In financial analysis, the widespread use of operations such as accrual and discounting. They are considered as effective tools for identifying the prospects for investing capital in certain projects taking into account inflation, profitability of production and other factors of an economic nature. What are the specifics of the corresponding operations? What formulas are used in the process of their implementation?
What is discounting?
For starters, we will examine the essence of the operations of accrual and discounting. It will also be useful to determine the fundamental difference between the two. Let's start with the specifics of discounting. This term is understood to mean the procedure by which a quantity is calculated that reflects the amount of money needed in the present time to obtain the required amount of capital in the future by investing in some project.
Discounting involves performing calculations that take into account indicators such as: the expected amount reflecting the results of the investment, the discount rate and the present amount — the amount that must be invested at the appropriate rate. From an economic point of view, discounting is necessary in order to determine how much investment you need to invest to obtain the desired financial result, taking into account the available rate. Consider by what formula the corresponding calculation is carried out.
Discount formula
The following basic elements are present in the discount formula: the value of the desired investment result (let's call it RI), the discount rate (SD), the time between the start of investment and the withdrawal of capital (VI). Thus, we need to find the amount of investments (ST) that must be invested in the project with the established SD in order to receive RI through VI. It can be noted that CB can sometimes also be called a reduced sum in some cases (but this is not always the case, and in the rest of the article we will consider why).
We agree that SD is 20%, RI is 10 million rubles, and VI is 1 year. In this case, you need to divide 10 million rubles into 1.2 - so we will determine the figure, which, increasing by 20%, will be equal to RI. In this case, it is 8.333 million rubles. This is SV - the amount of investments that at a rate of 20% per annum must be invested in the project in order to receive 10 million rubles in a year.
Build-up and discount operations are concepts that can be used in different interpretations. Which, for example?
The same discounting from the point of view of economic analysis can mean calculating the current value of an object taking into account its rise in price or cheaper over time under the influence of certain factors (as an option, inflation - if it is a currency; depreciation, technological obsolescence - if it is objects infrastructure). For example, a person has 100 dollars at his disposal, and he can buy them, relatively speaking, 10 kilograms of apples. In a year, based on inflationary processes, he will be able to buy only 8 kilograms of apples for $ 100. Thus, 100 discounted dollars of the next year are equal to 80 dollars of the current. The depreciation of the human currency due to inflation processes is 20%.
What is an extension?
We now study the specifics of the operations of the building.They mean the calculation of the amount reflecting the result of investing money in a project taking into account the current rate. In fact, the buildup allows you to determine how profitable the investment will be.
Build Formula
We study by means of which formula the indicator in question can be calculated. Its structure is very simple. The main elements of the formula in question will be: the amount of investment capital (we will agree to call it IR), the rate of increase (SN), investment time (VI).
In order to find the accumulated cost of capital (NA), you need to increase the IR on CH, expressed as a percentage. That is, if the IR is equal to 100 thousand rubles, and the SN is 20 percent per annum, then the NA invested in the corresponding project at the beginning of the year will amount to 120 thousand rubles in a year.
From the point of view, again, of economic analysis, the term “buildup” can be understood as calculating the future value of an object taking into account its rise in price or its cost over time. As a rule, its dynamics are affected by the same factors as in the case of discounting. In the case of currency, this is inflation. It is easy to calculate that the incremental cost of today's $ 100, based on their purchasing power relative to apples in accordance with the example discussed above, will be about 125 currency units in a year.
Thus, we can conclude that the increase and discount operations are closely related. Both indicators have the same utility in carrying out a financial analysis of an enterprise or economic processes. In fact, the discount operation is the opposite of the build operation. The first allows you to find out how much investment you need to invest in the project in order to get a result that reflects the increase in capital. The second - fixes the target value of the effectiveness of cash investments based on the size of the initial capital. Consider how both operations can be used in practice.
Growth and discounting - what is their practical significance?
Build-up and discount operations can be used as a tool for analyzing the effectiveness of investing in a business. So, an entrepreneur considering the prospects of investing in a particular company will be interested in the conditional $ 1,000 invested in the company today, to increase in a few years so that the corresponding investment is more profitable than any other available investment. For example, in the form of a deposit in a bank.
Build-up and discount operations can be useful in cases where the investor needs to calculate which business processes it is worth sending money to. So, it may turn out that in order to increase the profitability of the business, timely modernization of fixed assets will be required in some cases and investment in development in others.
The logic of discounting and buildup as a practical tool
Let us examine how the logic of operations of discounting (increasing) capital can, in practice, help an entrepreneur optimize an investment policy. In the case of an increase, as we already know, the value of the current amount of cash is calculated based on their purchasing power in the future. Thus, in the framework of this operation, the following are taken into account:
- amount of initial capital;
- build-up rate - usually expressed as a percentage;
- the length of the build-up period is usually in years.
In order to calculate the accumulated amount of initial capital when investing in a business, you need to know the estimated profitability of the enterprise. That is, determine the rate of increase. It can be calculated on the basis of average market indicators or from historical information about previous experience investing in a company or other enterprises of the same segment.
It is worth noting that the formulas used in the process of discounting (increasing) capital consist of elements that can be quite easily calculated if others are known. That is, if the investor knows the amount of the initial capital and received under the previous contract, then he can easily calculate the rate of increase, as well as the discount.
Universality of discount and build-up formulas
The formulas for the operations of discounting (increasing) capital are sufficiently universal. They can be involved not only in the analysis of investment prospects, but also, for example, in banking, in the study of macroeconomic processes, in studying trends in the development of individual segments of the national economy.
So, it is quite possible to carry out operations of increasing and discounting annuity payments and determine which loan amounts are optimal for the implementation of a project, and which banks (based on interest rates) offer the market the most favorable conditions. The same can be said about deposits, when the beneficiary is a client of a financial institution, which, in fact, is an investor.
Thus, not only financial organizations, but also their clients can use the instruments in question. Involving relevant operations is a common practice for a modern entrepreneur. The operations of accrual and discounting can be used in financial analysis - the activities of the enterprise as a whole or its individual divisions. Corresponding indicators can be an important factor in decision-making by the investor or company management regarding the prospects of capital investments in certain business areas.
Growth and discounting as an aspect of financial analysis
It will be useful to consider in more detail how the operations of accrual and discounting can be applied in the financial analysis of the performance indicators of a commercial enterprise. The considered tools allow you to identify the following points:
- what is the relationship between the amount of capital invested in the firm and the likely increase in production;
- how much more attractive business investment looks for an investor compared to alternative ways to increase the cost of capital;
- what are the optimal indicators of the company's profitability in terms of maintaining a balance between the interests of partners investing their capital in the company and the owners, for whom the expansion of sales markets may be a more important factor in building a business development strategy.
Thus, the operations in question are an effective tool for evaluating the decisions made by the management of the company and analyzing the results of the practical implementation of the measures provided for by their adoption.
The inflationary dimension of accrual and discounting
We noted above that the operations of accrual and discounting are tools that allow you to evaluate the purchasing power of capital, taking into account inflation factors. It will be useful to study this aspect in more detail. A market economy is characterized by a peculiarity: over time, the purchasing power of capital changes. As a rule, downward. This is due to inflation - rising prices. The discount rate, which correlates with the processes of depreciation of the currency, allows you to clearly fix that investing the same amounts of capital at different times differs significantly in efficiency.
The logic of capital discounting (accumulation) operations is therefore required to take into account inflationary, and in some cases deflationary processes, when, on the contrary, the cost of capital increases in the future due to lower prices. At the same time, inflation as an average for the economy can be considered, as well as a change in the dynamics of prices for individual segments of goods and services - depending on the tasks that the researcher faces. Apart from the economic criterion under consideration, the discounted cost of capital in practice also depends on factors such as the availability of alternative investments, the size of credit rates, the dynamics of supply and demand in the market segment where the capital goes, and the timing of investments.
Discount and present value: correlation of concepts
Consider one remarkable nuance that characterizes the specifics of discounting - the correlation of this term with the concept of present value. What is its feature?
The fact is that the discounted cost of capital and the reduced value are terms that are often regarded as synonyms, but they do not always mean the same thing. We have indicated above that the second term can be used to designate the amount of investments necessary to obtain the target value of the effectiveness of capital investment in a project with a set rate of return. The fact is that not only the future value of capital at the current moment can be brought, but also vice versa. That is, the corresponding indicator may be close to the increased amount of cash.
It can be noted that the term “present value” has taken root mainly in the Russian language. Foreign economists often use the concept of discounted financial flow. But in most cases, of course, present value is a term that is used as a synonym for the concept of discounted capital.
Summary
So, we studied the practical importance of the operations of accumulation and discounting in financial management, determined their nature and differences. What conclusions can we draw? First of all, it is worth noting that the operations of accrual and discount in the financial analysis are sufficiently universal in nature. They allow you to optimize the mechanism of attracting external funds (investment or borrowed), if it comes to a commercial project, to assess the attractiveness of the conditions for bank loans and deposits.
Accumulation and discounting operations at simple interest or taking into account other factors, for example, inflation, market conditions, allow us to track changes in the dynamics of the cost of capital. Therefore, their application is a significant factor in the implementation of successful investment projects and building constructive relationships between enterprises and banks in business.
In the study of the effectiveness of enterprises can also be involved in the operation of building and discounting. The use of these indicators in the financial analysis is carried out in order to assess the prospects of investing in firms, as well as to identify the potential for business growth.
