Tag Archives | opportunity

The Fraud Triangle

See Also:
Accounting Fraud Prevention using QuickBooks
Audit Scope
Bankruptcy Chapter 11
How to Hire New Employees

Fraud Triangle Definition

Donald Cressey created the concept of the fraud triangle. The creation of the theory required Cressey to interview about 200 convicted embezzlers around the Midwest which he dubbed “trust violators.” The people that had entered the work place with no intention of stealing peaked his interest. After the interviews Cressey formed the following hypothesis:

Trusted Persons become trust violators when they conceive of themselves as having a financial problem which is non-shareable, are aware this problem can be secretly resolved by violation of the position of financial trust, and are able to apply to their own conduct in that situation verbalizations which enable them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as trusted persons with their conceptions of themselves as users entrusted funds or property.

Cressey created the fraud triangle and the three fraud triangle components. These consist of all of the following:

The fraud triangle can best explain most all abuse unless the particular person entered the company with the intent of stealing in the first place.

Fraud Triangle Pressure

Pressure is the first leg of the fraud triangle. Define the pressure Cressey describes in his hypothesis as a non-shareable financial problem. These financial problems are usually personal to that person. But, they are too ashamed by the problem that they are unwilling to share with others. This is particularly disturbing when it is later understood that if the violator had talked about it others would have been willing to help.

(Have you ever wondered does fraud follow economic cycles?)

Fraud Triangle Opportunity

The second leg of the fraud triangle is an opportunity that exists within a company for fraud to take place. Opportunities usually occur from a lack of internal controls within a company. For example, the violator here feels that he/she can take advantage of the situation without getting caught. Of course, there has to be a certain level of technical skill to be able to define an opportunity which is why several violators find opportunities within their own job function.

(Discover the 7 warning signs of fraud!)

Fraud Triangle Rationalization

The third and final component of the fraud triangle is that of rationalization. Cressey found that many of the violators never felt that they were actually a criminal. This is because they had rationalized to themselves that the misdeed was ok. In fact, many of the violators Cressey interviewed felt that they were justified. Instead, the act was part of a general irresponsibility for which they were not completely accountable.

If you are dealing with fraud, then check out our free Internal Analysis whitepaper to help you solve the issues and prevent it from happening again.

fraud triangle
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Preemptive Subscription Rights

See Also:
Preferred Stocks
Initial Public Offering (IPO)
Stock Options Basics
Intrinsic Value – Stock Options
Insider Trading

Preemptive Subscription Rights Definition

Preemptive subscription rights give existing shareholders the opportunity to purchase new share offerings before they are available to the investing public. You can also call it preemption rights or subscription rights.

Basically, when a company decides to issue more shares of stock, current shareholders have the right to buy the new shares of common stock before the general public can buy the new shares of stock. The idea is to allow current shareholders to maintain their proportional ownership of company without experiencing value or control dilution caused by the new issue.

Preemptive rights often allow the existing shareholders to purchase shares of stock at a discount to the public offering price. Existing shareholders are allowed to purchase the new issue within a set window of opportunity, often two to four weeks. Preemptive rights also allow the existing shareholder to buy a set number of shares of the new issue. But this depends on how many shares the shareholder currently owns. Refer to the number of shares allowed to the shareholder relative to current holdings as the subscription ratio. The subscription ratio is stated in a document given to existing shareholders, called the subscription warrant.

Because the preemptive right often allows the shareholder to purchase the new issue at a discount, and because purchasing shares of the new issue allows the existing shareholder to maintain proportional ownership and voting power, it is usually in the shareholders best interest to make use of the preemptive right. They should also buy the maximum allowable shares of the new issue.

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Securities Act of 1933

See Also:
Primary Market
Securities Exchange Act of 1934
Investment Banks
Secondary Market
Initial Public Offering (IPO)

Securities Act of 1933

The Securities Act of 1933 was a landmark decision in the United States to regulate the issuance of newly issued shares into the market – an initial public offering. The act is also there for companies to register before the issuance as to ensure reliability.

Securities Act of 1933 Meaning

The Securities Act of 1933 followed the stock market crash in 1929. It was a movement to regulate the markets as to not mislead investors. Furthermore, the idea requires due diligence so that the best possible information would hit the market. The 1933 Securities Act was also meant to do away with insider information. By requiring this information to be provided pre-issuance investors presented with the opportunity to buy shares of the firm, during the investment banker’s road show, can make well informed decisions. The due diligence required by the 1933 Securities Act is to have a full audit and compliance with Generally Accepted Accounting Principles (GAAP). Without registration and a following of the 1933 Securities Act rules a firm cannot be listed on a U.S. stock exchange until the requirements are satisfied.

If you want to overcome obstacles and prepare how your company is going to react to external factors, then download your free External Analysis whitepaper.

securities act of 1933

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Purchase Option

Purchase Option Definition

Purchase option, defined as the opportunity to purchase a piece of property which is being leased after the lease is completed, is part of the many options available in a lease agreement. A purchase option is often agreed upon by the two parties involved before the contract is made.

Purchase Option Explanation

Purchase option, explained by many business owners as an option to “try it before you buy it”, is available on almost any leased asset. The value of a lease purchase option agreement is evident. A party wants to lease a piece of equipment because they can not afford to buy it. However, to keep their options open they decide on a purchase option lease. This benefits the lessor by allowing her to choose, at the final moment, whether the item has created value and is worth keeping. Additionally, the lessor can account for changes in needs, expectations, or operations by leaving their options open and opting for a purchase option.

For the lessee, it allows them to make the income from leasing the item while also making the income from selling the item. In this way, a purchase option provides a benefit to both parties. It also allows access to and income from the asset almost instantaneously. A purchase option fee may be accrued while choosing to engage in such a contract.

Purchase Option Example

Asal is renting a piece of equipment for her graphic printing firm. Asal, because of her vast equipment needs, has to watch to make sure she has the cash flow necessary to operate her business based on the current needs it has. She currently can not afford to buy this piece of equipment. Still, she sees the value in having it available in her office. Asal balances these two needs by agreeing on a purchase option with the lessor.

Asal is creating a short-term agreement to lease the piece of equipment, a commercial quality printer. She will keep this printer in her office for one year, at which point she will buy the item. Asal and her lessor agree on a fair market value for the printer. So Asal completes the purchase option agreement and begins use of the item.

One year later, Asal is seeing a lot of growth in her business. So much growth, in fact, that she is going to outsource the printing for her customers to a better equipped company. She trusts this vendor and knows the quality of the products they produce, so she trusts the company.

This change of pace negates her need to purchase the printer she was leasing. Asal is nearing the end of her lease agreement, so she informs the lessor that she will not be accepting the purchase option at end of lease. She has more important expenditures to make at this point.

Asal is happy that she made a purchase agreement. She made the right business decision and will soon see the fruits of her labor. She opens the office the next day with the feeling of success.

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Profitability Index Method

See Also:
Profitability Index Method Formula
Net Present Value Method
Net Present Value versus Internal Rate of Return
Time Value of Money
Adjusted Present Value (APV) Method of Valuation
Future Value

Profitability Index Definition

Profitability index method measures the present value of benefits for every dollar investment. In other words, it involves the ratio that is created by comparing the ratio of the present value of future cash flows from a project to the initial investment in the project. The Profitability Index Method is often times compared similarly to the Net Present Value Method for their close proximity. One should use caution when utilizing both the NPV and profitability index methods in tandem. Often times, it has been found that both methods can rank projects in a different way. One project could possibly be ranked number 1 for one of the methods while it ranks dead last in the other. Use digression when using both in tandem.

Application

Profitability index is primarily used as a tool to rank projects. The higher the value of profitability index, the more attractiveness of a proposed project is. For a single project, profitability index value of 1 or greater is acceptable. If a project has profitability index (>1), then a company should perform the project. However if a project has profitability index (<1), a company should reject the project.

There is relationship between profitability index and net present value method. If profitability index >1, the NPV is positive. If profitability index <1, NPV is negative. The profitability index is a relative measure of an investment’s value while NPV is an absolute measure. The profitability index method can be a useful substitute for NPV method when presenting a project’s benefits per dollar of investment. It makes the most sense to look at the concept from a project-by-project basis. The profitability index gives a company the opportunity to determine whether a project should be pursued or not. If the profitability index is above one, then a company can execute and pursue the project. If the profitability index is below one, then the project should be scrapped for the detrimental cash flow problems

Download the free Pricing for Profit Inspection Guide to learn how to price profitably.

Profitability Index Method

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How Factoring Can Make or Save Money

See Also:
What is Factoring Receivables
Accounting for Factored Receivables
Journal Entries for Factored Receivables
Can Factoring Be Better Than a Bank Loan?
History of Factoring
Factoring is Not for My Company
The What, When, and Where About Factoring
Nest Egg

How Factoring Can Make or Save Money

Opportunity for Discounts:

Lack of cash flow frequently causes a business to miss out on discounts offered by suppliers. Not taking advantage of these discount opportunities results in paying a higher cost of goods. Plus, many suppliers will negotiate even higher discounts for a customer who demonstrates the ability to consistently pay in cash within the discount period. Generally the best price is not the published price or terms. Rather, the best price is the negotiated price. This price is based on increased volume and negotiated terms backed by cash or quick pay. So, taking advantage of discounts gives a business the ability to add as much as 2 to 5 percent to its gross profit margin.

Administrative and Clerical Costs:

The clerical and data entry costs used in the physical processing of accounts are additional cost factors. Examples of physical processing include generating and stuffing statements. Depending on the size of the company and relative size of the accounts receivable, this may involve a full time employee, a larger accounting staff, or a current employee handling this responsibility as part of a diverse job description. The labor costs involved come into play on both ends. It includes:

  • The labor involved in generating and sending the statements
  • The administrative duties of receiving and posting account payments

Postage and printing costs add up when companies produce and mail large numbers of multi-colored statements on a regular basis. You must also consider these costs.

Management Resources:

Many overlook management’s time. In addition, many often overlook the missed opportunity of time spent doing something more productive. Reviewing accounts, placing calls to late-paying customers, and generating reports for analysis are all time consuming tasks involved in managing receivables and controlling cash flow.

Missed Opportunity:

Possible growth opportunities missed due to a lack of cash flow should also be taken into account when analyzing receivables management. Adequate cash flow is the single most important factor in achieving and sustaining business growth aside from market opportunity. Most businesses would have an extensive list of opportunities for growth and expansion to pursue if all receivables on the books were paid in cash today. Some examples of what could be accomplished if a company had access to cash instead of carrying customer debt include the following:

  • Bidding on new jobs
  • Investing in new equipment
  • Expanding the sales force

Furthermore, inadequate cash flow is like wearing handcuffs when it comes to growing a business. Improved receivables management, resulting in money in the bank and less or no debt, creates the environment and the attitude to set a goal and achieve the next level of growth and success.

Contributing Cost Factors

Once all contributing cost factors are estimated and totaled on an annualized basis, divide this number by total annual sales to determine a quantifiable cost for managing accounts receivable as a percentage of sales.

Payment Terms

Providing commercial customers with payment terms is a necessary part of doing business and an essential component of building good customer relationships. Performing this type of analysis on a regular basis highlights areas for additional savings and increases efficiency. In addition, knowing the actual cost of managing receivables and controlling cash flow allows for the implementation of more effective management strategies for the business as a whole. There are options available in the marketplace to help improve cash flow and receivables management, such as accounting consultant services, cash flow management systems, and factoring programs. Analyzing the true cost of receivables management is the first step in determining if these options make sense for a business by ultimately improving its bottom line.

If you want more tips on how to improve cash flow, then click here to access our 25 Ways to Improve Cash Flow whitepaper.

how factoring can make or save money
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Covariance

See Also:
Direct Labor Variance Formulas
Direct Material Variance Formulas
Variance Analysis
Financial Instruments
Common Stock Definition

Covariance Definition

The covariance in finance is the degree or amount that two stocks or financial instruments move together or apart from each other.

Meaning of Covariance

The covariance means that investors have the opportunity to seek out different investments based upon their respective risk adversity. If the covariance is negative then this means that the two instruments move opposite one another depending on the economy. This then becomes a way for investors to diversify some of their risks away.

If an investor were to buy two stocks with a negative covariance then in a boom period one would earn more than the other and vice versa for a recession.

If an investor were to care solely about the return and no risk then an investor might choose two stocks that have a positive covariance based solely on their expected returns. This means that this particular investor has the chance to make a big gain, but also a bad loss. This is because the two instruments will move with each other and there is no diversification in the portfolio of two stocks.

Covariance Example

Tim has been doing some research in the market and has narrowed his search down to three stocks. However, Tim only has enough money to invest in two of the stocks. The covariances are as follows:

A and B Stock = -100
A and C Stock = 100
B and C Stock = 0

Depending on Tim’s risk adversity he will make different decisions. If he is simply looking solely at the returns he will choose stocks A and C because they have the highest potential returns but also the highest potential loss. If he were very risk averse he would choose stocks A and B because the amount of risk has been diversified away. The final option would not be chosen because stocks B and C have no covariance or correlation between each other. The two stocks simply move independently and there is not as much potential to diversify or maximize the risk and return.

Note: The result assumes weights of 50% will be put into each stock for each investment opportunity.

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