What are financial assets?
According to AS-26, “A Financial Asset includes following:
Cash
Contractual right to receive cash or other financial asset
Contractual right to exchange financial instrument with another enterprise under conditions that are potentially favourable; or
An ownership interest in another enterprise.”
According to IND-AS, “A financial asset is any asset that is:
(a) Cash;
(b) An equity instrument of another entity;
(c) A contractual right:
To receive cash or another financial asset from another entity; or
To exchange financial assets or financial liabilities with another entity under conditions that are potentially favourable to the entity; or
(d) A contract that will or may be settled in the entity’s own equity instruments”
So, from the above definitions, we can conclude that financial assets are those assets which arise from contractual claims like equity shares, debentures held, cash & bank deposits. It is not necessary for it to exist in physical form. They derive their value from a contractual claim on an underlying asset.
The fair value of a financial asset may or may not be equal to its book value. For E.g.- Fair value of an equity share of a company in normal circumstances is not equal to its book value. Its value depends on market forces of demand and supply.
Origin of Financial Assets-
Humans have always treated material and non-material things as an “asset”. To the human beings alive hundreds and thousands of years ago in Before-Christ (B.C.) period, an asset might mean something which help him to just survive like and to a human today it might mean something which give him economic benefit. Financial assets have their origin from the time of barter system itself although it has been evolving since then with the evolving economic activities. Goods became assets when civilizations demanded gold jewellery or salt or oil.
Debt and bonds became means since we had freely transmittable money, and sovereigns became assets when governments demanded to fund wars they couldn't go through their own resources. As the industrial revolution fleetly increased complexity, we needed other ways to represent wealth and power therefore arose the company stock. First tradable commercial equity is generally traced to the Dutch East India Company’s stock issues in 1602. As urbanization swept Europe and North America in posterior centuries, further centralized passed and sanctioned exchanges sprang up, ultimately leading to the large associations we've moment.
Today we see, literally hundreds of different financial assets circulating in the financial system and these assets are continuously evolving and new ones are coming day by day. People nowadays generally prefer investing their savings and surplus in assets like stocks. The old method of keeping money in FDs and investing in real estate no longer appeal to people because of several reasons including high rates of inflation, low rate of return, long term blockage etc.
Equity Shares
“In finance, equity is ownership of assets that may have debts or other liabilities attached to them.”
The capital (amount invested by owners) of a company is divided into small fractions and each fraction is known as a share. A share can be of many times and classes, two most common types are preference (having some preferential rights) and equity shares. When investors buy these shares, they get the right to vote, share profits, and claim the assets of a company. As a shareholder, the investor also receives dividends from the company.
Brief History of Equity Shares
In 1600s, The Dutch East Indian company used to ship precious goods such as Gold, Porcelain, Spices and Silks across the globe. The cost of shipping was very high and therefore it was not possible for a single individual to afford the business and people were invited to invest in the shipping business and in return, they offered a share of the profits that the trip would make.
Share Certificate of Dutch East India Company
The first ever stock exchange called ‘The Amsterdam Stock Exchange’ was set up for the exchange of the shares. In India, during 1800’s 5 stockbrokers to exchange shares of different companies. Two decades later, as the number of brokers increased, a small group called ‘The Native Share & Stock Brokers Association’ was formed. This group today is known as Bombay Stock Exchange which is the oldest stock exchange of India and Asia. Today, BSE have more than 4000 listed companies.
Now let’s understand why a company issue equity shares and what are the advantages they have in doing so. So as stated earlier, share issue eventually started in 16th century because a company needed funds for its operation (shipping in that case) the reason today is pretty much same but with increase in complexity of business, the funds are required for a plethora of activities. With that, companies today also have several other ways to fulfil their finance requirements, then why companies issue equity shares, the reasons can be manifolded but let’s try and look at some of the benefits that equity financing have:
Firstly, it can be seen that capital raised by equity shares does not have to be paid back. It can also be seen that this particular amount can be utilized across any place where the company needs to utilize this amount. Secondly, it offers flexibility like there is no obligation to give dividends- it totally depends on management’s decision. Similarly, the company is not bound to return amount after a particular time, it can use the amount invested as long as it exists. Third, it can also be seen that equity shares tend to create a positive impact on the financials of the company. And fourth, the company does not need to offer any collateral or guarantee to raise funds. Because of all these reasons, the company can opt for Equity financing.
Advantage of investing in Equity
Liquidity- Equity shares are very liquid in nature and can be bought and sold at any time when the owner needs cash.
Higher return- Equity investing provides higher rate of return as compared to traditional methods of investing like FDs, bank deposits or real estate
Amount to invest- One can invest any amount available to him, not having huge amount to make investment is not an issue for investors
Limited legal liabilities -Beyond financial investments, profits and voting rights equity shareholders have limited legal liabilities. So, if the company gets into legal issues, the shareholders are not responsible in any case.
Disadvantages
Just like anything else, equity investing to have some disadvantages
Market Risk- The movement of price of shares depends upon market forces which depends upon a lot of factors, stock market is generally volatile in nature and therefore there are chances of losses also.
Financial Education- To invest in equity, one requires an understanding of business and share market to pick up stocks that are profitable. This requires certain skills which people might not have.
No surety of returns/dividends- A company can make huge profits and may not distribute it to shareholders as it not liable to do so, also equity shareholders do not have preferential rights in profits of the company
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