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how can households implement cost controls | cost controls are often associated with increasing the operating efficiency of a business however individuals and households can also benefit from such strategies to increase savings and cash flows establishing and sticking to a budget is one key strategy shopping around and comparing competitors prices is another way to keep prices down look to shop when items are on sale and consider second hand goods if possible | |
what is the cost of debt | the cost of debt is the total interest expense owed on a debt put simply the cost of debt is the effective interest rate or the total amount of interest that a company or individual owes on any liabilities such as bonds and loans this expense can refer to either the before tax or after tax cost of debt the degree of the cost of debt depends entirely on the borrower s creditworthiness so higher costs mean the borrower is considered risky investopedia julie bang | |
how the cost of debt works | debt is any money owed by one entity to another having debt is unavoidable for many entities and is rather common in fact companies and individuals may use debt to make large purchases or investments for further growth for corporations debt is one part of their capital structures which also includes equity capital structure deals with how a firm finances its overall operations and growth through different sources of funds which may include debt such as bonds or loans the cost of debt measure is helpful in understanding the overall rate being paid by a company to use these types of debt financing the measure can also give investors an idea of the company s risk level compared to others because riskier companies generally have a higher cost of debt the cost of debt is generally lower than cost of equity formula and calculation of cost of debtthere are a couple of different ways to calculate a company s cost of debt depending on the information available one way to calculate the cost of debt is by using the formula for the after tax cost of debt the risk free rate of return is the theoretical rate of return of an investment with zero risk most commonly associated with u s treasury bonds a credit spread is a difference in yield between a u s treasury bond and another debt security of the same maturity but different credit quality 1this formula is useful because it takes into account fluctuations in the economy as well as company specific debt usage and credit rating if the company has more debt or a low credit rating then its credit spread will be higher for example say the risk free rate of return is 1 5 and the company s credit spread is 3 its pretax cost of debt is 4 5 if its tax rate is 30 then the after tax cost of debt is 3 15 we can calculate this in the following way | |
what is the cost of equity | the cost of equity is the return that a company requires to decide if an investment meets capital return requirements firms often use it as a capital budgeting threshold for the required rate of return a firm s cost of equity represents the compensation that the market demands in exchange for owning the asset and bearing the risk of ownership the traditional formula for the cost of equity is the dividend capitalization model and the capital asset pricing model capm investopedia nez riazunderstanding the cost of equitythe cost of equity refers to two separate concepts depending on the party involved if you are the investor the cost of equity is the rate of return required on an investment in equity if you are the company the cost of equity determines the required rate of return on a particular project or investment there are two ways that a company can raise capital debt or equity debt is cheaper but the company must pay it back equity does not need to be repaid but it generally costs more than debt capital due to the tax advantages of interest payments since the cost of equity is higher than debt it generally provides a higher rate of return cost of equity formulausing the dividend capitalization model the cost of equity is cost of equity dpscmv grdwhere dps dividends per share for next yearcmv current market value of stockgrd growth rate of dividends begin aligned text cost of equity frac text dps text cmv text grd textbf where text dps text dividends per share for next year text cmv text current market value of stock text grd text growth rate of dividends end aligned cost of equity cmvdps grdwhere dps dividends per share for next yearcmv current market value of stockgrd growth rate of dividends special considerationsthe dividend capitalization model can be used to calculate the cost of equity but it requires that a company pays dividends the calculation is based on future dividends the theory behind the equation is that the company s obligation to pay dividends is the cost of paying shareholders and therefore the cost of equity this is a limited model in its interpretation of costs the capital asset pricing model however can be used on any stock even if the company does not pay dividends that said the theory behind capm is more complicated the theory suggests that the cost of equity is based on the stock s volatility and level of risk compared to the general market capm formulathe formula for the capital asset pricing model is coe rfrr b mrr rfrr where coe cost of equityrfrr risk free rate of returnb betamrr market rate of return begin aligned text coe text rfrr qquad quad text b times text mrr text rfrr textbf where text coe text cost of equity text rfrr text risk free rate of return text b text beta text mrr text market rate of return end aligned coe rfrr b mrr rfrr where coe cost of equityrfrr risk free rate of returnb betamrr market rate of return in this equation the risk free rate is the rate of return paid on risk free investments such as treasuries beta is a measure of risk calculated as a regression on the company s stock price the higher the volatility the higher the beta and relative risk compared to the general market 1the market rate of return is the average market rate in general a company with a high beta that is a company with a high degree of risk will have a higher cost of equity the cost of equity can mean two different things depending on who s using it investors use it as a benchmark for an equity investment while companies use it for projects or related investments cost of equity vs cost of capitalthe cost of capital is the total cost of raising capital taking into account both the cost of equity and the cost of debt a stable well performing company generally will have a lower cost of capital to calculate the cost of capital the cost of equity and the cost of debt must be weighted and then added together the cost of capital is generally calculated using the weighted average cost of capital | |
when considering the weighted average cost of capital companies may favor the financial option that is least expensive for example its cost of equity may be 8 while its cost of debt may be 4 assuming a company has a balanced capital structure 50 of each the company s total cost of capital is 6 | as a company goes out to seek additional capital it often compares which method is cheaper than its weighted average cost of capital in this case the company s average debt costs less so the company may be opposed to issuing additional equity at a higher cost | |
what is the cost of equity | the cost of equity is the return that a company must realize in exchange for a given investment or project when a company decides whether it takes on new financing for instance the cost of equity determines the return that the company must achieve to warrant the new initiative companies typically undergo two ways to raise funds through debt or equity each has differing costs and rates of return | |
how do you calculate the cost of equity | there are two primary ways to calculate the cost of equity the dividend capitalization model takes dividends per share dps for the next year divided by the current market value cmv of the stock and adds this number to the growth rate of dividends grd where cost of equity dps cmv grd conversely the capital asset pricing model capm evaluates if an investment is fairly valued given its risk and time value of money in relation to its anticipated return under this model cost of equity risk free rate of return beta market rate of return risk free rate of return | |
what is an example of cost of equity | consider company a trades on the s p 500 at a 10 rate of return meanwhile it has a beta of 1 1 expressing marginally more volatility than the market presently the t bill risk free rate is 1 using the capital asset pricing model capm to determine its cost of equity financing you would apply cost of equity risk free rate of return beta market rate of return risk free rate of return to reach 1 1 1 10 1 10 9 | |
what is the weighted average cost of equity | a company s weighted average cost of equity measures the cost of equity proportionally across the types of equity instead of taking the simple average cost across all types of equity i e common shares preferred shares etc the weighted average cost of equity proportionally considers the equity value of each type of equity to calculate the weighted average cost of equity multiple by the cost of any given specific equity type by the percentage of capital structure it represents the bottom linea company s cost of equity is an important consideration as companies determine the best way to raise capital calculated as the dividends issued per share divided by the current market price plus a growth rate or by using the capm the cost of equity is the expense a company should assume it must return back to investors based on prevailing costs the cost of equity is often compared to the cost of debt when making capital structure decisions | |
what is cost of goods sold cogs | cost of goods sold cogs refers to the direct costs of producing the goods sold by a company this amount includes the cost of the materials and labor directly used to create the good it excludes indirect expenses such as distribution costs and sales force costs cost of goods sold is also referred to as cost of sales investopedia xiaojie liu | |
why is cost of goods sold cogs important | cogs is an important metric on financial statements as it is subtracted from a company s revenues to determine its gross profit gross profit is a profitability measure that evaluates how efficient a company is in managing its labor and supplies in the production process because cogs is a cost of doing business it is recorded as a business expense on income statements knowing the cost of goods sold helps analysts investors and managers estimate a company s bottom line if cogs increases net income will decrease while this movement is beneficial for income tax purposes the business will have less profit for its shareholders businesses thus try to keep their cogs low so that net profits will be higher 1 | |
what is included in the cost of goods sold cogs | cost of goods sold cogs is the cost of acquiring or manufacturing the products or finished goods that a company then sells during a period so the only costs included in the measure are those that are directly tied to the production of the products including the cost of labor materials and manufacturing overhead 2for example cogs for an automaker would include the material costs for the parts that go into making the car plus the labor costs used to put the car together the cost of sending the cars to dealerships and the cost of the labor used to sell the car would be excluded furthermore costs incurred on the cars that were not sold during the year will not be included when calculating cogs whether the costs are direct or indirect in other words cogs includes the direct cost of producing goods or services that were purchased by customers during the year as a rule of thumb if you want to know if an expense falls under cogs ask would this expense have been an expense even if no sales were generated cogs only applies to those costs directly related to producing goods intended for sale 1 | |
what is the cost of goods sold cogs formula | cogs beginning inventory p ending inventory where p purchases during the period begin aligned text cogs text beginning inventory text p text ending inventory textbf where text p text purchases during the period end aligned cogs beginning inventory p ending inventorywherep purchases during the period inventory that is sold appears in the income statement under the cogs account the beginning inventory for the year is the inventory left over from the previous year that is the merchandise that was not sold in the previous year any additional productions or purchases made by a manufacturing or retail company are added to the beginning inventory at the end of the year the products that were not sold are subtracted from the sum of beginning inventory and additional purchases the final number derived from the calculation is the cost of goods sold for the year the balance sheet has an account called the current assets account under this account is an item called inventory the balance sheet only captures a company s financial health at the end of an accounting period this means that the inventory value recorded under current assets is the ending inventory | |
what are different accounting methods for cogs | the value of the cost of goods sold depends on the inventory valuation method adopted by a company there are three methods that a company can use when recording the level of inventory sold during a period first in first out fifo last in first out lifo and the average cost method the special identification method is used for high ticket or unique items 3the earliest goods to be purchased or manufactured are sold first since prices tend to go up over time a company that uses the fifo method will sell its least expensive products first which translates to a lower cogs than the cogs recorded under lifo hence the net income using the fifo method increases over time lifo is where the latest goods added to the inventory are sold first during periods of rising prices goods with higher costs are sold first leading to a higher cogs amount over time the net income tends to decrease the average price of all the goods in stock regardless of purchase date is used to value the goods sold taking the average product cost over a time period has a smoothing effect that prevents cogs from being highly impacted by the extreme costs of one or more acquisitions or purchases the special identification method uses the specific cost of each unit of merchandise also called inventory or goods to calculate the ending inventory and cogs for each period in this method a business knows precisely which item was sold and the exact cost further this method is typically used in industries that sell unique items like cars real estate and rare and precious jewels | |
what type of companies are excluded from a cogs deduction | many service companies do not have any cost of goods sold at all cogs is not addressed in any detail in generally accepted accounting principles gaap but cogs is defined as only the cost of inventory items sold during a given period not only do service companies have no goods to sell but purely service companies also do not have inventories if cogs is not listed on a company s income statement no deduction can be applied for those costs 1examples of pure service companies include accounting firms law offices real estate appraisers business consultants and professional dancers among others even though all of these industries have business expenses and normally spend money to provide their services they do not list cogs instead they have what is called cost of services which does not count towards a cogs deduction cost of revenue vs cogscosts of revenue exist for ongoing contract services that can include raw materials direct labor shipping costs and commissions paid to sales employees these items cannot be claimed as cogs without a physically produced product to sell however the irs website even lists some examples of personal service businesses that do not calculate cogs on their income statements these include doctors lawyers carpenters and painters 4many service based companies have some products to sell for example airlines and hotels are primarily providers of services such as transport and lodging respectively yet they also sell gifts food beverages and other items these items are definitely considered goods and these companies certainly have inventories of such goods both of these industries can list cogs on their income statements and claim them for tax purposes operating expenses vs cogsboth operating expenses and cost of goods sold cogs are expenditures that companies incur with running their business however the expenses are segregated on the income statement unlike cogs operating expenses opex are expenditures that are not directly tied to the production of goods or services 5typically sg a selling general and administrative expenses are included under operating expenses as a separate line item sg a expenses are expenditures such as overhead costs that are not directly tied to a product examples of operating expenses include the following | |
what is the difference between cost of sales and cost of goods sold | while these terms are often used interchangeably there s a subtle difference between the two cogs specifically refers to the direct costs associated with producing goods or acquiring inventory that has been sold during a particular period by contrast cos includes not only the direct costs of goods sold but also other costs directly related to generating revenue such as direct labor and direct overhead essentially cos encompasses a broader range of expenses than cogs as it may include additional costs associated with delivering the product or service to the customer | |
what are the limitations of cogs | cogs can easily be manipulated by accountants or managers looking to cook the books it can be altered by | |
when inventory is artificially inflated cogs will be under reported which in turn will lead to a higher than actual gross profit margin and hence an inflated net income | investors looking through a company s financial statements can spot unscrupulous inventory accounting by checking for inventory buildup such as inventory rising faster than revenue or total assets reported | |
how do you calculate cost of goods sold cogs | cost of goods sold cogs is calculated by adding up the various direct costs required to generate a company s revenues importantly cogs is based only on the costs that are directly utilized in producing that revenue such as the company s inventory or labor costs that can be attributed to specific sales by contrast fixed costs such as managerial salaries rent and utilities are not included in cogs inventory is a particularly important component of cogs and accounting rules permit several different approaches for how to include it in the calculation | |
what is included in the cost of goods sold | cost of goods sold represents the direct costs attributable to the production of goods sold by a company it includes various costs directly associated with the production or acquisition of the goods that a company sells during a specific period these costs typically include | |
are salaries included in cogs | cogs does not include salaries and other general and administrative expenses however certain types of labor costs can be included in cogs provided that they can be directly associated with specific sales for example a company that uses contractors to generate revenues might pay those contractors a commission based on the price charged to the customer in that scenario the commission earned by the contractors might be included in the company s cogs since that labor cost is directly connected to the revenues being generated 6 | |
how does inventory affect cogs | in theory cogs should include the cost of all inventory that was sold during the accounting period in practice however companies often don t know exactly which units of inventory were sold instead they rely on accounting methods such as the first in first out fifo and last in first out lifo rules to estimate what value of inventory was actually sold in the period if the inventory value included in cogs is relatively high then this will place downward pressure on the company s gross profit for this reason companies sometimes choose accounting methods that will produce a lower cogs figure in an attempt to boost their reported profitability the bottom linecost of goods sold is the direct cost of producing a good which includes the cost of the materials and labor used to create the good cogs directly impacts a company s profits as cogs is subtracted from revenue companies must manage their cogs to ensure higher profits if a company can reduce its cogs through better deals with suppliers or through more efficiency in the production process it can be more profitable | |
what is cost insurance and freight cif | cost insurance and freight cif is an international shipping agreement which represents the charges paid by a seller to cover the costs insurance and freight of a buyer s order while the cargo is in transit cost insurance and freight only applies to goods transported via a waterway sea or ocean the goods are exported to the buyer s port named in the sales contract once the goods are loaded onto the vessel the risk of loss or damage is transferred from the seller to the buyer however insuring the cargo and paying for freight remains the seller s responsibility 1cif is similar to carriage and insurance paid to cip but cif is used for only sea and waterway shipments while cip can be used for any mode of transport such as by truck understanding cost insurance and freight cif the contract terms of cif define when the liability of the seller ends and the liability of the buyer begins cif is only used when shipping goods overseas or via a waterway the seller has the responsibility for paying the cost and freight of shipping the goods to the buyer s port of destination usually exporters who have direct access to ships will use cif however the buyer has responsibilities as well which are outlined below under cif terms the seller s responsibilities include the seller must deliver the goods to the ship within the agreed upon timeframe and provide proof of delivery and loading once the goods have arrived at the buyer s destination port the buyer assumes responsibility for the costs associated with importing and delivering the goods some of these costs include the following it s important to note that when shipping internationally there can be different risk and cost transfer points between the buyer and seller depending on the type of shipping agreement under cif the risk transfer is at a different point than the cost transfer the exact details of the contract will determine when the liability for the goods transfers from seller to buyer since the seller pays the shipping freight and insurance costs until the cargo arrives at the buyer s destination port the cost transfer occurs when the goods have arrived at the buyer s port however the risk transfer occurs from the seller to the buyer when the goods have been loaded on the vessel although the seller must purchase insurance the buyer has ownership of the goods once loaded onto the ship and if the goods have been damaged during transit the buyer must file a claim with the seller s insurance company since the buyer assumes the risk only when the cargo has been loaded on the vessel certain situations may not be suitable for a cif agreement for example with containerized cargo shipments the goods may sit in a container for days before being loaded onto the vessel at the seller s port under cif the buyer would be at risk since the goods would not be insured while they sit in the container waiting to be loaded on the vessel as a result cif agreements would not be appropriate for shipments including containerized cargo cif is different from cost and freight provision cfr whereby sellers are not required to insure goods in transit the icc and cost insurance and freight cif cif is one of the international commerce terms known as incoterms incoterms are common trade rules developed by the international chamber of commerce icc in 1936 2 the icc established these terms to govern the shipping policies and responsibilities of buyers and sellers who engage in international trade incoterms are often similar to domestic terms such as the u s uniform commercial code but with international applications for example the parties to a contract must state the locale of the governing law for their terms the icc limits the use of cif when transporting goods to only those that move via inland waterways or by sea the icc s official definition of cif reads over the years the international chamber of commerce icc has made changes to the terms and guidelines for international trade in 2020 the icc made adjustments to the rules called incoterms 2020 which in part made changes to security requirements for shipments incoterms 2020 also made changes to the insurance coverage requirements under cif agreements sellers are now required to obtain a higher level or more comprehensive insurance than what was required under incoterms 2010 45there are seven incoterms 2020 rules for any type of transport and four incoterms rules for sea and inland waterway transports 6cif vs free on board fob cost insurance and freight cif and free on board fob are both international shipping agreements but have distinct differences between them each type of contract will cover different circumstances and much depend on your experience with international trade cif is an international agreement between a buyer and seller in which the seller has responsibility for the cost insurance and freight of a sea or waterway shipment although the possession of the shipment transfers to the buyer once the goods have been loaded on the boat or ship the seller is responsible for any shipping insurance and freight charges as a result the seller is responsible for the costs of moving the shipment until the goods have arrived at the buyer s destination port some of these costs include fees for shipping export customs clearance duty and taxes once the goods have been delivered to the buyer s destination port the buyer must pay the agreed price for the goods and is responsible for any import fees taxes or custom duty charges also any transportation inspection and licensing costs as well as the cost to transport the goods to their final location are the buyer s responsibility free on board means the seller has the responsibility for delivering and loading the product onto the ship including any costs associated with that process however the responsibilities transfer to the buyer once the goods have been loaded onto the ship the seller has the following responsibilities under fob under fob the buyer has the following responsibilities it s important to note that there are different types of fob agreements and the insurance coverage can be negotiated between the buyer and seller in other words there could be an agreement in which the buyer pays the freight charges or cost of delivery but the seller might agree to pay for the marine insurance cif and fob are helpful since these shipping agreements outline whether the buyer or seller has the responsibility for the freight during the shipment these terms are important since they indicate which parties are responsible for insurance freight charges and which party is held responsible in the event the goods are damaged during transport example of cost insurance and freight cif as an example let s say that best buy has ordered 1 000 flat screen televisions from sony using a cif agreement to kobe a japanese port sony has delivered the order to the port and loaded the product onto the ship for transport once loading has been completed the risk of loss is transferred from sony to best buy in return sony has purchased insurance and pays the freight and shipping costs until the ordered goods reach the buyer s port of destination while the ship is en route a fire breaks out in one of the cargo bays the cargo is damaged due to the fire and the water during fire fighting efforts since a cif agreement was in place best buy can file an insurance claim to cover the cost of the damaged goods | |
what does cif mean in shipping terms | cost insurance and freight cif is an international shipping agreement used when freight is shipped via sea or waterway under cif the seller is responsible for covering the costs insurance and freight of the buyer s shipment while in transit the buyer is responsible for any costs once the freight has reached the buyer s destination port who pays cif freight the seller must pay for the costs of transferring and shipping the freight as well as insuring the cargo until the goods have been delivered to the buyer s port | |
does cif include duty | duty charges for exporting the goods from the seller s port of destination are the responsibility of the seller however duty charges at the buyer s port of destination import duties are the responsibility of the buyer | |
when should i use cif | cif is only used when shipping goods via ocean or waterway meaning cif cannot be used for air freight cif can be easier for buyers who don t want to go through the trouble of obtaining insurance paying freight charges and assuming all of the responsibility for shipping internationally the bottom linecost insurance and freight cif is an international shipping term that describes the seller s responsibility for the cost of shipping freight charges and insuring the cargo being shipped via ocean or waterway cif means that the seller is responsible for the costs of transporting the cargo and obtaining insurance to protect the buyer from any damages to the goods during transport however the buyer assumes responsibility for the goods once the cargo has reached the buyer s port cif is different from cost and freight cfr which is when the seller is responsible for the shipping and freight costs but under cfr the seller is not responsible for obtaining marine insurance there are various types of international shipping agreements including cost insurance and freight cif free on board fob and cost and freight cfr as a result it s important that buyers and sellers understand all of the legal terms within these agreements before engaging in international trade correction april 30 2023 an earlier version of this article incorrectly stated that ownership transfers from the seller to the buyer when the goods reach the destination port in fact ownership transfers at the point that the goods are loaded on the ship | |
what is the cost of labor | the cost of labor is the sum of all wages paid to employees as well as the cost of employee benefits and payroll taxes paid by an employer the cost of labor is broken into direct and indirect overhead costs direct costs include wages for the employees who produce a product including workers on an assembly line while indirect costs are associated with support labor such as employees who maintain factory equipment these costs known as the burden rate include all auxiliary indirect and incidental costs of hiring and retaining an employee understanding cost of labor | |
when a manufacturer sets the sales price of a product the firm takes into account the costs of labor material and overhead the sales price must include the total costs incurred if any costs are left out of the sales price calculation the amount of profit is lower than expected if demand for a product declines or if competition forces the business to cut prices the company must reduce the cost of labor to remain profitable to do so a business can reduce the number of employees cut back on production require higher levels of productivity or reduce other factors in production cost | in some cases the cost of labor can be shifted directly toward the consumer for example in the hospitality sector tipping is often encouraged allowing businesses to reduce their cost of labor the differences between direct and indirect costs of laborassume that xyz furniture is planning the sales price for dining room chairs the direct labor costs are those expenses that can be directly traced to production xyz for example pays workers to run machinery that cuts wood into specific pieces for chair assembly and those expenses are direct costs on the other hand xyz has several employees who provide security for the factory and warehouse those labor costs are indirect because the cost cannot be traced to a specific act of production examples of fixed and variable costs of laborlabor costs are also classified as fixed costs or variable costs for example the cost of labor to run the machinery is a variable cost which varies with the firm s level of production a firm can easily increase or decrease variable labor cost by increasing or decreasing production fixed labor costs can include set fees for long term service contracts a firm might have a contract with an outside vendor to perform repair and maintenance on the equipment and that is a fixed cost factoring in undercosting and overcostingsince indirect labor costs can be difficult to allocate to the correct product or service xyz furniture may underallocate labor costs to one product and overallocate labor costs to another this situation is referred to as undercosting and overcosting and it can lead to incorrect product pricing assume for example that xyz manufactures both dining room chairs and wooden bed frames and that both products incur labor costs to run machinery which total 20 000 per month if xyz allocates too much of the 20 000 labor costs to wooden bed frames too little is allocated to dining room chairs the labor costs for both products are incorrect and the sale prices of the two goods will not reflect their true cost cost of labor vs cost of livingwhile the cost of labor refers to the sum of all wages paid to employees it should not be confused with the cost of living the cost of living is the cost needed to maintain a certain standard of living by a consumer in a specific geographic location this includes housing food transportation entertainment etc these rates can sometimes be much higher than the cost of labor especially in highly metropolitan areas for example the cost of living is higher in new york city than in a suburban city demand for housing and food is higher which means higher prices for consumers | |
what is the cost of living | the cost of living refers to the money needed for essentials like housing food taxes and healthcare in a specific location and time it is often used to compare the expenses of living in different cities higher living costs like in new york require higher salaries for affordability | |
how the cost of living is used | the cost of living can be a significant factor in personal wealth accumulation because a salary can provide a higher standard of living in a city where daily expenses such as rent food and entertainment are less in contrast a high salary can seem insufficient in an expensive city such as new york changes in the cpi are often a triggering event in labor and other contracts with escalation clauses the contract will detail exactly how any periodic adjustments happen and what parts of the contract will change in a 2024 survey mercer a global human resources firm finds the cities with the highest cost of living in order are hong kong singapore zurich geneva and basel 1new york city was ranked the costliest city in the united states followed by los angeles honolulu and san francisco 1the cost of living indexthe cost of living index compares the cost of living in a major city to a corresponding metropolitan area the index incorporates various living expenses creating an aggregate measure that workforce entrants can use as a benchmark as college graduates weigh employment alternatives and currently employed job seekers consider relocation the index provides an informative snapshot of rental transportation and grocery costs mercer s cost of living index measures prices in 226 urban areas for a basket of goods which includes 12 large eggs one liter of olive oil espresso coffee at a popular cafe one liter of gasoline unleaded 95 men s blue jeans and women s shampoo haircut and styling 1the economic policy institute updated its family budget calculator in january 2024 with data from 2023 the calculator helps families determine how much salary they will need to cover the cost of living in 3 143 counties in all 613 metro areas 2three out of five of the world s most expensive cities are in switzerland 1most expensive urban areas in the u s according to the council for community and economic research the 10 most expensive urban areas in the u s in 2023 were least expensive urban areas in the u s according to the council for community and economic research the 10 least expensive urban areas in the u s in 2023 were u s states ranked by cost of livingu s states districts and territories ranked by cost of living from lowest to highest as of q1 2024 as provided by the council for community and economic research is as follows cost of living and wagesthe rising cost of living has spurred debate over the u s federal minimum wage and the disparity between the lowest salary allowed by law and the earnings needed to maintain an adequate cost of living proponents of a hike in wages cite increased worker productivity levels since 1968 as inequitably correlated to the minimum hourly rate of pay as pay levels once tracked the increase in productivity the divergence between earnings and worker efficiency has reached historically disproportionate levels 5by contrast opponents of a minimum wage contend that a raise could spur higher consumer prices as employers offset rising labor costs 5multinational corporations use the cost of living to assess expatriate salary packages for international assignees wage increases and cost of living adjustments colas in 1973 congress enacted legislation to address cost of living adjustments colas cola adjustments for social security and supplemental security income ssi benefits were instituted so that the payments keep pace with inflation 6for example in december 2022 the cola was 8 7 due to the high levels of inflation as a result of the covid 19 pandemic and the increased amounts were paid starting in january 2023 federal ssi payment levels increased by the same percentage 78the social security act requires colas to be based on increases in the consumer price index for urban wage earners and clerical workers cpi w the social security administration states that | |
which u s state has the highest cost of living | hawaii has the highest cost of living as of q1 2024 it has a cost of living index of 186 2 that can be compared to the state with the lowest cost of living which is west virginia with a cost of living index of 83 8 4 | |
what is the most expensive city in the u s | the most expensive city in the u s is new york city as determined by various cost of living indexes 31 | |
is living in the u s expensive | living in the u s is considered to be generally expensive many cities in the u s rank high in cost of living indexes indicating a high living cost additionally expenses for healthcare and college for example are relatively high when compared to other countries as the u s is a large country living costs vary greatly depending on location the bottom linethe cost of living refers to the expenses required to sustain a particular standard of living including housing food taxes and healthcare it serves as a benchmark for comparing expenses across different areas and informs decisions about salaries and relocations a cost of living index aggregates these expenses offering a detailed measure that helps individuals understand the financial requirements of different locations rising living costs have ignited debates about wage increases and the need for cost of living adjustments these measures seek to ensure that earnings are in step with inflation so that purchasing power is not reduced and economic stability is maintained | |
what is a cost of living adjustment cola | a cost of living adjustment cola is an increase made to social security benefits and supplemental security income ssi to counteract the effects of inflation and rising prices in the economy colas are typically equal to the percentage increase in the consumer price index for urban wage earners and clerical workers cpi w for a specific period the consumer price index cpi represents the average prices of a basket of goods and is used to measure inflation 1the cola was 8 7 for 2023 so their annual benefit would increase to 10 870 if someone received 10 000 in social security benefits in 2022 the cola is just 3 2 for 2024 someone who received 10 000 in social security benefits in 2023 would see their 2024 annual benefit increase to 10 320 understanding the cost of living adjustment cola inflation was high during the 1970s so compensation related contracts real estate contracts and government benefits used colas to protect against inflation 2 the u s bureau of labor statistics bls determines the cpi w that the social security administration ssa uses to compute colas the formula applies the percentage increase in the cpi w from the third quarter of one year to the third quarter of the following year this information is updated regularly on the ssa website 34congress ratified a cola provision to offer automatic yearly colas based on the annual increase in the cpi w that went into effect in 1975 social security benefits were increased when congress approved special legislation before 1975 colas were based on the increase in the cpi w from the second quarter of 1974 to the first quarter of 1975 in that year they were based on the increases in the cpi w from the first quarter of the previous year to the first quarter of the current year from 1976 to 1983 colas have been dependent on the cpi w from the third quarter of the previous year to the third quarter of the current year since 1983 35inflation levels ranged from 3 3 to 11 3 in the 1970s the cola increase was 8 and the inflation rate was 9 1 in 1975 the cola reached the highest level in history at 14 3 in 1980 when the inflation rate was 13 5 drastically lower inflation rates prompted small cola increases averaging 2 to 3 per year during the 1990s that continued into the early 2000s when even lower inflation rates resulted in no cola increases at all in 2010 2011 and 2016 the cola for 2023 was 8 7 up from 5 9 in 2022 and 1 3 in 2021 due to the high inflation levels witnessed in 2022 inflation was 8 that year the cola is 3 2 for 2024 36 | |
how cola is determined | cola is reliant on two components the cpi w and the employer contracted cola percentage cpi determines the rate of inflation and is compared yearly recipients don t receive a cola when consumer prices drop or if inflation hasn t been high enough to substantiate a cola increase there s no cola increase if there s no cpi w increase 7the hold harmless provision in the social security act prevents the benefit amount for some social security beneficiaries from decreasing from one year to the next if there s an increase in their standard medicare part b premiums the part b premium will be reduced to ensure that the nominal value of the social security benefit will be the same if the increase in part b premiums causes the beneficiaries social security amount to be less few individuals are typically held harmless but they may be impacted by this provision in years where there s no social security cola there was a 2 social security cola in 2018 and 28 of part b enrollees were held harmless there was virtually no cola in 2016 and 70 of enrollees were held harmless from the part b premium increase 8other types of colassome employers such as the u s military occasionally give a temporary cola to employees who are required to perform work assignments in cities with a higher cost of living than their home city this cola expires when the work assignment is completed 9 | |
how much is the cola adjustment for 2024 | the cola adjustment for 2024 is 3 2 an individual s annual benefit would increase to 10 320 in 2024 if they received 10 000 in social security benefits in 2023 3 | |
how do you calculate your cola increase for 2024 | take your monthly payment and multiply it by 3 2 to calculate your cola increase for 2024 then add this number to the amount you received in 2023 this will show you the amount you ll receive in 2024 you can do the same for 2025 when the cola is announced for that year | |
does everyone on social security get the cola increase | yes everyone on social security will get the cola increase the purpose of cola is to ensure that benefits are not eroded because of inflation 3the bottom linesocial security and supplemental security income are both subject to cost of living increases the idea is to provide an increase in benefits equal to the pace of inflation the cola increase for 2024 is 3 2 plunging from 8 7 in 2022 there was no adjustment in 2009 2010 or 2015 5 | |
what is cost of revenue | the term cost of revenue refers to the total cost of manufacturing and delivering a product or service to consumers cost of revenue information is found in a company s income statement it is designed to represent the direct costs associated with the goods and services the company provides the service industry often favors using the cost of revenue metric because it is a more comprehensive account of the various costs associated with selling a good or service | |
how cost of revenue works | cost of revenue is the total cost incurred to produce and sell a product or service it includes all the costs associated with the production process such as raw materials labor overhead expenses it also includes any other direct costs related to the production and delivery of the product or service cost of revenue is important for businesses because it helps them determine their true gross profit margin companies should be interested in know how much residual revenue is left over after all costs of making and selling a product have been incurred this residual profit is used to pay overhead or indirect costs still vital to the operation of the company but not directly tied to making a product formula and calculation of cost of revenuethe formula for the cost of revenue is cost of revenue cogs shipping costs commissions warranties returns other direct coststo calculate cost of revenue it s important to first decide what period to use many companies will calculate cost of revenue on a monthly or quarterly basis to use for decision making during the course of the year another important aspect of calculating cost of revenue is determine what the beginning inventory was at the beginning of the period this figure is required because it is an integral part of calculating the cost of goods sold last companies need to be mindful of the other category depending on the nature of the company the product line may have a diverse set of direct costs not every company will have the same direct costs and these direct costs may change from one period to the next as a company evolves its manufacturing process cost of revenue is not a gaap approved calculation and is not included on publicly issued financial statements | |
what is included in cost of revenue | as mentioned before every company s direct costs and cost of revenue may be calculated differently here s a broad range of what is included in the cost of revenue though not all of these costs may be relevant and other direct costs not included in this list should be included direct materials are the costs of raw materials used in the production of a product direct materials often include any shipping or handling costs associated with acquiring these materials direct materials are included in the cost of goods sold component of the cost of revenue direct labor is the costs of wages salaries and benefits paid to employees directly involved in the production or delivery of the product or service companies may directly trace the payroll costs of specific employees to product lines though this often entails an allocation process especially for those employees who may work on different product lines direct labor is also included in the cost of goods sold component of cost of revenue sometimes there are costs a company simply can t directly trace however these costs are still necessary for the manufacturing of a product manufacturing overhead includes all non directly associated costs of the production process such as utilities or equipment maintenance these are also usually reported as part of the cost of goods sold freight and shipping are the costs of shipping finished products to customers or retailers these are included in the cost of revenue because they represent expenses necessary to distribute goods as part of the sale without these expenses customers and retailers would be unable to receive the products so these costs can often not be avoided in a similar manner duties and taxes may be required to distribute a good this is especially true for goods being distributed internationally that require importation or exportation though companies can choose to not distribute to these regions these costs are often avoidable once a company commits to distributing to a region returns are costs associated with good not kept or allowances given to customers such as shipping costs or restocking fees companies may expect that a certain percentage of goods will be returned as the normal course of business in addition companies may incur costs while products are under a warranty period these costs may be considered a cost of revenue because customers may be have been incentivized to buy a good partially because of the warranty period companies may pay commissions to sales agents distributors or other intermediaries involved in the sale of the product these commissions are often directly related to the product and not broadly related to the company as long as these costs can be tied to a product companies often include them in the cost of revenue because goods were often sold due to this extra incentive awarded to sellers as mentioned before companies have very different structures from one another there are often other direct costs unique to a specific product line or industry that necessitate inclusion into cost of revenue though the term ends with the word revenue cost of revenue is not a type of income it represents all of the costs that go into earning revenue cost of revenue vs cost of goods soldcost of revenue is different from cost of goods sold cogs because the former also includes costs outside of production such as distribution and marketing the cost of revenue takes into account the cost of goods sold cogs or cost of services provided plus any additional costs incurred to generate a sale although the cost of revenue factors in many costs associated with sales it does not take into account the indirect costs such as salaries paid to managers the costs considered part of the cost of revenue include a multitude of items such as the cost of labor commission materials and sales discounts | |
when comparing profit measures using a standard formula for profit margins such as those listed in an income statement creating a profit margin measure based on the cost of revenue would generate a lower value than those typically used by corporations for quarterly reporting that s because it includes the cogs or cost of services and other direct costs | the contribution margin includes total variable costs and the gross margin only includes the cogs or the cost of services a company with a low cost of revenue to total revenue percentage indicates that it is in stable financial health and may have strong sales cost of revenue examplehere s a hypothetical example of how the concept of cost of revenue works let s assume xyz inc sells electronics products and offers services to repair electronic equipment the company reports total revenue of 100 million cogs of 15 million and cost of services sold of 7 million the company has direct labor costs of 5 million marketing expenses of 1 million and direct overhead costs of 3 million xyz also pays 10 million to its management and records rental costs of 8 million we can determine from this information that the company s cost of revenue is 31 million for the fiscal period the 10 million paid to its management and the rental costs of 8 million are indirect costs which are not included in the cost of revenue since the company had total revenue of 100 million xyz inc has a cost of revenue margin of 100 million 31 million 69 million moreover the company has a cost of revenue to total revenue percentage of 31 or 31 million divided by 100 million | |
what is cost of revenue vs operating expenses | operating expenses are often limited to expenses not tied to the manufacturing process though some of these costs may still be considered cost of revenue expenses these are a more indirect type of cost cost of revenue is a broader group of expenses with many of the costs tied to the cost of goods sold | |
is cost of revenue an expense | yes cost of revenue is an accumulation of the costs necessary to generate income specific to a product be mindful that some aspects of cost of revenue i e returns or warranties may be reported as contra revenue accounts | |
why is cost of revenue important | cost of revenue is important because it allows a company to best understand all of the costs it incurs to generate income this goes beyond just the cost of goods sold this extends to other types of expenses needed to sell and distribute a good with this knowledge companies can more strategically deploy capital as they have a better sense of what capital is needed to raise certain amounts of revenue the bottom linecost of revenue is the total cost incurred to produce and sell a good it includes the cost of goods sold in addition to all sorts of other cost sof production it also includes costs not included in production but needed to deliver or market a product all of this information is used by a company to better understand the true profit margin of a product | |
what is cost per click cpc | cost per click cpc is an online advertising revenue model that websites use to bill advertisers based on the number of times visitors click on a display ad attached to their sites the primary alternative is the cost per mille cpm model which charges 1 000 ad impressions or views of the display ad regardless of whether or not a viewer clicks on the ad the cost per click model is also known as pay per click ppc understanding cost per click cpc advertisers commonly use cost per click with a set daily budget for a campaign when the advertiser s budget is reached the ad is automatically removed from the website s rotation for the remainder of the billing period for example a website with a cost per click rate of 10 would bill an advertiser 100 for 1 000 click throughs most publishers use a third party to match them with advertisers the largest such entity is google ads which uses a platform called google adsense 1a click costs no more than you re willing to pay through a bidding system for example you could bid a maximum of 1 per click on google ads the system runs through algorithms that evaluate your ads and charges you no more than your bid however there are some caveats the google ads system applies discounts to advertisers with higher ad quality scores this score is determined by the relevance of the ad and the advertiser s content to the search terms used you ll also be dinged in the position of your ad the lower you bid again adjusting for the other factors evaluated by the platform 2 | |
how is cost per click calculated | a formula may be used to determine the rate you pay per click one of the most popular ways to calculate your cpc is some publishers or platforms like google ads use a bidding process to set their rates for instance google ads asks you to select the maximum amount you re willing to pay per click 2 google s platform then uses ad rank thresholds to determine the actual cost when your ad is clicked 3this means your cost varies up to your maximum because the platform ranks your bid ad quality position user signals search topics and related auctions and sets the cost per click 3 you can even have google automate the bids for you to increase your click through 4the platform then positions your ad based on your maximum amount with higher maximums achieving a higher placement on the page 2 | |
how to lower cost per click | because advertising can become very expensive when paying by clicks you need to have a plan to keep from paying too much per click this means researching and creating a strategy with keywords to raise your quality score a large measure of how your ads compete with others your quality score is crucial to increasing your clicks and decreasing your costs you can improve your quality score by making adjustments to your 5keywords drive internet searches so it makes sense to ensure you have keywords in your ads that lead people to your website some techniques you can try are 6cost per click alternativesthere are plenty of alternatives to google adsense including media net infolinks amazon advertising and bidvertiser to name a few some specialize in small or large publishers and some offer a better deal than google adsense to stay competitive amazon advertising is designed to allow amazon website affiliates to place ads that reach shoppers on and off the website when searching for specific products 7meta ads manager allows advertisers to run campaigns on facebook and instagram 8cpc vs cpmin the print world advertisers choose publications that match their customer profiles and place ads in them they pay more for bigger ads and more prominent placement but the effectiveness of those ads can usually only be implied by tracking before and after sales numbers coupons and contests are among the strategies that help them track their ads effectiveness better in the online world advertisers know how many people are at least interested enough to click on their ads that has led to two of the primary ways to reach consumers through web advertising advantages and disadvantages of cpc advertisinghigher valuedrives website trafficmore expensive than cpmprices vary widelyless effective for brand and product awareness | |
what does cost per click mean | cost per click is how much it costs you when a propective customer clicks on your ad | |
how do you calculate cost per click | cost per click is generally calculated by dividing the overall cost of your ads by the number of clicks your ads received | |
what is cpc and cpm | cost per click is a measurement of the amount of money you pay when a consumer clicks your ads and cost per mille is the cost you pay per 1 000 ad impressions or 1 000 loads of a page with your ad on it | |
why is cost per click important | cost per click is significant because it shows you how much you re paying for your advertising and how effective your campaign is the bottom linedemographic targeting of advertising was created offline primarily by the print magazine industry it allowed advertisers to choose a specialty magazine that reached the audience that was most likely to be interested in their product the cost per click advertising model emerged with the internet it added an actionable element in the ability to immediately click on a link to get more information place an order claim a coupon or download an app the software for creating ads and buying ad space is growing increasingly sophisticated however the primary concern of advertisers in using either the cost per click or cost per impression models is accuracy in reporting the actual numbers that the ad reaches | |
what does cost per mille cpm mean | cost per mille cpm mille is latin for thousand is a pricing model used in digital marketing it is the average cost a company pays for 1 000 advertisement impressions an impression occurs when a consumer sees an advertisement cpm is a metric generally used in two ways it can help companies measure how efficient their advertising is by telling them how much money is paid for 1 000 views of their website ad and it can represent how much a digital publisher charges for advertising space understanding cost per mille cpm companies traditionally had only a few options to advertise their products and services notably through print radio and television over time these options grew to include various types of online advertising several metrics have been created to help companies determine how well their advertising works one of these is cost per mille thousand cost per mille is the most common method for pricing web ads in digital marketing this method relies on impressions which are defined as an advertisement displayed when a page is viewed impressions are generally considered ad views because it is likely they are seen when the page loads viewers may not do more than glance at it but it is possible it still created awareness or made an impression an impression measures how many times an ad is displayed on a site impressions are counted and metrics can be generated from the count for example many website owners charge advertisers a set fee for every 1 000 impressions of an ad the click through rate ctr measures whether an ad was clicked on representing the percentage of people who saw and acted on it advertisers frequently measure the success of a cpm campaign by its ctr an advertisement that receives two clicks for every 100 impressions has a 2 ctr but you can t measure an advertisement s success by ctr alone because an ad that a reader views but doesn t click still may have an impact cost per mille cpm vs cost per click cpc vs cost per acquisition cpa cpm represents one of several methods used to price website ads it is generally used with other metrics to help marketers analyze effectiveness and costs these include companies focused less on mass appeal and more on promoting a product to a niche audience gravitate toward cpc or cpa advertising because they have to pay only when visitors click through to their sites or purchase the advertised products special considerationsthere can be confusion between two crucial social media terms impressions and views the term impression refers to the presence of an ad or other content on a social media user s screen a view on the other hand refers to the time a user engages with any digital content like a video the number of ad impressions can differ from the number of visitors to the website displaying the ad an ad might receive placement in two locations on a website such as a horizontal banner across the top of the page and a vertical side banner beside the page s text the advertiser pays for two impressions per page view in this scenario rates for social media advertising tend to be higher and can vary depending on the platform the following is a list of average social media advertising costs on different social media sites website publishers generally like cpm advertising because they re paid for just displaying ads in some cases a website needs robust traffic to make decent money from cpm ads because rates are relatively low different pricing methods are more appropriate for some ad campaigns than others like the ones mentioned above cpm makes the most sense for a campaign focused on heightening brand awareness or delivering a specific message the click through rate matters less in this case because the exposure from having a prominent ad on a high traffic website helps promote a company s brand name or message even if visitors don t click on the ad | |
what does cpm mean | cost per mille cpm is the average cost a business pays to achieve 1 000 advertising impressions | |
what does 15 cpm mean | a cpm of 15 means it costs you an average of 15 to achieve 1 000 advertising impressions in other words you pay 15 for every 1 000 people who see your ad | |
what does cpm mean in youtube | cpm is the average cost per mille 1 000 advertising impressions so on youtube your cpm is how much you pay for 1 000 viewers to see your ad the bottom linecost per mille or cost per thousand is the average cost for achieving 1 000 advertisement impressions regardless of the medium used it is one of the figures used to charge advertisers for web ad pricing as well as a metric used by companies to determine how successful and costly a marketing was or is | |
what is a cost plus contract | a cost plus contract is an agreement to reimburse a company for expenses incurred plus a specific amount of profit usually stated as a percentage of the contract s full price these type of contracts are primarily used in construction where the buyer assumes some of the risk but also provides a degree of flexibility to the contractor in such a case the party drawing up the contract anticipates that the contractor will make good on their promises to deliver and agrees to pay extra so that the contractor can make additional profit upon completion cost plus contracts can be contrasted with fixed cost contracts in which two parties agree up front to a specific cost regardless of the actual expenses incurred by the contractor cost plus contracts may also be known as cost reimbursement contracts understanding cost plus contractscost plus contracts are generally used if the party drawing up the contract has budgetary restrictions or if the overall scope of the work can t be properly estimated in advance in construction cost plus contracts are drawn up so contractors can be reimbursed for almost every expense actually incurred on a project the cost plus contract pays the builder for direct costs and indirect or overhead costs all expenses must be supported by documentation of the contractor s spending in the form of invoices or receipts the contract moreover allows the contractor to collect a certain amount above the reimbursed amount so they may be able to make a profit hence the plus in cost plus contracts some contracts may limit the amount of reimbursement so not every expense would be covered this is especially true if the contractor makes an error during the course of the project or is found to be negligent in any part of the construction cost plus contracts are also used in research and development r d activities where a larger company may outsource r d activities to a smaller firm such as large pharmaceutical company contracting to the lab of a small biotech company the u s government also uses cost plus contracts with military defense companies that develop new technologies for national defense governments generally prefer cost plus contracts because they can choose the most qualified contractors instead of the lowest bidder types of cost plus contractscost plus contracts can be separated into four categories they each allow for the reimbursement of costs as well as an additional amount for profit advantages and disadvantages of using cost plus contractsthe pros and cons of using these types of contracts include the following they eliminate some risk for the contractor they allow the focus to shift from the overall cost to the quality of work being done they cover all the expenses related to the project so there are no surprises they may leave the final cost up in the air since they can t be predetermined they may lead to a longer timeline for the project might lead to disputes when trying to recover construction related expensesrequires additional resources to reproduce and justify all related costsexample of how a cost plus contract worksassume abc construction corp has a contract to build a 20 million office building and the agreement states that costs cannot exceed 22 million abc s profit is agreed at 15 of the contract s full price of 3 million additionally abc construction is eligible for an incentive fee if the project is completed within nine months abc must submit dated receipts for all expenses and the client will inspect the job site for quality to verify that specific components are completed to specification such as the plumbing electrical fixtures etc the contract allows abc to incur direct costs such as materials labor and costs incurred to hire subcontractors abc can also bill indirect or overhead costs which include insurance security and safety the contract states that overhead costs are billed at 50 per labor hour the above project uses the percentage of completion process to account for profit and to submit bills to the client and the contract provides specific percentages for billing assume for example that abc can bill for 20 of the full contract price once 20 of the materials are purchased and the client verifies the concrete foundation is in place at that point abc sends an invoice for 20 of the 20 million contract at 4 million and posts 20 of the firm s profit or 600 000 to the financial statements | |
what is cost push inflation | cost push inflation also known as wage push inflation occurs when overall prices increase due to increases in the cost of wages and raw materials higher costs of production can decrease the aggregate supply or the amount of total production in an economy if demand for affected goods hasn t changed the price increases from production are passed onto consumers creating cost push inflation cost push inflation can be compared with demand pull inflation investopedia theresa chiechiunderstanding cost push inflationinflation is a measure of the rate of price increases in an economy for a basket of selected goods and services inflation can erode a consumer s purchasing power if wages haven t increased enough or kept up with rising prices if a company s production costs rise the company s executive management might try to pass the additional costs onto consumers by raising the prices for their products if the company doesn t raise prices while production costs increase the company s profits will decrease the most common cause of cost push inflation starts with an increase in the cost of production which may be expected or unexpected for example the cost of raw materials or inventory used in production might increase leading to higher costs for cost push inflation to take place demand for the affected product must remain constant during the time the production cost changes are occurring to compensate for the increased cost of production producers raise the price to the consumer to maintain profit levels while keeping pace with expected demand causes of cost push inflationas stated earlier an increase in the cost of input goods used in manufacturing such as raw materials for example if companies use copper in the manufacturing process and the price of the metal suddenly rises companies might pass those increased costs on to their customers increased labor costs can create cost push inflation such as when mandatory wage increases for production employees due to an increase in the minimum wage per worker a worker strike due to stalled contract negotiations might also lead to a decline in production and as a result lead to higher prices unexpected causes of cost push inflation are often natural disasters which can include floods earthquakes fires or tornadoes if a large disaster causes unexpected damage to a production facility and results in a shutdown or partial disruption of the production chain higher production costs are likely to follow a company might have no choice but to increase prices to help recoup some of the losses from a disaster although not all natural disasters result in higher production costs and therefore wouldn t lead to cost push inflation other events might qualify if they lead to higher production costs such as a sudden change in government that affects the country s ability to maintain its previous output however government induced increases in production costs are more often seen in developing nations government regulations and changes in current laws although usually anticipated may cause costs to rise for businesses because they have no way to compensate for the increased costs associated with them for example the government might mandate that health care be provided driving up the cost of employees or labor cost push vs demand pullrising prices caused by consumers wanting more goods is called demand pull inflation demand pull inflation includes times when an increase in demand is so great that production can t keep up which typically results in higher prices in short cost push inflation is driven by supply costs while demand pull inflation is driven by consumer demand while both lead to higher prices passed onto consumers example of cost push inflationthe organization of the petroleum exporting countries opec is a cartel that consists of 12 member countries that both produce and export oil 1 in the early 1970s due to geopolitical events opec imposed an oil embargo on the united states and other countries opec banned oil exports to targeted countries and also imposed oil production cuts 2 | |
what causes inflation | inflation or a general rise in prices is thought to occur for several reasons and the exact reasons are still debated by economists monetarist theories suggest that the money supply is the root of inflation where more money in an economy leads to higher prices cost push inflation theorizes that as costs to producers increase from things like rising wages these higher costs are passed on to consumers demand pull inflation takes the position that prices rise when aggregate demand exceeds the supply of available goods for sustained periods of time | |
is inflation always bad | in theory a low amount of inflation can be a healthy sign of a growing economy 4 high inflation however can be damaging but deflation or declining prices can be too note that inflation isn t always bad for certain groups of people for example borrowers at fixed interest rates tend to benefit from inflation while lenders and savers are hurt by it | |
what is the wage price spiral | the wage price spiral a take on cost push inflation occurs when wages rise creating more demand which leads to higher prices these higher prices thus incentivize workers to demand even higher wages and so the cycle repeats | |
what is cost volume profit cvp analysis | cost volume profit cvp analysis is a method of cost accounting that looks at the impact that varying levels of costs and volume have on operating profit investopedia daniel fishelunderstanding cost volume profit cvp analysisthe cost volume profit analysis also commonly known as breakeven analysis looks to determine the breakeven point for different sales volumes and cost structures plotted on a profit volume chart which can be useful for managers making short term business decisions cvp analysis makes several assumptions including that the sales price fixed and variable costs per unit are constant running a cvp analysis involves using several equations for price cost and other variables which it then plots out on an economic graph the cvp formula can also calculate the breakeven point the breakeven point is the number of units that need to be sold or the amount of sales revenue that has to be generated in order to cover the costs required to make the product the cvp breakeven sales volume formula is breakeven sales volume f c c m where f c fixed costs c m contribution margin sales variable costs begin aligned text breakeven sales volume frac fc cm textbf where fc text fixed costs cm text contribution margin text sales text variable costs end aligned breakeven sales volume cmfc where fc fixed costscm contribution margin sales variable costs to use the above formula to find a company s target sales volume simply add a target profit amount per unit to the fixed cost component of the formula this allows you to solve for the target volume based on the assumptions used in the model cvp analysis also manages product contribution margin the contribution margin is the difference between total sales and total variable costs for a business to be profitable the contribution margin must exceed total fixed costs the contribution margin may also be calculated per unit the unit contribution margin is simply the remainder after the unit variable cost is subtracted from the unit sales price the contribution margin ratio is determined by dividing the contribution margin by total sales the contribution margin is used to determine the breakeven point of sales by dividing the total fixed costs by the contribution margin ratio the breakeven point of sales in terms of total dollars may be calculated for example a company with 100 000 of fixed costs and a contribution margin of 40 must earn revenue of 250 000 to break even profit may be added to the fixed costs to perform cvp analysis on the desired outcome for example if the previous company desired a profit of 50 000 the necessary total sales revenue is found by dividing 150 000 the sum of fixed costs and desired profit by the contribution margin of 40 this example yields a required sales revenue of 375 000 special considerationscvp analysis is only reliable if costs are fixed within a specified production level all units produced are assumed to be sold and all fixed costs must be stable in cvp analysis another assumption is all changes in expenses occur because of changes in activity level semi variable expenses must be split between expense classifications using the high low method scatter plot or statistical regression | |
how is cost volume profit cvp analysis used | cost volume profit analysis is used to determine whether there is an economic justification for a product to be manufactured a target profit margin is added to the breakeven sales volume which is the number of units that need to be sold in order to cover the costs required to make the product and arrive at the target sales volume needed to generate the desired profit the decision maker could then compare the product s sales projections to the target sales volume to see if it is worth manufacturing | |
what assumptions does cost volume profit cvp analysis make | the reliability of cvp lies in the assumptions it makes including that the sales price and the fixed and variable cost per unit are constant the costs are fixed within a specified production level all units produced are assumed to be sold and all fixed costs must be stable another assumption is all changes in expenses occur because of changes in activity level semi variable expenses must be split between expense classifications using the high low method scatter plot or statistical regression | |
what is contribution margin | the contribution margin can be stated on a gross or per unit basis it represents the incremental money generated for each product unit sold after deducting the variable portion of the firm s costs basically it shows the portion of sales that helps to cover the company s fixed costs any remaining revenue left after covering fixed costs is the profit generated so for a business to be profitable the contribution margin must exceed total fixed costs | |
what is a cottage industry | a cottage industry is a small manufacturing business that s owned and operated by an individual or a family typically operating out of a home rather than a purpose built facility cottage industries are defined by the small amount of investment that s required to start one they often focus on producing labor intensive goods but they can face a significant disadvantage when competing with factory based manufacturers of mass produced goods | |
how cottage industries work | the first cottage industries in the u s and europe were light manufacturing operations that engaged in subcontracted work including garment making textiles sewing shoemaking and small metal machine parts these cottage industries produced finished goods using raw materials supplied by the contract provider in many cases many contemporary industries that operate in factories in the developed world replaced cottage industries that thrived before the industrial revolution modern cottage industries serve a consumer market that seeks original handcrafted products as an alternative to mass produced name brand products these can include anything from clothing items to crafts or decorative home furnishings products created by cottage industries in the u s and europe can often be found at flea markets and farmers markets cottage industries in developing countriescottage industries play a significant role in the economies of developing countries they require very small investments to get off the ground developing nations have comparative advantages in creating successful cottage industries their lower cost of living makes it feasible to produce labor intensive goods at competitive prices allowing a small business to make a sufficient profit some cottage industries grow over time and employ others in the community their products tend to be handcrafted using traditional tools and machinery so their productivity is unlikely to rival the sheer volume of the products of mass manufacturing cottage industries are also an important source of supplemental income in rural areas some farmers turn to their cottage industries to produce income when the growing season ends a cottage industry in a village can grow over time as residents come together to produce crafts for sale in local markets or even for export abroad advantages and disadvantages of cottage industriescottage industries can thrive if their operators are content to remain small producers in niche markets working for the benefit of a single family business growth is possible but there are significant barriers a cottage industry can be created with minimal startup costs by a single individual with a skill that s valued only basic infrastructure is necessary the business operator needs a way to receive orders get supplies delivered and get the end products to the buyers mobile technology has greatly improved the ability of cottage industries to operate cottage industries are creating opportunities for people in remote rural areas to improve their living standards even in modern times cottage industries must compete with larger producers with deeper pockets this may require them to adopt new technologies that improve productivity they must also compete for labor if they grow this can be increasingly difficult as a country becomes more developed and wages increase minimal startup costslow overheadopportunity for rural dwellersreliant on basic infrastructure to get products to marketinability to ramp up production to meet demandcompetition from larger producersexample of a cottage industryniche markets that don t appeal to big producers can be an ideal fit for cottage industries competitive dancers figure skaters and other performers often wear original handmade costumes parents might make costumes for their children at the lowest levels of youth competition the demand for costumes of higher quality grows as performers rise to higher levels of competition creating opportunities for the most highly skilled costume designers to fill the demand designers who began by creating costumes for their children and maybe a few others can end up creating a cottage industry for themselves | |
why are they called cottage industries | cottage industries may be the original remote work system they opened a way for people living in rural areas before the industrial revolution to make a living doing labor intensive jobs such as spinning wool tanning leather and sewing clothing they were often subcontractors in modern terminology finishing goods and sending them on to businesses that packaged them for shipment to suppliers and retailers this work was predominantly done in cottages in europe and america primarily by women who didn t have access to other trades or professions | |
what are some modern cottage industries | take a look at etsy or amazon handmade for a comprehensive overview of the thousands of handmade products that are being created by skilled artisans working independently most are modern cottage industries this is going on all over the world with many artisans focusing on traditional local skills the top cottage industries in india are silk weaving carpet making leatherworking metalworking and specialty food processing | |
are cottage industries scalable | cottage industries generally aren t scalable by definition they re no longer cottage industries if they scale up the definition of success is different most cottage industries are intended to provide a decent income for a single individual or family there are the occasional breakout stars like burt s bees which got its start when a fed up photojournalist decided to move to rural maine and become a beekeeper but even burt needed a partner with bigger ambitions the bottom linecottage industries thrived in the pre industrial ages when people in remote areas were able to make a living though hardly an easy one by creating labor intensive products for larger businesses they appear to be thriving in modern times as well as niche businesses pop up in homes all over the world to serve the demand for high quality hand craftsmanship | |
what is a counteroffer | a counteroffer is a response given to an initial offer a counteroffer means the original offer was rejected and replaced with another one the counteroffer gives the original offerer three options accept the counteroffer reject it or make another offer counteroffers are prevalent in many types of business negotiations transactions contracts and private and public deals between two individuals or two entities you may find them in real estate deals employment negotiations car sales private placements mergers and acquisitions takeovers etc understanding counteroffers | |
when two parties get together to negotiate a transaction or business deal one may put an offer on the table a counteroffer is a reply to that original offer and may change the terms of the deal including the price the price may be greater or less than what was originally quoted depending on who makes it so if the person receiving the original offer doesn t accept or reject it they may decide to renegotiate with a counteroffer | for example ms x decides to put her house on the market for 300 000 mr y views it and makes an offer of 285 000 instead ms x decides to make a counteroffer of 295 000 instead thus putting the onus on mr y to accept reject or counter that offer and continue negotiations again there is no limit to the number of times each party can counter during negotiations when countering back and forth each offer should present a price less than the previous offer this conveys to the seller that the buyer is nearing the final offer neither party is obligated to settle until they agree on a contract which occurs once the counteroffer is accepted this is when a binding contract is formed the contract is enforceable against either party the counteroffer voids a previous offer and the entity that presented that offer is no longer legally responsible for it | |
when negotiating never let emotions affect negotiations instead ask questions do your research and ask for additional time to consider the new offer | terms of a counteroffera counteroffer may include explanations of the terms of the offer or requests for supplementary information finalizing counteroffer negotiations requires the buyer and the offerer to accept the terms without any additional conditions or modifications a counteroffer is generally conditional when the seller receives a low offer the seller can counter with a price that is deemed reasonable the buyer can either accept that offer or counter again the seller can counter the offer the person receiving the counteroffer does not have to accept it employer counteroffersif you propose employment terms like a desired salary figure and the potential employer comes back with a counteroffer that is lower there are a few strategies one can employ you can often get a handle on how much an employer desires you for your knowledge skills and experience as well as how much they like you as an individual and potential team member body language tone of voice and phrasing can all help you make a more informed decision on how to handle a counteroffer effectively the first strategy is to simply take the counteroffer and accept the lower salary if you think you were highballing your offer or if you really do not want to risk losing your dream job over tough negotiations you may want to consider the counteroffer as good enough the opposite strategy is to stick to your guns stand firm and decline the counteroffer by reiterating your original offer or terms while it does not have to be framed as a take it or leave it the employer will know where your salary requirements are and if they really want you may decide to pay up between these two is to meet their counteroffer in the middle this may begin a series of back and forth negotiations that arrive at fair terms for all parties involved a counteroffer may also be proposed to you by your current employer if they know that you are looking to leave and received an offer elsewhere you can use these same tactics to respond to this counteroffer and can even use it as leverage with the potential new employer although you can risk overplaying your hand if you have already received an offer elsewhere don t assume that another company will be willing to match that offer however it is always safer to begin tough negotiations if you know that the other offer is a fallback examples of counterofferfor example a seller wants to sell a vehicle for 20 000 a buyer arrives and offers 15 000 for the vehicle the offerer provides a counteroffer asking for 16 000 with the objective of obtaining a higher price if the offeree declines the offerer cannot force the buyer to purchase the vehicle at 15 000 even though the buyer suggested that price say that you are interviewing for a company that you are not really so sure you want to work at as you like your current job but want higher pay and more time off the new company offers you 10 higher pay and five extra vacation days you tell your current employer what you now have on the table and ask them for 20 and 10 days the employer makes a counteroffer at 15 pay and a week off take it or leave it | |
should you ever take a counteroffer | yes if the counteroffer is agreeable and will close the deal however a counteroffer that doesn t live up to all of your requirements may not be the best course of action moreover taking a counteroffer can tarnish your reputation with your current employer | |
how do i reject a counteroffer | if you decide to turn down a counteroffer do so respectfully and graciously it is helpful to explain your reasons for declining the offer in a short but honest way you may provide a referral to another potential candidate to fill your role and try to leave on good terms | |
should i accept the first salary i m offered | in most cases it is acceptable to try and negotiate if you do not succeed it is unlikely that you will lose the first offer altogether moreover many companies these days expect some degree of negotiation and therefore start with lower offers than they are willing to make 1the bottom linea counteroffer can be used in one of two ways in business the first is when negotiating the price for something such as a purchase or even a corporate takeover here an initial offer is declined but met with a lower counteroffer there may be a back and forth until an agreed upon price is reached the second is in the world of employment in which a counteroffer can refer to an offer made by your current employer to keep you working there after you have received an offer elsewhere | |
what is a counterparty | a counterparty is the other party that participates in a financial transaction every transaction must have a counterparty in order for the transaction to go through more specifically every buyer of an asset must be paired up with a seller who is willing to sell and vice versa for example the counterparty to an option buyer would be an option writer for any complete trade several counterparties may be involved for instance a buy of 1 000 shares is filled by 10 sellers of 100 shares each understanding counterpartiesthe term counterparty can refer to any entity on the other side of a financial transaction this can include deals between individuals businesses governments or any other organization additionally both parties do not have to be of equal standing this means an individual can be a counterparty to a business and vice versa in any instances where a general contract is met or an exchange agreement takes place one party would be considered the counterparty or the parties are counterparties to each other this also applies to forward contracts and other contract types a counterparty introduces counterparty risk into the equation this is the risk that the counterparty will be unable to fulfill their end of the transaction however in many financial transactions the counterparty is unknown and the counterparty risk is mitigated through the use of clearing firms in fact with typical exchange trading we do not ever know who our counterparty is on any trade and often times there will be several counterparties each making up a piece of the trade 1both parties do not have to be of equal standing an individual can be a counterparty to a business and vice versa counterparty examplesin the case of a purchase of goods from a retail store the buyer and retailer are counterparties in the transaction in terms of financial markets the bond seller and bond buyer are counterparties in certain situations multiple counterparties may exist as a transaction progresses each exchange of funds goods or services in order to complete a transaction can be considered as a series of counterparties for example if a buyer purchases a retail product online to be shipped to their home the buyer and retailer are counterparties as are the buyer and the delivery service in a general sense any time one party supplies funds or items of value in exchange for something from a second party counterparties exist counterparties reflect the dual sided nature of transactions types of counterpartiescounterparties in a trade can be classified in several ways having an idea of your potential counterparty in a given environment can provide insights into how the market is likely to act based on your presence orders transactions and other similar style traders here are just a few prime examples counterparty riskin dealings with a counterparty there is an innate risk that one of the people or entities involved will not fulfill their obligation this is especially true for over the counter otc transactions examples of this include the risk that a vendor will not provide a good or service after the payment is processed or that a buyer will not pay an obligation if the goods are provided first it can also include the risk that one party will back out of the deal before the transaction occurs but after an initial agreement is reached for structured markets such as the stock or futures markets financial counterparty risk is mitigated by the clearing houses and exchanges when you buy a stock you don t need to worry about the financial viability of the person on the other side of the transaction the clearing house or exchange steps up as the counterparty guaranteeing the stocks you bought or the funds you expect from a sale 1counterparty risk gained greater visibility in the wake of the 2008 global financial crisis aig famously leveraged its aaa credit rating to sell write credit default swaps cds to counterparties who wanted default protection in many cases on collateralized debt obligation cdo tranches when aig could not post additional collateral and was required to provide funds to counterparties in the face of deteriorating reference obligations the u s government bailed it out 2 | |
what does counterparty mean | a counterparty is simply the other participant in a transaction for every buyer there is a seller every transaction requires at least two parties whether it be buying stocks or purchasing groceries at a local supermarket | |
what is counterparty risk | counterparty risk is the risk that the other party in the transaction will not honor the agreement and fulfill its side of the deal fortunately in financial markets this often isn t an issue as counterparty risk is transferred to clearinghouses who is the counterparty in a loan if you take out a loan the main counterparty would be the financial institution lending you money the bottom line | |
when trading stocks or other financial instruments we seldom think about the person business on the other side of the trade clearinghouses function as an intermediary in financial markets overseeing transactions and ensuring that both the buyer and the seller honor their contractual obligations | that doesn t mean we shouldn t be curious though as discussed in this article knowing who your counterparty is can actually be quite illuminating | |
what is counterparty risk | counterparty risk is the likelihood or probability that one of those involved in a transaction might default on its contractual obligation counterparty risk can exist in credit investment and trading transactions understanding counterparty riskvarying degrees of counterparty risk exist in all financial transactions counterparty risk is also known as default risk default risk is the chance that companies or individuals will be unable to make the required payments on their debt obligations lenders and investors are exposed to default risk in virtually all forms of credit extensions counterparty risk is a risk that both parties should consider when evaluating a contract if one party has a higher risk of default a premium is usually attached to the transaction to compensate the other party the premium added due to counterparty risk is called a risk premium in retail and commercial financial transactions credit reports are often used by creditors to determine the counterparty s credit risk credit scores of borrowers are analyzed and monitored to gauge the level of risk to the creditor a credit score is a numerical value of an individual s or a company s creditworthiness which is based on many variables a person s credit score ranges from 300 to 850 and the higher the score the more financially trustworthy a person is considered to be to the creditor numerical values of credit scores are listed below many factors impact a credit score including a client s payment history the total amount of debt length of credit history and credit utilization which is the percentage of a borrower s total available credit that is currently being utilized the numerical value of a borrower s credit score reflects the level of counterparty risk to the lender or creditor a borrower with a credit score of 750 would have low counterparty risk while a borrower with a credit score of 450 would carry high counterparty risk if the borrower has a low credit score the creditor will likely charge a higher interest rate or premium due to the risk of default on the debt credit card companies for example charge interest rates in excess of 20 for those with low credit scores while they simultaneously offer 0 interest for customers who have stellar credit or high credit scores if the borrower is delinquent on payments by 60 days or more or exceeds the card s credit limit credit card companies usually tack on a risk premium or a penalty rate which can bring the interest rate of the card to more than 29 annually investors must consider the company that s issuing the bond stock or insurance policy to assess whether there s default or counterparty risk financial investment products such as stocks options bonds and derivatives carry counterparty risk bonds are rated by agencies such as moody s and standard and poor s from aaa to junk bond status to gauge the level of counterparty risk bonds that carry higher counterparty risk pay higher yields when counterparty risk is minimal the premiums or interest rates are low such as with money market funds for example a company that offers junk bonds will have a high yield to compensate investors for the added risk that the company could default on its obligations conversely a u s treasury bond has low counterparty risk and therefore is rated higher than corporate debt and junk bonds however treasurys typically pay a lower yield than corporate debt since there s a lower risk of default examples of counterparty risk | |
when the counterparty risk is miscalculated and a party defaults the impending damage can be severe for example the default of so many collateralized debt obligations cdos was a major cause of the real estate collapse in 2008 | mortgages are securitized into cdos for investment and backed by the underlying assets one of the major flaws of cdos before the economic crash was that they contained subprime and low quality mortgages but the cdos were given the same high grade ratings as corporate debt the high credit rating for cdos allowed them to receive institutional investment since funds are required to invest only in highly rated debt when borrowers began defaulting on mortgage payments the real estate bubble burst leaving the investors banks and reinsurers on the hook for massive losses the ratings agencies received a lot of blame for the collapse which eventually led to the financial market meltdown that defined the bear market of 2007 2009 american international group aig offers insurance products for real estate businesses and individuals the company needed a bailout from the u s government during the financial crisis of 2007 2009 for those who were insured by aig they suddenly faced an increase in counterparty risk as mentioned above investors must consider the company that s issuing the bond stock or insurance policy to assess the level of counterparty risk | |
what is an example of counterparty risk | counterparty risk refers to the likelihood that a transactor might default on its contractual obligation in the case of a lender like a bank one example of counterparty risk would be the borrower s credit score | |
what causes counterparty risk | despite best intentions defaults do occur for individuals who have borrowed money for instance a loss of a job or unexpected costs might contribute to an increase in the likelihood of defaulting on that loan for businesses internal factors like operations issues or external factors like a downturn in the economy might contribute there are a wide variety of factors that may lead to counterparty risk | |
what is the difference between counterparty risk and credit risk | credit risk and counterparty risk are related but different credit risk is a particular type of risk referring to the chance of a loss as a result of a borrower s failure to pay a loan typically credit risk is associated with banks and other lending institutions counterparty risk on the other hand broadly refers to the risk of a loss as a result of any party defaulting in a transaction the bottom linecounterparty risk exists in many types of transactions and refers to the chance that one party will default on its contractual obligations in the transaction lenders and investors are each exposed to a degree of counterparty risk if one party is determined to have a higher level of risk that party will typically have to pay a risk premium to compensate the other party | |
what is countertrade | countertrade is a reciprocal form of international trade in which goods or services are exchanged for other goods or services rather than for hard currency this type of international trade is more common in developing countries with limited foreign exchange or credit facilities countertrade can be classified into three broad categories barter counterpurchase and offset countertrade explainedin any form countertrade provides a mechanism for countries with limited access to liquid funds to exchange goods and services with other nations countertrade is part of an overall import and export strategy that ensures a country with limited domestic resources has access to needed items and raw materials additionally it provides the exporting nation with an opportunity to offer goods and services in a larger international market promoting growth within its industries bartering is the oldest countertrade arrangement it is the direct exchange of goods and services with an equivalent value but with no cash settlement the bartering transaction is referred to as a trade for example a bag of nuts might be exchanged for coffee beans or meat under a counterpurchase arrangement the exporter sells goods or services to an importer and agrees to also purchase other goods from the importer within a specified period unlike bartering exporters entering into a counterpurchase arrangement must use a trading firm to sell the goods they purchase and will not use the goods themselves in an offset arrangement the seller assists in marketing products manufactured by the buying country or allows part of the exported product s assembly to be carried out by manufacturers in the buying country this practice is common in aerospace defense and certain infrastructure industries offsetting is also more common for larger more expensive items an offset arrangement may also be referred to as industrial participation or industrial cooperation other examples of a countertradesbenefits and drawbacksa major benefit of countertrade is that it facilitates the conservation of foreign currency which is a prime consideration for cash strapped nations and provides an alternative to traditional financing that may not be available in developing nations other benefits include lower unemployment higher sales better capacity utilization and ease of entry into challenging markets a major drawback of countertrade is that the value proposition may be uncertain particularly in cases where the goods being exchanged have significant price volatility other disadvantages of countertrade include complex negotiations potentially higher costs and logistical issues additionally how the activities interact with various trade policies can also be a point of concern for open market operations opportunities for trade advancement shifting terms and conditions instituted by developing nations could lead to discrimination in the marketplace | |
what is a coupon rate | a coupon rate is the nominal yield paid by a fixed income security it is the annual coupon payments paid by the issuer relative to the bond s face or par value a coupon refers to the annual interest rate paid on a bond paid from issue date through maturity understanding coupon ratesthe coupon rate or coupon payment is the nominal yield the bond is stated to pay on its issue date this yield changes as the value of the bond changes thus giving the bond s yield to maturity ytm the coupon rate is the interest rate paid on a bond by its issuer for the term of the security the term coupon is derived from the historical use of actual coupons for periodic interest payment collections once set at the issuance date a bond s coupon rate remains unchanged and holders of the bond receive fixed interest payments at a predetermined time or frequency a bond issuer decides on the coupon rate based on prevalent market interest rates among other factors at the time of the issuance market interest rates change over time and as they move lower or higher than a bond s coupon rate the value of the bond increases or decreases respectively changing market interest rates affect bond investment results since a bond s coupon rate is fixed all through the bond s maturity a bondholder is stuck with receiving comparably lower interest payments when the market is offering a higher interest rate an equally undesirable alternative is selling the bond for less than its face value at a loss thus bonds with higher coupon rates provide a margin of safety against rising market interest rates if the market rate turns lower than a bond s coupon rate holding the bond is advantageous as other investors may want to pay more than the face value for the bond s comparably higher coupon rate coupon rate formulaa bond s coupon rate can be calculated by taking the sum of the security s annual coupon payments and dividing them by the bond s par value then multiplying by 100 in order to be represented as a percent the formula for coupon rate can be represented as sum of annual coupon payments par value x 100 coupon rate1for example a bond issued with a face value of 1 000 that pays a 25 coupon semiannually has a coupon rate of 5 all else held equal bonds with higher coupon rates are more desirable for investors than those with lower coupon rates excel software is also helpful for quickly calculating the bond s coupon rate coupon rate vs yield | |
when investors buy a bond initially at face value and then hold the bond to maturity the interest they earn on the bond is based on the coupon rate set at issuance for investors acquiring the bond on the secondary market depending on the prices they pay the return they earn from the bond s interest payments may be higher or lower than the bond s coupon rate this is the effective return called yield to maturity ytm another way to express this is that the current yield of a bond is the annual coupon payment divided by the current price of the bond | for example a bond with a par value of 100 but traded at 90 gives the buyer a yield to maturity higher than the coupon rate conversely a bond with a par value of 100 but traded at 110 gives the buyer a yield to maturity lower than the coupon rate example of coupon ratesan example can illustrate the difference between coupon rate and yield consider a scenario in which a bond has a par value of 100 and a coupon rate of 3 this bond provides an annual interest payment totaling 3 if an investor purchases that bond on the secondary market for 90 she will still receive the same 3 in interest payments over a year the current yield is thus 3 33 if a second investor purchases the same bond for 110 he will also receive the same 3 in annual interest payments the current yield of the bond changes again because of the new price becoming 2 73 | |
how are coupon rates affected by market interest rates | a bond issuer decides on the coupon rate based on prevalent market interest rates among others at the time of the issuance market interest rates change over time and as they move lower or higher than a bond s coupon rate the value of the bond increases or decreases respectively since a bond s coupon rate is fixed all through the bond s maturity bonds with higher coupon rates provide a margin of safety against rising market interest rates | |
what s the difference between coupon rate and ytm | the coupon rate is the annual income an investor can expect to receive while holding a particular bond it is fixed when the bond is issued and is calculated by dividing the sum of the annual coupon payments by the par value at the time it is issued a bond s yield to maturity ytm and its coupon rate are the same the ytm is the percentage rate of return for a bond assuming that the investor holds the asset until its maturity date it is based on the sum of all of its remaining coupon payments and will vary depending on its market value and how many payments remain to be made | |
what is the effective yield | the effective yield is the return on a bond that has its coupon payments reinvested at the same rate by the bondholder it is the total yield an investor receives in contrast to the nominal yield which is the coupon rate essentially effective yield takes into account the power of compounding on investment returns while nominal yield does not the bottom linethe coupon rate refers to the interest rate paid on a bond by its issuer for the term of the security bond issuers set the coupon rate based on market interest rates at the time of issuance a bond s coupon rate remains unchanged through maturity and bondholders receive fixed interest payments at a predetermined frequency as market interest rates change over time the value of the bond changes to reflect the relative attractiveness of the coupon rate while the coupon rate stays constant the bond s yield to maturity ytm varies depending on its market value and how many payments remain to be made | |
what is covariance | covariance is a statistical tool that measures the directional relationship between the returns on two assets a positive covariance means asset returns move together while a negative covariance means they move inversely covariance is calculated by analyzing at return surprises standard deviations from the expected return or multiplying the correlation between the two random variables by the standard deviation of each variable paige mclaughlin investopediaunderstanding covariancecovariance evaluates how the mean values of two random variables move together for example if stock a s return moves higher whenever stock b s return moves higher and the same relationship is found when each stock s return decreases these stocks are said to have positive covariance in finance covariances are calculated to help diversify security holdings | |
when an analyst has price information from a selected stock or fund covariance can be calculated using the following formula | covariance ret a b c avg a b c ret x y z avg x y z sample size 1 where ret a b c day s return for abc stock avg a b c abc s average return over the period ret x y z day s return for xyz stock avg x y z xyz s average return over the period sample size number of days sampled begin aligned text covariance sum frac text ret abc text avg abc times text ret xyz text avg xyz text sample size 1 textbf where text ret abc text day s return for abc stock text avg abc text abc s average return over the period text ret xyz text day s return for xyz stock text avg xyz text xyz s average return over the period text sample size text number of days sampled end aligned covariance sample size 1 retabc avgabc retxyz avgxyz where retabc day s return for abc stockavgabc abc s average return over the periodretxyz day s return for xyz stockavgxyz xyz s average return over the periodsample size number of days sampled types of covariancethe covariance equation is used to determine the direction of the relationship between two variables in other words whether they tend to move in the same or opposite directions a positive or negative covariance value determines this relationship a positive covariance between two variables indicates that these variables tend to be higher or lower at the same time in other words a positive covariance between stock one and two is where stock one is higher than average at the same points that stock two is higher than average and vice versa when charted on a two dimensional graph the data points will tend to slope upward | |
when the calculated covariance is less than negative this indicates that the two variables have an inverse relationship in other words a stock one value lower than average tends to be paired with a stock two value greater than average and vice versa | applications of covariancecovariances have significant applications in finance and modern portfolio theory mpt for example in the capital asset pricing model capm which is used to calculate the expected return of an asset the covariance between a security and the market is used in the formula for one of the model s key variables beta in the capm beta measures the volatility or systematic risk of a security compared to the market as a whole it s a practical measure that draws from the covariance to gauge an investor s risk exposure specific to one security meanwhile portfolio theory uses covariances to statistically reduce the overall risk of a portfolio by protecting against volatility through covariance informed diversification possessing financial assets with returns that have similar covariances does not provide very much diversification therefore a diversified portfolio would likely contain a mix of financial assets that have varying covariances covariance vs variancecovariance is related to variance a statistical measure for the spread of points in a data set both variance and covariance measure how data points are distributed around a calculated mean however variance measures the spread of data along a single axis while covariance examines the directional relationship between two variables in a financial context covariance is used to examine how different investments perform in relation to one another a positive covariance indicates that two assets tend to perform well at the same time while a negative covariance indicates that they tend to move in opposite directions investors might seek investments with a negative covariance to help them diversify their holdings covariance vs correlationcovariance is also distinct from correlation another statistical metric often used to measure the relationship between two variables while covariance measures the direction of a relationship between two variables correlation measures the strength of that relationship this is usually expressed through a correlation coefficient which can range from 1 to 1 while the covariance does measure the directional relationship between two assets it does not show the strength of the relationship between the two assets the coefficient of correlation is a more appropriate indicator of this strength a correlation is considered strong if the correlation coefficient has a value close to 1 positive correlation or 1 negative correlation a coefficient that is close to zero indicates that there is only a weak relationship between the two variables example of covariance calculationthe capital sigma symbol signifies the summation of all of the calculations so you need to calculate for each day and add the results for example to calculate the covariance between two stocks assume you have the stock prices for a period of four days and use the formula covariance ret a b c avg a b c ret x y z avg x y z sample size 1 begin aligned text covariance sum frac text ret abc text avg abc times text ret xyz text avg xyz text sample size 1 end aligned covariance sample size 1 retabc avgabc retxyz avgxyz you would find the day 1 average return for abc 1 675 and xyz 4 125 subtract them from the corresponding term and multiply them do this for each day day 1 1 2 1 675 3 1 4 125 0 487 begin aligned text day 1 1 2 1 675 times 3 1 4 125 0 487 end aligned day 1 1 2 1 675 3 1 4 125 0 487 day 2 1 8 1 675 4 2 4 125 0 009 begin aligned text day 2 1 8 1 675 4 2 4 125 0 009 end aligned day 2 1 8 1 675 4 2 4 125 0 009 day 3 2 2 1 675 5 0 4 125 0 459 begin aligned text day 3 2 2 1 675 5 0 4 125 0 459 end aligned day 3 2 2 1 675 5 0 4 125 0 459 day 4 1 5 1 675 4 2 4 125 0 013 begin aligned text day 4 1 5 1 675 4 2 4 125 0 013 end aligned day 4 1 5 1 675 4 2 4 125 0 013 add each day s result to the previous result 0 487 0 009 0 459 0 013 0 943 begin aligned 0 487 0 009 0 459 0 013 0 943 end aligned 0 487 0 009 0 459 0 013 0 943 your sample size is four so subtract one from four and divide the previous result by it 0 943 3 314 begin aligned frac 0 943 3 314 end aligned 30 943 314 this sample has a covariance of 0 314 a positive number suggesting that the two stocks are similar in returns | |
what does a covariance of 0 mean | a covariance of zero indicates that there is no clear directional relationship between the variables being measured in other words a high value for one stock is equally likely to be paired with a high or low value for the other | |
what is covariance vs variance | covariance and variance are used to measure the distribution of points in a data set however variance is typically used in data sets with only one variable and indicates how closely those data points are clustered around the average covariance measures the direction of the relationship between two variables a positive covariance means that both variables tend to be high or low at the same time a negative covariance means that when one variable is high the other tends to be low | |
what is the difference between covariance and correlation | covariance measures the direction of a relationship between two variables while correlation measures the strength of that relationship both correlation and covariance are positive when the variables move in the same direction and negative when they move in opposite directions however a correlation coefficient must always range from 1 to 1 with extreme values indicating a strong relationship | |
how is a covariance calculated | for a set of data points with two variables the covariance is measured by taking the difference between each variable and their respective means these differences are then multiplied and averaged across all of the data points in mathematical notation this is expressed as covariance returnabc averageabc returnxyz averagexyz sample size 1 the bottom linecovariance is an important statistical metric for comparing the relationships between multiple variables in investing covariance is used to identify assets that can help diversify a portfolio | |
what is a covenant | in its broadest sense a covenant is a promise agreement or contract between two parties as part of the covenant the two parties agree that certain activities will or will not be carried out covenants in finance most often relate to terms in a financial contract such as a loan document or bond issue stating the limits at which the borrower can further lend covenants in religion often convey the binding relationship between a deity and humanity investopedia nez riazunderstanding covenantsregarding business covenants are most often represented in terms of financial ratios that must be maintained such as a maximum debt to asset ratio or other such ratios covenants can cover everything from minimum dividend payments to levels that must be maintained in working capital to key employees remaining with the firm once a covenant is broken the lender typically has the right to call back the obligation from the borrower or take measures to reduce the lender s risk generally there are two types of primary covenants included in agreements affirmative covenants and negative covenants in addition a third type of covenant financial covenants is sometimes separated into its own category an affirmative or positive covenant is a clause in a loan contract that requires a borrower to perform specific actions 1 examples of affirmative covenants include requirements to maintain adequate levels of insurance requirements to furnish audited financial statements to the lender compliance with applicable laws and maintenance of proper accounting books and credit rating if applicable a violation of an affirmative covenant ordinarily results in outright default certain loan contracts may contain clauses that provide a borrower with a grace period to remedy the violation if not corrected creditors are entitled to announce default and demand immediate repayment of principal and any accrued interest negative covenants are put in place to make borrowers refrain from certain actions that could result in the deterioration of their credit standing and ability to repay existing debt 2 the most common forms of negative covenants restrict or forbid something from happening common examples include restricting a company from issuing dividends to its shareholders restricting management fees from being paid to related parties or restricting the amount of debt a business can carry a negative covenant can be circumnavigated with specific overriding approval of the covenant issuer for example imagine a company that wants to embark on a merger but is not allowed to due to a negative covenant should the opposite party in the covenant agree to release the restriction the company can proceed this may also be the case during the acquisition of real estate capital investments or disposition of assets lastly a covenant can be tied to a specific numerical metric this metric is often financial and may be a single number or calculation to derive a certain ratio for value a financial covenant is often monitored closely over time as it is the most likely covenant to suddenly change the argument could be made that a financial covenant is actually a positive or negative covenant for example imagine a company being required to maintain a certain financial ratio above a certain calculated amount since this is imposing a requirement it could technically be classified as a positive covenant however some view positive or negative covenants as a single outcome meanwhile financial covenants evaluate operating performance to ensure the overall health of the entity in business financial covenants are often separated into maintenance covenants or incurrence covenants maintenance covenants often stipulate operating performance that can not be breached an example is the interest coverage ratio to ensure a company has sufficient earnings to cover interest assessments incurrence covenants occur when a company takes action that impacts financial performance for example a company must maintain its debt to equity ratio above 0 40 should it wish to raise more debt it must ensure it satisfies the incurrence covenant in finance covenants are often put in place by lenders to protect themselves from borrowers defaulting on their obligations due to financial actions detrimental to themselves or the business types of covenantsdifferent industries and sectors have different types of covenants in general it s pretty common to see both positive and negative covenants across different industries debt covenants have been the example used most within this article a debt covenant arises when an entity works with a financial institution to take out a loan to secure the loan the entity must agree to meet certain criteria not perform certain activities and maintain good financial standing debt covenants can also impact the lender for instance imagine a company secures a line of credit and hopes to use this line over the next several years it is in the company s best interest to partner with a bank that maintains good financial standing and manages operational risk therefore the borrower may impose covenants on the lender as part of the agreement to ensure the borrower will have long term capabilities of securing financing a property covenant is an agreement between multiple parties that stipulates how real property or real estate will or will not be used 3 these types of covenants may restrict the landowner or require specific action to be taken for example homeowner association hoa covenants often require property to have trees trimmed to a certain height or outline how parking spaces are to be utilized some property covenants will run with the land or exist in perpetuity regardless of who the owner is 4 for example a property covenant may restrict the type or quantity of livestock allowed on a property should this covenant be transferrable to any new owner in the future the covenant is tied to the land covenants have been historically used to discriminate against race religion or sexual orientation for example more than 500 of these historical covenants were discovered applying to 20 000 properties in king county washington supreme court rulings and state law now make these discriminatory covenants illegal 5while covenants are legal agreements by their nature covenants are also simply part of the legal system law is a form of covenant as law covenants are often negative covenants that restrict an individual or company from performing certain actions the law may explain the outcome of what will happen should the covenant law be broken any common law intended to prevent criminal activity is an example of a law covenant covenants are often found in religion as a deity often makes promises or agreements to the people of the world or requires something of humankind although the types of religious covenants specifically within the bible are discussed below covenants are a common part of christianity islam hinduism and buddhism there are two types of covenants in the bible first conditional covenants are promises from god that certain outcomes will occur however for god to fulfill his part of the covenant humanity must do its part first second the bible includes unconditional covenants which are promises from god that he will fulfill an oath with his divine power without any associated conditions covenant violationsa covenant violation often called a breach of covenant is a failure to uphold the agreed upon terms of a covenant whether a party failed to execute a positive covenant performed a task it shouldn t have as outlined by a negative covenant or wasn t able to maintain certain operational metrics the contract has been broken a bond violation is a breach of the terms of the covenants of a bond bond covenants are designed to protect the interests of both parties where the inclusion of the covenant is in the bond s indenture which is the binding agreement contract or document between two or more parties | 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when an issuer violates a bond covenant it is considered to be in technical default a common penalty for violating a bond covenant is the downgrading of a bond s rating which could make it less attractive to investors and increase the issuer s borrowing costs for example moody s one of the major credit rating agencies in the united states rates a bond s covenant quality on a scale of 1 to 5 with five being the worst this means that a bond with a covenant rating of five is an indication that covenants are being violated consistently | lenders will often allow for remedy on violated covenants for financial covenants after a company has breached its covenant it must often in general a party may have legal recourse to seek compensation for damages should a different party have breached a covenant for property failure to comply with association rules or covenants may result in fines or liens though an hoa cannot force a homeowner to sell their home other types of property covenants may call for liquidation or transfer of ownership failure to comply with law covenants results in fines penalties fees or more serious legal punishment when you park your car on the side of the street you are subject to the covenant that stipulates you pay for that space during a specific time should you fail to comply you are subject to a parking ticket any court proceeding or case is an example of a failed covenant lastly different religions uphold different consequences for not adhering to specific teachings the quran states that should someone stray from believing in islamic teachings allah will never forgive them nor will he guide them to the right way example of bond or debt covenantsas part of its 2021 annual report amazon com inc publicly disclosed its note payable obligation because of the potential importance and restriction of covenants it chose to publicly state that the notes were not subject to any covenants 6conversely apple inc also report notes payable though there are terms and conditions as part of their debt obligation the following excerpt from its 2021 annual report outlines exceptions the limitations on additional interest on the notes the company will subject to the exceptions and limitations set forth below pay as additional interest on the notes such additional amounts additional amounts as are necessary in order that the net payment by the company or the paying agent of the company will not be less than the amount provided in the notes to be then due and payable 7apple further discusses covenants restricting consolidation or merger activity their covenant states they may perform these activities as long as |
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