Debits and Credits in Accounts

Debits and Credits in Accounts

Debits and credits are the building blocks of the double entry accounting system. Many accounting students find the usage of these words confusing. Many try to understand them by trying to draw an analogy with something they already know like plus and minus. However, debits and credits are distinctly different from plus and minus. Sometimes a debit entry may make an account balance go up whereas other times it will make an account balance go down. Let’s try and understand how this debit and credit system works.

The debit credit system can be understood to be a two layered system. The steps involved in deciding whether an account needs to be debited or credited are as follows:

1. Ascertain the type of account
2. Ascertain the type of transaction

Ascertaining the Type of Account

Accounts are of two types the debit and the credit types. Here is how they are distinguished

• The 4 Classifications: There are four major classifications of accounts in accounting. They are assets, liabilities, income and expenses. Any item can be classified as exactly one of these classifications. However, the same item may be split into two and be part asset and part expense and so on.
• Divide into Two Groups: We could consolidate these 4 categories into 2 categories. Expenses and assets denote outflow of resources from the firm. Income and Liabilities denote inflow of resources to the firm. Thus accounts can be classified as outflow and inflow
  1. The outflow accounts i.e. expenses and assets have a by default debit balance
  2. The inflow accounts i.e. income and sales have a by default credit balance

When you debit an account which has a default debit balance, you increase its value. When you credit an account which has a default debit balance, you decrease its value. The same is true for credit accounts as well.

Ascertain the Type of Transaction

Now you can decide whether to debit or credit an account. Let’s say you have to increase the cash balance. Cash is an asset and therefore has a default debit balance. When you debit it further, you increase its balance. Therefore, you will debit the cash account.

Similarly you can ascertain whether an item needs to be debited or credited. As a check, you must ensure that the debits in every transaction are equal to the credits. This is like the fundamental principle of accounting.

Golden Rules of Accounting

The Problem with Debit Credit Rules

The system of debit and credit is right at the foundation of double entry system of book keeping. It is very useful, however at the same time it is very difficult to use in reality. Understanding the system of debits and credits may require a sophisticated employee. However, no company can afford such ruinous waste of cash for record keeping. It is generally done by clerical staff and people who work at the store. Therefore, golden rules of accounting were devised.

Golden rules convert complex bookkeeping rules into a set of principles which can be easily studied and applied. Here is how the system is applied:

Ascertain the Type of Account

The types of accounts viz. real, nominal and personal have been explained in earlier articles. The golden rules of accounting require that you ascertain the type of account in question. Each account type has its rule that needs to be applied to account for the transactions. The golden rules have been listed below:

The Golden Rules of Accounting

1. Debit The Receiver, Credit The Giver
   This principle is used in the case of personal accounts. When a person gives something to the organization, it becomes an inflow and therefore the person must be credit in the books of accounts. The converse of this is also true, which is why the receiver needs to be debited.
2. Debit What Comes In, Credit What Goes Out
   This principle is applied in case of real accounts. Real accounts involve machinery, land and building etc. They have a debit balance by default. Thus when you debit what comes in, you are adding to the existing account balance. This is exactly what needs to be done. Similarly when you credit what goes out, you are reducing the account balance when a tangible asset goes out of the organization.
3. Debit All Expenses And Losses, Credit All Incomes And Gains
   This rule is applied when the account in question is a nominal account. The capital of the company is a liability. Therefore it has a default credit balance. When you credit all incomes and gains, you increase the capital and by debiting expenses and losses, you decrease the capital. This is exactly what needs to be done for the system to stay in balance.

The golden rules of accounting allow anyone to be a bookkeeper. They only need to understand the types of accounts and then diligently apply the rules.

The 3 Basic Golden Rules of Accounting. 

1. Personal Accounts Accounts recording transaction with persons or firms are known as Personal accounts. Accounts recording transaction which do not effect particular person, but effects business in general are known as Impersonal A/c’s Impersonal A/c’s may be either Real Accounts or Nominal Accounts. 

RULE 

Dr-TheReceiver 

Cr-The Giver 

2. Real Accounts Real Accounts are those accounts of property or possession. 

Example:Goods Accounts, Cash Account, Bank Account, Office Furniture Accounts. 

RULE 

 Dr-What Comes in 

 Cr-What Goes out 

3. Nominal or Fictitious Accounts Records Expenses, gains & losses. 

Examples:Rent A/c Salaries A/c Advertising A/c Interest Recd A/c Discount A/c Commission Recd A/c Wages A/c 

RULE

Dr-All Expenses & Losses 

Cr-All Income & Gains 

Accounting Treatment of Goodwill

ACCOUNTING TREATMENT of GOODWILL

1. Determine the fair value of the company's assets. As mentioned earlier, the carrying value of a business does not always equal the fair value (or the estimated value that someone in the market would pay for the business). The first step is to take the carrying value of the business (or the assets minus the liabilities), and figure out what the fair value of those net assets are.^[4]
   

   • For example, the carrying value of the business being purchased may be $1 million. However, due to recent strong market conditions, the fair value may be slightly higher, at $1.5 million. This means people would pay $1.5 million for those $1 million in assets.
   • Calculating fair value is usually fairly complex and requires plenty of background knowledge, and as a result, the fair value of a business is usually calculated by a certified professional, such an accountant or financial analyst.
   • Typically, figuring out fair value will involve looking at what other similar assets or businesses are selling for. One approach is to average the value of similar businesses being sold, and then price the value of the business being purchased above or below the average depending on the quality of the business.
2. Add together the values of all acquired assets. Once the fair value of assets has been determined, you can add them together. For example, assume the business being purchased has $200,000 in property, plant, and equipment, $500,000 in cash, and $800,000 in inventory.
   

   • The fair value of the business's assets would therefore be $1.5 million.
3. Subtract the business's liabilities from the assets. If the business has liabilities of $500,000, subtracting this from the business's assets of $1.5 million means the fair value of the company's carrying value is $1 million.
   

   • This simply means that if you subtract the business's assets from their liabilities to get a carrying value, and you determine what the market would pay in theory for those assets, the result in this case would be $1 million.
4. Subtract the fair value from the purchase price to calculate Goodwill.Goodwill is defined as the price paid in excess of the fair value of the firm's carrying value. To calculate it, simply subtract the total asset amount from the purchase price; this amount is nearly always a positive number.
   

   • For example, consider a firm that acquires another firm for $1,000,000. If the fair value of the acquired firm totals $800,000, then the amount of goodwill realized is (1,000,000 - 800,000) or $200,000.
5. Record the journal entry to recognize the acquisition. Once the amount of Goodwill is determined, open whatever accounting software you use to enter the appropriate general entries.
   

   • Continuing with the above example, the firm would debit Goodwill for $200,000, debit the acquired asset account for $800,000, and credit Cash for $1,000,000. Goodwill is an intangible asset account on the balance sheet.
   • This series of entries adds the $800,000 in assets to the books, adds the $200,000 in Goodwill, and subtracts $1 million in cash from the books to reflect cash leaving to fund the purchase.
6. Test the goodwill account for impairment each year. Each year, Goodwill needs to be tested for something known as impairment. Impairment occurs when something bad happens to a business, which causes the fair value of it's assets to decline below the carrying value. When this happens, Goodwill needs to be reduced by the amount the fair value falls below the carrying value. ^[5]
   

   • For example, assume you made a purchase for $1.5 million, where $500,000 is Goodwill, and the carrying value of the assets are $1 million. If sales drop dramatically, those $1 million of assets will not have a fair value of $1 million anymore. If the fair value drops to $800,000, would would need to reduce Goodwill by $200,000 to reflect the drop in the value of the assets.
7. Record the journal entry to recognize any goodwill impairment. If the goodwill account needs to be impaired, an entry is needed in the general journal. To record the entry, debit Loss on Impairment and credit Goodwill for the necessary amount.

Accounting Treatment of Purchased Goodwill

After having acquired purchased goodwill the first question that arises in your mind is – How to treat this acquired Goodwill in your books of accounts? Wheather to show it as an asset along with other possessions of the business and to slowly amortize it over its useful life or to retain it in the business or to immediately write it off against capital reserve. If you decide to amortize this goodwill you again have to decide how to write it off i.e. against your profits or against reserves. Here we are giving you some options to treat Purchased Goodwill in your books.

1) To show it as an asset in the Balance sheet of the company like other assets. Its estimated useful life is determined. It is then written off (amortized) over its estimated useful life through Profit and Loss account or Income statement.

2) To show it as an asset in the Balance sheet and amortize it over its estimated useful life against general reserve or capital reserve or both.

3) To eliminate it completely against capital reserves immediately on its acquisition.

4) To write it off just like any other expense through Profit and Loss account in the accounting period in which it was acquired.

5) To retain it in your business, unless a permanent reduction occurs in it due to circumstances.

Goodwill and Accounting Standard (AS) – 10 : Accounting For Fixed Assets:

AS-10 Accounting for Fixed asset requires you to treat Goodwill in your books as follow:

1) Goodwill can be recored in the books only when it has been acquired after paying some consideration in money;

2) On acquisition of a business entity by some another one for a price, If the price exceeds the value of net assets taken over, the difference in the price paid and the value of net assets is termed as Purchased Goodwill and it is shown in the Balance sheet of the acquiring concern.

3) Goodwill should be written off as early as possible.

Goodwill and Accounting Standard (AS) – 14: Accounting for Amalgamation:

It provides for the following treatment of Goodwill in the case of amalgamation in the nature of purchase:

1) Goodwill arising on amalgamation represents a payment made in the anticipation of future profits and it is appropriate to show it as asset in the books of accounts.

2)This Goodwill should be amortized to income over its useful life on a systematic basis.

3) It is appropriate to amortize Goodwill over a period not exceeding 5 years unless a longer period can be justified.

4) While estimating the useful life of Goodwill, the following factors should be considered:

i) The foreseeable life of the business or industry;

ii) The effect of product obsolescence, change in demand and other economic factors;

iii) The service life expectancies of the key individuals involved or group of employees;

iv) Expected actions by competitors or potential competitors; and

v) Legal, regulatory or contractual provisions affecting the useful life.

Accounting Entries for Goodwill in Partnership

We have researched for latest 2013 accounting entries for goodwill in partnership at the time of admission of a new partner in the partnership firm. As per Accounting standard 10 of Indian GAAP, we will treat the goodwill in the book of firm if a new partner will bring the goodwill in cash or cash's worth. Otherwise, there will not be any treatment.

Now on this basis, we are passing accounting entries for goodwill in partnership.

1. When A New Partner Gives the Goodwill in Cash Privately

If a new partner came and got his profit share from old partner and gave the goodwill in the pocket of old partner privately without any information or proof to public. Its accounting entry will not be in the books of account.

2. When A New Partner Gives Goodwill in Cash and Mentioned to Public

A new partner came. Goodwill gave to old partner in cash and he mentioned this in public. Same goodwill will be kept in the business as Asset . Following entries will be passed.

1st Entry

Cash / Bank Account Debit

Goodwill / Premium Account Credit

2nd Entry

Goodwill / Premium Account Debit

Old Partner's Capital Account Credit

( In sacrifice ratio, old partner will divide the goodwill)

3. When A New Partner Gives Goodwill in Cash and Old Partners Withdraw

A new partner came. Goodwill gave to old partner in cash and he mentioned this in public. Same goodwill will be kept in the business as Asset . But after this, same day or other day, old partner withdraw the goodwill. Following entries will be passed.

1st Entry

Cash / Bank Account Debit

Goodwill / Premium Account Credit

2nd Entry 

Goodwill / Premium Account Debit

Old Partner's Capital Account Credit

( In sacrifice ratio, old partner will divide the goodwill)

3rd Entry 

Old Partner's Capital Account Debit

Cash/ Bank

( In sacrifice ratio, old partner will withdraw the goodwill amount)

4. When A New Partner will not Pay Goodwill in Cash But Adjustment through His Capital Account 

At that time, we will pass following journal entry 

New Partner's Capital Account Debit 

Old Partner's Capital Account Credit 

( In sacrifice ratio, old partner will divide the goodwill proportion through new partner's capital adjustment. New partner's capital will decrease and new partner's capital will increase. )

5. When A New Partner will not Pay  whole in Cash Goodwill 

If a new partner has decided that he will some proportion of goodwill in cash and other in his capital adjustment. At that time, following entry will be pass. 

1st Entry

Cash / Bank Account Debit

Goodwill / Premium Account Credit ( suppose, it is the 60% of total payable goodwill by a new partner)

2nd Entry

Goodwill / Premium Account Debit ( 60% of total goodwill)

New Partner's Capital Account Debit (40% of total goodwill)

Old Partner's Capital Account Credit ( 100%)

( In sacrifice ratio, old partner will divide the goodwill)

6. When A New Partner will Give Goodwill in Kind of Any Asset 

when a new partner has decided to give the goodwill to old partner in the form of any asset. At that time, following entry will be passed. 

1st Entry 

Assets which is Given by New Partner Account Debit 

New Partner's Capital Account Credit 

Goodwill/ Premium Account Credit ( Difference between asset and capital)

2nd Entry 

Goodwill/Premium Account Debit 

Old Partner's Capital Account Credit 

( In sacrifice ratio, old partner will divide the goodwill)

7. When there is Goodwill in Balance Sheet or Books 

We do the action for  written off all these goodwill by transferring in old partners' capital account  and then all other above treatment will do. 

For Written off the goodwill in old balance sheet 

Old Partners' Capital Account Debit 

Goodwill/ Premium Account Credit 

( this goodwill will be written off in old sharing ratio between the old partners. )

Goodwill

Goodwill 

Goodwill in accounting is an intangible asset that arises when a buyer acquires an existing business, but pays more than the fair market value of the net assets (total assets - total liabilities).

An intangible asset that arises as a result of the acquisition of one company by another for a premium value. The value of a company’s brand name, solid customer base, good customer relations, good employee relations and any patents or proprietary technology represent goodwill. Goodwill is considered an intangible asset because it is not a physical asset like buildings or equipment. The goodwill account can be found in the assets portion of a company's balance sheet.

Negative goodwill arises when an acquirer pays less for an acquiree than the fair value of its assets and liabilities. This situation usually only arises as part of a distressed sale of a business.

Breaking Down

The value of goodwill typically arises in an acquisition when one company is purchased by another company. The amount the acquiring company pays for the target company over the target’s book value usually accounts for the value of the target’s goodwill. If the acquiring company pays less than the target’s book value, it gains “negative goodwill,” meaning that it purchased the company at a bargain in a distress sale.

Goodwill is difficult to price, but it does make a company more valuable. For example, a company like Coca-Cola (who has been around for decades, makes a wildly popular product based on a secret formula and is generally positively perceived by the public), would have a lot of goodwill. A competitor (a small, regional soda company that has only been in business for five years, has a small customer base, specializes in unusual soda flavors and recently faced a scandal over a contaminated batch of soda), would have far less goodwill, or even negative goodwill.

Because the components that make up goodwill have subjective values, there is a substantial risk that a company could overvalue goodwill in an acquisition. This overvaluation would be bad news for shareholders of the acquiring company, since they would likely see their share values drop when the company later has to write down goodwill. In fact, this happened in the AOL-Time Warner merger of 2001.

Goodwill vs Other Intangible Assets

Companies looking to grow and expand in their business strive not only to acquire tangible assets like land, buildings and factories, but also intangible assets like trademarks, copyrights, patents, formulas, franchises, goodwill, etc. And most major companies that you've heard of--companies with any kind of shelf life--rely heavily on both kinds of assets.

Intangible assets are non-physical assets; differently put, they don’t have a physical substance. These intangible assets can be either developed internally by a company or acquired from others. Intangible assets can sometimes outweigh tangible assets in terms of value, and they are a defining factor for the long-term success of a business. Despite their importance, however, intangible assets are sometimes difficult to recognize, define and measure.

Intangible assets can be further categorized into identifiable and unidentifiable intangibles. Intangibles such as patents, copyrights, licenses, secret formulas, franchise, trademarks, etc fall under the category of identifiable intangibles, while goodwill is the most common unidentifiable intangible. Intangible assets can further categorized as indefinite or definite, depending on the specifics. For example, a patent has a definite life or time frame, whereas such timelines don’t exist for a brand name company's reputation.

There are many factors that separate goodwill from the other intangible assets.

The value of a company may not always be correctly quantified by the assets. A business over a period of time develops customer loyalty, brand name and reputation--all of which make it worth more than its book value. This “X” factor that makes the business worth more than its quantifiable assets is “goodwill”. Say a soft drink company was sold for $120 million, it had assets worth $100 million and liabilities of $20 million. The sum of $40 million that was paid over and above $80 million (=assets - liabilities or $100 - $20) is the worth of goodwill and is recorded in the books as such.

Goodwill, as a typical unidentifiable intangible asset, cannot exist independently of the business, nor can it be sold, purchased or transferred separately without carrying out the same transactions for the business as a whole. In quantifiable terms, goodwill is usually represented by the excess of cost paid during an acquisition which is over and above the fair value of assets. Goodwill can be positive as well as negative and is a part of any acquisition. The life span of goodwill is not definite; it has a useful life which is indefinite unlike most of the other intangible assets.

Other intangible assets, however, can be quantified and have a separate identity of their own which is independent of the business as a whole. They can be bought and sold, rented or exchanged or acquired through legal or contractual rights. The common ones in this category are patents, copyrights, trademarks, etc. The intangible assets have different life spans according to the rules and regulations. For instance, the United States Patent and Trademark Office grants the owner of an invention, patent rights for a period of 20 years. A company can buy a patent by paying a specified amount for a specific period (a case where intangible asset is bought).

The Financial Accounting Standard Board (FASB) has come up with a new alternative rule for accounting of goodwill for private companies. The rules by FASB for public companies and non-profit organizations are to be addressed in a future project. The last amendment was made in 2001 and before that in the 1970s. During that time, goodwill was amortized against earnings over a period not to exceed 40 years. In 2001, there was a change in rules according to which goodwill could not be amortized; but rather was evaluated annually to determine impairment loss. The annual valuation process was expensive as well as time-consuming.

As per the alternative FASB rule for private companies (2014), goodwill can be amortized on a straight-line basis over a period not to exceed ten years. The need to test for impairment has decreased under this rule but not eliminated; test for impairment is conducted when some event occurs that signals that the fair value may be have gone below the carrying amount. The new alternative rule is likely to result in cost savings for private companies. These rules apply to businesses conforming to Generally Accepted Accounting Principles (GAAP) using a full accrual accounting method. Intangible assets having a finite useful life need to be amortized over the estimated useful life. If conditions indicate that the carrying value may not be recoverable, then tests for impairment are performed.

Small businesses using cash-basis accounting or modified cash-basis accounting can use the statutory rates set by the Internal Revenue Service (IRS). The IRS allows for a 15 year write-off period for the intangibles that have been purchased. There is a lot of overlap as well as contrast between the IRS and GAAP reporting. Be sure to understand them and then proceed correctly. Read more about reporting requirements of small businesses here.

Goodwill, patents, copyrights, licenses, franchises, etc. all fall under the category of intangible assets. These assets do not possess any physical substance but are of great importance to any business over the long term. Goodwill is a premium paid over the fair value of assets during the purchase process of a company. Hence, it is tagged to a company or business and cannot be sold or purchased independently, whereas other intangible assets like licenses, patents, etc. can be sold and purchased independently. Goodwill is perceived to have an indefinite life (as long as the company operates) while other intangible assets have a definite useful life and are amortized over those years.

COPYRIGHT vs. TRADEMARK vs. PATENT

PATENT vs. COPYRIGHT vs. TRADEMARK

Some people confuse patents, copyrights, and trademarks. Although there may be some similarities among these kinds of intellectual property protection, they are different and serve different purposes. 

What Is a Patent?

A patent for an invention is the grant of a property right to the inventor, issued by the Patent and Trademark Office. The term of a new patent is 20 years from the date on which the application for the patent was filed in the United States or, in special cases, from the date an earlier related application was filed, subject to the payment of maintenance fees. US patent grants are effective only within the US, US territories, and US possessions.

The right conferred by the patent grant is, in the language of the statute and of the grant itself, "the right to exclude others from making, using, offering for sale, or selling" the invention in the United States or "importing" the invention into the United States. What is granted is not the right to make, use, offer for sale, sell or import, but the right to exclude others from making, using, offering for sale, selling or importing the invention.

What Is a Copyright? 

A Copyright protects original creative works such as books, movies, songs, paintings, photographs, web content and choreography. As the owner of a federally registered copyright, you can control how your work is reproduced, distributed and presented publicly, and you can sue infringers in federal court and prevent others from importing infringing goods.

Copyright is a form of protection provided to the authors of "original works of authorship" including literary, dramatic, musical, artistic, and certain other intellectual works, both published and unpublished. The 1976 Copyright Act generally gives the owner of copyright the exclusive right to reproduce the copyrighted work, to prepare derivative works, to distribute copies or phonorecords of the copyrighted work, to perform the copyrighted work publicly, or to display the copyrighted work publicly.

The copyright protects the form of expression rather than the subject matter of the writing. For example, a description of a machine could be copyrighted, but this would only prevent others from copying the description; it would not prevent others from writing a description of their own or from making and using the machine. Copyrights are registered by the Copyright Office of the Library of Congress. 

What Is a Trademark or Servicemark?

A trademark is a word, name, symbol or device which is used in trade with goods to indicate the source of the goods and to distinguish them from the goods of others. A servicemark is the same as a trademark except that it identifies and distinguishes the source of a service rather than a product. The terms "trademark" and "mark" are commonly used to refer to both trademarks and servicemarks.

Trademark rights may be used to prevent others from using a confusingly similar mark, but not to prevent others from making the same goods or from selling the same goods or services under a clearly different mark. Trademarks which are used in interstate or foreign commerce may be registered with the Patent and Trademark Office. The registration procedure for trademarks and general information concerning trademarks is described in a separate pamphlet entitled "Basic Facts about Trademarks". 

A Trademark protects names, terms and symbols that are used to identify the source of goods and/or services on the market. In other words, a trademark lets the consumer distinguish one company's offerings from another's. Trademarks include brand names such as "Coca-Cola" and images such as Nike's famous "swoosh." As the owner of a federally registered trademark, you can sue for trademark infringement in federal court and prevent the importation of foreign goods that display your trademark. 

Copyright vs. Trademark

1.   The purpose of a copyright is to protect works of authorship as fixed in a tangible form of expression. Thus, copyright covers: a) works of art (2 or 3 dimensional), b) photos, pictures, graphic designs, drawings and other forms of images; c) songs, music and sound recordings of all kinds; d) books, manuscripts, publications and other written works; and e) plays, movies, shows, and other performance arts. 

2.   The purpose of a trademark is to protect words, phrases and logos used in federally regulated commerce to identify the source of goods and/or services. 

3.   There may be occasions when both copyright and trademark protection are desired with respect to the same business endeavor. For example, a marketing campaign for a new product may introduce a new slogan for use with the product, which also appears in advertisements for the product. However, copyright and trademark protection will cover different things. The advertisement's text and graphics, as published in a particular vehicle, will be covered by copyright - but this will not protect the slogan as such. The slogan may be protected by trademark law, but this will not cover the rest of the advertisement. If you want both forms of protection, you will have to perform both types of registration. 

4.   If you are interested in protecting a title, slogan, or other short word phrase, generally you want a trademark. Copyright law does not protect a bare phrase, slogan, or trade name. 

5.   Whether an image should be protected by trademark or copyright law depends on whether its use is intended to identify the source of goods or services. If an image is used temporarily in an ad campaign, it generally is not the type of thing intended to be protected as a logo. 

6.   The registration processes of copyright and trademark are entirely different. For copyright, the filing fee is small, the time to obtain registration is relatively short, and examination by the Copyright Office is limited to ensuring that the registration application is properly completed and suitable copies are attached. For trademark, the filing fee is more substantial, the time to obtain registration is much longer, and examination by the Trademark Office includes a substantive review of potentially conflicting marks which are found to be confusingly similar. While copyright registration is primarily an administrative process, trademark registration is very much an adversarial process. 

7.   Copyright law provides for compulsory licensing and royalty payments - there is no analogous concept in trademark law. Plus, the tests and definition of infringement are considerably different under copyright law and trademark law. 

Brand vs Trademark

Brand vs Trademark

Brand Names Defined

The Blackcoffee website article, "Creating a Brand Name," states that brand names are signals that carry meaning in the minds of consumers. A brand name should be memorable so that it carries a favorable image of your business in the minds of customers you wish to attract. When people see or hear the words "Kentucky Fried Chicken" or "Wal-Mart," they immediately know what those brands stand for. These brand names are also trademarks of these companies.

Trademark Definition

The U.S. Patent and Trademark Office defines a trademark as words, names, symbols and product design features that are used to distinguish the products or services of one manufacturer or seller from another.

Purpose

The goal of a brand name is to provide an easy to recognize and remember name that evokes a positive response in consumers. For example, many shoppers prefer to buy "brand name" products as opposed to the generic kind because of their perceived value.

A trademark provides legal protection of the brand name. Through registration, the company is able to seek legal action against others who copy or use the brand without permission.

Difference

It is commonly seen that people remain confused between brand and trademark of a company. The two concepts, despite many similarities have different purposes and nature that people either overlook, or are not aware of. Using them interchangeably as if the two were synonyms is a big mistake that many people commit, but this is perhaps because of the fact that all trademarks are brands, whereas not all brands are trademarks. In this article, differences between the two concepts will be highlighted for the benefit of those who fumble between them.

Did you know, the word brand comes from brandr meaning to burn? It actually, comes from an ancient practice of applying hot iron stamp on the body of sheep to differentiate them from other sheep. This branding ensured the owner could know instantly if the sheep was indeed his or not. In fact, branding sheep became so common place that when certain rancher called Samuel Maverick decided to leave his sheep unbranded as all others in his area were branded and he did not need any branding, the word maverick got associated with unbranded cattle.

It was after industrial revolution that factories could produce goods at a mass scale, and this necessitated their sale in wider areas. Factories wanted their goods to be known and remembered in larger areas, and this led to the development of brands that allowed people to know about a particular product just hearing the name. Do you need anything more after you hear names like IBM, Apple, Coca-Cola, KFC, Wal-Mart, and so on? This is what is known as brand power. When a brand is registered with the Patent and Trademarks office, it becomes a trade mark. Thus, there is not much of a difference between a brand and a trademark. Trademark is a legal device that protect unlawful use of the brand name by any one else, and grants the owner of the trademark exclusive rights over the use of the brand name.

Brand names are like signals that convey a meaning in the minds of consumers, and creates a favorable image of a product in their minds to attract them to the products or services of the company. Brand name has a commercial purpose and recollection value in the minds of the customers. Mostly brand names are visual identifiers of a business there are cases where a sound has become a brand name as in the case of MGM (the roar of a lion ) and Nokia (the original Nokia ring tone). Trade mark is in itself just a protector of a brand, and it gives the owner right to sue any unauthorized use of the trademark.

A brand is an image, a set of promises made by a company about its product, high quality, durability, and ease of use of a product as the case may be. It is this brand image that produces consumer loyalty, something that holds much greater value to a company than 100’s of one time customers.

Investment Banking

Investment Banking

Investment banking, or I-banking, as it is often called, is the term used to describe the business of raising capital for companies and advising them on financing and merger alternatives. Capital essentially means money. Companies need cash in order to grow and expand their businesses;

investment banks sell securities to public investors in order to raise this cash.

The biggest investment banks include Goldman Sachs, Merrill Lynch, Morgan Stanley, Credit Suisse First Boston, Citigroup’s Global Corporate Investment Bank, JPMorgan Chase and Lehman Brothers, among others.

Generally, the breakdown of an investment bank includes the following areas:

·        Corporate Finance (equity)

·        Corporate Finance (debt)

·        Mergers & Acquisitions (M&A)

·        Equity Sales

·        Fixed Income Sales

·        Syndicate (equity)

·        Syndicate (debt)

·        Equity Trading

·        Fixed Income Trading

·        Equity Research

·        Fixed Income Research

Corporate finance

The bread and butter of a traditional investment bank, corporate finance generally performs two different functions: 1) Mergers and acquisitions advisory and 2) Underwriting. On the mergers and acquisitions (M&A) advising side of corporate finance, bankers assist in negotiating and structuring a merger between two companies. If, for example, a company wants to buy another firm, then an investment bank will help finalize the purchase price, structure the deal, and generally ensure a smooth  transaction. The underwriting function within corporate finance involves shepherding the process of raising capital for a company. In the investment banking world, capital can be raised by selling either stocks or bonds (as well as some more exotic securities) to investors.

Sales

Sales is another core component of any investment bank. Salespeople take the form of: 1) the classic retail broker, 2) the institutional salesperson, or 3) the private client service representative. Retail brokers develop

relationships with individual investors and sell stocks and stock advice to the average Joe. Institutional salespeople develop business relationships with large institutional investors. Institutional investors are those who

manage large groups of assets, for example pension funds, mutual funds, or large corporations. Private Client Service (PCS) representatives lie somewhere between retail brokers and institutional salespeople, providing

brokerage and money management services for extremely wealthy individuals. Salespeople make money through commissions on trades made through their firms or, increasingly, as a percentage of their clients’ assets with the firm.

Trading

Traders also provide a vital role for the investment bank. In general, traders facilitate the buying and selling of stocks, bonds, and other securities such as currencies and futures, either by carrying an inventory of securities for

sale or by executing a given trade for a client. A trader plays two distinct roles for an investment bank:

(1) Providing liquidity: Traders provide liquidity to the firm’s clients (that is, providing clients with the ability to buy or sell a security on demand). Traders so this by standing ready to immediately buy the client’s

securities (for sell securities to the client) if the client needs to place a trade quickly. This is also called making a market, or acting as a market maker. Traders performing this function make money for the firm by selling securities at a slightly higher price than they pay for them. This price differential is known as the bid-ask spread. (The bid price at any given time is the price at which customers can sell a security, which is usually slightly lower than the ask price, which is the price at which customers can buy the same security.)

(2) Proprietary trading: In addition to providing liquidity and executing traders for the firm’s customers, traders also may take their own trading positions on behalf of the firm, using the firm’s capital hoping to benefit

from the rise or fall in the price of securities. This is called proprietary trading. Typically, the marketing-making function and the proprietary trading function is performed by the same trader for any given security. For example, Morgan Stanley’s Five Year Treasury Note trader will typically both make a market in the 5-Year Note as well as take trading  positions in the 5-Year Note for Morgan Stanley’s own account.

Research

Research analysts follow stocks and bonds and make recommendations on whether to buy, sell, or hold those securities. They also forecast companies’ future earnings. Stock analysts (known as equity analysts) typically focus on one industry and will cover up to 20 companies’ stocks at any given time. Some research analysts work on the fixed income side and will cover a particular segment, such as a particular industry’s high yield bonds.

Salespeople within the I-bank utilize research published by analysts to convince their clients to buy or sell securities through their firm. Corporate finance bankers rely on research analysts to be experts in the industry in

which they are working. Reputable research analysts can generate substantial corporate finance business for their firm as well as substantial trading  activity, and thus are an integral part of any investment bank.

Syndicate

The hub of the investment banking wheel, the syndicate group provides a vital link between salespeople and corporate finance. Syndicate exists to facilitate the placing of securities in a public offering, a knock-down dragout affair between and among buyers of offerings and the investment banks managing the process. In a corporate or municipal debt deal, syndicate also determines the allocation of bonds.

Commercial Banking vs. Investment Banking

While regulation has changed the businesses in which commercial and investment banks may now participate, the core aspects of these different businesses remain intact. In other words, the difference between how a

typical investment bank and a typical commercial operate bank can be simplified: A commercial bank takes deposits for checking and savings accounts from consumers while an investment bank does not.

Commercial banks

A commercial bank may legally take deposits for checking and savings accounts from consumers. The federal government provides insurance guarantees on these deposits through the Federal Deposit Insurance Corporation (the FDIC), on amounts up to $100,000. To get FDIC guarantees, commercial banks must follow a myriad of regulations. The typical commercial banking process is fairly straightforward. You deposit money into your bank, and the bank loans that money to consumers and companies in need of capital (cash). You borrow to buy a house, finance a car, or finance an addition to your home. Companies borrow to finance the growth of their company or meet immediate cash needs. Companies that borrow from commercial banks can range in size from the dry cleaner on the corner to a multinational conglomerate. The commercial bank generates a profit by paying depositors a lower interest rate than the bank charges on loans.

Investment banks

An investment bank operates differently. An investment bank does not have an inventory of cash deposits to lend as a commercial bank does. In essence, an investment bank acts as an intermediary, and matches sellers of

stocks and bonds with buyers of stocks and bonds.

Private Debt vs. Bonds – An Example

Let’s look at an example to illustrate the difference between private debt and bonds. Suppose Acme Cleaning Company needs capital, and estimates its need to be $200 million. Acme could obtain a commercial bank loan from Bank of New York for the entire $200 million, and pay interest on that loan just like you would pay on a $2,000 personal finance loan from Bank of New York. Alternately, it could sell bonds publicly using an investment bank such as Merrill Lynch. The $200 million bond issue raised by Merrill would be broken into many smaller bonds and then sold to the public. (For example, the issue could be broken into 200,000 bonds, each worth $1,000.) Once sold, the company receives its $200 million (less Merrill’s fees) and investors receive bonds worth a total of the same amount.

Over time, the investors in the bond offering receive coupon payments (the interest), and ultimately the principal (the original $1,000) at the end of the life of the loan, when Acme Corp buys back the bonds (retires the bonds). Thus, we see that in a bond offering, while the money is still loaned to Acme, it is actually loaned by numerous investors, rather than from a single bank.

Because the investment bank involved in the offering does not own the bonds but merely placed them with investors at the outset, it earns no interest – the bondholders earn this interest in the form of regular coupon payments. The investment bank makes money by charging the client (in this case, Acme) a small percentage of the transaction upon its completion. Investment banks call this upfront fee the “underwriting discount.” In contrast, a commercial bank making a loan actually receives the interest and simultaneously owns the debt.

The Buy-Side vs. the Sell-Side

The traditional investment banking world is considered the “sell-side” of the securities industry. Why? Investment banks create stocks and bonds, and sell these securities to investors. Sell is the key word, as I-banks continually sell their firms’ capabilities to generate corporate finance business, and salespeople sell securities to generate commission revenue. Who are the buyers (“buy-side”) of public stocks and bonds? They are individual investors (you and me) and institutional investors, firms like Fidelity and Vanguard, and organizations like Harvard University and state and coporate pension funds. The universe of institutional investors is appropriately called the buy-side of the securities industry.

Fidelity, T. Rowe Price, Janus and other mutual fund companies now represent a large portion of the buy-side business. Insurance companies like Prudential and Northwestern Mutual also manage large blocks of assets

and are another segment of the buy-side. Yet another class of buy-side firms manage pension fund assets – frequently, a company’s pension assets will be given to a specialty buy-side firm that can better manage the funds and hopefully generate higher returns than the company itself could have. There is substantial overlap among these money managers – some, such as Putnam and T. Rowe, manage both mutual funds for individuals as well as pension fund assets of large corporations.

Big-cap and small-cap

At a basic level, market capitalization or market cap represents the company’s value according to the market, and is calculated by multiplying the total number of shares by share price. (This is the equity value of the

company.) Companies and their stocks tend to be categorized into three broad categories: big-cap, mid-cap and small-cap.

While there are no hard and fast rules, generally speaking, a company with a market cap greater than $5 billion will be classified as a big-cap stock. These companies tend to be established, mature companies, although with

some IPOs rising rapidly, this is not necessarily the case. Sometimes huge companies with $25 billion and greater market caps, for example, GE and Microsoft, are called mega-cap stocks. Small-cap stocks tend to be riskier, but are also often the faster growing companies. Roughly speaking, a small-cap stock includes those companies with market caps less than $1 billion. And as one might expect, the stocks in between $1 billion and $5 billion are referred to as mid-cap stocks.

What moves the stock market?

Not surprisingly, the factors that most influence the broader stock market are economic in nature. Among equities, corporate profits and the interest rates are king.

Corporate profits: When Gross Domestic Product slows substantially, market investors fear a recession and a drop in corporate profits. And if economic conditions worsen and the market enters a recession, many

companies will face reduced demand for their products, company earnings will be hurt, and hence equity (stock) prices will decline. Thus, when the GDP suffers, so does the stock market.

Interest rates: When the Consumer Price Index heats up, investors fear inflation. Inflation fears trigger a different chain of events than fears of recession. Most importantly, inflation will cause interest rates to rise.

Companies with debt will be forced to pay higher interest rates on existing debt, thereby reducing earnings (and earnings per share). And compounding the problem, because inflation fears cause interest rates to rise, higher rates will make investments other than stocks more attractive from the investor’s perspective. Why would an investor purchase a stock that may only earn 8 percent (and carries substantial risk), when lower risk CD’s and government bonds offer similar yields with less risk? These inflation fears are known as capital allocations in the market (whether investors are putting money into stocks vs. bonds), which can substantially impact stock and bond prices. Investors typically re-allocate funds from stocks to low-risk bonds when the economy experiences a slowdown and vice versa when the opposite occurs.

What moves individual stocks?

When it comes to individual stocks, it’s all about earnings, earnings, earnings. No other measure even compares to earnings per share (EPS) when it comes to an individual stock’s price. Every quarter, public companies must report EPS figures, and stockholders wait with bated breath, ready to compare the actual EPS figure with the EPS estimates set by Wall Street research analysts. For instance, if a company reports $1.00 EPS for a quarter, but the market had anticipated EPS of $1.20, then the stock will almost certainly be dramatically hit in the market the next trading day. Conversely, a company that beats its estimates will typically rally in the markets.

It is important to note at this point, that in the frenzied Internet stock market of 1999 and early 2000, investors did not show the traditional focus on nearterm earnings. It was acceptable for these companies to operate at a loss for a year or more, because these companies, investors hoped, would achieve long term future earnings. However, when the markets turned in the spring of 2000 investors began to expect even “new economy”  companies to demonstrate more substantial near-term earnings capacity. The market does not care about last year’s earnings or even last quarter’s earnings. What matters most is what will happen in the near future. Investors maintain a tough, “what have you done for me lately” attitude, and forgive slowly a company that consistently fails to meet analysts’ estimates (“misses its numbers”).

Stock Valuation Measures and Ratios:

P/E ratio

You can’t go far into a discussion about the stock market without hearing about the all-important price to earnings ratio, or P/E ratio. By definition, a P/E ratio equals the stock price divided by the earnings per share. In

usage, investors use the P/E ratio to indicate how cheap or expensive a stock is.

Consider the following example. Two similar firms each have $1.50 in EPS. Company A’s stock price is $15.00 per share, and Company B’s stock price is $30.00 per share.

Company	Stock Price	Earnings Per share	P/E RATIO
A	15	1.5	10
B	30	1.5	20

Clearly, Company Ais cheaper than Company B with regard to the P/E ratio because both firms exhibit the same level of earnings, but A’s stock trades at a higher price. That is, Company A’s P/E ratio of 10 (15/1.5) is lower than Company B’s P/E ratio of 20 (30/1.5). Hence, Company A’s stock trades at a lower price. The terminology one hears in the market is, “Company A is trading at 10 times earnings, while Company B is trading at 20 times earnings.” Twenty times is a higher multiple.

PEG ratio:

Because companies grow at different rates, another comparison investors often make is between the P/E ratio and the stock’s expected growth rate in EPS. Returning to our previous example, let’s say Company A has an expected EPS growth rate of 10 percent, while Company B’s expected growth rate is 20 percent.

Company	Stock Price	Earnings Per share	P/E RATIO
A	15	1.5	10
B	30	1.5	20

We might propose that the market values Company A at 10 times earnings because it anticipates 10 percent annual growth in EPS over the next five years. Company B is growing faster – at a 20 percent rate – and therefore justifies the 20 times earnings stock price. To determine true cheapness, market analysts have developed a ratio that compares the P/E to the growth rate – the PEG ratio. In this example, one could argue that both companies are priced similarly (both have PEG ratios of 1).

Sophisticated market investors therefore utilize this PEG ratio rather than just the P/E ratio. Roughly speaking, the average company has a PEG ratio of 1:1 or 1 (i.e., the P/E ratio matches the anticipated growth rate). By

convention, “expensive” firms have a PEG ratio greater than one, and “cheap” stocks have a PEG ratio less than one.

Cash flow multiples:

For companies with no earnings (or losses) and therefore no EPS (or negative EPS), one cannot calculate the P/E ratio – it is a meaningless number. An alternative is to compute the firm’s cash flow and compare that

to the market value of the firm. The following example illustrates how a typical cash flow multiple like Enterprise Value/EBITDA ratio is calculated.

EBITDA:

 A proxy for cash flow, EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. To calculate EBITDA, work your way up the Income Statement, adding back the appropriate items to net income. (Note: For a more detailed explanation of this and other financial caculations, see the Vault Guide to Finance Interviews.) Adding together depreciation and amortization to operating earnings, a common subtotal on the income statement, can serve as a shortcut to calculating EBITDA.

Enterprise value (EV) = market value of equity + net debt. To

compute market value of equity, simply multiply the current stock price

times the number of shares outstanding. Net debt is simply the firm’s

total debt (as found on the balance sheet) minus cash.

Enterprise value to revenue multiple (EV/revenue):

If you follow startup companies or young technology or healthcare related

companies, you have probably heard the multiple of revenue lingo.

Sometimes it is called the price-sales ratio (though this technically is not

correct). Why use this ratio? For one, many firms not only have negative

earnings, but also negative cash flow. That means any cash flow or P/E

multiple must be thrown out the window, leaving revenue as the last

positive income statement number left to compare to the firm’s enterprise

value. Specifically one calculates this ratio by dividing EV by the last 12

months revenue figure.

Return on equity (ROE):

ROE = Net income divided by total shareholders equity. An important

measure, especially for financial services companies, that evaluates the

income return that a firm earned in any given year. Return on equity is

expressed as a percentage. Many firms’ financial goal is to achieve a

certain level of ROE per year, say 20 percent or more.

Value Stocks, Growth Stocks and Momentum Investors

It is important to know that investors typically classify stocks into one of two categories – growth and value stocks. Momentum investors buy a subset of the stocks in the growth category.

Value stocks are those that often have been battered by investors. Typically, a stock that trades at low P/E ratios after having once traded at high P/E’s, or a stock with declining sales or earnings fits into the value category. Investors choose value stocks with the hope that their businesses will turn around and profits will return. Or, investors perhaps realize that a stock is trading close to or even below its “break-up value” (net proceeds upon liquidation of the company), and hence have little downside.

.

Growth stocks are just the opposite. High P/E’s, high growth rates, and

often hot stocks fit the growth category. Technology stocks, with

sometimes astoundingly high P/E’s, may be classified as growth stocks,

based on their high growth potential. Keep in mind that a P/E ratio often

serves as a proxy for a firm’s average expected growth rate, because as

discussed, investors will generally pay a high P/E for a faster growing

company.

Momentum investors buy growth stocks that have exhibited strong upward

price appreciation. Usually trading at or near their “52-week highs” (the

highest trading price during the previous two weeks), momentum investors

cause these stocks to trade up and down with extreme volatility.

Momentum investors, who typically don’t care much about the firm’s

business or valuation ratios, will dump their stocks the moment they show

price weakness. Thus, a stock run-up by momentum investors can

potentially crash dramatically as they bail out at the first sign of trouble.

Basic Equity Definitions

Common stock: Also called common equity, common stock represents an ownership interest in a company. The vast majority of stock traded in the markets today is common. Common stock enables investors to vote on company matters.

Convertible preferred stock: This is a relatively uncommon type of

equity issued by a company, often when it cannot successfully sell

either straight common stock or straight debt. in a manner similar to the way a bond pays coupon payments. However, preferred stock

ultimately converts to common stock after a period of time. Preferred

stock can be viewed as a mix of debt and equity, and is most often used as a way for a risky company to obtain capital when neither debt nor equity works.

Non-convertible preferred stock: Sometimes companies (usually those with steady and predictable earnings) issue non-convertible preferred stock that pays steady dividends. This stock remains outstanding in perpetuity and trades similar to bonds. Utilities represent the best example of non-convertible preferred stock issuers. Preferred stock pays a dividend,