While in a single name context ratings are often criticized for being lagging indicators of credit quality, classifying bonds by rating is one widely used method to reflect the behavior of different risk classes in credit markets.
Many market participants argue that spreads themselves and spread volatilities are more timely indicators of an issuer’s credit risk than ratings. They consequently prefer to split the universe in spread class buckets. The disadvantage of this method is that it leads to relatively unstable compositions of the individual buckets and is less convenient, because the major index providers do not calculate indices based on spread classes. Since the different rating buckets constitute the corporate bond market as a whole, there is clearly a correlation between overall market fluctuations and the spread changes of the different rating subportfolios.
The risk profile of a credit portfolio, in absolute terms as well as relative to a benchmark index, is largely determined by the weighting of different risk classes. Of course, the allocation of capital to riskier asset classes not only increases risk, but also offers ample opportunities for outperformance. From a top-down perspective there are various methods to split the corporate bond universe in different risk classes. Here the three most popular approaches are introduced: dividing the universe by rating classes, by degrees of subordination or by the degree of cyclicality of the different industries.
Seeking help, you may approach a broker to recommend funds. Unfortunately, regret is likely to follow. A broker’s main interest is in loads and other commissions from frequent mutual fund sales. Loads of 5.75 percent are common. On a $10,000 investment, you are paying $575. You can buy an entire financial plan from a fee-only financial planner for less. If over the years you buy $100,000 of mutual funds, you will pay loads of $5,750. The sum of $5,750 buys several lifetimes of financial plans complete with tax savings ideas, estate planning tips, and zero-load mutual fund picks. However, unless you ask specifically and insist on an answer, you will not know the dollar amount you are paying for the privilege of buying a mediocre fund. Loads can be paid on purchase of a fund (a front-end load) or on the
sale of the fund (a back-end load) or both. A broker will use confusion and complexity against you.
Overwhelmed by the prospect of buying individual stocks, you may turn to mutual funds. Mutual funds are marketed as a simple way to own a diversified portfolio managed by a professional. Unfortunately, mutual funds are confusing and complex.
Confusion is rampant. There are as many mutual funds as there are individual stocks. Just when you think you have a fund picked out, the fund manager changes, the investment style is altered, and a load is imposed to purchase the former no-load fund. There are hundreds of styles and types of funds: micro cap, small cap, medium cap, and large cap, value, growth, blend, income, leveraged, unleveraged, closed-end, open-end, and so on.
Taxes are a mess. Those who buy the fund the day before the tax date have to pay taxes on capital gains that occurred before they owned the fund. Those who sell that day avoid the taxes even though they owned the fund while the gains occurred. Those who buy a day after the tax date have no taxes but a different cost basis even though they paid the same price for shares as those who bought before. Multiple systems can be used to declare your taxes and adjust your basis when you sell shares.
Calculating returns and comparing returns to other funds is equally complex. Unless you bought on January 1 and reinvested all dividends and capital gains, your returns and those in fund reports, the paper, and the magazines will be different. Ask yourself: How much complexity and confusion am I comfortable with? On these two criteria alone, mutual funds are outside the comfort zone of many investors.
This is a long-term process and you will be asked to repeat the steps outlined in Chapter 9 at least annually as your financial circumstances change over the years. However, if you have thoroughly worked the program outlined in this book and continue to be unhappy with your investments, do not be discouraged. The program in this book will teach you who you are in relation to investments, how to accept yourself as that person, and what investments work for that person. If nothing works for the person you discover yourself to be or if you cannot discover yourself in this process, then it is necessary to change yourself. Sometimes your investments are not wrong; instead, you need a new way to look at your investments and you need to give yourself the gift of getting those new glasses.
When companies are recording payments, it might make the most sense to run ACCOUNTS PAYABLE reviews more frequently than once or twice monthly, to keep better control of invoice due dates and to pay those invoices when they’re due and not before. The smaller the business, however, the more difficult this may be. At the very least, vendors should be paid on a timely basis and as regularly as possible.
No matter what the payment plan, the steps to follow usually will be the same from an accounting standpoint:
- Identify the invoices needing payment.
- Print the checks.
- Assemble the checks and invoices for review and signing.
- Sign and mail the checks.
- File supporting invoices and documentation in the appropriate batch.
- Post the amount paid to individual vendor accounts.
- Post the transaction to the ACCOUNTS PAYABLE subledger.
- Summarize the subledger to the general ledger.
Accounts payable may be affected by adjustments— decreased by vendor credits, for example, or increased by interest charges on delinquent accounts. The danger isn’t great from inappropriate crediting, but be cautious nonetheless. These adjustments should be treated with as much care as adjustments to accounts receivable. Supporting documentation for any vendor adjustment should be required.
As part of the process, the ACCOUNTS PAYABLE will be recording purchases. Most of that information comes from the vendor invoices, including vendor name, amount, and payment terms. If the invoice doesn’t arrive before close of business at the end of the month, the amount is accrued through adjusting entries to the current period. (That’s where accrual accounting comes in.) The transaction process, whether automated or manual, follows the three steps outlined earlier.
Many companies have added automated A/13 files to their general ledger systems. Most systems automatically track and report payables and provide summaries of amounts owed each vendor.
All in all, life becomes much easier with an automated system—providing the accounting department:
- Sets up vendor files properly.
- Sets up the A/1′ subledger to default to the general ledger.
- Establishes default files that categorize and track specific types of amounts owed and payments due.
The automated system includes the same types of information listed in the manual file, such as date of transaction, name of vendor, description of purchase, amount owed, and terms of payment. Using that data, the automated system will send the necessary information to the A/1′ subledger, which then batches all payables by entry date and balances the batch to the general ledger account.
Structured similarly to A/R, ACCOUNTS PAYABLE is another subledger that feeds the general ledger with summaries of more detailed information. Information about disbursements flows through the ACCOUNTS PAYABLE system from sources both within and outside the company and travels up to the general ledger to become part of your company’s overall financial picture.
A well-designed and well-managed accounts payable system will reliably track the amount owed each vendor and when to pay based on agreements with that vendor. The system keeps a running tally of amounts paid so it can be checked against budget. It also is the system that provides the necessary information for generating your company’s 1099 statements (for reporting amounts paid to suppliers).
Just as there are accounts receivable (A/R), or money that is owed to you, there are accounts payable (ACCOUNTS PAYABLE), or money that you owe to others. ACCOUNTS PAYABLE isn’t nearly as much fun as the former, but it’s a part of business life. Taking care of the A/1′ is important, because your company’s credit rating and reliability as a business could be at stake. As a manager, you will need to understand how this all comes into play.
Let’s start with a definition. Similar in structure but opposite in purpose to accounts receivable, accounts payable is a list of monies owed by the company to creditors, usually from the purchase of merchandise, materials, supplies, equipment, or services.
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