface. Investors who see losses and sell out of a position might be selling themselves short. Likewise, companies that downplay small losses that are the result of operational deficiencies do themselves a disservice. A loss is a loss, but it needs to come with context. Is the company growth hacking? Was the loss an irregular one? Is this part of a larger trend of business losses?

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Qualifying a loss gives it meaning, and it’s an important step in drawing reasonable conclusions about a company’s financial situation. 

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In fact, managerial accounting seeks to link a company’s financial performance to the individual factors that drive it. Revenue figures direct attention to the company’s sales practices. In addition, the balance sheet might prompt executives to pursue a specific reduction strategy. Whatever the circumstances, managerial accounting symbolizes the company’s willingness to apply financial data to operations. As a result, this will improve results in a measurable way. 

Managerial accounting is such an important tool for executives in both the day-to-day and broad-level oversight of an organization. Theerefore, let’s take a closer look…

Managerial Accounting vs. Financial Accounting

There’s often confusion between managerial accounting and financial accounting. Overall, both deal with the company’s financials, but in different ways. 

• Financial accounting is a purely quantitative practice that generalizes financial operations and provides high-level data about a business’ financial activities. 
• Managerial accounting helps executives measure the economic impact of their decision-making. It’s a yardstick for understanding the fiscal impact of operational changes.

It’s best to think about them sequentially. In general, accountants prepare high-level data about the company’s finances. Then, executives put that data to work. Financial accounting enables managerial accounting. Specifically, the more accurate and timely the insights provide, the quicker and more effectively management can prepare that data for beneficial change. 

Focuses of Managerial Accounting

What, exactly, does managerial accounting entail? In practice, it can refer to a broad range of practices. It’s wherever management uses financial reporting to identify operational changes.

Most Common Examples

• Product costing analysis. Managers examine products to determine the profit margin of each. It’s based on the cost of goods sold (COGS) and sales price. This allows them to better-price products to ensure strong revenues. 
• Cash flow analysis. Using financial data, managers look at cash inflows and outflows and the catalysts behind them. This can prompt decisions about how to ensure the company remains cash flow positive. 
• Accounts receivable management. Examining accounts receivable activity may prompt managers to reexamine how to extend credit to customers. This factors back into cash flow management. 
• General budgeting. Members of the c-suite use managerial accounting to establish budgets for the different business segments they oversee. Specifically, this data includes ongoing and new initiatives. And overall, these budgets all come together in the broad company budget. 
• Trend and variance analysis. What positive trends are prevailing within the company? Next, are there any negative, concerning trends? Financial modeling provides these insights so managers can deploy strategies. Finally, this is done to capitalize on positive trends and reverse negative ones. 

As mentioned, any time there’s an operational decision that relies on financial data, managerial accounting comes into play. A data-driven approach to problem-solving is the smartest way for companies to understand their inner workings. It allows them to take steps to maximize the efficiency and productivity of operations. 

Measuring and Reporting the Results

A crucial part of managerial accounting is measuring out operational changes. To illustrate, this is done by using financial data to gauge the effect of changes already put into motion. If an executive raises the prices of products, they’ll want to see how it affects sales. On the other hand, if they change purchasing trends, they need to know how it affects inventory turnover. These changes and others like them come through in financial insights, measured over time. The company’s financial statements inform decision-making. Moreover, they also yield insights about its effects, good or bad. 

Managers observe financial trends due to operational changes. Therefore, they compare and contrast them against key performance indicators, goals and other metrics. Even though managerial accounting is an internal practice, they are commonly included in a company’s public-facing financial reports. First, it will benefit investors to read them. Doing this will allow them to better understand certain operational decisions and financial trends. 

Commonly Used Reports in Managerial Accounting

Executives will often times rely on specific reports to provide contextual data for key aspects of operations. For example, these include:

• Budget reports show the company’s budget and its current progress (or deviation).
• Costing reports provide the necessary information about COGS and expenses.
• Inventory reports give a snapshot into current inventory levels and trends. 
• Statement of cash flows to better-understand monetary inflows and outflows. 

There are dozens more that management can use to qualify accounting data. For instance, this includes reports targeted at sales, expenses, employee reports and much more. Each financial report contains the insights needed to make managerial decisions. Those reports will eventually reflect the results of any and all decisions. 

Putting Financial Data to Work

The practice of financial accounting establishes the top-level facts and figures executives need to understand the health and stability of their company. It’s up to these top-level stakeholders to put that data to work, using managerial accounting to plan and predict impacts, and to measure them once they’re in effect. It’s the all-important “other side” of the accounting coin.

The complexities of accounting are too broad to explain in-depth here. However, it’s essential for every investor to understand the basics. Sign up for the Liberty Through Wealth e-letter to start building wealth in your life. These financial experts will provide market analysis, financial insights and more.

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