There are many figures and variables that investors take into consideration whenever they conduct their due diligence or research. Some of the most common metrics that new investors use in the field include but may not be limited to return on investment, price to earnings ratio, earnings per share, earnings per share growth, among others. Those who have a more solid background in economics, accounting, and actuarial sciences make use of more complex valuation methods. One of the best metrics to use is the internal rate of return (IRR).
A company or a security’s internal rate of return pertains to the rate in which the company or security earns the cash flow required in order for the net cash flow for a particular project or investment decision to be equal zero. At some point this may fundamentally be described as the rate in which the company or security enables the investor or project manager to reach a breakeven point (no loss and no profit, just breakeven). This is used in situations where capital budgeting is necessary. Basically, the higher the IRR is, the better because that means the investor would be able to recover the capital he shelled out to fund an investment project for example.
Why would a company prefer commercial paper to a bank loan? What are the risks?
Commercial papers are basically a form of debt instrument issued by a business or a big corporation. The purpose of issuing commercial papers is often to finance a business operation when the company’s cash reserves are running critically low, when the business is trying to create a minute expansion be it in terms of infrastructure or business operation, or when there are short term liabilities that need to be financially covered. Companies often prefer to issue commercial papers instead of borrowing money from the bank (i.e. bank loans) and there can only be one major reason behind it. The most probable reason would be the considerably low level of risk involved when issuing commercial papers.
Although both commercial papers and bank loans sets back a company financially because they both involved interest rates that the debtor has to cover, commercial papers are virtually risk free because they do not involve any form of collateral, unlike banks. Issuing commercial papers is also faster and easier because there is no long verification process involved; plus there is also no bank loan processing fee. Credit credibility requirements are however tighter when it comes to issuing commercial papers because only companies that has high debt ratings are the only ones that are allowed to issue commercial papers.
What are the Five “Cs” of Credit? Who uses them and for what?
The Five Cs of Credit includes the following: Character, capacity, Capital, Collateral, and Conditions. These are basically criteria that are used by lenders in assessing the credit worthiness of a potential debtor or borrower. Creditors are the ones who lend money to debtors. The only way for them to make money in doing that kind of business is to ensure that their debtors would pay the principal amount borrowed plus the interests incurred.
One way to ensure that all debtors who have outstanding debts with the lending company would be able to pay the total amount that they owe the lending company is to make sure that they (i.e. the debtors) are credit worthy. Lending companies evaluate their potential borrowers using each of the five Cs of credit.