In the modern-day and age, it can be seen that the importance of financial institutions can be gauged by the fact that consumer lending and borrowing is highest than it ever has been.
This is predominantly because of the high degree of emphasis that is placed on financial transactions to ensure that circular flow of resources within the economy continues at an accelerating pace.
Given the fact that numerous financial institutions, yet it can be seen that different financial institutions are specialized in different domains, and cater to different needs of the customers.
Types of Financial Institutions
As a matter of fact, it can be seen that there are 9 types of major financial institutions that predominantly provide a variety of services from mortgage loans to investment vehicles.
Therefore, some of these financial institutions have specialized offerings, and cater to a specific purpose, whilst others are more general and are directed towards the general public. The description of the different types of financial institutions is given below:
- Central Bank: Central Banks are referred to as the main financial institutions in an economy. This is because of the reason that the Central Bank is primarily responsible for overseeing the operations and managing all other banks within the company. In most cases, the Central Bank is also responsible for drafting the monetary policy and supervising the regulation of existing financial institutions.
- Retail and Commercial Banks: Retail banks offer products to retail customers, whereas commercial banks work directly with businesses. In this regard, this particular financial institution is seen to serve both commercials, and individual account holders, so that they are able to offer financial services in accordance with the policies that are set forth by the Central Bank.
- Internet Banks: Internet Banks are a fairly new addition to the financial institution market. They work on a similar domain as retail and conventional banks. However, the underlying difference between internet banks, and typical banks, is the fact that internet banks rely on the virtual presence and virtual functioning, as opposed to typical brick and mortar structures.
- Credit Unions: Credit Unions are mainly established to extend financial services to a particular demographic. They operate like retail banks but offer lesser services in comparison. Additionally, it can also be seen that credit unions are mainly owned by the members of the respective demographic, and therefore, they work for the benefit of the members only.
- Savings and Loan Associations: Savings and Loan Associations are held mutually, and they mainly rely on collaborative efforts to reach respective financial goals. Furthermore, individual consumers also make use of savings and loan associations for deposit accounts, personal loans, as well as mortgage lending.
- Investment Banks and Companies: Investment Banks do not accept deposits. They are mainly formed with the objective of helping businesses, individuals as well as governments to raise capital, with the help of securities. They are also referred to as mutual fund companies. They pool funds from individual and institutional investors in order to provide them access to considerably larger avenues in the securities market.
- Brokerage Firms: Brokerage firms mainly help individuals to buy and sell securities from the existing available investors. In this regard, users of brokerage firms have exposure to different types of stocks, securities as well as mutual funds.
- Insurance Companies: Insurance Companies are mainly Financial Institutions that are formed with the objective to mitigate the inherent risk involved. Therefore, individuals and companies mainly use it to protect against the financial loss because of health, or any other unprecedented action.
- Mortgage Companies: Mortgage Companies are financial institutions that are formed with the basis to originate or subsequently fund mortgage loans. Some of these mortgage companies are established with the basis to serve clients who are in between real estate transactions only.
Therefore, it can be seen that there are numerous types of financial institutions that are established to cater to different clients based on their requirements.
In this regard, it is also rudimentary to highlight the fact that all of the financial institutions are mostly formed, and subsequently looked after by the governments. Hence, all financial institutions are supposed to comply with the government to ensure that they work and operate under the law.
The importance of financial institutions can not be denied because of the important role they play in a given economic scenario. This is essentially because of the fact that they contribute immensely in building investor trust, as a result of which people do not hesitate to invest their savings into the options that suit them best.
Financial Intermediaries are formed in order to create a bridge between the borrowers and lenders, in order to facilitate the transaction between both the parties.
Therefore, in this regard, it becomes highly essential to ensure that both the borrower, as well as the lender are able to establish a reliable, safe, and convenient communication channel so that the transaction can be carried out in a smooth fashion.
Given the fact that financial intermediaries are formed on a different basis for different purposes, it can be seen that their underlying functionality tends to stay the same – to establish the link between the borrowers and lenders.
Characteristics of Financial Intermediaries
As mentioned earlier, Financial Intermediaries are mainly formed in order to ensure that borrower are able to meet lenders. In this regard, financial intermediaries have a given number of characteristics that are necessary to carry out their functions.
Firstly, it is absolutely pivotal that Financial Intermediaries are able to create a viable spread between the interest paid to the lender, and the interest received from the borrower.
This setting of interest rate is a very crucial role for any financial intermediary, because they have to account for a number of things, which include the market positioning and competitiveness, so that they are able to sustain in the market.
Setting of interest rates, is therefore, a very important characteristic of the financial intermediaries, because that determines the overall propensity with which it is feasible for the borrowers are able to afford the finance cost of the money. This tends to be a fundamental function, because it directly impacts the profitability of the financial intermediary.
Another important characteristic of the financial intermediary is the fact that they are supposed to do an inherent risk assessment for the individuals they lend out this money too. Risk assessment is an extremely crucial part because it gauges the overall probability with which the borrower will honor its debt and pay back the amount.
Hence, this also tends to be a characteristic of the financial intermediary, because they are supposed to take the risk on behalf of the lender, subsequently creating it necessary for them to carry out a risk assessment for the buyers.
However, regardless of the basic functionality of financial intermediaries, it is also inherently important to realize the fact that the main characteristic on basis of which these organizations were formed were to establish trust between the borrower, and the lender. This is because the lender in this case, transfers the risk to the borrower.
This means that regardless of the borrower paying back the amount to the financial intermediary or not, the lender is going to be paid by the financial intermediary. Therefore, the risk spread that is created and subsequently borne by the financial intermediary tends to be one of the main characteristics which justify the creation and subsequent establishment of the financial intermediary.
Additionally, when it comes to risk-related profiles, it is also important to realize the fact that financial intermediaries provide the borrowers with collaterals and contingencies in the case where lender is unable to pay the amount back.
Lastly, another important characteristic of financial intermediaries is provision of services to both the parties, in case of any disagreement, or nay unprecedented circumstance. The main rationale in this regard is to facilitate both the borrower and the lender in the situation where there are any deviations from the agreed plan.
For example, the borrower might need finance before the agreed amount, in case of which there might be disagreement and unnecessary conflict between both of these parties. In this case, an important role of the financial intermediary can be defined to act as a mediatory between both parties.
Therefore, it can be seen that the role of financial intermediaries in the modern day and age cannot be undermined. As a matter of fact, it is increasingly important to recognize the fact that financial intermediaries play a very important role to create sense and harmony within the financial transaction, so both parties feel safe and secure.
In this regard, it should also be highlighted that depending on the type of financial intermediary in place, the role and characteristic might change, should also be accounted for.
However, the characteristic that stays consistent across different financial intermediaries regardless of their specific functionality is their ability to set interest rates, diversify the risk portfolio of the investor, and facilitate loan processing on behalf of the borrower.
Financial Information can be regarded as a highly important factor that can be an increasingly important component of decision making for different types of stakeholders. The underlying objective behind the preparation of financial information vests on the grounds of presenting information relating to the performance of the company over the respective course of time.
Hence, the importance of financial statements can be judged from the fact that it stands to be an integral component that showcases how the company has performed on various different domains, which can be applied to various different stakeholders and scenarios depending on the information they require.
There are numerous different types of financial information that is presented and is relevant in order to conduct financial analysis of the company.
It is also important to realize the fact that financial information is presented by the company is supposed to be used for various different purposes, which primarily vest on the grounds of transparency and complete disclosure. Therefore, this information is disclosed, according to law and accounting. Hence, the types of financial information that is presented in the form of statements is presented below.
Types of Financial Information
Speaking of the Income Statement, it can be seen as a financial statement that presents the information in the form of revenue and expenses that have been earned or incurred over the respective time period. This includes information regarded the expenses that have been paid by the company, on different accounts, pertaining to different transactions that have taken place.
The financial information that is presented in the financial statements is mainly presented in order to depict the expense threshold of the company, in addition to the profitability of the company.
The profitability of the company is also depicted through the Income Statement because it presents surplus (or deficit) of revenue over expenses.
As far as the Balance Sheet is concerned, it can be seen that it provides financial information in the manner that it shows assets and liabilities in comparison to the capital that is generated by the company.
The Balance Sheet is therefore presented to depict financial information in order to help the stakeholders assess the underlying financial status of the company, in terms of the financial stability that the company has.
The financial information that is presented in the Balance Sheet is mainly represented in order to help stakeholders like creditors, and lenders to evaluate the ability of the company to pay them back.
Cash Flow Statement
The Cash Flow Statement is presented as Financial Information in order to list the cash incomings and outgoing of the company from the company’s bank account. The liquidity position of the company is a very important indicator that helps convey important information about the ability of the company to pay back its short term obligations.
The financial information that is presented in the cash flow statements is divided into three parts, including Operating Expenses, Investing Expenses, and Financing Expenses. The breakup is provided up in order to bifurcate expenses to depict which proportion of cash is spent on the respective areas.
Financial Information Uses
Therefore, it can be seen that financial information that is presented within the company is presented to ensure that decision making can be carried out on basis of historic performance of the company.
This is an integral part because it helps to identify the weaknesses of the company and subsequent areas of improvement. The financial information can be duly utilized in order to conduct vertical and horizontal analysis, including ratio analysis that can highlight the underlying issues within the company.
Therefore, financial information type exists within the company can be broadly categorized into transactions, annual statements, press releases, as well as other relevant information that can be used to draw financial analysis of the company.
Financial Information for a company forms to be increasingly important factor that helps decision makers to analyze the performance of the company based on the historic events that have taken place in the company.
In this aspect, the financial aspect can be broadly defined as information that acts as an aid to conduct a better financial analysis of the company, so that proper concrete information can be derived about the company on a comparative basis.
Hence, financial information that is presented by companies is used for multiple different purposes, for different users. Therefore, there are respective and different types of information that is prepared for different users, depending on the decision that they need to take in this regard.
Financial Intermediary can be defined as an organization that acts as a bridge between the investor and the borrower. The main underlying premise behind financial intermediary is the fact that it stands to ensure that the financial objectives are duly met for both organizations.
Therefore, they mainly act as a middle man between the investor and the borrower, where they obtain funds from the lender at lower interest rates, and then subsequently lends it out to the investor at higher rates.
In this regard, this is considered as their profit margin, in terms of the spread between the offering interest rate to the borrower, and the interest rate that they pay to their lenders.
The Need for a Financial Intermediary
The underlying need for financial intermediary arises in the case where there is a need to develop a trust between both the parties, the borrower, and the lender. When a financial transaction is taking place, the lender wants to ensure that his money is invested in a secure place, and he would be paid back the amount that he has lent.
Additionally, the lender needs to fins the respective buyer who for the amount. In this case, financial intermediaries are established in order to establish the link between the buyer and seller.
Types of Financial Intermediaries
There are different types of financial intermediaries in place that serve different purposes. The underlying reason for different types of financial intermediaries is because they cater to different needs of the consumers.
- Banks: The central and commercial banks are created constitute to be the most widely known used financial intermediaries. The main purpose of banks to offer their services as financial intermediaries vests on the grounds of creating a reliably, and simplified process for their customers.
- Credit Unions: Credit Unions can be regarded as cooperative financial units, which are meant to create financial lending and borrowing of funds in order to provide financial assistance to their members.
- Non-Banking Finance Companies: Non-Banking Financial Companies are mainly engaged with activities that offer relatively specialized services like advancing loans to their clients.
- Stock Exchanges: The stock exchanges are established to ensure that companies are able to raise capital from the general public, in exchange for ownership in the company. Therefore, it is a place where public limited companies are able to sell their stocks and securities, in exchange for money. The profit in this case is mainly generated from the spread obtained between the trading of these shares.
- Mutual Fund Companies: Mutual Fund Companies are formed with the premise to amalgamate the amount that is collected from various investors. In this regard, it can be seen that different investors have different pools within which they can be seen to have similar investment objectives as well as risk profile. In this regard, it can be seen that funds are then subsequently collected and then invested in bonds, marketable securities, and other options that can be utilized to get a capital gain in the longer run.
- Insurance Companies: Insurance Companies provide insurance policies to individuals that can ensure that individuals and companies are procured against unprecedented events. In this regard, they mainly rely on deposits that are in the form of premium, subsequently pooled to gain profitable returns for the company.
- Escrow Opinion: Escrow companies are companies that act as the third party which acts as an intermediary because they are responsible to get all the conditions fulfilled at the time of the loan transaction that takes place between both, the investor as well as the borrower. This mostly takes place in situations that involve a real estate mortgage. This financial intermediary is created to establish a bridge between the transaction taking place so that the deal is secured.
Therefore, it can be seen that financial intermediaries are mainly formed in order to act as a link between two parties conducting a financial transaction. The main purpose is to provide security to the borrower, as well as the lender. Furthermore, financial intermediaries provide a proper structure to carry forward a financial transaction in a proper manner.
The role of financial intermediaries in creating and establishing a good resonance in the financial system is quite important to facilitating transactions between the buyer and seller.
The trust deficit that would otherwise exist in the case where financial intermediaries do not exist, would deter any borrower from obtaining funds from any lender, and similarly, lender would not have any security before lending money, because of the credibility under question.
Over the course of time, it can be seen that the role of financial intermediaries has increased exponentially, primarily because of the underlying importance it has pertaining to establishment of a strong linkage between the borrowers and the lenders.
In this regard, the main premise of financial intermediaries is to establish a bridge between the two parties, so that they are able to divide the risks and proportionately manage their risks and returns to create a beneficial impact for all three parties involved, the borrower, the lender, as well as the financial intermediary involved.
Importance of Financial Intermediaries
The importance of financial intermediaries is often justified using the higher dependence of these organizations to create a positive impact when it comes to facilitating the transaction between the borrowers and lenders. In exception to this underlying principle, there are also a couple of other factors which make the existence of financial intermediaries highly important.
Firstly, it can be seen that financial intermediaries promote high degree of value transformation. This means that there are certain borrowers who require considerably large sums of money.
In this regard, they might find it hard to pay a single investor who would be ready to contribute that particular amount. However, in the case of financial intermediaries, they can pool smaller deposits together in order to lend this amount to those who are in need of larger funds.
Secondly, financial intermediaries also ensure that the relevant parties in the economic circuit are able to deal with the aspect of maturity transformation. This highly lies on the realm of the fact that most depositors are in search of depositing money for the shorter term, in order to retain a certain level of liquidity.
In this case, financial intermediaries are then able to manage liquidity preferences between the borrowers and the lenders by establishing a middle ground so that they are able to cater to both the parties, on the terms they want.
Financial Intermediaries are also important because they significantly reduce the transaction costs that are associated with the process.
For example, if borrowers and lenders are able to use the services of the intermediaries, they would not have to go through the legal process of establishing and writing contracts. This can also be considered as a significant cost saving advantage of financial intermediaries.
The overall risk profile of borrowers and lenders tends to differ on numerous grounds. Risk diversification, however, tends to be a common denominator in this regard, essentially because of the fact that both the parties want maximum return with least amount of risk.
Therefore, in this regard, financial intermediaries, share the risk (in return of their profit), by guaranteeing that in the case where a borrower defaults on the loan, the lender will still be paid back the amount from behalf of the financial intermediary himself. Additionally, it also reduces the risk of the borrower and the lender because the return on individual savings are not solely reliant on the performance of a single borrower.
Financial intermediaries are formed on basis of specialist knowledge and resources that are expected to assess the underlying risk, and the predicted profitability of the proposed projects. Therefore, the overall risk is further reduced on the part of lenders, since they have proper clarity about the inherent risk profile of the borrower. This expertise saves the lender from a lot of hassle, and a considerable amount of risk.
Therefore, in this regard, it is also highly important to understand the fact that these financial intermediaries are formed to provide a service, and therefore, they earn their profits from the interest spread that exists between the interest rate offered to the borrower versus the interest rate that is paid to the lender.
The importance of financial intermediaries cannot be undermined in comparison to the overall benefits it has for the economy at large. It is also important to understand how it ensures that the market functionality is smooth and normalized, without any misconceptions of trust deficits that would deter lenders from extending money to those in need.
The importance of financial intermediaries can therefore, be seen as factors which fuel the transactions within the economy, on grounds of ensuring that there is no trust deficit between the borrowers and the lenders. By acting as an extremely important chain of command, they ensure that they are able to create a positive working style, which can subsequently lead to higher transactions to contribute positively to the overall economy.
Accounting profit and economic profit is difference because of many reasons including the principles that use for calculation the profits, the usages as well as the requirements. Accounting profit is calculated by using the accounting principle and respect to accounting standard.It is used to present in entity financial statements, reporting to government related body, board of directors as well as any other official use.
However, economic profit is calculated by using the economic principle. Economic profit is sometime called Economic Value Added profit and the way how we calculate this profit is by making adjustment to accounting profit.
For example, marketing, promotion and research expenses are consider as operating expenses under accounting principle to calculate accounting profit. However, in calculation of economic profit, these expenses need to add back to profit and net assets.
This profit is normally use for management decision making, investment appraisal as well as performance appraisal. The formula and calculation is explain below. The following are the key points that make accounting profits difference from economic profits:
Accounting profit is reporting in the entity’s statements of financial transactions or income statements. The preparation of this statement as well as others financial statements are based on accounting standard that allow by relevance authority. There are two major accounting standards that use by most of entities. They are US GAAP and IFRS. US GAAP is normally use by entity that register in US or the subsidiary companies that their parent companies are in US.
However, IFRS is the global accounting standards that use and accept by majority countries in the wold. Others accounting profit is use local standard to prepared.
Accounting profit or financial statements are prepared based on the requirement of local authority, board of director, and shareholders of the companies. These financial statements are required to have an audit annually in most cases. But sometime, audit of financial statements are performed quarterly as per requirement. Accounting profit is generally prepared monthly, quarterly and annually.
Accounting profit as well as financial statements are used by local authority ; for example, to assess whether the entity had fulfill its tax obligation or not. These reports use also use by entity’s bankers, shareholders, board of directors, employees, customers, suppliers (creditors), as well as stock exchange.
- Accounting profit or loss = Total Revenue – Cost of Goods Sold = Gross Profit
- Net Operating Profit After Tax = Gross Profit – Operating Expenses – Interest Expenses – Tax Expenses
- Use economic principle: economic profits use economic principle to calculate. This is the main reason that make it different from account profit. The cost like marketing expenses normally deduct from the calculation in the accounting profit. However, the economic profit, these like of cost will benefit to the entity in the future and it normally not deduct. Economic profit is sometime called Economic Value Added (EVA).
- Time Frame: Based on management decision.
- Adjustment to accounting profit is required to get economic profit.
- Use for economic decision: The calculation this kind of profit is not required by law; however, most of decision making are made by using the variable economic profit calculation. Value added to the entity or the shareholders is the key principle of
- Economic Profits = Net Operating Profit After Tax ( NOPAT) – (WACC * Net Assets
- Net Operating Profit After Tax: This is the figure from accounting profit. NOPAT could be found in the income statement of entity or it might take from the specific project that being assess.
- WACC: This is the Weigh Averages Cost of Capital. You might need to find if it is not provided.
- Net Assets: Net Assets refer to the assets or fund that used to support the specific project. In other words, Net Assets are the capital employed for the project.