The business of business is making money, and the money business makes is called profit.

How it makes that

profit is by selling its goods for more than it costs to make them. For this lesson, we make the simplifying
assumption that nothing influences business other than maximizing profit. Although it is an exaggeration, it
is reasonably close to the truth, and accepting it as the truth simplifies our task considerably.
With the simplifying assumption of myopic profit maximization in place, we can break things down into the
cost side and the revenue side. Cost is the expense that businesses must incur to produce goods for sale.
Revenue is the money that comes into the firm from the sale of the goods.
In this lesson, we will care of the costs only. All costs can be classified as either fixed or variable
Fixed costs
During the short run, there are several important costs that are fixed. (In the long run, all costs changed).
Fixed costs do not change when the firm changes its level of output. That is the firm may produce nothing, it
may produce 1 unit, or it may produce 10,000 units, but its fixed costs remain unchanged. Fixed costs
include such items as interest on debts of the firm, payments for rent, insurance premiums, property taxes,
depreciation of equipment, salaries for workers. These are payments that must be made even though the firm
is not producing a single unit of output.
Variable costs
In contrast to fixed costs, variable costs increase as the firm increases its output. When a firm increases its
output, it must acquire more productive resources such as additional workers and raw materials. More fuel or
power will be needed in the plant, and there will be additional transportation costs. Some of the maintenance
costs will rise as the firm’s plant and equipment are used more intensively.
Marginal costs
Marginal costs can be defined as the additional cost of one more unit of production. Knowledge of marginal
cost is extremely important to the firm because it helps the firm to decide whether to increase or decrease
output. Marginal cost is the cost that the firm can control most directly. Because marginal cost is the cost
incurred by producing one more unit, it is the cost that can be eliminated simply by reducing total production
by one unit.
Constant cost
A constant cost situation is one in which the cost per unit of output remains the same even though output is
rising. An increase in demand might not result in higher prices in a competitive market, for the industry
could expand its output to meet the greater demand without experiencing higher unit costs. This might be the
case if raw material, labour, and other factors of production were so abundant that the industry could obtain
them without increasing the unit cost of production.
Costs over the Long Run
Over the long run, all costs are variable. Taxes, interest rates, and other costs that are fixed in the short run
can change. In the long run period, there is time for the industry to build new plants, and there is time for the
new firms to enter the industry. Costs may decrease, stay constant, or increase in the long run.
 KNOWLEDGE CHECK: KINDS OF COSTS

Circle the best word in brackets to complete the following sentences

1. Fixed costs are those which (change / remain the same) as the firm (changes / remains) its level of output.
2. Variable costs are those which (increase / remain the same) when the firm (increases / remains) its
output.
3. Companies (have to / don’t have to) pay fixed costs even though they are not producing anything.
4. Constant costs are the (changed / unchanged) cost per unit of production even though output is rising.
5. (Marginal costs / Variable costs) are the additional costs of one more unit of production, i.e. the costs
incurred by producing one more unit.
6. Payments for rent and salaries are examples of (constant cost / fixed cost).
7. Payments for raw material, fuel or power are examples of (marginal cost / variable cost).
8. Marginal costs can be (eliminated / controlled) by reducing the total production by one unit.
9. When factors of production are (abundant / limited), companies can increase production (without / by)
incurring higher unit costs.
10. In the long term, all costs are (fixed / variable).

KNOWLEDGE CHECK: KINDS OF COSTS

Circle the best word in brackets to complete the following sentences

1. Fixed costs are those which (change / remain the same) as the firm (changes / remains) its level of output.
2. Variable costs are those which (increase / remain the same) when the firm (increases / remains) its
output.
3. Companies (have to / don’t have to) pay fixed costs even though they are not producing anything.
4. Constant costs are the (changed / unchanged) cost per unit of production even though output is rising.
5. (Marginal costs / Variable costs) are the additional costs of one more unit of production, i.e. the costs
incurred by producing one more unit.
6. Payments for rent and salaries are examples of (constant cost / fixed cost).
7. Payments for raw material, fuel or power are examples of (marginal cost / variable cost).
8. Marginal costs can be (eliminated / controlled) by reducing the total production by one unit.
9. When factors of production are (abundant / limited), companies can increase production (without / by)
incurring higher unit costs.
10. In the long term, all costs are (fixed / variable).
THE ROLE OF PROFITS IN BUSINESS
Profit: an example
Naturally, the business person in a market economy is seeking profit. The intelligent executive will not be
satisfied, however, simply with the knowledge that the firm is making a profit. He or she will invariably want
to make the greatest profit possible – to maximize profits. If, on the other hand, the firm should be forced to
operate at a loss for a time, it will certainly attempt to incur the least loss possible – to minimize losses.
Whether a firm exists in a perfectly or imperfectly competitive market, it will try to maximize profits and
minimize losses. Profits or losses of a company are dependent, to a great extent, on the differential between
its revenues and costs.
A firm’s revenue is the amount it earns by selling goods or services in a given period such as a year.
The firm’s costs are the expenses incurred in producing goods or services during that period.
Profits are the excess of revenues over costs.
Thus we can write:
Profits = Revenue – Costs
In more technical terms, total revenues (TR, the total amount received for the sale of goods or services) are
compared with total costs (TC). If then, the profit or loss is simply the difference between the two. And here
we can restate our formula:
Profits = Total Revenues – Total Costs (Or Profits = TR – TC)
Obviously if total costs exceed total revenues, the firm is operating at a loss. We sometimes refer to losses as
negative profits.
The role of profits in business
Shutdown Point(điểm hòa vốn)
A firm compares total revenue with total costs (including opportunity costs) to see what profit or loss is. At
this point you might wonder why a firm would continue to operate if it were taking a loss. Remember that
there are fixed costs and variable costs. The fixed costs must be paid anyway, even if the firm is producing
nothing.
Suppose that a firm’s total cost is $300,000 at a certain level of output, with $200,000 made up of variable
costs (such as labour and raw material) and $100,000 made up of fixed costs (such as investment payments,
taxes and rent). If the firm’s total revenue is $240,000, it is clearly taking a loss. The difference between total
revenue and total costs in this case is $60,000 – this is its loss. But notice that the total revenue of $240,000
pays all the firm’s variable costs ($200,000) and also pays $40,000 of its fixed costs.
Thus as long as a firm can cover all its variable costs by remaining in operation, it will do so. Its shutdown
point will be where total revenue no longer covers total variable cost.
For example if the firm’s total revenue drops to $190,000, it can not clearly cover its variable cost of
$200,000 and is better off shutting down all together. If it shuts down it will be losing $110,000 (the
difference between the total cost of $300,000 and the total revenue of $190,000).
Thus as long as a firm can cover all its variable costs by remaining in operation, it will do so. Its shutdown
point will be where total revenue no longer covers total variable cost.
FACTORS THAT INFLUENCE THE CALCULATION OF PROFITS
Outstanding Bills
People do not always pay their bills immediately. At the end of 1987, Rent-a-Person has not been paid for all
the workers it hired out during the year. On the other hand, it has not paid its telephone bill for December.
From an economic viewpoint, the right definition of revenues and costs relates to the activities carried out
whether or not payments have yet been made.
This distinction between economic revenues and costs and actual receipts and payments raises the important
concept of cash flow. A firm’s cash flow is the net amount of money actually received during the period.
Profitable firms may still have a poor cash flow, for example when customers are slow to pay their bills.
A firm’s cash flow is the net amount of money actually received during the period.
Part of the problem of running a business is that cash flow at the beginning is bound to be slow. Set-up costs
must be incurred before revenues start to flow in. That is why firms need financial capital to start the
business. If the business prospers, revenues will build up and eventually there will be a healthy cash flow.
Capital and Depreciation
Physical capital is the machinery, equipment, and buildings used in production. And depreciation is the loss
in value resulting from the use of machinery during a certain period of time, usually a year. The cost during
the period of using a capital good is the depreciation or loss of value of that good, not its purchase price.
Physical capital is the machinery, equipment, and buildings used in production.
And depreciation is the loss in value resulting from the use of machinery during a certain period of time,
usually a year.
Suppose however that Rent-a-Person buys eight typewriters at the beginning of the year for $1,000 each. It
should not count $8,000 as the cost of typewriters in calculating costs and profits for that year. Rather the
cost should be calculated as the reduction in the value of the typewriters over the years. Suppose wear and
tear on the typewriters over the year has reduced their value from $1,000 to $700 each. The economic cost of
the use of 8 typewriters over the year is $2,400 ($300 x 8). This amount of depreciation is the cost during the
year.
The existence of depreciation again leads to a difference between economic profits and cash flow. When a
capital good is first purchased there is a large cash out flow, much larger than the depreciation cost of using
the good during the first year. Profits may be high but cash flow low. However, in subsequent years the firm
makes no further cash outlay, having already paid for the capital goods, but must still calculate depreciation
as an economic cost since the re-sale value of the good is reduced still further. Cash flow will now be higher
than economic profit.
The consequence of treating depreciation rather than purchase price as the true economic costs is thus to
spread the initial cost over the life of the capital good, but that is not the reason for undertaking the
calculation in this way. Rent-a-Person could always have sold its typewriters for $ 5,600 ($700 x 8) after one
year, restricting its costs to $ 2,400.
The fact that the firm chose to keep them for reuse in the next year indicates that the latter strategy is even
more profitable. Hence the true economic cost of using the typewriters in the first year can be at most
$2,400.
PROBLEMS IN PROFITS ACCOUNTING
Retained earnings
Finally, we must consider what the firm does with its profit after taxes. It can pay them out to shareholders as
dividends, or keep them in the firm as retained earnings. Retained earnings are the part of after tax profits
that is ploughed back into the business rather than paid out to shareholders as dividends. Retained earnings
affect the balanced sheet. If they are kept as cash or used to purchase equipment, they increase the asset side
of the balance sheet.
Retained earnings are the part of after-tax profits that is ploughed back into the business rather than paid
out to shareholders as dividends.
Alternatively, they may be used to reduce the firm’s liabilities, for example, by repaying the bank loan.
Either way, the firm’s net worth is increased.
Opportunity costs and Accounting costs
The income statement and the balance sheet of a company provide a useful guide to how that company is
doing. Economists and accountants do not always take the same view of costs and profits. Whereas the
accountant is chiefly interested in describing the actual receipts and payments of a company, the economist is
chiefly interested in the role of cost and profits as determinants of the firm’s decision, the allocation of
resources to particular activities. Accounting methods can be seriously misleading in two ways.
Economists identify the cost of using a resource not as the payment actually made but as its opportunity cost.
A self-employed sole trader might draw up an income statement and find that profits were $20,000 per
annum, and conclude that this business was a good thing. But this conclusion neglects the opportunity cost of
the individual’s labour, the money that could have been earned by working elsewhere. If that individual
could have earned a salary of $25,000 working for someone else, being self-employed is actually losing the
person $5,000 per annum even though the business is making an accounting profit of $20,000. If we wish to
understand the incentives that the market provides to guide people towards particular occupations, we must
use the economic concept of actual payment. Including the opportunity cost of 25,000 in the income
statement would quickly convince the individual that the business was not such a good idea.
The second place where opportunity cost must be counted is with respect to capital. Somebody has put up the
money to start the business. In calculating accounting profits, no cost is attached to the use of owned (as
opposed to borrowed) financial capital. This financial capital could have been used elsewhere, in an interest
bearing bank account or perhaps to buy share in a different company. This opportunity cost of that financial
capital is included in the economic costs. For example, if the owner could have earned a return of 10 percent
elsewhere, the opportunity cost of their funds is 10 percent times the money they put up. If after deducting
this cost, the business still makes a profit, economists call this supernormal profit.
Supernormal profit is the profit over and above the return which the owners could have earned by lending
their money elsewhere at the market rate of interest. Supernormal profits provide the true economic indicator
of how well the owners are doing by tying up their funds in the business. Supernormal profits, not
accounting profit, are the measure that will explain the incentive to shift resources into or out of a business.
Supernormal profit is the profit over and above the return which the owners could have earned by lending
their money elsewhere at the market rate of interest.

Rent-a-Person is a firm that hires people whom it then rents out to other firms that need
temporary workers. Rent-a-Person charges $10 per hour per worker but pays its workers
only $7 per hour. During 1987 it rented 100,000 hours of labour. Business expenses,
including leasing an office, buying advertising space, and paying telephone bills, came to
$200,000. Figure 14.1 shows the income statement or profit-and-loss account for 1987.
Profits or net income before taxes were 100,000. Taxes to central government (corporation
tax) plus taxes to local government (rates assessed on some of the property the firm owned,
referred to as property tax rates) came to $25,000. Rent-a-Person’s after-tax profits in 1987
were 75,000.
VAI TRÒ CỦA LỢI NHUẬN TRONG KINH DOANH
Lợi nhuận: một ví dụ
Đương nhiên, người kinh doanh trong nền kinh tế thị trường là tìm kiếm lợi nhuận. Tuy nhiên, giám
đốc điều hành thông minh sẽ không hài lòng, chỉ đơn giản là khi biết rằng công ty đang tạo ra lợi
nhuận. Người đó luôn muốn tạo ra lợi nhuận lớn nhất có thể - tối đa hóa lợi nhuận. Mặt khác, nếu
công ty bị buộc phải hoạt động thua lỗ trong một thời gian, thì công ty đó chắc chắn sẽ cố gắng chịu
mức lỗ ít nhất có thể - để giảm thiểu lỗ. Cho dù một công ty tồn tại trong một thị trường cạnh tranh
hoàn hảo hay không hoàn hảo, nó sẽ cố gắng tối đa hóa lợi nhuận và giảm thiểu tổn thất. Lợi nhuận
hoặc thua lỗ của một công ty, ở một mức độ lớn, phụ thuộc vào sự khác biệt giữa doanh thu và chi
phí của nó.
Doanh thu của một công ty là số tiền mà công ty kiếm được bằng cách bán hàng hóa hoặc dịch vụ
trong một khoảng thời gian nhất định, chẳng hạn như một năm.
Chi phí của công ty là chi phí phát sinh để sản xuất hàng hoá hoặc dịch vụ trong thời kỳ đó.
Lợi nhuận là phần vượt quá của doanh thu so với chi phí.
Vì vậy, chúng ta có thể viết:
Lợi nhuận = Doanh thu - Chi phí
Theo thuật ngữ kỹ thuật hơn, tổng doanh thu (TR, tổng số tiền nhận được để bán hàng hóa hoặc dịch
vụ) được so sánh với tổng chi phí (TC). Nếu sau đó, lãi hoặc lỗ chỉ đơn giản là sự khác biệt giữa hai.
Và ở đây chúng ta có thể trình bày lại công thức của mình:
Lợi nhuận = Tổng doanh thu - Tổng chi phí (Hoặc Lợi nhuận = TR - TC)
Rõ ràng là nếu tổng chi phí vượt quá tổng doanh thu, công ty đang hoạt động thua lỗ. Đôi khi chúng
tôi coi lỗ là lợi nhuận âm.
Vai trò của lợi nhuận trong kinh doanh
Shutdown Point (điểm hòa vốn)
Một công ty so sánh tổng doanh thu với tổng chi phí (bao gồm cả chi phí cơ hội) để xem lãi hoặc lỗ
là bao nhiêu. Tại thời điểm này, bạn có thể tự hỏi tại sao một công ty sẽ tiếp tục hoạt động nếu nó bị
thua lỗ. Hãy nhớ rằng có chi phí cố định và chi phí biến đổi. Dù sao thì chi phí cố định cũng phải
được thanh toán, ngay cả khi công ty không sản xuất gì.
Giả sử rằng tổng chi phí của một công ty là 300.000 đô la ở một mức sản lượng nhất định, với
200.000 đô la được tạo thành từ chi phí biến đổi (chẳng hạn như lao động và nguyên liệu) và
100.000 đô la được tạo thành từ chi phí cố định (chẳng hạn như thanh toán đầu tư, thuế và tiền thuê
nhà). Nếu tổng doanh thu của công ty là 240.000 đô la, thì rõ ràng công ty đang bị lỗ. Sự khác biệt
giữa tổng doanh thu và tổng chi phí trong trường hợp này là 60.000 đô la - đây là khoản lỗ của nó.
Nhưng lưu ý rằng tổng doanh thu 240.000 đô la trả cho tất cả các chi phí biến đổi của công ty
(200.000 đô la) và cũng trả 40.000 đô la chi phí cố định của công ty.
Do đó, miễn là một công ty có thể trang trải tất cả các chi phí biến đổi của mình bằng cách duy trì
hoạt động, thì công ty đó sẽ làm như vậy. Điểm ngừng hoạt động của nó sẽ là nơi mà tổng doanh thu
không còn bao gồm tổng chi phí biến đổi.
Ví dụ: nếu tổng doanh thu của công ty giảm xuống còn 190.000 đô la, thì công ty không thể trang
trải rõ ràng chi phí biến đổi là 200.000 đô la và tốt hơn là nên tắt tất cả cùng nhau. Nếu nó ngừng
hoạt động, nó sẽ mất 110.000 đô la (chênh lệch giữa tổng chi phí 300.000 đô la và tổng doanh thu là
190.000 đô la).
Do đó, miễn là một công ty có thể trang trải tất cả các chi phí biến đổi của mình bằng cách duy trì
hoạt động, thì công ty đó sẽ làm như vậy. Điểm ngừng hoạt động của nó sẽ là nơi mà tổng doanh thu
không còn bao gồm tổng chi phí biến đổi.

CÁC YẾU TỐ ẢNH HƯỞNG ĐẾN VIỆC TÍNH LỢI NHUẬN

Hóa đơn chưa thanh toán
Không phải lúc nào mọi người cũng thanh toán hóa đơn của họ ngay lập tức. Vào cuối năm 1987,
Rent-a-Person vẫn chưa được trả cho tất cả công nhân mà nó đã thuê trong năm. Mặt khác, nó vẫn
chưa thanh toán hóa đơn điện thoại cho tháng 12. Từ quan điểm kinh tế, định nghĩa đúng đắn về
doanh thu và chi phí liên quan đến các hoạt động được thực hiện dù chưa được thanh toán hay chưa.
Sự khác biệt này giữa doanh thu và chi phí kinh tế và các khoản thu và chi thực tế làm nảy sinh khái
niệm quan trọng về dòng tiền. Dòng tiền của một công ty là số tiền ròng thực tế nhận được trong kỳ.
Các công ty có lợi nhuận vẫn có thể có dòng tiền kém, ví dụ như khi khách hàng chậm thanh toán
hóa đơn của họ.
Dòng tiền của một công ty là số tiền ròng thực tế nhận được trong kỳ.
Một phần của vấn đề khi điều hành một doanh nghiệp là dòng tiền vào thời điểm ban đầu nhất định
phải chậm. Chi phí thiết lập phải được phát sinh trước khi doanh thu bắt đầu chảy vào. Đó là lý do
tại sao các công ty cần vốn tài chính để bắt đầu kinh doanh. Nếu công việc kinh doanh phát đạt,
doanh thu sẽ tăng lên và cuối cùng sẽ có một dòng tiền lành mạnh.
Vốn và Khấu hao
Vốn vật chất là máy móc, thiết bị và nhà cửa được sử dụng trong sản xuất. Và khấu hao là sự mất
mát về giá trị do sử dụng máy móc trong một thời gian nhất định, thường là một năm. Nguyên giá
trong thời gian sử dụng một hàng hóa vốn là sự hao mòn hoặc mất giá trị của hàng hóa đó, không
phải giá mua của nó.
Vốn vật chất là máy móc, thiết bị và nhà cửa được sử dụng trong sản xuất.
Và khấu hao là sự mất mát về giá trị do sử dụng máy móc trong một thời gian nhất định, thường là
một năm.
Tuy nhiên, giả sử rằng Rent-a-Person mua tám chiếc máy đánh chữ vào đầu năm với giá 1.000 đô la
mỗi chiếc. Nó không nên tính 8.000 đô la là chi phí của máy đánh chữ trong việc tính toán chi phí và
lợi nhuận cho năm đó. Thay vào đó, chi phí nên được tính là sự giảm giá trị của máy đánh chữ trong
những năm qua. Giả sử sự hao mòn của máy đánh chữ trong năm qua đã làm giảm giá trị của chúng
từ 1.000 đô la xuống còn 700 đô la mỗi chiếc. Chi phí kinh tế của việc sử dụng 8 máy đánh chữ
trong năm là $ 2,400 ($ 300 x 8). Số tiền khấu hao này là chi phí trong năm.
Sự tồn tại của khấu hao một lần nữa dẫn đến sự khác biệt giữa lợi nhuận kinh tế và dòng tiền. Khi
một hàng hóa vốn được mua lần đầu tiên sẽ có một dòng tiền lớn, lớn hơn nhiều so với chi phí khấu
hao của việc sử dụng hàng hóa đó trong năm đầu tiên. Lợi nhuận có thể cao nhưng dòng tiền thấp.
Tuy nhiên, trong những năm tiếp theo, công ty không trích xuất tiền mặt nữa, vì đã thanh toán cho
hàng hóa vốn, nhưng vẫn phải tính khấu hao như một chi phí kinh tế vì giá trị bán lại của hàng hóa
vẫn còn giảm thêm. Dòng tiền lúc này sẽ cao hơn lợi nhuận kinh tế.
Do đó, hậu quả của việc coi khấu hao thay vì giá mua là chi phí kinh tế thực sự là làm lan truyền chi
phí ban đầu trong vòng đời của hàng hóa vốn, nhưng đó không phải là lý do để thực hiện tính toán
theo cách này. Rent-a-Person luôn có thể bán máy đánh chữ của mình với giá 5.600 đô la (700 đô la
x 8) sau một năm, hạn chế chi phí xuống còn 2.400 đô la.
Việc công ty chọn giữ chúng để tái sử dụng trong năm tới cho thấy rằng chiến lược sau này thậm chí
còn mang lại nhiều lợi nhuận hơn. Do đó, chi phí kinh tế thực sự của việc sử dụng máy đánh chữ
trong năm đầu tiên có thể tối đa là 2.400 đô la.
CÁC VẤN ĐỀ TRONG KẾ TOÁN LỢI NHUẬN
Thu nhập giữ lại
Cuối cùng, chúng ta phải xem xét những gì công ty làm với lợi nhuận sau thuế của nó. Nó có thể trả
chúng cho các cổ đông dưới dạng cổ tức, hoặc giữ chúng trong công ty dưới dạng thu nhập giữ lại.
Lợi nhuận để lại là một phần của lợi nhuận sau thuế được chuyển trở lại hoạt động kinh doanh thay
vì được trả cho cổ đông dưới dạng cổ tức. Thu nhập giữ lại ảnh hưởng đến bảng cân đối kế toán.
Nếu chúng được giữ dưới dạng tiền mặt hoặc được sử dụng để mua thiết bị, chúng sẽ làm tăng phần
tài sản của bảng cân đối kế toán.
Lợi nhuận để lại là một phần của lợi nhuận sau thuế được chuyển trở lại hoạt động kinh doanh thay
vì được trả cho cổ đông dưới dạng cổ tức.
Ngoài ra, chúng có thể được sử dụng để giảm nợ phải trả của công ty, ví dụ, bằng cách trả nợ ngân
hàng. Dù bằng cách nào, giá trị ròng của công ty cũng được tăng lên.
Chi phí cơ hội và Chi phí kế toán
Báo cáo thu nhập và bảng cân đối kế toán của một công ty cung cấp một hướng dẫn hữu ích về cách
thức hoạt động của công ty đó. Các nhà kinh tế và kế toán không phải lúc nào cũng có cùng quan
điểm về chi phí và lợi nhuận. Trong khi kế toán chủ yếu quan tâm đến việc mô tả các khoản thu và
chi thực tế của một công ty, thì nhà kinh tế lại quan tâm nhiều nhất đến vai trò của chi phí và lợi
nhuận như những yếu tố quyết định đến quyết định của công ty, việc phân bổ nguồn lực cho các hoạt
động cụ thể. Các phương pháp kế toán có thể bị sai lệch nghiêm trọng theo hai cách.
Các nhà kinh tế xác định chi phí sử dụng một nguồn lực không phải là khoản thanh toán thực sự
được thực hiện mà là chi phí cơ hội của nó. Một nhà kinh doanh duy nhất tự kinh doanh có thể lập
báo cáo thu nhập và thấy rằng lợi nhuận là 20.000 đô la mỗi năm, và kết luận rằng công việc kinh
doanh này là một điều tốt. Nhưng kết luận này bỏ qua chi phí cơ hội của lao động cá nhân, số tiền
mà lẽ ra có thể kiếm được bằng cách làm việc ở nơi khác. Nếu cá nhân đó có thể kiếm được mức
lương 25.000 đô la khi làm việc cho người khác, thì việc tự kinh doanh thực sự khiến người đó mất
đi 5.000 đô la mỗi năm mặc dù doanh nghiệp đang tạo ra lợi nhuận kế toán là 20.000 đô la. Nếu
chúng ta muốn hiểu những ưu đãi mà thị trường cung cấp để hướng mọi người đến những nghề
nghiệp cụ thể, chúng ta phải sử dụng khái niệm kinh tế về thanh toán thực tế. Bao gồm chi phí cơ hội
là 25.000 trong báo cáo thu nhập sẽ nhanh chóng thuyết phục cá nhân rằng việc kinh doanh không
phải là một ý tưởng hay.
Vị trí thứ hai mà chi phí cơ hội phải được tính đến là đối với vốn. Ai đó đã bỏ tiền để bắt đầu kinh
doanh. Khi tính toán lợi nhuận kế toán, không có chi phí nào được gắn với việc sử dụng vốn tài
chính thuộc sở hữu (trái ngược với vốn vay). Vốn tài chính này có thể đã được sử dụng ở nơi khác,
trong một tài khoản ngân hàng chịu lãi suất hoặc có thể để mua cổ phần trong một công ty khác. Chi
phí cơ hội của vốn tài chính đó được tính vào chi phí kinh tế. Ví dụ: nếu chủ sở hữu có thể kiếm
được lợi nhuận 10 phần trăm ở nơi khác, thì chi phí cơ hội của quỹ của họ gấp 10 phần trăm số tiền
họ bỏ ra. Nếu sau khi trừ đi chi phí này, doanh nghiệp vẫn có lãi thì các nhà kinh tế gọi đây là lợi
nhuận siêu thường.
Lợi nhuận bất thường là lợi nhuận cao hơn lợi nhuận mà chủ sở hữu có thể kiếm được bằng cách cho
vay tiền của họ ở nơi khác với lãi suất thị trường. Lợi nhuận bất thường cung cấp chỉ số kinh tế thực
sự về việc các chủ sở hữu đang hoạt động tốt như thế nào bằng cách thắt chặt quỹ của họ vào công
việc kinh doanh. Lợi nhuận bất thường, không phải lợi nhuận kế toán, là thước đo sẽ giải thích động
cơ chuyển nguồn lực vào hoặc ra khỏi doanh nghiệp.
Lợi nhuận bất thường là lợi nhuận cao hơn lợi nhuận mà chủ sở hữu có thể kiếm được bằng cách cho
vay tiền của họ ở nơi khác với lãi suất thị trường.

KNOWLEDGE CHECK: CORPORATE

FINANCE
EXERCISE 1. Match each item in column A with its definition in column B

EXERCISE 2. Choose the letter of the item that best completes the statement or answer the question
1. Fixed costs are
a. The costs for rented buildings and machinery
b. The costs for materials inputs
c. Property taxes and wages for the workers
d. The costs that remain the same regardless of the firm’s productivity levels
2. Variable costs are
a. The total amount of money paid by the firm to additional workers and raw materials
b. The increased amount of money the firm has to pay as it increases its output
c. Fixed costs plus salaries paid to the workers
d. Fixed costs plus the maintenance costs
3. Profits are
a. The amount of money earned from selling goods and services to the market
b. The amount of money given out as dividends
c. The excess amount of revenue and costs
d. All of the above
4. The shutdown point is
a. The point where total revenue equals total costs
b. Total revenue is less than total costs
c. Total revenue equals total variable costs
d. Total revenue is less than total variable costs
5. Total revenue is
a. The total amount of money a firm can earn from selling out its products
b. Total profits plus total costs
c. Cost per unit times number of units sold plus total profits
 d. All of the above

All businesses need to maintain financial records in order to find out if they are making a profit. These
records exist in several forms. In daily business operations recordings of business transactions are first made
in a journal. This journal is sometimes called the book of original entry. In the journal, bookkeepers record
sales, uses of raw materials, and purchases. Periodically, bookkeepers transfer figures from the journals to
ledgers. This activity is known as posting. The ledger is a book containing all the accounts of a company. An
account is a financial record which contains information about a group of similar transactions. For example,
all sales activities are recorded in one account. Another account may be a record of all the costs of raw
materials.
Once, bookkeeping served as a good method of determining whether or not a company was making profits
and whether or not it owed any taxes. Small business owners could keep their own books and make business
decisions based on the information found there. Nowadays, a more sophisticated system of accounting is
needed. The design, maintenance, and interpretation of the information recorded in accounts is referred to as
accounting. Accountants use the information in accounts to construct financial statements. These statements
are analyzed by management and used as a basis for business decisions such as allocation of financial
resources, development of new products, and expansion of operations. The most important of these financial
statements are the balance sheet and the statement of income and expenses. These statements are also used
for determining income tax liabilities. Income - expense statements for different types of businesses vary
greatly. This lesson will discuss only the balance sheet, which is more standard in form. The balance sheet is
a financial statement which indicates the condition of a company on a specific date. It is called a balance
sheet because it expresses the basic accounting formula: Assets = Liabilities + Owners' Equity. (Owners'
equity is sometimes referred to as net worth.) The left side of the balance sheet itemizes the firm's assets.
Assets are anything of value to a company. On a balance sheet the value is always expressed in terms of
money. Companies have different types of assets. They are usually divided into two groups: current assets
and fixed assets.
Current assets are either cash or items which will be turned into cash during the current business period, such
as merchandise to be sold and payments to be received. In addition to cash, inventories, and receivables,
companies sometimes have stocks and bonds. These are referred to as securities. All of these assets, such as
cash and those readily turned into cash, are known as liquid assets. If a company needs to have more cash for
one reason or another, it can liquidate some of its stocks and bonds. On the other hand, merchandise which is
not selling quickly because there is not much demand is not very liquid, even though it is considered as
current assets.
Fixed assets are those that will be kept and used for a long time. Fixed assets are usually itemized according
to their use to the firm. New machinery and production equipment are valued at their cost. As the equipment
is used, its value decreases. This decrease in value is called depreciation. Used equipment is therefore carried
on the books at original cost less depreciation. Depreciation is usually calculated on a yearly basis by
dividing the total cost of the equipment by the number of years of useful life. For example, a taxicab may cost
$12,000 when new. The taxicab owner may use it for three years and then he will have to purchase a new
one. The depreciation on the taxicab is $4,000 per year. Therefore, after one year the value of the taxicab on
the balance sheet would be $12,000 - $4,000 = $8,000. After two years it would be $12,000 - $8,000 =
$4,000. There are various formulas and methods used for calculating depreciation. The depreciation schedule
may be part of the income tax laws of a country.
Other fixed assets are furniture and fixtures. Fixtures refer to equipment that is attached to the building. There
are light fixtures and plumbing fixtures. Fixtures would also include items such as shelves and air
conditioning and heating equipment. Buildings are another fixed asset. On the balance sheet the value of
fixtures and buildings would also indicate accumulated depreciation. Land is also a fixed asset, but its value
does not decline, and so it shows no depreciation.
The opposite side of the balance sheet shows the liabilities. These are amounts which the company owes.
Companies owe money to banks who supply credit to employees whom they haven't yet paid, to governments
for taxes, and to other companies who have sold them goods which they haven't yet paid for. Liabilities, like
assets, are divided into two groups. Current liabilities are debts which must be paid during the current
business cycle. They would include accounts payable, taxes payable, accrued wages payable, and interest on
borrowed money. Companies also have long term liabilities. These are debts which do not have to be repaid
for perhaps ten, twenty, or thirty years. Companies usually have to pay interest on long term debts. The debts
may be in the form of bonds, which are securities sold to banks or other investors, or a mortgage, which is
money borrowed from banks for the purpose of purchasing property or equipment. The payment of bonds is
usually guaranteed by the reputation of the company. Mortgages, on the other hand, are guaranteed by the
value of the mortgaged property.
After a company subtracts its debts from its assets, the figure arrived at is the net worth of the company or its
owners' equity. Depending upon the type of company, there are different types of owners. A corporation is
owned by stockholders, and so equity will be shown as the value of the stock. This value is the book value. It
may or may not be equal to the value of the stock on the stock exchange or market value. Companies
whose stock is selling at prices considerably below book value are likely to be taken over by other
companies. The owners' equity of a partnership is allocated according to the articles of co-partnership. For
a sole proprietor, there is only one owner and the owner's equity is the value of the business to him.

Unit 3: Báo cáo tài chính

Dịch bài: Tất cả các doanh nghiệp cần duy trì hồ sơ tài chính để tìm hiểu xem liệu họ có đang tạo ra
lợi nhuận hay không. Các bản ghi này tồn tại ở một số hình thức. Trong hoạt động kinh doanh hàng
ngày, việc ghi chép các giao dịch kinh doanh lần đầu tiên được ghi vào sổ nhật ký. Tạp chí này đôi
khi được gọi là cuốn sách của mục gốc. Trên sổ nhật ký, kế toán ghi sổ các khoản bán, sử dụng
nguyên vật liệu, và các khoản mua. Định kỳ, kế toán chuyển số liệu từ sổ nhật ký sang sổ cái. Hoạt
động này được gọi là đăng bài. Sổ cái là một cuốn sổ chứa tất cả các tài khoản của một công ty. Tài
khoản là một hồ sơ tài chính chứa thông tin về một nhóm các giao dịch tương tự. Ví dụ, tất cả các
hoạt động bán hàng được ghi lại trong một tài khoản. Một tài khoản khác có thể là một bản ghi tất cả
các chi phí nguyên vật liệu.
Trước đây, việc ghi sổ kế toán là một phương pháp tốt để xác định xem một công ty có đang tạo ra
lợi nhuận hay không và liệu nó có nợ bất kỳ khoản thuế nào hay không. Các chủ doanh nghiệp nhỏ
có thể lưu giữ sổ sách của riêng họ và đưa ra các quyết định kinh doanh dựa trên thông tin được tìm
thấy ở đó. Ngày nay, một hệ thống kế toán phức tạp hơn là cần thiết. Việc thiết kế, sản xuất chính và
giải thích thông tin được ghi trong các tài khoản được gọi là kế toán. Kế toán sử dụng thông tin
trong tài khoản để xây dựng báo cáo tài chính. Các báo cáo này được ban giám đốc phân tích và
được sử dụng làm cơ sở cho các quyết định kinh doanh như phân bổ nguồn lực tài chính, phát triển
sản phẩm mới và mở rộng hoạt động. Điều quan trọng nhất của các báo cáo tài chính này là bảng cân
đối kế toán và báo cáo thu nhập và chi phí. Các báo cáo này cũng được sử dụng để xác định nghĩa vụ
thuế thu nhập. Báo cáo thu nhập ¬- chi phí cho các loại hình kinh doanh khác nhau rất khác nhau.
Bài học này sẽ chỉ thảo luận về bảng cân đối kế toán, có hình thức chuẩn hơn. Bảng cân đối kế toán
là một báo cáo tài chính cho biết tình trạng của một công ty vào một ngày cụ thể. Nó được gọi là
bảng cân đối kế toán vì nó thể hiện công thức kế toán cơ bản: Tài sản = Nợ phải trả + Vốn chủ sở
hữu. (Vốn chủ sở hữu đôi khi được gọi là giá trị ròng.) Phần bên trái của bảng cân đối kế toán là tài
sản của công ty. Tài sản là bất cứ thứ gì có giá trị đối với một công ty. Trên bảng cân đối kế toán, giá
trị luôn được thể hiện bằng tiền. Các công ty có nhiều loại tài sản khác nhau. Chúng thường được
chia thành hai nhóm: tài sản lưu động và tài sản cố định.
Tài sản lưu động là tiền mặt hoặc các vật phẩm sẽ được chuyển thành tiền mặt trong kỳ kinh doanh
hiện tại, chẳng hạn như hàng hóa sẽ được bán và các khoản thanh toán sẽ được nhận. Ngoài tiền mặt,
hàng tồn kho và các khoản phải thu, các công ty đôi khi còn có cổ phiếu và trái phiếu. Chúng được
gọi là chứng khoán. Tất cả những tài sản này, chẳng hạn như tiền mặt và những tài sản sẵn sàng
chuyển thành tiền mặt, được gọi là tài sản lưu động. Nếu một công ty cần có thêm tiền mặt vì lý do
này hay lý do khác, công ty có thể thanh lý một số cổ phiếu và trái phiếu của mình. Mặt khác, hàng
hóa không bán nhanh do nhu cầu không nhiều nên không có tính thanh khoản cao, mặc dù nó được
coi là tài sản lưu động.
Tài sản cố định là những tài sản sẽ được lưu giữ và sử dụng lâu dài. Tài sản cố định thường được
chia thành từng khoản tùy theo mục đích sử dụng của chúng đối với doanh nghiệp. Máy móc và thiết
bị sản xuất mới được định giá theo giá thành của chúng. Khi thiết bị được sử dụng, giá trị của nó
giảm dần. Sự giảm giá trị này được gọi là khấu hao. Do đó, thiết bị đã qua sử dụng được ghi sổ theo
nguyên giá trừ khấu hao. Khấu hao thường được tính theo năm bằng cách lấy tổng chi phí của thiết
bị chia cho số năm sử dụng hữu ích. Ví dụ, một chiếc taxi có thể có giá 12.000 đô la khi còn mới.
Chủ sở hữu taxi có thể sử dụng nó trong ba năm và sau đó họ sẽ phải mua một cái mới. Khoản khấu
hao trên xe taxi là $ 4,000 mỗi năm. Do đó, sau một năm, giá trị của chiếc xe taxi trên bảng cân đối
kế toán sẽ là $ 12.000 - $ 4.000 = $ 8.000. Sau hai năm, nó sẽ là 12.000 đô la - 8.000 đô la = 4.000
đô la. Có nhiều công thức và phương pháp khác nhau được sử dụng để tính khấu hao. Lịch trình
khấu hao có thể là một phần của luật thuế thu nhập của một quốc gia.
Tài sản cố định khác là bàn ghế và đồ đạc. Đồ đạc liên quan đến thiết bị được gắn vào tòa nhà. Có
đèn chiếu sáng và ống nước. Đồ đạc cũng sẽ bao gồm các mặt hàng như kệ và thiết bị điều hòa nhiệt
độ và sưởi ấm. Tòa nhà là một tài sản cố định khác. Trên bảng cân đối kế toán, giá trị của đồ đạc và
tòa nhà cũng sẽ cho biết khấu hao lũy kế. Đất đai cũng là một tài sản cố định, nhưng giá trị của nó
không giảm, và vì vậy nó không có dấu hiệu mất giá.
Phần đối diện của bảng cân đối kế toán hiển thị các khoản nợ phải trả. Đây là những khoản mà công
ty nợ. Các công ty nợ các ngân hàng cung cấp tín dụng cho nhân viên mà họ chưa trả, các khoản
thuế chi trả, và các công ty khác đã bán cho họ những món hàng mà họ chưa trả. Nợ phải trả, giống
như tài sản, được chia thành hai nhóm. Nợ ngắn hạn là các khoản nợ phải trả trong chu kỳ kinh
doanh hiện tại. Chúng sẽ bao gồm các khoản phải trả, thuế phải trả, tiền lương phải trả tích lũy và lãi
của khoản tiền đã vay. Các công ty cũng có các khoản nợ dài hạn. Đây là những món nợ không phải
trả trong vòng mười, hai mươi hoặc ba mươi năm. Các công ty thường phải trả lãi cho các khoản nợ
dài hạn. Các khoản nợ có thể ở dạng trái phiếu, là chứng khoán được bán cho ngân hàng hoặc các
nhà đầu tư khác, hoặc một khoản thế chấp, là tiền vay từ ngân hàng với mục đích mua tài sản hoặc
thiết bị. Việc thanh toán trái phiếu thường được đảm bảo bởi danh tiếng của công ty. Mặt khác, thế
chấp được đảm bảo bằng giá trị của tài sản thế chấp.
Sau khi một công ty trừ đi các khoản nợ khỏi tài sản của mình, con số tính đến là giá trị ròng của
công ty hoặc vốn chủ sở hữu của nó. Tùy thuộc vào loại hình công ty mà có các loại chủ sở hữu
khác nhau. Một công ty thuộc sở hữu của các chủ sở hữu cổ phiếu, và do đó, vốn chủ sở hữu sẽ được
thể hiện dưới dạng giá trị của cổ phiếu. Giá trị này là giá trị sổ sách. Nó có thể bằng hoặc không
bằng giá trị cổ phiếu trên sàn chứng khoán hoặc giá trị thị trường. Các công ty có cổ phiếu được bán
với giá thấp hơn đáng kể so với giá trị sổ sách có khả năng bị các công ty khác tiếp quản. Vốn chủ
sở hữu của công ty hợp danh được phân bổ theo các điều khoản của công ty hợp danh. Đối với một
chủ sở hữu duy nhất, chỉ có một chủ sở hữu duy nhất và vốn chủ sở hữu là giá trị của doanh nghiệp
đối với anh ta.

KNOWLEDGE CHECK: FINANCIAL STATEMENTS

Match the words and phrases which have similar meanings.

1. Transactions -p a . the purchase of one company by another
2. transfer to the ledger - l b . assets minus liabilities
3. ledger -g c . money owed to the company
4. accounts-i d . securities sold by the electric company
5. income tax liability -m e . sales and expenditures, for example
6. asset -j f . long term money
7. receivable –c g . book of accounts
8. present -o h . cost of a share on the exchange
9. inventory -q i . records of similar transactions
10. liquidate -s j . something of value
11. fixed asset -t k . property which guarantees a mortgage
12. list -r l. post
13. thirty year mortgage -f m. tax which must be paid
14. utility bonds -d n . net worth divided by number of outstanding shares
15. finance -e o. current
16. net worth -b p . merchandise
17. book value-n q . obtain capital
18. market value -h r . itemize
19. secured property -k s . sell for cash
20. take over(thâu tóm) -a t . a building, for example
There are four critical areas of a company’s business which can be analyzed by applying ratio. These are
liquidity, capital structure, activity and efficiency, and profitability.
Measurements of liquidity should answer the question: Can a company pay its short-term debts? There are
two ratios commonly used to answer this question. Firstly, the current ratio, which measures the current
assets against the current liabilities. In most cases, a healthy company would show a ratio above 1, in other
words more current assets than current liabilities. Another method of measuring liquidity is the so-called
quick ratio – this is particularly appropriate in manufacturing industries where stock levels can disguise the
company’s true liquidity. The ratio is calculated in the same way as above but the stocks are deducted from
the current assets.
The balance sheet will also reveal the gearing of the company – this is an indicator of the company’s capital
structure and its ability to meet its long-term debts. The ratio expresses the relationship between
shareholders’ funds and loan capital. Income gearing is also important and shows the ratio between profit
and interest paid on borrowings. Relatively high borrowing would indicate vulnerability to an interest rate
rise. Highly geared companies generally represent a greater risk for investors.
The balance sheet and the profit and loss account can be used to assess how efficiently a company manages
its assets. Basically, sales are compared with investment in various assets. For example, in the retail sector,
an important ratio which indicates efficiency is sales divided by stock – the resulting figure should be much
higher than in the manufacturing sector where stock tends to show a much slower turnover. Another example
of efficiency measurement is to calculate the average collection period on debts. This is found by dividing
debtors by the sales per day. This can vary tremendously from industry to industry. In the retail sector it may
well be as low as one or two days, whereas in the heavy manufacturing and service sectors it can range from
thirty to ninety days.
Finally, profitability ratios show the manager’s use of the company’s resources. The profit margin figure
(profit before tax divided by sales and expressed as a percentage) indicates the operational day-to-day
profitability of the business. Return on capital employed can be calculated in a number of ways. One
common method is to take profit before taxes and divide by the total assets – this is a good indicator of the
use of all the assets of the company. From a shareholder’s point of view, the return on owner’s equity will be
an important ratio; this is calculated by dividing the profit before taxes by the owner’s equity and expressing
it as a percentage. If the company does not earn a reasonable return, the share price will fall and thus make it
difficult to attract additional capital.

Unit 4: Phân tích tài chính

Có bốn lĩnh vực quan trọng trong hoạt động kinh doanh của công ty có thể được phân tích bằng cách
áp dụng tỷ lệ. Đó là tính thanh khoản, cấu trúc vốn, hoạt động và hiệu quả, và khả năng sinh lời.
Các phép đo khả năng thanh toán cần trả lời câu hỏi: Liệu một công ty có thể thanh toán các khoản
nợ ngắn hạn của mình không? Có hai tỷ lệ thường được sử dụng để trả lời câu hỏi này. Thứ nhất, hệ
số thanh toán hiện hành, đo lường tài sản lưu động so với nợ ngắn hạn. Trong hầu hết các trường
hợp, một công ty lành mạnh sẽ có tỷ lệ trên 1, hay nói cách khác là tài sản lưu động nhiều hơn nợ
ngắn hạn. Một phương pháp khác để đo lường tính thanh khoản là cái gọi là hệ số thanh toán nhanh -
điều này đặc biệt thích hợp trong các ngành sản xuất, nơi lượng cổ phiếu có thể che giấu tính thanh
khoản thực sự của công ty. Tỷ lệ được tính theo cách tương tự như trên nhưng cổ phiếu được khấu
trừ khỏi tài sản lưu động.
Bảng cân đối kế toán cũng sẽ cho biết khả năng hoạt động của công ty - đây là một chỉ số về cấu trúc
vốn của công ty và khả năng đáp ứng các khoản nợ dài hạn của công ty. Tỷ số thể hiện mối quan hệ
giữa quỹ của cổ đông và vốn vay. Việc xác định thu nhập cũng rất quan trọng và thể hiện tỷ lệ giữa
lợi nhuận và lãi trả cho các khoản vay. Khoản vay tương đối cao sẽ cho thấy khả năng bị tổn thương
đối với việc tăng lãi suất. Các công ty có hộp số cao thường mang lại rủi ro lớn hơn cho các nhà đầu
tư.
Bảng cân đối kế toán và tài khoản lãi lỗ có thể được sử dụng để đánh giá mức độ hiệu quả của một
công ty quản lý tài sản của mình. Về cơ bản, doanh số bán hàng được so sánh với việc đầu tư vào
các tài sản khác nhau. Ví dụ, trong lĩnh vực bán lẻ, một tỷ lệ quan trọng cho thấy hiệu quả là doanh
số bán hàng chia cho số lượng hàng tồn kho - con số kết quả sẽ cao hơn nhiều so với lĩnh vực sản
xuất, nơi hàng hóa có xu hướng cho thấy doanh thu chậm hơn nhiều. Một ví dụ khác về đo lường
hiệu quả là tính toán kỳ thu tiền bình quân của các khoản nợ. Điều này được tìm thấy bằng cách chia
con nợ cho doanh số bán hàng mỗi ngày. Điều này có thể rất khác nhau giữa các ngành. Trong lĩnh
vực bán lẻ, con số này cũng có thể thấp nhất là một hoặc hai ngày, trong khi trong lĩnh vực sản xuất
nặng và dịch vụ, nó có thể dao động từ ba mươi đến chín mươi ngày.
Cuối cùng, tỷ suất sinh lời cho thấy việc người quản lý sử dụng các nguồn lực của công ty. Con số tỷ
suất lợi nhuận (lợi nhuận trước thuế chia cho doanh thu và được biểu thị bằng tỷ lệ phần trăm) cho
biết khả năng sinh lời hàng ngày của doanh nghiệp. Tỷ suất lợi nhuận trên vốn sử dụng lao động có
thể được tính theo một số cách. Một phương pháp phổ biến là lấy lợi nhuận trước thuế và chia cho
tổng tài sản - đây là một chỉ báo tốt về việc sử dụng tất cả các tài sản của công ty. Từ quan điểm của
cổ đông, lợi nhuận trên vốn chủ sở hữu sẽ là một tỷ lệ quan trọng; điều này được tính bằng cách chia
lợi nhuận trước thuế cho vốn chủ sở hữu và biểu thị nó dưới dạng tỷ lệ phần trăm. Nếu công ty
không thu được lợi nhuận hợp lý, giá cổ phiếu sẽ giảm và do đó khó thu hút thêm vốn.
 KNOWLEDGE CHECK: FINANCIAL ANALYSIS

EXERCISE 1. Complete the table below

Key indicators Ratios used Interpretation

Liquidity (i)Current ratio_________ which measures the current assets against

the current liabilities
_______________________________
(ii)Quick ratio
_ this is particularly appropriate in
manufacturing industries where stock levels
Capital structure can disguise the company’s true liquidity
______________________________
(i)The balance sheet
_________________ _ The ratio expresses the relationship
between shareholders’ funds and loan
capital
______________________________
(ii)_Income shows the ratio between profit and interest
gearing_________________ paid on borrowings
_______________________________
Efficiency
(i) The balance sheet can be used to assess how efficiently a
___________________ company manages its assets
_______________________________
_______________________________
(ii)the profit and loss account
_________________ _______________________________
_______________________________

Profitability (i) The profit margin figure Indicates the operational day-to-day
___________________ profitability of the business.
_______________________________

(ii) Return on capital employed this is a good indicator of the use of all the
__________________ assets of the company
______________________________
will be an important ratio; this is calculated
(iii) the return on owner’s equity
by dividing the profit before taxes by the
_________________
owner’s equity and expressing it as a
percentage
_______________________________
_______________________________
_______________________________
 _______________________________
_______________________________
_______________________________

EXERCISE 2. Which of the ratios is likely to be the key indicator for these groups?
1. Shareholders - the return on owner’s equity
2. Managers
3. Customers – current ratio
4. Suppliers
5. Employees -
To ensure a company’s long-term survival and prosperity, finance managers need to make decisions about
the gearing of the company. Gearing is the relationship between equity capital invested in the business and
long-term debt. The higher the gearing (in other words, the greater the proportion of long-term debt), the
more exposed the company is in times of economic difficulty.
The first form of equity is owner’s capital. This is the most exposed form of capital since a return is received
only after all other calls on a company’s profits have been satisfied. In an extreme case – bankruptcy – the
owner’s equity will be repaid only after everyone else, including employees, creditors, banks etc. has
received what they are owed. On the other hand, the owners have a claim on all the net profit of the
company.
An owner does not need to rely on his or her own funds. S/he can go to other sources of equity finance.
There are three main sources: firstly venture capital: this is usually provided by venture firms interested in
financing high – growth companies. However, the provider usually demands a much faster and higher rate of
return than an owner would expect from his/ her own capital. On the other hand, the venture capital company
does not usually interfere in the running of the company.
Another source of equity finance is the unlisted securities market – sometimes called the second or third
market. This has the advantage of allowing a company to raise money from outside investors without losing
much control of the company.
The last source is available only to large companies – the Stock Exchange. If a company gains a listing on
the Stock Exchange, this will provide the long-term opportunity of raising capital by issuing fresh shares.
However, at least 25 percent of the equity must be in public hands – thereby reducing the control of the
original owners.
Companies prepared to increase their gearing can raise capital through long-term loans. They can go to
sources such as the clearing banks, merchant banks and even pension funds. However, in all three cases they
will usually secure their debt over the fixed assets of the business and, of course, interest must be paid,
usually linked to bank base rate.
In times of prosperity, a high gearing will give the owners a much better return as net profits will be a much
higher percentage of equity after interest payments on the long-term debt. However, in harder times, the
owner’s earnings will drop dramatically as interest payments soak up most of the company’s profits.
Dịch:

Gây quỹ cho doanh nghiệp

Để đảm bảo sự tồn tại lâu dài và thịnh vượng của một công ty, các nhà quản lý tài chính cần đưa ra
quyết định về hoạt động của công ty. Lãi suất là mối quan hệ giữa vốn chủ sở hữu đầu tư vào doanh
nghiệp và nợ dài hạn. Lãi suất càng cao (nói cách khác, tỷ trọng nợ dài hạn càng lớn), công ty càng
phải chịu nhiều rủi ro hơn trong thời kỳ kinh tế khó khăn.
Hình thức đầu tiên của vốn chủ sở hữu là vốn của chủ sở hữu. Đây là hình thức huy động vốn nhiều
nhất vì lợi nhuận chỉ nhận được sau khi tất cả các cuộc gọi khác về lợi nhuận của công ty đã được
thỏa mãn. Trong một trường hợp cực đoan - phá sản - vốn chủ sở hữu sẽ chỉ được hoàn trả sau khi
những người khác, bao gồm nhân viên, chủ nợ, ngân hàng, v.v. đã nhận được những gì họ nợ. Mặt
khác, chủ sở hữu có yêu cầu đối với tất cả lợi nhuận ròng của công ty.
Chủ sở hữu không cần dựa vào quỹ của mình. Anh / chị ấy có thể tìm đến các nguồn vốn cổ phần
khác. Có ba nguồn chính: thứ nhất là vốn đầu tư mạo hiểm: nguồn này thường được cung cấp bởi
các công ty mạo hiểm quan tâm đến việc tài trợ cho các công ty tăng trưởng cao. Tuy nhiên, nhà
cung cấp thường đòi hỏi tỷ suất sinh lợi nhanh hơn và cao hơn nhiều so với mức mà chủ sở hữu
mong đợi từ vốn tự có của mình. Mặt khác, công ty đầu tư mạo hiểm thường không can thiệp vào
việc điều hành công ty.
Một nguồn tài chính vốn cổ phần khác là thị trường chứng khoán chưa niêm yết - đôi khi được gọi là
thị trường thứ hai hoặc thứ ba. Điều này có lợi thế là cho phép một công ty huy động tiền từ các nhà
đầu tư bên ngoài mà không mất nhiều quyền kiểm soát công ty.
Nguồn cuối cùng chỉ có sẵn cho các công ty lớn - Sở giao dịch chứng khoán. Nếu một công ty được
niêm yết trên Sở giao dịch chứng khoán, điều này sẽ mang lại cơ hội huy động vốn dài hạn bằng
cách phát hành cổ phiếu mới. Tuy nhiên, ít nhất 25% vốn chủ sở hữu phải nằm trong tay công chúng
- do đó làm giảm quyền kiểm soát của các chủ sở hữu ban đầu.
Các công ty chuẩn bị tăng lãi suất có thể huy động vốn thông qua các khoản vay dài hạn. Họ có thể
đến các nguồn như ngân hàng thanh toán bù trừ, ngân hàng thương mại và thậm chí là quỹ hưu trí.
Tuy nhiên, trong cả ba trường hợp, họ thường sẽ đảm bảo khoản nợ của mình bằng tài sản cố định
của doanh nghiệp và tất nhiên, lãi suất phải được trả, thường liên quan đến lãi suất cơ bản của ngân
hàng.
Trong thời kỳ thịnh vượng, việc trả lãi cao sẽ mang lại cho chủ sở hữu lợi nhuận tốt hơn nhiều vì lợi
nhuận ròng sẽ chiếm tỷ lệ cao hơn nhiều so với vốn chủ sở hữu sau khi trả lãi cho khoản nợ dài hạn.
Tuy nhiên, trong những thời điểm khó khăn hơn, thu nhập của chủ sở hữu sẽ giảm đáng kể khi các
khoản thanh toán lãi suất ngấm vào phần lớn lợi nhuận của công ty.

KNOWLEDGE CHECK: FUNDING THE BUSINESS

EXERCISE 1. Complete the chart

Sources of funds Advantages/ disadvantages

Low gearing (i) Owner’s capital Advantages:

- An owner does not need to rely on his or her
own funds. S/he can go to other sources of equity
finance.
Disadvantages:
- This is the most exposed form of capital since a
return is received only after all other calls on a
company’s profits have been satisfied.
- In an extreme case – bankruptcy – the owner’s
equity will be repaid only after everyone else,
including employees, creditors, banks etc. has
 received what they are owed.
(ii) Venture capital Advantage: this is usually provided by venture
firms interested in financing high – growth
companies
Disadvantages:
- The provider usually demands a much faster and
higher rate of return than an owner would expect
from his/ her own capital.
- The venture capital company does not usually
interfere in the running of the company.
Advantage: allowing a company to raise money
(iii)Unlisted securities
from outside investors without losing much
market
control of the company.
Advantage: this will provide the long-term
(iv) the Stock Exchange opportunity of raising capital by issuing fresh
shares
Disadvantage: However, at least 25 percent of the
equity must be in public hands – thereby reducing
the control of the original owners.
- can go to sources such as the clearing banks,
High gearing Long-term loans merchant banks and even pension funds
- Advantage: In times of prosperity, a high
gearing will give the owners a much better return
as net profits will be a much higher percentage of
equity after interest payments on the long-term
debt.
- Disadvantage: However, in harder times, the
owner’s earnings will drop dramatically as interest
payments soak up most of the company’s profits.

EXERCISE 2. Analyze the gearing of these two companies and comment on the dangers

Company A Company B

Equity $100.000 $250.000

Long-term debt 300.000 150.000
Profits 50.000 30.000
Interest paid (10%) 30.000 15.000
Earnings 20.000 15.000
Investment helps an economy expand and provide a better standard of living for its people. One of the most
popular ways for people to save money and to put it to work as an investment is through the purchase of
stocks.
Stock represents the ownership of a company. A company will issue hundreds, or thousands of shares of
stock that can be purchased by individuals as an investment. The money that is paid for stock goes to the
company for its use. When a company wants to expand or rebuild its factories, it can borrow money or it
can sell stock to raise the cash.
For an investor, shares of stock can be attractive in two ways. The company will pay a dividend to its
shareholders. This money comes from the profits of the company – money left over after a company pays
all of its costs of doing business. Typically, a company will announce every three months that it is paying a
dividend, say of $1, for each share of stock held on that day. If you own 100 shares you will receive $100 as
return on your stock investment.
The second attraction for the purchase of stocks is that they can grow in value. A corporation may have a
million shares of stock that are on sale for $10 a share. A person can buy 100 shares and start collecting any
dividends the company is paying. After a year, he might find that the shares are now selling at $15 a share.
The investor could then sell his shares and take a profit of 50% for the year or longer and hope that their price
will go even higher. Of course, it is possible the stock may fall in value and the investor would have to decide
between selling and waiting to see if the price will rise again. The reward can be high because the investor is
taking a risk when he invests his money. Investments that involve higher risks should pay higher returns to
the investor. More secure investments usually pay lower returns.
A bond is a debt owed by a company. It is a loan that has a guaranteed rate of interest to be paid over a fixed
period of time. Like stock, a bond can be traded or sold to someone else. A company might offer a bond of $1
million to be paid back over 20 years at 5% a year. The investor will examine the company carefully before
agreeing to buy such a bond. He is likely to read reports of private rating companies who evaluate a
borrower's ability to repay the bond. If the company is profitable and has good prospects for the future, the
bond is likely to be a good, secure investment. The company will pay its interest regularly and at the end of
the 20 years, pay off the original amount of the bond which is called the principal.
A bond as an investment has some advantages over shares of stock. For instance, a company must pay the
interest on its bonds before it pays dividends to stockholders. If a company gets into serious financial trouble
and goes bankrupt, those investors holding bonds must be paid first before stockholders. The downside for
bond holders is that the interest on bonds will stay the same for the life of the bond while interest rates are
rising on new investments. If a person sells a bond before it has run its full life, or matured, he may have
to sell for less than he paid for the bond because its rate of return is low compared with other
investments.
Governments borrow money just like corporations do and individuals can do the lending with near
absolute confidence that they will earn a return and that their money will be safe. This kind of lending
can be done by buying a government bond - usually a long-term loan or a note that is generally for
shorter periods.
Dịch bài:
 Cổ phiếu và trái phiếu
Đầu tư giúp nền kinh tế mở rộng và cung cấp mức sống tốt hơn cho người dân. Một trong những
cách phổ biến nhất để mọi người tiết kiệm tiền và sử dụng nó như một khoản đầu tư là mua cổ phiếu.
Cổ phiếu đại diện cho quyền sở hữu của một công ty. Một công ty sẽ phát hành hàng trăm, hoặc
hàng nghìn cổ phiếu có thể được mua bởi các cá nhân như một khoản đầu tư. Tiền được trả cho cổ
phiếu sẽ được chuyển cho công ty để sử dụng. Khi một công ty muốn mở rộng hoặc xây dựng lại các
nhà máy của mình, nó có thể vay tiền hoặc có thể bán cổ phiếu để huy động tiền mặt.
Đối với một nhà đầu tư, cổ phiếu chứng khoán có sức hấp dẫn theo hai cách. Công ty sẽ trả cổ tức
cho các cổ đông của mình. Số tiền này đến từ lợi nhuận của công ty - tiền còn lại sau khi một công
ty thanh toán tất cả các chi phí hoạt động kinh doanh của mình. Thông thường, một công ty sẽ thông
báo ba tháng một lần rằng họ đang trả cổ tức, chẳng hạn như $ 1, cho mỗi cổ phiếu nắm giữ vào
ngày đó. Nếu bạn sở hữu 100 cổ phiếu, bạn sẽ nhận được 100 đô la như lợi tức đầu tư vào cổ phiếu
của bạn.
Điểm hấp dẫn thứ hai đối với việc mua cổ phiếu là chúng có thể tăng giá trị. Một công ty có thể có
một triệu cổ phiếu đang được bán với giá 10 đô la một cổ phiếu. Một người có thể mua 100 cổ phiếu
và bắt đầu thu bất kỳ khoản cổ tức nào mà công ty đang trả. Sau một năm, anh ta có thể thấy rằng cổ
phiếu hiện đang được bán với giá 15 đô la một cổ phiếu. Sau đó, nhà đầu tư có thể bán cổ phiếu của
mình và thu lợi nhuận 50% trong năm hoặc lâu hơn và hy vọng rằng giá của chúng sẽ còn cao hơn
nữa. Tất nhiên, có thể cổ phiếu có thể giảm giá và nhà đầu tư sẽ phải quyết định giữa việc bán và
chờ xem giá có tăng trở lại hay không. Phần thưởng có thể cao vì nhà đầu tư chấp nhận rủi ro khi
đầu tư tiền của mình. Các khoản đầu tư có rủi ro cao hơn sẽ trả lợi nhuận cao hơn cho nhà đầu tư.
Các khoản đầu tư an toàn hơn thường trả lợi nhuận thấp hơn.
Trái phiếu là một khoản nợ của một công ty. Là một khoản vay có một tỷ lệ lãi suất được đảm bảo
phải trả trong một khoảng thời gian cố định. Giống như cổ phiếu, trái phiếu có thể được giao dịch
hoặc bán cho người khác. Một công ty có thể đưa ra một khoản trái phiếu trị giá 1 triệu đô la để
được trả lại trong 20 năm với mức 5% một năm. Nhà đầu tư sẽ xem xét công ty một cách cẩn thận
trước khi đồng ý mua một trái phiếu như vậy. Anh ta có khả năng đọc báo cáo của các công ty xếp
hạng tư nhân đánh giá khả năng trả nợ trái phiếu của người đi vay. Nếu công ty có lãi và có triển
vọng tốt trong tương lai, trái phiếu có khả năng là một khoản đầu tư tốt và an toàn. Công ty sẽ trả lãi
thường xuyên và vào cuối 20 năm, trả hết số tiền gốc của trái phiếu được gọi là tiền gốc.
Trái phiếu như một khoản đầu tư có một số lợi thế hơn so với cổ phiếu của cổ phiếu. Ví dụ, một
công ty phải trả lãi cho trái phiếu của mình trước khi trả cổ tức cho các cổ đông. Nếu một công ty
gặp rắc rối nghiêm trọng về tài chính và phá sản, những nhà đầu tư nắm giữ trái phiếu đó phải được
thanh toán trước trước những người sở hữu cổ phiếu. Nhược điểm đối với người nắm giữ trái phiếu
là lãi suất đối với trái phiếu sẽ giữ nguyên trong suốt thời gian tồn tại của trái phiếu trong khi lãi suất
đối với các khoản đầu tư mới đang tăng lên. Nếu một người bán một trái phiếu trước khi trái phiếu
đó hoạt động hết hạn hoặc đến hạn, anh ta có thể phải bán với giá thấp hơn số tiền mà anh ta đã trả
cho trái phiếu vì tỷ suất sinh lợi của nó thấp so với các khoản đầu tư khác.
Các chính phủ vay tiền giống như các tập đoàn làm và các cá nhân có thể thực hiện việc cho vay với
sự tin tưởng gần như tuyệt đối rằng họ sẽ thu được lợi nhuận và tiền của họ sẽ được an toàn. Loại
cho vay này có thể được thực hiện bằng cách mua một trái phiếu chính phủ - thường là một khoản
vay dài hạn hoặc một khoản vay thường là cho thời hạn ngắn hơn.
 KNOWLEDGE CHECK: STOCKS AND BONDS

EXERCISE 1. Read the text and decide if the following sentences True or False
1. The company may sell stock in order to raise capital for business expansion True
2. Return to investors has no relation with risks they have to take. False
3. Interest rate of bond may be adjusted to changes in the market during the life of the bond. False
4. Investment in bond is more secure than in stock.
5. Before its maturity, a bond can be sold at a discount.

EXERCISE 2. Fill in the blanks with suitable words

Secure, Dividend, Fixed, Return, Maturity, Stocks, Bankruptcy, Note
1. If I own stock, I can make a profit through ………….through increases in the value of my stock.
2. The ………….to investors is low because little risk is involved.
3. Investing in………….of individual companies can be risky because bad news can quickly cut their value.
4. He has a very ………….job in a computer company so he is unlikely to be unemployed in the future.
5. A lot of small companies are in danger of ………….because worse economic situation in the country and
in the world.
6. Because she wanted to invest her money for a short time, she decided to invest in …………instead of
bonds or stocks.
7. When prices are ………….by the government, it means that the market mechanism is not working.
8. On the ………….date, your term deposit will be automatically rolled over if you don’t contact the bank
for any further requests.

Different Kinds of Money

In prisoner – of – war camps, cigarettes served as money. In the nineteenth century money was mainly gold
and silver coins. These are examples of commodity money, ordinary goods with industrial uses (gold) and
consumption uses (cigarettes) which also serve as a medium of exchange. To use a commodity money,
society must either cut back on other uses of that commodity or devote scarce resources to producing
additional quantities of the commodity. But there are less expensive ways for society to produce money.
A token money is a means of payment whose value or purchasing power as money greatly exceeds its cost of
production or value in uses other than as money.
A £10 note is worth far more as money than as a 3x6 inch piece of high-quality paper. Similarly, the
monetary value of most coins exceeds the amount you would get by melting them down and selling off the
metals they contain. By collectively agreeing to use token money, society economizes on the scarce
resources required to produce money as a medium of exchange. Since the manufacturing costs are tiny, why
doesn’t everyone make £10 notes?
The essential condition for the survival of token money is the restriction of the right to supply it. Private
production is illegal.
Society enforces the use of token money by making it legal lender. The law says it must be accepted as a
means of payment.
In modern economies, token money is supplemented by IOU money is a medium of exchange based on the
debt of a private firm or individual.
A bank deposit is IOU money because it is a debt of the bank. When you have a bank deposit the bank owes
you money. You can write a cheque to yourself or a third party and the bank is obliged to pay whenever the
cheque is presented. Bank deposits are a medium of exchange because they are generally accepted as
payment.
Functions of money
Although the crucial feature of money is its acceptance as the means of payment or medium of exchange,
money has three other functions. It serves as a unit of account, as a store of value, and as a standard of
deferred payment. We discuss each of the four functions of money in turn.
The Medium of Exchange
Money, the medium of exchange, is used in one - half of almost all exchange. Workers exchange labor
services for money. People buy or sell goods in exchange for money. We accept money not to consume it
directly but because it can subsequently be used to buy things we do wish to consume. Money is the medium
through which people exchange goods and services.
To see that society benefits from a medium of exchange, imagine a barter economy.
A barter economy has no medium of exchange. Goods are traded directly or swapped for other goods.
In a barter economy, the seller and the buyer each must want something the other has to offer. Each person is
simultaneously a seller and a buyer. In order to see a film, you must hand over in exchange a good or service
that the cinema manager wants. There has to be a double coincidence of wants. You have to find a cinema
where the manager wants what you have to offer in exchange.
Trading is very expensive in a barter economy. People must spend a lot of time and effort finding others with
whom they can make mutually satisfactory swaps. Since time and efforts are scarce resources, a barter
economy is wasteful. The use of money – any commodity generally accepted in payment for goods, services,
and debts – makes the trading process simpler and more efficient.
Other Functions of Money
The unit of account is the unit in which prices are quoted and accounts are kept. In Britain prices are quoted
in pounds sterling, in France, in French francs. It is usually convenient to use the units in which the medium
of exchange is measured as the unit of account as well. However there are exceptions. During the rapid
German inflation of 1922-23 when prices in marks were changing very quickly. German shopkeepers found
it more convenient to use dollars as the unit of account. Prices were quoted in dollars even though payment
was made in marks, the German medium of exchange.
Money is a store of value because it can be used to make purchases in the future.
To be accepted in exchange, money has to be a store of value. Nobody would accept money as payment for
goods supplied today if the money was going to be worthless when they tried to buy goods with it tomorrow.
But money is neither the only nor necessarily the best store of value. Houses, stamp collections, and interest-
bearing bank accounts all serve as stores of value. Since money pays no interests and its real purchasing
power is eroded by inflation, there are almost certainly better ways to store value.
Finally, money serves as a standard of deferred payment or a unit of account over time. When you borrow,
the amount to be repaid next year is measured in pounds sterling. Although convenient, this is not an
essential function of money. UK citizens can get bank loans specifying in dollars the amount that must be
repaid next year. Thus the key feature of money is its use as a medium of exchange. For this, it must act as a
store of value as well. And it is usually, though not invariably, convenient to make money the unit of account
and standard of deferred payments as well.
 Knowledge check: money and its functions

EXERCISE 1. Decide if these statements are T or F according to the text.

1. Money provides a medium of exchange, a way of circulating value, a standard of deferred payments and
a method of saving.
2. Money has been used as a medium of exchange since the barter economy.
3. The second function of money is as a measure of value.
4. Money is only used at the moment, not used to make purchases in the future.
5. There is no need to have a double coincidence of wants in a barter economy.
EXERCISE 2. Match each of the terms in Column A with its definition in Column B

1. barter a. the unit in which prices are quoted and accounts are kept.

2. money b. payment expressed in terms of money to be paid in the future.

3. medium of exchange c. a system in which goods are used as a medium of exchange.

4. unit of account d. anything which is generally accepted as a medium of exchange.

5. store of value e. anything that is widely accepted in payment for goods and services.

6. unit of account over time f. something can be used to make purchases in the future.

Knowledge check: money and its functions

EXERCISE 1. Decide if these statements are T or F according to the text.
6. Money provides a medium of exchange, a way of circulating value, a standard of deferred payments and
a method of saving.
7. Money has been used as a medium of exchange since the barter economy.
8. The second function of money is as a measure of value.
9. Money is only used at the moment, not used to make purchases in the future.
10. There is no need to have a double coincidence of wants in a barter economy.
EXERCISE 2. Match each of the terms in Column A with its definition in Column B

1. barter a. the unit in which prices are quoted and accounts are kept.

2. money b. payment expressed in terms of money to be paid in the future.

3. medium of exchange c. a system in which goods are used as a medium of exchange.

4. unit of account d. anything which is generally accepted as a medium of exchange.

5. store of value e. anything that is widely accepted in payment for goods and services.

6. unit of account over time f. something can be used to make purchases in the future.
The Motives for Holding Money
Money is a stock. The distinguishing feature of money is its use as a medium of exchange, for which it must
also serve as a store of value. It is in these two functions of money that we must seek the reasons why people
wish to hold it.
People can hold their wealth in various forms – money, bills, bonds, equities, and property. For simplicity we
assume that there are only two assets: money, the medium of exchange that pays no interest, and bonds,
which we use to stand for all other interest – bearing assets that are not directly a means of payment. There is
an obvious cost in holding any money at all. The opportunity cost of holding money is the interest given up
by holding money rather than bonds. People will hold money only if there is a benefit to offset this cost. We
now consider what that benefit might be.
The Transactions Motive. In a monetary economy we use money to purchase goods and services and
receive money in exchange for the goods and services we sell. Without money, making transactions by direct
barter would be costly in time and effort. Holding money economizes on the time and effort involved in
understanding transactions.
If all transactions were perfectly synchronized, we would earn revenue from sales of goods and income from
sales of factor services at the same instant we made purchases of the goods and services we wish to consume.
Except at that instant, we need no money at all.
The transactions motive for holding money reflects the fact that payments and receipts are not perfectly
synchronized. We need to hold money between receiving payments and making subsequent purchases. How
much money we need to hold depends on two things, the value of the transactions we wish to make and the
degree of synchronization of our payments and receipts. People want money because of its purchasing power
in terms of the goods it will buy.
The second factor affecting the transactions motive for holding money is the degree of synchronization of
payments and receipts. Suppose that, instead of spreading their shopping evenly throughout the week,
households do all their shopping on the day they get a salary cheque from their employers. Over the week,
national income and total transactions are unaltered, but people now hold less money over the week.
A nation’s habits for making payments change only slowly. In our simplified model we assume that the
degree of synchronization remains constant over time. Thus we focus on real national income as the measure
of the transactions motive for holding real money balances.
The Precautionary Motive. Thus far we have assumed that people know exactly when they will obtain
receipts and make payments. But of course we live in an uncertain world. This uncertainty about the precise
timing of receipts and payments gives rise to a precautionary motive for holding money.
Suppose you decide to buy a lot of interest – earning bonds and try to get by with only a small amount of
money holdings. You are walking down the street and spot a great bargain in a shop window. But you do not
have enough money to take advantage immediately of this opportunity. By the time you have arranged for
some of your interest – earning bonds to be sold off in exchange for money, the sale may be over. Someone
else may have snapped up the video recorder on sale at half price. This is the precautionary motive for
holding money. We forgo interest and carry money for precautionary reasons, because having ready money
allows us to snap up unforeseen bargains, or stave off unforeseen crises by making immediate payments.
Together, the transactions and precautionary motives provide the main reasons for holding the medium of
exchange. They are the motives most relevant to the benefits from holding the narrow definition of money.
 Knowledge check: demand for money

Which part does each of the following statements belong to? Choose A, B or C
A. The motives for holding money
B. The transactions Motive
C. The Precautionary Motive

1. The uncertainty of our world makes holding money increase.

2. As people earn income, they deplete their wealth.
3. The interest given up by holding money rather than bonds is the opportunity cost of holding money.
4. Without money, making transactions by direct barter would be costly in time and effort.
5. People hold money to meet contingencies.

Knowledge check: demand for money

Which part does each of the following statements belong to? Choose A, B or C
A. The motives for holding money
B. The transactions Motive
C. The Precautionary Motive

1. The uncertainty of our world makes holding money increase.

2. As people earn income, they deplete their wealth.
3. The interest given up by holding money rather than bonds is the opportunity cost of holding money.
4. Without money, making transactions by direct barter would be costly in time and effort.
5. People hold money to meet contingencies.

Knowledge check: demand for money

Which part does each of the following statements belong to? Choose A, B or C
A. The motives for holding money
B. The transactions Motive
C. The Precautionary Motive

1. The uncertainty of our world makes holding money increase.

2. As people earn income, they deplete their wealth.
3. The interest given up by holding money rather than bonds is the opportunity cost of holding money.
4. Without money, making transactions by direct barter would be costly in time and effort.
5. People hold money to meet contingencies.
The goldsmith bankers were an early example of a financial intermediary.
A financial intermediary is an institution that specializes in bringing lenders and borrowers together.
A commercial bank borrows money from the public, creating them with a deposit. The deposit is a liability
of the bank. It is money owed to depositors. In turn the banks lend money to firms, households, or
governments wishing to borrow.
Banks are not the only financial intermediaries. Insurance companies, pension funds, and building societies
also take in money in order to relend it. The crucial feature of banks is that some of their liabilities are used
as a means of payment, and are therefore part of the money stock.
Commercial banks are financial intermediaries with a government license to make loans and issue deposits,
including deposits against which cheques can be written. We begin by looking at the present day UK
banking system. Although the details vary from country to country, the general principle is much the same
everywhere.
In the UK, the commercial banking system comprises about 600 registered banks, the National Girobank
operating through post offices, and about a dozen trustee savings banks. Much the most important single
group is the London clearing banks. The clearing banks are so named because they have a central clearing
house for handling payments by cheque.
A clearing system is set of arrangements in which debts between banks are settled by adding up all the
transactions in a given period and paying only the net amounts needed to balance inter – bank accounts.
Suppose you bank with Barclays but visit a supermarket that banks with Lloyds. To pay for your shopping
you write a cheque against your deposit at Barclays. The supermarket pays this cheque into its account at
Lloyds. In turn, Lloyds presents the cheque to Barclays which will credit Lloyds’ account at Barclays and
debit your account at Barclays by an equivalent amount. Because you purchased goods from a supermarket
using a different bank, a transfer of funds between the two banks is required. Crediting or debiting one
bank’s account at another bank is the simplest way to achieve this.
However on the same day someone else, call her Joan Groover, is probably writing a cheque on a Lloyd’s
deposit account to pay for some stereo equipment from a shop banking with Barclays. The stereo shop pays
the cheque into its Barclay’s account, increasing its deposit. Barclays then pay the cheque into its account at
Lloyds where Ms Groover’s account is simultaneously debited. Now the transfer flows from Lloyds to
Barclays.
Although in both cases the cheque writer’s account is debited and the cheque recipient’s account is credited,
it does not make sense for the two banks to make two separate inter – bank transactions between themselves.
The clearing system calculates the net flows between the member clearing banks and these are the
settlements that they make between themselves. Thus the system of clearing cheques represents another way
society reduces the costs of making transactions.
 Knowledge check: modern banking
I. Read the passage and decide if the following statements are T (True), F (False), or NG (Not given):
1. The role of a financial intermediary serves as a bridge to link lenders and borrowers
2. Banks are the biggest financial intermediaries.
3. Commercial banks are not allowed to lend and issue deposits.
4. Besides banks, there are other types of financial intermediaries, among which are insurance companies.
5. In a clearing system, debts between banks are settled by adding up all the transactions.
6. Settlements made between member clearing banks are calculated by the clearing system.
7. Society can benefit from the system of clearing cheques as it makes the costs of transactions lower.

II. Fill in the blanks with suitable words:

Clearing, deposits and loans, middleman, commercial
banks
1. A financial intermediary is an institution that acts as the …. between investors and firms raising funds.
Often referred to as financial institutions.
2. While … offer services to individuals, they are primarily concerned with receiving deposits and lending
to businesses.
3. Commercial banking may refer to a bank or a division of a bank that mostly deals with … from
corporations or large businesses, as opposed to normal individual members of the public.
4. In banking and finance, … denotes all activities from the time a commitment is made for a transaction
until it is settled. … is necessary because the speed of trades is much faster than the cycle time for
completing the underlying transaction.

Knowledge check: modern banking

I. Read the passage and decide if the following statements are T (True), F (False), or NG (Not given):
1. The role of a financial intermediary serves as a bridge to link lenders and borrowers
2. Banks are the biggest financial intermediaries.
3. Commercial banks are not allowed to lend and issue deposits.
4. Besides banks, there are other types of financial intermediaries, among which are insurance companies.
5. In a clearing system, debts between banks are settled by adding up all the transactions.
6. Settlements made between member clearing banks are calculated by the clearing system.
7. Society can benefit from the system of clearing cheques as it makes the costs of transactions lower.

II. Fill in the blanks with suitable words:

Clearing, deposits and loans, middleman, commercial
banks
1. A financial intermediary is an institution that acts as the …. between investors and firms raising funds.
Often referred to as financial institutions.
2. While … offer services to individuals, they are primarily concerned with receiving deposits and lending to
businesses.
3. Commercial banking may refer to a bank or a division of a bank that mostly deals with … from
corporations or large businesses, as opposed to normal individual members of the public.
4. In banking and finance, … denotes all activities from the time a commitment is made for a transaction
until it is settled. … is necessary because the speed of trades is much faster than the cycle time for
completing the underlying transaction.
Paragraph 1
The foreign exchange market enables banks and international corporations to trade foreign currencies in
large amounts. Capital flows arising from trade in goods and services, international investment and loans
together create this demand for foreign currency.
Paragraph 2
Foreign exchange trading is divided into spot and forward business. Generally speaking, spot transactions
are undertaken for an actual exchange of currencies (delivery or settlement) two business days later (the
value date). Forward transactions involve a delivery date further into the future, possibly as far as a year or
more ahead. By buying or selling in the forward market a bank can, on its own behalf or that of a customer,
protect the value of anticipated flows of foreign currency from exchange rate volatility.
Paragraph 3
Unlike some financial markets, the foreign exchange market has not single location – it is not dealt across a
trading floor. Instead, trading is via telephone, telex, and computer links between dealers in different centres
and, indeed, different continents.
Paragraph 4
London is the world’s largest foreign exchange centre. Banks here trade almost $200 billion each day in
foreign currencies. London’s trading position arises partly from the large volume of international financial
business here – insurance, Eurobonds, shipping, commodities and banking. London also benefits from its
geographical location which enables them to trade not only with Europe through – out the day but also with
the US and the Far East, whereas time difference makes it difficult for those two centres to trade with each
other. When banks in London begin trading at 8 a.m. they can deal with banks in Tokyo, Hong Kong,
Singapore whose trading day is just ending. From 1 p.m London Banks can trade with banks in New York
before they close at 5 p.m, their counterparts may be in Los Angeles or San Francisco. The foreign exchange
market thus trades 24 hours a day.
Paragraph 5
Broadly speaking, there are three types of participants in the market: customers, such as multinational
corporations, are in the market because they require foreign currency in the course of their cross border trade
or investment business. Some banks participate as market makers; their dealers will at all times quote buying
and selling rates for currencies – dollars to the pound, deutschemarks to the dollar and so on. Other banks or
corporations call them to ask for their rates, and then buy or sell as the caller chooses. The market makers
earn a profit on the difference between their buying and selling rates, but clearly they have to be ready to
change their prices very quickly so that they avoid holding large volumes of a depreciating currency, or
being short of a rising currency. The third type of participant, the brokers, acts as intermediaries between the
banks. They are specialist companies with the telephone lines to the banks throughout the world so that at
any time they should know which bank has the highest bid (buying) rate for a currency and which the lowest
offer (selling) rate. By calling a broker, therefore, it should be possible for banks to find the best dealing rate
currently available. The broker doesn’t deal on his own account but charges a commission for his services.
 Knowledge check: foreign exchange market

I. Decide if the following statements are True (T) or False (F) according to the passage
1. Banks and international companies trade in foreign exchange markets for domestic currencies in order to
buy and sell goods and services, invest and lend others.
2. Spot and forward contracts are different from each other in terms of the time when exchange rate is used.
3. Trading in foreign exchange market must be done by physical contact in a particular place.
4. London has an advantage over other foreign exchange centres in the world by its large number of financial
business and geographical location.
5. Banks can earn profit on the difference between their quoting rates and others’.
6. The brokers will help customers have the best benefit by their knowledge of the best rates.

II. Choose the most suitable heading for each paragraph from the List of Headings below. There are
more headings than paragraphs
List of headings:
A. Advantages and disadvantages of London foreign exchange centre.
B. Entities of the foreign exchange market.
C. Different types of transactions in foreign exchange market.
D. Special feature of foreign exchange market.
E. Definition of Foreign exchange markets.
F. Profits customers can enjoy from using services of banks and brokers.
G. Favorable conditions of the world’s largest foreign exchange market.

Knowledge check: foreign exchange market

I. Decide if the following statements are True (T) or False (F) according to the passage
1. Banks and international companies trade in foreign exchange markets for domestic currencies in order to
buy and sell goods and services, invest and lend others.
2. Spot and forward contracts are different from each other in terms of the time when exchange rate is used.
3. Trading in foreign exchange market must be done by physical contact in a particular place.
4. London has an advantage over other foreign exchange centres in the world by its large number of financial
business and geographical location.
5. Banks can earn profit on the difference between their quoting rates and others’.
6. The brokers will help customers have the best benefit by their knowledge of the best rates.

II. Choose the most suitable heading for each paragraph from the List of Headings below. There are
more headings than paragraphs
List of headings:
A. Advantages and disadvantages of London foreign exchange centre.
B. Entities of the foreign exchange market.
C. Different types of transactions in foreign exchange market.
D. Special feature of foreign exchange market.
E. Definition of Foreign exchange markets.
F. Profits customers can enjoy from using services of banks and brokers.
G. Favorable conditions of the world’s largest foreign exchange market.
An auditor finds out early in his training that he is a watchdog and not a bloodhound. From today, when the
Auditing Practices Committee (APC) issues its long - awaited guideline on auditors and fraud, an auditor
will also have consider himself a whistle - blower.
The guideline sets out to clarify auditors' responsibilities in relation to fraud, as well as other irregularities
and errors. It recommends that auditors take an active role in reporting fraud to third parties.
The document acknowledges that an auditor's primary duty is one of confidentially to the client. But the
document says an auditor should also consider throwing this narrow duty aside and think of the wider public
interest.
Taking its cue from an ethical statement issued in 1988, Professional Contact in Relation to Defaults or
Unlawful Acts, the document spells out the circumstances when the public interest could be served by a nod
and a wink to the Department of Trade and Industry or some other official authority.
Under normal circumstances, the auditor's first step would be alert the client's management to the existence
of fraud. But the guideline says that if senior managers or directors are involved in the fraud, the auditor may
see fit to go over the head of the board of directors, even non-executive directors and the audit committee, to
directly report to the regulatory authorities.
Alerting the authorities would be justified if the fraud is likely to result in a material gain or loss for any one
person or group of people; is likely to be "repeated with impunity" if not disclosed; or if "there is a
general management ethics of flouting the law and regulation". The strength of the auditor's evidence
is deemed important too.
Legal advice on the matter given to the APC said auditors should attach importance to the wider
interests of the company in any case "where the auditor considered that the directors could not be
relied upon to apply their minds properly to those interests".
The advice continued: "An auditor will not be in breach of any legal duty if, although entitled to
disclose, he fails to do so. His decision whether to do so or not is therefore a matter of professional
judgment and not a matter of law. It is a decision which should reflect the proper expectations which
the public has of his profession".
So despite the codification of responsibilities within the guideline, it is all a matter of professional
judgment. It appears that the only circumstances where the auditor of a company not in the financial
sector definitely must "blow the whistle" is when he stumbles upon treason; a practice for which there
is no APC guideline yet.
Responsibilities are different for companies covered by the special requirements of the Financial
Services Act 1986, the Building Societies Act of the same year and the banking Act 1987. Following
Professor Gower's reports on Investor Protection (in 1982 and 1984), companies covered by this
legislation can only be authorized to conduct business if they keep proper accounting records and have
adequate internal controls.
These Acts require that auditors make specific representations to the regulators on these and other
points and describe the circumstances when auditors should go directly to the authorities in order to
protect the interests of shareholders or depositors.
Today's guideline - which for the first time establishes rules for auditors reporting on companies not in
the financial sector - will offer solace to auditors confused about the precise nature of their duties.
The guideline makes it clear that the prime responsibility for detecting fraud rests with management.
The auditor must plan an audit so that he or she has a "reasonable expectation" of spotting serious
misstatements which impinge on the truth and fairness of a set of accounts.
Today's guideline from the APC is pitched towards the practitioner and not the business public at large. It is
unlikely to do much to tackle the gulf between what the public think auditors should do and what the auditors
themselves think that they are doing.
 Knowledge check: the roles of auditors
EXERCISE 1. Indicate whether the following statements are true or false
1. The report confirms an auditor's first responsibility of confidentiality to his client.
2. The report suggests auditors must also consider other publics.
3. Auditors should always go direct to the regulatory authorities in cases of fraud.
4. There are no cases where an auditor is legally obliged to disclose information to the authorities.
5. Most "professional people" are aware of what auditors do.

EXERCISE 2. Match these three roles of the auditors (the expressions are metaphors) with their
best definitions:

Roles Definitions

1. Watchdog A. Responsibility for overseeing a company’s finances.

B. Responsibility for informing the authorities of
malpractice.
2. Bloodhound
C. Responsibility for tracking down the instigators of
malpractice.
3. Whistle-blower
 Different Kinds of Money
In prisoner – of – war camps, cigarettes served as money. In the nineteenth century money was mainly gold
and silver coins. These are examples of commodity money, ordinary goods with industrial uses (gold) and
consumption uses (cigarettes) which also serve as a medium of exchange. To use a commodity money,
society must either cut back on other uses of that commodity or devote scarce resources to producing
additional quantities of the commodity. But there are less expensive ways for society to produce money.
A token money is a means of payment whose value or purchasing power as money greatly exceeds its cost of
production or value in uses other than as money.
A £10 note is worth far more as money than as a 3x6 inch piece of high-quality paper. Similarly, the
monetary value of most coins exceeds the amount you would get by melting them down and selling off the
metals they contain. By collectively agreeing to use token money, society economizes on the scarce
resources required to produce money as a medium of exchange. Since the manufacturing costs are tiny, why
doesn’t everyone make £10 notes?
The essential condition for the survival of token money is the restriction of the right to supply it. Private
production is illegal.
Society enforces the use of token money by making it legal lender. The law says it must be accepted as a
means of payment.
In modern economies, token money is supplemented by IOU money is a medium of exchange based on the
debt of a private firm or individual.
A bank deposit is IOU money because it is a debt of the bank. When you have a bank deposit the bank owes
you money. You can write a cheque to yourself or a third party and the bank is obliged to pay whenever the
cheque is presented. Bank deposits are a medium of exchange because they are generally accepted as
payment.

Dịch bài: Các loại tiền khác nhau

Trong các trại tù binh chiến tranh, thuốc lá được coi là tiền. Vào thế kỷ XIX tiền chủ yếu là tiền
vàng và bạc. Đây là những ví dụ về tiền hàng hóa, hàng hóa thông thường có mục đích sử dụng
trong công nghiệp (vàng) và tiêu dùng (thuốc lá) cũng được sử dụng như một phương tiện trao đổi.
Để sử dụng tiền hàng hóa, xã hội phải cắt giảm các mục đích sử dụng khác của hàng hóa đó hoặc
dành các nguồn lực khan hiếm để sản xuất thêm số lượng hàng hóa đó. Nhưng có những cách ít tốn
kém hơn để xã hội sản xuất tiền.

Tiền mã hóa là một phương tiện thanh toán có giá trị hoặc sức mua như tiền vượt quá chi phí sản
xuất hoặc giá trị sử dụng không phải là tiền.

Tờ 10 bảng Anh đáng giá hơn nhiều so với một tờ giấy chất lượng cao 3x6 inch. Tương tự, giá trị
tiền tệ của hầu hết các đồng xu vượt quá số tiền bạn sẽ nhận được bằng cách nấu chảy chúng và bán
bớt kim loại mà chúng chứa. Bằng cách đồng ý tập thể sử dụng tiền mã hóa, xã hội tiết kiệm được
các nguồn lực khan hiếm cần thiết để sản xuất tiền như một phương tiện trao đổi. Vì chi phí sản xuất
rất nhỏ, tại sao mọi người không ghi chú 10 bảng Anh?
Điều kiện thiết yếu cho sự tồn tại của tiền mã thông báo là hạn chế quyền cung cấp nó. Sản xuất tư
nhân là bất hợp pháp.
Xã hội thực thi việc sử dụng tiền mã hóa bằng cách biến nó thành người cho vay hợp pháp. Luật
pháp quy định nó phải được chấp nhận như một phương tiện thanh toán.

Trong các nền kinh tế hiện đại, tiền mã thông báo được bổ sung bởi tiền IOU là một phương tiện
trao đổi dựa trên khoản nợ của một công ty tư nhân hoặc cá nhân.

Tiền gửi ngân hàng là tiền IOU vì nó là khoản nợ của ngân hàng. Khi bạn có một khoản tiền gửi
ngân hàng, ngân hàng sẽ nợ bạn tiền. Bạn có thể viết séc cho chính mình hoặc bên thứ ba và ngân
hàng có nghĩa vụ thanh toán bất cứ khi nào séc được xuất trình. Tiền gửi ngân hàng là một phương
tiện trao đổi vì chúng thường được chấp nhận như một khoản thanh toán.

Demand for money

We single out three key variables that determine money demand: interest rates, the price level or average
price of goods and services, and real income. First, we reconsider why people hold money.
The Motives for Holding Money
Money is a stock. The distinguishing feature of money is its use as a medium of exchange, for which it must
also serve as a store of value. It is in these two functions of money that we must seek the reasons why people
wish to hold it.
People can hold their wealth in various forms – money, bills, bonds, equities, and property. For simplicity we
assume that there are only two assets: money, the medium of exchange that pays no interest, and bonds,
which we use to stand for all other interest – bearing assets that are not directly a means of payment. There is
an obvious cost in holding any money at all. The opportunity cost of holding money is the interest given up
by holding money rather than bonds.
People will hold money only if there is a benefit to offset this cost. We now consider what that benefit might
be.
The Transactions Motive. In a monetary economy we use money to purchase goods and services and receive
money in exchange for the goods and services we sell. Without money, making transactions by direct barter
would be costly in time and effort. Holding money economizes on the time and effort involved in
understanding transactions.
If all transactions were perfectly synchronized, we would earn revenue from sales of goods and income from
sales of factor services at the same instant we made purchases of the goods and services we wish to consume.
Except at that instant, we need no money at all.
The transactions motive for holding money reflects the fact that payments and receipts are not perfectly
synchronized. We need to hold money between receiving payments and making subsequent purchases. How
much money we need to hold depends on two things, the value of the transactions we wish to make and the
degree of synchronization of our payments and receipts. People want money because of its purchasing power
in terms of the goods it will buy.
The second factor affecting the transactions motive for holding money is the degree of synchronization of
payments and receipts. Suppose that, instead of spreading their shopping evenly throughout the week,
households do all their shopping on the day they get a salary cheque from their employers. Over the week,
national income and total transactions are unaltered, but people now hold less money over the week.
A nation’s habits for making payments change only slowly. In our simplified model we assume that the
degree of synchronization remains constant over time. Thus we focus on real national income as the measure
of the transactions motive for holding real money balances.
The Precautionary Motive. Thus far we have assumed that people know exactly when they will obtain
receipts and make payments. But of course we live in an uncertain world. This uncertainty about the precise
timing of receipts and payments gives rise to a precautionary motive for holding money.
Suppose you decide to buy a lot of interest – earning bonds and try to get by with only a small amount of
money holdings. You are walking down the street and spot a great bargain in a shop window. But you do not
have enough money to take advantage immediately of this opportunity. By the time you have arranged for
some of your interest – earning bonds to be sold off in exchange for money, the sale may be over. Someone
else may have snapped up the video recorder on sale at half price. This is the precautionary motive for
holding money. We forgo interest and carry money for precautionary reasons, because having ready money
allows us to snap up unforeseen bargains, or stave off unforeseen crises by making immediate payments.
Together, the transactions and precautionary motives provide the main reasons for holding the medium of
exchange. They are the motives most relevant to the benefits from holding the narrow definition of money
M1.

The foreign exchange market

The foreign exchange market enables banks and international corporations to trade foreign currencies in
large amounts. Capital flows arising from trade in goods and services, international investment and loans
together create this demand for foreign currency.
Foreign exchange trading is divided into spot and forward business. Generally speaking, spot transactions are
undertaken for an actual exchange of currencies (delivery or settlement) two business days later (the value
date). Forward transactions involve a delivery date further into the future, possibly as far as a year or more
ahead. By buying or selling in the forward market a bank can, on its own behalf or that of a customer, protect
the value of anticipated flows of foreign currency from exchange rate volatility.
Unlike some financial markets, the foreign exchange market has not single location – it is not dealt across a
trading floor. Instead, trading is via telephone, telex, and computer links between dealers in different centres
and, indeed, different continents.
London is the world’s largest foreign exchange centre. Banks here trade almost $200 billion each day in
foreign currencies. London’s trading position arises partly from the large volume of international financial
business here – insurance, Eurobonds, shipping, commodities and banking. London also benefits from its
geographical location which enables them to trade not only with Europe through – out the day but also with
the US and the Far East, whereas time difference makes it difficult for those two centres to trade with each
other. When banks in London begin trading at 8 a.m. they can deal with banks in Tokyo, Hong Kong,
Singapore whose trading day is just ending. From 1 p.m London Banks can trade with banks in New York
before they close at 5 p.m, their counterparts may be in Los Angeles or San Francisco. The foreign exchange
market thus trades 24 hours a day.
Broadly speaking, there are three types of participants in the market: customers, such as multinational
corporations, are in the market because they require foreign currency in the course of their cross border trade
or investment business. Some banks participate as market makers; their dealers will at all times quote buying
and selling rates for currencies – dollars to the pound, deutschemarks to the dollar and so on. Other banks or
corporations call them to ask for their rates, and then buy or sell as the caller chooses. The market makers
earn a profit on the difference between their buying and selling rates, but clearly they have to be ready to
change their prices very quickly so that they avoid holding large volumes of a depreciating currency, or
being short of a rising currency. The third type of participant, the brokers, acts as intermediaries between the
banks. They are specialist companies with the telephone lines to the banks throughout the world so that at
any time they should know which bank has the highest bid (buying) rate for a currency and which the lowest
offer (selling) rate. By calling a broker, therefore, it should be possible for banks to find the best dealing rate
currently available. The broker doesn’t deal on his own account but charges a commission for his services.
 International finance
International finance is an area of study concerned with the balance of payments (BOP) and the international
monetary system. One of the main areas of international finance is the balance of payment which sets the
stage for a discussion of the international monetary system and foreign exchange.
One way of measuring a country’s economic activity is by looking at its balance of payments. The balance of
payments (BOP) is the record of the value of all transactions between a country’s residents and the rest of the
world. There is a wide variety of accounts that determine the BOP, but for purposes of analysis they can be
grouped into three broad categories: current account items, capital account items, and reserves.
BOP is a double-entry system, similar to that used in accounting. Every transaction is recorded in terms of
both a debit and a credit. Debits record transactions such as the import of a good or service, an increase in
assets, or a reduction in liabilities. Credits record the export of a good or service, a decrease in assets, or an
increase in liabilities. The following discussion examines the three broad BOP categories.
The current account consists of merchandise trade, services, and unrequited transfers.
Merchandise trade is typically the first part of the current account. It receives more attention than any of the
other accounts because this is where the imports and exports of goods are reported, and these are often the
largest single component of all international transactions. In this account, sales of goods to foreigners
(exports) are reported as credits because they are a source of funds or a claim against the purchasing country.
Conversely, purchases of goods from overseas (imports) are recorded as debits because they use funds. This
payment can be made by either reducing current claims on foreigners or increasing foreign liabilities.
Merchandise trade transactions can affect a country’s BOP in a number of ways. Assume that Nissan Motor
of Japan has sold General Motors in the United States $600,000 worth of engines and these engines will be
paid for from GM’s account in a Detroit bank. In this case the imports are a debit to the current account and a
credit to the “other short-term, private” capital account. Here is how the entry would be recorded.

Debit Credit

Merchandise imports $600,000

Increase in domestic short-term assets held by foreigners $600,000

The result of this purchase is that the United States has transferred currency to foreigners and thus reduced
its ability to meet other claims.
The services category includes many payments such as freight and insurance on international shipments;
tourist travel; profits and income from overseas investment; personal expenditures by government, civilians,
and military personnel overseas; and payments for management fees, royalties, film rental, and construction
services. Purchases of these services are recorded as debits, while sales of these services are similar to
exports and are recorded as credits. For example, extending the earlier example of Nissan and GM, assume
that the US automaker must pay $125,000 to Nissan to ship the engines to the United States. The transaction
would be recorded this way:

Debit Credit

Shipment $125,000
 Other short-term private capital $125,000

GM purchased a Japanese shipping service (a debit to the current account) and paid for this by increasing the
domestic short-term assets held by foreigners (a credit to the capital account).
Unrequited transfers are transactions that do not involve repayment or the performance of any service.
Examples include the American Red Cross sending $10 million in food to refugees in Somalia; the United
States paying military pensions to residents of the Philippines who served in the US army during World War
II; and British workers in Kuwait shipping money home to their families in London. Here is how the
American Red Cross transaction would appear in the US BOP:

Debit Credit

Unrequited transfers, private $10 million

Merchandise exports $10 million

Capital account items are transactions that involve claims in ownership. Direct investment involves
managerial participation in a foreign enterprise along with some degree of control. The United States
classifies direct investments as those investments that give the investor more than 10 per cent ownership.
Portfolio investment is investment designed to obtain income or capital gains. For example, if Exxon shipped
$20 million of equipment to an overseas subsidiary the entry would be:

Debit Credit

Direct investment $20 million

Exports $20 million

Reserves
Reserves are used for bringing BOP accounts into balance. There are four major types of reserves available
to monetary authorities in meeting BOP deficits. These reserves are analogous to cash or near-cash assets of
a private firm. Given that billions of dollars in transactions are reported in BOP statements, it should come as
no surprise that the amount of recorded debits are never equal to the amount of credits. This is why there is
an entry in the reserve account for net errors and omissions. If a country’s reporting system is weak or there
is a large number of clandestine transactions, this discrepancy can be quite large.
 UNIT 10: INTERNATIONAL FINANCE
International finance is an area of study concerned with the balance of payments (BOP) and the international
monetary system. One of the main areas of international finance is the balance of payment which sets the
stage for a discussion of the international monetary system and foreign exchange.
One way of measuring a country’s economic activity is by looking at its balance of payments. The balance
of payments (BOP) is the record of the value of all transactions between a country’s residents and the rest of
the world. There is a wide variety of accounts that determine the BOP, but for purposes of analysis they can
be grouped into three broad categories: current account items, capital account items, and reserves.
BOP is a double-entry system, similar to that used in accounting. Every transaction is recorded in terms of
both a debit and a credit. Debits record transactions such as the import of a good or service, an increase in
assets, or a reduction in liabilities. Credits record the export of a good or service, a decrease in assets, or an
increase in liabilities. The following discussion examines the three broad BOP categories.
The current account consists of merchandise trade, services, and unrequited transfers.
Merchandise trade is typically the first part of the current account. It receives more attention than any of the
other accounts because this is where the imports and exports of goods are reported, and these are often the
largest single component of all international transactions. In this account, sales of goods to foreigners
(exports) are reported as credits because they are a source of funds or a claim against the purchasing country.
Conversely, purchases of goods from overseas (imports) are recorded as debits because they use funds. This
payment can be made by either reducing current claims on foreigners or increasing foreign liabilities.
Merchandise trade transactions can affect a country’s BOP in a number of ways. Assume that Nissan Motor
of Japan has sold General Motors in the United States $600,000 worth of engines and these engines will be
paid for from GM’s account in a Detroit bank. In this case the imports are a debit to the current account and a
credit to the “other short-term, private” capital account. Here is how the entry would be recorded.

Debit Credit
Merchandise imports $600,000
Increase in domestic short-term assets held by foreigners $600,000

The result of this purchase is that the United States has transferred currency to foreigners and thus reduced
its ability to meet other claims.
The services category includes many payments such as freight and insurance on international shipments;
tourist travel; profits and income from overseas investment; personal expenditures by government, civilians,
and military personnel overseas; and payments for management fees, royalties, film rental, and construction
services. Purchases of these services are recorded as debits, while sales of these services are similar to
exports and are recorded as credits. For example, extending the earlier example of Nissan and GM, assume
that the US automaker must pay $125,000 to Nissan to ship the engines to the United States. The transaction
would be recorded this way:
Debit Credit
Shipment $125,000
 Other short-term private capital $125,000

GM purchased a Japanese shipping service (a debit to the current account) and paid for this by increasing the
domestic short-term assets held by foreigners (a credit to the capital account).
Unrequited transfers are transactions that do not involve repayment or the performance of any service.
Examples include the American Red Cross sending $10 million in food to refugees in Somalia; the United
States paying military pensions to residents of the Philippines who served in the US army during World War
II; and British workers in Kuwait shipping money home to their families in London. Here is how the
American Red Cross transaction would appear in the US BOP:
Debit Credit
Unrequited transfers, private $10 million
Merchandise exports $10 million

Capital account items are transactions that involve claims in ownership. Direct investment involves
managerial participation in a foreign enterprise along with some degree of control. The United States
classifies direct investments as those investments that give the investor more than 10 per cent ownership.
Portfolio investment is investment designed to obtain income or capital gains. For example, if Exxon shipped
$20 million of equipment to an overseas subsidiary the entry would be:
Debit Credit
Direct investment $20 million
Exports $20 million

Reserves
Reserves are used for bringing BOP accounts into balance. There are four major types of reserves available
to monetary authorities in meeting BOP deficits. These reserves are analogous to cash or near-cash assets of
a private firm. Given that billions of dollars in transactions are reported in BOP statements, it should come as
no surprise that the amount of recorded debits are never equal to the amount of credits. This is why there is
an entry in the reserve account for net errors and omissions. If a country’s reporting system is weak or there
is a large number of clandestine transactions, this discrepancy can be quite large.
 Knowledge check: INTERNATIONAL FINANCE

Match the word or phrase on the left with the statement on the right. Only one statement is
appropriate for each item.
1. The balance of payments Record the export of a good or service, a decrease in assets, or an
increase in liabilities
2. Debit An agency that seeks to maintain balance of payments stability in the
international financial system
3. Credit Consists of merchandise trade, services, and unrequited transferred
4. International Monetary fund Reports the imports and exports of goods
5. Current account Include payments like freight and insurance on international shipments,
tourist travel, profit and income from overseas ….
6. Merchandise trade Transactions that do not involve repayment or the performance of any
service
7. Services Record transactions such as the import of a good or service, an increase
in assets, or a reduction in liabilities
8. Unrequited transfers Record the value of all transactions between a country’s residents, and
the rest of the world …

Match the word or phrase on the left with the statement on the right. Only one statement is
appropriate for each item.
1. The balance of payments Record the export of a good or service, a decrease in assets, or an
increase in liabilities
2. Debit An agency that seeks to maintain balance of payments stability in the
international financial system
3. Credit Consists of merchandise trade, services, and unrequited transferred
4. International Monetary fund Reports the imports and exports of goods
5. Current account Include payments like freight and insurance on international shipments,
tourist travel, profit and income from overseas ….
6. Merchandise trade Transactions that do not involve repayment or the performance of any
service
7. Services Record transactions such as the import of a good or service, an increase
in assets, or a reduction in liabilities
8. Unrequited transfers Record the value of all transactions between a country’s residents, and
the rest of the world …

INTRODUCTION
Accounting for trillions in assets worldwide, the banking system is a crucial component of the global
economy. While money-changing and money-lending may be as old as money, banking dates back to 15th
century medieval Italy, and played a major role in the rise of the Italian city-states as world economic
powers. Ever since, the health of an economy and the health of its banks have been interrelated; the global
credit crisis, precipitated by the collapse of the subprime-fueled U.S. housing bubble, is only the most recent
example.
Banks are just one part of the world of financial institutions, standing alongside investment banks, insurance
companies, finance companies, investment managers and other companies that profit from the creation and
flow of money. As financial intermediaries, banks stand between depositors who supply capital and
borrowers who demand capital. Given how much commerce and individual wealth rests on healthy banks,
banks are also among the most heavily regulated businesses in the world

COMMERCIAL BANKING: WHAT BANKS DO

Accept Deposits / Make Loans
At the most basic level, what banks do is fairly simple. Banks accept deposits from customers, raise capital
from investors or lenders, and then use that money to make loans, buy securities and provide other financial
services to customers. These loans are then used by people and businesses to buy goods or expand business
operations, which in turn leads to more deposited funds that make their way to banks.
If banks can lend money at a higher interest rate than they have to pay for funds and operating costs, they
make money. An illustration of this very basic concept can be found in the old "3-6-3 Rule," a tongue-in-
cheek "rule" that said a banker would pay out 3% for deposits, charge 6% for loans and hit the golf course by
3 p.m.
Provide Safety
Banks also provide security and convenience to their customers. Part of the original purpose of banks, and
the goldsmiths that predated them, was to offer customers safe keeping for their money. Of course, this was
back in a time when a person's wealth consisted of actual gold and silver coins, but to a large extent this
function is still relevant. By keeping physical cash at home, or in a wallet, there are risks of loss due to theft
and accidents, not to mention the loss of possible income from interest. With banks, consumers no longer
need to keep large amounts of currency on hand; transactions can be handled with checks, debit cards or
credit cards, instead.
While banks do not keep gold or silver bullion as currency on hand anymore, many, if not most, banks still
maintain vaults and will rent out space to customers, in the form of safe deposit boxes. This allows
customers to keep precious or irreplaceable items in a secure setting and gives the bank an opportunity to
earn a little extra money, without risk to its capital.
Act as Payment Agents
Banks also serve often under-appreciated roles as payment agents within a country and between nations. Not
only do banks issue debit cards that allow account holders to pay for goods with the swipe of a card, they can
also arrange wire transfers with other institutions. Banks essentially underwrite financial transactions by
lending their reputation and credibility to the transaction; a check is basically just a promissory note between
two people, but without a bank's name and information on that note, no merchant would accept it. As
payment agents, banks make commercial transactions much more convenient; it is not necessary to carry
around large amounts of physical currency when merchants will accept the checks, debit cards or credit cards
that banks provide.
 Knowledge check: WHAT BANKS DO

Match the roles of the banks with the uses described in the sentences below
A. Accept Deposits / Make Loans
B. Provide Safety
C. Act as Payment Agents

1. Enterprises get the bank to guarantee their payments in their business with foreign partners.
2. International business can be facilitated via the use of letter of credit as a payment method for their
transactions.
3. Enterprises in lack of capital may seek the necessary loans from the bank for business expansion.
4. Customers do not need to carry a big bag of cash with them every time they go shopping.
5. Individuals with idle money may put it to work and earn interest.
6. Travellers do not need to bring big amounts of cash for their expenditures during their journeys.
7. Bankers underwrite the financial transactions between two business partners.
8. Individuals may keep their valuable items such as gold or diamond in a security setting in the bank.
9. Banks transfer money from those who have money to lend and are willing to lend to earn an interest to
those who need money and are willing to pay an interest to borrow it.
10. Customers can use debit cards or credit cards to pay for goods or services they buy.

Knowledge check: WHAT BANKS DO

Match the roles of the banks with the uses described in the sentences below
A. Accept Deposits / Make Loans
B. Provide Safety
C. Act as Payment Agents

1. Enterprises get the bank to guarantee their payments in their business with foreign partners.
2. International business can be facilitated via the use of letter of credit as a payment method for their
transactions.
3. Enterprises in lack of capital may seek the necessary loans from the bank for business expansion.
4. Customers do not need to carry a big bag of cash with them every time they go shopping.
5. Individuals with idle money may put it to work and earn interest.
6. Travellers do not need to bring big amounts of cash for their expenditures during their journeys.
7. Bankers underwrite the financial transactions between two business partners.
8. Individuals may keep their valuable items such as gold or diamond in a security setting in the bank.
9. Banks transfer money from those who have money to lend and are willing to lend to earn an interest to
those who need money and are willing to pay an interest to borrow it.
10. Customers can use debit cards or credit cards to pay for goods or services they buy.
COMMERCIAL BANKING: ECONOMIC CONCEPTS IN BANKING
Banks both create and issue money. While commercial banks no longer issue their own banknotes, they are
effectively the distribution system for the notes printed, and the coins minted, by the U.S. Treasury. The
Federal Reserve buys coins and paper money from the Treasury and distributes them through the banking
system, as needed. Banks effectively buy currency from the Fed, or sell it back when they have excess
amounts on hand.
Settle Payments
Every day there are millions of financial transactions in the United States, some conducted with paper
currency, but many more done with checks, wire transfers and various types of electronic payments. Banks
play an invaluable role in the settling of these payments, making sure that the proper accounts are credited or
debited, in the proper amounts and with relatively little delay.
Credit Intermediation
Banks play a major role as financial intermediaries. Banks collect money from depositors, essentially
borrowing the money, and then simultaneously lend it out to other borrowers, forging a chain of debts. This
is especially significant when asset values decline. As asset values decline, those assets are less able to
service debt, which in turn makes it more difficult for borrowers to borrow, and reduces lending capacity.
What follows is a decrease in the flow of credit from savers to spenders and a decline in economic activity.
At the same time, banks often find that they must raise capital, and their capital needs compete with those
available savings.
Maturity Transformation
Maturity transformation is part and parcel of what banks do on a daily basis. Many investors are willing to
invest on a very short term basis, but many projects require long-term financial commitments. What banks
do, then, is borrow short-term, in the form of demand deposits and short-term certificates of deposit, but lend
long-term; mortgages, for instance, are frequently repaid over 30 years. By doing this, banks transform debts
with very short maturities (deposits) into credits with very long maturities (loans), and collect the difference
in the rates as profit. However, they are also exposed to the risk that short-term funding costs may rise much
faster than they can recoup through lending.
Money Creation
One of the most vital roles of banks is in money creation. Importantly, money creation at the individual bank
level is not the same thing as "printing money;" currency is just one type of money. Instead, banks create
money through fractional reserve banking. Fractional reserve banking is a key concept to understanding
modern banking and money creation.
Fractional reserve banking refers to the fact that banks keep only a small portion of their deposits on hand.
When a customer comes into the bank and deposits $100, perhaps $10 of that will be kept on hand in the
form of cash or easily-liquidated securities. The remaining $90 will be lent out to customers as loans, or used
to acquire the stock or bonds of other companies. This phenomenon is known as the money multiplier and
can be expressed as the formula: m = 1 / reserve requirement. If the reserve requirement is 10% (or 0.1),
every dollar deposited with a bank can become $10 of new money.
This is a key concept, because this is how banks increase the money supply and effectively create money. If
banks simply acted as storehouses or vaults for money, there would be far less money available to lend.
 Knowledge check: ECONOMIC CONCEPTS IN BANKING

Circle the correct completion to the sentences below

1. Banks get money from depositors / borrowers then simultaneously lend it out to other lenders /
borrowers forging a chain of debts.
2. Banks settle the payments that their clients make by crediting / debiting their accounts in the proper
amounts and with relatively little delay.
3. Banks collect the difference in the rates as profit by making sure that the rate of deposit / loans is higher
than the rate of credit / deposit.
4. Commercial banks are not entitled to print / can issue bank notes.
5. Long-term / Short-term loans to be paid over 30 years often require fixed assets as security for the
loans.
6. Banks create money by printing money / through fractional reserve banking.
7. Banks are required to keep a minimum portion of their deposits in the forms of easily-liquidated
securities / long maturities credits.
8. Demand deposit is the example of long-term / short – term loans by individuals to the banks.
9. Commercial banks should lend out a minimum/maximum possible portion of their deposits to
customers as loans.
10. In the US banking system, the Treasury / Federal Rerseve is in charge of printing money while
Treasury / Federal Rerseve is responsible for distributing money through the banking system.

Knowledge check: ECONOMIC CONCEPTS IN BANKING

Circle the correct completion to the sentences below

1. Banks get money from depositors / borrowers then simultaneously lend it out to other lenders /
borrowers forging a chain of debts.
2. Banks settle the payments that their clients make by crediting / debiting their accounts in the proper
amounts and with relatively little delay.
3. Banks collect the difference in the rates as profit by making sure that the rate of deposit / loans is higher
than the rate of credit / deposit.
4. Commercial banks are not entitled to print / can issue bank notes.
5. Long-term / Short-term loans to be paid over 30 years often require fixed assets as security for the
loans.
6. Banks create money by printing money / through fractional reserve banking.
7. Banks are required to keep a minimum portion of their deposits in the forms of easily-liquidated
securities / long maturities credits.
8. Demand deposit is the example of long-term / short – term loans by individuals to the banks.
9. Commercial banks should lend out a minimum/maximum possible portion of their deposits to
customers as loans.
10. In the US banking system, the Treasury / Federal Rerseve is in charge of printing money while
Treasury / Federal Rerseve is responsible for distributing money through the banking system.
COMMERCIAL BANKING – HOW BANKS MAKE MONEY
As mentioned before, banks basically make money by lending money at rates higher than the cost of the
money they lend. More specifically, banks collect interest on loans and interest payments from the debt
securities they own, and pay interest on deposits, and short-term borrowings. The difference is known as the
"spread," or the net interest income, and when that net interest income is divided by the bank's earning assets,
it is known as the net interest margin.
Deposits
The largest source by far of funds for banks is deposits; money that account holders entrust to the bank for
safekeeping and use in future transactions, as well as modest amounts of interest. Generally referred to as
"core deposits," these are typically the checking and savings accounts that so many people currently have.
In most cases, these deposits have very short terms. While people will typically maintain accounts for years
at a time with a particular bank, the customer reserves the right to withdraw the full amount at any time.
Customers have the option to withdraw money upon demand and the balances are fully insured, up to
$250,000, therefore, banks do not have to pay much for this money. Many banks pay no interest at all on
checking account balances, or at least pay very little, and pay interest rates for savings accounts that are well
below U.S. Treasury bond rates.
Wholesale Deposits
If a bank cannot attract a sufficient level of core deposits, that bank can turn to wholesale sources of funds.
In many respects these wholesale funds are much like interbank. There is nothing necessarily wrong with
wholesale funds, but investors should consider what it says about a bank when it relies on this funding
source. While some banks de-emphasize the branch-based deposit-gathering model, in favor of wholesale
funding, reliance on this source of capital can be a warning that a bank is not as competitive as its peers.
Investors should also note that the higher cost of wholesale funding means that a bank either has to settle for
a narrower interest spread, and lower profits, or pursue higher yields from its lending and investing, which
usually means taking on greater risk.
Share Equity
While deposits are the primary source of loanable funds for almost every bank, shareholder equity is an
important part of a bank's capital. Several important regulatory ratios are based upon the amount of
shareholder capital a bank has and shareholder capital is, in many cases, the only capital that a bank knows
will not disappear.
Common equity is straight forward. This is capital that the bank has raised by selling shares to outside
investors. While banks, especially larger banks, do often pay dividends on their common shares, there is no
requirement for them to do so.
Banks often issue preferred shares to raise capital. As this capital is expensive, and generally issued only in
times of trouble, or to facilitate an acquisition, banks will often make these shares callable. This gives the
bank the right to buy back the shares at a time when the capital position is stronger, and the bank no longer
needs such expensive capital.
Equity capital is expensive, therefore, banks generally only issue shares when they need to raise funds for an
acquisition, or when they need to repair their capital position, typically after a period of elevated bad loans.
Apart from the initial capital raised to fund a new bank, banks do not typically issue equity to fund loans.
Debt
Banks will also raise capital through debt issuance. Banks most often use debt to smooth out the ups and
downs in their funding needs, and will call upon sources like repurchase agreements or the Federal Home
Loan Bank system, to access debt funding on a short term basis.
There is frankly nothing particularly unusual about bank-issued debt, and like regular corporations, bank
bonds may be callable and/or convertible. Although debt is relatively common on bank balance sheets, it is
not a critical source of capital for most banks. Although debt/equity ratios are typically over 100% in the
banking sector, this is largely a function of the relatively low level of equity at most banks. Seen differently,
debt is usually a much smaller percentage of total deposits or loans at most banks and is, accordingly, not a
vital source of loanable funds.
Use of Funds
Loans
For most banks, loans are the primary use of their funds and the principal way in which they earn income.
Loans are typically made for fixed terms, at fixed rates and are typically secured with real property; often the
property that the loan is going to be used to purchase. While banks will make loans with variable or
adjustable interest rates and borrowers can often repay loans early, with little or no penalty, banks generally
shy away from these kinds of loans, as it can be difficult to match them with appropriate funding sources.
Part and parcel of a bank's lending practices is its evaluation of the credit worthiness of a potential borrower
and the ability to charge different rates of interest, based upon that evaluation. When considering a loan,
banks will often evaluate the income, assets and debt of the prospective borrower, as well as the credit
history of the borrower. The purpose of the loan is also a factor in the loan underwriting decision; loans
taken out to purchase real property, such as homes, cars, inventory, etc., are generally considered less risky,
as there is an underlying asset of some value that the bank can reclaim in the event of nonpayment.
As such, banks play an under-appreciated role in the economy. To some extent, bank loan officers decide
which projects, and/or businesses, are worth pursuing and are deserving of capital.
Consumer Lending
Consumer lending makes up the bulk of North American bank lending, and of this, residential mortgages
make up by far the largest share. Mortgages are used to buy residences and the homes themselves are often
the security that collateralizes the loan. Mortgages are typically written for 30 year repayment periods and
interest rates may be fixed, adjustable, or variable. Although a variety of more exotic mortgage products
were offered during the U.S. housing bubble of the 2000s, many of the riskier products, including "pick-a-
payment" mortgages and negative amortization loans, are much less common now.
Automobile lending is another significant category of secured lending for many banks. Compared to
mortgage lending, auto loans are typically for shorter terms and higher rates. Banks face extensive
competition in auto lending from other financial institutions, like captive auto financing operations run by
automobile manufacturers and dealers.
Prior to the collapse of the housing bubble, home equity lending was a fast-growing segment of consumer
lending for many banks. Home equity lending basically involves lending money to consumers, for whatever
purposes they wish, with the equity in their home, that is, the difference between the appraised value of the
home and any outstanding mortgage, as the collateral.
As the cost of post-secondary education continues to rise, more and more students find that they have to take
out loans to pay for their education. Accordingly, student lending has been a growth market for many banks.
Student lending is typically unsecured and there are three primary types of student loans in the United States:
federally sponsored subsidized loans, where the federal government pays the interest while the student is in
school, federally sponsored unsubsidized loans and private loans.
Credit cards are another significant lending type and an interesting case. Credit cards are, in essence,
personal lines of credit that can be drawn down at any time. While Visa and MasterCard are well-known
names in credit cards, they do not actually underwrite any of the lending. Visa and MasterCard simply run
the proprietary networks through which money (debits and credits) is moved around between the shopper's
bank and the merchant's bank, after a transaction.
Not all banks engage in credit card lending and the rates of default are traditionally much higher than in
mortgage lending or other types of secured lending. That said, credit card lending delivers lucrative fees for
banks: Interchange fees charged to merchants for accepting the card and entering into the transaction, late-
payment fees, currency exchange, over-the-limit and other fees for the card user, as well as elevated rates on
the balances that credit card users carry, from one month to the next.
 Knowledge check: HOW BANKS MAKE MONEY

Decide if the following statements are true or false

1. The largest source of money mobilization of the banks is deposits.
2. Customers cannot get back the full amount of their deposits if they wish to withdraw their money before
maturity.
3. Banks should consider carefully before borrowing money from wholesale deposits as it may badly affect
their image in the eyes of investors.
4. Preferred shares are shares sold to outside investors when the banks are in financial troubles and can be
bought back when their capital position is stronger.
5. Banks are required to pay dividends to shareholders holding common shares.
6. Bank loans are generally secured over fixed assets of the borrowers.
7. Consumer lending consists of loans issued to individuals for such purposes as buying houses and
automobiles, paying for education or using credit cards.
8. Loans are the main use of a bank’s funds.
9. Lending rates charged on credit cards are normally lower than lending rates on mortgage or other types
of secured lending.
10. Banks may also borrow money by issuing bonds.

Knowledge check: HOW BANKS MAKE MONEY

Decide if the following statements are true or false
1. The largest source of money mobilization of the banks is deposits.
2. Customers cannot get back the full amount of their deposits if they wish to withdraw their money before
maturity.
3. Banks should consider carefully before borrowing money from wholesale deposits as it may badly affect
their image in the eyes of investors.
4. Preferred shares are shares sold to outside investors when the banks are in financial troubles and can be
bought back when their capital position is stronger.
5. Banks are required to pay dividends to shareholders holding common shares.
6. Bank loans are generally secured over fixed assets of the borrowers.
7. Consumer lending consists of loans issued to individuals for such purposes as buying houses and
automobiles, paying for education or using credit cards.
8. Loans are the main use of a bank’s funds.
9. Lending rates charged on credit cards are normally lower than lending rates on mortgage or other types
of secured lending.
10. Banks may also borrow money by issuing bonds.
 The Banking System: Commercial Banking - Business Lending
By Stephen D. Simpson, CFA
Commercial lending - lending to businesses - is really a two-tier market in the United States. At the level of
large corporations, bank lending is not as significant in the United States as in many other countries, as there
are a larger number of accessible alternative sources of funds for businesses, like the bond market. For small
businesses, though, bank lending is often a crucial source of capital.
Business lending includes commercial mortgages (loans used to purchase buildings), equipment lending,
loans secured by accounts receivable and loans intended for expansion and other corporate purposes.
Traditionally, the residential construction industry has been a major borrower; using bank loans to acquire
land and pay for the construction of houses or apartments, and then repaying the loans when the dwellings
are completed or sold. Many banks effectively "double dip" in their lending to the housing market, lending
money to homebuyers as residential mortgages, and lending to developers and contractors engaged in
building new homes.
Business lending can also take the form of mezzanine financing, project financing or bridge loans.
Mezzanine lending is not all that common for most commercial banks, but bridge loans and project financing
is often extended on a short-term basis, until the borrower finds a more permanent source of funds.
Buy/Hold Securities
Banks also frequently use their capital to acquire investment securities. Regulators in all countries require
that banks hold back some percentage of capital as reserves. Debt securities issued by the national, state, and
local governments are frequently treated as safe as cash, or close to it, by regulators. Therefore, banks will
often hold these instruments as a way of earning some income on their reserves.
Many banks will also buy and hold securities as an alternative to lending. In cases where prevailing loan
rates are inadequate to satisfy a bank's risk-weighted pricing, certain debt securities may be more attractive
as alternate uses of capital. Accordingly, the bank sector is a major buyer of government debt securities.
Banks are also frequent buyers of municipal bonds. In the case of so-called "bank qualified bonds," banks
can earn interest that is free from Federal taxation.
It is less common for banks to hold common stock. Though many common stocks do pay dividends, U.S.
regulators have traditionally punished equity holdings by giving them poor risk weightings.
It is much more common overseas for banks to hold equity. Many banks in Europe and Asia view their
relationships with businesses as something akin to partnerships, and will hold equity for a variety of reasons,
including both a stake in the upside of the company, as well as the influence that significant ownership can
provide.
Non-Interest Income
In the past couple of decades, non-interest income has become a key component of the profits of many
commercial banks in North America. As the name suggests, this is income that does not originate as interest
on loaned funds. Non-interest income typically requires minimal risk for the bank and minimal capital. It is
not fair to say that non-interest income is "free money," employees still have to be paid, for instance, but it is
accurate to say that non-interest income often carries very attractive margins and returns on capital, and is a
crucial source of income for many banks.
Fees On Deposits and Loans
Customers may revile bank service fees, but they are a large part of how many banks make money. Banks
can charge fees for simply allowing a customer to have an account open, typically if, or when, the account
balance is below a certain break-point, as well as fees for using ATMs or overdrawing accounts. Banks will
also earn income from fees for services like cashier's checks and safe deposit boxes.
Banks also frequently attach a host of fees and charges when they make loans. While banks gamely try to
defend these fees as important to defraying the costs of paperwork and so forth, in practice they're a
honeypot of profits for the bank. Congress and has moved aggressively, in the wake of the subprime crisis, to
restrict some of the fees that banks can charge customers. In many cases these new rules simply mean that
customers have to actively select and approve certain account features, like automatic "overdraft insurance,"
but there are increasing limitations on what services banks can charge for, and how much they can charge.
Business Operations – Insurance and Leasing
Insurance is another surprisingly popular non-banking activity for many banks. Perhaps the popularity of
insurance is due to its similarities to banking; both businesses are predicated on adequately evaluating and
pricing risk, and supporting a large amount of liability on a thin layer of capital. Both businesses also happen
to be highly regulated, though insurance is regulated almost exclusively at the state level.
Likewise, given the similarities between lending and leasing, it is perhaps not surprising that many banks
establish leasing operations. Relatively few banks look to take ownership of the underlying assets, but many
banks look to form financing relationships with equipment dealers, paying a small fee to the dealer for every
leasing agreement signed, and then collecting interest on the lease. In effect, these operations allow banks to
expand their business lending, while leveraging the infrastructure of other businesses such as the equipment
dealers, for example.
Treasury Services
Treasury services are a broad collection of services that banks will offer to corporate/business clients, such as
company CFOs or treasurers. In addition to simple services like deposit-gathering and check writing, banks
will also help companies manage their accounts receivable and accounts payable. Managing working capital
and payroll is a significant headache for many companies, and while banks charge for these services, many
customers find that the charges are less than the cost of fully staffing and operating their own treasury
functions.
Payment Services
Larger banks can also earn non-interest income from payment processing services. Banks will help
merchants, frequently small or mid-sized businesses, set up payment systems that will allow them to accept
debit and/or credit cards, handle checks electronically, convert currency and automate much of the back-
office work, to ensure faster payment and less hassle.
Along similar lines, banks can help businesses set up automated/electronic payment networks that make
invoicing and supplier payments faster and less of a hassle. Of course, the banks charge for these services,
often earning a small amount on every transaction that they handle or help process. Given that a single
network can support large numbers of clients with minimal incremental expenses, these services can be very
profitable for a bank, once they have reached a certain scale.
Loan Sales
Although making mortgage loans and collecting the interest is certainly part of everyday "interest income"
operations at banks, there are aspects of lending that fall into the non-interest income bucket. In some cases,
banks are willing and able to lend money, but not especially well-equipped to manage the back office tasks
that go into servicing those loans.
In situations like this, a bank can sell the rights to service that loan, collecting and forwarding payments,
handling escrow accounts, responding to borrower questions, etc., to another financial institution. While this
can be done for almost any kind of loan, it is most common with mortgages and student loans; mortgage
servicing rights (MSR) constitutes a multi-billion dollar industry. (For more, check out The New Mortgage
Business: More Than Just Loans.)
Other Sources of Income
In their drive for additional sources of income, most commercial banks have expanded into offering various
investment and retirement products to banking customers. In many cases, banks will offer an array of
products like mutual funds, annuities and portfolio advice. Larger banks may actually operate these funds
themselves, through a subsidiary, but others will simply act as a commission-gathering agent.
Although the deposit guarantees that cover bank deposits do not extend to retirement accounts, many
investors are under the misconception that they do, and will buy securities from banks under the
misconception that they are less risky.
 The Banking System: Commercial Banking - Operations
Retail Banking
Retail banking is the banking that almost every reader will find most familiar. Retail banking is the business
of making consumer loans, mortgages and the like, taking deposits and offering products such as checking
accounts and CDs. Retail banking generally requires significant investment in branch offices, as well as other
customer service points of contact, like ATMs and bank tellers.
Retail banks frequently compete on convenience, the accessibility of branches and ATMs for example, cost
such as(interest rates, and account service fees, or some combination of the two. Retail banks also attempt to
market multiple services to customers by encouraging customers who have a checking account to also open a
savings account, borrow through its mortgage loan office, transfer retirement accounts, and so on.
Business Banking
Business banking is not altogether that different than consumer retail banking; operations still revolve around
collecting deposits, making loans and convincing customers to use other fee-generating services.
One of the primary differences is that business customers tend to have somewhat more sophisticated
demands from their banks, often leaning on banks for assistance in managing their payables, receivables and
other treasury functions. Business banking also tends to be less demanding in terms of branch networks and
infrastructure, but more competitive in terms of rates and fees.
Private Banking
There is a shrinking number of independent financial institutions that focus exclusively on private banking,
as it is increasingly conducted as a department of a larger bank. Private banking is a euphemism for banking
and financial services offered to wealthy customers, typically those with more than $1 million of net worth.
In addition to standard bank service offerings, like checking and savings accounts and safe deposit boxes,
private banks often offer a host of trust, tax and estate planning services. Perhaps not surprisingly, the bank
secrecy laws of countries like Switzerland have made them attractive locations for conducting private
banking.
Investment Banking
Since the repeal of Glass-Steagall, the law that forced entities to separate commercial and investment
banking activities after the Great Depression, many commercial banks have acquired investment banks.
Investment banking is a very different business than commercial banking, but is nevertheless a major source
of revenue and profits for many of the largest banks in the United States.
Investment banks specialize in underwriting securities (equity and/or debt), making markets for securities,
trading for their own accounts and providing advisory services to corporate clients. Although underwriting
derivatives can expose an investment bank to significant risks, as seen in the cases of Bear Stearns and
Lehman Brothers, investment banking is generally a high-margin, but volatile, enterprise.
Countdown
1 What is the difference between a private company and a public company? Which of them is listed on a
stock market?
2 What information does a stock index, like the FTSE 100 or S&P 500 contain?
3 Where can you find the stock market indices below? Match the indices with the cities where they are
based, one of the cities matches with two indices.

1 Dow Jones
2 FTSE 100
3 Nikkei
4 CAC40
5 DAX
6 Hang Seng
7 NASDAQ
8 Bovespa
9 MICEX
10 Straits Times Index

4 Look at the news items below. Which sectors of the market would they affect the most? Would they have
a positive or negative effect on these sectors?
Central bank cuts interest rates Oil prices hit a 2-year high

London wins Olympic bid Consumer debt levels continue to rise

5 What is the main index in your country? What are the biggest companies in it?

Reading
Stock markets
When a university in Moscow invited an equity broker to the university to introduce students to the stock
market, they asked students for questions to find out what they wanted to know about markets.
Look at the list of questions students submitted online below. First, work in pairs and see how many of the
questions you can answer together before you read the text.
1 What is the difference between a share and a stock?
2 What rights do you get if you buy a company's shares?
3 What is a dividend?
4 Who decides how much dividend to pay?
5 Why do some companies not pay dividends?
6 What are the two main ways shareholders make money from shares?
7 How does a company become a listed company?
8 What is an IPO?
9 What does it mean when an investment bank 'underwrites' a company's shares?
10 What is the difference between a primary listing and the secondary market?
11 What is the role of the market regulators?
12 What is a rights issue?
13 When a company makes a rights issue, the share price usually goes down. Why is that?
You are going to work together by sharing information to check your answers to the questions.

Student A Student B
Read your extract from the text of the broker's Read your extract from the text of the broker's
speech and check your answers to the questions. speech and check your answers to the questions.
Make notes. Make notes.
Every day people buy and sell about £16bn of What do they do on the stock market every day?
shares on the stock market in London. But what Basically, the biggest markets in the world, like
exactly are they buying? Wall Street, try to value companies every day
Basically, when you buy a share you become an according to the economic prospects of the company
owner of part of that company. The English and the progress of the economy. A company that
markets use the word 'share', the American wants to offer its shares to the public must first come
markets also use the word 'stocks'. As a to the market through an IPO, an Initial Public
shareholder or stockholder, your investment gives Offering.
you rights to vote at the annual company meeting
When it has this 'listing' the price of the shares can
(the AGM) and to receive a percentage of the
be 'quoted' every day in trading. This initial offer to
profits that a company will hopefully make.
investors is organized by an investment bank which
The profit is distributed to you as a dividend, supports the company and organizes the first day of
usually paid twice a year. This is because the trading. They work, of course, with the market
Board of Directors who run the company decide regulators, like the Financial Services Authority
each year how much of the profit to give back to (FSA) in the UK or the Securities and Exchanges
the shareholders as a return on their investment Commission (SEC) in the US, to make sure that the
and how much to retain for the company to use to company follows all the regulations and the
invest in new projects. Some very big companies company is not trying to defraud investors. The
do not pay dividends because they feel that the investment bank will 'underwrite' the shares by
profit made by the company is better retained in promising to buy the shares if no other investors are
the company to grow that business. That way, the interested. Market participants call this first offer a
shareholder benefits long term because if the primary listing.
company succeeds, the shares will increase in
Once a stock has a quoted price, investors can buy
value. So when they sell the shares they will get a
and sell the stock every day, so the stock exists in
higher price.
what they call 'the secondary market: Sometimes
That is why an investor in shares expects to make companies need to raise more capital to grow their
two kinds of return: a dividend and a capital business and then they can issue new shares in what
increase when they sell. The value of the shares, of is called a rights issue. By selling new shares, the
course, changes every day as people trade the company, of course, is getting new money, but at the
stock, and so the market capitalization or total same time it also means that each individual share in
value of the company is never constant. the company is now worth less because it represents
a smaller percentage of the whole company.

Listening
Why do stock markets move?
What do you think are the main factors behind the daily movements of a stock market?
1 Which three of these factors have the biggest effect on the performance of a company's share price?
• Company announcements
• The views of analysts
• Movements in interest rates
• Inflation data
• Business / consumer confidence surveys
• Sector outlook
• Company financial results
• Performance of competitors

2 Listen to an interview with a fund

manager who is explaining why stock
markets move.
Complete the two slides that she uses to
explain the stock market.

3 Listen again and write T (true) or F

(false).
1 The New York market was up today,
but the London market was down.
2 A fall in interest rates will boost the
stock market.
3 Analysts upgrade a stock because they
want to attract buyers.
4 The share price tells you about the
probable future profits.
5 Retail investors have the biggest
influence on profits.
6 Hedge funds make about 30% profit
per year.

Professional skills
In 2008, the US investor Warren Buffet, the so-called 'Sage of Omaha', was ranked by Forbes magazine
as the richest person in the world with an estimated fortune of $62 billion. His philosophy to investing is
as follows: 'The basic ideas of investing are to look at stacks as business, use the market's fluctuations to
your advantage, and seek a margin of safety.' Simple if you know how!

Investment Strategies
Look at these tips from an online forum in which people explain their investment strategies. Work in pairs.
Which three of these strategies do you think could be the most successful?
If you want to invest in the markets, you should spread your risks by investing in several companies
in different sectors. That way you reduce your exposure to any one company.

I believe that it is best to invest in large international companies with strong brands. Small companies
are just too risky.

Take Warren Buffet’s advice: ·Be fearful when others are greedy and greedy when others are fearful

D. The only way to make money on the markets is to invest your money for at least five years. Buying
and selling quickly - or day trading – is just a way to lose your money.

E. The best way to invest in the stock market is to invest in a general fund, in which a manager
decides which shares to buy or sell.

F. Watch the discussion boards for good stories about companies. Then 'buy on the rumor. Sell on
the news'.
If the thought of investing in the stock market scares you, you aren't alone. False promises and highly public
stories of investors striking it rich or losing everything skew perceptions of the reality of the average
investor. By understanding a little more about the stock market – and how the stock market works – you'll
likely find it isn't as scary as you may think and that it's a viable investment.
What is a Stock or Share?
When you buy a stock you're buying a piece of the company. When a company needs to raise money, it
issues shares. This is done through an initial public offering (IPO), in which the price of shares is set based
how much the company is estimated to be worth, and how many shares are being issued. The company gets
to keep the money raised to grow its business, while the shares (also called stocks) continue to trade on an
exchange, such as the New York Stock Exchange (NYSE).
Traders and investors continue to buy and sell the stock of the company on the exchange, although the
company itself no longer receives any money from this type of trading. The company only receives money
from the IPO.
Why Buy Shares?
Traders and investors continue to trade a company's stock after the IPO because the perceived value of
company changes over time. Investors can make or lose money depending on whether their perceptions are
in agreement with "the market." The market is the vast array of investors and traders who buy and sell the
stock, pushing the price up or down.
Trying to predict which stock will rise or fall, and when, is very difficult. Over time stocks as a whole tend to
rise, which is why many investors choose to buy a basket of stocks in various sectors (this is called
diversification) and hold them for the long-term. Investors who use this approach do not concern themselves
with moment-to-moment fluctuations in stock prices. The ultimate goal of buying shares is to make money
by buying stocks in companies you expect to do well, those whose perceived value (in the form of the share
price) will rise.
Mature and established companies may also pay a dividend to shareholders. A dividend is a cut of the
company's profit, which the company sends to shareholders as long as the company continues to pay the
dividend. Aside from the dividend, the share price will continue to fluctuate; the losses and gains associated
with the share price are independent of the dividend. Dividends can be large or small – or nonexistent (many
stocks don't pay them). Investors seeking regular income from their stock market investments tend to
favoring buying stocks that pay high dividends.
When you buy shares of a company, you own a piece of that company and therefore have a vote in how it is
run. While there are different classes of shares (a company can issue shares more than once), typically
owning shares gives you voting rights equal to the number of shares you own. Shareholders as a whole,
based on their individual votes, select a board of directors and can vote on major decisions the company is
making.
Why Sell Shares?
For every stock transaction, there must be a buyer and a seller. When you buy 100 shares of stock (called a
"lot") someone else must sell it to you. Either buyers or sellers can be more aggressive than the other,
pushing the price up or down.
When the price of a stock goes down, sellers are more aggressive because they are willing to sell at a lower
and lower price. The buyers are also timid and only willing to buy at lower at lower prices. The price will
continue to fall until the price reaches a point where buyers step in and become more aggressive and willing
to buy at higher prices, pushing the price back up.
Investors don't all have the same agenda, which leads traders to sell stocks at different times. One investor
may hold stock that has grown significantly in price and sells to lock in that profit and extract the cash.
Another trader may have bought at a higher price than the stock now sells for, putting the trader in a losing
position. That trader may sell to keep the loss from getting bigger. Investors and traders may also sell
because they believe a stock is going to go down, based on their research, and want to take their money out
before it does.
Volume
How many shares change hands in a day is called volume. Many stocks on major exchanges such as NYSE
or NASDAQ have millions of shares issued. That means potentially thousands of investors in a stock may
decide to buy or sell on any particular day. A stock that has lots of daily volume is attractive to investors
because the volume means they can easily buy or sell their shares whenever they please.
When volume is inadequate, or no one is actively trading a stock, it's still usually possible to dispose of a
small number of shares because the exchanges mandate certain traders (firms) to provide volume. These
traders are commonly referred to as market makers, and act as buyers and sellers of last resort when there are
no buyers or sellers. They don't have to stop a stock from rising or falling though, which is why most traders
and investors still choose to trade stocks with lots of volume, and thus not rely on these "market makers,"
which are now mostly electronic and automated. There are still people on the floor of the NYSE. Those men
and women in the blue jackets trade stocks for their firms and also help facilitate orders from the public (see
above).
The Bottom Line
Stock are issued by companies to raise cash, and the stock then continues to trade on a exchange. Overall
stocks have risen over the long-term, which makes owning shares attractive. There are also additional perks
such as dividends (income), profit potential and voting rights. Share prices also fall, though, which is why
investors typically choose to invest in a wide array of stocks, only risking a small percentage of their capital
on each one. Shares can be bought or sold at any time, assuming there is enough volume available to
complete the transaction, which means investors can cut losses or take profits whenever they wish.
Reading
Accounting and auditing
1 Before you read, work with a partner to test what you know about the differences between accounting and
auditing. Circle the correct option for each sentence.
1 Accountants /Auditors prepare the financial accounts of a company.
2 Accountants / Auditors investigate and test the accuracy of the accounts.
3 Accountants / Auditors are appointed by the shareholders.
4 Accountants / Auditors prepare the statutory accounts at the end of every financial year.
5 The accounts / auditor's report record(s) the financial results of a company.
2 Now work together to find out more about the differences. Make notes and prepare for discussion.
Student A: Accounting
Read the following text about the purpose of accounting and write notes to answer the questions below. You will need
to use these notes to explain to your partner what accountants do.
1 What information can you find in the books or ledgers of a company?
2 What is the purpose of the management accounts?
3 What is the reason for having the statutory financial accounts?
4 What are accounting standards? Give three examples.
5 What is the role of the IFSA?

Accounting
In the past, a company's financial records were kept in real books or ledgers - hence the term bookkeeping –
so a company kept a separate sales ledger for sales made, a purchasing ledger for things bought, a cash
ledger, and others. Today, of course, these records are mostly kept on computers in electronic form.
Even today, the company accountants may use these books to prepare the management accounts. These are
prepared monthly, or even weekly in very big companies. They are not published outside the company, but
provide information for controlling the business by giving an up-to-date statement of the company's current
financial trading. They help to answer questions such as: 'Are sales going to plan?' and 'What is happening to
our costs?'
But a modern company is also regulated by laws (e.g. the Companies Acts in the UK), and these laws require
a company to publish official financial statements for regulators and shareholders to inspect. This means that
the accountants have to prepare a second annual summary set of accounts, the Statutory Financial Accounts
which include a balance sheet, income statement, and cash-flow statement, according to recognised
accounting standards.
These statutory accounts summarize the financial statements for the last year. But the accountants must make
sure that the company reports its official results according to the accounting standards created by the
accounting profession. For example, the company must follow a principle of 'consistency' (it cannot keep
changing its accounting systems every year); it must be 'prudent' (careful) in its estimate of the value of
things it owns: and the directors must believe that the company has enough money to continue trading next
year as a 'going concern'.
These basic principles have been incorporated into national accounting standards in different ways in
different countries. But globalization has created a growing pressure for all companies worldwide to use the
same reporting standards developed by the international accounting organization, the IFSA.

Student B: Auditing
Read the text opposite about the purpose of auditing and write notes to answer the questions below. You will
need to use these notes to explain to your partner what auditors do.
1 Why do the owners of a company appoint external auditors?
2 How often does a public company have to do an external audit?
3 Who do the external auditors work for?
4 What kinds of documents do the auditors inspect?
5 What is the purpose of the substantive tests?
6 How do the auditors report the first results of their tests?
7 What do the auditors do if they are not happy with the results of their audit?
Auditing
How do the owners of a company know if the management are really telling them what is happening in the
company's finances and not hiding information or even committing fraud?
The answer is that every year the owners appoint an 'external auditor' to check the company's accounts and to
write a report on the accuracy of the financial statements: the auditor's report. This is now a legal
requirement for public companies.
The auditors must give an independent opinion of the accounts and make tests to see if the accounts are
properly prepared according to accounting standards, and if they give 'a true and fair view' of the company's
finances.
The auditors will look at all the company's documents, like invoices and receipts, the books and bank
statements and check if these have been recorded properly. Have the staff really followed both the
accountancy standards and the company's rules? Are there systems in place to prevent mistakes or fraud?
It is also important to know if the assets a company claims to own really exist. So the auditors will run
'substantive tests' and will visit the factories and warehouses to physically see items recorded. Because of the
quantity of information, the auditors will usually test this by taking samples of information, rather than
looking at every document.
At the end of their tests the auditors write a letter that they send first to the management - the letter to
management - describing what they have found and what needs to be corrected before they are happy to
'sign off' the accounts. They can then complete the audit report in which they declare that 'in their opinion'
the accounts are accurate and give a 'true and fair view' of the company's position.
If, occasionally, they are unable to demonstrate this, they will issue a 'qualified opinion' in which they will
point out the things that they could not prove. This, of course, will give a serious warning to the company's
owners and investors.

Listening
The steps of an audit

1 Listen to a presentation in which the

leader of an audit team explains to a client
the steps of the audit he will carry out in
the company. Write down the sequence of
steps by putting the numbers (1- 6) in the
first column of the table.

2 Listen again and make a note in the

second column of what preparation the
company should do for each step.
An auditor finds out early in his training that he is a watchdog and not a bloodhound. From today, when the
Auditing Practices Committee (APC) issues its long - awaited guideline on auditors and fraud, an auditor
will also have consider himself a whistle - blower.
The guideline sets out to clarify auditors' responsibilities in relation to fraud, as well as other irregularities
and errors. It recommends that auditors take an active role in reporting fraud to third parties.
The document acknowledges that an auditor's primary duty is one of confidentially to the client. But the
document says an auditor should also consider throwing this narrow duty aside and think of the wider public
interest.
Taking its cue from an ethical statement issued in 1988, Professional Contact in Relation to Defaults or
Unlawful Acts, the document spells out the circumstances when the public interest could be served by a nod
and a wink to the Department of Trade and Industry or some other official authority.
Under normal circumstances, the auditor's first step would be alert the client's management to the existence
of fraud. But the guideline says that if senior managers or directors are involved in the fraud, the auditor may
see fit to go over the head of the board of directors, even non-executive directors and the audit committee, to
directly report to the regulatory authorities.
Alerting the authorities would be justified if the fraud is likely to result in a material gain or loss for any one
person or group of people; is likely to be "repeated with impunity" if not disclosed; or if "there is a
general management ethics of flouting the law and regulation". The strength of the auditor's evidence
is deemed important too.
Legal advice on the matter given to the APC said auditors should attach importance to the wider
interests of the company in any case "where the auditor considered that the directors could not be
relied upon to apply their minds properly to those interests".
The advice continued: "An auditor will not be in breach of any legal duty if, although entitled to
disclose, he fails to do so. His decision whether to do so or not is therefore a matter of professional
judgment and not a matter of law. It is a decision which should reflect the proper expectations which
the public has of his profession".
So despite the codification of responsibilities within the guideline, it is all a matter of professional
judgment. It appears that the only circumstances where the auditor of a company not in the financial
sector definitely must "blow the whistle" is when he stumbles upon treason; a practice for which there
is no APC guideline yet.
Responsibilities are different for companies covered by the special requirements of the Financial
Services Act 1986, the Building Societies Act of the same year and the banking Act 1987. Following
Professor Gower's reports on Investor Protection (in 1982 and 1984), companies covered by this
legislation can only be authorized to conduct business if they keep proper accounting records and have
adequate internal controls.
These Acts require that auditors make specific representations to the regulators on these and other
points and describe the circumstances when auditors should go directly to the authorities in order to
protect the interests of shareholders or depositors.
Today's guideline - which for the first time establishes rules for auditors reporting on companies not in
the financial sector - will offer solace to auditors confused about the precise nature of their duties.
The guideline makes it clear that the prime responsibility for detecting fraud rests with management.
The auditor must plan an audit so that he or she has a "reasonable expectation" of spotting serious
misstatements which impinge on the truth and fairness of a set of accounts.
Today's guideline from the APC is pitched towards the practitioner and not the business public at large. It is
unlikely to do much to tackle the gulf between what the public think auditors should do and what the auditors
themselves think that they are doing.