Three Interesting Questions On Finance!

Here is what I find something really interesting and weird in the world of finance. To start with, it is the relation between assets, debt and equity.

As you might be knowing, or if you are unaware better get to know this very basic equation,

Assets = Debt + Equity

Sure, it can be found replicated all over the internet and finance books start with this basic equation in their introductory chapters.

Please note this is applicable at the corporate level and not at your personal level. At a personal level, you do not have any equity. So, removing equity from the equation, it makes it

Assets = Debt

:P :P
If you can read it, that is the surest way to bankruptcy!! Buy your assets on debt! Jokes apart, the point that I am trying to drive home is that there is a large difference between corporate perspective and an individual's perspective. Sometimes, the things can be absolutely upside down as well.
At corporate level, debt increases financial leverage. At a personal level, having high debt absolutely reduces your leverage!

That is fine. But, as usual, my critical mind has a very trivial query.

Image Credit: themillionairesecret.net

Why is it that a company has to fund its assets by opting for debt or using money raised through equity? Both, debt as well as equity are not owned by the company! Can't the company use its own money for funding its assets???


I really cannot understand that! Why has the company got to use others' money for building/constructing/buying its assets? And there is one more from my side.



Earnings, Cash Surplus are a liability in balance sheet.


Ohh, the very basic fundamental of a business is to earn profits, right? Then, why is it that earnings or cash surplus is seen as a liability! For those not from a finance background, a balance sheet should have sum of assets equal to sum of liabilities. I honestly think that earnings, the very purpose of a company's creation, are a 'liability' just because some odd financial analyst found it an eureka moment discovering that the equation, sum of assets = sum of liabilities would always be solved by putting earnings in liability!

As I type this, my mind has got one more query.



Why is it that in a balance sheet, the sum of assets should always equal sum of liabilities?


Well, that is the rule of a balance sheet, you can get it confirmed by checking a balance sheet of any year of a company. Going by definition, an asset is what you 'own', whereas a liability is what you 'owe'. If I am an owner of a company, from my company's perspective, it is quite obvious that I want to 'own' more than what I 'owe'. That is why companies are built, to own more money and not equal it by owing to someone else!
So, why the hell do we equal it every time as if it is a mandate? It is time rules of the world changed and not follow blindly what some finance guru in the '60s found something to be an eureka moment!

On a serious note, please comment through the answers section if you know the answer for the questions that I have posed up in bold. Please, or else my critical mind won't be satisfied!

Does Investing in Real Estate Make Sense?

NO!

The question is answered. How? That's what the post is all about. Just spare 4 minutes of your life's time to read a counter view on why it does not make sense to invest in real estate.

I am sure, most of the people in the world have hypnotized you by now that investment in real estate is the best investment. Especially, if you are a visitor from the eastern countries, particularly India, I can understand your emotions for real estate. Put all your emotions aside, and let logic and rationality come into the fore of your mind when it comes to money matters.

First, just ask a question to yourself, are these fans of real estate investment financially literate? Probability is that 9 out of those 10 brains you know would not be aware about what goes in he capital markets, stock markets, etc. All their brains know is cash in, cash out without any concern for time value of money.

We have been brought out to think that real estate is an asset, not a liability. It is both, let us elaborate on the difference which is more important for you. For living, you and your family would not need more than a 2BHK (bedrooms, hall and kitchen) or a 3BHK flat. Sure, that is an asset, or rather a necessity as you do not have to worry about rents and any conditions laid out by your owner. But, if you possess any more property than your necessity of living, it is all a liability.

Image Credit: Examiner.com

How? The taxes to be paid, the interest to be paid in case if it is on loan amount, it's maintenance, etc. You never know what's going on the land you bought, is it safe or not? It does not ensure you cash-in-hand. Buying property and selling off is another tiresome process which would involve real estate agents or brokers, their fees, selling it would take some time depending on the demand supply equations, real estate agent's commission once again.. Rather than this, think if you can potentially surf the internet and make yourself more financially literate!

Now, how exactly is that a liability? Our assets and liability are measured by cash value, where these definitions have come from accountancy. If you are aware, economics>finance>accountancy. Robert Kiyosaki's book, 'Rich Dad Poor Dad' offers a practical and different world-view of assets and liability than the normal. It is based on the cash flow and not cash value. Out of the 3 major financial statements that a corporation gives out every year, viz., Income Statement (also called Profit and Loss Statement), Balance Sheet and Cash Flow, Cash Flow has it's own and highest importance for the financial community. And that is why, I think, measuring assets or liability based on cash flow  is more important than anything else.

If you own a house, which is not rented, or rather no one is ready to take it on rent, you are unable to maintain which depreciates value, and you are supposed to pay property tax, water bills, electricity bills howsoever small they may sound, it is not an asset from any viewpoint. It is a liability as there is no inward cash flow involved although cash value appears high.

Moe importantly, cash is the emperor whereas profit is the king is an oft repeated statement in the world of finance. You might think that it would be profitable to sell it in the long run (with all the costs), but it would still involve time and no cash-in-hand which is more important. Putting the same amount in banks savings account, time deposits, investment plans, could have potentially turned out better with lesser hassles as you could do all this with the help of a few clicks!

If you believe in the hypothesis that real estate/property rates never fall, think again. Property rates have seen a steady downfall in UK and US! Nothing is recession proof.

Most importantly, if you believe there would be a real estate boom at some time in the future, which I am sure there would be one, a smart move would be to buy stocks of cement companies, lock manufacturing companies, paint companies, furniture companies, real estate companies, retail sector, FMCG sector, as all of it is bound to rise as real estate goes up! It would take only a few clicks to do this and you would be helping the economy of your country as well. How? The very money that you would put in shares or other financial instruments would be used by these major companies to fund their operations. They would become stronger, grow and create more job opportunities in future. On the contrary, what would a dead investment in some lone land at a far off place contribute to the economy except that agent's commission and a minuscule tax for the government?

And finally, there are hoards of people looking for buying property when not needed who are financially not literate. Leave it for them, they would keep buying! I have always wondered why those of my friends and acquaintances investing in shares have had a blind eye towards real estate... A few reasons were listed, a few would be written later in coming blog posts, so stay subscribed or keep visiting!