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Interest Rate in Selecting a Loan

See Also:
What is Compound Interest
Effective Rate of Interest Calculation
Interest Expense
Nominal Interest Rate
Interest Rate Swaps

Interest Rate in Selecting a Loan

Why is the interest rate in selecting a loan not the best indicator? First off, the interest rate is always important. It determines the size of your loan payments.

There are, however, other considerations which may lead a borrower to not select the loan with the lowest interest rate.

Flexibility

A lender who is willing to structure the terms of a loan more favorably from the borrower’s perspective may be offering a more attractive deal than a competing loan with a lower interest rate and more stringent terms.

Experience

A banker who understands the nuances of your company’s industry and has contacts within the industry may make a loan at a higher interest rate worth it. In addition, if you are considering a potential sale of your business a lender experienced in such transactions may make for a much smoother transaction.

Turnaround

Often it is crucial to have expedited access to borrowed funds. A lender who can process your loan within a short period of time may be your best option.

Relationship

Does the prospective lender have a significant interest in obtaining your business due to their size or their desire to enter a new industry? This may afford you the opportunity to establish a relationship and eventually obtain more favorable terms, including a lower interest rate in the future for your borrowing needs.

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interest rate in selecting a loan
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Rule of 72

The rule of 72 is an approximation tool used to determine the amount of time it will take for money to double on the earnings of compound interest.

Rule of 72 Explained

The rule of 72 is essentially an estimation for determining the amount of years or the doubling time of an investment. Do this by taking the interest available on the investment. Then divide it by 72. This type of investing is usually fairly accurate, it is more accurate with lower interest rates than it is for higher ones. It is normally used solely for compound interest situations and is not a very good indicator if the investment earns a simple interest at the end of the investment term. This rule is most useful if an investor cannot perform an exponential function and simply needs to do simple math for an estimate of an investment.

Rule of 72 Formula

Use the following rule of 72 formula:

Doubling Time (# years) = 72/Interest Rate

Example

What is the doubling time for an investment with a compound interest rate of 8%? A person using the rule of 72 equation would find the doubling time equal to 9 years. Calculate it by dividing 8 by 72. By performing this, the investor can tell that it will take approximately 9 years to double the principal. It is fairly accurate as the exponential function yields an actual doubling time of 9.006 years.

rule of 72

See Also:
Investment Banks
NPV vs Payback Method
Internal Rate of Return Method
Weighted Average Cost of Capital (WACC)
Effective Rate of Interest Calculation

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Fixed Charge Coverage Ratio Definition

Fixed Charge Coverage Ratio Definition

Fixed Charge coverage ratio, defined as a measure of how well a company can meet its fixed financial obligations (such as interest and leases) with its operating profit, also serves as a measure of the ability of a company to pay bills owed. It indicates the financial risk involved in paying fixed costs within a company’s business operation. This ratio acts as a risk indicator.

In a sense, the Fixed Charge Coverage Ratio allows a company, as well as outside companies, to know if a business can fulfill its financial obligations. Within the company, the fixed charge coverage ratio allows a company to fully understand the capabilities of the organization. More specifically, it allows the company to understand what projects can be undertaken and which projects must be scrapped for another time. More accurately put, the fixed charge coverage ratio is a strong indicator of how successful a company is going to be, both from inside the company and from the outside looking in.

Fixed Charge Coverage Ratio Explanation

Fixed charge coverage ratio, explained, is a strong indicator of a company’s future problems if sales drop to any extent. It is especially important for a company who spends heavily on leases. The lower the operation profit, the worse negative effects of fixed payments will become. For example, a company will feel heavier burden of lease payments combined with interest expense with declining sales. At the same time, this could deter possible outside investors to support a company with a negative fixed charge coverage ratio.

Though the ratio is just a numerical figure, the implications of this number have important effects on a company. Though, it is not completely impossible to improve a company’s fixed charge coverage ratio. As a company improves its ability to pay bills and debts, the ratio will improve. If a company’s ratio is not quite as good as they would like, it is beneficial to at least show a positive trend in where the ratio is headed.

If you want to increase the value of your organization, then click here to download the Know Your Economics Worksheet.

fixed charge coverage ratio definition

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fixed charge coverage ratio definition

See Also:
Fixed Charge Coverage Ratio Analysis
Financial Ratios
Key Performance Indicators (KPIs)

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Daily Sales Outstanding Calculation

See Also:
DSO – Daily Sales Outstanding
Daily Sales Outstanding Formula

Daily Sales Outstanding Calculation

The daily sales outstanding calculation requires little more than a basic understanding of mathematics. Maintaining proper financials allows this and other essential calculations to be performed. The days sales outstanding formula, ultimately, leads to monitoring the health and wealth of your business. As a whole, perform the calculation of Daily Sales Outstanding using different periods of time as the overall indicator. Whether it be by years, months, or days, the organization as a whole needs to decide which method of time is the most appropriate for successful figures and for impressions. This is important because the different time periods can portray different results in cash flows and statistical models.

Calculating Daily Outstanding Sales is fairly simple, as said before. First, divide the total (or average depending on if you need actual or average days) accounts receivable balance by the total credit sales. Then multiply this remaining number by the total number of days or months in the time period. This also depends upon whether you desire average or total days. See the following example below.

Example of Daily Sales Outstanding Calculation

For example, assume Total Credit Sales are $1,000,000 and Average Accounts Receivable is $100,000.

(DSO) Days Sales Outstanding Calculation: 365 X (100,000 / 1,000,000) = 36.5 days

This is a simplified explanation of how to calculate daily sales outstanding. What the days represent is essentially the average number of days that are needed in order to collect the total accounts receivable balance from clients. A trained CFO can provide more extensive analysis and solutions. At the same time, it would not be overly difficult to produce the same quality work as a trained CFO.

After you complete the calculation, match the figures against the competition in the industry. Then determine the overall health of the organization. As far as the final figures go, calculating the Daily Outstanding Sales can tell you a couple of things about the state of your business. If the credit sales are substantially higher than is customary, then your services are being handed out much like a loan. The customers are purchasing this service without paying. A consequence of this could be a negative effect on a company’s cash flows so extensive credit sales should be avoided without collection.

Download the A/R Checklist to see how simple changes in your A/R process can free up a significant amount of cash.

daily sales outstanding calculation

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Business Cycle

See Also:
Efficient Market Theory
Economic Indicators
Economic Value Added
Supply and Demand Elasticity
Porters Five Forces of Competition

Business Cycle Definition

The business cycle refers to recurring patterns of expansion and contraction in an economy. It is also called the economic cycle. During the expansion phase of the cycle of business, the economy is prospering and growing. During the contraction phase of the business cycle, economic activity is in decline. Economists and other interested parties watch certain macroeconomic indicators to gauge the condition of the economy and to try to forecast changes in the business cycle.

According to this cycle, economic activity expands until it reaches a peak, then it contracts until it reaches a trough, and then it begins to expand again. Measure business cycles from peak to peak. Furthermore, the duration of an average business cycle is around five years. However, they do not run like clockwork – the durations of the individual phases as well as the entire business cycles vary widely. In the U.S., these cycles are measured and peaks and troughs are declared by the National Bureau of Economic Research (NBER).


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Phases of the Business Cycle

The business cycle consists of the four following phases: expansion, peak, contraction, and trough. During the expansion phase, also called the recovery phase, gross domestic product is growing, business activity is flourishing, and the economy is prospering. Expansion phases typically last around three to four years, but may be longer or shorter. The expansion phase ends at the peak, which is the high point of economic activity and the transition to contraction.

Economic contraction, also called recession, is often defined as two consecutive quarters of declining gross domestic product. During a contraction, business activity is slowing, unemployment is increasing, and the economy is struggling. A recession typically lasts about one year, but may be longer or shorter. The contraction phase of the business cycle follows the peak and continues till the trough. The trough is the bottom of the downturn, and represents the end of the contraction and the transition back to expansion.

4 Business Cycle Stages

1. Expansion
2. Peak
3. Contraction
4. Trough

Business Cycle Indicators

Economists watch certain macroeconomic indicators to gauge the condition of the economy. In the U.S., the Conference Board issues an index of several key economic indicators. There are three main types of economic indicators, including: leading indicators, lagging indicators, and coincident indicators.

Leading indicators considered predictors of economic trends. Analysts use these data to try to forecast changes in the business cycle. Examples of leading indicators include stock prices, building permits, average weekly initial claims for unemployment insurance and an index of consumer expectations.

Coincident indicators fluctuate simultaneously with the business cycle and reflect the current condition of the economy. Examples of coincident indicators include industrial production data, nonagricultural payroll data, and manufacturing and trade sales data.

Lagging indicators appear after the completion of economic trends and changes in the business cycle. Furthermore, they can be used to analyze the economy in retrospect or to confirm other economic data. Examples of lagging indicators include the following: average duration of unemployment, average prime rate charged by banks, and change in labor cost per unit of output.

Historic Data

To see historic business cycle data for the U.S., go to: nber.org/cycles

Conference Board Index

To see economic indicators issued by the Conference Board, go to: conference-board.org

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business cycle

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FDIC Bank Failure Watch List: Leading or Lagging Indicator?

The FDIC produces the FDIC bank failure watch list every Friday at 7:00p.m. As of April 24th there were 29 failed banks in 2009. There were only 25 failed banks in 2008! If this trend holds true we should have 85 to 90 bank failures in 2009! A 350% increase in bank failures in 2009 over 2008.

Analysis on FDIC Bank Failure Watch List

I suppose that isn’t really a surprise given the turmoil in the banking system. My question is whether the bank failure watch list is a leading or lagging indicator of the economy. If you look further back into previous years you see that 2007 had only three failed banks; and 2005 through 2006 had no banks failing. Should we have seen a stock market top with so few failed banks insured by the FDIC? If the banks are doing so well does that indicate easy money? Should we have been reducing our exposure to the stock market?

Now the trends are going the other way. It is time to ask: Should we buy stocks when the bank failures peak? When we no longer have an increase in the number of banks failing does that indicate that the economy is bottoming out?

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FDIC Bank Failure Watch List

FDIC Bank Failure Watch List

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